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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

                (Mark One)


[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended August 30, 2003

OR

[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from                  to                   

Commission File Number: 0-12853

ELECTRO SCIENTIFIC INDUSTRIES, INC.

Oregon   93-0370304  
(State or other jurisdiction of incorporation
or organization)		  (I.R.S. Employer Identification No.) 
  
13900 N.W. Science Park Drive, Portland, Oregon  97229 
(Address of principal executive offices)  (Zip Code) 

Registrant’s telephone number: (503) 641-4141

Registrant’s web address: www.esi.com

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes x No ¨

The number of shares outstanding of the Registrant’s Common Stock at October 2, 2003 was 27,925,171 shares.



ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION Page
     
Item 1. Consolidated Condensed Financial Statements (unaudited)  
     
  Consolidated Condensed Balance Sheets - August 30, 2003 and May 31, 2003 2
     
  Consolidated Condensed Statements of Operations - Three Months Ended August 30, 2003 and August 31, 2002 3
 
     
  Consolidated Condensed Statements of Cash Flows - Three Months Ended August 30, 2003 and August 31, 2002 4
   
     
  Notes to Consolidated Condensed Financial Statements 5
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
     
Item 4 Controls and Procedures 24
     
PART II - OTHER INFORMATION    
     
Item 1 Legal Proceedings 26
     
Item 6 Exhibits and Reports on Form 8-K 28
     
Signatures   29


1

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
(Unaudited)
August 30,
2003
 May 31,
2003
Assets            
Current assets:  
    Cash and cash equivalents   $ 7,821   $ 18,270  
    Marketable securities    230,690    224,090  
    Restricted securities    6,208    9,422  
        Total cash and securities    244,719    251,782  
 
   Trade receivables, net of allowances of $ 2,245    32,103    37,160  
    Income tax refund receivable    22,049    16,499  
    Inventories, net    42,427    42,067  
    Shipped systems pending acceptance    12,221    7,058  
    Deferred income taxes    14,794    14,794  
    Assets held for sale    8,842    6,451  
    Other current assets    4,052    3,445  
        Total current assets     381,207    379,256  
 
Long-term marketable securities    49,897    53,452  
Long-term restricted securities    3,047    3,018  
         Total long-term securities    52,944    56,470  
 
Property, plant and equipment, net of accumulated  
  depreciation of $37,091 and $35,091    36,241    36,592  
Deferred income taxes    6,183    5,188  
Other assets    10,970    13,796  
        Total assets   $ 487,545   $ 491,302  
Liabilities and shareholders' equity  
Current liabilities:  
    Accounts payable   $ 4,794   $ 4,395  
    Accrued liabilities    19,129    21,477  
    Deferred revenue    21,684    13,222  
        Total current liabilities    45,607    39,094  
Convertible subordinated notes    142,108    141,891  
        Total liabilities    187,715    180,985  
 
Shareholders' equity:  
    Preferred stock, without par value; 1,000 shares  
        authorized; no shares issued    --    --  
   Common stock, without par value; 100,000  
        authorized; 27,858 and 27,843 shares  
        issued and outstanding    140,696    140,231  
    Retained earnings    160,108    169,475  
    Accumulated other comprehensive income (loss)    (974 )  611  
       Total shareholders' equity    299,830    310,317  
       Total liabilities and shareholders' equity   $ 487,545   $ 491,302  

The accompanying notes are an integral part of these statements.

2

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
For the Three Months Ended
    August 30, 2003            August 31, 2002
Net sales     $ 20,876   $ 39,360  
Cost of sales    16,036    23,503  
Gross profit    4,840    15,857  
Operating expenses:  
    Selling, service and administration    14,625    14,570  
    Research, development and engineering    5,748    7,645  
      20,373    22,215  
Operating loss    (15,533 )  (6,358 )
 
Interest income    2,580    2,943  
Interest expense    (1,927 )  (2,007 )
Other expense, net    (476 )  (436 )
     177    500  
Loss before income taxes    (15,356 )  (5,858 )
Benefit for income taxes    (5,989 )  (2,464 )
Net loss   $ (9,367 ) $ (3,394 )
Net loss per share - basic and diluted   $ (0.34 ) $ (0.12 )
Weighted average number of shares - basic and diluted    27,840    27,650  

The accompanying notes are an integral part of these statements.

3

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
              For the Three Months Ended              
August 30, 2003                    August 31, 2002
Cash flows from operating activities:            
   Net loss   $ (9,367 ) $ (3,394 )
   Adjustments to reconcile net loss to cash  
      provided by (used in) operating activities:  
         Depreciation and amortization    2,410    2,463  
         Tax benefit of stock options exercised    78    57  
         Provision for doubtful accounts    --    129  
         Deferred income taxes    (924 )  344  
  Changes in operating accounts:  
         (Increase) decrease in trade receivables, net    4,611    (1,582 )
         (Increase) decrease in income tax refund receivable    (5,550 )  3,418  
         (Increase) decrease in inventories, net    (951 )  5,025  
         Increase in shipped systems pending acceptance    (5,163 )  (2,351 )
         Increase in other current assets    (596 )  (229 )
         Decrease in other current liabilities    (1,689 )  (1,735 )
         Increase in deferred revenue    8,462    3,824  
               Net cash provided by (used in) operating activities    (8,679 )  5,969  
 
Cash flows from investing activities:  
   Purchase of property, plant and equipment    (510 )  (2,738 )
   Maturity of restricted securities    3,185    3,073  
   Purchase of securities    (71,117 )  (36,312 )
   Proceeds from sales of securities and maturing securities    66,564    40,613  
   Increase in other assets    (279 )  (2,585 )
               Net cash provided by (used in) investing activities    (2,157 )  2,051  
Cash flows from financing activities:  
   Proceeds from exercise of stock options and stock plans    387    866  
               Net cash provided by financing activities    387    866  
Net change in cash and cash equivalents    (10,449 )  8,886  
 
Cash and cash equivalents:  
   Beginning of period    18,270    29,435  
   End of period   $ 7,821   $ 38,321  
Supplemental cash flow information:  
   Cash paid for interest   $ 3,334   $ 3,330  
   Income tax refunds received    808    5,863  
   Cash paid for income taxes    371    --  

The accompanying notes are an integral part of these statements.

4

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)

Note 1 — Basis of Presentation

We have prepared the unaudited interim consolidated condensed financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted in these interim statements. We believe that the interim statements include all adjustments (consisting of only normal recurring accruals) necessary for a fair presentation of results for the interim periods. These consolidated condensed financial statements are to be read in conjunction with the financial statements and notes included in our 2003 Annual Report on Form 10-K. Certain prior year amounts have been reclassified to conform to current year presentation.

Results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

Note 2 — Inventories

Inventories are principally valued at standard costs, which approximate the lower of cost (on a first-in, first-out basis) or market. Components of inventories were as follows (in thousands):

                                                August 30,   May 31,      
              2003               2003  
 
   
Raw materials and purchased parts  $    25,319   $    25,412     
Work-in-process  6,020   2,074  
Finished goods  11,088   14,581  
 
   
Total inventories  $    42,427   $    42,067     
 
   

Note 3 – Assets Held For Sale

At August 30, 2003, assets held for sale include a 60,000 square foot plant on 10 acres of land near Escondido, California, which was used to house our Electronic Component Systems product line that has been moved to our headquarters in Portland, Oregon, and a parcel of land in Taiwan.

We have contracted with real estate agents to find buyers for these properties and anticipate that we will sell the assets within one year.

Based on current market information provided by our real estate agents, we determined that the market values of the property, less selling costs, exceeds our current book value for the properties. Accordingly, we have reflected the property on our consolidated condensed balance sheet as assets held for sale at book value and have ceased depreciation.

The components of net assets held for sale were as follows (in thousands):



                                                August 30,   May 31,        
         2003         2003  
 
   
                          Land  $         5,016   $         2,625     
                          Buildings  3,826   3,826  
 
   
   $         8,842   $         6,451     
 
   


5

Note 4 – Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

  August 30,   May 31,
  2003   2003
 
 
Payroll related $            6,610    $            6,562 
Warranty 3,501    3,501 
Interest payable 1,130    2,781 
Other 7,888    8,633 
 
 
  $         19,129    $         21,477 
 
 

Note 5 – Product Warranty

We evaluate our obligations related to product warranties quarterly. We offer a standard one-year warranty to our customers. Costs include labor to repair the system and replacement parts for defective items, as well as other costs incidental to warranty repairs. Any cost recoveries from warranties offered to us by our suppliers covering defective components are also considered. This data is then used to calculate the warranty reserve based on remaining warranty periods. If circumstances change, or if a material change in warranty-related incidents occurs, our estimate of the warranty reserve could change significantly. We record warranties issued and changes in estimates as an adjustment to cost of sales. Accrued warranty is included on our balance sheet as a component of accrued liabilities.

The following is a reconciliation of the changes in the aggregate warranty liability for the quarter ended
August 30, 2003 (in thousands):



Warranty accrual, May 31, 2003 $    3,501   
Reductions for warranty payments made (746)
Warranties issued and changes in estimates 746 
 
 
Warranty accrual, August 30, 2003 $    3,501   
 
 


Note 6 — Earnings Per Share

Because we incurred a loss in each of the three-month periods ended August 30, 2003 and August 31, 2002, the number of shares outstanding for the calculation of earnings (loss) per share (“EPS”) was the same for both the basic and diluted calculations.

The following common stock equivalents were excluded from the diluted EPS calculations because inclusion would have had an antidilutive effect (in thousands):

       
  Three Months Ended
 
  August 30,   August 31,
  2003   2002
 
 
Employee stock options 3,544            3,777         
Convertible subordinated notes 3,816            3,947         
 
 
  7,360            7,724         
 
 


6

Note 7 — Comprehensive Loss

The components of comprehensive loss, 1net of tax, are as follows (in thousands):

       
  Three Months Ended
 
  August 30,
2003		   August 31,
2002
 
 
Net loss $               (9,367)        $               (3,394)     
Net unrealized gain (loss) on derivative instruments (4)        14       
Foreign currency translation adjustment (73)        84       
Net unrealized gain (loss) on securities (1,508)        452       
 
 
Total comprehensive loss $               (10,952)        $               (2,844)