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EX-31.1 - EXHIBIT 31.1 - ELECTRO SCIENTIFIC INDUSTRIES INCex-311certificationofthech.htm
EX-31.2 - EXHIBIT 31.2 - ELECTRO SCIENTIFIC INDUSTRIES INCex-312certificationofthech.htm
EX-32.2 - EXHIBIT 32.2 - ELECTRO SCIENTIFIC INDUSTRIES INCex-322certificationofchief.htm
EX-32.1 - EXHIBIT 32.1 - ELECTRO SCIENTIFIC INDUSTRIES INCex-321certificationofchief.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 26, 2015
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, including area code: 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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨    
 
Accelerated  filer 
ý
Non-accelerated filer
¨    
 
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The number of shares outstanding of the Registrant’s Common Stock as of October 30, 2015 was 31,033,459 shares.
 



ELECTRO SCIENTIFIC INDUSTRIES, INC.
2016 FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
 
Part I
FINANCIAL INFORMATION
 
Financial Statements (Unaudited)
 
 
 
 
 
 
Part II
OTHER INFORMATION
 
 







ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
Sep 26, 2015
 
Mar 28, 2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
43,642

 
$
50,994

Short-term investments
16,607

 
6,612

Trade receivables, net of allowances of $832 and $712
49,097

 
42,295

Inventories, net
58,035

 
56,637

Shipped systems pending acceptance
2,499

 
2,516

Deferred income taxes, net
135

 
178

Other current assets
3,475

 
6,090

Total current assets
173,490

 
165,322

Non-current assets:
 
 
 
Property, plant and equipment, net of accumulated depreciation of $105,425 and $102,901
24,650

 
25,858

Non-current deferred income taxes, net
85

 
174

Goodwill
7,445

 
7,717

Acquired intangible assets, net of accumulated amortization of $20,606 and $19,880
8,230

 
8,958

Other assets
11,258

 
13,211

Total assets
$
225,158

 
$
221,240

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
19,347

 
$
9,514

Accrued liabilities
18,913

 
18,666

Deferred income tax liability, net
174

 
173

Deferred revenue
12,662

 
12,376

Total current liabilities
51,096

 
40,729

Non-current liabilities:
 
 
 
Income taxes payable
1,278

 
1,176

Deferred income tax liability, net
407

 
443

Other liabilities
2,585

 
1,571

Commitments & contingencies (see Note 13 "Commitments & Contingencies")
 
 
 
Shareholders’ equity:
 
 
 
Preferred stock, without par value; 1,000 shares authorized; no shares issued

 

Common stock, without par value; 100,000 shares authorized; 31,448 and 30,704 issued and outstanding
191,948

 
189,134

Accumulated deficit
(21,366
)
 
(11,741
)
Accumulated other comprehensive loss
(790
)
 
(72
)
Total shareholders’ equity
169,792

 
177,321

Total liabilities and shareholders’ equity
$
225,158

 
$
221,240

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements


3


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands, except per share amounts)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Net sales:
 
 
 
 
 
 
 
Systems
$
35,570

 
$
30,273

 
$
67,632

 
$
53,697

Service
10,902

 
12,583

 
21,931

 
24,189

Total net sales
46,472

 
42,856

 
89,563

 
77,886

Cost of sales:
 
 
 
 
 
 
 
Systems
22,345

 
20,742

 
43,630

 
37,676

Service
5,706

 
7,349

 
12,135

 
13,157

Total cost of sales
28,051

 
28,091

 
55,765

 
50,833

Gross profit
18,421

 
14,765

 
33,798

 
27,053

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
12,534

 
11,899

 
25,151

 
24,052

Research, development and engineering
8,283

 
8,424

 
16,928

 
17,569

Acquisition and integration costs
40

 

 
194

 

Restructuring costs
591

 

 
653

 

Net operating expenses
21,448

 
20,323

 
42,926

 
41,621

Operating loss
(3,027
)
 
(5,558
)
 
(9,128
)
 
(14,568
)
Non-operating income (expense):
 
 
 
 
 
 
 
Interest and other income (expense), net
6

 
(244
)
 
1

 
(198
)
Total non-operating income (expense), net
6

 
(244
)
 
1

 
(198
)
Loss before income taxes
(3,021
)
 
(5,802
)
 
(9,127
)
 
(14,766
)
Provision for (benefit from) income taxes
239

 
441

 
497

 
(272
)
Net loss
$
(3,260
)
 
$
(6,243
)
 
$
(9,624
)
 
$
(14,494
)
Net loss per share—basic
$
(0.10
)
 
$
(0.20
)
 
$
(0.31
)
 
$
(0.48
)
Net loss per share—diluted
$
(0.10
)
 
$
(0.20
)
 
$
(0.31
)
 
$
(0.48
)
Weighted average number of shares—basic
31,384

 
30,552

 
31,280

 
30,452

Weighted average number of shares—diluted
31,384

 
30,552

 
31,280

 
30,452

Cash dividends declared per outstanding common share
$

 
$
0.08

 
$

 
$
0.16

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements


4




ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)

 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Net loss
$
(3,260
)
 
$
(6,243
)
 
$
(9,624
)
 
$
(14,494
)
Other comprehensive (loss) income:
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of taxes of $17, $179, $0 and $179
(756
)
 
(216
)
 
(725
)
 
318

Accumulated other comprehensive income related to benefit plan obligation, net of taxes of $(2), $2, $(4) and $4
4

 
4

 
8

 
7

Net unrealized loss on available-for-sale securities, net of taxes of $0, $(5), $0 and $(5)
(1
)
 
(6
)
 
(1
)
 
(7
)
Comprehensive loss
$
(4,013
)
 
$
(6,461
)
 
$
(10,342
)
 
$
(14,176
)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements


5



ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Two fiscal quarters ended
(In thousands)
Sep 26, 2015
 
Sep 27, 2014
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net loss
$
(9,624
)
 
$
(14,494
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
3,803

 
3,909

Amortization of acquired intangible assets
725

 
857

Share-based compensation expense
2,626

 
2,363

Loss (gain) on disposition of property and equipment, net
6

 
(56
)
Provision for doubtful accounts
127

 

Decrease (increase) in deferred income taxes
106

 
(170
)
Changes in operating accounts, net of acquisitions:

 

Increase in trade receivables, net
(3,953
)
 
(2,085
)
(Increase) decrease in inventories, net
(2,668
)
 
2,851

Decrease (increase) in shipped systems pending acceptance
17

 
(3,126
)
Decrease in other current assets
2,736

 
679

Increase in accounts payable and accrued liabilities
10,308

 
245

Increase in deferred revenue
286

 
5,925

Net cash provided by (used in) operating activities
4,495

 
(3,102
)
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Purchase of investments
(261,978
)
 
(279,918
)
Proceeds from sales and maturities of investments
251,982

 
303,793

Purchase of property, plant and equipment
(2,185
)
 
(2,365
)
Proceeds from sale of property, plant and equipment

 
154

Decrease (increase) in other assets
386

 
(857
)
Net cash (used in) provided by investing activities
(11,795
)
 
20,807

CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Cash dividends paid to shareholders

 
(4,834
)
Payment of withholding taxes on stock-based compensation
(603
)
 
(1,203
)
Proceeds from issuance of common stock
737

 
941

Share repurchases

 
(1,456
)
Net cash provided by (used in) financing activities
134

 
(6,552
)
Effect of exchange rate changes on cash
(186
)
 
(359
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
(7,352
)
 
10,794

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
50,994

 
68,461

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
43,642

 
$
79,255

SUPPLEMENTAL CASH FLOW INFORMATION
 
 
 
Cash paid for interest
$
(57
)
 
$
(2
)
Cash paid for income taxes
(478
)
 
(489
)
Income tax refunds received
110

 
557

Net increase in property, plant and equip. & other assets related to transfers from inventory
622

 
344

Non-cash additions to property, plant and equipment
227

 
274

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

6


ELECTRO SCIENTIFIC INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation

These unaudited interim condensed consolidated financial statements have been prepared 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 U.S. generally accepted accounting principles have been condensed or omitted in these interim statements. Accordingly, these condensed consolidated financial statements are to be read in conjunction with the financial statements and notes included in the Company's Annual Report on Form 10-K for its fiscal year ended March 28, 2015. These interim statements include all adjustments (consisting of only normal recurring adjustments and accruals) necessary for a fair presentation of results for the interim periods presented. The results for interim periods are not necessarily indicative of the results of operations for the entire year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates.

Management believes that the estimates used are reasonable. Significant estimates made by management include: revenue recognition; inventory valuation; product warranty reserves; allowance for doubtful accounts; accrued restructuring costs; share-based compensation; income taxes including the valuation of deferred tax assets; fair value measurements; valuation of cost method equity investments; valuation of long-lived assets; valuation of goodwill; and valuation of acquired technology.

There have been no significant changes to the Company's significant accounting policies from those presented in Note 2 “Summary of Significant Accounting Policies” to the consolidated financial statements included in the Company's Annual Report on Form 10-K for its fiscal year ended March 28, 2015. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.

In the first quarter of 2016, certain prior period amounts were revised to conform to current year presentation. Please see Note 7 "Trade Accounts Receivable" and Note 10 "Accrued Current Liabilities & Other Liabilities".
2. Recent Accounting Pronouncements
    
In June 2014, the FASB issued ASU No. 2014-12, "Compensation - Stock Compensation (Topic 718)." ASU No. 2014-12 addresses accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. ASU 2014-12 indicates that, in such situations, the performance target should be treated as a performance condition and, accordingly, the performance target should not be reflected in estimating the grant-date fair value of the award. Instead, compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. We do not expect the adoption of ASU 2014-12 to have a material effect on our financial position, results of operations or cash flows.

In April 2015, the FASB issued ASU 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40).” ASU 2015-05 provides guidance regarding the accounting for a customer's fees paid in a cloud computing arrangement, specifically about whether a cloud computing arrangement includes a software license, and if so, how to account for the software license. ASU 2015-05 is effective for public companies' annual periods, including interim periods, beginning after December 15, 2015. Early adoption is permitted. We do not expect the adoption of ASU 2015-05 to have a material effect on our financial position, results of operations or cash flows.

In July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-11, “Simplifying the Measurement of Inventory (Topic 330).” ASU 2015-11 simplifies the accounting for the valuation of all inventory not accounted for using the last-in, first-out (“LIFO”) method by prescribing inventory be valued at the lower of cost and net realizable value. ASU 2015-11 is effective for public companies' annual periods, including interim periods within those fiscal years, beginning after December 15, 2016 on a prospective basis. Early adoption is permitted. We do not expect the adoption of ASU 2015-11 to have a material effect on our financial position, results of operations or cash flows.

7



In August 2015, the FASB issued ASU No. 2015-14, which defers the effective date of ASU No. 2014-09 "Revenue from Contracts with Customers" one year to interim and annual reporting periods beginning after December 15, 2017. This guidance may be adopted retrospectively or under a modified retrospective method where the cumulative effect is recognized at the date of initial application. The Company is currently evaluating the impact of adopting this guidance on its Consolidated Financial Statements and disclosures included within Notes to Consolidated Financial Statements.
3. Share-Based Compensation

The Company recognizes expense related to the fair value of its share-based compensation awards using the Black-Scholes model to estimate the fair value of awards on the date of grant, except for unvested restricted stock unit awards which are valued at the fair value of the Company's stock on the date of award. The Company recognizes compensation expense for all share-based compensation awards on a straight-line basis over the requisite service period of the award.

Stock-settled stock appreciation rights (SARs) grant the right to receive shares of the Company's stock equivalent to the increase in stock value of a specified number of shares over a specified period of time, divided by the stock price at the time of exercise. Similar to options, SARs are measured at the fair value of the award on the grant date and the expense is recognized on a straight-line basis over the requisite service period of the award.
The Company granted a total of 703,700 restricted stock units (RSUs), 467,000 SARs, and zero stock options during the first two quarters of 2016. The Company granted 513,700 RSUs and 260,000 SARs, and zero stock options during the first two quarters of 2015.
Share-based compensation expense was included in the Company’s Condensed Consolidated Statements of Operations as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Cost of sales
$
114

 
$
151

 
$
243

 
$
320

Selling, general and administrative
746

 
602

 
1,461

 
1,467

Research, development and engineering
206

 
280

 
425

 
576

Total share-based compensation expense
$
1,066

 
$
1,033

 
$
2,129

 
$
2,363

No share-based compensation costs were capitalized in the first two quarters of 2016. As of September 26, 2015, the Company had $9.1 million of total unrecognized share-based compensation costs, net of estimated forfeitures, which are expected to be recognized over a weighted average period of 2.2 years. The amounts shown in the table above for the fiscal quarter ended September 26, 2015 and two fiscal quarters ended September 26, 2015, do not include $173 thousand and $497 thousand, respectively, in expense related to acquisitions. Refer to Note 5 "Business Acquisitions" for discussion of stock amounts considered compensation related to acquisitions.
4. Fair Value Measurements
Financial Assets Measured at Fair Value
ASC Topic 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include the following:
Level 1, defined as observable inputs such as quoted prices in active markets for identical assets or liabilities;
Level 2, defined as inputs that are observable either directly or indirectly such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and other inputs that can be corroborated by observable market data; and
Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

8


The Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis as of September 26, 2015 and March 28, 2015 was as follows (in thousands):
September 26, 2015
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
Money market securities
$
4,141

 
$

 
$

 
$
4,141

Commercial paper

 
11,629

 

 
11,629

Government agencies

 
500

 

 
500

Total cash equivalents
$
4,141

 
$
12,129

 
$

 
$
16,270

 
 
 
 
 
 
 
 
Short term investments - available for sale:
 
 
 
 
 
 
 
Commercial paper
$

 
$
3,099

 
$

 
$
3,099

Government agencies

 
11,647

 

 
11,647

Total short-term investments - available for sale
$

 
$
14,746

 
$

 
$
14,746

 
 
 
 
 
 
 
 
Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen
$

 
$
(25
)
 
$

 
$
(25
)
New Taiwan Dollar

 
(25
)
 

 
(25
)
Korean Won

 
(34
)
 

 
(34
)
Euro

 
(4
)
 

 
(4
)
British Pound

 
(35
)
 

 
(35
)
Chinese Renminbi

 
4

 

 
4

Singapore Dollar

 
(2
)
 

 
(2
)
Total forward contracts
$

 
$
(121
)
 
$

 
$
(121
)
 
 
 
 
 
 
 
 
Deferred compensation plan assets:
 
 
 
 
 
 
 
Money market securities
$
463

 
$

 
$

 
$
463

Mutual funds and exchange traded funds
1,861

 

 

 
1,861

Total deferred compensation plan assets
$
2,324

 
$

 
$

 
$
2,324

March 28, 2015
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
Money market securities
$
14,280

 
$

 
$

 
$
14,280

Commercial paper

 
15,537

 

 
15,537

Government agencies

 
2,702

 

 
2,702

Total cash equivalents
$
14,280

 
$
18,239

 
$

 
$
32,519

 
 
 
 
 
 
 
 
Short term investments - available for sale:
 
 
 
 
 
 
 
Corporate bonds
$

 
$
853

 
$

 
$
853

Municipal bonds

 
3,872

 

 
3,872

Total short-term investments - available for sale
$

 
$
4,725

 
$

 
$
4,725

 
 
 
 
 
 
 
 
Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen
$

 
$
(7
)
 
$

 
$
(7
)
New Taiwan Dollar

 
17

 

 
17

Korean Won

 
(44
)
 

 
(44
)
Euro

 
277

 

 
277

British Pound

 
(133
)
 

 
(133
)
Chinese Renminbi

 
(34
)
 

 
(34
)
Total forward contracts
$

 
$
76

 
$

 
$
76

 
 
 
 
 
 
 
 
Deferred compensation plan assets:
 
 
 
 
 
 
 
Money market securities
$
190

 
$

 
$

 
$
190

Mutual funds and exchange traded funds
1,885

 

 

 
1,885

Total deferred compensation plan assets
$
2,075

 
$

 
$

 
$
2,075

For Level 1 assets, the Company utilized quoted prices in active markets for identical assets.

9


For Level 2 assets, exclusive of forward contracts, the Company utilized quoted prices in active markets for similar assets. For forward contracts, spot prices at September 26, 2015 and March 28, 2015 were utilized to calculate fair values.
During the first two quarters of 2016, there were no transfers between Level 1, 2 or 3 assets.
Investments
The Company’s investments at September 26, 2015 and March 28, 2015 were as follows (in thousands): 
 
 
 
Unrealized
 
 
September 26, 2015
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Commercial paper
$
14,728

 
$

 
$

 
$
14,728

Government agencies
12,146

 
1

 

 
12,147

Mutual funds and exchange traded funds*
2,320

 
5

 

 
2,325

 
$
29,194

 
$
6

 
$

 
$
29,200

 
 
 
 
 
 
 
 
 
 
 
Unrealized
 
 
March 28, 2015
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Commercial paper
$
15,537

 
$

 
$

 
$
15,537

Government agencies
2,702

 

 

 
2,702

Corporate bonds
853

 

 

 
853

Municipal bonds
3,870

 
2

 

 
3,872

Mutual funds and exchange traded funds*
1,950

 
125

 

 
2,075

 
$
24,912

 
$
127

 
$

 
$
27,114

*These investments represent assets held in trust for our deferred compensation plan
 
 
 
 
 
 
For purposes of determining gross realized gains and losses and reclassification out of accumulated other comprehensive loss, the cost of securities sold is based on specific identification. Net unrealized holding gains and losses on current available-for-sale securities included in accumulated other comprehensive loss were insignificant as of September 26, 2015 and March 28, 2015.
Investments with underlying maturities within one year at September 26, 2015, including cash equivalents, totaled $29.2 million.
5. Business Acquisitions
Fiscal 2015
On January 15, 2015, the Company acquired all of the outstanding shares of Wuhan Topwin Optoelectronics Technology Co., Ltd. (Topwin), a Chinese manufacturer of laser-based systems and as of March 28, 2015 the company performed a preliminary determination and allocation of purchase price to the identifiable acquired assets and liabilities. In the first quarter of 2016, the Company finalized the determination of purchase price, including the valuation of total consideration and the related contractual adjustments to working capital, and valuation of acquired assets and assumed liabilities. Analysis supporting the purchase price allocation included a valuation of assets and liabilities as of the closing date, an analysis of intangible assets and a detailed review of the opening balance sheet to determine other significant adjustments required to recognize assets and liabilities at fair value. Consideration was comprised of $7.6 million in cash and 748,944 shares of ESI common stock issuable over a three year period, valued at approximately $2.9 million as of the acquisition date. Of the $2.9 million in equity, one-half, or 374,472 shares, is contingent-based consideration and one-half, or 374,472 shares, is non-contingent and will be issued over a three year period beginning June 30, 2015. The contingent consideration is based on future performance of Topwin, as evaluated against targets for net income for each year over a three year period. One-third of the contingent shares will be issued after each year if the target is met for that year; however failing to meet stated targets will result in none of the contingent shares being issued for that year. As of the acquisition date, the fair value of the contingent consideration was estimated to be $0.4 million and of the 374,472 shares of non-contingent consideration was estimated to be $2.5 million. The fair value of the non-contingent and contingent shares was determined based on the estimated share price as of the issuance date derived through Monte Carlo simulation, discounted back to the acquisition date. The value of the contingent shares included consideration of the estimated probability of attainment of the net income targets. Additionally, the Company will issue, on the same terms described above, approximately 513,328 shares valued at $2.0 million, which, together

10


with cash amounts of $0.2 million, is treated as compensation to a Principal in the Company who was also a former shareholder of Topwin. Compensation expense will be recognized over the Principal's term of employment or related service period required by the purchase agreement through December 31, 2017. In the first two quarters of fiscal 2016, we have recognized approximately $0.5 million in compensation expense related to this agreement, comprised primarily of share-based compensation.
The total purchase price of approximately $10.5 million, net of cash acquired, was allocated to the underlying assets acquired and liabilities assumed based on their fair values, as shown in the following table:
(In thousands)
 
Accounts receivable
$
454

Inventory
544

Prepaid expense and other current assets
295

Property, plant and equipment
23

Acquired intangibles
3,618

Goodwill
7,445

Accounts payable and other accrued liabilities
(1,859
)
Total purchase price, net of cash acquired
$
10,520

The acquisition is expected to enable the Company to gain entry into the low total-cost-of-ownership solutions market in China and the goodwill of approximately $7.4 million recognized as a result of the acquisition was assigned to the Topwin reporting unit. The premium paid over the fair value of the individual assets acquired and liabilities assumed reflects the Company’s view that this acquisition was the result of a competitive bid process and has provided the Company with innovative design and manufacturing capabilities for laser-based manufacturing solutions across a variety of complementary applications, together with direct access to local China market, supply chain and opto-electronics knowledge center. None of the goodwill is expected to be deductible for tax purposes.
As a result of the acquisition, the Company recorded approximately $4.9 million of identifiable assets, including $3.6 million of identifiable intangible assets, and $1.9 million of identifiable liabilities. The acquired intangible assets consist primarily of $3.5 million of developed technology and will be amortized over their useful lives, which range from one to ten years.
In the first two quarters of 2016, the Company incurred approximately $0.2 million in acquisition-related costs. In 2015, the Company incurred approximately $0.8 million in acquisition-related costs which were included in Selling, general and administrative expenses in the Consolidated Statements of Operations. The operating results of this acquisition are included in the Company’s results of operations since the date of acquisition. Pro forma financial information has not been provided for the acquisition of Topwin as it was not material to the Company’s operations and overall financial position.
6. Inventories
Inventories are principally valued at standard costs, which approximate the lower of cost (first-in, first-out) or market. Components of inventories were as follows:
(In thousands)
Sep 26, 2015
 
Mar 28, 2015
Raw materials and purchased parts
$
39,859

 
$
37,991

Work-in-process
12,715

 
14,834

Finished goods
5,461

 
3,812

 
$
58,035

 
$
56,637

7. Trade Accounts Receivable
Trade accounts receivable consisted of the following:
(In thousands)
Sep 26, 2015
 
Mar 28, 2015
Current trade accounts receivable, net
$
49,097

 
$
42,295

Non-current trade accounts receivable
794

 
3,656

 
$
49,891

 
$
45,951

Non-current trade accounts receivable are included in Other assets in the Condensed Consolidated Balance Sheets. Presentation of $3.7 million of non-current trade accounts receivable previously shown as current at March 28, 2015 was revised to reflect these amounts as non-current, which conforms to current period presentation.
In the current quarter we factored $1.2 million in letters of credit by entering into a non-recourse letter of credit discounting agreement with Silicon Valley Bank. The cost to the Company to factor these letters of credit was insignificant.

11


8. Other Current Assets
Other current assets consisted of the following:
(In thousands)
Sep 26, 2015
 
Mar 28, 2015
Prepaid expenses
$
2,195

 
$
2,595

Acquisition related receivable

 
1,180

Value added tax receivable
891

 
802

Other
389

 
1,513

 
$
3,475

 
$
6,090

9. Other Assets
Other assets consisted of the following:
(In thousands)
Sep 26, 2015
 
Mar 28, 2015
Consignment and demo equipment, net
$
7,649

 
$
7,164

Non-current trade accounts receivable
794

 
3,656

Long term deposits and other
2,815

 
2,391

 
$
11,258

 
$
13,211

10. Accrued Current Liabilities & Other Liabilities
Accrued current liabilities consisted of the following:
(In thousands)
Sep 26, 2015
 
Mar 28, 2015
Payroll-related liabilities
$
6,766

 
$
6,723

Product warranty accrual
3,256

 
3,342

Purchase order commitments and receipts
2,557

 
1,815

Restructuring costs payable
1,552

 
1,997

Professional fees payable
1,285

 
1,237

Other current liabilities
3,497

 
3,552

 
$
18,913

 
$
18,666

Included in other current liabilities above are accrued amounts for customer deposits, value-added taxes, freight, income taxes, and other similar items.
Other liabilities (non-current) consisted of the following:
(In thousands)
Sep 26, 2015
 
Mar 28, 2015
Product warranty accrual
$
1,195

 
$

Other non-current liabilities
1,390

 
1,571

 
$
2,585

 
$
1,571

Presentation of $1.6 million of Other non-current liabilities previously shown as current at March 28, 2015 was revised to reflect these amounts as non-current, which conforms to current period presentation.
11. Product Warranty
The following is a reconciliation of the changes in the aggregate product warranty accrual:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Product warranty accrual, beginning
$
4,021

 
$
3,487

 
$
3,342

 
$
4,215

Warranty charges incurred, net
(2,063
)
 
(1,780
)
 
(3,547
)
 
(3,720
)
Provision for warranty charges
2,493

 
1,445

 
4,656

 
2,657

Product warranty accrual, ending
$
4,451

 
$
3,152

 
$
4,451

 
$
3,152


12


Net warranty charges incurred include labor charges and costs of replacement parts for system repairs under warranty. These costs are recorded net of any estimated cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Company’s suppliers for defective components. The provision for warranty charges reflects the estimate of future anticipated net warranty costs to be incurred for all products under warranty at quarter end and is recorded to cost of sales. Of the total of $4.5 million in product warranty accrual at September 26, 2015, $1.2 million is non-current and is included in Other liabilities on the Condensed Consolidated Balance Sheets.
12. Deferred Revenue

Generally, revenue is recognized upon fulfillment of acceptance criteria at the Company's factory and transfer of risk and title. Revenue is deferred whenever title transfer is pending, risk has not transferred, and/or acceptance criteria have not yet been fulfilled. Deferred revenue occurrences include sales to Japanese customers, shipments of substantially new products and shipments with custom specifications and acceptance criteria. In sales involving multiple element arrangements, the relative selling price of any undelivered elements, including installation services, is deferred until the elements are delivered and acceptance criteria are met. Revenue related to maintenance and service contracts is deferred and recognized ratably over the duration of the contracts.
The following is a reconciliation of the changes in deferred revenue:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Deferred revenue, beginning
$
14,961

 
$
12,268

 
$
12,376

 
$
10,515

Revenue deferred
17,871

 
15,141

 
33,591

 
26,949

Revenue recognized
(20,170
)
 
(10,969
)
 
(33,305
)
 
(21,024
)
Deferred revenue, ending
$
12,662

 
$
16,440

 
$
12,662

 
$
16,440

13. Commitments & Contingencies
On March 20, 2015, the Company entered into a loan and security agreement ("Loan Agreement") with Silicon Valley Bank, as lender. The Loan Agreement provides for a senior secured asset-based revolving credit facility (the “Credit Facility”) with up to $30 million available on a revolving basis, including a $15 million sublimit for letters of credit. The credit agreement expires March 20, 2018. At September 26, 2015, we had no revolving loans or letters of credit outstanding under our Credit Facility, we were in compliance with all covenants, and were not in default under the Loan Agreement. The commitment fee on the amount of unused credit was 0.3 percent.
We mitigate credit risk by transacting with highly rated counterparties for foreign exchange contracts, letters of credit and other transactions where counterparty risk is a factor. We have evaluated the non-performance risks associated with our lenders and other parties and believe them to be insignificant. From time to time we may be party to litigation arising in the normal course of business. Currently we are not party to any litigation we believe would have a material adverse effect on our financial position, results of operations, or cash flows.
14. Loss Per Share
The following is a reconciliation of weighted average shares outstanding used in the calculation of basic and diluted earnings per share:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands, except per share data)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Net loss
$
(3,260
)
 
$
(6,243
)
 
$
(9,624
)
 
$
(14,494
)
Weighted average shares used for basic earnings per share
31,384

 
30,552

 
31,280

 
30,452

Weighted average shares used for diluted earnings per share
31,384

 
30,552

 
31,280

 
30,452

Net loss per share:
 
 
 
 
 
 
 
Net loss — basic
$
(0.10
)
 
$
(0.20
)
 
$
(0.31
)
 
$
(0.48
)
Net loss — diluted
$
(0.10
)
 
$
(0.20
)
 
$
(0.31
)
 
$
(0.48
)

13


Awards of stock options, SARs and unvested RSUs representing an additional 3.7 million and 2.8 million shares of stock for the second quarter of 2016 and 2015, respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.
15. Segment and Geographic Information
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our Chief Executive Officer. Prior to the fourth quarter of 2015, we operated in one segment, high-technology manufacturing equipment, which was comprised of products that were classified in three groups: interconnect and micromachining, semiconductor and component. As a result of changes in our go-to-market strategies, common customer characteristics, and information utilized to manage our business, we realigned our products into two segments. Since the fourth quarter 2015 the Company has operated in two segments, Component Processing and Micromachining.
Net sales by segment were as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Component Processing
$
32,754

 
$
32,358

 
$
71,038

 
$
62,656

Micromachining
13,718

 
10,498

 
18,525

 
15,230

 
$
46,472

 
$
42,856

 
$
89,563

 
$
77,886

Gross profit by segment was as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Component Processing
$
13,387

 
$
13,106

 
$
27,497

 
$
25,673

Micromachining
5,473

 
2,036

 
7,135

 
2,373

Corporate and other
(439
)
 
(377
)
 
(834
)
 
(993
)
 
$
18,421

 
$
14,765

 
$
33,798

 
$
27,053

Net sales by geographic area, based on the location of the end user, were as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 26, 2015
 
Sep 27, 2014
 
Sep 26, 2015
 
Sep 27, 2014
Asia
$
37,029

 
$
34,516

 
$
70,565

 
$
59,234

Americas
6,805

 
2,482

 
13,161

 
8,656

Europe
2,638

 
5,858

 
5,837

 
9,996

 
$
46,472

 
$
42,856

 
$
89,563

 
$
77,886

16. Restructuring and Cost Management Plans
In March 2015, as a part of the plan to streamline its manufacturing and development activities, the Company initiated a restructuring plan to close the assembly plant and development center located in Chelmsford, Massachusetts. The estimated completion date of the plan is the end of fiscal 2016. See the Company's Form 10-K for the year ended March 28, 2015 for additional information related to restructuring and cost management plans.
Net restructuring costs of $0.7 million in the first two quarters of 2016 included severance and wind-up costs. These costs relate to the restructuring plan described above and our previously disclosed action to close our Beijing facility. At September 26, 2015 and March 28, 2015, the amount of unpaid restructuring costs included in accrued liabilities was $1.6 million and $2.0 million, respectively.

The following table presents the amounts related to restructuring costs payable (in thousands):

14


Restructuring & cost management amounts payable as of March 28, 2015
$
1,997

Employee severance and related benefits:
 
Costs incurred and other adjustments
653

Cash payments
(1,098
)
Restructuring & cost management amounts payable as of September 26, 2015
$
1,552

17. Shareholders’ Equity
Share Repurchase Program
In December 2011, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of our outstanding common stock. The repurchases are to be made at management’s discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors.
The Company did not repurchase any shares during the first two quarters of 2016. In the first two quarters of 2015 the Company repurchased 207,738 shares for $1.5 million under this authorization at an average price of $7.01 per share, calculated inclusive of commissions and fees.
There is no fixed completion date for the repurchase program.
Dividends
In February 2015, the Board of Directors suspended the quarterly dividend which was adopted by the Company in December 2011. The Company paid dividends in the first three quarters of 2015 under the 2011 dividend policy in the aggregate amount of $0.24 per share.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The statements contained in this report that are not statements of historical fact, including without limitation, statements containing the words “believes,” “expects,” “anticipates” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may materially differ as a result of many factors, including the risks described in Part II, Item 1A “Risk Factors.”
Overview of Business
Electro Scientific Industries, Inc. and its subsidiaries (ESI) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. ESI's integrated solutions allow industrial designers and process engineers to control the power of laser light to transform materials in ways that differentiate their consumer electronics, wearable devices, semiconductor circuits and high-precision components for market advantage. ESI’s laser-based manufacturing solutions feature the micro-machining industry’s highest precision and speed, and target the lowest total cost of ownership. Founded in 1944, ESI is headquartered in Portland, Oregon, with global operations from the Pacific Northwest to the Pacific Rim.
Laser microfabrication is comprised of a set of precise micron-level processes, including drilling, scribing, dicing, singulation, cutting, ablating, trimming, and precision marking on multiple types of materials. These processes require application-specific laser systems that are able to meet our customers’ exacting performance and productivity requirements. Our laser-based systems are utilized in the production of consumer electronics, flexible and rigid printed circuit boards, semiconductor devices, advanced semiconductor packaging, electronic sensors, touch-panel glass, flat panel liquid crystal displays (LCDs) and other high value components and devices to enable functionality, increase performance and improve production yields.
Additionally, we produce high-capacity test and inspection equipment that is critical to the quality control process during the production of multilayer ceramic capacitors (MLCCs). Our equipment ensures that each component meets the electrical and physical tolerances required to perform properly.
Historically and during much of fiscal 2015 we operated in one segment, high technology manufacturing equipment, which was comprised of products classified into three groups: interconnect and micromachining, semiconductor, and component test. As a result of changes in our go-to-market strategies, common customer characteristics, and information

15


utilized to manage our business, during the fourth quarter of 2015 we realigned our products into two segments: Component Processing (CP) and Micromachining (MM). Included within Component Processing are Interconnect Products (IP), Semiconductor Products (SP), and Component Test Products (CTP), which are sold primarily to manufacturers of electronic components to drill, cut, trim, ablate, test and mark features that improve the yield or functionality of the component. Micromachining Products (MP) are sold primarily to manufacturers of end devices across multiple industries and are used to drill, cut, or mark features on a variety of materials, generally on the casing or external surfaces of the end device. ESI does not maintain or monitor operating expenses or assets at the segment level.
Summary of Sequential Quarterly Results
The financial results of the second quarter of 2016 ended September 26, 2015, reflected sequential growth in orders, sales and earnings. Total order volume for the second quarter of 2016 increased to $51.5 million from $41.9 million in the first quarter, primarily driven by application wins in the MM segment, strength in the flex market and inclusion of a legacy memory repair order. Net sales increased to $46.5 million from $43.1 million in the first quarter of 2016 which ended June 27, 2015.
CP segment sales decreased to $32.8 million in second quarter of 2016 from $38.3 million in the prior quarter. The decrease relates to higher sales of Semiconductor and Component Test products in the prior quarter that did not recur at the same level in the current quarter, primarily due to timing of orders for wafer processing and wafer trim systems, lower service revenue, and customers' near term capital budget reductions for MLCC systems. Sales remained relatively flat for Interconnect products. Sales in the MM segment grew substantially to $13.7 million in the second quarter of 2016 compared to $4.8 million in the first quarter, fueled primarily by an application win for the Lumen series micromachining platform.
Total shipments were $44.0 million in the second quarter of 2016 compared to $46.2 million in the first quarter of 2016.
Gross profit was $18.4 million in the second quarter of 2016 compared to a gross profit of $15.4 million in the first quarter of 2016. This increase was primarily due to increased sales and production volumes, combined with gross margin improvement. Gross margin was 39.6% on net sales of $46.5 million in the second quarter of 2016 compared to a gross margin of 35.7% on net sales of $43.1 million in the first quarter of 2016. The gross margin improvement was primarily driven by more beneficial product mix, lower material costs, decreases in service repair expenses, and improved warranty cost.
Net operating expense of $21.4 million in the second quarter of 2016 decreased slightly from $21.5 million in the first quarter of 2016, the result of cost savings efforts largely offset by $0.6 million in restructuring charges incurred in the second quarter. Research, development, and engineering (RD&E) decreased $0.4 million primarily due to headcount reductions. Selling, general and administrative (SG&A) expenses decreased $0.1 million primarily due to cost savings efforts.
Operating loss was $3.0 million in the second quarter of 2016 compared to an operating loss of $6.1 million in the first quarter of 2016, a decrease of $3.1 million. The decrease in operating loss was principally due to higher sales volumes and improved gross margins, combined with lower operating expenses.
Provision for income taxes was $0.2 million in the second quarter of 2016 compared to a provision of $0.3 million in the first quarter of 2016.
Net loss was $3.3 million in the second quarter of 2016 compared to a net loss of $6.4 million in the first quarter of 2016.

16


Quarter Ended September 26, 2015 Compared to Quarter Ended September 27, 2014
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Fiscal quarter ended
 
Sep 26, 2015
 
Sep 27, 2014
Net sales
100.0
 %
 
100.0
 %
Cost of sales
60.4

 
65.5

Gross profit
39.6

 
34.5

Selling, general and administrative
27.0

 
27.8

Research, development and engineering
17.8

 
19.7

Acquisition and integration costs
0.1

 

Restructuring costs
1.3

 

Operating loss
(6.5
)
 
(13.0
)
Interest and other income (expense), net

 
(0.6
)
Total non-operating income (expense), net

 
(0.6
)
Loss before income taxes
(6.5
)
 
(13.6
)
Provision for income taxes
0.6

 
1.1

Net loss
(7.0
)%
 
(14.7
)%
Net Sales
The following table presents net sales information by product group:
 
Fiscal quarter ended
  
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Component Processing
 
 
 
 
 
 
 
Interconnect Products (IP)
$
21,500

 
46.2
%
 
$
16,102

 
37.6
%
Semiconductor Products (SP)
6,763

 
14.6

 
9,767

 
22.8

Component Test Products (CTP)
4,491

 
9.7

 
6,489

 
15.1

 
$
32,754

 
70.5
%
 
$
32,358

 
75.5
%
Micromachining
 
 
 
 
 
 
 
Micromachining Products (MP)
$
13,718

 
29.5
%
 
$
10,498

 
24.5
%
Net Sales
$
46,472

 
100.0
%
 
$
42,856

 
100.0
%
Net sales for the second quarter of 2016 increased $3.6 million or 8.4% from net sales for the second quarter of 2015. Sales in the CP and MM segments increased by 1.2% and 30.7% respectively.
CP segment sales for the second quarter of 2016 increased $0.4 million compared to the second quarter of 2015. The increase in CP segment sales was driven by increased demand for our flex via drilling products, including the new GemStone product, partially offset by lower sales for wafer trim, repair activity, and MLCC systems.
MM segment sales for the second quarter of 2016 increased $3.2 million compared to the second quarter of 2015. The increase was driven by an application win for our new Lumen series platform.
The following table presents net sales information by geographic region:
 
Fiscal quarter ended
  
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
37,029

 
79.7
%
 
$
34,516

 
80.5
%
Americas
6,805

 
14.6

 
2,482

 
5.8

Europe
2,638

 
5.7

 
5,858

 
13.7

 
$
46,472

 
100.0
%
 
$
42,856

 
100.0
%

17


Gross Profit
 
Fiscal quarter ended
  
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Component Processing
$
13,387

 
40.9
 %
 
$
13,106

 
40.5
 %
Micromachining
5,473

 
39.9

 
2,036

 
19.4

Corporate and other
(439
)
 
(0.9
)
 
(377
)
 
(0.9
)
Gross Profit
$
18,421

 
39.6
 %
 
$
14,765

 
34.5
 %
Gross profit was $18.4 million for the second quarter of 2016, an increase of $3.7 million compared to the second quarter of 2015. The gross profit increase was principally due to higher sales volume. Gross margins were 39.6% and 34.5% for the second quarters of 2016 and 2015, respectively. The higher gross margin is due primarily to beneficial changes in sales mix, the positive impact of higher volumes and lower manufacturing costs.
Gross margin for the CP segment increased slightly from 40.5% to 40.9% on slight volume increases. MM segment gross margins increased from 19.4% to 39.9% due to significant volume and mix improvements, driven principally by increased sales of the Lumen series platform, as well as general reductions in manufacturing expenses and decreased repair costs. Additionally, fixed costs are allocated between segments based on annual business levels as projected at the beginning of each year, resulting in lower costs allocated to the MM segment in the second quarter 2016 compared to the second quarter of 2015.
Operating Expenses
 
Fiscal quarter ended
  
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Expense / (Income)
 
% of Net Sales
 
Expense / (Income)
 
% of Net Sales
Selling, general and administrative
$
12,534

 
27.0
%
 
$
11,899

 
27.8
%
Research, development and engineering
8,283

 
17.8

 
8,424

 
19.7

Acquisition and integration costs
40

 
0.1

 

 

Restructuring costs
591

 
1.3

 

 

 
$
21,448

 
46.2
%
 
$
20,323

 
47.5
%
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses primarily consist of labor and other employee-related expenses including share-based compensation expense, travel expenses, professional fees, sales commissions and facilities costs.
SG&A expenses for the second quarter of 2016 increased $0.6 million compared to the second quarter of 2015. This increase was attributable to increases in variable pay, stock compensation and Topwin-related expenses in the second quarter of 2016.
Research, Development and Engineering
Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials costs, equipment costs and facilities costs. RD&E expenses for the second quarter of 2016 decreased $0.1 million compared to the second quarter of 2015. This decrease was primarily due to labor cost reductions.
Acquisition and Integration Costs
Acquisition and integration costs consisted mainly of consulting, travel and legal expenses associated with the acquisition and integration of Topwin Optoelectronics, which was acquired in January 2015.
Restructuring Costs
Restructuring costs of $0.6 million consisted primarily of expenses associated with actions to reduce labor cost and transition resources to Asia. We anticipate the restructuring activities to conclude in the third quarter of 2016 and we expect to incur approximately $1.5 million to $2.0 million of restructuring costs primarily associated with consolidation of our facilities.

18


Non-operating Income and Expense, net
 
Fiscal quarter ended
 
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Interest and Other (Expense) Income, net
 
% of Net Sales
 
Interest and Other (Expense) Income, net
 
% of Net Sales
Interest and other income (expense), net
6

 

 
(244
)
 
(0.6
)
Interest and other income, net, consists primarily of net interest income and expense, market gains and losses on assets held in employees’ deferred compensation accounts, realized and unrealized foreign exchange gains and losses, bank charges and investment management fees. Net interest and other income was $6 thousand in the second quarter of 2016 compared to expense of $244 thousand in second quarter of 2015. The improvement was primarily due to foreign exchange losses in the second quarter of 2015, which did not repeat.
Income Taxes
 
Fiscal quarter ended
 
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Income Tax Provision
 
Effective
Tax Rate
 
Income Tax Provision
 
Effective
Tax Rate
Provision for income taxes
$
239

 
(7.9
)%
 
$
441

 
(7.6
)%
The provision for income taxes for the second quarter of 2016 was $0.2 million on the pretax loss of $3.0 million, an effective tax rate of (7.9)% resulting primarily from foreign taxes. For the second quarter of 2015, the provision for income taxes was $0.4 million on pretax loss of $5.8 million, an effective rate of (7.6)%. The negative tax rate is driven by income tax in foreign jurisdictions, despite pretax losses for the Company as a whole.
Net Loss
 
Fiscal quarter ended
 
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Net Loss
 
% of Net Sales
 
Net Loss
 
% of Net Sales
Net loss
$
(3,260
)
 
(7.0
)%
 
$
(6,243
)
 
(14.7
)%
Net loss for the second quarter of 2016 was $3.3 million, or $0.10 per basic and diluted share, compared to net loss of $6.2 million, or $0.20 per basic and diluted share for the second quarter of 2015.

19


Two Quarters Ended September 26, 2015 Compared to Two Quarters Ended September 27, 2014
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Two fiscal quarters ended
 
Sep 26, 2015
 
Sep 27, 2014
Net sales
100.0
 %
 
100.0
 %
Cost of sales
62.3

 
65.3

Gross profit
37.7

 
34.7

Selling, general and administrative
28.1

 
30.8

Research, development and engineering
18.9

 
22.6

Acquisition and integration costs
0.2

 

Restructuring costs
0.7

 

Operating loss
(10.2
)
 
(18.7
)
Interest and other expense, net

 
(0.3
)
Total non-operating income (expense), net

 
(0.3
)
Loss before income taxes
(10.2
)
 
(19.0
)
Provision for income taxes
0.5

 
(0.4
)
Net loss
(10.7
)%
 
(18.6
)%
Net Sales
The following table presents net sales information by product group:
 
Two fiscal quarters ended
  
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Component Processing
 
 
 
 
 
 
 
Interconnect Products (IP)
$
42,145

 
47.0
%
 
$
32,318

 
41.5
%
Semiconductor Products (SP)
17,904

 
20.0

 
20,516

 
26.3

Component Test Products (CTP)
10,989

 
12.3

 
9,822

 
12.6

 
$
71,038

 
79.3

 
$
62,656

 
80.4

Micromachining
 
 
 
 
 
 
 
Micromachining Products (MP)
$
18,525

 
20.7

 
$
15,230

 
19.6

Net Sales
$
89,563

 
100.0
%
 
$
77,886

 
100.0
%
Net sales for the first two quarters of 2016 increased $11.7 million or 15.0% from net sales for the first two quarters of 2015. Sales in CP increased by $8.4 million or 13.4% and MP increased by $3.3 million or 21.6%.
The increase in CP sales for the first two quarters of 2016 compared to the first two quarters of 2015 was primarily due to a $9.8 million improvement in Interconnect sales resulting from higher demand for our flex products. This increase was partially offset by lower sales of circuit trim systems.
The increase in MP sales for the first two quarters of 2016 compared to the first two quarters of 2015 was primarily driven by increased sales volume for new applications of our Lumen series platform.
The following table presents net sales information by geographic region:
 
Two fiscal quarters ended
  
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
70,565

 
78.8
%
 
$
59,234

 
76.1
%
Americas
13,161

 
14.7

 
8,656

 
11.1

Europe
5,837

 
6.5

 
9,996

 
12.8

 
$
89,563

 
100.0
%
 
$
77,886

 
100.0
%

20


Gross Profit
 
Two fiscal quarters ended
  
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Component Processing
$
27,497

 
38.7
 %
 
$
25,673

 
41.0
 %
Micromachining
7,135

 
38.5

 
2,373

 
15.6

Corporate and other
(834
)
 
(0.9
)
 
(993
)
 
(1.3
)
Gross Profit
$
33,798

 
37.7
 %
 
$
27,053

 
34.7
 %
Gross profit was $33.8 million for the first two quarters of 2016 and increased $6.7 million compared to the first two quarters of 2015. Gross profit improved primarily due to overall increased sales volume, favorable product mix and favorable repair activity. Gross margins for the CP segment decreased slightly from 41.0% to 38.7% on higher warranty costs. MM segment gross margins increased from 15.6% to 38.5% due to significant volume and mix improvements, driven principally by increased sales of the Lumen series platform, as well as general reductions in manufacturing expenses and decreased repair costs. Additionally, fixed costs are allocated between segments based on annual business levels as projected at the beginning of each year, resulting in lower costs allocated to the MM segment in the first two quarters of 2016 compared to the first two quarters 2015.

Operating Expenses
 
Two fiscal quarters ended
  
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, general and administrative
$
25,151

 
28.1
%
 
$
24,052

 
30.8
%
Research, development and engineering
16,928

 
18.9

 
17,569

 
22.6

Acquisition and integration costs
194

 
0.2

 

 

Restructuring costs
653

 
0.7

 

 

 
$
42,926

 
47.9
%
 
$
41,621

 
53.4
%
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses primarily consist of labor and other employee-related expenses including share-based compensation expense, travel expenses, professional fees, sales commissions and facilities costs.
SG&A expenses for the first two quarters of 2016 increased $1.1 million compared to the first two quarters of 2015. This change was attributable to increases in variable pay, stock compensation and Topwin-related expenses in 2016 as compared to 2015, somewhat mitigated by cost savings efforts in other areas such as professional services and consulting.
Research, Development and Engineering
Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials costs, equipment costs and facilities costs. RD&E expenses for the first two quarters of 2016 decreased $0.6 million compared to the first two quarters of 2015. This decrease was primarily due to labor cost reductions.
Acquisition and Integration Costs
Acquisition and integration costs consisted mainly of consulting, legal and travel expenses associated with the acquisition and integration of Topwin Optoelectronics, which was acquired in January 2015.
Restructuring Costs
Restructuring costs consisted primarily of expenses associated with severance costs related to further efforts to shift resources to Asia and lower overall costs. We anticipate the restructuring activities to conclude in the third quarter of 2016 and we expect to incur approximately $1.5 million to $2.0 million of restructuring costs primarily associated with consolidation of our facilities.
Non-operating Income and Expense, net

21


 
Two fiscal quarters ended
 
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Interest and Other Income, net
 
% of Net Sales
 
Interest and Other Expense, net
 
% of Net Sales
Interest and other income (expense), net
$
1

 
%
 
$
(198
)
 
(0.3
)%
Interest and other income, net, consists primarily of interest income and expense, market gains and losses on assets held in employees’ deferred compensation accounts, realized and unrealized foreign exchange gains and losses, bank charges and investment management fees. Net interest and other expense was negligible for the first two quarters of 2016 compared to net interest and other expense of $0.2 million in the first two quarters of 2015. This improvement was primarily due to foreign exchange losses in 2015 which did not repeat, partially offset by increased market losses on assets held in deferred compensation accounts in 2016.

Income Taxes
 
Two fiscal quarters ended
 
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Income Tax Provision
 
Effective
Tax Rate
 
Income Tax Benefit
 
Effective
Tax Rate
Provision for income taxes
$
497

 
(5.4
)%
 
$
(272
)
 
1.8
%
The income tax provision for the first two quarters of 2016 was $0.5 million on pretax loss of $9.1 million, an effective tax rate of (5.4)%. For the first two quarters of 2015, the income tax benefit was $0.3 million on pretax loss of $14.8 million, an effective rate of 1.8%. The provision for taxes in 2016 relates to income taxes arising in foreign jurisdictions and the net income tax benefit in 2015 was driven by a favorable tax assessment related to the legal settlement with All Ring.
Net Loss
 
Two fiscal quarters ended
 
Sep 26, 2015
 
Sep 27, 2014
(In thousands, except percentages)
Net Loss
 
% of Net Sales
 
Net Loss
 
% of Net Sales
Net loss
$
(9,624
)
 
(10.7
)%
 
$
(14,494
)
 
(18.6
)%
Net loss for the first two quarters of 2016 was $9.6 million, or $0.31 per basic and diluted share, compared to net loss of $14.5 million, or $0.48 per basic and diluted share for the first two quarters of 2015.
Financial Condition and Liquidity
At September 26, 2015, our principal sources of liquidity were cash and cash equivalents of $43.6 million, short-term investments of $16.6 million and current accounts receivable of $49.1 million. At September 26, 2015, we had a current ratio of 3.40 and had no outstanding debt. Working capital of $122.4 million decreased $2.2 million compared to the March 28, 2015 balance of $124.6 million, substantially impacted by operating losses in the first two quarters of 2016.
In February 2015, the Board of Directors suspended the quarterly dividend which was adopted by the Company in December 2011. The Company paid dividends in the first three quarters of 2015 under the 2011 dividend policy in the aggregate amount of $0.24 per share. The Company did not pay any dividends in the first two quarter of 2016.
Sources and Uses of Cash
Net cash provided by operating activities of $4.5 million for the two quarters ended September 26, 2015 was a result of $9.6 million of net loss, or $2.2 million in losses after adjusting for non-cash items, more than offset by cash flow improvements related to changes in working capital. Significant changes in working capital in the first two quarters of 2016 consisted of a $9.8 million increase in accounts payable driven by normalization of timing of inventory receipts and extension of payment terms with certain vendors, somewhat offset by a $6.8 million increase in accounts receivable driven by higher shipments, and a $1.4 million increase in inventories.
Net cash used in investing activities of $11.8 million was primarily the result of $10.0 million of net purchases of investments and $2.2 million of capital expenditures for purchases of property, plant and equipment (PP&E). Accounts payable balance includes $0.2 million for amounts owed on PP&E purchases as of September 26, 2015.

22


For the first two quarters of 2016, net cash provided by financing activities of $0.1 million related to issuances from employee stock plans, net of payments of associated withholding taxes.
We believe that our existing cash, cash equivalents and short-term investments are adequate to fund our operations and contractual obligations for at least the next twelve months.
Critical Accounting Policies and Estimates
We reaffirm the “Critical Accounting Policies and Estimates” in Part II Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations reported in our Form 10-K for the year ended March 28, 2015.
Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in the market risk disclosure contained in our Form 10-K for the year ended March 28, 2015.
Item 4. Controls and Procedures
Attached to this quarterly report as exhibits 31.1 and 31.2 are the certifications of our President and Chief Executive Officer (CEO) and our Chief Financial Officer (CFO) required by Section 302 of the Sarbanes-Oxley Act of 2002 (the Section 302 Certifications). This portion of our quarterly report on Form 10-Q is our disclosure of the conclusions of our management regarding the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report based on management’s evaluation of those disclosure controls and procedures. This disclosure should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.

Disclosure Controls and Procedures
Our management has evaluated, under the supervision and with the participation of our CEO and CFO, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (Exchange Act). Based on the evaluation, our CEO and CFO have concluded that our disclosure controls and procedures were not effective as of September 26, 2015, because of the material weaknesses described in Management’s Report on Internal Control over Financial Reporting in our annual Form 10-K dated March 28, 2015. Management is still in process of evaluating and remediating the related deficiencies.

Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting during the second quarter of 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of business, we are involved in various legal matters, either asserted or unasserted, and investigations. In the opinion of management, ultimate resolution of these matters will not have a material effect on our consolidated financial position, results of operations or cash flows.
Item 1A. Risk Factors
The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes,” “expects” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time, we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may differ materially. The following information highlights some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors. Factors that may result in such variances include, but are not limited to, the following:
Risks Related to Our Competition and Customers
Volatility of Our Customers’ Industries
Our business is dependent upon the capital expenditures of manufacturers of microelectronics, semiconductors, computers, wireless communications and other electronic products. The capital equipment market for microelectronics, semiconductor, and consumer electronics manufacturers has historically been characterized by sudden and severe cyclical variations in product supply and demand due to a number of factors including capacity utilization, timing of customers’ new product introductions and demand for their products, inventory levels relative to demand and access to affordable capital. The timing, severity and duration of these market cycles are difficult or impossible to predict. As a result, business levels can vary significantly from quarter to quarter or year to year. Significant volatility in investment cycles in the market for

23


microelectronics, PCB's and semiconductors used in electronic devices or in the market for consumer electronics reduce demand for our products and may materially and adversely affect our business, financial condition and results of operations. The degree of the impact of any downturn on our business depends on a number of factors, including: the strength of the global economies, particularly those of Asia and the United States; the overall level of demand for consumer electronics products; the stability of global financial systems; and the overall health of the microelectronics, semiconductor, and consumer electronics industries.
Expansion into New Markets
Our future success depends in large part on our successful penetration of new markets adjacent to our existing markets and of the Chinese market for lower cost systems. These markets are new to us and our success is dependent on our displacing entrenched competitors who are familiar with these markets and are known to customers. There is no assurance that we will be successful in penetrating these new markets significantly or at all. If we fail to successfully penetrate these markets our business, financial condition and results of operations could be materially and adversely affected.
Highly Competitive Markets
We face substantial competition from established competitors throughout the world, some of which have greater financial, engineering, manufacturing and marketing resources than we do. Those competitors with greater resources may, in addition to other things, be able to better withstand periodic downturns, compete more effectively on the basis of price and technology, or more quickly develop enhancements to, and new generations of, products that compete with the products we manufacture and market. New companies may enter the markets in which we compete, or industry consolidation may occur, further increasing competition in those markets. We have also experienced new entrants to our markets offering aggressive price and payments terms in an attempt to gain market share. Some competitors, particularly in China, also develop low cost products employing processes or technology developed by us. We believe that to be competitive we must continue to expend significant financial resources in order to, among other things, invest in new product development and enhancements. We may not be able to compete successfully in the future and increased competition may result in price reductions, reduced profit margins and loss of market share.
Revenues are Largely Dependent on Few Customers
We depend on a few significant customers for a large portion of our revenues. In 2015, our top ten customers accounted for approximately 40% of total net sales. We anticipate that sales of our products to a relatively small number of customers will continue to account for a significant portion of our revenues. Consolidation between customers, changes in technologies or solutions used by customers, changes in products manufactured by customers or in end-user demand for those products, selection of suppliers other than us, customer bankruptcies or customer departures from their respective industries all may result in even fewer customers accounting for a high percentage of our revenue and reduced demand from any single major customer. Also, business levels with several of our top customers are dependent on our winning new designs and features each product cycle, and there is no guarantee of future business based on past design wins. Furthermore, none of our customers have any long-term obligation to continue to buy our products or services and may therefore delay, reduce or cease ordering our products or services at any time. The cancellation, reduction or deferral of purchases of our products by even a single customer could significantly reduce our revenues in any particular quarter. For example, revenues from Apple, Inc. decreased from $27 million in 2014 to $15 million in 2015. If we were to lose any of our significant customers or suffer a material reduction in their purchase orders, revenue could decline and our business, financial condition and results of operations could be materially and adversely affected.
Increased Price Pressure
We have experienced and continue to experience pricing pressure in the sale of our products, from both competitors and customers. Pricing pressures typically have become more intense during cyclical downturns when competitors seek to maintain or increase market share, reduce inventory or introduce more technologically advanced products or lower cost products. In addition, we may agree to pricing concessions or extended payment terms with our customers in connection with volume orders or to improve cost of ownership in highly competitive applications. Our business, financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and intense price-based competition.
Revenues are Largely Based on the Sale of a Small Number of Product Units
We derive a substantial portion of our revenue from the sale of a relatively small number of products. Accordingly, our revenues, margins and other operating results could fluctuate significantly from quarter to quarter depending upon a variety of factors in addition to those described above, including:
changes in the timing of orders and terms or acceptance of product shipments by our customers;
changes in the mix of products and services that we sell;
timing and market acceptance of our new product introductions; and

24


delays or problems in the planned introduction of new products, or in the performance of any such products following delivery to customers.
As a result of these risks, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance.
Risks Related to Our Supply Chain and Production
Variability of Production Capacity
To meet rapidly changing demand in the industries we serve, we must effectively manage our resources and production capacity. During periods of decreasing demand for our products, we must be able to appropriately align our cost structure with prevailing market conditions and effectively manage our supply chain. Our ability to rapidly and effectively reduce our cost structure in response to such downturns is limited by the fixed nature of many of our expenses in the near term and by our need to continue our investment in next-generation product technology and to support and service our products. Conversely, when upturns occur in the markets we serve, we may have difficulty rapidly and effectively increasing our manufacturing capacity or procuring sufficient materials to meet sudden increases in customer demand that could result in the loss of business to our competitors and harm to our relationships with our customers. If we are not able to timely and appropriately adapt to changes in our business environment, our business, financial condition or results of operations may be materially and adversely affected.
Reliance on Critical Suppliers
We use a wide range of components from numerous suppliers in the manufacture of our products, including custom electronic, laser, optical and mechanical components. We generally do not have guaranteed supply arrangements with our suppliers. We seek to reduce the risk of production and service interruptions and shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. Although we make reasonable efforts to ensure that parts are available from multiple suppliers, some key parts are available only from a single supplier or a limited group of suppliers in the short term. In addition, some of the lasers we use in our products are difficult to manufacture, and as a result we may not receive an adequate supply of lasers in a timely fashion to fill orders. Operations at our suppliers’ facilities are subject to disruption or discontinuation for a variety of reasons, including changes in business relationships, competitive factors, financial difficulties, work stoppages, fire, natural disasters or other causes. Any such disruption or discontinuation to our suppliers’ operations could interrupt or reduce our manufacturing activities and delay delivery of our products, any or all of which could materially and adversely affect our results of operations. In addition, when markets recover from economic downturns, there is a heightened risk that one or more of our suppliers may not be able to meet our increased demand requirements, adversely impacting our ability to fulfill orders and win business with our customers.
Utilization of Contract Manufacturers
We have arrangements with contract manufacturers to complete the manufacturing of certain of our product subcomponents. Any significant interruption in our contract manufacturers’ ability to provide manufacturing services to us as a result of contractual disputes with us or another party, labor disruptions, financial difficulties, natural disasters, delay or interruption in the receipt of inventory, customer prioritization or other causes could result in reduced manufacturing capabilities or delayed deliveries for certain of our products, any or all of which could materially and adversely affect our results of operations.
Charges for Excess or Obsolete Inventory
One factor on which we compete is the ability to ship products on schedules required by customers. In order to facilitate timely shipping, management forecasts demand, both in type and amount of products, and these forecasts are used to determine inventory to be purchased. We also order materials based on our technology roadmap, which represents management’s assessment of technology that will be utilized in new products that we develop. Certain types of inventory, including lasers and optical equipment, are particularly expensive and may only be used in the production of a single type of product. If actual demand is lower than forecast with respect to the type or amount of products actually ordered, or both, our inventory levels may increase. As a result, there is a risk that we may have to incur material accounting charges for excess and obsolete inventory if inventory cannot be used, which would negatively affect our financial results. Also, if we alter our technology or product development strategy, we may have inventory that may not be usable under the new strategy, which may also result in material accounting charges. For example, during 2015, we recorded approximately $1.0 million of charges in cost of sales for inventory written-off associated with discontinued products.
Uncertainties Resulting from Conflict Minerals Regulation

25


On August 22, 2012, the SEC adopted a new rule requiring disc