-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Wwb3tmuYVjrBlrcqKOUsAPTjVRZ4J0vj8flVSauUGjZVaY5XUFFx3s79YnauRvGi XsQmUOaXk8wsTZcqrjfvJg== 0001157523-03-000060.txt : 20030114 0001157523-03-000060.hdr.sgml : 20030114 20030113172049 ACCESSION NUMBER: 0001157523-03-000060 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20021130 FILED AS OF DATE: 20030113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ELECTRO SCIENTIFIC INDUSTRIES INC CENTRAL INDEX KEY: 0000726514 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS ELECTRICAL MACHINERY, EQUIPMENT & SUPPLIES [3690] IRS NUMBER: 930370304 STATE OF INCORPORATION: OR FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-12853 FILM NUMBER: 03512586 BUSINESS ADDRESS: STREET 1: 13900 NW SCIENCE PARK DR CITY: PORTLAND STATE: OR ZIP: 97229 BUSINESS PHONE: 5036414141 MAIL ADDRESS: STREET 1: 13900 NW SCIENCE PARK DRIVE CITY: PORTLAND STATE: OR ZIP: 97229-5497 10-Q 1 newa4318132_10-q.htm ELECTRO SCIENTIFIC INDUSTRIES 10-Q 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended November 30, 2002

Commission File Number: 0-12853

ELECTRO SCIENTIFIC INDUSTRIES, INC.

(an Oregon corporation)

93-0370304
(I.R.S. Employer Identification No.)

13900 N.W. Science Park Drive, Portland, Oregon 97229

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 |_|

The number of shares outstanding of the Registrant’s Common Stock at November 30, 2002 was 27,719,627 shares.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

	Page No.

Part I. Financial Information	2

Item 1. Consolidated Financial Statements (Unaudited)	2

Consolidated Condensed Balance Sheets	2
November 30, 2002 and June 1, 2002

Consolidated Statements of Operations	4
Three Months and Six Months Ended November 30, 2002 and December 1, 2001

Consolidated Statements of Cash Flows	5
Six Months Ended November 30, 2002 and December 1, 2001

Notes to Consolidated Condensed Financial Statements	6

Item 2. Management’s Discussion and Analysis of Financial	12
Condition and Results of Operations

Item 3. Market Risks	25

Item 4. Controls & Procedures	25

Part II. Other Information	26

Item 1. Legal Proceedings	26

Item 4. Submission of Matters to a Vote of Security Holders	27

Item 6. Exhibits and Reports on Form 8K	27

Signature	28

Certifications	29

Exhibit	35

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Part I. Financial Information

Item 1. Consolidated Financial Statements

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands except per share data)

	Nov. 30, 2002			June 1, 2002

ASSETS

Current assets:
Cash and cash equivalents	$	29,152		$	29,435
Marketable securities		223,686			181,019
Restricted securities		9,438			6,353

Total cash and securities		262,276			216,807

Trade receivables, net		52,487			55,810
Income tax refund receivable		13,262			13,948
Inventory		54,447			63,690
Deferred income taxes		7,630			7,630
Other current assets		7,399			5,260

Total current assets		397,501			363,145


Long-term marketable securities		41,487			73,445
Long-term restricted securities		5,998			12,047

Net property, plant and equipment held for sale		7,599			—

Property, plant and equipment, at cost		83,157			96,233
Less - accumulated depreciation		(33,479	)		(37,449	)

Net property, plant and equipment		49,678			58,784


Deferred income taxes		—			882
Other assets		18,076			16,944

Total assets	$	520,339		$	525,247

The accompanying notes are an integral part of these statements.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands except per share data)

	Nov. 30, 2002		June 1, 2002

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	4,307	$	3,246
Accrued liabilities		17,509		16,062
Deferred revenue		2,001		1,948

Total current liabilities		23,817		21,256


Convertible subordinated notes		146,347		145,897

Total liabilities	$	170,164	$	167,153


Shareholders’ equity:
Preferred stock, without par value; 1,000 shares authorized; no		—		—
shares issued
Common stock, without par value;
100,000 shares authorized;
27,720 and 27,619 shares issued and outstanding at
November 30, 2002 and June 1, 2002, respectively	$	137,768	$	136,370
Retained earnings		211,987		221,377
Accumulated other comprehensive income		420		347

Total shareholders’ equity		350,175		358,094

Total liabilities and shareholders’ equity	$	520,339	$	525,247

The accompanying notes are an integral part of these statements.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
(unaudited)

	Three Months Ended						Six Months Ended
	Nov. 30, 2002			Dec. 1, 2001			Nov. 30, 2002			Dec. 1, 2001


Net sales	$	43,302		$	39,606		$	86,263		$	89,113

Cost of sales		34,508			19,937			57,493			47,991

Gross margin		8,794			19,669			28,770			41,122

Operating expenses:
Selling, service and administrative		17,171			13,430			30,351			32,417
Research, development and engineering		6,945			8,167			14,613			20,331
Non-recurring operating items		—			1,620			—			5,971

Total operating expenses		24,116			23,217			44,964			58,719

Operating loss		(15,322	)		(3,548	)		(16,194	)		(17,597	)

Interest income		2,353			1,620			5,902			3,557
Interest expense		(1,774	)		(51	)		(3,781	)		(78	)
Other income (expense), net		701			(208	)		264			(22	)

Loss before income taxes		(14,042	)		(2,187	)		(13,809	)		(14,140	)

Benefit for income taxes		(4,494	)		(722	)		(4,419	)		(4,666	)


Net loss	$	(9,548	)	$	(1,465	)	$	(9,390	)	$	(9,474	)


Net loss per share - basic	$	(0.34	)	$	(0.05	)	$	(0.34	)	$	(0.35	)


Net loss per share - diluted	$	(0.34	)	$	(0.05	)	$	(0.34	)	$	(0.35	)


Weighted average number of shares - basic		27,714			27,246			27,682			27,199
Weighted average number of shares - diluted		27,714			27,246			27,682			27,199

The accompanying notes are an integral part of these statements.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Six Months Ended
	Nov. 30, 2002			June 1, 2002

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(9,390	)	$	(9,474	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Depreciation and amortization		4,728			5,532
Tax benefit of stock options exercised		181			731
Other non-cash charges		11,249			930
Deferred income taxes		400			4,859
Changes in operating accounts:
Decrease in trade receivable		4,815			24,510
(Increase) decrease in inventory		1,186			(1,027	)
Decrease in income tax refund receivable		686			—
Increase in other current assets		(2,102	)		(882	)
Increase (decrease) in current liabilities		1,096			(33,498	)

Net cash provided by (used in) operating activities		12,849			(8,319	)


CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment		(6,164	)		(9,486	)
Proceeds from the sale of property, plant and equipment		45			633
Maturity of restricted securities		2,964			—
Purchase of securities		(141,941	)		(89,891	)
Proceeds from sales of securities and maturing securities		131,793			74,740
Increase in other assets		(1,046	)		(801	)

Net cash used in investing activities		(14,349	)		(24,805	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and stock plans		1,217			3,253

Net cash provided by financing activities		1,217			3,253


NET CHANGE IN CASH AND CASH EQUIVALENTS		(283	)		(29,871	)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		29,435			68,522

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	29,152		$	38,651

Cash payments for interest were $3,368 and $12 for the six months ended November 30, 2002 and December 1, 2001, respectively. Cash refunds for income taxes were $5,152 for the six months ended November 30, 2002. Cash payments for income taxes were $2,334 for the six months ended December 1, 2001.

The accompanying notes are an integral part of these statements.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(in thousands except per share data unless otherwise noted)
(unaudited)

Note 1 — Basis of Presentation

We have prepared the condensed consolidated financial statements included herein without audit, 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 condensed consolidated financial statements are to be read in conjunction with the financial statements and notes thereto included in our 2002 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 — Accounts Receivable, Net

We entered into an agreement that allows us to sell accounts receivable from selected customers at a discount to a financial institution. Receivables sold under these provisions have terms and credit risk characteristics similar to our overall receivables portfolio. Receivable sales have the effect of increasing cash and reducing accounts receivable and days sales outstanding. Accounts receivable sales under these agreements were $12.0 million for the six months ended November 30, 2002. Discounting fees were recorded as interest expense and were not material for the six months ended November 30, 2002 and December 1, 2001. At November 30, 2002, $2.2 million of receivables sold under these agreements remained outstanding.

Note 3 — Inventory

Inventory is principally valued at standard cost, which approximates the lower of cost (first-in, first-out) or market. Components of inventory were as follows:

	Nov. 30, 2002		June 1, 2002


Raw materials and purchased parts	$	31,922	$	40,938
Work-in-process		3,474		1,942
Finished goods		19,051		20,810


Total inventory	$	54,447	$	63,690

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
(in thousands except per share data unless otherwise noted)
(unaudited)

Note 4 — Assets held for Sale

In order to better align operating expenses with anticipated revenues, we implemented a restructuring plan during June 2001. This restructuring plan included vacating several buildings. We own a 29,000 square foot building on 3 acres of land near Minneapolis, Minnesota that we expect to sell in the third quarter of fiscal 2003.

On October 2, 2002, we announced a plan to relocate the manufacturing of our Electronic Component Systems product line from Escondido, California to our headquarters in Portland, Oregon. The consolidation of the facilities was completed on December 31, 2002. We own a 60,000 square foot plant on 10 acres of land near Escondido, California. As of November 30, 2002, we contracted with a real estate agent to find a buyer and anticipate we will sell the assets within one year. Based on current market information provided by our real estate agents on both the Minnesota and California properties, we believe the market values individually to be in excess of net book value.

Components of net assets held for sale were as follows:

	Nov. 30, 2002		June 1, 2002


Land	$	2,909	$	—
Building		4,690		—

Total net assets held for sale	$	7,599	$	—

Note 5 — Earnings Per Share

We compute net income per share in accordance with Statement of Financial Accounting Standards 128, “Earnings Per Share” (SFAS 128). All earnings per share amounts in the following table are presented to conform to the SFAS 128 requirements.

	Three Months Ended						Six Months Ended
	Nov. 30, 2002			Dec. 1, 2001			Nov. 30, 2002			Dec. 1, 2001

Net loss	$	(9,548	)	$	(1,465	)	$	(9,390	)	$	(9,474	)

Weighted average number of share of common
stock and common stock equivalents
outstanding:
Weighted-average number of shares
outstanding - basic		27,714			27,246			27,682			27,199
Dilutive effect of employee stock options		—			—			—			—

Weighted-average number of shares outstanding - diluted		27,714			27,246			27,682			27,199

Net loss per share - basic	$	(0.34	)	$	(0.05	)	$	(0.34	)	$	(0.35	)

Net loss per share - diluted	$	(0.34	)	$	(0.05	)	$	(0.34	)	$	(0.35	)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
(in thousands except per share data unless otherwise noted)
(unaudited)

For purposes of computing diluted earnings per share, weighted average common share equivalents do not include the following stock options or shares issuable upon conversion of our 4¼% convertible subordinated notes due 2006 because inclusion would have an anti-dilutive effect on the earnings per share calculation.

	Three Months Ended		Six Months Ended
	Nov. 30, 2002	Dec. 1, 2001	Nov. 30, 2002	Dec. 1, 2001


Employee stock options	4,584	3,888	4,584	3,888
4 ¼% convertible subordinated notes	3,947	—	3,947	—

Note 6 — Comprehensive Loss

The components of comprehensive loss, net of tax, are as follows:

	Three Months Ended						Six Months Ended
	Nov. 30, 2002			Dec. 1, 2001			Nov. 30, 2002			Dec. 1, 2001


Net loss	$	(9,548	)	$	(1,465	)	$	(9,390	)	$	(9,474	)

Net unrealized gain (loss) on derivative instruments		(1	)		(87	)		13			1
Foreign currency translation adjustment		(9	)		(19	)		(502	)		(17	)
Net unrealized gain on securities		334			551			561			367


Total comprehensive loss	$	(9,224	)	$	(1,020	)	$	(9,318	)	$	(9,123	)

Note 7 — Income Taxes

The effective income tax rate for the interim period is based on estimates of annual amounts of taxable income, tax credits and other factors. The income tax rate for the three months ended November 30, 2002 and December 1, 2001 was 32% and 33%, respectively.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
(in thousands except per share data unless otherwise noted)
(unaudited)

Note 8 — Recent Accounting Pronouncements

In December 2002, the EITF published the Consensus on Issue 00-21, “Revenue Arrangements with Multiple Deliverables.” The consensus provides guidance on when and how to allocate revenue from bundled sales transactions. The Consensus is applicable for fiscal years beginning after June 15, 2003. We are currently evaluating the impact of Issue 00-21.

In August 2002, the FASB issued SFAS 146 “Accounting for costs associated with exit or disposal activities.” SFAS 146 nullifies EITF Issue 94-3, “Liability recognition for certain Employee termination benefits and other costs to exit an activity.” Under SFAS 146, liabilities for exit or disposal activities are recognized and measured initially at fair value only when the liability is incurred. This statement is effective for exit costs initiated after December 31, 2002, and will be applied on prospective transactions only.

In June 2001, the Financial Accounting Standards Board issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143), which is effective for fiscal years beginning after June 15, 2002. SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development, and normal operation of a long-lived asset, except for certain lease obligations. We are evaluating the impact of SFAS 143, but do not expect the adoption of SFAS 143 to have a significant impact on our financial position or the results of our operations.

On June 1, 2002, we adopted Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria for classifying an asset as held-for-sale. Classification as held-for-sale is an important distinction since such assets are not depreciated and are stated at the lower of fair value or carrying amount. SFAS 144 also requires expected future operating losses from discontinued operations to be displayed in the period in which the losses are incurred, rather than as of the measurement date as presently required. The adoption of SFAS 144 did not have a material impact on our financial position or the results of our operations.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
(in thousands except per share data unless otherwise noted)
(unaudited)

Note 9 — Non-Recurring Operating Items

In order to better align our operating expenses with anticipated revenues, we implemented a restructuring plan during June 2001. Pursuant to this plan, we reduced our work force by 419 employees in June and August 2001. An additional 97 employees were terminated in October 2001. This reduction impacted all employee groups. In connection with this plan, we recorded a charge of $3.5 million in employee severance and early retirement, $0.3 million in employee relocation and $0.2 million in other employee expenses for the six months ended December 1, 2001.

The restructuring plan also included vacating buildings located in California, Massachusetts, Michigan, Minnesota, and Texas. As a result, we recorded a charge of approximately $1.6 million for the six months ended December 1, 2001, which consisted of $1.1 million for lease termination fees, $.4 million for the write-off of certain leasehold improvements and other consolidation costs of $0.1 million. In the second quarter of fiscal year 2002, we disposed of certain property and equipment as part of the restructuring plan. The net gain associated with the asset write down recorded in the three months ended December 1, 2001 of $0.4 million consisted of the sale of equipment in conjunction with the discontinuing of certain products.

The following table displays the amounts included as a non-recurring charge for the three months and six months ended November 30, 2002 and December 1, 2001.

	Three Months Ended					Six Months Ended
	Nov. 30, 2002		Dec. 1, 2001			Nov. 30, 2002		Dec. 1, 2001

Employee severance and other employee expenses	$	—	$	1,439		$	—	$	4,013
Facility consolidation and lease termination costs		—		147			—		1,604
Net asset write-downs		—		(384	)		—		(308	)
Other expenses		—		418			—		662

Total restructuring charge	$	—	$	1,620		$	—	$	5,971

In the current year, all restructuring costs have been included in the line items to which they functionally relate, as discussed in Note 10.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
(in thousands except per share data unless otherwise noted)
(unaudited)

Note 10 — Restructuring

At November 30, 2002, we had $1.1 million remaining in accrued liability relating to our restructuring plan implemented in June 2001, compared to $1.0 million at June 1, 2002. A portion of the remaining accrued liability is related to lease termination fees and other facility consolidation costs expected to be incurred through 2006.

As discussed in Note 4, we are currently relocating the manufacturing of our Electronic Component Systems product line from Escondido, California to our headquarters in Portland, Oregon. Accrued employee severance of $0.6 million is related to this facilities consolidation. With the move from Escondido and other restructuring steps, we expect that employment will decline to approximately 700 people during the third quarter, down from 875 at the beginning of the fiscal year 2003. These reductions in force were across all department levels. In the current year, all restructuring costs have been included in the line items to which they functionally relate.

The following table displays rollforwards of the accruals established related to the restructuring from June 1, 2002 to November 30, 2002.

	Accruals at June 1, 2002		Fiscal 2003 Net Charges		Fiscal 2003 Amounts Used		Accruals at November 30, 2002

Employee severance	$	0	$	948	$	333	$	615
Lease termination fees and other
facility consolidation costs	$	664	$	0	$	220	$	444
Purchase order obligations	$	334	$	0	$	334	$	0

In addition to the special charges included in operating expenses for the three months ended November 30, 2002, we expect to incur approximately $3.0 million to $4.0 million of restructure related expenses in future quarters.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS

Overview

Electro Scientific Industries, Inc. and its subsidiaries (“ESI”) provide high technology manufacturing equipment to the global electronics market. Our customers are primarily manufacturers of semiconductors, passive electronic components and electronic interconnect devices. Our equipment enables these manufacturers to reduce production costs, increase yields and improve the quality of their products. The components and devices manufactured by our customers are used in a wide variety of end-use products in the computer, communications and automotive industries.

We believe we are the leading supplier of advanced laser systems used to improve the production yield of semiconductor devices, high-speed test and termination equipment used in the high-volume production of multi-layer ceramic capacitors (MLCCs) and other passive electronic components, and advanced laser systems used to fine tune electronic components and circuitry. Additionally, we produce a family of laser drilling systems for production of high-density interconnect (HDI) circuit boards and advanced electronic packaging, as well as inspection systems and original equipment manufacturer (OEM) machine vision products.

Results of Operations

Net sales of $43.3 million for the quarter ended November 30, 2002 were $3.7 million or 9.3% higher than the second quarter of fiscal 2002, and were $0.3 million or 0.8% higher than for the quarter ended August 31, 2002. Net sales of $86.3 million for the six months ended November 30, 2002 were $2.9 million lower or 3.2% lower than net sales for the six months ended December 1, 2001. Semiconductor yield improvement systems and advanced electronic packaging systems experienced higher sales volume compared to both the three months ended August 31, 2002 and the three months ended December 1, 2001, while sales of electronic component manufacturing systems, circuit fine tuning systems, and vision inspection systems decreased over both the prior quarter and the same quarter of the prior year. We continue to see normal pricing pressure in all of our markets due to the continued softness in overall electronics demand and pressure on our customers’ earnings. Semiconductor yield improvement systems comprised the largest percentage of sales for the quarter at 43.4% of total sales versus 40.2% in the second quarter of the prior year and 39.8% for the quarter ended August 31, 2002.

The following data represents sales by product line for the periods indicated (in thousands):

	Three Months Ended				Six Months Ended
	Nov. 30, 2002		Dec. 1, 2001		Nov. 30, 2002		Dec. 1, 2001

Semiconductor Yield Improvement Systems	$	18,782	$	15,927	$	35,891	$	38,959
Electronic Component Manufacturing Systems		7,770		8,819		15,890		22,267
Advanced Electronic Packaging Systems		8,648		5,396		15,318		9,566
Vision and Inspection Systems		2,305		2,397		6,149		5,075
Circuit Fine Tuning Systems		5,797		7,067		13,015		13,246

Net Sales	$	43,302	$	39,606	$	86,263	$	89,113

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

On October 2, 2002, we announced a plan to relocate the manufacturing of our Electronic Component Systems product line from Escondido, California to our headquarters in Portland, Oregon. The consolidation of these facilities was completed on December 31, 2002. 37 employees from our Escondido facility accepted relocation offers to our headquarters. The remaining employees were offered a severance package following a sixty-day required notice period. As a result of the closure of the California facility and other cost reduction steps, we expect that headcount will decline to approximately 700 people during the third quarter of fiscal 2003. In addition to the special charges included in operating expenses for the three months ended November 30, 2002, we expect to incur approximately $3.0 million to $4.0 million of restructure related expenses in future quarters.

Gross margin for the three months ended November 30, 2002 decreased to 20.3% from 49.7% for the same period in the prior fiscal year and 46.5% for the quarter ended August 31, 2002. Included in costs of goods sold for the three months ended November 30, 2002 were special charges of $11.3 million. These charges include costs associated with the consolidation of our Escondido operation of $4.1 million in inventory write-downs related to the discontinuance of certain electronic component manufacturing product lines, $0.4 million in employee severance and other employee related expenses, and $0.1 in other facilities consolidation costs. Also included in special charges was $6.7 million in write-downs for estimated excess and obsolete inventory across virtually all of our ongoing product lines. During the quarter ended November 30, 2002, it became apparent that the forecasted industry wide rebound, projected in the spring/summer 2002, would not occur at the rate as originally anticipated. In addition, the adoption by our customers of higher capability machines occurred at a faster rate than anticipated, causing excess and obsolete components relating to some of our older models. Gross margin for the six months ended November 30, 2002 decreased to 33.4% from 46.1% for the same period in the prior year.

Selling, service and administrative expenses for the three months ended November 30, 2002 were $17.2 million, 27.9% or $3.7 million higher than for the second quarter of fiscal 2002 and 30.3% or $4.0 million higher compared to the prior quarter. Selling, service and administrative expenses as a percentage of sales for the three months ended November 30, 2002 increased from 33.9% to 39.7% compared to the second quarter of fiscal year 2002 and increased from 30.7% to 39.7% over the prior quarter. As a result of the Escondido consolidation and other restructuring steps, included in selling, service and administrative expenses for the three months ended November 30, 2002 was employee severance and other employee expense of $1.1 million, $1.2 million in restructure related consulting fees, $0.5 million in net asset write-downs and $0.3 million in facilities consolidation costs.

For the six months ended November 30, 2002, selling, service and administrative expenses were $30.4 million, 6.4% or $2.1 million lower compared to the six months ended December 1, 2001. Selling, service and administrative expenses as a percentage of sales for the six months ended November 30, 2002 decreased from 36.4% to 35.2% compared to the six months ended December 1, 2001. A reduction of force, cost reduction efforts, and a one-time credit of $1.0 million related to a change in employee benefits for our Asian subsidiaries, resulted in decreased selling, service, and administrative expense compared to prior year levels.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Future operating results are highly dependent on our ability to maintain a competitive advantage in the products and services we provide. To protect this advantage we continue to make investments in our research and development efforts. Expenses associated with research, development and engineering for the three months ended November 30, 2002 were $6.9 million, 15.0% or $1.2 million lower than for the same period in the prior fiscal year and 9.4% or $0.7 million lower compared to the prior quarter. Research, development and engineering expenses as a percentage of sales for the three months ended November 30, 2002 decreased from 20.6% to 16.0% compared to the second quarter of fiscal year 2002 and decreased from 17.8% to 16.0% over the prior quarter. As a result of the Escondido consolidation and other restructuring steps, included in research, development and engineering expenses for the three months ended November 30, 3002 was employee severance and other employee expense of $0.8 million and $0.1 million in facilities consolidation costs. Research and development spending often fluctuates from quarter to quarter as engineering projects move through their life cycles. We continue to invest in a significant number of development and engineering projects that we see as important to our future.

In order to better align our operating expenses with anticipated revenues, we implemented a restructuring plan in the first quarter of fiscal year 2002. The restructuring plan consisted of reducing our work force and vacating several buildings. This reorganization resulted in restructuring charges to operating expenses of $4.4 million in the first quarter of fiscal year 2002 and $1.6 million in the second quarter of fiscal 2002. We also recorded a $3.5 million inventory write-down related to discontinuing the manufacturing of certain products in the six months ended December 1, 2001. This inventory write-down was reflected in costs of sales. In the current year, all restructuring costs have been included in the line items to which they functionally relate.

Interest income for the three months ended November 30, 2002 was $2.4 million, $0.7 million higher than for the three months ended December 1, 2001. This increase is mainly due to an increase in investment balances generated from our sale of $150 million aggregate principal amount of 4¼% convertible subordinated notes due 2006.

Interest expense for the three months ended November 30, 2002 was $1.8 million, $1.7 million higher than for the three months ended December 1, 2001 and $3.7 million higher than for the six months ended December 1, 2001. These increases in expense are primarily due to the sale of $150 million aggregate principal amount of 4¼% convertible subordinated notes due 2006.

Net other income and expense for the three months ended November 30, 2002 was $0.7 million, $0.9 million higher than for the three months ended December 1, 2001 and $1.1 million higher than the prior quarter. These increases in income are primarily due to a gain of $0.5 million related to a legal settlement agreement and a $0.3 million gain on sale of securities.

The income tax rate for the three months ended November 30, 2002 was 32.0% versus 33.0% for the three months ended December 1, 2001. This is the rate we currently expect to record for the full year, subject to variability depending on our earnings mix.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Net loss for the quarter ended November 30, 2002 was $9.5 million or $0.34 per diluted share, compared to a net loss of $1.5 million or $0.05 per diluted share in the second quarter of the prior year. Net loss for the six months ended November 30, 2002 was $9.4 million or $0.34 per diluted share, compared to a net loss of $9.5 million or $0.35 per diluted share for the same period in the prior year.

Ending backlog on November 30, 2002 was $15.8 million compared to $15.5 million on August 31, 2002 and $21.7 million at the end of the second quarter of the prior fiscal year.

Liquidity and Capital Resources

At November 20, 2002, our principal sources of liquidity consist of existing cash, cash equivalents and marketable securities of $294.3 million and accounts receivable of $52.5 million. At November 30, 2002, we had a current ratio of 16.7:1 and long-term debt of $146.3 million. Working capital increased to $373.7 million at November 30, 2002 compared to $341.9 million at June 1, 2002. Due to better collections of accounts receivable with extended terms, accounts receivable decreased $4.8 million from June 1, 2002 to November 30, 2002. Other current assets increased $2.1 million. Property, plant and equipment increased $6.2 million from June 1, 2002 to November 30, 2002. The increase in property, plant and equipment is primarily due to a new corporate headquarters in Portland, Oregon. Current liabilities increased $1.1 million from June 1, 2002.

Critical Accounting Policies and Estimates

We reaffirm the critical accounting policies and our use of estimates as reported in our annual report on Form 10-K for the year-ended June 1, 2002.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Factors That May Affect Future Results

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 issue other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may materially differ. 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:

The industries that comprise our primary markets are volatile and unpredictable.

Our business depends upon the capital expenditures of manufacturers of components and circuitry used in wireless communications, computers, automotive electronics and other electronic products. In the past, the markets for electronic devices have experienced sharp downturns. During these downturns, electronics manufacturers, including our customers, have delayed or canceled capital expenditures, which has had a negative impact on our financial results.

The current economic downturn has resulted in a reduction in demand for our products and significant reductions in our profitability and net sales. We had net loss of $9.5 million during the three months ended November 30, 2002 on net sales of $43.3 million and a net loss of $16.0 million for the year ended June 1, 2002. We cannot assure you that demand for our products will increase. If demand for our product does increase, there may be significant fluctuations in our profitability and net sales.

During any downturn, including the current downturn, it will be difficult for us to maintain our sales levels. As a consequence, in order to maintain profitability we will need to reduce our operating expenses. However, much of our operating expenses are fixed and our ability to reduce such expenses is limited. Moreover, we may be unable to defer capital expenditures, and we will need to continue investment in certain areas such as research and development. We may incur charges related to impairment of assets and inventory write-offs. We also may experience delays in payments from our customers. The combined effect of these will have a negative effect on our financial results.

If the markets for our products improve, we must attract, hire and train a sufficient number of employees, including technical personnel, to meet increased customer demand. Our inability to achieve these objectives in a timely and cost-effective manner could have a negative impact on our business.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Our recent capacity expansion may not be utilized successfully or effectively, which could negatively affect our business.

In November 2002, we completed construction of a 62,000 square foot corporate headquarters building in Portland, Oregon. The project was funded with existing capital resources and internally generated funds. Our capacity expansion involves risks. For example, the electronics industry has historically been cyclical and subject to significant economic downturns characterized by over-capacity and diminished demand for products of the type manufactured by us. In fiscal 2002 we adopted a restructuring plan that involved the closure of several of our manufacturing facilities in response to the current economic downturn. Unfavorable economic conditions affecting the electronics industry in general, or any of our major customers, may affect our ability to successfully utilize our additional manufacturing capacity in an effective manner, which could adversely affect our operating results.

Our ability to reduce costs is limited by our need to invest in research and development.

Our industry is characterized by the need for continued investment in research and development. Because of intense competition in the industries in which we compete, if we were to fail to invest sufficiently in research and development, our products could become less attractive to potential customers, and our business and financial condition could be materially and adversely affected. As a result of our need to maintain our spending levels in this area, our operating results could be materially harmed if our net sales fall below expectations. In addition, as a result of our emphasis on research and development and technological innovation, our operating costs may increase further in the future, and research and development expenses may increase as a percentage of total operating expenses and as a percentage of net sales.

We depend on a few significant customers and we do not have long-term contracts with any of our customers.

Twelve large, multinational electronics companies represented 49.4% of our fiscal 2002 net sales, and the loss of any of these customers could significantly harm our business. In addition, none of our customers have any long-term obligation to continue to buy our products or services, and any customer could delay, reduce or cease ordering our products or services at any time.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Delays in shipment or manufacturing of our products could substantially decrease our sales for a period.

We will continue to derive a substantial portion of our revenues from the sale of a relatively small number of products with high average selling prices, some with prices as high as $2.0 million per unit. We generally recognize revenue upon shipment of our products. As a result, the timing of revenue recognition from a small number of orders could have a significant impact on our net sales and operating results for a reporting period. Shipment delays could significantly impact our recognition of revenue and could be further magnified by announcements from us or our competitors of new products and technologies, which announcements could cause our customers to defer purchases of our existing systems or purchase products from our competitors. Any of these delays could result in a material adverse change in our results of operations for any particular period.

We depend on manufacturing flexibility to meet the changing demands of our customers. Any significant delay or interruption of manufacturing operations as a result of software deficiencies, natural disasters, or other causes could result in ineffective manufacturing capabilities or delayed product deliveries, any or all of which could materially and adversely affect our results of operations.

Failure of critical suppliers of parts, components and manufacturing equipment to deliver sufficient quantities to us in a timely and cost-effective manner could negatively affect our business.

We use a wide range of materials in the production of our products, including custom electronic and mechanical components, and we use numerous suppliers to supply materials. 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, key parts may be available only from a single supplier or a limited group of suppliers. Operations at our suppliers’ facilities are subject to disruption for a variety of reasons, including work stoppages, fire, earthquake, flooding or other natural disasters. Such disruption could interrupt our manufacturing. Our business may be harmed if we do not receive sufficient parts to meet our production requirements in a timely and cost-effective manner.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

We may make additional acquisitions in the future, and these acquisitions may subject us to risks associated with integrating these businesses into our current business.

Although we have no commitments or agreements for any acquisitions, we have made, and plan in the future to make, acquisitions of, or significant investments in, businesses with complementary products, services or technologies. Acquisitions involve numerous risks, many of which are unpredictable and beyond our control, including:

•	Difficulties and increased costs in connection with integration of the personnel, operations, technologies and products of acquired companies;

•	Diversion of management’s attention from other operational matters;

•	The potential loss of key employees of acquired companies;

•	Lack of synergy, or inability to realize expected synergies, resulting from the acquisition;

•	The risk that the issuance of our common stock in a transaction could be dilutive to our shareholders if anticipated synergies are not realized; and

•	Acquired assets becoming impaired as a result of technological advancements or worse-than-expected performance by the acquired company.

Our inability to effectively manage these acquisition risks could materially and adversely affect our business, financial condition and results of operations. In addition, if we issue equity securities to pay for an acquisition the ownership percentage of our existing shareholders would be reduced and the value of the shares held by our existing shareholders could be diluted. If we use cash to pay for an acquisition the payment could significantly reduce the cash that would be available to fund our operations or to use for other purposes. In addition, the Financial Accounting Standards Board has disallowed the pooling-of-interests method of acquisition accounting. This could result is significant charges resulting from amortization of intangible assets recorded in connection with future acquisitions.

Our markets are subject to rapid technological change, and to compete effectively we must continually introduce new products that achieve market acceptance.

The markets for our products are characterized by rapid technological change and innovation, frequent new product introductions, changes in customer requirements and evolving industry standards. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address technological changes as well as current and potential customer requirements. The introduction by us or by our competitors of new and enhanced products may cause our customers to defer or cancel orders for our existing products, which may harm our operating results. We have in the past experienced a slowdown in demand for our existing products and delays in new product development, and similar delays may occur in the future. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements or, where necessary, to license these technologies from others. Product development delays may result from numerous factors, including:

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

•	Changing product specifications and customer requirements;

•	Difficulties in hiring and retaining necessary technical personnel;

•	Difficulties in reallocating engineering resources and overcoming resource limitations;

•	Difficulties with contract manufacturers;

•	Changing market or competitive product requirements; and

•	Unanticipated engineering complexities.

The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Any failure to respond to technological change would significantly harm our business.

We are exposed to the risks that others may violate our proprietary rights, and our intellectual property rights may not be well protected in foreign countries.

Our success is dependent upon the protection of our proprietary rights. In the high technology industry, intellectual property is an important asset that is always at risk of infringement. We incur substantial costs to obtain and maintain patents and defend our intellectual property. For example, we have initiated litigation alleging that certain parties have violated various of our patents. We rely upon the laws of the United States and of foreign countries in which we develop, manufacture or sell our products to protect our proprietary rights. These proprietary rights may not provide the competitive advantages that we expect, however, or other parties may challenge, invalidate or circumvent these rights.

Further, our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States. Many U.S. companies have encountered substantial problems in protecting their proprietary rights against infringement in foreign countries. If we fail to adequately protect our intellectual property in these countries, it could be easier for our competitors to sell competing products in foreign countries.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

We may be subject to claims of intellectual property infringement.

Several of our competitors hold patents covering a variety of technologies, applications and methods of use similar to some of those used in our products. From time to time, we and our customers have received correspondence from our competitors claiming that some of our products, as used by our customers, may be infringing one or more of these patents. For example, in February 2001, Cognex Corporation filed a lawsuit against us claiming we infringed a patent owned by it. Competitors or others may assert infringement claims against our customers or us in the future with respect to current or future products or uses, and these assertions may result in costly litigation or require us to obtain a license to use intellectual property rights of others. If claims of infringement are asserted against our customers, those customers may seek indemnification from us for damages or expenses they incur.

If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question or defending our position. These licenses, however, may not be available on satisfactory terms or at all. If we are not able to negotiate the necessary licenses on commercially reasonable terms or successfully defend our position, our financial condition and results of operations could be materially and adversely affected.

We are exposed to the risks of operating a global business, including risks associated with exchange rate fluctuations and legal and regulatory changes.

International shipments accounted for 73.6% of net sales for fiscal 2002, with 57.5% of our net sales to customers in Asia. We expect that international shipments will continue to represent a significant percentage of net sales in the future. Our non-U.S. sales and operations are subject to risks inherent in conducting business abroad, many of which are outside our control, including the following:

•	Periodic local or geographic economic downturns and unstable political conditions;

•	Price and currency exchange controls;

•	Fluctuation in the relative values of currencies;

•	Difficulties protecting intellectual property;

•	Unexpected changes in trading policies, regulatory requirements, tariffs and other barriers; and

•	Difficulties in managing a global enterprise, including staffing, collecting accounts receivable, managing distributors and representatives and repatriation of earnings.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

In addition, as a result of our significant reliance on international sales, we may also be adversely affected by challenges to U.S. tax laws that benefit companies with certain foreign sales. In February 2000, the World Trade Organization (WTO) ruled that foreign sales corporations (FSCs), which provide an overall reduction in effective tax rates for companies with FSCs, violate U.S. obligations under the General Agreement on Tariffs and Trade (GATT). Responding to the WTO’s decision that FSCs constitute an illegal export subsidy, the U.S. government repealed the FSC rules effective October 1, 2000, subject to certain transition rules, and created a new income tax benefit that permanently excludes “foreign extraterritorial income” from taxable income. The extraterritorial income (ETI) regime, which applies to transactions after September 30, 2000, provides a similar tax benefit for export sales as the FSC regime did. Following a European Union (EU) complaint, the WTO concluded in August 2001 that the ETI provisions are also not WTO-compliant because provisions violate the GATT agreements. The United States appealed the decision, but in January 2002, an appellate body denied the appeal. On August 30, 2002, a WTO arbitration panel issued a report approving the retaliatory tariffs requested by the EU. The EU now has the authority to begin imposing trade sanctions on U.S. exports up to the level approved by the arbitrators and the authority for such sanctions will continue until the United States rectifies the WTO violation. We believe the U.S. government will choose to rectify the violation to avoid retaliatory trade sanctions and it is considering several options to do so. The U.S. government may repeal the ETI regime and if the government does not replace it with an equivalent form of tax relief for foreign income, our future results of operations may be adversely affected.

Our establishment of direct sales in Asia exposes us to the risks related to having employees in foreign countries.

We have established direct sales and service organizations in China, Taiwan, Korea and Singapore. Previously, we sold our products through a network of commission-based sales representatives in these countries. Our shift to a direct sales model in these regions involves risks. For example, we may encounter labor shortages or disputes that could inhibit our ability to effectively sell and market our products. We also are subject to compliance with the labor laws and other laws governing employers in these countries and we will incur additional costs to comply with these regulatory schemes. Additionally we will incur new fixed operating expenses associated with the direct sales organizations, particularly payroll related costs and lease expenses. If amounts saved on commission payments formerly paid to our sales representatives do not offset these expenses, our operating results may be adversely affected.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Our business is highly competitive, and if we fail to compete our business will be harmed.

The industries in which we operate are highly competitive. We face substantial competition from established competitors, some of which have greater financial, engineering, manufacturing and marketing resources than we do. If we are unable to compete effectively with these companies, our market share may decline and our business could be harmed. Our competitors can be expected to continue to improve the design and performance of their products and to introduce new products. Furthermore, our technological advantages may be reduced or lost as a result of technological advances by our competitors. Their greater resources in these areas may enable them to:

•	Better withstand periodic downturns;

•	Compete more effectively on the basis of price and technology;

•	More quickly develop enhancements to and new generations of products; and

•	More effectively retain existing customers and obtain new customers.

In addition, new companies may in the future enter the markets in which we compete, further increasing competition in those markets.

We believe that our ability to compete successfully depends on a number of factors, including:

•	Performance of our products;

•	Quality of our products;

•	Reliability of our products;

•	Cost of using our products;

•	Our ability to ship products on the schedule required;

•	Quality of the technical service we provide;

•	Timeliness of the services we provide;

•	Our success in developing new products and enhancements;

•	Existing market and economic conditions; and

•	Price of our products as compared to our competitors’ products.

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.

The possibilities of terrorist attacks and military action against Iraq have increased uncertainties for our business.

Like other U.S. companies, our business and operating results are subject to uncertainties arising out of the possibility of terrorist attacks on the United States, including the potential worsening or extension of the current global economic slowdown, the economic consequences of military action or additional terrorist activities and associated political instability, and the impact of heightened security concerns on domestic and international travel and commerce. In particular, due to these uncertainties we are subject to:

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

•	The risk that future tightening of immigration controls may adversely affect the residence status of non-U.S. engineers and other key technical employees in our U.S. facilities or our ability to hire new non-U.S. employees in such facilities;

•	The risk of more frequent instances of shipping delays.

•	The risk that demand for our products may not increase or may decrease.

The loss of key management or our inability to attract and retain sufficient numbers of managerial, engineering and other technical personnel could have a material adverse effect upon our results of operations.

Our continued success depends, in part, upon key managerial, engineering and technical personnel as well as our ability to continue to attract and retain additional personnel. The loss of key personnel could have a material adverse effect on our business or results of operations. We may not be able to retain our key managerial, engineering and technical employees. Our growth may be affected by our ability to hire new highly skilled and qualified technical personnel, and personnel that can implement and monitor our financial and managerial controls and reporting systems. Attracting qualified personnel is difficult, and our recruiting efforts to attract and retain these personnel may not be successful.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Item 3. Market Risk Disclosure

Interest Rate Risk

As of November 30, 2002, our investment portfolio includes marketable debt securities of $265.2 million. These securities are subject to interest rate risk, and will decline in value if interest rates increase. These securities are classified as Securities Available for Sale; therefore, the impact of interest rate changes is reflected as a separate component of shareholder’s equity. Due to the short duration of our investment portfolio, generally less than one year, an immediate 10% increase in interest rates would not have a material effect on our financial condition or the results of our operations. Our $150 million aggregate principal amount of 4¼% convertible subordinated notes due 2006 is at a fixed interest rate. Therefore, there is no associated volatility.

Foreign Currency Exchange Rate Risk

We have limited involvement with derivative financial instruments and do not use them for trading purposes. Hedging derivatives are used to manage well-defined foreign currency risks. We enter into forward exchange contracts to hedge the value of accounts receivable denominated in Japanese yen. The impact of exchange rates on the forward contracts will be substantially offset by the impact of such changes on the underlying transactions. The effect of an immediate 10% change in exchange rates on the forward exchange contracts and the underlying hedged positions, denominated in Japanese yen, would not be material to our financial position or results of operations.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Acting Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. Based on their review of our disclosure controls and procedures, the President and Chief Executive Officer and the Acting Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings.

Internal Controls and Procedures

There were no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Part II. Other Information

Item 1. Legal Proceedings

We initiated litigation against Dynamic Details, Inc. and GSI Lumonics, Inc. for patent infringement in March 2000 in the U.S. District Court for the Central District of California (Electro Scientific Industries v. Dynamic Details, Inc. and GSI Lumonics, Inc., No. SACV00-272 AHS (ANX)). The complaint alleges that Dynamic Details infringes and that GSI Lumonics has actively induced infringement of, and contributorily infringed our U.S. patent 5,847,960 entitled “Multi-tool Positioning System”. In August 2001, the District Court issued an order granting Dynamic Details and GSI Lumonics’ motion for summary judgment of non-infringement. We appealed the District Court’s order to the U.S. Court of Appeals for the Federal Circuit. In October 2002 the Court of Appeals vacated the District Court’s judgment of non-infringement on the basis that the District Court erred in its claim construction of our patent 5,847,960 and remanded the case to the District Court for a determination of infringement based on a complete claim construction. In November 2002, we reached an agreement with GSI Lumonics and Dynamic Details pursuant to which the case was dismissed without prejudice. In connection with the agreement, GSI Lumonics paid us $0.5 million.

Item 4. Submission of Matters to a Vote of Security Holders

The 2002 Annual Meeting of Shareholders was held on Wednesday, September 18, 2002.

The following items were approved by the vote indicated:

Barry L. Harmon, W. Arthur Porter, and Gerald F. Taylor, were re-elected to the Board of Directors for a three-year term. David F. Bolender, Larry L. Hansen, Vernon B. Ryles, Keith L. Thomson and Jon D. Tompkins continue as directors.

	Votes For	Withheld

Barry L. Harmon	25,475,003	194,472
W. Arthur Porter	25,488,188	181,287
Gerald F. Taylor	25,488,723	180,752

2.	Selection of KPMG LLP as independent auditors for the Company was approved.

Votes For	Against	Abstain

24,814,823	790,512	64,140

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

Exhibit 10 — Employment Agreement (including change in Control Agreement) between the Company and James T. Dooley, dated December 13, 2002.

(b)	Report on Form 8-K

None

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.

ELECTRO SCIENTIFIC INDUSTRIES, INC.

Dated: January 13, 2003

By  /s/ JOSEPH L. REINHART
       ——————————————
       Joseph L. Reinhart
       Vice President, Corporate Secretary
       and Acting Chief Financing Officer

SARBANES-OXLEY ACT SECTION 302(a) CERTIFICATION

I, James T. Dooley, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Electro Scientific Industries, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: January 13, 2003

/s/ JAMES T. DOOLEY
————————————————
James T. Dooley
President and Chief Executive Officer

SARBANES-OXLEY ACT SECTION 302(a) CERTIFICATION

I, Joseph L. Reinhart, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Electro Scientific Industries, Inc.;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date: January 13, 2003

/s/ JOSEPH L. REINHART
———————————————
Joseph L. Reinhart
Vice President, Corporate Secretary
and Acting Chief Financing Officer

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with this quarterly report on Form 10Q of Electro Scientific Industries, Inc. (the “Company”) for the period ended November 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, James T. Dooley, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ JAMES T. DOOLEY
————————————————
James T. Dooley
President and Chief Executive Officer
January 13, 2003

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with this quarterly report on Form 10Q of Electro Scientific Industries, Inc. (the “Company”) for the period ended November 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Joseph L. Reinhart, Vice President, Corporate Secretary, and Acting Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ JOSEPH L. REINHART
————————————————
Joseph L. Reinhart
Vice President, Corporate Secretary and
Acting Chief Financing Officer
January 13, 2003

EX-10 3 a4318132ex-10.htm ELECTRO SCIENTIFIC INDUSTRIES, INC. EX-10

Exhibit 10

ELECTRO SCIENTIFIC INDUSTRIES, INC.
EMPLOYMENT AGREEMENT

Executive

James T. Dooley
3200 N.W. Linmere Drive
Portland, OR 97229

ESI

Electro Scientific Industries, Inc.,
an Oregon corporation
13900 NW Science Park Dr.
Portland, OR 97229

In consideration of the mutual covenants contained herein, and other good and valuable consideration, the parties hereto agree as follows.

1. Employment. ESI hereby employs Executive as the President and Chief Executive Officer of ESI and Executive accepts such employment with ESI, on the terms and conditions set forth in this Employment Agreement (this “Agreement”).

2. Period of Employment. Executive’s employment hereunder shall commence on the date hereof (the “Effective Date”) and shall continue until terminated in accordance with the provisions of section 8.

3. Executive’s Duties. Executive shall, during the term of this Agreement, faithfully and diligently perform all such acts and duties, and furnish such services, as ESI’s Board of Directors (the “Board”) shall reasonably direct and are consistent with the position of Chief Executive Officer, including but not limited to strategic planning, implementation of business objectives and supervision of day-to-day business affairs of ESI. Executive shall devote such time, energy, and skill to ESI’s business as shall reasonably be required for the performance of his duties.

4. Annual Salary and Bonus.

(a) Base Salary. Beginning with the effective date of this Agreement, ESI shall pay Executive a base salary of $400,000 per fiscal year (prorated for any portion of a year), payable in equal periodic installments in accordance with ESI’s customary practices (the “Base Salary”). The amount of the Base Salary shall be reviewed annually and may be increased from time to time in the sole discretion of the Board.

(b) Stock Options. ESI shall grant Executive an option to purchase 150,000 shares of ESI Common Stock. The date of the option grant shall be the Effective Date and the terms of the option grant shall be consistent with the customary terms of option grants previously provided Executive. A Stock Option Agreement detailing the option terms will be provided to Executive. Additional stock options may be granted to Executive from time to time in the sole discretion of the Board.

(c) Annual Performance Bonus. Executive shall be eligible to receive an annual bonus calculated in accordance with Exhibit A hereto upon his achievement of performance goals to be established by the Board (the “Annual Bonus”). Such performance goals shall be reviewed annually by the Board and adjusted in a manner consistent with performance goals for other ESI executives.

5. Benefits and Reimbursement.

(a) Vacation and Sick Leave. Executive shall be entitled to paid annual vacation, all paid ESI holidays and reasonable sick leave each in accordance with ESI’s standard policies applicable to other employees.

(b) Benefit Plans. Executive shall be entitled to participate in all employee benefit plans and incentive compensation plans of ESI, to the extent such plans are available to other similarly situated executives or employees of ESI.

(c) Reimbursed Business Expenses. ESI shall reimburse Executive for all expenses and disbursements reasonably incurred at ESI’s request or in accordance with ESI’s policies, and substantiated by Executive, in the performance of Executive’s duties hereunder.

6. Change in Control Agreement. Concurrently with the execution of this Agreement, the parties hereto shall enter into a Change in Control Agreement in the form attached hereto as Exhibit B (the “Change in Control Agreement”).

7. Definitions. The following terms shall have the following meanings for purposes of this Agreement:

(a) “Cause” shall mean (i) the willful and continued failure by Executive substantially to perform his reasonably assigned duties with ESI (consistent with those duties assigned to Executive prior to any Change in Control), other than a failure resulting from Executive’s incapacity due to physical or mental illness or impairment, after a written demand for performance has been delivered to Executive by the Chairman of the Board which specifically identifies the manner in which the Chairman believes that Executive has not substantially performed his duties, or (ii) the willful engaging by Executive in illegal conduct which is materially and demonstrably injurious to ESI. For purposes of this subsection (a), no act, or failure to act, on Executive’s part shall be considered “willful” unless done, or omitted to be done, by Executive in knowing bad faith and without reasonable belief that his action or omission was in, or not opposed to, the best interests of ESI. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or based upon the advise of counsel for ESI shall be conclusively presumed to be done, or omitted to be done, by Executive in good faith and in the best interests of the corporation. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for the purpose (after reasonable notice to Executive and an opportunity for Executive, together with his counsel, to be heard before the Board), finding that in the good faith opinion of the Board, Executive has engaged in the conduct set forth above in (i) or (ii) of this paragraph (a) and specifying the particulars thereof in detail.

(b) “Change in Control” shall have the meaning given to it in the Change in Control Agreement.

(c) “Disability” shall mean the absence of Executive from his duties with ESI on a full-time basis for 180 consecutive days as a result of Executive’s incapacity due to physical or mental illness, unless within 30 days after a Notice of Termination (as defined below) is given to Executive following such absence, Executive shall have returned to the full performance of Executive’s duties.

8. Term, Extension of Term and Early Termination.

(a) Term. Except as provided in Section 8(b), this Agreement shall terminate on December 31, 2005 (the “Termination Date”).

(b) Termination. This Agreement and Executive’s employment hereunder may be terminated prior to the Termination Date by either party by providing the other party with written notice that indicates the specific termination provision in this Agreement relied upon and sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive’s employment under the provision so indicated (a “Notice of Termination”). The effective date of any such termination of this Agreement shall be: (i) if Executive’s employment is terminated for Disability, 30 days after a Notice of Termination is given (provided that Executive shall not have returned to the performance of Executive’s duties on a full-time basis during such 30-day period), (ii) if Executive’s employment is terminated by ESI for Cause, the date on which the Notice of Termination is given, and (iii) if Executive’s employment is terminated by Executive or by ESI for any other reason, the date specified in the Notice of Termination, which shall be a date no earlier than 90 days after the date on which the Notice of Termination is given, unless an earlier date has been agreed to by the party receiving the Notice of Termination either in advance of, or after, receiving such Notice of Termination. Notwithstanding anything in the foregoing to the contrary, if the party receiving a Notice of Termination has not previously agreed to the termination, then within 30 days after the Notice of Termination is given, the party receiving the Notice of Termination may notify the other party that a dispute exists concerning the termination, in which event the Date of Termination shall be the date set either by mutual written agreement of the parties or by the arbitrators in a proceeding as provided in Section 12(e).

9. Effect of Termination.

(a) Termination by ESI. If, within two years following a Change in Control Executive’s employment by ESI is terminated based on an event occurring concurrent with or subsequent to a Change in Control, Executive shall be entitled to severance pay and benefits as provided in the Change in Control Agreement.

(b) Termination by Executive or by ESI for Cause. If ESI terminates Executive’s employment for Cause or Executive terminates his employment prior to the Termination Date, Executive shall be entitled to receive only the Base Salary and Annual Bonus earned and payable through the effective date of Executive’s termination, together with any other compensation or benefits which have been earned or become payable as of the date of termination but which have not yet been paid to Executive.

(c) Termination by ESI Without Cause. Except as provided in section 9(a), if ESI terminates Executive’s employment without Cause prior to the Termination Date, Executive shall be entitled to receive:

(i) the Base Salary and Annual Bonus earned and payable through the effective date of Executive’s termination, together with any other compensation or benefits which have been earned or become payable as of the date of termination but which have not yet been paid to Executive;

(ii) a severance payment (subject to applicable taxes and withholding) paid in equal installments in accordance with the ESI’s normal pay practices in an amount equal to two times Executive’s Base Salary at the time of termination; provided that payments made pursuant to this subsection (ii) shall be repaid by Executive in the event Executive violates in any material respect the provisions of section 11 hereof; and

(iii) until such time as Executive becomes eligible for Medicare or retirement benefits, maintenance in effect of all employee medical and dental benefit plans which are substantially equivalent to those in which Executive was participating immediately prior to termination.

(d) Termination on Termination Date. Except as provided in section 9(a), if ESI terminates Executive’s employment without Cause on the Termination Date, Executive shall be entitled to receive:

(i) the Base Salary and Annual Bonus earned and payable through the effective date of Executive’s termination, together with any other compensation or benefits which have been earned or become payable as of the Termination Date but which have not yet been paid to Executive;

(ii) a severance payment (subject to applicable taxes and withholding) paid in equal installments in accordance with the ESI’s normal pay practices in an amount equal to one year of the Executive’s Base Salary at the time of termination; provided that payments made pursuant to this subsection (ii) shall be repaid by Executive in the event Executive violates in any material respect the provisions of section 11 hereof; and

(e) Death. If Executive’s employment is terminated as a result of Executive’s death, Executive shall be entitled to receive the Base Salary and Annual Bonus earned and payable through the date on which Executive’s employment is terminated, together with any other compensation or benefits which have been earned or become payable as of the date of termination but which have not yet been paid to Executive; and

(f) Disability. If Executive’s employment is terminated as a result of Executive’s Disability, Executive shall be entitled to receive:

(i) the Base Salary and Annual Bonus payable through the date on which Executive’s employment is terminated, together with any other compensation or benefits which have been earned or become payable as of the date of termination but which have not yet been paid to Executive; and

(ii) until such time as Executive becomes eligible for MediCare or retirement benefits, maintenance in effect of all employee medical and dental benefit plans in which Executive was participating immediately prior to termination.

(g) Date of Payment. Except as otherwise provided herein, all cash payments and lump-sum awards required to be made pursuant to the provisions of this section 9 shall be made no later than the 30th day following the effective date of Executive’s termination.

(h) Release of Claims. ESI shall have the right to require Executive to executive a limited release with respect to claims that could be brought by Executive hereunder as a condition to Executive’s receipt of any payments pursuant to section 9(c) or 9(d).

10. Resignation of Corporate Offices. Executive shall resign as a director of ESI and as a director and/or officer of any affiliate of ESI, effective as of the date of termination of this Agreement. Executive agrees to provide ESI such written resignation(s) upon request and that no amounts will be paid under this Agreement until such resignation(s) are provided.

11. Non-Competition and Non-Disclosure; Executive Cooperation.

(a) Without the consent in writing of the Board, upon termination of Executive’s employment for any reason, Executive shall not for a period of two years thereafter, acting alone or in conjunction with others, directly or indirectly (i) engage (either as owner, partner, stockholder, employer, employee, director, consultant or agent) in any business which is directly in competition with a business conducted by ESI or any of its subsidiaries; (ii) induce any customers of ESI or any of its subsidiaries with whom Executive has had contacts or relationships, directly or indirectly, during and within the scope of his employment with ESI or any of its subsidiaries, to curtail or cancel their business with such companies or any of them; (iii) solicit or canvas business from any person who was a customer of ESI or any of its subsidiaries at or during the two-year period immediately preceding termination of Executive’s employment; or (iv) induce, or attempt to influence, any employee of ESI or any of its subsidiaries to terminate his employment; provided, however, that the limitation of subsection (i) shall not apply if Executive’s employment is terminated as a result of a termination by ESI without Cause. The provisions of subsections (i), (ii), (iii) and (iv) above are separate and distinct commitments independent of each of the other subsections. It is agreed that the ownership of not more than 1/2 of 1% of the equity securities of any company having securities listed on an exchange or regularly traded in the over-the-counter market shall not, of itself, be deemed inconsistent with clause (i) of this subsection (a).

(b) Executive shall not, at any time during the term of this Agreement or following Executive’s termination of employment for any reason whatsoever, disclose, use, transfer or sell, except in the course of employment with ESI, any confidential or proprietary information of ESI and its subsidiaries so long as such information has not otherwise been publicly disclosed by ESI or is not otherwise in the public domain, except as required by law or pursuant to legal process.

(c) Executive agrees to cooperate with ESI, by making himself available to testify on behalf of ESI or any subsidiary or affiliate of ESI, in any action, suit or proceeding, whether civil, criminal, administrative or investigative, and to assist ESI, or any subsidiary or affiliate of ESI in any such action, suit or proceeding, by providing information and meeting and consulting with the Board or its representatives or counsel, or representatives or counsel of ESI, or any subsidiary or affiliate of ESI, as requested by the Board, representatives or counsel. ESI agrees to reimburse Executive, on an after-tax basis, for all expenses actually incurred in connection with his provision of testimony or assistance.

12. Miscellaneous.

(a) Withholding. Payment of all compensation under this Agreement, including but not limited to the Base Salary and Annual Bonus, shall be subject to all applicable federal, state and local tax withholding.

(b) Successors. Upon Executive’s written request, ESI will seek to have any Successor (as hereinafter defined), by agreement in form and substance satisfactory to Executive, assent to the fulfillment by ESI of its obligations under this Agreement. For purposes of this Agreement, “Successor” shall mean any Person that succeeds to, or has the practical ability to control (either immediately or with the passage of time), ESI’s business directly, by merger, consolidation or purchase of assets, or indirectly, by purchase of ESI’s voting securities or otherwise.

(c) Assignment; Binding Agreement. Neither party may assign or transfer this Agreement or any rights or obligations under this Agreement without the prior written consent of the other party, provided, however, that ESI may, without Executive’s consent, assign its rights and obligations under this Agreement to any Successor, and the provisions hereof shall inure to the benefit of and be binding upon each Successor. This Agreement shall inure to the benefit of and be enforceable by Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees.

(d) Governing Law. This Agreement shall be construed in accordance with and governed by the laws of the State of Oregon.

(e) Dispute Resolution. Executive agrees that, to the fullest extent permitted by applicable law and with the exception of disputes arising out of section 11, any dispute concerning Executive’s employment or this Agreement shall first be submitted to confidential mediation before a mediator selected by the parties. Should any dispute not be resolved through mediation, it shall be submitted and settled exclusively by confidential binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association or such comparable rules as may be agreed upon by the parties.

Notwithstanding anything to the contrary in this section 12(d), Executive acknowledges that ESI has a compelling business interest in preventing unfair competition stemming from the intentional or inadvertent use or disclosure of ESI’s confidential information or the solicitation of ESI’s customers or suppliers. Executive further acknowledges and agrees that damages for a breach or threatened breach of any of the covenants set forth in section 11 of this Agreement will be difficult to determine and will not afford a full and adequate remedy, and therefore agrees that ESI, in additional to seeking all other damages in connection therewith, may seek specific enforcement of any such covenant in any court of competent jurisdiction, including without limitation, by the issuance of a temporary or permanent injunction without the necessity of showing any actual damages or posting any bond or furnishing any other security, and that the specific enforcement of the provisions of this Agreement will not diminish Executive’s ability to earn a livelihood or create or impose upon Executive any undue hardship. Executive also agrees that any request for such relief by ESI shall be in addition to, and without prejudice to, any claim for monetary or other damages that ESI may elect to assert.

(f) Attorneys’ Fees. Each party shall bear his or its own costs and attorneys’ fees which have been or may be incurred in connection with any matter herein or in connection with the negotiation and consummation of this Agreement or any attachment or exhibit hereto or in any action to enforce the provisions of this Agreement or any attachment or exhibit hereto.

(g) Notices. All notices, requests, demands, consents, approvals, declarations and other communications required by this Agreement shall be in writing and shall be deemed delivered (i) if given by facsimile, when transmitted and the appropriate telephonic confirmation is received; (ii) if given by first-class air mail (certified and return receipt requested), when delivered; and (iii) when given by a nationally recognized overnight courier, when received or personally delivered, in each case, with all charges prepaid and addressed to the respective party set forth on the first page of this Agreement, or to such other address as any party shall specify in a notice delivered to all other parties in accordance with this section 12 (g).

(h) Entire Agreement. This Agreement, including the attachments and exhibits hereto and the Change in Control Agreement contain the entire agreement between Executive and ESI concerning the subject matters discussed herein. This Agreement supersedes all prior negotiations, agreements and understandings of the parties with respect to Executive’s employment relationship with ESI and the other subject matter herein.

(i) Modification. Modification of this Agreement shall be effective only if in writing and signed by each party or its duly authorized representative.

(j) No Waiver. The waiver of any breach of this Agreement by one party shall not constitute waiver by the non-breaching party of any other breach of the Agreement.

(k) Severability. If any of the provisions or terms of this Agreement shall for any reason be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other terms of this Agreement, and this Agreement shall be construed as if such unenforceable term had never been contained in this Agreement.

(l) Surviving Provisions. Not withstanding anything in this Agreement to the contrary, sections 9, 10, 11 and this section 12 shall survive the termination of Executive’s employment and this Agreement.

(m) Interpretation. Unless specifically identified as a reference to another document, any reference to a “section” or “subsection” herein shall be deemed to be a reference to a section or subsection of this Agreement. Whenever the terms hereof call for any notice, payment or other action on a day which is not a business day, such payment or action may be taken, or such notice given, as the case may be, on the next succeeding business day.

(n) Counterparts and Facsimile Signatures. This Agreement may be executed in two or more counterparts, each of which shall constitute one and the same instrument. Facsimile signatures may be used in place of original signatures on this Agreement.

[SIGNATURE PAGE FOLLOWS]

IN WITNESS WHEREOF, the undersigned has executed this Agreement as of the 13th day of December, 2002.

ELECTRO SCIENTIFIC INDUSTRIES, INC.

By: /s/ DAVID F. BOLENDER
      ——————————————
      David F. Bolender
      Chairman of the Board of Directors

EXECUTIVE

By: /s/ JAMES T. DOOLEY
——————————————
James T. Dooley

Exhibit A:

Calculation of Annual Bonus

Exhibit B:

Change in Control Agreement

EXHIBIT A

CALCULATION OF ANNUAL BONUS

Executive shall be eligible to receive an annual cash bonus that is targeted at payment of 80 percent of Executive’s Base Salary (the “Annual Bonus”). The Annual Bonus will be earned and deemed payable in a manner consistent with the terms of the Annual Bonus Program approved by the Compensation Committee of ESI’s Board of Directors. The terms of the Annual Bonus Program for ESI’s fiscal year 2003 are further described below.

Goal vs. Target Bonus:

Payment Structure

•

Measurement Period: 06/02/02 to 05/31/03

•

Payout Date: August 2003

•

Total corporate payout will not exceed 20% of operating profits

•

Maximum bonus payout will not exceed 200% of target

•

Operating profit margin of less than 5% will result in zero payout

•

Bonus target is split between 70% corporate results and 30% individual objectives to equal 100% of targeted bonus

•

Individual objectives must be agreed and approved by the Board of Directors each year

•

Unless the operating profit margin threshold is achieved, no funding is available for corporate or individual bonuses

Operating profit margin is operating profit divided by revenue. Operating profit is the profit after deducting operating costs from gross profit. Generally Accepted Accounting Principles (GAAP) will be used to determine operating profit.

EXHIBIT B

CHANGE IN CONTROL AGREEMENT

Electro Scientific Industries, Inc., an Oregon corporation (the “Company”), considers the establishment and maintenance of a sound and vital management to be essential to protecting and enhancing the best interest of the Company and its shareholders. In this connection, the Company recognizes that, as is the case with many publicly held corporations, the possibility of a change in control may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its shareholders. Accordingly, the Board of Directors of the Company (the “Board”) has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company’s management to their assigned duties without distraction in circumstances arising from the possibility of a change in control of the Company.

In order to induce you to remain in the employ of the Company, this agreement, the form of which has been approved by the Board, sets forth the severance benefits which the Company agrees will be provided to you in the event your employment with the Company is terminated subsequent to a “change in control” of the Company under the circumstances described below.

1. Agreement to Provide Services; Right to Terminate.

(i) Except as otherwise provided in paragraph (ii) below, the Company or you may terminate your employment at any time, subject to the provisions of any employment agreement between you and the Company and the Company’s providing the benefits hereinafter specified in accordance with the terms hereof.

(ii) In the event of a potential change in control of the Company as defined in Section 4 hereof, you agree that you will not leave the employ of the Company (other than as a result of Disability or upon Retirement, as such terms are hereinafter defined) and will render the services contemplated in the recitals to this Agreement until the earliest of (a) a date which is 270 days from the occurrence of such potential change in control of the Company, or (b), a termination of your employment pursuant to which you become entitled under this Agreement to receive the benefits provided in Section 6(iii) below.

2. Effective Date. The Effective Date of this agreement is January 1, 2003.

3. Term of Agreement. This Agreement shall commence on the Effective Date and shall continue in effect until December 31, 2003; provided, however, that commencing on the first day of the new year following the Effective Date and each January 1 thereafter, the term of this Agreement shall automatically be extended for one additional year unless at least 90 days prior to such January 1 date, the Company or you shall have given notice that this Agreement shall not be extended (provided that no such notice may be given by the Company during the pendency of a potential change in control); and provided, further, that this Agreement shall continue in effect for a period of twenty-four (24) months beyond the term provided herein if a change in control of the Company, as defined in Section 4 hereof, shall have occurred during such term. Notwithstanding anything in this Section 3 to the contrary, this Agreement shall terminate if you or the Company terminate your employment prior to a change in control of the Company as defined in Section 4 hereof. In addition, the Company may terminate this Agreement during your employment if, prior to a change in control of the Company as defined in Section 4 hereof, you cease to hold your current position with the Company, except by reason of a promotion.

4. Change in Control; Potential Change in Control; Person.

(i) For purposes of this Agreement, a “change in control” of the Company shall mean the occurrence of any of the following events:

(A) The approval by the shareholders of the Company of:

(1) any consolidation, merger or plan of share exchange involving the Company (a “Merger”) in which the Company is not the continuing or surviving corporation or pursuant to which shares of Common Stock of the Company (“Company Shares”) would be converted into cash, securities or other property, other than a Merger involving Company Shares in which the holders of Company Shares immediately prior to the Merger have the same proportionate ownership of common stock of the surviving corporation immediately after the Merger;

(2) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of the Company; or

(3) the adoption of any plan or proposal for the liquidation or dissolution of the Company;

(B) At any time during a period of two consecutive years, individuals who at the beginning of such period constituted the Board (“Incumbent Directors”) shall cease for any reason to constitute at least a majority thereof, unless each new director elected during such two-year period was nominated or elected by two-thirds of the Incumbent Directors then in office and voting (with new directors nominated or elected by two-thirds of the Incumbent Directors also being deemed to be Incumbent Directors); or

(C) Any Person (as hereinafter defined) shall, as a result of a tender or exchange offer, open market purchases, or privately negotiated purchases from anyone other than the Company, have become the beneficial owner (within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of securities of the Company ordinarily having the right to vote for the election of directors (“Voting Securities”) representing twenty percent (20%) or more of the combined voting power of the then outstanding Voting Securities.

Notwithstanding anything in the foregoing to the contrary, unless otherwise determined by the board, no change in control shall be deemed to have occurred for purposes of this Agreement if (1) you acquire (other than on the same basis as all other holders of the Company Shares) an equity interest in an entity that acquires the Company in a change in control otherwise described under subparagraph (A) above, or (2) you are part of group that constitutes a Person which becomes a beneficial owner of Voting Securities in a transaction that otherwise would have resulted in a change in control under subparagraph (C) above.

(ii) For purposes of this Agreement, a “potential change in control” of the Company shall be deemed to have occurred if:

(A) the Company enters into an agreement, the approval of which by the shareholders would result in the occurrence of a change in control of the Company;

(B) any Person (including the Company) publicly announces an intention to take or to consider taking actions which if consummated would constitute a change in control of the Company; or

(C) the Board adopts a resolution to the effect that, for purposes of this Agreement, a potential change in control of the Company has occurred.

(iii) For purposes of this Agreement, the term “Person” shall mean and include any individual, corporation, partnership, group, association or other “person”, as such term is used in Section 14 (d) of the Securities Exchange Act of 1934 (the “Exchange Act”), other than the Company or any employee benefit plan(s) sponsored by the Company.

5. Termination Following Change in Control. If any of the events described in Section 4 hereof constituting a change in control of the Company shall have occurred, you shall be entitled to the benefits provided in Section 6(iii) hereof upon the termination of your employment within twenty-four (24) months after such event, unless such termination is (a) because of your death or Retirement, (b) by the Company for Cause or Disability or (c) by you other than for Good Reason based on an event occurring concurrent with or subsequent to a change in control (as all such capitalized terms are hereinafter defined).

(i) Disability. Termination by the Company of your employment based on “Disability” shall mean termination because of your absence from you duties with the Company on a full-time basis for one hundred eighty (180) consecutive days as a result of your incapacity due to physical or mental illness, unless within thirty (30) days after Notice of Termination (as hereinafter defined) is given to you following such absence you shall have returned to the full-time performance of your duties.

(ii) Retirement. Termination by you or by the Company of your employment based on “Retirement” shall mean termination on or after your 65th birthday.

(iii) Cause. Termination by the Company of your employment for “Cause” shall mean termination upon (a) the willful and continued failure by you to perform substantially your reasonably assigned duties with the Company consistent with those duties assigned to you prior to the change in control (other than any such failure resulting from your incapacity due to physical or mental illness) after a demand for substantial performance is delivered to you by the Chairman of the Board of the Company which specifically identifies the manner in which such executive believes that you have not substantially performed your duties, or (b) the willful engaging by you in illegal conduct which is materially and demonstrably injurious to the Company. For purposes of this paragraph (iii), no act, or failure to act, on your part shall be considered “willful” unless done, or omitted to be done, by you in knowing bad faith and without reasonable belief that your action or omission was in, or not opposed to, the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or based upon the advise of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by you in good faith and in the best interests of the corporation. Notwithstanding the foregoing, you shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to you a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for the purpose (after reasonable notice to you and an opportunity for you, together with your counsel, to be heard before the Board), finding that in the good faith opinion of the Board you were guilty of the conduct set forth above in (a) or (b) of this paragraph (iii) and specifying the particulars thereof in detail.

(iv) Good Reason. Termination by you of your employment for “Good Reason” shall mean termination based on:

(A) a change in your status, title, position(s) or responsibilities as an officer of the Company which, in your reasonable judgment, does not represent a promotion from your status, title,
position(s) and responsibilities as in effect immediately prior to the change in control, or the assignment to you of any duties or responsibilities which, in your reasonable judgment, are inconsistent with such status, title or position(s), or any removal of you from or any failure to reappoint or reelect you to such position(s), except in connection with the termination of your employment for Cause, Disability or Retirement or as a result of your death or by you other than for Good Reason; provided, however, that a position equivalent to that of chief operating officer or chief financial officer of a business substantially the same as that operated by the Company on the Effective Date shall not be deemed grounds for termination for Good Reason;

(B) a reduction by the Company in your base salary as in effect immediately prior to the change in control;

(C) the failure by the Company to continue in effect any Plan (as hereinafter defined) in which you are participating at the time of the change in control of the Company (or Plans providing you with at least substantially similar benefits) other than as a result of the normal expiration of any such Plan in accordance with its terms as in effect at the time of the change in control, or the taking of any action, or the failure to act, by the Company which would adversely affect your continued participation in any of such Plans on at least as favorable a basis to you as in the case on the date of the change in control or which would materially reduce your benefits in the future under any of such Plans or deprive you of any material benefit enjoyed by you at the time of the change in control;

(D) the failure by the Company to provide and credit you with the number of paid vacation days to which you are then entitled in accordance with the Company’s normal vacation policy as in effect immediately prior to the change in control;

(E) the Company’s requiring you to be based anywhere other than where your office is located immediately prior to the change in control except for required travel on the Company’s business to an extent substantially consistent with the business travel obligations which you undertook on behalf of the Company prior to the change in control;

(F) the failure by the Company to obtain from any Successor (as hereinafter defined) the assent to this Agreement contemplated by Section 7 hereof; or

(G) any purported termination by the Company of your employment which is not effected pursuant to a Notice of Termination satisfying the requirements of paragraph (v) below (and, if applicable, paragraph (iii) above); and for purposes of this Agreement, no such purported termination shall be effective.

For purpose of this Agreement, “Plan” shall mean any compensation plan such as an incentive, stock option or restricted stock plan or any employee benefit plan such as a thrift, pension, profit sharing, medical, disability, accident, life insurance, or relocation plan or policy or any other plan, program or policy of the Company intended to benefit employees.

(v) Notice of Termination. Any purported termination by the Company or by you following a change in control shall be communicated by written Notice of Termination to the other party hereto. For purposes of this Agreement, a “Notice of Termination” shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of your employment under the provision so indicated.

(vi) Date of Termination. “Date of Termination” following a change in control shall mean (a) if your employment is to be terminated for Disability, thirty (30) days after Notice of Termination is given (provided that you shall not have returned to the performance of your duties on a full-time basis during such thirty (30) day period), (b) if your employment is to be terminated by the Company for Cause, the date on which a Notice of Termination is given, and (c) if your employment is to be terminated by you or by the Company for any other reason, the date specified in the Notice of Termination, which shall be a date no earlier than ninety (90) days after the date on which a Notice of Termination is given (provided that if the termination is by you for Good Reason the circumstances giving rise to the Good Reason have not been fully corrected by the specified date), unless an earlier date has been agreed to by the party receiving the Notice of Termination either in advance of, or after, receiving such Notice of Termination. Notwithstanding anything in the foregoing to the contrary, if the party receiving the Notice of Termination has not previously agreed to the termination, then within thirty (30) days after any Notice of Termination is given, the party receiving such Notice of Termination may notify the other party that a dispute exists concerning the termination, in which event the Date of Termination shall be the date set either by mutual written agreement of the parties or by the arbitrators in a proceeding as provided in Section 13 hereof.

6. Severance Benefit.

(i) If, within twenty-four (24) months after a change in control of the Company shall have occurred, as defined in Section 4 above, your employment by the Company shall be terminated (a) by the Company other than for Cause, Disability or Retirement or (b) by you for Good Reason based on an event occurring concurrent with or subsequent to a change in control, then, by no later than the fifth day following the Date of Termination (except as otherwise provided), you shall be entitled, without regard to any contrary provisions of any Plan, to a severance benefit (the “Severance Benefit”) equal to the lesser of (x) the Specified Benefits (as defined in subsection (A) below), or (y) the Capped Benefit (as defined in subsection (B) below).

(A) The “Specified Benefits” are as follows:

(1) the Company shall pay your full base salary through the Date of Termination at the rate in effect just prior to the time a Notice of Termination is given plus any benefits or awards (including both cash and stock components) which pursuant to the terms of any Plans have been earned or become payable, but which have not yet been paid to you (including amounts which previously had been deferred at your request);

(2) as severance pay and in lieu of any further salary for periods subsequent to the Date of Termination, the Company shall pay to you in a single payment an amount in cash equal to three times the higher of (a) your annual base salary at the rate in effect just prior to the time a Notice of Termination is given or (b) your annual base salary in effect immediately prior to the change in control of the Company;

(3) for a thirty-six (36) month period after the Date of Termination, the Company shall arrange to provide you and your dependents with life, accident, medical and dental insurance benefits substantially similar to those which you were receiving immediately prior to the change in control of the Company. Notwithstanding the foregoing, the Company shall not provide any benefit otherwise receivable by you pursuant to this paragraph (3) to the extent that a similar benefit is actually received by you from a subsequent employer during such thirty-six (36) month period, and any such benefit actually received by you shall be reported to the Company; and

(4) the Company shall pay you for any vacation time earned but not taken at the Date of Termination, at an hourly rate equal to your annual base salary as in effect immediately prior to the time a Notice of Termination is given divided by 2080.

(B) The “Capped Benefit” equals the Specified Benefits, reduced by the minimum amount necessary to prevent any portion of the Specified Benefits from being a “parachute payment” as defined in Section 280G (b)(2) of the Internal Revenue Code of 1986, as amended (“IRC”), or any successor provision. The amount of the Capped Benefit shall therefore equal (1) three times the “base amount” as defined in IRC, § 280G (b)(3)(A) reduced by $1 (One Dollar), and further reduced by (2) the present value of all other payments and benefits you are entitled to receive from the Company that are contingent upon a change in control of the Company within the meaning of IRC § 280G (b)(2)(A)(i), including accelerated vesting of options and other awards under the Company’s stock option plans, and increased by (3) all Specified Benefits that are not contingent upon a change in control within the meaning of IRC § 280G (b)(2)(A)(i). If you receive the Capped Benefit, you may determine the extent to which each of the Specified Benefits shall be reduced. The parties recognize that there is some uncertainty regarding the computations under IRC § 280G which must be applied to determine the Capped Benefit. Accordingly, the parties agree that, after the Severance Benefit is paid, the amount of the Capped Benefit may be retroactively adjusted to the extent any subsequent Internal Revenue Service regulations, rulings, audits or other pronouncements establish that the original calculation of the Capped Benefit was incorrect. In that case, amounts shall be paid or reimbursed between the parties so that you will have received the Severance Benefit you would have received if the Capped Benefit had originally been calculated correctly.

(ii) Except as specifically provided above, the amount of any payment provided for in this Section 6 shall not be reduced, offset or subject to recovery by the Company by reason of any compensation earned by you as the result of employment by another employer after the Date of Termination, or otherwise. Your entitlements under Section (6)(iii) are in addition to, and not in lieu of, any rights, benefits or entitlements you may have under the terms or provisions of any Plan.

7. Successors; Binding Agreement.

(i) Upon your written request, the Company will seek to have any Successor (as hereinafter defined), by agreement in form and substance satisfactory to you, assent to the fulfillment by the Company of its obligations under this Agreement. Failure of the Company to obtain such assent prior to or at the time a Person becomes a Successor shall constitute Good Reason for termination by you of your employment and, if a change in control of the Company has occurred, shall entitle you immediately to the benefits provided in Section 6(iii) hereof upon delivery by you of a Notice of Termination which the Company, by executing this Agreement, hereby assents to. For purposes of this Agreement, “Successor” shall mean any Person that succeeds to, or has the practical ability to control (either immediately or with the passage of time), the Company’s business directly, by merger, consolidation or purchase of assets, or indirectly, by purchase of the Company’s Voting Securities or otherwise.

(ii) This Agreement shall inure to the benefit of and be enforceable by your personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If you should die while any amount would still be payable to you hereunder if you had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to your devisee, legatee or other designee or, if there be no such designee, to your estate.

8. Fees and Expenses. The Company shall pay all legal fees and related expenses incurred by you as a result of (i) your termination following a change in control of the Company (including all such fees and expenses, if any, incurred in contesting or disputing any such termination) or (ii) your seeking to obtain or enforce any right or benefit provided by this Agreement.

9. Survival. The respective obligations of, and benefits afforded to, the Company and you as provided in Section 6, 7(ii), 8 and 13 of this Agreement shall survive termination of this Agreement.

10. Notice. For the purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid and addressed to the address of the respective party set forth on the first page of this Agreement, provided that all notices to the Company shall be directed to the attention of the Chairman of the Board or President of the Company, with a copy to the Secretary of the Company, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt.

11. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such modification, waiver or discharge is agreed to in a writing signed by you and the Chairman of the Board or President of the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or of compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not expressly set forth in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Oregon.

12. Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect.

13. Arbitration. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in Portland, Oregon by three arbitrators in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrators’ award in any court having jurisdiction; provided, however, that you shall be entitled to seek specific performance of your right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. The Company shall bear all costs and expenses arising in connection with any arbitration proceeding pursuant to this Section 13.

14. RelatedAgreements. To the extent that any provision of any other agreement between the Company or any of its subsidiaries and you shall limit, qualify or be inconsistent with any provision of this Agreement, then for purposes of this Agreement, while the same shall remain in force, the provision of this Agreement shall control and such provision of such other agreement shall be deemed to have been superseded, and to be of no force or effect, as if such other agreement had been formally amended to the extent necessary to accomplish such purpose.

15. Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same instrument.

If this correctly sets forth our agreement on the subject matter hereof, kindly sign and return to the Company the enclosed copy of this letter which will then constitute our agreement on this subject.

[Signature page follows.]

Electro Scientific Industries, Inc.

By: /s/ DAVID F. BOLENDER
——————————————
Name: David F. Bolender
Title: Chairman of the Board of Directors

Agreed to this 13th day of December, 2002

/s/ JAMES T. DOOLEY
—————————————————
JAMES T. DOOLEY

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UNITED STATESSECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended November 30, 2002

Commission File Number: 0-12853

ELECTRO SCIENTIFIC INDUSTRIES, INC.

(an Oregon corporation)

13900 N.W. Science Park Drive, Portland, Oregon 97229

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

Registrant’s web address: www.esi.com

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Part I. Financial Information

Item 1. Consolidated Financial Statements

Note 1 — Basis of Presentation

Note 2 — Accounts Receivable, Net

Note 3 — Inventory

Note 4 — Assets held for Sale

Note 5 — Earnings Per Share

Note 6 — Comprehensive Loss

Note 7 — Income Taxes

Note 8 — Recent Accounting Pronouncements

Note 9 — Non-Recurring Operating Items

Note 10 — Restructuring

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS

Overview

Results of Operations

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Liquidity and Capital Resources

Critical Accounting Policies and Estimates

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Factors That May Affect Future Results

The industries that comprise our primary markets are volatile and unpredictable.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Our recent capacity expansion may not be utilized successfully or effectively, which could negatively affect our business.

Our ability to reduce costs is limited by our need to invest in research and development.

We depend on a few significant customers and we do not have long-term contracts with any of our customers.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Delays in shipment or manufacturing of our products could substantially decrease our sales for a period.

Failure of critical suppliers of parts, components and manufacturing equipment to deliver sufficient quantities to us in a timely and cost-effective manner could negatively affect our business.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

We may make additional acquisitions in the future, and these acquisitions may subject us to risks associated with integrating these businesses into our current business.

Our markets are subject to rapid technological change, and to compete effectively we must continually introduce new products that achieve market acceptance.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

We are exposed to the risks that others may violate our proprietary rights, and our intellectual property rights may not be well protected in foreign countries.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

We may be subject to claims of intellectual property infringement.

We are exposed to the risks of operating a global business, including risks associated with exchange rate fluctuations and legal and regulatory changes.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Our establishment of direct sales in Asia exposes us to the risks related to having employees in foreign countries.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

Our business is highly competitive, and if we fail to compete our business will be harmed.

The possibilities of terrorist attacks and military action against Iraq have increased uncertainties for our business.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

The loss of key management or our inability to attract and retain sufficient numbers of managerial, engineering and other technical personnel could have a material adverse effect upon our results of operations.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Item 3. Market Risk Disclosure

Item 4. Controls and Procedures

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Part II. Other Information

Item 1. Legal Proceedings

Item 4. Submission of Matters to a Vote of Security Holders

Item 6. Exhibits and Reports on Form 8-K

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

SARBANES-OXLEY ACT SECTION 302(a) CERTIFICATION

SARBANES-OXLEY ACT SECTION 302(a) CERTIFICATION

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Exhibit 10

ELECTRO SCIENTIFIC INDUSTRIES, INC.EMPLOYMENT AGREEMENT

[SIGNATURE PAGE FOLLOWS]

EXHIBIT A

CALCULATION OF ANNUAL BONUS

Goal vs. Target Bonus:

Payment Structure

EXHIBIT B

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

ELECTRO SCIENTIFIC INDUSTRIES, INC.
EMPLOYMENT AGREEMENT