-----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, PaAiBRl5C6TU/SUrRoFMheG1j+e5vuprxf+C/cOLBxFhsK85E670iQ1/673BsR4e c1bKci3o7AMeREE2RR9Crg== 0001157523-03-004034.txt : 20030811 0001157523-03-004034.hdr.sgml : 20030811 20030811160620 ACCESSION NUMBER: 0001157523-03-004034 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20021130 FILED AS OF DATE: 20030811 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/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-12853 FILM NUMBER: 03834677 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/A 1 a4452171.txt ELECTRO SCIENTIFIC 10-Q/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A Amendment No. 1 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____ to ____ Commission File Number: 0-12853 ELECTRO SCIENTIFIC INDUSTRIES, INC. (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 |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_| The number of shares outstanding of the Registrant's Common Stock at November 30, 2002 was 27,719,627 shares. This Amendment No. 1 on Form 10-Q/A amends our quarterly report on Form 10-Q for the fiscal quarter ended November 30, 2002 which was filed on January 13, 2003. The amendment is a result of the restatement of our audited consolidated financial statements for the fiscal year ended June 1, 2002 (and the quarters contained therein) and our unaudited consolidated condensed financial statements for the quarterly periods ended August 31, 2002 and November 30, 2002. The restatement reflects adjustments to net sales, cost of sales and certain operating expenses, and the related balance sheet accounts. We have amended each item of our quarterly report on Form 10-Q for the fiscal quarter ended November 30, 2002 that has been affected by the restatement. This Amendment No. 1 does not reflect events occurring after the January 13, 2003 filing of our Form 10-Q or modify or update the disclosures set forth therein in any way, except as required to reflect the effects of the restatement. The items of our quarterly report on Form 10-Q for the fiscal quarter ended November 30, 2002 that are amended and restated herein are Items 1, 2 and 4 of Part I and Item 6 of Part II. The remaining items originally contained in our Form 10-Q for the fiscal quarter ended November 30, 2002 as filed with the Securities and Exchange Commission on January 13, 2003 are unchanged. This Amendment No. 1 on Form 10-Q/A should be read in conjunction with our quarterly report on Form 10-Q for the fiscal quarter ended March 1, 2003 as filed on August 11, 2003, including the materials under the subheading "Factors That May Affect Future Results" in Part I, Item 2. ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page Item 1. Consolidated Condensed Financial Statements (unaudited and restated) Consolidated Condensed Balance Sheets - November 30, 2002 (restated) and June 1, 2002 (restated) 2 Consolidated Condensed Statements of Operations - Three and Six Months Ended November 30, 2002 (restated) and December 1, 2001 (restated) 3 Consolidated Condensed Statements of Cash Flows - Six Months Ended November 30, 2002 (restated) and December 1, 2001 (restated) 4 Notes to Consolidated Condensed Financial Statements (restated) 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (restated) 12 Item 4. Controls and Procedures 24 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 27 Signatures 28
1 ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (In thousands) (Restated) (Unaudited) November 30, June 1, 2002 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 of allowances of $1,358 at November 30 and $1,437 at June 1 52,471 55,810 Income tax refund receivable 17,544 14,402 Inventories, net 51,140 63,916 Shipped systems pending acceptance 4,539 2,007 Deferred income taxes 8,243 8,243 Assets held for sale 7,563 - Other current assets 7,098 4,960 ------------ ------------ Total Current Assets 410,874 366,145 Long-term marketable securities 41,487 73,445 Long-term restricted securities 5,998 12,047 Property, plant and equipment, at cost 82,616 95,656 Less - accumulated depreciation (33,910) (37,610) ------------ ------------ Net property, plant and equipment 48,706 58,046 Other assets 15,640 16,589 ------------ ------------ Total Assets $ 522,705 $ 526,272 ============ ============ Liabilities and Shareholders' Equity Current Liabilities: Accounts payable $ 5,057 $ 3,246 Accrued liabilities 21,075 16,062 Deferred revenue 8,748 5,308 ------------ ------------ Total Current Liabilities 34,880 24,616 Convertible subordinated notes 146,347 145,897 ------------ ------------ Total Liabilities 181,227 170,513 Shareholders' Equity: Preferred stock, without par value; 1,000 shares authorized; no shares issued - - Common stock, without par value; 100,000 authorized; 27,720 and 27,619 shares issued and outstanding at November 30, 2002 and June 1, 2002, respectively 137,769 136,370 Retained earnings 203,259 219,561 Accumulated other comprehensive income (loss) 450 (172) ------------ ------------ Total Shareholders' Equity 341,478 355,759 ------------ ------------ Total Liabilities and Shareholders' Equity $ 522,705 $ 526,272 ============ ============ The accompanying notes are an integral part of these statements. 2 ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited) (Restated)
For the Three Months Ended For the Six Months Ended ---------------------------- ------------------------------- Nov. 30, 2002 Dec. 1, 2001 Nov. 30, 2002 Dec. 1, 2001 -------------- ------------ -------------- --------------- Net sales $ 43,416 $ 37,538 $ 82,776 $ 86,226 Cost of sales 40,456 19,042 63,959 46,747 -------------- ------------ -------------- --------------- Gross margin 2,960 18,496 18,817 39,479 Operating expenses: Selling, service and administration 16,551 14,651 31,121 37,193 Research, development and engineering 7,267 8,736 14,912 21,526 -------------- ------------ -------------- --------------- 23,818 23,387 46,033 58,719 -------------- ------------ -------------- --------------- Operating loss (20,858) (4,891) (27,216) (19,240) Interest income 2,809 1,620 5,752 3,557 Interest expense (1,774) (51) (3,781) (78) Other income (expense), net 701 (208) 265 (22) -------------- ------------ -------------- --------------- 1,736 1,361 2,236 3,457 -------------- ------------ -------------- --------------- Loss before income taxes (19,122) (3,530) (24,980) (15,783) Benefit for income taxes (6,214) (1,219) (8,678) (5,274) -------------- ------------ -------------- --------------- Net loss $ (12,908) $ (2,311) $ (16,302) $ (10,509) ============== ============ ============== =============== Net loss per share - basic and diluted $ (0.47) $ (0.08) $ (0.59) $ (0.39) ============== ============ ============== =============== Weighted average number of shares - basic and diluted 27,714 27,246 27,682 27,199 ============== ============ ============== ===============
The accompanying notes are an integral part of these statements. 3 ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (In thousands, except per share data) (Unaudited) (Restated) For the Six Months Ended ------------------------- November 30, December 1, 2002 2001 ------------ ------------ Cash flows from operating activities: Net loss $ (16,302)$ (10,509) Adjustments to reconcile net loss to cash provided by (used in) operating activities: Depreciation and amortization 5,096 5,532 Tax benefit of stock options exercised 181 731 Provision for doubtful accounts 129 292 Loss on disposal and impairment of property and equipment 260 930 Deferred income taxes 174 4,859 Changes in operating accounts: Decrease in trade receivables, net 4,623 24,218 (Increase) decrease in inventories, net 15,477 (2,380) Increase in income taxes receivable (3,142) - Increase in other current assets (2,101) (882) Increase in deferred revenue 3,440 1,692 Increase (decrease) in current liabilities 5,389 (32,911) ------------ ------------ Net cash provided by (used in) operating activities 13,224 (8,428) Cash flows from investing activities: Purchase of property, plant and equipment (6,148) (9,486) Proceeds from the sale of property, plant and equipment 45 633 Maturity of restricted securities 2,964 - Purchase of securities (141,997) (89,891) Proceeds from sales of securities and maturing securities 131,793 74,740 Increase in other assets (1,381) (692) ------------ ------------ Net cash used in investing activities (14,724) (24,696) 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: Beginning of period 29,435 68,522 ------------ ------------ End of period $ 29,152 $ 38,651 ============ ============ Supplemental cash flow information: Cash paid for interest $ 3,368 $ 12 Income tax refunds received 5,152 - Cash paid for income taxes - 2,334 The accompanying notes are an integral part of these statements. 4 ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) Note 1 - Basis of Presentation We have prepared the consolidated condensed 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 consolidated condensed 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/A. 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 - Investigation and Restatements of Financial Statements In March 2003, our Audit Committee commenced an internal investigation of the circumstances surrounding the reversal of an employee benefits accrual that occurred in the first quarter of 2003. The investigation also identified and addressed: (1) unsupported accounting adjustments and clerical errors primarily relating to inventory and cost of goods sold, and (2) certain other areas where potential accounting errors could have occurred, including revenue recognition. Restatement of 2002 Financial Statements We have restated our financial statements for the fiscal year ended June 1, 2002 (and the quarters contained therein) principally related to the deferral of revenue for certain transactions where customer specified acceptance criteria existed but were not properly considered in determining whether our criteria for revenue recognition had been met as of year-end. We also corrected our financial statements for other matters we identified, including: the failure to write-off fixed assets that were sold prior to year-end, but had not been removed from our books, the write-off of inventory due to a change in our accounting for defective parts being returned by customers, an unauthorized change in depreciation methods and the correction of a bank error related to amortization of bond premiums/discounts. Restatement of Fiscal 2003 First and Second Quarters We have also restated the financial statements for the quarters ended August 31, 2002 and November 30, 2002 related to the deferral of revenue, an unauthorized change in depreciation method and the amortization of bond premiums/discounts as described above. For the first quarter of fiscal 2003, the financial statements have also been restated to reflect the reinstatement of an inappropriately reversed accrual for employee benefits. Other matters corrected for that quarter primarily include the following: the write-down of inventory that was double counted, the write-down of inventory due to an error in the computation of overhead, an increase in operating expenses due to improper capitalization of a period expense and an increase in warranty expense due to an unauthorized change in accounting method. 5 For the second quarter of fiscal 2003, the financial statements have also been restated for other matters primarily including: the write-down of inventory due to an unauthorized change in our accounting for parts inventory at customer locations, the write-down of inventory that was double counted, an increase in accrued liabilities related to purchase commitments for excess and obsolete inventory and an increase in warranty expense due to an unsupported accounting entry. We have restated our net sales, cost of sales, operating expense, tax benefit and earnings for the three and six month periods ended November 30, 2002 and our related balance sheet accounts at November 30, 2002 as follows (in thousands):
Tax Cost of Operating Other (Benefit)/ Net Sales Sales Expense Income Expense Net Income -------------- ------------ ------------ ---------- ------------- -------------- As previously reported - three months $ 43,302 $ 34,508 $ 24,116 $ 1,280 $ (4,494) $ (9,548) ended November 30, 2002 Revenue deferrals, net 214 (181) - - - 395 Increase to sales discount (100) - - - - (100) Write-down of inventory and long-term assets - 4,594 - - - (4,594) Increase to warranty expense - 1,316 - - - (1,316) Changes to depreciation expense - 219 (33) - - (186) Adjustments due to timing of operating expenses - - (136) - - 136 Adjustment to amortization of bond premium - - - 456 - 456 Decrease in bad debt expense - - (129) - - 129 Tax effect of adjustments - - - - (1,720) 1,720 -------------- ------------ ------------ ---------- ------------- -------------- Total impact of adjustments 114 5,948 (298) 456 (1,720) (3,360) -------------- ------------ ------------ ---------- ------------- -------------- As restated - three months ended November 30, 2002 $ 43,416 $ 40,456 $ 23,818 $ 1,736 $(6,214) $(12,908) ============== ============ ============ ========== ============= ============== Tax Cost of Operating Other (Benefit)/ Net Income Net Sales Sales Expense Income Expense (Loss) -------------- ------------ ------------ ---------- ------------- -------------- -------------- ------------ ------------ ---------- ------------- -------------- As previously reported - six months ended November 30, 2002 $ 86,263 $57,493 $ 44,964 $2,385 $ (4,419) $ (9,390) Revenue deferrals (3,387) (2,532) - - - (855) Increase to sales discount (100) - - - - (100) Write-down of inventory and long-term assets - 6,233 - - - (6,233) Increase to warranty expense - 2,431 - - - (2,431) Changes to depreciation expense 334 (65) (269) Increase to employee benefit accrual - - 977 - - (977) Adjustments due to timing of operating expenses - - 157 - - (157) Adjustment to amortization of bond premium - - - 283 - 283 Reclass of interest on tax refund - - - (432) (432) - Tax effect of adjustments - - - - (3,827) 3,827 -------------- ------------ ------------ ---------- ------------- -------------- Total impact of adjustments (3,487) 6,466 1,069 (149) (4,259) (6,912) -------------- ------------ ------------ ---------- ------------- -------------- As restated - six months ended November 30, 2002 $ 82,776 $63,959 $ 46,033 $2,236 $ (8,678) $(16,302) ============== ============ ============ ========== ============= ==============
With the recognition of the above adjustments, our net loss per share was restated to $0.47 per share and $0.59 per share for the three and six months ended November 30, 2002, respectively, compared to the previously reported net loss per share of $0.34 per share and $0.34 per share, respectively. 6 Adjustments to our balance sheet as a result of the restatements were as follows (in thousands):
Shipped Systems Inventory Other Current Long-Term Total Assets Pending Acceptance Assets Assets ------------------- ------------ --------------- ----------- --------------- Total assets as previously reported - November 30, 2002 $ - $54,447 $350,618 $115,274 $520,339 Revenue deferrals, current period, net 181 - - - 181 Revenue deferrals, prior periods 4,358 - - - 4,358 Adjustments to inventory, other assets and long-term assets - (3,307) 31 (3,443) (6,719) Increase to sales discounts - - (400) (400) Adjustments to prepaid expenses - - 52 - 52 Tax effect of adjustments - - 4,894 - 4,894 ------------------- ------------ --------------- ----------- --------------- Total impact of adjustments 4,539 (3,307) 4,577 (3,443) 2,366 ------------------- ------------ --------------- ----------- --------------- Total assets as restated - November 30, 2002 $ 4,539 $51,140 $355,195 $111,831 $522,705 =================== ============ =============== =========== =============== Total Liabilities Other Share- and Current Long-Term holders' Shareholders' Deferred Revenue Liabilities Liabilities Equity Equity ------------------- ------------ --------------- ----------- --------------- Total liabilities and equity as reported $ 2,001 $21,816 $146,347 $350,175 $520,339 - - November 30, 2002 Revenue deferrals, current period (214) - - - (214) Revenue deferrals, prior periods 6,961 - - - 6,961 Adjustments due to timing of operating expenses - 827 - 827 Increase to employee benefits accrual - 977 - 31 1,008 Accrual for open purchase commitments - 2,512 - - 2,512 Net loss effect of adjustments - current period - - - (3,360) (3,360) Net loss effect of adjustments -prior periods - - - (5,368) (5,368) ------------------- ------------ --------------- ----------- --------------- Total impact of adjustments 6,747 4,316 - (8,697) 2,366 ------------------- ------------ --------------- ----------- --------------- Total liabilities and equity as restated - - November 30, 2002 $ 8,748 $26,132 $146,347 $341,478 $522,705 =================== ============ =============== =========== ===============
Information in the following notes and in the Management's Discussion and Analysis of Financial Condition and Results of Operations has been restated, as appropriate, to reflect the restatements. Note 3 - 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 this agreement 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. 7 Note 4 - 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 (in thousands): November 30, 2002 June 1, 2002 ------------------- ---------------- (restated) (restated) Raw materials and purchased parts $28,979 $ 41,013 Work-in-process 3,474 1,942 Finished goods 18,687 20,961 ------------------- ---------------- Total inventories $51,140 $ 63,916 =================== ================ Included in accrued liabilities at November 30, 2002 is $2.5 million related to purchase commitments for excess and obsolete inventory. Note 5 - 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 that we will sell the assets within one year. We account for long-lived assets to be disposed of in accordance with Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets," which we adopted effective June 1, 2002. SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Based on market information provided by our real estate agents on both the Minnesota and California properties, we determined that the market values of the properties, less selling costs, exceeded our book values for the properties. Accordingly, we have reflected the properties on our consolidated balance sheet at book value and are no longer depreciating them. Components of net assets held for sale were as follows: November 30, 2002 ---------------------- Land $2,909 Buildings 4,654 ---------------------- $7,563 ====================== 8 Note 6 - Earnings Per Share Because we incurred losses in the three and six month periods ended November 30, 2002 and December 1, 2001, the number of shares outstanding for the calculation of loss per share ("EPS") was the same for both the basic and the diluted calculations. The following common stock equivalents were excluded from the diluted EPS calculations because inclusion would have had an antidilutive effect (in thousands): Three and Six Months Ended ------------------------------------- November 30, 2002 December 1, 2001 ----------------- ----------------- Employee stock options 4,584 3,888 4 1/4% convertible subordinated notes 3,947 - ----------------- ----------------- 8,531 3,888 ================= ================= Note 7 - Comprehensive Loss The components of comprehensive loss, net of tax, are as follows (in thousands):
Three Months Ended Six Months Ended --------------------------------- ------------------------------- November 30, December 1, November 30, December 1, 2002 2001 2002 2001 -------------- --------------- ------------- ------------- (restated) (restated) (restated) (restated) Net loss $(12,908) $(2,311) $(16,302) $(10,509) Net unrealized gain on derivative instruments (1) (87) 13 1 Foreign currency translation adjustment 21 (19) 105 (17) Net unrealized gain (loss) on securities 52 551 504 367 -------------- --------------- ------------- ------------- Total comprehensive loss $(12,836) $(1,866) $(15,680) $(10,158) ============== =============== ============= =============
Note 8 - 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 32.5% and 34.5%, respectively. Note 9 - 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 Financial Accounting Standards Board (FASB) issued SFAS No. 146, "Accounting for Costs Associated With Exit or Disposal Activities." SFAS No. 146 nullifies EITF Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." Under SFAS No. 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. 9 In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which is effective for fiscal years beginning after June 15, 2002. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 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 No. 143, but do not expect the adoption of SFAS No. 143 to have a significant impact on our financial position or the results of our operations. On June 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 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 less selling costs or carrying amount. SFAS No. 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 previously required. The adoption of SFAS No. 144 did not have a material impact on our financial position or the results of our operations. Note 10 - Restructuring and Special Charges 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 a total of 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, $0.4 million for the write-off of certain leasehold improvements and $0.1 million for other consolidation costs. In the second quarter of fiscal 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 discontinuation of certain products. 10 The following table displays the amounts included as restructuring and special charges for the three and six month periods ended December 1, 2001 (in thousands).
Three Months Ended Six Months Ended December 1, 2001 December 1, 2001 --------------------------- ----------------------- Employee severance and other employee expenses $1,439 $4,013 Facility consolidation and lease termination 147 1,604 costs Net gain on disposal of assets (384) (308) Other expenses 418 662 --------------------------- ----------------------- $1,620 $5,971 =========================== =======================
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, the discontinuance of certain electronic component manufacturing product lines 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 $17.6 million of restructuring and special charges related to these activities and excess and obsolete inventory that are included in cost of sales and operating expenses for the three and six months ended November 30, 2002, we expect to incur approximately $3.0 million to $4.0 million of restructuring related expenses in future quarters. In both the current year and the prior year, all restructuring costs have been included in the line items to which they functionally relate. Note 11 - Restructuring Accrual At November 30, 2002, we had $1.1 million remaining in accrued liabilities related to our restructuring activities, compared to $1.0 million at June 1, 2002. The following table displays the rollforward of the restructuring accruals from June 1, 2002 to November 30, 2002 (in thousands):
Accruals at Accruals at Charges to November 30, June 1, 2002 Accruals Amounts Used 2002 -------------- ---------------- ---------------- ----------------- Lease termination fees and other facility consolidation costs $ 664 $ - $ (220) $ 444 Purchase order obligations $ 334 $ - $ (334) $ - Employee severance $ - $ 948 $ (333) $ 615
Accrued lease termination fees and other facility consolidation costs will be paid through 2006, and accrued employee severance will be paid through the first quarter of fiscal 2004. 11 Item 2. Management's Discussion and Analysis of Financial Condition and - -------- --------------------------------------------------------------- Results of Operations (restated) --------------------- 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. Restatement In March 2003 our Audit Committee commenced an internal investigation of certain accounting matters. The investigation involved the review of (1) the circumstances surrounding the reversal of an accrual for employee benefits, (2) unsupported accounting adjustments and clerical errors primarily relating to inventory and cost of goods sold, and (3) certain other areas where potential accounting errors could have occurred, including revenue recognition. As a result of the investigation, we determined that the unaudited consolidated condensed financial statements for the three months ended August 31, 2002 and November 30, 2002, and the audited consolidated financial statements for the year ended June 1, 2002 (and the quarters contained therein) required restatement. For the three and six month periods ended November 30, 2002, we restated our financial statements to correct improper accounting entries, including entries for revenue recognition, inventory write-downs, warranty expense and employee benefits expense. The aggregate impact of these adjustments, and related tax effects, was to increase our net loss for the three and six months ended November 30, 2002 from $9.5 million and $9.4 million, respectively, to $12.9 million and $16.3 million, respectively, and to increase our basic and diluted net loss per share from $0.34 and $0.34, respectively, to $0.47 and $0.59, respectively. A summary of the impact of the adjustments on our previously issued unaudited consolidated condensed statements of operations for the three and six months ended November 30, 2002 and unaudited consolidated condensed balance sheet as of November 30, 2002 is presented in Note 2 to our notes to consolidated condensed financial statements contained elsewhere in this amended report. 12 Results of Operations Net sales increased $5.9 million, or 15.7%, to $43.4 million for the quarter ended November 30, 2002 (the second quarter of fiscal 2003) compared to $37.5 million for the quarter ended December 1, 2001 (the second quarter of fiscal 2002). Net sales decreased $3.5 million, or 4.0%, to $82.8 million for the six months ended November 30, 2002 compared to $86.2 million for the six months ended December 1, 2001. The increase in net sales in the second quarter of fiscal 2003 compared to the second quarter of fiscal 2002 is due to increases in sales of our semiconductor yield improvement systems and advanced electronic packaging systems. These increases were offset in part by decreases in sales of our electronic component manufacturing systems, circuit fine tuning systems and vision inspection systems. The decrease in net sales for the six months ended November 30, 2002 compared to the six months ended December 1, 2001 is due to decreases in sales of electronic component manufacturing systems, circuit fine tuning systems and semiconductor yield improvement systems. These decreases were partially offset by increases in vision inspection improvement systems and advanced electronic packaging systems. 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 second quarter of fiscal 2003 at 41.3% of total sales versus 38.4% in the second quarter of the prior year and 43.5% for the first quarter of fiscal 2003. Certain information regarding our net sales by product line is as follows (net sales in thousands):
Three Months Ended Three Months Ended November 30, 2002 (as restated) December 1, 2001 (as restated) -------------------------------- ------------------------------- Percent of Percent of Net Sales Total Net Sales Net Sales Total Net Sales Semiconductor Yield Improvement Systems $17,917 41.3% $ 14,402 38.4% Electronic Component Manufacturing Systems 7,878 18.1 8,636 23.0 Advanced Electronic Packaging Systems 9,243 21.3 4,932 13.1 Vision and Inspection Systems 2,305 5.3 2,397 6.4 Circuit Fine Tuning Systems 6,073 14.0 7,171 19.1 ------- ---- -------- ---- $43,416 100.0% $ 37,538 100.0% ======= ====== ======== ====== Six Months Ended Six Months Ended November 30, 2002 (as restated) December 1, 2001 (as restated) -------------------------------- ------------------------------- Percent of Percent of Net Sales Total Net Sales Net Sales Total Net Sales Semiconductor Yield Improvement Systems $35,026 42.3% $37,390 43.4% Electronic Component Manufacturing Systems 15,712 19.0 22,084 25.6 Advanced Electronic Packaging Systems 12,974 15.7 8,627 10.0 Vision and Inspection Systems 6,149 7.4 5,075 5.9 Circuit Fine Tuning Systems 12,915 15.6 13,050 15.1 ------- ---- -------- ---- $82,776 100.0% $86,226 100.0% ======= ====== ======= ======
13 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, the discontinuance of certain electronic component manufacturing product lines 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 $17.6 million of restructuring and special charges related to these activities and excess and obsolete inventory that are included in cost of sales and operating expenses for the three and six months ended November 30, 2002, we expect to incur approximately $3.0 million to $4.0 million of restructuring related expenses in future quarters. The amount included in costs of sales for these charges in the three and six months ended November 30, 2002 was $13.8 million. These charges included $6.8 million for the write-down of excess and obsolete inventory, $4.1 million for inventory write-downs related to the discontinuance of certain electronic component manufacturing product lines, $2.5 million related to open purchase commitments on excess and obsolete inventory, $0.4 million in employee severance and other employee related expenses, and $0.1 in other facilities consolidation costs. Gross margin for the second quarter of fiscal 2003 decreased to $3.0 million (6.8% of net sales) from $18.5 million (49.3% of net sales) for the second quarter of fiscal 2002. Gross margin in the second quarter of fiscal 2003 includes $13.8 million of restructuring and/or special charges (see Note 10). Gross margin as a percentage of net sales was 40.3% for the first quarter of fiscal 2003. Gross margin for the six months ended November 30, 2002 was $18.8 million (22.7% of net sales) compared to $39.5 million (45.8% of net sales) for the same period in the prior year. Gross margin for the six months ended November 30, 2002 and December 1, 2001 includes $13.8 million and $3.5 million, respectively, of restructuring and/or special charges (see Note 10). Selling, service and administrative expenses increased $1.9 million to $16.6 million (38.1% of net sales) for the second quarter of fiscal 2003 compared to $14.7 million (39.0% of net sales) for the second quarter of fiscal 2002. As a result of the Escondido consolidation and other restructuring steps discussed above, included in selling, service and administrative expenses for the second quarter of fiscal 2003 were employee severance and other employee expenses of $1.0 million, restructuring related consulting fees of $1.3 million, net asset write-downs of $0.5 million and facilities consolidation costs of $0.1 million. As a result of the restructuring plan we implemented in June 2001, included in selling, service and administrative expense for the second quarter of fiscal 2002 were employee severance and other employee expenses of $0.9 million, facility consolidation and lease termination costs of $1.0 million and a net gain on the disposal of assets of $0.4 million (see Note 10). 14 For the six months ended November 30, 2002, selling, service and administrative expenses decreased $6.1 million to $31.1 million (37.6% of net sales) from $37.2 million (43.1% of net sales) for the six months ended December 1, 2001. Included in selling, service and administrative expense for the six months ended December 1, 2001 is $2.7 million of employee severance and other employee expenses and $1.6 million of facility consolidation and lease termination costs (see Note 10). Lower sales volumes in the first quarter of fiscal 2003 and a reduction of force, resulting in lower commissions and payroll expense, and cost reduction efforts resulted in decreased selling, service and administrative expense in the first six months of fiscal 2003 compared to the same period of the prior year. These decreases were partially offset by the increases discussed above related to restructuring and special charges. 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 decreased $1.5 million and $6.6 million, respectively, to $7.3 million (16.7% of net sales) and $14.9 million (18.0% of net sales), respectively, for the three and six month periods ended November 30, 2002 compared to $8.7 million (23.3% of net sales) and $21.5 million (25.0% of net sales), respectively, for the comparable periods of fiscal 2002. As a result of the Escondido consolidation and other restructuring steps discussed above, included in research, development and engineering expenses for the three and six month periods ended November 30, 2002 was employee severance and other employee expense of $0.8 million and facilities consolidation costs of $0.1 million. As a result of the restructuring plan we implemented in June 2001, research, development and engineering expenses for the three and six months ended December 1, 2001 include $0.5 million and $1.1 million, respectively, of employee severance and other employee expenses (see Note 10). 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. Interest income for the three and six months ended November 30, 2002 was $2.8 million and $5.8 million, respectively, compared to $1.6 million and $3.6 million, respectively, for the comparable periods of fiscal 2002. These increases are mainly due to an increase in investment balances generated from our sale, in December 2001 and January 2002, of $150 million aggregate principal amount of 4 1/4% convertible subordinated notes due 2006. Interest expense for the three and six months ended November 30, 2002 was $1.8 million and $3.8 million, respectively, compared to $51,000 and $78,000, respectively, for the comparable periods of fiscal 2002. These increases are primarily due to the sale, in December 2001 and January 2002, of $150 million aggregate principal amount of 4 1/4% convertible subordinated notes due 2006. Quarterly interest related to these notes totals $1.6 million plus $0.2 million for the accretion of underwriting discounts. Net other income of $0.7 million in the second quarter of fiscal 2003 includes a gain of $0.5 million related to a legal settlement agreement and a $0.3 million gain on the sale of securities. 15 Our effective income tax rate for the six months ended November 30, 2002 and December 1, 2001 was 34.7% and 33.4%, respectively. The lower tax rate as compared to the statutory federal and state tax rates is largely a result of tax benefits related to the extraterritorial income exclusion. Net loss was $12.9 million ($0.47 per diluted share) and $16.3 million ($0.59 per diluted share), respectively, for the three and six month periods ended November 30, 2002 compared to $2.3 million ($0.08 per diluted share) and $10.5 million ($0.39 per diluted share), respectively, for the comparable periods of fiscal 2002. Ending backlog on November 30, 2002 was $12.1 million compared to $10.9 million on August 31, 2002 and $22.6 million at June 1, 2002. Liquidity and Capital Resources At November 30, 2002, our principal sources of liquidity consisted 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 11.8:1 and long-term debt of $146.3 million. Working capital increased to $376.0 million at November 30, 2002 compared to $341.5 million at June 1, 2002. Inventory decreased by $12.8 million from June 1, 2002 to November 30, 2002 due to the transfer of $2.5 million of inventory to shipped systems pending acceptance, a $4.1 million write-down for the discontinuance of certain electronic component manufacturing lines and a $6.8 million write-down for excess and obsolete inventory. Purchases of property, plant and equipment of $6.1 million in the first half of fiscal 2003 were primarily for the continued construction of a new corporate headquarters in Portland, Oregon. Current liabilities increased $10.3 million from June 1, 2002 primarily due to a $3.4 million increase in deferred revenue as a result of an increase in shipments of new products pending acceptance and a $5.0 million increase in accrued liabilities, which resulted primarily from accrued interest expense generated from our 4 1/4% convertible subordinated notes due 2006. We pay approximately $3.2 million of interest on the subordinated notes semiannually on each June 21 and December 21. At November 30, 2002 we had $146.3 million recorded on our balance sheet related to our 4 1/4% convertible subordinated notes. The difference between the $150.0 million face value and the $146.3 million balance at November 30, 2002 relates to underwriting discounts, which originally totaled $4.5 million and are being amortized as additional interest expense over the life of the subordinated notes at a rate of $0.2 million per quarter. 16 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/A for the year-ended June 1, 2002, as filed with the Securities and Exchange Commission on August 11, 2003. 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 $12.9 million during the three months ended November 30, 2002 on net sales of $43.4 million and a net loss of $17.8 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. 17 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 50.0% 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. 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. 18 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. 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. 19 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: - -- 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. 20 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. 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. We are not able to reliably estimate the loss, if any, related to this matter at this time. 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 74.8% of net sales for fiscal 2002, with 46.8% 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: 21 - -- 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. 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. 22 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: 23 - -- 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. Item 4. Controls and Procedures - -------------------------------- Immediately following the signature page of this amended quarterly report are certifications of our President and Chief Executive Officer and our Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002 (the "Section 302 Certification"). This portion of our amended quarterly report on Form 10-Q/A is our disclosure of the results of our controls evaluation conducted under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, and within 90 days prior to the filing of this amended quarterly report referred to in paragraphs (4), (5) and (6) of the Section 302 Certification and should be read in conjunction with the Section 302 Certification for a more complete understanding of the topics presented. In March 2003 the Audit Committee of our Board of Directors, with the assistance of outside legal counsel and forensic accountants, commenced an internal investigation of certain accounting matters. The investigation involved the review of (1) the circumstances surrounding the reversal of an accrual for employee benefits, (2) unsupported accounting adjustments and clerical errors primarily relating to inventory and cost of goods sold, and (3) certain other areas where potential accounting errors could have occurred, including revenue recognition. On July 15, 2003, we announced that the Audit Committee had completed its review of these matters. As a result of the review, we determined that the unaudited consolidated condensed financial statements for the three months ended August 31, 2002 and November 30, 2002 and the audited consolidated financial statements for the year ended June 1, 2002 required restatement. 24 Management has advised the Audit Committee that upon reviewing the restatement adjustments and performing an evaluation of our controls and disclosure procedures, management noted deficiencies in internal controls relating to: 1. Lack of complete sales documentation, particularly as it relates to customer specified acceptance criteria; 2. Lack of adequate job transition/cross training and poorly documented "desk" processes and procedures in the finance/accounting area; 3. Changes to accounting methodologies without notification to, or proper authorization by, accounting oversight parties (i.e., the audit committee and independent auditors); and 4. Lack of adequate tracking and monitoring of finished goods inventory that was transferred out of the inventory management information system. The independent auditors advised the Audit Committee that these internal control deficiencies constitute reportable conditions and, collectively, a material weakness as defined in Statement of Auditing Standards No. 60. Certain of these internal control weaknesses may also constitute deficiencies in our disclosure controls. While we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, are in the process of implementing a more effective system of disclosure controls and procedures, we have instituted controls, procedures and other changes to ensure that information required to be disclosed in this amended quarterly report on Form 10-Q/A has been recorded, processed, summarized and reported. The steps that we have taken to ensure that all material information about our company is accurately disclosed in this report include: 1. The appointment of an independent director to be Chairman of the Board in April 2003, who was previously the Chief Executive Officer and Chairman of the Board of KLA-Tencor Corporation; 2. The appointment of a previously independent director to be President and Chief Executive Officer in April 2003, who was previously Chief Financial Officer of Apex, Inc. and was the former Senior Vice President and Chief Financial Officer of ESI for seven years until 1998; 3. The appointment of a new Chief Financial Officer in May 2003, who was previously Chief Financial Officer of SpeedFam-IPEC, Inc. and Vice President and Corporate Controller of Novellus Systems, Inc.; 4. The engagement of outside professionals specializing in accounting and finance to assist our management in the collection, substantiation and analysis of the information contained in this report; and 5. The performance of additional procedures by us designed to ensure that these internal control deficiencies did not lead to material misstatements in our consolidated financial statements. 25 We have also increased by two the number of independent directors on our board by electing Richard J. Faubert, who previously served as President and Chief Executive Officer of SpeedFam-IPEC, Inc. and held senior management positions at Tektronix, Inc. and Genrad, Inc., and Frederick A. Ball, who previously served as Senior Vice President and Chief Financial Officer of Borland Software Corporation and as Vice President of Finance of KLA-Tencor Corporation. Based in part on the steps listed above, our President and Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. In addition, in order to address further the deficiencies described above and to improve our internal disclosure and control procedures for future periods, we will: 1. Review and revise our processes and procedures for applying revenue recognition policies, including more formalized training of finance, sales, order management and other staffs; 2. Enhance accounting/finance training programs and desk processes and procedures documentation as well as retain additional full-time experienced accounting/finance personnel; 3. Provide additional management oversight and perform detailed reviews of disclosures and reporting with the assistance of outside legal counsel; 4. Account for all completed systems in the inventory management information system; and 5. Use outside resources, as necessary, to supplement our employees in the preparation of the consolidated financial statements and other reports filed or submitted under the Securities Exchange Act of 1934. These steps will constitute significant changes in internal controls. We will continue to evaluate the effectiveness of our disclosure controls and internal controls and procedures on an ongoing basis, and will take further action as appropriate. 26 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K - ----------------------------------------- (a) Exhibits This list is intended to constitute the exhibit index. 10 Employment Agreement (including Change in Control Agreement) between the Company and James T. Dooley, dated December 13, 2002 (incorporated by reference from Exhibit 10 to the Company's previously filed Quarterly Report on Form 10-Q for the quarter ended November 30, 2002, as filed on January 31, 2003). 99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K None 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to be signed by the undersigned thereunto duly authorized. Dated: August 11, 2003 ELECTRO SCIENTIFIC INDUSTRIES, INC. By /s/ Barry L. Harmon --------------------------------- Barry L. Harmon President and Chief Executive Officer (Principal Executive Officer) By /s/ J. Michael Dodson --------------------------------- J. Michael Dodson Vice President of Administration and Chief Financial Officer (Principal Financial and Accounting Officer) 28 CERTIFICATION PURSUANT TO SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002 I, Barry L. Harmon, certify that: 1. I have reviewed this amended quarterly report on Form 10-Q/A of Electro Scientific Industries, Inc.; 2. Based on my knowledge, this amended 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 amended 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 amended quarterly report; 4. The registrant's other certifying officer 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 amended 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 amended 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 officer 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 officer and I have indicated in this amended 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: August 11, 2003 /s/ Barry L. Harmon - ---------------------- Barry L. Harmon President and Chief Executive Officer 29 CERTIFICATION PURSUANT TO SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002 I, J. Michael Dodson, certify that: 1. I have reviewed this amended quarterly report on Form 10-Q/A of Electro Scientific Industries, Inc.; 2. Based on my knowledge, this amended 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 amended 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 amended quarterly report; 4. The registrant's other certifying officer 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 amended 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 amended 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 officer 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 officer and I have indicated in this amended 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: August 11, 2003 /s/ J. Michael Dodson - ---------------------------- J. Michael Dodson Vice President of Administration and Chief Financial Officer 30 EX-99 3 a4452171_ex991.txt ELECTRO SCIENTIFIC EXHIBIT 99.1 EXHIBIT 99.1 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 amended quarterly report on Form 10-Q/A of Electro Scientific Industries, Inc. (the "Company") for the quarterly period ended November 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Barry Harmon, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 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/ Barry L. Harmon - ------------------------- Barry L. Harmon President and Chief Executive Officer August 11, 2003 This certification is made solely for the purpose of 18 U.S.C. Section 1350, and not for any other purpose. A signed original of this written statement required by Section 906 has been provided to Electro Scientific Industries, Inc. and will be retained by Electro Scientific Industries, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. 31 EX-99 4 a4452171_ex992.txt ELECTRO SCIENTIFIC EXHIBIT 99.2 EXHIBIT 99.2 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 amended quarterly report on Form 10-Q/A of Electro Scientific Industries, Inc. (the "Company") for the quarterly period ended November 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, J. Michael Dodson, Vice President of Administration and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 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/ J. Michael Dodson - --------------------------- J. Michael Dodson Vice President of Administration and Chief Financial Officer August 11, 2003 This certification is made solely for the purpose of 18 U.S.C. Section 1350, and not for any other purpose. A signed original of this written statement required by Section 906 has been provided to Electro Scientific Industries, Inc. and will be retained by Electro Scientific Industries, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. 32 -----END PRIVACY-ENHANCED MESSAGE-----