10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 29, 2007

OR

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

For the transition period from                to                

Commission File Number: 0-12853

ELECTRO SCIENTIFIC INDUSTRIES, INC.

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

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

Registrant’s web address: www.esi.com

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

Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨                Accelerated filer  x                Non-accelerated filer  ¨

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

The number of shares outstanding of the Registrant’s Common Stock at November 5, 2007 was 27,813,446 shares.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	2
	Consolidated Condensed Balance Sheets – September 29, 2007 and June 2, 2007	2
	Consolidated Condensed Statements of Operations – Three Months Ended September 29, 2007 and September 2, 2006, and One Month Ended June 30, 2007	3
	Consolidated Condensed Statements of Cash Flows – Three Months Ended September 29, 2007 and September 2, 2006, and Four Months Ended September 29, 2007	4
	Notes to Consolidated Condensed Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25
Item 4.	Controls and Procedures	26
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	28
Item 2.	Issuer Purchases of Equity Securities	36
Item 5.	Other Information	36
Item 6.	Exhibits	37
Signatures		38

1

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands)

(Unaudited)

	September 29, 2007		June 2, 2007
Assets
Current assets:
Cash and cash equivalents	$	102,795	$	100,462
Marketable securities		53,166		124,607
Total cash and securities		155,961		225,069
Trade receivables, net of allowances of $759 and $626		56,489		55,722
Inventories		91,891		80,981
Shipped systems pending acceptance		6,714		1,817
Deferred income tax asset, net		10,214		9,504
Prepaid and other current assets		9,399		5,776
Total current assets		330,668		378,869
Long-term marketable securities		23,246		3,622
Property, plant and equipment, net of accumulated depreciation of $63,783 and $58,701		46,782		43,859
Deferred income tax asset, net		7,996		11,246
Goodwill		12,866		1,442
Acquired intangible assets, net of accumulated amortization of $567 and $0		11,744		—
Other assets		33,307		26,630
Total assets	$	466,609	$	465,668
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	16,217	$	13,826
Accrued liabilities		28,081		25,465
Deferred revenue		19,365		12,290
Total current liabilities		63,663		51,581
Income tax liability		7,843		5,757
Commitments and contingencies
Shareholders’ equity:
Preferred stock, without par value; 1,000 shares authorized; no shares issued		—		—
Common stock, without par value; 100,000 shares authorized; 27,844 and 28,766 shares issued and outstanding		142,160		162,719
Retained earnings		252,494		245,546
Accumulated other comprehensive income		449		65
Total shareholders’ equity		395,103		408,330
Total liabilities and shareholders’ equity	$	466,609	$	465,668

The accompanying notes are an integral part of these statements.

2

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	For the three months ended					For the month ended
	September 29, 2007		September 2, 2006			June 30, 2007
Net sales	$	82,318	$	60,368		$	16,961
Cost of sales		45,509		34,103			8,886
Gross profit		36,809		26,265			8,075
Operating expenses:
Selling, service and administration		15,380		12,051			3,745
Research, development and engineering		11,093		9,304			2,886
Write-off of acquired in-process research & development		2,800		—			—
Insurance recovery		—		(1,287	)		—
		29,273		20,068			6,631
Operating income		7,536		6,197			1,444
Interest and other income, net		2,060		2,812			816
Income before income taxes		9,596		9,009			2,260
Provision for income taxes		4,066		2,807			842
Net income	$	5,530	$	6,202		$	1,418
Net income per share - basic	$	0.20	$	0.21		$	0.05
Net income per share - fully diluted	$	0.19	$	0.21		$	0.05
Weighted average number of shares - basic		28,161		29,076			28,617
Weighted average number of shares - fully diluted		28,647		29,243			29,038

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)

(Unaudited)

	For the three months ended						For the four months ended
	September 29, 2007			September 2, 2006			September 29, 2007
Cash flows from operating activities:
Net income	$	5,530		$	6,202		$	6,948
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Depreciation		2,353			1,969			3,034
Amortization of intangible assets		567			—			567
Write-off of in-process research & development		2,800			—			2,800
Insurance recovery		—			(1,287	)		—
Stock-based compensation expense		1,044			577			1,239
Provision for doubtful accounts		—			104			—
Loss on disposal of property and equipment		2			—			3
Deferred income taxes		(73	)		2,711			(73	)
Changes in operating accounts, net of assets acquired:
(Increase) decrease in trade receivables, net		1,210			(12,723	)		6,120
(Increase) decrease in inventories		137			(6,744	)		(4,608	)
(Increase) decrease in shipped systems pending acceptance		(4,588	)		588			(4,897	)
(Increase) decrease in prepaid and other current assets		879			(1,124	)		558
Increase (decrease) in accounts payable and other current liabilities		(6,880	)		1,539			(4,849	)
Increase (decrease) in deferred revenue		5,218			(1,162	)		5,472
Net cash provided by (used in) operating activities		8,199			(9,350	)		12,314
Cash flows from investing activities:
Purchase of property, plant and equipment		(1,907	)		(4,285	)		(2,473	)
Purchase of securities		(134,041	)		(135,617	)		(167,482	)
Proceeds from sales of securities and maturing securities		163,156			147,195			219,210
Cash paid for acquisition of NWR, net of cash acquired		(36,159	)		—			(36,159	)
Minority equity investment		—			(6,000	)		—
Insurance recovery		—			1,287			—
(Increase) decrease in other assets		1,123			1,430			(1,077	)
Net cash provided by (used in) investing activities		(7,828	)		4,010			12,019
Cash flows from financing activities:
Proceeds from exercise of stock options and stock plans		2,037			665			2,184
Share repurchases		(18,878	)		—			(24,866	)
Excess tax benefits realized from stock options exercised		682			40			682
Net cash provided by (used in) financing activities		(16,159	)		705			(22,000	)
Net change in cash and cash equivalents		(15,788	)		(4,635	)		2,333
Cash and cash equivalents:
Beginning of period		118,583			79,961			100,462
End of period	$	102,795		$	75,326		$	102,795
Supplemental cash flow information:
Cash paid for interest	$	—		$	(1	)	$	—
Income tax refunds received		18			8			18
Cash paid for income taxes		(4,173	)		(328	)		(4,173	)

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

These unaudited interim consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted in these interim statements. Accordingly, these interim statements include all adjustments (consisting of only normal recurring adjustments and accruals) necessary for a fair presentation of results for the interim periods presented. These consolidated condensed financial statements are to be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K.

Results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. With the exception of the adoption of Financial Accounting Standards Board Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”) as discussed in Note 16, the Company’s significant accounting policies remain unchanged from those presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K filed for the fiscal year ended June 2, 2007.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates. Management believes that the estimates used are reasonable. Significant estimates made by management include: inventory write-downs; allowances for uncollectible trade accounts receivables; valuation of minority equity investments, long-lived assets valuations; product warranty reserves; loss contingency reserves; revenue recognition; purchase accounting; stock compensation valuation and income tax benefits, expenses and deferred taxes.

On July 3, 2007, the Company’s Board of Directors approved a change in the Company’s reporting periods that results in a fiscal year end on the Saturday nearest March 31. Accordingly, the Company’s fiscal year 2008 will consist of approximately a ten month period containing 43 weeks ending on March 29, 2008. The Company has elected to file its interim financial statements in Quarterly Reports on Form 10-Q based on the reporting periods in its new fiscal year ending March 29, 2008. The current year financial statements are presented for the three months ended September 29, 2007 and the one month ended June 30, 2007. Due to the implementation of its enterprise resource system in the fourth quarter of fiscal 2006, the Company performed full close and reporting procedures on a fiscal quarter basis only during fiscal 2007 and comparative data for the three months ended September 30, 2006 are not available and are not cost beneficial to prepare. As such, comparative data has been provided for the prior year using the fiscal quarter ending on the date nearest to September 29, which is the first quarter of fiscal 2007 ended September 2, 2006. The Company believes that the first quarter of fiscal 2007 provides a meaningful comparison to the second quarter of fiscal 2008. The Company does not believe that there are any meaningful factors, seasonal or otherwise, that would impact the comparability of information or trends, if results for the three months ended September 30, 2006 were presented in lieu of results for the first quarter of fiscal 2007.

Certain reclassifications have been made in the accompanying consolidated condensed financial statements for prior periods to conform to the current presentation.

5

During the third quarter of fiscal 2007, the Company revised its results of operations for the first quarter of fiscal 2007 for certain immaterial corrections and the amounts presented for the three months ended September 2, 2006 in the consolidated condensed financial statements and related notes are the revised amounts, as shown in the table below.

	Three months ended September 2, 2006
(in thousands, except per share amounts)	As Reported			Adjustment			As Revised
Consolidated Condensed Statement of Operations:
Net sales	$	60,164		$	204		$	60,368
Cost of sales		32,883			1,220			34,103
Gross profit		27,281			(1,016	)		26,265
Selling, service and administration		12,158			(107	)		12,051
Research, development and engineering		9,304			—			9,304
Insurance recovery		(1,287	)		—			(1,287	)
Operating income		7,106			(909	)		6,197
Interest and other income, net		2,910			(98	)		2,812
Income before income taxes		10,016			(1,007	)		9,009
Provision for income taxes		3,244			(437	)		2,807
Net income	$	6,772		$	(570	)	$	6,202
Net income per share - basic and diluted	$	0.23		$	(0.02	)	$	0.21

As shown in the table above, the revisions to the first quarter of fiscal year 2007 include the following:

• Increase in net sales of $0.2 million related to deferral of the fair value of certain undelivered elements and the timing of recording credit memos issued to certain customers;

• Increase in cost of sales of $1.2 million primarily related to inaccurate inventory transactions recorded within the new enterprise resource planning (ERP) system and, to a lesser degree, late freight and duty invoices received from an offshore service provider;

• Decrease in variable expenses included in selling, service and administration of $0.1 million resulting from the above adjustments;

• Decrease in other income of $0.1 million due to revised net foreign exchange loss; and

• Net decrease in tax expense of $0.4 million resulting from the above revisions.

Based on the above adjustments, the net cash used in operating activities presented in the consolidated condensed statement of cash flows for the first quarter of fiscal 2007 decreased by $0.7 million and net cash provided by investing activities increased by $0.7 million.

Note 2 – Acquisition of New Wave Research, Incorporated

On July 20, 2007, the Company acquired New Wave Research, Incorporated (“NWR”), a privately held company headquartered in Fremont, California. NWR is a global leader in the development of high-end lasers and laser-based systems and its products are used in the semiconductor market for sapphire wafer scribing, flat-panel display repair and semiconductor failure analysis, among other applications. The acquisition was an investment aimed at leveraging the companies’ combined core competencies into adjacent markets and driving revenue growth and shareholder value, which supports the premium paid over the fair market value of individual assets.

The Company acquired 100% of NWR’s outstanding common stock for approximately $36.2 million, comprised of $34.9 million in cash and merger-related transaction costs of $1.3 million. The contractual

6

purchase price of $36.0 million was reduced by $1.1 million related to certain net working capital adjustments and indemnity payments agreed to prior to closing. The purchase price was allocated to the underlying assets acquired and liabilities assumed based on their fair values. Analysis supporting the purchase price allocation includes a valuation of assets and liabilities as of the closing date, a third party valuation of intangible assets and a detailed review of the opening balance sheet to determine other significant adjustments required to recognize assets and liabilities at fair value. The purchase price allocation is subject to further changes, including the finalization of purchase price adjustments for payments to former NWR shareholders relating to the amount of NWR’s net working capital on the date of acquisition, the resolution of various tax-related matters and liabilities and additional merger-related transaction costs.

The following table presents the preliminary allocation of the purchase price of $36.2 million to the assets acquired and liabilities assumed based on their fair values (in thousands):

Accounts receivable	$	5,437
Inventory		6,110
Prepaid expense and other current assets		3,457
Property, plant and equipment		2,579
Intangible assets		12,311
In-process research & development		2,800
Goodwill		11,424
Other long-term assets		1,129
Accounts payable and accrued liabilities		(12,915	)
Deferred revenue(1)		(1,603	)
Net assets acquired		30,729
Escrow deposits pending disbursement(2)		5,430
Total purchase price, net of cash acquired	$	36,159

(1) The amount recorded for deferred revenue represents the fair value of the remaining obligation assumed related to custom acceptance criteria and remaining revenue on extended warranties.

(2) The final disbursement of escrow deposits will increase the goodwill recorded in the acquisition by the amount of the disbursement. This amount is included in other long-term assets at September 29, 2007.

The following table presents the details of the intangible assets purchased in the NWR acquisition as of July 20, 2007 and accumulated amortization to date at September 29, 2007 (in thousands):

	Useful life	Estimated Fair Value at Acquisition		Accumulated Amortization			Recorded value at September 29, 2007
Developed technology	7 years	$	8,100	$	(222	)	$	7,878
Customer relationships	6 years		2,700		(148	)		2,552
Customer backlog	1 year		700		(134	)		566
Trade name and trademarks	3 years		400		(26	)		374
Change of control agreements	1 year		100		(19	)		81
Fair value of below-market lease (non-current portion)	3.8 years		311		(18	)		293
Subtotal – long term			12,311		(567	)		11,744
Fair value of below-market lease (current portion)			110		—			110
Total acquired intangible assets		$	12,421	$	(567	)	$	11,854

Amortization expense for intangible assets purchased in the NWR acquisition was approximately $0.6 million for the three month period ended September 29, 2007 and has been recorded in the consolidated condensed statement of operations as follows (in thousands):

Cost of sales	$	222
Selling, service and administration		345
	$	567

7

The estimated amortization expense of intangible assets purchased in the NWR acquisition for the current fiscal year, including amounts amortized to date, and in future years is as follows (in thousands):

Fiscal Year	Amortization
2008	$	2,052
2009		2,330
2010		1,954
2011		1,734
2012		1,472
2013		1,325
2014		1,197
2015		357
	$	12,421

At the acquisition date, NWR had in-process research and development valued at $2.8 million and the immediate write-off of this amount has been included in operating expenses for the three month period ended September 29, 2007. The in-process research and development related to three programs consisting of development on a diode-pumped solid-state LED wafer-scribing system, a next-generation Advanced Beam Delivery System and a next-generation laser product. The value of the in-process research and development was based on the excess earnings method of the income approach, which measures the value of an asset by calculating the present value of related future economic benefits, such as cash earnings. In determining the value of in-process research and development, the assumed commercialization date for these products was April 2008. The modeled cash flow was discounted back to the net present value and was based on estimates of revenues and operating profits related to the project. Significant assumptions used in the valuation of in-process research and development included: stage of development of the project, future revenues, the estimated life of the product’s underlying technology, future operating expenses, and a discount rate of 18% to reflect present value.

Purchase accounting adjustments were made to record inventory at fair value on the date of acquisition. These adjustments resulted in $0.9 million in additional purchase accounting charges to cost of sales in the second quarter of fiscal 2008.

The NWR results of operations are included in our consolidated financial statements from the date of acquisition forward. The NWR acquisition was not significant, as defined in Regulation S-X of the Securities and Exchange Commission, compared to our overall financial position. Accordingly, pro forma financial statements of the combined entities are not presented.

Note 3 – Marketable Securities

As of September 29, 2007, the Company had a total of $19.6 million invested in auction rate securities. These securities historically provided short-term liquidity through a Dutch auction process that reset the applicable interest rate at pre-determined calendar intervals, generally every 28 days. This mechanism allows existing investors to either retain their holdings or liquidate their holdings by selling such securities at par. The recent uncertainties in the credit markets have reduced the liquidity of these securities as recent auctions have not been completed. As such, the Company has reclassified these securities, which were previously included in current assets, as long-term marketable securities on the consolidated condensed balance sheet at September 29, 2007. The Company believes that these securities will ultimately be liquidated in orderly transactions at an amount equal to the cost of the assets and as such, no unrealized gain or loss has been recorded in other comprehensive income. These investments continue to be of high credit quality and the respective credit ratings of the securities issuers have not been lowered. Accordingly, the Company believes there has been no impairment of the value of these securities.

8

Note 4 – Inventories

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

	September 29, 2007		June 2, 2007
Raw materials and purchased parts	$	54,139	$	50,021
Work-in-process		23,517		19,170
Finished goods		14,235		11,790
	$	91,891	$	80,981

Note 5 – Other Assets

Other assets consisted of the following (in thousands):

	September 29, 2007		June 2, 2007
Patents, net	$	168	$	188
Consignment and demo equipment, net		6,859		7,516
Minority equity investment		11,000		11,000
All-Ring patent suit court bond		9,046		6,901
Acquisition escrow deposit		5,430		—
Other		804		1,025
	$	33,307	$	26,630

As discussed in Note 15, in June 2007, the Company paid an additional $2.1 million to increase its Taiwan dollar security bond posted with the Kaohsiung Court in Taiwan related to the filing of a patent infringement suit against All Ring Tech Co., Ltd. in that jurisdiction.

As discussed in Note 2, the escrow deposits totaling $5.4 million related to the NWR acquisition are included in other assets pending final disbursement.

Note 6 – Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

	September 29, 2007		June 2, 2007
Payroll-related	$	8,281	$	11,391
Product warranty		4,424		3,893
Income taxes payable		3,664		2,961
Value-added taxes payable		1,613		648
Unbilled receipts		2,510		908
Other		7,589		5,664
	$	28,081	$	25,465

See Note 7 for a discussion of the accrual for product warranty.

9

Note 7 – Product Warranty

The Company evaluates obligations related to product warranties quarterly. A standard one-year warranty is provided on products. Warranty charges are comprised of costs to service the warranty, including labor to repair the system and replacement parts for defective items, as well as other costs incidental to the repairs. Warranty charges are recorded net of any cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Company’s suppliers for defective components. Using historical data, the Company estimates average warranty cost per system or part type and records the provision for such charges as an element of cost of goods sold upon recognition of the related revenue. Additionally, the overall warranty accrual balance is separately analyzed using the remaining warranty periods outstanding on systems and items under warranty, and any resulting changes in estimates are recorded as an adjustment to cost of sales. If circumstances change, or if a material change in warranty-related incidents occurs, the estimate of the warranty accrual could change significantly. Accrued product warranty is included on the consolidated condensed balance sheets as a component of accrued liabilities.

Following is a reconciliation of the change in the aggregate accrual for product warranty for the three months ended September 29, 2007 and September 2, 2006 and the four months ended September 29, 2007 (in thousands):

	Three months ended						Four months ended
	September 29, 2007			September 2, 2006			September 29, 2007
Product warranty accrual, beginning	$	3,630		$	3,716		$	3,893
NWR warranty reserve acquired		774			—			774
Warranty charges incurred		(2,348	)		(2,830	)		(3,040	)
Inventory credits		1,901			1,453			1,742
Provision for warranty charges		467			1,427			1,055
Product warranty accrual, ending	$	4,424		$	3,766		$	4,424

Note 8 – Deferred Revenue

Generally, revenue is recognized upon fulfillment of acceptance criteria at the Company’s factory and title transfer which frequently occur at the time of delivery to a common carrier. Revenue is deferred when title transfer is pending and/or acceptance criteria have not yet been fulfilled. These deferred revenue occurrences include sales to Japanese end-user customers, shipments of substantially new products and shipments with custom specifications and acceptance criteria. In sales involving multiple element arrangements, the fair value of any undelivered elements, including installation services, is deferred until the elements are delivered and acceptance criteria are met. Revenue related to maintenance and service contracts is deferred and recognized ratably over the duration of the contracts.

The following is a reconciliation of the changes in deferred revenue for the three months ended September 29, 2007 and September 2, 2006 and the four months ended September 29, 2007 (in thousands):

	Three months ended						Four months ended
	September 29, 2007			September 2, 2006			September 29, 2007
Deferred revenue, beginning	$	12,544		$	13,321		$	12,290
NWR deferred revenue acquired		1,603			—			1,603
Revenue deferred		14,005			5,632			16,003
Revenue recognized		(8,787	)		(6,794	)		(10,531	)
Deferred revenue, ending	$	19,365		$	12,159		$	19,365

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Note 9 – Earnings Per Share

The following is a reconciliation of weighted average shares outstanding used in the calculation of basic and diluted earnings per share (EPS) for the three months ended September 29, 2007 and September 2, 2006 (in thousands):

	Three months ended			Three months ended
	September 29, 2007			September 2, 2006
	Income		Shares	Income		Shares
Net income available to common shareholders – basic	$	5,530	28,161	$	6,202	29,076
Effect of dilutive shares		—	486		—	167
Net income available to common shareholders – diluted	$	5,530	28,647	$	6,202	29,243

The following is a reconciliation of weighted average shares outstanding used in the calculation of basic and diluted EPS for the one month ended June 30, 2007 (in thousands):

	One month ended
	June 30, 2007
	Income		Shares
Net income available to common shareholders – basic	$	1,418	28,617
Effect of dilutive shares		—	421
Net income available to common shareholders – diluted	$	1,418	29,038

In the diluted EPS calculations for the three months ended September 29, 2007 and September 2, 2006, employee stock options equal to 2,591,734 and 3,678,219 common stock equivalent shares, respectively, were excluded because inclusion would have had an antidilutive effect. In the diluted EPS calculation for the one month ended June 30, 2007, 2,671,805 antidilutive common stock equivalent shares were excluded.

Note 10 – Comprehensive Income

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

	Three months ended						One month ended
	September 29,			September 2,			June 30,
	2007			2006			2007
Net income	$	5,530		$	6,202		$	1,418
Other comprehensive income		5			(5	)		—
Foreign currency translation adjustment		333			(184	)		135
Net unrealized gain (loss) on securities classified as available for sale		(134	)		263			45
	$	5,734		$	6,276		$	1,598

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Note 11 – Share Repurchase Program

On March 9, 2007, the Company’s Board of Directors authorized the repurchase of up to $50 million in shares of the Company’s outstanding common stock beginning April 17, 2007 through transactions in the open market or in negotiated transactions with brokers or shareholders. During the three months ended September 29, 2007, approximately 825,000 shares were repurchased at a total purchase price of $18.8 million. Approximately 1,125,000 shares were purchased in the four months ended September 29, 2007 at a total purchase price of $25.1 million. Cash used to settle the repurchase transactions in the four months ended September 29, 2007 totaled $24.9 million and is reflected as a component of cash used in financing activities in the consolidated statements of cash flows. Accrued liabilities include $0.8 million and $0.6 million for amounts owed on the unsettled repurchase transactions as of September 29, 2007 and June 2, 2007, respectively. On October 9, 2007, the Company suspended purchase transactions under its share repurchase program. In total, the Company repurchased approximately 1.7 million shares for $37.3 million.

Note 12 – Stock-Based Compensation Plans

The Company uses the Black-Scholes model to estimate the fair value of all stock-based compensation awards on the date of grant, except for unvested stock awards which are valued at the fair market value on the date of award. The Company generally recognizes compensation expense for options and unvested stock awards on a straight-line basis over the requisite service period of each award.

Stock-based compensation was included in our consolidated statements of operations as follows (in thousands):

	Three months ended						One month ended
	September 29, 2007			September 2, 2006			June 30, 2007
Cost of sales	$	130		$	108		$	27
Selling, service, and administration		702			344			124
Research, development, and engineering		212			125			44
Stock-based compensation expense before income taxes		1,044			577			195
Income tax benefit		(288	)		(154	)		(45	)
Total stock-based compensation expense after income taxes	$	756		$	423		$	150

The total amount of cash received from the exercise of stock options and stock plans for the three months ended September 29, 2007 was $2.0 million. For the three months ended September 29, 2007, there was $0.7 million in excess tax benefit realized from the exercise of stock options and ESPP purchases. The total amount of cash received from the exercise of stock options and stock plans for the month ended June 30, 2007 was $0.1 million. For the month ended June 30, 2007, there was no excess tax benefit realized from the exercise of stock options and ESPP purchases. Upon exercise of stock options, the Company issues new shares of common stock from its authorized shares.

As of September 29, 2007, no stock-based compensation costs were capitalized and the Company had $12.8 million of total unamortized stock-based compensation costs, net of estimated forfeitures, to be recognized over a weighted average period of 3.1 years.

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At September 29, 2007, the Company had 9,741,096 shares of its common stock reserved for issuance under all of its plans combined. Of those shares, 4,592,272 are subject to issuance under currently outstanding stock options and stock awards and 5,148,824 shares are available for future grants. The weighted-average fair-value of stock-based compensation awards, including stock option awards granted and vested during the period, unvested stock awards granted during the period and the intrinsic value of stock options exercised during the period were (in thousands, except per share data):

	Three months ended				One month ended
	September 29, 2007		September 2, 2006		June 30, 2007
Stock Option Awards:
Grant date fair value per share	$	10.82	$	—	$	—
Total fair value of options granted		1,780		—		—
Total fair value of options vested		699		450		5
Total intrinsic value of options exercised		514		19		6
Unvested Stock Awards:
Grant date fair value per share	$	22.73	$	18.64	$	20.86
Total fair value of awards granted		8,419		1,746		17
Employee Stock Purchase Plan:
Grant date fair value per share	$	6.50	$	5.52		—
Total grant date fair value		63		387		—

Information with respect to stock option activity for the four months ended September 29, 2007 is as follows:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value (in thousands)
Outstanding as of June 3, 2007	4,292,422		$	25.03
Granted	164,499		$	20.06
Exercised	(124,862	)	$	19.37
Expired or forfeited	(273,084	)	$	22.35
Outstanding as of September 29, 2007	4,058,975		$	25.18	6.13 years	$	9,185
Vested and expected to vest as of September 29, 2007	4,026,895		$	25.22	6.10 years	$	9,082
Exercisable as of September 29, 2007	3,778,463		$	25.54	5.90 years	$	8,163

Information with respect to unvested stock awards activity for the four months ended September 29, 2007 is as follows:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Weighted Average Grant Date Fair Value (in thousands)
Outstanding as of June 3, 2007	223,194		$	20.01
Granted	371,841		$	22.73
Exercised	(57,488	)	$	24.34
Expired or forfeited	(4,250	)	$	22.66
Outstanding as of September 29, 2007	533,297		$	21.71	2.72 years	$	12,778

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Note 13 – Geographic and Product Information

Net sales by product type were as follows (in thousands):

	Three months ended				One month ended
	September 29, 2007		September 2, 2006		June 30, 2007
Semiconductor Group	$	38,176	$	31,884	$	7,566
Passive Component Group		23,791		18,661		4,418
Interconnect Micro-Machining Group		20,351		9,823		4,977
	$	82,318	$	60,368	$	16,961

Sales by geographic area, based on the location of the end user, were as follows (in thousands):

	Three months ended				One month ended
	September 29, 2007		September 2, 2006		June 30, 2007
Asia	$	63,586	$	43,653	$	15,626
Americas		12,930		13,005		951
Europe		5,802		3,710		384
	$	82,318	$	60,368	$	16,961

Note 14 – Insurance Recovery

In June 2006, the Company received $1.3 million in insurance proceeds for demonstration systems that were destroyed in a fire at a customer’s plant. As the book value of these assets had previously been written off, the Company recorded a gain on the recovery which is included as an offset to operating expenses in the consolidated condensed statement of operations.

Note 15 – Legal Proceedings

All Ring Patent Infringement Prosecution

In August 2005, the Company commenced a proceeding in the Kaohsiung District Court of Taiwan (the Court) directed against All Ring Tech Co., Ltd. (All Ring) of Taiwan. The Company alleged that All Ring’s Capacitor Tester Model RK-T6600 (the Capacitor Tester) infringes ESI’s Taiwan Patent No. 207469, entitled “Circuit Component Handler” (the 207469 patent). This patent corresponds to ESI’s U.S. Patent No. 5,842,579. The patented technology is used in the Model 3340 Multifunction MLCC Tester. The Court issued a Provisional Attachment Order (PAO) in August 2005 and All Ring filed a bond with the Court to obtain relief from the attachment of its assets. In July 2007, pursuant to the Company’s application, the Court issued a second PAO and approximately US$6.0 million was restricted in All Ring’s accounts. All Ring appealed the second PAO to the High Court in August 2007 and the High Court revoked the second PAO in September 2007. The Company has appealed the High Court’s decision and the Supreme Court has not yet ruled on the Company’s appeal. The second PAO remains in effect unless and until the High Court’s ruling becomes final.

Pursuant to the Court’s orders, in October 2005 the Company was required to post with the Court a Taiwan dollar security bond, which is valued at approximately US$6.9 million and is included in other assets on the Company’s consolidated condensed balance sheets. An additional bond amount of US$2.1 million was posted in June 2007 related to the second Provisional Attachment Order.

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In October 2005, the Court executed a Preliminary Injunction Order that prohibits All Ring from manufacturing, selling, offering for sale or using the Capacitor Tester until final judgment is entered in the formal patent infringement action. In October 2007, All Ring filed an application to revoke the Preliminary Injunction Order. The Company has filed a defense brief responding to the application and the Court has not yet ruled on the application.

In October 2005, the Company filed a formal patent infringement action against All Ring in the Court. In May 2006, after all parties filed briefs on the topic, the Court appointed an expert to conduct a patent infringement assessment. The Court-appointed expert has completed the assessment of the Capacitor Tester and concluded that it infringes every claim of the 207469 patent. The Court-appointed expert subsequently concluded that All Ring’s RK-T2000 also infringes on every claim of the 207469 patent and that All Ring’s RK-L50 infringes on a number of the claims as well.

In November 2005, All Ring filed a cancellation action against ESI’s 207469 patent in the Taiwan Intellectual Property Office (the IPO). On July 5, 2007, the IPO issued a notice requiring the Company to cancel two of the claims in the 207469 patent. No other claims of the patent have been rejected. The Company filed a response canceling the two claims and amending the remaining claims accordingly in August 2007. The Company intends to vigorously pursue its patent infringement claims against All Ring and defend against the cancellation action.

Note 16 – Adoption of FIN 48

Effective June 3, 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 specifies the way companies are to account for uncertainty in income tax reporting, and prescribes a methodology for recognizing, reversing, and measuring the tax benefits of a tax position taken, or expected to be taken, in a tax return. The Company has previously accounted for uncertain tax positions under SFAS 5 and SFAS 109. The adoption of FIN 48 has not resulted in any adjustments to existing reserves for income taxes as of the beginning of fiscal 2008.

As of June 3, 2007, the total gross amount of reserves for income taxes, which is reported as non-current income tax liabilities, was $5.8 million. Any future adjustments to reserves for income taxes will be recorded as an increase or decrease to provision for income taxes and would impact the effective tax rate. In addition, interest is accrued related to reserves for income taxes and penalties in the provision for income taxes. The gross amount of interest accrued as of the beginning of our 2008 fiscal year was $0.4 million.

As of September 29, 2007, the total gross reserves for income tax was $8.1 million, of which $7.8 million was included in non-current income tax liabilities and $0.3 million was included in current income taxes payable. These reserves are inclusive of $0.7 million of accrued interest. The $2.0 million increase in income tax reserves from June 2, 2007 is due to the inclusion of the NWR tax reserves. Any future adjustments to the reserves related to the NWR acquisition would be reflected as an adjustment to goodwill and would not impact the effective tax rate. The Company anticipates no significant changes in unrecognized tax benefits in the next 12 months as the result of examinations or lapse of statutes of limitation.

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The Company operates globally but considers its significant tax jurisdictions to include the United States, Taiwan, China, Korea, Japan, Singapore and the United Kingdom. As of June 3, 2007, the following tax years remained subject to examination by the major tax jurisdictions indicated:

Major Jurisdictions	Open Tax Years
China	2004 and forward
Japan	2003 and forward
Korea	2001 and forward
Singapore	2000 and forward
Taiwan	2001 and forward
United Kingdom	2000 and forward
United States	2003 and forward

Note 17 – New Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 does not impose fair value measurements on items not already accounted for at fair value; rather it applies, with certain exceptions, to other accounting pronouncements that either require or permit fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact, if any, of adopting SFAS 157 on its financial position and results of operations.

In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159),” which permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company has not yet determined the impact that the elective adoption of SFAS 159 may have on our results of operations or financial position.

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

Forward Looking Statements

The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes,” “expects” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may materially differ as a result of many factors, including the risks described in Part II, Item 1A. under the heading “Risk Factors.”

Overview

Electro Scientific Industries, Inc. and its subsidiaries (ESI) provide high-technology manufacturing equipment to the global electronics market, including advanced laser systems that are used to microengineer electronic device features in high-volume production environments. Our customers are primarily manufacturers of semiconductors, passive components and interconnect devices. Our equipment enables these manufacturers to achieve the yield and productivity gains in their manufacturing processes that can be critical to their profitability. The components and devices manufactured by our customers are used in a wide variety of end products in the computer, consumer electronics, and communications industries.

We supply advanced laser microengineering systems that allow electronics manufacturers to physically alter select device features during high-volume production in order to heighten performance and boost production yields of semiconductor devices, passive components and circuitry, high-density interconnect (HDI) circuit boards, advanced semiconductor packaging and high-bright LEDs and flat panel LCD displays. Laser microengineering comprises a set of precise fine-tuning processes (laser micro-machining, link cutting and via drilling) that require application-specific laser systems able to meet semiconductor and microelectronics manufacturers’ exacting performance and productivity requirements.

Additionally, we produce high-speed test, inspection and termination equipment used in the high-volume production of multi-layer ceramic capacitors (MLCC) and other passive components, as well as original equipment manufacturer machine vision products.

Acquisition of New Wave Research, Incorporated

On July 20, 2007, we acquired New Wave Research, Incorporated (“NWR”), a privately held company headquartered in Fremont, California. NWR is a global leader in the development of high-end lasers and laser-based systems and its products are used in the semiconductor market for sapphire wafer scribing, flat-panel display repair and semiconductor failure analysis, among other applications. The acquisition was an investment aimed at leveraging our combined core competencies into adjacent markets and driving revenue growth and shareholder value.

We acquired 100% of NWR’s outstanding common stock for approximately $36.2 million, comprised of $34.9 million in cash and merger-related transaction costs of $1.3 million. The contractual purchase price of $36.0 million was reduced by $1.1 million related to certain net working capital adjustments and indemnity payments agreed to prior to closing. The results for the current quarter include the results of our NWR division from the date of acquisition forward.

Purchase accounting charges totaling $4.3 million were recorded in the three months ended September 29, 2007, comprised of $1.1 million included in cost of sales related to the fair value adjustments to

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inventory and amortization of acquired intangibles and $3.2 million included in operating expenses for the amortization of acquired intangibles. The purchase accounting charges included in operating expenses were largely comprised of the write-off of $2.8 million of in-process research & developments, as further discussed below in the comparison of current quarter results to the first quarter of fiscal 2007.

Change in Fiscal Reporting Periods

On July 3, 2007, our Board of Directors approved a change in ESI’s reporting periods that results in a fiscal year end on the Saturday nearest March 31. Accordingly, our fiscal year 2008 will consist of approximately a ten month period containing 43 weeks ending on March 29, 2008. We have elected to file our interim financial statements in Quarterly Reports on Form 10-Q based on the reporting periods of our new fiscal year ending March 29, 2008. Due to the implementation of our enterprise resource system in the fourth quarter of fiscal 2006, we performed full close and reporting procedures on a fiscal quarter basis only during fiscal 2007. Accordingly, comparative data for the three months ended September 30, 2007 is not available and is not cost beneficial to prepare. We believe that the first quarter of fiscal 2007, the three months ended September 2, 2006, provides a meaningful comparison to the second quarter of fiscal 2008. We do not believe that there are any meaningful factors, seasonal or otherwise, that would impact the comparability of information or trends, if the results for the three months ended September 30, 2006 were presented in lieu of results for the first quarter of fiscal 2007.

Summary of Sequential Quarterly Results

Due to the change in our fiscal year, the following information includes results from our second quarter of fiscal 2008, the three month period ended September 29, 2007. Where appropriate, we make sequential comparisons to the fourth quarter of fiscal 2007, which was our last full three-month fiscal period prior to the current fiscal quarter.

The second quarter of fiscal 2008 reflected another period of strong demand for our products stimulated by industry strength and successful introduction of new products. Orders of $74.3 million increased $2.1 million, including $5.6 million due to the acquisition of NWR. Excluding the contribution of NWR, orders decreased by 3% in the current quarter compared to the fourth quarter of fiscal 2007, primarily due to the timing of orders in our semiconductor group, partially offset by increases in our other product groups.

Orders for our semiconductor group products decreased by 35% compared to the fourth quarter of fiscal 2007, despite a 5% increase resulting from the acquisition of NWR. The remaining 40% decrease is largely due to the timing of specific large orders received in the first period of fiscal 2008, which consisted of the four weeks ending June 30, 2007. Despite the impact of timing on our semiconductor group product orders, we experienced continued strength in demand for our semiconductor group products on a fiscal year-to-date basis.

Passive component group orders increased by 36% compared to the fourth quarter of fiscal 2007, driven by multiple orders for our new Model 3550 high capacitance testing system and large orders for our 3300 series and 6650 test systems. This reflects continued strength in the MLCC manufacturing market and our continued penetration into the Japanese MLCC market.

Due to increasing focus on tools designed for micro-machining applications, we have designated our electronic interconnect products as the interconnect/micro-machining group (IMG). Orders for our IMG products increased by 64%, including an increase of 23% due to the acquisition of NWR. This growth in orders is due to strong demand for micro-machining applications and our continued expansion in the flex-circuit and IC packaging segments of this market.

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Gross margins were 44.7% on net sales of $82.3 million in the second quarter of fiscal 2008, compared to 46.4% on net sales of $71.7 million in the fourth quarter of fiscal 2007. Included in cost of sales in the current quarter were $1.1 million in purchase accounting charges, which resulted in a 1.3 percentage point reduction of gross margin in the current quarter.

Operating expenses increased $6.5 million to $29.3 million in the second quarter of fiscal 2008, compared to $22.8 million in the fourth quarter of fiscal 2007. The increase included $3.2 million in purchase accounting charges, including $2.8 million to write off in-process research & development, and $3.7 million in NWR operating expenses.

Operating income decreased to $7.5 million in the second quarter of fiscal 2008, compared to $10.5 million in the fourth quarter of fiscal 2007. Non-operating income decreased to $2.1 million from $2.6 million, primarily due to lower interest income resulting from lower average invested assets resulting from funds used for the acquisition of NWR and share repurchases.

The tax provision decreased to $4.1 million in the current quarter compared to $5.2 million in the fourth quarter of fiscal 2007, but the effective tax rate increased to 42% compared to 39%. The second quarter effective tax rate exceeded our normalized estimated effective tax rate of 32% as the $4.3 million in purchase accounting charges are not deductible for tax purposes but do reduce pretax income. Net income for the current quarter was $5.5 million or $0.20 per basic and $0.19 per diluted share, compared to net income of $7.9 million or $0.27 per basic and diluted share in the fourth quarter of fiscal 2007.

Revision of Statement of Operations for the First Quarter of Fiscal 2007

During the third quarter of fiscal 2007, we revised our results of operations for the first quarter of fiscal 2007 for certain immaterial corrections. The amounts presented for the three months ended September 2, 2006 in the consolidated condensed financial statements and related management’s discussion and analysis include these adjustments, which are detailed in Note 1 to the consolidated condensed financial statements presented in Part I, Item 1 of this Report on Form 10-Q.

Results of Operations – Comparison of the three month periods ended September 29, 2007 and September 2, 2006

Due to the change in our fiscal reporting periods, current year financial statements are presented for the three months ended September 29, 2007 and the one month ended June 30, 2007. For the purposes of management’s discussion and analysis, comparative data has been provided for the prior year using the fiscal quarter ending on the date nearest to September 29, which is the three months ended September 2, 2006. Prior year comparative data is not available for the one-month period ended June 30, 2007. The results for the current quarter include the results of our NWR division from the date of acquisition forward.

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The following table sets forth results of operations data as a percentage of net sales.

	Three months ended
	September 29,		September 2,
	2007		2006
Net sales	100.0	%	100.0	%
Cost of sales	55.3		56.5
Gross margin	44.7		43.5
Selling, service and administrative	18.7		20.0
Research, development and engineering	13.5		15.4
Write-off of acquired in-process research & development	3.4		—
Insurance recovery	—		(2.1	)
Operating income	9.2		10.3
Total other income, net	2.5		4.7
Income before taxes	11.7		14.9
Income tax provision	4.9		4.6
Net income	6.7	%	10.3	%

Net Sales

Net sales were $82.3 million for the quarter ended September 29, 2007, an increase of $21.9 million or 36% compared to net sales of $60.4 million for the quarter ended September 2, 2007. The overall increase was driven by increases in all three of our product groups, as well as the impact of NWR net sales totaling $5.2 million for the period after the acquisition on July 20, 2007.

Information regarding our net sales by product group is as follows (net sales in thousands):

	Three months ended
	September 29, 2007				September 2, 2006
	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Semiconductor (SG)	$	38,176	46.4	%	$	31,884	52.8	%
Passive Components (PCG)		23,791	28.9			18,661	30.9
Interconnect/micro-machining (IMG)		20,351	24.7			9,823	16.3
	$	82,318	100.0	%	$	60,368	100.0	%

SG sales in the second quarter of fiscal 2008 increased $6.3 million or 20% compared to the first quarter of fiscal 2007, including an increase of $2.6 million resulting from the acquisition of NWR. The remaining net sales increase was primarily due to increased volume sales of our dual-beam UV-based Model 9850.

Second quarter PCG sales increased $5.1 million or 27% compared to sales in the first quarter of fiscal 2007. The rise in PCG net sales was driven by strong demand for our Model 3300 series electrical test systems, and increased penetration in the Asian market, as manufacturers seek to build production capacity for MLCC products. End-market demand for MLCC products has increased for wireless handsets, dual core microprocessors, flat panel displays and automotive electronics.

IMG sales were $20.4 million in the second quarter of fiscal 2008, an increase of $10.6 million or 108% compared to IMG sales of $9.8 million in the first quarter of fiscal 2007, including an increase of $2.6 million resulting from the acquisition of NWR. The remaining increase was led by sales volumes of our Model 5300 series UV laser micro-via drilling systems.

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Net sales by geographic region were as follows (net sales in thousands):

	Three months ended
	September 29, 2007				September 2, 2006
	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Asia	$	63,586	77.3	%	$	43,653	72.3	%
Americas		12,930	15.7			13,005	21.5
Europe		5,802	7.0			3,710	6.2
	$	82,318	100.0	%	$	60,368	100.0	%

Compared to the first quarter of fiscal 2007, the percentage of net sales to Asia in the current quarter of fiscal 2008 increased by 5 percentage points. The net $19.9 million increase in net sales to Asia was driven primarily by increases in China and Korea resulting from volume increases in net sales of SG products, and increases in Japan due to higher net sales of PCG products. Partially offsetting these increases, the impact of NWR net sales by region reduced our percentage of total net sales to Asia by approximately 2 percentage points, compared to 79.5% percent of total net sales excluding NWR in the second quarter of fiscal 2008.

Gross Profit

Gross profit was $36.8 million (44.7% of net sales) for the second quarter of fiscal 2008 compared to $26.3 million (43.5% of net sales) for the first quarter of fiscal 2007. Cost of sales in the current quarter included $1.1 million in purchase accounting charges, which reduced the gross margin percentage by 1.3 percentage points. Excluding the impact of purchase accounting, the 2.5 percentage point increase in gross profit is due to volume-based manufacturing efficiencies on shipments that increased by $27.8 million or 46%, which includes $6.1 million in NWR shipments compared to first quarter of fiscal 2007.

Operating Expenses

Selling, Service and Administrative Expenses

The primary items included in selling, service and administrative expenses are labor and other employee-related expenses, travel expenses, professional fees and facilities costs. Selling, service and administrative expenses were $15.4 million (18.7% of net sales) in the second quarter of fiscal 2008, an increase of $3.3 million compared to $12.1 million (20.0% of net sales) in the first quarter of fiscal 2007. The increase was significantly impacted by the acquisition of NWR, which added $2.6 million in operating expenses. The remaining increase was primarily due to expenses to support higher volume sales and service activity as well as incremental costs related to the acquisition and integration of NWR.

Research, Development and Engineering Expenses

Research, development and engineering expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials, equipment and facilities costs. Expenses associated with research, development and engineering totaled $11.1 million (13.5% of net sales) for the second quarter of fiscal 2008, representing a $1.8 million increase from $9.3 million (15.4% of net sales) for the first quarter of fiscal 2007, including an increase of $1.2 million related to the acquisition of NWR. The remaining $0.6 million increase is primarily related to increased project materials and project consulting costs as well as higher professional fees related to patents.

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Write-off of In-process Research & Development

At the acquisition date, NWR had in-process research and development valued at $2.8 million and the immediate write-off of this amount has been included in operating expenses for the three-month period ended September 29, 2007. The in-process research and development related to three programs consisting of development on a diode-pumped solid-state LED wafer-scribing system, a next-generation Advanced Beam Delivery System and a next-generation laser product. The value of the in-process research and development was based on the excess earnings method of the income approach, which measures the value of an asset by calculating the present value of related future economic benefits, such as cash earnings. In determining the value of in-process research and development, the assumed commercialization date for these products was April 2008. The modeled cash flow was discounted back to the net present value and was based on estimates of revenues and operating profits related to the project. Significant assumptions used in the valuation of in-process research and development included: stage of development of the project, future revenues, the estimated life of the product’s underlying technology, future operating expenses, and a discount rate of 18% to reflect present value.

Insurance Recovery

In June 2006, the Company received $1.3 million in insurance proceeds for demonstration systems that were destroyed in a fire at a customer’s plant. As the book value of these assets had previously been written off we recorded a gain on the recovery which is included as an offset to operating expenses in the consolidated statement of operations in the first quarter of fiscal 2007.

Interest and Other Income, Net

Net interest and other income was $2.1 million in the second quarter of 2008 compared to $2.8 million in the first quarter of 2007, a decrease of $0.7 million. The decrease was primarily due to a reduction in interest income resulting from lower average invested assets due to the funding of our acquisition of NWR and the impact of our share repurchase program. Our average invested assets were $201.7 million in the second quarter of fiscal 2008 compared to $221.4 million in the first quarter of fiscal 2007. Additionally, during the first quarter of fiscal 2007, we recorded $0.3 million in non-recurring interest income on income tax refunds.

Income Taxes

The income tax provision recorded for the second quarter of fiscal 2008 was $4.1 million on pretax income of $9.6 million, an effective rate of 42%. Comparatively, the income tax provision was $2.1 million on pretax income of $5.9 million in the first quarter of fiscal 2007, an effective tax rate of 36%. Excluding purchase accounting charges of $4.3 million, the effective tax rate would be 29%, as these charges are not deductible for tax return purposes but do reduce pretax income for financial reporting purposes.

The effective tax rate for the third quarter of fiscal 2008 is expected to be approximately 37%. The projected decrease in the effective tax rate results from the reduction in purchase accounting adjustments from $4.3 million in the current quarter to approximately $1.0 million for the third quarter of fiscal 2008. This will result in a reduction in the effective tax rate of approximately 5%. Our effective tax rate is subject to fluctuation based upon the occurrence and timing of numerous discrete events, including, for example, changes in tax laws or their interpretations, extensions or expirations of research and experimentation credits, closure of tax years subject to examination and finalization of income tax returns. Based on currently available information, we are not aware of any such discrete events which are likely to occur that would have a materially adverse effect on our financial position, expected cash flows or results of operations. We expect our normalized annual effective tax rate to be approximately 32%, excluding the impact of purchase accounting. We anticipate no significant changes in unrecognized tax benefits in the next 12 months as the result of examinations or lapse of statutes of limitation.

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Net Income

Net income for the second quarter of fiscal 2008 was $5.5 million (6.7% of net sales), or $0.20 per basic share and $0.19 per diluted share, compared to a net income of $6.2 million (10.3% of net sales), or $0.21 per share on a basic and fully diluted basis in the first quarter of fiscal year 2007. Net income in the current quarter was impacted by purchase accounting adjustments totaling $4.3 million, which reduced earnings per share by $0.15 per basic and diluted share.

Financial Condition and Liquidity

At September 29, 2007, our principal sources of liquidity consisted of cash, cash equivalents and marketable securities of $179.2 million and accounts receivable of $56.5 million. At September 29, 2007, we had a current ratio of 5.2:1 and no long-term debt. Working capital decreased to $267.0 million at September 29, 2007 from $327.3 million at June 2, 2007, primarily due to the use of cash for the acquisition of NWR and the funding of our share repurchase program.

On July 20, 2007 we completed our acquisition of NWR for approximately $36.2 million including merger-related transaction fees and net of cash acquired.

On March 9, 2007, the Board of Directors authorized the repurchase of up to $50 million in shares of our outstanding common stock beginning April 17, 2007 through transactions in the open market or in negotiated transactions with brokers or shareholders. Through the end of the second quarter of fiscal 2008, we had funded approximately $34.7 million in share repurchases. We suspended purchase transactions under our current share repurchase program effective October 9, 2007. In total, we repurchased a total of approximately 1.7 million shares for $37.3 million. We believe that our existing cash, cash equivalents and marketable securities are adequate to fund our operations for at least the next twelve months.

As of September 29, 2007, we had a total of $19.6 million invested in auction rate securities. Historically, these securities provided liquidity through a Dutch auction process that reset the applicable interest rate at pre-determined calendar intervals, generally every 28 days. This mechanism allowed existing investors to either retain their holdings or liquidate their holdings by selling such securities at par. The recent uncertainties in the credit markets have reduced the liquidity of these securities as recent auctions have not been completed. We believe that these securities will ultimately be liquidated in orderly transactions in the future and we do not expect to need to sell these securities to fund our operations in the next twelve months.

Cash flows provided by operating activities totaled $12.3 million in the period from June 3, 2007 through September 29, 2007. Cash totaling $14.5 million was provided by net income adjusted for non-cash items. Other significant factors impacting cash flows from operations included collections on trade receivables, purchases of inventories and increases in current liabilities.

Net trade receivables were $56.5 million at September 29, 2007, compared to $55.7 million at June 2, 2007, an increase of $0.8 million, which includes the acquisition of NWR receivables of $5.5 million. Cash flows from the collection of accounts receivable for the four months ended September 29, 2007 totaled $6.1 million and a higher percentage of shipments were sent mid-quarter, resulting in a greater percentage being collected prior to the end of the period. Days sales outstanding decreased from 71 days at June 2, 2007 to 63 at the end of the current quarter.

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Net inventories increased $10.9 million from June 2, 2007 to $91.9 million at September 29, 2007, which includes the acquisition of NWR inventories of $5.5 million. The remaining $5.4 million increase is comprised primarily of an increase in raw materials and work-in-process inventories to meet expected demand for passive component and interconnect products.

Operating cash flows from changes in deferred revenue, net of related changes in shipped systems pending acceptance, totaled $0.6 million.

Payables and current liabilities were $44.3 million at September 29, 2007 compared to $39.3 million at June 2, 2007, and increase of $5.0 million which includes the acquisition of $10.8 million in NWR liabilities. Cash used to settle current liabilities totaled $4.8 million, primarily due to the annual profit sharing payment for fiscal 2007 paid in August.

Cash flows provided by investing activities totaled $12.0 million for the four months ended September 29, 2007. We also generated $51.7 million net in cash and cash equivalents through the maturity and sale of investments in our portfolio of marketable securities. We invested approximately $36.2 million in the acquisition of NWR. Additionally, we invested $2.5 million in property, plant and equipment and other assets.

Cash flows used in financing activities of $22.0 million were comprised of $24.9 million in cash used to settle repurchase transactions for approximately 1.1 million shares of ESI common stock pursuant to the share repurchase program discussed above, partially offset by $2.9 million in proceeds and tax benefits from the exercise of stock options and ESPP purchases for the four months ended September 29, 2007.

Critical Accounting Policies and Estimates

Except as detailed below, we reaffirm the critical accounting policies and our use of estimates as reported in our annual report on Form 10-K for our fiscal year ended June 2, 2007 as filed with the Securities and Exchange Commission on August 15, 2007.

Goodwill and Intangible Assets

The Company accounts for goodwill and intangible assets pursuant to SFAS No. 141 “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill no longer be amortized, but instead be tested for impairment at least annually in accordance with the provision of SFAS No. 142. We will perform our annual impairment test in the fourth quarter of fiscal 2008. SFAS No. 142 requires purchased intangible assets, other than goodwill, to be amortized over their estimated useful lives, unless an asset has an indefinite life. Purchased intangible assets with definite useful lives are carried at cost less accumulated amortization. Amortization expense is recognized on a straight-line basis over the estimated useful lives of the intangible assets, which range from one to seven years. The valuation of intangibles and their useful lives are subject to change as the purchase price allocations of NWR are still under review.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the market risk disclosure contained in our 2007 Annual Report on Form 10-K for our fiscal year ended on June 2, 2007. The information regarding liquidity of auction rate securities under the heading “Financial Condition and Liquidity” in Item 2 of Part I of this report is incorporated herein by reference.

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Item 4. Controls and Procedures

Attached to this quarterly report as exhibits 31.1 and 31.2 are the certifications of our President and Chief Executive Officer and our Interim Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002 (the Section 302 Certifications). This portion of our quarterly report on Form 10-Q is our disclosure of the conclusions of our management, including our President and Chief Executive Officer and our Interim Chief Financial Officer, regarding the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report based on management’s evaluation of those disclosure controls and procedures. You should read this disclosure in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.

Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our President and Chief Executive Officer and Interim Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (Exchange Act). Based on that evaluation, our President and Chief Executive Officer and our Interim Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our President and Chief Executive Officer and our Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during our fiscal quarter ended September 29, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We completed the acquisition of NWR on July 20, 2007. In connection with this acquisition, we are currently reviewing our internal control over financial reporting and implementing new processes and procedures to integrate the activities associated with accounting for NWR. We excluded NWR from our assessment of the effectiveness of our internal control over financial reporting as of September 29, 2007

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

All Ring Patent Infringement Prosecution

In August 2005, ESI commenced a proceeding in the Kaohsiung District Court of Taiwan (the Court) directed against All Ring Tech Co., Ltd. (All Ring) of Taiwan. We alleged that All Ring’s Capacitor Tester Model RK-T6600 (the Capacitor Tester) infringes our Taiwan Patent No. 207469, entitled “Circuit Component Handler” (the 207469 patent). This patent corresponds to our U.S. Patent No. 5,842,579. The patented technology is used in the Model 3340 Multifunction MLCC Tester. The Court issued a Provisional Attachment Order (PAO) in August 2005 and All Ring filed a bond with the Court to obtain relief from the attachment of its assets. In July 2007, pursuant to our application, the Court issued a second PAO and approximately US$6.0 million was restricted in All Ring’s accounts. All Ring appealed the second PAO to the High Court in August 2007 and the High Court revoked the second PAO in September 2007. We have appealed the High Court’s decision and the Supreme Court has not yet ruled on the our appeal. The second PAO remains in effect unless and until the High Court’s ruling becomes final.

Pursuant to the Court’s orders, in October 2005 we were required to post with the Court a Taiwan dollar security bond, which is valued at approximately US$6.9 million and is included in other assets on our consolidated condensed balance sheets. An additional bond amount of US$2.1 million was posted in June 2007 related to the second Provisional Attachment Order.

In October 2005, the Court executed a Preliminary Injunction Order that prohibits All Ring from manufacturing, selling, offering for sale or using the Capacitor Tester until final judgment is entered in the formal patent infringement action. In October 2007, All Ring filed an application to revoke the Preliminary Injunction Order. We have filed a defense brief responding to the application and the Court has not yet ruled on the application.

In October 2005, we filed a formal patent infringement action against All Ring in the Court. In May 2006, after all parties filed briefs on the topic, the Court appointed an expert to conduct a patent infringement assessment. The Court-appointed expert has completed the assessment of the Capacitor Tester and concluded that it infringes every claim of the 207469 patent. The Court-appointed expert subsequently concluded that All Ring’s RK-T2000 also infringes on every claim of the 207469 patent and that All Ring’s RK-L50 infringes on a number of the claims as well.

In November 2005, All Ring filed a cancellation action against our 207469 patent in the Taiwan Intellectual Property Office (the IPO). On July 5, 2007, the IPO issued a notice requiring us to cancel two of the claims in the 207469 patent. No other claims of the patent have been rejected. We filed a response canceling the two claims and amending the remaining claims accordingly in August 2007. We intend to vigorously pursue its patent infringement claims against All Ring and defend against the cancellation action.

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Item 1A. Risk Factors

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 make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may materially differ. 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 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. In the event of a downturn, we will not be able to assure you when demand for our products will increase or that demand will not decrease. Even if demand for our products does increase, there may be significant fluctuations in our profitability and net sales.

During any downturn, it will be difficult for us to maintain our sales levels. As a consequence, to maintain profitability we will need to reduce our operating expenses. Our ability to quickly reduce operating expenses is dependent upon the nature of the actions we take to reduce expense and our subsequent ability to implement those actions and realize expected cost savings. Additionally, we may be unable to defer capital expenditures and we will need to continue to invest in certain areas such as research and development. An economic downturn may also cause us to incur charges related to impairment of assets and inventory write-offs and we may also experience delays in payments from our customers, which would have a negative effect on our financial results.

In addition, because we derive a substantial portion of our revenue from the sale of a relatively small number of products, the timing of, or changes to, orders by our customers may also cause our order levels and results of operations to fluctuate between periods, perhaps significantly. For example, in the second quarter of fiscal 2007, a customer requested that the Company convert part of a previous order for UV-based semiconductor systems to IR-based systems and to postpone shipment of additional UV-based systems, which resulted in approximately $18 million being removed from backlog. Accordingly, order levels or results of operations for a given period may not be indicative of order levels or results of operations for following periods.

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

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

We also have an arrangement with a contract manufacturer in Singapore to complete the manufacture of certain of our products. Any significant interruption in this contract manufacturer’s ability to provide manufacturing services to us as a result of contractual disputes with us or another party, labor disruptions, natural disasters, delay or interruption in the receipt of inventory or other causes could result in reduced manufacturing capabilities or delayed deliveries for certain of our products, any or all of which could materially and adversely affect our results of operations

In addition, we derive a substantial portion of our revenue from the sale of a relatively small number of products. Consequently, shipment and/or customer acceptance delays, including acceptance delays related to new product introductions or customizations, could significantly impact 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 systems, change existing orders 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.

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 for those 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, some key parts are available only from a single supplier or a limited group of suppliers in the short term. Operations at our suppliers’ facilities are subject to disruption for a variety of reasons, including changes in business relationships, competitive factors, work stoppages, and 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 depend on a few significant customers and we do not have long-term contracts with any of our customers.

Our top ten customers for fiscal 2007 accounted for approximately 62% of total net sales in fiscal 2007, with two customers each accounting for more than 10% of total net sales in fiscal 2007. In addition, none of our customers has 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.

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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, change or cancel orders for our existing products, which may harm our operating results. In the past we have also experienced delays in new product development. 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 that may render our current products or technologies obsolete could significantly harm our business.

We acquire inventory based upon projected demand. If these projections are incorrect we may carry inventory that cannot be used, which may result in significant charges for excess and obsolete inventory.

Our business is highly competitive and one factor on which we compete is the ability to ship products on the schedule required by customers. In order to facilitate timely shipping, management forecasts demand, both in type and amount of products, and these forecasts are used to determine our inventory to be purchased. Certain types of inventory, including lasers and optical equipment, are particularly expensive and can only be used in the production of a single type of product. If actual demand is lower than forecast with respect to the type or amount of products actually ordered, or both, our inventory levels may increase. As a result, there is a risk that we may have to incur material accounting charges for excess and obsolete inventory if inventory cannot be used, which could negatively affect our financial results.

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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 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 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 patents of ours, such as the action we initiated in Taiwan against All Ring Tech Co., Ltd. in August 2005. 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. However, these proprietary rights may not provide the competitive advantages that we expect 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, which could result in reduced sales and gross margins.

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. Competitors or others have in the past and may in the future assert infringement claims against our customers or us 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.

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Our business is highly competitive, and if we fail to compete effectively, 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. New companies may enter the markets in which we compete, or industry consolidation may occur, further increasing competition in those markets. Furthermore, our technological advantages may be reduced or lost as a result of technological advances by our competitors.

Our competitors’ greater resources in the areas described above may enable them to:

• Better withstand periodic downturns;

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

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

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;

• The ability to upgrade our products;

• Consistent availability of critical components;

• 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;

• Our understanding of the needs of our customers;

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

Our continued success depends, in part, upon key managerial, financial, engineering and technical personnel as well as our ability to continue to attract, retain and assimilate 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, financial, engineering and technical employees. For example, our Chief Financial Officer retired on September 29, 2007. We have not identified a new Chief Financial Officer at this time. Attracting qualified personnel may be difficult and our efforts to attract and retain these personnel may not be successful. In addition, we may not be able to assimilate qualified personnel, including any new members of senior management, which could disrupt our operations.

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Our worldwide direct sales and service operations and our overseas research and development facility expose us to employer-related risks in foreign countries.

We have established direct sales and service organizations throughout the world. We have also established a research and development facility in China. Having overseas employees involves certain risks. We are subject to compliance with the labor laws and other laws governing employers in the countries where our operations are located and as a result we may incur additional costs to comply with these local regulations. Additionally, we may encounter labor shortages or disputes that could inhibit our ability to effectively sell, market and service our products. If we cannot effectively manage the risks related to employing persons in foreign countries, our operating results could be adversely affected.

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

We recently completed the acquisition of New Wave Research, Incorporated (NWR) and in the future we may make acquisitions of, or significant investments in, other businesses with complementary products, services or technologies.

Acquisitions, including the acquisition of NWR, 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;

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

• Difficulties establishing satisfactory internal controls at acquired companies; and

• Incurring liabilities for which we may not be indemnified in full or at all.

Our inability to effectively manage these acquisition risks could materially and adversely affect our business, financial condition and results of operations and could cause us not to realize the anticipated benefits of an acquisition on a timely basis or at all. 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 accounting for acquisitions, including the NWR acquisition, could result in significant charges resulting from amortization of intangible assets related to such acquisitions. We have made, and in the future may make, strategic investments in development stage companies, which investments are subject to a high degree of risk, and therefore it is possible that we could lose our entire investment.

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

International shipments accounted for 84% of net sales in fiscal 2007, with 75% 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. We also have an arrangement with a contract manufacturer in Singapore to complete the manufacture of certain of our products. Our non-U.S. sales, purchases and operations, including contract manufacturing, 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;

• Local labor disputes;

• Shipping delays and disruptions;

• Increases in shipping costs, caused by increased fuel costs or otherwise, which we may not be able to pass on to our customers;

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

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

Our business and operating results are subject to uncertainties arising out of the possibility of regional or global economic disruptions (including those resulting from natural disasters and outbreaks of infectious disease), the economic consequences of military action or 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:

• 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; and

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

We reported a material weakness in our internal control over financial reporting in a prior fiscal year and if additional material weaknesses are discovered in the future, our internal controls over financial reporting could be adversely affected.

In connection with our management’s assessment of the effectiveness of our internal control over financial reporting at the end of the third quarter of fiscal 2007, we concluded that, as of March 3, 2007, our disclosure controls and procedures were not effective in ensuring accurate reporting of financial information due to a material weakness in our processes, procedures and controls related to the review and analysis of inventory cost variances resulting from certain inventory transactions. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected.

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We have taken the steps necessary to remediate the previously identified material weakness. However, the identification of one or more additional material weaknesses in the future could result in material misstatements in our financial reports and could lead us or our auditors to conclude that we do not have effective controls over financial reporting as required under Section 404 of the Sarbanes-Oxley Act. This may negatively impact the market’s view of our control environment and, potentially, our stock price.

No market currently exists for auction rate securities we hold and as a result we may not be able to liquidate them for par value, if at all. In addition, if the credit quality of the issuers declines we may have to recognize an impairment with respect to those securities.

As of September 29, 2007, the Company had a total of $19.6 million invested in auction rate securities. These securities historically provided short-term liquidity through a Dutch auction process that reset the applicable interest rate at pre-determined calendar intervals, generally every 28 days. This mechanism allows existing investors to either retain their holdings or liquidate their holdings by selling such securities at par. The recent uncertainties in the credit markets have reduced the liquidity of these securities as recent auctions have not been completed. As such, we have reclassified these securities, which were previously included in current assets, as long-term marketable securities on our consolidated condensed balance sheet at September 29, 2007. We believe that these securities will ultimately be liquidated in orderly transactions at an amount equal to the cost of the assets. However, if we need to liquidate the securities in the near future or if no orderly liquidation occurs, we may not be able liquidate these securities at par or at all, which could impair our liquidity. In addition, while these investments continue to be of high credit quality and the respective credit ratings of the securities issuers have not been lowered, if their credit quality decreases or such credit ratings decline we may have to recognize an impairment to the value of the securities, which could harm our financial results. It is possible that continued uncertainty in the credit markets could also impact the liquidity of our other investments and cash equivalents, which could impair our liquidity or require us to recognize an impairment to the value of those investments, which could harm our business.

Our tax rates are subject to fluctuation, which could impact our financial position, and our estimates of tax liabilities may be subject to audit, which could result in additional assessments.

Our effective tax rates are subject to fluctuation as the income tax rates for each year are a function of: (a) taxable income levels and the effects of a mix of profits (losses) earned by ESI and our subsidiaries in numerous tax jurisdictions with a broad range of income tax rates, (b) our ability to utilize recorded deferred tax assets, (c) taxes, interest or penalties resulting from tax audits, (d) the magnitude of various credits and deductions as a percentage of total taxable income and (e) changes in tax laws or the interpretation of such tax laws. Changes in the mix of these items may cause our effective tax rates to fluctuate between periods, which could have a material adverse effect on our financial position.

We are subject to income taxes in both the United States and numerous foreign jurisdictions. During the ordinary course of business there are transactions and calculations for which the ultimate tax determination is uncertain. Significant judgment is exercised in determining our world wide provisions for income taxes. Furthermore, we are occasionally under audit by tax authorities. Although we believe our tax estimates are reasonable, the final outcome of tax audits and examinations and the impact of changes in tax laws or the interpretation of tax laws could result in material differences from what is reflected in historical income tax accruals. For example, we recorded an additional $1.0 million of income taxes payable in the fourth quarter of fiscal 2007 due to new technical guidance from the Internal Revenue Service regarding foreign sales and leasing income. If additional taxes are assessed as a result of an examination, a material effect on our financial results, tax positions or cash flows could occur in the period or periods in which the determination is made.

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Item 2. Issuer Purchases of Equity Securities

On March 9, 2007, the Board of Directors authorized the repurchase of up to $50 million in shares of our outstanding common stock beginning April 17, 2007 through transactions in the open market or in negotiated transactions with brokers or shareholders. During the four months ended September 29, 2007, we repurchased 1,124,578 shares at an average price of $22.34. The following table sets forth information about the share repurchase transactions in accordance with SEC Regulation S-K, Item 703:

Period	(a) Total Number of Shares (or Units) Purchased	(b) Average Price Paid per Share (or Unit)		(c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs	(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
6/3/07 to 6/30/07	300,000	$	21.07	300,000	$	33,248,095
7/1/07 to 8/4/07	329,174	$	22.23	329,174	$	25,929,302
8/5/07 to 9/1/07	258,400	$	22.77	258,400	$	20,045,757
9/2/07 to 9/30/07	237,004	$	23.62	237,004	$	14,447,280
Total	1,124,578	$	22.34	1,124,578	$	14,447,280

On October 9, 2007, the Company suspended purchase transactions under its share repurchase program. In total, the Company repurchased approximately 1.7 million shares for $37.3 million since April 17, 2007.

Item 5. Other Information

Shareholder Proposals not in the Company’s Proxy Statement

We held our last annual meeting of shareholders on October 25, 2007. As a result of the change in our fiscal year, our next annual meeting of shareholders will be held more than 30 days before the anniversary date of our last annual meeting. In the definitive proxy statement for our October 25, 2007 meeting, filed September 6, 2007, we advised our shareholders that we expected to hold our next annual meeting of shareholders on August 21, 2008. The Company has now determined that our next annual meeting of shareholders will be held on August 5, 2008. Accordingly, under the guidelines described below, any notice relating to a shareholder proposal for the 2008 annual meeting, to be timely, must be received by the Company between April 7, 2008 and May 7, 2008.

Shareholders wishing to present proposals for action at this annual meeting or at another shareholders’ meeting must do so in accordance with the Company’s Bylaws. A shareholder must give timely notice of the proposed business to the Secretary. To be timely, a shareholder’s notice must be in writing and delivered to the secretary not less than 90 days nor more than 120 days prior to the anniversary date of the proxy statement for the prior year’s annual meeting of shareholders; provided, however, that in the event that the date of the annual meeting is advanced by more than 30 days or delayed (other than as a result of adjournment or postponement) by more than 70 days from the anniversary of the previous year’s annual meeting, notice by the shareholder, to be timely, must be received by the Secretary no earlier than 120 days before such annual meeting and no later than the later of 90 days before such annual meeting or 10 days following the day on which public announcement of the date of the meeting was first made. A shareholder proposal must include the information specified in the Company’s Bylaws, and a copy of the relevant provisions of the Bylaws will be provided to any shareholder upon written request to the Company’s Secretary. The chairman of the meeting may, if the facts warrant, determine and declare that the business was not properly brought before the meeting in accordance with the Company’s Bylaws.

36

Shareholders who wish to submit a shareholder proposal should do so in writing addressed to the Board of Directors, c/o Chairman of the Board, Electro Scientific Industries, Inc., 13900 NW Science Park Drive, Portland, Oregon 97229-5497.

Shareholder Proposals in the Company’s Proxy Statement

Shareholders wishing to submit proposals for inclusion in the Company’s proxy statement for the 2008 annual meeting of shareholders must submit the proposals for receipt by the Company not later than February 29, 2008.

Item 6. Exhibits

This list is intended to constitute the exhibit index.

2.1	Agreement and Plan of Merger dated as of July 4, 2007, by and among the Company, New Wave Research, Incorporated, Neptune Merger Corp. and the Security holder Representative. Incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on July 25, 2007.
3.1	Restated Articles of Incorporation. Incorporated by reference to Exhibit 3-A of the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 1991.
3.2	Articles of Amendment of Third Restated Articles of Incorporation. Incorporated by reference to Exhibit 3-B of the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 1999.
3.3	Articles of Amendment of Third Restated Articles of Incorporation. Incorporated by reference to Exhibit 3 of the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended December 2, 2000.
3.4	2004 Restated Bylaws, as amended. Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on October 21, 2004.
4.1	Amended and Restated Rights Agreement, dated as of March 1, 2001, between the Company and Mellon Investor Services, relating to rights issued to all holders of Company common stock. Incorporated by reference to Exhibit 4-A of the Company’s Annual Report on Form 10-K for the fiscal year ended June 2, 2001.
10.1	Separation and Release Agreement, dated July 27, 2007, between the Company and John Metcalf. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on August 2, 2007.
10.2	2004 Stock Incentive Plan, as amended.
31.1	Certification of the Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
31.2	Certification of the Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
32.1	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.
32.2	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.

37

SIGNATURES

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

Dated: November 7, 2007	ELECTRO SCIENTIFIC INDUSTRIES, INC.
	By	/s/ Nicholas Konidaris
	Nicholas Konidaris
	President and Chief Executive Officer
	(Principal Executive Officer)
	By	/s/ Kerry Mustoe
	Kerry Mustoe
	Vice President, Interim Chief Financial Officer,
	Corporate Controller and Chief Accounting Officer
	(Principal Financial and Accounting Officer)

38

EX-10.2

EXHIBIT 10.2

ELECTRO SCIENTIFIC INDUSTRIES, INC.

2004 STOCK INCENTIVE PLAN

(As amended January 25, 2005, April 20, 2005 and October 25, 2007)

1. Purpose. The purpose of this 2004 Stock Incentive Plan (the “Plan”) is to enable Electro Scientific Industries, Inc. (the “Company”) to attract and retain the services of (i) selected employees, officers and directors of the Company or any parent or subsidiary of the Company and (ii) selected non-employee agents, consultants, advisors and independent contractors of the Company or any parent, subsidiary of the Company. For purposes of this Plan, a person is considered to be employed by or in the service of the Company if the person is employed by or in the service of any entity (the “Employer”) that is either the Company or a parent or subsidiary of the Company.

2. Shares Subject to the Plan. Subject to adjustment as provided below and in Section 12, the shares to be offered under the Plan shall consist of Common Stock of the Company (“Common Stock”), and the total number of shares of Common Stock that may be issued under the Plan shall be 3,000,000 shares plus any shares that at the time the Plan is approved by shareholders are available for grant under the Company’s 1989 Stock Option Plan, 1996 Stock Incentive Plan and 2000 Stock Option Incentive Plan, which plans were previously approved by shareholders of the Company, and the Company’s 2000 Stock Option Plan, which plan was not previously approved by the Company’s shareholders (collectively, the “Prior Plans”), or that may subsequently become available for grant under any of the Prior Plans through the expiration, termination, forfeiture or cancellation of grants. If an option, stock appreciation right or Performance-Based Award granted under the Plan expires, terminates or is canceled, the unissued shares subject to that option, stock appreciation right or Performance-Based Award shall again be available under the Plan. If shares awarded as a bonus pursuant to Section 9 or sold pursuant to Section 10 under the Plan are forfeited to or repurchased by the Company, the number of shares forfeited or repurchased shall again be available under the Plan.

3. Effective Date and Duration of Plan.

3.1 Effective Date. The Plan shall become effective as of July 15, 2004. No awards shall be made under the Plan until the Plan is approved by shareholders of the Company in accordance with rules of The Nasdaq Stock Market.

3.2 Duration. The Plan shall continue in effect until all shares available for issuance under the Plan have been issued and all restrictions on the shares have lapsed. The Board of Directors may suspend or terminate the Plan at any time except with respect to Awards then outstanding under the Plan. Termination shall not affect any Awards or any right of the Company to repurchase shares or the forfeitability of shares issued under the Plan.

4. Administration.

4.1 Board of Directors. The Plan shall be administered by the Board of Directors of the Company, which shall determine and designate the individuals to whom awards shall be made, the amount of the awards and the other terms and conditions of the awards. Subject to the provisions of the Plan, the Board of Directors may adopt and amend rules and regulations relating to administration of the Plan, advance the lapse of any waiting period, accelerate any exercise date, waive or modify any

restriction applicable to shares (except those restrictions imposed by law) and make all other determinations in the judgment of the Board of Directors necessary or desirable for the administration of the Plan. The interpretation and construction of the provisions of the Plan and related agreements by the Board of Directors shall be final and conclusive. The Board of Directors may correct any defect or supply any omission or reconcile any inconsistency in the Plan or in any related agreement in the manner and to the extent it deems expedient to carry the Plan into effect, and the Board of Directors shall be the sole and final judge of such expediency.

4.2 Committee. The Board of Directors may delegate to any committee of the Board of Directors (the “Committee”) any or all authority for administration of the Plan. If authority is delegated to the Committee, all references to the Board of Directors in the Plan shall mean and relate to the Committee, except (i) as otherwise provided by the Board of Directors and (ii) that only the Board of Directors may amend or terminate the Plan as provided in Sections 3 and 13.

5. Types of Awards; Eligibility; Limitations.

5.1 Types of Awards, Eligibility. The Board of Directors may, from time to time, take the following actions, separately or in combination, under the Plan (“Awards”): (i) grant Incentive Stock Options, as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”), as provided in Sections 6.1, 6.2 and 8; (ii) grant options other than Incentive Stock Options (“Non-Statutory Stock Options”) as provided in Sections 6.1, 6.3 and 8; (iii) grant stock appreciation rights as provided in Sections 7 and 8; (iv) award stock bonuses (including bonuses in the form of restricted stock units) as provided in Section 9; (v) sell shares subject to restrictions as provided in Sections 10; (vi) award Performance-Based Awards as provided in Section 11. Awards may be made to employees, including employees who are officers or directors, and to non-employee directors; provided, however, that only employees of the Company or any parent or subsidiary of the Company (as defined in subsections 424(e) and 424(f) of the Code) are eligible to receive Incentive Stock Options under the Plan. The Board of Directors shall select the individuals to whom awards shall be made and shall specify the action taken with respect to each individual to whom an award is made.

5.2 Per Employee Share Limitations. No employee may be granted options and/or stock appreciation rights for more than an aggregate of 500,000 shares of Common Stock in any calendar year or restricted stock or restricted stock units for more than an aggregate of 170,000 shares of Common Stock in any calendar year; provided, however, that to the extent the annual limitation is not fully used in any year for an employee, any shares not used may be added to the number of shares for which options and/or stock appreciation rights or restricted stock and/or restricted stock units, as applicable, may be granted to that employee in any future year.

5.3 Prohibition on Option Repricing. Except as provided in Section 12, without the prior approval of the Company’s shareholders, an option issued under the Plan may not be repriced by lowering the option exercise price or by cancellation of an outstanding option with a subsequent replacement or regrant of an option with a lower exercise price.

5.4 Maximum Number of Shares Issuable Upon Exercise of ISOs. The maximum aggregate number of shares of Common Stock that may be issued under the Plan upon exercise of Incentive Stock Options shall be equal to the sum of 3,000,000 shares plus any shares that at July 15, 2004 are available for grant under the Prior Plans or that may subsequently become available for grant under any of the Prior Plans through the expiration, termination, forfeiture or cancellation of grants, which number will not exceed 9,568,684 shares.

5.5 Reservation of Additional Shares. Except as provided in Section 12, additional shares of Common Stock may not be reserved for issuance under the Plan without the approval of the Company’s shareholders.

6. Stock Options.

6.1 General Rules Relating to Options.

6.1-1 Terms of Grant. The Board of Directors may grant options under the Plan. With respect to each option grant, the Board of Directors shall determine the number of shares subject to the option, the exercise price, the period of the option, the time or times at which the option may be exercised and whether the option is an Incentive Stock Option or a Non-Statutory Stock Option. At the time of the grant of an option or at any time thereafter, the Board of Directors may provide that an optionee who exercised an option with Common Stock of the Company shall automatically receive a new option to purchase additional shares equal to the number of shares surrendered and may specify the terms and conditions of such new options.

6.1-2 Nontransferability. Each Incentive Stock Option and, unless otherwise determined by the Board of Directors, each other option granted under the Plan by its terms (i) shall be nonassignable and nontransferable by the optionee, either voluntarily or by operation of law, except by will or by the laws of descent and distribution of the state or country of the optionee’s domicile at the time of death, and (ii) during the optionee’s lifetime, shall be exercisable only by the optionee.

6.1-3 Purchase of Shares. Unless the Board of Directors determines otherwise, on or before the date specified for completion of the purchase of shares pursuant to an option exercise, the optionee must pay the Company the full purchase price of those shares in cash or by check or, with the consent of the Board of Directors, in whole or in part, in Common Stock of the Company valued at fair market value, restricted stock or other contingent awards denominated in either stock or cash, promissory notes and other forms of consideration. Unless otherwise determined by the Board of Directors, any Common Stock provided in payment of the purchase price must have been previously acquired and held by the optionee for at least six months. The fair market value of Common Stock provided in payment of the purchase price shall be the closing price of the Common Stock last reported before the time payment in Common Stock is made or, if earlier, committed to be made, if the Common Stock is publicly traded, or another value of the Common Stock as specified by the Board of Directors. No shares shall be issued until full payment for the shares has been made, including all amounts owed for tax withholding. With the consent of the Board of Directors, an optionee may request the Company to apply automatically the shares to be received upon the exercise of a portion of a stock option (even though stock certificates have not yet been issued) to satisfy the purchase price for additional portions of the option.

6.1-4 Limitations on Grants to Non-Exempt Employees. Unless otherwise determined by the Board of Directors, if an employee of the Company or any parent or subsidiary of the Company is a non-exempt employee subject to the overtime compensation provisions of Section 7 of the Fair Labor Standards Act (the “FLSA”), any option granted to that employee shall be subject to the following restrictions: (i) the option price shall be at least 85 percent of the fair market value, as

described in Section 6.2-4, of the Common Stock subject to the option on the date it is granted; and (ii) the option shall not be exercisable until at least six months after the date it is granted; provided, however, that this six-month restriction on exercisability will cease to apply if the employee dies, becomes disabled or retires, there is a change in ownership of the Company, or in other circumstances permitted by regulation, all as prescribed in Section 7(e)(8)(B) of the FLSA.

6.2 Incentive Stock Options. Incentive Stock Options shall be subject to the following additional terms and conditions:

6.2-1 Limitation on Amount of Grants. If the aggregate fair market value of stock (determined as of the date the option is granted) for which Incentive Stock Options granted under this Plan (and any other stock incentive plan of the Company or its parent or subsidiary corporations, as defined in subsections 424(e) and 424(f) of the Code) are exercisable for the first time by an employee during any calendar year exceeds $100,000, the portion of the option or options not exceeding $100,000, to the extent of whole shares, will be treated as an Incentive Stock Option and the remaining portion of the option or options will be treated as a Non-Statutory Stock Option. The preceding sentence will be applied by taking options into account in the order in which they were granted. If, under the $100,000 limitation, a portion of an option is treated as an Incentive Stock Option and the remaining portion of the option is treated as a Non-Statutory Stock Option, unless the optionee designates otherwise at the time of exercise, the optionee’s exercise of all or a portion of the option will be treated as the exercise of the Incentive Stock Option portion of the option to the full extent permitted under the $100,000 limitation. If an optionee exercises an option that is treated as in part an Incentive Stock Option and in part a Non-Statutory Stock Option, the Company will designate the portion of the stock acquired pursuant to the exercise of the Incentive Stock Option portion as Incentive Stock Option stock by issuing a separate certificate for that portion of the stock and identifying the certificate as Incentive Stock Option stock in its stock records.

6.2-2 Limitations on Grants to 10 percent Shareholders. An Incentive Stock Option may be granted under the Plan to an employee possessing more than 10 percent of the total combined voting power of all classes of stock of the Company or any parent or subsidiary (as defined in subsections 424(e) and 424(f) of the Code) only if the option price is at least 110 percent of the fair market value, as described in Section 6.2-4, of the Common Stock subject to the option on the date it is granted and the option by its terms is not exercisable after the expiration of five years from the date it is granted.

6.2-3 Duration of Options. Subject to Sections 6.2-2, 8.1 and 8.2, Incentive Stock Options granted under the Plan shall continue in effect for the period fixed by the Board of Directors, except that by its terms no Incentive Stock Option shall be exercisable after the expiration of 10 years from the date it is granted.

6.2-4 Option Price. The option price per share shall be determined by the Board of Directors at the time of grant. Except as provided in Section 6.2-2, the option price shall not be less than 100 percent of the fair market value of the Common Stock covered by the Incentive Stock Option at the date the option is granted. The fair market value shall be the closing price of the Common Stock last reported on the date the option is granted, if the stock is publicly traded, or another value of the Common Stock as specified by the Board of Directors.

6.2-5 Limitation on Time of Grant. No Incentive Stock Option shall be granted on or after the tenth anniversary of the last action by the Board of Directors adopting the Plan or approving an increase in the number of shares available for issuance under the Plan, which action was subsequently approved within 12 months by the shareholders.

6.2-6 Early Dispositions. If within two years after an Incentive Stock Option is granted or within 12 months after an Incentive Stock Option is exercised, the optionee sells or otherwise disposes of Common Stock acquired on exercise of the Option, the optionee shall within 30 days of the sale or disposition notify the Company in writing of (i) the date of the sale or disposition, (ii) the amount realized on the sale or disposition and (iii) the nature of the disposition (e.g., sale, gift, etc.).

6.3 Non-Statutory Stock Options. Non-Statutory Stock Options shall be subject to the following terms and conditions, in addition to those set forth in Sections 6.1 and 8.

6.3-1 Option Price. The option price for Non-Statutory Stock Options shall be determined by the Board of Directors at the time of grant. The option price shall not be less than 100 percent of the fair market value of the Common Stock covered by the Non-Statutory Stock Option at the date the option is granted. The fair market value shall be the closing price of the Common Stock last reported on the date the option is granted, if the stock is publicly traded, or another value of the Common Stock as specified by the Board of Directors.

6.3-2 Duration of Options. Non-Statutory Stock Options granted under the Plan shall continue in effect for the period fixed by the Board of Directors, except that no Non-Statutory Option shall be exercisable after the expiration of 10 years from the date it is granted.

7. Stock Appreciation Rights.

7.1 Grant. Stock appreciation rights may be granted under the Plan by the Board of Directors, subject to such rules, terms, and conditions as the Board of Directors prescribes. The Board of Directors may provide that stock appreciation rights may be granted in substitution for stock options granted under the Plan. With respect to each grant, the Board shall determine the number of shares subject to the stock appreciation right, the exercise price of the stock appreciation right, the period of the stock appreciation right, and the time or times at which the stock appreciation right may be exercised. Stock appreciation rights shall continue in effect for the period fixed by the Board of Directors.

7.2 Stock Appreciation Rights Granted in Connection with Options. If a stock appreciation right is granted in connection with an option, the stock appreciation right shall be exercisable only to the extent and on the same conditions that the related option could be exercised. Upon exercise of a stock appreciation right, any option or portion thereof to which the stock appreciation right relates terminates. If a stock appreciation right is granted in connection with an option, upon exercise of the option, the stock appreciation right or portion thereof to which the grant relates terminates.

7.3 Exercise. Each stock appreciation right shall entitle the holder, upon exercise, to receive from the Company in exchange therefor an amount equal in value to the excess of the fair market value on the date of exercise of one share of Common Stock of the Company over the exercise price as determined by the Board of Directors (or, in the case of a stock appreciation right granted in connection with an option, the option price per share under the option to which the stock appreciation right relates),

multiplied by the number of shares covered by the stock appreciation right, or portion thereof, that is surrendered. Payment by the Company upon exercise of a stock appreciation right may be made in Common Stock valued at fair market value, in cash, or partly in Common Stock and partly in cash, all as determined by the Board of Directors. For this purpose, the fair market value of the Common Stock shall be the closing price of the Common Stock last reported before the time of exercise, or such other value of the Common Stock as specified by the Board of Directors.

7.4 Fractional Shares. No fractional shares shall be issued upon exercise of a stock appreciation right. In lieu thereof, cash may be paid in an amount equal to the value of the fraction or, if the Board of Directors shall determine, the number of shares may be rounded downward to the next whole share.

7.5 Nontransferability. Each stock appreciation right granted in connection with an Incentive Stock Option and, unless otherwise determined by the Board of Directors, each other stock appreciation right granted under the Plan, by its terms shall be nonassignable and nontransferable by the holder, either voluntarily or by operation of law, except by will or by the laws of descent and distribution of the state or country of the holder’s domicile at the time of death, and each stock appreciation right by its terms shall be exercisable during the holder’s lifetime only by the holder.

8. Exercise of Options and Stock Appreciation Rights.

8.1 Exercise. Except as provided in Section 8.2 or as determined by the Board of Directors, no option or stock appreciation right granted under the Plan may be exercised unless at the time of exercise the holder is employed by or in the service of the Company and shall have been so employed or provided such service continuously since the date the option or stock appreciation right was granted. Except as provided in Sections 8.2, 12 and 17, options and stock appreciation rights granted under the Plan may be exercised from time to time over the period stated in each option or stock appreciation right in amounts and at times prescribed by the Board of Directors, provided that options and stock appreciation rights may not be exercised for fractional shares. Unless otherwise determined by the Board of Directors, if a holder does not exercise an option or stock appreciation right in any one year for the full number of shares to which the holder is entitled in that year, the holder’s rights shall be cumulative and the holder may acquire those shares in any subsequent year during the term of the option or stock appreciation right.

8.2 Termination of Employment or Service.

8.2-1 General Rule. Unless otherwise determined by the Board of Directors, if a holder’s employment or service with the Company terminates for any reason other than because of total disability or death as provided in Sections 8.2-2 and 8.2-3, his or her option or stock appreciation right may be exercised at any time before the expiration date of the option or stock appreciation right or the expiration of 3 months after the date of termination, whichever is the shorter period, but only if and to the extent the holder was entitled to exercise the option or stock appreciation right at the date of termination. Notwithstanding the foregoing, unless otherwise determined by the Board of Directors, if a holder’s employment or service with the Company terminates for any reason other than because of total disability or death as provided in Sections 8.2-2 and 8.2-3, and such holder dies before the expiration date of the option or stock appreciation right and the expiration of 3 months after the date of termination, his or her option or stock appreciation right may be exercised at any time before the expiration date of the option or stock appreciation right or before the date 12 months after the date of termination,

whichever is the shorter period, but only if and to the extent the holder was entitled to exercise the option or stock appreciation right at the date of termination and only by the person or persons to whom the holder’s rights under the option or stock appreciation right shall pass by the holder’s will or by the laws of descent and distribution of the state or country of domicile at the time of death.

8.2-2 Termination Because of Total Disability. Unless otherwise determined by the Board of Directors, if a holder’s employment or service with the Company terminates because of total disability, his or her option or stock appreciation right may be exercised at any time before the expiration date of the option or stock appreciation right or before the date 12 months after the date of termination, whichever is the shorter period, but only if and to the extent the holder was entitled to exercise the option or stock appreciation right at the date of termination. The term “total disability” means a medically determinable mental or physical impairment that is expected to result in death or has lasted or is expected to last for a continuous period of 12 months or more and that, in the opinion of the Company and two independent physicians, causes the holder to be unable to perform his or her duties as an employee, director or officer of the Employer and unable to be engaged in any substantial gainful activity. Total disability shall be deemed to have occurred on the first day after the two independent physicians have furnished their written opinion of total disability to the Company and the Company has reached an opinion of total disability.

8.2-3 Termination Because of Death. Unless otherwise determined by the Board of Directors, if a holder dies while employed by or providing service to the Company, his or her option or stock appreciation right may be exercised at any time before the expiration date of the option or stock appreciation right or before the date 12 months after the date of death, whichever is the shorter period, but only if and to the extent the holder was entitled to exercise the option or stock appreciation right at the date of death and only by the person or persons to whom the holder’s rights under the option or stock appreciation right shall pass by the holder’s will or by the laws of descent and distribution of the state or country of domicile at the time of death.

8.2-4 Amendment of Exercise Period Applicable to Termination. The Board of Directors may at any time extend the 3-month and 12-month exercise periods any length of time not longer than the original expiration date of the option or stock appreciation right. The Board of Directors may at any time increase the portion of an option or stock appreciation right that is exercisable, subject to terms and conditions determined by the Board of Directors.

8.2-5 Failure to Exercise Option or Stock Appreciation Right. To the extent that the option or stock appreciation right of any deceased holder or any holder whose employment or service terminates is not exercised within the applicable period, all further rights to purchase shares pursuant to the option or stock appreciation right shall cease and terminate.

8.2-6 Leave of Absence. Absence on leave approved by the Employer or on account of illness or disability shall not be deemed a termination or interruption of employment or service. Unless otherwise determined by the Board of Directors, vesting of options and stock appreciation rights shall continue during a medical, family or military leave of absence or other leave approved by the Employer, whether paid or unpaid, and vesting of options and stock appreciation rights shall be suspended during any other unpaid leave of absence.

8.3 Notice of Exercise or Surrender. Unless the Board of Directors determines otherwise, shares may be acquired pursuant to an option or stock appreciation right granted under the Plan only upon the Company’s receipt of written notice from the holder of the holder’s binding commitment to purchase shares, specifying the number of shares the holder desires to acquire under the option or stock appreciation right and the date on which the holder agrees to complete the transaction, and, if required to comply with the Securities Act of 1933, containing a representation that it is the holder’s intention to acquire the shares for investment and not with a view to distribution. Unless the Board of Directors determines otherwise, cash may be paid upon surrender of a stock appreciation right granted under the Plan only upon the Company’s receipt of written notice from the holder of the holder’s binding commitment to surrender the stock appreciation right, specifying the number of shares subject to the stock appreciation right being surrendered and the date on which the holder agrees to complete the surrender.

8.4 Tax Withholding. Each holder who has exercised an option or stock appreciation right shall, immediately upon notification of the amount due, if any, pay to the Company in cash or by check amounts necessary to satisfy any applicable federal, state and local tax withholding requirements. If additional withholding is or becomes required (as a result of exercise of an option or stock appreciation right or as a result of disposition of shares acquired pursuant to exercise of an option or stock appreciation right) beyond any amount deposited before delivery of the certificates, the holder shall pay such amount, in cash or by check, to the Company on demand. If the holder fails to pay the amount demanded, the Company or the Employer may withhold that amount from other amounts payable to the holder, including salary, subject to applicable law. With the consent of the Board of Directors, a holder may satisfy this obligation, in whole or in part, by instructing the Company to withhold from the shares to be issued upon exercise or by delivering to the Company other shares of Common Stock; provided, however, that the number of shares so withheld or delivered in connection with an option exercise shall not exceed the minimum amount necessary to satisfy the required withholding obligation.

8.5 Reduction of Reserved Shares. Upon the exercise of an option or stock appreciation right, the number of shares reserved for issuance under the Plan shall be reduced by the number of shares issued upon exercise of the option or stock appreciation right. Cash payments of stock appreciation rights shall not reduce the number of shares of Common Stock reserved for issuance under the Plan.

9. Stock Bonuses. The Board of Directors may award shares under the Plan as stock bonuses, including restricted stock units that provide for delivery of Common Stock at a later date. Shares awarded as a bonus shall be subject to the terms, conditions and restrictions determined by the Board of Directors. The restrictions may include restrictions concerning transferability and forfeiture of the shares awarded, together with any other restrictions determined by the Board of Directors. The Board of Directors may require the recipient to sign an agreement as a condition of the award, but may not require the recipient to pay any monetary consideration other than amounts necessary to satisfy tax withholding requirements. The agreement may contain any terms, conditions, restrictions, representations and warranties required by the Board of Directors. The certificates representing the shares awarded shall bear any legends required by the Board of Directors. The Company may require any recipient of a stock bonus to pay to the Company in cash or by check upon demand amounts necessary to satisfy any applicable federal, state or local tax withholding requirements. If the recipient fails to pay the amount demanded, the Company or the Employer may withhold that amount from other amounts payable to the recipient, including salary, subject to applicable law. With the consent of the Board of Directors, a recipient may satisfy this obligation, in whole or in part, by instructing the Company to withhold from any shares to be issued or by delivering to the Company other shares of Common Stock; provided,

however, that the number of shares so withheld or delivered shall not exceed the minimum amount necessary to satisfy the required withholding obligation. Upon the issuance of a stock bonus, the number of shares reserved for issuance under the Plan shall be reduced by the number of shares issued.

10. Restricted Stock.

10.1 Restricted Stock. The Board of Directors may issue shares under the Plan for any consideration (including promissory notes and services) determined by the Board of Directors. Shares issued under the Plan shall be subject to the terms, conditions and restrictions determined by the Board of Directors; provided, however, that any award made under this Section 10 the vesting for which is time-based will provide for a restriction period of at least three years, with the restriction to lapse no more quickly than with respect to one-third of the shares annually over the three-year restriction period. Subject to the provisions of the Plan, the restrictions may include restrictions concerning transferability, repurchase by the Company and forfeiture of the shares issued, together with any other restrictions determined by the Board of Directors. All Common Stock issued pursuant to this Section 10.1 shall be subject to a Restricted Stock Agreement, which shall be executed by the Company and the prospective recipient of the shares before the delivery of certificates representing the shares. The Agreement may contain any terms, conditions, restrictions, representations and warranties required by the Board of Directors.

10.2 Other Provisions. The certificates representing shares of restricted stock shall bear any legends required by the Board of Directors. The Company may require any participant receiving restricted stock to pay to the Company in cash or by check upon demand amounts necessary to satisfy any applicable federal, state or local tax withholding requirements. If the participant fails to pay the amount demanded, the Company or the Employer may withhold that amount from other amounts payable to the participant, including salary, subject to applicable law. With the consent of the Board of Directors, a participant may satisfy this obligation, in whole or in part, by instructing the Company to withhold from any shares to be issued or by delivering to the Company other shares of Common Stock; provided, however, that the number of shares so withheld or delivered shall not exceed the minimum amount necessary to satisfy the required withholding obligation. Upon the issuance of restricted stock, the number of shares reserved for issuance under the Plan shall be reduced by the number of shares issued.

11. Performance-Based Awards. The Board of Directors may grant awards intended to qualify as qualified performance-based compensation under Section 162(m) of the Code and the regulations thereunder (“Performance-Based Awards”). Performance-Based Awards shall be denominated at the time of grant either in Common Stock (“Stock Performance Awards”) or in dollar amounts (“Dollar Performance Awards”). Payment under a Stock Performance Award or a Dollar Performance Award shall be made, at the discretion of the Board of Directors, in Common Stock (“Performance Shares”), or in cash or in any combination thereof. Performance-Based Awards shall be subject to the following terms and conditions:

11.1 Award Period. The Board of Directors shall determine the period of time for which a Performance-Based Award is made (the “Award Period”).

11.2 Performance Goals and Payment. The Board of Directors shall establish in writing objectives (“Performance Goals”) that must be met by the Company or any subsidiary, division or other unit of the Company (“Business Unit”) during the Award Period as a condition to payment

being made under the Performance-Based Award. The Performance Goals for each award shall be one or more targeted levels of performance with respect to one or more of the following objective measures with respect to the Company or any Business Unit: earnings, earnings per share, stock price increase, total shareholder return (stock price increase plus dividends), return on equity, return on assets, return on capital, economic value added, sales, revenues, operating income, inventories, inventory turns, cash flows, or any of the foregoing before the effect of acquisitions, divestitures, accounting changes, restructuring and special charges, extraordinary items and all items of gain, loss or expense determined to be extraordinary or unusual in nature or infrequent in occurrence (determined according to criteria established by the Board of Directors). The Board of Directors shall also establish the number of Performance Shares or the amount of cash payment to be made under a Performance-Based Award if the Performance Goals are met or exceeded, including the fixing of a maximum payment (subject to Section 11.4). The Board of Directors may establish other restrictions to payment under a Performance-Based Award, such as a continued employment requirement, in addition to satisfaction of the Performance Goals. Some or all of the Performance Shares may be issued at the time of the award as restricted shares subject to forfeiture in whole or in part if Performance Goals or, if applicable, other restrictions are not satisfied.

11.3 Computation of Payment. During or after an Award Period, the performance of the Company or Business Unit, as applicable, during the period shall be measured against the Performance Goals. If the Performance Goals are not met, no payment shall be made under a Performance-Based Award. If the Performance Goals are met or exceeded, the Board of Directors shall certify that fact in writing and certify the number of Performance Shares earned or the amount of cash payment to be made under the terms of the Performance-Based Award.

11.4 Maximum Awards. No participant may receive in any fiscal year Stock Performance Awards under which the aggregate amount payable under the Awards exceeds the equivalent of 200,000 shares of Common Stock or Dollar Performance Awards under which the aggregate amount payable under the Awards exceeds $4,000,000.

11.5 Tax Withholding. Each participant who has received Performance Shares shall, upon notification of the amount due, pay to the Company in cash or by check amounts necessary to satisfy any applicable federal, state and local tax withholding requirements. If the participant fails to pay the amount demanded, the Company or the Employer may withhold that amount from other amounts payable to the participant, including salary, subject to applicable law. With the consent of the Board of Directors, a participant may satisfy this obligation, in whole or in part, by instructing the Company to withhold from any shares to be issued or by delivering to the Company other shares of Common Stock; provided, however, that the number of shares so delivered or withheld shall not exceed the minimum amount necessary to satisfy the required withholding obligation.

11.6 Effect on Shares Available. The payment of a Performance-Based Award in cash shall not reduce the number of shares of Common Stock reserved for issuance under the Plan. The number of shares of Common Stock reserved for issuance under the Plan shall be reduced by the number of shares issued upon payment of an award. Cash payments of Performance-Based Awards shall not reduce the number of shares of Common Stock reserved for issuance under the Plan.

12. Changes in Capital Structure.

12.1 Stock Splits, Stock Dividends. If the outstanding Common Stock of the Company is hereafter increased or decreased or changed into or exchanged for a different number or kind of shares or other securities of the Company by reason of any stock split, combination of shares, dividend payable in shares, recapitalization or reclassification, appropriate adjustment shall be made by the Board of Directors in the number and kind of shares available for grants under the Plan and in all other share amounts set forth in the Plan. In addition, the Board of Directors shall make appropriate adjustment in the number and kind of shares subject to any Awards theretofor granted, and the exercise and settlement prices of those Awards, if any, so that the holder’s proportionate interest before and after the occurrence of the event is maintained without changing the aggregate exercise or settlement price, if any. Notwithstanding the foregoing, the Board of Directors shall have no obligation to effect any adjustment that would or might result in the issuance of fractional shares, and any fractional shares resulting from any adjustment may be disregarded or provided for in any manner determined by the Board of Directors. Any such adjustments made by the Board of Directors shall be conclusive.

12.2 Mergers, Reorganizations, Etc. In the event of a merger, consolidation, plan of exchange, acquisition of property or stock, split-up, split-off, spin-off, reorganization or liquidation to which the Company is a party or any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company (each, a “Transaction”), the Board of Directors shall, in its sole discretion and to the extent possible under the structure of the Transaction, select one or more of the following alternatives for treating outstanding Awards under the Plan, with the Board of Directors having the discretion to apply different alternatives to various outstanding Awards:

12.2-1 Outstanding Awards shall remain in effect in accordance with their terms.

12.2-2 Outstanding Awards shall be converted into Awards with respect to stock in one or more of the corporations, including the Company, that are the surviving or acquiring corporations in the Transaction, with such conversion to occur by assumption of the Plan, assumption of Awards, or substitution of Awards. The amount, type of securities subject thereto and exercise or settlement price of the converted Awards shall be determined by the Board of Directors of the Company, taking into account the relative values of the companies involved in the Transaction and the exchange rate, if any, used in determining shares of the surviving corporation(s) to be held by holders of shares of the Company following the Transaction. Unless otherwise determined by the Board of Directors, the converted Awards shall be vested or released from restrictions on transfer and repurchase and forfeiture rights only to the extent that the vesting requirements or restrictions relating to Awards granted hereunder have been satisfied.

12.2-3 The Board of Directors shall provide a period of 30 days or less before the completion of the Transaction during which outstanding Awards may be exercised to the extent then exercisable, and upon the expiration of that period, all outstanding Awards (including Awards that are not options or stock appreciation rights) shall immediately terminate.

12.2-4 Outstanding Awards shall be cancelled immediately prior to the completion of the Transaction in exchange for a payment with respect to each vested or exercisable share subject to such cancelled Award in (i) cash, (ii) stock in one or more corporations that are the surviving or acquiring corporations in the Transaction, or (iii) other property which, in any such case, shall have a

fair market value equal to the fair market value of the consideration to be paid per share of Common Stock in the Transaction over the exercise or settlement price per share under the Award, if any (the “Spread”). In the event such determination is made by the Board of Directors, the Spread (reduced by applicable withholding taxes, if any) shall be paid to the holders in respect of their cancelled Awards as soon as practicable following the closing of the Transaction. This provision shall not apply to Incentive Stock Options awarded prior to October 25, 2007.

The Board of Directors may, in its sole discretion, accelerate in full or in part the vesting or exercisability of Awards under the Plan and the full or partial release from restrictions on transfer and repurchase or forfeiture rights of Award under the Plan, on such terms and conditions as the Board of Directors may specify prior to the completion of the Transaction.

12.3 Dissolution of the Company. In the event of the dissolution of the Company, options and stock appreciation rights shall be treated in accordance with Section 12.2-3.

12.4 Rights Issued by Another Corporation. The Board of Directors may also grant options, stock appreciation rights, stock bonuses and Performance-Based Awards and issue restricted stock under the Plan with terms, conditions and provisions that vary from those specified in the Plan, provided that any such awards are granted in substitution for, or in connection with the assumption of, existing options, stock appreciation rights, stock bonuses, Performance-Based Awards or restricted stock granted, awarded or issued by another corporation and assumed or otherwise agreed to be provided for by the Company pursuant to or by reason of an acquisition of another entity, business or an interest in another entity whether by merger, stock purchase, asset purchase or other form of transaction.

13. Amendment of the Plan. The Board of Directors may at any time modify or amend the Plan in any respect. Except as provided in Section 12, however, no change in an award already granted shall be made without the written consent of the holder of the award if the change would adversely affect the holder.

14. Approvals. The Company’s obligations under the Plan are subject to the approval of state and federal authorities or agencies with jurisdiction in the matter. The Company will use its best efforts to take steps required by state or federal law or applicable regulations, including rules and regulations of the Securities and Exchange Commission and any stock exchange on which the Company’s shares may then be listed, in connection with the grants under the Plan. The foregoing notwithstanding, the Company shall not be obligated to issue or deliver Common Stock under the Plan if such issuance or delivery would violate state or federal securities laws.

15. Employment and Service Rights. Nothing in the Plan or any award pursuant to the Plan shall (i) confer upon any employee any right to be continued in the employment of an Employer or interfere in any way with the Employer’s right to terminate the employee’s employment at will at any time, for any reason, with or without cause, or to decrease the employee’s compensation or benefits, or (ii) confer upon any person engaged by an Employer any right to be retained or employed by the Employer or to the continuation, extension, renewal or modification of any compensation, contract or arrangement with or by the Employer.

16. Rights as a Shareholder. The recipient of any award under the Plan shall have no rights as a shareholder with respect to any shares of Common Stock until the date the recipient becomes the holder of record of those shares. Except as otherwise expressly provided in the Plan, no adjustment shall be made for dividends or other rights for which the record date occurs before the date the recipient becomes the holder of record.

17. Suspension or Termination of Awards; Claw-Back. Notwithstanding any provision of the Plan to the contrary, if at any time (including after a notice of exercise has been delivered with respect to an Award that is an option or stock appreciation right), the Board of Directors, including any Committee authorized pursuant to Section 4.2 (the Board of Directors or such Committee, the “Committee” for purposes of this Section), reasonably believes that a participant, other than a non-employee director, has committed an act of misconduct as described in this section, the Committee may suspend the participant’s right to exercise any stock option or stock appreciation right or the vesting of restricted stock or restricted stock unit awards pending a determination of whether an act of misconduct has been committed. If the Committee determines a participant, other than a non-employee director, has committed an act of embezzlement, fraud, dishonesty, nonpayment of any obligation owed to the Company or its subsidiaries, breach of fiduciary duty or deliberate disregard of Company rules resulting in loss, damage or injury to the Company, or if a participant makes an unauthorized disclosure of any Company trade secret or confidential information, engages in any conduct constituting unfair competition, induces any customer to breach a contract with the Company or induces any principal for whom the Company or its subsidiaries acts as agent to terminate such agency relationship, neither the participant nor his or her estate shall be entitled to exercise any stock option or stock appreciation right whatsoever and the participant’s restricted stock or restricted stock unit agreement shall be terminated and cancelled. In addition, for any participant who is designated an “executive officer” by the Board of Directors, if the Committee determines that the participant engaged in an act of embezzlement, fraud or breach of fiduciary duty during the participant’s employment that contributed to an obligation to restate the Company’s financial statements (“Contributing Misconduct”), the participant shall be required to repay to the Company, in cash and upon demand, the Option Proceeds and/or Restricted Stock Proceeds, as applicable, resulting from the sale or other disposition (including to the Company) of shares issued or issuable upon exercise of a stock option or stock appreciation right or upon vesting of restricted stock or a restricted stock unit, as applicable, if the sale or disposition was effected during the 12-month period following the first public issuance or filing with the Securities and Exchange Commission of the financial statements required to be restated. The term “Option Proceeds” means, with respect to any sale or other disposition (including to the Company) of shares issued or issuable upon exercise of an option or stock appreciation right, an amount determined appropriate by the Committee to reflect the effect of the restatement on the Company’s stock price, up to the amount equal to the number of shares sold or disposed of multiplied by the difference between the market value per share at the time of such sale or disposition and the exercise price. The term “Restricted Stock Proceeds” means, with respect to any sale or other disposition (including to the Company) of restricted stock or a restricted stock unit, an amount determined appropriate by the Committee to reflect the effect of the restatement on the Company’s stock price, up to the amount equal to the market value per share at the time of such sale or other disposition multiplied by the number of shares or units sold or disposed of. The return of Option Proceeds and/or Restricted Stock Proceeds is in addition to and separate from any other relief available to the Company due to the executive officer’s Contributing Misconduct. Any determination by the Committee with respect to the foregoing shall be final, conclusive and binding on all parties. For any participant who is an “executive officer,” the determination of the Committee shall be subject to the approval of the Board of Directors.

EX-31.1

EXHIBIT 31.1

CERTIFICATION PURSUANT TO

SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, Nicholas Konidaris, certify that:

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

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 7, 2007

/s/ Nicholas Konidaris

Nicholas Konidaris

President and Chief Executive Officer

1

EX-31.2

EXHIBIT 31.2

CERTIFICATION PURSUANT TO

SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, Kerry Mustoe, certify that:

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

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 7, 2007

/s/ Kerry Mustoe

Kerry Mustoe

Vice President and Interim Chief Financial Officer

EX-32.1

EXHIBIT 32.1

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 quarterly report on Form 10-Q of Electro Scientific Industries, Inc. (the “Company”) for the quarterly period ended September 29, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Nicholas Konidaris, 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/ Nicholas Konidaris

Nicholas Konidaris

President and Chief Executive Officer

Dated: November 7, 2007

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.

EX-32.2

EXHIBIT 32.2

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 quarterly report on Form 10-Q of Electro Scientific Industries, Inc. (the “Company”) for the quarterly period ended September 29, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Kerry Mustoe, Vice President, Interim Chief Financial Officer and Corporate Controller, 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/ Kerry Mustoe

Kerry Mustoe

Vice President and Interim Chief Financial Officer

Dated: November 7, 2007

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.