UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended November 30, 2002

Commission File Number: 0-12853

ELECTRO SCIENTIFIC INDUSTRIES, INC.

(an Oregon corporation)

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

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

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

Registrant’s web address: www.esi.com

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

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

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Part I. Financial Information

Item 1. Consolidated Financial Statements

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

The accompanying notes are an integral part of these statements.

2

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

The accompanying notes are an integral part of these statements.

3

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

The accompanying notes are an integral part of these statements.

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

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

The accompanying notes are an integral part of these statements.

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

Note 1 — Basis of Presentation

We have prepared the condensed consolidated financial statements included herein without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted in these interim statements. We believe that the interim statements include all adjustments (consisting of only normal recurring accruals) necessary for a fair presentation of results for the interim periods. These condensed consolidated financial statements are to be read in conjunction with the financial statements and notes thereto included in our 2002 Annual Report on Form 10-K. Certain prior year amounts have been reclassified to conform to current year presentation.

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

Note 2 — Accounts Receivable, Net

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

Note 3 — Inventory

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

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

Note 4 — Assets held for Sale

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

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

Components of net assets held for sale were as follows:

Note 5 — Earnings Per Share

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

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

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

Note 6 — Comprehensive Loss

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

Note 7 — Income Taxes

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

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

Note 8 — Recent Accounting Pronouncements

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

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

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

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

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

Note 9 — Non-Recurring Operating Items

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

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

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

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

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

Note 10 — Restructuring

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

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

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

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

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

Overview

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

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

Results of Operations

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Liquidity and Capital Resources

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

Critical Accounting Policies and Estimates

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

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

Factors That May Affect Future Results

The statements contained in this report that are not statements of historical fact, including without limitation, statements containing the words “believes,” “expects,” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time we may issue other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may materially differ. The following information highlights some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors. Factors that may result in such variances include, but are not limited to the following:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

We use a wide range of materials in the production of our products, including custom electronic and mechanical components, and we use numerous suppliers to supply materials. We generally do not have guaranteed supply arrangements with our suppliers. We seek to reduce the risk of production and service interruptions and shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. Although we make reasonable efforts to ensure that parts are available from multiple suppliers, key parts may be available only from a single supplier or a limited group of suppliers. Operations at our suppliers’ facilities are subject to disruption for a variety of reasons, including work stoppages, fire, earthquake, flooding or other natural disasters. Such disruption could interrupt our manufacturing. Our business may be harmed if we do not receive sufficient parts to meet our production requirements in a timely and cost-effective manner.

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

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

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

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

Diversion of management’s attention from other operational matters;

The potential loss of key employees of acquired companies;

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

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

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

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

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

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

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

Changing product specifications and customer requirements;

Difficulties in hiring and retaining necessary technical personnel;

Difficulties in reallocating engineering resources and overcoming resource limitations;

Difficulties with contract manufacturers;

Changing market or competitive product requirements; and

Unanticipated engineering complexities.

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

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

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

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

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

We may be subject to claims of intellectual property infringement.

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

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

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

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

Periodic local or geographic economic downturns and unstable political conditions;

Price and currency exchange controls;

Fluctuation in the relative values of currencies;

Difficulties protecting intellectual property;

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

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

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

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

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

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

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

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

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

Better withstand periodic downturns;

Compete more effectively on the basis of price and technology;

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

More effectively retain existing customers and obtain new customers.

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

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

Performance of our products;

Quality of our products;

Reliability of our products;

Cost of using our products;

Our ability to ship products on the schedule required;

Quality of the technical service we provide;

Timeliness of the services we provide;

Our success in developing new products and enhancements;

Existing market and economic conditions; and

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

We may not be able to compete successfully in the future, and increased competition may result in price reductions, reduced profit margins, and loss of market share.

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

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

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

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

The risk of more frequent instances of shipping delays.

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

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

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

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Item 3. Market Risk Disclosure

Interest Rate Risk

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

Foreign Currency Exchange Rate Risk

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

Item 4. Controls and Procedures

Disclosure Controls and Procedures

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

Internal Controls and Procedures

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

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Part II. Other Information

Item 1. Legal Proceedings

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

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

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

The following items were approved by the vote indicated:

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

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

Item 6. Exhibits and Reports on Form 8-K

Exhibits

Report on Form 8-K

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

SIGNATURES

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

ELECTRO SCIENTIFIC INDUSTRIES, INC.

28

SARBANES-OXLEY ACT SECTION 302(a) CERTIFICATION

I, James T. Dooley, certify that:

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Date: January 13, 2003

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

30

SARBANES-OXLEY ACT SECTION 302(a) CERTIFICATION

I, Joseph L. Reinhart, certify that:

31

Date: January 13, 2003

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

32

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

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

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

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

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

33

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

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

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

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

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

34