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 March 1, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number: 0-12853
ELECTRO SCIENTIFIC INDUSTRIES, INC.
(an Oregon corporation)
93-0370304
(I.R.S. Employer Identification No.)
13900 N.W. Science Park Drive, Portland, Oregon 97229
Registrant's telephone number: (503) 641-4141
Registrant's web address: www.esi.com
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
--- ---
The number of shares outstanding of the Registrant's Common Stock at August
1, 2003 was 27,837,914 shares.
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1. Consolidated Condensed Financial Statements (Unaudited)
Consolidated Condensed Balance Sheets - March 1, 2003 and
June 1, 2002 (restated) 2
Consolidated Condensed Statements of Operations -
Three and Nine Months Ended March 1, 2003 and
March 2, 2002 (restated) 3
Consolidated Condensed Statements of Cash Flows -
Nine Months Ended March 1, 2003 and March 2, 2002 (restated) 4
Notes to Consolidated Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
Item 4. Controls and Procedures 28
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 33
Signatures 34
1
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
(Unaudited)
March 1, June 1,
2003 2002
------------------- -------------------
Assets (Restated)
Current Assets:
Cash and cash equivalents $ 14,241 $ 29,435
Marketable securities 228,791 181,019
Restricted securities 6,293 6,353
------------------- -------------------
Total cash and securities 249,325 216,807
Trade receivables, net of allowances of
$1,462 at March 1 and $1,437 at June 1 50,397 55,810
Income tax refund receivable 27,018 14,402
Inventories, net 42,321 63,916
Shipped systems pending acceptance 7,192 2,007
Deferred income taxes 8,243 8,243
Assets held for sale 6,576 -
Other current assets 5,298 4,960
------------------- -------------------
Total Current Assets 396,370 366,145
Long-term marketable securities 42,499 73,445
Long-term restricted securities 6,053 12,047
Property, plant and equipment, at cost 85,803 95,656
Less - accumulated depreciation (35,872) (37,610)
------------------- -------------------
Net property, plant and equipment 49,931 58,046
Other assets 12,104 16,589
------------------- -------------------
------------------- -------------------
Total Assets $ 506,957 $ 526,272
=================== ===================
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ 3,964 $ 3,246
Accrued liabilities 18,074 16,062
Deferred revenue 12,600 5,308
------------------- -------------------
Total Current Liabilities 34,638 24,616
Convertible subordinated notes 141,675 145,897
------------------- -------------------
Total Liabilities 176,313 170,513
Shareholders' Equity:
Preferred stock, without par value; 1,000 shares
authorized; no shares issued - -
Common stock, without par value; 100,000
authorized; 27,825 and 27,619 shares issued
and outstanding at March 1, 2003 and
June 1, 2002, respectively 139,741 136,370
Retained earnings 190,270 219,561
Accumulated other comprehensive income 633 (172)
------------------- -------------------
Total Shareholders' Equity 330,644 355,759
------------------- -------------------
Total Liabilities and Shareholders' Equity $ 506,957 $ 526,272
=================== ===================
The accompanying notes are an integral part of these statements
2
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
For the Three Months Ended For the Nine Months Ended
--------------------------------------------------------------------------------
March 1, 2003 March 2, 2002 March 1, 2003 March 2, 2002
---------------- ---------------- ---------------- ----------------
(Restated) (Restated)
Net sales $ 31,631 $ 36,244 $ 114,407 $ 122,470
Cost of sales 32,175 19,529 96,134 66,276
---------------- ---------------- ---------------- ----------------
Gross margin (544) 16,715 18,273 56,194
Operating expenses:
Selling, service and administration 16,140 14,467 47,261 51,660
Research, development and engineering 5,706 7,774 20,618 29,300
---------------- ---------------- ---------------- ----------------
21,846 22,241 67,879 80,960
---------------- ---------------- ---------------- ----------------
Operating loss (22,390) (5,526) (49,606) (24,766)
Interest income 2,729 2,122 8,481 5,679
Interest expense (1,810) (1,571) (5,591) (1,649)
Other income (expense), net (224) (83) 41 (105)
---------------- ---------------- ---------------- ----------------
---------------- ---------------- ---------------- ----------------
695 468 2,931 3,925
---------------- ---------------- ---------------- ----------------
Income (loss) before income taxes (21,695) (5,058) (46,675) (20,841)
Provision (benefit) for income taxes (8,706) (6,300) (17,384) (11,574)
---------------- ---------------- ---------------- ----------------
Net income (loss) $ (12,989) $ 1,242 $ (29,291) $ (9,267)
================ ================ ================ ================
Net income (loss) per share - basic $ (0.47) $ 0.05 $ (1.06) $ (0.34)
================ ================ ================ ================
Net income (loss) per share - diluted $ (0.47) $ 0.04 $ (1.06) $ (0.34)
================ ================ ================ ================
Weighted average number of shares - basic 27,782 27,392 27,715 27,263
================ ================ ================ ================
Weighted average number of shares - diluted 27,782 28,087 27,715 27,263
================ ================ ================ ================
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 Nine Months Ended
--------------------------------------------------
March 1, 2003 March 2, 2002
-------------------- --------------------
(Restated)
Cash flows from operating activities:
Net loss $ (29,291) $ (9,267)
Adjustments to reconcile net loss to cash
provided by (used in) operating activities:
Depreciation and amortization 7,752 8,436
Tax benefit of stock options exercised 108 1,088
Provision for doubtful accounts 275 319
(Gain) loss on disposal and impairment of property and equipment (269) 1,135
Gain on debt extinguishment (218) -
Deferred income taxes 322 4,902
Changes in operating accounts:
Decrease in trade receivables, net 7,463 21,725
(Increase) decrease in inventories, net 19,005 (3,424)
Increase in income taxes receivable (12,616) (18,521)
Increase in other current assets (223) (5,057)
Increase in deferred revenue 7,292 1,627
(Increase) decrease in current liabilities 252 (17,929)
-------------------- --------------------
Net cash used in operating activities (148) (14,966)
Cash flows from investing activities:
Purchase of property, plant and equipment (8,040) (12,076)
Proceeds from the sale of property, plant and equipment 1,074 633
Maturity (purchase) of restricted securities 6,054 (18,179)
Purchase of securities (196,396) (522,835)
Proceeds from sales of securities and maturing securities 180,237 357,480
Decrease in other assets 3,438 544
-------------------- --------------------
Net cash used in investing activities (13,633) (194,433)
Cash flows from financing activities:
Proceeds from the sale of convertible notes - 145,500
Repurchase of ESI-issued convertible notes (4,676) -
Proceeds from exercise of stock options and stock plans 3,263 6,742
-------------------- --------------------
Net cash provided by financing activities (1,413) 152,242
Net change in cash and cash equivalents (15,194) (57,157)
Cash and cash equivalents:
Beginning of period 29,435 68,522
-------------------- --------------------
End of period $ 14,241 $ 11,365
==================== ====================
Supplemental cash flow information:
Cash paid for interest $ 6,410 $ 121
Income tax refunds received 5,604 -
Cash paid for income taxes 1,245 2,540
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
General
We have prepared the consolidated condensed financial statements included herein
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted in these interim statements. We believe that the interim
statements include all adjustments (consisting of only normal recurring
accruals) necessary for a fair presentation of results for the interim periods.
These consolidated condensed financial statements are to be read in conjunction
with the financial statements and notes thereto included in our 2002 Annual
Report on Form 10-K/A. Certain prior year amounts have been reclassified to
conform to current year presentation.
Results of operations for interim periods are not necessarily indicative of the
results to be expected for the full year.
Investigation and Restatements of Financial Statements
In March 2003, our Audit Committee commenced an internal investigation of
the circumstances surrounding the reversal of an employee benefits accrual that
occurred in the first quarter of 2003. The investigation also identified and
addressed: (1) unsupported accounting adjustments and clerical errors primarily
relating to inventory and cost of goods sold, and (2) certain other areas where
potential accounting errors could have occurred, including revenue recognition.
Restatement of 2002 Financial Statements
We have restated our financial statements for the fiscal year ended June 1,
2002 (and the quarters contained therein) principally related to the deferral of
revenue for certain transactions where customer specified acceptance criteria
existed but were not properly considered in determining whether our criteria for
revenue recognition had been met as of year-end. We also corrected our financial
statements for other matters we identified, including: the failure to write-off
fixed assets that were sold prior to year-end, but had not been removed from our
books, the write-off of inventory due to a change in our accounting for
defective parts being returned by customers, an unauthorized change in
depreciation methods and the correction of a bank error related to amortization
of bond premiums/discounts.
Restatement of Fiscal 2003 First and Second Quarters
We have also restated the financial statements for the quarters ended August 31,
2002 and November 30, 2002 related to the deferral of revenue, an unauthorized
change in depreciation method and the amortization of bond premiums/discounts as
described above.
5
For the first quarter of fiscal 2003, the financial statements have also been
restated to reflect the reinstatement of an inappropriately reversed accrual for
employee benefits. Other matters corrected for that quarter primarily include
the following: the write-down of inventory that was double counted, the
write-down of inventory due to an error in the computation of overhead, an
increase in operating expenses due to improper capitalization of a period
expense and an increase in warranty expense due to an unauthorized change in
accounting method.
For the second quarter of fiscal 2003, the financial statements have also
been restated for other matters primarily including: the write-down of inventory
due to an unauthorized change in our accounting for parts inventory at customer
locations, the write-down of inventory that was double counted, an increase in
accrued liabilities related to purchase commitments for excess and obsolete
inventory and an increase in warranty expense due to an unsupported accounting
entry.
These restated financial statements are included in our amended quarterly
reports on Form 10-Q/A for the fiscal quarters ended August 31, 2002 and
November 30, 2002 and our amended annual report on Form 10-K/A for the fiscal
year ended June 1, 2002, each of which was filed on August 11, 2003.
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 nine months
ended March 1, 2003. There were no accounts receivable sales for the nine months
ended March 2, 2002. Discounting fees were recorded as interest expense and were
not material for the nine months ended March 1, 2003 and March 2, 2002. At March
1, 2003, none of the 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
(in thousands):
March 1, 2003 June 1, 2002
---------------------- ----------------
(restated)
Raw materials and purchased parts $25,121 $ 41,013
Work-in-process 1,184 1,942
Finished goods 16,016 20,961
---------------------- ----------------
Total inventories $42,321 $ 63,916
====================== ================
6
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. During the third quarter of fiscal 2003, we
sold our 29,000 square foot building on 3 acres of land near Minneapolis,
Minnesota for $1.0 million, which resulted in a gain of $0.6 million that is
included as a component of selling, service and administration expense on our
consolidated condensed statements of operations for the three and nine month
periods ended March 1, 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. We have contracted with a real estate agent to
find a buyer and anticipate that we will sell the assets within one year.
We account for long-lived assets to be disposed of in accordance with Statement
of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which we adopted effective June 1, 2002. SFAS
No. 144 requires that long-lived assets that are to be disposed of by sale be
measured at the lower of book value or fair value less cost to sell. Based on
current market information provided by our real estate agent on the California
property, we determined that the market values of the property, less selling
costs, exceeds our book value for the property. Accordingly, we have reflected
the property on our consolidated condensed balance sheet as assets held for sale
at book value and have ceased depreciation.
Components of net assets held for sale were as follows (in thousands):
March 1, 2003
----------------------
Land $2,626
Buildings 3,931
Automobiles 19
----------------------
$6,576
======================
Note 5 - Earnings Per Share
Following is a reconciliation of basic earnings (loss) per share ("EPS") and
diluted EPS (in thousands, except per share amounts):
Three Months Ended March 1, 2003 Three Months Ended March 2, 2002
(restated)
------------------------------------ ------------------------------------
Per Share Per Share
Basic EPS Loss Shares Amount Income Shares Amount
- --------- ------------------------------------ ------------------------------------
Net income (loss) available to
common shareholders $ (12,989) 27,782 $ (0.47) $ 1,242 27,392 $ 0.05
=========== =============
Diluted EPS
Effect of dilutive stock options - - - 695
------------------------ ----------------------
Net income (loss) available to
common shareholders $ (12,989) 27,782 $ (0.47) $ 1,242 28,087 $ 0.04
=========== =============
7
Nine Months Ended March 1, 2003 Nine Months Ended March 2, 2002
(restated)
------------------------------------ ------------------------------------
Per Share Per Share
Basic EPS Loss Shares Amount Loss Shares Amount
- --------- ------------------------------------ ------------------------------------
Net loss available to common
shareholders $ (29,291) 27,715 $ (1.06) $ (9,267) 27,263 $ (0.34)
=========== =============
Diluted EPS
Effect of dilutive stock options - - - -
------------------------ ----------------------
Net loss available to common
shareholders $ (29,291) 27,715 $ (1.06) $ (9,267) 27,263 $ (0.34)
=========== =============
The following common stock equivalents were excluded from the diluted EPS
calculations because inclusion would have had an antidilutive effect (in
thousands):
Three and Nine Months Ended
----------------------------------
March 1, 2003 March 2, 2002
--------------- ---------------
Employee stock options 4,465 3,766
4 1/4% convertible subordinated notes 3,816 3,947
--------------- ---------------
8,281 7,713
=============== ===============
Note 6 - Comprehensive Income (Loss)
The components of comprehensive income (loss), net of tax, are as follows (in
thousands):
Three Months Ended Nine Months Ended
------------------------------------- -------------------------------------
March 1, 2003 March 2, 2002 March 1, 2003 March 2, 2002
------------------- ---------------- ---------------- -------------------
(restated) (restated)
Net income (loss) $ (12,989) $ 1,242 $ (29,291) $ (9,267)
Net unrealized gain (loss) on
derivative instruments (1) (1) 12 -
Foreign currency translation adjustment 21 (152) 126 (169)
Net unrealized gain (loss) on securities 163 (334) 667 33
------------------- ---------------- ---------------- -------------------
Total comprehensive income (loss) $ (12,806) $ 755 $ (28,486) $ (9,403)
=================== ================ ================ ===================
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 March 1, 2003 and March 2, 2002 was 40.1% and
124.6%, respectively. The tax rate for the three months ended March 2, 2002
included a benefit for the effect of the research and development tax credit
recognized during this quarter totaling 87.4%.
Note 8 - Recent Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board (FASB) issued SFAS No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." SFAS No. 149 addresses certain accounting issues related to hedging
activity and derivative instruments embedded in other contracts. In general, the
amendments require contracts with comparable characteristics to be accounted for
similarly. In addition, SFAS No. 149 provides guidance as to when a financing
component of a derivative must be given special reporting treatment in the
statement of cash flows. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003. We are currently evaluating the effects of SFAS
No. 149, but do not expect that the adoption of SFAS No. 149 will have a
material effect on our financial position or results of operations.
8
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities, An Interpretation of ARB No. 51."
FIN 46 provides guidance on: 1) the identification of entities for which control
is achieved through means other than through voting rights, known as "variable
interest entities" (VIEs); and 2) which business enterprise is the primary
beneficiary and when it should consolidate the VIE. This new model for
consolidation applies to entities: 1) where the equity investors (if any) do not
have a controlling financial interest; or 2) whose equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, FIN 46 requires
that both the primary beneficiary and all other enterprises with a significant
variable interest in a VIE make additional disclosures. FIN 46 is effective for
all new VIEs created or acquired after January 31, 2003. For VIEs created or
acquired prior to February 1, 2003, the provision of FIN 46 must be applied for
the first interim or annual period beginning after June 15, 2003. Certain
disclosures are effective immediately. We are in the process of assessing the
effects of FIN 46, but do not expect its implementation to have a material
effect on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation" to provide two additional alternative
transition methods if a company voluntarily decides to change its method of
accounting for stock-based employee compensation to the fair-value method. SFAS
No. 148 also amends the disclosure requirements of SFAS No. 123 by requiring
that companies make quarterly disclosures regarding pro forma effects of using
the fair-value method of accounting for stock-based compensation, effective for
interim periods beginning after December 15, 2002. We will adopt the disclosure
provisions of SFAS No. 148 during the fourth quarter of fiscal 2003.
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 the Consensus on Issue 00-21.
On December 31 2002, we adopted FASB Interpretation No. 45 (FIN 45), "Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 requires a liability to be
recognized at the time a company issues a guarantee for the fair value of the
obligations assumed under certain guarantee agreements. Additional disclosures
about guarantee agreements are also required in the interim and annual financial
statements. The adoption of FIN 45 did not have a material effect on our
financial position or the results of our operations.
9
In August 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
With Exit or Disposal Activities." SFAS No. 146 nullifies EITF Issue 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity." Under SFAS No. 146, liabilities for exit or disposal
activities are recognized and measured initially at fair value only when the
liability is incurred. This statement is effective for exit costs initiated
after December 31, 2002, and will be applied on prospective transactions only.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which is effective for fiscal years beginning after June 15, 2002.
SFAS No. 143 addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. SFAS No. 143 applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development, and normal operation of a long-lived asset, except
for certain lease obligations. We are evaluating the impact of SFAS No. 143, but
do not expect the adoption of SFAS No. 143 to have a significant effect on our
financial position or the results of our operations.
On June 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 provides a single accounting model
for long-lived assets to be disposed of and significantly changes the criteria
for classifying an asset as held-for-sale. Classification as held-for-sale is an
important distinction since such assets are not depreciated and are stated at
the lower of fair value or carrying amount. SFAS No. 144 also requires expected
future operating losses from discontinued operations to be displayed in the
period in which the losses are incurred, rather than as of the measurement date
as presently required. The adoption of SFAS No. 144 did not have a material
effect on our financial position or the results of our operations.
Note 9 - Restructuring and Special Charges
In order to better align our operating expenses with anticipated revenues, we
implemented a restructuring plan during June 2001. Pursuant to this plan, we
reduced our work force by a total of 419 employees in June and August 2001. An
additional 97 employees were terminated in October 2001. This reduction impacted
all employee groups. The restructuring plan also included vacating buildings
located in California, Massachusetts, Michigan, Minnesota, and Texas. We also
recorded a $3.5 million inventory write-down related to discontinuing the
manufacturing of certain products, which is reflected in costs of sales. The
following table displays the amounts included as restructuring and/or special
charges for the three and nine month periods ended March 2, 2002 (in thousands).
Three Months Ended Nine Months Ended
March 2, 2002 March 2, 2002
---------------------------- -------------------------
Employee severance and other employee expenses $ 391 $4,404
Facility consolidation and lease termination costs 56 1,660
Gain on disposal of equipment - (308)
Other expenses 208 870
---------------------------- -------------------------
655 6,626
Inventory write-downs (reflected in cost of sales) (388) 3,109
---------------------------- -------------------------
Total restructuring and special charges $ 267 $9,735
============================ =========================
10
On October 2, 2002, we announced a plan to relocate the manufacturing of our
Electronic Component Systems product line from Escondido, California to our
headquarters in Portland, Oregon. The consolidation of these facilities was
completed on December 31, 2002. 37 employees from our Escondido facility
accepted relocation offers to our headquarters. The remaining employees were
offered a severance package following a sixty-day required notice period. As a
result of the closure of the California facility, the discontinuance of certain
electronic component manufacturing product lines and other cost reduction steps,
headcount declined to approximately 700 employees at the end of the third
quarter of fiscal 2003. Included in cost of sales and operating expenses for the
three and nine months ended March 1, 2003 is $4.9 million and $22.6 million,
respectively, of restructuring and special charges related to these activities
and inventory write-downs related to the discontinuance of certain electronic
component manufacturing product lines.
In both the current and prior year, all restructuring costs have been included
in the line items to which they functionally relate.
Note 10 - Restructuring Accrual
At March 1, 2003, we had $0.7 million remaining in accrued liabilities relating
to our restructuring plans implemented in fiscal 2002 and 2003, compared to $1.0
million at June 1, 2002. The following table displays rollforwards of the
accruals from June 1, 2002 to March 1, 2003 (in thousands):
Accruals at Accruals at
June 1, Charges to Amounts March 1,
2002 Accruals Used 2003
-------------- ---------------- ---------------- -----------------
Lease termination fees and other
facility consolidation costs $ 664 $ 396 $ (440) $ 620
Purchase order obligations $ 334 $ - $ (334) $ -
Employee severance $ - $ 1,538 $ (1,438) $ 100
Accrued lease termination fees and other facility consolidation costs will
be paid through fiscal 2006 and accrued employee severance will be paid through
the first quarter of fiscal 2004.
Note 11 - Repurchase of Convertible Subordinated Notes
In December 2001 and January 2002, we sold $150 million aggregate principal
amount of 4 1/4% convertible subordinated notes due 2006 in a private offering.
In January 2003, our Board of Directors approved the repurchase of up to $50.0
million aggregate principal amount of these notes during calendar 2003. In
February 2003, we repurchased $5.0 million principal amount of our outstanding
convertible subordinated notes. For the three and nine month periods ended March
1, 2003, we recorded a gain of $0.2 million related to this repurchase, which is
reflected as other income on our consolidated condensed statements of
operations.
11
Note 12 - Legal Matters
Between March 26, 2003 and May 20, 2003, three putative class action lawsuits
were filed in the United States District Court for the District of Oregon
against ESI and David F. Bolender, James T. Dooley, and Joseph L. Reinhart, who
are current and/or former officers and directors of ESI. Lead plaintiffs and
lead counsel for plaintiffs have been appointed. Plaintiffs' consolidated class
action complaint is due to be filed 45 days following the filing of our restated
financial statements referred to below. In March 2003, our Audit Committee
commenced an investigation into certain accounting matters. As a result of the
investigation, which was completed on July 11, 2003, we have restated our
financial statements for the fiscal year ended June 1, 2002 and for the quarters
ended August 31, 2002 and November 30, 2002. The restated financial statements
are set forth in our annual report on Form 10-K/A and quarterly reports on Form
10-Q/A for the corresponding periods, filed August 11, 2003. The consolidated
class action complaint had not been filed and discovery had not yet commenced
when this report was filed, and we were in the early stages of our assessment of
the possible outcomes of this litigation. We expect, however, that the
litigation will be costly and will to some degree divert management's attention
from daily operations.
On March 31, 2003 and April 28, 2003, two separate purported shareholder
derivative complaints were filed in the Circuit Court of Oregon in Washington
County. The named defendants include certain current and/or former officers and
directors of ESI. ESI is named as a "nominal defendant." Lead plaintiffs and
lead counsel for plaintiffs have been appointed. The parties have stipulated
that the plaintiffs will file a consolidated complaint within 45 days of the
filing of our restated financial statements referred to above. The existing
complaints allege that certain defendants breached fiduciary duties to ESI and
were unjustly enriched. The complaint seeks an unspecified amount of monetary
damages and seeks various equitable remedies, including a constructive trust on
the proceeds received by the defendants from trading ESI common stock. As filed,
the complaints are derivative in nature and do not seek monetary damages from,
or the imposition of equitable remedies on, ESI. We have entered into
indemnification agreements in the ordinary course of business with our officers
and directors and may be obligated throughout this action to advance payment of
legal fees and costs incurred by the defendant current and former officers and
directors pursuant to the indemnification agreements and applicable Oregon law.
The special litigation committee of our board of directors, with the assistance
of independent legal counsel, is conducting an investigation relating to the
allegations asserted in the complaints.
On February 14, 2001, Cognex Corporation (Cognex) filed a lawsuit in the United
States District Court for the District of Massachusetts (Cognex Corporation v.
Electro Scientific Industries, Inc., No. 01-10287 RCL). The lawsuit alleges that
our CorrectPlace ver. 5.0 product infringes United States Patent 5,371,690,
which is owned by Cognex. The patent concerns the inspection of surface mount
devices that are attached to the surface of an electronic circuit board. Cognex
seeks injunctive relief, damages, costs and attorneys' fees. We filed a motion
for summary judgment of non-infringement on October 8, 2002, which remains
pending. Cognex filed motions for summary judgment on the issues of
unenforceability and mismarking on October 8, 2002. The court denied Cognex's
motion on the issue of unenforceability on April 25, 2003.
12
The motion on the issue of mismarking remains pending. We believe we have
meritorious defenses to the action and intend to pursue them vigorously. Fact
discovery is completed in the lawsuit. Additionally, certain of our customers
have notified us that, in the event it is subsequently determined that their use
of CorrectPlace ver. 5.0 infringes any patent, they may seek indemnification
from us for damages or expenses resulting from this matter.
In addition to the legal matters previously discussed, in the ordinary course of
business, we are involved in various other legal matters and investigations.
Total amounts included in accrued expenses related to all of our legal
activities, which represent estimated awards and assessments as well as unpaid
legal services incurred through March 1, 2003, was approximately $1.2 million.
In the opinion of management, amounts accrued for awards or assessments in
connection with these matters, which specifically excludes the class action
lawsuits and related derivative complaints noted above, are management's best
estimate and ultimate resolution of these matters will not have a material
effect on our consolidated financial position, results of operations or cash
flow. We can not reliably estimate the costs related to the class action
lawsuits and related derivative complaints at this time.
Note 13 - Subsequent Event - Legal Matters
See Note 12 for a discussion of changes to our legal matters subsequent to March
1, 2003.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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.
13
Fiscal 2003 Results
For certain information about our results of operations for the three months and
fiscal year ended May 31, 2003 and our financial condition at that date, please
see our Current Report on Form 8-K filed with the Securities and Exchange
Commission on August 11, 2003.
Results of Operations
Net sales decreased $4.6 million to $31.6 million for the quarter ended March 1,
2003 (the third quarter of fiscal 2003) from $36.2 million for the quarter ended
March 2, 2002 (the third quarter of fiscal 2002). Net sales decreased $8.1
million to $114.4 million for the nine months ended March 1, 2003 from $122.5
million for the nine months ended March 2, 2002.
The decrease in the third quarter of fiscal 2003 compared to the third quarter
of fiscal 2002 is a result of decreases in sales in all of our product lines
with the exception of the Advanced Electronic Packaging Systems product group.
While this market continues to be very competitive, we were successful in
winning sales at key customers. The largest sales decrease was in our Electronic
Component Systems product group. This market remains over-sold with significant
unused capacity. Semiconductor yield improvement systems comprised the largest
percentage of sales for the quarter at 37.9% of total sales versus 37.5% in the
third quarter of the prior year.
In addition to the above factors, the decrease in the nine months ended March 1,
2003 compared to the nine months ended March 2, 2002 is due to continued pricing
pressure in all of our markets, which resulted from continued softness in
overall electronics demand and pressure on our customers' earnings.
Certain information regarding our net sales by product line is as follows (net
sales in thousands):
Three Months Ended Three Months Ended
March 1, 2003 March 2, 2002
-------------------------------- -------------------------------
(restated)
Percent of Percent of
Net Sales Total Net Sales Net Sales Total Net Sales
--------- --------------- --------- ---------------
Semiconductor Yield Improvement Systems $ 11,989 37.9% $ 13,584 37.5%
Electronic Component Manufacturing Systems 6,544 20.7 10,569 29.1
Advanced Electronic Packaging Systems 6,293 19.9 2,999 8.3
Vision and Inspection Systems 3,229 10.2 3,705 10.2
Circuit Fine Tuning Systems 3,576 11.3 5,387 14.9
-------- ------ -------- ------
$ 31,631 100.0% $ 36,244 100.0%
-------- ------ ======== ======
14
Nine Months Ended Nine Months Ended
March 1, 2003 March 2, 2002
-------------------------------- -------------------------------
(restated)
Percent of Percent of
Net Sales Total Net Sales Net Sales Total Net Sales
--------- --------------- --------- ---------------
Semiconductor Yield Improvement Systems $ 47,015 41.1% $50,974 41.6%
Electronic Component Manufacturing Systems 22,255 19.5 32,653 26.7
Advanced Electronic Packaging Systems 19,267 16.8 11,626 9.5
Vision and Inspection Systems 9,378 8.2 8,780 7.2
Circuit Fine Tuning Systems 16,492 14.4 18,437 15.0
--------- ------ -------- ------
$ 114,407 100.0% $122,470 100.0%
--------- ------ ======== ======
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. Thirty-seven employees from our Escondido
facility accepted relocation offers to our headquarters. The remaining employees
were offered a severance package following a sixty-day required notice period.
As a result of the closure of the California facility, the discontinuance of
certain electronic component manufacturing product lines and other cost
reduction steps, headcount declined to approximately 700 employees at the end of
the third quarter of fiscal 2003. Included in cost of sales and operating
expenses for the three and nine months ended March 1, 2003 is $4.9 million and
$22.6 million, respectively, of restructuring and special charges related to
these activities and inventory write-downs related to the discontinuance of
certain electronic component manufacturing product lines.
The amount of restructuring and special charges included in costs of sales for
the three and nine months ended March 1, 2003 was $2.0 million and $15.9
million, respectively. For the nine month period, these charges included $6.8
million in inventory write-downs for excess and obsolete inventory, $2.5 million
of write-offs related to open purchase order commitments, $4.1 million in
inventory write-downs related to the discontinuance of certain electronic
component manufacturing product lines, $1.8 million in inventory write-downs and
long term asset impairments related to the discontinuance of certain other
product lines, $0.6 million in employee severance and other employee related
expenses and $0.3 million in other facilities consolidation costs, offset by a
$0.2 million gain on the disposal of equipment.
Gross margin decreased $17.3 million to $(0.5) million for the third quarter of
fiscal 2003 from $16.7 million (46.1% of net sales) for the third quarter of
fiscal 2002. Gross margin decreased $37.9 million to $18.3 million (16.0% of net
sales) for the nine month period ended March 1, 2003 from $56.2 million (45.9%
of net sales) for the comparable period of the prior fiscal year. As discussed
above, included in costs of sales for the three and nine month periods ended
March 1, 2003 were restructuring and special charges totaling $2.0 million and
$15.9 million, respectively. In comparison, the gross margin for three and nine
month periods ended March 2, 2002 included a gain of $0.4 million and a charge
of $3.1 million, respectively, for such charges, net. In addition to these
charges, the primary reasons for the decreases in our gross margins are low
utilization of our factory capacity, changes in our product mix and downward
pricing pressures.
15
Selling, service and administrative expenses were $16.1 million (51.0% of net
sales) and $47.3 million (41.3% of net sales), respectively, for the three and
nine month periods ended March 1, 2003 compared to $14.5 million (39.9% of net
sales) and $51.7 million (42.2% of net sales), respectively, for the comparable
periods of fiscal 2002. As a result of the Escondido consolidation and other
restructuring steps discussed above, included in selling, service and
administrative expenses for the three and nine month periods ended March 1, 2003
were $2.6 million and $5.6 million, respectively, of restructuring and/or
special charges. As a result of the restructuring plan we implemented in June
2001 as discussed in Note 9, included in selling, service and administrative
expenses for the three and nine month periods ended March 2, 2002, were
restructuring and special charges totaling $0.5 million and $5.3 million,
respectively. Increases in selling, service and administrative expenses in the
fiscal 2003 periods due to these charges were offset in part by a reduction in
force and other cost reduction efforts compared to prior year levels. Selling,
service and administrative expense is expected to increase significantly in the
fourth quarter of fiscal 2003 as a result of professional fees incurred in
connection with the internal investigation of certain accounting matters,
defending the shareholder and derivative suits described in Part II, Item 1,
"Legal Proceedings," and complying with the Sarbanes-Oxley Act of 2002. We
expect to continue to incur additional expenses in fiscal 2004 in connection
with defending the shareholder and derivative suits and complying with the
Sarbanes-Oxley Act. We also expect to pay increased premiums for our directors'
and officers' liability insurance in fiscal 2004.
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. Research, development and engineering expenses were $5.7 million (18.0%
of net sales) and $20.6 million (18.0% of net sales), respectively, for the
three and nine month periods ended March 1, 2003 compared to $7.8 million (21.4%
of net sales) and $29.3 million (23.9% of net sales) for the comparable periods
in the prior fiscal year. As a result of the Escondido consolidation and other
restructuring steps discussed above, included in research, development and
engineering expenses for the three and nine month periods ended March 1, 2003
were restructuring and special charges totaling $0.3 million and $1.2 million,
respectively. As a result of the restructuring plan we implemented in June 2001
as discussed in Note 9, included in research, development and engineering
expenses for the three and nine month periods ended March 2, 2002, were
restructuring and special charges totaling $0.1 million and $1.3 million,
respectively. Increases in research, development and engineering expenses due to
these charges were more than offset by reductions due to the relocation of our
Electronic Component Systems group to our headquarters in Portland, Oregon from
Escondido, California. Research and development spending often fluctuates from
quarter to quarter as engineering projects move through their life cycles. We
continue to invest in a significant number of development and engineering
projects that we see as important to our future.
Interest income was $2.7 million and $8.5 million, respectively, for the three
and nine month periods ended March 2, 2003 compared to $2.1 million and $5.7
million, respectively, for the comparable periods of fiscal 2002. The increases
in the fiscal 2003 periods compared to the fiscal 2002 periods are due to an
increase in our investment balances as a result of our sale of $150 million
aggregate principal amount of 4 1/4% convertible subordinated notes due 2006
(the "Convertible Notes") in December 2001 and January 2002.
16
Interest expense was $1.8 million and $5.6 million, respectively, for the three
and nine month periods ended March 1, 2003 compared to $1.6 million for both of
the comparable periods of the prior fiscal year. These increases are primarily
due to the sale in December 2001 and January 2002 of $150 million aggregate
principal amount of Convertible Notes. Quarterly interest related to the
Convertible Notes, after the $5.0 million principal amount repurchase in the
third quarter of fiscal 2003, totals $1.5 million plus $0.2 million for the
accretion of underwriting discounts.
Net other loss of $0.2 million in the three months ended March 1, 2003 includes
a $0.4 million loss on securities, offset in part by a $0.2 million gain related
to the repurchase of $5.0 million principal amount of Convertible Notes
described above. The $41,000 of other income in the nine month period ended
March 1, 2003 includes a gain of $0.6 million related to legal settlements and a
$0.2 million gain related to the repurchase of $5.0 million principal amount of
Convertible Notes, offset by a net $0.5 million loss on the sale of securities
and $0.2 million of bank charges.
The income tax rate for the nine months ended March 1, 2003 was 37.2% compared
to 55.5% for the comparable period of fiscal 2002. The rate in fiscal 2002
includes the effects of a $4.6 million tax credit due to a re-evaluation of our
application of the research and development tax credit for the years 1996
through 2001.
Net loss was $13.0 million, or $0.47 per diluted share, and $29.3 million, or
$1.06 per diluted share, respectively, for the three and nine month periods
ended March 1, 2003 compared to net income of $1.2 million, or $0.04 per diluted
share, and a net loss of $9.3 million, or $0.34 per diluted share, in the
comparable periods of fiscal 2002.
Liquidity and Capital Resources
At March 1, 2003, our principal sources of liquidity consisted of existing
cash, cash equivalents and marketable securities of $285.5 million and accounts
receivable of $50.4 million. At March 1, 2003, we had a current ratio of 11.4:1
and with a long-term debt carrying value of $141.7 million. Working capital
increased to $361.7 million at March 1, 2003 compared to $341.5 million at June
1, 2002.
Trade receivables decreased $5.4 million to $50.4 million at March 1, 2003 from
$55.8 million at June 1, 2002 due lower sales and fewer sales with extended
terms.
Income tax refunds receivable increased $12.6 million to $27.0 million at March
1, 2003 from $14.4 million at June 1, 2002 due to the availability of tax
benefits related to the carry-back of our fiscal 2003 net losses.
Inventory decreased $21.6 million to $42.3 million at March 1, 2003 from
$63.9 million at June 1, 2002. Inventories were written down by a total of $11.9
million in the nine months ended March 1, 2003 for excess, obsolescence and
discontinued product lines. In addition, we transferred $5.2 million of
inventory to shipped systems pending acceptance during the nine months ended
March 1, 2003.
17
Purchases of property, plant and equipment of $8.0 million in the first nine
months of fiscal 2003 were primarily for the continued construction and
completion of our new corporate headquarters in Portland, Oregon.
At March 1, 2003 we had $141.7 million recorded on our balance sheet related to
the Convertible Notes. During the third quarter of fiscal 2003, we repurchased
$5.0 million principal amount of the Convertible Notes. The difference between
the remaining $145.0 million face value and the $141.7 million balance at March
1, 2003 relates to underwriting discounts, which originally totaled $4.5 million
and are being amortized as additional interest expense over the life of the
Convertible Notes at a rate of $0.2 million per quarter.
Critical Accounting Policies and Estimates
We reaffirm the critical accounting policies and our use of estimates as
reported in our annual report on Form 10-K/A for the year-ended June 1, 2002, as
filed with the Securities and Exchange Commission on August 11, 2003.
Factors That May Affect Future Results
The statements contained in this report that are not statements of historical
fact, including without limitation, statements containing the words "believes,"
"expects," and similar words, constitute forward-looking statements that are
subject to a number of risks and uncertainties. From time to time we may issue
other forward-looking statements. Investors are cautioned that such
forward-looking statements are subject to an inherent risk that actual results
may materially differ. The following information highlights some of the factors
that could cause actual results to differ materially from the results expressed
or implied by our forward-looking statements. Forward-looking statements should
be considered in light of these factors. Factors that may result in such
variances include, but are not limited to the following:
The industries that comprise our primary markets are volatile and unpredictable.
Our business depends upon the capital expenditures of manufacturers of
components and circuitry used in wireless communications, computers, automotive
electronics and other electronic products. In the past, the markets for
electronic devices have experienced sharp downturns. During these downturns,
electronics manufacturers, including our customers, have delayed or canceled
capital expenditures, which has had a negative impact on our financial results.
The current economic downturn has resulted in a reduction in demand for our
products and significant reductions in our profitability and net sales. We had a
net loss of $29.3 million during the nine months ended March 1, 2003 on net
sales of $114.4 million and a net loss of $17.8 million for the year ended June
1, 2002. We cannot assure you that demand for our products will increase. If
demand for our product does increase, there may be significant fluctuations in
our profitability and net sales.
18
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.
Pending or future litigation could have a material adverse impact on our
operating results and financial condition.
In addition to intellectual property litigation, we have been, from time to
time, subject to legal proceedings and claims, including a putative securities
class action lawsuit and other securities-related litigation. See Part II, Item
1, "Legal Proceedings."
Where we can make a reasonable estimate of the liability relating to pending
litigation, we record a liability. As additional information becomes available,
we assess the potential liability and revise estimates as appropriate. Because
of uncertainties relating to litigation, however, the amount of our estimates
could be wrong. Moreover, plaintiffs may not specify an amount of damages
sought. In addition to the direct costs of litigation and the use of cash,
pending or future litigation could divert management's attention and resources
from the operation of our business. Accordingly, our operating results and
financial condition could suffer.
We face risks relating to a pending SEC inquiry and the results of
our internal investigation of accounting matters.
On March 20, 2003, we contacted the SEC in connection with our issuance of a
press release announcing the need to restate our financial results for the
quarters ended August 31, 2002 and November 30, 2002. In March 2003, the audit
committee of our board of directors, with the assistance of outside legal
counsel and independent forensic accountants, commenced an internal
investigation of certain accounting matters. The investigation involved the
review of (1) the circumstances surrounding the reversal of an accrual for
employee benefits, (2) unsupported accounting adjustments and clerical errors
primarily relating to inventory and cost of goods sold, and (3) certain other
areas where potential accounting errors could have occurred, including revenue
recognition. As a result of the investigation, we determined that our unaudited
consolidated condensed financial statements for the three months ended August
31, 2002 and November 30, 2002, and our audited consolidated financial
statements for the year ended June 1, 2002 required restatement. We will
continue to cooperate with any government investigation into the matters
addressed by the internal investigation. Depending on the scope, timing and
result of any governmental investigation, management's attention and our
resources could be diverted from operations, which could adversely affect our
operating results and contribute to future stock price volatility. Governmental
investigations also could lead to further restatement of our prior period
financial statements or require that we take other actions not currently
contemplated.
19
Our management is implementing what it believes to be improvements in our
internal and disclosure controls and procedures. See Item 4. Controls and
Procedures. Nonetheless, future accounting restatements could occur because
these controls and procedures prove to be ineffective or for other reasons.
During the pendency of its internal investigation, our audit committee was in
contact with attorneys in the SEC's Enforcement Division and kept them informed
of the progress of the investigation. Our audit committee completed its
investigation and delivered a final report to the SEC on August 1, 2003. After
its review of the final report, the SEC could commence a formal investigation
into the accounting matters. Such an investigation would result in a diversion
of management's attention and resources which could negatively impact our
operating results and may contribute to current and future stock price
volatility. Moreover, an SEC investigation could lead to further restatement of
our prior period financial statements or require that we take other actions not
currently contemplated. Our management is implementing a more effective system
of internal controls, however, there can be no assurance that these efforts will
be adequate to prevent future restatements.
In addition to a potential SEC investigation, the restatement of our previously
issued financial statements may lead to new litigation, may expand the claims
and the class periods in pending litigation, and may increase the cost of
defending or resolving current litigation.
Our operating results could suffer as we have recently experienced
significant changes in our senior management and plan to add new members to our
management team.
Several members of our senior management have only joined ESI as employees in
the last few months and we intend to continue to add new members to our senior
management team. Changes in management may be disruptive to our business and
negatively impact our operating results and may result in the departure of
existing employees or customers. Further, it could take an extended period of
time to locate, retain and integrate qualified management personnel.
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 and 2003 we adopted restructuring plans 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.
20
Our ability to reduce costs is limited by our need to invest in research and
development.
Our industry is characterized by the need for continued investment in research
and development. Because of intense competition in the industries in which we
compete, if we were to fail to invest sufficiently in research and development,
our products could become less attractive to potential customers, and our
business and financial condition could be materially and adversely affected. As
a result of our need to maintain our spending levels in this area, our operating
results could be materially harmed if our net sales fall below expectations. In
addition, as a result of our emphasis on research and development and
technological innovation, our operating costs may increase further in the
future, and research and development expenses may increase as a percentage of
total operating expenses and as a percentage of net sales.
We depend on a few significant customers and we do not have long-term contracts
with any of our customers.
Twelve large, multinational electronics companies represented 50.0% of our
fiscal 2002 net sales, and the loss of any of these customers could
significantly harm our business. In addition, none of our customers have any
long-term obligation to continue to buy our products or services, and any
customer could delay, reduce or cease ordering our products or services at any
time.
Delays in shipment or manufacturing of our products could substantially
decrease our sales for a period.
We will continue to derive a substantial portion of our revenues from the sale
of a relatively small number of products with high average selling prices, some
with prices as high as $2.0 million per unit. We generally recognize revenue
upon shipment of our products. As a result, the timing of revenue recognition
from a small number of orders could have a significant impact on our net sales
and operating results for a reporting period. Shipment delays could
significantly impact our recognition of revenue and could be further magnified
by announcements from us or our competitors of new products and technologies,
which announcements could cause our customers to defer purchases of our existing
systems or purchase products from our competitors. Any of these delays could
result in a material adverse change in our results of operations for any
particular period.
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.
21
Failure of critical suppliers of parts, components and manufacturing
equipment to deliver sufficient quantities to us in a timely and cost-effective
manner could negatively affect our business.
We use a wide range of materials in the production of our products, including
custom electronic and mechanical components, and we use numerous suppliers to
supply materials. We generally do not have guaranteed supply arrangements with
our suppliers. We seek to reduce the risk of production and service
interruptions and shortages of key parts by selecting and qualifying alternative
suppliers for key parts, monitoring the financial stability of key suppliers and
maintaining appropriate inventories of key parts. Although we make reasonable
efforts to ensure that parts are available from multiple suppliers, key parts
may be available only from a single supplier or a limited group of suppliers.
Operations at our suppliers' facilities are subject to disruption for a variety
of reasons, including work stoppages, fire, earthquake, flooding or other
natural disasters. Such disruption could interrupt our manufacturing. Our
business may be harmed if we do not receive sufficient parts to meet our
production requirements in a timely and cost-effective manner.
We may make additional acquisitions in the future, and these acquisitions
may subject us to risks associated with integrating these businesses into our
current business.
Although we have no commitments or agreements for any acquisitions, we have
made, and plan in the future to make, acquisitions of, or significant
investments in, businesses with complementary products, services or
technologies.
Acquisitions involve numerous risks, many of which are unpredictable and beyond
our control, including:
- -- Difficulties and increased costs in connection with integration of the
personnel, operations, technologies and products of acquired companies;
- -- Diversion of management's attention from other operational matters;
- -- The potential loss of key employees of acquired companies;
- -- Lack of synergy, or inability to realize expected synergies, resulting from
the acquisition;
- -- The risk that the issuance of our common stock in a transaction could be
dilutive to our shareholders if anticipated synergies are not realized; and
- -- Acquired assets becoming impaired as a result of technological advancements
or worse-than-expected performance by the acquired company.
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.
22
Our markets are subject to rapid technological change, and to compete
effectively we must continually introduce new products that achieve market
acceptance.
The markets for our products are characterized by rapid technological change and
innovation, frequent new product introductions, changes in customer requirements
and evolving industry standards. Our future performance will depend on the
successful development, introduction and market acceptance of new and enhanced
products that address technological changes as well as current and potential
customer requirements. The introduction by us or by our competitors of new and
enhanced products may cause our customers to defer or cancel orders for our
existing products, which may harm our operating results. We have in the past
experienced a slowdown in demand for our existing products and delays in new
product development, and similar delays may occur in the future. We also may not
be able to develop the underlying core technologies necessary to create new
products and enhancements or, where necessary, to license these technologies
from others. Product development delays may result from numerous factors,
including:
- -- Changing product specifications and customer requirements;
- -- Difficulties in hiring and retaining necessary technical personnel;
- -- Difficulties in reallocating engineering resources and overcoming resource
limitations;
- -- Difficulties with contract manufacturers;
- -- Changing market or competitive product requirements; and
- -- Unanticipated engineering complexities.
The development of new, technologically advanced products is a complex and
uncertain process, requiring high levels of innovation and highly skilled
engineering and development personnel, as well as the accurate anticipation of
technological and market trends. We cannot assure you that we will be able to
identify, develop, manufacture, market or support new or enhanced products
successfully, if at all, or on a timely basis. Further, we cannot assure you
that our new products will gain market acceptance or that we will be able to
respond effectively to product announcements by competitors, technological
changes or emerging industry standards. Any failure to respond to technological
change would significantly harm our business.
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.
23
Further, our efforts to protect our intellectual property may be less effective
in some foreign countries where intellectual property rights are not as well
protected as in the United States. Many U.S. companies have encountered
substantial problems in protecting their proprietary rights against infringement
in foreign countries. If we fail to adequately protect our intellectual property
in these countries, it could be easier for our competitors to sell competing
products in foreign countries.
We may be subject to claims of intellectual property infringement.
Several of our competitors hold patents covering a variety of technologies,
applications and methods of use similar to some of those used in our products.
From time to time, we and our customers have received correspondence from our
competitors claiming that some of our products, as used by our customers, may be
infringing one or more of these patents. For example, in February 2001, Cognex
Corporation filed a lawsuit against us claiming we infringed a patent owned by
it. Competitors or others may assert infringement claims against our customers
or us in the future with respect to current or future products or uses, and
these assertions may result in costly litigation or require us to obtain a
license to use intellectual property rights of others. If claims of infringement
are asserted against our customers, those customers may seek indemnification
from us for damages or expenses they incur. Total amounts included in accrued
expenses related to all of our legal activities, which represent estimated
awards and assessments as well as unpaid legal services incurred through March
1, 2003, was approximately $1.2 million.
If we become subject to infringement claims, we will evaluate our position and
consider the available alternatives, which may include seeking licenses to use
the technology in question or defending our position. These licenses, however,
may not be available on satisfactory terms or at all. If we are not able to
negotiate the necessary licenses on commercially reasonable terms or
successfully defend our position, our financial condition and results of
operations could be materially and adversely affected.
We are exposed to the risks of operating a global business, including risks
associated with exchange rate fluctuations and legal and regulatory changes.
International shipments accounted for 74.8% of net sales for fiscal 2002, with
46.8% of our net sales to customers in Asia. We expect that international
shipments will continue to represent a significant percentage of net sales in
the future. Our non-U.S. sales and operations are subject to risks inherent in
conducting business abroad, many of which are outside our control, including the
following:
- -- 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.
24
In addition, our ability to address normal business transaction issues
internationally is at risk due to outbreaks of serious contagious diseases. For
example, in response to the recent Severe Acute Respiratory Syndrome outbreak in
Asia, management limited travel to Asia in accordance with the World Health
Organization's recommendations.
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.
25
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.
Possibilities of terrorist attacks 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.
26
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.
- -- The risk that demand for our products may not increase or may decrease.
Our inability to attract and retain sufficient numbers of managerial,
financial, 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, financial,
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. In April 2003,
Barry L. Harmon became President and Chief Executive Officer of ESI with the
understanding that he will serve in that capacity until a permanent successor is
hired. Recently, The Board of Directors decided to commence a search in the fall
for a new Chief Executive Officer to succeed Mr. Harmon. In addition, there are
several key positions open in our finance department. We are in the process of
recruiting highly skilled accounting and financial reporting personnel to fill
these finance positions. It could take longer than anticipated, however, to hire
and train the appropriately qualified professionals. Moreover, we cannot be
certain that the employees hired to fulfill these duties will perform at the
level necessary to ensure that our internal controls are not compromised. It may
also take longer than anticipated to hire a new Chief Executive Officer. In
addition, we may not be able to retain our key managerial, financial,
engineering and technical employees. Our growth may be affected by our ability
to hire new managerial personnel, highly skilled and qualified technical
personnel, and personnel that can implement and monitor our financial controls
and reporting systems. Attracting and retaining qualified personnel is
difficult, and our recruiting efforts to attract and retain these personnel may
not be successful.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
As of March 1, 2003, our investment portfolio included marketable debt
securities of $271.3 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 shareholders' 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 $145 million
aggregate principal amount of 4 1/4% convertible subordinated notes due 2006 is
at a fixed interest rate. Therefore, there is no associated volatility.
27
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
Immediately following the signature page of this quarterly report are
certifications of our President and Chief Executive Officer and our Chief
Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002 (the
"Section 302 Certification"). This portion of our quarterly report on Form 10-Q
is our disclosure of the results of our controls evaluation conducted under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, and within 90 days prior to the
filing of this quarterly report referred to in paragraphs (4), (5) and (6) of
the Section 302 Certification and should be read in conjunction with the Section
302 Certification for a more complete understanding of the topics presented.
In March 2003 the Audit Committee of our Board of Directors, with the assistance
of outside legal counsel and forensic accountants, commenced an internal
investigation of certain accounting matters. The investigation involved the
review of (1) the circumstances surrounding the reversal of an accrual for
employee benefits, (2) unsupported accounting adjustments and clerical errors
primarily relating to inventory and cost of goods sold, and (3) certain other
areas where potential accounting errors could have occurred, including revenue
recognition. On July 15, 2003, we announced that the Audit Committee had
completed its review of these matters. As a result of the review, we determined
that the unaudited consolidated condensed financial statements for the three
months ended August 31, 2002 and November 30, 2002 and the audited consolidated
financial statements for the year ended June 1, 2002 required restatement.
28
Management has advised the Audit Committee that upon reviewing the restatement
adjustments and performing an evaluation of our controls and disclosure
procedures, management noted deficiencies in internal controls relating to:
1. Lack of complete sales documentation, particularly as it relates to
customer specified acceptance criteria;
2. Lack of adequate job transition/cross training and poorly documented
"desk" processes and procedures in the finance/accounting area;
3. Changes to accounting methodologies without notification to, or proper
authorization by, accounting oversight parties (i.e., the audit
committee and independent auditors); and
4. Lack of adequate tracking and monitoring of finished goods inventory
that was transferred out of the inventory management information
system.
The independent auditors advised the Audit Committee that these internal
control deficiencies constitute reportable conditions and, collectively, a
material weakness as defined in Statement of Auditing Standards No. 60. Certain
of these internal control weaknesses may also constitute deficiencies in our
disclosure controls.
While we, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, are in the process of
implementing a more effective system of disclosure controls and procedures, we
have instituted controls, procedures and other changes to ensure that
information required to be disclosed in this quarterly report on Form 10-Q has
been recorded, processed, summarized and reported. The steps that we have taken
to ensure that all material information about our company is accurately
disclosed in this report include:
1. The appointment of an independent director to be Chairman of the Board
in April 2003, who was previously the Chief Executive Officer and
Chairman of the Board of KLA-Tencor Corporation;
2. The appointment of a previously independent director to be President
and Chief Executive Officer in April 2003, who was previously Chief
Financial Officer of Apex, Inc. and was the former Senior Vice
President and Chief Financial Officer of ESI for seven years until
1998;
3. The appointment of a new Chief Financial Officer in May 2003, who was
previously Chief Financial Officer of SpeedFam-IPEC, Inc. and Vice
President and Corporate Controller of Novellus Systems, Inc.;
4. The engagement of outside professionals specializing in accounting and
finance to assist our management in the collection, substantiation and
analysis of the information contained in this report; and
5. The performance of additional procedures by us designed to ensure that
these internal control deficiencies did not lead to material
misstatements in our consolidated financial statements.
29
We have also increased by two the number of independent directors on our
board by electing Richard J. Faubert, who previously served as President and
Chief Executive Officer of SpeedFam-IPEC, Inc. and held senior management
positions at Tektronix, Inc. and Genrad, Inc., and Frederick A. Ball, who
previously served as Senior Vice President and Chief Financial Officer of
Borland Software Corporation and as Vice President of Finance of KLA-Tencor
Corporation.
Based in part on the steps listed above, our President and Chief Executive
Officer and our Chief Financial Officer have concluded that our disclosure
controls and procedures are effective to ensure that information we are required
to disclose in reports that we file or submit under the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.
In addition, in order to address further the deficiencies described above and to
improve our internal disclosure and control procedures for future periods, we
will:
1. Review and revise our processes and procedures for applying revenue
recognition policies, including more formalized training of finance,
sales, order management and other staffs;
2. Enhance accounting/finance training programs and desk processes and
procedures documentation as well as retain additional full-time
experienced accounting/finance personnel;
3. Provide additional management oversight and perform detailed reviews
of disclosures and reporting with the assistance of outside legal
counsel;
4. Account for all completed systems in the inventory management
information system; and
5. Use outside resources, as necessary, to supplement our employees in
the preparation of the consolidated financial statements and other
reports filed or submitted under the Securities Exchange Act of 1934.
These steps will constitute significant changes in internal controls. We
will continue to evaluate the effectiveness of our disclosure controls and
internal controls and procedures on an ongoing basis, and will take further
action as appropriate.
30
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Between March 26, 2003 and May 20, 2003, three putative class action lawsuits
were filed in the United States District Court for the District of Oregon
against the Company and David F. Bolender, James T. Dooley, and Joseph L.
Reinhart, who are current and/or former officers and directors of ESI. The
complaints were filed on behalf of a purported class of persons who purchased
ESI's common stock between September 17, 2002 and at the latest April 15, 2003.
The complaints assert causes of action (and seek unspecified damages) for
alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and
Rule 10b-5 promulgated thereunder, as well as Section 20(a) of the Act. In
particular, the complaints allege that the defendants were involved in making
false and misleading statements during the putative class period about ESI's
business, prospects, and operations, all of which resulted in artificially
inflating ESI's stock price. The complaints have been consolidated under the
name In re Electro Scientific Industries, Inc. Securities Litigation, Case No.
CV 03-404-HA. Lead plaintiffs and lead counsel for plaintiffs have been
appointed. Plaintiffs' consolidated class action complaint is due to be filed 45
days following the filing of our restated financial statements referred to
below. In March 2003, our Audit Committee commenced an investigation into
certain accounting matters. As a result of the investigation, which was
completed on July 11, 2003, we have restated our financial statements for the
fiscal year ended June 1, 2002 and for the quarters ended August 31, 2002 and
November 30, 2002. The restated financial statements are set forth in our annual
report on Form 10-K/A and quarterly reports on Form 10-Q/A for the corresponding
periods, filed August 11, 2003. The consolidated class action complaint had not
been filed and discovery had not yet commenced when this report was filed, and
we were in the early stages of our assessment of the possible outcomes of this
litigation. We expect, however, that the litigation will be costly and will to
some degree divert management's attention from daily operations.
On March 31, 2003 and April 28, 2003, two separate purported shareholder
derivative complaints were filed in the Circuit Court of Oregon in Washington
County. The named defendants include certain current and/or former officers and
directors of ESI. ESI is named as a "nominal defendant." The complaints have
been consolidated under the name In Re Electro Scientific Industries, Inc.
Derivative Litigation, Lead Case No. C 031067 CV. Lead plaintiffs and lead
counsel for plaintiffs have been appointed. The parties have stipulated that the
plaintiffs will file a consolidated complaint within 45 days of the filing of
our restated financial statements referred to above. The existing complaints
allege that certain defendants breached fiduciary duties to ESI and were
unjustly enriched. The complaint seeks an unspecified amount of monetary damages
and seeks various equitable remedies, including a constructive trust on the
proceeds received by the defendants from trading ESI common stock. As filed, the
complaints are derivative in nature and do not seek monetary damages from, or
the imposition of equitable remedies on, ESI. We have entered into
indemnification agreements in the ordinary course of business with our officers
and directors and may be obligated throughout this action to advance payment of
legal fees and costs incurred by the defendant current and former officers and
directors pursuant to the indemnification agreements and applicable Oregon law.
The special litigation committee of our board of directors, with the assistance
of independent legal counsel, is conducting an investigation relating to the
allegations asserted in the complaints.
31
On February 14, 2001, Cognex Corporation (Cognex) filed a lawsuit in the United
States District Court for the District of Massachusetts (Cognex Corporation v.
Electro Scientific Industries, Inc., No. 01-10287 RCL). The lawsuit alleges that
our CorrectPlace ver. 5.0 product infringes United States Patent 5,371,690,
which is owned by Cognex. The patent concerns the inspection of surface mount
devices that are attached to the surface of an electronic circuit board. Cognex
seeks injunctive relief, damages, costs and attorneys' fees. We filed a motion
for summary judgment of non-infringement on October 8, 2002, which remains
pending. Cognex filed motions for summary judgment on the issues of
unenforceability and mismarking on October 8, 2002. The court denied Cognex's
motion on the issue of unenforceability on April 25, 2003. The motion on the
issue of mismarking remains pending. We believe we have meritorious defenses to
the action and intend to pursue them vigorously. Fact discovery is completed in
the lawsuit. Additionally, certain of our customers have notified us that, in
the event it is subsequently determined that their use of CorrectPlace ver. 5.0
infringes any patent, they may seek indemnification from us for damages or
expenses resulting from this matter.
Item 5. Other Information
Changes in Management and Board of Directors
On April 15, 2003, James T. Dooley, our President and Chief Executive
Officer, was placed on administrative leave of absence pending the results of a
review of our financial statements for the first two quarters of fiscal 2003.
Mr. Dooley remained on our Board of Directors at this time. During Mr. Dooley's
leave of absence, Mr. Barry L. Harmon, who was, at the time of Mr. Dooley's
being placed on leave, a member of our Board of Directors and our Audit
Committee, served as our President and Chief Executive Officer. On June 9, 2003,
Mr. Dooley was terminated and resigned from our board of directors. Mr. Harmon
continues to serve as our Chief Executive Officer.
In addition, also on April 15, 2003, Mr. Larry L. Hansen, a member of our Board
of Directors and our Compensation and Governance and Nominating Committees,
became a member of our Audit Committee and Mr. Jon D. Tompkins was named
Chairman of the Board of Directors, succeeding Mr. David F. Bolender, who
remains a director of ESI.
On May 5, 2003, we hired J. Michael Dodson to be our Vice President of
Administration and Chief Financial Officer. Mr. Dodson replaced Richard Okumoto
who resigned. Mr. Okumoto was hired by ESI in February 2003.
Mr. Richard J. Faubert and Mr. Frederick Ball were elected to our Board of
Directors on June 3, 2003 and July 17, 2003, respectively.
Restatements
In March 2003 our Audit Committee commenced an internal investigation of certain
accounting matters. The investigation involved the review of (1) the
circumstances surrounding the reversal of an accrual for employee benefits, (2)
unsupported accounting adjustments and clerical errors primarily relating to
inventory and cost of goods sold, and (3) certain other areas where potential
accounting errors could have occurred, including revenue recognition. As a
result of the investigation, we determined that the unaudited consolidated
condensed financial statements for the three months ended August 31, 2002 and
November 30, 2002, and the audited consolidated financial statements for the
year ended June 1, 2002 (and the quarters contained therein) required
restatement.
32
These restated financial statements are included in our amended quarterly
reports on Form 10-Q/A for the fiscal quarters ended August 31, 2002 and
November 30, 2002 and our amended annual report on Form 10-K/A for the fiscal
year ended June 1, 2002, each of which was filed on August 11, 2003.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
This list is intended to constitute the exhibit index.
10.1 Agreement and Release of All Claims by and between Electro Scientific
Industries, Inc. and Mr. Robert E. Belter dated September 19, 2001.
10.2 Separation Agreement by and between Electro Scientific Industries,
Inc. and Mr. Kevin Longe dated September 12, 2002.
10.3 Separation Agreement by and between Electro Scientific
Industries, Inc. and Mr. Brad Cooley dated February 24, 2003.
10.4 Separation Agreement by and between Electro Scientific
Industries, Inc. and Mr. Gary Kapral dated June 11, 2003.
10.5 Change in Control Agreement by and between Electro Scientific
Industries, Inc. and Mr. Bob Chamberlain dated January 16, 2003.
10.6 Change in Control Agreement by and between Electro Scientific
Industries, Inc. and Mr. Jack Isselmann dated January 16, 2003.
10.7 Change in Control Agreement by and between Electro Scientific
Industries, Inc. and Mr. Joe Reinhart dated January 16, 2003.
10.8 Change in Control Agreement by and between Electro Scientific
Industries, Inc. and Mr. Ed Swenson dated January 16, 2003.
10.9 Change in Control Agreement by and between Electro Scientific
Industries, Inc. and Mr. Keith Taft dated January 16, 2003.
10.10 Employment Agreement by and between Electro Scientific
Industries, Inc. and Mr. Mike Dodson dated May 5, 2003.
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended
March 1, 2003:
-- Dated and filed December 16, 2002 pursuant to Item 5., "Other Events,"
regarding the appointment of James T. Dooley as President and Chief
Executive Officer of the Company;
-- Dated January 16, 2003 and filed January 22, 2003 pursuant to Item 5.,
"Other Events," regarding the approval by the Board of Directors for
the Company to repurchase up to $50.0 million aggregate principal
amount of the Company's 4 1/4% Convertible Subordinated Notes during
2003;
-- Dated and filed February 18, 2003 pursuant to Item 5., "Other Events,"
regarding the Company's revenue expectations for its third fiscal
quarter ending March 1, 2003; and
-- Dated and filed February 18, 2003 pursuant to Item 5., "Other Events,"
regarding the appointment of Richard Okumoto as Vice President of
Administration and Chief Financial Officer of the Company.
33
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.
Dated: August 11, 2003 ELECTRO SCIENTIFIC INDUSTRIES, INC.
By /s/ Barry L. Harmon
Barry L. Harmon
President and Chief Executive Officer
(Principal Executive Officer)
By /s/ J. Michael Dodson
J. Michael Dodson
Vice President of Administration and
Chief Financial Officer
(Principal Financial and Accounting Officer)
34
CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Barry L. Harmon, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Electro Scientific
Industries, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report fairly present, in all
material respects, the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: August 11, 2003
/s/ Barry L. Harmon
- -----------------------
Barry L. Harmon
President and Chief Executive Officer
35
CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, J. Michael Dodson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Electro Scientific
Industries, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report fairly present, in all
material respects, the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
amended quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: August 11, 2003
/s/ J. Michael Dodson
- ---------------------------
J. Michael Dodson
Vice President of Administration and
Chief Financial Officer
36