ELECTRO SCIENTIFIC INDUSTRIES INC - FORM 10-Q - November 6, 2018

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 29, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-12853
 
 
 
ELECTRO SCIENTIFIC INDUSTRIES, INC.
 
 
 

Oregon
 
93-0370304
(State or other jurisdiction of incorporation
or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
13900 N.W. Science Park Drive, Portland, Oregon
 
97229
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: 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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨    
Accelerated filer 
ý
Non-accelerated filer
¨    
Smaller reporting company
¨
Emerging growth company
¨


If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The number of shares outstanding of the Registrant’s Common Stock as of November 1, 2018 was 34,296,541 shares.
 


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
2019 FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
 
Part I
FINANCIAL INFORMATION
 
Financial Statements (Unaudited)
 
 
 
 
 
 
Part II
OTHER INFORMATION
 
 





ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
Sep 29, 2018
 
Mar 31, 2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
66,183

 
$
76,792

Short-term investments
112,004

 
47,121

Trade receivables, net of allowances of $218 and $832
38,422

 
63,044

Inventories, net
81,434

 
87,686

Shipped systems pending acceptance
1,831

 
4,734

Other current assets
4,474

 
5,493

Total current assets
304,348

 
284,870

Non-current assets:
 
 
 
Property, plant and equipment (PP&E), net of accumulated depreciation of $85,654 and $83,159
24,711

 
22,025

Deferred income taxes, net
43,734

 
43,518

Goodwill
2,626

 
2,626

Acquired intangible assets, net of accumulated amortization of $23,480 and $22,766
4,456

 
5,169

Other assets
12,997

 
14,780

Total assets
$
392,872

 
$
372,988

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
16,675

 
$
37,354

Accrued liabilities
28,430

 
34,533

Deferred revenue
8,535

 
9,818

Total current liabilities
53,640

 
81,705

Non-current liabilities:
 
 
 
Long-term debt
12,550

 
12,766

Income taxes payable
2,349

 
1,901

Other liabilities
7,932

 
10,258

Total liabilities
76,471

 
106,630

Commitments and contingencies (See Note 11: Commitments and Contingencies)


 


Shareholders’ equity:
 
 
 
Preferred stock, without par value; 1,000 shares authorized; no shares issued
—

 
—

Common stock, without par value; 100,000 shares authorized; 34,699 and 34,387 issued and outstanding
214,485

 
210,995

Retained earnings
102,836

 
54,816

Accumulated other comprehensive (loss) income
(920
)
 
547

Total shareholders’ equity
316,401

 
266,358

Total liabilities and shareholders’ equity
$
392,872

 
$
372,988

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements


3

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands, except per share amounts)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Net sales:
 
 
 
 
 
 
 
Systems
$
71,263

 
$
60,316

 
$
168,120

 
$
122,409

Services
14,654

 
10,651

 
28,421

 
21,242

Total net sales
85,917

 
70,967

 
196,541

 
143,651

Cost of sales:
 
 
 
 
 
 
 
Systems
40,539

 
38,179

 
90,633

 
79,605

Services
6,311

 
6,256

 
13,643

 
11,094

Total cost of sales
46,850

 
44,435

 
104,276

 
90,699

Gross profit
39,067

 
26,532

 
92,265

 
52,952

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
10,838

 
11,648

 
20,968

 
24,456

Research, development and engineering
9,154

 
8,274

 
19,213

 
17,208

Restructuring costs
—

 
2,162

 
—

 
3,373

Total operating expenses
19,992

 
22,084

 
40,181

 
45,037

Operating income
19,075

 
4,448

 
52,084

 
7,915

Non-operating income (expense):
 
 
 
 
 
 
 
Interest and other income (expense), net
383

 
(229
)
 
835

 
(413
)
Total non-operating income (expense)
383

 
(229
)
 
835

 
(413
)
Income before income taxes
19,458

 
4,219

 
52,919

 
7,502

Provision (benefit) for income taxes
2,623

 
(41
)
 
4,941

 
340

Net income
$
16,835

 
$
4,260

 
$
47,978

 
$
7,162

Net income per share - basic
$
0.49

 
$
0.13

 
$
1.39

 
$
0.21

Net income per share - diluted
$
0.47

 
$
0.12

 
$
1.34

 
$
0.21

Weighted average number of shares - basic
34,606

 
33,861

 
34,529

 
33,647

Weighted average number of shares - diluted
35,959

 
34,874

 
35,916

 
34,716

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements


4

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Net income
$
16,835

 
$
4,260

 
$
47,978

 
$
7,162

Other comprehensive (loss) income:
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of taxes of $113, $0, $257 and $0
(400
)
 
180

 
(1,484
)
 
388

Benefit plan obligation, net of taxes of $(1), $(3), $(3) and $(5)
3

 
5

 
7

 
9

Net unrealized loss on available-for-sale securities, net of taxes of $2, $0, $(3) and $0
(7
)
 
—

 
10

 
(1
)
Other comprehensive (loss) income:
(404
)
 
185

 
(1,467
)
 
396

Comprehensive income
$
16,431

 
$
4,445

 
$
46,511

 
$
7,558

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

5

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Two fiscal quarters ended
(In thousands)
Sep 29, 2018
 
Sep 30, 2017
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income
$
47,978

 
$
7,162

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization, including acquired intangible amortization
4,442

 
4,126

Share-based compensation expense
3,164

 
2,797

Impairment of PP&E and other long-term assets due to restructuring
—

 
5,610

(Recovery of) provision for doubtful accounts
(383
)
 
371

Deferred income taxes
(47
)
 
(31
)
Impairment of inventory
—

 
8,248

Other adjustments
225

 
—

Changes in operating accounts:

 

Decrease (increase) in trade receivables, net
24,282

 
(7,094
)
Decrease (increase) in inventories
3,338

 
(7,874
)
Decrease (increase) in shipped systems pending acceptance
2,903

 
(2,051
)
Decrease in other current assets
2,291

 
970

(Decrease) increase in accounts payable and accrued liabilities
(26,123
)
 
12,392

(Decrease) increase in deferred revenue
(1,230
)
 
1,070

Net cash provided by operating activities
60,840

 
25,696

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Purchase of investments
(123,879
)
 
(38,336
)
Proceeds from sales and maturities of investments
58,612

 
10,861

Purchase of property, plant and equipment
(5,238
)
 
(1,445
)
Proceeds from sale of property, plant and equipment
—

 
37

Decrease (increase) in other assets
255

 
(4,503
)
Net cash used in investing activities
(70,250
)
 
(33,386
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Repayment of debt
(222
)
 
(212
)
Payment of withholding taxes on stock-based compensation
(867
)
 
(1,684
)
Proceeds from issuance of common stock
1,180

 
665

Net cash provided by (used in) financing activities
91

 
(1,231
)
Effect of exchange rate changes on cash
(1,283
)
 
260

NET CHANGE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH
(10,602
)
 
(8,661
)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH AT BEGINNING OF PERIOD
77,885

 
57,732

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT END OF PERIOD
$
67,283

 
$
49,071

SUPPLEMENTAL CASH FLOW INFORMATION
 
 
 
Cash paid for interest
$
(321
)
 
$
(331
)
Cash paid for income taxes
(1,166
)
 
(500
)
Income tax refunds received
32

 
67

Net increase (decrease) in PP&E and other assets related to transfers from inventory
2,506

 
(2,052
)
Non-cash additions to PP&E
978

 
112

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

6

ELECTRO SCIENTIFIC INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
These unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with United States generally accepted accounting principles (U.S. GAAP) have been condensed or omitted in these interim statements. Accordingly, these condensed consolidated financial statements should be read in conjunction with the financial statements and notes included in the Annual Report of Electro Scientific Industries, Inc. (the Company) on Form 10-K for its fiscal year ended March 31, 2018. These interim statements include all adjustments (consisting of only normal recurring adjustments and accruals) necessary for a fair presentation of results for the interim periods presented. The results for interim periods are not necessarily indicative of the results of operations for the entire year.
On October 29, 2018, the Company signed a definitive agreement for MKS Instruments, Inc. (NASDAQ:MKSI) to acquire the Company. See Note 19: Merger Agreement for further details.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates.
Management believes that the estimates used are reasonable. Estimates made by management include: revenue recognition; inventory valuation; valuation of investments; accrued restructuring costs; share-based compensation; income taxes, including the valuation of deferred tax assets; valuation of long-lived assets, including intangibles; valuation of goodwill and acquisition accounting.
All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted. The fiscal quarters ended September 29, 2018 and September 30, 2017 each consisted of 13-week periods. Similarly, the two quarters ended September 29, 2018 and the two quarters ended September 30, 2017 each consisted of 26-week periods.

7

Restricted Cash
Cash and cash equivalents that are restricted as to withdrawal or use under the terms of certain contractual agreements are recorded in Other current assets on our balance sheet for fiscal 2019 and in Other long-term assets in fiscal 2018. The following table provides a summary of the Company's cash, cash equivalents and restricted cash position:
(In thousands)
Sep 29, 2018
 
Mar 31, 2018
 
Sep 30, 2017
Cash and cash equivalents
$
66,183

 
$
76,792

 
$
47,973

Restricted cash included in other current assets
1,100

 
—

 
—

Restricted cash included in other long-term assets
—

 
1,093

 
1,098

Total cash, cash equivalents and restricted cash
$
67,283

 
$
77,885

 
$
49,071

Changes to Significant Accounting Policies
The only significant changes to the Company's significant accounting policies from those presented in Note 2: Summary of Significant Accounting Policies to the consolidated financial statements included in the Company's Annual Report on Form 10-K for its fiscal year ended March 31, 2018 were due to the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 606, "Revenue from Contracts with Customers". Changes to associated accounting policies are summarized below.
Accounts Receivable and Allowance for Doubtful Accounts
Trade receivables are stated at the amount the Company has an unconditional right to bill and generally do not bear interest, net of any estimated allowance for doubtful accounts. The Company establishes and monitors the collectability of amounts due from customers and sets appropriate credit limits based on an evaluation of the financial condition of customers and other relevant factors, including but not limited to obtaining credit ratings and customers' financial statements. With certain customers, letters of credit are obtained to mitigate credit risk. Subsequent to entering into a contract, if it is determined or expected that a customer will be unable to fully meet its financial obligation, such as in the case of a bankruptcy filing or other material events impacting its business, a specific allowance for bad debt is recorded to reduce the related receivable to the amount expected to be recovered. Bad debts are historically insignificant for the Company, and allowances for doubtful accounts are established based on actual experience.
Unbilled receivables arise when the Company has performed services and earned amounts related to a customer contract, but has not yet billed those amounts. Unbilled receivables were $1.2 million as of September 29, 2018 and were included as a component of Trade receivables, net of allowances, on the Condensed Consolidated Balance Sheets.
Shipped Systems Pending Acceptance
Shipped systems pending acceptance represent deferred costs of sales related to systems shipped to the customer, but where revenue has been deferred pending the customer's final acceptance. These contracts also generally result in a deferred revenue contract liability. Once the criteria for revenue recognition have been met for these contracts, the deferred costs are recognized as a cost of sales together with the associated revenue.
Contract Assets and Liabilities Arising from Contracts with Customers
Customer deposits (see Note 6: Accrued Liabilities) are a contract liability representing amounts collected from customers prior to any performance of the contract on the part of the Company. Customer deposits are included as a component of Accrued liabilities on our balance sheet.
Deferred revenues (see Note 8: Deferred Revenue) are a contract liability representing the amount of billings for contracts where the Company has an unconditional right to consideration, in excess of revenues recognized and amounts billed. The value of customer deposits and deferred revenues will increase or decrease based on the timing of invoices and recognition of revenue.
Revenue Recognition
The Company recognizes revenue according to the five steps required by ASC 606; (1) identifying the contract with a customer, (2) identifying the performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to performance obligations in the contract, and (5) recognizing revenue when (or as) the Company satisfies a performance obligation.
The Company's revenue streams primarily come from two sources, system sales and service sales.

8

Systems Revenues: The Company sells high-value capital equipment to customers and these system sales generally include the base system, supporting components (such as input devices and related tooling), and a standard warranty. The performance obligations related to system sales are generally satisfied at a point-in-time upon transfer of control. Transfer of control is determined with consideration of commercial and billing terms, physical movement, transfer of the risks and rewards of ownership, transfer of title, and customer acceptance or a track record of acceptance and any other relevant factors. If the Company has a demonstrable track record of acceptance for a system sold, the Company deems transfer of control to have occurred in accordance with commercial terms, even if customer acceptance has not been received, as the acceptance is a formality and is not considered substantive. Payment on system sales is generally due within 90 days of shipment or less. Standard warranties on systems are assurance-type warranties and are recorded as a liability at the time of shipment (see Note 7: Product Warranty).
Service Revenues: The Company offers additional services directly associated with the capital equipment it sells. These are generally in two major categories: (1) service contracts, which are generally recognized over time, and (2) point-in-time services. Service contracts recognized over time include extended service contracts (labor and materials), consumables and materials contracts, and labor-only contracts. Most service contracts recognized over time have a stated contract period and revenue is recognized over that period. Certain contracts may be consumption-based, in which case the revenue is recognized ratably in relation to the associated consumption. Service contracts are generally billed and are due in advance of the service period. Point-in-time services include spare parts sales, labor, trouble-shooting services, and similar items, and these are recognized at a point in time upon shipment or transfer of control, and are generally billed concurrent with recognition. Standard warranties on parts are assurance-type warranties and are recorded as a liability at the time of shipment (see Note 7: Product Warranty).
The Company must make various judgments and estimates that vary in level of significance and subjectivity when recognizing revenue. The primary judgments include an evaluation of any credit risk, as described in our policy on accounts receivable, the identification of variable consideration in the contract, the determination of performance obligations in a contract, the determination of standalone selling prices for performance obligations, and the determination of when performance obligations are fulfilled.
Generally, our revenue streams are subject to little variable consideration as we have minimal historical or expected future returns or other adjustments to selling price. Accordingly, standalone selling price is used to determine how to allocate the overall transaction price for a contract. Standalone selling price is based on historical transactions where available and relevant, and when not available, on a method that maximizes the use of observable inputs, which is generally a cost plus reasonable margin approach. Performance obligations are typically documented and evident from our contracts with customers and the associated triggers for transfer of control are generally objective as they are based on attributes such as shipment, customer acceptance, and other similar criteria. From time to time, however, the Company must exercise judgment to determine if transfer of control has occurred based on criteria such as whether a track record of acceptance has been established and acceptance terms are substantive, whether the risks and rewards of ownership have been transferred, or whether there are other facts and circumstances that could impact the timing and amount of revenue recognized. These judgmental determinations are made based on a weighting of all available evidence.
Revenues associated with sales to customers under local contracts in Japan are typically recognized upon title transfer, which generally occurs upon customer acceptance.
Revenues are recorded net of taxes collected from customers, which are subsequently submitted to governmental authorities.
Practical Expedients Related to Revenue Recognition
For contracts with customers which have a duration of less than 12 months, the Company has elected the practical expedient to recognize commission costs when paid, as the amortization period would generally be one year or less. Commissions associated with contracts with a duration over 12 months are immaterial. Commission costs are recorded as a component of Selling, general and administrative expenses.
As the Company's contracts with customers generally have a duration of less than 12 months, and for certain contracts with a duration over 12 months, a right to payment exists as services are performed, the Company has elected to not disclose the remaining performance obligations for those contracts. For contracts where the Company has a right to consideration from a customer in an amount that corresponds directly to the services delivered to-date and for which the Company has a right to invoice, the Company recognizes revenue for the services rendered.

The Company's contracts are generally not paid more than 12 months in advance or more than 12 months after delivery and therefore do not typically have a significant financing element. Accordingly, the Company has elected to not assess whether a contract has a significant financing component in performing the revenue assessment.

For contracts where control transfers prior to delivery, the Company accounts for shipping and handling costs as a fulfillment cost and not as a performance obligation for revenue recognition purposes.

9

2. Recent Accounting Pronouncements
Adopted accounting pronouncements:
In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which made six targeted amendments to ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities. These amendments mostly affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. ASU 2018-03 became effective as of the Company's second quarter of fiscal 2019 ending September 29, 2018. Adopting ASU 2018-03 had no material effect on the Company's financial position, results of operations or cash flows.
In February 2018, the FASB issued ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, in response the enactment of the Tax Cuts and Jobs Act (the Tax Act) and the subsequent questions and concerns of stakeholders regarding how to apply the changes to the income tax effects of deferred tax assets and liabilities sitting in accumulated other comprehensive income. The guidance eliminates the resulting stranded tax effects and improves the usefulness of the information reported to users of the financial statements. ASU 2018-02 was effective for the Company as of April 1, 2018, the beginning of fiscal 2019. Adopting ASU 2018-02 had no material effect on the Company's financial position, results of operations or cash flows.
In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, which amends the scope of modification accounting surrounding share-based payment arrangements as issued in ASU 2016-09 by providing guidance on the various types of changes which would trigger modification accounting for share-based payment awards, specifically an entity would not apply modification accounting under ASC 718 if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. ASU 2017-09 was effective for the Company as of April 1, 2018, the beginning of fiscal 2019. The adoption of ASU 2017-09 has not had a material effect on the Company's financial position, results of operations or cash flows.
In March 2017, the FASB issued ASU 2017-07, Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires companies to disaggregate the current-service-cost component from other components of net benefit cost and provides specific guidance for presentation in the income statement. ASU 2017-07 was effective for the Company as of April 1, 2018, the beginning of fiscal 2019. The adoption of ASU 2017-07 has not had a material effect on the Company's financial position, results of operations or cash flows.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, to improve and simplify the accounting for the income tax consequences of intra-entity transfers of assets other than inventory, requiring companies to recognize income tax consequences upon the transfer of the asset to a third party. ASU 2017-09 was effective for the Company as of April 1, 2018, the beginning of fiscal 2019. The adoption of ASU 2016-16 has not had a material effect on the Company's financial position, results of operations or cash flows.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09), to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that the Company expects to be entitled to for those goods or services. The FASB has continued to issue ASU topics to further clarify ASU 2014-09. These have included ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2016-20. The new standards were effective for the Company as of April 1, 2018, the beginning of fiscal 2019. The Company elected the modified retrospective approach as its transition method. The new standard resulted in an immaterial change to revenue recognition related to system sales and service contracts, the Company's major revenue streams. The cumulative effect of the changes made to our consolidated balance sheet as of April 1, 2018 related to the adoption of ASC 606 for contracts not completed at the date of adoption were as follows:

10

(In thousands)
Mar 31, 2018
 
Adjustments
 
Apr 1, 2018
ASSETS
 
 
 
 
 
Non-current assets:
 
 
 
 
 
Deferred income taxes, net
$
43,518

 
$
(12
)
 
$
43,506

Total assets
$
372,988

 
$
(12
)
 
$
372,976

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Deferred revenue
$
9,818

 
$
(52
)
 
$
9,766

Total current liabilities
81,705

 
(52
)
 
81,653

Total liabilities
106,630

 
(52
)
 
106,578

Shareholders’ equity:
 
 
 
 
 
Retained earnings
54,816

 
40

 
54,856

Total shareholders’ equity
266,358

 
40

 
266,398

Total liabilities and shareholders’ equity
$
372,988

 
$
(12
)
 
$
372,976

The adoption of ASC 606 did not have a material impact on the Company's financial position, results of operations or cash flows for the second quarter of 2019 or the first two quarters of fiscal 2019. Additionally, we do not expect the adoption of the standard to have a material impact to our financial position on an ongoing basis.
Recently issued accounting pronouncements not yet adopted
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, to improve disclosures of the key provisions of ASC 820 by adding, modifying, and removing certain targeted disclosure requirements. ASU 2018-13 is effective for annual periods beginning after December 15, 2019, and interim periods within those annual periods, which would be the Company's fiscal year ending April 3, 2021. Early adoption is permitted, including adoption in any interim period, for public business entities for reporting periods for which financial statements have not yet been issued and early adoption is permitted for any removed or modified disclosure while delaying adoption of the remaining disclosures until their effective date. While the Company does not expect the adoption of ASU 2018-13 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2018-13 may have on its financial position, results of operations or cash flows.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, in order to (i) improve disclosures related to an entity's risk management activities through better transparency and understandability and (ii) simplify and reduce the complexity of hedge accounting by preparers. ASU 2017-12 is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods, which would be the Company's fiscal year ending March 28, 2020. Early adoption is permitted, including adoption in any interim period, for public business entities for reporting periods for which financial statements have not yet been issued. The FASB also issued ASU 2018-16 to modify and clarify portions of ASU 2017-12. While the Company does not expect the adoption of ASU 2017-12 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2017-12 may have on its financial position, results of operations or cash flows.
In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosing key information about leasing arrangements. The FASB has issued ASU 2018-11 to clarify ASU 2016-02 comparative reporting requirements for initial adoption. ASU 2016-02 is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods, which would be the Company's fiscal year ending March 28, 2020. The Company is still evaluating any potential impact that adoption of ASU 2016-02 may have on its financial position, results of operations or cash flows. The Company is in the preliminary scoping phase of implementation and is currently identifying the impacted leases and preparing to perform initial quantification of the potential impacts. The Company has developed a plan to develop and implement any associated business processes, as well as perform applicable accounting and reporting evaluations in advance of the effective date of the standard.

11

3. Fair Value Measurements
Financial Assets and Liabilities Measured at Fair Value
ASC Topic 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include the following:
•
Level 1, defined as observable inputs such as quoted prices in active markets for identical assets or liabilities;
•
Level 2, defined as inputs that are observable either directly or indirectly such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and other inputs that can be corroborated by observable market data; and
•
Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 29, 2018 and March 31, 2018 was as follows (in thousands):
September 29, 2018
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
Money market securities
$
29,871

 
$
—

 
$
—

 
$
29,871

Commercial paper
—

 
6,495

 
—

 
6,495

Total cash equivalents
$
29,871

 
$
6,495

 
$
—

 
$
36,366

Short term investments - available for sale:
 
 
 
 
 
 
 
U.S. treasury fund
$
26,793

 
$
—

 
$
—

 
$
26,793

Commercial paper
—

 
48,904

 
—

 
48,904

Corporate bonds
—

 
36,307

 
—

 
36,307

Total short-term investments - available for sale
$
26,793

 
$
85,211

 
$
—

 
$
112,004

Forward purchase or sale contracts:
 
 
 
 
 
 
 
Japanese Yen
$
—

 
$
(31
)
 
$
—

 
$
(31
)
New Taiwan Dollar
—

 
(18
)
 
—

 
(18
)
Korean Won
—

 
(24
)
 
—

 
(24
)
Euro
—

 
(5
)
 
—

 
(5
)
British Pound
—

 
(10
)
 
—

 
(10
)
Chinese Renminbi
—

 
12

 
—

 
12

Singapore Dollar
—

 
(1
)
 
—

 
(1
)
Total forward contracts
$
—

 
$
(77
)
 
$
—

 
$
(77
)
Deferred compensation plan assets:*
 
 
 
 
 
 
 
Mutual funds and exchange traded funds
$
2,234

 
$
—

 
$
—

 
$
2,234

Money market securities
208

 
—

 
—

 
208

Total deferred compensation plan assets
$
2,442

 
$
—

 
$
—

 
$
2,442


12

March 31, 2018
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
Money market securities
$
41,752

 
$
—

 
$
—

 
$
41,752

U.S. treasury fund
2,500

 
—

 
—

 
2,500

Commercial paper
—

 
3,498

 
—

 
3,498

Corporate bonds
—

 
1,999

 
—

 
1,999

Total cash equivalents
$
44,252

 
$
5,497

 
$
—

 
$
49,749

Short term investments - available for sale:
 
 
 
 
 
 
 
U.S. treasury fund
$
10,458

 
$
—

 
$
—

 
$
10,458

Commercial paper
—

 
25,913

 
—

 
25,913

Corporate bonds
—

 
10,750

 
—

 
10,750

Total short-term investments - available for sale
$
10,458

 
$
36,663

 
$
—

 
$
47,121

Forward purchase or sale contracts:
 
 
 
 
 
 
 
Japanese Yen
$
—

 
$
(23
)
 
$
—

 
$
(23
)
New Taiwan Dollar
—

 
3

 
—

 
3

Korean Won
—

 
(12
)
 
—

 
(12
)
Euro
—

 
7

 
—

 
7

British Pound
—

 
49

 
—

 
49

Chinese Renminbi
—

 
(29
)
 
—

 
(29
)
Singapore Dollar
—

 
(1
)
 
—

 
(1
)
Total forward contracts
$
—

 
$
(6
)
 
$
—

 
$
(6
)
Deferred compensation plan assets:*
 
 
 
 
 
 
 
Mutual funds and exchange traded funds
$
1,841

 
$
—

 
$
—

 
$
1,841

Money market securities
207

 
—

 
—

 
207

Total deferred compensation plan assets
$
2,048

 
$
—

 
$
—

 
$
2,048

*These investments represent assets held in trust for the deferred compensation plan
For Level 1 assets, the Company utilized quoted prices in active markets for identical assets.
For Level 2 assets, exclusive of forward contracts, the Company utilized quoted prices in active markets for similar assets. For forward contracts, spot prices at September 29, 2018 and March 31, 2018 were utilized to calculate fair values.
During the first two quarters of fiscal 2019 and 2018, there were no transfers between Level 1, 2 or 3 assets.

13

Investments
The Company’s investments, including investments classified as cash equivalents, at September 29, 2018 and March 31, 2018 were as follows (in thousands): 
 
 
 
Unrealized
 
 
September 29, 2018
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
U.S. treasury fund
$
26,800

 
$
—

 
$
(7
)
 
$
26,793

Commercial paper
55,399

 
—

 
—

 
55,399

Corporate Bonds
36,322

 
—

 
(15
)
 
36,307

Total investments (current)
$
118,521

 
$
—

 
$
(22
)
 
$
118,499

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Mutual funds, exchange traded funds and money market securities*
$
2,150

 
$
292

 
$
—

 
$
2,442

Total investments (non-current)
$
2,150

 
$
292

 
$
—

 
$
2,442

 
 
 
Unrealized
 
 
March 31, 2018
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
U.S. treasury fund
$
12,975

 
$
—

 
$
(17
)
 
$
12,958

Commercial paper
29,411

 
—

 
—

 
29,411

Corporate bonds
12,768

 
—

 
(19
)
 
12,749

Total investments (current)
$
55,154

 
$
—

 
$
(36
)
 
$
55,118

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Mutual funds, exchange traded funds and money market securities*
$
1,881

 
$
167

 
$
—

 
$
2,048

Total investments (non-current)
$
1,881

 
$
167

 
$
—

 
$
2,048

*These investments represent assets held in trust for the deferred compensation plan
For purposes of determining gross realized gains and losses and reclassification out of accumulated other comprehensive income (loss), the cost of securities sold is based on specific identification. Net unrealized holding gains and losses on current available-for-sale securities included in accumulated other comprehensive income (loss) were insignificant as of September 29, 2018 and March 31, 2018.
4. Inventories
Inventories are principally valued at standard cost, which approximates the lower of cost or net realizable value on a first-in, first-out basis. Components of inventories were as follows:
(In thousands)
Sep 29, 2018
 
Mar 31, 2018
Raw materials and purchased parts
$
60,329

 
$
52,591

Work-in-process
15,038

 
18,634

Finished goods
6,067

 
16,461

 
$
81,434

 
$
87,686

5. Other Assets
Other assets consisted of the following:
(In thousands)
Sep 29, 2018
 
Mar 31, 2018
Demo and leased equipment, net
$
6,658

 
$
6,746

Long term deposits and non-trade receivables
3,261

 
3,232

Non-current restricted cash
—

 
1,093

Other non-current assets
3,078

 
3,709

 
$
12,997

 
$
14,780


14

Depreciation expense for demo and leased equipment totaled $0.1 million in the second quarter of fiscal 2019 and $0.1 million for the second quarter of fiscal 2018. For the first two quarters of fiscal 2019 depreciation expense for demo and leased equipment totaled $0.6 million compared to $0.1 million in the first two quarters of fiscal 2018. Of the total $6.7 million and $6.7 million of demo and leased equipment at September 29, 2018 and March 31, 2018, $1.4 million and $3.4 million were leased assets at customer sites generating revenue.
Included in Other non-current assets are long-term investments held in a trust for the deferred compensation plan and other similar items.
6. Accrued Liabilities
Accrued liabilities consisted of the following:
(In thousands)
Sep 29, 2018
 
Mar 31, 2018
Payroll-related liabilities
$
8,579

 
$
15,879

Product warranty accrual
5,667

 
4,646

Income taxes payable
4,090

 
1,152

Purchase order commitments and receipts
2,904

 
2,978

Customer deposits
1,075

 
2,214

Current portion, long-term debt
432

 
421

Other current liabilities
5,683

 
7,243

 
$
28,430

 
$
34,533

Included in other current liabilities above are accrued amounts for value-added taxes, income taxes, freight, restructuring activities and other similar items.
7. Product Warranty
The following is a reconciliation of the changes in the aggregate product warranty accrual:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Product warranty accrual, beginning
$
11,525

 
$
6,538

 
$
10,220

 
$
5,474

Warranty charges incurred, net
(742
)
 
(2,666
)
 
(4,343
)
 
(5,111
)
Provision for warranty charges
(1,560
)
 
3,284

 
3,346

 
6,793

Product warranty accrual, ending
$
9,223

 
$
7,156

 
$
9,223

 
$
7,156

Net warranty charges incurred include labor charges and costs of replacement parts for repairs under warranty. These costs are recorded net of any estimated cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Company’s suppliers for defective components. The provision for warranty charges reflects the estimate of future anticipated net warranty costs to be incurred for all products under warranty at quarter end and is recorded to cost of sales. Of the total of $9.2 million and $7.2 million of product warranty accruals as of September 29, 2018 and September 30, 2017, $3.6 million and $2.3 million were non-current and were included in Other Liabilities on the Condensed Consolidated Balance Sheets. The provision for warranty charges decreased $1.6 million in the second quarter of fiscal 2019, as the cost of supporting our systems decreased by more than the cost of new warranty set-ups.
8. Deferred Revenue
Generally, revenue is recognized upon satisfaction of performance obligations, which includes fulfillment of acceptance criteria at the Company's factory and transfer of risk of loss and title. Revenue is deferred whenever title transfer is pending, risk of loss has not transferred, and/or acceptance criteria have not yet been fulfilled. Deferred revenue arises from, among other factors, sales to Japanese customers, shipments of substantially new products and shipments with custom specifications and other acceptance criteria where the Company cannot demonstrate a track record of acceptance. For sales involving multiple performance obligations, the stand-alone selling price of any undelivered performance obligation, is deferred until the performance obligations are delivered and acceptance criteria are met. Revenue related to maintenance and service contracts is deferred and recognized ratably over the duration of the contracts.

15

The following is a reconciliation of the changes in deferred revenue:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Deferred revenue, beginning
$
9,246

 
$
15,616

 
$
10,514

 
$
15,397

Revenue deferred
8,558

 
31,182

 
28,284

 
46,652

Revenue recognized
(9,253
)
 
(30,429
)
 
(30,247
)
 
(45,680
)
Deferred revenue, ending
$
8,551

 
$
16,369

 
$
8,551

 
$
16,369

Of the total of $8.6 million and $16.4 million of deferred revenue at September 29, 2018 and September 30, 2017, $16 thousand and $0.6 million were non-current and were included in Other Liabilities on the Condensed Consolidated Balance Sheets. For the second quarter of fiscal 2019 and the first two quarters of fiscal 2019, revenue recognized that was included in the opening deferred revenue balance was $2.6 million and $6.9 million, respectively. For the second quarter of fiscal 2019 and the first two quarters of fiscal 2019, $7.9 million and $2.0 million of the beginning customer deposit balance was utilized in each of the periods, respectively. Customer deposits are included as a component of Accrued liabilities on our balance sheet (see Note 6: Accrued Liabilities). The amount of revenue recognized from performance obligations satisfied in prior periods was not material.
9. Long-term Debt
ESI Leasing, LLC (ESI Leasing), a wholly owned subsidiary of the Company, has a loan agreement (Loan Agreement) with First Technology Federal Credit Union (Lender) which provides for a term loan from the Lender to ESI Leasing in the principal amount of $14 million (Loan). The interest rate of the Loan is fixed at 4.75% per annum, except that it may be increased if certain covenants under the Loan Agreement are not satisfied and after and during the continuation of an “Event of Default” as defined in the Loan Agreement. The Loan amortizes over a period of approximately 20 years, with the outstanding principal maturing and becoming due on January 1, 2027. ESI Leasing pays monthly principal and interest payments on the Loan totaling $1.1 million annually through the maturity of the Loan. The Company unconditionally guarantees the Loan. The Company is required to maintain certain deposits with the Lender through March 31, 2019, at which point the restriction will be removed as long as it is in compliance with certain minimum covenants.
The principal maturities for each of the next five twelve-month periods ending on September 29 are as follows:
(In thousands)
2019
 
2020
 
2021
 
2022
 
2023
Principal maturities
$
466

 
$
487

 
$
512

 
$
537

 
$
563

Total debt outstanding on the Loan Agreement were as follows:
(In thousands)
Sep 29, 2018
 
Mar 31, 2018
Total debt outstanding
$
12,982

 
$
13,187

Less: Current portion, long-term debt
(432
)
 
(421
)
Long-term debt
$
12,550

 
$
12,766

Deferred debt issuance costs related to the above long-term debt as of September 29, 2018 and March 31, 2018 were $285 thousand and $302 thousand, respectively.
10. Revolving Credit Facility
The Company is party to a loan and security agreement (Credit Facility) with Silicon Valley Bank (SVB), which was initially entered into on March 20, 2015 and amended on July 12, 2016. The Credit Facility provides for a senior secured asset-based revolving facility with availability up to $30.0 million, including a $15.0 million sublimit for letters of credit. In the fourth quarter of fiscal 2017, the Company amended and extended the Credit Facility by one year. With this extension, the Credit Facility expires March 20, 2019. At September 29, 2018, the Company had no amounts outstanding under the Credit Facility, was in compliance with all covenants, and was not in default under the Credit Facility. The commitment fee on the amount of unused credit was 0.3 percent. As amended, the Credit Facility allows for a greater level of EBITDA losses, but reduces the level of permitted acquisitions and purchases of capital equipment. If the Company fails to meet the covenants in its Credit Facility or its lenders fail to fund, access to the facility may be limited or the facility may become unavailable altogether.

16

11. Commitments and Contingencies
The Company mitigates credit risk by transacting with highly rated counterparties for foreign exchange contracts, letters of credit and other transactions where counterparty risk is a factor. The Company has evaluated the non-performance risks associated with the Company's lenders and other parties and believes them to be insignificant.
From time to time the Company may be party to litigation arising in the normal course of business. Currently, the Company is not party to any litigation it believes would have a material adverse effect on the Company's financial position, results of operations or cash flows.
12. Shareholders’ Equity
Share Repurchase Program
In December 2011, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of the Company's outstanding common stock. The repurchases are to be made at management’s discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, acceptable share price and other factors. The Company did not repurchase any shares during fiscal 2018 or the first two quarters of fiscal 2019. There is no expiration date for the repurchase program and $18.3 million still remains for future repurchases.
13. Accumulated Other Comprehensive Income (Loss)
The following is a reconciliation of the changes in accumulated other comprehensive income (AOCI):
 
Foreign currency translation adjustment
 
Accumulated other comprehensive income related to benefit plan obligation
 
Net unrealized loss on available-for-sale securities
 
Total
Balance at March 31, 2018
$
590

 
$
(16
)
 
$
(27
)
 
$
547

Other comprehensive (loss) income before reclassifications and taxes
(1,741
)
 
10

 
13

 
(1,718
)
Amounts reclassified from AOCI
—

 
—

 
—

 
—

Tax effect
257

 
(3
)
 
(3
)
 
251

Other Comprehensive (loss) income
(1,484
)
 
7

 
10

 
(1,467
)
Balance at September 29, 2018
$
(894
)
 
$
(9
)
 
$
(17
)
 
$
(920
)
14. Share-Based Compensation
The Company's share-based compensation consists of restricted stock unit awards with a service condition (time-based RSUs), restricted stock unit awards with a market performance condition (market-based RSUs), restricted stock unit awards with a performance condition other than market performance (performance-based RSUs), an employee stock purchase plan and stock-settled stock appreciation rights (SARs).
The fair value of time-based and performance-based restricted stock units (RSUs) are measured on the grant date based on the market value of the Company's common stock. The market-based RSUs must achieve the total shareholder return (TSR) measures in order for the awards to vest, and the grant date fair value of the awards is calculated using a Monte Carlo simulation model. The Company recognizes expense related to the fair value of the 1990 Employee Stock Purchase Plan (ESPP) and SARs using the Black-Scholes model to estimate the fair value of awards on the date of grant.
Except for performance-based RSUs, the Company recognizes compensation expense for all share-based compensation awards, net of estimated forfeitures, on a straight-line basis over the requisite service period of the award. Expense for performance-based RSUs is recognized based on the probability of achievement of the performance criteria. The compensation cost for market-based RSUs is recognized over the related service period, even if the market condition is never satisfied. The impact of adjustments related to awards where the requisite service period was not completed is reflected as an offset to current period shared-based compensation expense.
The Company granted a total of 276,715 time-based RSUs and 92,500 market-based RSUs during the first two quarters of fiscal 2019, but did not grant any SARs or performance-based RSUs. Grants for the second quarter of fiscal 2019 consisted of 37,715 time-based RSUs.

17

Share-based compensation expense under the stock incentive plans is included in the Company’s Condensed Consolidated Statements of Operations as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Cost of sales
$
122

 
$
77

 
$
228

 
$
144

Selling, general and administrative
1,279

 
1,070

 
2,427

 
2,131

Research, development and engineering
264

 
183

 
509

 
333

Total share-based compensation expense
$
1,665

 
$
1,330

 
$
3,164

 
$
2,608

The Company incurred $13 thousand of capitalizable share-based compensation costs during the two fiscal quarters of 2019. The capitalizable cost was incurred for internal labor hours allocated to the enterprise resource planning software and related systems implementation, which will support the Company's operating and financial function. No capitalized share-based compensation costs were incurred during the 2018 fiscal year. As of September 29, 2018, the Company had $10.9 million of total unrecognized share-based compensation costs, net of estimated forfeitures, which are expected to be recognized over a weighted average period of 2.0 years.
15. Revenues, Product and Geographic Information
Operating segments are defined as components of an enterprise about which separate financial information is available and evaluated regularly by the chief operating decision maker (CODM) in deciding how to allocate resources and in assessing performance. The Company's CODM is its Chief Executive Officer (CEO).
The Company and its consolidated subsidiaries operate in a single segment, defined as a manufacturer of high-technology microfabrication and related equipment. This segment sells products into a variety of end markets that are grouped into four major categories for the purpose of providing an understanding of the principal end markets for the products manufactured by the Company, specifically: (1) Printed Circuit Board (PCB), (2) Component Test, (3) Semiconductor, and (4) Industrial Machining. Service sales are interrelated with all major end markets of the Company and are separately presented.
The following table presents net sales information by the four major market categories and associated service sales addressed by the Company's single segment:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Printed Circuit Board
$
38,816

 
$
38,187

 
$
105,153

 
$
84,372

Component Test
18,555

 
7,007

 
27,960

 
14,455

Semiconductor
11,227

 
9,641

 
30,004

 
14,822

Industrial Machining
2,665

 
5,481

 
5,003

 
8,760

Service
14,654

 
10,651

 
28,421

 
21,242

Net sales
$
85,917

 
$
70,967

 
$
196,541

 
$
143,651

The following table presents net sales information by timing of delivery:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Point-in-time
$
79,898

 
$
65,494

 
$
183,954

 
$
132,820

Over-time
6,019

 
5,473

 
12,587

 
10,831

Net sales
$
85,917

 
$
70,967

 
$
196,541

 
$
143,651

Net sales by geographic area, based on the location of the end user, were as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Asia
$
76,334

 
$
64,053

 
$
175,700

 
$
130,616

Europe
6,468

 
3,978

 
11,363

 
5,929

Americas
3,115

 
2,936

 
9,478

 
7,106

Net sales
$
85,917

 
$
70,967

 
$
196,541

 
$
143,651


18

16. Restructuring and Cost Management Plans
2017 Corporate Restructuring:
In the fourth quarter of 2017, the Company initiated a restructuring plan to improve business effectiveness and streamline operations to achieve a stated target profit level for the Company as a whole. As a part of the restructuring plan, the management team was reorganized from a business unit to a functional structure; the Company closed facilities in Montreal, Canada; Napa, California; and Sunnyvale, California; the Company discontinued certain products; and the Company made select reductions in headcount across the Company. Actions under this plan were completed as of the end of the third quarter of fiscal 2018.
Total expenses related to the plan were $17.1 million in 2018, while no expenses have been incurred in the first two quarters of fiscal 2019. Included in the fiscal 2018 expenses are approximately $13.3 million of charges impacting gross margins, all incurred in the first and second quarters of fiscal 2018, primarily related to impairment of other assets and inventory stemming from the product portfolio program reviews which resulted in discontinuing certain products. Operating expense charges included $2.3 million of facilities and fixed assets charges related to streamlining facilities and discontinued products and $1.3 million of employee severance and related costs. Product portfolio reviews related to the restructuring plan were completed as of the end of the third quarter of fiscal 2018. The impacts of the decisions made in the portfolio reviews involve the use of certain estimates.
The following table presents the total expected restructuring costs as of September 29, 2018 (in thousands):
 
Total Expected Costs for the Plan
 
Costs Recognized from inception of the plan through the Quarter ended Sep 29, 2018
 
Remaining Costs to be Recognized Subsequent to Sep 29, 2018
Employee severance and related personnel costs
$
4,925

 
$
4,925

 
$
—

Site closure costs
1,516

 
1,516

 
—

Current asset impairments and other gross profit charges(1)
14,947

 
14,947

 
—

Non-current asset impairments
3,033

 
3,033

 
—

Other costs
239

 
239

 
—

Total
$
24,660

 
$
24,660

 
$
—

(1) Current asset impairments include inventory charges recorded in cost of sales.
The following table presents the amounts payable related to the 2017 Corporate Restructuring (in thousands):
 
Employee severance and related personnel costs
 
Site closure costs
 
Current asset impairments and other gross profit charges
 
Non-current asset impairments
 
Other Costs
 
Total
Balance as of April 1, 2017
$
3,247

 
$
888

 
$
—

 
$
—

 
$
—

 
$
4,135

Costs incurred
1,337

 
627

 
13,278

 
1,657

 
175

 
17,074

Cash payments
(4,445
)
 
(1,515
)
 
(2,402
)
 
32

 
(175
)
 
(8,505
)
Non-cash items
—

 
—

 
(10,876
)
 
(1,689
)
 
—

 
(12,565
)
Balance as of March 31, 2018
$
139

 
$
—

 
$
—

 
$
—

 
$
—

 
$
139

Costs incurred
—

 
—

 
—

 
—

 
—

 
—

Cash (payments) receipts
(58
)
 
—

 
—

 
—

 
—

 
(58
)
Non-cash items
—

 
—

 
—

 
—

 
—

 
—

Balance as of September 29, 2018
$
81

 
$
—

 
$
—

 
$
—

 
$
—

 
$
81

    
Other restructuring plans:
The Company's previously disclosed other restructuring plans are largely complete. No net restructuring costs related to these plans were recorded in the first two quarters of fiscal 2019 while $0.4 million were recorded in fiscal 2018. The amounts payable of $0.1 million at September 29, 2018 are expected to be future cash outflows, primarily relating to facility costs to be paid through the end of the third quarter of fiscal 2019. The Company does not expect to incur additional expenses related to these plans.

19

The following table presents the amounts related to restructuring costs payable (in thousands):
Restructuring and cost management amounts payable as of April 1, 2017
$
861

Cash payments and other adjustments
(980
)
Costs incurred
409

Restructuring and cost management amounts payable as of March 31, 2018
290

Cash payments and other adjustments
(196
)
Costs incurred
—

Restructuring and cost management amounts payable as of September 29, 2018
$
94

Overall restructuring reserve:
As of September 29, 2018, and March 31, 2018, the amount of unpaid restructuring costs included in accrued liabilities on the Consolidated Balance Sheets were $0.2 million and $0.4 million, respectively. Included in the payable balance are amounts for severance and employee benefits, and net lease commitments.
17. Income Taxes
The Tax Cuts and Jobs Act (the Tax Act) was enacted into law in the United States on December 22, 2017. The Tax Act includes various changes to the tax law, including a reduction in the U.S. corporate income tax rate from 35% to 21%.
The Tax Act added section 250 to the Internal Revenue Code, effectively creating a new preferential tax rate for income derived by domestic corporations from serving foreign markets. The new deduction is described as a deduction for foreign-derived intangible income. This lower tax rate provides a new benefit for owning intangible property and conducting business operations in the United States.
The Tax Act also includes a base erosion and anti-abuse tax (BEAT), applicable to corporations with annual gross receipts of at least $500 million for the prior 3-years, which requires U.S. multinationals making “excessive” deductible payments to their foreign affiliates to pay a 10 percent tax on their income without those deductions, after a one-year, 5 percent transition rate. The Company does not expect the BEAT provisions to apply until it meets the threshold. Further the Tax Act imposes a tax on global intangible low-taxed income (GILTI) on controlled foreign corporations’ aggregate net income over a 10% benchmark return on qualified business asset investment less interest expense. The Company continues to assess the impacts of these provisions on the Company’s financial position, results of operations or cash flows.
The Securities and Exchange Commission Staff Accounting Bulletin No. 118 allows the use of provisional amounts in the Company’s financial statements during a measurement period if accounting for the income tax effects of the Tax Act has not been completed when the Company’s financial statements are issued. This measurement period may extend no longer than one year. The Company continues to evaluate the impact the new legislation will have on its financial position, results of operations, and cash flows. Additional technical guidance from the Department of Treasury, the FASB, and other relevant rule-making bodies continue to evolve, which is likely to impact the interpretation of various provisions of the Tax Act. Areas where changes may still occur include, but are not limited to, GILTI, and calculation of deemed repatriation.
18. Earnings Per Share
The following is a reconciliation of weighted average shares outstanding used in the calculation of basic and diluted earnings per share:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands, except per share data)
Sep 29, 2018
 
Sep 30, 2017
 
Sep 29, 2018
 
Sep 30, 2017
Net income
$
16,835

 
$
4,260

 
$
47,978

 
$
7,162

Weighted average shares used for basic earnings per share
34,606

 
33,861

 
34,529

 
33,647

Incremental diluted shares
1,353

 
1,013

 
1,387

 
1,069

Weighted average shares used for diluted earnings per share
35,959

 
34,874

 
35,916

 
34,716

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.49

 
$
0.13

 
$
1.39

 
$
0.21

Diluted
$
0.47

 
$
0.12

 
$
1.34

 
$
0.21


20

RSUs and SARs representing an additional 0.3 million shares of stock for the second quarter of fiscal 2018 and 0.6 million shares of stock for the first two quarters of fiscal 2018 were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive. Antidilutive shares were immaterial for the second quarter of fiscal 2019 and the first two quarters of fiscal 2019.
19. Merger Agreement
Merger Agreement
On October 29, 2018, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with MKS Instruments, Inc., a Massachusetts corporation (MKS) and EAS Equipment, Inc., a Delaware corporation and a wholly owned subsidiary of MKS (Merger Sub). The Merger Agreement provides for, subject to the terms and conditions of the Merger Agreement, the acquisition of the Company by MKS at a price of $30.00 per share in cash, without interest and subject to deduction for any required withholding tax, through the merger of Merger Sub into the Company (the Merger), with the Company surviving the Merger as a wholly owned subsidiary of MKS.

21

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

The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes”, “expects”, “projects”, “anticipates,” “plan,” “continue,” “could,” “estimates,” “intends,” “should,” “will,” “may” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. Forward looking statements include any statements regarding anticipated sales, gross margins, our profitability in future periods, our proposed Merger with MKS, our expectations regarding customer processes and our products, our strategies and beliefs regarding the markets in which we compete or may compete and our product development plans to address these markets, the sufficiency of our financial resources to meet our working capital needs for at least the next 12 months, our expectations regarding taxes and tax adjustments, particularly with respect to the Tax Act, our expectations regarding various legal matters, our ability to rapidly increase our production capacity to accommodate demand, sources of our future revenue, the effect of new or recently adopted accounting standards on our business, financial results, results of operations or cash flows, future impairment of goodwill, future anticipated net warranty costs, our products’ ability to satisfy the needs of manufacturers, our relationships with suppliers and customers, trends that drive increases in applications for laser processing, the size and growth of our markets, increased use of our MLCC components, strong global demand for consumer electronics, automotive and other devices using radio frequency for communications, our expected inventory levels, our expected capital expenditures over the next 12 months, our growth of foreign operations, our customer concentrations, the adequacy of our liquidity and financing and our expectations regarding access to credit and our ability to meet the covenants of our Credit Facility, our expectation that we will invest in new product development and enhancements, and working capital requirements and resources. From time to time, we may make other forward-looking statements. Investors are cautioned that such forward-looking statements involve estimates, assumptions, risks, and uncertainties and are subject to an inherent risk that actual results may differ materially. Factors that may cause or contribute to differences include those discussed below in Item 1A Risk Factors.
Overview of Business
Electro Scientific Industries, Inc., and its wholly-owned subsidiaries (ESI, we, our, or the Company), is a leading supplier of innovative laser-based microfabrication solutions for industries reliant on microtechnologies. ESI enables its customers to commercialize technology using precision laser processes. ESI's solutions produce the industry's highest quality and throughput, and we target the lowest total cost of ownership. Founded in 1944, ESI is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Europe and North America.
Laser microfabrication comprises a set of precise micron-level processes, including drilling, scribing, dicing, singulation, cutting, ablating, trimming, and precision marking on multiple types of materials. These processes require application-specific laser systems that are able to meet our customers’ exacting performance and productivity requirements. Our laser-based systems are utilized in the production of flexible and rigid printed circuit board (PCB), semiconductor devices, advanced semiconductor packaging, consumer electronics, electronic sensors, touch-panel glass, flat panel liquid crystal displays (LCDs), organic light emitting diode (OLED) displays, applications within the automotive, aerospace, medical and display end markets as well as other high-value components and devices to enable functionality, increase performance and improve production yields.
Additionally, we produce high-capacity test and inspection equipment that is critical to the quality control process during the production of multilayer ceramic capacitors (MLCCs). Our equipment ensures that each component meets the electrical and physical tolerances required to perform properly.
The second quarter of fiscal 2019 ended September 29, 2018, the first quarter of fiscal 2019 ended June 30, 2018, and the second quarter of fiscal 2018 ended September 30, 2017 were all 13-week periods. Similarly, the two quarters ended September 29, 2018 and the two quarters ended September 30, 2017 each consisted of 26-week periods.
Merger Agreement with MKS Instruments, Inc.
On October 29, 2018, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with MKS Instruments, Inc., a Massachusetts corporation (MKS) and EAS Equipment, Inc., a Delaware corporation and a wholly owned subsidiary of MKS (Merger Sub). The Merger Agreement provides for, among other things, the acquisition by MKS of the Company. See Note 19: Merger Agreement of the Notes to Condensed Consolidated Financial Statements for additional information. Please also see Item 1A. Risk Factors.

22

Results of Operations
Second Quarter of Fiscal 2019 Highlights:
•
Total net sales increased by 21% year-over-year to $85.9 million in the second quarter of fiscal 2019 primarily driven by the Component Test market due to increased use of MLCC components, particularly in consumer electronics and automotive applications, which require our tools for processing. Additionally, sales were driven by increased service revenue and increased sales of our wafer mark tools. Backlog at the end of the second quarter of fiscal 2019 remained strong at $105.2 million.
•
Orders in the second quarter of fiscal 2019 were $66.9 million primarily due to increased capacity spend by MLCC producers, as described above. Orders for flex via drilling have experienced cyclical reduction in the first half of fiscal 2019 due to capacity build-up.
•
Gross margin was 45.5% in the second quarter of fiscal 2019, up significantly from 37.4% in the second quarter of fiscal 2018, primarily due to higher sales and lower charges due to restructuring as compared to fiscal 2018.
•
Operating expenses were $20.0 million in the second quarter of fiscal 2019, and represent a $2.1 million decrease compared to the second quarter of fiscal 2018. The decrease was primarily driven by lower restructuring costs as well as lower variable expense. These decreases were partially offset by increased investment in new product development.
•
Net income was $0.47 per diluted share, compared to $0.12 per share a year ago, on higher sales and gross profit combined with lower operating expenses.
•
Operating cash flows were $51.1 million, compared to $18.3 million in the second quarter of fiscal 2018, on higher net income and increased collections of accounts receivable.
Second Quarter Ended September 29, 2018 Compared to Second Quarter Ended September 30, 2017
The following table presents results of operations data as a percentage of net sales:
 
Fiscal quarter ended
 
Sep 29, 2018
 
Sep 30, 2017
Net sales
100.0
%
 
100.0
 %
Cost of sales
54.5

 
62.6

Gross profit
45.5

 
37.4

Selling, general and administrative
12.6

 
16.5

Research, development and engineering
10.7

 
11.7

Restructuring costs
—

 
3.0

Operating income
22.2

 
6.2

Interest and other income (expense), net
0.4

 
(0.3
)
Total non-operating income (loss)
0.4

 
(0.3
)
Income before income taxes
22.6

 
5.9

Provision for income taxes
3.0

 
(0.1
)
Net income
19.6
%
 
6.0
 %
Net Sales
The following table presents net sales information by the five major product categories addressed by the Company's single segment:
 
Fiscal quarter ended
  
Sep 29, 2018
 
Sep 30, 2017
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Printed Circuit Board
$
38,816

 
45.1
%
 
$
38,187

 
53.8
%
Component Test
18,555

 
21.6

 
7,007

 
9.9

Semiconductor
11,227

 
13.1

 
9,641

 
13.6

Industrial Machining
2,665

 
3.1

 
5,481

 
7.7

Service
14,654

 
17.1

 
10,651

 
15.0

Net sales
$
85,917

 
100.0
%
 
$
70,967

 
100.0
%

23

Net sales for the second quarter of fiscal 2019 of $85.9 million increased $15.0 million or 21% when compared to net sales for the second quarter of fiscal 2018.
Sales of products into the PCB market for the second quarter of fiscal 2019 increased $0.6 million or 2% compared to the second quarter of fiscal 2018. Both quarters reflected the impact of increased demand for flex systems due to the most recent market demand cycle. While the quarters are consistent, the second quarter of fiscal 2018 was due to order demand earlier in the market demand cycle while the second quarter of fiscal 2019 reflected fulfillment against backlog stemming from orders received later in the same market demand cycle. The strong environment was driven by unit growth in consumer electronics and associated capacity additions plus new materials, technologies and applications that require increased levels of complex flexible circuits.
Sales of products into the Component Test market for the second quarter of fiscal 2019 increased $11.5 million or 165% compared to the second quarter of fiscal 2018, primarily driven by equipment capacity shortages resulting from increased demand for MLCC components, particularly in consumer electronics and automotive applications, many of which require our tools for processing.
Sales of products into Semiconductor applications for the second quarter of fiscal 2019 increased $1.6 million or 16% compared to the second quarter of fiscal 2018. This increase was primarily driven by increased sales of our wafer mark and wafer trim products and sales of our new UltrusTM wafer scribing tool.
Sales of products into Industrial Machining applications for the second quarter of 2019 decreased $2.8 million or 51% compared to the second quarter of fiscal 2018. This was primarily due to decreased sales of micromachining systems into PCB cutting applications.
Service revenues for the second quarter of fiscal 2019 increased $4.0 million or 38% compared to the second quarter of fiscal 2018. The increase was primarily driven by increased spare parts revenues resulting from products that we shipped in the last 18 months beginning to come off their warranty period.
The following table presents net sales information by geographic region:
 
Fiscal quarter ended
  
Sep 29, 2018
 
Sep 30, 2017
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
76,334

 
88.9
%
 
$
64,053

 
90.3
%
Europe
6,468

 
7.5

 
3,978

 
5.6

Americas
3,115

 
3.6

 
2,936

 
4.1

Net sales
$
85,917

 
100.0
%
 
$
70,967

 
100.0
%
Net sales to Asia increased by $12.3 million or 19% primarily due to higher sales of our MLCC testing tools. Net sales to Europe increased primarily due to increased sales of wafer and circuit trim products.
Gross Profit
 
Fiscal quarter ended
  
Sep 29, 2018
 
Sep 30, 2017
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Gross Profit
$
39,067

 
45.5
%
 
$
26,532

 
37.4
%
Gross profit was $39.1 million for the second quarter of fiscal 2019, an increase of $12.5 million compared to $26.5 million in the second quarter of fiscal 2018. The gross profit increase was primarily driven by higher net sales across both systems and service as well as $6.1 million of inventory and other asset impairment charges in the second quarter of fiscal 2018 which did not recur in the second quarter of fiscal 2019. The gross margin increase was also driven by the non-recurring impairment charges as well as the favorable impact of higher production volumes and improved mix from greater service revenues.

24

Operating Expenses
 
Fiscal quarter ended
  
Sep 29, 2018
 
Sep 30, 2017
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, general and administrative
$
10,838

 
12.6
%
 
$
11,648

 
16.5
%
Research, development and engineering
9,154

 
10.7

 
8,274

 
11.7

Restructuring costs
—

 
—

 
2,162

 
3.0

Operating Expenses
$
19,992

 
23.3
%
 
$
22,084

 
31.2
%
Selling, General and Administrative
Selling, general and administration (SG&A) expenses primarily consist of labor and other employee-related expenses, including share-based compensation expense, travel expenses, professional fees, sales commissions and facilities costs. SG&A expenses for the second quarter of fiscal 2019 decreased $0.8 million compared to the second quarter of fiscal 2018. The decrease was primarily due to lower variable expenses and restructuring actions taken in the prior year.
Research, Development and Engineering
Research, development and engineering (RD&E) expenses primarily comprise labor and other employee-related expenses, including share-based compensation expense, professional fees, project materials costs, equipment costs and facilities costs. RD&E expenses for the second quarter of fiscal 2019 increased $0.9 million compared to the second quarter of fiscal 2018, primarily due to increased consulting and materials costs related to investment in new product development.
Restructuring Costs
In the fourth quarter of fiscal 2017, we initiated a restructuring plan to improve business effectiveness, streamline operations and achieve a stated target cost level for the Company as a whole. Restructuring costs of $2.2 million in the second quarter of fiscal 2018 primarily consisted of $1.2 million of fixed asset write-offs, $0.5 million of facilities lease obligations and $0.5 million of severance and related benefits charges. There were no restructuring costs in the second quarter of 2019. See Note 16: Restructuring and Cost Management Plans for further discussion.
Non-operating Income and Expense
 
Fiscal quarter ended
  
Sep 29, 2018
 
Sep 30, 2017
(In thousands, except percentages)
Non-Operating
Income
(Expense)
 
% of Net Sales
 
Non-Operating
Income
(Expense)
 
% of Net Sales
Interest and other income (expense), net
$
383

 
0.4
%
 
$
(229
)
 
(0.3
)%
Total non-operating income (expense)
$
383

 
0.4
%
 
$
(229
)
 
(0.3
)%
Non-operating income, net, consists of interest income and expense, market gains and losses on non-operating assets, realized and unrealized foreign exchange gains and losses, bank charges, investment management fees, and other miscellaneous non-operating items, such as investment impairment. Net non-operating income was $383 thousand in the second quarter of fiscal 2019 compared to expense of $229 thousand in the second quarter of fiscal 2018. The increased income in the second quarter of fiscal 2019 was due primarily to a $0.4 million increase in interest income due to our increased investments balance and $0.1 million due to gains from foreign exchange fluctuations.
Income Taxes
 
Fiscal quarter ended
 
Sep 29, 2018
 
Sep 30, 2017
(In thousands, except percentages)
Income Tax Provision
 
Effective
Tax Rate
 
Income Tax Benefit
 
Effective
Tax Rate
Provision (benefit) for income taxes
$
2,623

 
13.5
%
 
$
(41
)
 
(1.0
)%
The income tax provision for the second quarter of fiscal 2019 was $2.6 million on pretax income of $19.5 million for an effective tax rate of 13.5%, compared to a $41 thousand tax benefit on pretax income of $4.2 million for an effective tax rate of (1.0)% in the second quarter of fiscal 2018. The 2019 effective tax rate is higher due to a release of valuation allowance at the end of 2018 and higher profits leading to increased foreign taxes.

25

Two Quarters Ended September 29, 2018 Compared to Two Quarters Ended September 30, 2017
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Two fiscal quarters ended
 
Sep 29, 2018
 
Sep 30, 2017
Net sales
100.0
%
 
100.0
 %
Cost of sales
53.1

 
63.1

Gross profit
46.9

 
36.9

Selling, general and administrative
10.7

 
17.1

Research, development and engineering
9.8

 
12.0

Restructuring costs