10-K 1 esi10-k3292014.htm 10-K ESI 10-K 3.29.2014
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K 
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 29, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-12853
ELECTRO SCIENTIFIC INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
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
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
Series A No Par Preferred Stock Purchase Rights
 
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  ý
Indicate by check mark if the Registrant is not required to file reports pursuant Section 13 or Section 15(d) of the Act.    Yes  ¨    No  ý
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K.  ý
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ¨    Accelerated  filer  ý         Non-accelerated filer  ¨    Smaller reporting company   ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý



The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the last sales price $11.68 as reported by the NASDAQ Stock Market, as of the last business day of the Registrant’s most recently completed second fiscal quarter (September 28, 2013) was $305,127,637.
The number of shares outstanding of the Registrant’s Common Stock as of June 5, 2014 was 30,188,462 shares.
Documents Incorporated by Reference
The Registrant has incorporated into Part III of this Form 10-K, by reference, portions of its Proxy Statement for its 2014 Annual Meeting of Shareholders.




ELECTRO SCIENTIFIC INDUSTRIES, INC.
2014 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
 
Part I
Part II
Part III
Part IV
 
 
 




PART I
Item 1. Business
This annual report on Form 10-K contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ materially from the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below in Item 1A Risk Factors.
Where You Can Find More Information
We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 as amended (Exchange Act). You can inspect and copy our reports, proxy statements and other information filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. The SEC maintains an Internet site at www.sec.gov where you can obtain most of our SEC filings. We also make available, free of charge on our website at www.esi.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after they are filed electronically with the SEC. The information found on our website is not part of this Form 10-K. You can also obtain copies of these reports by contacting Investor Relations at (503) 641-4141.


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Fiscal Year
Our fiscal year consists of 52 or 53 weeks ending on the Saturday nearest March 31. Accordingly, our fiscal 2014 reporting period consisted of a 52-week period ending on March 29, 2014, our fiscal 2013 consisted of a 52-week period ending on March 30, 2013 and our fiscal 2012 reporting period consisted of a 52-week period ending on March 31, 2012. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.
Business Overview
Electro Scientific Industries, Inc. and its subsidiaries (ESI) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. Our advanced laser systems enable precise structuring of micron to submicron features in components and on devices which are used in a wide variety of end products in the consumer electronics, computer, semiconductor, communications and other markets. These features enable our customers to increase performance, enable functionality, alter physical characteristics, or improve production yields and productivity in their manufacturing processes that can be critical to their product differentiation or profitability. Founded in 1944, ESI is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Canada, Europe and the United States.
Our advanced laser microfabrication systems allow microelectronics, semiconductor and other microtechnology manufacturers to physically alter select device features during high-volume production in order to increase performance and improve production yields. 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 enable improved performance or improve production yields for flexible and rigid high density interconnect printed circuit boards, semiconductor devices, advanced semiconductor packaging, touch-panel glass, flat panel liquid crystal displays (LCDs) and other high value components.
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. Lastly, we produce systems that use photonic technology to perform precision inspection for quality control and defect identification.
Industry Overview
The microelectronics and semiconductor industries continue to be driven by demand for advanced features and improved functionality in increasingly smaller and smarter consumer devices. The technologies for consumer electronic devices such as smart phones, tablets, personal computers, mobile computing devices, video game systems and high-definition televisions have developed rapidly as increasingly affordable products have been introduced that offer more functionality in smaller packages. In addition, semiconductor and other advanced technologies are being used in a broadening set of markets and applications, including automotive, aerospace, medical, security and general lighting.
These dynamics in turn are driving the need for faster, smaller, more complex, less expensive and higher-quality electronic devices and components. To achieve these improvements, component and other device manufacturers are increasing the circuit and feature densities in these devices and investing in new technologies.
For example, smaller and lighter semiconductor devices are driving the need to shrink the physical dimensions of the semiconductor packaging and the high density interconnect (HDI) circuit board on which they are mounted. Higher operating speeds of computers and communication products require more input and output channels within packages and between the packages and the HDI circuit board. These trends require smaller, more accurate, and precisely tapered or shaped holes, known as vias, to create connections between layers and interconnecting devices. The continual trend toward smaller and smarter devices requires the use of an increasing amount of flexible interconnect material between PCBs and other components. These flexible circuits require the smallest and most accurate vias to create the connections between these devices.
In addition, the ability to shrink the actual dimensions of a device is becoming increasingly more difficult, and producers are investing in new technologies, such as stacking thin silicon wafers to create advanced three dimensional (3D) chip packages. We believe this trend may drive additional applications for laser processing, including scribing and dicing of ultra-thin wafers, drilling of through silicon vias (TSV) and scribing of next generation thin films.
Smaller and more complex devices also require more capacitance to be designed into the circuit. This has resulted in an increase in the use of smaller, higher-capacitance passive components such as MLCCs. In calendar year 2013, estimated production of MLCCs was nearly 3 trillion units. These MLCCs must be tested electrically and optically to characterize

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performance and ensure reliability. Automated equipment to test these MLCCs in the manufacturing environment, like our high capacitance tester, can test and sort up to one million parts per hour on parts with dimensions as small as 0.4 by 0.2 millimeters.
A significant portion of our business is derived from specialized microfabrication applications. Any material that can be cut, drilled, marked or joined using a mechanical process can be microfabricated with greater precision and accuracy using a laser-based solution. As consumer electronics and other products or devices become more compact, mechanical processes will not be able to meet the stringent specifications demanded by producers. We believe the capabilities of laser-based solutions for microfabrication will enable our customers to continue to move beyond the limitations of mechanical processes and generate significant growth for us in the future.
Our Solutions
We believe our products address the needs of microelectronics and semiconductor manufacturers by providing them with a high return on their investment due to measurable production benefits such as lower cost, higher performance, continued miniaturization, greater reliability, and improved production yield.
Our core competencies enable us to design, manufacture, and market a variety of integrated laser-based solutions for microfabrication applications in high-volume manufacturing environments. These core competencies include a deep understanding of laser/material interaction, laser beam positioning, optics and illumination including image processing and optical character recognition, high-speed motion control, small parts handling, proprietary laser technology and systems engineering. We combine this technology expertise with a thorough understanding of our customers’ processes, and our manufacturing agility to respond rapidly to customer demand to develop and deliver integrated solutions and products that address multiple markets and applications.
Our customers manufacture components, interconnect/packaging devices, semiconductors, displays or other parts that serve a wide range of electronic applications. Our systems enable the manufacturing of these components and devices. The primary end-market applications for our customers are consumer electronics, including smart mobile devices such as smart phones and tablets, computers and semiconductors. These devices and applications are also utilized in a variety of other industries including automotive, aerospace, medical, security and general lighting.
Our Strategy
Our strategy is to leverage our core competencies to be a cost of ownership leader in laser-based microfabrication for microtechnology industries, including microelectronics, semiconductor and other micro-industrial applications. These core competencies, combined with an understanding of our customers’ processes and the use of common platforms, enable us to address a broad range of laser-based applications and end markets within these industries. We intend to focus our efforts on businesses and applications where our differentiated capability enables us to be a market leader. The elements of our strategy are to (1) capture expanding opportunities driven by technology changes and growth in consumer electronics, (2) identify and capitalize on broader laser machining applications, (3) leverage proprietary laser technology to create competitive advantage, (4) strengthen marketing capability and broaden customer focus, and (5) develop and leverage flexible platforms for cost of ownership and time to market advantage in new applications.
Capture expanding opportunities driven by technology changes and growth in consumer electronics
Growth in consumer electronics, smart phones, tablets, notebook computers and other smart devices is driving increased miniaturization and complexity of the underlying components and materials, which in turn is creating additional opportunities for laser-based microfabrication. In addition, these materials and components are being adopted in electronic devices, sensors, display, and other technologies ubiquitously across many markets and applications including automotive, aerospace, medical, communications, appliances, security, general lighting, energy, and entertainment. Our strategy is to expand the number of applications we address in the areas of machining both the devices themselves and the components within them. For example, in 2014 we introduced new capabilities for in-line inspection of parts with real-time tailored laser machining, ultrafast laser scribing of thin films on semiconductor wafers and singulation of next generation strengthened cover glass for touch panel displays. We believe growth from consumer electronics applications will be driven by overall growth in the market for these devices, new technologies, and expanding our addressable applications.
Identify and capitalize on broader laser machining applications
Laser microfabrication is a large and growing market, and applications for its use extend far beyond the consumer electronics industry. Advancing technologies in products that serve the medical, military, automotive, and security markets, for example, are creating the need for laser machining in the manufacture of devices and components. Our strategy is to leverage

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our laser technology and understanding to address new applications in new industries which ESI has traditionally not served in the past. Adding capability and scale to our sales channel will be a key component to successfully implementing this strategy.
Leverage proprietary laser technology to create competitive advantage
ESI has been a pioneer in laser/material interaction and has developed deep expertise in the use of multiple types of laser technology to develop customer solutions. Over the last three years we have invested in proprietary laser technology through the acquisitions of Pyrophotonics Lasers Inc., Eolite Systems and the Semiconductor Systems business of GSI Group, Inc. These acquisitions, combined with internally developed capability, provide us with access to tailored pulse fiber technology, high power UV nanosecond, and low cost picosecond fiber lasers with a unique, scalable architecture. Our strategy is to utilize these technologies to enable differentiated capability with our systems, lower cost, and generate incremental revenue for the company.
Strengthen marketing capability and broaden customer focus
The company’s close collaboration with key customers who are leaders in their respective industries has enabled ESI to develop world-class technologies that meet the emerging needs of these demanding customers. Our strategy is to modify our approach to product development so we can meet the needs of entire market segments as opposed to key customers only. We believe this new approach will enable our products to serve the needs of a far larger portion of the laser microfabrication market. We plan to strengthen our marketing capability and channel reach through external hiring, employee training and development, increased localization, and use of channel partners.
Leverage flexible platforms and technology for cost of ownership and time to market advantage
Our key technological capabilities include laser/material interaction, laser beam positioning, optics and illumination, high-speed motion control systems, small parts handling systems and systems integration. Our strategy is to incorporate these capabilities into a series of flexible platforms that have multiple common elements but are tailored to specific applications. Our strategy is to leverage our investment in these platforms to address multiple new applications and market opportunities.
Our Products
We operate in one segment, high-technology manufacturing equipment, which is comprised of products that are classified in three groups: interconnect & microfabrication, semiconductor and components.
Interconnect & Microfabrication Group (IMG)
Our Interconnect & Microfabrication Group products address an expanding number of applications and materials on a broad set of substrates, including panels, continuous-feed reels and discrete three dimensional components or devices.
Interconnect Via Drilling
For electrical interconnect applications, our laser via micro fabrication systems target applications that require the highest accuracy and smallest via (hole) dimensions to create electrical connections between layers in flexible circuits, high-density circuit boards and IC packages. Our micro via drilling technology addresses the rapidly changing applications in IC packages, multichip modules and HDI circuit boards. Our ultraviolet (UV) laser processing systems employ state-of-the-art technology in lasers, optics and motion control. These products include single-beam and multi-beam systems that produce high-quality vias with the best-in-class placement accuracy for improved yield of packages and substrates.
Advanced Microfabrication
As technologies enable consumer electronics and other devices to become more compact, mechanical processes are not able to meet the stringent specifications demanded by manufacturers. We offer several platforms that enable customers to perform precision drilling, scribing, cutting, etching, routing or marking on many different types of materials and devices including glass, metal, plastic, paint and ceramics. We also offer laser ablation systems that ablate material for identification and analysis applications, including forensics, mineral analysis and research.
During 2014 the company entered the glass cutting market for next-generation strengthened glass and shipped two systems for pilot production. Our incremental revenue opportunity in this emerging market will be paced by the rate of adoption of the new glass and the "One Glass Solution" manufacturing process by touch panel manufacturers.
In June 2012, we acquired Eolite Systems, a designer and manufacturer of unique high-power fiber lasers in Pessac, France. The acquisition of Eolite provides us access to high power UV nanosecond and low cost picosecond fiber lasers with a

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unique, scalable architecture. We believe these lasers can be used internally in a variety of laser microfabrication applications as well as provide potential additional commercial revenue for the company with the ability to customize lasers to specific customer applications with differentiated capability and lower cost.
Semiconductor Group (SG)
Our Semiconductor Group products address multiple applications that utilize laser energy to process materials on wafer-based substrates and semiconductor devices and packages. Applications include processing of silicon wafers, mixed signal devices, hybrid circuits, sensors, and resistors.
Semiconductor Systems
In May 2013, we acquired the assets of the Semiconductor Systems business from GSI Group Inc. These products include industry leading wafer marking equipment, wafer and circuit trim tools, and LCD repair tools. Wafer marking equipment is used for serialization and wafer identification by both manufacturers of semiconductor wafers and within semiconductor fabs. Wafer and circuit trim tools are laser systems that adjust the electrical performance of semiconductor devices or hybrid circuits by removing a precise amount of material from one or more circuit components.
3D Semiconductor Wafer Processing
The advent of 3D chip packaging technologies is driving the need for silicon wafers to become thinner in order to allow for stacking of wafers within the same packaging geometry. As wafers become thinner, they become more challenging to cut into discrete chips using traditional mechanical saws. Our model 9900 uses a laser to dice ultra-thin silicon wafers, those with a thickness of 50 microns or below, and to singulate interposers. In addition, this platform can be used to scribe next generation thin film materials that lend themselves to laser processing. As 3D technologies are developed, we believe the use of advanced laser technology will become increasingly important to productivity and performance.
LCD Repair
Our laser LCD repair systems are critical to improving yields in the manufacture of flat panel displays. During production, individual pixels of a display may develop electrical defects that result in no light emission or the emission of only a steady white light. To correct these defects, flat panel display producers employ a laser repair process to isolate the electrical defects during production by cutting the inputs to the pixel. Our laser systems are primarily sold to the manufacturers of LCD repair tools as a key component of their products.
Components Group (CG)
We design and manufacture products that combine high-speed small parts handling technology with real-time control systems to provide highly automated, cost-effective inspection solutions for manufacturers of MLCCs and other passive components such as capacitor arrays, inductors, resistors, varistors and hybrid circuits. These components, produced in quantities of trillions of units per year, process analog, digital and high-frequency signals and are used extensively in nearly all electronic products. Our MLCC test systems employ high-speed handling and positioning techniques to precisely load, test and sort MLCCs based on their electrical energy storage capacity, or capacitance, and their electrical energy leakage, or dissipation factor. Our 35XX series is the most productive tester in the market today. Our latest 3510 model enables high speed testing of the industry’s smallest metric 0402 capacitors used primarily in advanced cell phone and tablet designs. We also produce consumable products such as carrier plates and termination belts, both of which are used to hold MLCCs during the manufacturing and testing process.
Customers
Our top ten customers for 2014, 2013 and 2012 accounted for approximately 41%, 61% and 56% of total net sales, respectively. One customer, Apple Inc., and its affiliates, accounted for approximately 15%, 31% and 29% of total net sales in 2014, 2013 and 2012, respectively.
Sales, Marketing and Service
We sell our products worldwide through direct sales and service offices, value-added resellers and independent representatives located around the world. ESI has direct sales and service personnel in Oregon, California and several other states; China, Japan, Korea, Singapore and Taiwan in Asia; and France, Germany and the United Kingdom in Europe. We serve selected customers in the Americas, Europe, Israel and additional countries through manufacturers’ representatives.

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We have a substantial base of installed products in use by leading microelectronics and semiconductor manufacturers. We emphasize strong working relationships with these customers to meet their needs for additional systems and to facilitate the successful development and sale of new products to these customers.
We generally employ service personnel wherever we have a significant installed base. We offer a variety of warranty, maintenance and parts replacement programs to service the requirements of our customers’ high-volume manufacturing environments.
Backlog
Backlog consists of purchase orders for products and spare parts that we expect to ship within 12 months and service contracts for performance generally within 24 months. Backlog does not include deferred system revenue. Backlog was $27.4 million at March 29, 2014 compared to $32.8 million at March 30, 2013, representing a decrease of 16% primarily as a result of lower orders in the fourth quarter of 2014 compared to the fourth quarter of 2013. Our stated backlog is not necessarily indicative of sales for any specific future period, because of possible order cancellations or deferrals, shipping or acceptance delays, nor does backlog represent any assurance that we will realize a profit from filling the orders.
Research, Development and Technology
We believe that our ability to compete effectively and deliver customer solutions depends, in part, on our ability to maintain and expand our expertise in core technologies and product applications. Our primary core competencies and capabilities include:
laser/material interaction;
high-speed, micron-level motion control systems;
precision optics;
proprietary laser technology;
image processing and optical character recognition;
high-speed, small parts handling;
real-time production-line electronic measurement;
real-time operating systems; and
systems integration.
Our research and development expenditures for 2014, 2013 and 2012 were $37.8 million (21% of net sales), $37.2 million (17% of net sales) and $42.6 million (17% of net sales), respectively.
Competition
Our markets are dynamic, cyclical and highly competitive. The principal competitive factors in our markets are total cost of ownership, product performance, ease of use, reliability, service, technical support, product roadmap, price, proprietary technology, manufacturing responsiveness and relationships with customers. We believe that our products compete favorably with respect to these factors. Some of our competitors have greater financial, engineering and manufacturing resources and larger distribution networks than we do. Some of our customers develop, or have the ability to develop, manufacturing equipment similar to our products. Competition in our markets may intensify and our technological advantages may be reduced or lost as a result of technological advances by competitors or customers or changes in electronic device processing technology.
Our Interconnect & Microfabrication Group competes with laser systems provided by Hitachi Via Mechanics, Ltd., Eo Technics Co., Ltd., LPKF Laser & Electronics AG, Mitsubishi Electric Corporation, Orbotech Ltd., InnoLas Systems GmbH and several Chinese and Korean companies who compete within their local markets. The principal competitors for our Semiconductor Group are DISCO Corporation, and Laser Solutions, Inc. LCD repair competitors include Quantel USA, Inc. and HOYA Corporation. For the Components Group, our competitors include Humo Laboratory, Ltd. as well as component manufacturers that develop systems for internal use.
Manufacturing and Supply
Our primary production facilities are located in Singapore; Portland, Oregon; Chelmsford, Massachusetts; and Klamath Falls, Oregon. Our Singapore facility is our primary systems manufacturing facility and manufactures certain IMG, SG, CG and laser ablation products. The Portland facility primarily provides advanced manufacturing and prototype capability. The Chelmsford facility manufactures our Semiconductor Systems business wafer trim and circuit trim products. The Klamath Falls facility manufactures CG consumable products. Our Singapore and Chelmsford operations are located in leased facilities. As we continue our efforts to streamline the organization and improve efficiencies, we expect a growing percentage of final systems will be shipped from Singapore.

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We use qualified manufacturers to supply many components and sub-system modules for our products. Our systems use high-performance computers, peripherals, lasers and other components from various suppliers. Some of the components we use are obtained from a single source or a limited group of suppliers. An interruption in the supply of a particular component would have a temporary adverse impact on us. We believe our relationships with our suppliers are good.
Patents and Other Intellectual Property
We have a policy of seeking patents, when appropriate, on inventions relating to new products and improvements that are discovered or developed as part of our ongoing research, development and manufacturing activities. We owned 414 United States patents and 682 patents issued outside of the United States as of March 29, 2014. Additionally, as of March 29, 2014, we had 235 patent applications pending in the United States and 870 patent applications pending outside of the United States. Although our patents are important, we believe that the competitiveness of our products also depends on the technical competence and innovation of our employees.
We rely on copyright protection for our proprietary software. We also rely upon trade secret protection for our confidential and proprietary information. Others may independently develop substantially equivalent proprietary information and techniques, and we may be unable to meaningfully protect our trade secrets.
Employees
As of March 29, 2014, we employed 658 people of whom 633 were permanent and 25 were temporary. Many of our employees are highly skilled, and our success will depend in part upon our ability to attract and retain such employees, who are in great demand. We have never had a work stoppage or strike, and no employees are represented by a labor union or covered by a collective bargaining agreement. We consider our employee relations to be good.
Environmental Compliance
During fiscal 2014, we retained ISO 14001 certification via Surveillance Assessment for our environmental management system for our Portland, Oregon operations. We do not expect compliance with international, federal, state and local provisions that have been enacted or adopted related to the discharge of materials into the environment or otherwise relating to protection of the environment to have a material effect on our capital expenditures, earnings or competitive position.
Item 1A. Risk Factors
The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes,” “expects” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time, we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may differ materially. 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:
Risks Related to Our Competition and Customers
Volatility of Our Customers’ Industries
Our business is dependent upon the capital expenditures of manufacturers of microelectronics, semiconductors, computers, wireless communications and other electronic products. The capital equipment market for microelectronics, semiconductor, and consumer electronics manufacturers has historically been characterized by sudden and severe cyclical variations in product supply and demand due to a number of factors including capacity utilization, timing of customers’ new product introductions and demand for their products, inventory levels relative to demand and access to affordable capital. The timing, severity and duration of these market cycles are difficult or impossible to predict. As a result, business levels can vary significantly from quarter to quarter or year to year. Significant volatility in investment cycles in the market for microelectronics, and semiconductors used in electronic devices or in the market for consumer electronics reduce demand for our products and may materially and adversely affect our business, financial condition and results of operations. For example, starting in the second half of fiscal 2012, we experienced the negative impact of an uncertain economic environment, slower market growth and overcapacity in several of our markets, which resulted in overall lower order and revenue levels. As a result of these circumstances, our total order volume declined in 2013 compared to 2012 and continued to decline in 2014. The degree of the impact of any downturn on our business depends on a number of factors, including: the strength of the global and United States economies; the overall level of demand for consumer electronics products; the stability of global financial systems; and the overall health of the microelectronics, semiconductor, and consumer electronics industries.

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Highly Competitive Markets
We face substantial competition from established competitors throughout the world, some of which have greater financial, engineering, manufacturing and marketing resources than we do. Those competitors with greater resources may, in addition to other things, be able to better withstand periodic downturns, compete more effectively on the basis of price and technology, or more quickly develop enhancements to, and new generations of, products that compete with the products we manufacture and market. New companies may enter the markets in which we compete, or industry consolidation may occur, further increasing competition in those markets. We have also experienced new entrants to our markets offering aggressive price and payments terms in an attempt to gain market share. Some competitors, particularly in China, also develop low cost products employing processes or technology developed by us. We believe that to be competitive we must continue to expend significant financial resources in order to, among other things, invest in new product development and enhancements. 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.
Increased Price Pressure
We have experienced and continue to experience pricing pressure in the sale of our products, from both competitors and customers. Pricing pressures typically have become more intense during cyclical downturns when competitors seek to maintain or increase market share, reduce inventory or introduce more technologically advanced products or lower cost products. In addition, we may agree to pricing concessions or extended payment terms with our customers in connection with volume orders or to improve cost of ownership in highly competitive applications. Our business, financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and intense price-based competition.
Revenues are Largely Dependent on Few Customers
We depend on a few significant customers for a large portion of our revenues. In 2014, our top ten customers accounted for approximately 41% of total net sales, with one customer, Apple Inc. and its affiliates accounting for approximately 15% of total net sales. We anticipate that sales of our products to a relatively small number of customers will continue to account for a significant portion of our revenues. Consolidation between customers, changes in technologies or solutions used by customers, changes in products manufactured by customers or in end-user demand for those products, selection of suppliers other than us, customer bankruptcies or customer departures from their respective industries all may result in even fewer customers accounting for a high percentage of our revenue and reduced demand from any single major customer. Also, business levels with several of our top customers are dependent on our winning new designs and features each product cycle, and there is no guarantee of future business based on past design wins. Furthermore, none of our customers have any long-term obligation to continue to buy our products or services and may therefore delay, reduce or cease ordering our products or services at any time. The cancellation, reduction or deferral of purchases of our products by even a single customer could significantly reduce our revenues in any particular quarter. For example, revenues from Apple, Inc. decreased from $67 million or 31% of revenue in 2013 to $27 million or 15% of revenue in 2014. If we were to lose any of our significant customers or suffer a material reduction in their purchase orders, revenue could decline and our business, financial condition and results of operations could be materially and adversely affected.
Revenues are Largely Based on the Sale of a Small Number of Product Units
We derive a substantial portion of our revenue from the sale of a relatively small number of products. Accordingly, our revenues, margins and other operating results could fluctuate significantly from quarter to quarter depending upon a variety of factors in addition to those described above, including:
changes in the timing of orders and terms or acceptance of product shipments by our customers;
changes in the mix of products and services that we sell;
timing and market acceptance of our new product introductions; and
delays or problems in the planned introduction of new products, or in the performance of any such products following delivery to customers.
As a result of these risks, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance.
Risks Related to Our Supply Chain and Production
Variability of Production Capacity

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To meet rapidly changing demand in the industries we serve, we must effectively manage our resources and production capacity. During periods of decreasing demand for our products, we must be able to appropriately align our cost structure with prevailing market conditions and effectively manage our supply chain. Our ability to rapidly and effectively reduce our cost structure in response to such downturns is limited by the fixed nature of many of our expenses in the near term and by our need to continue our investment in next-generation product technology and to support and service our products. Conversely, when upturns occur in the markets we serve, we may have difficulty rapidly and effectively increasing our manufacturing capacity or procuring sufficient materials to meet sudden increases in customer demand that could result in the loss of business to our competitors and harm to our relationships with our customers. If we are not able to timely and appropriately adapt to changes in our business environment, our business, financial condition or results of operations may be materially and adversely affected.
Reliance on Critical Suppliers
We use a wide range of components from numerous suppliers in the manufacture of our products, including custom electronic, laser, optical and mechanical components. We generally do not have guaranteed supply arrangements with our suppliers. We seek to reduce the risk of production and service interruptions and shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. Although we make reasonable efforts to ensure that parts are available from multiple suppliers, some key parts are available only from a single supplier or a limited group of suppliers in the short term. In addition, some of the lasers we use in our products are difficult to manufacture, and as a result we may not receive an adequate supply of lasers in a timely fashion to fill orders. Operations at our suppliers’ facilities are subject to disruption or discontinuation for a variety of reasons, including changes in business relationships, competitive factors, financial difficulties, work stoppages, fire, natural disasters or other causes. Any such disruption or discontinuation to our suppliers’ operations could interrupt or reduce our manufacturing activities and delay delivery of our products, any or all of which could materially and adversely affect our results of operations. In addition, when markets recover from economic downturns, there is a heightened risk that one or more of our suppliers may not be able to meet our increased demand requirements, adversely impacting our ability to fulfill orders and win business with our customers.
Utilization of Contract Manufacturers
We have arrangements with contract manufacturers to complete the manufacturing of certain of our products or product subcomponents. Any significant interruption in our contract manufacturers’ ability to provide manufacturing services to us as a result of contractual disputes with us or another party, labor disruptions, financial difficulties, natural disasters, delay or interruption in the receipt of inventory, customer prioritization or other causes could result in reduced manufacturing capabilities or delayed deliveries for certain of our products, any or all of which could materially and adversely affect our results of operations.
Charges for Excess or Obsolete Inventory
One factor on which we compete is the ability to ship products on schedules required by customers. In order to facilitate timely shipping, management forecasts demand, both in type and amount of products, and these forecasts are used to determine inventory to be purchased. We also order materials based on our technology roadmap, which represents management’s assessment of technology that will be utilized in new products that we develop. Certain types of inventory, including lasers and optical equipment, are particularly expensive and may only be used in the production of a single type of product. If actual demand is lower than forecast with respect to the type or amount of products actually ordered, or both, our inventory levels may increase. As a result, there is a risk that we may have to incur material accounting charges for excess and obsolete inventory if inventory cannot be used, which would negatively affect our financial results. Also, if we alter our technology or product development strategy, we may have inventory that may not be usable under the new strategy, which may also result in material accounting charges. For example, during 2014, we recorded $12.8 million of charges in cost of sales for inventory written-off associated with discontinued products.
Uncertainties Resulting from Conflict Minerals Regulation
On August 22, 2012, the SEC adopted a new rule requiring disclosures of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured by companies filing public reports. The new rule requires a disclosure report to be filed annually with the SEC and this report will require companies to perform due diligence, disclose, and report whether such minerals originate from the Democratic Republic of Congo or an adjoining country. The new rule could affect sourcing at competitive prices and availability in sufficient quantities of certain minerals used in the manufacture of our products, including tantalum, tin, gold, and tungsten. The number of suppliers who provide conflict-free minerals may be limited. In addition, there may be material costs associated with complying with the disclosure requirements, such as costs related to determining the source of certain minerals used in our

12


products, as well as costs of possible changes to products, processes, or sources of supply as a consequence of such verification activities. Since our supply chain is complex, we may not be able to sufficiently verify the origins of the relevant minerals used in our products through the due diligence procedures that we implement, which may harm our reputation. In addition, we may encounter challenges to satisfy those customers who require that all of the components of our products be certified as conflict-free, which could place us at a competitive disadvantage if we are unable to do so.
Risks Related to Our Organization
Operating a Global Business
International shipments accounted for 83% of net sales in 2014, with 76% of our net shipments to customers in Asia. We expect that international shipments will continue to represent a significant percentage of net sales in the future. We also have significant foreign operations, including manufacturing facilities in Singapore, research and development facilities in Canada, France and Taiwan, and sales and service offices in various countries. Under our globalization strategy, we intend to increase our foreign operations in the future. Our non-U.S. sales, purchases 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;
difficulty in repatriating money, whether as a result of tax laws or otherwise;
difficulties protecting intellectual property;
compliance with labor laws and other laws governing employees;
local labor disputes;
shipping delays and disruptions;
unexpected changes in trading policies, regulatory requirements, tariffs and other barriers; and
difficulties in managing a global enterprise, including staffing, collecting accounts receivable, and managing suppliers, distributors and representatives.
Our business and operating results could also be impacted, directly or indirectly, by natural disasters, outbreaks of infectious disease, military action, international conflicts, terrorist activities, civil unrest and associated political instability. Many of our facilities, including our Portland, Oregon headquarters, are in areas with known earthquake risk. Some of these events or circumstances may also result in heightened security concerns with respect to domestic and international travel and commerce, which may further affect our business and operating results. In particular, due to these uncertainties, we are subject to the following additional risks:
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;
more frequent instances of shipping delays;
demand for our products may not increase or may decrease; and
our customers or suppliers may experience financial difficulties or cease operations.
Implementation and Modification of Globalization Strategy
We are continuing to implement and expand our globalization strategy in which we are moving certain operational resources and capabilities to different countries in Asia to be closer to many of our significant customers to reduce costs and to develop low cost follow-on solutions to our products. We believe this strategy will enhance customer relationships, improve our responsiveness, reduce our manufacturing costs for certain products and allow us to compete with low cost competitors who develop systems employing processes developed by us. We opened a manufacturing facility in Singapore in the fourth quarter of 2010, which manufactures certain IMG, SG, CG and laser ablation products and is now our primary system manufacturing facility.
Our globalization strategy is subject to a variety of complexities and risks, many of which may divert a substantial amount of management’s time. These risks include:
challenges in designing facilities that can be scaled for future expansion, replicating current processes and bringing new facilities up to full operation;
unpredictable costs, redundancy costs and cost overruns for developing facilities and acquiring equipment;
building local management teams, technical personnel and other staff for functions that we have not previously conducted outside of the United States;
technical obstacles such as poor production or process yield and loss of quality control during the ramp of a new facility;
re-qualifications and other procedures that may be required by our customers;
our ability to bring up local suppliers to meet our quality and cycle-time needs;

13


our ability to reduce costs in the United States as we add costs elsewhere;
rapidly changing business conditions that may require plans to be changed or abandoned before they are fully implemented; and
challenges posed by distance and by differences in language and culture.
These and other factors could delay the continuing development, expansion and implementation of our strategy, as well as impair our gross margins, delay shipments and deliveries, cause us to lose sales, require us to write off investments already made, damage our reputation and harm our business, financial condition and results of operations. If we decide to change our globalization strategy, we may incur charges for certain costs incurred.
Acquisitions and Divestitures
We may make acquisitions of, or significant investments in, other businesses with complementary products, services or technologies, such as our June 2012 acquisition of Eolite Systems and May 2013 acquisition of the Semiconductor Systems business from GSI Group, Inc. Acquisitions involve numerous risks, many of which are unpredictable and beyond our control, including:
difficulties and increased costs in connection with integration of personnel, operations, technologies and products of the acquired businesses;
implementation of our enterprise resource planning (ERP) system into the acquired company’s operations;
diversion of management’s attention from other operational matters;
the potential loss of key employees of the acquired company;
lack of synergy or inability to realize expected synergies resulting from the acquisition;
acquired assets becoming impaired as a result of technological advancements or worse-than-expected performance by the acquired company;
difficulties establishing satisfactory internal controls at the acquired company;
risks and uncertainties relating to the performance of the combined company following the transaction; and
acquiring unanticipated liabilities for which we will not be indemnified.
Furthermore, the accounting for an acquisition could result in significant charges resulting from amortization or write-off of intangible assets we acquire. Our inability to effectively manage these risks could result in our inability to realize the anticipated benefits of an acquisition on a timely basis, or at all, and materially and adversely affect our business, financial condition and results of operations. In addition, all acquisition transaction costs must be expensed as incurred rather than capitalized, which may have a material adverse effect on our results of operations.
The means by which we finance an acquisition may also significantly affect our business or the value of the shares of our common stock. If we issue common stock to pay for an acquisition, the ownership percentage of our existing shareholders will be diluted and the value of the shares held by our existing shareholders could be reduced. If we use cash on hand 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. If we borrow funds in connection with an acquisition, we would be required to use cash to service the debt and to comply with financial and other covenants.
We may from time to time also make strategic investments in development stage companies. Investments in development stage companies are subject to a high degree of risk. We could lose all or a portion of our investment in any such company or could be required to recognize an impairment charge with respect to our investment. For example, in 2014 we recognized a $9.7 million impairment with respect to our investment in OmniGuide, Inc. based upon a reduction in the company's estimated valuation.
Hiring and Retention of Personnel
Our continued success depends in part upon the services of our key managerial, financial and technical personnel. The loss of key personnel, or our inability to attract, assimilate and retain qualified personnel, could result in the loss of customers, inhibit our ability to operate and grow our business and otherwise have a material adverse effect on our business and results of operations. We have previously had to, and may in the future have to, impose salary reductions on employees during economic downturns in an effort to maintain our financial position. On several occasions in recent years executives and other employees have received limited or no annual bonuses due to our financial performance relative to the performance parameters in our annual bonus plans. These events may have an adverse effect on employee loyalty and may make it more difficult for us to attract and retain key personnel. Competition for qualified personnel in the industries in which we compete is intense, and we may not be successful in attracting and retaining qualified personnel. We may incur significant costs in our efforts to recruit and retain key personnel, which could affect our financial position and results of operations.

14


Our ability to retain key personnel and execute our strategy may also be adversely affected by the transition to a new CEO. In February 2014 Edward C. Grady became our President and Chief Executive Officer, replacing Nicholas Konidaris who held the position since 2004.
Risks Related to Technology
Markets Characterized by Rapid Technological Change
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 and the requirements of current and potential customers. 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. The introduction by us or by our competitors of new or enhanced products, or alternative technologies, may cause our customers to defer, change or cancel orders for our existing products or cease purchasing our products altogether. Further, we cannot assure that our new products will gain timely market acceptance or that we will be able to respond effectively to product announcements by competitors, technology changes or emerging industry standards. If we are unable to develop new or enhanced products to address product or technology changes or new industry standards on a timely basis or at all, or if our new or enhanced products are not accepted by the market, or if our customers adopt alternative technologies, our business, financial condition and results of operations may be adversely affected.
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 our current and potential customers or obsolete, 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 decline. In addition, as a result of our emphasis on research and development and technological innovation, our operating costs may increase in the future, and research and development expenses may increase as a percentage of total operating expenses and as a percentage of net sales.
Need to Broaden our Marketing and Channel Capability
The laser microfabrication industry is comprised of broad set of markets and applications and represents significant opportunities for growth. In order to access these opportunities; we need to broaden our approach from customer centric to being market based. This will require the hiring, development, and application of new marketing capability and channel access. Our ability to successfully access and compete in these broader markets will be partially dependent on our development of these new skills and capabilities. Our inability to do so would harm our business and adversely affect our revenues and profitability.
Products are Highly Complex
Our products are highly complex, and our extensive product development, manufacturing and testing processes may not be adequate to detect all defects, errors, failures and quality issues that could impact customer satisfaction or result in claims against us. As a result, we may have to replace certain components or provide remediation in response to the discovery of defects in products after they are shipped. The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by our customers and other losses to us or to our customers. These occurrences could also result in the loss of, or delay in, market acceptance of our products, loss of sales and increased expenses and warranty costs, which would harm our business and adversely affect our revenues and profitability.
Risks Related to Legal Matters
Protection of Proprietary Rights – Generally
Our success depends significantly upon the protection of our proprietary rights. We attempt to protect our proprietary rights through patents, copyrights, trademarks, maintenance of trade secrets and other measures, including entering into confidentiality agreements. We incur substantial costs to obtain and maintain patents and to defend our intellectual property rights. We rely upon the laws of the United States and foreign countries where we develop, manufacture or sell our products to

15


protect our proprietary rights. We may not be successful in protecting these proprietary rights, these rights may not provide the competitive advantages that we expect, or other parties may challenge, invalidate or circumvent these rights.
Protection of Proprietary Rights – Foreign Jurisdictions
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 United States companies have encountered substantial problems in protecting their proprietary rights against infringement in foreign countries. If we fail to adequately protect our intellectual property in these countries, it could be easier for our competitors to sell competing products in foreign countries, which could result in reduced sales and gross margins.
Intellectual Property Infringement Claims
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. While we attempt in our designs to avoid patent infringement, from time to time we and our customers have received correspondence from our competitors claiming that some of our products, as used by our customers, may be infringing one or more of these patents. Competitors or others have in the past and may in the future assert infringement claims against our customers or us with respect to current or future products or uses, and these assertions may result in costly litigation or require us to obtain a license to use intellectual property rights of others. If claims of infringement are asserted against our customers, those customers may seek indemnification from us for damages or expenses they incur.
If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question or defending our position. These licenses, however, may not be available on satisfactory terms or at all. If we are not able to negotiate the necessary licenses on commercially reasonable terms or successfully defend our position, our financial condition and results of operations could be materially and adversely affected.
We also defend our patent and intellectual property portfolio. We initiated litigation in 2014 against Humo Laboratory, LTD. in Japan and against Eo Technics Co., Ltd., in South Korea in May 2014 for infringement of key patents. There is no assurance that this litigation will be successful, and we may incur significant legal fees to prosecute these claims.
Tax Audits and Changes in Tax Law
We are periodically under audit by United States and foreign tax authorities and may have exposure to additional tax liabilities as a result. Significant judgment is required in determining our provision for income and other tax liabilities. Although we believe our tax estimates are reasonable, the final outcome of tax audits and the impact of changes in tax laws or the interpretation of tax laws could result in material differences from what is reflected in historical income tax accruals. If additional taxes are assessed as a result of an examination, a material effect on our financial results, tax positions or cash flows could occur in the period or periods in which the determination is made.
We currently benefit from a tax incentive program in Singapore pursuant to which we pay no Singapore income tax with respect to our manufacturing income. The incentive commenced on July 1, 2006 and will continue through June 30, 2016 assuming we are able to satisfy applicable requirements. The Company has failed to meet certain of the associated requirements in the past, however has obtained a waiver for certain periods. There is no assurance we will be able to satisfy these requirements and failure to meet such requirements may lead to reduction in future or past tax benefits. The Company believes that it is more likely than not the Company will continue to receive the associated tax incentives and there is no indication that past benefits received would be rescinded.
Legal Proceedings
From time to time we are subject to various legal proceedings, including breach of contract claims and claims that involve possible infringement of patent or other intellectual property rights of third parties or by third parties. It is inherently difficult to assess the outcome of litigation matters, and there can be no assurance that we will prevail in any litigation. Any litigation could result in substantial cost and diversion of management’s attention, which by itself could have a material adverse effect on our financial condition and results of operations. Further, adverse determinations in such litigation could result in loss of our property rights, subject us to significant liabilities, require us to seek licenses from others or prevent us from manufacturing or selling our products, any of which could materially adversely affect our business, financial condition, results of operations or cash flows.
Provisions Restricting Our Acquisition
Our articles of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our Board of Directors. Our Board of Directors has also adopted a shareholder rights plan, or “poison

16


pill,” which would significantly dilute the ownership of a hostile acquirer. In addition, the Oregon Control Share Act and the Oregon Business Combination Act limit the ability of parties who acquire a significant amount of voting stock to exercise control over us. These provisions may have the effect of lengthening the time required for a person to acquire control of us through a proxy contest or the election of a majority of our Board of Directors, may deter efforts to obtain control of us and may make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by our shareholders.
Risks Related to Financial Matters
Unfavorable Currency Exchange Rate Fluctuations
Currency exchange rate fluctuations could have an adverse effect on our sales and results of operations and we could experience losses with respect to forward exchange contracts into which we may enter. Unfavorable currency fluctuations could require us to increase prices to foreign customers, which could result in lower net sales by us to those customers. Alternatively, if we do not adjust the prices for our products in response to unfavorable currency fluctuations, our results of operations could be materially and adversely affected. In addition, some of our foreign sales are denominated in the currency of the country in which these products are sold and the currency we receive in payment for such sales could be less valuable at the time of receipt as a result of exchange rate fluctuations. From time to time, we enter into forward exchange contracts to hedge the value of accounts receivable primarily denominated in euros and other currencies. However, we cannot be certain that our efforts will be adequate to protect us against significant currency fluctuations or that such efforts will not expose us to additional exchange rate risks, which could adversely affect our results of operations.
Fluctuations in Effective Tax Rate
As a global company, we are subject to taxation in the United States and numerous foreign jurisdictions. Our effective tax rate is subject to fluctuation from one period to the next because the income tax rates for each year are a function of many factors, including: (a) taxable income levels and the effects of a mix of profits (losses) earned by ESI and our subsidiaries in numerous tax jurisdictions with a broad range of income tax rates; (b) our ability to utilize deferred tax assets; (c) taxes, refunds, interest or penalties resulting from tax audits; (d) the magnitude of various credits and deductions as a percentage of total taxable income; and (e) changes in tax laws or the interpretation of such tax laws. In addition, we currently have a valuation allowance against domestic tax assets as a result of historic losses recorded in the United States. Changes in the mix of these items may cause our effective tax rate to fluctuate between periods, which could have a material adverse effect on our financial position and results of operations.
Impairment of Intangible Assets
We held a total of $6.8 million in acquired intangible assets and $7.9 million in goodwill at March 29, 2014. We review our acquired intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment using a quantitative approach at least annually or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below the carrying value.
We performed a review of our acquired intangible assets in the fourth quarter of 2014, including a review for impairment based on certain triggering events and no significant impairments of intangible assets were detected.
We performed our annual goodwill impairment analysis during the fourth quarter of 2014 and determined that goodwill was not impaired. If at any time management determines that an impairment exists the Company may be required to record the impaired value as part of operating income, which will result in a reduction in earnings and a corresponding reduction in our net asset value in the period such impairment is identified. The assessment of whether goodwill is impaired is sensitive to stock price and the assumed control premium. A significant deterioration in either may trigger impairment.
Stock Price Volatility
The market price of our common stock has fluctuated widely. During fiscal 2014, our stock price fluctuated between a high of $12.35 per share and a low of $9.04 per share, and subsequent to the end of the fiscal year and prior to June 1, 2014 has been as low as $6.61. Consequently, the current market price of our common stock may not be indicative of future market prices, and we may be unable to sustain or increase the value of an investment in our common stock. Factors affecting our stock price, many of which are outside of our control, may include:
variations in operating results from quarter to quarter;
changes in earnings estimates by analysts or our failure to meet analysts’ expectations;
changes in the market price per share of our public company customers;
market conditions in the consumer electronics, semiconductor and other industries into which we sell products;

17


general economic conditions;
political changes, hostilities or natural disasters;
low trading volume of our common stock;
change in our dividend policy;
the number of analysts covering our common stock; and
the number of firms making a market in our common stock.
In addition, the stock market has experienced significant price and volume fluctuations in recent years. These fluctuations have particularly affected the market prices of the securities of high-technology companies like ours. These market fluctuations could adversely affect the market price of our common stock.
Reduction or Cessation of Dividends
Our Board of Directors first adopted a dividend policy in December 2011. We intend to pay quarterly dividends subject to capital availability and periodic determinations by our Board of Directors that cash dividends are in the best interest of our shareholders and are in compliance with all laws and agreements applicable to the declaration and payment of cash dividends. Future dividends may be affected by, among other factors: our views on overall levels of current or projected profitability; potential future capital requirements for investments in acquisitions; funding of research and development; legal risks; stock repurchase programs; changes in federal and state income tax laws or corporate laws; and changes to our business model. Our dividend payments may change from time to time, and we cannot provide assurance that we will continue to declare dividends at all or in any particular amounts. Further, the special dividend declared by the Board of Directors in December 2012 should not be considered a recurring event. A reduction or cessation in our dividend payments could have a negative effect on our stock price.
Impairment of Investments
Our investment portfolio is primarily comprised of commercial paper, debt securities issued by U.S. governmental agencies and municipal debt securities. These investments are intended to be highly liquid and low risk. If the markets for these securities were to deteriorate for any reason, including as a result of a downgrade in the credit rating of U.S. government securities, the liquidity and value of these investments could be negatively affected, which could result in impairment charges. Any such impairment charges may have a material impact on our financial condition and results of operations.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our executive and administrative headquarters, which houses our primary engineering and marketing functions, advanced manufacturing capability for new products, and manufacturing of select legacy products are located in a three-building complex with 197,838 square feet of space on 10.15 acres in Portland, Oregon. Additionally, our Components Group (CG) consumable products are manufactured at a 53,000 square foot plant on 31 acres in Klamath Falls, Oregon. We own all of these buildings.

18


We believe the productive capacity of these facilities to be adequate and suitable for the requirements of our business for the foreseeable future.
Our primary system manufacturing facilities are located in leased facilities in Singapore. We lease approximately 26,000 square feet of facilities in Singapore where we manufacture certain Interconnect & Microfabrication Group (IMG), LED, CG and laser ablation products. We also lease approximately 32,500 square feet of facilities in Chelmsford, Massachusetts that are used primarily for engineering and manufacture of our Semiconductor Systems products and a 23,000 square foot facility in Sunnyvale, California that is used primarily for engineering, marketing and as a demonstration center for our microfabrication systems. Additionally, we lease other office and facility space in various locations throughout the United States and various foreign countries.
Item 3. Legal Proceedings
In the ordinary course of business, we are involved in various legal matters, either asserted or unasserted, and investigations. In the opinion of management, ultimate resolution of these matters will not have a material effect on our consolidated financial position, results of operations or cash flows.
Item 4. Mine Safety Disclosures
Not Applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Common Stock Prices
Our common stock trades on the NASDAQ Stock Market under the symbol ESIO. There were approximately 470 shareholders of record as of June 5, 2014, and on that date there were 30,188,462 common shares outstanding. The closing price on June 5, 2014 was $7.03.
The following table shows the high and low closing prices for our common stock as reported on the NASDAQ Stock Market for the fiscal quarters indicated:
Fiscal 2014
High
 
Low
Quarter 1
$
11.63

 
$
9.97

Quarter 2
12.35

 
10.61

Quarter 3
12.19

 
9.59

Quarter 4
11.44

 
9.04

 
Fiscal 2013
High
 
Low
Quarter 1
$
15.20

 
$
10.89

Quarter 2
13.16

 
10.49

Quarter 3
12.84

 
9.46

Quarter 4
11.63

 
9.74

Share Repurchase Program
On December 9, 2011, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of our 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, share price and other factors. We did not repurchase any shares under this program in 2013. As of March 29, 2014 a total of 19,832 shares had been repurchased under this authorization for $0.2 million. There is no fixed completion date for the repurchase program.
The following table provides information with respect to share repurchases by the Company during 2014.
Total number of shares purchased
Average price paid per share
Total value of shares repurchased
Maximum value of shares that may yet be purchased under the program
19,832
$9.65
$0.2 million
$20.0 million
Disclosures related to securities authorized for issuance under our Equity Compensation Plans are incorporated by reference into Item 12 of this annual report on Form 10-K, Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters, from our Proxy Statement for our fiscal 2014 annual meeting.

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Dividends
In December 2011, the Board of Directors adopted a dividend policy under which we intend to pay quarterly cash dividends. The following table summarizes the quarterly dividends declared and paid by us in 2013 and 2014:
Date Declared
 
Record Date
 
Payable Date
 
Amount per Share
February 13, 2014
 
February 27, 2014
 
March 13, 2014
 
$
0.08

November 7, 2013
 
November 19, 2013
 
December 4, 2013
 
$
0.08

August 8, 2013
 
August 19, 2013
 
September 3, 2013
 
$
0.08

May 14, 2013
 
June 5, 2013
 
June 19, 2013
 
$
0.08

February 7, 2013
 
February 28, 2013
 
March 14, 2013
 
$
0.08

November 8, 2012
 
November 21, 2012
 
December 5, 2012
 
$
0.08

August 9, 2012
 
August 24, 2012
 
September 10, 2012
 
$
0.08

May 10, 2012
 
June 4, 2012
 
June 18, 2012
 
$
0.08

A special dividend of $2.00 per share was declared by the Board of Directors on December 3, 2012 after the successful patent settlement. The special dividend should not be considered a recurring event.
We paid aggregate dividends of $9.6 million and $68.1 million in 2014 and 2013, respectively. Subsequent to the year ended March 29, 2014, the Board of Directors declared a $0.08 per outstanding common share cash dividend on May 15, 2014, payable June 10, 2014 to shareholders of record on May 27, 2014. The estimated amount to be paid as a result of the May 15, 2014 declaration is $2.4 million.
We currently anticipate that we will continue to pay cash dividends on a quarterly basis in the future, although the declaration, timing and amount of any future cash dividends are at the discretion of the Board of Directors and will depend on our financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interest of our shareholders.

20


Stock Performance Graph
The graph below compares the cumulative 58-month total return to holders of Electro Scientific Industries, Inc. common stock with the cumulative total returns of the S&P 500 Index and the S&P Information Technology Index for the same period. The graph assumes that the value of the investment in Electro Scientific Industries, Inc. common stock and in each of the indices (including reinvestment of dividends) was $100.00 on March 28, 2009 and tracks it through March 29, 2014.
Historical stock price performance should not be relied upon as indicative of future stock price performance.
*$100 invested on 3/28/09 in stock or 3/31/09 in index, including reinvestment of dividends.
Indexes calculated on month-end basis.


  
Cumulative Total Return1
  
March 28, 2009
 
April 03,
2010
 
April 2,
2011
 
March 31,
2012
 
March 30,
2013
 
March 29, 2014
Electro Scientific Industries, Inc.
100.00

 
203.98

 
271.34

 
240.17

 
217.26

 
200.63

S&P 500
100.00

 
149.77

 
173.20

 
187.99

 
214.24

 
261.06

S&P Information Technology Index
100.00

 
158.01

 
176.78

 
212.51

 
210.13

 
263.90

 
1. Copyright© 2014 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved


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 Item 6. Selected Financial Data
(In thousands, except per share data)
2014
 
2013
 
2012
 
2011
 
2010
Statement of Operations Data
 
 
 
 
 
 
 
 
 
Net sales
$
181,167

 
$
216,625

 
$
254,229

 
$
256,811

 
$
148,893

Provision for (benefit from) income taxes
(92
)
 
39,851

 
(1,417
)
 
390

 
(9,778
)
Net (loss) income
(38,334
)
 
(54,716
)
 
4,904

 
7,934

 
(11,984
)
Net (loss) income per share—basic
(1.28
)
 
(1.86
)
 
0.17

 
0.28

 
(0.44
)
Net (loss) income per share—diluted
(1.28
)
 
(1.86
)
 
0.17

 
0.28

 
(0.44
)
Cash dividends paid per outstanding common share
0.32

 
2.32

 
0.08

 

 

Balance Sheet Data
 
 
 
 
 
 
 
 
 
Cash and cash equivalents, restricted cash, short-term investments and auction rate securities7,8,9,10
$
106,905

 
$
145,057

 
$
198,723

 
$
201,592

 
$
171,320

Working capital
164,835

 
194,406

 
269,532

 
259,739

 
253,728

Net property, plant and equipment
27,930

 
27,894

 
32,103

 
39,661

 
40,590

Total assets
270,209

 
322,208

 
433,210

 
440,167

 
394,418

Long-term debt

 

 

 

 

Shareholders’ equity
222,881

 
264,142

 
378,670

 
362,299

 
342,662


1.
Fiscal 2014 included $1.1 million for restructuring costs, which primarily consisted of $0.8 million charge towards obligations for our outgoing Chief Executive Officer and $0.2 million of charges related to asset write-offs. Fiscal 2014 also included $12.8 million of charges in cost of sales for inventory write-offs, $9.7 million for impairment of an investment, $6.1 million for share-based compensation expense, $2.9 million for amortization of acquired intangible assets, including $0.3 million of accelerated amortization, $1.3 million for net gain on sale of property and equipment, $0.6 million of accelerated depreciation on assets that will no longer be utilized and a $0.5 million of gain on acquisition of Semiconductor Systems business.
2.
Fiscal 2013 included $2.6 million for restructuring costs, which primarily consisted of $1.5 million of employee severance costs and $1.1 million of charges related to asset write-offs. Fiscal 2013 also included $21.0 million of charges in cost of sales for inventory write-offs, $8.1 million for share-based compensation expense, $4.8 million for amortization of acquired intangible assets, including $2.3 million of accelerated amortization, $1.2 million for net gain on sale of property and equipment, and a $15.3 million benefit for net legal settlement proceeds.
3.
Fiscal 2013 included a charge of $46.9 million to increase the valuation allowance on deferred tax assets.
4.
Fiscal 2012 included $3.8 million for restructuring costs, which primarily consisted of $1.9 million of employee severance costs and $1.7 million of accelerated depreciation for certain assets. Fiscal 2012 also included $2.0 million of charges in cost of sales for an inventory write-off, $11.5 million for share-based compensation expense, $1.7 million for amortization of acquired intangible assets, $1.2 million for loss on disposal of assets and the write-off of engineering materials, $0.6 million for legal settlement costs, and a gain of $2.7 million from sale of previously impaired auction rate securities.
5.
Fiscal 2011 included $9.3 million for share-based compensation expense, $1.4 million for legal settlement costs, $0.8 million for restructuring costs, $2.0 million for amortization of acquired intangible assets, and a gain of $0.7 million from sale of previously impaired auction rate securities.
6.
Fiscal 2010 included $7.7 million for share-based compensation expense, $2.1 million for amortization of acquired intangible assets, a charge of $1.3 million for other-than-temporary impairment of auction rate securities, and a benefit of $4.5 million for net merger termination proceeds.
7.
No investments in auction rate securities were held at the end of fiscal 2012, fiscal 2013 or fiscal 2014.
8.
Fiscal 2011 included auction rate securities at a fair value of $5.2 million.
9.
Fiscal 2010 included auction rate securities at a fair value of $5.0 million.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview of Business

22


Electro Scientific Industries, Inc. and its subsidiaries (ESI) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. Our advanced laser systems enable precise structuring of micron to submicron features in components and devices which are used in a wide variety of end products in the consumer electronics, computer, semiconductor, communications and other markets. These features enable our customers to achieve functionality, or improve yield and productivity in their manufacturing processes that can be critical to their profitability. Founded in 1944, ESI is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Canada, Europe and the United States.
Our advanced laser microfabrication systems allow microelectronics, semiconductor, and other microtechnology manufacturers to physically alter select device features during high-volume production in order to increase performance, enable functionality, alter physical characteristics or improve production yields. 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 improve production yields or enable improved performance for flexible and rigid high density interconnect printed circuit boards, semiconductor devices, advanced semiconductor packaging, touch-panel glass, flat panel liquid crystal displays (LCDs) and other high value components.
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. Lastly, we produce systems that use photonic technology to perform precision inspection for quality control and defect identification.
Overview of Financial Results
Our fiscal year consists of 52 or 53 weeks ending on the Saturday nearest March 31. Accordingly, our fiscal 2014 reporting period consisted of a 52-week period ending on March 29, 2014, our fiscal 2013 reporting period consisted of a 52-week period ending on March 30, 2013 and our fiscal 2012 reporting period consisted of a 52-week period ending on March 31, 2012. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.
In 2014, we saw a decline in orders primarily due to lower orders for advanced microfabrication and overcapacity in our MLCC markets, offset by an increase related to our acquisition of the Semiconductor Systems business. Our total order volume in 2014 was $172.2 million, down approximately 4%, compared to orders of $179.5 million in 2013. Total revenue in 2014 was $181.2 million, down approximately 16.3%, compared to revenue of $216.6 million in 2013. Orders for our Interconnect & Microfabrication (IMG) products declined due to lower orders for advanced microfabrication products from our largest customer as a result of few new designs and utilization of upgrades to satisfy capacity needs. Orders for our Components Group (CG) products decreased primarily due to ongoing over capacity partially offset by technology buys for latest generation MLCC testers. These declines were offset primarily by our acquired Semiconductor Systems business, which saw strong activity and demand in circuit trim and wafer trim applications.
Total shipments were $183.6 million in 2014 compared to $215.8 million in 2013. By product group, SG shipments increased by approximately 129% due to the acquired Semiconductor Systems business while IMG and CG shipments decreased due to lower orders in their respective markets. Backlog was $27.4 million as of March 29, 2014 compared to $32.8 million as of March 30, 2013 primarily as a result of lower orders in the fourth quarter of 2014 compared to the fourth quarter of 2013.
Gross profit was $64.0 million in 2014 compared to $64.3 million in 2013. Overall gross profit was impacted by a decrease in volume and an increase in inventory step-up purchase accounting costs, offset by lower inventory and intangible write-offs associated with discontinued products.
Gross profit as a percentage of net sales increased to 35.3% in 2014 compared to 29.7% in 2013. This increase in gross margin was primarily due to lower inventory and intangible write-offs associated with discontinued products, more favorable product mix and improvements in warranty and manufacturing costs resulting in lower expenses, partially offset by the impact of lower volume.
Net operating expenses of $92.9 million in 2014 increased $13.5 million from $79.4 million in 2013. This increase was primarily due to the non-recurring net legal settlement proceeds of $15.3 million which favorably impacted operating expenses in 2013. In addition, net expenses increased approximately $7.8 million due to the acquisition of the Semiconductor Systems business. These increases were offset by net cost reductions in headcount and discretionary spending across the organization as part of restructuring actions taken in late 2013 of approximately $6.3 million, lower share based compensation of $1.8 million, and a decrease in restructuring costs of $1.5 million. Operating loss was $28.8 million in 2014 compared to operating loss of $15.1 million in 2013, an increase of $13.7 million.

23


Non-operating expense was $9.6 million in 2014 compared to income of $0.3 million in 2013. The increase was primarily due to a $9.7 million impairment against our minority equity investment in OmniGuide, Inc.
Benefit from income taxes was $0.1 million in 2014 compared to a provision of $39.9 million in 2013, primarily due to a $46.9 million valuation allowance recorded in 2013 on deferred tax assets. Net loss was $38.3 million in 2014 compared to net loss of $54.7 million in 2013.
Results of Operations
The following table presents results of operations data as a percentage of net sales for the years ended March 29, 2014March 30, 2013 and March 31, 2012:
 
2014
 
2013
 
2012
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales
64.7

 
70.3

 
57.6

Gross profit
35.3

 
29.7

 
42.4

Selling, service and administration
30.8

 
25.9

 
23.0

Research, development and engineering
20.9

 
17.2

 
16.8

Restructuring costs
0.6

 
1.2

 
1.5

(Gain) loss on sale of property and equipment, net
(0.7
)
 
(0.6
)
 
0.4

Gain on acquisition of Semiconductor Systems business
(0.3
)
 

 

Legal settlement (proceeds) costs, net

 
(7.0
)
 
0.2

Operating (loss) income
(15.9
)
 
(7.0
)
 
0.5

Gain on sale of previously impaired auction rate securities

 

 
1.1

Other-than-temporary impairment of cost method investments
(5.4
)
 

 

Interest and other income (expense), net
0.1

 
0.1

 
(0.2
)
(Loss) income before income taxes
(21.2
)
 
(6.9
)
 
1.4

(Benefit from) provision for income taxes
(0.1
)
 
18.4

 
(0.5
)
Net (loss) income
(21.2
)%
 
(25.3
)%
 
1.9
 %
Fiscal Year Ended March 29, 2014 Compared to Fiscal Year Ended March 30, 2013
Net Sales
The following table presents net sales information by product group:
  
2014
 
2013
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Interconnect & Microfabrication Group (IMG)
$
120,947

 
66.8
%
 
$
170,360

 
78.6
%
Components Group (CG)
24,441

 
13.5

 
27,511

 
12.7

Semiconductor Group (SG)
35,779

 
19.7

 
18,754

 
8.7

 
$
181,167

 
100.0
%
 
$
216,625

 
100.0
%
Net sales for 2014 decreased $35.5 million or 16.4% from net sales for 2013.
IMG sales for 2014 decreased $49.4 million or 29% compared to 2013. The decrease in IMG sales was primarily driven by the shipment of advanced microfabrication systems to our largest customer in the first half of 2013 which did not repeat at the same level in 2014, partially offset by a $3.0 million increase in service revenue.
CG sales for 2014 decreased $3.1 million or 11% compared to 2013. The decrease was primarily driven by customer utilization of existing capacity, reflecting only modest growth in end user demand for consumer electronics, partially offset by improved sales of the next generation MLCC testers.
SG sales for 2014 increased $17.0 million or 91% compared to 2013. The increase in SG revenues was primarily driven by the addition of our Semiconductor Systems business, which we acquired in the first quarter of 2014 and higher service revenues.
The following table presents net sales information by geographic region:

24


  
2014
 
2013
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
136,336

 
75.3
%
 
$
186,346

 
86.0
%
Americas
31,596

 
17.4

 
20,907

 
9.7

Europe
13,235

 
7.3

 
9,372

 
4.3

 
$
181,167

 
100.0
%
 
$
216,625

 
100.0
%
In 2014, net sales to Americas and Europe increased by $10.7 million and $3.9 million, respectively compared to 2013. The increase was primarily driven by additional sales from our acquired Semiconductor Systems business. Net sales to Asia decreased by $50.0 million due to lower orders for advanced microfabrication products from our largest customer as a result of few new designs and utilization of upgrades to satisfy capacity needs.
Gross Profit
  
2014
 
2013
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Gross Profit
$
64,026

 
35.3
%
 
$
64,253

 
29.7
%
Gross profit was $64.0 million in 2014 compared to $64.3 million in 2013. Overall gross profit was impacted by a decrease in volume and an increase in inventory step-up purchase accounting costs, offset by lower inventory and intangible write-offs associated with discontinued products.
Gross profit as a percentage of net sales increased to 35.3% in 2014 compared to 29.7% in 2013. This increase in gross margin was primarily due to lower inventory and intangible write-offs associated with discontinued products, more favorable product mix and improvements in warranty and manufacturing costs resulting in lower expenses, partially offset by the impact of lower volume.
Operating Expenses
  
2014
 
2013
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, service and administration
$
55,753

 
30.8
 %
 
$
56,051

 
25.9
 %
Research, development and engineering
37,839

 
20.9

 
37,196

 
17.2

Restructuring costs
1,070

 
0.6

 
2,612

 
1.2

Gain on sale of property and equipment, net
(1,301
)
 
(0.7
)
 
(1,226
)
 
(0.6
)
Gain on acquisition of Semiconductor Systems business
(499
)
 
(0.3
)
 

 

Legal settlement proceeds, net

 

 
(15,262
)
 
(7.0
)
 
$
92,862

 
51.3
 %
 
$
79,371

 
36.7
 %
Selling, Service and Administration
Selling, service and administration (SS&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. SS&A expenses for 2014 decreased $0.3 million compared to 2013. This decrease was primarily attributable to the impact of restructuring actions taken at the end of 2013, and a decrease in share-based compensation expenses, partially offset by increased expenses resulting from addition of the Semiconductor Systems business.
Research, Development and Engineering
Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials costs, equipment costs and facilities costs. RD&E expenses for 2014 increased $0.6 million compared to 2013. The increase was primarily due to our acquisition of the Semiconductor Systems business and the development and installation expenses related to a new strategic customer win, partially offset by lower headcount and other variable expenses.


25


Restructuring Costs
Restructuring costs for 2014 were $1.1 million, primarily due to $0.8 million of contractual payments to our outgoing Chief Executive Officer and $0.3 million in accelerated depreciation charges on certain assets that are no longer being utilized.
In 2013, we initiated a restructuring plan to improve efficiency, transition from memory repair and other legacy products, and focus on laser microfabrication for consumer electronics, emerging technologies related to semiconductor 3D packaging, and proprietary laser technology. Additionally, this plan included consolidation of certain development and manufacturing activities in Asia at our Singapore facility. Although this plan is substantially complete, we will continue to wind down both our physical and legal presence in the vacated regions over the next year.
Gain on Sale of Property and Equipment, net
During 2014, we sold a portion of land and a building in Portland, Oregon for $3.7 million resulting in a pre-tax gain of $1.3 million. In 2013, we sold a facility located in China, for $2.0 million, resulting in a pre-tax gain of $1.3 million, partially offset by loss on disposal of certain fixed assets primarily used in testing and development.
Gain on acquisition of Semiconductor Systems Business
Gain on acquisition of Semiconductor Systems business was $0.5 million in 2014. This purchase resulted in an overall gain as the estimated fair value of the assets purchased was in excess of the total purchase consideration, primarily due to the recognition of certain intangible assets, comprised of developed technology and order backlog.
Legal Settlement Proceeds, net
Legal settlement proceeds net of costs, were $15.3 million in 2013, which consisted of the settlement proceeds of $16.3 million related to a patent suit in Taiwan, partially offset by court and legal fees associated with the All Ring Tech Co Ltd., litigation and other non-recurring legal matters. The settlement of these proceedings allowed for the release of $22.3 million of restricted cash in the fourth quarter of 2013.
Share-Based Compensation
The table of operating expenses shown above also includes $5.4 million and $7.2 million of share-based compensation expense for 2014 and 2013, respectively. The decrease was primarily driven by decreased attainment of performance-based grants in 2014, award cancellations and, to a lesser extent, fewer overall awards granted.
Non-operating Income and Expense, net

 
2014
 
2013
(In thousands, except percentages)
Interest and Other Expense, net
 
% of Net Sales
 
Interest and Other Income, net
 
% of Net Sales
Other-than-temporary impairment of cost method investments
$
(9,703
)
 
(5.4
)%
 
$

 
%
Interest and other income, net
113

 
0.1
 %
 
253

 
0.1
%
Total non-operating (expense) income
$
(9,590
)
 
0.1
 %
 
$
253

 
0.1
%
Other-than-temporary impairment of cost method investments
As of March 30, 2013, the Company had made a total investment in the equity of OmniGuide, Inc., of $9.0 million. The investment is accounted for as a cost method investment. In the second quarter of 2014, the Company invested an additional $5.0 million in OmniGuide Series F Preferred Stock. As this Series F Preferred Stock round of equity financing was priced below previous rounds, it was considered a triggering event and the Company recorded a $3.6 million impairment charge of Series D and Series E investments at that time. In the fourth quarter of 2014, further triggering events were identified due to poor operating results through the end of the year combined with decreasing cash levels. As a result the Company performed an updated valuation of these investments and recorded an additional impairment of $6.1 million, for a total other-than-temporary impairment of $9.7 million in 2014. Remaining carrying value of these cost method investments as of March 29, 2014 was $4.3 million.


26


Interest and Other Income (Expense), net
Interest and other income (expense), net, consists of interest income and expense, market gains and losses on assets held in employees’ deferred compensation accounts, realized and unrealized foreign exchange gains and losses, bank charges, investment management fees, and other miscellaneous non-operating items.
Income Taxes
 
2014
 
2013
(In thousands, except percentages)
Income Tax Benefit
 
Effective
Tax Rate
 
Income Tax Provision
 
Effective
Tax Rate
(Benefit) provision for income taxes
$
(92
)
 
0.2
%
 
$
39,851

 
(268.1
)%
The income tax benefit for 2014 was $0.1 million on pretax loss of $38.4 million, an effective tax rate of 0.2%. For 2013, the income tax provision was $39.9 million on pretax loss of $14.9 million, an effective rate of 268.1%. The 2014 tax benefit was primarily from US tax refunds resulting from the conclusion of a tax audit and refundable credits, offsetting tax expense incurred on our foreign income. In 2013, we recorded a $49.7 million valuation allowance against our U.S. deferred tax assets and attributes. We continue to believe that these tax assets and attributes do not meet the threshold for recognition based on our operating results, future forecasts, and consideration of available tax planning strategies.
Our effective tax rate is subject to fluctuation based upon the mix of income and relative tax rates between jurisdictions, and the occurrence and timing of numerous discrete events such as changes in tax laws or their interpretations, extensions or expirations of research and experimentation credits, closure of tax years subject to examination, finalization of income tax returns, the relationship of fixed deductions to overall changes in estimated and actual pretax income or loss and the tax jurisdictions where income or loss is generated. Based on currently available information, we are not aware of any further discrete events which are likely to occur that would have a material effect on our financial position, expected cash flows or results of operations.
Net (Loss) Income
 
2014
 
2013
(In thousands, except percentages)
Net Loss
 
% of Net Sales
 
Net Loss
 
% of Net Sales
Net (loss) income
$
(38,334
)
 
(21.2
)%
 
$
(54,716
)
 
(25.3
)%
As a result of the factors discussed above, net loss for 2014 was $38.3 million, or $1.28 per basic share, compared to net loss of $54.7 million, or $1.86 per basic share for 2013.

Fiscal Year Ended March 30, 2013 Compared to Fiscal Year Ended March 31, 2012
Net Sales
The following table presents net sales information by product group:
 
2013
 
2012
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Interconnect & Microfabrication Group (IMG)
$
170,360

 
78.6
%
 
$
166,477

 
65.5
%
Components Group (CG)
27,511

 
12.7

 
28,976

 
11.4

Semiconductor Group (SG)
18,754

 
8.7

 
58,776

 
23.1

 
$
216,625

 
100.0
%
 
$
254,229

 
100.0
%
Net sales for 2013 decreased $37.6 million or 14.8% from net sales for 2012. Sales in IMG increased by 2% while CG and SG decreased by 5% and 68%, respectively.
IMG sales for 2013 increased $3.9 million compared to 2012. The increase in IMG sales was driven by higher sales of our flex-circuit via drilling and advanced microfabrication systems especially in the first half of 2013. Shipments in the flex-circuit and integrated circuit packaging segments of the market strengthened in 2013 as a result of growth in portable consumer electronics such as smart phones and tablet computers.

27


CG sales for 2013 decreased $1.5 million compared to 2012. The decrease was primarily driven by end user utilization of existing capacity reflecting only modest growth in the demand for overall electronics, partially offset by technology buys for new systems for next generation MLCC's.
SG sales for 2013 decreased $40.0 million compared to 2012. The decrease in SG revenues was primarily driven by overcapacity and lower sales of our memory repair and LED systems. Within DRAM memory repair, slowing bit growth, industry consolidation, and adoption of alternative technologies have resulted in a near saturation of the market.
The following table presents net sales information by geographic region:
 
2013
 
2012
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
186,346

 
86.0
%
 
$
224,100

 
88.2
%
Americas
20,907

 
9.7

 
19,448

 
7.6

Europe
9,372

 
4.3

 
10,681

 
4.2

 
$
216,625

 
100.0
%
 
$
254,229

 
100.0
%
Gross Profit
 
2013
 
2012
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Gross Profit
$
64,253

 
29.7
%
 
$
107,691

 
42.4
%
Gross profit was $64.3 million for 2013, a decrease of $43.4 million compared to 2012. This decrease was primarily due to $23.3 million of charges in cost of sales for inventory write-offs and accelerated amortization of acquired intangible assets related to our corporate restructuring program, lower sales and production volumes, and product mix. Gross profit as a percentage of net sales was 29.7% and 42.4% for 2013 and 2012, respectively.
Operating Expenses
 
2013
 
2012
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, service and administration
$
56,051

 
25.9
 %
 
$
58,555

 
23.0
%
Research, development and engineering
37,196

 
17.2

 
42,640

 
16.8

Restructuring costs
2,612

 
1.2

 
3,785

 
1.5

(Gain) loss on sale of property and equipment, net
(1,226
)
 
(0.6
)
 
966

 
0.4

Legal settlement (proceeds) costs, net
(15,262
)
 
(7.0
)
 
550

 
0.2

 
$
79,371

 
36.7
 %
 
$
106,496

 
41.9
%
Selling, Service and Administration
Selling, service and administration (SS&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.
SS&A expenses for 2013 decreased $2.5 million compared to 2012. This decrease was primarily attributable to a $2.9 million decrease in share-based compensation expenses, which was driven by accelerated expenses associated with the Chief Executive Officer's retirement eligibility date in 2012 and decreased attainment in 2013 of performance-based grants. In addition, labor and other variable expenses declined in 2013, but were offset by certain restructuring and Eolite integration expenses.
Research, Development and Engineering
Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials costs, equipment costs and facilities costs. RD&E expenses for 2013 decreased $5.4 million compared to 2012. This decrease was primarily due to lower labor costs from selective headcount reductions, combined with declines in project material costs and depreciation.
Restructuring Costs

28


In 2013, we initiated a restructuring plan to improve efficiency, transition from memory repair and other legacy products, and focus on laser microfabrication for consumer electronics, emerging technologies related to semiconductor 3D packaging, and proprietary laser technology. The plan was substantially completed by the end of 2014.
The restructuring costs of $2.6 million recognized in 2013 were comprised primarily of $1.5 million of employee severance and related benefits and $1.1 million of charges related to accelerated depreciation on assets that will no longer be utilized.
As part of our globalization strategy, during 2011, we initiated a restructuring plan to reduce our worldwide cost structure through transition of certain procurement and manufacturing activities to Asia. In 2012, we continued our globalization efforts and we additionally identified and initiated other cost reduction actions. As a result of these actions, we recognized $3.8 million of restructuring costs in 2012. We completed these actions December 29, 2012.
The restructuring costs of $3.8 million incurred in 2012 were comprised primarily of $1.9 million in employee severance and related benefits and $1.7 million of accelerated depreciation for certain assets. We shortened the depreciable lives of these assets in the fourth quarter of 2012 largely as a result of consolidating facilities in the United States and Asia.
(Gain) Loss on Sale of Property, Plant and Equipment, net
In 2013, we sold a facility located in China, for $2.0 million, resulting in a pre-tax gain of $1.3 million, partially offset by loss on disposal of certain fixed assets primarily used in testing and development. In 2012, as a part of our globalization strategy and cost reduction actions discussed above, we recognized a loss of $1.0 million resulting from disposal of certain fixed assets primarily used in testing and development.
Legal Settlement Costs
Legal settlement proceeds net of costs, were $15.3 million in 2013, which consisted of the All Ring litigation settlement proceeds of $16.3 million partially offset by court and legal fees associated with the All Ring litigation and other non-recurring legal matters. The settlement of these proceedings allowed for the release of $22.3 million of restricted cash in the fourth quarter of 2013.
In 2012, we recognized $0.6 million in legal settlement costs arising from the settlement of an arbitration matter with James Dooley, a former Chief Executive Officer of the Company.
Share-Based Compensation
The table of operating expenses shown above includes $7.2 million and $10.4 million of share-based compensation expense for 2013 and 2012, respectively. The decrease in share-based compensation expense was driven by accelerated expenses associated with the Chief Executive Officer’s retirement eligibility date in 2012 and decreased attainment in 2013 of performance-based grants.
Non-operating Income and Expense
Gain on Sale of Previously Impaired Auction Rate Securities (ARS)
During the first quarter of 2012, we sold all of our remaining ARS with a total par value of $14.7 million for approximately $6.5 million. We recorded a total gain of $2.7 million, which included $1.4 million in reclassification of previously recorded unrealized gains out of accumulated other comprehensive income. See Note 5 “Fair Value Measurements” to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data for further discussion.
Interest and Other Income (Expense), net
Interest and other expense, net, consists of interest income and expense, market gains and losses on assets held in employees’ deferred compensation accounts, realized and unrealized foreign exchange gains and losses, bank charges, investment management fees, and other miscellaneous non-operating items. Net interest and other income (expense) were as follows:

 
2013
 
2012
(In thousands, except percentages)
Interest and Other Income, net
 
% of Net Sales
 
Interest and Other Expense, net
 
% of Net Sales
Interest and other income (expense), net
$
253

 
0.1
%
 
$
(437
)
 
(0.2
)%

29


Net interest and other income was $0.3 million in 2013 compared to net interest and other expense of $0.4 million in 2012. The increase was primarily attributable to smaller foreign exchange losses compared to 2012 and increases on market gains on assets held for our deferred compensation plan.
Income Taxes
 
2013
 
2012
(In thousands, except percentages)
Income Tax Provision
 
Effective
Tax Rate
 
Income Tax Benefit
 
Effective
Tax Rate
 Provision for (benefit from) income taxes
$
39,851

 
(268.1
)%
 
$
(1,417
)
 
(40.6
)%
The income tax provision for 2013 was $39.9 million on pretax loss of $14.9 million, an effective rate of 268.1%. For 2012, the income tax benefit was $1.4 million on pretax income of $3.5 million, an effective rate of 40.6%. In 2013, our effective tax rate was significantly impacted by the valuation allowance established against U.S. deferred tax assets and attributes. We recorded this valuation allowance based on the operating results of the company, significant restructuring of the business, changes in our forecast for the U.S. jurisdiction, transition of production overseas, and consideration of available tax planning strategies. These factors led us to provide a valuation allowance against our deferred tax assets and attributes, which we believed no longer met the threshold for recognition.
Our effective tax rate is subject to fluctuation based upon the mix of income and relative tax rates between jurisdictions, and the occurrence and timing of numerous discrete events such as changes in tax laws or their interpretations, extensions or expirations of research and experimentation credits, closure of tax years subject to examination, finalization of income tax returns, the relationship of fixed deductions to overall changes in estimated and actual pretax income or loss and the tax jurisdictions where income or loss is generated. Based on currently available information, we are not aware of any further discrete events which are likely to occur that would have a material effect on our financial position, expected cash flows or results of operations.
Net (Loss) Income
 
2013
 
2012
(In thousands, except percentages)
Net Loss
 
% of Net Sales
 
Net Income
 
% of Net Sales
Net (loss) income
$
(54,716
)
 
(25.3
)%
 
$
4,904

 
1.9
%
As a result of the factors discussed above, net loss for 2013 was $54.7 million, or $1.86 per basic and diluted share, compared to net income of $4.9 million, or $0.17 per basic and diluted share for 2012.
Financial Condition and Liquidity
At March 29, 2014, our principal sources of liquidity were cash and cash equivalents of $68.5 million, short-term investments of $38.4 million and accounts receivable of $37.8 million. At March 29, 2014, we had a current ratio of 4.61 and held no long-term debt. Working capital of $164.8 million decreased $29.6 million compared to the March 30, 2013 balance of $194.4 million. We also held approximately $4.0 million of non-current investments at March 29, 2014. As of March 29, 2014, we have permanently reinvested $28.8 million of foreign earnings primarily related to manufacturing operations in Singapore.
In December 2011, the Board of Directors adopted a dividend policy under which we intend to pay quarterly cash dividends. The following table summarizes the quarterly dividends declared and paid by us in 2013 and 2014:
Date Declared
 
Record Date
 
Payable Date
 
Amount per Share
February 13, 2014
 
February 27, 2014
 
March 13, 2014
 
$
0.08

November 7, 2013
 
November 19, 2013
 
December 4, 2013
 
$
0.08

August 8, 2013
 
August 19, 2013
 
September 3, 2013
 
$
0.08

May 14, 2013
 
June 5, 2013
 
June 19, 2013
 
$
0.08

February 7, 2013
 
February 28, 2013
 
March 14, 2013
 
$
0.08

November 8, 2012
 
November 21, 2012
 
December 5, 2012
 
$
0.08

August 9, 2012
 
August 24, 2012
 
September 10, 2012
 
$
0.08

May 10, 2012
 
June 4, 2012
 
June 18, 2012
 
$
0.08


30


A special dividend of $2.00 per share was declared by the Board of Directors on December 3, 2012 after the successful patent settlement of our patent litigation in Taiwan. The special dividend should not be considered a recurring event.
We paid aggregate dividends of $9.6 million in 2014 and $68.1 million in 2013. The change is primarily due to the special dividend payment of $2.00 per share discussed above. Subsequent to the year ended March 29, 2014, the Board of Directors declared a $0.08 per outstanding common share cash dividend on May 15, 2014. The estimated amount to be paid as a result of the May 15, 2014 declaration is $2.4 million.
We currently anticipate that we will continue to pay cash dividends on a quarterly basis in the future, although the declaration, timing and amount of any future cash dividends are at the discretion of the Board of Directors and will depend on our financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interest of our shareholders.
In December 2011, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of our 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, share price and other factors. We did not repurchase any shares under this program in 2013. As of March 29, 2014, a total of 19,832 shares had been repurchased under this authorization for $0.2 million at an average price of $9.65 per share, calculated inclusive of commissions and fees, all of which were purchased in the fourth quarter of 2014. There is no fixed completion date for the repurchase program.


31


Sources and Uses of Cash
Net cash used in operating activities totaled $19.1 million for 2014 due to $38.3 million in net loss and $10.0 million of cash outflows from working capital, partially offset by $29.2 million in non-cash charges. In 2014, the primary uses of cash from working capital consisted of $13.7 million decreases in accounts payable and accrued liabilities, $2.2 million increases in trade receivables, $1.0 million increases in shipped systems pending acceptance and $0.7 million from increases in other current assets, partially offset by $7.6 million decreases in inventories and $0.1 million increases in deferred revenue.
In 2014, net cash provided by investing activities of $7.8 million primarily resulted from $26.1 million of proceeds from sales and maturities of investments, net of purchases, and $0.4 million due to decreases in other assets, partially offset by $9.7 million for the acquisition of the Semiconductor Systems business, $5.0 million in additional investment in OmniGuide, Inc., and $3.9 million of net purchases and sales of property, plant and equipment.
In 2014, net cash used by financing activities of $9.1 million primarily resulted from $9.6 million of cash dividends paid to shareholders and $0.2 million for stock repurchases partially offset by $0.6 million in net inflow from stock plan activity.
We believe that our existing cash, cash equivalents and short-term investments are adequate to fund our operations, any dividends which may be declared, our share repurchase program and contractual obligations for at least the next twelve months.
Contractual Obligations
The contractual commitments below represent our estimates of future payments under these obligations. The actual payments may differ from these estimates due to changes in our business needs, cancellation provisions, and other factors. We cannot provide certainty regarding the timing of the payment schedule and the amounts of payments.
The following table summarizes our contractual obligations as of March 29, 2014, by the fiscal year in which they are due:
(In thousands)
Total
 
2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
Purchase commitments
$
14,021

 
$
14,009

 
$
12

 
$

 
$

 
$

 
$

Operating leases
7,213

 
2,661

 
1,762

 
1,065

 
909

 
803

 
13

 
$
21,234

 
$
16,670

 
$
1,774

 
$
1,065

 
$
909

 
$
803

 
$
13

This table does not include $9.4 million of unrecognized tax benefits due to the uncertainty with respect to the timing of future cash flows as of March 29, 2014. We are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities and the total amounts of income tax payable and the timing of such tax payments may depend on the resolution of current and future tax examinations which cannot be estimated.
Critical Accounting Policies and Estimates
The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Our estimates are based on historical experience and on various assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Our critical accounting policies and estimates include the following:
Revenue recognition;
Inventory valuation;
Product warranty reserves;
Allowance for doubtful accounts;
Accrued restructuring costs;
Share-based compensation;
Income taxes including the valuation of deferred tax assets;
Fair value measurements;
Valuation of cost method equity investments;
Valuation of long-lived assets; and
Valuation of goodwill.

32


Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. Title and risk of loss generally pass to the customer at the time of delivery of the product to a common carrier. Revenue is recognized upon such delivery, provided that fulfillment of acceptance criteria can be demonstrated prior to shipment. Where the acceptance criteria cannot be demonstrated prior to shipment, or in the case of substantially new products, revenue is deferred until acceptance has been received. For multiple element arrangements, the relative fair values of any undelivered elements are deferred until the elements are delivered and acceptance criteria are met. Revenues are recorded net of taxes collected which are required to be submitted to government authorities. Installation services are not essential to the functionality of the delivered equipment and installation revenue is deferred until installation is complete. Historically, neither the costs of installation accrued nor the fair value of installation service revenue deferred has been material.
Revenues associated with sales to customers under local contracts in Japan are recognized upon title transfer, which generally occurs upon customer acceptance. Revenues related to spare parts and consumable sales are generally recognized upon shipment. Revenues related to maintenance and service contracts are recognized ratably over the duration of the contracts.
Inventory Valuation
We regularly evaluate the carrying value of inventory based on a combination of factors including, but not limited to, the following: product lifecycle, forecasted sales or usage, historical usage rates, estimated service period, product end-of-life dates, estimated current and future market values, service inventory requirements and new product introductions. Purchasing requirements and alternative uses for the inventory are explored within these processes to mitigate inventory exposure. Inventory materials with quantities in excess of forecasted usage are reviewed quarterly for obsolescence. Obsolescence write-downs are typically caused by engineering change orders or product life cycle changes.
Research and development product costs are generally expensed as incurred. Engineering materials that are expected to provide future value are generally classified as raw materials inventory.
Finished goods are reviewed quarterly by product marketing and operating personnel to determine if inventory carrying value exceeds market selling prices. When necessary, we record inventory write-downs as an increase to cost of sales based on the above factors and take into account worldwide quantities on hand, product lifecycle and forecasted demand into our analysis. Additionally, from time to time, we make strategic decisions to exit or alter product lines which may result in an inventory write-down. If circumstances related to our inventories change, our estimates of the value of inventory could materially change. The Company recorded $12.8 million and $20.9 million of inventory write-off related charges for discontinued products in 2014 and 2013, respectively.
Product Warranty Reserves
We evaluate obligations related to product warranties quarterly. A standard one-year warranty is provided on most products. Warranty charges are comprised of costs to service the warranty, including labor to repair the system and replacement parts for defective items, as well as other costs incidental to the repairs. Warranty charges are recorded net of any cost recoveries resulting from either successful repair of damaged parts or from warranties offered by our suppliers for defective components. Using historical data, we estimate average warranty cost per system or part type and record the provision for such charges as an element of cost of goods sold upon recognition of the related revenue. Additionally, the overall warranty accrual balance is separately analyzed using the remaining warranty periods outstanding on systems and items under warranty, and any resulting changes in estimates are recorded as an adjustment to cost of sales. If circumstances change, or if a significant change in warranty-related incidents occurs, the impact of the change in the warranty accrual could be material. Accrued product warranty is included on the Consolidated Balance Sheets as a component of accrued liabilities.
Allowance for Doubtful Accounts
Credit limits are established by reviewing the financial history and stability of each customer. Where appropriate, we obtain credit rating reports and financial statements of customers to establish and modify their credit limits. On certain foreign sales, we require letters of credit. We regularly evaluate the collectability of our trade receivable balances based on a combination of factors. When a customer’s account becomes past due, we contact the customer to determine the cause. If we determine that a customer may be unable to fully meet its financial obligation to us, such as in the case of a bankruptcy filing or other material events impacting its business, we record a specific reserve for bad debt to reduce the related receivable to the amount we expect to recover based on all available information then available. If circumstances change related to specific customers, our estimates of the recoverability of receivables could materially change. We record estimated bad debt expense as an increase to selling, service and administration expenses.

33


Accrued Restructuring Costs
We have engaged, and may continue to engage, in restructuring actions, which require us to make estimates in certain areas including expenses for severance and other employee separation costs. Because we have a history of paying severance benefits, expenses and liabilities associated with exit or disposal activities are recognized when probable and estimable. For further discussion on the restructuring activities and related charges in 2014, refer to our discussion of “Restructuring Costs” in the “Results of Operations” section above.
Share-Based Compensation
We measure and recognize compensation expense for all share-based payment awards granted to our employees and directors, including employee stock options, stock-settled stock appreciation rights (SARs), non-vested restricted stock units and purchases under the employee stock purchase plan, based on the estimated fair value of the award on the grant date. We use the Black-Scholes valuation model as our method of valuation for stock option and SAR awards.
The use of the Black-Scholes valuation model to estimate the fair value of stock option and SAR awards requires us to make assumptions regarding the risk-free interest rate, expected dividend yield, expected term and expected volatility over the expected term of the award. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates based on our historical data, but these estimates involve inherent uncertainties and the recognition of expense could be materially different in the future.
Compensation expense is only recognized on awards that are estimated to ultimately vest. Therefore, based on historical forfeiture rates and patterns, the estimated future forfeitures are factored into the compensation expense to be recognized over the vesting period. We update our forfeiture estimates at least annually and recognize any changes to accumulated compensation expense in the period of change. If actual forfeitures differ significantly from our estimates, our results of operations could be materially impacted.
Income Taxes
We are subject to income taxes in the United States and in numerous foreign jurisdictions and in the ordinary course of business, there are transactions and calculations where the ultimate tax determination is uncertain. We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. We recognize interest and penalties, if any, related to the unrecognized tax benefits in income tax expense.
In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss carryforward, a Similar Tax Loss, or a Tax Credit carryforward Exists, which the Company has adopted. This ASU requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss (NOL) carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction, and the entity intends to use the deferred tax asset for that purpose.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those assets and liabilities are recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. When management determines that it is more likely than not that a deferred tax asset will not be fully realized, a valuation allowance is established to reduce deferred tax assets to the amount expected to be realized. As a result, at the end of fiscal 2013 we recorded a valuation allowance of $46.9 million against our U.S. deferred tax assets and attributes. Should management’s assumptions and expectations be inaccurate, our financial condition and results of operations could be adversely affected in future periods.
Fair Value Measurements
Fair value is defined under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 820 “Fair Value Measurements and Disclosures” (ASC Topic 820). When determining fair value on the financial assets and liabilities, we consider the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants in the principal or most advantageous market. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.
Valuation of Cost Method Equity Investments
The Company accounts for certain equity investments using the cost method. The total carrying value of these investments were $9.0 million at March 30, 2013 and an additional investment of $5.0 million was made in the second quarter of 2014 for a total investment of $14.0 million life-to-date, representing a 15% interest. At each reporting period, we determine whether events or circumstances have occurred that are likely to have a significant adverse effect on the fair value of our

34


investments. If there are no events or circumstances identified that would adversely affect the fair value of the investments, the fair values of the investments are not calculated as it is not practicable to do so. As the OmniGuide, Inc., Series F Preferred Stock round of equity financing was priced below previous rounds it was considered a triggering event and the Company recorded a $3.6 million impairment charge of Series D and Series E investments in the second quarter of 2014. In the fourth quarter of 2014, further triggering events were identified due to poor operating results through the end of the year combined with decreasing cash levels. We performed an updated valuation of our investment in the fourth quarter and recorded an additional $6.1 million impairment, for an ending carrying value of these investments of $4.3 million. The net carrying value of our minority investment is included in Other assets on the Consolidated Balance Sheets.
Valuation of Long-Lived Assets
    
The assumptions and estimates used to determine future values and remaining useful lives of our intangible and other long-lived assets are complex and subjective. They can be affected by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our forecasts for specific product lines.
Identified Intangibles

We assess the recoverability of purchased finite-lived intangible assets whenever events or changes in circumstances indicate that an impairment may exist. Recoverability of finite-lived intangible assets is measured by comparing the carrying amount of the asset to the future undiscounted cash flows that the asset is expected to generate. In the fourth quarter of 2014, we identified intangible assets relating to acquired in-process research and development programs that we no longer expect to derive value from and as a result recorded $0.3 million of accelerated amortization. There were no other events or circumstances during 2014 that would indicate the carrying value of our long-lived assets may not be recoverable.
    
We perform an annual impairment assessment in the fourth quarter of each year for indefinite-lived intangible assets, or more frequently if indicators of potential impairment exist, to determine whether it is more likely than not that the carrying value of the assets may not be recoverable. Recoverability of indefinite-lived intangible assets is measured by comparing the carrying amount of the asset to the future discounted cash flows that the asset is expected to generate. If we determine that an individual asset is impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
Property, Plant and Equipment

Property, plant and equipment is reviewed for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable. We evaluate recoverability of assets to be held and used by comparing the carrying amount of an asset to estimated future net undiscounted cash flows to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.
Valuation of Goodwill

Goodwill is recorded when the purchase price for an acquisition exceeds the estimated fair value of the net tangible and identified intangible assets acquired. The carrying value of goodwill was $7.9 million as of March 29, 2014 and March 30, 2013.

We perform an annual impairment assessment in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine whether the fair value of the reporting unit is less than its carrying value. In performing this assessment in 2014 we concluded that goodwill was not impaired and we were not required to perform the second step of the goodwill impairment test. The assessment of whether goodwill is impaired is sensitive to stock price and the assumed control premium. A significant deterioration in either may trigger impairment. Our stock price has recently traded around or below our book value of equity, thereby placing more emphasis on the determination of a reasonable control premium.


Item 7A. Quantitative and Qualitative Disclosures about Market Risk

35


The primary objectives of our investment activities are to preserve principal and maintain liquidity to meet operating needs. To achieve these objectives, we maintain an investment portfolio of cash, cash equivalents, and investments in a variety of securities, including commercial paper, corporate bonds and U.S. government agency notes.
Interest Rate Risk
Our investment securities are subject to interest rate risk and will decline in value if interest rates increase. The majority of these securities are classified as available-for-sale securities; therefore, the impact on fair value of interest rate changes is reflected as a separate component of shareholders’ equity. Due to the short duration of our investment portfolio, an immediate 10% change in interest rates would not have a material effect on the fair value of our invested assets.
Investment Risk
Our marketable securities are classified as available-for-sale securities measured at fair value. The market value of our investments is influenced by market risks, liquidity risk and the credit worthiness of underlying issuers of our investment. We strive to minimize the investment risk by investing in high quality securities and by utilizing experienced and high credit quality financial institutions to manage the investment portfolio.
Foreign Currency Exchange Rate Risk
We purchase derivative financial instruments on a limited basis and do not use them for trading purposes. We do, however, use derivatives to manage well-defined foreign currency risks. We enter into forward exchange contracts to hedge the value of material non-functional currency monetary asset and liability balances. The net effect of an immediate 10% change in exchange rates on the forward exchange contracts and the underlying hedged positions would not be material to our financial position or the results of our operations.

36


The table below summarizes, by currency, the notional amounts of our forward exchange contracts in U.S. dollars as of March 29, 2014 and March 30, 2013. The “bought” amounts represent the net U.S. dollar equivalents of commitments to purchase foreign currencies, and the “sold” amounts represent the net U.S. dollar equivalents of commitments to sell foreign currencies. The foreign currency amounts have been translated into a U.S. dollar equivalent value using the exchange rates at the reporting date.
 
Bought (Sold)
(In thousands)
2014
 
2013
Japanese Yen
$
4,346

 
$
4,136

Euro
13,322

 
6,471

New Taiwan Dollar
(440
)
 
(783
)
Korean Won
(1,917
)
 
(2,654
)
British Pound
(3,664
)
 
(4,272
)
Chinese Renminbi
(1,917
)
 
(1,542
)
Singapore Dollar
(716
)
 
(204
)
Canadian Dollar
(136
)
 

 
$
8,878

 
$
1,152




37


Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
Electro Scientific Industries, Inc.:

We have audited the accompanying consolidated balance sheets of Electro Scientific Industries, Inc. and subsidiaries as of March 29, 2014 and March 30, 2013, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended March 29, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Electro Scientific Industries, Inc. and subsidiaries as of March 29, 2014 and March 30, 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended March 29, 2014, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Electro Scientific Industries, Inc.’s internal control over financial reporting as of March 29, 2014, based on criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated June 12, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Portland, Oregon
June 12, 2014


38


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of March 29, 2014 and March 30, 2013
(In thousands)
2014
 
2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
68,461

 
$
88,913

Short-term investments
38,444

 
56,144

Trade receivables, net of allowances of $404 and $442
37,813

 
31,779

Inventories
58,902

 
63,067

Shipped systems pending acceptance
2,054

 
1,007

Deferred income taxes, net
161

 
1,682

Other current assets
4,674

 
3,898

Total current assets
210,509

 
246,490

Non-current assets:
 
 
 
Non-current investments
3,985

 
12,329

Property, plant and equipment, net
27,930

 
27,894

Non-current deferred income taxes, net
704

 
3,766

Goodwill
7,889

 
7,889

Acquired intangible assets, net
6,845

 
9,088

Other assets
12,347

 
14,752

Total assets
$
270,209

 
$
322,208

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
14,465

 
$
16,958

Accrued liabilities
20,524

 
24,930

Deferred income tax liability, net
170

 

Deferred revenue
10,515

 
10,196

Total current liabilities
45,674

 
52,084

Non-current liabilities:
 
 
 
Income taxes payable
1,654

 
5,982

Commitments and contingencies (Notes 18 and 21)


 


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

 

Common stock, without par value; 100,000 shares authorized; 30,155 and 29,583 issued and outstanding
183,193

 
176,631

Retained earnings
39,336

 
87,228

Accumulated other comprehensive income
352

 
283

Total shareholders’ equity
222,881

 
264,142

Total liabilities and shareholders’ equity
$
270,209

 
$
322,208

See Accompanying Notes to Consolidated Financial Statements


39


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended March 29, 2014March 30, 2013 and March 31, 2012
(In thousands, except per share amounts)
2014
 
2013
 
2012
Net sales
$
181,167

 
$
216,625

 
$
254,229

Cost of sales
117,141

 
152,372

 
146,538

Gross profit
64,026

 
64,253

 
107,691

Operating expenses:
 
 
 
 
 
Selling, service and administration
55,753

 
56,051

 
58,555

Research, development and engineering
37,839

 
37,196

 
42,640

Restructuring costs
1,070

 
2,612

 
3,785

(Gain) loss on sale of property and equipment, net
(1,301
)
 
(1,226
)
 
966

Gain on acquisition of Semiconductor Systems business
(499
)
 

 

Legal settlement (proceeds) costs, net

 
(15,262
)
 
550

Net operating expenses
92,862

 
79,371

 
106,496

Operating (loss) income
(28,836
)
 
(15,118
)
 
1,195

Non-operating (expense) income:
 
 
 
 
 
Gain on sale of previously impaired auction rate securities

 

 
2,729

Other-than-temporary impairment of cost method investments
(9,703
)
 

 

Interest and other income (expense), net
113

 
253

 
(437
)
Total non-operating (expense) income
(9,590
)
 
253

 
2,292

(Loss) income before income taxes
(38,426
)
 
(14,865
)
 
3,487

(Benefit from) provision for income taxes
(92
)
 
39,851

 
(1,417
)
Net (loss) income
$
(38,334
)
 
$
(54,716
)
 
$
4,904

Net (loss) income per share—basic
$
(1.28
)
 
$
(1.86
)
 
$
0.17

Net (loss) income per share—diluted
$
(1.28
)
 
$
(1.86
)
 
$
0.17

Weighted average number of shares—basic
29,974

 
29,357

 
28,749

Weighted average number of shares—diluted
29,974

 
29,357

 
29,461

Cash dividends paid per outstanding common share
$
0.32

 
$
2.32

 
$
0.08


See Accompanying Notes to Consolidated Financial Statements


40



ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the years ended March 29, 2014March 30, 2013 and March 31, 2012

(In thousands)
2014
 
2013
 
2012
Net (loss) income
$
(38,334
)
 
$
(54,716
)
 
$
4,904

Other comprehensive (loss) income:
 
 
 
 
 
Foreign currency translation adjustment, net of taxes of $21, $0 and $12
37

 
(198
)
 
277

Reclassification of unrealized gain on auction rate securities

 

 
(1,445
)
Accumulated other comprehensive income (expense) related to benefit plan obligation, net of taxes of $19, $8, and ($15)
22

 
9

 
(23
)
Net unrealized gain (loss) on available-for-sale securities, net of taxes of $5, $0, and ($3)
9

 
(34
)
 
7

Comprehensive (loss) income
$
(38,266
)
 
$
(54,939
)
 
$
3,720


See Accompanying Notes to Consolidated Financial Statements

41


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended March 29, 2014March 30, 2013 and March 31, 2012

 
Common Stock
 
Retained
Earnings
 
Accumulated
Comprehensive
Income (Loss)
 
Total
Shareholders’
Equity
(In thousands)
Shares
 
Amount
 
Balance at April 3, 2011
28,299

 
153,189

 
207,420

 
1,690

 
362,299

Cash dividends paid ($0.08 per outstanding common share)

 

 
(2,303
)
 

 
(2,303
)
Employee stock plans
671

 
14,449

 

 

 
14,449

Tax impact of stock options exercised

 
505

 

 

 
505

Net income

 

 
4,904

 

 
4,904

Other comprehensive loss

 

 

 
(1,184
)
 
(1,184
)
Balance at March 31, 2012
28,970

 
168,143

 
210,021

 
506

 
378,670

Cash dividends paid ($2.32 per outstanding common share)

 

 
(68,077
)
 

 
(68,077
)
Employee stock plans
613

 
8,488

 

 

 
8,488

Net loss

 

 
(54,716
)
 

 
(54,716
)
Other comprehensive loss

 

 

 
(223
)
 
(223
)
Balance at March 30, 2013
29,583

 
176,631

 
87,228

 
283

 
264,142

Cash dividends paid ($0.32 per outstanding common share)

 

 
(9,558
)
 

 
(9,558
)
Employee stock plans
592

 
6,753

 

 

 
6,753

Share repurchases
(20
)
 
(191
)
 

 

 
(191
)
Net loss

 

 
(38,334
)
 

 
(38,334
)
Other Comprehensive income

 

 

 
69

 
69

Balance at March 29, 2014
30,155

 
$
183,193

 
$
39,336

 
$
352

 
$
222,881



See Accompanying Notes to Consolidated Financial Statements

42


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended March 29, 2014March 30, 2013 and March 31, 2012
(In thousands)
2014
 
2013
 
2012
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
 
Net (loss) income
$
(38,334
)
 
$
(54,716
)
 
$
4,904

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
 
 
 
 
 
Depreciation and amortization
7,642

 
9,905

 
12,489

Amortization of acquired intangible assets
2,985

 
4,746

 
1,722

Share-based compensation expense
6,105

 
7,861

 
11,451

Provision for doubtful accounts

 

 
50

Gain on sale of previously impaired auction rate securities

 

 
(2,729
)
(Gain) loss on sale of property and equipment, net
(1,138
)
 
680

 
1,007

Gain on acquisition of Semiconductor Systems business
(499
)
 

 

Other-than-temporary impairment of cost method investments
9,703

 

 

Decrease (increase) in deferred income taxes
4,377

 
40,971

 
(5,724
)
Changes in operating accounts, net of acquisitions:
 
 
 
 
 
(Increase) decrease in trade receivables, net
(2,195
)
 
1,232

 
11,191

Decrease (increase) in inventories
7,567

 
3,564

 
(4,389
)
(Increase) decrease in shipped systems pending acceptance
(1,047
)
 
353

 
3,929

(Increase) decrease in other current assets
(728
)
 
633

 
2,559

(Decrease) increase in accounts payable and accrued liabilities
(13,694
)
 
2,550

 
(16,886
)
Increase (decrease) in deferred revenue
140

 
(672
)
 
(5,261
)
Net cash (used in) provided by operating activities
(19,116
)
 
17,107

 
14,313

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
 
Purchase of investments
(268,132
)
 
(1,061,654
)
 
(929,201
)
Proceeds from sales and maturities of investments
294,182

 
1,123,156

 
876,822

Proceeds from sale of auction rate securities

 

 
6,450

Purchase of property, plant and equipment
(7,583
)
 
(6,213
)
 
(4,937
)
Proceeds from sale of property, plant and equipment
3,657

 
2,030

 
26

Decrease (increase) in restricted cash

 
22,269

 
(11,500
)
Cash paid for business acquisitions, net of cash acquired
(9,731
)
 
(9,466
)
 

Minority equity investment
(5,000
)
 

 

Decrease (increase) in other assets
438

 
625

 
(131
)
Net cash provided by (used in) investing activities
7,831

 
70,747

 
(62,471
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
 
Cash dividends paid to shareholders
(9,557
)
 
(68,077
)
 
(2,303
)
Stock plan activity, net
648

 
627

 
2,999

Share repurchases
(191
)
 

 

Excess tax benefit of share-based compensation

 
307

 
546

Net cash (used in) provided by financing activities
(9,100
)
 
(67,143
)
 
1,242

Effect of exchange rate changes on cash
(67
)
 
(1,578
)
 
284

NET CHANGE IN CASH AND CASH EQUIVALENTS
(20,452
)
 
19,133

 
(46,632
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
88,913

 
69,780

 
116,412

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
68,461

 
$
88,913

 
$
69,780

SUPPLEMENTAL CASH FLOW INFORMATION
 
 
 
 
 
Cash paid for interest
$

 
$
(21
)
 
$

Cash paid for income taxes
$
(3,256
)
 
$
(1,823
)
 
$
(4,371
)
Income tax refunds received
$
163

 
$
890

 
$
132

See Accompanying Notes to Consolidated Financial Statements

43


ELECTRO SCIENTIFIC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company
Electro Scientific Industries, Inc. together with its wholly-owned subsidiaries (collectively, the Company) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. The Company’s advanced laser systems enable precise structuring of micron to submicron features in components and devices which are used in a wide variety of end products in the consumer electronics, computer, semiconductor, communications and other markets. These features enable the Company’s customers to achieve functionality, or improve yield and productivity in their manufacturing processes that can be critical to their profitability. Founded in 1944, the Company is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Canada, Europe and the United States.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Electro Scientific Industries, Inc. and its subsidiaries. All intercompany accounts and transactions have been eliminated.
The Company’s fiscal year consists of 52 or 53 weeks ending on the Saturday nearest March 31. Accordingly, the fiscal 2014 reporting period consisted of a 52-week period ending on March 29, 2014, the fiscal 2013 reporting period consisted of a 52-week period ending on March 30, 2013 and the fiscal 2012 reporting period consisted of a 52-week period ending on March 31, 2012. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.
Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (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. Significant estimates made by management include: revenue recognition; inventory valuation; product warranty reserves; allowance for doubtful accounts; accrued restructuring costs; share-based compensation; income taxes including the valuation of deferred tax assets; fair value measurements; valuation of cost method equity investments; valuation of long-lived assets; and valuation of goodwill.
Risks and Uncertainties
The Company uses financial instruments that potentially subject it to concentrations of credit risk. Such instruments include cash equivalents, available-for-sale marketable securities, trade receivables and financial instruments used in hedging activities. The Company invests cash in cash deposits, money market funds, commercial paper, certificates of deposit and readily marketable securities. Investments are placed with high credit quality financial institutions and the credit exposure from any one institution or instrument is minimized. See Note 5 “Fair Value Measurements” for further discussion on these investments.
The Company sells a significant portion of its products to a small number of large semiconductor and microelectronics manufacturers. The top ten customers accounted for approximately 41%, 61% and 56% of total net sales in 2014, 2013 and 2012, respectively. One consumer electronics manufacturer accounted for approximately 15%, 31% and 29% of total net sales in 2014, 2013 and 2012, respectively. No other customer individually accounted for more than 10% of total net sales in 2014, 2013 or 2012. The Company’s operating results may be adversely affected if orders and revenues from these key customers decline.
The Company uses qualified manufacturers to supply many components and sub-system modules of its products. The systems that the Company manufactures use high-performance computers, peripherals, lasers and other components from various suppliers. The Company obtains some of the components from a single source or a limited group of suppliers. An interruption in the supply of a particular component would have a temporary adverse impact on the Company’s operating results.
The Company’s net investment exposure in foreign subsidiaries translated into U.S. dollars using the period-end exchange rates at March 29, 2014 and March 30, 2013 was approximately $55.4 million and $56.4 million, respectively. The potential loss in fair value resulting from a hypothetical 10% adverse change in foreign exchange rates would be approximately

44


$5.5 million and $5.6 million at March 29, 2014 and March 30, 2013, respectively. Foreign exchange rate gains or losses on foreign investments as of March 29, 2014 were reflected as a cumulative translation adjustment, net of tax, and do not affect the Company’s results of operations.
The Company’s operations involve a number of other risks and uncertainties including but not limited to those relating to the cyclicality of the microelectronics and semiconductor markets, the effect of general economic conditions, rapid changes in technology and international operations.
Cash Equivalents and Investments
All highly liquid investments with a maturity of 90 days or less at the date of purchase are considered to be cash equivalents. Short-term investments reflect marketable securities that have maturities of less than one year or are subject to immediate pre-payment or call provisions. These securities consist primarily of marketable debt securities and are classified as “available-for-sale securities” and recorded at fair market value. Unrealized gains and losses on short-term investments are recorded as a component of accumulated other comprehensive income (loss). To determine whether any existing impairment is other-than-temporary and requires recognition of an impairment loss in the results of operations, the Company evaluates its marketable securities based on the nature of the investments and the Company’s intent and ability to hold the securities until the securities are no longer in an unrealized loss position.
Accounts Receivable and Allowance for Doubtful Accounts
Trade accounts receivable are stated at the amount the Company expects to collect and do not bear interest. Credit limits are established by reviewing the financial history and stability of each customer. Where appropriate, the Company obtains credit rating reports and financial statements of the customer to establish or modify credit limits. On certain foreign sales, letters of credit are obtained. The collectability of trade receivable balances is regularly evaluated based on a combination of factors such as customer reputation and credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. If it is determined or estimated 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 reserve for bad debt is recorded to reduce the related receivable to the amount expected to be recovered.
Accrued Restructuring Costs
The Company has engaged, and may continue to engage, in restructuring actions, which require it to make estimates in certain areas including expenses for severance and other employee separation costs. Because the Company has a history of paying severance benefits, expenses associated with exit or disposal activities are recognized when probable and estimable. Should the actual amounts differ from our estimates, the amount of the restructuring charges could be materially impacted. See Note 24 “Restructuring and Cost Management Plans” for further discussion.
Inventories
Inventories are principally valued at standard costs, which approximate the lower of cost (first-in, first-out) or market. Costs utilized for inventory valuation purposes include material, labor and manufacturing overhead.
Shipped Systems Pending Acceptance
Shipped systems pending acceptance relate to systems that have been ordered and shipped to the customer, but have been deferred in accordance with the Company’s revenue recognition policy. Shipped systems pending acceptance are recognized as cost of sales once all criteria for revenue recognition have been met and revenue is recorded. Shipped systems pending acceptance are valued at standard costs, which approximate the lower of cost (first-in, first-out) or market. Costs utilized in the valuation of shipped systems pending acceptance include material, labor and manufacturing overhead and exclude costs of installation.
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets. Expenditures for maintenance, repairs and minor improvements are expensed as incurred. Major improvements and additions are capitalized. When assets are sold or retired, the cost and related accumulated depreciation and amortization are removed from the accounts and the resulting gain or loss is included as a component of operating expenses.
Long-Lived Asset Impairment

45


Long-lived assets, principally property, plant and equipment and identifiable definite-lived intangibles, are reviewed for impairment whenever events or circumstances indicate that the carrying amount of the assets may not be recoverable. The Company evaluates recoverability of assets to be held and used by comparing the carrying amount of an asset to estimated future net undiscounted cash flows generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.
The Company’s purchased patents are amortized over their estimated useful lives, generally 9 to 17 years.
Other purchased intangible assets with definite useful lives are carried at cost less accumulated amortization. Amortization expense is recognized on a straight-line method over the estimated useful lives of the intangible assets, which range from 1 to 9 years.
Goodwill Impairment
The Company accounts for goodwill pursuant to Accounting Standards Codification (ASC) Topic 350 as amended in September 2011 by Accounting Standard Update (ASU) 2011-08, “Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment” (ASC ASU 2011-08). ASC Topic 350 requires that goodwill be tested for impairment at least annually. ASC ASU 2011-08 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. The Company tests goodwill for impairment using a quantitative approach at least annually or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below the carrying value. Goodwill was tested for impairment in the fourth quarter of 2014 and it was determined that there was no impairment as of March 29, 2014.
Other Assets
Other assets include consignment, demonstration (demo) equipment, minority equity investments and long-term deposits.
Consignment, demo and training equipment are recorded at the lower of standard costs or estimated market values, until the assets are sold.
The Company has minority equity investments in the preferred stock of OmniGuide, Inc. (OmniGuide), a private company. These investments are accounted for as cost method investments and the Company does not have the ability to significantly influence OmniGuide. At the end of each reporting period, the Company determines whether events or circumstances have occurred that are likely to have a significant adverse effect on the fair value of these investments. If there are no identified events or circumstances that may have a significant adverse effect on the fair value of these investments, the fair value of the investments are not calculated as it is not practicable to do so. The total carrying value of $4.3 million and $9.0 million at March 29, 2014 and March 30, 2013, respectively, is included in Other assets on the Consolidated Balance Sheets.
Fair Value of Financial Instruments
The carrying amounts of financial instruments, including cash equivalents and accrued liabilities approximate fair value because of the nature of the underlying transactions and short-term maturities involved. Current and non-current marketable securities are recorded at fair value which is defined under Financial Accounting Standards Board (FASB) ASC Topic 820 “Fair Value Measurements and Disclosures” (ASC Topic 820). 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 in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Derivative Financial Instruments
The Company’s primary objective for holding derivative financial instruments is to manage currency risk. The Company’s accounting policies for these instruments are based on whether they meet the Company’s criteria for designation as hedging transactions, either as cash flow or fair value hedges. A hedge of the exposure to variability in the cash flows of an asset or a liability, or of a forecasted transaction, is referred to as a cash flow hedge. A hedge of the exposure to changes in fair

46


value of an asset or a liability, or of an unrecognized firm commitment, is referred to as a fair value hedge. The criteria for designating a derivative as a hedge include the instrument’s effectiveness in risk reduction and, in most cases, a one-to-one matching of the derivative instrument to its underlying transaction. The Company enters into foreign currency exchange contracts to offset the earnings impact relating to the variability in exchange rates on certain short-term monetary assets and liabilities denominated in non-functional currencies. The Company does not designate these foreign currency contracts as hedges. The change in fair value of these derivative instruments not designated as hedging instruments is reported each period in other income (expense), net, in our Consolidated Statement of Operations.
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. Title and risk of loss generally pass to the customer at the time of delivery of the product to a common carrier. Revenue is recognized upon such delivery, provided that fulfillment of acceptance criteria can be demonstrated prior to shipment. Where the acceptance criteria cannot be demonstrated prior to shipment, or in the case of substantially new products, revenue is deferred until acceptance has been received. For multiple element arrangements, the relative fair value of any undelivered elements is deferred until the elements are delivered and acceptance criteria are met. Revenues are recorded net of taxes collected which are required to be submitted to government authorities. Installation services are not essential to the functionality of the delivered equipment and installation revenue is deferred until installation is complete. Neither the costs of installation accrued nor the fair value of installation service revenue deferred has been material.
Revenues associated with sales to customers under local contracts in Japan are recognized upon title transfer, which generally occurs upon customer acceptance. Revenues related to spare parts and consumable sales are generally recognized upon shipment. Revenues related to maintenance and service contracts are recognized ratably over the duration of the contracts.
Product Warranty
The Company evaluates obligations related to product warranties quarterly. A standard one-year warranty from the date of acceptance is provided on most products. Warranty charges are comprised of costs to service the warranty, including labor to repair the system and replacement parts for defective items, as well as other costs incidental to the repairs. Warranty charges are recorded net of any cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Company’s suppliers for defective components. Using historical data, the Company estimates average warranty cost per system or part type and records the provision for such charges as an element of cost of goods sold upon recognition of the related revenue. Additionally, the overall warranty accrual balance is separately analyzed using the remaining warranty periods outstanding on systems and items under warranty, and any resulting changes in estimates are recorded as an adjustment to cost of sales. If circumstances change, or if a significant change in warranty-related incidents occurs, the impact of the change in the warranty accrual could be material. Accrued product warranty is included on the Consolidated Balance Sheets as a component of accrued liabilities.
Research and Development
Research and development costs, which include labor and related employee expenses, patent maintenance fees, project materials costs, development tool placement and installation costs, project subcontractors, depreciation of engineering equipment, building costs and other administration expenses, are generally expensed as incurred. Engineering materials that are expected to provide future value are included in inventories.
Taxes on Unremitted Foreign Income
The Company provides for income taxes on its foreign subsidiaries’ taxable income based on the effective income tax rate in each respective jurisdiction. The Company provides for deferred taxes on the undistributed earnings of a subsidiary, except to the extent that the income is intended to be indefinitely reinvested or remitted in a tax-free liquidation. The only foreign jurisdiction where the Company is permanently reinvested is Singapore. The cumulative amount of earnings upon which U.S. income taxes have not been provided was $28.8 million and $25.8 million as of March 29, 2014 and March 30, 2013, respectively. The unrecognized deferred tax liability related to these earnings was $10.0 million and $9.0 million as of March 29, 2014 and March 30, 2013, respectively.
Comprehensive Income (Loss)
Comprehensive income (loss) includes net income (loss) and “other comprehensive income,” which includes charges or credits to equity that are not the result of transactions with shareholders. Comprehensive income (loss) within these consolidated financial statements includes primarily cumulative foreign currency translation adjustments and unrealized gains

47


and losses on securities available for sale. The cumulative translation adjustment included in accumulated other comprehensive income (loss) at March 29, 2014 and March 30, 2013 was $0.4 million and $0.4 million, respectively.
Earnings Per Share
Basic earnings per share (EPS) is computed utilizing the weighted average number of shares outstanding during the period. Diluted EPS also considers common stock equivalents, such as stock options, stock-settled stock appreciation rights (SARs), employee stock purchase plan (ESPP) shares and restricted stock units, to the extent that they are not antidilutive.
Share-Based Compensation
The Company recognizes expense related to the fair value of its share-based compensation awards. The Company uses the Black-Scholes model to estimate the fair value of all share-based compensation awards on the date of grant, except for unvested restricted stock units, which are valued at the fair market value of the Company’s stock on the date of award. The Company recognizes the compensation expense for options, SARs and unvested restricted stock units on a straight-line basis over the requisite service period of the award.
Segment Reporting
The Company complies with ASC Topic 280 “Segment Reporting” (ASC Topic 280). ASC Topic 280, which is based on a management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report annually entity-wide disclosures about products, major customers and the geographies in which the entity holds material assets and reports revenue. An operating segment is defined as a component that engages in business activities whose operating results are reviewed by the chief operating decision maker and for which discrete financial information is available. Based on the provisions of ASC Topic 280, the Company has determined that it operates in one segment. The Company manages its resources and assesses its performance on an enterprise-wide basis.
Employee Benefit Plans
The Company has an employee savings plan under the provisions of Section 401(k) of the Internal Revenue Code. During 2014 and 2013, contributions to the plan by the Company were $0.2 million and $0.3 million, respectively.
The Company has defined benefit retirement plans at certain of its foreign subsidiaries. The Company accounts for these plans based on the provisions of ASC Topic 715 “Compensation-Retirement Benefits”.
3. Recent Accounting Pronouncements
    
On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on March 26, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
    
In February 2013, the FASB issued ASU 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income" (ASC ASU 2013-02). ASC ASU 2013-02 is intended to improve the reporting of reclassifications out of accumulated other comprehensive income. Accordingly, an entity is required to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. The amendments in this ASU supersede the presentation requirements for reclassifications out of accumulated other comprehensive income in ASC ASU 2013-05 and ASC ASU 2013-12. ASC ASU 2013-02 is effective for reporting periods beginning after December 15, 2012. The adoption of ASC ASU 2013-02 in the first quarter of fiscal year 2014 did not have a material effect on the measurement of net earnings or other comprehensive income.

In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2013-11, "Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists". This update specifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a

48


similar tax loss, or a tax credit carryforward, except as follows: To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU 2013-11 was effective for fiscal years beginning after December 15, 2013 and the Company adopted this pronouncement in 2014, which resulted in the reclassification of $4.4 million from non-current deferred income taxes, net to income taxes payable.
4. Share-Based Compensation
The Company recognizes expense related to the fair value of its share-based compensation awards using the Black-Scholes model to estimate the fair value of awards on the date of grant, except for unvested restricted stock unit awards, which are valued at the fair market value of the Company’s stock on the date of award. The Company recognizes compensation expense for all share-based compensation awards on a straight-line basis over the requisite service period of the award.
Stock Plans
In October 2004, the shareholders approved the adoption of the 2004 Stock Incentive Plan (the 2004 Plan) that replaced various stock compensation plans that were previously approved by the shareholders or the Board of Directors (the Replaced Plans), except with respect to options and other awards previously outstanding. Outstanding options and awards remained subject to the terms of the Replaced Plans under which they were originally granted. At that time, the shareholders also approved the reservation of 3,000,000 shares of common stock for issuance under the 2004 Plan. These shares are in addition to any shares of common stock that, at the time the 2004 Plan was approved by shareholders, were available for grant under the Replaced Plans or that may subsequently become available for grant under any of the Replaced Plans through the expiration, termination, forfeiture or cancellation of grants. In January 2005, the Board of Directors approved certain amendments to the 2004 Plan. These amendments prohibit grants of stock options or SARs with an exercise price less than fair market value, require that time-based restricted stock awards have a minimum vesting period of at least three years, with the subject shares vesting no more quickly than one-third annually over the three-year period, and expressly prohibit the reservation of additional shares under the 2004 Plan without shareholder approval. In October 2007, the shareholders approved an additional amendment to the 2004 Plan to permit awards to non-employee service providers and implement certain claw-back provisions.
The 2004 Plan allows for grants of stock options, stock appreciation rights, stock bonuses (including restricted stock units), restricted stock, performance-based awards and dividend equivalents. Stock options and SARs outstanding under the 2004 Plan and the Replaced Plans vest over variable periods determined at the grant date, generally with terms of immediate vesting or up to four years, and expire ten years from the date of grant. Options and SARs issued under the 2004 Plan and the Replaced Plans are exercisable at prices not less than fair market value on the date of the grant. The 2004 Plan prohibits repricing of options and SARs granted without prior shareholder approval. Certain restricted stock units awarded under the 2004 Plan vest based on performance criteria that are tied to the Company’s results of operations, personal performance criteria, and, in certain cases, length of service. Unvested restricted stock unit awards are credited with dividend equivalents in the form of additional unvested restricted stock units at the same time and in the same amount as dividends paid to shareholders of the Company. The dividend equi