ELECTRO SCIENTIFIC INDUSTRIES INC (Form: 10-Q, Received: 02/03/2015 15:08:10)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)



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

For the quarterly period ended December 27, 2014



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

For the transition period from to

Commission File Number: 0-12853




ELECTRO SCIENTIFIC INDUSTRIES, INC.



Oregon		93-0370304
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

13900 N.W. Science Park Drive, Portland, Oregon		97229
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: 503-641-4141

Registrant’s web address: www.esi.com

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer 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 Exchange Act). Yes ¨ No ý

The number of shares outstanding of the Registrant’s Common Stock as of February 2, 2015 was 30,394,188 shares.

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ELECTRO SCIENTIFIC INDUSTRIES, INC.

2015 FORM 10-Q QUARTERLY REPORT

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Part I	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets - at December 27, 2014 and March 29, 2014	3
	Condensed Consolidated Statements of Operations - for the fiscal quarter and three fiscal quarters ended December 27, 2014 and December 28, 2013	4
	Condensed Consolidated Statements of Comprehensive Loss - for the fiscal quarter and three fiscal quarters ended December 27, 2014 and December 28, 2013	4
	Condensed Consolidated Statements of Cash Flows - for the three fiscal quarters ended December 27, 2014 and December 28, 2013	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	21
Item 4.	Controls and Procedures	21
Part II	OTHER INFORMATION
Item 1.	Legal Proceedings	21
Item 1A.	Risk Factors	21
Item 4.	Mine Safety Disclosures	29
Item 6.	Exhibits and Financial Statement Schedules	30
SIGNATURES		31

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



(In thousands)	Dec 27, 2014		Mar 29, 2014
ASSETS
Current assets:
Cash and cash equivalents	$	70,066	$	68,461
Short-term investments	9,565		38,444
Trade receivables, net of allowances of $410 and $404	40,503		37,813
Inventories	59,424		58,902
Shipped systems pending acceptance	948		2,054
Deferred income taxes, net	145		161
Other current assets	3,812		4,674
Total current assets	184,463		210,509
Non-current assets:
Non-current investments	—		3,985
Property, plant and equipment, net of accumulated depreciation of $101,347 and $98,333	27,187		27,930
Non-current deferred income taxes, net	628		704
Goodwill	7,889		7,889
Acquired intangible assets, net of accumulated amortization of $19,488 and $18,378	5,733		6,845
Other assets	13,200		12,347
Total assets	$	239,100	$	270,209
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	14,175	$	14,465
Accrued liabilities	19,429		20,524
Deferred income tax liability, net	170		170
Deferred revenue	7,823		10,515
Total current liabilities	41,597		45,674
Non-current liabilities:
Income taxes payable	1,298		1,654
Commitments and contingencies
Shareholders’ equity:
Preferred stock, without par value; 1,000 shares authorized; no shares issued	—		—
Common stock, without par value; 100,000 shares authorized; 30,606 and 30,155 issued and outstanding	184,696		183,193
Retained earnings	11,200		39,336
Accumulated other comprehensive income, other	309		352
Total shareholders’ equity	196,205		222,881
Total liabilities and shareholders’ equity	$	239,100	$	270,209

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

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



	Fiscal quarter ended						Three fiscal quarters ended
(In thousands, except per share amounts)	Dec 27, 2014			Dec 28, 2013			Dec 27, 2014			Dec 28, 2013
Net sales	$	43,661		$	38,267		$	121,547		$	144,086
Cost of sales	27,884			21,986			76,754			83,787
Gross profit	15,777			16,281			44,793			60,299
Operating expenses:
Selling, service and administration	13,397			12,408			39,412			41,206
Research, development and engineering	8,383			9,768			25,952			27,912
Gain on sale of property and equipment, net	—			(1,301		)	—			(1,301		)
Gain on acquisition of Semiconductor Systems business	—			—			—			(499		)
Net operating expenses	21,780			20,875			65,364			67,318
Operating loss	(6,003		)	(4,594		)	(20,571		)	(7,019		)
Non-operating income (expense):
Other-than-temporary impairment of cost based investments	—			—			—			(3,588		)
Interest and other income (expense), net	64			95			(134		)	115
Total non-operating income (expense)	64			95			(134		)	(3,473		)
Loss before income taxes	(5,939		)	(4,499		)	(20,705		)	(10,492		)
Provision for income taxes	437			141			165			209
Net loss	$	(6,376	)	$	(4,640	)	$	(20,870	)	$	(10,701	)
Net loss per share—basic	$	(0.21	)	$	(0.15	)	$	(0.68	)	$	(0.36	)
Net loss per share—diluted	$	(0.21	)	$	(0.15	)	$	(0.68	)	$	(0.36	)
Weighted average number of shares—basic	30,617			30,054			30,507			29,922
Weighted average number of shares—diluted	30,617			30,054			30,507			29,922
Cash dividends paid per outstanding common share	$	0.08		$	0.08		$	0.24		$	0.24

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)



	Fiscal quarter ended						Three fiscal quarters ended
(In thousands)	Dec 27, 2014			Dec 28, 2013			Dec 27, 2014			Dec 28, 2013
Net loss	$	(6,376	)	$	(4,640	)	$	(20,870	)	$	(10,701	)
Other comprehensive income (loss):
Foreign currency translation adjustment, net of taxes of $179, $(86), $0 and $22	(359		)	(153		)	(41		)	39
Accumulated other comprehensive income related to benefit plan obligation, net of taxes of $(2), $2, $(6) and $5	3			3			10			9
Net unrealized (loss) gain on available-for-sale securities, net of taxes of $0, $(2), $5 and $3	(5		)	(3		)	(12		)	5
Comprehensive loss	$	(6,737	)	$	(4,793	)	$	(20,913	)	$	(10,648	)

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

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



	Three fiscal quarters ended
(In thousands)	Dec 27, 2014			Dec 28, 2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(20,870	)	$	(10,701	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	5,880			5,636
Amortization of acquired intangible assets	1,112			2,133
Share-based compensation expense	3,402			5,130
Gain on sale of property and equipment, net	(8		)	(1,264		)
Gain on acquisition of Semiconductor Systems business	—			(499		)
Other-than-temporary impairment of cost based investments	—			3,588
Decrease (increase) in deferred income taxes	2			(317		)
Changes in operating accounts, net of acquisitions:
(Increase) decrease in trade receivables, net	(3,284		)	8,047
Increase in inventories	(2,169		)	(1,389		)
Decrease (increase) in shipped systems pending acceptance	1,106			(172		)
Decrease (increase) in other current assets	783			(924		)
Increase (decrease) in accounts payable and accrued liabilities	217			(9,460		)
Decrease in deferred revenue	(2,692		)	(3,681		)
Net cash used in operating activities	(16,521		)	(3,873		)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments	(357,046		)	(237,113		)
Proceeds from sales and maturities of investments	389,900			253,265
Purchase of property, plant and equipment	(3,608		)	(5,344		)
Proceeds from sale of property, plant and equipment	154			3,617
Cash paid for business acquisitions	—			(9,731		)
Minority equity investment	—			(5,000		)
Increase in other assets	(980		)	(408		)
Net cash provided by (used in) investing activities	28,420			(714		)
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid to shareholders	(7,266		)	(7,158		)
Payment of withholding taxes on stock-based compensation	(1,850		)	(1,587		)
Proceeds from issuance of common stock	1,407			1,670
Share repurchases	(1,456		)	—
Net cash used in financing activities	(9,165		)	(7,075		)
Effect of exchange rate changes on cash	(1,129		)	(77		)
NET CHANGE IN CASH AND CASH EQUIVALENTS	1,605			(11,739		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	68,461			88,913
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	70,066		$	77,174
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest	$	(2	)	$	—
Cash paid for income taxes	$	(863	)	$	(3,072	)
Income tax refunds received	$	564		$	65

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

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ELECTRO SCIENTIFIC INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

These unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted in these interim statements. Accordingly, these condensed consolidated financial statements are to be read in conjunction with the financial statements and notes included in the Company's Annual Report on Form 10-K for its fiscal year ended March 29, 2014 . These interim statements include all adjustments (consisting of only normal recurring adjustments and accruals) necessary for a fair presentation of results for the interim periods presented. The results for interim periods are not necessarily indicative of the results of operations for the entire year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates.

Management believes that the estimates used are reasonable. Significant estimates made by management include: 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; valuation of goodwill; and valuation of acquired technology.

There have been no significant changes to the Company's significant accounting policies from those presented in Note 2 “Summary of Significant Accounting Policies” to the consolidated financial statements included in the Company's Annual Report on Form 10-K for its fiscal year ended March 29, 2014 . All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.

2. Recent Accounting Pronouncements

Recent Accounting Pronouncements issued by the financial accounting standards board (FASB) and the SEC did not have a material impact on the Company's financial statements.

3. 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 (RSUs) which are valued at the fair 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-settled stock appreciation rights (SARs) grant the right to receive shares of the Company's stock equivalent to the increase in stock value of a specified number of shares over a specified period of time, divided by the stock price at the time of exercise. The Company uses the Black-Scholes model to estimate the fair value of SARs. Similar to options, SARs are recorded at the fair value of the award at grant date and the expense is recognized on a straight-line basis over the requisite service period of the award.

The Company granted a total of 827,700 RSUs and 634,523 SARs during the first three quarters of 2015 , but did not grant any stock options. The Company granted 621,000 RSUs and did not grant any SARs or stock options during the first three quarters of 2014 .

Share-based compensation expense was included in the Company’s Condensed Consolidated Statements of Operations as follows:

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	Fiscal quarter ended				Three fiscal quarters ended
(In thousands)	Dec 27, 2014		Dec 28, 2013		Dec 27, 2014		Dec 28, 2013
Cost of sales	$	154	$	184	$	474	$	558
Selling, service and administration	629		728		2,096		3,488
Research, development and engineering	256		350		832		1,084
Total share-based compensation expense	$	1,039	$	1,262	$	3,402	$	5,130

No share-based compensation costs were capitalized in the first three quarters of 2015 . As of December 27, 2014 , the Company had $6.8 million of total unrecognized share-based compensation costs, net of estimated forfeitures, which are expected to be recognized over a weighted average period of 2.1 years.

4. Fair Value Measurements

Financial Assets Measured at Fair Value

ASC Topic 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include the following:


•	Level 1 , defined as observable inputs such as quoted prices in active markets for identical assets or liabilities;


•	Level 2 , defined as inputs that are observable either directly or indirectly such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and other inputs that can be corroborated by observable market data; and


•	Level 3 , defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

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The Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis as of December 27, 2014 and March 29, 2014 was as follows (in thousands):



December 27, 2014	Level 1		Level 2			Level 3		Total
Money market securities	$	1,215	$	—		$	—	$	1,215
Municipal bonds	—		3,871			—		3,871
Commercial paper	—		3,400			—		3,400
Government agencies	—		3,001			—		3,001
Corporate Bonds	—		852			—		852
Forward purchase or (sale) contracts:
Japanese Yen	—		149			—		149
New Taiwan Dollar	—		24			—		24
Korean Won	—		(9		)	—		(9		)
Euro	—		287			—		287
British Pound	—		(19		)	—		(19		)
Chinese Renminbi	—		3			—		3
Singapore Dollar	—		(19		)	—		(19		)



March 29, 2014	Level 1		Level 2			Level 3		Total
Money market securities	$	9,456	$	—		$	—	$	9,456
Commercial paper	—		6,700			—		6,700
Government agencies	—		8,037			—		8,037
Corporate bonds	—		17,328			—		17,328
Municipal bonds	—		12,725			—		12,725
Forward purchase or (sale) contracts:
Japanese Yen	—		25			—		25
New Taiwan Dollar	—		(6		)	—		(6		)
Korean Won	—		(44		)	—		(44		)
Euro	—		39			—		39
British Pound	—		(19		)	—		(19		)
Chinese Renminbi	—		(2		)	—		(2		)
Singapore Dollar	—		1			—		1

For Level 1 assets, the Company utilized quoted prices in active markets for identical assets.

For Level 2 assets, exclusive of forward contracts, the Company utilized quoted prices in active markets for similar assets. For forward contracts, spot prices at December 27, 2014 and March 29, 2014 were utilized to calculate fair values.

During the first three quarters of 2015 , there were no transfers between Level 1, 2 or 3 assets.

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Investments

Certain information regarding the Company’s investments at December 27, 2014 and March 29, 2014 was as follows (in thousands):



			Unrealized
December 27, 2014	Cost		Gain		Loss		Fair Value
Available-for-sale securities (current):
Municipal Bonds	$	3,865	$	6	$	—	$	3,871
Commercial paper	3,400		—		—		3,400
Government agencies	3,001		—		—		3,001
Corporate Bonds	852		—		—		852
	$	11,118	$	6	$	—	$	11,124
Available-for-sale securities (non-current):
	$	—	$	—	$	—	$	—

			Unrealized
March 29, 2014	Cost		Gain		Loss		Fair Value
Available-for-sale securities (current):
Commercial paper	$	6,700	$	—	$	—	$	6,700
Government agencies	8,035		2		—		8,037
Corporate Bonds	17,321		7		—		17,328
Municipal Bonds	8,737		4		—		8,741
	$	40,793	$	13	$	—	$	40,806
Available-for-sale securities (non-current):
Municipal Bonds	3,976		9		—		3,985
	$	3,976	$	9	$	—	$	3,985

For purposes of determining gross realized gains and losses and reclassification out of accumulated other comprehensive income (loss), the cost of securities sold is based on specific identification. Net unrealized holding gains and losses on current available-for-sale securities included in accumulated other comprehensive income (loss) were insignificant as of December 27, 2014 and March 29, 2014 .

At December 27, 2014 , $11.1 million in investments had maturities within one year.

5. Business Acquisitions

Fiscal 2014

On May 3, 2013, the Company purchased the assets related to the Semiconductor Systems business of GSI Group Inc. for a total purchase price of $9.7 million . The acquisition provided the Company with direct access to industry-leading wafer marking, wafer trimming and circuit trimming laser systems. The purchase price was allocated to the underlying assets acquired and liabilities assumed based on their fair values and resulted in a net gain on bargain purchase of $0.5 million . The fair value of the acquired net assets of $10.5 million was in excess of the total purchase consideration of $9.7 million , primarily due to the recognition of certain intangible assets. The resulting gain of $0.8 million was partially offset by $0.3 million of deferred tax liabilities. Analysis supporting the purchase price allocation included a valuation of assets and liabilities as of the closing date, an analysis of intangible assets and a detailed review of the opening balance sheet to determine other significant adjustments required to recognize assets and liabilities at fair value. The acquisition was an asset purchase for tax purposes.

As a result of the acquisition, the Company recorded approximately $8.2 million of inventory, $3.9 million of accounts receivable and other current assets, $0.7 million of identifiable intangible assets, $2.3 million of current liabilities, and a gain on bargain purchase of $0.8 million . The $0.7 million of identifiable intangible assets includes approximately $0.5 million of backlog and $0.2 million of developed technology. The acquired intangibles are amortized over their estimated useful lives, which ranged from one to three years.

In 2014, the Company also incurred approximately $1.5 million in acquisition related costs which are included in Selling, service and administration expenses in the Condensed Consolidated Statements of Operations.

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The operating results of this purchase are included in the Company’s results of operations since the date of acquisition. Pro forma financial information has not been provided for the purchase as it was not material to the Company’s overall financial position.

6. Inventories

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



(In thousands)	Dec 27, 2014		Mar 29, 2014
Raw materials and purchased parts	$	44,759	$	38,747
Work-in-process	10,716		12,914
Finished goods	3,949		7,241
	$	59,424	$	58,902

7. Other Current Assets

Other current assets consisted of the following:



(In thousands)	Dec 27, 2014		Mar 29, 2014
Prepaid expenses	$	2,086	$	2,601
Value added tax receivable	880		779
Other	846		1,294
	$	3,812	$	4,674

8. Other Assets

Other assets consisted of the following:



(In thousands)	Dec 27, 2014		Mar 29, 2014
Consignment and demo equipment, net	$	6,572	$	5,938
Minority equity investments	4,263		4,263
Other	2,365		2,146
	$	13,200	$	12,347

Minority equity investments represent the Company's investment in OmniGuide, Inc., which is accounted for as a cost method investment. 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 investments. If there are no identified events or circumstances that may have a significant adverse effect on the fair value of investments and the fair value of those investments are not practicable to calculate, the fair value is not calculated.

The total carrying value of the Company's investment in OmniGuide, Inc., was $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, or a 15% interest. In the second quarter of 2014, OmniGuide, Inc., engaged in a Series F Preferred Stock round of equity financing priced below previous rounds, which was considered a triggering event and the Company recorded a $3.6 million impairment charge on its Series D and Series E investment 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 and we performed an updated valuation of our investments at that time and, as a result, recorded an additional $6.1 million impairment charge.

The Company's minority equity investment may be further impaired if OmniGuide, Inc. is unable to raise sufficient funding to continue operations in the near term, if the terms of any such funding are unfavorable to our position, if business results deteriorate, or if the company is sold for an amount that results in proceeds to us less than our carrying value. The total carrying value of $4.3 million at December 27, 2014 and March 29, 2014 is included in Other assets on the Condensed Consolidated Balance Sheets.

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9. Accrued Liabilities

Accrued liabilities consisted of the following:



(In thousands)	Dec 27, 2014		Mar 29, 2014
Payroll-related liabilities	$	7,023	$	6,166
Product warranty accrual	3,493		4,215
Pension benefit liabilities	1,881		1,912
Purchase order commitments and receipts	1,809		2,569
Professional fees payable	1,454		1,933
Customer deposits	1,454		375
Freight accrual	170		503
Income taxes payable	106		162
Restructuring & cost management amounts payable	264		1,050
Value added taxes payable	427		332
Other	1,348		1,307
	$	19,429	$	20,524

10. Product Warranty

The following is a reconciliation of the changes in the aggregate product warranty accrual:



	Fiscal quarter ended						Three fiscal quarters ended
(In thousands)	Dec 27, 2014			Dec 28, 2013			Dec 27, 2014			Dec 28, 2013
Product warranty accrual, beginning	$	3,152		$	5,563		$	4,215		$	5,411
Warranty charges incurred, net	(1,240		)	(1,755		)	(4,960		)	(5,298		)
Provision for warranty charges	1,581			815			4,238			4,510
Product warranty accrual, ending	$	3,493		$	4,623		$	3,493		$	4,623

Net warranty charges incurred include labor charges and costs of replacement parts for system repairs under warranty. These costs are recorded net of any estimated cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Company’s suppliers for defective components. The provision for warranty charges reflects the estimate of future anticipated net warranty costs to be incurred for all products under warranty at quarter end and is recorded to cost of sales.

11. Deferred Revenue

Generally, revenue is recognized upon fulfillment of acceptance criteria at the Company's factory and title transfer which frequently occurs at the time of delivery to a common carrier. Revenue is deferred whenever title transfer is pending and/or acceptance criteria have not yet been fulfilled. Deferred revenue includes sales to Japanese customers, shipments of substantially new products and shipments with custom specifications or acceptance criteria. In sales involving multiple elements, the relative selling price of any undelivered elements, including installation services, is deferred until the elements are delivered and acceptance criteria are met. Revenue related to maintenance and service contracts is deferred and generally recognized ratably over the duration of the contracts.

The following is a reconciliation of the changes in deferred revenue:



	Fiscal quarter ended						Three fiscal quarters ended
(In thousands)	Dec 27, 2014			Dec 28, 2013			Dec 27, 2014			Dec 28, 2013
Deferred revenue, beginning	$	16,440		$	7,855		$	10,515		$	10,196
Revenue deferred	6,509			5,294			33,458			18,892
Revenue recognized	(15,126		)	(6,455		)	(36,150		)	(22,394		)
Deferred revenue, ending	$	7,823		$	6,694		$	7,823		$	6,694

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12. Earnings (Loss) Per Share

The following is a reconciliation of weighted average shares outstanding used in the calculation of basic and diluted earnings per share:



	Fiscal quarter ended						Three fiscal quarters ended
(In thousands, except per share data)	Dec 27, 2014			Dec 28, 2013			Dec 27, 2014			Dec 28, 2013
Net loss	$	(6,376	)	$	(4,640	)	$	(20,870	)	$	(10,701	)
Weighted average shares used for basic earnings per share	30,617			30,054			30,507			29,922
Incremental diluted shares	—			—			—			—
Weighted average shares used for diluted earnings per share	30,617			30,054			30,507			29,922
Net loss per share:
Basic	$	(0.21	)	$	(0.15	)	$	(0.68	)	$	(0.36	)
Diluted	$	(0.21	)	$	(0.15	)	$	(0.68	)	$	(0.36	)

Awards of options, SARs and RSUs representing an additional 2.8 million and 3.8 million shares of stock for the third quarter of 2015 and 2014 , respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.

For the three quarters ended December 27, 2014 and December 28, 2013 , awards of options, SARs, and unvested RSUs representing an additional 2.8 million and 4.0 million shares, respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.

13. Product and Geographic Information

Net sales by product type were as follows:



	Fiscal quarter ended				Three fiscal quarters ended
(In thousands)	Dec 27, 2014		Dec 28, 2013		Dec 27, 2014		Dec 28, 2013
Interconnect & Microfabrication Group (IMG)	$	28,043	$	25,378	$	75,591	$	98,096
Semiconductor Group (SG)	11,453		8,535		31,969		25,083
Components Group (CG)	4,165		4,354		13,987		20,907
	$	43,661	$	38,267	$	121,547	$	144,086

Net sales by geographic area, based on the location of the end user, were as follows:



	Fiscal quarter ended				Three fiscal quarters ended
(In thousands)	Dec 27, 2014		Dec 28, 2013		Dec 27, 2014		Dec 28, 2013
Asia	$	33,604	$	29,087	$	92,838	$	117,361
Americas	5,602		4,761		14,258		15,470
Europe	4,455		4,419		14,451		11,255
	$	43,661	$	38,267	$	121,547	$	144,086

14. Restructuring and Cost Management Plans

In 2013, the Company 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 is substantially complete, however restructuring and wind-down related activities will continue through 2015. See the Company's Form 10-K for the year ended March 29, 2014 for additional information related to restructuring and cost management plans.

In the first three quarters of 2015 , net restructuring costs of $37 thousand were recognized. At December 27, 2014 and March 29, 2014 , the amount of unpaid restructuring costs included in accrued liabilities was $0.3 million and $1.1 million , respectively.

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The following table presents the amounts related to restructuring costs payable (in thousands):



Restructuring costs payable balance as of March 29, 2014	$	1,050
Employee severance and related benefits:
Cash payments	(823		)
Other adjustments	37
Restructuring costs payable balance as of December 27, 2014	$	264

15. Shareholders’ Equity

Share Repurchase Program

On December 9, 2011, the Board of Directors authorized a share repurchase program totaling $20 million to acquire shares of the Company’s outstanding common stock. The repurchases are to be made at management’s discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors.

In the first quarter of 2015 the Company repurchased 207,738 shares for $1.5 million under this authorization at an average price of $7.01 per share, calculated inclusive of commissions and fees. Cash used to settle the repurchase as of December 27, 2014 totaled $1.5 million . The Company did not repurchase any shares during the second and third quarters of 2015 .

In 2014 the Company repurchased 19,832 shares for $0.2 million at an average price of $9.65 per share. The Company has repurchased a total of 227,570 shares life to date under this authorization as a part of its publicly announced plan.

There is no fixed completion date for the repurchase program.

Dividends

In December 2011, the Board of Directors adopted a dividend program. The following table summarizes the quarterly dividend declared and paid by the Company since the third quarter of 2014 :



Date Declared	Record Date	Payable Date	Amount per Share
November 18, 2014	December 1, 2014	December 15, 2014	$0.08
August 21, 2014	September 2, 2014	September 12, 2014	$0.08
May 15, 2014	May 27, 2014	June 10, 2014	$0.08
February 13, 2014	February 27, 2014	March 13, 2014	$0.08
November 7, 2013	November 19, 2013	December 4, 2013	$0.08

A special dividend of $2.00 per share was declared by the Board of Directors on December 3, 2012 after the successful settlement of a patent dispute. The special dividend should not be considered a recurring event.

The Company paid aggregate dividends of $7.3 million and $7.2 million in the first three quarters of 2015 and 2014 , respectively.

The declaration, timing and amount of any future cash dividends are at the discretion of the Board of Directors and will depend on the Company’s financial condition, results of operations, capital requirements and growth investment objectives, business conditions and other factors, as well as a determination that cash dividends are in the best interest of the shareholders.

16. Subsequent Events

On January 15, 2015, the Company completed the acquisition of Topwin Optoelectronics Technology Co., Ltd. ("Topwin") for $9.0 million in cash, subject to certain closing working capital adjustments, plus $4.5 million in stock to be paid out over the next three years. Upon achieving certain financial targets, up to an additional $4.5 million in stock will be issued, for total potential consideration of $18.0 million. The Company will record the fair value of the assets acquired and liabilities assumed on January 15, 2015, the date the Company obtained control of the operations, and include the results of their operations and cash flows in the Company's consolidated financial statements from that date forward.

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

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

Overview of Business

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.

Summary of Sequential Quarterly Results

The financial results of the third quarter of 2015 ended December 27, 2014 , reflected a slight increase in sales to $43.7 million compared to $42.9 million in the second quarter of 2015 . By product group, IMG increased $1.4 million primarily due to an increase in microfabrication equipment sales due to customer acceptance of new products, SG increased $1.7 million primarily due to increase in wafer mark and scribing system sales and CG revenues decreased $2.3 million primarily due to cyclically reduced demand for MLCC systems.

Total order volume for the third quarter of 2015 declined from $43.0 million to $40.6 million , primarily driven by timing of service contract bookings, partially offset by increased orders for flex via drilling and semiconductor wafer-scribing systems.

Gross profit was $15.8 million in both the third and second quarters of 2015 . Gross margin was 36.1% on net sales of $43.7 million in the third quarter of 2015 compared to a gross margin of 36.8% on net sales of $42.9 million in the second quarter of 2015 . The gross margin change was primarily driven by higher warranty costs in the IMG products, partially offset by improvements in product mix.

Net operating expenses of $21.8 million in the third quarter of 2015 increased $0.5 million from $21.3 million in the second quarter of 2015 . Selling, service and administration (SS&A) increased $0.5 million primarily due to costs related to the Topwin acquisition and higher commissions. Research, development and engineering (RD&E) expenses were fairly consistent with the previous quarter.

Operating loss was $6.0 million in the third quarter of 2015 compared to $5.6 million in the second quarter of 2015 , a change of $0.4 million .

Non-operating income was $0.1 million in the third quarter of 2015 compared to expense of $0.2 million in the second quarter of 2015 . The change was primarily due to market gains and interest income in our non-qualified deferred compensation plan, combined with decreases in foreign exchange losses.

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Provision for income taxes was $437 thousand in the third quarter of 2015 compared to $441 thousand in the second quarter of 2015 .

Net loss was $6.4 million in the third quarter of 2015 compared to a net loss of $6.2 million in the second quarter of 2015 .

Quarter Ended December 27, 2014 Compared to Quarter Ended December 28, 2013

Results of Operations

The following table presents results of operations data as a percentage of net sales:



	Fiscal quarter ended
	Dec 27, 2014		Dec 28, 2013
Net sales	100.0	%	100.0	%
Cost of sales	63.9		57.5
Gross profit	36.1		42.5
Selling, service and administration	30.6		32.4
Research, development and engineering	19.2		25.5
Gain on sale of property and equipment, net	—		(3.4	)
Operating loss	(13.7	)	(12.0	)
Interest and other income, net	0.1		0.2
Loss before income taxes	(13.6	)	(11.8	)
Provision for income taxes	1.0		0.3
Net loss	(14.6	)%	(12.1	)%

Net Sales

The following table presents net sales information by product group:



	Fiscal quarter ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Interconnect & Microfabrication Group (IMG)	$	28,043	64.2	%	$	25,378	66.3	%
Semiconductor Group (SG)	11,453		26.2		8,535		22.3
Components Group (CG)	4,165		9.5		4,354		11.4
	$	43,661	100.0	%	$	38,267	100.0	%

Net sales for the third quarter of 2015 increased $5.4 million or 14% from net sales for the third quarter of 2014 . Sales in IMG and SG increased by 11% and 34% , respectively, while CG decreased by 4% .

IMG sales for the third quarter of 2015 increased $2.7 million compared to the third quarter of 2014 . The increase in IMG sales was primarily driven by increase in microfabrication, flex via drilling and service sales.

SG sales for the third quarter of 2015 increased $2.9 million compared to the third quarter of 2014 . The increase was primarily driven by increase in service, wafer mark, scribing and circuit trim systems sales.

CG sales for the third quarter of 2015 decreased $0.2 million compared to the third quarter of 2014 , fairly consistent with the seasonally lower levels of the previous year.

The following table presents net sales information by geographic region:

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	Fiscal quarter ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Asia	$	33,604	77.0	%	$	29,087	76.0	%
Americas	5,602		12.8		4,761		12.4
Europe	4,455		10.2		4,419		11.6
	$	43,661	100.0	%	$	38,267	100.0	%

Gross Profit



	Fiscal quarter ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Gross Profit		% of Net Sales		Gross Profit		% of Net Sales
Gross Profit	$	15,777	36.1	%	$	16,281	42.5	%

Gross profit was $15.8 million for the third quarter of 2015 , a decrease of $0.5 million compared to the third quarter of 2014 . Gross margin was 36.1% and 42.5% for the third quarter s of 2015 and 2014 , respectively. These decreases were primarily driven by higher warranty and net laser repair costs, less favorable product mix in the SG group and less favorable absorption of fixed costs on lower systems production.

Operating Expenses



	Fiscal quarter ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Expense		% of Net Sales		Expense			% of Net Sales
Selling, service and administration	$	13,397	30.6	%	$	12,408		32.4	%
Research, development and engineering	8,383		19.2		9,768			25.5
Gain on sale of property and equipment, net	—		—		(1,301		)	(3.4	)
	$	21,780	49.8	%	$	20,875		54.5	%

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 the third quarter of 2015 increased $1.0 million compared to the third quarter of 2014 . This increase was primarily attributable to higher variable expenses due to business volumes combined with increases in legal, audit and depreciation expenses, partially offset by decreases in travel, facilities and share-based compensation 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 the third quarter of 2015 decreased $1.4 million compared to the third quarter of 2014 . This decrease was primarily due to lower project materials and patent legal charges, and to a lesser degree by lower travel and share-based compensation expenses.

Gain on Sale of Property and Equipment, net

During the third quarter of 2014, we sold a facility in Portland, Oregon for $3.6 million, resulting in a pre-tax gain of $1.3 million .

Non-operating Income and Expense

Non-operating income and expense 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 non-operating income was $0.1 million in both of the third quarter s of 2015 and 2014 .

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Income Taxes



	Fiscal quarter ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Income Tax Provision		Effective Tax Rate		Income Tax Provision		Effective Tax Rate
Provision for income taxes	$	437	(7.4	)%	$	141	(3.1	)%

The income tax provision for the third quarter of 2015 was $437 thousand on pretax loss of $5.9 million , an effective tax rate of (7.4)% . For the third quarter of 2014 , the income tax provision was $141 thousand on pretax loss of $4.5 million , an effective rate of (3.1)% . The change in the effective tax rate was primarily due to the relative quarterly income or loss level, the mix of income between foreign and domestic jurisdictions and their relative tax rates.

Net Loss



	Fiscal quarter ended
	Dec 27, 2014					Dec 28, 2013
(In thousands, except percentages)	Net Loss			% of Net Sales		Net Loss			% of Net Sales
Net loss	$	(6,376	)	(14.6	)%	$	(4,640	)	(12.1	)%

Net loss for the third quarter of 2015 was $6.4 million , or $0.21 per basic and diluted share, compared to net loss of $4.6 million , or $0.15 per basic and diluted share, for the third quarter of 2014 .

Three Quarters Ended December 27, 2014 Compared to Three Quarters Ended December 28, 2013

Results of Operations

The following table presents results of operations data as a percentage of net sales:



	Three fiscal quarters ended
	Dec 27, 2014		Dec 28, 2013
Net sales	100.0	%	100.0	%
Cost of sales	63.1		58.2
Gross profit	36.9		41.8
Selling, service and administration	32.4		28.6
Research, development and engineering	21.4		19.4
Gain on sale of property and equipment, net	—		(0.9	)
Gain on acquisition of Semiconductor Systems business	—		(0.4	)
Operating loss	(16.9	)	(4.9	)
Other-than-temporary impairment of cost based investments	—		(2.5	)
Interest and other (expense) income, net	(0.1	)	0.1
Total non-operating expense	(0.1	)	(2.4	)
Loss before income taxes	(17.0	)	(7.3	)
Provision for income taxes	0.1		0.1
Net loss	(17.2	)%	(7.4	)%

Net Sales

The following table presents net sales information by product group:



	Three fiscal quarters ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Interconnect & Microfabrication Group (IMG)	$	75,591	62.2	%	$	98,096	68.1	%
Semiconductor Group (SG)	31,969		26.3		25,083		17.4
Components Group (CG)	13,987		11.5		20,907		14.5
	$	121,547	100.0	%	$	144,086	100.0	%

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Net sales for the first three quarters of 2015 decreased $22.5 million or 15.6% from net sales for the first three quarters of 2014 . Sales in IMG and CG decreased by 22.9% and 33.1% , respectively, while sales in SG increased by 27.5% .

IMG sales for the first three quarters of 2015 decreased $22.5 million compared to the first three quarters of 2014 . The decrease in IMG sales was primarily driven by the shipment of advanced microfabrication systems to Korea in 2014 which did not repeat at the same level in 2015.

SG sales for the first three quarters of 2015 increased $6.9 million compared to the first three quarters of 2014 . The increase in SG sales was primarily driven by increased sales of circuit trim, wafer trim and service from the Semiconductor Systems business which was acquired during the first quarter of 2014, and initial sales of scribing systems.

CG sales for the first three quarters of 2015 decreased $6.9 million compared to the first three quarters of 2014 . The decrease was primarily driven by reduced demand for MLCC systems in 2015 due to continued utilization of existing capacity, partially offset by increased tooling sales.

The following table presents net sales information by geographic region:



	Three fiscal quarters ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Asia	$	92,838	76.4	%	$	117,361	81.5	%
Americas	14,258		11.7		15,470		10.7
Europe	14,451		11.9		11,255		7.8
	$	121,547	100.0	%	$	144,086	100.0	%

Gross Profit



	Three fiscal quarters ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Gross Profit		% of Net Sales		Gross Profit		% of Net Sales
Gross Profit	$	44,793	36.9	%	$	60,299	41.8	%

Gross profit was $44.8 million for the first three quarters of 2015 , a decrease of $15.5 million compared to the first three quarters of 2014 . Gross margin was 36.9% and 41.8% for the first three quarters of 2015 and 2014 , respectively. These decreases were primarily due to lower IMG sales and production volumes, with less favorable absorption of fixed costs, along with higher warranty costs, continued pricing pressure and less favorable mix, partially offset by reductions in intangible asset amortization.

Operating Expenses



	Three fiscal quarters ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Expense		% of Net Sales		Expense			% of Net Sales
Selling, service and administration	$	39,412	32.4	%	$	41,206		28.6	%
Research, development and engineering	25,952		21.4		27,912			19.4
Gain on sale of property and equipment, net	—		—		(1,301		)	(0.9	)
Gain on acquisition of Semiconductor Systems business	—		—		(499		)	(0.4	)
	$	65,364	53.8	%	$	67,318		46.7	%

Selling, Service and Administration

SS&A expenses for the first three quarters of 2015 decreased $1.8 million compared to the first three quarters of 2014 . This decrease was primarily due to lower expenses for share-based compensation, travel, facilities and consulting, partially offset by higher audit and legal fees. Share-based compensation expenses were lower primarily due to lower attainment on

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performance based restricted stock awards and lower number of overall grants, combined with lower fair value for new awards granted in 2015.

Research, Development and Engineering

RD&E expenses for the first three quarters of 2015 decreased $2.0 million compared to the first three quarters of 2014 . This decrease was primarily due to lower expenses for project materials, travel, patent legal fees and share-based compensation, partially offset by higher labor and consulting costs.

Gain on Sale of Property and Equipment, net

During the third quarter of 2014, we sold a facility in Portland, Oregon for $3.6 million, resulting in a pre-tax gain of $1.3 million .

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.

Non-operating Income and Expense

Non-operating income and 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, such as investment impairment.

Non-operating income and expense were as follows:



	Three fiscal quarters ended
	Dec 27, 2014					Dec 28, 2013
(In thousands, except percentages)	Non-Operating Income (Expense)			% of Net Sales		Non-Operating Income (Expense)			% of Net Sales
Other-than-temporary impairment of cost based investments	$	—		—	%	$	(3,588	)	(2.5	)%
Interest and other (expense) income, net	$	(134	)	(0.1	)%	$	115		0.1	%
Total non-operating expense	$	(134	)	(0.1	)%	$	(3,473	)	(2.4	)%

Other-than-temporary impairment of cost based investments

Other-than-temporary impairment of cost based investments was 3.6 million in first three quarters of 2014 and relates to our minority interest investment in OmniGuide, Inc. During the second quarter of 2014, OmniGuide, Inc. engaged in a Series F Preferred Stock round of equity financing at pricing below previous rounds which was considered a triggering event. As a result of that event we performed a valuation of the investment which resulted in a $3.6 million impairment charge of our Series D and Series E investments in that quarter.

Interest and other (expense) income, net

Net interest and other expense was $134 thousand in the first three quarters of 2015 compared to net interest and other income of $115 thousand in the first three quarters of 2014 . The decrease in income was primarily attributable to lower market gains on assets held in deferred compensation accounts and higher foreign exchange losses, and to a lesser extent, lower interest income.

Income Taxes



	Three fiscal quarters ended
	Dec 27, 2014				Dec 28, 2013
(In thousands, except percentages)	Income Tax Provision		Effective Tax Rate		Income Tax Provision		Effective Tax Rate
Provision for income taxes	$	165	(0.8	)%	$	209	(2.0	)%

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The income tax provision for the first three quarters of 2015 was $0.2 million on pretax loss of $20.7 million , an effective tax rate of (0.8)% . For the first three quarters of 2014 , the income tax provision was $0.2 million on pretax income of $10.5 million , an effective rate of (2.0)% . The change in the effective tax rate was primarily due to the relative income level, the mix of income between foreign and domestic jurisdictions and their relative tax rates, and a discrete benefit resulting from filing of the Company's tax returns.

Net Loss



	Three fiscal quarters ended
	Dec 27, 2014					Dec 28, 2013
(In thousands, except percentages)	Net Loss			% of Net Sales		Net Loss			% of Net Sales
Net loss	$	(20,870	)	(17.2	)%	$	(10,701	)	(7.4	)%

Net loss for the first three quarters of 2015 was $20.9 million , or $0.68 per basic and diluted share, compared to net loss of $10.7 million , or $0.36 per basic and diluted share for the first three quarters of 2014 .

Financial Condition and Liquidity

At December 27, 2014 , our principal sources of liquidity were cash and cash equivalents of $70.1 million , short-term investments of $9.6 million and accounts receivable of $40.5 million . At December 27, 2014 , we had a current ratio of 4.43 and held no long-term debt. Working capital of $142.9 million decreased $22.0 million compared to the March 29, 2014 balance of $164.8 million . Cash and cash equivalents were substantially impacted by operating losses, net working capital changes, the payment of quarterly dividends and share repurchases. Cash outflows also included payments totaling $2.7 million relating to an executive termination and distribution of his deferred compensation account.

In December 2011, the Board of Directors adopted a dividend program. The following table summarizes the quarterly dividend declared and paid by us since the third quarter of 2014:



Date Declared	Record Date	Payable Date	Amount per Share
November 18, 2014	December 1, 2014	December 15, 2014	$0.08
August 21, 2014	September 2, 2014	September 12, 2014	$0.08
May 15, 2014	May 27, 2014	June 10, 2014	$0.08
February 13, 2014	February 27, 2014	March 13, 2014	$0.08
November 7, 2013	November 19, 2013	December 4, 2013	$0.08

We paid aggregate dividends of $7.3 million and $7.2 million for the first third quarter s of 2015 and 2014 , respectively.

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 and growth investment objectives, business conditions and other factors, as well as a determination that cash dividends are in the best interest of our shareholders.

Sources and Uses of Cash

Net cash used in operating activities of $16.5 million for the three quarters ended Dec 27, 2014 , was due to $10.5 million of net loss adjusted for non-cash items and $6.0 million of cash outflows due to changes in working capital.

For the three quarters ended December 27, 2014 , net cash provided by investing activities of $28.4 million was the result of $32.9 million net proceeds from sales, maturities and purchases of investments, partially offset by $3.6 million of capital expenditures for purchases of property, plant and equipment (PP&E) and $1.0 million of expenditure for other assets. Accounts payable includes $0.9 million for amounts owed on PP&E purchases as of December 27, 2014 .

For the three quarters ended December 27, 2014 , net cash used in financing activities of $9.2 million primarily resulted from $7.3 million of cash dividends paid to shareholders and $1.5 million of share repurchase settlements.

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.

Critical Accounting Policies and Estimates

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We reaffirm the “Critical Accounting Policies and Estimates” in Part II Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations reported in our Form 10-K for the year ended March 29, 2014 .

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in the market risk disclosure contained in our Form 10-K for the year ended March 29, 2014 .

Item 4. Controls and Procedures

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

Disclosure Controls and Procedures

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

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the third quarter of 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. 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 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

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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 and 2015. 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.

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 competitive products, in some cases 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.

We intend to enter into existing markets that are adjacent to our current markets. In these markets we will be competing against established competitors with recognized brands, customer relationships and proven products. If we fail to compete successfully against these competitors our ability to penetrate these markets will be limited, which could have an adverse effect on our financial results.

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;

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•	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

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 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 in connection with discontinued products.

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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 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 a manufacturing facility in Singapore, research, development and pre-production facilities in Canada, France and China, 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, enforcing internal controls, 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. In January 2015 we acquired a Chinese laser systems manufacturer, Topwin Optoelectronics Technology to gain entry into the low cost Chinese laser systems market.

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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;


•	our ability to reduce costs in the United States as we add costs elsewhere;


•	challenges resulting from implementing a sales representative model in certain regions rather than our historical direct sales model;


•	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 2013 acquisition of Eolite Systems, our 2014 acquisition of the Semiconductor Systems business from GSI Group, Inc. and our January 2015 acquisition of Wuhan Topwin Optoelectronics Technology. Acquisitions involve numerous risks, many of which are unpredictable and beyond our control, including:


•	difficulties and increased costs in connection with integration of personnel, culture, operations, technologies and products of the acquired businesses;


•	language and cultural differences in the case of international acquisitions;


•	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.

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

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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.

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.

Need to Broaden our Marketing and Channel Capability

The laser microfabrication industry is comprised of a 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 being 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 may harm our business and adversely affect our revenues and profitability.

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. We also will incur research and development expenses as we develop products for the adjacent markets we intend to enter. 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.

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

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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 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 each of Humo Laboratory, LTD. in Japan and Eo Technics Co., Ltd., in South Korea 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, and 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

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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 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 $5.7 million in acquired intangible assets and $7.9 million in goodwill at December 27, 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 impairment 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. 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.

Stock Price Volatility

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The market price of our common stock has fluctuated widely. During the third quarter of 2015, our stock price fluctuated between a high of $7.92 per share and a low of $6.03 per share, and subsequent to the end of the fiscal quarter and prior to January 31, 2015 has been a low of $6.27. 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;


•	general economic conditions;


•	political changes, hostilities or natural disasters;


•	low trading volume of our common stock;


•	change in our dividend program;


•	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 declared a quarterly dividend in December 2011. The declaration, timing and amount of any future cash dividends are subject to capital availability and regular 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; working capital requirements; 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.

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 minority equity investment in OmniGuide, Inc. based upon a reduction in the investment's estimated fair value. The Company's investment may be further impaired if OmniGuide, Inc., is unable to raise sufficient funding to continue operations in the near term, if the terms of any such funding are unfavorable to our position, if business results deteriorate, or if the company is sold for an amount that results in proceeds to us less than our carrying value.

Item 4. Mine Safety Disclosures

Not Applicable.

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Item 6. Exhibits

This list is intended to constitute the exhibit index.



3.1		Third Restated Articles of Incorporation, as amended. Incorporated by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended April 3, 2010.
3.2		2009 Amended and Restated Bylaws, as amended. Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on November 9, 2012.
4.1		Rights Agreement, dated as of May 18, 2009, between Electro Scientific Industries, Inc. and Mellon Investor Services. Incorporated by reference to Exhibit 4.1 of the Company's Current Report on Form 8-K filed on May 19, 2009.
10.1		Form of Change in Control Agreement between the Company and Edward Grady
10.2		Form of Stock Settled Stock Appreciation Rights Agreement between the Company and Edward Grady (November 18, 2014 awards)
10.3		Form of Performance-Based Restricted Stock Unit Award Agreement between the Company and Edward Grady (November 18, 2014)
10.4		Form of Performance-Based Restricted Stock Unit Award Agreement between the Company and executives other than Edward Grady (November 18, 2014)
31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS		XBRL Instance Document *
101.SCH		XBRL Taxonomy Extension Schema Document *
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document *
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document *
101.LAB		XBRL Taxonomy Extension Label Linkbase Document *
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document *

* Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities and Exchange Act of 1934, and otherwise are not subject to liability under those sections.

Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



Date:	February 3, 2015	ELECTRO SCIENTIFIC INDUSTRIES, INC.
		By:	/s/ Edward C. Grady
			Edward C. Grady
			President and Chief Executive Officer
			(Principal Executive Officer)

		By:	/s/ Paul Oldham
			Paul Oldham
			Vice President of Administration, Chief Financial Officer and Corporate Secretary
			(Principal Financial Officer)

		By:	/s/ Kerry Mustoe
			Kerry Mustoe
			Vice President, Corporate Controller and Chief Accounting Officer
			(Principal Accounting Officer)

CHANGE IN CONTROL AGREEMENT

Edward C. Grady

_______________

________________ “Executive”

Electro Scientific Industries, Inc., “Company”

an Oregon corporation

13900 N.W. Science Park Dr.

Portland, OR 97229

Electro Scientific Industries, Inc., an Oregon corporation (the “Company”), considers the establishment and maintenance of a sound and vital management to be essential to protecting and enhancing the best interest of the Company and its shareholders. In this connection, the Company recognizes that, as is the case with many publicly held corporations, the possibility of a change in control may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its shareholders. Accordingly, the Board of Directors of the Company (the “Board”) has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company’s management to their assigned duties without distraction in circumstances arising from the possibility of a change in control of the Company.

In order to induce Executive to remain in the employ of the Company, this Agreement, the form of which has been approved by the Board, sets forth the severance benefits which the Company agrees will be provided to Executive in the event Executive’s employment with the Company is terminated in connection with a “Change in Control” of the Company under the circumstances described below.

1. Employment at Will; Agreement to Provide Services; Right to Terminate.

(i) Except as otherwise provided in paragraph (ii) below, the Company or Executive may terminate Executive’s employment at any time, subject to the provisions of any employment agreement between Executive and the Company and the Company’s providing the benefits in accordance with the terms of this Agreement.

(ii) In the event of a Potential Change in Control of the Company as defined in Section 4, Executive agrees that Executive will not leave the employ of the Company (other than as a result of Disability or upon Retirement, as such terms are defined in Section 4), and will render the services contemplated in the recitals to this Agreement until the earliest of (A) a date which is 270 days from the occurrence of such Potential Change in Control of the Company or (B) a termination of Executive’s employment pursuant to which Executive becomes entitled under this Agreement to receive the benefits provided in Section 6.

2. Effective Date . The Effective Date of this Agreement is November 18, 2014.

3. Term of Agreement . This Agreement shall commence on the Effective Date and shall continue in effect until December 31, 2014; provided, however, that commencing on the first day of the new year following the Effective Date and each January 1 thereafter, the term of this Agreement shall automatically be extended for one additional year unless at least 90 days prior to such January 1 date, the Company or Executive shall have given notice that this Agreement shall not be extended (provided that no such notice may be given by the Company during the pendency of a Potential Change in Control); and provided, further, that this Agreement shall continue in effect for a period of 12 months beyond the term provided herein if a Change in Control of the Company, as defined in Section

4, shall have occurred during such term. Notwithstanding anything in this Section 3 to the contrary, this Agreement shall terminate if Executive or the Company terminate Executive’s employment prior to a Change in Control.

4. Definitions . The following terms shall have the following meanings for purposes of this Agreement:

(i) “Cause” shall mean (A) the willful and continued failure by Executive substantially to perform Executive’s reasonably assigned duties with the Company consistent with those duties assigned to Executive prior to the Change in Control, other than a failure resulting from Executive’s incapacity due to physical or mental illness, after a written demand for performance has been delivered to Executive by the Chairman of the Board which specifically identifies the manner in which the Chairman believes that Executive has not substantially performed Executive’s duties, (B) the conviction of guilty or entering of a nolo contendere plea to a felony, which is materially and demonstrably injurious to the Company, or (C) the commission of an act by Executive, or the failure by Executive to act, which constitutes gross negligence or gross misconduct. For purposes of this Section 4(i), no act, or failure to act, on Executive’s part shall be considered “willful” unless done, or omitted to be done, by Executive in bad faith. Any act, or failure to act, expressly authorized by a resolution duly adopted by the Board or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by Executive in good faith. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless the Company shall have delivered to Executive a copy of a resolution duly adopted by the Board finding, after reasonable notice to Executive and an opportunity for Executive to be heard with respect to such matter, that in the good faith opinion of the Board, Executive has engaged in the conduct set forth above in (A), (B), or (C) of this Section 4(i). Any such determination by the Board shall be subject to de novo review in mediation or in arbitration conducted pursuant to Section 15.

(ii) “Change of Control” of the Company shall mean the occurrence of any of the following events:

(A) any consolidation, merger, plan of share exchange, or other reorganization involving the Company (a “Merger”) as a result of which the holders of outstanding securities of the Company ordinarily having the right to vote for the election of directors (“Voting Securities”) immediately prior to the Merger do not continue to hold at least 50% of the combined voting power of the outstanding Voting Securities of the surviving or continuing corporation immediately after the Merger, disregarding any Voting Securities issued or retained by such holders in respect of securities of any other party to the Merger;

(B) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of the Company;

(C) at any time during a period of two consecutive years, individuals who at the beginning of such period constituted the Board (“Incumbent Directors”) shall cease for any reason to constitute at least a majority thereof, unless each new director elected during such two-year period was nominated or elected by two-thirds of the Incumbent Directors then in office and voting (with new directors nominated or elected by two-thirds of the Incumbent Directors also being deemed to be Incumbent Directors); or

(D) any Person (as hereinafter defined) shall have become the beneficial owner (within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934 (the “Exchange Act”)), directly or indirectly, of securities of the Company ordinarily having the right to vote for the election of directors (“Voting Securities”) representing 50% or more of the combined voting power of the then outstanding Voting Securities.

Notwithstanding anything in the foregoing to the contrary, unless otherwise determined by the Board, no Change in Control shall be deemed to have occurred for purposes of this Agreement if (1) Executive acquires (other than on the same basis as all other holders of the Company shares) an equity interest in an entity that acquires the Company in a Change in Control otherwise described under Section 4(ii)(A) or (B) above, or (2) Executive is part of group that constitutes a Person which becomes a beneficial owner of Voting Securities in a transaction that otherwise would have resulted in a Change in Control under Section 4(ii)(D) above.

(iii) “Disability” shall mean the absence of Executive from Executive’s duties with the Company on a full time basis for 180 consecutive days as a result of Executive’s incapacity due to physical or mental illness, unless,

within 30 days after a Notice of Termination (as defined below) is given to Executive following such absence, Executive shall have returned to the full performance of Executive’s duties.

(iv) “Good Reason” shall mean:

(A) a diminution of Executive’s status, title, position(s), or responsibilities from Executive’s status, title, position(s), and responsibilities as in effect immediately prior to the Change of Control or the assignment to Executive of any duties or responsibilities which are inconsistent with such status, title, position(s), or responsibilities (in either case other than isolated, insubstantial or inadvertent actions which are remedied after notice), or any removal of Executive from such position(s), except in connection with the termination of Executive’s employment for Cause, Disability or as a result of Executive’s death or voluntarily by Executive other than for Good Reason;

(B) a reduction by the Company in Executive’s rate of base salary, bonus or incentive opportunity or a substantial reduction in benefits (other than reductions that do not impact Executive's compensation opportunity, taken as a whole, or a reduction in benefits applicable to substantially all employees); or

(C) the Company’s requiring Executive to be based more than 50 miles from the principal office at in which Executive is based immediately prior to the Change in Control, except for reasonably required travel on the Company’s business.

(v) “Potential Change in Control” of the Company shall mean the occurrence of any of the following:

(A) the Company enters into an agreement, the approval of which by the shareholders would result in the occurrence of a Change in Control of the Company;

(B) any Person (including the Company) publicly announces an intention to take or to consider taking actions which if consummated would constitute a Change in Control of the Company; or

(C) the Board adopts a resolution to the effect that, for purposes of this Agreement, a Potential Change in Control of the Company has occurred.

(vi) “Person” shall mean and include any individual, corporation, partnership, group, association or other “person”, as such term is used in Section 14 (d) of the Securities Exchange Act of 1934 (the “Exchange Act”), other than the Company, any subsidiary of the Company or any employee benefit plan(s) sponsored by the Company.

(vii) “Retirement” shall mean termination by Executive on or after Executive’s 65th birthday other than for Good Reason.

5. Notice of Termination; Effective Date of Termination . Any purported termination by the Company or by Executive following of a Change in Control shall be communicated by written Notice of Termination to the other party hereto. For purposes of this Agreement, a “Notice of Termination” shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive’s employment under the provision so indicated. The “Date of Termination” following a Change in Control shall mean (a) if Executive’s employment is to be terminated for Disability, 30 days after Notice of Termination is given (provided that Executive shall not have returned to the performance of Executive’s duties on a full-time basis during such 30 day period), (b) if Executive’s employment is to be terminated by the Company for Cause, the date on which a Notice of Termination is given, and (c) if Executive’s employment is to be terminated by Executive or by the Company for any other reason, the date specified in the Notice of Termination, which shall be a date no earlier than 60 days after the date on which a Notice of Termination is given (provided that if the termination is by Executive for Good Reason the circumstances giving rise to the Good Reason have not been fully corrected by the specified date), unless an earlier date has been agreed to by the party receiving the Notice of Termination either in advance of, or after, receiving such Notice of Termination. Notwithstanding anything

in the foregoing to the contrary, if the party receiving the Notice of Termination has not previously agreed to the termination, then within 30 days after any Notice of Termination is given, the party receiving such Notice of Termination may notify the other party that a dispute exists concerning the termination, in which event the Date of Termination shall be the date set either by mutual written agreement of the parties or by the arbitrators in a proceeding as provided in Section 15.

6. Change in Control Benefits .

(i) If within 12 months after a Change in Control, Executive’s employment by the Company shall be terminated (A) by the Company other than for Cause or Disability, (B) by Executive for Good Reason based on an event occurring during such period or (C) by Executive upon Retirement not less than 60 days after the Change in Control, then, Executive shall be entitled, without regard to any contrary provisions of any plan, to the following severance benefits:

(A) the Company shall pay Executive’s full base salary through the Date of Termination at the rate in effect immediately prior to the time a Notice of Termination is given plus any benefits or awards (including both cash and stock components) which pursuant to the terms of any plans have become payable, but which have not yet been paid to Executive;

(B) as severance pay and in lieu of any further salary for periods subsequent to the Date of Termination, the Company shall pay to Executive an amount in cash (subject to applicable taxes and withholdings) equal to twice Executive’s annual base salary at the rate in effect just prior to the time of the Notice of Termination, with one-quarter of such amount payable in six monthly installments as a salary continuation at the existing rate during the six month period following the Date of Termination (with the first installment paid on the last day of the month in which the Date of Termination occurs and each later installment paid on the last day of each successive month) and the balance paid in a lump sum on the date that is six months after the Date of Termination, plus (b) without duplication of the bonus payment referred to in clause (ii) below, an amount equal to Executive’s target bonus under the Company’s annual cash bonus plan for the year in which the Date of Termination occurs with payment of this amount made on the date that is six months after the Date of Termination; and

(C) for a 12 month period after the Date of Termination, the Company shall arrange to provide Executive and Executive’s dependents with medical and dental insurance benefits substantially similar to those which Executive and Executive’s dependents were receiving immediately prior to the Change in Control and with the same employee contribution rate towards the premium applicable at the Date of Termination or at the date of the Change in Control, if greater. Notwithstanding the foregoing, the Company shall not provide any benefit otherwise receivable by Executive pursuant to this paragraph (C) to the extent that a similar benefit is actually received by Executive from a subsequent employer during such 12 month period, and any such benefit actually received by Executive shall be reported to the Company.

(ii) Upon a Change in Control while Executive is employed by the Company, Executive shall be entitled to Executive’s full, unreduced payout under the Company’s annual cash bonus plan calculated at the greater of target or performance through the date of the Change in Control. Payment of this amount shall be made within 30 days of the Change in Control.

(iii) If Executive is a “specified employee” within the meaning of Internal Revenue Code (the “Code”) Section 409A(a)(2)(B)(i) and any payment required to be made pursuant to this Section 6 is subject to Section 409A of the Code and not exempt from those requirements under any applicable regulations or other guidance of general applicability, then any such payment otherwise payable on account of Executive’s termination of employment during the period ending on the date that is six months after the Date of Termination shall be paid in a lump sum on the date that is six months after Executive’s Date of Termination (or the next business day if such date is not a business day) instead of the date on which it would otherwise be paid.

(iv) Except as specifically provided in Section 6(i)(C) above, the amount of any payment provided for in this Section 6 shall not be reduced, offset or subject to recovery by the Company by reason of any compensation earned by Executive as the result of employment by another employer after the Date of Termination, or otherwise.

(v) The treatment of any options, restricted stock, restricted stock units or other equity awards held by Executive on a Change in Control or termination of employment shall be governed by the terms of the applicable plans and agreements.

7. Release of Claims . The Company shall have the right to require Executive to execute a general release of claims relating to Executive’s employment at the Company and termination of employment at the Company that could be brought by Executive under this Agreement as a condition to Executive’s receipt of any payments pursuant to Section 6(i)(B) or (C) (or Section 6(i)(D) if Executive’s employment is terminated simultaneously with the Change in Control); provided that the Company and each of its affiliates shall release any and all claims that each of them may have against Executive as a condition of any such release. The Company shall deliver a form of release to Executive within 10 days after Executive’s termination of employment. If the Company requires Executive to execute a release, no payment shall be made pursuant to Section 6(i)(B) and (C) unless Executive’s release has become effective and enforceable on or before the date that is 60 days after termination of employment. Subject to Section 6(iv), to the extent that any payments described in this Section 7 constitute a “deferral of compensation” within the meaning of Section 409A, amounts that otherwise would be paid on or before the effectiveness of the release shall be held and paid on the first business day following the day on which the release becomes effective; provided, however, that if the 60-day period starts in one calendar year and ends in the following calendar year, any the payments shall be made on the first business day of such following calendar year.

8. [Intentionally Omitted.]

9. Successors; Binding Agreement.

(i) Upon Executive’s written request, the Company will seek to have any Successor (as hereinafter defined), by agreement in form and substance satisfactory to you, assent to the fulfillment by the Company of its obligations under this Agreement. Failure of the Company to obtain such assent prior to or at the time a Person becomes a Successor shall constitute Good Reason for termination by Executive of Executive’s employment if a Change in Control of the Company has occurred. For purposes of this Agreement, “Successor” shall mean any Person that succeeds to, or has the practical ability to control (either immediately or with the passage of time), the Company’s business directly, by merger, consolidation or purchase of assets, or indirectly, by purchase of the Company’s Voting Securities or otherwise.

(ii) This Agreement shall inure to the benefit of and be enforceable by Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If Executive should die while any amount would still be payable to Executive hereunder if Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Executive’s devisee, legatee or other designee or, if there be no such designee, to Executive’s estate.

10. Fees and Expenses . Each party shall bear its own costs and attorney’s fees which have been incurred. The Company shall pay all legal fees and related expenses incurred by Executive as a result of (i) Executive’s termination within 12 months following a Change in Control of the Company (including all such fees and expenses, if any, incurred in contesting or disputing any such termination) or (ii) Executive’s seeking to obtain or enforce any right or benefit provided by this Agreement. If Executive is a “specified employee” within the meaning of Section 409A(a)(2)(B)(i) of the Code, then any payment to Executive pursuant to this Section 10 shall be made not earlier than the date that is six months after the Date of Termination (or the next business day if such date is not a business day).

11. Survival . The respective obligations of, and benefits afforded to, the Company and Executive as provided in Section 6, 7, 10, 15 and 17 of this Agreement shall survive termination of this Agreement.

12. Notice . For the purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when (i) if delivered personally, (ii) if given by email or fax, when transmitted and evidence of confirmed transmission is received, (iii) if given by a nationally recognized overnight courier, when received or personally delivered, or (iv) mailed by United States registered or certified mail, return receipt requested and, when delivered, and, in all case, with all charges prepaid and addressed to the address of the respective party set forth on the first page of this Agreement, provided that all notices to the Company shall be directed to the attention of the Chairman of the Board of the Company, with a copy to the Secretary of the Company, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt.

13. Miscellaneous . No provision of this Agreement may be modified, waived or discharged unless such modification, waiver or discharge is agreed to in a writing signed by Executive and the Chairman of the Board or on behalf of the Board of Directors or the Compensation Committee of the Board of Directors. No waiver by either party hereto at any time of any breach by the other party hereto of, or of compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not expressly set forth in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Oregon.

14. Validity . The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect.

15. Arbitration . Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in Portland, Oregon by three arbitrators in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrators’ award in any court having jurisdiction; provided, however, that Executive shall be entitled to seek specific performance of Executive’s right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. The Company shall bear all costs and expenses arising in connection with any arbitration proceeding pursuant to this Section 15.

16. Related Agreements . To the extent that any provision of any other agreement between the Company or any of its subsidiaries and Executive shall limit, qualify or be inconsistent with any provision of this Agreement, then for purposes of this Agreement, while the same shall remain in force, the provision of this Agreement shall control and such provision of such other agreement shall be deemed to have been superseded, and to be of no force or effect, as if such other agreement had been formally amended to the extent necessary to accomplish such purpose.

17. Code Section 409A Compliance . This Agreement shall, to the extent possible, be interpreted and administered so that payments hereunder do not constitute a deferral of compensation or, if so, will constitute a deferral for which the payment and other terms are compliant with Section 409A of the Code. The Company may amend this Agreement, adopt policies and procedures, or take other actions (including amendments, policies, procedures and actions with retroactive effect) that the Company determines are necessary or appropriate to exempt any payment or benefit under this Agreement from the application of Section 409A or to cause any payment or benefit to comply with the requirements of Section 409A. To the extent that any payment or benefit provided for in this Agreement arises in connection with Executive’s termination of employment and constitutes a “deferral of compensation” within the meaning of Section 409A, such payment or benefit shall be payable only upon Employee’s “separation from service” within the meaning of Section 409A. Each payment or benefit to be made or provided pursuant to this Agreement is hereby designated as a separate payment, rather than a part of a larger single payment or one of a series of payments. Notwithstanding the foregoing provisions of this Section 17, the Company makes no representation or warranty as to compliance with Section 409A and shall have no liability to Executive or any other person for any adverse consequences arising under Section 409A.

18. Counterparts . This Agreement may be executed in several counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same instrument.

If this correctly sets forth our agreement on the subject matter hereof, kindly sign and return to the Company the enclosed copy of this letter which will then constitute our agreement on this subject.

Electro Scientific Industries, Inc.

By: __________________________

Name: Richard Wills

Title: Vice Chairman of the Board

_________________________________

Edward C. Grady

ELECTRO SCIENTIFIC INDUSTRIES, INC.

STOCK APPRECIATION RIGHTS AGREEMENT

This STOCK APPRECIATION RIGHTS AGREEMENT dated as of November 18, 2014, is between Electro Scientific Industries, Inc., an Oregon corporation (the “Company”), and Edward C. Grady (the “Recipient”), pursuant and subject to the Company’s 2004 Stock Incentive Plan (the “Plan”). The Company and the Recipient agree as follows:

1. SAR Grant . The Company hereby grants to the Recipient on the terms and conditions of this Agreement 350,000 stock appreciation rights (“SARs”). Upon exercise of a SAR in accordance with this Agreement, Recipient shall receive the number of shares of the Company’s Common Stock (“Common Stock”) equal to (i) the excess of the closing price of the Common Stock on the date of exercise (the “Market Price”) over $7.00, (ii) multiplied by the number of SARs being surrendered, and (iii) dividing the result by the Market Price. No fractional shares shall be issued upon exercise of a SAR and in lieu thereof the Company will pay Recipient cash in an amount equal to the fraction. The terms and conditions of the SAR grant set forth in attached Exhibit A are incorporated into and made a part of this Agreement.

2. Grant Date . The Grant Date for this SAR is November 18, 2014. The SAR shall continue in effect until the date ten years after the Grant Date (the “Expiration Date”) unless earlier terminated as provided in Section 1.5 of Exhibit A or pursuant to the Plan.

3. Time of Exercise . Except as provided in Exhibit A or in the Plan, the SAR may be exercised from time to time in the following amounts:

116,667 on May 18, 2015;

116,667 on May 18, 2016; and

116,666 on May 18, 2017.

(Signature Page Follows)

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date written above.

ELECTRO SCIENTIFIC INDUSTRIES, INC. RECIPIENT

By: _______________________________ ____________________________

Name: __________________________________ ____________________________

Title: [Chairman] [Vice Chairman] [Print Name]

_______________________

[address]

EXHIBIT A

SAR TERMS AND CONDITIONS

2004 Stock Incentive Plan

Pursuant to the Company’s 2004 Stock Incentive Plan (the “2004 Plan”), the Board of Directors has voted in favor of granting to the Recipient stock settled stock appreciation rights to receive Common Stock of the Company (the “SAR”) in the amount determined pursuant to the attached Agreement.

1. The SAR is granted upon the following terms:

1.1 Duration of SAR. Subject to reductions in the SAR period as hereinafter provided, in the event of termination of employment or death of the Recipient, the SAR shall continue in effect for a period of 10 years from the Grant Date.

1.2 Time of Exercise. Except as provided in paragraphs 1.5 and 1.6 and the Plan (including Section 17 thereof), the SAR may be exercised as set forth in Section 3 of the Agreement.

1.3 Limitations on Rights to Exercise. Except as provided in paragraphs 1.5 and 1.6, the SAR may not be exercised unless at the time of such exercise the Recipient is employed by the Company or any parent or subsidiary of the Company and shall have been so employed continuously since the date such SAR was granted.

1.4 Nonassignability. The SAR is nonassignable and nontransferable by the Recipient except by will or by the laws of descent and distribution of the state or country of the Recipient’s domicile at the time of death, and is exercisable during the Recipient’s lifetime only by the Recipient.

1.5 Termination of Service.

(a) Unless otherwise determined by the Board of Directors, if a Recipient’s employment or service with the Company terminates for any reason other than in the circumstances specified in subsection (b) or (c) below or Section 1.6, his or her SAR may be exercised at any time before the expiration date of the SAR or the expiration of five years after the date of termination, whichever is the shorter period, but only if and to the extent the Recipient was entitled to exercise the SAR at the date of termination.

(b) Unless otherwise determined by the Board of Directors, if a Recipient’s employment or service with the Company terminates because of total disability, his or her SAR may be exercised at any time before the expiration date of the SAR or before the fifth anniversary after the date of termination, whichever is the shorter period, but only if and to the extent the Recipient was entitled to exercise the SAR at the date of termination. The term “total disability” means a medically determinable mental or physical impairment that is expected to result in death or has lasted or is expected to last for a continuous period of 12 months or more and that, in the opinion of the Company and two independent physicians approved by the Company, causes the Recipient to be unable to perform his or her duties as an employee, director, officer or consultant of the Company and unable to be engaged in any substantial gainful activity. Total disability shall be deemed to have occurred after both of the following have occurred:

(A) The two independent physicians have furnished their written opinion of total disability to the Company; and

(B) The Company has reached an opinion of total disability.

(c) Unless otherwise determined by the Board of Directors, if a Recipient dies while employed by or providing service to the Company, his or her SAR may be exercised at any time before the expiration date of the SAR or before the fifth anniversary after the date of death, whichever is the shorter period, but only if and to the extent the Recipient was entitled to exercise the SAR at the date of death and only by the person or persons to whom the Recipient’s rights under the SAR shall pass by the Recipient’s will or by the laws of descent and distribution of the state or country of domicile at the time of death.

(d) To the extent the SAR held by any deceased Recipient or by the Recipient whose employment is terminated shall not have been exercised within the limited periods provided above, all further rights to receive shares pursuant to the SAR shall cease and terminate at the expiration of such periods.

(e) Absence on leave approved by the Company or on account of illness or disability shall not be deemed a termination or interruption of employment or service. Unless otherwise determined by the Board of Directors, vesting of SARs shall continue during a medical, family, military or other leave of absence, whether paid or unpaid.

1.6 Double Trigger Acceleration on Change in Control.

(a) All of the SARs shall immediately vest if a Change in Control (as defined below) occurs and at any time after the Change in Control and on or before the first anniversary of the Change in Control, (i) the Recipient’s employment or service is terminated by the Company (or its successor) without Cause (as defined below), (ii) the Recipient’s employment is terminated by the Recipient for Good Reason (as defined below) or (iii) the Recipient’s employment is terminated by the Recipient upon retirement on or after Recipient’s 65th birthday not less than 60 days after the Change in Control.

(b) For purposes of this Agreement, a “Change in Control” of the Company shall mean the occurrence of any of the following events:

(A) At any time during a period of two consecutive years, individuals who at the beginning of such period constituted the Board of Directors of the Company (“Incumbent Directors”) shall cease for any reason to constitute at least a majority thereof; provided, however, that the term “Incumbent Director” shall also include each new director elected during such two-year period whose nomination or election was approved by two-thirds of the Incumbent Directors then in office;

(B) Any “person” or “group” (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange Act) shall, as a result of a tender or exchange offer, open market purchases or privately negotiated purchases from anyone other than the Company, have become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act), directly or indirectly, of more than fifty percent (50%) of the then outstanding Common Stock of the Company;

(C) A consolidation, merger or plan of exchange involving the Company (“Merger”) as a result of which the holders of outstanding securities of the Company ordinarily having the right to vote for the election of directors (“Voting Securities”) immediately prior to the Merger do not continue to hold at least 50% of the combined voting power of the outstanding Voting Securities of the surviving corporation or a parent corporation of the surviving corporation immediately after the Merger, disregarding any Voting Securities issued to or retained by such holders in respect of securities of any other party to the Merger; or

(D) A sale, lease, exchange, or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Company.

(c) For purposes of this Agreement, “Cause” shall mean (a) the willful and continued failure to perform substantially the Recipient’s reasonably assigned duties with the Company (or its successor) (other than any such failure resulting from incapacity due to physical or mental illness) after a demand for substantial performance is delivered to the Recipient by the Company (or its successor) which specifically identifies the manner in which the Company (or its successor) believes that the Recipient has not substantially performed the Recipient’s duties, (b) the willful engagement in illegal conduct which is materially and demonstrably injurious to the Company (or its successor), or (c) the commission of an act by Recipient, or the failure of Recipient to act, which constitutes gross negligence or gross misconduct. No act, or failure to act, shall be considered “willful” if the Recipient reasonably believed that the action or omission was in, or not opposed to, the best interests of the Company (or its successor).

(d) For purposes of this Agreement, “Good Reason” shall mean:

(A) the assignment of a different title, job or responsibilities that results in a decrease in the level of responsibility of the Recipient after the Change in Control when compared to the Recipient’s level of responsibility for the Company’s operations prior to the Change in Control; provided that Good Reason shall not exist if the Recipient continues to have the same or a greater general level of responsibility for Company operations after the Change in Control as the Recipient had prior to the Change in Control even if the Company operations are a subsidiary or division of the surviving company,

(B) a reduction in the Recipient’s base pay as in effect immediately prior to the Change in Control,

(C) a material reduction in total benefits available to the Recipient under cash incentive, stock incentive and other employee benefit plans after the Change in Control compared to the total package of such benefits as in effect prior to the Change in Control, or

(D) the Recipient is required to be based more than 50 miles from where the Recipient’s office is located immediately prior to the Change in Control except for required travel on company business to an extent substantially consistent with the business travel obligations which the Recipient undertook on behalf of the Company prior to the Change in Control.

1.7 Method of Exercise. Shares may be acquired pursuant to the award only upon receipt by the Company of notice in writing from the Recipient of the Recipient’s intention to exercise, specifying the number of SARs as to which the Recipient desires to exercise the award and the date on which the Recipient desires to complete the transaction, which shall not be more than 30 days after receipt of the notice, and, unless in the opinion of counsel for the Company such a representation is not required in order to comply with the Securities Act of 1933, as amended, containing a representation that it is the Recipient’s present intention to acquire the shares for investment and not with a view to distribution. The Recipient shall have none of the rights of a shareholder until a certificate for shares is issued to the Recipient. No fractional shares shall be issued and in lieu thereof the Company shall pay Recipient cash equal to the value of such fractional share on the date of exercise. The Recipient may elect in the applicable notice of exercise to have the Company reduce the number of shares deliverable to the Recipient by an amount necessary to allow the Company to satisfy all applicable federal, state and local withholding tax requirements. If the Recipient does not so elect, the Recipient shall, upon notification of the amount due, if any, and prior to or concurrently with delivery of the certificates representing the shares with respect to which the SAR was exercised, pay to the Company amounts necessary to satisfy any applicable federal, state and local withholding tax requirements. If additional withholding becomes required beyond any amount deposited before delivery of the certificates, the Recipient shall pay such amount to the Company on demand.

1.8 Changes in Capital Structure. In the event that the outstanding shares of Common Stock of the Company are hereafter increased or decreased or changed into or exchanged for a different number or kind of shares or other securities of the Company or another corporation, by reason of any reorganization, merger, consolidation, recapitalization, reclassification, stock split-up, combination of shares, or dividend payable in shares, appropriate adjustment shall be made by the Board of Directors in the number of SARs subject to this Agreement and/or the amount payable on exercise of the SARs. Any such adjustment made by the Board of Directors shall be conclusive.

2. The obligations of the Company under this Agreement are subject to the approval of such state or federal authorities or agencies, if any, as may have jurisdiction in the matter. The Company will use its best efforts to take such steps as may be required by state or federal law or applicable regulations, including rules and regulations of the Securities and Exchange Commission and any stock exchange on which the Company’s shares may then be listed, in connection with the issuance or sale of any shares acquired upon the exercise of the SAR.

3. Nothing in the 2004 Plan or this Agreement shall confer upon the Recipient any right to be continued in the employment of the Company or any subsidiary of the Company, or to interfere in any way with the right of the Company or any subsidiary by whom the Recipient is employed to terminate the Recipient’s employment at any time, with or without cause.

4. This Agreement shall be binding upon and shall inure to the benefit of any successor or successors of the Company but except as hereinabove provided the SAR herein granted shall not be assigned or otherwise disposed of by the Recipient.

PERFORMANCE-BASED RESTRICTED STOCK UNITS AWARD AGREEMENT

This Award Agreement (the “Agreement”) is entered into as of November 18, 2014 by and between Electro Scientific Industries, Inc., an Oregon corporation (the “Company”), and Edward C. Grady (“Recipient”), for the grant of restricted stock units with respect to the Company’s Common Stock (“Common Stock”). By accepting this award Recipient agrees to be bound by the terms and conditions of this Agreement.

On November 18, 2014, the Compensation Committee of the Company’s Board of Directors made a restricted stock units award to Recipient pursuant to the Company’s 2004 Stock Incentive Plan (the “Plan”). The award is intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986. Recipient desires to accept the award subject to the terms and conditions of this Agreement.

IN CONSIDERATION of the mutual covenants and agreements set forth in this Agreement, the parties agree to the following:

1. Grant and Terms of Restricted Stock Units . The Company grants to Recipient under the Plan 155,000 restricted stock units, subject to the adjustments, restrictions, terms and conditions set forth in this Agreement; provided, however, that to the extent Recipient may be entitled to receive more than 155,000 restricted stock units under this Agreement, the grant of such excess amount shall be contingent on shareholder approval of an amendment to the Plan increasing the annual grant limit for restricted stock units to at least 325,000 shares.

(a) Rights under Restricted Stock Units . A restricted stock unit (an “RSU”) represents the unsecured right to require the Company to deliver to Recipient one share of Common Stock for each RSU. The number of shares of Common Stock deliverable with respect to each RSU is subject to adjustment as determined by the Board of Directors of the Company as to the number and kind of shares of stock deliverable upon any merger, reorganization, consolidation, recapitalization, stock dividend, spin-off or other change in the corporate structure affecting the Common Stock generally.

(b) Vesting . The RSUs issued under this Agreement shall initially be 100% unvested and subject to forfeiture as set forth below.

(i) Except as set forth in Section 1(d), if Recipient ceases to be employed by the Company for any reason or for no reason prior to the end of the Company’s 2017 fiscal year, the unvested RSUs shall be forfeited to the Company.

(ii) To the extent that the number of RSUs first specified above are reduced in accordance with Section 1(b)(iii) and except as provided in Section 1(d), the reduction shall be forfeited to the Company. The extent to which any Performance Goal is achieved, if at all, shall be determined by a date that is no later than December 31, 2017 (the “Determination Date”). Nothing contained in this Agreement shall confer upon Recipient any right to be employed by the Company or to continue to provide services to the Company or to interfere in any way with the right of the Company to terminate Recipient’s services at any time for any reason, with or without cause.

(iii) The RSUs shall be earned based on two “Performance Goals,” as follows:

(A) 77,500 of the RSUs will be earned based on the Company’s fiscal 2017 revenue in accordance with the following: vesting starts at revenue of $225 million and RSUs vest linearly up to revenue of $275 million, at which level 100% vesting occurs. Additional RSUs vest linearly based on revenue between $275 million and $385 million, at which level 200% vesting occurs. Vesting shall not exceed 200%. No amount shall be earned if revenue is less than $225 million.

(B) 77,500 of the RSUs will be earned based on the Company’s fiscal 2017 OIBT (as defined below) in accordance with the following: vesting starts on OIBT of 2% and RSUs vest linearly up to OIBT of 6%, at which level 100% vesting occurs. Additional RSUs vest linearly based on OIBT between 6% and 10%, at which level 200% vesting occurs. Vesting shall not exceed 200%. No amount shall be earned if OIBT is less than 2%.

(C) Notwithstanding (A) and (B) above, no RSUs shall vest under either such provision unless at least the minimum vesting measure under the other provision is achieved.

(D) “OIBT” means the operating income of the Company on a consolidated basis determined in accordance with GAAP, adjusted to exclude stock compensation expense, variable pay, purchase accounting and other one-time charges, as a percentage of revenue.

(E) The number of RSUs determined pursuant to clauses (A) and (B) of this Section 1(b)(iii) shall vest on the last day of fiscal 2017, subject to Section 1(b)(i). Except as provided in Section 1(d), any RSUs that are not vested at that time shall be forfeited.

(c) Delivery Date . Except as set forth in Section 1(d)(iv), the delivery date for shares of Common Stock with respect to RSUs earned subject to this Agreement shall be as soon as practicable on or after the end of the fiscal 2017, but in no event later than December 31, 2017.

(d) Proration upon Termination for Certain Reasons Prior to End of Performance Period; Treatment on Change in Control.

(i) Proration on Death or Total Disability . If Recipient ceases to be an employee of the Company prior to the end of fiscal 2017 by reason of Recipient’s death or total disability, the RSUs shall not be forfeited under Section 1(b)(i) and the following shall apply:

(1) The number of RSUs Recipient would otherwise be entitled to receive pursuant to Section 1(b)(iii) if Recipient were employed through the end of fiscal 2017 (the “Base Payout”) shall be reduced to a number determined by multiplying the Base Payout by a percentage calculated by dividing the number of months elapsed from the beginning of the Company’s fiscal year 2015 to the date of termination of employment (rounded down to the whole month) by 36 (the “Pro Rata Percentage”). RSUs that exceed the reduced number shall be forfeited to the Company.

(2) The shares of Common Stock with respect to RSUs determined under (1) shall be delivered as soon as practicable on or after the end of fiscal 2017, but in no event later than December 31, 2017.

(3) The term “total disability” means a medically determinable mental or physical impairment that is expected to result in death or has lasted or is expected to last for a continuous period of 12 months or more and that, in the opinion of the Company and two independent physicians approved by the Company, causes Recipient to be unable to perform his or her duties as an employee, director, officer or consultant of the Company and unable to engage in any substantial gainful activity. Total disability shall be deemed to have occurred after both of the following have occurred:

(A) The two independent physicians have furnished their written opinion of total disability to the Company; and

(B) The Company has reached an opinion of total disability.

(ii) Double Trigger Acceleration on Change in Control .

(1) The number of unvested RSUs Recipient would otherwise be entitled to receive pursuant to Section 1(b)(iii) if Recipient were employed through the end of fiscal 2017 shall immediately vest (provided, however, that if vesting occurs pursuant to this Section 1(d)(ii) during or prior to fiscal 2017 it will be conclusively presumed that each Performance Goal would have been at the 100% vesting level for each such unfinished fiscal year) if a Change in Control (as defined below) occurs and either:

(A) at any time after the Change in Control and on or before the first anniversary of the Change in Control, (i) the Recipient’s employment is terminated by the Company (or its successor) without Cause (as defined below), (ii) the Recipient’s employment is terminated by the Recipient for Good Reason (as defined below) or (iii) the Recipient’s employment is terminated by the Recipient upon retirement on or after Recipient’s 65th birthday not less than 60 days after the Change in Control; or

(B) at any time after the Change in Control the Company or the surviving or acquiring entity terminates this Agreement and all similar agreements, including because the achievement of any of the Performance Goals becomes reasonably unable to be determined;

Notwithstanding the foregoing, the RSUs may also immediately vest in connection with a sale of the Company as provided in Section 1(d)(iii) below.

(2) For purposes of this Agreement, a “Change in Control” of the Company shall mean the occurrence of any of the following events:

(C) A consolidation, merger or plan of exchange involving the Company (“Merger”) as a result of which the holders of outstanding securities of the Company ordinarily having the right to vote for the election of directors (“Voting Securities”) immediately prior to the Merger do not continue to hold at least fifty percent (50%) of the combined voting power of the outstanding Voting Securities of the surviving corporation or a parent corporation of the surviving corporation immediately after the Merger, disregarding any Voting Securities issued to or retained by such holders in respect of securities of any other party to the Merger; or

(D) A sale, lease, exchange, or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Company.

(3) For purposes of this Agreement, “Cause” shall mean (a) the willful and continued failure to perform substantially the Recipient’s reasonably assigned duties with the Company (or its successor) (other than any such failure resulting from incapacity due to physical or mental illness) after a demand for substantial performance is delivered to the Recipient by the Company (or its successor) which specifically identifies the manner in which the Company (or its successor) believes that the Recipient has not substantially performed the Recipient’s duties, (b) the willful engagement in illegal conduct which is materially and demonstrably injurious to the Company (or its successor), or (c) the commission of an act by Recipient, or the failure of Recipient to act, which constitutes gross negligence or gross misconduct. No act, or failure to act, shall be considered “willful” if the Recipient reasonably believed that the action or omission was in, or not opposed to, the best interests of the Company (or its successor).

(4) For purposes of this Agreement, “Good Reason” shall mean:

(B) a reduction in the Recipient’s base pay as in effect immediately prior to the Change in Control,

(iii) Sale of the Company . If there shall occur a merger, consolidation or plan of exchange involving the Company pursuant to which the outstanding shares of Common Stock of the Company are converted into cash or other stock, securities or property, or a sale, lease, exchange or other transfer (in one transaction or a series of related

transactions) of all, or substantially all, the assets of the Company, then, as determined by the Committee or the Board of Directors, either:

(1) the unvested RSUs shall be converted into restricted stock units for stock of the surviving or acquiring corporation in the applicable transaction, with the amount and type of shares subject thereto to be conclusively determined by the Committee, taking into account the relative values of the companies involved in the applicable transaction and the exchange rate, if any, used in determining shares of the surviving corporation to be held by the former holders of the Company’s Common Stock following the applicable transaction, and disregarding fractional shares, with the dates for vesting of RSUs and delivery of shares of Common Stock unchanged;

(2) the unvested RSUs shall be converted into a cash payment obligation of the surviving or acquiring corporation in an amount equal to the proceeds a holder of the underlying shares would have received in proceeds from such transaction with respect to those shares; or

(3) all of the unvested RSUs shall immediately vest and all underlying shares shall be delivered simultaneously with the closing of the applicable transaction such that the Recipient will participate as a shareholder in receiving proceeds from such transaction with respect to those shares.

(iv) Delivery Date . For purposes of Section 1(d)(ii) or (iii), the delivery date for shares of Common Stock with respect to RSUs shall be as soon as practicable on or after the vesting described in such sections.

(e) Forfeiture of RSUs on Other Terminations of Employment . If Recipient ceases to be an employee of the Company for any reason that does not result in acceleration or payment pursuant to Section 1(d), Recipient shall immediately forfeit all outstanding but unvested RSUs granted pursuant to this Agreement and Recipient shall have no right to receive the related Common Stock.

(f) Restrictions on Transfer and Delivery on Death . Recipient may not sell, transfer, assign, pledge or otherwise encumber or dispose of the RSUs. Recipient may designate beneficiaries to receive stock if Recipient dies before the delivery date by so indicating on Exhibit A, which is incorporated into and made a part of this agreement. If Recipient fails to designate beneficiaries on Exhibit A, the shares will be delivered to Recipient’s estate.

(g) Reinvestment of Dividend Equivalents . On each date on which the Company pays a dividend on a share of Common Stock with respect to an RSU, the number of RSUs subject to this Agreement shall be increased by a number equal to the number of whole or fractional shares of Common Stock with a value equal to the value of the dividends that would have been paid on the stock deliverable pursuant to the RSUs (if such shares were outstanding), divided by the closing stock price on the dividend payment date. If the vesting date for any RSUs subject to this Agreement occurs within seven business days of the payment date for a dividend, the Company, at its option, may elect to pay to Recipient cash, net of withholding, equal to the cash dividend payable on the RSUs which so vest in lieu of increasing the number of RSUs subject to this Agreement.

(h) Delivery on Delivery Date . On the delivery date the Company shall deliver to Recipient a certificate for the number of shares of Common Stock represented by all RSUs having a delivery date on the same date, rounded down to the whole share. No fractional shares of Common Stock shall be issued. The Company shall pay to Recipient in cash an amount equal to the value of any fractional shares that would otherwise have been issued, valued as of the delivery date. If shares or cash are to be delivered on a particular date, the shares or cash shall be deemed delivered on that date for purposes of compliance with the terms of this Agreement if the cash or shares are actually delivered within 45 days after the specified date as determined in the Company’s discretion with the Recipient having no right to determine the delivery date. Recipient shall not have any right to determine or direct the date of actual delivery; provided however, that delivery required to be made in no event later than December 31 of the calendar year in which the Performance Period ends must be made on or before such date.

(i) Recipient’s Rights as Shareholder . Recipient shall have no rights as a shareholder with respect to the RSUs or the shares underlying them until the Company delivers the shares to Recipient on the delivery date.

Common Stock to be delivered with respect to the RSUs or other shares of the Company’s Common Stock valued at the closing market price for the Company’s Common Stock on the vesting date. If Recipient pays the withholding amount in shares of Common Stock, the Company shall pay to Recipient in cash the amount of any resulting over payment.

(k) Section 409A . The award made pursuant to this Agreement shall be interpreted in accordance with Section 409A and Treasury regulations and other interpretive guidance issued thereunder, including without limitation any such regulations or other guidance issued after the grant of the award. For example, notwithstanding anything to the contrary in this Agreement, (i) a termination of employment shall be determined with respect to standards for “separation from service” within the meaning of applicable regulations; (ii) the provisions described in Sections 1(d)(ii)(1)(B), 1(d)(iii)(2) and 1(d)(iii)(3) shall apply only if such events qualify as a “termination or liquidation of the plan” within the meaning of Treas. Reg. § 1.409A‑3(j)(4)(ix); and the provision described in Section 1(d)(iii)(1) shall apply only if such events qualify as a “change of control event” within the meaning of Treas. Reg. § 1.409A-3(i)(5)(i).

(i) Notwithstanding any provision of the award to the contrary, the Company may adopt such amendments to the award or adopt other policies and procedures (including amendments, policies and procedures with retroactive effect), or take any other actions, that the Company determines are necessary or appropriate to (1) exempt the award from the application of Section 409A or preserve the intended tax treatment of the benefits provided with respect to the award, or (2) comply with the requirements of Section 409A.

(ii) If an amount is determined to be subject to applicable provisions of Section 409A of the Code, payment in connection with termination of employment for a reason other than death may not start or be made to Recipient if the Company determines Recipient is a “key employee” as defined in Section 416(i) of the Code, without regard to Section 416(i)(5) of the Code, before the date which is six months after the date of termination, notwithstanding any other provisions for time of payment in this Agreement, if such delay in payment is necessary to comply with Section 409A of the Code. The Company may determine that Recipient is a key employee in the event of doubt or to avoid impractical efforts or expense to make an exact determination of key employees. Recipient shall have no claim, rights or remedy if the determination is not correct.

2. Miscellaneous .

(a) Entire Agreement; Amendment . This Agreement and the Plan (including without limitation Section 17 thereof) constitute the entire agreement of the parties with regard to the subjects hereof and may be amended only by written agreement between the Company and the Recipient.

(b) Notices . Any notice required or permitted under this Agreement shall be in writing and shall be deemed sufficient when delivered personally to the party to whom it is addressed or when deposited into the United States mail as registered or certified mail, return receipt requested, postage prepaid, addressed to Electro Scientific Industries, Inc., Attention: Corporate Secretary, at its principal executive offices or to the Recipient at the address of Recipient in the Company’s records, or at such other address as such party may designate by ten (10) days’ advance written notice to the other party.

(c) Rights and Benefits . The rights and benefits of this Agreement shall inure to the benefit of and be enforceable by the Company’s successors and assigns and, subject to the restrictions on transfer of this Agreement, be binding upon the Recipient’s heirs, executors, administrators, successors and assigns.

(d) Further Action . The parties agree to execute such further instruments and to take such further action as may reasonably be necessary to carry out the intent of this Agreement.

(e) Applicable Law; Attorneys’ Fees . The terms and conditions of this Agreement shall be governed by the laws of the State of Oregon. In the event either party institutes litigation hereunder, the prevailing party shall be entitled to reasonable attorneys’ fees to be set by the trial court and, upon any appeal, the appellate court.

ELECTRO SCIENTIFIC INDUSTRIES, INC.

By:___________________________________

Authorized Officer

EXHIBIT A

DESIGNATION OF BENEFICIARY

Name _____________________________ Social Security Number ____-___-_____

I designate the following person(s) to receive any restricted stock units outstanding upon my death under the Performance-Based Restricted Stock Units Award Agreement with Electro Scientific Industries, Inc.:

Primary Beneficiary(ies)

Name ________________________ Social Security Number ____-___-_____

Birth Date ____________________ Relationship ________________________

Address__________________________ City__________ State____ Zip ________

Name ________________________ Social Security Number ____-___-_____

Birth Date ____________________ Relationship ________________________

Address__________________________ City__________ State____ Zip ________

Name ________________________ Social Security Number ____-___-_____

Birth Date ____________________ Relationship ________________________

Address__________________________ City__________ State____ Zip ________

If more than one primary beneficiary is named, the units will be divided equally among those primary beneficiaries who survive the undersigned.

Secondary Beneficiary(ies)

In the event no Primary Beneficiary is living at the time of my death, I designate the following the person(s) as my beneficiary(ies):