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."

Business Overview

Electro Scientific Industries, Inc. and its subsidiaries (ESI) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. Our advanced laser systems enable precise structuring of micron to submicron features in components and devices which are used in a wide variety of end products in the consumer electronics, computer, communications and other industries. 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 and improve production yields. Laser microfabrication comprises a set of precise micron-level processes, including via drilling, wafer scribing and dicing, material ablation, semiconductor memory-link cutting, electronic device trimming, and nano-level structuring to alter material characteristics such as color and texture. These processes require application-specific laser systems able to meet our customers' exacting performance and productivity requirements. Our laser-based systems improve production yields or enable improved performance for flexible interconnect material, semiconductor devices, light emitting diodes (LEDs), high-density interconnect (HDI) circuits, advanced semiconductor packaging, 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. We also produce products building on this technology that are used to test the electrical and optical characteristics, including color and intensity, of packaged LEDs.

Summary of Sequential Quarterly Results

The first quarter of 2013, ended June 30, 2012, reflected sequential improvement in our financial results despite continued challenges in some of our markets. Strong demand for our advanced microfabrication products contributed to sequential orders growth. Total order volume for the first quarter of 2013 was $74.1 million, compared to $70.3 million for the fourth quarter of 2012, which ended March 31, 2012. The sequential increase in orders was driven by orders for microfabrication and MLCC products. Demand remained weak in our DRAM and LED business.

Orders for our Interconnect & Microfabrication Group (IMG) products decreased modestly compared to the prior quarter, primarily driven by lower flex interconnect orders. Flex interconnect orders declined after a record quarter in March 2012 as customers absorbed significant capacity ordered in the last two quarters. The flex interconnect business continues to have robust customer activity, primarily a result of increasing use of flexible circuitry and market growth of mobile electronics, particularly in smart phones and tablet devices.

Orders for our Semiconductor Group (SG) products remained low in the first quarter with virtually no demand from the dynamic random access memory (DRAM) market. Our LED wafer scribing products saw a slight increase in demand, although the market remains in an over-supply condition.

Orders for our Components Group (CG) products more than doubled compared to the prior quarter. The increase was primarily driven by demand for our new 3510 MLCC MicroChip tester which addresses the new smallest size capacitors, used in smart phones and tablets.

Net sales of $59.0 million for the first quarter of 2013 increased $13.5 million from $45.5 million for the prior quarter. The increase in net sales was driven primarily by our IMG products, which increased $16.0 million as a result of higher sequential shipments of our flex interconnect systems ordered last quarter. SG product sales decreased $4.6 million due to slowing demand from our memory repair customers. CG sales increased $2.1 million driven by demand from our MLCC customers.

Gross margin improved to 40.1% on net sales of $59.0 million for the first quarter of 2013 compared to 37.0% on net sales of $45.5 million for the prior quarter. Gross margin rates improved due to the benefit of higher production volumes and lower inventory write-offs, partially offset by the mix impact of quantity pricing on high volume orders.

Net operating expenses of $25.2 million in the first quarter of 2013 decreased $2.1 million compared to $27.3 million in the prior quarter. This decrease was primarily due to $2.9 million in restructuring costs and $1.0 million in loss on disposal of assets incurred in the fourth quarter of 2012 that did not repeat in the first quarter of 2013. Additionally, research, development and engineering (RD&E) expenses decreased by $0.7 million compared to the prior quarter. These decreases were partially offset by an increase of $2.4 million in selling, service and administration (SS&A) expenses. The restructuring costs and the loss on disposal of assets in the fourth quarter of 2012 were primarily a result of implementing our globalization strategy and other cost control measures. The decrease in RD&E expenses during the first quarter of 2013 was primarily due to lower project materials and new product development costs. SS&A expenses increased primarily due to share-based compensation expense as well as acquisition and integration costs for Eolite Systems. Share-based compensation expense increased primarily due to accelerated expense associated with Chief Executive Officer's retirement eligibility date and immediate vesting of the annual board of director share grants.

Operating loss was $1.5 million in the first quarter of 2013, a decrease of $8.9 million compared to an operating loss of $10.5 million in the prior quarter. The decrease was primarily due to higher net sales and lower operating expenses discussed above.

The effective tax rate was 44.3% for the first quarter of 2013, resulting from an income tax benefit of $0.8 million, compared to an effective rate of 26.4% for the prior quarter that resulted from an income tax benefit of $2.8 million. The primary factor impacting the effective tax rate for first quarter of 2013 was the level of net loss for the quarter and the proportion of foreign earnings relative to pretax income or loss.

Net loss for the first quarter of 2013 was $0.9 million compared to net loss of $7.7 million in the prior quarter due to the impact of the items discussed above.

Quarter Ended June 30, 2012 Compared to Quarter Ended July 2, 2011

Results of Operations

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



                                                              Fiscal quarter ended
                                                     Jun 30, 2012               Jul 2, 2011
Net sales                                                      100 %                   100.0 %
Cost of sales                                                 59.9                      56.2

Gross margin                                                  40.1                      43.8
Selling, service and administration                           26.5                      21.4
Research, development and engineering                         16.2                      14.6
Legal settlement costs                                          -                        0.7

Operating (loss) income                                       (2.6 )                     7.1
Gain on sale of previously impaired auction
rate securities                                                 -                        3.5
Interest and other expense, net                               (0.3 )                    (0.1 )

(Loss) income before income taxes                             (2.9 )                    10.5
(Benefit from) provision for income taxes                     (1.3 )                     2.8

Net (loss) income                                             (1.6 )%                    7.7 %

Net Sales

Net sales were $59.0 million for the first quarter of 2013, a decrease of $18.1 million or 23% compared to net sales of $77.0 million for the first quarter of 2012. Revenue decreased primarily due to lower demand for SG products, specifically in the memory repair and LED scribing markets. We also experienced lower demand for our CG products.

The following table presents net sales information by product group:

                                                                        Fiscal quarter ended
(In thousands, except percentages)                    Jun 30, 2012                                 Jul 2, 2011
                                            Net Sales          % of Net Sales           Net Sales          % of Net Sales
Interconnect & Microfabrication Group
(IMG)                                      $    47,698                    80.9 %       $    48,212                    62.6 %
Semiconductor Group (SG)                         3,566                     6.0              18,025                    23.4
Components Group (CG)                            7,705                    13.1              10,809                    14.0

                                           $    58,969                   100.0 %       $    77,046                   100.0 %

IMG sales in the first quarter of 2013 decreased slightly by $0.5 million or 1% compared to the first quarter of 2012. The decrease was driven by lower revenue from our advanced microfabrication customers, which was particularly strong in the first quarter of 2012 due to a large follow-on order received that quarter. The decrease in microfabrication was mostly offset by increased sales in the flex-circuit market driven by strong demand for smart phones and tablets which utilize an increased amount of flex circuitry in their designs.

SG sales in the first quarter of 2013 decreased $14.5 million or 80% compared to the first quarter of 2012. The decrease in sales was driven by a lack of demand for memory repair and lower orders for LED systems. The DRAM and LED markets are currently in an over-capacity condition and are negatively impacted by slow macroeconomic growth.

CG sales in the first quarter of 2013 decreased $3.1 million or 29% compared to the first quarter of 2012. The decrease is a result of most MLCC customers continuing to absorb capacity created by systems delivered in prior quarters and by lower overall demand for MLCC's.

The following table presents net sales information by geographic region:

                                                                        Fiscal quarter ended
(In thousands, except percentages)                    Jun 30, 2012                                 Jul 2, 2011
                                            Net Sales          % of Net Sales           Net Sales          % of Net Sales
Asia                                       $    52,454                    89.0 %       $    68,933                    89.4 %
Americas                                         4,174                     7.0               5,742                     7.5
Europe                                           2,341                     4.0               2,371                     3.1

                                           $    58,969                   100.0 %       $    77,046                   100.0 %

Compared to the first quarter of 2012, net sales for the first quarter of 2013 decreased $16.5 million or 24% in Asia, decreased $1.6 million or 27% in the Americas and remained flat in Europe. The decreases in Asia were primarily due to lower sales for our SG products, which were the result of the over-supply condition discussed above. Net sales in the Americas and Europe remain a lower percentage of total sales as purchases in these regions are primarily for specialized uses or research and development purposes, as compared to the trend by our Asian customers to source their high-volume manufacturing in that region.

Gross Profit

The following table presents gross profit information:

Fiscal quarter ended (In thousands, except percentages) Jun 30, 2012 Jul 2, 2011 Gross Profit % of Net Sales Gross Profit % of Net Sales Gross Profit $ 23,653 40.1 % $ 33,760 43.8 %

Gross profit for the first quarter of 2013 was $23.7 million, a decrease of $10.1 million compared to gross profit of $33.8 million for the first quarter of 2012. Gross profit as a percentage of net sales decreased to 40.1% for the first quarter of 2013 from 43.8% for the first quarter of 2012. These decreases were primarily related to lower revenue levels and the resulting decrease in production capacity utilization, combined with the mix impact of quantity pricing on high volume orders.

Operating Expenses

The following table presents operating expense information:



                                                                      Fiscal quarter ended
(In thousands, except percentages)                    Jun 30, 2012                             Jul 2, 2011
                                            Expense          % of Net Sales          Expense          % of Net Sales
Selling, service and administration         $ 15,663                    26.5 %       $ 16,496                    21.4 %
Research, development and engineering          9,534                    16.2           11,234                    14.6
Legal settlement costs                            -                       -               550                     0.7

                                            $ 25,197                    42.7 %       $ 28,280                    36.7 %

Selling, Service and Administration

Selling, service and administration (SS&A) expenses primarily consist of labor and other employee-related expenses including share-based compensation expense, travel expenses, professional fees, sales commissions and facilities costs.

SS&A expenses were $15.7 million for the first quarter of 2013, a decrease of $0.8 million compared to the first quarter of 2012. This decrease was primarily related to a $1.7 million reduction in share-based compensation, partially offset by an increase of $0.8 million in acquisition and integration costs for Eolite Systems. The decrease in share-based compensation primarily resulted from a decrease in estimated attainment of performance based grants, the prior year accelerated expense associated with the Chief Executive Officer's retirement eligibility date and the lower grant date fair value for new awards granted in the first quarter of 2013.

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 were $9.5 million for the first quarter of 2013, a decrease of $1.7 million compared to the first quarter of 2012. The decrease was primarily due to a reduction in project material and consulting costs, and to a lesser extent, lower labor costs associated with selective decreases in headcount.

Legal Settlement Costs

There were no legal settlement costs in the first quarter of 2013. Legal settlement costs for the first quarter of 2012 were $0.6 million, and consisted of court and legal fees associated with the All Ring litigation and other legal matters.

Non-operating Income and Expense

Gain on sale of Previously Impaired Auction Rate Securities (ARS)

During the first quarter of 2012, we sold all of our remaining ARS with a total par value of $14.7 million for approximately $6.5 million. We recorded a total gain of $2.7 million, which included $1.4 million in reclassification of previously recorded unrealized gains out of accumulated other comprehensive income. As of June 30, 2012, we did not hold any ARS investment. See Note 5 "Fair Value Measurements" to the Condensed Consolidated Financial Statements in Item 1 Financial Statements and Supplementary Data for further discussion.

Interest and Other (Expense) Income, net

Interest and other income, net, consists of interest income and expense, market gains and losses on assets held for our deferred compensation plan, realized and unrealized foreign exchange gains and losses, bank charges, investment management fees and other miscellaneous non-operating items. Net interest and other expense of $0.2 million for the first quarter of 2013 remained fairly flat compared to the first quarter of 2012.

Income Taxes

The following table presents income tax information:



                                                          Fiscal quarter ended
(In thousands, except percentages)           Jun 30, 2012                      Jul 2, 2011
                                     Income Tax        Effective        Income Tax       Effective
                                       Benefit         Tax Rate         Provision        Tax Rate
Income tax (benefit) provision       $      (750 )           44.3 %    $      2,159            26.7 %

The income tax benefit for the first quarter of 2013 was $0.8 million on pretax loss of $1.7 million, an effective tax benefit rate of 44.3%. For the first quarter of 2012, the income tax provision was $2.2 million on pretax income of $8.1 million, an effective tax rate of 26.7%. The primary factor impacting the effective tax rate for first quarter of 2013 was the level of loss for the quarter and the proportion of foreign earnings relative to pretax income or loss.

Our effective tax rate is subject to fluctuation based upon the mix of income and relative tax rates between jurisdictions, and the occurrence and timing of numerous discrete events such as changes in tax laws or their interpretations, extensions or expirations of research and experimentation credits, closure of tax years subject to examination, finalization of income tax returns, the relationship of fixed deductions to overall changes in estimated and actual pretax income or loss and the tax jurisdictions where income or loss is generated, or the ability to fully utilize our deferred tax assets. Based on currently available information, we are not aware of any further discrete events which are likely to occur that would have a material effect on our financial position, expected cash flows or results of operations.

Net Income (Loss)

The following table presents net income (loss) information:

Fiscal quarter ended (In thousands, except percentages) Jun 30, 2012 Jul 2, 2011 Net Loss % of Net Sales Net Income % of Net Sales Net (loss) income $ (944 ) (1.6 )% $ 5,913 7.7 %

Net loss for the first quarter of 2013 was $0.9 million, or $0.03 per share, compared to net income of $5.9 million, or $0.21 per basic share and $0.20 per diluted share for the first quarter of 2012. The decline was primarily due to lower revenue in the first quarter of 2013 partially offset by lower overall operating expenses.

Financial Condition and Liquidity

At June 30, 2012, our principal sources of liquidity were cash and cash equivalents of $84.3 million, short-term investments of $100.6 million and accounts receivable of $28.1 million. We also held $22.3 million in restricted cash which represented collateral for commercial letters of credit related to our ongoing legal proceedings against All Ring Tech Co., Ltd. At June 30, 2012, we had a current ratio of 6.17 and held no long-term debt. Working capital of $268.6 million declined slightly compared to the March 31, 2012 balance of $269.5 million. We also held approximately $13.0 million of non-current investments at June 30, 2012.

In May 2008, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of our outstanding common stock primarily to offset dilution from equity compensation programs.

In December 2011, the Board of Directors terminated the 2008 repurchase program and authorized a new share repurchase program totaling $20.0 million to acquire shares of our outstanding common stock. The repurchases are to be made at management's discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors. We did not repurchase any shares under this program either in the first quarter of 2013 or in 2012. There is no fixed completion date for the repurchase program. See the Form 10-K for the year ended March 31, 2012 for additional discussion related to these share repurchase programs.

In December 2011, the Board of Directors adopted a dividend policy under which we intend to pay quarterly cash dividends. The following table summarizes the dividend declared and paid by us during the first quarter of 2013 and the fourth quarter of 2012:

      Date Declared      Record Date        Payment Date        Amount per Share
      May 10, 2012       June 4, 2012       June 18, 2012            $0.08
      December 9, 2011   January 27, 2012   February 17, 2012        $0.08

During the first quarter of 2013, the dividend amount paid as a result of the May 10, 2012 declaration was $2.3 million.

We currently anticipate that we will continue to pay cash dividends on a quarterly basis in the future, although the declaration, timing and amount of any future cash dividends are at the discretion of the Board of Directors and will depend on our financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interest of our shareholders.

Sources and Uses of Cash

Net cash provided by operating activities totaled $11.4 million for the first quarter of 2013 due to our $0.9 million net loss offset significantly by inflows from working capital and non-cash changes. During the first quarter of 2013, the primary sources of cash inflow from working capital consisted of a $4.9 million decrease in trade receivables, $3.9 million increase in accounts payable and accrued liabilities, $1.0 million decrease in shipped systems pending acceptance, and a $0.5 million decrease in other current assets, partially offset by a $1.9 million increase in inventories and a $0.2 million decrease in deferred revenue.

For the first quarter of 2013, net cash provided by investing activities of $6.1 million was primarily due to $330.3 million of proceeds from sales and maturities of investments, partially offset by $313.9 million of purchases of investments, and $9.5 million of net cash paid for acquisition of Eolite Systems, a designer and manufacturer of unique fiber lasers. Net cash used in financing activities of $2.9 million primarily resulted from $2.3 million of cash dividends paid to shareholders and $0.6 million of cash used in net stock plan activity including employee tax deposits related to stock awards, partially offset by employee stock purchase activity.

We believe that our existing cash, cash equivalents and short-term investments are adequate to fund our operations, any dividends which may be declared, our share repurchase program and contractual obligations for at least the next twelve months.

Critical Accounting Policies and Estimates

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 31, 2012.