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 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) provide high-technology manufacturing equipment to the global semiconductor and micro-electronics markets, including advanced laser systems that are used to micro-engineer electronic device features in high-volume production environments. Our customers are primarily manufacturers of semiconductors, passive components, electronic interconnect devices, and other components used in a wide variety of end products in the computer, consumer electronics, communications and other industries. Our equipment enables these manufacturers to achieve yield and productivity gains in their manufacturing processes that can be critical to their profitability. ESI was founded in 1944, is headquartered in Portland, Oregon, and has subsidiaries in the U.S., Europe and Asia.

Our advanced laser microengineering and inspection systems allow semiconductor and micro-electronics manufacturers to physically alter select device features during high-volume production in order to heighten performance and boost production yields. Laser micro-engineering comprises a set of precise fine-tuning processes, including micro-machining, wafer scribing and dicing, semiconductor memory-link cutting, device trimming and via drilling, that requires 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 during the manufacturing process for semiconductor devices, high-density interconnect (HDI) circuits, including flexible interconnect material and advanced semiconductor packaging, high-brightness light emitting diodes (LED), flat panel liquid crystal displays (LCD) and general micro-machining applications.

Additionally, we produce high-capacity test and optical inspection equipment that is critical to the quality control process during the production of multi-layer ceramic capacitors (MLCCs). Our equipment ensures that each MLCC meets both the electrical and physical tolerances required to perform properly.

Summary of Sequential Quarterly Results

The financial results of the fiscal quarter ended June 27, 2009 reflected some signs of improvement from the prior quarter in virtually all of our markets. Total order volume for the first quarter of 2010 was $28.7 million, compared to total order volume for the fourth quarter of 2009 of $16.1 million. The increase in orders was driven by improvements in all our business groups. However, market conditions remain very difficult, as semiconductor memory prices remain relatively weak and capacity utilization, while improving, is below the level that drives significant capacity purchases.

Orders for our Semiconductor Group (SG) products more than doubled compared to the historically low level of orders in the fourth quarter of 2009. The increase in orders for SG products was reflected in higher levels of spending in our LED scribing business and also due in part to qualification of our new wafer repair application.

Orders for our Passive Components Group (PCG) almost tripled compared to the very low levels in the fourth quarter of 2009. This increase was driven by a multi-system order for our high-capacitance tester as well as increased orders for our consumable and tooling products, reflecting increased utilization and low channel inventory.

Orders for our Interconnect/Micro-machining Group (IMG) products increased by approximately 25% compared to the fourth quarter of 2009. This increase was driven primarily by strong orders for our flex interconnect applications and increased activity in general-purpose micromachining applications.

Gross margins were 26.4% on net sales of $22.6 million in the first quarter of 2010, compared to 25.7% on net sales of $18.1 million in the fourth quarter of 2009. The slight increase in gross margin percentage reflects the benefit from higher sales volume, partially offset by an unfavorable product mix compared to the prior quarter. Included in cost of sales in both quarters were $0.3 million of amortization of intangible assets acquired in the acquisition of New Wave Research, Incorporated (NWR) in July, 2007.

Total operating expenses decreased $11.4 million to $14.9 million in the first quarter of 2010, compared to $26.3 million in the fourth quarter of 2009. Approximately $6.4 million of the sequential decrease was due to a receipt of $4.5 million in net proceeds in the first quarter of 2010 from a merger termination fee compared to $1.9 million of merger related expenses incurred in the fourth quarter of 2009. Additionally, we incurred a $4.1 million charge in the fourth quarter of 2009 to write-off material from a research, development and engineering program due to a change in our product development strategy and restructuring charges totaling $2.0 million. Partially offsetting these reductions, share-based compensation increased $1.2 million due to a change in the vesting schedule of current year board of director grants, incremental cost of the Company's annual stock grant, and lower expenses recognized in the prior quarter based on reduced achievement against existing performance grants. Excluding the impact of these items, expenses decreased approximately $0.1 million due to continued efforts to manage our cost structure and timing of engineering project costs between quarters.

Operating loss decreased to $8.9 million in the first quarter of fiscal 2010 compared to $21.7 million in the fourth quarter of fiscal 2009, driven by the net decrease of $11.4 million in net operating expenses and increased gross profit of $1.3 million.

There was no other-than-temporary impairment charge related to our auction rate securities (ARS) during the first quarter of 2010 compared to a $1.1 million charge in the fourth quarter of 2009, reflecting a slight improvement of financial markets during the first quarter of 2010.

Net interest and other income of $0.3 million in the first quarter of 2010 increased slightly from $0.2 million in the fourth quarter of 2009. The increase was driven by improved foreign currency results partially offset by lower interest income, the result of declines in average market interest rates.

The effective tax rate was 35.7% in the first quarter of 2010, resulting in an income tax benefit of $3.1 million, compared to an effective rate of 33.9% for the fourth quarter of 2009, resulting in an income tax benefit of $7.7 million.

Net loss for the first quarter of 2010 was $5.5 million or $0.20 per basic and diluted share, compared to a net loss of $14.9 million or $0.55 per basic and diluted share in the fourth quarter of 2009.

Results of Operations

The following table presents results of operations data as a percentage of net
sales for the fiscal quarters ended June 27, 2009 and June 28, 2008:



                                                             Fiscal quarter ended
                                                     June 27, 2009           June 28, 2008
Net sales                                                    100.0 %                 100.0 %
Cost of sales                                                 73.6                    60.5

Gross margin                                                  26.4                    39.5
Selling, service and administration                           53.0                    23.5
Research, development and engineering                         33.0                    15.0
Restructuring costs                                             -                      1.2
Merger termination proceeds, net                             (20.0 )                    -

Operating loss                                               (39.6 )                  (0.2 )
Other-than-temporary impairment of auction
rate securities                                                 -                     (8.0 )
Interest and other income, net                                 1.5                     1.3

Loss before income taxes                                     (38.1 )                  (6.9 )
Benefit from income taxes                                     13.6                     2.6

Net loss                                                     (24.5 )%                 (4.3 )%

Fiscal Quarter Ended June 27, 2009 Compared to Fiscal Quarter Ended June 28, 2008

Net Sales

Net sales were $22.6 million for the first quarter of 2010, a decrease of $41.4 million or 64.7% compared to net sales of $64.0 million for the first quarter of 2009. Revenue decreased in each of our product groups, reflecting the extremely difficult global economic environment. Our worldwide customers have been severely affected by depressed consumer demand and weak memory prices that persisted throughout calendar 2008 and to date in calendar 2009.

Net sales by product group for the fiscal quarters ended June 27, 2009 and June 28, 2008 were as follows:

                                                                    Fiscal quarter ended
                                                      June 27, 2009                       June 28, 2008
(In thousands, except percentages)             Net Sales     % of Net Sales        Net Sales     % of Net Sales
Semiconductor Group (SG)                      $     5,260              23.3 %     $    21,728              33.9 %
Passive Components Group (PCG)                      5,150              22.8 %          13,275              20.7 %
Interconnect/Micro-machining Group (IMG)           12,193              53.9 %          29,021              45.4 %

                                              $    22,603             100.0 %     $    64,024             100.0 %

SG sales in the first quarter of 2010 decreased $16.5 million or 75.8% compared to the first quarter of 2009. The overall decrease in sales was due to the significant downturn in the memory markets and its impact to our memory repair customers' demand for capital equipment.

PCG sales in the first quarter of 2010 declined $8.1 million or 61.2% compared to the first quarter of 2009. The decrease in PCG net sales was driven by global reduction in demand for consumer electronics which has reduced the utilization of existing systems at our MLCC manufacturing customers and impacted their demand for additional products.

IMG sales in the first quarter of 2010 decreased $16.8 million or 58.0% compared to the first quarter of 2009. The decrease was primarily due to strong sales that occurred in the first quarter of 2009 for our micro-machining products driven by initial demand for the Model 5800 released during that quarter. Sales for the first quarter of 2010 reflect lower order levels from micro-machining customers partially offset by continued demand from flex circuit and integrated circuit packaging segments of the market.

Net sales by geographic region for the fiscal quarters ended June 27, 2009 and June 28, 2008 were as follows:

                                                                    Fiscal quarter ended
                                                      June 27, 2009                       June 28, 2008
(In thousands, except percentages)             Net Sales     % of Net Sales        Net Sales     % of Net Sales
Asia                                          $    16,087              71.1 %     $    44,439              69.4 %
Americas                                            4,287              19.0 %          12,903              20.2 %
Europe                                              2,229               9.9 %           6,682              10.4 %

                                              $    22,603             100.0 %     $    64,024             100.0 %

Compared to the fiscal quarter ended June 28, 2008, net sales for the fiscal quarter ended June 27, 2009 declined $28.4 million or 63.8% in Asia, $8.6 million or 66.8% in the Americas, and $4.5 million or 66.6% in Europe. These decreases reflect the impact of the global economic recession on all of our markets.

Gross Profit

Gross profit for the fiscal quarters ended June 27, 2009 and June 28, 2008 was as follows:

Fiscal quarter ended June 27, 2009 June 28, 2008 (In thousands, except percentages) Gross Profit % of Net Sales Gross Profit % of Net Sales Gross Profit $ 5,961 26.4 % $ 25,291 39.5 %

Gross profit for the fiscal quarter ended June 27, 2009 was $6.0 million, a decline of $19.3 million compared to gross profit of $25.3 million for the fiscal quarter ended June 28, 2008. Gross profit also declined as a percentage of net sales, decreasing to 26.4% for the first quarter of 2010 from 39.5% for the first quarter of 2009. These decreases were primarily related to decreased revenue levels along with an associated reduction in capacity utilization. As a response to the decline in business, management implemented cost reduction efforts throughout fiscal 2009, including reductions in manufacturing labor and overhead, which partially mitigated the impact of lower production volumes.

Operating Expenses

Operating expenses for the fiscal quarters ended June 27, 2009 and June 28, 2008
were as follows:



                                                                   Fiscal quarter ended
                                                     June 27, 2009                        June 28, 2008
(In thousands, except percentages)           Expense         % of Net Sales        Expense      % of Net Sales
Selling, Service and Administration          $ 11,971                  53.0 %      $ 15,100               23.5 %
Research, Development and Engineering           7,455                  33.0           9,658               15.0
Restructuring Costs                                -                     -              749                1.2
Merger Termination Proceeds, net               (4,516 )               (20.0 )            -                  -

                                             $ 14,910                  66.0 %      $ 25,507               39.7 %

Selling, Service and Administration Expenses

The primary items included in selling, service and administration (SS&A) expenses are labor and other employee-related expenses including share-based compensation expense, travel expenses, professional fees, sales commissions and facilities costs. SS&A expenses were $12.0 million for the fiscal quarter ended June 27, 2009, a decrease of $3.1 million compared to $15.1 million in the fiscal quarter ended June 28, 2008. The decrease in SS&A expenses was primarily attributable to restructuring and cost management activities completed in fiscal 2009. These actions have included company-wide reductions in force and related decreases in compensation, labor, and travel-related costs. Additionally, we have implemented several temporary cost reduction measures, including salary reductions, furloughs, and elimination of the Company match of 401(k) contributions. The impact of these reductions was partially offset by an increase of $0.9 million in SS&A share-based compensation expense. Share-based compensation expense increased compared to the same quarter of the prior year primarily due to a change to immediate vesting for annual grants to the board of directors in May of 2009 and the incremental cost of the Company's annual stock grant. To the extent that any of the temporary cost reduction measures cited above are discontinued in future quarters, employee-related expenses will increase accordingly.

Research, Development and Engineering Expenses

Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials, equipment costs and facilities costs. RD&E expenses totaled $7.5 million for the fiscal quarter ended June 27, 2009, which represents a decline of $2.2 million compared to $9.7 million for the fiscal quarter ended June 28, 2008. This decrease was primarily due to reductions in employee-related expense resulting from our cost containment actions, and to a lesser extent, lower project materials expense.

Restructuring Costs

No restructuring expenses were incurred during the fiscal quarter ended June 27, 2009 compared to $0.7 million during the fiscal quarter ended June 28, 2008. The expenses for the fiscal quarter ended June 28, 2008 were incurred as the result of reductions in workforce announced in that quarter, which were taken in response to weakness in the memory market and reductions in customer capital spending.

Merger Termination Proceeds, Net

For the quarter ended June 27, 2009, we recorded a net benefit of $4.5 million in operating expenses related to a merger termination fee. This amount represents the receipt of a $5.4 million merger termination fee offset by an additional $0.9 million of merger transaction costs.

Non-operating Income and Expense

Other-than-temporary Impairment of Auction Rate Securities

No other-than-temporary impairment charges related to our auction rate securities (ARS) were recorded during the fiscal quarter ended June 27, 2009 compared to a charge of $5.1 million during the fiscal quarter ended June 28, 2008. The charge in fiscal 2009 was incurred as the result of instability of the global financial markets throughout fiscal 2009, which created a prolonged period of decline in the values of ARS. Given the continued challenges in the financial markets and the prolonged credit crisis, we cannot reasonably predict when these ARS will become liquid. See Note 6 "Fair Value Measurements" for further discussion.

Interest and Other Income, Net

Interest and other income, 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, ARS valuation fees and other miscellaneous non-operating items. Net interest and other income for the fiscal quarters ended June 27, 2009 and June 28, 2008 was as follows:

                                                              Fiscal quarter ended
                                              June 27, 2009                         June 28, 2008
                                      Interest and                          Interest and
                                      Other Income,                         Other Income,
(In thousands, except percentages)         net         % of Net Sales            net         % of Net Sales
Interest and Other Income, net       $           342              1.5 %    $           860              1.3 %

Interest and other income, net, for the first quarter of 2010 declined $0.5 million compared to the first quarter of 2009. The decrease was primarily attributable to a $0.8 million decrease in interest income due to significant declines in market interest rates on short-term, high-quality securities over this period, partially offset by $0.3 million of foreign currency gains.

Income Taxes

The income tax benefit recorded for the fiscal quarter ended June 27, 2009 was $3.1 million on pretax loss of $8.6 million, an effective rate of 35.7%. Comparatively, the income tax benefit was $1.7 million on a pretax loss of $4.5 million for the fiscal quarter ended June 28, 2008, an effective tax rate of 38.0%.

Our effective tax rate is subject to fluctuation based upon 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 and finalization of income tax returns. Based on currently available information, we are not aware of any such discrete events which are likely to occur that would have a materially adverse effect on our financial position, expected cash flows or results of operations. We anticipate no significant changes in unrecognized tax benefits in the next twelve months as the result of examinations or lapsed statutes of limitation.

Net Loss

Net loss for the fiscal quarters ended June 27, 2009 and June 28, 2008 was as follows:

Fiscal quarter ended June 27, 2009 June 28, 2008 (In thousands, except percentages) Net Loss % of Net Sales Net Loss % of Net Sales Net Loss $ (5,530 ) (24.5 )% $ (2,758 ) (4.3 )%

Net loss for the first quarter of 2010 was $5.5 million, or $0.20 per basic and diluted share, compared to net loss for the first quarter of 2009 of $2.8 million, or $0.10 per basic and diluted share. The decline was primarily the result of the reduction in revenues and gross profit, partially offset by the benefit from cost containment actions and the net merger termination proceeds, as discussed above.

Financial Condition and Liquidity

At June 27, 2009, our principal sources of liquidity consisted of cash, cash equivalents and current marketable investments of $155.2 million and accounts receivable of $20.1 million. At June 27, 2009, we had a current ratio of 9.2 and held no long-term debt. Working capital of $243.7 million was down slightly compared to the March 28, 2009 balance of $246.9 million.

During fiscal 2009, we announced that we had agreed to acquire Zygo Corporation, but in the fourth quarter of fiscal 2009 we elected to pursue the termination of the proposed merger. As a result, we wrote off fees associated with the merger of $1.9 million as operating expenses on the Consolidated Statement of Operations for the year ended March 28, 2009. During the first quarter of fiscal 2010, the termination was formalized through the establishment of the Settlement Agreement with Zygo Corporation. Pursuant to the terms of the Settlement Agreement, we received a merger termination fee of $5.4 million in April 2009. The receipt of this fee, combined with additional merger-related costs of $0.9 million, resulted in a net benefit of $4.5 million in the first quarter of 2010. This benefit is reflected as Merger termination proceeds, net, on the Condensed Consolidated Statement of Operations for the fiscal quarter ended June 27, 2009.

On May 15, 2008, the Board of Directors authorized a share repurchase program for $20 million in shares of the Company's outstanding common stock primarily to offset dilution from equity compensation programs. Repurchases under the program 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. During the first quarter of fiscal 2010, the Company repurchased 64,960 shares for $0.6 million under this share repurchase program at an average price per share of $8.55, which was calculated inclusive of commissions and fees. As of June 27, 2009, a total of 372,825 shares have been repurchased at an average price of $14.16 per share, which was calculated inclusive of commissions and fees, totaling $5.3 million under this authorization. Cash used to settle repurchase transactions is reflected as a component of cash used in financing activities in the Condensed Consolidated Statements of Cash Flows. There is no fixed completion date for the repurchase program.

As of June 27, 2009, we held a total of $15.6 million invested in auction rate securities (ARS) at par value. Additionally, we held $4.0 million of par value ARS which were converted by the bond issuer to its preferred stock during the third quarter of 2009. The ARS are comprised predominately of securities issued by insurance companies to raise funds to meet regulatory capital reserve requirements and the ARS assume the credit ratings of the bond insurers who guarantee the timely payment of principal and interest on these insured securities. At the time of purchase in 2007, these ARS were rated AAA and AA. The contractual maturities of these securities range up to calendar year 2050, and several securities and the preferred stock do not have stated maturities. Prior to September 2007, these securities provided short-term liquidity through a Dutch auction process that reset the applicable interest rate at pre-determined calendar intervals, generally every 28 to 35 days. This mechanism previously allowed existing investors to either retain or liquidate their holdings by selling such securities at par. As a result of the liquidity issues experienced in the global credit and capital markets, during the second quarter of 2008, our ARS began to experience failed auctions.

Since that time, none of these securities have traded through the auction process and very few market transactions for these securities have been observed. Additionally, the bond insurers of the ARS and preferred stock experienced credit rating downgrades throughout fiscal 2009. Consequently, it was determined that the declines in fair value of these securities during 2009 represented other-than-temporary impairments in accordance with U.S. generally accepted accounting principles. Accordingly, at the end of each quarter of 2009, the cost bases of these securities were written down to their estimated fair values with other-than-temporary impairment charges totaling $13.6 million, of which $5.1 million was recorded during the first quarter of 2009. As of the first quarter of 2010, in accordance with the adoption of

FSP FAS No. 115-2 and FAS No. 124-2, we recorded a cumulative-effect adjustment to the opening balance of retained earnings of $0.4 million for the non-credit loss portion of the ARS. We also recorded a fair value adjustment to accumulated other comprehensive income of $1.1 million to reflect the estimated fair value of the ARS. The credit loss portion of the ARS was determined by direct estimation of the change in fair value attributable to market movements. We utilized market indices representing investments of constant credit quality over time and measured the index yield, which is considered attributable to non-credit related factors, at the beginning and end of the period. The effect of this change in yield on the value of the security was measured and subtracted . . .