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) 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 our second quarter of fiscal 2010, which ended September 26, 2009, reflected improvement from the prior quarter. Total order volume for the second quarter was $29.3 million, compared to $28.7 million for the first quarter of fiscal 2010, which ended June 27, 2009. The sequential increase in orders was driven by increases in our Semiconductor Group (SG) which offset lower orders in our Passive Components Group (PCG).

Orders for our SG products increased by over 25% for the second quarter compared to the prior quarter. The increase in orders for SG products reflected modest spending in non-memory markets as some customers chose to replace older systems to increase capacity.

Orders for our PCG products declined during the second quarter compared to the prior quarter. The decrease was driven primarily by timing of system orders as we received a multi-system order in the first quarter; however, orders for consumables and tooling increased due to improvements in our customers' utilization of existing tools.

Orders for our Interconnect/Micro-machining Group (IMG) products increased slightly during the second quarter compared to the first quarter.

Net sales increased $5.0 million for the second quarter to $27.6 million compared to $22.6 million for the prior quarter. This increase reflects improvements in each of our product groups.

Gross margin was 34.1% on net sales of $27.6 million for the second quarter compared to 26.4% on net sales of $22.6 million for the prior quarter. The increase in gross margin percentage reflects the benefit from higher sales volume and factory utilization as well as a favorable product and service 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.

Net operating expenses increased $3.9 million to $18.8 million in the second quarter compared to $14.9 million in the prior quarter. This increase was primarily driven by a one-time receipt of $4.5 million in the prior quarter of net proceeds from a merger termination fee. Excluding the net merger termination proceeds, net operating expenses decreased $0.6 million due to a $0.3 million decrease in share-based compensation, timing of project expenses between quarters and continued efforts to manage our cost structure. In our third quarter of fiscal 2010, we expect net operating expenses to increase as the quarter will include fourteen weeks rather than the usual thirteen weeks and also due to the partial reinstatement of temporary pay reductions.

Operating loss increased to $9.4 million in the second quarter compared to $8.9 million in the prior quarter. The increase was primarily due to the receipt of net merger termination proceeds of $4.5 million in the first quarter, partially offset by increased gross profit in the second quarter.

Net interest and other income of $0.4 million remained essentially flat in the second quarter compared to the prior quarter.

The effective tax rate was 32.1% for the second quarter, resulting in an income tax benefit of $2.9 million, compared to an effective rate of 35.7% for the prior quarter that resulted in an income tax benefit of $3.1 million.

Net loss for the second quarter was $6.1 million or $0.22 per basic and diluted share, compared to a net loss of $5.5 million or $0.20 per basic and diluted share in the prior quarter.

Results of Operations

Quarter Ended September 26, 2009 Compared to Quarter Ended September 27, 2008

The following table presents results of operations data as a percentage of net
sales for the quarters ended September 26, 2009 and September 27, 2008:



                                                             Fiscal quarter ended
                                                     Sep 26, 2009            Sep 27, 2008
Net sales                                                   100.0 %                 100.0 %
Cost of sales                                                65.9                    57.5

Gross margin                                                 34.1                    42.5
Selling, service and administration                          41.1                    27.7
Research, development and engineering                        26.9                    17.0
Restructuring costs                                            -                      2.4

Operating loss                                              (33.9 )                  (4.6 )
Other-than-temporary impairment of auction
rate securities                                                -                    (10.8 )
Interest and other income, net                                1.3                     2.2

Loss before income taxes                                    (32.6 )                 (13.2 )
Benefit from income taxes                                   (10.5 )                  (4.9 )

Net loss                                                    (22.1 )%                 (8.3 )%

Net Sales

Net sales were $27.6 million for the quarter ended September 26, 2009, a decrease of $22.0 million or 44.3% compared to net sales of $49.6 million for the quarter ended September 27, 2008. Compared to the prior year, revenue decreased in each of our product groups, reflecting the impact of the global economic downturn, which resulted in declining revenues throughout fiscal 2009. Although we experienced sequential improvement in net sales from the latter part of fiscal 2009, our revenue volume in the second quarter of fiscal 2010 was lower than a year ago as our worldwide customers continue to be severely affected by depressed demand for consumer electronics.

Net sales by product group for the quarter ended September 26, 2009 and September 27, 2008 were as follows:

                                                                     Fiscal quarter ended
                                                      Sep 26, 2009                          Sep 27, 2008
(In thousands, except percentages)            Net Sales      % of Net Sales         Net Sales      % of Net Sales
Semiconductor Group (SG)                     $     7,714               27.9 %      $    12,520               25.2 %
Passive Components Group (PCG)                     6,098               22.1 %            6,719               13.6 %
Interconnect/Micro-machining Group (IMG)          13,826               50.0 %           30,371               61.2 %

                                             $    27,638              100.0 %      $    49,610              100.0 %

SG sales in the quarter ended September 26, 2009 decreased $4.8 million or 38.4% compared to the quarter ended September 27, 2008. The overall decrease in sales was due to the continued weakness in the memory markets, as customer utilization of existing systems is below calendar 2008 capacity levels and has reduced the demand for new memory repair capital equipment.

PCG sales in the quarter ended September 26, 2009 decreased $0.6 million or 9.2% compared to the quarter ended September 27, 2008. Although PCG quarterly net sales have increased sequentially for the last three quarters, they continue to be impacted by the economic downturn and its impact on the demand for our customers' products and their need for expanding capacity.

IMG sales in the quarter ended September 26, 2009 decreased $16.5 million or 54.5% compared to the quarter ended September 27, 2008. Although the economic downturn has negatively impacted IMG sales, the year-over-year decrease was also impacted by large micro-machining sales that occurred in the second quarter of fiscal 2009.

Net sales by geographic region for the quarter ended September 26, 2009 and September 27, 2008 were as follows:

                                                                Fiscal quarter ended
                                                 Sep 26, 2009                          Sep 27, 2008
(In thousands, except percentages)       Net Sales      % of Net Sales         Net Sales      % of Net Sales
Asia                                    $    22,565               81.6 %      $    38,483               77.6 %
Americas                                      2,917               10.6 %            8,182               16.5 %
Europe                                        2,156                7.8 %            2,945                5.9 %

                                        $    27,638              100.0 %      $    49,610              100.0 %

Compared to the quarter ended September 27, 2008, net sales for the quarter ended September 26, 2009 decreased $15.9 million or 41.4% in Asia, $5.3 million or 64.3% in the Americas, and $0.8 million or 26.8% in Europe. These decreases reflect the impact of the global economic downturn experienced in each of our markets throughout 2009 and into fiscal 2010.

Gross Profit

Gross profit for the quarter ended September 26, 2009 and September 27, 2008 was
as follows:



                                                              Fiscal quarter ended
                                            Sep 26, 2009                               Sep 27, 2008
(In thousands, except
percentages)                      Gross Profit       % of Net Sales          Gross Profit       % of Net Sales
Gross profit                      $       9,426                34.1 %       $       21,072                42.5 %

Gross profit for the quarter ended September 26, 2009 was $9.4 million, a decrease of $11.6 million compared to gross profit of $21.1 million for the quarter ended September 27, 2008. Gross profit as a percentage of net sales decreased to 34.1% for the quarter ended September 26, 2009 from 42.5% for the quarter ended September 27, 2008. These decreases were primarily related to lower revenue levels along with an associated reduction in production capacity utilization. In response to the reduction 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 quarter ended September 26, 2009 and September 27,
2008 were as follows:



                                                               Fiscal quarter ended
                                                 Sep 26, 2009                       Sep 27, 2008
(In thousands, except percentages)        Expense      % of Net Sales        Expense      % of Net Sales
Selling, service and administration       $ 11,355               41.1 %      $ 13,746               27.7 %
Research, development and engineering        7,441               26.9           8,446               17.0
Restructuring costs                             -                  -            1,174                2.4

                                          $ 18,796               68.0 %      $ 23,366               47.1 %

Selling, Service and Administration

Selling, service and administration (SS&A) primarily consists of labor and other employee-related expenses including share-based compensation expense, travel expense, professional fees, sales commissions and facilities costs. SS&A expenses were $11.4 million for the quarter ended September 26, 2009, a decrease of $2.4 million compared to $13.7 million in the quarter ended September 27, 2008. The decrease in SS&A expenses was primarily attributable to restructuring and cost management activities completed in 2009. These actions have included company-wide reductions in force and related decreases in compensation and labor-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 $0.8 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 the incremental cost of the Company's annual stock grant. In our third quarter, we expect SS&A expenses to increase as the quarter will include fourteen weeks rather than the usual thirteen weeks and also due to the partial reinstatement of temporary pay reductions.

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, equipment costs and facilities costs. RD&E expenses totaled $7.4 million for the quarter ended September 26, 2009 compared to $8.5 million for the quarter ended September 27, 2008. This decrease was primarily due to reductions in employee-related expenses resulting from our cost containment actions, and to a lesser extent, lower project materials expense. Engineering project expenses can fluctuate from quarter-to-quarter depending upon the various project timelines and content. In our third quarter, we expect RD&E expenses to increase as the quarter will include fourteen weeks rather than the usual thirteen weeks and also due to the partial reinstatement of temporary pay reductions.

Restructuring Costs

No restructuring expenses were incurred during the quarter ended September 26, 2009. During the quarter ended September 27, 2008, $1.2 million of restructuring expenses were incurred as a result of reductions in workforce taken in that quarter in response to lower customer demand, resulting from weakness in the memory market and reductions in customer capital spending.

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 quarter ended September 26, 2009. During the quarter ended September 27, 2008, $5.4 million of impairment charges were incurred as instability in the global financial markets impacted the estimated fair values of our ARS. Given the continued challenges in the financial markets and the prolonged credit crisis, we cannot reasonably predict when or if these ARS will become liquid. See Note 4 "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 quarter ended September 26, 2009 and September 27, 2008 were as follows:

                                                              Fiscal quarter ended
                                            Sep 26, 2009                                Sep 27, 2008
                                  Interest and                                Interest and
(In thousands, except             Other Income,                               Other Income,
percentages)                           Net            % of Net Sales               Net            % of Net Sales
Interest and other income,
net                              $           357                 1.3 %       $         1,117                 2.2 %

Interest and other income, net, for the quarter ended September 26, 2009 decreased $0.8 million compared to the quarter ended September 27, 2008. The decrease was primarily attributable to a $0.7 million decrease in interest income attributable to declines in market interest rates during this period.

Income Taxes

The income tax benefit for the quarter ended September 26, 2009 was $2.9 million on pretax loss of $9.0 million, an effective tax rate of 32.1%. Comparatively, the income tax benefit was $2.4 million on a pretax loss of $6.6 million for the quarter ended September 27, 2008, an effective tax rate of 37.3%.

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, finalization of income tax returns and also due to the relationship of fixed deductions to overall changes in pretax income or loss. 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 losses for the quarter ended September 26, 2009 and September 27, 2008 were as follows:

Fiscal quarter ended Sep 26, 2009 Sep 27, 2008 (In thousands, except percentages) Net Loss % of Net Sales Net Loss % of Net Sales Net loss $ (6,120 ) (22.1 )% $ (4,109 ) (8.3 )%

Net loss for the quarter ended September 26, 2009 was $6.1 million, or $0.22 per basic and diluted share, compared to net loss of $4.1 million, or $0.15 per basic and diluted share for the quarter ended September 27, 2008. The decrease was primarily the result of lower revenues and reduced gross profit.

Two Quarters Ended September 26, 2009 Compared to Two Quarters Ended
September 27, 2008

The following table presents results of operations data as a percentage of net
sales for the two quarters ended September 26, 2009 and September 27, 2008:



                                                          Two fiscal quarters ended
                                                     Sep 26, 2009            Sep 27, 2008
Net sales                                                   100.0 %                 100.0 %
Cost of sales                                                69.4                    59.2

Gross margin                                                 30.6                    40.8
Selling, service and administration                          46.5                    25.3
Research, development and engineering                        29.6                    15.9
Restructuring costs                                            -                      1.7
Merger termination proceeds, net                             (9.0 )                    -

Operating loss                                              (36.5 )                  (2.1 )
Other-than-temporary impairment of auction
rate securities                                                -                     (9.2 )
Interest and other income, net                                1.4                     1.7

Loss before income taxes                                    (35.1 )                  (9.6 )
Benefit from income taxes                                   (11.9 )                  (3.6 )

Net loss                                                    (23.2 )%                 (6.0 )%

Net Sales

Net sales for the two quarters ended September 26, 2009 of $50.2 million decreased by $63.4 million or 55.8% over net sales for the two quarters ended September 27, 2008. Revenue decreased in each of our product groups, reflecting the impact to customer demand resulting from the global economic recession. Our worldwide customers have been severely affected by depressed consumer demand for consumer electronics that started in calendar 2008 and has continued throughout calendar 2009.

Net sales by product group for the two quarters ended September 26, 2009 and September 27, 2008 were as follows:

                                                            Two fiscal quarters ended
                                                Sep 26, 2009                         Sep 27, 2008
(In thousands, except percentages)      Net Sales      % of Net Sales        Net Sales      % of Net Sales
Semiconductor Group (SG)               $    12,974               25.8 %      $   34,248               30.1 %
Passive Components Group (PCG)              11,248               22.4 %          19,994               17.6 %
Interconnect/Micro-machining Group
(IMG)                                       26,019               51.8 %          59,392               52.3 %

                                       $    50,241              100.0 %      $  113,634              100.0 %

SG sales in the two quarters ended September 26, 2009 decreased $21.3 million or 62.1% compared to the two quarters ended September 27, 2008. The decrease in sales was due to continued weakness in the memory markets, as customer utilization of existing systems is below calendar 2008 capacity levels and has reduced the demand for new memory repair capital equipment.

PCG sales in the two quarters ended September 26, 2009 decreased $8.7 million or 43.7% compared to the two quarters ended September 27, 2008. The decrease in PCG sales was driven by higher sales volumes in the first quarter of 2009 resulting from capacity buys from key customers in that quarter. Following that point, we saw demand for our products drop as lower consumer demand and utilization rates impacted our customers.

IMG sales in the two quarters ended September 26, 2009 decreased $33.4 million or 56.2% compared to the two quarters ended September 27, 2008. The decrease was primarily due to strong sales that occurred in the two quarters ended September 27, 2008 for our micro-machining products driven by initial demand for the Model 5800 released during the first quarter of 2009.

Net sales by geographic region for the two quarters ended September 26, 2009 and September 27, 2008 were as follows:

                                                            Two fiscal quarters ended
                                                Sep 26, 2009                         Sep 27, 2008
(In thousands, except percentages)      Net Sales      % of Net Sales        Net Sales      % of Net Sales
Asia                                   $    38,652               76.9 %      $   82,922               73.0 %
Americas                                     7,204               14.4 %          21,085               18.6 %
Europe                                       4,385                8.7 %           9,627                8.4 %

                                       $    50,241              100.0 %      $  113,634              100.0 %

Compared to the two quarters ended September 27, 2008, net sales for the two quarters ended September 26, 2009 decreased $44.3 million or 53.4% in Asia, $13.9 million or 65.8% in the Americas, and $5.2 million or 54.5% in Europe. The decreases in each of these regions reflect the impact of the global economic downturn.

Gross Profit

Gross profit for the two quarters ended September 26, 2009 and September 27, 2008 was as follows:

Two fiscal quarters ended Sep 26, 2009 Sep 27, 2008 (In thousands, except percentages) Gross Profit % of Net Sales Gross Profit % of Net Sales Gross profit $ 15,387 30.6 % $ 46,363 40.8 %

Gross profit for the two quarters ended September 26, 2009 was $15.4 million, a decrease of $31.0 million compared to gross profit of $46.4 million for the two quarters ended September 27, 2008. Gross profit as a percentage of net sales decreased to 30.6% for the two quarters ended September 26, 2009 from 40.8% for the two quarters ended September 27, 2008. These decreases were primarily related to decreased revenue levels along with an associated reduction in production capacity utilization. In response to the reductions in business, . . .