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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the quarterly period ended December 2, 2006

OR



| ̈ | 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



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ELECTRO SCIENTIFIC INDUSTRIES,
INC.



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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: (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  x    No ̈

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x

The number
of shares outstanding of the Registrants Common Stock at January 3, 2006 was 26,156,689 shares.



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##### Table of Contents

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

TABLE OF CONTENTS



|                               |  |                                                                                                                            |  |   
|------------------------------ |  | -------------------------------------------------------------------------------------------------------------------------- |  | --
|                               |  | Page                                                                                                                      
|PART I - FINANCIAL INFORMATION |  |                                                                                                                           
|                               |  |                                                                                                                           
|Item 1 .                       |  | Consolidated Condensed Financial Statements (unaudited)                                                                    |  |   
|                               |  |                                                                                                                           
|                               |  | Consolidated Condensed Balance Sheets  December 2, 2006 and June 3, 2006                                                  |  | 2 
|                               |  |                                                                                                                           
|                               |  | Consolidated Condensed Statements of Operations  Three Months and Six Months Ended December 2, 2006 and November 26, 2005 |  | 3 
|                               |  |                                                                                                                           
|                               |  | Consolidated Condensed Statements of Cash Flows  Six Months Ended December 2, 2006 and November 26, 2005                  |  | 4 
|                               |  |                                                                                                                           
|                               |  | Notes to Consolidated Condensed Financial Statements                                                                       |  | 5 
|                               |  |                                                                                                                           
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                      |  | 17
|                               |  |                                                                                                                           
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                                                                 |  | 24
|                               |  |                                                                                                                           
|Item 4.                        |  | Controls and Procedures                                                                                                    |  | 24
|                               | 
|PART II - OTHER INFORMATION    |  |                                                                                                                           
|                               |  |                                                                                                                           
|Item 1.                        |  | Legal Proceedings                                                                                                          |  | 25
|                               |  |                                                                                                                           
|Item 1A.                       |  | Risk Factors                                                                                                               |  | 25
|                               |  |                                                                                                                           
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                                                        |  | 33
|                               |  |                                                                                                                           
|Item 6.                        |  | Exhibits                                                                                                                   |  | 34
|                               | 
|Signatures                     |  | 35                                                                                                                        



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##### Table of Contents

PART 1 - FINANCIAL INFORMATION

Item 1. Financial Statements

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands)

(Unaudited)



|                                                                                                     |  |                 |         |             |   |         |  
|---------------------------------------------------------------------------------------------------- |  | --------------- | ------- | ----------- | - | ------- | -
|                                                                                                     |  | December 2,2006 |         | June 3,2006 |  
|Assets                                                                                               |  |                 |         |             |   |         |  
|Current assets:                                                                                      |  |                 |         |             |   |         |  
|Cash and cash equivalents                                                                            |  | $               | 89,271  |             | $ | 79,961  |  
|Marketable securities                                                                                |  |                 | 125,184 |             |   | 140,106 |  
|                                                                                                     |  |                 |         |             |   |         |  
|Total cash and securities                                                                            |  |                 | 214,455 |             |   | 220,067 |  
|                                                                                                     |  |                
|Trade receivables, net of allowances of $627 and $689                                                |  |                 | 53,582  |             |   | 47,978  |  
|Income tax refund receivable                                                                         |  |                 | 691     |             |   | 1,570   |  
|Inventories                                                                                          |  |                 | 72,302  |             |   | 63,834  |  
|Shipped systems pending acceptance                                                                   |  |                 | 3,221   |             |   | 3,941   |  
|Deferred income taxes                                                                                |  |                 | 12,104  |             |   | 11,982  |  
|Prepaid and other current assets                                                                     |  |                 | 8,250   |             |   | 4,410   |  
|                                                                                                     |  |                 |         |             |   |         |  
|Total current assets                                                                                 |  |                 | 364,605 |             |   | 353,782 |  
|                                                                                                     |  |                
|Long-term marketable securities                                                                      |  |                 | 3,009   |             |   | 9,265   |  
|Property, plant and equipment, net of accumulated depreciation of $55,118 and $51,162                |  |                 | 45,050  |             |   | 43,338  |  
|Deferred income taxes, net                                                                           |  |                 | 10,128  |             |   | 13,318  |  
|Other assets                                                                                         |  |                 | 31,924  |             |   | 17,762  |  
|                                                                                                     |  |                 |         |             |   |         |  
|Total assets                                                                                         |  | $               | 454,716 |             | $ | 437,465 |  
|                                                                                                     |  |                 |         |             |   |         |  
|Liabilities and shareholders equity                                                                 |  |                 |         |             |   |         |  
|Current liabilities:                                                                                 |  |                 |         |             |   |         |  
|Accounts payable                                                                                     |  | $               | 13,298  |             | $ | 11,272  |  
|Accrued liabilities                                                                                  |  |                 | 25,608  |             |   | 24,705  |  
|Deferred revenue                                                                                     |  |                 | 13,344  |             |   | 13,321  |  
|                                                                                                     |  |                 |         |             |   |         |  
|Total current liabilities                                                                            |  |                 | 52,250  |             |   | 49,298  |  
|                                                                                                     |  |                
|Commitments and contingencies                                                                        |  |                 |         |             |   |         |  
|                                                                                                     |  |                
|Shareholders equity:                                                                                |  |                 |         |             |   |         |  
|Preferred stock, without par value; 1,000 shares authorized; no shares issued                        |  |                 |        |             |   |        |  
|Common stock, without par value; 100,000 authorized; 29,154 and 29,051 shares issued and outstanding |  |                 | 169,492 |             |   | 166,459 |  
|Retained earnings                                                                                    |  |                 | 232,583 |             |   | 222,022 |  
|Accumulated other comprehensive income (loss)                                                        |  |                 | 391     |             |   | (314    | )
|                                                                                                     |  |                 |         |             |   |         |  
|Total shareholders equity                                                                           |  |                 | 402,466 |             |   | 388,167 |  
|                                                                                                     |  |                 |         |             |   |         |  
|Total liabilities and shareholders equity                                                           |  | $               | 454,716 |             | $ | 437,465 |  
|                                                                                                     |  |                 |         |             |   |         |  

The accompanying notes are an integral part of these statements.



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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(unaudited)



|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|------------------------------------------------- |  | -------------------------- | ------ | ------------------------ | ----------------- | - | ---------------- |  | - | ----------------- | - |  | - | ------
|                                                  |  | For the three months ended |        | For the six months ended
|                                                  |  | December 2, 2006           |        |                          | November 26, 2005 |   | December 2, 2006 |  |   | November 26, 2005
|Net sales                                         |  | $                          | 59,301 |                          |                   | $ | 48,643           |  | $ | 119,465           |   |  | $ | 93,151
|Cost of sales                                     |  |                            | 35,027 |                          |                   |   | 27,475           |  |   | 67,910            |   |  |   | 52,336
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|Gross profit                                      |  |                            | 24,274 |                          |                   |   | 21,168           |  |   | 51,555            |   |  |   | 40,815
|                                                  |  |                            |        |                         
|Operating expenses:                               |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|Selling, service and administration               |  |                            | 12,023 |                          |                   |   | 11,365           |  |   | 24,181            |   |  |   | 22,442
|Research, development and engineering             |  |                            | 9,617  |                          |                   |   | 7,983            |  |   | 18,921            |   |  |   | 15,812
|Insurance recoveries                              |  |                            | (1,000 | )                        |                   |   |                 |  |   | (2,287            | ) |  |   |      
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|                                                  |  |                            | 20,640 |                          |                   |   | 19,348           |  |   | 40,815            |   |  |   | 38,254
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|Operating income                                  |  |                            | 3,634  |                          |                   |   | 1,820            |  |   | 10,740            |   |  |   | 2,561 
|Interest and other income, net                    |  |                            | 2,278  |                          |                   |   | 2,270            |  |   | 5,188             |   |  |   | 3,511 
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|Income before income taxes                        |  |                            | 5,912  |                          |                   |   | 4,090            |  |   | 15,928            |   |  |   | 6,072 
|Provision for income taxes                        |  |                            | 2,123  |                          |                   |   | 902              |  |   | 5,367             |   |  |   | 1,537 
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|Net income                                        |  | $                          | 3,789  |                          |                   | $ | 3,188            |  | $ | 10,561            |   |  | $ | 4,535 
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|Net income per share - basic and fully diluted    |  | $                          | 0.13   |                          |                   | $ | 0.11             |  | $ | 0.36              |   |  | $ | 0.16  
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|Weighted average number of shares - basic         |  |                            | 29,128 |                          |                   |   | 28,705           |  |   | 29,102            |   |  |   | 28,674
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       
|Weighted average number of shares - fully diluted |  |                            | 29,522 |                          |                   |   | 28,997           |  |   | 29,303            |   |  |   | 28,896
|                                                  |  |                            |        |                          |                   |   |                  |  |   |                   |   |  |   |       

The accompanying notes are an integral part of these statements.



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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASHFLOWS

(In thousands)

(Unaudited)



|                                                                                  |  |                          |          |   |                   |   |          |  
|--------------------------------------------------------------------------------- |  | ------------------------ | -------- | - | ----------------- | - | -------- | -
|                                                                                  |  | For the six months ended |         
|                                                                                  |  | December 2, 2006         |          |   | November 26, 2005 |  
|Cash flows from operating activities:                                             |  |                          |          |   |                   |   |          |  
|Net income                                                                        |  | $                        | 10,561   |   |                   | $ | 4,535    |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                          |          |   |                   |   |          |  
|Depreciation and amortization                                                     |  |                          | 4,108    |   |                   |   | 3,858    |  
|Insurance recovery on damaged equipment                                           |  |                          | (1,287   | ) |                   |   |         |  
|Stock-based compensation expense                                                  |  |                          | 1,488    |   |                   |   | 936      |  
|Tax benefit of stock options exercised                                            |  |                          |         |   |                   |   | 890      |  
|Provision for doubtful accounts                                                   |  |                          | 104      |   |                   |   | (144     | )
|Loss on disposal of property and equipment                                        |  |                          |         |   |                   |   | 46       |  
|Deferred income taxes                                                             |  |                          | 2,947    |   |                   |   | 320      |  
|Changes in operating accounts:                                                    |  |                          |          |   |                   |   |          |  
|Increase in trade receivables, net                                                |  |                          | (5,344   | ) |                   |   | (491     | )
|Decrease in income tax refund receivable                                          |  |                          | 879      |   |                   |   | 7,809    |  
|(Increase) decrease in inventories, net                                           |  |                          | (12,142  | ) |                   |   | 1,578    |  
|Decrease in shipped systems pending acceptance                                    |  |                          | 720      |   |                   |   | 749      |  
|Increase in prepaid and other current assets                                      |  |                          | (3,722   | ) |                   |   | (1,855   | )
|Increase in accounts payable and other current liabilities                        |  |                          | 2,927    |   |                   |   | 7,533    |  
|Increase in deferred revenue                                                      |  |                          | 23       |   |                   |   | 356      |  
|                                                                                  |  |                          |          |   |                   |   |          |  
|Net cash provided by operating activities                                         |  |                          | 1,262    |   |                   |   | 26,120   |  
|                                                                                  |  |                         
|Cash flows from investing activities:                                             |  |                          |          |   |                   |   |          |  
|Purchase of property, plant and equipment                                         |  |                          | (5,718   | ) |                   |   | (9,478   | )
|Purchase of securities                                                            |  |                          | (281,840 | ) |                   |   | (275,932 | )
|Proceeds from sales of securities and maturing securities                         |  |                          | 303,512  |   |                   |   | 296,507  |  
|Purchase of minority equity investments                                           |  |                          | (11,000  | ) |                   |   |         |  
|Insurance recovery on damaged equipment                                           |  |                          | 1,287    |   |                   |   |         |  
|(Increase) decrease in other assets                                               |  |                          | 397      |   |                   |   | (6,373   | )
|                                                                                  |  |                          |          |   |                   |   |          |  
|Net cash provided by investing activities                                         |  |                          | 6,638    |   |                   |   | 4,724    |  
|                                                                                  |  |                         
|Cash flows from financing activities:                                             |  |                          |          |   |                   |   |          |  
|Proceeds from exercise of stock options and stock plans                           |  |                          | 1,410    |   |                   |   | 1,750    |  
|                                                                                  |  |                          |          |   |                   |   |          |  
|Net cash provided by financing activities                                         |  |                          | 1,410    |   |                   |   | 1,750    |  
|                                                                                  |  |                          |          |   |                   |   |          |  
|Net change in cash and cash equivalents                                           |  |                          | 9,310    |   |                   |   | 32,594   |  
|                                                                                  |  |                         
|Cash and cash equivalents:                                                        |  |                          |          |   |                   |   |          |  
|Beginning of period                                                               |  |                          | 79,961   |   |                   |   | 61,314   |  
|                                                                                  |  |                          |          |   |                   |   |          |  
|End of period                                                                     |  | $                        | 89,271   |   |                   | $ | 93,908   |  
|                                                                                  |  |                          |          |   |                   |   |          |  
|Supplemental cash flow information:                                               |  |                          |          |   |                   |   |          |  
|Income tax refunds received                                                       |  | $                        | 331      |   |                   | $ | 8,603    |  
|Cash paid for income taxes                                                        |  |                          | (939     | ) |                   |   | (1,156   | )

The accompanying notes are an integral part of these statements.



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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of Presentation

These unaudited interim consolidated
condensed 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 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. These consolidated condensed 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.

Results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

With the exception of the accounting for minority equity investments as discussed in Note 3 and the adoption of SFAS 123R, Share-Based Payment, as discussed
in Note 9, the Companys significant accounting policies remain unchanged from those presented in Note 1 to the consolidated financial statements included in the Companys Annual Report on Form 10-K filed for the fiscal year ended
June 3, 2006.

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: inventory write-downs; allowances for uncollectible trade accounts
receivables; long-lived assets valuations; product warranty reserves; loss contingency reserves; revenue recognition; and income tax benefits, expenses and deferred taxes. Beginning in the first quarter of fiscal 2007, the calculation of stock-based
compensation expense under Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, requires the use of valuation methodologies and a number of assumptions, estimates and conclusions regarding matters such as
expected forfeitures, expected volatility of the Companys stock price, the expected dividend rate with respect to the Companys common stock and the exercise behavior of its employees.

Note 2 - Inventories

Inventories are principally valued at standard
costs, which approximate the lower of cost (on a first-in, first-out basis) or market. Components of inventories were as follows (in thousands):



|                                  |  |                 |        |             |   |       
|--------------------------------- |  | --------------- | ------ | ----------- | - | ------
|                                  |  | December 2,2006 |        | June 3,2006
|Raw materials and purchased parts |  | $               | 45,190 |             | $ | 41,830
|Work-in-process                   |  |                 | 16,569 |             |   | 9,498 
|Finished goods                    |  |                 | 10,543 |             |   | 12,506
|                                  |  |                 |        |             |   |       
|                                  |  | $               | 72,302 |             | $ | 63,834
|                                  |  |                 |        |             |   |       



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Note 3  Other Assets

Other assets consisted of the following (in thousands):



|                                    |  |                 |        |             |   |       
|----------------------------------- |  | --------------- | ------ | ----------- | - | ------
|                                    |  | December 2,2006 |        | June 3,2006
|Goodwill                            |  | $               | 1,442  |             | $ | 1,442 
|Patents, net                        |  |                 | 218    |             |   | 249   
|Consignment and demo equipment, net |  |                 | 11,660 |             |   | 8,335 
|Minority equity investment          |  |                 | 11,000 |             |   |      
|Other                               |  |                 | 7,604  |             |   | 7,736 
|                                    |  |                 |        |             |   |       
|                                    |  | $               | 31,924 |             | $ | 17,762
|                                    |  |                 |        |             |   |       

Consigned, demonstration and training equipment is recorded at the lower of standard costs or estimated market
values, until the assets are sold. Demonstration equipment consists of equipment removed from inventory to support system demonstrations at the Companys regional sales offices as well as at customer locations. Demonstration equipment sent to
customer sites is subject to a contractual loan agreement. These loan agreements do not include requirements to purchase the equipment either during or at the end of the loan period. Historically, this equipment is subsequently sold at amounts in
excess of standard cost, and any write downs from standard cost required to reflect net realizable value have been insignificant to date. These assets are reviewed quarterly for impairment.

In the first quarter of fiscal 2007, the Company invested $6.0 million in a Series D preferred stock financing for OmniGuide, Inc. The Companys investment
represents an 11% interest in OmniGuide, Inc. In the second quarter of fiscal 2007, the Company invested $5.0 million in a Series D preferred stock financing for Axsun Technologies, Inc. The Companys investment represents a 14.5% interest in
Axsun Technologies, Inc. These investments are accounted for as cost method investments as specified by APB 18, The Equity Method of Accounting for Investments in Common Stock. In accordance with EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, assessments of potential impairment for these investments are performed for each applicable reporting period. The Company determined that there was no impairment at
December 2, 2006.

Note 4  Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):



|                                         |  |                 |        |             |   |       
|---------------------------------------- |  | --------------- | ------ | ----------- | - | ------
|                                         |  | December 2,2006 |        | June 3,2006
|Payroll-related                          |  | $               | 7,269  |             | $ | 8,445 
|Product warranty                         |  |                 | 3,822  |             |   | 3,716 
|Accrual for loss on purchase commitments |  |                 | 287    |             |   | 287   
|Income taxes payable                     |  |                 | 6,649  |             |   | 4,846 
|Other                                    |  |                 | 7,581  |             |   | 7,411 
|                                         |  |                 |        |             |   |       
|                                         |  | $               | 25,608 |             | $ | 24,705
|                                         |  |                 |        |             |   |       

See Note 5 for a discussion of the accrual for product warranty.

Note 5  Product Warranty

The Company evaluates obligations
related to product warranties quarterly. A standard one-year warranty is provided on most products. Warranty charges are comprised of costs to service the warranty, including labor to repair the system and replacement parts for defective items, as
well as other costs incidental to the repairs. Warranty charges are recorded net of any cost recoveries resulting from either



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successful repair of damaged parts or from warranties offered by the Companys suppliers for defective components.
Using historical data, the Company estimates average warranty cost per system or part type and records the provision for such charges as an element of cost of goods sold. Additionally, the overall warranty accrual balance is separately analyzed
using the remaining warranty periods outstanding on systems and items under warranty, and any resulting changes in estimates are recorded as an adjustment to cost of sales. If circumstances change, or if a material change in warranty-related
incidents occurs, the estimate of the warranty accrual could change significantly. Accrued product warranty is included on the balance sheet as a component of accrued liabilities.

Following is a reconciliation of the change in the aggregate accrual for product warranty for the six months ended December 2, 2006 and November 26, 2005 (in thousands):



|                                    |  |                 |        |   |                  |   |        |  
|----------------------------------- |  | --------------- | ------ | - | ---------------- | - | ------ | -
|                                    |  | December 2,2006 |        |   | November 26,2005 |  
|Product warranty accrual, beginning |  | $               | 3,716  |   |                  | $ | 3,625  |  
|Warranty charges incurred, net      |  |                 | (2,573 | ) |                  |   | (2,397 | )
|Provision for warranty charges      |  |                 | 2,679  |   |                  |   | 2,050  |  
|                                    |  |                 |        |   |                  |   |        |  
|Product warranty accrual, ending    |  | $               | 3,822  |   |                  | $ | 3,278  |  
|                                    |  |                 |        |   |                  |   |        |  

Note 6  Deferred Revenue

Revenue is deferred pending title transfer and fulfillment of acceptance criteria, which frequently occur at the time of delivery to a common carrier. Shipments for which title transfer has not occurred and/or
acceptance criteria cannot be demonstrated at the Companys factory include sales to Japanese end-user customers and shipments of substantially new products. In sales involving multiple element arrangements, the fair value 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 recognized ratably over the duration of the contracts.

The following is a reconciliation of the changes in deferred revenue for the six months ended December 2, 2006 and November 26, 2005 (in
thousands):



|                            |  |                 |         |   |                  |   |        |  
|--------------------------- |  | --------------- | ------- | - | ---------------- | - | ------ | -
|                            |  | December 2,2006 |         |   | November 26,2005 |  
|Deferred revenue, beginning |  | $               | 13,321  |   |                  | $ | 12,986 |  
|Revenue deferred            |  |                 | 13,584  |   |                  |   | 9,547  |  
|Revenue recognized          |  |                 | (13,561 | ) |                  |   | (9,191 | )
|                            |  |                 |         |   |                  |   |        |  
|Deferred revenue, ending    |  | $               | 13,344  |   |                  | $ | 13,342 |  
|                            |  |                 |         |   |                  |   |        |  



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Note 7  Earnings Per Share

Following is a reconciliation of weighted average shares outstanding and adjustments to net income used in the calculation of basic and diluted earnings per share (EPS) for the three months and six months ended
December 2, 2006 and November 26, 2005 (in thousands):



|                                                            |  |                                    |  |                                     |  |            |       |        |       
|----------------------------------------------------------- |  | ---------------------------------- |  | ----------------------------------- |  | ---------- | ----- | ------ | ------
|                                                            |  | Three months endedDecember 2, 2006 |  | Three months endedNovember 26, 2005
|                                                            |  | Net Income                         |  | Shares                              |  | Net Income |       | Shares
|Net income available to common shareholders  basic         |  | 3,789                              |  | 29,128                              |  | $          | 3,188 |        | 28,705
|Effect of dilutive stock options                            |  |                                   |  | 394                                 |  |            |      |        | 292   
|                                                            |  |                                    |  |                                     |  |            |       |        |       
|Net income available to common shareholders  fully diluted |  | 3,789                              |  | 29,522                              |  | $          | 3,188 |        | 28,997
|                                                            |  |                                    |  |                                     |  |            |       |        |       



|                                                                   |  |                                  |  |                                   |  |            |       |        |       
|------------------------------------------------------------------ |  | -------------------------------- |  | --------------------------------- |  | ---------- | ----- | ------ | ------
|                                                                   |  | Six months endedDecember 2, 2006 |  | Six months endedNovember 26, 2005
|                                                                   |  | Net Income                       |  | Shares                            |  | Net Income |       | Shares
|Net income available to common shareholders  basic                |  | 10,561                           |  | 29,102                            |  | $          | 4,535 |        | 28,674
|Effect of dilutive stock options                                   |  |                                 |  | 201                               |  |            |      |        | 222   
|                                                                   |  |                                  |  |                                   |  |            |       |        |       
|Net income available to common common shareholders  fully diluted |  | 10,561                           |  | 29,303                            |  | $          | 4,535 |        | 28,896
|                                                                   |  |                                  |  |                                   |  |            |       |        |       

For the three months ended December 2, 2006 and November 26, 2005, there were approximately 2,748,000
and 2,603,000, respectively, common stock equivalents excluded from the diluted EPS calculations because inclusion would have had an antidilutive effect. For the six months ended December 2, 2006 and November 26, 2005, there were
approximately 3,606,000 and 2,720,000, respectively, antidilutive common stock equivalents excluded from the diluted EPS calculations.

Note 8 -
Comprehensive Income

The components of comprehensive income, net of tax, are as follows (in thousands):



|                                                                          |  |                    |       |   |                  |   |       |                 |  |   |                  |   |  |   |       |  
|------------------------------------------------------------------------- |  | ------------------ | ----- | - | ---------------- | - | ----- | --------------- |  | - | ---------------- | - |  | - | ----- | -
|                                                                          |  | Three months ended |       |   | Six months ended |  
|                                                                          |  | December 2,2006    |       |   | November 26,2005 |   |       | December 2,2006 |  |   | November 26,2005 |  
|Net income                                                                |  | $                  | 3,789 |   |                  | $ | 3,188 |                 |  | $ | 10,561           |   |  | $ | 4,535 |  
|Net unrealized gain (loss) on foreign exchange hedge contracts            |  |                    | (6    | ) |                  |   | 18    |                 |  |   | (11              | ) |  |   | 29    |  
|Foreign currency translation adjustment                                   |  |                    | 406   |   |                  |   | (353  | )               |  |   | 222              |   |  |   | (590  | )
|Net unrealized gain (loss) on securities classified as available for sale |  |                    | 231   |   |                  |   | (81   | )               |  |   | 494              |   |  |   | (148  | )
|                                                                          |  |                    |       |   |                  |   |       |                 |  |   |                  |   |  |   |       |  
|                                                                          |  | $                  | 4,420 |   |                  | $ | 2,772 |                 |  | $ | 11,266           |   |  | $ | 3,826 |  
|                                                                          |  |                    |       |   |                  |   |       |                 |  |   |                  |   |  |   |       |  



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Note 9  Stock Based Compensation Plans

On June 4, 2006, the Company adopted the provisions of SFAS 123R, Share-Based Payment, requiring the Company to recognize expense related to the fair value of its stock-based compensation awards. The
Company has elected to use the modified prospective transition method as permitted by SFAS 123R and therefore financial statement amounts for the prior periods presented in this Form 10-Q have not been restated to reflect the fair value method of
expensing stock-based compensation. Under this method, the provisions of SFAS 123R apply to all awards granted or modified after the date of adoption. Additionally, stock-based compensation expense under SFAS 123R includes expense for unvested
stock-based payment awards granted prior to June 3, 2006 based on the grant date fair value determined in accordance with the pro forma provisions of SFAS 123, Accounting for Stock-Based Compensation. The Company uses the
Black-Scholes model to estimate the fair value of all stock-based compensation awards on the date of grant, except for unvested stock awards which are valued at the fair market value on the date of award. The Company recognizes the compensation
expense for options and unvested stock awards on a straight-line basis over the requisite service period of each award.

In October 2004, the shareholders
approved the adoption of the 2004 Stock Incentive Plan (the 2004 Plan) that replaced various stock compensation plans that were previously approved by the shareholders or the Board of Directors (the Replaced Plans), except with respect to options
and other awards previously outstanding. Outstanding options and awards remained subject to the terms of the Replaced Plans under which they were originally granted. At that time, the shareholders also approved the reservation of 3,000,000 shares of
common stock for issuance under the 2004 Plan. These shares are in addition to any shares of common stock that, at the time the 2004 Plan was approved by shareholders, were available for grant under the Replaced Plans or that may subsequently become
available for grant under any of the Replaced Plans through the expiration, termination, forfeiture or cancellation of grants. In January 2005, the Board of Directors approved certain amendments to the 2004 Plan. These amendments prohibit option
grants with an exercise price less than fair market value, require that time-based restricted stock awards have a minimum vesting period of at least three years, with the subject shares vesting no more quickly than one-third annually over the
three-year period, and expressly prohibit the reservation of additional shares under the 2004 Plan without shareholder approval. In April 2005, the Board of Directors approved another amendment to the 2004 Plan extending the period during which an
option may be exercised following termination of employment or service if an optionee dies within the 90-day exercise period following termination.

The
2004 Plan allows for grants of stock options, stock bonuses, restricted stock or performance-based awards. Stock options outstanding under the 2004 Plan and the Replaced Plans vest over variable periods determined at the grant date, generally with
terms of immediate vesting or up to four years, and expire ten years from the date of grant. Certain options granted in fiscal 2006 vested immediately or prior to the end of the fiscal year with sale restrictions. Options issued under the 2004 Plan
and the Replaced Plans are exercisable at prices not less than fair market value on the date of the grant. The 2004 Plan prohibits repricing of options granted without prior shareholder approval. Restricted stock grants issued under the Replaced
Plans vest based on certain performance criteria that are tied to the Companys results of operations, stock price and/or length of service. Certain restricted stock units awarded under the 2004 Plan vest based on performance criteria that are
tied to the Companys results of operations, personal performance criteria, and, in certain cases, length of service.

On June 28, 2004 and
January 25, 2005, the Compensation Committee of the Board of Directors (the Compensation Committee) accelerated the vesting of certain unvested stock options awarded to employees that had an option price equal to or greater than the closing
sale price per share on those respective acceleration dates. No compensation expense was recorded in the consolidated statements of operations related to those modifications as the market price of the common stock on the date of the modification was
lower than the exercise price of the accelerated items.



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Additionally, on January 25, 2005, the Compensation Committee accelerated certain options granted to Nicholas
Konidaris, the Companys President and Chief Executive Officer. For book reporting purposes, the Company accelerated approximately $1.5 million of unamortized expense related to the awards.

During fiscal 2005, the Company granted two options to purchase 25,000 and 50,000 shares, respectively, to certain key executives. During fiscal 2007, the Company
granted an option to purchase 100,000 shares to another key executive. These grants were inducements for joining the Company and were not made under a shareholder approved plan. The exercise price for each option grant is the fair market value of
the Companys stock on the date of the grant. Each option becomes exercisable with respect to 25 percent of the underlying shares over four years.

In
September 1990, the shareholders approved the adoption of the 1990 Employee Stock Purchase Plan, as amended in September 1998, October 2003 and October 2004 (the ESPP), pursuant to which 1,900,000 shares of common stock have been reserved for
issuance to participating employees. Eligible employees may elect to contribute up to 15 percent of their base wage and any commissions during each pay period. Prior to January 8, 2004, the ESPP provided for one 12-month offering period
beginning January 8 of each calendar year and ending with a purchase date on January 7.

In October 2003, the Board of Directors approved an
amendment to the ESPP to provide that, beginning January 8, 2004, the ESPP would have separate overlapping 24-month offerings starting every three months. Each offering would have eight purchase dates occurring every three months on designated
dates. The offerings under the ESPP commence on January 15, April 15, July 15 and October 15 of each calendar year. Any eligible employee may participate in only one offering at a time and may purchase shares only
through payroll deductions permitted under the ESPP. Eligible employees may elect to contribute up to 15 percent of their base wage and any commission during each pay period. At the end of each three-month purchase period, the purchase price is
determined and the accumulated funds are used to automatically purchase shares of common stock. The purchase price per share is equal to 85 percent of the lower of the fair market value of the common stock on (a) the first day of the offering
period or (b) the date of purchase. The October 2003 amendment also provides that if the fair market value of the common stock on the first day of the new offering period is less than or equal to the fair market value of the common stock on the
first date of any ongoing offering, employees participating in any such ongoing offering will be automatically withdrawn from it and enrolled in the new offering.



10



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Prior to June 4, 2006, we accounted for stock options using the intrinsic value method as prescribed by APB 25. We
provided disclosures of net income (loss) and net income (loss) per share for these prior periods prescribed by SFAS No. 123, Accounting for Stock-Based Compensation, as if the fair value of stock-based awards to employees had been
applied. This pro forma information for the three months and six months ended November 26, 2005 is as follows (in thousands, except per share data):



|                                                                                                                                                |  |                                      |        |   |                                  |   |        |  
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | - | -------------------------------- | - | ------ | -
|                                                                                                                                                |  | Three months ended November 26, 2005 |        |   | Six months endedNovember 26,2005 |  
|Net income, as reported                                                                                                                         |  | $                                    | 3,188  |   |                                  | $ | 4,535  |  
|Add  Stock-based employee compensation expense included in reported net income, net of related tax effects                                     |  |                                      | 119    |   |                                  |   | 599    |  
|Deduct  Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax
effect |  |                                      | (2,218 | ) |                                  |   | (4,957 | )
|                                                                                                                                                |  |                                      |        |   |                                  |   |        |  
|Net income, pro forma                                                                                                                           |  | $                                    | 1,089  |   |                                  | $ | 177    |  
|                                                                                                                                                |  |                                      |        |   |                                  |   |        |  
|Net income per share  basic and fully diluted, as reported                                                                                     |  | $                                    | 0.11   |   |                                  | $ | 0.16   |  
|                                                                                                                                                |  |                                      |        |   |                                  |   |        |  
|Net income per share  basic and fully diluted, pro forma                                                                                       |  | $                                    | 0.04   |   |                                  | $ | 0.01   |  
|                                                                                                                                                |  |                                      |        |   |                                  |   |        |  

The following table presents the impact of the adoption of SFAS 123R on selected items from the Companys
consolidated financial statements for the three months and six months ended December 2, 2006 (in thousands, except per share data):



|                                           |  |                                    |            |                                  |   |                             |  |                         |              |  |   |             
|------------------------------------------ |  | ---------------------------------- | ---------- | -------------------------------- | - | --------------------------- |  | ----------------------- | ------------ |  | - | ------------
|                                           |  | Three months endedDecember 2, 2006 |            | Six months ended December 2,2006
|                                           |  | As reportedunder SFAS123(R)        |            | If reported underAPB 25          |   | As reportedunder SFAS123(R) |  | If reported underAPB 25
|Consolidated Statements of Operations:     |  |                                    |            |                                  |   |                             |  |                         |              |  |   |             
|Operating income                           |  | $                                  | 3,634      |                                  | $ | 4,144                       |  | $                       | 10,740       |  | $ | 11,567      
|Income before income taxes Net income      |  |                                    | 5,9123,789 |                                  |   | 6,4224,322                  |  |                         | 15,92810,561 |  |   | 16,75511,277
|Basic and fully diluted earnings per share |  | $                                  | 0.13       |                                  | $ | 0.15                        |  | $                       | 0.36         |  | $ | 0.39        
|                                           |  |                                    |            |                                 
|Consolidated Statement of Cash Flows:      |  |                                    |            |                                  |   |                             |  |                         |              |  |   |             
|Net cash used in operating activities      |  | $                                  | 9,911      |                                  | $ | 9,911                       |  | $                       | 1,262        |  | $ | 1,262       
|Net cash provided by financing activities  |  |                                    | 705        |                                  |   | 705                         |  |                         | 1,410        |  |   | 1,410       



11



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Stock based compensation was included in our consolidated statements of operations as follows (in thousands):



|                                                          |  |                    |     |   |                  |   |     |                 |  |   |                  |   |  |   |      |  
|--------------------------------------------------------- |  | ------------------ | --- | - | ---------------- | - | --- | --------------- |  | - | ---------------- | - |  | - | ---- | -
|                                                          |  | Three months ended |     |   | Six months ended |  
|                                                          |  | December 2,2006    |     |   | November 26,2005 |   |     | December 2,2006 |  |   | November 26,2005 |  
|Cost of sales                                             |  | $                  | 172 |   |                  | $ |    |                 |  | $ | 280              |   |  | $ |     |  
|Selling, service, and administration                      |  |                    | 506 |   |                  |   | 186 |                 |  |   | 850              |   |  |   | 936  |  
|Research, development, and engineering                    |  |                    | 233 |   |                  |   |    |                 |  |   | 358              |   |  |   |     |  
|                                                          |  |                    |     |   |                  |   |     |                 |  |   |                  |   |  |   |      |  
|Stock-based compensation expense before income taxes      |  |                    | 911 |   |                  |   | 186 |                 |  |   | 1,488            |   |  |   | 936  |  
|Income tax benefit                                        |  |                    | (74 | ) |                  |   | (67 | )               |  |   | (174             | ) |  |   | (337 | )
|                                                          |  |                    |     |   |                  |   |     |                 |  |   |                  |   |  |   |      |  
|Total stock-based compensation expense after income taxes |  | $                  | 837 |   |                  | $ | 119 |                 |  | $ | 1,314            |   |  | $ | 599  |  
|                                                          |  |                    |     |   |                  |   |     |                 |  |   |                  |   |  |   |      |  

The total amount of cash received from the exercise of stock options in the three months and six months ended
December 2, 2006 was $0.2 million and $0.3 million, respectively. There was no material related tax benefit realized from the exercise of the stock options. Upon exercise of stock options, the Company issues new shares of common stock from its
authorized shares.

As of December 2, 2006, no stock-based compensation costs were capitalized and the Company had $5.3 million of total unrecognized
stock-based compensation costs, net of estimated forfeitures, to be recognized over a weighted average period of 2.13 years.

The Black-Scholes model is
utilized to determine the fair value of stock-based awards and the following weighted average assumptions were used in calculating the value of stock options granted during the periods presented:



|                        |  |                    |   |  |                  |   |  |                 |   |  |                  |  
|----------------------- |  | ------------------ | - |  | ---------------- | - |  | --------------- | - |  | ---------------- | -
|                        |  | Three months ended |   |  | Six months ended |  
|                        |  | December 2,2006    |   |  | November 26,2005 |   |  | December 2,2006 |   |  | November 26,2005 |  
|Risk-free interest rate |  | 4.5                | % |  | 4.21             | % |  | 4.5             | % |  | 3.93             | %
|Expected dividend yield |  | 0                  | % |  | 0                | % |  | 0               | % |  | 0                | %
|Expected lives          |  | 4.6 years          |   |  | 4.9 years        |   |  | 4.6 years       |   |  | 5.0 years        |  
|Expected volatility     |  | 50.85              | % |  | 57.85            | % |  | 50.85           | % |  | 59.33            | %

The following weighted average assumptions were made in calculating the value of all shares projected to be issued
under the ESPP during the periods presented:



|                        |  |                    |   |  |                  |   |  |                 |   |  |                  |  
|----------------------- |  | ------------------ | - |  | ---------------- | - |  | --------------- | - |  | ---------------- | -
|                        |  | Three months ended |   |  | Six months ended |  
|                        |  | December 2,2006    |   |  | November 26,2005 |   |  | December 2,2006 |   |  | November 26,2005 |  
|Risk-free interest rate |  | 4.91               | % |  | 4.15             | % |  | 4.94            | % |  | 4.06             | %
|Expected dividend yield |  | 0                  | % |  | 0                | % |  | 0               | % |  | 0                | %
|Expected lives          |  | 1.1 years          |   |  | 1.1 years        |   |  | 1.1 years       |   |  | 1.1 years        |  
|Expected volatility     |  | 33.31              | % |  | 39.18            | % |  | 33.34           | % |  | 42.15            | %

The risk-free rate used is based on the U.S. Treasury yield over the estimated term. The expected term and
forfeiture estimates for stock options are based on an analysis of actual exercise behavior. The expected term for the ESPP is the weighted average length of the purchase periods. The Company uses historical volatility as the expected volatility.



12



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The weighted-average fair-value of stock-based compensation awards granted and vested, and the intrinsic value of stock
options exercised during the period were (in thousands, except per share data):



|                                           |  |                    |       |                  |   |                 |  |                  |       |  |   |      
|------------------------------------------ |  | ------------------ | ----- | ---------------- | - | --------------- |  | ---------------- | ----- |  | - | -----
|                                           |  | Three months ended |       | Six months ended
|                                           |  | December 2,2006    |       | November 26,2005 |   | December 2,2006 |  | November 26,2005
|Stock Option Awards:                       |  |                    |       |                  |   |                 |  |                  |       |  |   |      
|Grant date fair value per share            |  | $                  | 9.40  |                  | $ | 11.91           |  | $                | 9.40  |  | $ | 10.83
|Total fair value of options granted        |  | $                  | 940   |                  | $ | 179             |  | $                | 940   |  | $ | 6,216
|Total fair value of options vested         |  | $                  | 530   |                  |   |                |  | $                | 980   |  | $ | 7,959
|Total intrinsic value of options exercised |  | $                  | 80    |                  | $ | 221             |  | $                | 103   |  | $ | 353  
|Unvested Stock Awards                      |  |                    |       |                  |   |                 |  |                  |       |  |   |      
|Grant date fair value per share            |  | $                  | 20.49 |                  |   |                |  | $                | 18.81 |  | $ | 19.56
|Total fair value of awards granted         |  | $                  | 201   |                  |   |                |  | $                | 1,947 |  | $ | 587  
|Employee Stock Purchase Plan               |  |                    |       |                  |   |                 |  |                  |       |  |   |      
|Grant date fair value per share            |  | $                  | 6.63  |                  | $ | 7.50            |  | $                | 6.36  |  | $ | 7.28 
|Total fair value                           |  | $                  | 1,455 |                  | $ | 155             |  | $                | 1,842 |  | $ | 228  

Information with respect to stock option activity is as follows:



|                                    |  |           |   |  |                              |       |                                         |      |                                       |   |      
|----------------------------------- |  | --------- | - |  | ---------------------------- | ----- | --------------------------------------- | ---- | ------------------------------------- | - | -----
|                                    |  | Shares    |   |  | WeightedAverageExercisePrice |       | WeightedAverageRemainingContractualTerm |      | Aggregate Intrinsic Value (thousands)
|Outstanding as of September 3, 2006 |  | 4,326,354 |   |  | $                            | 25.28 |                                         |      |                                       |   |      
|Granted                             |  | 100,000   |   |  | $                            | 19.83 |                                         |      |                                       |   |      
|Exercised                           |  | (13,738   | ) |  | $                            | 14.60 |                                         |      |                                       |   |      
|Forfeited                           |  | (29,750   | ) |  | $                            | 24.68 |                                         |      |                                       |   |      
|                                    |  |           |   |  |                              |       |                                         |      |                                       |   |      
|Outstanding as of December 2, 2006  |  | 4,382,866 |   |  | $                            | 25.19 |                                         | 6.90 |                                       | $ | 2,113
|                                    |  |           |   |  |                              |       |                                         |      |                                       |   |      
|Exercisable as of December 2, 2006  |  | 4,206,366 |   |  | $                            | 25.45 |                                         | 6.81 |                                       | $ | 1,985
|                                    |  |           |   |  |                              |       |                                         |      |                                       |   |      

Information with respect to unvested stock activity is as follows:



|                                    |  |         |  |                              |  |                                         |  |                                       |      
|----------------------------------- |  | ------- |  | ---------------------------- |  | --------------------------------------- |  | ------------------------------------- | -----
|                                    |  | Shares  |  | WeightedAveragePurchasePrice |  | WeightedAverageRemainingContractualTerm |  | Aggregate Intrinsic Value (thousands)
|Outstanding as of September 3, 2006 |  | 204,920 |  |                             |  |                                         |  |                                       |      
|Awarded                             |  | 15,474  |  |                             |  |                                         |  |                                       |      
|Released                            |  |        |  |                             |  |                                         |  |                                       |      
|Forfeited                           |  |        |  |                             |  |                                         |  |                                       |      
|                                    |  |         |  |                              |  |                                         |  |                                       |      
|Outstanding as of December 2, 2006  |  | 220,394 |  |                             |  | 2.30                                    |  | $                                     | 4,289
|                                    |  |         |  |                              |  |                                         |  |                                       |      



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Note 10  Geographic and Product Information

Net sales by product type were as follows (in thousands):



|                              |  |                    |        |                  |   |                 |  |                  |         |  |   |       
|----------------------------- |  | ------------------ | ------ | ---------------- | - | --------------- |  | ---------------- | ------- |  | - | ------
|                              |  | Three months ended |        | Six months ended
|                              |  | December 2,2006    |        | November 26,2005 |   | December 2,2006 |  | November 26,2005
|Semiconductor Group           |  | $                  | 29,440 |                  | $ | 25,237          |  | $                | 61,183  |  | $ | 53,138
|Passive Component Group       |  |                    | 15,892 |                  |   | 12,033          |  |                  | 34,524  |  |   | 23,082
|Electronic Interconnect Group |  |                    | 13,969 |                  |   | 11,373          |  |                  | 23,758  |  |   | 16,931
|                              |  |                    |        |                  |   |                 |  |                  |         |  |   |       
|                              |  | $                  | 59,301 |                  | $ | 48,643          |  | $                | 119,465 |  | $ | 93,151
|                              |  |                    |        |                  |   |                 |  |                  |         |  |   |       

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



|         |  |                    |        |                  |   |                 |  |                  |         |  |   |       
|-------- |  | ------------------ | ------ | ---------------- | - | --------------- |  | ---------------- | ------- |  | - | ------
|         |  | Three months ended |        | Six months ended
|         |  | December 2,2006    |        | November 26,2005 |   | December 2,2006 |  | November 26,2005
|Asia     |  | $                  | 43,165 |                  | $ | 38,956          |  | $                | 86,615  |  | $ | 69,894
|Americas |  |                    | 11,727 |                  |   | 7,250           |  |                  | 24,731  |  |   | 16,800
|Europe   |  |                    | 4,409  |                  |   | 2,437           |  |                  | 8,119   |  |   | 6,457 
|         |  |                    |        |                  |   |                 |  |                  |         |  |   |       
|         |  | $                  | 59,301 |                  | $ | 48,643          |  | $                | 119,465 |  | $ | 93,151
|         |  |                    |        |                  |   |                 |  |                  |         |  |   |       

Note 11  Insurance Recoveries

In November 2006, the Company settled litigation related to the insurance coverage for the shareholder and derivative lawsuits related to the restatement of financial results announced in 2003. The Company recorded a
gain of $1.0 million in the second quarter of fiscal 2007 and a non-trade receivable amount of $1.0 million is included in other current assets at December 2, 2006. The Company received the payment during the third quarter of fiscal 2007. All
related costs were expensed as incurred in prior periods.

In June 2006, the Company received a $1.3 million insurance recovery for demonstration systems
that were destroyed in a fire at a customers plant. The book value of these assets had previously been written off. As a result of the insurance recovery, the Company recorded a gain of $1.3 million in the first quarter of fiscal 2007.

Note 12  Legal Proceeding

On August 24,
2005, the Company executed a Provisional Attachment Order (the Attachment Order) issued by the Kaohsiung District Court of Taiwan (the Court) directed against All Ring Tech Co., Ltd. (All Ring) of Taiwan. In the petition requesting the Attachment
Order, the Company alleged that All Rings Capacitor Tester Model RK-T6600 (the Capacitor Tester) infringes ESIs Taiwan Patent No. 207469, entitled Circuit Component Handler (the 207469 patent). This patent corresponds to
ESIs U.S. Patent No. 5,842,579. The patented technology is used in the Model 3340 Multifunction MLCC Tester. All Ring has filed a bond with the Court to obtain relief from the attachment of its assets. The bond provides security to ESI
with respect to its patent infringement claim against All Ring.

In October 2005, the Court executed a Preliminary Injunction Order that prohibits All Ring
from manufacturing, selling, offering for sale or using the Capacitor Tester, or importing the Capacitor Tester for any of these purposes, until final judgment is entered in the formal patent infringement action. Pursuant to the Courts order,
the Company was required to post with the Court a Taiwan dollar security bond, which is valued at approximately US$7.0 million included in other assets on the consolidated condensed balance sheet.



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##### Table of Contents

In October 2005, ESI filed a formal patent infringement action against All Ring in the Court. In early May 2006, after
all parties filed briefs on the topic, the Court appointed an expert to conduct a patent infringement assessment. The Court-appointed expert has completed the assessment of the Capacitor Tester and concluded that it infringes every claim of the
207469 patent. A hearing on this matter has been scheduled for January 12, 2007.

In November 2005, All Ring filed a cancellation action against
ESIs 207469 patent in the Taiwan Intellectual Property Office. The Company filed a defense brief in March 2006. On November 6, 2006, the Company and All Ring had an interview with examiners at the Taiwan Intellectual Property Office
concerning the cancellation action. The Company intends to vigorously pursue its patent infringement claims against All Ring and defend against the cancellation action.

Note 13 - New Accounting Pronouncements

In November 2005, the Financial Accounting Standards Board (FASB) issued
FASB Staff Position No. 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. This pronouncement provides an alternative method of calculating the excess tax benefits available to
absorb any tax deficiencies recognized subsequent to the adoption of SFAS 123R. The Company, which is currently evaluating its available transition alternatives, has until June 2, 2007 to make its one-time election.

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109
(FIN 48). This pronouncement prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company is currently evaluating the affect of FIN 48 on its consolidated financial statements.

In September
2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) Topic 1N, Financial Statements - Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements (SAB 108). The SEC staff is providing guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current
years financial statements are materially misstated. The SEC staff indicates that registrants must quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on
the current year financial statements. If correcting a misstatement in the current year would materially misstate the current years income statement, the SEC staff indicates that the prior year financial statements should be adjusted.
These adjustments to prior year financial statements are necessary even though such adjustments were appropriately viewed as immaterial in the prior year. If the Company determines that an adjustment to prior year financial statements is required
upon adoption of SAB 108 and does not elect to restate its previous financial statements, then it must recognize the cumulative effect of applying SAB 108 in fiscal 2007 beginning balances of the affected assets and liabilities with a corresponding
adjustment to the fiscal 2007 opening balance in retained earnings. The Company is currently evaluating the impact of the guidance on its current and prior year financial statements.



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In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines
fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 does not impose fair value measurements on items not already accounted for at fair value; rather it applies, with certain
exceptions, to other accounting pronouncements that either require or permit fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is
currently evaluating the impact of adopting SFAS 157 on its consolidated financial position and results of operations.



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

Forward Looking
Statements

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. under the heading Risk Factors.

Overview

Electro Scientific Industries, Inc. and its
subsidiaries (ESI) provide high-technology manufacturing equipment to the global electronics market, including advanced laser systems that are used to microengineer electronic device features in high-volume production environments. Our customers are
primarily manufacturers of semiconductors, passive components and electronic interconnect devices. Our equipment enables these manufacturers to achieve the yield and productivity gains in their manufacturing processes that can be critical to their
profitability. The components and devices manufactured by our customers are used in a wide variety of end products in the computer, consumer electronics, communications and automotive industries.

We supply advanced laser microengineering systems that allow electronics manufacturers to physically alter select device features during high-volume production in order
to heighten performance and boost production yields of semiconductor devices, advanced semiconductor packaging, flex circuits and passive components and circuitry. Laser microengineering comprises a set of precise fine-tuning processes (laser
trimming, link cutting and via drilling) that require application-specific laser systems able to meet semiconductor and microelectronics manufacturers exacting performance and productivity requirements.

Additionally, we produce high-speed test, inspection and termination equipment used in the high-volume production of multi-layer ceramic capacitors (MLCCs) and other
passive components, as well as passive component inspection systems.

Fiscal 2006 order activity reflected steady growth. Quarterly orders in 2006 grew
from $34.8 million in the first quarter to $61.1 million in the fourth quarter. Orders in the first half of fiscal 2007 reflect continued industry strength, with orders in the first quarter of $67.6 million and orders in the second quarter of $62.4
million.

The sequential decrease in orders is primarily due to a 16% reduction in our semiconductor group (SG) orders. As is inherent in the businesses we
serve, the timing of orders can cause our order levels to fluctuate from period to period. Our SG business remained strong, with customers continuing to ramp capacity to meet end-market demand. Additionally, the customer base for our ultraviolet
(UV)-based DRAM link-processing tool is growing.

Passive component group (PCG) orders increased 5% in the second quarter of fiscal 2007 compared to the
first quarter. Orders from customers in Asia for both test and termination equipment remained strong. Our customers are reporting high levels of factory utilization and continued strong demand for the smallest MLCC components.



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Electronic interconnect group (EIG) orders reflected a 2% decline in the second quarter of fiscal 2007 compared to the
first quarter of fiscal 2007. Demand in this market continues to be driven primarily by single-head UV drill systems for flex-circuit manufacturers.

Shipments of $60.5 million in the second quarter of fiscal 2007 increased $0.9 million or 2% from shipments of $59.6 million in the first quarter of fiscal 2007, primarily due to increased SG and EIG shipments, offset by a reduction in PCG
shipments. Backlog decreased to $41.9 million at the close of the current quarter, compared to $58.0 million at the end of the prior quarter. Backlog was adjusted downward by approximately $18 million during the second quarter of fiscal 2007 due to
a customers request to convert part of a previous order for UV-based semiconductor group systems to infrared (IR)-based systems and to postpone delivery of additional UV-based systems beyond the twelve month period we require to be included in
backlog. This request was a specific decision by the customer to extend the utilization of IR-based technology on current fuse designs in the near-term, with the intention of utilizing UV-based technology over the longer term.

Gross margins were 40.9% on net sales of $59.3 million in the second quarter of fiscal 2007, compared to 45.3% on net sales of $60.2 million in the first quarter of
fiscal 2007. Operating expenses increased $0.4 million to $20.6 million in the second quarter of fiscal 2007, compared to $20.2 million in the first quarter. The increase is substantially due to an increase in research, development and engineering
expenses.

Operating income decreased to $3.6 million in the current quarter, compared to operating income of $7.1 million in the first quarter of fiscal
2007. Non-operating income decreased to $2.3 million in the second quarter compared to $2.9 million in the first quarter of fiscal 2007. Our effective income tax rate increased to 36% for the second quarter compared to a net income tax rate of 32%
for the first quarter of fiscal 2007. Net income was $3.8 million in the second quarter of fiscal 2007, compared to $6.8 million in the first quarter of fiscal 2007.

Shipments and net sales in the third quarter of fiscal 2007 are currently estimated to be in the range of $55 million to $65 million. Gross margins in the third quarter are expected to be approximately 43% to 44%. We
anticipate operating expenses for the third quarter of fiscal 2007 will be consistent with the second quarter of fiscal 2007, excluding the impact of the $1.0 million insurance recovery in the second quarter. As a result of the recent extension of
the research and experimentation credit, we expect the tax rate in the third quarter to decrease to approximately 20%.

Results of Operations

The following table sets forth results of operations data as a percentage of net sales.



|                                      |  |                    |   |  |                  |   |  |                 |   |  |                  |  
|------------------------------------- |  | ------------------ | - |  | ---------------- | - |  | --------------- | - |  | ---------------- | -
|                                      |  | Three months ended |   |  | Six months ended |  
|                                      |  | December 2,2006    |   |  | November 26,2005 |   |  | December 2,2006 |   |  | November 26,2005 |  
|Net sales                             |  | 100.0              | % |  | 100.0            | % |  | 100.0           | % |  | 100.0            | %
|Cost of sales                         |  | 59.1               |   |  | 56.5             |   |  | 56.8            |   |  | 56.2             |  
|                                      |  |                    |   |  |                  |   |  |                 |   |  |                  |  
|Gross margin                          |  | 40.9               |   |  | 43.5             |   |  | 43.2            |   |  | 43.8             |  
|Selling, service and administrative   |  | 20.3               |   |  | 23.4             |   |  | 20.2            |   |  | 24.1             |  
|Research, development and engineering |  | 16.2               |   |  | 16.4             |   |  | 15.8            |   |  | 17.0             |  
|Insurance recovery                    |  | (1.7               | ) |  |                 |   |  | (1.9            | ) |  |                 |  
|                                      |  |                    |   |  |                  |   |  |                 |   |  |                  |  
|Operating income                      |  | 6.1                |   |  | 3.7              |   |  | 9.0             |   |  | 2.7              |  
|Total other income, net               |  | 3.8                |   |  | 4.7              |   |  | 4.3             |   |  | 3.8              |  
|                                      |  |                    |   |  |                  |   |  |                 |   |  |                  |  
|Income before taxes                   |  | 10.0               |   |  | 8.4              |   |  | 13.3            |   |  | 6.5              |  
|Income tax provision                  |  | 3.6                |   |  | 1.9              |   |  | 4.5             |   |  | 1.7              |  
|                                      |  |                    |   |  |                  |   |  |                 |   |  |                  |  
|Net income                            |  | 6.4                | % |  | 6.6              | % |  | 8.8             | % |  | 4.9              | %
|                                      |  |                    |   |  |                  |   |  |                 |   |  |                  |  



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##### Table of Contents

Net Sales

Net
sales were $59.3 million for the quarter ended December 2, 2006, an increase of $10.7 million or 22% compared to $48.6 million for the quarter ended November 26, 2005. The overall increase was driven by increases in all three of our
product groups.

Information regarding our net sales by product group is as follows (net sales in thousands):



|                              |  |                    |        |                |                   |   |           |   |                |  |     |  
|----------------------------- |  | ------------------ | ------ | -------------- | ----------------- | - | --------- | - | -------------- |  | --- | -
|                              |  | Three months ended |       
|                              |  | December 2, 2006   |        |                | November 26, 2005 |  
|                              |  | Net Sales          |        | % of Net Sales |                   |   | Net Sales |   | % of Net Sales | 
|Semiconductor (SG)            |  | $                  | 29,440 |                | 50                | % |           | $ | 25,237         |  | 52  | %
|Passive Components (PCG)      |  |                    | 15,892 |                | 27                |   |           |   | 12,033         |  | 25  |  
|Electronic Interconnect (EIG) |  |                    | 13,969 |                | 23                |   |           |   | 11,373         |  | 23  |  
|                              |  |                    |        |                |                   |   |           |   |                |  |     |  
|                              |  | $                  | 59,301 |                | 100               | % |           | $ | 48,643         |  | 100 | %
|                              |  |                    |        |                |                   |   |           |   |                |  |     |  



|                              |  |                  |         |                |                   |   |           |   |                |  |     |  
|----------------------------- |  | ---------------- | ------- | -------------- | ----------------- | - | --------- | - | -------------- |  | --- | -
|                              |  | Six months ended |        
|                              |  | December 2, 2006 |         |                | November 26, 2005 |  
|                              |  | Net Sales        |         | % of Net Sales |                   |   | Net Sales |   | % of Net Sales | 
|Semiconductor (SG)            |  | $                | 61,183  |                | 51                | % |           | $ | 53,138         |  | 57  | %
|Passive Components (PCG)      |  |                  | 34,524  |                | 29                |   |           |   | 23,082         |  | 25  |  
|Electronic Interconnect (EIG) |  |                  | 23,758  |                | 20                |   |           |   | 16,931         |  | 18  |  
|                              |  |                  |         |                |                   |   |           |   |                |  |     |  
|                              |  | $                | 119,465 |                | 100               | % |           | $ | 93,151         |  | 100 | %
|                              |  |                  |         |                |                   |   |           |   |                |  |     |  

SG sales in the second quarter of fiscal 2007 of $29.4 million increased $4.2 million or 17% compared to the same
period in the prior fiscal year. The sales increase was primarily due to increased volume sales of our thin-film-on-silicon (TFOS) trimming system due to our increased share of the mixed signal market. Additionally, sales of our semiconductor link
processing tools have increased as our customers experience growth in demand for DRAM devices to support new operating systems, as well as associated demand increases from next-generation game consoles, upgrade modules, and mobile communications.

Second quarter PCG sales of $15.9 million increased $3.9 million or 32% compared to sales in the second quarter of fiscal 2006. The rise in PCG net sales
was driven by strong demand for our electrical test systems as manufacturers seek to build production capacity for MLCC components. End-market demand for MLCC products has increased in the wireless handset market, the dual core microprocessor
market, the flat panel display market and the automotive electronics market.

EIG sales were $14.0 million in the second quarter of fiscal 2007, an
increase of $2.6 million or 23% compared to EIG sales of $11.4 million in the second quarter of fiscal 2006. The increase in net sales was due to higher sales volumes of our single-head UV micro-via drilling systems for flex circuits, many of which
are finding their way into cell phones, personal digital cameras and notebook PCs. Sales volumes also increased for our dual-head IC packaging tool, which offers improved cost-of-ownership, yield, and performance compared to our earlier models.

Net sales were $119.5 million for the six months ended December 2, 2006, an increase of $26.3 million or 28% compared to $93.2 million for the six
months ended November 26, 2005. The increases in net sales for the first half of fiscal 2007 compared to the prior year are attributable to the factors described above.



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Net sales by geographic region were as follows (net sales in thousands):



|              |  |                    |        |                |                   |   |           |   |                |  |     |  
|------------- |  | ------------------ | ------ | -------------- | ----------------- | - | --------- | - | -------------- |  | --- | -
|              |  | Three months ended |       
|              |  | December 2, 2006   |        |                | November 26, 2005 |  
|              |  | Net Sales          |        | % of Net Sales |                   |   | Net Sales |   | % of Net Sales | 
|Asia          |  | $                  | 43,165 |                | 73                | % |           | $ | 38,956         |  | 80  | %
|United States |  |                    | 11,727 |                | 20                |   |           |   | 7,250          |  | 15  |  
|Europe        |  |                    | 4,409  |                | 7                 |   |           |   | 2,437          |  | 5   |  
|              |  |                    |        |                |                   |   |           |   |                |  |     |  
|              |  | $                  | 59,301 |                | 100               | % |           | $ | 48,643         |  | 100 | %
|              |  |                    |        |                |                   |   |           |   |                |  |     |  



|              |  |                  |         |                |                   |   |           |   |                |  |     |  
|------------- |  | ---------------- | ------- | -------------- | ----------------- | - | --------- | - | -------------- |  | --- | -
|              |  | Six months ended |        
|              |  | December 2, 2006 |         |                | November 26, 2005 |  
|              |  | Net Sales        |         | % of Net Sales |                   |   | Net Sales |   | % of Net Sales | 
|Asia          |  | $                | 86,615  |                | 72                | % |           | $ | 69,894         |  | 75  | %
|United States |  |                  | 24,731  |                | 21                |   |           |   | 16,800         |  | 18  |  
|Europe        |  |                  | 8,119   |                | 7                 |   |           |   | 6,457          |  | 7   |  
|              |  |                  |         |                |                   |   |           |   |                |  |     |  
|              |  | $                | 119,465 |                | 100               | % |           | $ | 93,151         |  | 100 | %
|              |  |                  |         |                |                   |   |           |   |                |  |     |  

Total net sales in the second quarter of fiscal 2007 to Asia, the United States and Europe increased $4.2 million,
$4.5 million and $2.0 million, respectively, compared to the same quarter in the prior fiscal year consistent with the market trends described above. Sales in the United States increased as a percentage of total sales in the second quarter of fiscal
2007 compared to the prior year due to stronger sales of semiconductor group products, including our TFOS systems, to domestic customers. For the six months ended December 2, 2006, compared to the six months ended November 26, 2005, sales
by region were relatively consistently weighted to Asia.

Gross Profit

Gross profit was $24.3 million (40.9% of net sales) for the second quarter of fiscal 2007 compared to $21.2 million (43.5% of net sales) for the second quarter of fiscal 2006. Gross profit for the six month period
ended December 2, 2006 was $51.6 million (or 43.2% of net sales) compared to $40.8 million (or 43.8% of net sales) for the same six month period in the prior fiscal year. Shipments of $60.5 million in the second quarter of fiscal 2007 increased
24% compared to the same quarter in fiscal 2006 and shipments of $120.0 million in the first half of fiscal 2007 increased 29% compared to the first half of fiscal 2006. However, our gross margin rates were lower in the current quarter and the first
half of fiscal 2007 compared to the same periods in the prior year due to changes in product sales mix, both between our product groups and within the product groups. The semiconductor group comprises our highest-margin products, and that
groups revenue as a percentage of net sales decreased by 2% of total revenue for the current quarter compared to the second quarter of fiscal 2006, and by 6% of total revenue in the first half of fiscal 2007 compared to 57% for the same period
in the prior year. Additionally, to a lesser degree, gross margin was negatively impacted in the current quarter by various incremental manufacturing expenses related to the timing of freight, duty and warranty charges.

Operating Expenses

Selling, Service and Administrative
Expenses

The primary items included in selling, service and administrative expenses are employee compensation and other related expenses, travel
expenses, professional fees and facilities costs. Selling, service and administrative expenses were $12.0 million (20.3% of net sales) in the second quarter of fiscal 2007, an increase of $0.6 million compared to $11.4 million (23.4% of net sales)
in the second quarter of fiscal 2006. The increase is primarily due to higher stock compensation costs related to the adoption of SFAS 123R beginning in fiscal year 2007 combined with lower salary and consulting expenses in fiscal 2006.



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A majority of consulting charges incurred in connection with our enterprise resource planning (ERP) system development
were capitalized during fiscal 2006, along with a portion of employee compensation costs for those directly engaged in ERP development, and hence were not included in operating expenses during the second quarter of fiscal 2006. These same factors
are also the major drivers for the $1.7 million increase in selling, service and administration expenses for the first six months of fiscal year 2007 compared to the same period in the prior fiscal year.

Research, Development and Engineering Expenses

Research, development
and engineering expenses are primarily comprised of employee compensation and other related expenses, professional fees, project materials, equipment and facilities costs. Expenses associated with research, development and engineering totaled $9.6
million (16.2% of net sales) for the second quarter of fiscal 2007, representing a $1.6 million increase from expenses of $8.0 million (16.4% of net sales) for the second quarter of fiscal 2006. This increase is due primarily to higher compensation
costs related to the 15% increase in headcount over the last twelve months and other project investments for costs related to our increased investment in the development of new products in existing and emerging markets. Similarly, research,
development and engineering expenses increased $3.1 million to $18.9 million (15.8% of net sales) in the first six months of fiscal 2007 compared to $15.8 million (17.0% of net sales) for the six months ended November 26, 2005 indicative of our
increased investment in research and development.

Insurance Recoveries

In November 2006, the Company recorded a gain of $1.0 million in the second quarter of fiscal 2007 related to the insurance coverage for the shareholder and derivative lawsuits related to the restatement of financial
results announced in 2003.

In June 2006, we received a $1.3 million insurance recovery for demonstration systems that were destroyed in a fire at a
customers plant. The book value of these assets had previously been written off. As a result of the insurance recovery, we recorded a gain of $1.3 million in the first quarter of fiscal 2007.

Interest and Other Income, Net

Interest and other income was $2.3
million in the second quarter of fiscal 2007, consistent with the second quarter of fiscal 2006. The second quarter of the prior fiscal year included $0.7 million of interest relating to income tax refunds. Exclusive of the interest on tax refunds,
interest income in the current quarter increased $0.7 million. This increase is due to an increase in investment yields due to rising market interest rates, offset by a lower average volume of invested assets. Cash and securities totaled $230.8
million at November 26, 2005 and decreased to $217.5 million at December 2, 2006 due to uses of cash to fund increased inventory, accounts receivable and minority equity investments. See further discussion below in Financial
Condition and Liquidity.

Interest and other income was $5.2 million in the first six months of fiscal 2007, compared to $3.5 million in the same six
months of fiscal 2006, an increase of $1.7 million. Interest income increased substantially due to higher investment yields. The increase in income due to rising market interest rates was offset by a decrease in interest related to income tax
refunds. During the first half of fiscal 2007, we received interest related to tax refunds totaling $0.3 million, compared to $0.7 million in the first half of fiscal 2006. Weighted average invested assets for the first half of fiscal 2007 decreased
slightly compared to the first half of fiscal 2006.



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Income Taxes

The income tax provision recorded for the second quarter of fiscal 2007 was $2.1 million on pretax income of $5.9 million, an effective tax rate of 36%. Comparatively, the income tax provision was $0.9 million on pretax income of $4.1
million in the second quarter of fiscal 2006, an effective tax rate of 22%. The increase in the effective tax rate is due primarily to the expiration of the research and experimentation tax credit as of December 31, 2005 and the impact of the
adoption of SFAS 123R.

The fiscal year-to-date provision for income taxes at December 2, 2006 is $5.4 million on pretax income of $15.9 million, an
effective tax rate of 34%, compared to an income tax provision of $1.5 million on pretax income of $6.1 million in the six months ended November 26, 2005, an effective tax rate of 25%. The increase in the effective tax rate in the current
fiscal year compared to the same period in fiscal 2006 is also due to the factors discussed above.

The effective tax rate for the third quarter of fiscal
2007 is expected to be approximately 20%. The projected decrease in the effective tax rate is due to the recent extension in December 2006 of the research and experimentation credit and the related estimated impact of this benefit for both the
latter portion of fiscal 2006 as well as the current fiscal year. Our effective tax rate is subject to fluctuation based upon the occurrence and timing of numerous discrete events, including, for example, 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 expect our normalized effective tax rate to be approximately 32%.

Net Income

Net income for the three and six months ended
December 2, 2006 was $3.8 million (6.4% of net sales) or $0.13 per share on a basic and fully diluted basis and $10.6 million (8.8% of net sales) or $0.36 per basic and fully diluted share, respectively. For the three and six months ended
November 26, 2005, we recorded a net income of $3.2 million (6.6% of net sales) or $0.11 per basic and fully diluted share and $4.5 million (4.9% of net sales) or $0.16 per basic and fully diluted share, respectively.

Financial Condition and Liquidity

At December 2, 2006, our
principal sources of liquidity consisted of existing cash, cash equivalents and marketable securities of $217.5 million and accounts receivable of $53.6 million. At December 2, 2006, we had a current ratio of 7:1 and no long-term debt. Working
capital increased to $312.4 million at December 2, 2006 from $304.5 million at June 3, 2006. We believe that our existing cash, cash equivalents and marketable securities are adequate to fund our operations for at least the next twelve
months.

Cash provided by operating activities totaled $1.3 million in the first six months of fiscal 2007. Cash totaling $17.9 million was provided by net
income adjusted for non-cash items. Other significant factors impacting cash flows from operations included increases in trade receivables, inventories, prepaid and other current assets, partially offset by increases in current liabilities.

Net inventories increased $8.5 million to $72.3 million at December 2, 2006, compared to $63.8 million at June 3, 2006. The rise is primarily
due to increases in raw materials and work in process balances of $3.4 million and $7.1 million, respectively. These increases were driven by mid-period changes in forecast product sales mix. Additionally, work-in-process inventories include $1.7
million of engineering



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inventory for new product development. Finished goods decreased by $2.0 million due to strong shipments just prior to the
end of the second quarter of fiscal 2007. The change in inventory balances also includes a non-cash transfer of $3.7 million from other non-current assets for previously capitalized demonstration systems.

Net trade receivables were $53.6 million at December 2, 2006, compared to $48.0 million at June 3, 2006, an increase of $5.6 million. The increase is primarily
due to the timing of shipments near the end of the current quarter compared to the quarter ended June 3, 2006. Although days sales outstanding increased from 76 days at June 3, 2006 to 82 at the end of the current quarter, our aging of
accounts receivable improved compared to the end of the prior fiscal year.

Prepaid and other current assets increased $3.9 million to $8.3 million at
December 2, 2006 from $4.4 million at June 3, 2006. The increase is due primarily to a $1.0 million insurance recovery receivable, an increase of $1.2 million in value-added tax (VAT) receivables pending the filing of returns with foreign
taxing authorities and $1.1 million in higher prepaid insurance premiums and property taxes.

Payables and current liabilities were $38.9 million at
December 2, 2006 compared to $36.0 million at June 3, 2006. The increase is primarily due to a rise of $2.0 million in accounts payable resulting from increased purchases to support inventory requirements for second quarter shipment
forecasts. Additionally, VAT payables increased by $0.9 million and accrued income taxes payable increased $1.8 million. These increases were partially offset by a $1.2 million decrease in payroll-related liabilities due primarily to the annual
profit sharing payment made in the first quarter of fiscal 2007 and decreases in various other accrued liabilities.

Cash flows from investing activities
totaled $6.6 million for the first six months of fiscal 2007. Capital expenditures totaled $5.7 million during this period and were principally comprised of costs related to a major refurbishment of research and development clean rooms and
laboratories. We also generated $21.7 million net in cash and cash equivalents through the maturity and investments in our portfolio of marketable securities offset by certain reinvestments. During the first two quarters of fiscal 2007, we invested
$6.0 million in a Series D financing of OmniGuide, Inc. and $5.0 million in a Series D financing of Axsun Technologies, Inc. Included in cash flow from investing activities was a $1.3 million insurance recovery received during the first quarter of
fiscal 2007 for damaged demonstration systems.

Cash flows from financing activities of $1.4 million were comprised of proceeds from the exercise of stock
options and ESPP purchases for the six months ended December 2, 2006.

Critical Accounting Policies and Estimates

Except for the addition of stock-based compensation below, we reaffirm the critical accounting policies and our use of estimates as reported in our annual report on Form
10-K for our fiscal year ended June 3, 2006 as filed with the Securities and Exchange Commission on August 15, 2006.

Stock-Based
Compensation

On June 4, 2006, we adopted SFAS 123R which requires the measurement and recognition of compensation expense for all share-based
payment awards granted to our employees and directors, including employee stock options, non-vested stock and purchases under the employee stock purchase plan, based on the estimated fair value of the award on the grant date. Upon the adoption of
SFAS 123R, we maintained our method of valuation for stock option awards using the Black-Scholes valuation model, which has historically been used for the purpose of providing pro-forma financial disclosures in accordance with SFAS No. 123.



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The use of the Black-Scholes valuation model to estimate the fair value of stock option awards requires us to make
assumptions regarding the risk-free interest rate, expected dividend yield, expected term and expected volatility over the expected term of the award. The assumptions used in calculating the fair value of share-based payment awards represent
managements best estimates based on our historical data, but these estimates involve inherent uncertainties and the application of expense could be materially different in the future.

Compensation expense is only recognized on awards that ultimately vest. Therefore, we have reduced the compensation expense to be recognized over the vesting period for
anticipated future forfeitures. Forfeiture estimates are based on historical forfeiture patterns. We will update our forfeiture estimates quarterly and recognize any changes to accumulated compensation expense in the period of change. If actual
forfeitures differ significantly from our estimates, our results of operations could be materially impacted.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the market
risk disclosure contained in our 2006 Annual Report on Form 10-K for our fiscal year ended on June 3, 2006.

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 and our Chief Financial Officer 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, including our President and Chief Executive Officer and our Chief Financial Officer, 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. You should read this disclosure 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 President and Chief Executive Officer and Chief Financial Officer, 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 President and Chief Executive Officer and our Chief Financial Officer 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 President and Chief Executive Officer and our Chief Financial Officer, 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 our fiscal quarter ended December 2, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II  OTHER INFORMATION

Item 1. Legal Proceedings

On August 24, 2005, ESI executed a Provisional Attachment Order (the Attachment Order)
issued by the Kaohsiung District Court of Taiwan (the Court) directed against All Ring Tech Co., Ltd. (All Ring) of Taiwan. In our petition requesting the Attachment Order, we alleged that All Rings Capacitor Tester Model RK-T6600 (the
Capacitor Tester) infringes our Taiwan Patent No. 207469, entitled Circuit Component Handler (the 207469 patent). This patent corresponds to ESIs U.S. Patent No. 5,842,579. The patented technology is used in the Model
3340 Multifunction MLCC Tester. All Ring has filed a bond with the Court to obtain relief from the attachment of its assets. The bond provides security to ESI with respect to our patent infringement claim against All Ring.

In October 2005, the Court executed a Preliminary Injunction Order that prohibits All Ring from manufacturing, selling, offering for sale or using the Capacitor Tester,
or importing the Capacitor Tester for any of these purposes, until final judgment is entered in the formal patent infringement action. Pursuant to the Courts order, we were required to post with the Court a Taiwan dollar security bond, which
is valued at approximately US$7.0 million.

In October 2005, ESI filed a formal patent infringement action against All Ring in the Court. In early May
2006, after all parties filed briefs on the topic, the Court appointed an expert to conduct a patent infringement assessment. The Court-appointed expert has completed the assessment of the Capacitor Tester and concluded that it infringes every claim
of the 207469 patent. A hearing on this matter has been scheduled for January 12, 2007.

In November 2005, All Ring filed a cancellation action
against ESIs 207469 patent in the Taiwan Intellectual Property Office. We filed a defense brief in March 2006. On November 6, 2006, ESI and All Ring had an interview with examiners at the Taiwan Intellectual Property Office concerning the
cancellation action. We intend to vigorously pursue our patent infringement claims against All Ring and defend against the cancellation action.

Item 1A. Risk Factors

Factors That May Affect Future Results

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. 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:



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The industries that comprise our primary markets are volatile and unpredictable.

Our business depends upon the capital expenditures of manufacturers of components and circuitry used in wireless communications, computers and other electronic products.
In the past, the markets for electronic devices have experienced sharp downturns. During these downturns, electronics manufacturers, including our customers, have delayed or canceled capital expenditures, which has had a negative impact on our
financial results. In the event of a downturn, we will not be able to assure you when demand for our products will increase or that demand will not further decrease. Even if demand for our products does increase, there may be significant
fluctuations in our profitability and net sales.

During any downturn, it will be difficult for us to maintain our sales levels. As a consequence, to
maintain profitability we will need to reduce our operating expenses. Our ability to quickly reduce operating expenses is dependent upon the nature of the actions we take to reduce expense and our subsequent ability to implement those actions and
realize expected cost savings. Additionally, we may be unable to defer capital expenditures and we will need to continue to invest in certain areas such as research and development. An economic downturn may also cause us to incur charges related to
impairment of assets and inventory write-offs and we may also experience delays in payments from our customers, which would have a negative effect on our financial results.

In addition, because we derive a substantial portion of our revenue from the sale of a relatively small number of products, the timing of orders by our customers may also cause our order levels and results of
operations to fluctuate between periods, perhaps significantly. For example, in the second quarter of fiscal 2007, a customer requested that the Company convert part of a previous order for UV-based semiconductor systems to IR-based systems and to
postpone shipment of additional UV-based systems, which resulted in approximately $18 million being removed from backlog. As a result, order levels or results of operations for a given period may not be indicative of order levels or results of
operations for following periods.

Delays in manufacturing, shipment or customer acceptance of our products could substantially decrease our sales
for a period.

We depend on manufacturing flexibility to meet the changing demands of our customers. Any significant delay or interruption in
receiving raw materials or in our manufacturing operations as a result of software deficiencies, natural disasters, or other causes could result in reduced manufacturing capabilities or delayed product deliveries, any or all of which could
materially and adversely affect our results of operations.

In addition, we derive a substantial portion of our revenue from the sale of a relatively small
number of products. Consequently, shipment and/or customer acceptance delays, including acceptance delays related to new product introductions or customizations, could significantly impact recognition of revenue and could be further magnified by
announcements from us or our competitors of new products and technologies, which announcements could cause our customers to defer purchases of our systems or purchase products from our competitors. Any of these delays could result in a material
adverse change in our results of operations for any particular period.



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Failure of critical suppliers of parts, components and manufacturing equipment to deliver sufficient quantities to
us in a timely and cost-effective manner could negatively affect our business.

We use a wide range of materials in the production of our products,
including custom electronic and mechanical components, and we use numerous suppliers for those materials. 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. Operations at our suppliers facilities are subject to disruption for a variety of reasons,
including changes in business relationships, competitive factors, work stoppages, and fire, earthquake, flooding or other natural disasters. Such disruption could interrupt our manufacturing. Our business may be harmed if we do not receive
sufficient parts to meet our production requirements in a timely and cost-effective manner.

We depend on a few significant customers and we do not
have long-term contracts with any of our customers.

Our top ten customers for fiscal 2006 accounted for approximately 55% of total net sales in
fiscal 2006, with three customers each accounting for more than 10% of total net sales in fiscal 2006. In addition, none of our customers has any long-term obligation to continue to buy our products or services, and any customer could delay, reduce
or cease ordering our products or services at any time.

Our markets are subject to rapid technological change, and to compete effectively we must
continually introduce new products that achieve market acceptance.

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 as well as current and potential customer requirements. The introduction by us or by our competitors of new and enhanced products may cause our customers to defer or cancel orders for our existing products, which may
harm our operating results. In the past we have also experienced delays in new product development. Similar delays may occur in the future. We also may not be able to develop the underlying core technologies necessary to create new products and
enhancements or, where necessary, to license these technologies from others.

Product development delays may result from numerous factors, including:



| |  |  | Changing product specifications and customer requirements;
| | - |  | ----------------------------------------------------------



| |  |  | Difficulties in hiring and retaining necessary technical personnel;
| | - |  | -------------------------------------------------------------------



| |  |  | Difficulties in reallocating engineering resources and overcoming resource limitations;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | Difficulties with contract manufacturers;
| | - |  | -----------------------------------------



| |  |  | Changing market or competitive product requirements; and
| | - |  | --------------------------------------------------------



| |  |  | Unanticipated engineering complexities.
| | - |  | ---------------------------------------



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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. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological
changes or emerging industry standards. Any failure to respond to technological change that may render our current products or technologies obsolete could significantly harm our business.

Our ability to reduce costs is limited by our 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 potential customers, and our business and financial condition could be materially and adversely affected. As a result of our need to maintain our spending levels in this area,
our operating results could be materially harmed if our net sales fall below expectations. 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.

We are exposed to the
risks that others may violate our proprietary rights, and our intellectual property rights may not be well protected in foreign countries.

Our
success is dependent upon the protection of our proprietary rights. In the high technology industry, intellectual property is an important asset that is always at risk of infringement. We incur substantial costs to obtain and maintain patents and
defend our intellectual property. For example, we have initiated litigation alleging that certain parties have violated various patents of ours, such as the action we initiated in Taiwan against All Ring Tech Co., Ltd. in August 2005. We rely upon
the laws of the United States and of foreign countries in which we develop, manufacture or sell our products to protect our proprietary rights. However, these proprietary rights may not provide the competitive advantages that we expect or other
parties may challenge, invalidate or circumvent these rights.

Further, 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 U.S. 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.

We may be subject to claims of intellectual property infringement.

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. 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.



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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.

Our business is highly competitive, and if we fail to compete effectively, our business will be harmed.

The industries in which we
operate are highly competitive. We face substantial competition from established competitors, some of which have greater financial, engineering, manufacturing and marketing resources than we do. If we are unable to compete effectively with these
companies, our market share may decline and our business could be harmed. Our competitors can be expected to continue to improve the design and performance of their products and to introduce new products. New companies may enter the markets in which
we compete, or industry consolidation may occur, further increasing competition in those markets. Furthermore, our technological advantages may be reduced or lost as a result of technological advances by our competitors.

Our competitors greater resources in the areas described above may enable them to:



| |  |  | Better withstand periodic downturns;
| | - |  | ------------------------------------



| |  |  | Compete more effectively on the basis of price and technology; and
| | - |  | ------------------------------------------------------------------



| |  |  | More quickly develop enhancements to and new generations of products.
| | - |  | ---------------------------------------------------------------------

We
believe that our ability to compete successfully depends on a number of factors, including:



| |  |  | Performance of our products;
| | - |  | ----------------------------



| |  |  | Quality of our products;
| | - |  | ------------------------



| |  |  | Reliability of our products;
| | - |  | ----------------------------



| |  |  | Cost of using our products;
| | - |  | ---------------------------



| |  |  | The ability to upgrade our products;
| | - |  | ------------------------------------



| |  |  | Consistent availability of critical components;
| | - |  | -----------------------------------------------



| |  |  | Our ability to ship products on the schedule required;
| | - |  | ------------------------------------------------------



| |  |  | Quality of the technical service we provide;
| | - |  | --------------------------------------------



| |  |  | Timeliness of the services we provide;
| | - |  | --------------------------------------



| |  |  | Our success in developing new products and enhancements;
| | - |  | --------------------------------------------------------



| |  |  | Existing market and economic conditions; and
| | - |  | --------------------------------------------



| |  |  | Price of our products as compared to our competitors products.
| | - |  | ---------------------------------------------------------------

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.



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The loss of key personnel or our inability to attract, retain and assimilate sufficient numbers of managerial,
financial, engineering and other technical personnel could have a material effect upon our results of operations.

Our continued success depends, in
part, upon key managerial, financial, engineering and technical personnel as well as our ability to continue to attract, retain and assimilate additional personnel. The loss of key personnel could have a material adverse effect on our business or
results of operations. We may not be able to retain our key managerial, financial, engineering and technical employees. Attracting qualified personnel may be difficult and our efforts to attract and retain these personnel may not be successful. In
addition, we may not be able to assimilate qualified personnel, including any new members of senior management, which could disrupt our operations.

Our worldwide direct sales and service operations expose us to employer-related risks in foreign countries.

We have established
direct sales and service organizations throughout the world. A worldwide direct sales and service model in foreign countries involves certain risks. We are subject to compliance with the labor laws and other laws governing employers in the countries
where our operations are located and as a result we may incur additional costs to comply with these local regulations. Additionally, we may encounter labor shortages or disputes that could inhibit our ability to effectively sell, market and service
our products. If we cannot effectively manage the risks related to employing persons in foreign countries, our operating results could be adversely affected.

We may make acquisitions in the future, and these acquisitions may subject us to risks associated with integrating these businesses into our current business.

In the future we may make acquisitions of, or significant investments in, businesses with complementary products, services or technologies.

Acquisitions involve numerous risks, many of which are unpredictable and beyond our control, including:



| |  |  | Difficulties and increased costs in connection with integration of the personnel, operations, technologies and products of acquired companies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Diversion of managements attention from other operational matters;
| | - |  | -------------------------------------------------------------------



| |  |  | The potential loss of key employees of acquired companies;
| | - |  | ----------------------------------------------------------



| |  |  | 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; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Difficulties establishing satisfactory internal controls at acquired companies.
| | - |  | -------------------------------------------------------------------------------

Our inability to effectively manage these acquisition risks could materially and adversely affect our business, financial condition and results of operations. In addition, if we issue equity securities to pay for an acquisition the
ownership percentage of our existing shareholders would be reduced and the value of the shares held by our existing shareholders could be diluted. If we use cash 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. Further, the accounting for future acquisitions could result in significant charges resulting from amortization of intangible assets related to such acquisitions. In addition, we have
made and may make strategic investments in development stage companies, which are subject to a high degree of risk, and therefore it is possible that we could lose our entire investment.



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We are exposed to the risks of operating a global business, including risks associated with exchange rate
fluctuations, legal and regulatory changes and the impact of regional and global economic disruptions.

International shipments accounted for 82% of
net sales in fiscal 2006, with 75% of our net sales to customers in Asia. We expect that international shipments will continue to represent a significant percentage of net sales 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;
| | - |  | -------------------------------------------------



| |  |  | Difficulties protecting intellectual property;
| | - |  | ----------------------------------------------



| |  |  | Local labor disputes;
| | - |  | ---------------------



| |  |  | Shipping delays and disruptions;
| | - |  | --------------------------------



| |  |  | Increases in shipping costs, caused by increased fuel costs or otherwise, which we may not be able to pass on to our customers;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



| |  |  | Unexpected changes in trading policies, regulatory requirements, tariffs and other barriers; and
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | Difficulties in managing a global enterprise, including staffing, collecting accounts receivable, managing suppliers, distributors and representatives, and repatriation of earnings.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our business and operating results are subject to uncertainties arising out of the possibility of regional or global economic disruptions
(including those resulting from natural disasters and outbreaks of infectious disease), the economic consequences of military action or terrorist activities and associated political instability, and the impact of heightened security concerns on
domestic and international travel and commerce. In particular, due to these uncertainties we are subject to:



| |  |  | The risk that 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;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The risk of more frequent instances of shipping delays; and
| | - |  | -----------------------------------------------------------



| |  |  | The risk that demand for our products may not increase or may decrease.
| | - |  | -----------------------------------------------------------------------

Failure to maintain effective internal controls could have a material adverse effect on our business, operating results and stock price.

In connection with our fiscal 2006 audit, we documented and tested our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the
effectiveness of our internal controls over financial reporting and a report by our independent registered public accounting firm addressing these assessments. If we fail to maintain the adequacy of our internal controls, we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, effective internal controls, particularly those related to
revenue recognition, are necessary for us to produce reliable financial reports and are important to prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed,
investors could lose confidence in our reported financial information, and the trading price of our stock could drop significantly.



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Our tax rates are subject to fluctuation, which could impact our financial position, and our estimates of tax
liabilities may be subject to audit, which could result in additional assessments.

Our effective tax rates are subject to fluctuation as the income
tax rates for each year are a function of: (a) 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 recorded deferred
tax assets, (c) taxes, interest or penalties resulting from tax audits and (d) changes in tax laws or the interpretation of such tax laws. Changes in the mix of these items may cause our effective tax rates to fluctuate between periods,
which could have a material adverse effect on our financial position.

We are subject to income taxes in both the United States and numerous foreign
jurisdictions. During the ordinary course of business there are many transactions and calculations for which the ultimate tax determination is uncertain. Significant judgment is exercised in determining our world wide provisions for income taxes.
Furthermore, we are regularly under audit by tax authorities. Although we believe our tax estimates are reasonable, the final outcome of tax audits and examinations could be materially different than what is reflected in historical income tax
accruals. For example, in the third quarter of fiscal 2006, a significant tax benefit was recorded upon the reversal of accrued income taxes due to the statutory closure of returns for various open tax years. 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.

Our reported results of operations have been materially and adversely affected by our adoption of SFAS 123R.

SFAS 123R, Share-Based Payment, was effective in our first quarter of fiscal 2007, and resulted in recognition of substantial compensation expense relating to our stock incentive plan and employee stock purchase plan. We
previously used the intrinsic value method to measure compensation expense for stock-based awards to our employees. Under that standard, we generally did not recognize compensation expense related to stock option grants or the discounts we provide
under our employee stock purchase plan. Under the new rules, we are required to adopt a fair value-based method for measuring the compensation expense related to employee stock awards, which led to $0.8 million in additional pre-tax compensation
expense in the first six months of fiscal 2007. Total pre-tax stock-based compensation in the first six months of fiscal 2007 was $1.5 million. Future results of operations may be materially and adversely affected by the expense recorded in
accordance with SFAS 123R on future grants of stock awards. Additionally, tax expense treatment under SFAS 123R does not provide for recording of deferred taxes consistent with the timing of recording stock-based compensation expense for incentive
stock options. As such, the impact of non-compensatory plans may increase our effective tax rate.



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Item 4. Submission of Matters to a Vote of Security Holders

The 2006 Annual Meeting of Shareholders of the Company
was held pursuant to notice at 1:00 p.m. Pacific time on October 5, 2006 at the Companys offices in Portland, Oregon to consider and vote upon:



|           |  |                                                                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------------------------------------------------------
|Proposal 1 |  | To elect three directors for a term of three years.                                                                                         
|Proposal 2 |  | To ratify the appointment of KPMG LLP as the Companys independent registered public accounting firm for the fiscal year ending June 2, 2007

The results of the voting on these proposals were as follows:

Proposal 1



|                      |  |            |  |          
|--------------------- |  | ---------- |  | ---------
|Election of Directors |  | For        |  | Withheld 
|Richard J. Faubert    |  | 27,118,704 |  | 307,676  
|Keith L. Thomson      |  | 25,568,426 |  | 1,857,954
|Jon D. Tompkins       |  | 25,733,784 |  | 1,692,596



|           |  |            |  |           |  |            
|---------- |  | ---------- |  | --------- |  | -----------
|           |  | For        |  | Against   |  | Abstentions
|Proposal 2 |  | 22,895,483 |  | 4,508,215 |  | 22,682     



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Item 6. Exhibits

This list is intended to constitute the exhibit index.



|     |  |                                                                                                                                                                                                                                                                                                                   
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1  |  | Restated Articles of Incorporation. Incorporated by reference to Exhibit 3-A of the Companys Annual Report on Form 10-K for the fiscal year ended May 31, 1991.                                                                                                                                                  
|     | 
|3.2  |  | Articles of Amendment of Third Restated Articles of Incorporation. Incorporated by reference to Exhibit 3-B of the Companys Annual Report on Form 10-K for the fiscal year ended May 31,
1999.                                                                                                                   
|     | 
|3.3  |  | Articles of Amendment of Third Restated Articles of Incorporation. Incorporated by reference to Exhibit 3 of the Companys Quarterly Report on Form 10-Q for the fiscal quarter ended
December 2, 2000.                                                                                                           
|     | 
|3.4  |  | 2004 Restated Bylaws, as amended. Incorporated by reference to Exhibit 3.1 of the Companys Current Report on Form 8-K filed on October 21, 2004.                                                                                                                                                                 
|     | 
|4.1  |  | Amended and Restated Rights Agreement, dated as of March 1, 2001, between the Company and Mellon Investor Services, relating to rights issued to all holders of Company common stock. Incorporated
by reference to Exhibit 4-A of the Companys Annual Report on Form 10-K for the fiscal year ended June 2, 2001.
|     | 
|10.1 |  | Form of Change in Control Agreement. Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed September 26, 2006.                                                                                                                                                              
|     | 
|10.2 |  | Form of Performance and Time-Based Restricted Stock Units Award Agreement with Nick Konidaris. Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed
October 11, 2006.                                                                                                      
|     | 
|31.1 |  | Certification of the Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                        
|     | 
|31.2 |  | Certification of the Chief Financial Officer pursuant to Section 302(a) 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.                                                                                                                                                                



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SIGNATURES

Pursuant to the requirements 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.



|                       |  |                                     |  |                                                                                 
|---------------------- |  | ----------------------------------- |  | --------------------------------------------------------------------------------
|Dated: January 4, 2007 |  | ELECTRO SCIENTIFIC INDUSTRIES, INC.
|                       |  |                                    
|                       |  | By                                  |  | /s/ Nicholas Konidaris                                                          
|                       |  |                                     |  | Nicholas Konidaris                                                              
|                       |  |                                     |  | President and Chief Executive Officer (Principal
Executive Officer)             
|                       |  |                                    
|                       |  | By                                  |  | /s/ John Metcalf                                                                
|                       |  |                                     |  | John Metcalf                                                                    
|                       |  |                                     |  | Senior Vice President of Administration,                                        
|                       |  |                                     |  | Chief Financial Officer and Corporate Secretary (Principal Financial Officer)   
|                       |  |                                    
|                       |  | By                                  |  | /s/ Kerry Mustoe                                                                
|                       |  |                                     |  | Kerry Mustoe                                                                    
|                       |  |                                     |  | Corporate Controller and Chief Accounting Officer (Principal Accounting Officer)



35