Electro Scientific Industries Inc – ‘424B1’ on 11/26/97

As of:  Wednesday, 11/26/97   ·   Accession #:  893877-97-691   ·   File #:  333-36681

in

this entire Filing. an “Entity” Search.

Show

Documents searched

and

each “hit”. the 1st “hit”.

↓↑Hints

Prospectus   —   Rule 424(b)(1)
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 424B1       Prospectus                                           193    815K 

Document Table of Contents

424B1
1st Page of 193
TOC
↑Top
Previous
Next
↓Bottom
Just 1st
 
                                                Filed Pursuant to Rule 424(b)(1)
                                                      Registration No. 333-36681

     ELECTRO SCIENTIFIC INDUSTRIES, INC.       APPLIED INTELLIGENT SYSTEMS, INC.

      PROSPECTUS                                 CONSENT AND
                                                 INFORMATION STATEMENT

 1,200,000 Shares of Common Stock,
 Without Par Value

------------------------

This Prospectus, Consent and Information Statement (the "Prospectus/  
Information Statement") relates to the proposed merger (the "Merger") of        
Asteroid Merger Corp. ("Merger Corp."), a wholly-owned subsidiary of Electro    
Scientific Industries, Inc. ("ESI"), with and into Applied Intelligent Systems, 
Inc. ("AISI") pursuant to which AISI will become a wholly-owned subsidiary of   
ESI in accordance with the terms of an Agreement of Reorganization and Merger,  
dated as of September 29, 1997, among ESI, AISI and Merger Corp. (the "Merger   
Agreement"). In the Merger, each outstanding share of common stock of AISI      
("AISI Common Stock") will be converted into and represents the right to receive
the number of shares of ESI Common Stock that corresponds to a ratio (the       
"Conversion Ratio") determined by dividing 1,400,000 by the sum of the total    
shares of AISI Common Stock outstanding plus the total number of AISI shares    
subject to stock options as of the day of the closing of the Merger (the        
"Closing Date"). Cash will be paid in lieu of any fractional share of ESI Common
Stock.                                                                          

   To effect the Merger, ESI proposes to issue up to 1,400,000 shares of ESI
Common Stock. Approximately 1,125,681 shares of ESI Common Stock will be issued 
in connection with the Merger upon conversion of the outstanding shares of AISI 
Common Stock, and approximately 274,319 shares of ESI Common Stock will be      
issuable upon exercise of outstanding AISI stock options.                       

  This Prospectus/Information Statement also constitutes the Prospectus of
ESI with respect to the 1,200,000 shares of ESI Common Stock to be issued in    
connection with the Merger. ESI Common Stock is traded on the Nasdaq National   
Market ("Nasdaq") under the symbol "ESIO." On November 25, 1997, the closing    
sale price for ESI Common Stock as reported on Nasdaq was $40.875 per share.    

This Prospectus/Information Statement is being delivered to the AISI  
shareholders for consent and information purposes on or about November 26, 1997.

------------------------

SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY AISI SHAREHOLDERS. 

------------------------

     All information contained in this Prospectus/Information Statement relating
to AISI has been furnished by AISI and ESI is relying upon the accuracy of that 
information. All information contained in this Prospectus/Information Statement 
relating to ESI has been furnished by ESI and AISI is relying upon the accuracy 
of that information.                                                            

    This Prospectus/Information Statement includes a discussion of anticipated
future performance of ESI after the Merger, including possible cost savings and 
other financial consequences of the proposed Merger. This discussion is based on
assumptions that are inherently uncertain, including without limitation factors 
related to general economic and competitive conditions. Accordingly, actual     
future results or values may vary significantly from such estimates.            

424B1
2nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 2nd
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
 EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION
 OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS/INFORMATION STATEMENT. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.

------------------------

 THE DATE OF THIS PROSPECTUS/INFORMATION STATEMENT IS NOVEMBER 25, 1997.

------------------------

No person has been authorized to give any information or to make any  
representations not contained or incorporated in this Prospectus/Information    
Statement in connection with the matters referred to herein and, if given or    
made, such information or representations must not be relied upon as having been
so authorized by AISI or by ESI. This Prospectus/Information Statement does not 
constitute an offer of any securities other than the registered securities to   
which it relates or an offer to any person in any jurisdiction where such offer 
would be unlawful. The delivery of this Prospectus/Information Statement shall  
not, under any circumstances, create any implication that the information herein
is correct as of any time subsequent to date hereof.                            

ii

424B1
3rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 3rd
 AVAILABLE INFORMATION

     ESI is subject to the informational requirements of the Securities Exchange
Act of 1934 and in accordance therewith files periodic reports and other        
information with the Securities and Exchange Commission (the "SEC"). Such       
reports, proxy statements, and other information concerning ESI may be inspected
and copies may be obtained at prescribed rates at the offices of the SEC,       
Judiciary Plaza, 450 Fifth Street, NW, Washington, D.C. 20549, as well as at the
following regional offices: Suite 1300, Seven World Trade Center, New York, New 
York 10048; and 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.   
ESI has filed with the SEC a Registration Statement under the Securities Act of 
1933, as amended, with respect to the securities offered pursuant to this       
Prospectus/Information Statement. For further information, reference is made to 
the Registration Statement and the exhibits thereto, which are available for    
inspection at no fee at the public reference section of the SEC at its principal
office at Judiciary Plaza, 450 Fifth Street, NW, Washington, D.C. 20549. The SEC
maintains an Internet Web site at http://www.sec.gov.                           

iii 

424B1
4th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 4th
 TABLE OF CONTENTS
FOR PROSPECTUS/INFORMATION STATEMENT

                                                                            Page

SUMMARY OF PROSPECTUS/INFORMATION STATEMENT....................................1

RISK FACTORS...................................................................6

SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION........................9
         ESI Selected Historical Financial Information.........................9
         AISI Selected Historical Financial Information.......................10
         Unaudited Pro Forma Summary of Selected Financial Information........11

EQUIVALENT PER COMMON SHARE DATA..............................................12

MARKET AND MARKET PRICES FOR COMMON STOCK ....................................13

AISI SHAREHOLDERS WRITTEN CONSENT.............................................14

THE MERGER....................................................................15
         DESCRIPTION..........................................................15
         BACKGROUND OF THE MERGER.............................................15
         REASONS FOR THE MERGER...............................................18
                  ESI's Reasons for the Merger................................18
                  AISI's Reasons for the Merger...............................19

FAIRNESS OPINION OF AISI FINANCIAL ADVISORS ..................................19
         MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES........................22
         ACCOUNTING TREATMENT.................................................23
         INTERESTS OF CERTAIN PERSONS IN THE MERGER...........................23
         REGULATORY MATTERS...................................................25
         NO DISSENTER RIGHTS..................................................25

THE MERGER AGREEMENT..........................................................25
         EFFECTIVE TIME OF THE MERGER.........................................25
         CONVERSION OF SHARES.................................................25
         TREATMENT OF AISI STOCK OPTIONS......................................26
         RESALE OF ESI COMMON STOCK...........................................26
         AISI'S CONDUCT OF BUSINESS PENDING THE MERGER........................27
         NONSOLICITATION OF ALTERNATIVE TRANSACTIONS..........................27
         CORPORATE STRUCTURE AND RELATED MATTERS AFTER THE MERGER.............28
         CERTAIN COVENANTS....................................................28
         CONDITIONS TO THE MERGER.............................................28
         INDEMNITY AND ESCROW AGREEMENT.......................................29
         TERMINATION; BREAKUP FEES............................................29
         FEES AND EXPENSES....................................................30
         CONFIDENTIALITY......................................................30

INFORMATION CONCERNING ESI....................................................30
         Business ............................................................30
         Electronics Industry Overview........................................31
         Overview of Markets, Products and Strategy...........................31
         Sales, Marketing and Service.........................................35
         Backlog  ............................................................36
         Research, Development and Technology.................................36
         Competition..........................................................36
         Manufacturing and Supply.............................................37
         Employees............................................................37
         Patents and Other Intellectual Property..............................37
         Properties...........................................................38
         Legal Proceedings....................................................38
         ESI Management.......................................................38
         Beneficial Ownership of Principal ESI Shareholders and Management....41
         ESI Executive Compensation...........................................42
         Summary Compensation Table...........................................42
         ESI Options Table....................................................43
         ESI Option Exercises and Fiscal Year-End Option Value Table..........44
         ESI Long Term Incentive Plans--Awards in Last Fiscal Year............44

iv

424B1
5th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 5th
         Severance Agreements.................................................44
         Performance Graph....................................................45
         Compensation Committee Report on Executive Compensation..............45
         Compensation Committee Interlocks and Insider Participation..........47

ESI MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL                           
         CONDITION AND RESULTS OF OPERATIONS..................................47
Three Months Ended August 31, 1997 Compared to Three Months   
                  Ended August 31, 1996 ......................................47
      Fiscal Year Ended May 31, 1997 Compared to Fiscal Year Ended May 31,
                  1996........................................................48
      Fiscal Year Ended May 31, 1996 Compared to Fiscal Year Ended May 31,
                  1995........................................................49
         Financial Condition and Liquidity....................................49
         Factors That May Affect Future Results...............................51

DESCRIPTION OF ESI CAPITAL STOCK..............................................52
         Common Stock.........................................................52
         Preferred Stock......................................................52
         Rights Agreement.....................................................52

INFORMATION CONCERNING AISI...................................................55
         Business ............................................................55
         Products ............................................................56
         Markets  ............................................................56
         Technology...........................................................56
         Strategy ............................................................58

AISI MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL RESULTS................59
Nine Months Ended September 30, 1997 Compared to Nine Months  
                  Ended September 30, 1996 ...................................59
         Years Ended December 31, 1994, 1995 and 1996 ........................60
         Liquidity and Capital Resources .....................................62
         Business Environment ................................................63

DESCRIPTION OF AISI CAPITAL STOCK.............................................64

AISI VOTING SECURITIES AND PRINCIPAL SHAREHOLDERS.............................64

COMPARISON OF SHAREHOLDER RIGHTS..............................................66
     Amendment of Certificate or Articles of Incorporation; Amendment of
                  Bylaws......................................................66
         Special Meetings of Shareholders.....................................67
         Dividends............................................................68
         Capital Stock........................................................68
         Dissenters' Rights...................................................68
         Provisions Relating to Directors.....................................69
         Anti-Takeover Statutes...............................................70

LEGAL MATTERS.................................................................72

EXPERTS  .....................................................................72

SHAREHOLDER PROPOSALS.........................................................73

FINANCIAL STATEMENTS.........................................................F-1

LISTS OF ANNEXES

Annex A     Agreement of Reorganization and Merger                              
Annex B     Fairness Opinion                                                    

v 

424B1
6th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 6th
 SUMMARY OF PROSPECTUS/INFORMATION STATEMENT

  The following is a summary of certain information contained elsewhere in
this Prospectus/Information Statement and is qualified in its entirety by       
reference to the full text of this Prospectus/Information Statement and the     
Annexes hereto. Shareholders are urged to read this Prospectus/Information      
Statement and the accompanying Annexes in their entirety. See "Risk Factors" for
certain information that should be considered by the shareholders of AISI.      

THE COMPANIES                                                                   

Electro Scientific Industries, Inc.                                             

    ESI provides electronics manufacturers with equipment necessary to produce
key components used in wireless telecommunications, computers, automotive       
electronics, and many other electronic products. ESI believes it is the leading 
supplier of advanced laser systems used to adjust (trim) electronic circuitry   
and to improve the yield of semiconductor memory devices. ESI believes it is a  
significant producer of high-speed test and termination equipment used in the   
high-volume production of miniature capacitors. Additionally, ESI designs and   
manufactures machine vision products and electronic packaging systems for       
manufacturers of printed circuit boards, electronics and other products. ESI's  
products enable these manufacturers to reduce production costs, increase yields 
and improve the quality of their products. ESI's customers include manufacturers
of: wireless telecommunication products (Ericsson, Motorola and Siemens);       
automotive electronics (Delco, Ford, Nippon-Denso and Siemens); miniature       
capacitors (Kemet, Kyocera/AVX, Murata, Philips, Samsung and TDK) and           
semiconductor memory devices (Fujitsu, Hitachi, Hyundai, IBM, Samsung and Texas 
Instruments). See "Information Concerning ESI."                                 

ESI's executive offices are located at 13900 NW Science Park Drive,   
Portland, Oregon 97229 and its telephone number is (503) 641-4141.              

Applied Intelligent Systems, Inc.                                               

   AISI provides electronics manufacturers with machine vision solutions for
automated process control and visual inspection for the assembly of computer    
chips and electronic printed circuit boards. AISI offers a low cost computer    
architecture, easy-to-use software development tools, and powerful application  
software which emulates the human thought process. AISI's vision computers are  
configurable with a chain of multiple computer processors working               
simultaneously. Neural network software uses this increased capability to       
perform billions of calculations per second, analyzing an image as if the vision
system were a human brain. AISI markets its products through direct sales, sales
representatives, and value added resellers in North America, Europe, and Asia.  
Significant customers include: Kulicke & Soffa, Motorola and Universal          
Instruments in the United States; Siemens in Germany; Philips N.V. in Holland;  
Canon, Japan-EM, Sanyo Silicon and Toshiba in Japan; Haitai Electronics and     
Samsung in Korea; and Motorola plants in Malaysia, Taiwan, Hong Kong and the    
Philippines. See "Information Concerning AISI."                                 

 AISI's executive offices are located at 3923 Ranchero Drive, Ann Arbor,
Michigan 48108 and its telephone number is (313) 332-7100.                      

Asteroid Merger Corp.                                                           

     Merger Corp. was recently organized by ESI for the purpose of effecting the
acquisition of AISI. It has no material assets and has not engaged in any       
activities except in connection with the Merger. Its executive offices are      
located at 13900 NW Science Park Drive, Portland, Oregon 97229-5497. Its        
telephone number at that address is (503) 641-4141.                             

1 

424B1
7th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 7th
THE MERGER                                                                      

  As a result of the proposed Merger, Merger Corp. will be merged with and
into AISI and AISI will thereby become a wholly-owned subsidiary of ESI. Each   
outstanding share of AISI Common Stock will be converted into the right to      
receive a number of shares of ESI Common Stock that corresponds to the          
Conversion Ratio. See "The Merger Agreement--Conversion of Shares" and "The     
Merger Agreement--Corporate Structure and Related Matters After the Merger."    

The terms and provisions of all outstanding AISI stock options (the   
"Options") will continue in full force and effect following the Merger. At the  
Effective Time, each Option will be assumed by ESI and will be converted into an
option to purchase ESI Common Stock after giving effect to the Conversion Ratio.
The exercise price per share will also be redetermined based upon the Conversion
Ratio. If all outstanding AISI Options were to be exercised after the Merger,   
the aggregate proceeds to ESI from such exercise would be approximately $2.3    
million. The term, exercisability, vesting schedule, status as an "Incentive    
Stock Option" under Section 422 of the Code, if applicable, and all other terms 
and conditions of the Options will to the extent permitted by law and otherwise 
reasonably practicable be unchanged. See "The Merger Agreement--Treatment of    
AISI Stock Options."                                                            

 Shares of ESI Common Stock received by certain AISI shareholders in the
proposed Merger will be subject to certain resale restrictions under applicable 
accounting rules and securities laws. See "The Merger Agreement-- Resale of ESI 
Common Stock."                                                                  

EFFECTIVE TIME OF THE MERGER                                                    

As promptly as practicable after the satisfaction or waiver of the    
conditions set forth in the Merger Agreement, the parties thereto will file     
articles of merger with the Secretaries of State of each of Oregon and Michigan.
The merger will become effective at the time of the later of those filings (the 
"Effective Time"). It is anticipated that the Merger will occur in late November
or early December 1997.                                                         

CONDITIONS TO THE MERGER                                                        

  Consummation of the Merger is subject to the satisfaction of a number of
conditions, including but not limited to (i) expiration or termination of the   
Hart-Scott-Rodino Antitrust Improvements Act waiting period described at        
"Regulatory Matters" below; (ii) listing of up to 1,200,000 shares of ESI Common
Stock issued in connection with the Merger in the Nasdaq National Market; (iii) 
the absence of any restrictive court orders or any other legal restraints or    
prohibitions, and of any pending governmental proceedings, preventing or making 
illegal the consummation of the Merger; (iv) the continuing accuracy of the     
representations and warranties made in the Merger Agreement on and as of the    
Effective Time (except those limited by their terms to a different date); and   
(v) the receipt by ESI and AISI of certain opinions regarding tax and accounting
matters. See "The Merger Agreement--Conditions to the Merger."                  

     AISI has agreed that it will not encourage, initiate or solicit alternative
acquisition proposals, subject to the exercise of AISI directors' fiduciary     
duties. See "The Merger Agreement--Nonsolicitation of Alternative Transactions."

INDEMNITY AND ESCROW AGREEMENT                                                  

The Merger Agreement provides for a limited indemnification of ESI and
Merger Corp. by each AISI shareholder against damages resulting from breach of  
AISI representations, warranties and covenants under the Merger Agreement, and  
against damages related to litigation involving AISI.                           

2 

424B1
8th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 8th
 Pursuant to an escrow agreement (the "Escrow Agreement"), 10 percent of
each AISI shareholder's shares of ESI Common Stock to be received in the Merger,
rounded down to the nearest full share, will be delivered to an escrow agent    
(the "Escrow Agent") and be subject to the terms of the escrow described in the 
Escrow Agreement (the "Escrow"). Claims on the Escrow are subject to amount and 
timing limitations, including, among others, the requirement that AISI balance  
sheet reserves must be used before any claim on the Escrow may be made.         

In no event will any AISI shareholder have any liability in excess of 
shares held in the Escrow.                                                      

   Three persons will be appointed to act on behalf of all AISI shareholders
in connection with the Escrow (the "Shareholder Representatives") and will be   
signatories to the Escrow Agreement. See "The Merger Agreement-- Indemnity and  
Escrow Agreement."                                                              

TERMINATION; BREAKUP FEES                                                       

The Merger Agreement may be terminated and the Merger may be abandoned
prior to the Effective Time, under the circumstances specified in the Merger    
Agreement, including by mutual written agreement of ESI and AISI and by either  
party if the Merger is not consummated by December 31, 1997. Under certain      
termination circumstances, a breakup fee of $3 million is payable by AISI or by 
ESI. See "The Merger Agreement--Termination; Breakup Fees."                     

AISI SHAREHOLDERS WRITTEN CONSENT                                               

     Approval of the Merger by AISI shareholders will be obtained by the written
consent of the holders of at least a majority of the AISI Common Stock. See     
"AISI Shareholders Written Consent" and "AISI Voting Securities and Principal   
Shareholders."                                                                  

NO AISI DISSENTER RIGHTS                                                        

     The Michigan Business Corporation Act ("MBCA") does not provide dissenters'
rights in connection with the Merger. Although the Merger Agreement originally  
provided for dissenters' rights in connection with the Merger, Amendment No. 2  
to the Merger Agreement deleted all references to dissenters' rights.           

REASONS FOR THE MERGER                                                          

ESI'S Reasons for the Merger                                                    

The Merger is expected to add to ESI's ability to serve the expanding 
capital equipment needs of its global, multi-national customers in the          
electronics industry. The Merger also offers the possibility of achieving       
operating efficiencies through elimination of duplicate efforts and avoidance of
expected investments in research and development and in sales and distribution  
channels that would occur if the businesses of the two companies were not       
combined. ESI believes that AISI, operating independently, would incur          
significant expenses to establish offices in Europe, Japan and other locations  
in the Far East in order to expand its sales and service customers. ESI         
estimates that the combined companies will reduce duplicative professional fees 
and personnel costs and may save between $500,000 and $1 million annually. See  
"The Merger--Reasons for the Merger--ESI's Reasons for the Merger."             

AISI'S Reasons for the Merger                                                   

    After exploring various other strategic alternatives, including an initial
public offering, AISI concluded that a sale of AISI to ESI would provide market 
liquidity and would offer the greatest potential for achieving                  

3 

424B1
9th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 9th
long-term value for AISI Shareholders. See "The Merger--Reasons for the         
Merger--AISI's Reasons for the Merger."                                         

FAIRNESS OPINION OF AISI FINANCIAL ADVISOR                                      

In its role as financial advisor to AISI, Adams, Harkness & Hill, Inc.
("AH&H") was asked to render its opinion to the AISI Board as to the fairness to
the shareholders of AISI, from a financial point of view, of the consideration  
to be received by AISI in the Merger. On September 29, 1997, AH&H delivered its 
oral opinion to the AISI Board that the consideration to be received by the AISI
shareholders in the Merger is fair from a financial point of view. AH&H         
subsequently delivered its written opinion.                                     

   A copy of the AH&H Opinion is attached hereto as Annex B. Holders of AISI
Common Stock are urged to read the opinion in its entirety for a summary of the 
assumptions made, procedures followed, other matters considered and the limits  
of the review by AH&H. The summary of the AH&H Opinion set forth in this        
Prospectus/Information Statement is qualified in its entirety by reference to   
the full text of such opinion. The AH&H Opinion was prepared for the AISI Board,
is directed only to the fairness, as of September 29, 1997, from a financial    
point of view, of the consideration to be received by the holders of AISI Common
Stock, and does not constitute a recommendation to any stockholder as to how to 
vote with regard to the Merger. See "The Merger --Fairness Opinion of AISI      
Financial Advisor."                                                             

INTERESTS OF CERTAIN PERSONS IN THE MERGER                                      

     Vesting of options granted to AISI officers and employees will be partially
accelerated as a result of the Merger. See "The Merger--Interests of Certain    
Persons in the Merger."                                                         

SURRENDER OF CERTIFICATES                                                       

     If the Merger becomes effective, ESI will cause First Chicago Trust Company
of New York (the "Transfer Agent") to mail a letter of transmittal (the "Letter 
of Transmittal") and other documents, with instructions to all holders of record
of AISI Common Stock as of the Effective Time for use in surrendering their     
stock certificates in exchange for certificates representing ESI Common Stock   
and a cash payment in lieu of fractional shares.                                

     The Letter of Transmittal will provide for, among other things, transmittal
of each holder of record's shares of AISI Common Stock to the Transfer Agent,   
agreement to the indemnification provisions contained in the Merger Agreement,  
agreement to the terms of the Escrow Agreement, including the escrow of shares  
of ESI Common Stock on behalf of such shareholder and the appointment of the    
Shareholder Representatives. See "The Merger Agreement--Conversion of Shares"   
and "The Merger Agreement--Indemnification and Escrow Agreement."               

The other documents with the Letter of Transmittal will include stock 
powers to be endorsed in blank by each AISI shareholder with respect to the     
shares of ESI Common Stock to be held pursuant to the Escrow Agreement on behalf
of such shareholder.                                                            

CERTIFICATES SHOULD NOT BE SURRENDERED BY AISI SHAREHOLDERS UNTIL THE 
LETTER OF TRANSMITTAL AND OTHER DOCUMENTS DESCRIBED ABOVE HAVE BEEN RECEIVED.   

ACCOUNTING TREATMENT                                                            

   The Merger is expected to be accounted for as a pooling of interests. See
"The Merger--Accounting Treatment."                                             

   As a condition to the Merger, each of ESI and AISI will have received the
opinion of Arthur Andersen LLP, independent public accountants, to the          

4 

424B1
10th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 10th
effect that the Merger will qualify for pooling of interests accounting. See    
"The Merger Agreement--Conditions to the Merger."                               

MATERIAL FEDERAL INCOME TAX CONSEQUENCES                                        

The Merger is intended to qualify as a tax-free reorganization under  
Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"). As
a reorganization, holders of AISI Common Stock would not recognize gain or loss 
for federal income tax purposes upon receipt of ESI Common Stock solely in      
exchange for their shares of AISI Common Stock, except for cash received in lieu
of fractional shares. See "The Merger--Material U.S. Federal Income Tax         
Consequences."                                                                  

REGULATORY MATTERS                                                              

    Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended
(the "HSR Act"), and the rules promulgated thereunder by the United States      
Federal Trade Commission (the "FTC"), the Merger may not be consummated until   
notifications have been given and certain information has been furnished to the 
FTC and the Antitrust Division of the United States Justice Department (the     
"Antitrust Division"), and the specified waiting period has expired. The        
applicable waiting period under the HSR Act terminated on October 31, 1997. See 
"The Merger--Regulatory Matters."                                               

5 

424B1
11th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 11th
RISK FACTORS

  The following factors should be carefully considered, in addition to the
other information presented in this Prospectus/Information Statement. This      
Prospectus/Information Statement contains forward-looking statements which      
involve risks and uncertainties. ESI's actual results could differ materially   
from those anticipated in these forward-looking statements as a result of such  
risks and uncertainties, including those set forth in the following risk factors
and elsewhere in this Prospectus/Information Statement.                         

UNCERTAINTIES RELATED TO THE INTEGRATION OF NEW BUSINESS                        

     The successful combination of companies in the high technology industry may
be more difficult to accomplish than in other industries. There can be no       
assurance that ESI will be successful in integrating its own distribution       
channels with those of AISI, that ESI will be successful in coordinating the    
activities of the AISI and ESI sales forces or in selling AISI's products to    
ESI's customer base, in integrating AISI into ESI's management information      
systems or integrating AISI's technology so that it can be fully utilized by    
ESI. In addition, ESI is in the process of integrating two other businesses,    
Dynamotion Corp. and Chip Star Inc., which were acquired by ESI in June 1997.   
Integrating three businesses will require management resources and may make it  
more difficult to integrate AISI into ESI. There can be no assurance that ESI   
can effectively integrate AISI into ESI's operations.                           

UNCERTAINTIES RELATED TO COMBINED OPERATIONS AFTER THE MERGER                   

  While the acquisition of AISI by ESI offers the possibility of achieving
operating efficiencies, it also entails the diversion of management's attention 
to the assimilation of operations and personnel of AISI, which might have       
possible adverse short-term effects on ESI's operating results. There can be no 
assurance that the combined companies will retain their respective key personnel
or customers, the same volume of business from such customers, or that ESI will 
realize any of the potential benefits of the Merger.                            

ELECTRONICS INDUSTRY DOWNTURNS MAY ADVERSELY AFFECT OPERATING RESULTS           

ESI's business depends in large part upon the capital expenditures of 
manufacturers of electronic devices, including miniature capacitors and         
semiconductor memory devices, and circuits used in wireless telecommunications  
equipment, including pagers and cellular phones, automotive electronics, and    
computers. The markets for products manufactured by ESI's customers are highly  
cyclical and have historically experienced periodic downturns, which often have 
had a severe effect on the demand for capital equipment such as that sold by    
ESI. There is no assurance that these markets will not experience downturns in  
the future or that such downturns will not have a material adverse effect on    
ESI's operating results.                                                        

RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW PRODUCT INTRODUCTIONS AND         
PRODUCT ENHANCEMENTS                                                            

The market for ESI's products is characterized by rapidly changing    
technology and evolving industry standards. There can be no assurance that ESI's
current technology base will continue to address current and evolving customer  
needs. ESI believes that its future success will depend on its ability to       
develop and manufacture new products and product enhancements and to introduce  
them successfully into the market. Failure to do so in a timely fashion could   
harm ESI's competitive position. The announcements or introductions of new      
products by ESI or its competitors may adversely affect ESI's operating results,
since these announcements or introductions may cause customers to defer or      
forego ordering products from ESI's existing product lines.                     

6 

424B1
12th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 12th
VARIABILITY OF QUARTERLY OPERATING RESULTS                                      

ESI has experienced and expects to continue to experience significant 
fluctuations in its quarterly operating results due to a variety of factors,    
including the timing of new product announcements and releases by ESI and its   
competitors, market acceptance of new and enhanced versions of ESI's products,  
timing and shipment of significant orders, mix of products sold, customer       
cancellations or shipment delay, production delays, exchange rate fluctuations, 
management decisions to commence or discontinue products, length of sales cycles
and cyclicality in the electronics industry.                                    

ESI derives a substantial portion of its net sales from the sale of a 
relatively small number of systems, which typically range in price from $150,000
to over $1 million. As a result, the timing of a single transaction could have a
significant impact on ESI's quarterly net sales and operating results.          

 ESI's backlog at the beginning of a quarter does not include all orders
needed to achieve ESI's sales objectives for that quarter. Consequently, ESI's  
net sales and operating results for a quarter will depend upon ESI generating   
orders to be shipped in the same quarter that the order is received.            
Furthermore, a substantial portion of ESI's net sales has historically been     
realized near the end of each quarter. Accordingly, the failure to receive      
anticipated orders or delays in shipments near the end of a particular quarter, 
due, for example, to unanticipated shipment reschedulings or cancellations by   
customers or unexpected manufacturing difficulties, may cause net sales in a    
particular quarter to fall significantly below ESI's expectations, which would  
have a material adverse effect on ESI's operating results for such quarter.     

   The need for continued expenditures for research and development, capital
equipment and worldwide customer service and support would make it difficult for
ESI to reduce its expenses in a particular quarter if ESI's sales goals for such
quarter are not met. Accordingly, there can be no assurance that ESI will not   
sustain losses in future quarters.                                              

COMPETITION                                                                     

   The electronics capital equipment industry is highly competitive. In each
of the markets it serves, ESI faces substantial competition from established    
competitors, some of which have greater financial, engineering, manufacturing   
and marketing resources than ESI. In addition, many of ESI's customers are in   
effect competitors of ESI because they have developed, or have the ability to   
develop, manufacturing equipment for internal use. ESI's competitors in each    
product area can be expected to continue to improve the design and performance  
of their products and to introduce new products with competitive                
price/performance characteristics. Competitive pressures, including systems     
development efforts by certain of ESI's customers, often necessitate price      
reductions which can adversely affect operating results. Although ESI believes  
that it has certain technical and other advantages over its competitors,        
maintaining such advantages will require a continued high level of investment by
ESI in research and development and sales and marketing. There can be no        
assurance that ESI will have sufficient resources to continue to make such      
investments or that ESI will be able to make the technological advances         
necessary to maintain such competitive advantages. See "Information Concerning  
ESI--Competition."                                                              

PATENTS AND OTHER INTELLECTUAL PROPERTY                                         

ESI's success depends in part on its proprietary technology. While ESI
attempts to protect its proprietary technology through patents, copyrights and  
trade secrets, it believes that its success will depend largely upon continued  
innovation and technological expertise. There can be no assurance that ESI will 
be able to protect its technology or that competitors will not be able to       
develop similar technology independently. No assurance can be given that the    
claims allowed on any patents held by ESI will be sufficiently broad to         

7 

424B1
13th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 13th
protect ESI's technology. In addition, no assurance can be given that any       
patents issued to ESI will not be challenged, invalidated or circumvented or    
that the rights granted thereunder will provide competitive advantages to ESI.  

   In addition, ESI and its customers from time to time receive letters from
third parties, including some of ESI's competitors, alleging infringement of    
such parties' patent rights by ESI's products. While such letters are prevalent 
in ESI's industry and ESI has in the past been able to license necessary patents
or technology on commercially reasonable terms, there can be no assurance that  
ESI would prevail in any litigation seeking damages or expenses from ESI or to  
enjoin ESI from selling its products on the basis of such alleged infringement, 
or that ESI would be able to license any valid and infringed patents on         
reasonable terms.                                                               

Some customers using certain products of ESI have received a notice of
infringement from Jerome H. Lemelson, alleging that equipment used in the       
manufacture of electronic devices infringes patents issued to Mr. Lemelson      
relating to "machine vision" or "barcode reader" technologies. Certain of these 
customers are engaged in litigation with Mr. Lemelson and, together with certain
other customers, have notified ESI that they may be seeking indemnification from
ESI for any damages and expenses resulting from this matter. One of ESI's       
customers has settled its litigation with Mr. Lemelson, and several other       
customers are currently engaged in litigation involving Mr. Lemelson's patents. 
ESI cannot predict the outcome of this or similar litigation or its effect upon 
ESI, and there can be no assurance that any such litigation or claim would not  
have a material adverse effect upon ESI's financial condition or results of     
operations. See "Information Concerning ESI--Patents and Other Intellectual     
Property."                                                                      

FLUCTUATIONS IN INTERNATIONAL SALES AND CURRENCY EXCHANGE RATES CAN ADVERSELY   
AFFECT RESULTS                                                                  

International sales accounted for 70.8%, 66.9%, and 71.0% of ESI's net
sales for fiscal years ended May 31, 1995, 1996 and 1997, respectively. ESI     
expects that international sales will continue to represent a significant       
percentage of net sales in the future. As a result, a significant portion of    
ESI's sales will be subject to certain risks, including changes in demand       
resulting from fluctuations in interest and currency exchange rates, as well as 
by factors such as the risk of government financed competition, changes in trade
policies, tariff regulations, difficulties in obtaining U.S. export licenses and
the difficulties of staffing and managing foreign operations. See "Information  
Concerning ESI--Sales, Marketing and Service."                                  

DEPENDENCE ON KEY EMPLOYEES                                                     

   The future success of ESI is dependent, in part, on its ability to retain
certain key personnel. ESI also needs to attract additional skilled personnel in
many areas of its business to continue to grow. There can be no assurance that  
ESI will be able to retain its existing personnel or attract additional         
qualified employees in the future. ESI does not carry key person life insurance 
on any of its key employees.                                                    

DEPENDENCE ON SUPPLIERS                                                         

 Certain of the components included in ESI's systems are obtained from a
single source or a limited group of suppliers. ESI's relationship with its      
suppliers is formalized by purchase orders, not long term contracts. Although   
ESI seeks to reduce dependence on those sole and limited source suppliers, the  
partial or complete loss of certain of these sources could have at least a      
temporary adverse effect on ESI's results of operations and damage customer     
relationships. Further, a significant increase in the price of one or more of   
these components could adversely affect ESI's results of operations. See        
"Information Concerning ESI--Manufacturing and Supply."                         

8 

424B1
14th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 14th
 SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION

Selected Historical Financial Information                                       

   The selected financial data presented below should be read in conjunction
with the financial statements and the notes thereto included elsewhere in this  
Prospectus/Information Statement for ESI and AISI. In June 1997, ESI acquired   
Chip Star, Inc., a privately-held company based in San Marcos, California in a  
merger accounted for as a pooling of interests. Accordingly, all ESI financial  
statements and footnotes incorporated by reference and summary selected         
historical and pro forma financial information have been restated to reflect    
this acquisition.                                                               

   ESI Selected Historical Financial Information. The consolidated statement
of operations data set forth below for the fiscal years ended May 31, 1995, 1996
and 1997 and the consolidated balance sheet information as of May 31, 1996 and  
1997 have been derived from the audited Consolidated Financial Statements and   
Notes thereto included elsewhere in this Prospectus/Information Statement. The  
consolidated statement of operations data for the fiscal years ended May 31,    
1993 and 1994 and the consolidated balance sheet information as of May 31, 1993,
1994 and 1995 are derived from audited consolidated financial statements not    
included in or incorporated by reference in this Prospectus/Information         
Statement. The consolidated statement of operations data for the three-month    
periods ended August 31, 1996 and 1997 and the consolidated balance sheet data  
as of August 31, 1997 have been derived from unaudited consolidated financial   
statements of ESI included elsewhere in this Prospectus/Information Statement.  
In the opinion of management, such unaudited consolidated financial statements  
have been prepared on the same basis as the audited consolidated financial      
statements referred to above and include all adjustments, consisting of normal  
recurring accruals, necessary for a fair presentation of the financial position 
of ESI and the results of operations for the indicated periods. Operating       
results for the three months ended August 31, 1997 are not necessarily          
indicative of the results that may be expected for the entire fiscal year ending
May 31, 1998.                                                                   

                                                        [Enlarge/Download Table]

                                                                                                          Three Months     
                                                                 ESI                                          Ended        
                                                       Fiscal Year Ended May 31                            August 31,      
                                    ----------------------------------------------------------------  -------------------- 
                                        1993          1994           1995         1996          1997     1996         1997 
                                    --------      --------       --------     --------      --------  -------     -------- 
                                                                                                          (Unaudited)      
                                                             (In thousands, except per share data)                         
                                                                                                                           
Consolidated                                                                                                               
Statement of                                                                                                               
Operations Data                                                                                                            

Net Sales                           $ 67,851      $ 72,550       $112,900     $166,310      $160,149  $36,199     $ 48,356 
Net income (loss)(1)(2)............ $  2,244      $  7,740       $ 12,217     $ 17,299      $ 21,250  $ 4,603     $ (3,861)
                                    ========      ========       ========     ========      ========  =======     ======== 
Net income (loss)                   $   0.37      $   1.09       $   1.49     $   1.86      $   2.27  $  0.49     $  (0.39)
per share:(1)(2)                                                                                                           

9 

424B1
15th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 15th
                                                        [Enlarge/Download Table]

                                                                   May 31                                         
                                     ----------------------------------------------------------------   August 31,
                                         1993          1994           1995         1996          1997     1997    
                                     --------      --------       --------     --------      --------   --------  
                                                                                                                  
Consolidated Balance                                        (In thousands)                             (Unaudited)
Sheet Data                                                                                                        

Working capital....................  $ 28,883      $ 36,148       $ 76,413     $ 94,400      $116,628   $117,561  
Net property, plant and                                                                                           
equipment..........................    16,696        14,662         15,699       16,821        16,404     18,120  
Total assets.......................    61,161        62,997        112,921      135,458       154,813    169,297  
Long-term debt.....................     4,809           200             --           --            --         --  
Shareholders' equity...............    43,950        53,559         95,156      116,845       139,114    149,530  

---------------                                                                                                   

(1)  Fiscal 1996 includes the $6.0 million in-process research and development                                    
     write-off associated with the acquisition of XRL, Inc.                                                       

(2)  The three month period ended August 31, 1997 includes $11.1 million of                                       
     acquired in-process research and development and merger-related expenses                                     
     associated with the Dynamotion Corp. and Chip Star, Inc. acquisitions.                                       

   AISI Selected Historical Financial Information. The income statement data
for the years ended December 31, 1994, 1995 and 1996, and the balance sheet data
at December 31, 1995 and 1996 are derived from the audited financial statements 
included elsewhere in this Prospectus/Information Statement. The income         
statement data for the years ended December 31, 1992 and 1993, and the balance  
sheet data at December 31, 1992, 1993 and 1994, are derived from audited        
financial statements not included herein. The income statement data for the nine
months ended September 30, 1996 and 1997 and the balance sheet data at September
30, 1997 are derived from unaudited financial statements that are included      
elsewhere in this Prospectus/Information Statement and include, in the opinion  
of management of AISI, all adjustments, consisting only of normal, recurring    
adjustments, necessary for a fair presentation of the information set forth     
therein. The income statement data for the nine months ended September 30, 1997 
is not necessarily indicative of future results.                                

10

424B1
16th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 16th
                                                        [Enlarge/Download Table]

                                                                                                             Nine Months    
                                                                  AISI                                          Ended       
                                                      Fiscal Year Ended December 31,                        September 30,   
                                     ----------------------------------------------------------------   --------------------
                                         1992          1993           1994         1995          1996      1996         1997
                                      -------     ---------      ---------     --------      --------   -------     --------
                                                                                                             (Unaudited)    
                                                                                                                            
Income Statement Data:                                         (In thousands, except per share data)                        

Sales................................ $ 7,012     $  10,763      $  14,804     $ 22,579      $ 16,610   $13,530     $ 22,096
Cost of vision system sales..........   2,356         3,506          5,337        9,959         9,943     6,842        9,749
                                      -------      --------       --------     --------      --------   -------     --------
Gross margin ........................   4,656         7,257          9,467       12,620         6,667     6,688       12,347
                                      -------      --------       --------     --------      --------   -------     --------
Operating expenses:                                                                                                         
     Selling, service and               2,199         3,191          4,027        4,711         4,138     3,174        3,664
     administrative .................                                                                                       
     Research, development and                                                                                              
           engineering...............   2,025         2,906          3,996        4,513         5,067     3,883        4,803
                                      -------      --------       --------     --------      --------   -------     --------
     Total operating expenses........   4,224         6,097          8,023        9,224         9,205     7,007        8,467
                                      -------      --------       --------     --------      --------   -------     --------
Operating income (loss)..............     432         1,160          1,444        3,396        (2,538)     (319)       3,880
Other income (expense), net..........     (18)          (67)           159(1)       (95)         (582)       66           77
Income (loss) before provision for                                                                                          
income taxes.........................     414         1,093          1,603        3,301        (3,120)     (253)       3,957
Provision for income taxes...........      --            15             93          437            52        53          315
                                      -------      --------       --------     --------      --------   -------     --------
Net income (loss).................... $   414      $  1,078       $  1,510     $  2,864       ($3,172)  $  (306)    $  3,642
                                      =======      ========       ========     ========      ========   =======     ========
Net income (loss) per share.......... $  0.11      $   0.29       $   0.40     $   0.70        ($0.90)   ($0.09)    $   0.92
                                      =======      ========       ========     ========      ========   =======     ========
Number of shares used in                                                                                                    
computing per share amounts..........   3,664         3,673          3,820        4,121         3,515     3,493        3,976

                                                        [Enlarge/Download Table]

                                                                         December 31,                                        
                                              ----------------------------------------------------------------  September 30,
                                                  1993          1994           1995         1996          1997      1997     
                                              --------      --------       --------     --------      --------  ------------ 
                                                                                                                             
                                                               (In thousands)                                                
                                                                                                                 (Unaudited) 
Working capital..........................     $    528      $  1,252       $  2,188     $  4,525      $  1,572     $  5,482  
Total assets.............................        2,765         5,057          8,286       11,675         6,980       12,889  
Long-term capital lease obligations                                                                                          
and notes payable, including current                                                                                         
portion..................................           --            --             --          289           112          315  
Shareholders' equity.....................        1,484         2,583          4,210        6,794         4,156        8,006  

(1)  Includes $229 gain from insurance proceeds on equipment theft.                                                          

Unaudited Pro Forma Summary of Selected Financial Information(1)                

     THE PRO FORMA INFORMATION BELOW IS UNAUDITED AND PRESENTED FOR ILLUSTRATIVE
PURPOSES ONLY. THE INFORMATION PRESENTED BELOW IS NOT NECESSARILY INDICATIVE OF 
THE RESULTS OR FINANCIAL POSITION THAT ACTUALLY WOULD HAVE BEEN OBTAINED IF THE 
MERGER HAD BEEN CONSUMMATED, NOR IS IT NECESSARILY INDICATIVE OF FUTURE         
OPERATING RESULTS OR FINANCIAL POSITION.                                        

11

424B1
17th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 17th
                                                        [Enlarge/Download Table]


                                                                                             Three Months Ended      
                                                Fiscal Year Ended May 31                -----------------------------
                                         --------------------------------------         August 31,         August 31,
                                             1995           1996           1997              1997               1996 
                                         --------       --------       --------         ---------          --------- 
                                                            (In thousands, except per share data)                    
                                                                                                                     
Pro Forma Consolidated Statements                                                                                    
of Income                                                                                                            
Net Sales(2)............................ $130,736       $189,440       $180,036          $ 57,119           $ 39,583 
Net income (loss)(2)....................   14,780         20,407         19,459            (1,917)             3,861 

Net income (loss) per share (2).........     1.54           1.91           1.81             (0.17)              0.36 

                                                        [Enlarge/Download Table]

                                                               May 31                           August 31,         
                                               --------------------------------------  ----------------------------
                                                   1995           1996           1997       1997               1996
                                               --------       --------       --------  ---------          ---------
                                                            (In thousands)                                         
                                                                                                                   
Pro Forma Consolidated Balance                                                                                     
Sheet Data                                                                                                         
Total assets............................       $123,307       $148,532       $167,351  $ 183,076          $ 150,983
Long-term obligations, including                                                                                   
current portion.........................             --             80            193        170                 58

(1)  Pro forma information is based on combined ESI and AISI after giving effect                                   
     to the proposed Merger on a pooling of interests accounting basis, assuming                                   
     the Merger had been effective during all periods presented above.                                             

(2)  Net sales, net income and net income per share for fiscal 1997 does not                                       
     include the pro forma effects of the Dynamotion acquisition on June 9,                                        
     1997, which was accounted for as a purchase. Pro forma net sales, net                                         
     income and net income per share for fiscal 1997 assuming the Dynamotion                                       
     transaction had occurred as of June 1, 1996 is $192,674, $13,465 and $1.21,                                   
     respectively.                                                                                                 

EQUIVALENT PER COMMON SHARE DATA

  The following table sets forth selected historical per common share data
for ESI and AISI, pro forma data per share of ESI Common Stock, and equivalent  
pro forma data per share of AISI Common Stock after giving effect to the        
proposed Merger on a pooling-of-interests accounting basis, assuming the Merger 
had been effective during all the periods presented. The pro forma equivalent   
data for AISI are based on the historical amounts per share, multiplied by the  
Conversion Ratio. The data should be read in conjunction with the consolidated  
financial statements and notes thereto and other financial information with     
respect to ESI and AISI set forth elsewhere in this Prospectus/Information      
Statement, and such data are qualified in their entirety by reference thereto.  

12

424B1
18th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 18th
                                                        [Enlarge/Download Table]


                                                                           May 31                        August 31,       
                                                           -------------------------------------    --------------------- 
                                                            1995            1996           1997      1997           1996  
                                                           -----            -----          -----    ------          ----- 
                                                                                                                          
ESI Common Stock(1)                                                                                                       
Net Income (loss) per share:(2)                                                                                           
         Historical.................................       $ 1.49           $ 1.86         $ 2.27    (0.39)          0.49 
         Pro forma combined.........................         1.54             1.91           1.81    (0.17)          0.36 
Book value per share at period-end(3):                                                                                    
         Historical.................................        10.49            12.49          14.69    15.07                
         Pro forma combined.........................         9.66            11.61          13.35    13.86                
AISI Common Stock(1)                                                                                                      
Net income (loss) per share:(2)                                                                                           
         Historical.................................         0.48             0.59          (0.46)    0.47          (0.18)
         Pro forma equivalent.......................         0.47             0.58           0.55    (0.05)          0.11 
Book value per share at period-end(3)                                                                                     
         Historical.................................         1.49             2.11           1.67     2.04                
         Pro forma equivalent.......................         2.95             3.54           4.07     4.23                

(1)  Neither ESI nor AISI paid any cash dividends for any of the periods                                                  
     presented.                                                                                                           

(2)  Represents the 12 months ended May 31, 1995, 1996 and 1997 and three months                                          
     ended August 31, 1996 and 1997 for ESI combined with the twelve months                                               
     ended June 30, 1995, 1996, and 1997 and three months ended August 31, 1996                                           
     and 1997 for AISI.                                                                                                   

(3)  Represents May 31, 1995, 1996 and 1997 and August 31, 1997 for ESI and June                                          
     30, 1995, 1996 and 1997 and August 31, 1997 for AISI.                                                                

 MARKET AND MARKET PRICES FOR COMMON STOCK

   ESI Common Stock is traded on the Nasdaq National Market under the symbol
"ESIO." At August 31, 1997 there were 9,922,624 shares of Common Stock          
outstanding and held by 317 record holders. The information presented in the    
table below represents the high and low sales prices per share for ESI Common   
Stock for the periods indicated. On September 26, 1997, the last full trading   
day prior to public announcement of the Merger, the last sale price for ESI     
Common Stock was $56, and on November 25, 1997, the most recent practicable     
trading day for which quotations were available prior to the date of this       
Prospectus/Information Statement, the last sale price for ESI Common Stock was  
$40.875. Following the Merger, ESI Common Stock will continue to be traded on   
the Nasdaq National Market.                                                     

  There is no established public trading market for AISI Common Stock. The
following prices of AISI Common Stock were determined by multiplying the price  
of ESI Common stock by 0.3046025, which is the Conversion Ratio calculated as of
November 14, 1997, and rounded to three places. Because AISI has ageed to not   
issue any more shares of its Common Stock or stock options, the parties do not  
expect the Conversion Ratio to change prior to Closing.                         

                                                        [Enlarge/Download Table]

 Fiscal                                                                                                   
  Year                                                         ESI COMMON STOCK       AISI COMMON STOCK   
 ------                                                     ----------------------  ----------------------
                                                                                                          
 1995                                                          High           Low      High           Low 
         First Quarter..................................... $13-3/4        $ 8-5/8  $ 4.188        $ 2.627
         Second Quarter....................................  20-1/4         12-1/4    6.168          3.731

                                     13                                                                   

424B1
19th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 19th
         Third Quarter.....................................  23-1/4         17-1/2    7.082          5.331
         Fourth Quarter....................................  29-5/8         18-3/4    9.024          5.711
1996                                                                                                      
         First Quarter.....................................  39-3/4         24-5/8   12.108          7.501
         Second Quarter....................................  41-1/2         24-1/2   12.641          7.463
         Third Quarter.....................................  30-1/2         18-3/4    9.290          5.711
         Fourth Quarter....................................  28-3/4         16-3/4    8.757          5.102
1997                                                                                                      
         First Quarter.....................................  27-1/4         15-1/2    8.300          4.721
         Second Quarter....................................  26             17-1/4    9.920          5.254
         Third Quarter.....................................  31-3/4         22-1/2    9.671          6.854
         Fourth Quarter....................................  39-1/4         23-3/4   11.956          7.234
1998                                                                                                      
         First Quarter.....................................  52-15/16       35       16.125         10.661

 ESI has not paid any cash dividends on ESI Common Stock during the last
five fiscal years. ESI intends to retain its earnings for its business and does 
not anticipate paying any cash dividends on its Common Stock in the foreseeable 
future.                                                                         

AISI has never paid any cash dividends on AISI Common Stock and has no
intention of paying cash dividends in the foreseeable future.                   

   AISI SHAREHOLDERS ARE ADVISED TO OBTAIN CURRENT MARKET QUOTATIONS FOR ESI
COMMON STOCK. NO ASSURANCE CAN BE GIVEN CONCERNING THE MARKET PRICE FOR ESI     
COMMON STOCK BEFORE OR AFTER THE DATE ON WHICH THE MERGER IS CONSUMMATED. THE   
MARKET PRICE FOR ESI COMMON STOCK WILL FLUCTUATE BETWEEN THE DATE OF THIS       
PROSPECTUS/INFORMATION STATEMENT AND THE DATE ON WHICH THE MERGER IS CONSUMMATED
AND THEREAFTER.                                                                 

 AISI SHAREHOLDERS WRITTEN CONSENT

     Approval of the Merger by AISI's shareholders will be by written consent of
the holders of at least a majority of the outstanding shares of AISI Common     
Stock, in lieu of a shareholders meeting. The record date for voting by AISI    
shareholders on the Merger is October 10, 1997. Pursuant to applicable law, the 
Merger must be completed within 60 days after the record date, and each consent 
must be dated no earlier than ten days prior to the record date. Consents will  
be obtained only from the five largest AISI shareholders, who hold in the       
aggregate 69 percent of the outstanding shares of AISI Common Stock. All of the 
five largest shareholders have voting or observer representation on the AISI    
board of directors, which unanimously approved the Merger. The five AISI        
shareholders who will execute the written consent, the number of shares owned by
each consenting shareholder and the percentage of all shares outstanding        
represented by that ownership are as follows: (i) Morgenthaler Venture Partners 
(445,967 shares; 12.1%), (ii) Morgenthaler Venture Partners II (563,009 shares; 
15.3%); (iii) Michigan Strategic Fund (400,000 shares; 10.8%); (iv) State of    
Michigan, Department of Treasury (626,435 shares; 17.0%); and (v) Herbert D.    
Doan (509,630 shares; 13.8%). Mr. Doan is a member of the Board of Directors of 
AISI; the Chairman of AISI's Board of Directors, Robert D. Pavey, is a principal
of Morgenthaler Venture Partners and Morgenthaler Venture Partners II; and      
Michigan                                                                        

14

424B1
20th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 20th
Strategic Fund and State of Michigan, Department of Treasury, have an           
observer on AISI's Board of Directors who participates in discussions, but has  
no voting power. None of the five AISI shareholders executing the written       
consent is an employee of AISI, and there is no agreement, written or oral, with
any of these shareholders to induce his or its approval of the Merger. There    
will be no general solicitation of consents, and this Prospectus/Information    
Statement will be provided to all AISI shareholders other than the five largest 
shareholders solely for informational purposes.                                 

    Directors, officers and employees of AISI will communicate in person or by
telephone with the five largest AISI shareholders regarding the consents,       
without additional compensation. Written consents given may be revoked until    
AISI obtains written consents from the holders of at least a majority of the    
outstanding shares of AISI Common Stock and the notice required by the Michigan 
Business Corporation Act has been mailed to all AISI shareholders. Consents may 
be revoked by duly executing a later written revocation and delivering it to    
AISI, Attention: Corporate Secretary, at 3923 Ranchero Drive, Ann Arbor, MI     
48108.                                                                          

THE MERGER

DESCRIPTION                                                                     

Under the Merger Agreement, Asteroid Merger Corp. ("Merger Corp."), a 
wholly-owned subsidiary of ESI formed for this purpose, will be merged with and 
into AISI, with AISI continuing as the surviving corporation. At the Effective  
Time, each outstanding share of AISI Common Stock will be converted into the    
right to receive a number of shares that corresponds to the Conversion Ratio.   

BACKGROUND OF THE MERGER                                                        

ESI uses high performance machine vision in its semiconductor yield   
improvement product. ESI's management has long pursued a strategy to increase   
the speed and accuracy of machine vision in semiconductor yield improvement     
products. Also, ESI is enhancing the value of other ESI product lines with      
machine vision and creating vision products which could be sold to other        
end-users and original equipment manufacturers ("OEMs").                        

  The first step in implementing this strategy was the purchase of certain
assets of Intelledex, Inc. in June 1991. In July 1992, Donald R. VanLuvanee,    
President and Chief Executive Officer, joined ESI. His experience includes      
incorporating machine vision into semiconductor assembly equipment over twenty  
years ago. For several years, he was the President of Kulicke & Soffa, Inc., the
most significant customer of AISI. His experience and the previously expressed  
interest of ESI's Board of Directors in developing machine vision sales caused  
ESI to begin to focus in this area.                                             

     The ESI Vision Products Division integrated its machine vision product into
the ESI semiconductor yield improvement product in fiscal 1993. During fiscal   
1994, ESI added key technical and sales personnel to increase its presence in   
the machine vision business. In July 1995 ESI acquired XRL, Inc., previously a  
competitor in the semiconductor yield improvement market, and added additional  
machine vision products and engineering personnel. In fiscal 1996, ESI purchased
certain assets of Cybernetic Systems and Automation, Inc. and hired its founders
to extend product offerings to the broader electronics industry. Cybernetic     
Systems and Automation, Inc. developed and sold products to inspect and align   
the solder paste applied to printed circuit boards.                             

 The machine vision industry has grown dramatically since ESI's Board of
Directors approved the purchase of the former Intelledex assets. Machine vision 
capability in general and for solutions to specific problems is a fundamental   
requirement in a broad array of products used to make or assemble semiconductor 
and electronic products. ESI's vision-related sales have more than tripled from 
a small base since fiscal 1992; however, penetration of OEM accounts was        
limited. In late fiscal 1995, ESI's management decided to alter its general     
application, custom hardware focus and to begin to create specific vision       
products that run as software in a general purpose, PC-based environment. During
fiscal 1996 and                                                                 

15

424B1
21st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 21st
1997, ESI concentrated its efforts on selling those products to OEM suppliers of
semiconductor and electronics equipment. This effort has been modestly          
successful.                                                                     

AISI also has focused on forming OEM business arrangements for the key
discrete steps in the manufacture of semiconductors and electronic printed      
circuit boards. AISI uses its machine vision technology to provide its OEM      
customers with well-defined competitive advantages. By selectively focusing on  
key customers, AISI seeks to achieve a premium price for the OEM's product,     
which allows AISI the opportunity to maximize the value of its vision products. 

   AISI has long term OEM relationships with Universal Instruments, Philips,
and Kulicke & Soffa. New OEMs include Canon, Toshiba Automation, Sanyo Silicon, 
Samsung Aerospace, and Haitai Electronics. In 1996, $13.2 million of systems    
were sold to these eight customers. Motorola, Intel, Siemens, Samsung           
Electronics, Ishikawajima-Harima Heavy Industries, Kyokuto Boeki Kaisha, Ltd.   
and Japan E-M have used AISI's systems for automating a variety of manufacturing
operations. In 1996, $2.8 million of systems were sold to these seven accounts. 

Based upon its knowledge and experience in the OEM vision market, AISI
believes it is the second largest supplier and has been increasing its market   
share. However, it is considerably smaller than the market leader in total      
sales. The size of a vision supplier is an issue for large OEM's and            
semiconductor companies, and it is preferable for the supplier to be a public   
company.                                                                        

Between 1981 to 1989, AISI received $23 million of equity funding. For
several years the shareholders had anticipated a merger or a public sale of     
equity securities. These considerations, combined with the growth and           
profitability of the past five years, and the desire of AISI's shareholders for 
liquidity, resulted in the objective to either successfully complete an initial 
public offering of the Company's stock or merge AISI into a public company      
whereby significant operating synergies would be created between AISI and that  
company.                                                                        

  In July 1995 and periodically through the remainder of the calendar year
Joseph L. Reinhart, Director of Business Development for ESI and Robert D.      
Pavey, Chairman of the Board of AISI had discussions regarding the combination  
of AISI and ESI. During these discussions Mr. Pavey noted that AISI was         
examining several business and financial options including selling the company  
and offering shares to the public. Concurrently, ESI recognized its need to     
focus on developing electronic industry OEM accounts and the value of a high    
performance machine vision system.                                              

   ESI and AISI first considered the possibility of a combination of the two
companies in July 1995. At the time, AISI was investigating several business    
options, including selling the company or conducting an initial public offering.
Later that year, AISI selected underwriters and commenced the process of going  
public. However, the process was postponed in October 1995, as the shares of    
other technology companies began to decline in value and the outlook for        
business conditions became more uncertain.                                      

  In January 1996, AISI and ESI agreed to commence preliminary discussions
regarding the merger of AISI into ESI. Ultimately, after many meetings and      
considerable due diligence, each party concluded that a merger would be mutually
beneficial; on May 13, 1996, the parties executed an Agreement of Reorganization
and Merger. However, the merger was not completed, because a major customer of  
AISI reduced its order forecast, materially reducing the value of the merger to 
ESI's shareholders.                                                             

     In July 1997, AISI and ESI began to re-examine the possibility of effecting
a business combination between the two companies. While discussions between ESI 
and AISI continued, on August 29, 1997, AISI received a proposal from Cognex    
Corporation ("Cognex") to acquire AISI. Discussions then ensued between Cognex  
and AISI regarding the terms of a possible business combination; the proposal   
was modified several times during the course of these discussions. The existence
of these discussions and the proposed terms are subject to a Nondisclosure      
Agreement dated August 29, 1997 between the parties, which generally prohibits  
public                                                                          

16

424B1
22nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 22nd
disclosure without mutual consent until October 31, 2002. The Board of Directors
of AISI met on several occasions to consider the proposals advanced by Cognex,  
and on September 12, 1997, AISI rejected the most recent proposal, because AISI 
considered the price inadequate and the terms unacceptable, and AISI made a     
counter-proposal. While AISI awaited a response to its counter-proposal to      
Cognex, a merger offer was received from ESI.                                   

   In meetings on September 19, 26, 27 and 29, AISI's Board of Directors met
to consider the possibility of effecting a business combination with ESI and,   
specifically, the terms of the ESI offer; the discussions also included full    
consideration of the Cognex proposal, as if it had been modified to reflect the 
terms proposed in AISI's counter-proposal. The Board of Directors of AISI       
concluded that the Merger with ESI would be in the best interest of its         
shareholders, primarily because of the speed and certainty with which the merger
with ESI could be completed and the potential for increase in shareholder value 
following the merger. ESI's Board of Directors met to discuss the proposed      
merger on September 19, 1997. After considering a number of factors, including  
the ability of the combined businesses to serve customers in the electronics    
industry, the potential operating and financial performance of the combined     
businesses, and the extent to which AISI's business complements ESI's business, 
the Board of Directors approved the Merger. On September 29, 1997, following    
approval of AISI's Board of Directors, the Merger Agreement was executed by ESI 
and AISI, and the signing was announced in a press release.                     

   On October 6, 1997, Cognex issued a press release to announce that it had
made an offer to acquire AISI for approximately $105 million in a transaction   
involving the exchange of shares of the common stock of Cognex for all the      
outstanding shares of the common stock of AISI. While the remaining terms of    
that offer are subject to the confidentiality provisions of the Nondisclosure   
Agreement between AISI and Cognex, AISI's Board of Directors concluded that     
accepting those terms would not be in the best interests of AISI's shareholders.

On October 8, 1997, AISI and ESI executed an amendment to their Merger
Agreement to extend the time in which to complete the merger, to remove certain 
conditions to ESI's obligation to complete the Merger, including the receipt of 
a fairness opinion from ESI's financial advisers, the satisfactory completion of
ESI's due diligence investigation of AISI and ESI's determination that the      
Merger would be accretive to ESI.                                               

On October 9, 1997, Cognex presented two alternative offers to acquire
AISI. The terms of those offers are subject to the Nondisclosure Agreement with 
Cognex. The purchase price included as a term of each offer consisted of common 
stock of Cognex having a market value less than the price set forth in the offer
that Cognex made public in its October 6, 1997 press release. Each offer was    
conditioned upon Hart-Scott-Rodino approval, receipt of a fairness opinion by   
Cognex from its financial advisers and the satisfactory completion of a due     
diligence investigation of AISI by Cognex; in addition, each offer imposed upon 
AISI onerous conditions in dealing with its major customer, Kulicke & Soffa     
Industries, Inc. ("K&S"), that AISI could not meet without adversely impacting  
AISI's business, financial condition and results of operations. The principal   
difference in the terms of the two Cognex offers was price and the severity of  
conditions imposed upon AISI in its dealings with K&S. K&S is AISI's largest    
customer, and AISI at the time faced the impending expiration of its principal  
agreement with K&S on October 17, 1997; AISI could not wait to agree on the     
terms of a continuing relationship with K&S, until a possible transaction with  
Cognex could be completed. Moreover, on October 8, 1997, prior to receiving the 
Cognex offers, and in the normal course of business, AISI had agreed with K&S to
make certain changes to the principal agreement between AISI and K&S that would 
not be permitted under either Cognex offer. Those changes were reflected in a   
written amendment to the agreement delivered to K&S by AISI on October 8, 1997  
and executed by K&S on October 13, 1997. The AISI Board met on October 10, 1997 
to consider the Cognex offers and concluded that, notwithstanding the fact that 
neither offer from Cognex could be considered viable, given the changes to the  
K&S agreement to which AISI had agreed, the price differential would not justify
the considerable risk that the conditions to the obligation of Cognex to close  
might not be satisfied. Given the relative rankings of AISI and Cognex in the   
relevant industry, the AISI board concluded that there was a significant risk   
that Hart-Scott-Rodino approval could not be obtained. Conversely, there        

17

424B1
23rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 23rd
appeared to be no problem in obtaining Hart-Scott-Rodino approval of the        
proposed transaction with ESI, and in fact the waiting period before completing 
the transaction with ESI has now expired. Accordingly, the AISI Board elected   
not to respond to the Cognex offers. The Cognex offers expired at 4:00 p.m. on  
October 10, 1997.                                                               

     On October 17, 1997, following a decline in the market, Cognex made another
offer. The price consisted of Cognex common stock (again with a market value    
substantially less than the price included in the offer that Cognex announced in
its press release on October 6, 1997), and the offer was no longer subject to   
conditions with respect to AISI's dealings with K&S; but in every other relevant
respect the terms of the Cognex offer were identical to the terms set forth in  
the Merger Agreement dated September 29, 1997 with ESI and did not reflect the  
revised terms of the October 8, 1997 amendment to the Merger Agreement.         
Accordingly, the obligation of Cognex to complete the transaction with AISI,    
under the terms of its October 17, 1997 offer, would be subject to the receipt  
of a fairness opinion from the financial advisers of Cognex, the satisfactory   
completion of the due diligence investigation of AISI by Cognex and a           
determination that the merger would be accretive to Cognex. In addition, and    
perhaps most importantly, the merger with Cognex would be subject to            
Hart-Scott-Rodino approval. The offer initially expired by its terms at 9:30    
a.m. on October 20, 1997; although Cognex later communicated to AISI that the   
expiration date could be ignored, AISI has received no written confirmation that
the offer continues to be outstanding. In any event, AISI's Board of Directors  
met on October 20, 1997 to consider the Cognex offer. The Board agreed that     
AISI's financial advisers would contact the financial advisers of Cognex to     
determine if Cognex would offer more favorable terms, primarily to compensate   
for the significant Hart-Scott-Rodino approval risk. Pursuant to the terms of   
the Merger Agreement, ESI was notified in writing of the action that AISI was   
taking. In the discussions that followed between financial advisers, Cognex     
indicated that it might be willing to escrow a substantial sum that would be    
paid to AISI if the merger with Cognex were not completed for any reason,       
including failure to obtain Hart-Scott-Rodino approval, but Cognex has made no  
firm offer in that regard and did not agree to increase the purchase price.     
During the course of these discussions, AISI's Board of Directors met several   
times to consider the progress of negotiations with Cognex. Finally, the Board  
met on October 28, 1997 and concluded, given (i) the volatility of the market   
and the attendant concern that market conditions might result in a material     
adverse change in the business, financial condition and results of operations of
AISI that could preclude a business combination with ESI, Cognex or any other   
person, and (ii) the absence of a firm escrow offer from Cognex or a substantial
increase in the purchase price, that it was in the best interests of AISI's     
shareholders to complete the Merger with ESI at the earliest practicable date.  

REASONS FOR THE MERGER                                                          

General                                                                         

     The Merger will effect a combination of AISI's business with ESI's business
on terms that have been carefully considered by the Boards of Directors of each 
of AISI and ESI and which are believed by them to be fair and equitable to their
respective shareholders. The Merger Agreement is the result of arm's length     
negotiations between AISI and ESI and represents a consideration of many        
factors, including a judgment as to the nature and potential of the businesses  
in which the companies are engaged and a judgment as to the potential for the   
combined operations.                                                            

     The Boards of Directors of AISI and ESI each believe that the activities of
the companies are compatible and that the Merger will enhance the product       
development potential of the combined operations.                               

ESI's Reasons for the Merger                                                    

The Merger is expected to add to ESI's ability to serve the expanding 
capital equipment needs of its global, multi-national customers in the          
electronics industry. All electronic products are subject to markets which      
demand higher performance or lower cost over time. Machine vision improves the  

18

424B1
24th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 24th
quality and increases the efficiency of electronic device production. The       
strengths of greater technical resources and worldwide selling and customer     
support presence will uniquely position the combined business of ESI and AISI to
enhance or add machine vision in all aspects of semiconductor fabrication and   
the assembly of electronic devices. The Merger also offers the possibility of   
achieving improved operating efficiencies through elimination of duplicate      
efforts. ESI estimates that the combined companies will reduce duplicative      
professional fees and personnel costs and may save between $500,000 and $1      
million annually.                                                               

 The Board of Directors of ESI believes the combined business of ESI and
AISI will have the potential to realize increased market share and improved     
operating and financial performance compared to the two entities operated       
independently. In addition to the above benefits, the Board of Directors of ESI 
has identified the following potential benefits for ESI's shareholders:         

o    AISI develops and supplies high performance machine vision systems targeted
   at the OEM electronics industry, providing a complement to ESI's existing
product offering and the vision requirements of ESI's customers.      

o    The addition of AISI to ESI will result in the combined business being     
 among the recognized suppliers to the machine vision market. Due to the
relative size of the machine vision market in comparison to the other 
 markets served by ESI, the combined business will offer ESI substantial
    opportunity to increase the size of its overall business through effective
utilization of combined resources.                                    

o    The majority of AISI's revenues have been from domestic customers, whereas 
the majority of ESI's revenues have been from off-shore customers. The
   combined business will benefit from complementary distribution strengths.

AISI's Reasons for the Merger                                                   

 In 1995, after several years of profitability, AISI explored options to
provide market liquidity to its shareholders and increase value, including an   
initial public offering and merger with a public company. AISI first opted for a
public offering, but ultimately decided against proceeding with the offering    
because of customer and market uncertainty. AISI then considered merger options,
including a merger with ESI. Among the factors considered were: the price that  
could be obtained for AISI's common stock; synergies between AISI and ESI;      
future appreciation in the value of the stock of ESI's Common Stock; the        
business, results of operations, asset quality and financial condition of ESI;  
the ability to account for the Merger as a pooling of interests; the            
qualification of the Merger as a tax-free reorganization; and the speed with    
which the Merger could be completed. After considering all these factors, the   
Board of Directors of AISI concluded that the Merger would provide the desired  
market liquidity and the best prospect for increasing long-term value for AISI  
shareholders.                                                                   

FAIRNESS OPINION OF AISI FINANCIAL ADVISORS                                     

   In connection with the Merger, AISI retained AH&H to act as its financial
advisor. AH&H assisted in AISI's discussions and negotiations with ESI leading  
up to the execution of the Merger Agreement and in the consideration by the AISI
Board of the Merger. On September 29, 1997, AH&H delivered its oral opinion to  
the AISI Board that the consideration to be received by the AISI shareholders in
the Merger is fair from a financial point of view. AH&H subsequently delivered  
its written opinion. Although AH&H assisted AISI in determining the amount of   
consideration to be received in the Merger, the amount of consideration set     
forth in the Merger Agreement was determined through negotiations between AISI  
and ESI.                                                                        

   A copy of the AH&H Opinion is attached hereto as Annex B. Holders of AISI
Common Stock are urged to read the opinion in its entirety for a summary of the 
assumptions made, procedures followed, other matters considered and the limits  
of the review by AH&H. The summary of the AH&H Opinion set forth in this        
Prospectus/Information Statement includes a discussion of all material financial
and comparative analyses performed by AH&H. The summary is qualified in its     

19

424B1
25th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 25th
entirety by reference to the full text of such opinion. The AH&H Opinion was    
prepared for the AISI Board, is directed only to the fairness, as of September  
29, 1997, from a financial point of view, of the consideration to be received by
the holders of AISI Common Stock, and does not constitute a recommendation to   
any stockholder as to how to vote with regard to the Merger.                    

    In rendering its opinion, AH&H did not make or seek to obtain appraisal of
any of the assets of ESI in connection with its analyses of the valuation of ESI
or the ESI common stock. AH&H relied without independent verification upon the  
accuracy and completeness of all of the financial information reviewed by it for
the purposes of its opinion. The AH&H Opinion does not constitute an opinion as 
to the price at which ESI common stock will actually trade at any time. No      
limitations were imposed by the AISI Board upon AH&H with respect to the        
investigation made or the procedures followed by AH&H in rendering its opinion. 

  In rendering its opinion, AH&H, among other things: (i) analyzed certain
publicly available financial statements and other information concerning ESI;   
(ii) analyzed certain internal financial statements and forecasts and other     
financial and operating data concerning AISI prepared by the management of AISI;
(iii) analyzed certain forecasts and related assumptions pertaining to ESI      
obtained from third party research analysts; (iv) discussed the past and current
operations and financial condition and the prospects of AISI and ESI with the   
management of AISI and ESI, respectively, and analyzed the pro forma impact of  
the Merger on ESI's earnings per share; (v) reviewed certain of the reported    
prices and trading activity of ESI's Common Stock over the past 33 months; (vi) 
compared the financial performance of ESI and certain of the prices and trading 
activity of ESI's Common Stock with that of certain other comparable publicly   
traded companies and their securities; (vii) reviewed the financial terms, to   
the extent publicly available, of certain comparable acquisition transactions;  
(viii) reviewed and discussed with the senior management of AISI the strategic  
rationale for the Merger and the benefits of the Merger to AISI; (ix) reviewed a
draft of the Agreement dated as of September 29, 1997; (x) discussed with senior
management of AISI the impact of its customer concentration on its financial and
operating results; and (xi) performed such other studies, analyses and inquiries
and considered such other information as AH&H deemed relevant.                  

In rendering its opinion to the AISI Board, AH&H performed certain    
financial and comparative analyses, with such other factors as it deemed        
relevant, including, among other things:                                        

   Historical Stock Trading and Financial Statement Analysis: As part of its
analysis, AH&H reviewed and analyzed selected historical trading prices and     
volumes for ESI Common Stock. In addition, AH&H reviewed and analyzed selected  
annual and quarterly income statements and selected annual balance sheets for   
each of AISI and ESI.                                                           

   Peer Group Comparison: AH&H compared certain financial information of ESI
with a group of several publicly traded companies in the semiconductor capital  
equipment/machine vision systems industry, including, but not limited to, Adept 
Technology, Inc., Cognex Corporation, Cyberoptics Corporation, Medar, Inc.,     
Perceptron Inc., PPT Vision, Inc., and Robotic Vision Systems, Inc. Such        
financial information included, among other things, market valuation, market    
value as a multiple of earnings, and market value as a multiple of revenues. In 
particular, such analysis showed that on average, as of September 26, 1997,     
based on the closing prices of the respective common stocks and on research     
analysts' estimates as reported by First Call Corporation, this group of common 
stocks traded at 34.1 times annualized 1997 estimated earnings per share and    
20.2 times annualized 1998 forecasted earnings per share.                       

Analysis of Selected Precedent Transactions: AH&H examined selected   
precedent transactions involving semiconductor capital equipment companies. In  
total, AH&H reviewed and examined 33 precedent transactions involving both      
publicly traded and privately held companies; recent transactions analyzed      
include, but are not limited to, LAM Research Corporation's acquisition of      
Ontrak Systems, Inc.; Millipore Corporation's acquisition of Tylan General; and 
Applied Materials' acquisitions of Opal Inc. and Orbot Instruments. Analysis of 
such 33 precedent transactions resulted in a mean transaction valuation of 30.6 
times last twelve months net income and 2.0 times last twelve months revenues.  

20

424B1
26th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 26th
  Multiple Analysis: Using the Conversion Ratio, AH&H prepared an analysis
that reviewed the aggregate consideration to be paid to the holders of AISI     
Common Stock pursuant to the Merger Agreement using the closing price of ESI    
Common Stock on September 26, 1997, as a multiple of various financial operating
parameters of AISI (and assuming the Merger were not to occur), including       
revenue, earnings before interest and taxes ("EBIT"), and fully-taxed net       
income. Such analysis indicated that the aggregated consideration to be paid to 
the holders of AISI common stock (i) as a multiple of calendar year ("CY") 1997 
estimated revenue and CY 1998 projected revenue was 2.6x and 2.2x, respectively;
(ii) as a multiple of calendar year CY 1997 estimated EBIT and CY 1998 projected
EBIT was 13.0x and 10.2x, respectively; and (iii) as a multiple of calendar year
CY 1997 estimated net income and CY 1998 projected net income was 13.8x and     
10.8x, respectively.                                                            

     Contribution Analysis: AH&H analyzed the pro forma contribution of each ESI
and AISI to the combined company if the Merger were to be consummated. Such     
analysis was based on financial data provided by the management AISI and ESI,   
and equity research reports prepared independently by securities firms not      
involved in the Merger. Such analysis showed that for CY 1998, AISI would       
contribute approximately 14% of the revenues and earnings before interest and   
taxes of the combined company.                                                  

  Pro Forma Analysis of the Merger: AH&H analyzed and reviewed certain pro
forma financial information for the combined entity based on 1998 management    
budgets for AISI and 1998 financial projections obtained from third party       
research analysts. Without taking into account potential synergies and          
redundancies based on the Merger, the analysis performed by AH&H showed that for
ESI's fiscal year 1998, the Merger was non-dilutive to ESI's earnings compared  
to ESI's pre-merger earnings.                                                   

In conducting its analysis, AH&H considered the following consensus   
estimates of industry analysts (all of which are publicly available) of ESI's   
projected fiscal year 1998 earnings per share for the four fiscal quarters      
ending August 31, 1997, November 30, 1997, February 28, 1998 and May 31, 1998,  
respectively: $0.66, $0.73, $0.78 and $0.80. AH&H also considered the following 
projections, provided by AISI's management, of (i) AISI's calendar year 1998    
quarterly revenues: $8.6 million, $8.8 million, $8.9 million and $9.5 million   
respectively; and (ii) AISI's calendar year 1998 quarterly earnings: $1.4       
million, $1.7 million, $1.8 million and $2.3 million, respectively. Based on    
this information, AH&H analyzed the pro forma impact of the Merger on ESI's     
projected fiscal year 1998 earnings per share for the four fiscal quarters      
ending August 31, 1997, November 30, 1997, February 28, 1998 and May 31, 1998 as
a $0.02 increase, $0.04 increase, $0.01 decrease and $0.01 increase,            
respectively. Any other components of the companies' financial projections did  
not play a significant factor in AH&H's analysis.                               

   The Summary of the AH&H analyses set forth above does not purport to be a
complete description of the presentation by AH&H to the AISI Board. In          
performing its analyses, AH&H made numerous assumptions with respect to industry
performance, general business and economic conditions and other matters, many of
which are beyond the control of AISI and ESI. The analyses performed by AH&H are
not necessarily indicative of actual values or actual future results, which may 
be significantly more or less favorable than suggested by such analyses. In     
addition, analyses relating to value of businesses do not purport to be         
appraisals or to reflect the prices at which businesses actually may be sold.   
The analyses and the summary set forth above should be considered as a whole as 
any consideration of only selected portions of the AH&H analyses, or of the     
above summary, could create an incomplete view of the process underlying the    
analyses performed by AH&H in connection with the preparation of its opinion    
letter.                                                                         

     The AISI Board selected AH&H as its financial advisor due to its experience
in acting as a financial advisor in connection with mergers and acquisitions in 
the technology industry and its familiarity with AISI and its business. Pursuant
to a letter agreement dated as of November 20, 1995 between AISI and AH&H (the  
"Engagement Letter"), AISI has agreed to pay AH&H (i) a retainer fee of $50,000 
and (ii) an investment banking advisory services fee based upon the selling     
price of AISI in the Merger, calculated at 1% of the first $80,000,000 of       
aggregate consideration to be paid either present of future, and the liabilities
to be                                                                           

21

424B1
27th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 27th
assumed, and 3% of such remainder above $80,000,000. The retainer fee has been  
paid to AH&H. The investment banking advisory services fee will become payable  
upon the closing of the Merger. In addition, AISI has agreed to reimburse AH&H  
for all of its reasonable out-of-pocket expenses up to a maximum of $25,000     
without the approval of AISI, including but not limited to legal fees and travel
expenses. AISI has also agreed to indemnify and hold harmless AH&H against      
certain liabilities, including liabilities under federal securities laws arising
out of, or in connection with its rendering of services under the Engagement    
Letter. In the event such indemnification were not available, however, AISI has 
agreed to contribute to the settlement, loss or expenses involved in the        
proportion that the relevant financial interest of AISI and its stockholders    
bear to AH&H's relevant financial interest.                                     

  AH&H has not provided financial advisory services except pursuant to the
Engagement Letter to AISI prior to the Merger. AH&H, as part of its investment  
banking business, is continually engaged in the valuation of businesses and     
their securities in connection with mergers and acquisitions, negotiated        
underwritings, secondary distributions of listed and unlisted securities,       
private placements and valuations for estate, corporate and other purposes.     

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES                                   

  The following discussion summarizes the material U.S. federal income tax
consequences of the Merger that are generally applicable to ESI, Merger Corp.,  
AISI and holders of AISI Common Stock. This discussion is based on current      
provisions of the Internal Revenue Code of 1986, as amended (the "Code"),       
existing regulations thereunder (including final, temporary or proposed), and   
current administrative rulings and court decisions as of the date of this       
Prospectus/Information Statement, all of which are subject to change. Any such  
change, which may or may not be retroactive, could alter the tax consequences   
described herein.                                                               

The following discussion is intended only as a summary of the material
principal U.S. federal income tax consequences of the Merger and does not       
purport to be a complete analysis or listing of all of the potential tax        
effects. In particular, this discussion does not address all U.S. federal income
tax considerations that may be relevant to particular AISI shareholders in light
of their particular circumstances, such as shareholders who are dealers in      
securities, corporations, trusts, financial institutions, insurance companies,  
tax-exempt organizations, or AISI shareholders who are subject to the "golden   
parachute" provisions of the Code, who hold their shares as part of a "straddle"
or "conversion transaction," who are subject to the alternative minimum tax     
provisions of the Code, who are foreign persons, or who acquired their shares in
connection with stock option or stock purchase plans or in other compensatory   
transactions. The discussion also does not address the effects of the Merger on 
holders of AISI Options. In addition, the following discussion does not address 
the tax consequences of the Merger under foreign, state or local tax laws or the
tax consequences of transactions effectuated prior to or after the Merger       
(whether or not such transactions are in connection with the Merger), including 
without limitation transactions in which shares of AISI Common Stock are        
acquired or shares of ESI Common Stock are disposed of. This discussion assumes 
that the AISI shareholders hold their AISI Common Stock as capital assets within
the meaning of Section 1221 of the Code.                                        

EACH AISI SHAREHOLDER SHOULD CONSULT HIS OWN TAX ADVISOR AS TO THE    
PARTICULAR TAX CONSEQUENCES TO HIM OF THE MERGER, INCLUDING THE APPLICABILITY   
AND EFFECT OF FOREIGN, STATE, LOCAL AND OTHER TAX LAWS.                         

  The Merger is intended to qualify as a reorganization under U.S. federal
income tax law. It is a condition to the obligations of ESI to consummate the   
Merger that Brouse & McDowell, counsel to AISI, render to ESI at the Closing an 
opinion that the Merger, if consummated on the terms of the Merger Agreement as 
described in this Prospectus/Information Statement, will constitute a           
reorganization under Section 368(a)(1)(A) and (a)(2)(E) of the Code and ESI,    
AISI and Merger Corp. will each be "a party to a reorganization" within the     
meaning of Section 368(b) of the Code. In rendering such opinion, counsel has   
relied in                                                                       

22

424B1
28th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 28th
part upon certain written representations, warranties and covenants of ESI,     
AISI, and certain shareholders of AISI.                                         

    No ruling has been sought from the Internal Revenue Service as to the U.S.
federal income tax consequences of the Merger, and the opinion of counsel is not
binding on the Internal Revenue Service or any court. There is no assurance that
the IRS will not successfully assert a contrary position.                       

  The following is a summary of the opinion that has been provided to ESI.
The opinion of counsel provides that the Merger, as a tax-free reorganization,  
will have the following federal income tax consequences for AISI shareholders,  
AISI and ESI:                                                                   

     (1) No gain or loss will be recognized by the shareholders of AISI upon the
exchange of all of their AISI Common Stock for ESI Common Stock (including any  
fractional share interests).                                                    

   (2) Each shareholder of AISI receiving cash in lieu of a fractional share
interest in ESI Common Stock in the Merger will be treated as if such           
shareholder actually received the fractional share interest and the fractional  
share interest was subsequently redeemed by ESI. The deemed redemption will be  
treated as a distribution not essentially equivalent to a dividend within the   
meaning of Section 302(b)(1) of the Code. The cash to be received by each such  
shareholder will be treated as a distribution in full payment in exchange for   
the shareholder's fractional share interest under Section 302(a) of the Code.   
Gain or loss will be recognized measured by the difference between the amount of
cash received and the basis of the AISI Common Stock surrendered therefor,      
properly allocated to the fractional share interest.                            

(3) The tax basis of ESI Common Stock (including ESI Common Stock     
considered as received in respect of any fractional share interest) to be       
received by a shareholder of AISI in the Merger will be the same as the basis of
the AISI Common Stock surrendered in exchange therefor.                         

(4) The holding period of ESI Common Stock (including ESI Common Stock
considered as received in respect of any fractional share interest) to be       
received by a shareholder of AISI in the Merger will include the period during  
which the AISI Common Stock exchanged for such ESI Common Stock was held by such
shareholder of AISI.                                                            

   (5) No gain or loss will be recognized by AISI as a result of the Merger.

   (6) No gain or loss will be recognized by either ESI or Merger Corp. as a
result of the Merger.                                                           

ACCOUNTING TREATMENT                                                            

The Merger is expected to be treated as a "pooling of interests" for  
accounting purposes. This accounting method permits the recorded assets and     
liabilities of both ESI and AISI to be carried forward to the surviving         
corporation at their recorded historical amounts and no recognition of goodwill 
in the combination is required of either company in the Merger.                 

As a condition to the Merger, ESI and AISI shall have each received an
opinion of Arthur Andersen LLP, independent public accountants, to the effect   
that, based upon certain material facts and certain representations and         
warranties described in such opinion, the Merger will qualify for treatment as a
pooling of interests.                                                           

INTERESTS OF CERTAIN PERSONS IN THE MERGER                                      

   Pursuant to certain Shareholders' Agreements dated February 17, 1984, and
January 18, 1985 and a certain Agreement dated July 24, 1987, several           
shareholders of AISI's Common Stock are required to vote any voting securities  
of AISI that they may own at any time for the election as directors of the      
designees                                                                       

23

424B1
29th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 29th
of certain shareholders of AISI Common Stock. These arrangements will terminate 
on or prior to the Merger.                                                      

 Under the original terms of the Options granted pursuant to AISI's 1989
Incentive Stock Option Plan, its 1991 Incentive Stock Option Plan, its 1992     
Incentive Stock Option Plan, its 1995 Incentive Stock Option Plan, and the three
non-qualified stock option agreements between AISI and Barry Borgerson (dated   
May 4, 1993), Dale Compton (dated April 10, 1990) and Jon G. Ehrmann (dated July
30, 1990) (collectively, the "AISI Stock Plans"), a portion of all outstanding  
Options, whether or not vested, will automatically become vested and exercisable
upon a change in control (as defined therein). The consummation of the Merger   
will constitute a change in control for purposes of such agreements. For James  
E. Anderson, President and Chief Executive Officer of AISI, and Jon G. Ehrmann, 
Chief Financial Officer of AISI, their option vesting will accelerate by 40     
percent, and for all other optionees option vesting will accelerate by 20       
percent. Additionally, pursuant to the Merger Agreement, each Option granted    
under the AISI Stock Plans which is outstanding and unexercised immediately     
prior to the Effective Time will be converted at the Effective Time into, and   
will become, a stock option to purchase ESI Common Stock and will continue to be
governed by the terms of the AISI Stock Plans as assumed. See "The Merger       
Agreement--Treatment of AISI Stock Options."                                    

     The Merger will constitute a change of control for the purposes of the AISI
Stock Plans, and will have the effect of accelerating the vesting of a portion  
of Options granted to various persons under those plans. The chart below details
the effects of such accelerated vesting for AISI officers, expressed as shares  
of ESI Common Stock.                                                            

                                                        [Enlarge/Download Table]

                                                        Total Number of                            
                                                      Options for Which                            
                                                        Vesting Will Be                 Approximate
                                                            Accelerated                    Value of
                              Scheduled Dates      (expressed in shares       Exercise  Accelerated
Employee                   for Option Vesting          ESI Common Stock)       Price $      Options
--------                   ------------------      --------------------       --------  -----------
                                                                                                   
James E. Anderson              August 7, 2000             3,050                $13.11     $135,756 

Stephen S. Wilson              August 7, 2000               610                $13.11     $ 27,151 

Donald Redding                 April 26, 2000             1,830                $13.11     $ 81,454 
                               August 7, 2000               610                $13.11     $ 27,151 

Jon G. Ehrmann                 August 7, 2000             1,220                $13.11     $ 54,302 

Philip White                     July 7, 1999             2,669                $13.11     $118,787 

Yvette Puskarich             October 25, 1999             1,220                $13.11     $ 54,302 
                               April 26, 2000               458                $13.11     $ 20,363 

*    The values shown reflect the difference between the aggregate value of the                    
     shares of ESI Common Stock subject to Options based upon the closing price                    
     on September 23, 1997 of $57.63 per share of ESI Common Stock, less the                       
     aggregate exercise price under such Options.                                                  

 All shares of ESI Common Stock to be issued pursuant to exercise of the
AISI Options are included in the total 1,400,000 shares of ESI Common Stock to  
be issued in connection with the Merger. If all outstanding AISI Options were to
be exercised after the Merger, ESI would receive proceeds of approximately $2.3 
million.                                                                        

  The Merger Agreement provides that ESI will, or will cause the surviving
corporation to, subject to the conditions set forth in the Merger Agreement,    

24

424B1
30th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 30th
continue in effect AISI's directors and officers liability insurance policy (or 
any equivalent therefor) for officers and directors of AISI immediately prior to
the Merger.                                                                     

REGULATORY MATTERS                                                              

Under the HSR Act and the rules promulgated thereunder by the FTC, the
Merger may not be consummated until notifications have been given and certain   
information has been furnished to the FTC and the Antitrust Division, and the   
specified waiting period requirements has expired. ESI and AISI each filed      
notification and report forms under the HSR Act with the FTC and the Antitrust  
Division on October 1, 1997. The waiting period under the HSR Act terminated on 
October 31, 1997. At any time before or after consummation of the Merger, the   
FTC, the Antitrust Division, state attorneys general or others could take action
under the antitrust laws with respect to the Merger, including seeking to enjoin
the consummation of the Merger or seeking divestiture of substantial assets of  
ESI or AISI.                                                                    

NO DISSENTER RIGHTS                                                             

     The Michigan Business Corporation Act ("MBCA") does not provide dissenters'
rights in connection with the Merger. Although the Merger Agreement originally  
provided for dissenters' rights in connection with the Merger, Amendment No. 2  
to the Merger Agreement deleted all references to dissenters' rights.           

THE MERGER AGREEMENT

    The following paragraphs summarize, among other things, the material terms
of the Merger Agreement, which is attached hereto as Annex A and incorporated by
reference herein. Recipients of this Prospectus/Information Statement are urged 
to read the Merger Agreement in its entirety for a more complete description of 
the Merger.                                                                     

EFFECTIVE TIME OF THE MERGER                                                    

As promptly as practicable after the satisfaction or waiver of the    
conditions set forth in the Merger Agreement, the parties thereto will file     
certificates of merger with the Secretaries of State of both Oregon and         
Michigan. The Merger will become effective upon the later of such filings (the  
"Effective Time").                                                              

CONVERSION OF SHARES                                                            

    At the Effective Time, each outstanding share of AISI Common Stock will be
converted into the right to receive a number of shares of ESI Common Stock that 
corresponds to the Conversion Ratio. ESI determined that the consideration it   
was willing to pay for all of the outstanding securities of AISI was 1,400,000  
shares of ESI Common Stock. This total consideration will not change. The       
Conversion Ratio is determined by dividing 1,400,000 by the sum total of AISI   
Common Stock outstanding plus AISI shares subject to options at Closing. The    
Conversion Ratio is not expected to change because AISI has covenanted not to   
issue new shares prior to Closing other than pursuant to specified outstanding  
options. As with other publicly traded stocks, the market value of the ESI      
Common Stock issued as consideration in the Merger fluctuates.                  

     At the Effective Time Merger Corp. will merge with and into AISI, with AISI
as the surviving corporation. First Chicago Trust Company of New York has been  
designated as the transfer agent ("Transfer Agent") in the Merger.              

 As promptly as practicable after the Effective Time, ESI will cause the
Transfer Agent to mail to each AISI shareholder, who is a shareholder of record 
as of the Effective Time, transmittal material for use in exchanging            
certificates of AISI Common Stock for certificates of ESI Common Stock. The     
transmittal materials will contain information and instructions with respect to 
the surrender of AISI Common Stock certificates in exchange for new certificates
representing                                                                    

25

424B1
31st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 31st
ESI Common Stock and cash in payment for any fractional shares resulting from   
the exchange.                                                                   

The form of transmittal letter to be signed by each AISI shareholder  
provides for, among other things, transmittal of such shareholder's shares of   
AISI Common Stock to the Transfer Agent, agreement to the indemnification       
provisions contained in the Merger Agreement, agreement to the Escrow and the   
Escrow Agreement and the appointment of the Shareholder Representatives.        

The transmittal package also will include a form of stock power to be 
endorsed in blank by each AISI Shareholder with respect to the shares of ESI    
Common Stock subject to the Escrow. See "The Merger Agreement--Indemnity and    
Escrow Agreement."                                                              

   AISI SHAREHOLDERS SHOULD NOT SURRENDER ANY AISI COMMON STOCK CERTIFICATES
UNTIL THE LETTER OF TRANSMITTAL AND OTHER DOCUMENTS DESCRIBED ABOVE HAVE BEEN   
RECEIVED.                                                                       

 Fractional shares of ESI Common Stock will not be issued in the Merger.
Instead, each shareholder of AISI who would otherwise be entitled to a fraction 
of a share will receive, in lieu thereof, an amount of cash (rounded to the     
nearest whole cent) equal to the product of such fraction and the Average Sales 
Price. For this purpose "Average Sales Price" means the average of the high and 
low prices of ESI Common Stock, as reported in The Wall Street Journal, for the 
trading day immediately preceding the Closing Date.                             

TREATMENT OF AISI STOCK OPTIONS                                                 

 The terms and provisions of the Options will continue in full force and
effect following the Merger. At the Effective Time, each Option will be assumed 
by ESI and will be converted into an option to purchase the whole number of     
shares of ESI Common Stock corresponding to the number of shares of AISI Common 
Stock which the holder of the Option would have been entitled to receive had    
such holder exercised the Option in full immediately prior to the Effective Time
(whether or not such Option would then have been exercisable), which number of  
shares will be equal to the product (rounded to the nearest whole number) of (x)
the number of shares of AISI Common Stock for which such Option is exercisable  
multiplied by (y) the Conversion Ratio. The exercise price per share will be    
redetermined by dividing the per share exercise price immediately prior to the  
Effective Time by the Conversion Ratio. If all outstanding AISI Options were to 
be exercised after the Merger, ESI would receive aggregate proceeds of          
approximately $2.3 million.                                                     

   The term, exercisability, vesting schedule, status as an "Incentive Stock
Option" under Section 422 of the Code, if applicable, and all other terms and   
conditions of the Options will to the extent permitted by law and otherwise     
reasonably practicable be unchanged; each Option which is an Incentive Stock    
Option will be adjusted in accordance with the requirements of Section 425(a) of
the Code so as not to constitute a modification, renewal or extension of the    
Option within the meaning of Section 424 of the Code. Continuous employment with
AISI will be credited to the optionee for purposes of determining the vesting of
the number of shares of ESI Common Stock subject to exercise under the          
optionee's converted Option after the Effective Time.                           

RESALE OF ESI COMMON STOCK                                                      

    A condition to ESI's obligations under the Merger Agreement, among others,
is that certain of the "major" shareholders of AISI and other AISI shareholders 
who are other "affiliates" of AISI will have delivered letters confirming their 
understanding and agreement that they will not, among other things, sell,       
transfer or otherwise reduce their interest in the shares of ESI Common Stock   
they receive in the Merger or reduce their risk relating thereto until after ESI
has published financial results covering at least the 30 days of combined       
operations occurring after the Closing Date.                                    

    In addition, such parties have agreed that they will not sell or otherwise
dispose of any shares of ESI Common Stock unless such sale or disposition is    
permitted pursuant to the provisions of Rule 145 under the Securities Act, is   

26

424B1
32nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 32nd
otherwise exempt from registration under the Securities Act, or is effected     
pursuant to a registration statement under the Securities Act.                  

AISI'S CONDUCT OF BUSINESS PENDING THE MERGER                                   

 Pending the consummation of the Merger, AISI has agreed to carry on its
business in the ordinary and usual manner and not to take any of the following  
actions without the prior written consent of ESI: (a) amend its Articles of     
Incorporation or Bylaws; (b) enter into any new agreements that have the effect 
of increasing compensation or benefits payable to its officers or employees,    
other than indemnification agreements with its officers and directors on terms  
consistent with the provisions of AISI's Articles of Incorporation and Bylaws;  
(c) change its authorized capitalization; (d) declare, set aside or pay any     
dividends; (e) issue, sell, pledge, dispose of or encumber any additional shares
of, or securities convertible into or exchangeable for, or options, warrants,   
calls, commitments or rights of any kind to acquire, any shares of its capital  
stock of any class other than pursuant to the exercise of AISI stock options    
outstanding on June 30, 1997; (f) redeem, purchase or otherwise acquire any     
shares of its capital stock, merge into or consolidate with any other           
corporation or permit any other corporation to merge into or consolidate with   
it, liquidate or sell or dispose of any of its assets, or close any plant or    
business operation; (g) incur, assume or guarantee any indebtedness, or modify  
or repay any existing indebtedness; (h) enter into any transaction, make any    
commitment (whether or not subject to the approval of the Board of Directors of 
AISI) or modify any contracts or take or omit to take any action which could be 
reasonably anticipated to have a material adverse effect on the business,       
properties, financial condition or results of operations of AISI; (i) transfer, 
lease, license, guarantee, sell, mortgage, pledge, or dispose of, any property  
or assets (including without limitation any intellectual property), encumber any
property or assets or incur or modify any liability, other than the sale of     
inventory in the ordinary and usual course of business; (j) authorize capital   
expenditures other than in the ordinary course of business, form any subsidiary,
or make any acquisition of, or investment in, assets or stock of any other      
person or entity; (k) make any tax election; (l) permit any insurance policy    
naming it as a beneficiary or a loss payable payee to be canceled, terminated or
renewed without prior notice to ESI; (m) change its method of accounting as in  
effect at December 31, 1996, except as required by changes in generally accepted
accounting principles as concurred with by the AISI's independent auditors, or  
change its fiscal year; (n) conduct any transactions which, in the opinion of   
ESI or Arthur Andersen LLP, could disqualify the Merger for pooling of interests
accounting; or (o) authorize or enter into an agreement to do any of the actions
referred to in paragraphs (a) through (n) above.                                

NONSOLICITATION OF ALTERNATIVE TRANSACTIONS                                     

     AISI has agreed that it will not directly or indirectly encourage, initiate
or solicit any inquiries or the submission of any proposals or offers from any  
person relating to any merger, consolidation, sale of all or substantially all  
of its assets or similar business transaction involving AISI (each, an          
"Acquisition Transaction"). AISI has further agreed that it will not participate
in any negotiations regarding, furnish to any other person any information with 
respect to, or otherwise assist or participate in, any attempt by any third     
party to propose or effect any such transaction. Notwithstanding, nothing in the
Merger Agreement is intended to prohibit (i) AISI from furnishing information   
to, or entering into discussions or negotiations with, any person or entity that
makes an unsolicited proposal of an Acquisition Transaction if and to the extent
that (a) the Board of Directors of AISI determines in good faith, upon advice of
legal counsel, that such action is required for the directors of AISI to fulfill
their fiduciary duties and obligations under Michigan law and (b) prior to      
furnishing such information to, or entering into discussions or negotiations    
with, such person or entity, AISI provides immediate written notice to ESI to   
the effect that it is furnishing information to, or entering into discussions or
negotiations with, such person or entity, or (ii) the Board of Directors of AISI
from acting to withdraw or modify its approval of the Merger following receipt  
of an unsolicited proposal for an Acquisition Transaction if it determines in   
good faith, upon advice of legal counsel, that such action is required for the  
directors of AISI to fulfill their fiduciary duties and obligations under       
Michigan law.                                                                   

27

424B1
33rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 33rd
CORPORATE STRUCTURE AND RELATED MATTERS AFTER THE MERGER                        

     At the Effective Time, Merger Corp. will be merged with and into AISI. As a
result, the separate corporate existence of Merger Corp. will cease and AISI    
will be the surviving corporation. From and after the Effective Time, the Board 
of Directors and officers of Merger Corp. in office immediately before the      
Effective Time will be the Board of Directors and officers of the surviving     
corporation.                                                                    

Each share of Common Stock of Merger Corp. issued and outstanding     
immediately prior to the Effective Time will be converted into one share of the 
surviving corporation.                                                          

     Prior to or at the closing of the Merger Agreement, AISI will cause each of
its employees who will become employees of the surviving corporation to sign a  
confidentiality and noncompetition agreement in the form signed by ESI's        
employees.                                                                      

Prior to or at the closing of the Merger Agreement, ESI, certain AISI 
shareholders and the Shareholder Representatives will execute the Escrow        
Agreement and will cause an Escrow Agent to also execute the Escrow Agreement.  
At the Effective Time one-tenth of the shares of ESI Common Stock that otherwise
would be delivered to the AISI shareholders will be delivered to the Escrow     
Agent and held by the Escrow Agent subject to the indemnity and escrow          
arrangements described below. See "The Merger Agreement--Indemnity and Escrow   
Agreement."                                                                     

CERTAIN COVENANTS                                                               

     The Merger Agreement contains mutual covenants of ESI and AISI to use their
reasonable best efforts to secure all consents and approvals required for the   
Merger and to cooperate with respect to publicity.                              

    In addition to covenants relating to the conduct of its business described
above (see "The Merger Agreement--AISI's Conduct of Business Pending the        
Merger"), AISI also covenants to give ESI and its agents access to AISI and its 
book and records, to timely make all necessary filings to be made by it under   
the Hart-Scott-Rodino Act, to obtain necessary shareholder approvals and to     
provide information in connection with the preparation of this                  
Prospectus/Information Statement.                                               

ESI covenants (a) to not take or omit to take any action that could   
reasonably be anticipated to have a material adverse effect on ESI, (b) to take 
necessary actions in connection with the filing and effectiveness of this       
Registration Statement, (c) to promptly list up to 1,200,000 shares of ESI      
Common stock in the Nasdaq National Market System, (d) to timely make all       
necessary filings to be made by it under the Hart-Scott-Rodino Act, (e) after   
the Effective Time, to issue stock certificates representing shares of ESI      
Common Stock to be issued in the Merger, (f) to register the ESI Common Stock   
issuable upon exercise of the Options on SEC Form S-8, and (g) for a period of  
two years after the Effective Time, to continue in effect the present AISI      
directors and officers insurance policies.                                      

   Merger Corp. covenants to not engage in any corporate activity other than
the Merger and other transactions contemplated under the Merger Agreement.      

CONDITIONS TO THE MERGER                                                        

Consummation of the Merger is subject to the satisfaction of various  
conditions, including (a) expiration or termination of the waiting period under 
the Hart-Scott-Rodino Act; (b) no order, decree or injunction that would prevent
consummation of the Merger; (c) no material adverse change in the businesses of 
ESI or AISI; (d) AISI Shareholder approval of the Merger; (e) registration of up
to 1,200,000 shares of ESI Common Stock under the Securities Act of 1933 and    
listing on the Nasdaq National Market System; (f) opinion of counsel with       
respect to tax and other matters; (g) opinion of Arthur Andersen LLP with       
respect to treatment of the Merger as a "pooling of interests"; (h) delivery to 
ESI by certain persons and entities who are affiliates of AISI of affiliate     
representation letters containing certain representations and warranties with   

28

424B1
34th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 34th
respect to such person's ownership of AISI Common Stock and certain             
representations, warranties and covenants with respect to the shares of ESI     
Common Stock to be acquired by such persons or entities; (i) a physical count of
all AISI tangible assets as of a mutually agreed date; (j) delivery to ESI of   
confidentiality agreements by all continuing employees; and (k) accuracy of     
representations and warranties. The conditions in clauses (a), (b), (d), (e) and
(g) are conditions to the obligations of both ESI and AISI, and may be waived   
(to the extent allowed by law) only by both parties. ESI must waive or be       
satisfied with respect to conditions in clauses (c) (with respect to changes in 
the business of AISI), (f), (h), (i), (j) and (k) (with respect to the          
representations and warranties of AISI); the tax opinion required by (f) above, 
dated November 18, 1997 has been delivered to ESI. AISI must waive or be        
satisfied with respect to the conditions in clause (c) (with respect to changes 
in the business of ESI) and (k) (with respect to the representations and        
warranties of ESI). In the event of a waiver of the condition in clause (g), and
a resulting decision not to treat the Merger as a pooling of interests, a       
revised Prospectus/Information Statement will be delivered to AISI shareholders 
for consideration.                                                              

INDEMNITY AND ESCROW AGREEMENT                                                  

   The Merger Agreement provides for indemnification of ESI and Merger Corp.
by each AISI shareholder, pro rata and to the extent of such shareholder's      
shares of ESI Common Stock delivered to the Escrow Agent pursuant to the Merger 
Agreement and the Escrow Agreement, for and against (a) any losses, costs,      
expenses, damages and liabilities, including reasonable attorneys' fees         
(collectively, "Damages"), incurred by ESI, Merger Corp. or the surviving       
corporation by reason of or arising out of any inaccuracy in any representation 
or warranty or the breach of any covenant of AISI made in the Merger Agreement, 
and (b) any Damages (excluding, in this instance, attorneys' fees) incurred in  
connection with the prosecution, defense of counterclaim or settlement of       
certain litigation involving AISI.                                              

   The Merger Agreement further provides that 10% of each AISI shareholder's
shares of ESI Common Stock to be received in the Merger, rounded down to the    
nearest full share, will be delivered to the Escrow Agent and be subject to the 
terms of the Escrow.                                                            

Claims for indemnification must be made under the indemnity during the
first nine months following the Closing Date. No liability exists under the     
indemnity for the first $100,000 of any claim. In addition, reserves against    
probable contingencies existing on AISI's balance sheet as of the Closing Date  
must be used before any claim (excluding claims related to representations      
regarding taxes) may be made.                                                   

    The Escrow will terminate as early as possible after the nine-month period
if no claims are pending. If claims are pending at the end of the nine-month    
period, the Escrow must terminate not later than the anniversary of the Closing 
Date.                                                                           

   In no event will any AISI shareholder have any liability in excess of the
shares held in the Escrow.                                                      

TERMINATION; BREAKUP FEES                                                       

The Merger Agreement may be terminated and the Merger may be abandoned
prior to the Effective Time, under the circumstances specified therein,         
including (i) by mutual written agreement of ESI and AISI; (ii) by either ESI or
AISI, if the Merger shall not have been consummated by December 31, 1997 and if 
the terminating party has not caused the failure of the Merger to be consummated
by its own willful failure to fulfill any of its material obligations under the 
Merger Agreement; (iii) by either ESI or AISI, if the shareholders of AISI do   
not approve the Merger by December 31, 1997 ; (iv) by either ESI or AISI if a   
court or a governmental agency prohibits, by order, decree, ruling or any other 
action, the transactions contemplated by the Merger Agreement; (v) by ESI if the
AISI Board of Directors shall have withdrawn or modified in a manner adverse to 
ESI approval of the Merger, the Merger Agreement or the transactions            
contemplated thereby; (vi) by ESI if AISI or its representatives shall have     
taken actions to respond to unsolicited proposals or offers without providing   
prior notices and                                                               

29

424B1
35th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 35th
cooperation to ESI; and (vii) by AISI if the Board of Directors of AISI         
determines in good faith, upon advice of legal counsel, that such termination of
this Agreement is required for the directors of AISI to fulfill their fiduciary 
duties and obligations under Michigan law.                                      

     The Merger Agreement provides that AISI will pay a $3 million fee to ESI if
the Merger Agreement is terminated because (i) AISI's Shareholders do not       
approve the Merger, (ii) the AISI Board of Directors withdraws or modifies the  
approval of the Merger in a manner adverse to ESI or if AISI or its             
representatives respond to unsolicited proposals or offers in a manner not      
permitted by the Merger Agreement, or (iii) the AISI Board of Directors makes a 
determination, on advice of legal counsel, that to do so is required by the     
fiduciary duties of the directors under Michigan Law, and within one year after 
termination agrees to a transaction which results in a change in the beneficial 
ownership of more than 50 percent of the voting power of the capital stock of   
AISI.                                                                           

     The Merger Agreement provides that ESI will pay a $3 million fee to AISI if
the Agreement is terminated by ESI (except in circumstances where termination by
ESI is permitted, as described above) even though all of the conditions to the  
obligations of ESI and Merger Corp. have been fulfilled.                        

FEES AND EXPENSES                                                               

    Except as set forth above (see "The Merger Agreement--Termination; Breakup
Fees"), all fees and expenses incurred in connection with the Merger Agreement  
and the transactions contemplated thereby will be paid by the party incurring   
such expenses, whether or not the Merger is consummated.                        

ESI will pay all fees and expenses, other than AISI's attorneys' fees,
incurred in relation to the filing of the Prospectus/Information Statement, the 
Registration Statement and any amendments or supplements thereto.               

CONFIDENTIALITY                                                                 

Each party to the Merger Agreement has agreed to keep confidential,   
pursuant to the Confidentiality Agreements dated December 7, 1995 (in favor of  
AISI) and March 1, 1996 (in favor of ESI)(collectively, the "Confidentiality    
Agreements"), information provided to the other party pursuant to the Merger    
Agreement with respect to the business, properties and personnel of the party   
furnishing such information. The Confidentiality Agreements contain terms       
restricting the disclosure and use of confidential information exchanged between
the two parties in evaluating the Merger and otherwise.                         

INFORMATION CONCERNING ESI

Business                                                                        

    ESI provides electronics manufacturers with equipment necessary to produce
key components used in wireless telecommunications, computers, automotive       
electronics, and many other electronic products. ESI believes it is the leading 
supplier of advanced laser systems used to adjust (trim) electronic circuitry   
and to improve the yield of semiconductor memory devices. ESI believes it is a  
significant producer of high-speed test and termination equipment used in the   
high-volume production of miniature capacitors. Additionally, ESI designs and   
manufactures machine vision products and electronic packaging systems for       
manufacturers of printed circuit boards, electronics and other products. ESI's  
products enable these manufacturers to reduce production costs, increase yields 
and improve the quality of their products. ESI's customers include manufacturers
of: wireless telecommunication products (Ericsson, Motorola and Siemens);       
automotive electronics (Delco, Ford, Nippon-Denso and Siemens); miniature       
capacitors (Kemet, Kyocera/AVX, Murata, Philips, Samsung and TDK) and           
semiconductor memory devices (Fujitsu, Hitachi, Hyundai, IBM, Samsung and Texas 
Instruments). In the aggregate, the foregoing customers accounted for           
approximately 41.5 percent of ESI's total revenues in fiscal 1997.              

30

424B1
36th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 36th
Electronics Industry Overview                                                   

The electronic content of telecommunications products, automobiles and
personal computers continues to increase. For example, automobile manufacturers 
now routinely include electronic fuel ignition and other electronic systems in  
place of components that in the past were predominantly mechanical. In addition,
markets for consumer-oriented electronic products such as cellular telephones,  
facsimile machines, pagers, camcorders and personal computers have developed    
rapidly as increasingly affordable products have been introduced. Demand for    
electronics manufacturing equipment is driven by the demand for electronic      
devices and circuits. Electronic components are used in virtually all electronic
products, from inexpensive consumer electronics to the most sophisticated       
computers. These components are produced in very large unit volumes.            

The demands upon manufacturers to supply increasing quantities of     
electronic components have been accompanied by demands for increased complexity 
and reduced size. As electronic products become more powerful and portable, the 
devices and circuits in these products must be faster, smaller and more         
reliable. To achieve these attributes of higher performance, the electronic     
device manufacturers increase densities and tune the devices to precise         
electrical values. Manufacturers of cellular telephones, for example, must use  
miniaturized circuits to accommodate the size limitations of the finished       
product. These circuits must also operate within precise frequency              
specifications, typically requiring component values with less than 0.5 percent 
tolerance, in order for the existing cellular frequency bands to accommodate the
expanding number of cellular users without interchannel interference.           

    As electronic device densities and performance demands have increased, the
manufacturers of capacitors and resistors, which are basic components of        
assembled electronic devices, have been compelled to reduce size and to improve 
performance of these individual components. The increasing miniaturization of   
these components makes production, testing and termination difficult.           

   In addition to quantity, size and performance demands, a trend throughout
the electronics industry is cost reduction. The highly competitive markets for  
electronic products create cost limitations at the consumer level, and result in
cost pressure on component manufacturers. The manufacturers continuously seek to
reduce device costs by improving throughput, yield and quality in device        
production.                                                                     

Overview of Markets, Products and Strategy                                      

    Pagers, cellular telephones, personal computers and automotive electronics
represent the largest end-market applications for electronic devices and        
circuits that are produced using ESI's systems. ESI's customers also serve a    
wide range of other electronic applications.                                    

    ESI believes it is critical that each of its products provide the customer
with measurable production benefits, such as improved yield, increased          
throughput, greater reliability, or increased flexibility, resulting in a high  
return on investment. ESI also designs its production systems with a migration  
path for system upgrade, thereby providing its customers flexibility to add     
capacity or improve product performance at a reasonable incremental cost.       

ESI believes it is the leading merchant equipment supplier to three   
specialized markets: laser trimming, miniature capacitor testing and production 
and semiconductor memory yield improvement. ESI also serves the machine vision  
and electronic packaging markets.                                               

Laser Trimming Systems. ESI's laser trimming systems are used to tune the       
precise frequency of electronic circuits that receive and transmit signals in   
pagers, cellular telephones and other wireless devices. ESI's laser trimming    
systems are also used to tune automotive electronic assemblies such as engine   
control circuits.                                                               

ESI's laser systems are used by manufacturers supplying the           
telecommunications, automotive, and consumer markets. Customers include Delco,  
Ericsson, Ford, IBM, Motorola, Nippon-Denso, KOA, Siemens, and Kyocera.         

31

424B1
37th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 37th
  The laser adjusts the electrical performance of an electrical product or
assembly containing many circuits. The laser removes a precise amount of        
material from one or more components in the circuit to achieve the desired      
electrical specification for the entire product. This process is called         
"functional trimming," and is performed while the product or assembly is under  
power. For example, in pagers, laser trimming of a few selected components in   
the product is used to tune the electrical performance of the entire product to 
the desired frequency specification.                                            

    ESI's systems also adjust the electrical performance of individual devices
such as film resistors, resistor networks, capacitors and hybrid circuits. Laser
trimming is required because the screening process used to manufacture resistors
cannot cost effectively deposit material precisely enough to provide consistent 
electrical values. The trimming system can also be rapidly reprogrammed to trim 
devices of different values.                                                    

 The following chart summarizes the models, typical applications and key
features of ESI's current laser trimming products:                              

                                                        [Enlarge/Download Table]

-------------------------------------------------------------------------------------------------------  
                           ESI LASER TRIMMING PRODUCTS                                                   

                                                                 Beam                                    
                                                              Positioning        Throughput        Work  
                                                              Resolution        (trims per         Area  
  Product             Typical Application                      (microns)          second)        (inches)
                                                                                                         
Model 4300            Surface mount capacitor and                 2.50              50            4 x 4  
                      resistor trimming                                                                  
Model 977             Test intensive, thick film,                 1.55              50            3 x 3  
                      functional trimming                                                                
Model 4990            Thick film functional trimming              1.27              50            3 x 3  
Model 907             Chip resistor trimming                      1.27             100            3 x 3  
Model 4410            Thick/thin film functional                  1.01              15            3 x 3  
                      trimming                                                                           
-------------------------------------------------------------------------------------------------------  

Test and Production Systems for Miniature Capacitors. ESI's product offering    
consists of automated test, production and handling equipment for manufacture of
miniature multi-layer ceramic capacitors (MLCCs) which are used in very large   
numbers in nearly all types of electronic circuits. Large numbers of MLCCs are  
used in circuits that process analog signals or operate at high frequencies such
as in video products (VCRs and camcorders), voice communication products,       
wireless telecommunication products and computers. Principal customers for ESI's
MLCC test and production equipment are Kemet, Kyocera/AVX, Murata, Philips,     
Samsung and TDK. In the aggregate, purchases of such systems by the foregoing   
customers accounted for approximately 17.9 percent of ESI's total revenues in   
fiscal 1997.                                                                    

   The worldwide miniature surface mount capacitor market is estimated to be
approximately $4.5 billion (240 billion units) in 1997. Most of the leading     
producers are in Japan, led by Kyocera, Murata and TDK. ESI believes it is the  
leading merchant supplier of equipment to the MLCC industry for production of   
miniature capacitors. Production demands imposed by miniaturization are leading 
capacitor manufacturers to increasingly consider merchant equipment suppliers as
an alternative to internal development of manufacturing equipment.              

As circuit sizes have shrunk, the size of commonly used miniature     
capacitors has also shrunk to as small as .04" x .02" x .01". These minute sizes
and the high unit volumes place extraordinary demands on manufacturers. ESI's   
products combine high-speed, small parts handling technology with               
microprocessor-based systems to provide highly automated solutions for MLCC     
manufacturers. ESI's test and termination equipment and specialty handling tools
perform a broad range of functions in the manufacturing process.                

Test. Virtually all capacitors are tested and sorted by capacitance (electrical 
energy storage) and dissipation (electrical energy leakage). ESI's equipment    
employs high-speed handling and positioning techniques to precisely load, test  
and sort capacitors based upon these electrical values.                         

32

424B1
38th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 38th
Termination. MLCCs are manufactured in a lamination process, layering conductive
and insulation materials. ESI's microprocessor-based termination systems apply  
conductive material to the ends of surface mountable MLCCs, permitting          
connection of the device in a circuit. Chip Star, Inc., a subsidiary purchased  
on June 26, 1997, produces a fully automated product line for termination of    
MLCCs and capacitor arrays. These products, the CS 325A and CS 750, are capable 
of processing the smallest sized (.04 x .02) parts available on the commercial  
market.                                                                         

Handling Tooling. ESI offers a wide range of specialized production fixtures and
tools for various stages of the manufacturing process, including a series of    
patented carrier plates capable of handling up to 8,000 devices per plate for   
termination application. The decreasing size and growing volumes of MLCCs       
produced cause manufacturers to continuously seek new tools and fixtures to     
improve throughput and handling efficiency.                                     

 The following chart summarizes the models, typical applications and key
features of ESI's current miniature capacitor test and production products:     

                                                        [Enlarge/Download Table]

--------------------------------------------------------------------------------------------------------
              ESI MINIATURE CAPACITOR TEST AND PRODUCTION PRODUCTS                                      

       Product                         Application                              Key Features            

Test Systems                                                                                            
                                                                                                        
Models 16A and 18             Tests capacitance, dissipation            High speed rotary tester with   
                              factor and voltage capability             throughput of up to 50,000      
                              for small (Model 18) and medium           parts/hour.                     
                              (Model 16A) size MLCCs                                                    

Models 3002 and 3001          Tests insulation resistance (IR)          High speed parallel tester with 
IR                            of MLCCs                                  throughput of up to 50,000      
                                                                        parts/hour. Model 3001 IR       
                                                                        includes automatic bulk loading.

Model 3300                    Test capacitance dissipation              High speed rotary tester with   
                              factor and voltage capability             throughput of up to 180,000     
                              for small and medium size MLCCs;          parts/hour.                     
                              tests insulation resistance                                               
Termination Systems                                                                                     
Models 2001 and 2020          Electrical contact attachment             Microprocessor controlled       
                              on MLCCs                                  surface mount termination system
                                                                        with throughput up to 130,000   
                                                                        parts/hour. Model 2020 includes 
                                                                        an integrated kiln.             

Model 2007                    Electrical contact attachment             High productivity microprocessor
                              on MLCCs                                  controlled surface mount        
                                                                        termination system with         
                                                                        throughput up to 470,000        
                                                                        parts/hour.                     

CS 325A                       Electrical contact attachment             Automated termination of        
                              on MLCCs                                  smallest size capacitors with   
                                                                        throughput up to 100,000.       

CS 750                        Electrical contact attachment             Automated termination of        
                              on MLCC arrays                            smallest size capacitor arrays  
                                                                        with throughput up to 50,000.   
Handling Tooling                                                                                        
Carrier Plates                Plates to batch handle MLCCs for          Patented composite carriers to  
                              test and termination                      handle the full range of MLCC   
                                                                        sizes and up to 8,000 pieces per
                                                                        batch.                          

Test Tooling                  Test fixtures for use with                Permits precise location and    
                              ESI systems                               positioning of MLCCs during the 
                                                                        test operation.                 
--------------------------------------------------------------------------------------------------------

33

424B1
39th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 39th
Memory Yield Improvement Systems. Memory yield improvement systems are used by  
nearly all manufacturers of dynamic random access memories (DRAMs) to increase  
production yields. Personal computers and high performance workstations are the 
largest market for semiconductor memory, although photocopiers, facsimile       
machines and telecommunications equipment represent products requiring          
increasing amounts of memory. Customers of ESI's memory systems include Fujitsu,
LG, Hitachi, Hyundai, IBM, NEC, Samsung, Siemens, and Texas Instruments. In the 
aggregate, purchases of memory yield improvement systems by the foregoing       
customers accounted for approximately 21.9 percent of ESI's total revenues in   
fiscal 1997.                                                                    

Memory device manufacturers use a laser process that removes defective
circuit elements while programming spare elements to be replacements and thereby
salvaging a memory device. Cost reductions and demand for higher capacity memory
devices have led manufacturers to reduce the size of circuit elements while     
increasing the number of circuit elements per device. This increased density in 
memory devices has required leading edge semiconductor processes, resulting in  
lower manufacturing yields.                                                     

     The yield enhancement process begins with circuit designers adding extra or
spare elements to the memory array. During the manufacturing process each device
is tested to determine yield. When a defective element is identified, its       
location or address is recorded and given to ESI's laser system to effect a     
replacement or repair. The laser system positions a laser beam over connecting  
links to the defective element and cuts or breaks the electrical path.          
Replacements are added by programming the failed address into a new or spare    
element. Redundancy is used by every significant manufacturer of DRAMs and is   
increasingly being used by manufacturers of other semiconductor memory          
applications, such as SRAMs, DSPs, and other logic devices.                     

   ESI began shipments of the Model 9300 Laser Repair system in August 1996.
This system features a patented laser system technology operating at a 1.3      
micron wavelength that enables manufacturers to use metal links which are       
required for advanced memory devices. This system is recognized as the new      
industry standard for laser repair systems.                                     

   ESI also offers the Model 1225ci and Model 9250 series systems. The Model
1225ci uses patented stage plus galvanometer beam positioning to provide        
throughput benefits, a small footprint, and a high cost performance ratio. It is
used by manufacturers requiring increased capacity of four and sixteen megabit  
devices. The ESI Model 9250 series provides high throughput and high reliability
for those manufacturers using poly-link materials, even for advanced memory     
devices.                                                                        

Vision Systems. ESI's vision systems combine advanced computer technology,      
proprietary software and optical equipment to reduce application development    
time and provide machine vision inspection that facilitates quality products and
fast throughput. The Turbo HR+ vision system is integrated in ESI's laser memory
repair systems and is also marketed independently to electronic and             
semiconductor industry customers for general purpose inspection, part position  
verification for manufacturing processes, wafer identification using OCR,       
measurement, alignment, machine guidance and assembly verification. Customers   
for ESI's vision products include Hewlett Packard and IBM. In the aggregate,    
Hewlett Packard and IBM purchases of vision system products accounted for       
approximately 1.9 percent of ESI's fiscal 1997 revenues.                        

Electronic Packaging Systems. ESI provides a cost effective method for forming  
electrical connections between layers, called vias, in a multiple layer printed 
circuit board. Applications in this market include new generations of integrated
circuits packages, multi chip modules, and high density circuit boards. The     
primary advantage of the technology is the ability to process very small vias in
a wide variety of materials. Electronic industry materials include ceramic,     
traditional glass reinforced circuit boards, copper, and new organic compounds. 
Customers include Automata, Erricson, Sheldahl, Siemens and W.L. Gore. In the   
aggregate, purchases of electronic packaging systems by the foregoing customers 
accounted for approximately 2.2 percent of ESI's total revenues in fiscal 1997. 

34

424B1
40th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 40th
In addition, IBM and Johnson-Matthey/ACI are significant customers of Dynamotion
Corp., an ESI subsidiary acquired after fiscal year 1997.                       

Drilling Products. The Model 5100, introduced in June 1996, is the current      
product being marketed, and features the capability to drill up to 10,000       
micro-vias per minute. The Model 5100 includes a proprietary laser, operating in
the ultraviolet region of the spectrum, which can cleanly cut copper and        
glass-reinforcement without damaging or burning organic materials. The system   
can form blind or through holes in all of the common circuit board materials and
uses a unique real-time inner layer alignment to deliver high placement         
accuracy. In this way, the user can achieve the smallest pad dimensions enabling
the routing of today's emerging high density packages.                          

Dynamotion, a subsidiary purchased on June 9, 1997, produces          
computer-controlled drilling equipment which is sold to manufacturers of printed
circuit boards (PCBs) and semiconductor packages. The drilling machines are used
to produce thousands of very small holes, sometimes as small as .004" in        
diameter.                                                                       

   Four product lines of computer-controlled drilling equipment are produced
by Dynamotion: (1) DM 9400/9500 with a patented vacuum pre-load air bearing     
guiding design for the high-dynamic stability necessary for micro-drilling; (2) 
Six-PAKTM with its new innovative design (economical, accurate, compact and     
extremely productive) for the commercial, high-volume PCB market; (3) Modular   
Systems offer the same characteristics as the DM 9400/9500 to the prototype and 
quick-turn market; and (4) Smart DrillTM with its patented vision optimization  
capability offers a fast, highly accurate method of optimizing and drilling for 
the most sophisticated multilayer board manufacturers.                          

Routing Products. Dynamotion produces computer-controlled routers which are sold
to computer manufacturers and manufacturers of PCBs. Routers are used to cut and
shape individual PCBs out of panels. Currently, the two primary machining       
processes required to produce a PCB are routing and drilling. In contrast to a  
drill, which makes thousands of tiny holes on a PCB, the router cuts the shape  
of the PCB, the larger holes and special cavities for mounting of semiconductor 
die. The computer-controlled cuts made by the router can be very complex since  
the position of the cuts are pre-programmed in three axes.                      

   Newly emerging PCB chip carrier technology creates unusual demands on the
routing process. Perfect registration of routed edges with respect to the       
circuitry features and the internal layers are required to successfully produce 
chip carriers. Very accurate depth control is necessary for cavity routing.     
Dynamotion produces two product lines of computer controlled routers: the       
SMARTTM Driller/Router and the Six-PAKTM Router Drill.                          

Sales, Marketing and Service                                                    

   ESI sells its products worldwide through direct sales and service offices
located in or near:                                                             

Boston, Massachusetts                                                 
Dallas, Texas                                                         
Portland, Oregon                                                      
San Diego California                                                  
Santa Ana, California                                                 
Leiderdorp, Netherlands                                               
London, United Kingdom                                                
Munich, Germany                                                       
Nagoya, Japan                                                         
Paris, France                                                         
Seoul, Republic of Korea                                              
Taipei, Taiwan                                                        
Tokyo, Japan                                                          

ESI serves customers in approximately 30 additional countries through           
manufacturers representatives.                                                  

ESI has a substantial base of installed products in use by leading    
worldwide electronics manufacturers. ESI emphasizes strong working relationships

35

424B1
41st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 41st
with these leading manufacturers in order to meet their needs for additional    
systems and to facilitate the successful development and sale of new products to
these customers.                                                                

 ESI maintains service personnel wherever it has a significant installed
base and provides service anywhere its equipment is installed. New systems are  
tested to ensure they meet requirements and acceptance criteria incorporated    
into customer orders. ESI also offers a variety of maintenance contracts and    
parts replacement programs.                                                     

ESI has an OEM contract with Advantest Ltd. to supply memory yield    
improvement systems in Japan through December 31, 1997. Sales to Advantest      
amounted to 9.8%, 6.5% and 6.9% of net sales for the fiscal years 1997, 1996,   
and 1995. ESI has appointed Canon as its distributor for such products in Japan,
effective January 1998. ESI maintains a presence in Korea through a wholly-owned
subsidiary.                                                                     

 Sales outside the United States accounted for 71.0%, 66.9% and 70.8% of
ESI's net sales for fiscal years 1997, 1996 and 1995.                           

   In fiscal years 1997 and 1996, no one customer exceeded 10% of sales. One
customer accounted for 11.9% of ESI's sales in fiscal 1995.                     

Backlog                                                                         

    Backlog consists of written purchase orders for products for which ESI has
assigned shipment dates within the following twelve months. Backlog also        
includes written purchase orders for spare parts and service to be delivered or 
performed within the next twelve months. Backlog was $25 million at May 31, 1997
versus $35 million at May 31, 1996 and $26 million at May 31, 1995. Backlog was 
$30 million at August 31, 1997. ESI expects all of its existing backlog to ship 
within the next twelve months.                                                  

Research, Development and Technology                                            

   ESI believes that its ability to compete effectively depends, in part, on
whether it can maintain and expand its expertise in core technologies and       
product applications. The primary emphasis of ESI's research and development is 
to advance ESI's capabilities in:                                               

o        Lasers and laser/material interaction                
o        High speed, sub-micron motion control systems        
o        Precision optics                                     
o        High speed, small parts handling                     
o        Image processing and optical character recognition   
o        Real-time production line electronic measurement     
o        Real-time software                                   
o        Systems integration                                  

  ESI's research and development expenditures for fiscal years 1997, 1996,
and 1995 were $17.0 million (10.6% of net sales), $16.7 million (10.0% of net   
sales), and $13.5 million (12.0% of net sales), respectively. The foregoing     
figures do not include the effect of research and development expenditures      
funded by the Advanced Research Projects Agency (ARPA) of the U.S. Government.  

   In addition, research and development expenditures for the year ended May
31, 1996 do not include the acquired in-process research and development expense
of $6.0 million incurred in connection with the purchase price allocation of    
XRL, Inc.                                                                       

Competition                                                                     

 ESI's markets are competitive. The principal competitive factors in the
industry are product performance, reliability, service and technical support,   
product improvements, price, established relationships with customers and       
product familiarity. ESI believes that its products compete favorably with      
respect to these factors. Some of ESI's competitors have greater financial,     
engineering and manufacturing resources than ESI and larger service             
organizations. In addition,                                                     

36

424B1
42nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 42nd
certain of ESI's customers develop, or have the ability to develop, similar     
manufacturing equipment. There can be no assurance that competition in ESI's    
markets will not intensify or that ESI's technological advantages may not be    
reduced or lost as a result of technological advances by competitors or         
customers or changes in electronic device processing technology.                

     For laser trimming systems, major competitors are NEC and General Scanning.
In miniature capacitor test and production equipment, ESI's competition comes   
mainly from manufacturers that develop systems for internal use, and in Japan,  
from test equipment manufactured by Tokyo Weld and Humo, among others. ESI's    
major competitors for memory repair systems are Nikon and General Scanning. ESI 
also competes with stand alone vision suppliers such as Cognex and Robotic      
Vision Systems, and with robotics and factory automation companies, such as     
Allen Bradley. There are also numerous other vision companies and captive       
vendors in Japan, North America and Europe. ESI's electronic packaging systems  
compete with mechanical drilling manufacturers such as Hitachi-Seiko, Excellon  
and laser system provider Lumonics.                                             

Manufacturing and Supply                                                        

ESI's laser system manufacturing operations consist of electronic     
subassembly, laser production and final system assembly. Principal production   
facilities are headquartered in Portland, Oregon. Miniature capacitor test and  
production systems are manufactured by ESI's Palomar and Chip Star subsidiaries 
near San Diego, California. Dynamotion drilling and routing products are        
produced in Santa Ana, California. ESI also uses qualified manufacturers to     
supply many components of its products.                                         

     ESI's laser systems use high performance computers, peripherals, lasers and
other components from various vendors. Some components used by ESI are obtained 
from a single source or a limited group of suppliers. An interruption in the    
supply of a particular component could require substitutions which would have a 
temporary adverse impact on ESI. ESI believes it has good relationships with its
suppliers.                                                                      

Employees                                                                       

     As of May 31, 1997, ESI employed 680 persons, including 203 in engineering,
research and development, 270 in manufacturing and 207 in marketing, sales,     
customer service and support. Many of ESI's employees are highly skilled, and   
ESI's success will depend in part upon its ability to attract and retain such   
employees, who are in great demand. ESI has never had a work stoppage or strike 
and no employees are represented by a labor union or covered by a collective    
bargaining agreement. ESI considers its employee relations to be good.          

Patents and Other Intellectual Property                                         

     ESI has a policy of seeking patents when appropriate on inventions relating
to new products and improvements which are discovered or developed as part of   
ESI's ongoing research, development and manufacturing activities. ESI owns 42   
United States patents and has applied for 19 patents in the United States. In   
addition, ESI has 35 foreign patents and has applied for 40 additional foreign  
patents. Although ESI's patents are important, ESI believes that the success of 
its business depends to a greater degree on the technical competence and        
innovation of its employees.                                                    

   ESI relies on copyright protection for its proprietary software. ESI also
relies upon trade secret protection for its confidential and proprietary        
information. There can be no assurance that others will not independently       
develop substantially equivalent proprietary information and techniques, or that
ESI can meaningfully protect its trade secrets.                                 

Some customers using certain products of ESI have received a notice of
infringement from Jerome H. Lemelson, alleging that equipment used in the       
manufacture of semiconductor products infringes patents issued to Mr. Lemelson  
relating to "machine vision" or "barcode reader" technologies. Certain of these 
customers have notified ESI that they may be seeking indemnification from ESI   
for any damages and expenses resulting from this matter. One of ESI's customers 
has                                                                             

37

424B1
43rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 43rd
settled litigation with Mr. Lemelson, and several other customers are currently 
engaged in litigation involving Mr. Lemelson's patents. While ESI cannot predict
the outcome of this or similar litigation or its effect upon ESI, ESI believes  
that it will not have a material adverse effect on its financial condition or   
results of operations.                                                          

Properties                                                                      

 The Company's executive and administrative offices, and principal laser
system manufacturing facilities are located in a two-building complex located on
16 acres in Sunset Science Park, in Portland, Oregon. The buildings are owned by
ESI, and contain approximately 134,000 square feet of floor space. Palomar is   
located in an owned 64,000 square foot plant on ten acres of land in Escondido, 
California.                                                                     

     In addition, approximately 15,000 square feet of industrial space is leased
in Canton, Massachusetts. The Company also leases 7,000 square feet of office   
space in Portland, Oregon for its Vision Products Division, 8,000 square feet of
office and industrial space in San Marcos, California for its Chip Star         
subsidiary, 30,000 square feet of office and industrial space in Santa Ana,     
California for its Dynamotion subsidiary, and office and service space in       
several additional locations in the United States, and in seven foreign         
countries.                                                                      

Legal Proceedings                                                               

     On December 26, 1996, ESI filed a lawsuit against General Scanning, Inc. in
the United States District Court for the Northern District of California for    
patent infringement. The complaint alleges that General Scanning is infringing  
two of ESI's patents used in the Model 9300 laser repair systems (patent numbers
5,265,114 "System and Method for Selectively Laser Processing a Target Structure
of One of More Materials of a Multimaterial, Multilayer Device" and 5,473,624   
"Laser System and Method for Selectively Severing Links"). ESI is seeking       
damages and an injunction against further infringement. General Scanning has    
filed counterclaims alleging that certain ESI patents are invalid and           
unenforceable and that ESI has interfered with General Scanning's business      
reputation. General Scanning is seeking damages and declaratory judgments that  
the ESI patents are not infringed, are invalid and are unenforceable. ESI and   
General Scanning are currently taking depositions of witnesses and supplying    
requested documents to each other. The trial date for this case is expected to  
be December 1998. While ESI cannot predict the outcome of this or similar       
litigation or its effect upon ESI, ESI believes that it will not have a material
adverse effect on its financial condition or results of operations.             

ESI Management                                                                  

The directors and executive officers of ESI as of June 30, 1997 are as
follows:                                                                        

Name                            Age    Position                             
----                            ---    ---------                            

 Donald R. VanLuvanee(1)         53     Chief Executive Officer, President and
          Director
Robert E. Belter(1)             56     Vice President                       
Robert C. Cimino(1)             52     Director of Human Resources          
  Barry L. Harmon(1)              43     Chief Financial Officer and Senior Vice
           President
Jon R. Hopper(1)                37     Vice President                       
Jonathan C. Howell(1)           43     Vice President                       
Mark W. Klug(1)                 58     Vice President                       
John R. Kurdock(1)              52     Vice President                       
 Larry T. Rapp(1)                57     Corporate Secretary and Vice President
Joseph L. Reinhart(1)           38     Vice President                       
Joseph Z. Rivlin(1)             62     Vice President                       
Vernon R. Swearingen(1)         57     Vice President                       
Edward J. Swenson(1)            58     Senior Vice President                
David F. Bolender               65     Director                             

38

424B1
44th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 44th
Keith L. Thomson                58     Director                             
Larry L. Hansen                 68     Director                             
W. Arthur Porter                56     Director                             
Vernon B. Ryles, Jr.            59     Director                             
Douglas C. Strain               77     Director                             

------------------                                                              

(1)  Officers are appointed annually by the Board of Directors.                 

     Mr. VanLuvanee joined ESI in 1992 as Chief Executive Officer, President and
a Director. His term as a Director expires in 1998. From July 1991 to July 1992,
Mr. VanLuvanee was President, Chief Executive Officer and a Director at         
Mechanical Technology Inc., a supplier of contract research and development     
services and a manufacturer of technologically advanced equipment. From 1990 to 
1991, he was President and Chief Executive Officer of BCT Spectrum, Inc., a     
supplier of vacuum deposition systems. From 1984 to 1990, he was President,     
Chief Operating Officer and a Director of Kulicke and Soffa Industries, Inc., a 
supplier of capital equipment and consumables to the microelectronics industry. 
Mr. VanLuvanee is also a Director of Micro Component Technology, Inc., a leading
manufacturer of automated test handling equipment, and FEI Company, which       
designs, manufactures and markets focused ion beam workstations and both ion and
electron emitter and focusing column components.                                

  Mr. Belter joined ESI in May, 1997 and was elected President and General
Manager of the Palomar subsidiary and a Corporate Vice President. Mr. Belter is 
responsible for the ceramic capacitor production equipment business unit,       
including the Palomar and Chip Star subsidiaries. Prior to joining ESI, Mr.     
Belter served as a consultant to ESI in marketing and product development for   
one year. Mr. Belter has extensive prior experience in the electronic component 
industry, including four years as President and General Manager of Johanson     
Dielectrics, and ten years as President and General Manager of Kyocera          
Northwest, North American Electronic Components.                                

  Mr. Cimino joined ESI in 1993 as Director of Human Resources. Mr. Cimino
was employed by Eastman Kodak prior to joining ESI. He held management positions
at Kodak in human resources, customer service, sales, and real estate asset     
management.                                                                     

Mr. Harmon joined ESI in 1992 and has served ESI in various financial 
management positions. In January 1995, he was elected Chief Financial Officer   
and Senior Vice President. Mr. Harmon held various financial management         
positions with the Global Private Banking Group of Citibank from 1985 to 1991.  
He was employed by Arthur Andersen LLP from 1976 until 1983. Mr. Harmon is a    
licensed CPA.                                                                   

     Mr. Hopper joined ESI as a Group Vice President in the Electronic Packaging
Business Unit upon Dynamotion's merger with ESI on June 9, 1997. Previously, he 
was Chairman, President and Chief Executive Officer of Dynamotion from April    
1995. Mr. Hopper's experience includes several management positions in high     
technology businesses during the period from 1990 to 1994.                      

  Mr. Howell joined ESI in April 1993 as Director of MIS. In June 1995, he
was appointed Managing Director of the Vision Products Division. In September   
1995, Mr. Howell was elected Vice President. Since July 1996, Mr. Howell is     
responsible for ESI's technical staff and resources. Mr. Howell has extensive   
management experience from Citibank, Gulf and Western and Arthur Young & Co.    

    Mr. Klug joined Palomar Systems, Inc. in August 1992 and in April 1993 was
elected a Corporate Vice President. Mr. Klug is responsible for the test segment
of the capacitor equipment business unit. From 1988 to 1992, Mr. Klug was Vice  
President of Engineering for Symtek Systems, Inc., and between 1983 and 1988 he 
held senior management positions with Kulicke and Soffa Industries, Inc.,       
including Senior Vice President of U.S. Operations and Vice President of        
Engineering.                                                                    

     Mr. Kurdock joined ESI in February 1997 as Group Vice President and General
Manager of Portland Operations. Prior to joining ESI, Mr. Kurdock served as Vice

39

424B1
45th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 45th
President of the Surface Mount Division for Universal Instruments. He has also  
held senior operating positions with the Silicon Valley Group and Perkin Elmer. 

Mr. Rapp joined ESI in 1966 and has served in various capacities in   
engineering. In 1982 he became the Government Relations and Patent Manager. He  
served as Assistant Secretary from 1988 to 1991, and in January 1992 was elected
Corporate Secretary and Legal Manager. In September 1995, Mr. Rapp was elected  
Vice President.                                                                 

     Mr. Reinhart joined ESI in 1993 as Communications and Contracts Manager and
was promoted to Director of Business Development in April 1995. He was elected a
Vice President in September 1996. His experience includes finance, venture      
funding, mergers and acquisitions and administration in high-technology         
businesses.                                                                     

    Mr. Rivlin, who joined ESI in 1994, was elected Vice President of Sales in
February 1995. Prior to joining ESI, Mr. Rivlin was Vice President of Sales and 
Service for Solbourne Computer, and President and CEO of XRL, Inc. He has held  
other management positions at GenRad, Fairchild Camera and Instrument Corp., and
Veeco Instruments, Inc.                                                         

 Mr. Swearingen joined ESI in November 1992 as Director of Laser Systems
Business Unit and was elected Vice President in April 1993. From 1990 to 1991,  
Mr. Swearingen was President of Quantum Engineering, Inc., a project engineering
firm, and from 1988 to 1990 he held a management position with Kulicke and Soffa
Industries, Inc.                                                                

   Mr. Swenson joined ESI in 1961 as a project and applications engineer. In
1970, he initiated the manufacture of computer-controlled laser systems for     
trimming and scribing microcircuits. He became Manager of the Systems Business  
Unit in 1978, Vice President, Advanced Development in 1979, Vice President,     
Advanced Technology Division in 1985 and Senior Vice President, Advanced        
Technology Group in 1987.                                                       

     Mr. Bolender retired in 1991 from the position of President of the Electric
Operations Group of PacifiCorp, a diversified public utility located in         
Portland, Oregon. Mr. Bolender is a Director of United States National Bank of  
Oregon, Benson Industries Incorporation, and Protocol Systems, Inc. He joined   
the Board of Directors in 1988 and in January 1992, Mr. Bolender became         
Chairman. Mr. Bolender is a member of the Audit Committee of the Board of       
Directors. Mr. Bolender's term expires in the year 2000.                        

Keith L. Thomson, Vice President of Intel Corporation and Oregon Site 
Manager. Mr. Thomson joined Intel in 1969 and moved to the Intel, Oregon        
operation in 1978. Prior to that he worked for Lockhead Missiles and Space      
Corporation, and the Semiconductor Division of Fairchild Camera and Instruments.
Mr. Thomson was elected to the Board of Directors in 1994 and is the Chairman of
the Compensation Committee of the Board of Directors. Mr. Thomson's term expires
in the year 2000.                                                               

Larry L. Hansen retired in 1992 from the position of Executive Vice   
President of Tylan General Inc., a manufacturer of high technology components   
for industrial processes located in San Diego, California. Prior to December    
1988 he was Executive Vice President and a Director of Varian Associates, Inc., 
an electronics manufacturer located in Palo Alto, California. Mr. Hansen is also
a Director of Signal Technology Corp., and Micrel, Inc. Mr. Hansen joined the   
Board in 1986 and is a member of the Compensation Committee. Mr. Hansen's term  
expires in 1998.                                                                

W. Arthur Porter, President of the Houston Advanced Research Center,  
Adjunct Professor of Electrical Engineering at Rice University. Dr. Porter is a 
Director of Stewart Information Services Corporation, and Medici Medical Group  
Inc. Dr. Porter, formerly Chairman of the Board of Directors, serves as Chairman
of the Audit Committee of the Board of Directors. He joined the Board in 1980.  
Mr. Porter's term expires in 1998.                                              

Vernon B. Ryles, Jr., President and CEO of Poppers Supply Co., a      
manufacturer of popcorn snacks and jobber/distributor of recreational food and  

40

424B1
46th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 46th
equipment. In addition, Mr. Ryles is on the Board of Directors of Northwest Pipe
and Casing, a manufacturer of steel pipe. He is a Director and former Board     
Chairman of the National Association of Concessionaires and on the Advisory     
Council of the Oregon State University Agricultural Trade and Marketing Program.
Mr. Ryles joined the Board in 1995 and is a member of the Compensation          
Committee. Mr. Ryles' term expires in 1999.                                     

Douglas C. Strain, Vice Chairman of the Board of Directors, formerly  
Chairman of the Board. Mr. Strain founded ESI and has been a Director since     
1949. Mr. Strain is also a Director of Lattice Semiconductor Corporation. Mr.   
Strain is a member of the Audit Committee of the Board of Directors. Mr.        
Strain's term expires in 1999.                                                  

Beneficial Ownership of Principal ESI Shareholders and Management               

    The following table, which, except as otherwise noted, was prepared on the
basis of information furnished by the persons described, shows ownership of     
ESI's Common Stock as of May 31, 1997, by (i) each Director, (ii) each Executive
Officer named in the summary Compensation Table, (iii) all Directors and        
Executive Officers as a group, and (iv) each beneficial owner of more than five 
percent of ESI's Common Stock.                                                  

                                                        [Enlarge/Download Table]

                                                              Amount and Nature of   Approximate
Name of Beneficial Owner                                    Beneficial Ownership(1)      Percent
------------------------                                    -----------------------  -----------
                                                                                                
David F. Bolender.....................................            52,141(2)              *      
Larry L. Hansen.......................................            10,237(3)              *      
Barry L. Harmon.......................................            32,949(4)              *      
Jonathan C. Howell....................................            24,345(5)              *      
Mark W. Klug..........................................            32,205(6)              *      
W. Arthur Porter......................................             7,750(7)              *      
Joseph Z. Rivlin......................................            15,401(8)              *      
Vernon B. Ryles, Jr...................................               250(3)              *      
Douglas C. Strain.....................................           168,513(9)(3)        1.8%      
Keith L. Thomson......................................               650(3)              *      
Donald R. VanLuvanee..................................            89,007(10)             *      
18 Directors and executive officers                              504,132(11)          5.3%      
as a group                                                                                      
J & W Seligman & Co., Incorporated....................         1,291,290(12)         13.6%      
  100 Park Avenue, New York, NY 10017                                                           
The Parnassus Fund....................................           600,000(13)          6.3%      
  One Market, Stewart Tower, Ste 1600                                                           
  San Francisco, CA 94105                                                                       
EQSF Advisor Incorporated.............................           557,700(14)          5.9%      
  767 Third Ave, New York, NY 10017                                                             

------------------------                                                                        

*    Less than 1 percent.                                                                       
(1)  Shares are held directly with sole investment and voting power unless                      
     otherwise indicated. Includes shares awarded as performance-based                          
     restricted stock and time-based restricted stock that are subject to                       
     forfeiture in certain circumstances.                                                       
(2)  Includes 23,000 shares owned by Mr. Bolender's wife, as to which he                        
     disclaims beneficial ownership and includes 2,203 shares that are subject                  
     to stock options exercisable at May 31, 1997.                                              
(3)  Includes 250 shares that are subject to stock options exercisable at May                   
     31, 1997.                                                                                  

                                       41                                                       

424B1
47th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 47th
(4)  Includes 15,920 shares that are subject to stock options exercisable at May                
     31, 1997.                                                                                  
(5)  Includes 11,812 shares that are subject to stock options exercisable at May                
     31, 1997.                                                                                  
(6)  Includes 10,599 shares that are subject to stock options exercisable at May                
     31, 1997.                                                                                  
(7)  Includes 7,750 shares that are subject to stock options exercisable at May                 
     31, 1997.                                                                                  
(8)  Includes 5,913 shares that are subject to stock options exercisable at May                 
     31, 1997 or exercisable within 60 days of May 31, 1997.                                    
(9)  Includes 14,297 shares owned by Mr. Strain's wife and 216 shares owned by                  
     Douglas C. Strain and Leila Cleo Strain Charitable Remainder Trust, as to                  
     which he disclaims beneficial ownership.                                                   
(10) Includes 64,484 shares that are subject to stock options exercisable at May                
     31, 1997.                                                                                  
(11) Includes 165,147 shares that are subject to stock options exercisable at                   
     May 31, 1997 or exercisable within 60 days of May 31, 1997.                                
(12) Based solely on information provided as of February 13, 1997 in a Schedule                 
     13G filed by the shareholder.                                                              
(13) Based solely on information provided as of February 14, 1997 in a Schedule                 
     13G filed by the shareholder.                                                              
(14) Based solely on information provided as of February 13, 1997 in a Schedule                 
     13G filed by the shareholder.                                                              

ESI Executive Compensation                                                      

  The following table shows, as to the Chief Executive Officer and each of
the next four most highly compensated executive officers of ESI, information    
concerning compensation paid for services to ESI in all capacities during the   
fiscal year ended May 31, 1997, as well as total compensation paid to each such 
individual for ESI's two previous fiscal years (if such person was the Chief    
Executive Officer or an executive officer, as the case may be, during any part  
of such fiscal year):                                                           

                                                        [Enlarge/Download Table]

Summary Compensation Table                                                                                                         

                                                                                    Long-Term Compensation                         
                                                      Annual Compensation      -------------------------------                     
                                        Fiscal     ------------------------    Restricted Stock      Options        All Other      
Name & Principal Position                Year        Salary       Bonus (1)      Awards ($) (2)    Granted (#)  Compensation (3)   
-------------------------               ------     --------       ---------    ----------------    -----------  ----------------   
                                                                                                                                   
Donald R. VanLuvanee                     1997      $285,000             ---            $218,500          6,674       $     2,098   
   Chief Executive Officer and           1996      $281,212        $235,001                 ---          5,681       $       950   
   President                             1995      $243,892        $208,511                 ---         10,750       $   195,056(4)

Barry L. Harmon                          1997      $171,250             ---            $201,400          3,430       $    2,098    
   Chief Financial Officer and           1996      $156,189        $107,633                 ---          3,974       $    2,022    
   Sr. Vice President, Finance           1995      $141,636        $ 73,297                 ---          4,610       $    1,837    

Mark W. Klug                             1997      $157,083             ---            $191,900          3,430       $    2,098    
   Vice President                        1996      $150,233        $ 39,807                 ---          3,974       $    1,922    
                                         1995      $142,677        $ 59,977                 ---          4,520       $    1,923    

Joseph Z. Rivlin                         1997      $228,379(5)          ---            $ 28,500          3,430       $    2,098    
   Vice President                        1996      $152,424        $ 27,394                 ---          3,974       $   10,437(6) 
                                         1995      $  72,131       $ 50,058                 ---          9,840       $    3,817(7) 

Jonathan C. Howell                       1997      $145,760             ---            $133,000          3,430       $    2,098    
   Vice President                        1996      $128,881        $ 63,563                 ---          3,974       $    1,922    
                                         1995      $102,536        $ 32,926                 ---          2,530       $    1,923    

-----------------------                                                                                                            

(1)  As of August 31, 1997 bonuses for fiscal year 1997 performance had not yet                                                    
     been determined.                                                                                                              

(2)  Represents the closing market price of ESI's Common Stock on the date of                                                      
     grant multiplied by the number of shares awarded. Messrs. VanLuvanee,                                                         
     Harmon, Klug, Rivlin and Howell were awarded 11,500, 10,600, 10,100, 1,500,                                                   
     and 7,000                                                                                                                     

                                       42                                                                                          

424B1
48th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 48th
     restricted shares in fiscal year 1997, respectively. Each award vested for                                                    
     50% of the shares on April 12, 1997 and will vest for the balance of the                                                      
     shares on April 12, 1998 if the recipient remains an employee of ESI. At                                                      
     May 31, 1997, Messrs. VanLuvanee, Harmon, Klug, Rivlin and Howell held                                                        
     5,750, 5,300, 5,050, 750, and 3,500 unvested restricted shares,                                                               
     respectively, valued at $218,500, $201,400, $191,900, $28,500, and                                                            
     $133,000, respectively, based on the closing market price of ESI's Common                                                     
     Stock on May 31, 1997. Performance- based restricted stock awards are not                                                     
     shown above, but instead are reported in the Long-Term Incentive Plans                                                        
     table below.                                                                                                                  

(3)  Except as otherwise indicated, represents 401K matching contributions made                                                    
     by ESI.                                                                                                                       

(4)  Includes $193,200 in moving and relocation expenses.                                                                          

(5)  Includes $75,046 in commissions.                                                                                              

(6)  Includes $8,172 in relocation expenses.                                                                                       

(7) Includes $1,437 in relocation expenses.                                                                                        

ESI Options Table                                                               

   The following table sets forth details regarding stock options granted to
the named executive officers in fiscal year 1997. In addition, there are shown  
the hypothetical gains or "option spreads" that would exist for the respective  
options, assuming rates of annual compound stock appreciation of 5% and 10% from
the date the options were granted over the full option term.                    

                                                        [Enlarge/Download Table]

                                                                                                        Potential Realizable
                                                                                                            Value of Assumed
                                                                                                       Annual Rates of Stock
                                                                                                      Price Appreciation for
Option Grants in Last Fiscal Year                                                                                Option Term
-----------------------------------------------------------------                                     ----------------------
                                                      % of Total                                                            
                                                       Options                                                              
                                                      Granted to        Exercise                                            
                                      Options        Employees in        or Base    Expiration                              
Name                               Granted(1)(#)     Fiscal Year      Price ($/Sh)     Date       5%($)               10%($)
----                               -------------    -------------     ------------    ------    --------            --------
                                                                                                                            
Donald R. VanLuvanee                   6,674              3%             $27.125     04/11/07   $113,850            $288,519
Barry L. Harmon                        3,430              1%             $27.125     04/11/07   $ 58,512            $148,280
Mark W. Klug                           3,430              1%             $27.125     04/11/07   $ 58,512            $148,280
Joseph Z. Rivlin                       3,430              1%             $27.125     04/11/07   $ 58,512            $148,280
Jonathan C. Howell                     3,430              1%             $27.125     04/11/07   $ 58,512            $148,280

-------------------                                                                                                         

(1)  All options become exercisable for 25 percent of the shares covered by the                                             
     option on each of the first four anniversaries of the grant date. The grant                                            
     date for each option shown in the table above was April 11, 1997. All                                                  
     options become fully exercisable upon termination of the Optionee's                                                    
     employment within one year after a "change in control" of ESI as defined in                                            
     the Stock Option Plan. Unless the transaction is approved by the Board of                                              
     Directors, a "change in control" generally includes (a) the acquisition by                                             
     any person of 20 percent or more of ESI's Common Stock and (b) the election                                            
     of a new majority of ESI's directors without the approval of the incumbent                                             
     directors.                                                                                                             

43

424B1
49th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 49th
ESI Option Exercises and Fiscal Year-End Option Value Table                     

The following table sets forth information with respect to the named  
executive officers concerning options exercised and the status of exercisable   
and unexercisable options held as of May 31, 1997.                              

                                                        [Enlarge/Download Table]

                           Options Exercised                                         Value of Unexercised      
                              During Year            Number of Unexercised           In-the-Money Options      
                          Ended May 31, 1997        Options at May 31, 1997             at May 31, 1997        
                      ---------------------------  ----------------------------  ----------------------------- 
                         Shares                                                                                
                        Acquired         Value                                                                 
Name                  on Exercise    Realized ($)  Excisable      Unexercisable  Exercisable      Unexercisable
----                  -----------    ------------  ---------      -------------  -----------      -------------
                                                                                                               
Donald R. VanLuvanee      ---              0        64,484           22,551       $2,450,392         $856,938  
Barry L. Harmon           ---              0        15,920           11,530       $ 604,960          $438,140  
Mark W. Klug              ---              0        10,599           11,365       $ 402,762          $431,870  
Joseph Z. Rivlin          ---              0         4,426           11,639       $ 168,188          $442,282  
Jonathan C. Howell        ---              0        11,812            9,429       $ 448,818          $358,302  

ESI Long Term Incentive Plans--Awards in Last Fiscal Year                       

The following table sets forth information with respect to            
performance-based restricted stock awards made to named executive officers in   
fiscal year 1997.                                                               

                                                        [Enlarge/Download Table]

                                                                                Performances or Other Period
Name                                                       Number of Shares    Until Maturation or Payout(1)
----                                                       ----------------    -----------------------------
                                                                                                            
Donald R. VanLuvanee.....................................       5,335                   3 to 5 Years        
Barry L. Harmon..........................................       2,742                   3 to 5 Years        
Mark W. Klug.............................................       2,742                   3 to 5 Years        
Joseph Z. Rivlin.........................................       2,742                   3 to 5 Years        
Jonathan C. Howell.......................................       2,742                   3 to 5 Years        

-------------------                                                                                         

(1)  The base price for these awards is $27.125 per share, the closing market                               
     price of ESI's Common stock on April 11, 1997, the date of grant. Awards                               
     are subject to forfeiture unless (i) the market price of the Common Stock                              
     increases at a rate in excess of 15% per year, compounded annually, over a                             
     minimum 3-year period following the grant as measured based on the average                             
     closing price of ESI's Common Stock during any one of the 8 fiscal quarters                            
     of ESI between June 1, 2000 and May 31, 2002, and (ii) the award recipient                             
     is employed by ESI at the time the performance measure is achieved.                                    

Severance Agreements                                                            

In July 1991, the Board of Directors of ESI approved ESI's entry into 
severance agreements with executive officers of ESI. These agreements generally 
provide for the payment upon the termination of the employee's employment by ESI
without cause or by the employee for "good reason" (as defined in the severance 
agreement) within two years following a change of control of ESI of an amount   
equal to three times the employee's annual salary and three years continued     
coverage under life, accident and health plans. The benefit is capped as        
necessary to prevent any portion of the benefit from being subject to excise    
tax. Each employee is obligated under the severance agreement to remain in the  
employ of ESI for a period of 270 days following a                              

44

424B1
50th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 50th
"potential change in control" (as defined in the severance agreements). All     
executive officers of ESI have executed severance agreements.                   

Performance Graph                                                               

[graphic line chart depicting indexed stock price performance]                  

Assumes that $100.00 was invested on May 31, 1992 in Electro Scientific         
Industries, Inc. (ESIO) Common Stock, the S&P 500 and the S&P High Tech Index,  
and that all dividends were reinvested.                                         

                                                                [Download Table]

                                 ESIO   Index  S&P 500  Index  S&P High Tech  Index
                                -----  ------  -------  -----  -------------  -----
                                                                                   
5/31/1992......................  3.50   100.0   413.35  100.0         199.21  100.0
5/31/1993......................  9.50   271.4   450.19  108.4         224.22  112.6
5/31/1994...................... 10.50   300.0   465.50  112.1         248.20  124.6
5/31/1995...................... 24.38   696.6   533.40  128.4         354.09  177.7
5/31/1996...................... 26.50   757.1   669.12  161.1         350.00  175.7
5/30/1997...................... 38.00  1085.7   848.28  204.2         653.99  328.3

Compensation Committee Report on Executive Compensation                         

    The Compensation Committee of the Board of Directors makes recommendations
to the Board regarding the general compensation policies for ESI, including     
salaries and incentives for executive officers. The Committee also has general  
authority to make option grants and other awards under ESI's 1989 Stock Option  
Plan and 1996 Stock Inventive Plan. The Committee is composed of three          
directors.                                                                      

 The Compensation Committee's executive compensation recommendations and
actions during the 1997 fiscal year were in three areas: (1) compensation       
adjustments for the chief executive and other executive officers of ESI; (2) the
key employee cash incentive bonus program; and (3) the key employee long-term   
incentive program.                                                              

   The Compensation Committee policies for compensation of ongoing executive
officers are designed to fairly compensate ESI's executives and to provide      
incentives for the officers to manage and operate ESI for long-term success. The
Compensation Committee recommends, and the Board of Directors determines based  
on such recommendation, compensation for the Chief Executive Officer. The       
Compensation Committee also recommends compensation levels for the remaining    
executive officers of ESI based on the recommendations of the Chief Executive   
Officer.                                                                        

45

424B1
51st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 51st
     The total compensation of the executive officers takes into account several
factors, including competitive compensation in the electronics industry,        
individual experience and performance, and the performance of ESI. The Committee
does not assign a specific weight to these factors. ESI operates in marketplaces
which are global, cyclical and subject to technology shifts. The Committee's    
evaluations of individual performance considers the leadership of each          
individual's contribution toward achieving ESI's corporate objectives. The      
objectives include: (1) adequate return on, and efficient use of, invested      
capital and (2) generating positive earnings throughout the entire range of     
business conditions.                                                            

The methodology used in determining salary, cash incentive bonus and  
long-term incentive grants is as follows:                                       

    Target compensation for each executive is set annually by the Compensation
Committee. These targets are based on the results of periodic salary surveys of 
comparable-sized companies in the electronics industries conducted by ESI's     
independent compensation consultants and on the level of individual             
responsibility and job complexity. ESI's target is to pay executives at the     
mid-point based on the surveys.                                                 

Base salaries are determined annually for each executive officer with 
reference to the target level for the individual. Salary increases are given    
when warranted by individual performance and when base salary levels are        
relatively low as compared to companies that compete with ESI for executive     
talent to keep base salaries competitive.                                       

The Chief Executive's base salary was $285,000 during the fiscal year,
representing no change from the prior year and a level at approximately the     
mid-point of salary survey data. The Board conducted a performance review of the
President and CEO at its July 1997 meeting, concluding that performance was very
favorable.                                                                      

   Cash incentives in the form of cash bonuses are paid at the discretion of
the Compensation Committee to executive officers who the Committee determines   
have made substantial contributions to the profits of ESI in the preceding      
fiscal year. At the beginning of each fiscal year, the Board of Directors       
approves the business plan for the year, including sales and pre-tax profit     
goals. At the same time, the Board of Directors approves a target bonus         
percentage for executive officers if the established goals are met. If the goals
are met, the Compensation Committee determines, on an individual basis, the     
extent to which the officer will be awarded the target bonus. Factors considered
include individual performance, responsibility and contribution to profits. ESI 
met the goals set for fiscal year 1997 and expects to pay bonuses to officers.  

    ESI has historically used stock options to reward senior management and to
link executive compensation to shareholder interests reflected in increases in  
share value. In April 1996, ESI decided to expand the stock incentive program to
include performance-based restricted stock grants as well as stock options,     
subject to shareholder approval of the new 1996 Stock Incentive Plan which was  
obtained on September 20, 1996. By using a combination of annual options and    
restricted stock awards, ESI intends to provide a potential level of incentive  
compensation to executive officers equal to approximately 90% of competitive    
levels as determined by ESI's compensation consultant, without excessive        
shareholder dilution. In determining the size of option grants and restricted   
stock awards, the Compensation Committee takes into account the executive's     
position and job responsibilities. All options are granted at an exercise price 
equal to the fair market value of the shares on the date of grant, and vest in  
25 percent annual increments during the four-year period following the date of  
grant. The number of options granted to executive officers in fiscal year 1997  
was 35,590 including 6,674 to Donald R. VanLuvanee. The number of shares of     
performance-based restricted stock granted to executive officers in fiscal year 
1997, subject to shareholder approval, was 28,451 including 5,335 to Mr.        
VanLuvanee.                                                                     

     During fiscal year 1997, ESI also made restricted stock awards to executive
officers that vest based solely on continued employment with ESI.               

46

424B1
52nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 52nd
These awards were made to make up for prior years in which long-term incentive  
compensation award levels were significantly below competitive levels. ESI has  
no plan to make additional time-based restricted stock awards to executive      
officers.                                                                       

    Deductibility of Compensation. Section 162(m) of the Internal Revenue Code
of 1986 limits to $1,000,000 per person the amount that ESI may deduct for      
compensation paid to any of its most highly compensated officers in any year.   
The levels of salary and bonus generally paid by ESI do not exceed this limit.  
Substantially all of the options granted under ESI's 1989 Stock Option Plan have
been Incentive Stock Options. ESI receives no tax deduction from the exercise of
an Incentive Stock Option unless the optionee disposes of the acquired shares   
before satisfying certain holding periods. Under IRS regulations, the $1,000,000
cap on deductibility applies to compensation recognized by an optionee upon such
an early disposition, as well as compensation recognized upon the exercise of a 
Nonstatutory Stock Option, unless the option meets certain requirements. It is  
ESI's policy generally to grant options that meet the requirements of the IRS   
regulations so that any such compensation recognized by an optionee will be     
fully deductible. The Committee believes that the grant of Incentive Stock      
Options, despite the general nondeductibility, benefits ESI by encouraging the  
long-term ownership of Company stock by officers and other employees.           
Performance-based restricted stock awards are also intended to be granted in    
compliance with the IRS regulations so that any compensation recognized on      
vesting of such awards will be fully deductible.                                

By the Compensation Committee:  Keith L. Thomson, Chairman; Larry L. Hansen,    
and Vernon B. Ryles, Jr.                                                        

Compensation Committee Interlocks and Insider Participation                     

     The Compensation Committee consists of Directors Keith L. Thomson, Larry L.
Hansen, and Vernon B. Ryles, Jr. No Compensation Committee member is or has been
an employee of ESI.                                                             

 ESI MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION AND RESULTS OF OPERATIONS

Results of Operations                                                           

Three Months Ended August 31, 1997 Compared to Three Months Ended August 31,    
1996                                                                            

     Revenue of $48.4 million for the quarter ended August 31, 1997 was 33.7% or
$12.2 million higher as compared to the same quarter of the prior year, and was 
4.7% or $2.2 million higher than that in the prior quarter. The increase in     
revenues was due to higher demand for semiconductor yield improvement and       
electronic packaging equipment, coupled with an improved market for capacitor   
test and termination equipment.                                                 

    Gross margin for the three months ended August 31, 1997 decreased to 56.0%
from 57.2% for the same period of the prior year. Increased margins for         
semiconductor yield improvement and capacitor test and termination equipment    
were more than offset by a decline in margin for circuit fine tuning products   
and lower margin Dynamotion products.                                           

   Selling, service and administrative expenses were $3.0 million higher for
the three months ended August 31, 1997 than for the first quarter of the prior  
year. The increase is due to higher selling commissions associated with         
increased sales volumes and higher incentive compensation accruals. Selling     
service and administrative expenses, as a percentage of sales, decreased to     
25.3% from 25.5%.                                                               

     Research, development and engineering expenses for the quarter ended August
31, 1997 increased by $0.7 million as compared to the same quarter of the prior 
year. Research, development and engineering expenses, as a percentage of sales, 
decreased to 10.4% from 12.0% for the first quarter of                          

47

424B1
53rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 53rd
fiscal 1997. The comparison between current year and prior year does not include
the acquired in-process research and development charge incurred in connection  
with the purchase price allocation of Dynamotion, Corp. In connection with the  
purchase price allocation, an analysis of the fair value of the intangible      
assets acquired indicated that substantially all of the acquired intangible     
assets consisted of research and development projects in process. The           
development of these projects had not reached technological feasibility and the 
technology has no alternative future use. In accordance with generally accepted 
accounting principles, the acquired in-process research and development was     
charged to expense during the quarter ended August 31, 1997. ESI currently      
believes that the research and development efforts will result in commercially  
feasible products in the next 24 months at an estimated additional cost of $2   
million.                                                                        

   Net income for the quarter ended August 31, 1997, excluding $11.1 million
in transaction costs associated with the acquisitions of Dynamotion, Corp. and  
Chip Star, Inc, was $6.7 million or $0.68 per share compared to $4.6 million or 
$0.49 per share for the same period of the prior year. Including acquired       
in-process research and development and merger related expenses, a net loss of  
$(3.9) million or $(0.39) per share was recorded.                               

   Ending backlog on August 1, 1997 was $30 million, compared to $25 million
on May 31, 1997. Customer demand in each of ESI's served markets is strong and  
the products introduced over the last year continue to represent a growing      
percentage of sales.                                                            

Fiscal Year Ended May 31, 1997 Compared to Fiscal Year Ended May 31, 1996       

    Revenue for fiscal 1997 was $160.1 million, which was 3.7% or $6.2 million
lower than for fiscal 1996. The decline was due to lower shipments of capacitor 
production equipment during the first half of fiscal 1997, as customers absorbed
capacity added in the prior year, and lower sales of circuit fine tuning laser  
systems throughout the year. These declines were partially offset by an increase
in laser-based electronics packaging from $4.8 to $10.8 million and smaller     
increases in the sales of semiconductor memory yield improvement and vision     
systems.                                                                        

   Gross margin of 54.4% for the year ended May 31, 1997, was slightly below
the 54.8% gross margin for fiscal 1996. The sales decline in capacitor          
production equipment was the most significant factor causing the decrease in    
margin. Increased sales of higher margin semiconductor yield improvement        
systems, electronic packaging equipment and machine vision systems positively   
affected gross margin.                                                          

  Selling, service and administrative expenses were $2.6 million lower for
the year ended May 31, 1997. The decrease is a result of lower selling          
commissions associated with decreased sales volumes and lower incentive         
compensation. Selling, service and administrative expenses decreased as a       
percentage of sales to 24.3% from 25.0% from year to year.                      

   Research, development and engineering expenses for the year ended May 31,
1997 were $0.3 million higher than the prior year. Research, development and    
engineering expenses increased as a percentage of sales to 10.6% for 1997 from  
10.1% for the prior year. The comparison between spending of the current year   
and the prior year does not include the acquired in-process research and        
development charge of $6.0 million incurred in connection with the purchase     
price allocation of XRL, Inc in fiscal 1996.                                    

   The effective tax rate of 34.6% for the year ended May 31, 1997 decreased
from 36.7% as a result of an increased benefit recognized on foreign sales.     

   Net income for the year ended May 31, 1997 was $21.3 million or $2.27 per
share compared to $17.3 million or $1.86 per share for the same period of the   
prior year.                                                                     

48

424B1
54th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 54th
Fiscal Year Ended May 31, 1996 Compared to Fiscal Year Ended May 31, 1995       

Net sales increased 47.3% or $53.4 million. The increasing electronics
content, complexity and decreasing size of consumer communication devices,      
automotive components and computers is directly related to the increased demand 
for ESI's products. Sales of semiconductor yield improvement systems more than  
doubled. The acquisition of XRL, Inc. in July 1995 contributed $18.9 million    
toward the increase in semiconductor yield improvement sales. Increased volume  
and a more favorable product mix of capacitor manufacturing products and circuit
fine tuning systems also contributed significantly to the revenue growth. ESI's 
emerging electronic packaging business reported modest growth.                  

   Gross margin increased from 52.8% for fiscal 1995 to 54.8% as a result of
increased volume of semiconductor yield improvement equipment sold, increased   
sales of higher margin circuit fine tuning systems, and productivity            
improvements in the capacitor carrier plate manufacturing process.              

   Selling, service and administrative expenses decreased as a percentage of
sales to 25.0% from 25.8% for fiscal 1996 compared to the same period of the    
prior year. Selling, service and administrative expenses increased $12.5 million
compared to the prior year as a result of higher selling commissions, travel    
associated with increased sales levels, salaries and employee incentive         
compensation.                                                                   

   Research, development and engineering expenses increased $3.3 million for
the year ended May 31, 1996 compared to the prior year. Increased product       
development efforts resulted in additional project material costs and           
compensation related to new hires. Engineering costs associated with XRL also   
contributed to the increase. Research, development and engineering expenses     
declined as a percentage of sales to 10.1% for fiscal 1996 from 11.9% for the   
prior year as sales grew faster than spending increases.                        

  The acquired in-process research and development expense of $6.0 million
occurred in connection with the purchase price allocation of XRL, Inc. An       
analysis of the fair value of intangible assets acquired indicated that         
substantially all of the acquired intangible assets consisted of research and   
development in process. In accordance with generally accepted accounting        
principles, the acquired in-process research and development was expensed during
the first quarter ended August 31, 1995.                                        

   The effective tax rate of 36.7% for the year ended May 31, 1996 increased
from 30.1% for the prior year as a result of utilizing tax loss and credit      
carryovers in fiscal 1995.                                                      

   Net income for the year ended May 31, 1996 was $17.3 million or $1.86 per
share compared to $12.2 million or $1.49 per share for the prior year. Net      
income per share, excluding the effect of the acquired in-process research and  
development charge of $6.0 million, was $2.27 in fiscal 1996, a 52.3% increase  
over the prior year.                                                            

Financial Condition and Liquidity                                               

     ESI's principal sources of liquidity are existing cash and cash equivalents
and marketable debt securities of $44.6 million, accounts receivable of $49.9   
million, and a $7.0 million line of credit, none of which was outstanding at    
August 31, 1997. ESI has no debt and a current ratio of 7.0:1. Working capital  
increased to $117.6 million at August 31, 1997, from $116.6 million at May 31,  
1997. Inventory increased by $6.1 million from the May 31, 1997 level due to    
inventories acquired in the purchase of Dynamotion, Corp.                       

At May 31, 1997 ESI had cash, cash equivalents and marketable debt    
securities of $45.7 million, accounts receivable of $50.9 million, and a $7.0   
million line of credit, none of which was outstanding at May 31, 1997. ESI had  
no debt and a current ratio of 8.4:1 as of May 31, 1997. Working capital        
increased to $116.6 million at May 31, 1997, from $94.4 million at May 31, 1996.
Accounts receivable increased as product payment terms are longer for the       
recently introduced models 9300, 5100 and 3300. Current liabilities             

49

424B1
55th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 55th
decreased from May 31, 1996 due to acceleration of income tax payments and      
reduced incentive compensation accruals.                                        

     In June 1997, ESI closed two mergers, Dynamotion / ATI Corp. and Chip Star,
Inc. Both of these companies operate from a single location in Southern         
California and develop and sell capital equipment that is complementary to      
existing ESI markets and customers. Refer to Business Environment in the Notes  
to Consolidated Financial Statements for additional information.                

     The total consideration for both mergers was 1,047,000 shares of ESI stock.
In addition, Dynamotion debt liabilities of approximately $11.0 million were    
liquidated immediately after the merger was closed with ESI's existing          
resources. Debt liabilities are not expected to be used to finance future       
Dynamotion working capital requirements.                                        

Production capacity for these acquired businesses is expected to be   
satisfied from existing facilities, which are leased, or their replacement.     

In connection with ESI's Portland based operations, ESI is undertaking
renovations to improve space utilization and may consider the lease or purchase 
of additional facilities to satisfy growth potential. The fiscal 1998 capital   
expenditures are expected to increase approximately 50.0% over the level        
incurred during the past three years due to these renovations and will be       
satisfied with existing cash resources. ESI may acquire or invest in other      
complementary businesses, product lines or technologies. These acquisitions or  
investments may require additional debt or equity capital to fund such          
activities.                                                                     

A summary of cash flow activities is as follows (in thousands):       

                                                        [Enlarge/Download Table]

                                                   1997              1996             1995 
                                                ------------------------------------------ 
                                                                                           
Cash flows provided by (used in):                                                          

         Operating activities                   $10,110           $11,815          $   511 

         Investing activities 1                 (13,705)           (5,017)         (21,537)

         Financing activities 2                   1,796             1,246           24,324 
                                                ------------------------------------------ 

Increase (decrease) in cash                                                                
 and cash equivalents 3                         $(1,799)          $ 8,044          $ 3,298 
                                                ========================================== 

1    Reflects the net purchase of $9.5 million, $1.1 million, and $17.0 million            
     in marketable debt securities during fiscal 1997, 1996, and 1995,                     
     respectively.                                                                         

2    Reflects net proceeds from stock offering in fiscal 1995.                             

3    Total cash and securities increased from $38.0 million on May 31, 1996 to             
     $45.7 million on May 31, 1997.                                                        

    Operating Activities: Operating activities provided $10.1 million in cash.
The increase in trade receivables of $11.6 million is due to longer product     
payment terms for the recently introduced models 9300, 5100 and 3300. Collection
of receivables in June 1997 reduced this balance by approximately $10.0 million.
The decrease in accrued liabilities of $4.1 million is a function of lower      
incentive compensation and an acceleration of income tax payments.              

Investing Activities: Net cash of $13.7 million was used in investing 
activities. ESI made purchases in the amount of $3.5 million to upgrade         
computing resources and improve manufacturing capabilities by investing in      
equipment that will decrease costs and improve quality. In addition, net        
purchases of highly liquid marketable debt securities utilized $9.5 million.    

50

424B1
56th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 56th
     Financing Activities: Net cash of $1.8 million was generated from financing
activities in the form of stock option exercises and the related tax benefit.   

Factors That May Affect Future Results                                          

ESI's business depends in large part upon the capital expenditures of 
manufacturers of electronic devices, including miniature capacitors,            
semiconductor memory devices and circuits used in wireless telecommunications   
equipment, including pagers and cellular phones, automotive electronics and     
computers. The markets for products manufactured by ESI's customers are cyclical
and have historically experienced periodic downturns, which often have had a    
negative effect on the demand for capital equipment such as that sold by ESI.   
Several large, multinational electronics companies constituted 47.1% of ESI's   
fiscal 1997 sales and therefore, the loss of any of these customers would be    
significant.                                                                    

The market for ESI's products is characterized by rapidly changing    
technology and evolving industry standards. ESI believes that its future success
will depend on its ability to develop and manufacture new products and product  
enhancements and to introduce them successfully into the market. Failure to do  
so in a timely fashion could harm ESI's competitive position. The announcements 
or introductions of new products by ESI or its competitors may adversely affect 
ESI's operating results, since these announcements may cause customers to defer 
or forego ordering products from ESI's existing product lines.                  

International shipments accounted for 71.0% of sales for fiscal 1997  
compared to 66.9% of sales for fiscal 1996. International shipments accounted   
for 55% of first quarter sales for fiscal 1998 compared to 70% for the first    
quarter of fiscal 1997. ESI expects that international shipments will continue  
to represent a majority of net sales in the future. As a result, a significant  
portion of ESI's net sales will be subject to certain risks, including changes  
in demand resulting from fluctuations in interest and currency exchange rates,  
as well as factors such as government financed competition, changes in trade    
policies, tariff regulations, difficulties in obtaining US export licenses and  
the difficulties of staffing and managing foreign operations.                   

   Most of ESI's sales are transacted in dollars and ESI's products are made
in the United States. Many Japanese customers pay in yen; therefore, ESI hedges 
these sales transactions to mitigate currency risks. The European and Asian     
sales subsidiaries' operating expenses are denominated in their respective local
currencies. These transactions represent approximately 15.6% of fiscal 1997     
consolidated operating expenses, and 8.5% of total operating expenses for the   
first quarter of fiscal 1998, and are equally split between Europe and Asia.    
Changes in the value of the local currency, as measured in US dollars, will     
commensurably increase or decrease operating expenses.                          

 ESI believes that it has the product offerings and resources needed for
continuing success; however, future revenue and margin trends cannot be reliably
predicted and may cause ESI to adjust its operations. Factors external to ESI   
can result in volatility of ESI's common stock price. Because of the foregoing  
factors, recent trends should not be considered reliable indicators of future   
stock prices or financial results.                                              

Information in the Management Discussion and Analysis regarding       
expectations for future product demand, customers, international shipments and  
future product offerings and resources constitute forward-looking statements    
that involve a number of risks and uncertainties. In addition, ESI may from time
to time issue other forward-looking statements. The following factors are among 
the factors that could cause actual results to differ materially from the       
forward-looking statements: general economic conditions, including their impact 
on capital expenditures; business conditions in the electronics industry,       
including the cyclical nature of the market for ESI's products; rapidly changing
technology and evolving industry standards; availability and continued validity 
of intellectual property protection; competitive factors, including increased   
competition, new product offerings by competitors and                           

51

424B1
57th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 57th
price pressures; availability of supplies from third party suppliers on a timely
basis and at reasonable prices; and international business conditions, including
fluctuations in interest and currency exchange rates, government financed       
competition, changes in trade policies, tariff regulations, and the difficulties
of staffing and managing foreign operations. The forward-looking statements     
should be considered in light of these factors.                                 

DESCRIPTION OF ESI CAPITAL STOCK

     The authorized capital stock of ESI consists of 40,000,000 shares of Common
Stock, without par value, and 1,000,000 shares of No Par Serial Preferred Stock.

Common Stock                                                                    

  Holders of Common Stock are entitled to one vote per share on any matter
submitted to the stockholders and do not have cumulative voting rights. The     
Common Stock is not redeemable or convertible and the stockholders do not have  
any preemptive right to purchase any securities to ESI. Subject to the rights of
any holders of Preferred Stock, the holders of Common Stock are entitled to     
receive dividends as and when declared by the Board of Directors of ESI out of  
funds legally available therefor and to share pro rate in any distribution to   
stockholders. Upon dissolution or liquidation of ESI, subject to the rights of  
the holders of any shares of Preferred Stock, the holders of Common Stock are   
entitled to receive ratably all of the assets legally available for             
distribution to stockholders.  All outstanding shares of Common Stock are       
fully paid and nonassessable.                                                   

ESI's Third Restated Articles of Incorporation (the "Articles of      
Incorporation") require the affirmative vote of 66 2/3 percent of the shares    
entitled to vote thereon in connection with the removal of any Director of ESI  
without cause or any amendment to the Articles of Incorporation relating to such
requirement. ESI's Articles of Incorporation also require, in certain cases, the
affirmative vote of 66 2/3 percent of ESI's voting stock to approve a Business  
Transaction between ESI (or a company controlled by or under common control with
ESI) and any person who owns 25 percent or more of ESI's voting stock (a        
"Related Person") or any Business Transaction in which a Related Person has an  
interest (except proportionately as a stockholder of ESI). for this purpose, a  
Business Transaction is defined to include mergers, acquisitions, or sales of 15
percent or more of the assets of ESI, and other similar arrangements. The       
provision is not applicable if the proposed transaction is approved by a        
majority of ESI's Continuing Directors (defined as the Board of Directors as of 
August 22, 1983 and certain future Board members) or if the consideration to be 
received by ESI's stockholders is not less than the highest purchase price paid 
for other shares acquired by the Related Person in the previous two years. These
provisions of the Articles of Incorporation may not be amended, altered,        
changed, or repealed except by the affirmative vote of at least 66 2/3 percent  
of ESI's voting stock.                                                          

Preferred Stock                                                                 

 No shares of Preferred Stock are outstanding. Such shares may be issued
from time to time at the discretion of the Board of Directors, without          
stockholder approval. The Board of Directors is authorized to issue such shares 
in different series and, with respect to each series, to determine the dividend 
rate, the redemption provisions, conversion provisions, liquidating preferences,
and such other rights and privileges not in conflict with ESI's Articles of     
Incorporation and any qualifications, limitations, or restrictions on such      
shares. The Board of Directors authorized Series A No Par Preferred Stock in    
connection with the adoption of a Shareholder Rights Agreement, as described    
below.                                                                          

Rights Agreement                                                                

   On May 12, 1989, the Board of Directors of ESI declared a dividend of one
Right for each outstanding share of ESI's Common Stock to shareholders of record
at the close of business on June 23, 1989. Each Right entitles the              

52

424B1
58th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 58th
registered holder to purchase from ESI one one-hundredth of a share of Series A 
No Par Preferred Stock (the "Preferred Stock") at a Purchase Price of $55,      
subject to adjustment. The description and terms of the Rights are set forth in 
a Rights Agreement (the "Rights Agreement") between ESI and United States       
National Bank of Oregon, as Rights Agent.                                       

 Initially, the Rights will be attached to the certificates representing
outstanding shares of Common Stock, and no separate Rights Certificates will be 
distributed. The Rights will separate from the Common Stock and a Distribution  
Date will occur upon the earlier of (i) 10 days following a public announcement 
that a person or group of affiliated or associated persons (an "Acquiring       
Person") has acquired, or obtained the right to acquire from shareholders,      
beneficial ownership of 20 percent or more of the outstanding Common Stock (the 
"Stock Acquisition Date"), (ii) 10 business days following the commencement of a
tender offer or exchange offer that would result in a person or group           
beneficially owning 20 percent or more of such outstanding shares of Common     
Stock, or (iii) 10 business days after the Board of Directors of ESI shall      
declare any person to be an Adverse Person, upon a determination that such      
person, alone or together with its affiliates and associates, has become the    
beneficial owner of an amount of Common Stock which the Board of Directors      
determines to be substantial (which amount shall be more than 10% of the shares 
of Common Stock then outstanding) and a determination by at least a majority of 
the Board of Directors who are not officers of ESI, after reasonable inquiry and
investigation, including consultation with such persons as such directors shall 
deem appropriate, that (a) such beneficial ownership by such person is intended 
to cause ESI to repurchase the Common Stock beneficially owned by such person or
to cause pressure on ESI to take action or enter into a transaction or series of
transactions intended to provide such person with short-term financial gain     
under circumstances where the Board of Directors determines that the best       
long-term interests of ESI and its stockholders would not be served by taking   
such action or entering into such transactions or series of transactions at that
time or (b) such beneficial ownership is causing or reasonably likely to cause a
material adverse impact (including, but not limited to, impairment of           
relationships with customers or impairment of ESI's ability to maintain its     
competitive position) on the business or prospects of ESI.                      

   Until the Distribution Date, (i) the Rights will be evidenced by and will
be transferred with and only with such Common Stock certificates, (ii) new      
Common Stock certificates issued after June 23, 1989 will contain a legend      
incorporating the Rights Agreement by reference, and (iii) the surrender for    
transfer of any certificates for Common Stock will also constitute the transfer 
of the Rights associated with the Common Stock represented by such certificate. 

    The Rights are not exercisable until the Distribution Date and will expire
at the close of business on May 12, 1999, unless earlier redeemed by ESI as     
described below.                                                                

 As soon as practicable after the Distribution Date, Rights Certificates
will be mailed to holders of record of the Common Stock as of the close of      
business on the Distribution. Date, and thereafter, the separate Rights         
Certificates alone will represent the Rights. Except as otherwise determined by 
the Board of Directors, only shares of Common Stock issued prior to the         
Distribution Date or issued upon exercise or conversion of rights, warrants,    
options or convertible securities issued prior to the Distribution Date will be 
issued with Rights.                                                             

     In the event that (i) the Board of Directors determines that a person is an
Adverse Person or (ii) any person acquires more than 20 percent of the Common   
Stock (except pursuant to a tender offer or exchange offer approved by a        
majority of the Continuing Directors of ESI as in the best interests of         
shareholders), each holder of a Right shall thereafter have the right to        
receive, upon exercise, shares of Common Stock of ESI (or, in certain           
circumstances, cash, property or other securities of ESI) having a value equal  
to two times the exercise price of the Right. However, Rights are not           
exercisable following the occurrence of the event set forth in (ii) above until 
such time as the Rights are no longer redeemable by ESI as set forth            

53

424B1
59th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 59th
below. Notwithstanding any of the foregoing, following the occurrence of the    
event set forth in this paragraph, all Rights that are, or (under certain       
circumstances specified in the Rights Agreement) were, beneficially owned by an 
Acquiring Person will be null and void.                                         

     For example, at an exercise price of $55 per Right, each Right not owned by
the Acquiring Person or Adverse Person (or by certain related parties or        
transferees) following the event set forth in the preceding paragraph would     
entitle its holder to purchase $110 worth of Common Stock (or other             
consideration, as noted above) for $55. Assuming that the Common Stock had a per
share value of $13.75 at such time, the holder of each valid Right would be     
entitled to purchase 8 shares of Common Stock for $55.                          

  In the event that, at any time following the Stock Acquisition Date, (i)
ESI is acquired in a merger or other business combination transaction in which  
ESI is not the surviving corporation or in which the Common Stock is exchanged  
for stock or other securities or property (other than a merger which follows a  
tender offer or exchange offer approved by the Continuing Directors as described
in the second preceding paragraph), or (ii) 50 percent or more of ESI's assets  
or earning power is sold or transferred, each holder of a Right (except Rights  
which previously have been voided as set forth above) shall thereafter have the 
right to receive, upon exercise, common stock of the acquiring company having a 
value equal to two times the exercise price of the Right. The events set forth  
in this paragraph and in the second preceding paragraph are referred to as the  
"Triggering Events."                                                            

     The Purchase Price payable, and the number of one one-hundredths of a share
of Preferred Stock or other securities or property issuable upon exercise of the
Rights are subject to adjustment from time to time to prevent dilution (i) in   
the event of a stock dividend on, or a subdivision, combination or              
reclassification of, the Preferred Stock or the Common Stock, (ii) if holders of
the Preferred Stock are granted certain rights or warrants to subscribe for     
Preferred Stock or convertible securities at less than the current market price 
of the Preferred Stock, (iii) if holders of Common Stock are granted certain    
rights or warrants to subscribe for Common Stock or convertible securities at   
less than the current market price of the Common Stock, or (iv) upon the        
distribution to holders of Preferred Stock or Common Stock of evidences of      
indebtedness or assets (excluding regular quarterly cash dividends) or of       
subscription rights or warrants (other than those referred to above).           

    With certain exceptions, no adjustment in the Purchase Price or the number
of shares of Preferred Stock issuable upon exercise of a Right will be required 
until cumulative adjustments would require an increase or decrease of at least 1
percent. No fractional shares of Preferred Stock will be issued and, in lieu    
thereof, an adjustment in cash will be made based on the market price of the    
Preferred Stock on the last trading date prior to the date of exercise.         

   At any time until a determination that any person is an Adverse Person or
10 days following the Stock Acquisition Date, ESI may redeem the Rights in      
whole, but not in part, at a price of $.01 per Right. Immediately upon the      
action of the Board of Directors, with the concurrence of the Continuing        
Directors, ordering redemption of the Rights, the Rights will terminate and the 
only right of the holders of Rights will be to receive the $.01 redemption      
price.                                                                          

    The term "Continuing Director" means a director who either was a member of
the Board of Directors of ESI immediately prior to the date of the Rights       
Agreement or who subsequently became a director of ESI and whose election, or   
nomination for election by ESI's shareholders, was approved by a vote of a      
majority of the Continuing Directors.                                           

Until a Right is exercised, the holder thereof, as such, will have no 
rights as a shareholder of ESI, including, without limitation, the right to vote
or to receive. dividends. While the distribution of the Rights will not be      
taxable to shareholders or to ESI, shareholders may, depending upon the         
circumstances, recognize taxable income in the event that the Rights become     

54

424B1
60th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 60th
exercisable for Common Stock (or other consideration) of ESI or for common stock
of the acquiring company as set forth above.                                    

 The Preferred Stock will be non-redeemable and will rank on a parity in
respect of the preference as to dividends an the distribution of assets with all
other classes or series of ESI's preferred stock. Each share of Preferred Stock 
will be entitled to an aggregate of 100 times the cash and non-cash (payable in 
kind) dividends-and distributions (other than dividends and distributions       
payable in Common Stock) declared on ESI's Common Stock. In the event of        
liquidation, the holders of Preferred Stock will be entitled to receive a       
liquidation payment in an amount equal to 100 times the payment made per share  
of Common Stock, plus an amount equal to declared and unpaid dividends and      
distributions thereon. In the event of any merger, consolidation or other       
transaction in which shares of Common Stock are exchanged, each share of        
Preferred Stock will be entitled to receive 100 times the amount received per   
share of Common Stock. The dividend and liquidation rights of the Preferred     
Stock are protected by antidilution provisions. Except as otherwise provided by 
law, the Preferred Stock is not entitled to vote on matters submitted to the    
shareholders.                                                                   

     Other than those provisions relating to the principal economic terms of the
Rights, any of the provisions of the Rights Agreement may be amended by the     
Board of Directors with the concurrence of the Continuing Directors prior to the
Distribution Date. After the Distribution Date, the provisions of the Rights    
Agreement may be amended by the Board with the concurrence of the Continuing    
Directors in order to cure any ambiguity, to make changes which do not adversely
affect the interests of holders of Rights (excluding the interests of any       
Acquiring Person), or to shorten or lengthen any time period under the Rights   
Agreement; provided, however, that no amendment to adjust the time period       
governing redemption may be made at such time as the Rights are not redeemable. 

    As long as the Rights are attached to the Common Stock, ESI will issue one
Right with each share of Common Stock that becomes outstanding on or after June 
23, 1989 so that all shares of Common Stock will have attached Rights.          

The Rights have certain anti-takeover effects. The Rights will cause  
substantial dilution to a person or group that attempts to acquire ESI on terms 
not approved by the Board of Directors unless the offer is conditioned on a     
substantial number of Rights being acquired. Thus, the Rights are intended to   
encourage persons who may seek to acquire control of ESI to initiate such an    
acquisition through negotiations with the Board of Directors. However, the      
effect of the Rights may be to discourage a third party from making a partial   
tender offer or otherwise attempting to obtain a substantial equity position in 
the equity securities of, or seeking to obtain control of, ESI. To the extent   
any potential acquirers are deterred by the Rights, the Rights may have the     
effect of preserving incumbent management in office. The Rights should not      
interfere with any merger or other business combination approved by the Board of
Directors, with the concurrence of a majority of the continuing Directors, since
the Rights may be redeemed for $.0l per Right by the Board of Directors, with   
the concurrence of the Continuing Directors, in the circumstances described     
above.                                                                          

 INFORMATION CONCERNING AISI

Business                                                                        

 AISI was incorporated on November 12, 1975 and adopted the name Applied
Intelligent Systems, Inc. on May 28, 1982. AISI provides machine vision         
solutions for automated process control and visual inspection. AISI uses        
innovative technology and aggressive customer support to provide solutions which
replace the human eye on the factory floor. Today, AISI products are primarily  
used in the semiconductor and electronics industries to assemble computer chips 
and electronic printed circuit boards. Machine vision has become the technique  
of choice in today's advanced industries, to meet the demands for increased     
standards of reliability and accuracy.                                          

55

424B1
61st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 61st
AISI technology provides a low cost computer architecture, easy-to-use
software development tools, and powerful application software which emulate the 
human thought process. AISI produces computer vision systems capable of making  
intelligent decisions in response to changing situations machine vision that    
goes beyond simple "seeing" to actual understanding. AISI's vision computers are
configurable with a chain of multiple computer processors working               
simultaneously. Neural network software uses this increased capability to       
perform billions of simple calculations per second, analyzing an image as if the
vision system were a human brain.                                               

Products                                                                        

  A machine vision system is a computer-based digital image processing and
analysis machine that replaces human vision in industrial applications where    
human vision is inadequate due to speed, resolution or fatigue factors or the   
inability to resolve and communicate the position or condition of an object to a
robot or other computer system in real time.                                    

    A machine vision system consists of image analysis software and high-speed
computer hardware to run the software in real time. When connected to a video   
camera, the vision system interprets the video image and provides information   
about objects in that image.                                                    

Machine vision systems are widely used in the manufacturing of        
semiconductor components and electronic printed circuit boards. Growth in the   
machine vision market is driven by the trends in the semiconductor and          
electronics market and improvements in machine vision technologies which has    
resulted in increased penetration in these markets.                             

Markets                                                                         

    The worldwide semiconductor industry is large and growing. The increase in
demand is driven by growth in traditional markets for semiconductors such as    
computers, networking, telecommunications and other advanced electronics        
applications, the proliferation of semiconductor devices into new products and  
markets such as cellular telephones, pagers, automobiles, medical products,     
household appliances and other consumer products, and the rise in semiconductor 
content in electronic products due, primarily, to the transition from analog to 
digital equipment.                                                              

Strong semiconductor demand requires semiconductor manufacturers to   
increase substantially their investment in plant and equipment. Today, a typical
fabrication plant costs in excess of $1 billion to construct, with more than    
two-thirds of the cost allocated to equipment. In a typical fabrication plant of
the 1980's, the cost of equipment represented approximately 50% of the total    
facility cost, but this percentage has risen as the complexity of the average   
device has increased. This complexity has been driven by the customers of       
semiconductor manufacturers who demand integrated circuits that perform more    
complex tasks, run faster, generate less heat and consume less power, while also
being both smaller and less expensive.                                          

Technology                                                                      

    In order to incorporate more complex functionality into a smaller package,
to improve performance (which is affected by the distance signals travel through
the circuitry) and to control power consumption and heat production,            
manufacturers are forced to use smaller and smaller device features. A decade   
ago, integrated circuits generally had feature sizes of three microns or more.  
Today's more complex integrated circuits may have line geometries and feature   
sizes of less than 0.5 microns, and devices which will require geometries of    
less than 0.25 microns are under development. To package these newer devices,   
assembly equipment must be able to handle smaller, more complex packages with   
higher pin counts or leads. As feature sizes shrink and device densities        
increase, huge demands are placed on the semiconductor equipment manufacturers. 

This move toward devices that are denser and more complex has allowed 
machine vision to emerge as a critical technology in the manufacture of         

56

424B1
62nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 62nd
semiconductors. Machine vision enables semiconductor manufacturers to achieve   
the precision necessary to produce these devices while increasing equipment     
speed and lowering error rates. Machine vision pervades the manufacturing       
process from wafer production through integrated circuit packaging, and is used 
to control steppers, probers, dicers, die bonders, wire bonders and packaging   
equipment.                                                                      

     The electronics assembly equipment market is growing. This growth is driven
primarily by the increased demand for consumer electronics, automotive and      
telecommunication products which require increasingly sophisticated electronic  
assembly techniques. Improvements in integrated circuit design and fabrication  
have increased the complexity of individual components and have facilitated     
significant changes in the methods of making interconnections between components
and circuit boards. For example, for surface mounted devices with leads, as the 
number of leads increases and the spacing between leads is reduced, the device  
becomes more fragile and placement becomes more difficult. Machine vision allows
electronics manufacturers to deal with these obstacles while increasing         
production speeds and quality. Electronics assembly equipment manufacturers are 
currently using machine vision in the following process steps: bare board       
inspection, solder paste screening, solder inspection, glue dispensing, device  
placement and post solder inspection.                                           

    Today, semiconductor and electronics manufacturers are seeking to increase
productivity by improving speed, accuracy and quality, while reducing plant,    
equipment and labor costs. In response to these pressures and the increasing    
complexity of manufactured products, manufacturers are beginning to merge       
discrete assembly steps, incorporate in-line inspection and embedded process    
control, generate statistical information for process control, overlap          
electrical and mechanical assembly, add flexibility required for shorter        
life-cycles, and provide more precision than can be afforded by mechanical      
components.                                                                     

   In response to these manufacturing requirements, machine vision suppliers
are required to deliver systems that provide faster application speeds, process 
larger images, deliver more accuracy and robustness and provide capabilities for
defect detection and analysis. Higher vision application speeds require faster  
vision algorithms or computers. Compounding the problem, however, is the ongoing
trend toward larger image sizes. Over the last decade, image sizes have grown   
from 128 x 128 pixels, through 256 x 256, to the current standard of 512 x 512  
pixels per image. Each doubling of the image size requires four times the       
computer speed to do the same job, because the number of pixels quadruples.     
Higher quality requires more accuracy and robustness. More accuracy and         
robustness can only come from improved software algorithms or processing more   
pixels within a given field of view. Recognizing errors, or defect detection and
analysis, is a very difficult problem in machine vision. Size differences, shape
differences, feature relationship differences, texture differences and missing  
or additional material in the image, may all be considered defects. Vision      
systems must employ sophisticated hardware and software approaches to meet these
challenges.                                                                     

AISI's solutions to the demands of the semiconductor and electronics  
industries are based on a proprietary hardware architecture and an intelligent  
software approach. AISI's proprietary hardware architecture utilizes massively  
parallel processing with many processing elements, greatly increasing processing
speeds. AISI manufactures linear, Single Instruction, Multiple Data (SIMD)      
massively parallel computers, which may provide a dedicated computer processing 
element for every column of pixels in an image. This architecture was designed  
to be the best trade-off between cost and performance for processing images.    
AISI's software approach is based upon high level cognitive functions, such as  
neural networks, mathematical morphology and fuzzy logic, which are designed to 
emulate human-like, feature-based processing. AISI's proprietary hardware       
architecture and intelligent software approach provide the AISI system with the 
flexibility to address the varying challenges confronted by machine vision      
suppliers.                                                                      

Higher vision application speeds are often realized if accuracy of    
alignment is increased or computers become faster. High alignment accuracy is   

57

424B1
63rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 63rd
achieved with AISI's proprietary pattern recognition software ("Vector          
Correlation") and its improved automated pattern teaching algorithm, insuring   
that the selected pattern is unique within the image. AISI believes that its    
Vector Correlation algorithm can be up to twice as accurate in production as    
typical template matching algorithms, with accuracies being largely maintained  
even as the quality of the subject images degrades. AISI utilizes a unique,     
massively parallel processor (MPP) architecture, because faster CPUs alone do   
not solve problems presented by large amounts of data generated by machine      
vision applications. The MPP's ability to simultaneously process a large number 
of data provides an inherent speed benefit over comparable serial processing    
systems.                                                                        

 Larger image sizes can be processed by AISI's MPP architecture which is
scalable and can be expanded as image sizes increase. Each time an image doubles
in size, AISI's array of processing elements can be doubled resulting in higher 
throughput than serial processing.                                              

    AISI's products provide accuracy and robustness through Vector Correlation
and supporting algorithms. Vector Correlation is independent of both lighting   
levels and shading, and it is more robust than other known algorithms as the    
object becomes occluded and the background becomes more complex. Algorithms may 
include fuzzy logic to extend robustness by allowing a defined amount of        
ambiguity to enter into the algorithm.                                          

  AISI's software and hardware are optimized for the detection of defects.
Defect detection is best done by mathematical morphology. Although mathematical 
morphology is too memory access intensive to be effective on a serial vision    
computer, AISI's unique MPP morphology is well suited to this task and is the   
result of a search for hardware that optimizes morphology. Defect analysis goes 
beyond defect detection and is the determination of the cause and impact of     
errors introduced in production. AISI provides defect analysis by using         
intelligent neural networks to analyze image features instead of pixels. This is
the way a human would examine an image. Features might be damaged but yet fully 
recognizable by a neural network or a human. Neural networks are powerful tools 
for analyzing defects, but they require powerful computer hardware, such as     
AISI's MPP.                                                                     

Strategy                                                                        

   AISI has worked closely with its customers in developing new capabilities
for machine image recognition. AISI's strategy has been to develop standard     
hardware and software products which are integrated by customers into their     
industrial environment. AISI's approach is to make available the entire software
development environment, enabling customers to design and refine applications of
their own. AISI's commitment to quality support and training has resulted in    
long-term relationships with several of the world's leading semiconductor and   
electronic devices manufacturers and equipment suppliers.                       

    AISI markets its products through direct sales, sales representatives, and
value added resellers in North America, Europe, and Asia. Significant customers 
include: Motorola, Intel, Universal Instruments, and Kulicke & Soffa in the     
United States; Siemens in Germany; Philips N.V. in Holland; Canon, Sanyo        
Silicon, Toshiba, Japan-EM and Ishikawajima-Harima Heavy Industries in Japan;   
Samsung and Haitai Electronics in Korea; and Motorola plants in Malaysia,       
Taiwan, Hong Kong and the Philippines.                                          

58

424B1
64th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 64th
AISI MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL RESULTS

 Results of Operations. The following table sets forth certain financial
data as a percentage of revenues for the periods indicated:                     

                                                        [Enlarge/Download Table]

                                                                                Nine Months Ended   
                                                                                  September 30,     
                                              Year Ended December 31,              (unaudited)      
                                        -----------------------------------    -------------------- 
                                         1994           1995           1996     1996           1997 
                                        -----          -----          -----    -----          ----- 
                                                                                                    
Sales ................................. 100.0%         100.0%         100.0%   100.0%         100.0%

Cost of vision system sales............  36.1           44.1           59.9     50.6           44.1 
                                        -----          -----          -----    -----          ----- 
Gross profit ..........................  63.9           55.9           40.1     49.4           55.9 
                                        -----          -----          -----    -----          ----- 
Operating expenses:                                                                                 
Selling, general and                                                                                
administrative expenses ...............  27.2           20.9           24.9     23.5           16.6 
Research, development and                                                                           
engineering expenses ..................  27.0           20.0           30.5     28.3           21.7 
                                        -----          -----          -----    -----          ----- 
Total operating expenses ..............  54.2           40.9           55.4     51.8           38.3 
                                        -----          -----          -----    -----          ----- 
Operating income (loss) ...............   9.7           15.0          (15.3)    (2.4)          17.6 
Interest Income .......................   0.1            0.1            0.7      0.6            0.4 
Interest Expense ......................  (0.5)          (0.3)          (0.1)    (0.1)          (0.1)
Other income (expense) ................   1.5           (0.2)          (4.1)     0.0            0.0 
                                        -----          -----          -----    -----          ----- 
Income (loss) before provision for                                                                  
 income taxes .........................  10.8           14.6          (18.8)    (1.9)          17.9 
Provision for income taxes ............   0.6            1.9            0.3      0.4            1.4 
                                        -----          -----          -----    -----          ----- 
Net income (loss) .....................  10.2%          12.7%         (19.1%)   (2.3%)         16.5%
                                        =====          =====          =====    =====          ===== 

Nine Months Ended September 30, 1997 Compared to Nine Months Ended September 30,
1996                                                                            

Sales                                                                 

   Sales increased 63.3% to $22.1 million in the nine months ended September
30, 1997 from $13.5 million in the nine months ended September 30, 1996. This   
increase was primarily attributable to a 64.5% increase in system sales volumes.
The increase in sales volumes was partially offset by lower average sales       
prices. International sales decreased to 10.6% of sales in the nine months ended
September 30, 1997 from 15.1% of sales in the nine months ended September 30,   
1996.                                                                           

The following table sets forth the components of AISI's sales:                  

                                                        [Enlarge/Download Table]

                                                                        Nine Months Ended  
                                                                          September 30,    
                                                                     ----------------------
                                                                        1996           1997
                                                                     -------        -------
                                                                          (unaudited)      
                                                                         (in thousands)    
                                                                                           
Sales:                                                                                     
     Vision system sales ........................................... $13,389        $22,023
     Development funding and software sales ........................     141             73
                                                                     -------        -------
          Total sales............................................... $13,530        $22,096
                                                                     =======        =======

    Vision system sales. The increase in vision system sales was due primarily
to an increase in unit shipments to existing customers offset by a decrease in  
the average selling price of each unit. Vision system sales to AISI's two       
largest customers during the first nine months of 1997 increased $8.8 million or
87.0% over the same period of the prior year.                                   

    Development funding and software sales. Revenues recorded from development
funding and software sales during the nine months ended September 30, 1997 and  
the nine months ended September 30, 1996 represent the revenues from several    
sales to existing customers.                                                    

59

424B1
65th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 65th
     Gross Profit. The following table sets forth AISI's vision system sales and
gross profit from vision system sales:                                          

                                                        [Enlarge/Download Table]

                                                                       Nine Months Ended   
                                                                         September 30,     
                                                                     ----------------------
                                                                        1996           1997
                                                                     -------        -------
                                                                          (unaudited)      
                                                                         (in thousands)    
                                                                                           
Vision system sales ................................................ $13,389        $22,023
Cost of vision system sales ........................................   6,842          9,733
                                                                     -------        -------
Vision system gross profit ......................................... $ 6,547        $12,290
Vision system gross profit as a percentage                                                 
 of vision system sales ............................................   48.9%          55.8%

     Vision system gross profit as a percentage of vision system sales increased
to 55.8% in the nine months ended September 30, 1997 from 48.9% in the nine     
months ended September 30, 1996. This improvement in gross profit margin is     
primarily attributable to product mix issues resulting from increased shipments 
of LANTERN products and decreased costs of components used in two main product  
lines. AISI expects to maintain the current level of gross margin.              

Research, Development and Engineering Expense                         

Research, development and engineering expenses increased 25.3% to $4.8
million or 21.7% of sales in the nine months ended September 30, 1997 from $3.8 
million or 28.3% of sales in the nine months ended September 30, 1996. This     
expense increase is attributable to an increase in engineering personnel and    
increased development cost related to new products.                             

Selling, General and Administrative Expense                           

Selling, general and administrative expenses increased 15.4% to $3.7  
million or 16.6% of revenues in the nine months ended September 30, 1997 from   
$3.2 million or 23.5% of sales in the nine months ended September 30, 1996. This
expense increase is attributable to the accrual of a management bonus in 1997,  
versus no bonus accrual in 1996.                                                

Income Taxes                                                          

     The effective tax rates are lower than statutory rates primarily due to the
utilization of prior years net operating losses.                                

Years Ended December 31, 1994, 1995  and 1996                                   

Sales                                                                 

AISI derives revenues principally from sales of vision systems. In    
addition, AISI has received non-recurring development funding revenues from     
strategic partners and customers in connection with product development         
projects. Sales increased $7.8 million or 52.5% from 1994 to 1995, and decreased
$6.0 million or 26.4% from 1995 to 1996. The decline from 1995 to 1996 was      
reflective of an industry-wide slowdown in capital equipment purchases for      
semiconductor and electronics manufacturing which began in early 1996. This     
slowdown began to turn around in early 1997, as evidenced by the 63.3% increase 
in sales for the nine months ended September 30, 1997 compared to the nine      
months ended September 30, 1996, as noted above. International sales as a       
percentage of total sales declined from 27.0% in 1994 to 12.9% in 1995, and rose
to 15.0% in 1996. The amount of sales recorded from international sources has   
historically been related to the level of development funding and software sales
recorded.                                                                       

60

424B1
66th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 66th
The following table sets forth the components of AISI's sales:        

                                                        [Enlarge/Download Table]

                                                                                  Year Ended December 31,              
                                                                     --------------------------------------------------
                                                                         1994                 1995                 1996
                                                                     --------             --------             --------
                                                                                      (in thousands)                   
                                                                                                                       
Sales:                                                                                                                 
   Vision system sales ............................................. $ 12,715             $ 22,046             $ 16,364
   Development funding and software sales ..........................    2,089                  533                  246
                                                                     --------             --------             --------
       Total sales ................................................. $ 14,804             $ 22,579             $ 16,610
                                                                     ========             ========             ========

   Vision system sales. AISI's significant increase in revenues from 1994 to
1995 was due primarily to an increase in unit shipments partially offset by a   
decrease in the average selling price of each unit. The decrease from 1995 to   
1996 resulted from the industry-wide slowdown as discussed above. Product sales 
to AISI's two largest customers rose $8.3 million from 1994 to 1995, and        
declined $4.6 million from 1995 to 1996.                                        

    Development funding and software sales. Revenues from development services
and software sales in 1994 principally represents revenues recorded from        
projects with two customers. In 1995 and 1996, revenues were derived from       
several projects. Development funding from 1994 to 1995 decreased significantly 
due to the completion of a major program in 1994. This program generated over $2
million in revenue in 1994. Product sales are AISI's primary source of revenue. 
Development funding is expected to continue to vary significantly from year to  
year.                                                                           

Gross Profit                                                          

  The following table sets forth AISI's system sales and gross profit from
system sales:                                                                   

                                                        [Enlarge/Download Table]

                                                                                 Year Ended December 31,               
                                                                    -------------------------------------------------- 
                                                                        1994                 1995                 1996 
                                                                    --------             --------             -------- 
                                                                                     (in thousands)                    
                                                                                                                       
Vision system sales ............................................... $ 12,715             $ 22,046             $ 16,364 
Cost of vision system sales........................................    5,337                9,959                9,943 
                                                                    --------             --------             -------- 
Vision system gross profit ........................................ $  7,378             $ 12,087             $  6,421 
Vision system gross profit as a percentage                                                                             
of vision system revenues  ........................................     58.0%                54.8%                39.2%

  AISI's vision system gross profit margin is affected by several factors,
including production volumes, mix between products, manufacturing yields, repair
activity, warranty costs and inventory valuation adjustments.                   

 The decline in vision system gross profit margins from 1994 to 1995 was
primarily attributable to increased costs on two proprietary components used on 
the 3000 family of products. These products accounted for 87.9% and 87.7% of    
system revenues in 1994 and 1995, respectively. In 1994, the Company also       
introduced the LANTERN product family, developed to replace the 3000 product    
family. This product transition had some impact upon system gross margin, as    
margins on the initial production versions of the LANTERN products which were   
shipped in 1994 and 1995 had lower margins than the 3000 products. Revenues     
derived from the LANTERN product family accounted for 11.6% and 12.3% of system 
revenues in 1994 and 1995, respectively. Vision system gross profit was also    
negatively impacted by increases to warranty and inventory reserves in          
anticipation of the complete crossover to LANTERN products.                     

 The decline in vision system gross profit margins from 1995 to 1996 was
primarily attributable to a $1.2 million inventory valuation allowance recorded 
for the 3000 product family of vision computers which was nearing the end of its
product life cycle. System gross profit in 1996 was also negatively impacted by 
a $200,000 increase to warranty reserves due to the failure of a purchased      
component part, and a less favorable product shipment mix.                      

61

424B1
67th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 67th
   The 3000 family of vision systems accounted for 87.9%, 87.7% and 44.8% of
system revenues in 1994, 1995 and 1996, respectively. The discontinuations of   
these products did not have an adverse impact on total revenue or operating     
income in these years since the discontinued products were replaced with the    
1994 introduction of the LANTERN family of vision computers discussed above. Nor
is the discontinuation of the 3000 product family expected to have any adverse  
impact upon future revenue or results from operations. Revenues derived from the
LANTERN product family accounted for 11.6%, 12.3% and 55.0% of system revenues  
in 1994, 1995 and 1996, respectively.                                           

Research, Development and Engineering Expense                         

  Research, development and engineering expenses increased $0.5 million or
12.9% from 1994 to 1995 and $0.5 million or 12.3% from 1995 to 1996. However,   
such costs decreased as a percentage of total revenues from 27.0% in 1994 to 20%
in 1995, and increased to 30.5% in 1996. The increase in research, development  
and engineering expense from 1994 to 1995, and from 1995 to 1996, was           
attributable to increased staffing and component parts purchases to support     
hardware engineering efforts directed at the LANTERN products and increased     
application engineering efforts to support existing customers. Additionally,    
increased usage of computer and test equipment resulted in an increase in       
depreciation expense and equipment rental expense.                              

Selling, General and Administrative Expense                           

Selling, general and administrative expenses were $4.1 million, $4.7  
million and $4.1 million representing 27.5%, 20.9% and 24.9% of total sales in  
1994, 1995 and 1996, respectively. The increase in selling, general and         
administrative expense from 1994 to 1995 was due to increased staffing and      
accelerated amortization of capitalized patent and trademark costs. During 1995 
the Company reviewed the carrying values of its patent intangibles. In view of  
rapid technological changes in the business, management concluded these assets  
were not recoverable and recorded a pre-tax expense of approximately $149,000 to
write them down. The decrease from 1995 to 1996 was due to the absence of patent
amortization in 1996 as the balance was fully amortized in 1995, and lower third
party commissions and lower increases to the allowance for doubtful accounts    
both as a result of the lower level of revenue in 1996.                         

Income Taxes                                                          

  The federal income tax provision recorded by AISI reflects the impact of
the Alternative Minimum Tax rules. The effective tax rates are lower than       
statutory rates primarily due to the utilization of prior years net operating   
losses.                                                                         

Liquidity and Capital Resources                                                 

   AISI has funded its operations to date through the private sale of equity
securities, lease financing, bank borrowings and cash generated from operations.
Working capital was $5.5 million as of September 30, 1997. Principal sources of 
liquidity at September 30, 1997 consisted of $4.2 million in cash and a lease   
line availability of $1.7 million. AISI had a $3 million revolving, unsecured   
line of credit under a loan agreement with a commercial bank, which expired on  
September 30, 1997. Renewal of the agreement has been approved by the bank but  
has not yet been executed by AISI. The renewed agreement would contain financial
covenants and restrictions relating to various matters. Net worth requirements  
in the loan agreement could restrict AISI's ability to pay dividends to its     
shareholders. AISI has not paid dividends at any time in the past and has no    
present intention to pay dividends at any time in the foreseeable future.       

   Net cash provided by operating activities was $0.4 million, $3.2 million,
and $1.4 million for 1994, 1995, and 1996, respectively, and $3.8 million for   
the nine months ended September 30, 1997. The increase in cash generated from   
operations from 1994 to 1995 was primarily due to higher net income, and the    
decrease in cash generated from operations                                      

62

424B1
68th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 68th
from 1995 to 1996 was due to the loss experienced in 1996. The increase in cash 
from 1996 to 1997 was primarily due to the operating cash flows generated by    
AISI.                                                                           

    Net cash used for investing activities was $1.4 million, $1.2 million, and
$1.4 million in 1994, 1995 and 1996, respectively, and $0.8 million for the nine
months ended September 30, 1997. In 1994 and 1995, cash used for investing      
activities consisted primarily of capital equipment purchases, primarily for    
computers and manufacturing equipment. In 1996, the cash used for investing     
activities consisted primarily of leasehold improvements and furniture and      
fixture purchases, due to the move to a new location.                           

    Cash provided by financing activities in 1994 was due to net borrowings of
$0.8 million under AISI's bank line of credit and $0.1 million received upon the
exercise of stock options. Net cash used for financing activities was $1.3      
million in 1995. In 1996 the $0.2 million used for financing activities was     
largely offset by the exercise of stock options, resulting in net cash used for 
financing activities of $2,700. Net cash provided by financing for the first    
nine months of 1997 is $0.4 million.                                            

Business Environment                                                            

  AISI's business success depends on the accurate identification of viable
markets, timely development of technologically superior products, cost effective
production processes and providing excellent products to a small number of      
customers.                                                                      

    The cost of product development requires AISI to make large investments in
relationship to its ability to recover from unforseen market shifts. A          
significant portion of AISI's future revenues will come from new products.      
However, a number of uncertainties exist, including AISI's product performance  
and uncertain market conditions. AISI will also continue to be challenged to    
balance product cost with continued downward pricing pressure. Accordingly, AISI
cannot determine the ultimate effect new products will have on sales or income  
from existing operations.                                                       

     AISI is introducing a new, single board VME vision system which is expected
to improve gross margins after successful integration by major customers. The   
extent of the impact on gross margins from volume shipments of products will    
depend heavily upon the product mix and timing of the completion of the         
engineering process.                                                            

   AISI has recently adopted an outsourcing strategy for the assembly of its
existing vision products. Currently, one contract manufacturer is meeting all of
AISI's manufacturing needs for its high volume products. The use of contract    
manufacturers is expected to improve quality, decrease manufacturing costs, and 
provide manufacturing flexibility. AISI expects that contract manufacturers will
provide most if not all of AISI's future manufacturing services. Additionally,  
as part of its strategy to improve inventory management AISI has entered into a 
distributor kitting relationship with its contract manufacturer. As a result of 
these transitions, AISI may experience product shipment delays and short term   
increases in manufacturing costs, both of which would negatively impact         
operating results.                                                              

Revenues have increased and AISI has been profitable in 1997; however,
there can be no assurance that AISI's revenues will grow in future periods, that
they will grow at historical rates or that AISI will remain profitable in future
periods. As a result, AISI believes historical results of its operations should 
not be relied upon as indications of future performance.                        

  AISI's revenues are currently dependent on sales to a few OEM customers:
86% of AISI's sales for the nine months ended September 30, 1997 were derived   
from two OEM customers. In 1994, 1995 and 1996 AISI's                           

63

424B1
69th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 69th
two largest customers in each year accounted for approximately 61.4%, 76.9% and 
76.5% of AISI's total sales, respectively. AISI has no long-term purchase       
commitments from any of its customers and expects a significant portion of its  
future sales to remain concentrated within a small number of customers. The loss
of any of these customers or any reductions in purchases from these customers   
would be significant. Operating results for 1996 compared to 1995 and 1997 are  
evidence of the impact of such changes. Because of this uncertainty, the Company
is unable to conclude that it is more likely than not that they will realize the
benefit of the net operating loss carryforwards and therefore, the Company has  
provided a full valuation allowance on its deferred tax assets related to its   
net operating loss carryforward. However, the Company believes it has adequate  
liquidity in place to sustain its operations in the short term.                 

     AISI's operating results fluctuate, therefore cash flows can be uneven. The
key to assuring adequate liquidity is positive earnings. A bank line of credit  
is used to balance short-term disparities between cash receipts and             
disbursements, and remains an integral part of AISI's capital resources. The    
cost to develop new products has a long-term benefit for AISI; nevertheless, it 
is a current operating expense. Balancing generation of income with the         
investment in research and development is critical to AISI's future success.    

 DESCRIPTION OF AISI CAPITAL STOCK

     As of September 1, 1997, there were 3,690,943 shares of AISI Common
Stock outstanding held by 273 holders of record. The issued and outstanding     
shares of AISI Common Stock are validly issued, fully paid and nonassessable.   
There is no established public trading market for AISI's Common Stock.          

The holders of outstanding shares of AISI Common Stock are entitled to
receive dividends out of assets legally available therefor at such times and in 
such amounts as the Board of Directors may from time to time determine, provided
that the the payment of any such dividends does not violate net worth           
requirements in AISI's loan agreement with National Bank of Detroit. The shares 
of AISI Common stock are neither redeemable nor convertible, and the holders    
thereof have no preemptive or subscription rights to purchase any securities of 
AISI. Upon liquidation, dissolution or winding up of AISI, the holders of AISI  
Common Stock are entitled to receive pro rata the assets of AISI which are      
legally available for distribution, after payment of all debts and other        
liabilities and subject to the prior rights of any holders of preferred stock   
then outstanding. Each outstanding share of AISI Common Stock is entitled to one
vote on all matters submitted to a vote of stockholders. There is no cumulative 
voting.                                                                         

 AISI VOTING SECURITIES AND PRINCIPAL SHAREHOLDERS

 AISI Common Stock is the only outstanding authorized voting security of
AISI. On September 1, 1997 there were 3,690,943 shares of AISI Common Stock     
outstanding, entitled to one vote per share. AISI Common Stock does not have    
cumulative voting rights.                                                       

The following table sets forth certain information with respect to the
beneficial ownership of AISI's Common Stock as of September 1, 1997 by (i) each 
person who is known by AISI to own beneficially more than 5% of the outstanding 
shares of AISI Common Stock, (ii) each director of AISI who owns AISI's Common  
Stock, (iii) each of the executive officers who own AISI's Common Stock, and    
(iv) all executive officers and directors of AISI as a group.                   

64

424B1
70th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 70th
                                                        [Enlarge/Download Table]

                                                                             Beneficial Ownership(1)(2)
Name and Address of Beneficial Owner                                         Shares             Percent
------------------------------------                                        -------             -------
                                                                                                       
Morgenthaler Venture Partners I (3)                                         445,967               12.1%
Morgenthaler Venture Partners II (3)                                        563,009               15.3%
     700 National City Bank Building                                                                   
     Cleveland, Ohio  44114                                                                            
State of Michigan                                                           626,435               17.0%
     Department of the Treasury                                                                        
     P.O. Box 15128                                                                                    
     Lansing, Michigan  48901                                                                          
Michigan Strategic Fund                                                     400,000               10.8%
     525 West Ottawa Street                                                                            
     Third Floor, Law Building                                                                         
     Lansing, Michigan  48933                                                                          
Robert D. Pavey (3)                                                               0                  0%
     700 National City Bank Building                                                                   
     Cleveland, Ohio  44114                                                                            
Herbert D. Doan                                                             509,630               13.8%
     P.O. Box 169                                                                                      
     Midland, Michigan  48640                                                                          
James E. Anderson (4)                                                       184,397                4.8%
Jon G. Ehrmann (5)                                                          113,364                3.0%
Hwei-Kai Hsi (6)                                                             96,500                2.6%
Yvette M. Puskarich (7)                                                      26,750                0.7%
Donald D. Redding (8)                                                        32,833                0.9%
Philip H. White (9)                                                          41,250                1.1%
Stephen S. Wilson (10)                                                      138,888                3.6%
W. Dale Compton                                                              15,000                0.4%
All executive officers and directors as a group (10 individuals)(11)      1,158,612               31.4%

(1)  Beneficial ownership is determined in accordance with the rules of the                            
     Securities and Exchange Commission. In computing the number of shares                             
     beneficially owned by each person and the percentage ownership of that                            
     person, shares of AISI Common Stock subject to options held by that person                        
     that are currently exercisable or exercisable within 60 days of September                         
     1, 1997 are deemed outstanding. Such shares, however, are not deemed                              
     outstanding for the purposes of computing the percentage ownership of each                        
     other person. Except as indicated in the footnotes to this table and                              
     pursuant to applicable community property laws, the persons named in the                          
     table have sole voting and investment power with respect to the shares set                        
     forth opposite such person's name.                                                                

(2)  Applicable percentage of ownership is based on 3,690,943 shares of AISI                           
     Common Stock outstanding on September 1, 1997.                                                    

(3)  Mr. Pavey, the Chairman of the Board of Directors of AISI, is a general                           
     partner of Morgenthaler Venture Partners I and Morgenthaler Venture                               
     Partners II. Voting and investment power with respect to the shares of AISI                       
     Common Stock owned by Morgenthaler Venture Partners and Morgenthaler                              
     Venture Partners II is shared by the general partners of the respective                           
     management partnerships of Morgenthaler Venture Partners I and Morgenthaler                       
     Venture Partners II.                                                                              

(4)  Includes 183,733 shares issuable upon exercise of options that are                                
     exercisable within 60 days of September 1, 1997.                                                  

(5)  Includes 76,833 shares issuable upon exercise of options that are                                 
     exercisable within 60 days of September 1, 1997.                                                  

(6)  Includes 64,500 shares issuable upon exercise of options that are                                 
     exercisable within 60 days of September 1, 1997.                                                  

                                       65                                                              

424B1
71st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 71st
(7)  Includes 26,750 issuable upon exercise of options that are exercisable                            
     within 60 days of September 1, 1997.                                                              

(8)  Includes 32,833 shares issuable upon exercise of options that are                                 
     exercisable within 60 days of September 1, 1997.                                                  

(9)  Includes 41,250 shares issuable upon exercise of options that are                                 
     exercisable within 60 days of September 1, 1997.                                                  

(10) Includes 120,733 shares issuable upon exercise of options that are                                
     exercisable within 60 days of September 1, 1997.                                                  

(11) Includes an aggregate of 546,632 shares issuable upon exercise of options                         
     held by officers and directors that are exercisable within 60 days of                             
     September 1, 1997.                                                                                

COMPARISON OF SHAREHOLDER RIGHTS

ESI and AISI are incorporated in Oregon and Michigan, respectively.   
Shareholders of AISI receiving ESI Common Stock in connection with the Merger,  
whose rights as shareholders are currently governed by the Michigan Business    
Corporation Act and other laws of the State of Michigan ("Michigan Law"), AISI's
Articles of Incorporation, as amended (the "AISI Articles") and AISI's Bylaws   
(the "AISI Bylaws") (the AISI Articles and the AISI Bylaws are referred to as   
the "AISI Charter Documents") will, upon the Effective Time of the Merger,      
automatically become shareholders of ESI, and their rights will be governed by  
the Oregon Business Corporation Act and other laws of the State of Oregon       
("Oregon Law"), ESI's Articles of Incorporation, as amended (the "ESI           
Articles"), and ESI's Bylaws (the "ESI Bylaws") (the ESI Articles and the ESI   
Bylaws are referred to as the "ESI Charter Documents").                         

     The following is a summary of material similarities and differences between
the rights of ESI shareholders under the ESI Articles, the ESI Bylaws and Oregon
Law on the one hand, and AISI shareholders under the AISI Articles, AISI Bylaws 
and Michigan Law on the other hand. The following discussion is not meant to be 
relied upon as an exhaustive list or detailed description of such differences   
and is not intended to constitute a detailed comparison or description of the   
provisions of the ESI Charter Documents, the AISI Charter Documents, Michigan   
Law or Oregon Law. The following discussion is qualified in its entirety by     
reference to the ESI Charter Documents, the AISI Charter Documents, Michigan Law
and Oregon Law, and holders of AISI Stock are referred to the complete texts of 
such documents and laws. Additional information concerning the ESI Common Stock 
also is provided in the documents incorporated by reference. See "Additional    
Information" and "Incorporation by Reference."                                  

Amendment of Certificate or Articles of Incorporation; Amendment of             
Bylaws                                                                          

Articles of Incorporation                                             

 Both Oregon Law and Michigan Law generally provide that in order for an
amendment to a corporation's articles of incorporation to be adopted, the       
proposed amendment must be submitted to a vote at a meeting of shareholders.    
Oregon Law requires that, prior to submission to the shareholders, the board of 
directors must adopt a resolution setting forth the proposed amendment and      
direct that it be submitted to the shareholders.                                

     Under Oregon Law, an amendment to the articles of incorporation is approved
if a quorum exists and the votes cast favoring the amendment exceed the votes   
cast opposing the action, unless the amendment would create dissenters' rights, 
in which case a majority of the votes entitled to be cast is required for       
approval. Supermajority voting requirements may be imposed and maintained by the
articles of                                                                     

66

424B1
72nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 72nd
incorporation, and may be imposed by the board of directors with respect to any 
proposed amendment. The ESI Articles contain no supermajority provisions with   
respect to amending the ESI Articles, except with respect to amending provisions
dealing with the following issues: (1) amendments to the ESI Bylaws, (2) the    
removal of a director without cause, and (3) approval of certain "Business      
Transactions" with "Related Persons." In each of these cases, an amendment to   
the ESI Articles would require a vote of two-thirds (2/3) of the shareholders   
entitled to vote with respect to that issue.                                    

   Under Michigan Law, in order for an amendment to a corporation's articles
of incorporation to be adopted, the amendment must be approved by a majority of 
the outstanding stock entitled to vote thereon and, if any class or series of   
shares is entitled to vote thereon as a class, a majority of the outstanding    
stock of each class or series entitled to vote thereon. Supermajority voting    
requirements may be imposed and maintained by the articles of incorporation. The
AISI Articles contain no supermajority voting provisions.                       

Bylaws                                                                

 Under Oregon Law, either the board of directors or the shareholders may
amend or repeal the corporation's bylaws unless the articles of incorporation   
reserve the power to amend the bylaws exclusively to the Shareholders in whole  
or in part, or the Shareholders, in amending or repealing a particular bylaw,   
provide expressly that the board of directors may not amend or repeal that      
bylaw. Under the ESI Articles, the ESI Board has the power to alter, amend or   
repeal the ESI Bylaws or to adopt new bylaws subject to repeal or change by the 
ESI shareholders, but the ESI Bylaws may not be adopted, altered, amended or    
repealed in any respect by the ESI shareholders unless such action is approved  
by the affirmative vote of the holders of not less than seventy-five percent    
(75%) of the outstanding shares of ESI Common Stock.                            

   Under Michigan Law, either the board of directors or the shareholders may
amend or repeal the corporation's bylaws, unless the articles of incorporation  
or the bylaws provide that the power to adopt new bylaws is reserved exclusively
to the shareholders or that the bylaws or any particular bylaw may not be       
altered or repealed by the board of directors. The AISI Articles do not address 
amendments to the AISI Bylaws. The AISI Bylaws, however, provide that they may  
be further added to, altered, amended or repealed by either (1) the vote of not 
less than a majority of the members of the Board then in office at any regular  
or special meeting, or (2) by the shareholders at any annual or special meeting 
if notice of the proposed addition, alteration, amendment or repeal is included 
in the notice of the meeting or waived in writing.                              

Special Meetings of Shareholders                                                

     Oregon Law provides that a special meeting of shareholders may be called by
the board of directors or the holders of 10% or more of the votes entitled to be
cast on any issue proposed to be considered at the special meeting, or by such  
persons as are specified in the articles of incorporation or bylaws. The ESI    
Bylaws grant authority to the president to call a special meeting of the ESI    
shareholders.                                                                   

    Michigan Law provides that a special meeting of shareholders may be called
by the board of directors, or by officers, directors or shareholders as provided
in the corporation's bylaws. In addition, the holders of 10% or more of the     
votes entitled to be cast on any issue may, for good cause shown, apply to a    
court for an order calling a special meeting of the shareholders. The AISI      
Bylaws grant authority to the president and the chairman of the board to call a 
special meeting of the AISI Shareholders, and also allow the holders of shares  
representing at least 20% of any class of stock to call a special meeting of the
AISI Shareholders without applying for a court order as described above.        

67

424B1
73rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 73rd
Dividends                                                                       

Under both Oregon Law and Michigan Law, the board of directors of a   
corporation may authorize and the corporation may make distributions (including 
dividends) to shareholders only if after giving effect to the distribution (i)  
the corporation would be able to pay its debts as they become due in the usual  
course of business and (ii) the corporation's total assets would at least equal 
the sum of the total liabilities plus, unless the corporation's articles of     
incorporation permit otherwise, the amount that would be needed if the          
corporation were to be dissolved at the time of the distribution to satisfy the 
preferential rights upon dissolution of shareholders whose preferential rights  
are superior to those receiving the distribution.                               

Capital Stock                                                                   

Unlike ESI, which has two authorized classes of stock (common and     
preferred), there is only one class of AISI stock, that being common stock, no  
par value. The voting rights of holders of AISI Common Stock are comparable to  
those of holders of ESI Common Stock discussed above. The voting rights of ESI  
Preferred Stock are designated by the ESI Board. As provided in the ESI         
Articles, for the one series of ESI Preferred Stock for which the ESI Board has 
designated rights, there are no voting rights except as required by law.        

    In certain limited circumstances, if AISI were to issue additional shares,
the AISI Articles provide that current AISI shareholders are entitled to receive
additional shares as protection against their ownership in AISI being diluted.  
There is no similar provision in the ESI Articles.                              

Dissenters' Rights                                                              

Under Michigan Law, shareholders that otherwise would be entitled to  
exercise dissenters' rights with respect to an articles amendment, a merger,    
disposition of assets, or other extraordinary transaction do not have any       
dissenters' rights if (a) the stock affected is either listed on a national     
securities exchange or designated as a national market system security on an    
interdealer quotation system by the National Association of Securities Dealers  
or (b) such shareholders receive cash or shares (or any combination thereof) and
such shares, if any, are either listed on a national securities exchange or     
designated as a national market system security on an interdealer quotation     
system by the National Association of Securities Dealers.                       

     Under Oregon Law, shareholders that otherwise would be entitled to exercise
dissenters' rights do not have such rights if the stock affected is listed on a 
national securities exchange or is a national market system security, but the   
type of consideration to be received for such stock does not affect the         
availability of dissenters' rights as it does under Michigan Law.               

     AISI's Common Stock is neither listed on a national securities exchange nor
as a national market system security. ESI's Common Stock is listed as a national
market system security. Except as follows, the matters with respect to which    
shareholders of a Michigan corporation such as AISI and shareholders of an      
Oregon corporation such as ESI may have dissenters' rights are generally        
comparable:                                                                     

(i) Michigan Law contains a specific provision that affords 
     dissenters' rights to shareholders of an acquiring corporation concerning a
   merger with or an acquisition of shares or assets of another entity where
the consideration for the merger or acquisition is to be shares of the
  acquiring corporation's common stock (or convertibles) and the merger or
acquisition would have a specified substantial dilutive effect.       

68

424B1
74th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 74th
     (ii) Dissenters' rights are available under Michigan Law, but not
   under Oregon Law, for an amendment to the articles of incorporation which
either (A) materially abolishes or alters a preferential right of a   
shareholder's shares having preferences, or (B) creates, alters or    
   abolishes a material provision or right in respect of the redemption of a
  shareholder's shares or a sinking fund for the redemption or purchase of
those shares.                                                         

          (iii) Dissenters' rights are available under Oregon Law, but not under
Michigan Law, for amendments to the articles of incorporation which   
materially and adversely affect the rights of a shareholder's shares  
    because the amendment either (A) alters or abolishes a preemptive right of
   the shareholder to acquire shares or other securities, or (B) reduces the
   number of shares owned by the shareholder to a fraction of a share if the
    fractional share so created is to be acquired for cash by the corporation.

The procedural provisions of Michigan Law and Oregon Law relating to  
dissenters' rights do not differ significantly.                                 

Provisions Relating to Directors                                                

Number of Directors                                                   

    Under both Oregon Law and Michigan Law, a corporation must have a board of
directors consisting of at least one director. The ESI Bylaws provide that the  
ESI Board must consist of at least six and no more than ten directors. Within   
that range, the ESI Board has the authority to set the actual number, the       
current number being set at seven. The AISI Bylaws provide that the AISI Board  
must consist of at least three and no more than seven directors. Within that    
range, the AISI Board has the authority to set the actual number, the current   
number being set at five.                                                       

Cumulative Voting for Directors                                       

Both Oregon Law and Michigan Law allow for cumulative voting in the   
election of directors, but only if the articles of incorporation of the         
corporation so provide. Under cumulative voting, each share of stock normally   
having one vote is entitled to a number of votes equal to the number of         
directors to be elected. A shareholder may then cast all such votes for a single
candidate or may allocate the votes among as many candidates as the Shareholder 
may desire. Without cumulative voting, the holders of a majority of the shares  
voting in the election of directors would have the power to elect all the       
directors to be elected, and no person could be elected without the support of  
holders of a majority of the shares. Neither the ESI Articles nor the AISI      
Articles provides for cumulative voting.                                        

Voting for Directors by Proxy                                         

    Under both Oregon Law and Michigan Law, every shareholder entitled to vote
at an election of directors has the right to vote either in person or by proxy. 

Vacancies                                                             

Both Oregon Law and Michigan Law provide that, unless the articles of 
incorporation provide otherwise, a vacancy in the board of directors (including 
a vacancy created by an increase in the authorized number of directors) may be  
filled by the shareholders or by the directors then in office (even though fewer
than necessary to form a quorum of the board of directors). The AISI Bylaws     
provide that the directors remaining in office may temporarily fill any vacancy 
on the AISI Board, but the shareholders have the authority to elect a director  
to fill any vacancy temporarily filled by the AISI Board, failing which the     
director appointed by the AISI Board serves until his successor is elected at an

69

424B1
75th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 75th
annual or special shareholders' meeting and is qualified. The ESI Articles do   
not contain a similar provision.                                                

Removal                                                               

   Under both Oregon Law and Michigan Law, a director may be removed with or
without cause unless the articles of incorporation provide that directors may be
removed only for cause. Under Oregon Law, a director may be removed only at a   
meeting of the shareholders called for the purpose of removing the director, and
the meeting notice must state that the purpose, or one of the purposes, of the  
meeting is the removal of a director. Under the ESI Articles, a director may be 
removed without cause only upon the vote of the holders of two-thirds (2/3) of  
the shares entitled to vote at an election of directors. The AISI Articles      
contain no provision respecting the removal of directors.                       

Limitation on Liability                                               

   As permitted by Michigan Law, the AISI Articles provide that, to the full
extent permitted by law, AISI's directors will not be liable to AISI or its     
shareholders for monetary damages for breach of fiduciary duty. Under Michigan  
Law, such provision cannot eliminate or limit director liability for a breach of
the duty of loyalty, acts or omissions not in good faith or which involve       
intentional misconduct or knowing violation of law, distributions made in       
contravention of Michigan Law, transactions from which directors receive an     
improper personal benefit or any act or omission which occurred prior to the    
date on which the provision became effective (April 28, 1992). This provision   
would ordinarily eliminate the liability of directors for monetary damages to   
AISI and its shareholders even in instances in which the directors had been     
negligent or grossly negligent. The provision does not affect the ability of    
AISI or its shareholders to seek equitable remedies such as injunction and does 
not limit the liability of directors under federal securities laws. The ESI     
Articles contain a provision which is in all material respects identical to the 
provision in AISI's articles of incorporation, and Oregon Law is likewise       
similar to Michigan Law in this respect.                                        

Anti-Takeover Statutes                                                          

Business Combinations                                                 

   Michigan. Michigan Law contains provisions ("Chapter 7A") which
provide that business combinations between a Michigan corporation and an        
"interested shareholder" generally require the approval of 90% of the votes of  
each class of stock entitled to be cast, and not less than two-thirds of the    
votes of each class of stock entitled to be cast other than voting shares owned 
by such interested shareholder. An "interested shareholder" is a person directly
or indirectly owning 10% or more of a corporation's outstanding voting power, or
an affiliate of a corporation who at any time within two years prior to the date
in question directly or indirectly owned 10% of more of such voting power.      
However, the requirements cited above will not apply if (i) the corporation's   
board of directors approves the transaction prior to the time the interested    
shareholder becomes such or (ii) the transaction satisfies certain fairness     
standards (generally relating to the amount and type of consideration to be     
paid), certain other conditions are met and the interested shareholder has been 
such for at least five years. Additionally, Chapter 7A does not apply to a      
corporation which, on the date Chapter 7A became effective (May 29, 1984), had  
an existing interested shareholder, unless the articles or by-laws of such      
corporation specifically make Chapter 7A applicable or the corporation's board  
of directors elects by resolution to make the corporation subject thereto       
(either generally or as to specific interested shareholders or business         
combinations). On May 28, 1984, AISI had one or more "interested shareholders," 
and therefore AISI is not subject to Chapter 7A, although AISI's Board may, by  
resolution and without a shareholder                                            

70

424B1
76th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 76th
vote, cause AISI to become subject to Chapter 7A. AISI has no present intention 
to elect to become subject to Chapter 7A.                                       

     Oregon. Oregon has enacted a business combination statute that is
contained in ss.ss. 60.825 - 60.845 of the Oregon Business Corporation Act (the 
"Oregon Combination Law"), which provides that any person who acquires 15% or   
more of a corporation's voting stock (thereby becoming an "interested           
shareholder") may not engage in certain "business combinations" with the target 
corporation for a period of three years following the date the person became an 
interested shareholder, unless (1) the board of directors of the corporation has
approved, prior to that acquisition date, either the business combination or the
transaction that resulted in the person becoming an interested shareholder, (2) 
upon consummation of the transaction that resulted in the person becoming an    
interested shareholder, that person owns at least 85% of the corporation's      
voting stock outstanding at the time the transaction is commenced (excluding    
shares owned by persons who are both directors and officers and shares owned by 
employee stock plans in which participants do not have the right to determine   
confidentially whether shares will be tendered in a tender or exchange offer),  
or (3) the business combination is approved by the board of directors and       
authorized by the affirmative vote (at an annual or special meeting and not by  
written consent) of at least 662/3% of the outstanding voting stock not owned by
the interested shareholder.                                                     

 Under the Oregon Combination Law, for purposes of determining whether a
person is the "owner" of 15% or more of a corporation's voting stock, ownership 
is defined broadly to include the right, directly or indirectly, to acquire the 
stock or to control the voting or disposition of the stock. A "business         
combination" is also defined broadly to include (1) mergers and sales or other  
dispositions of 10% or more of the assets of a corporation with or to an        
interested shareholder, (2) certain transactions resulting in the issuance or   
transfer to the interested shareholder of any stock of the corporation or its   
subsidiaries, (3) certain transactions which would result in increasing the     
proportionate share of the stock of a corporation or its subsidiaries owned by  
the interested shareholder, and (4) receipt by the interested shareholder of the
benefit (except proportionately as a Shareholder) of any loans, advances,       
guarantees, pledges, or other financial benefits.                               

These restrictions placed on interested shareholders by the Oregon    
Combination Law do not apply under certain circumstances, including, but not    
limited to, the following: (1) if the corporation's original articles of        
incorporation contain a provision expressly electing not to be governed by the  
Oregon Combination Law, (2) within 90 days after April 4, 1991, the corporation,
by action of its board of directors, adopts an amendment to its bylaws expressly
electing not to be governed by the Oregon Combination Law, or (3) if the        
corporation, by action of its shareholders, adopts an amendment to its bylaws or
articles of incorporation expressly electing not to be governed by the Oregon   
Combination Law, provided that such an amendment is approved by the affirmative 
vote of not less than a majority of the outstanding shares entitled to vote and 
that such an amendment will not be effective until 12 months after its adoption 
and will not apply to any business combination with a person who became an      
interested shareholder at or prior to such adoption. None of these circumstances
exist with respect to ESI; accordingly, the requirements of the Oregon          
Combination Law apply to ESI.                                                   

Control Shares                                                        

    Michigan. Michigan Law contains provisions ("Chapter 7B"), which
provide that "control shares" of a corporation acquired in a control share      
acquisition have no voting rights except as granted by the shareholders of the  
corporation. "Control shares" are shares which, when added to shares then owned 
or controlled by a shareholder, increase such shareholder's control of voting   
power above one of three                                                        

71

424B1
77th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 77th
thresholds: more than 20%, more than 33-1/3% or more than 50% of the outstanding
voting power of the corporation. Voting rights for shares acquired in a control 
share acquisition must be approved by a majority of the votes cast by holders of
shares entitled to vote, excluding shares voted or controlled by the acquiror   
and certain officers and directors. However, no such approval is required for   
gifts or other transactions not involving consideration, for a merger to which  
the corporation is a party, or certain other transactions described in Chapter  
7B. Submission for shareholder consideration of a resolution to grant voting    
rights to control shares must be preceded by the filing with the corporation of 
an acquiring person statement providing certain specified information.          

     If a corporation's articles of incorporation or by-laws so provide prior to
a control share acquisition, control shares acquired in a control share         
acquisition may be redeemed at "fair value" by the corporation (i) if no        
acquiring person statement has been filed, at any time during the period ending 
60 days after the last control share acquisition, or (ii) if an acquiring person
statement has been filed, after the meeting at which the voting rights of the   
control shares are submitted for shareholder consideration, if the control      
shares are not accorded full voting rights. Unless otherwise provided in a      
corporation's articles of incorporation or by-laws, in the event that control   
shares acquired in a control share acquisition are accorded full voting rights  
and the acquiring person has acquired a majority of all voting power of the     
corporation, the shareholders of the corporation, other than the acquiring      
person, have dissenters' rights. "Fair value" means a value not less than the   
highest price paid per share by the acquiring person in the control share       
acquisition.                                                                    

    The AISI charter documents currently contain no provisions with respect to
control shares.                                                                 

     Oregon. Oregon has enacted a control share statute that is in all
material respects identical to the Chapter 7B of Michigan Law.                  

   The ESI charter documents currently contain no provisions with respect to
control shares.                                                                 

 LEGAL MATTERS

 The legality of the shares of ESI Common Stock to be issued to the AISI
shareholders in connection with the Merger, and certain other legal matters in  
connection with the Merger, will be passed upon by Stoel Rives LLP, 900 SW Fifth
Avenue, Suite 2300, Portland, OR 97204-1268. Certain tax matters in connection  
with the Merger will be passed upon by Brouse & McDowell, A Legal Professional  
Association, 500 First National Tower, Akron, Ohio 44308-1471.                  

 EXPERTS

The audited consolidated financial statements of ESI included in this 
Prospectus/Information Statement and elsewhere in the Registration Statement    
have been audited by Arthur Andersen LLP, independent public accountants, as    
indicated in their report with respect thereto, and are included herein in      
reliance upon the authority of said firm as experts in giving said report.      

The audited financial statements of AISI included in this             
Prospectus/Information Statement and elsewhere in the Registration Statement    
have been audited by Arthur Andersen LLP, independent public accountants, as    
indicated in their report with respect thereto, and are included herein in      
reliance upon the authority of said firm as experts in giving said report.      

72

424B1
78th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 78th
 SHAREHOLDER PROPOSALS

     If the Merger is consummated, shareholders of AISI will become shareholders
of ESI. ESI's 1998 annual meeting of shareholders will take place in September  
1998. Any shareholder proposals to be considered for inclusion in proxy material
for ESI's annual meeting in September 1998 must have been received at the       
principal executive office of ESI no later than April 13, 1998.                 

73

424B1
79th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 79th
 INDEX TO FINANCIAL STATEMENTS

                                                                            Page

APPLIED INTELLIGENT SYSTEMS, INC.                                               

    Report of Independent Public Accountants.................................F-2

Balance Sheets as of December 31, 1995 and 1996 and                     
    September 30, 1997 (unaudited) ..........................................F-3

Statements of Operations for the years ended December 31, 1994,         
1995 and 1996 and for the nine months ended September 30, 1996          
    (unaudited) and 1997 (unaudited).........................................F-4

Statements of Stockholders' Equity for the years ended                  
December 31, 1994, 1995 and 1996 and for the nine months                
    ended September 30, 1997 (unaudited).....................................F-5

Statements of Cash Flows for the years ended December 31, 1994,         
1995 and 1996 and for the nine months ended September 30, 1996          
    (unaudited) and 1997 (unaudited).........................................F-6

    Notes to Financial Statements............................................F-7

ELECTRO SCIENTIFIC INDUSTRIES, INC.                                             

    Report of Independent Public Accountants................................F-17

Consolidated Balance Sheets as of May 31, 1996 and 1997                 
    and for the three months ended August 31, 1997..........................F-18

Consolidated Statements of Income for the years ended                   
May 31, 1995, 1996 and 1997 and for the three months                    
    ended August 31, 1996 and 1997..........................................F-19

Consolidated Statements of Shareholder's Equity for the                 
years ended May 31, 1995, 1996 and 1997 and for the                     
    three months ended August 31, 1997......................................F-20

Consolidated Statements of Cash Flows for the years                     
ended May 31, 1995, 1996 and 1997 and for the three months              
    ended August 31, 1997...................................................F-21

    Notes to Consolidated Financial Statements..............................F-23

 F-1

424B1
80th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 80th
 APPLIED INTELLIGENT SYSTEMS, INC.

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Shareholders of                                   
Applied Intelligent Systems, Inc.:                                              

We have audited the accompanying balance sheets of Applied Intelligent Systems, 
Inc. (a Michigan Corporation) as of December 31, 1996 and 1995, and the related 
statements of operations, stockholders' equity and cash flows for each of the   
three years in the period ended December 31, 1996. These financial statements   
are the responsibility of the Company's management. Our responsibility is to    
express an opinion on these financial statements based on our audits.           

We conducted our audits in accordance with generally accepted auditing          
standards. Those standards require that we plan and perform the audit to obtain 
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting 
the amounts and disclosures in the financial statements. An audit also includes 
assessing the accounting principles used and significant estimates made by      
management, as well as evaluating the overall financial statement presentation. 
We believe that our audits provide a reasonable basis for our opinion.          

In our opinion, the financial statements referred to above present fairly, in   
all material respects, the financial position of Applied Intelligent Systems,   
Inc. as of December 31, 1996 and 1995 and the results of its operations and its 
cash flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.                       

                 ARTHUR ANDERSEN LLP

Ann Arbor, Michigan,                                                            
September 26, 1997                                                              

 F-2

424B1
81st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 81st
                                                        [Enlarge/Download Table]

                        APPLIED INTELLIGENT SYSTEMS, INC.                                                      

                                 BALANCE SHEETS                                                                
                                 (in thousands)                                                                

                                                                            December 31,          September 30,
                                                                        1995               1996       1997     
                                                                    --------           --------   ------------ 
                                                                                                   (unaudited) 
                              ASSETS                                                                           
                                                                                                               
Current Assets                                                                                                 
  Cash and equivalents                                              $    805           $    771     $  4,222   
  Trade receivables, less allowance for doubtful                                                               
  accounts of $155 and $147 at December 31, 1995                                                               
  and 1996 and $162 at September 30, 1997                              4,378              1,569        3,193   
  Inventories                                                          4,020              1,879        2,228   
  Other current assets                                                    85                138          564   
                                                                    --------           --------     --------   
     Total current assets                                              9,288              4,357       10,207   
                                                                     -------           --------     --------   
Property and equipment, at cost                                        4,637              4,791        5,484   
Less - Accumulated depreciation and amortization                      (2,365)            (2,173)      (2,877)  
                                                                    -------            -------      --------   
Property and Equipment - Net                                           2,272              2,618        2,607   
                                                                     -------           --------     --------   
Other Assets                                                             115                  5           75   
                                                                    --------           --------     --------   
                                                                    $ 11,675           $  6,980     $ 12,889   
                                                                    ========           ========     ========   
LIABILITIES AND STOCKHOLDERS' EQUITY                                                                           
Current Liabilities                                                                                            
  Current portion of obligations under capital leases                                                          
  and notes payable                                                 $    171           $     73     $    157   
  Accounts payable                                                     2,594                846          872   
  Accrued compensation                                                   310                308          917   
  Deferred revenue                                                       668                 97          872   
  Income taxes payable                                                   279                223          428   
  Accrued warranty                                                       330                610          644   
  Other accrued expenses                                                 411                628          835   
                                                                    --------           --------     --------   
     Total current liabilities                                         4,763              2,785        4,725   
                                                                    --------           --------     --------   
Long Term Capital Lease Obligations and Notes Payable                                                          
                                                                         118                 39          158   
                                                                    --------           --------     --------   
Stockholders' Equity                                                                                           
  Common stock, no par value, stated value of $.01 per share,                                                  
  10,000,000 shares authorized, 3,578,578 and 3,454,044 shares                                                 
  issued and outstanding in 1996 and 1995, respectively                   35                 36           37   
  Additional paid-in capital                                          23,469             23,643       23,850   
  Accumulated deficit                                                (16,351)           (19,523)     (15,881)  
  Note receivable and related accrued interest                          (359)                --           --   
                                                                    --------           --------     --------   
     Total stockholders' equity                                        6,794              4,156        8,006   
                                                                    --------           --------     --------   
                                                                    $ 11,675           $  6,980     $ 12,889   
                                                                    ========           ========     ========   

              The accompanying notes are an integral part of these                                             
                             financial statements.                                                             

 F-3

424B1
82nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 82nd
                                                        [Enlarge/Download Table]

                        APPLIED INTELLIGENT SYSTEMS, INC.                                                            

                            STATEMENTS OF OPERATIONS                                                                 
                      (in thousands, except per share data)                                                          

                                                                For the years ended            Nine months           
                                                                    December 31,           ended September 30,       
                                                           1994          1995          1996        1996        1997  
                                                        -------       -------       -------     -------      ------- 
                                                                                                                     
Sales                                                                                                (unaudited)     
     System sales                                       $12,715       $22,046       $16,364     $13,389      $22,023 
     Software and other sales                             2,089           533           246         141           73 
                                                        -------       -------       -------     -------      ------- 
     Total sales                                         14,804        22,579        16,610      13,530       22,096 
Cost of system sales                                      5,337         9,959         9,943       6,842        9,749 
                                                        -------       -------       -------     -------      ------- 
Gross margin                                              9,467        12,620         6,667       6,688       12,347 
Operating expenses:                                                                                                  
     Selling, general and administrative                  4,027         4,711         4,138       3,174        3,664 
     Research, development and engineering                3,996         4,513         5,067       3,833        4,803 
                                                        -------       -------       -------     -------      ------- 
     Total operating expenses                             8,023         9,224         9,205       7,007        8,467 
                                                        -------       -------       -------     -------      ------- 
Operating Income (loss)                                   1,444         3,396        (2,538)       (319)       3,880 
Interest income                                              --            21           110          86           94 
Interest expense                                            (68)          (66)          (12)         (9)         (18)
Gain from insurance proceeds on equipment                                                                            
theft                                                       229            --            --          --           -- 
Other, net                                                   (2)          (50)         (167)        (11)           1 
Provision for reserve against note receivable                --            --          (410)         --           -- 
Provision for impairment of cost investment                  --            --          (103)         --           -- 
                                                        -------       -------       -------     -------      ------- 
Income (loss) before provision for income                                                                            
taxes                                                     1,603         3,301        (3,120)       (253)       3,957 
Provision for income taxes                                   93           437            52          53          315 
                                                        -------       -------       -------     -------      ------- 
Net income (loss)                                       $ 1,510       $ 2,864       $(3,172)    $  (306)     $ 3,642 
                                                        =======       =======       =======     =======      ======= 
Net income (loss) per share                             $   .40       $   .70       $ (0.90)    $ (0.09)     $  0.92 
                                                        =======       =======       =======     =======      ======= 
Weighted average number of shares used in                                                                            
     computing per share amounts                          3,820         4,121         3,515       3,493        3,976 
                                                        =======       =======       =======     =======      ======= 

              The accompanying notes are an integral part of these                                                   
                             financial statements.                                                                   

 F-4

424B1
83rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 83rd
                                                        [Enlarge/Download Table]

                        APPLIED INTELLIGENT SYSTEMS, INC.                                                               

                       STATEMENTS OF STOCKHOLDERS' EQUITY                                                               
        For the years ended December 31, 1994, 1995 and 1996 and the nine                                               
                 months ended September 30, 1997 (in thousands)                                                         

                                       Common Stock                                                Note           Total 
                                 ----------------------            Additional  Accumulated   Receivable,  Stockholders' 
                                   Shares        Amount       Paid-in Capital      Deficit          Net          Equity 
                                 --------      --------       ---------------  -----------   ----------   ------------- 
                                                                                                                        
BALANCE AT                                                                                                              
DECEMBER 31, 1993                   3,335      $     33             $  23,275     ($20,725)    $     --        $  2,583 
Exercise of stock options              70             1                   116           --           --             117 
Net Income                             --            --                    --        1,510           --           1,510 
                                 --------      --------             ---------     --------     --------        -------- 
BALANCE AT                                                                                                              
DECEMBER 31, 1994                   3,405            34                23,391      (19,215)          --           4,210 
Exercise of stock options              64             1                    72           --           --              73 
Grant of common stock                   1            --                     6           --           --               6 
Abandonment of                                                                                                          
common stock                          (16)           --                    --           --           --              -- 
Note receivable and                                                                                                     
related accrued interest               --            --                    --           --         (359)           (359)
Net income                             --            --                    --        2,864           --           2,864 
                                 --------      --------             ---------     --------     --------        -------- 
BALANCE AT                                                                                                              
DECEMBER 31, 1995                   3,454            35                23,469      (16,351)        (359)          6,794 
Exercise of stock options             124             1                   173           --           --             174 
Grant of common stock                  --            --                     1           --           --               1 
Interest earned                        --            --                    --           --          (21)            (21)
Additional amount                                                                                                       
loaned                                 --            --                    --           --          (30)            (30)
Reserve against note                                                                                                    
receivable                             --            --                    --           --          410             410 
Net loss                               --            --                    --       (3,172)          --          (3,172)
                                 --------      --------             ---------     --------     --------        -------- 
BALANCE AT                                                                                                              
DECEMBER 31, 1996                   3,578            36                23,643      (19,523)          --           4,156 
Exercise of stock options             116             1                   207           --           --             208 
Interest earned on note                                                                                                 
receivable                             --            --                    --           --           16              16 
Reserve against interest                                                                                                
earned on note                                                                                                          
receivable                             --            --                    --           --          (16)            (16)
Net Income                             --            --                    --        3,642           --           3,642 
                                 --------      --------             ---------     --------     --------        -------- 
BALANCE AT                                                                                                              
JUNE 30, 1997                                                                                                           
(unaudited)                         3,694      $     37             $  23,850    ($15,881)     $      0        $  8,006 
                                 ========      ========             =========     ========     ========        ======== 

              The accompanying notes are an integral part of these                                                      
                             financial statements.                                                                      

 F-5

424B1
84th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 84th
                                                        [Enlarge/Download Table]

                        APPLIED INTELLIGENT SYSTEMS, INC.                                                             

                            STATEMENTS OF CASH FLOWS                                                                  
                                 (in thousands)                                                                       

                                                                    For the years ended             Nine months       
                                                                        December 31,             ended September 30,  
                                                             --------------------------------   --------------------- 
                                                               1994         1995         1996       1996         1997 
                                                           --------     --------     --------   --------     -------- 
                                                                                                   (unaudited)        
                                                                                                                      
CASH FLOWS FROM OPERATING ACTIVITIES                                                                                  
   Net income (loss)                                       $  1,510     $  2,864     $ (3,172)  $   (306)    $  3,642 
   Adjustments to reconcile net income (loss) to net                                                                  
   cash provided by operating activities:                                                                             
      Depreciation and amortization                             434          984          861        603          707 
      Loss on disposal of property and equipment                 23           42          167          5            4 
      Provision for impairment of cost investment                --           --          103         --           -- 
      Provision for reserve against note receivable              --           --          410         --           16 
      Gain from insurance proceeds on equipment theft          (229)          --           --         --           -- 
      Compensation expense on stock grants                       --            6            1          1           -- 
      Changes in operating assets and liabilities:                                                                    
         Accounts receivable                                 (1,117)        (804)       2,809      3,019       (1,624)
         Inventories                                           (929)      (2,071)       2,141        915         (349)
         Prepaid expenses and other assets                      (56)          (9)         (46)      (179)        (426)
         Accounts and taxes payable, accrued expenses                                                                 
        and deferred revenue                                    777        2,217       (1,880)    (2,314)       1,856 
                                                           --------     --------     --------   --------     -------- 
            Net cash provided by operating activities           413        3,229        1,394      1,744        3,826 
                                                           --------     --------     --------   --------     -------- 
CASH FLOWS FROM INVESTING ACTIVITIES                                                                                  
   Expenditures for property and equipment                   (1,164)      (1,385)      (1,380)      (862)        (700)
   Proceeds from sale of property and equipment                  11           11            6          6           -- 
   Insurance proceeds from equipment theft                      301           --           --         --           -- 
   Proceeds from loan repayment                                  --          484           --         --           -- 
   Other investment                                              --           --           --         --          (70)
   Increase in note receivable and accrued                                                                            
   interest                                                    (500)        (309)         (51)       (46)         (16)
                                                           --------     --------     --------   --------     -------- 
         Net cash used in investing activities               (1,352)      (1,199)      (1,425)      (902)        (786)
                                                           --------     --------     --------   --------     -------- 
CASH FLOWS FROM FINANCING ACTIVITIES                                                                                  
   Net borrowings (repayments) under line of credit             825       (1,600)        (100)      (100)          -- 
   Proceeds from financing of equipment                          --          221           --         --          309 
   Repayments of capital lease obligations                       --          (33)         (77)       (59)        (106)
   Proceeds from exercise of stock options and notes                                                                  
   payable                                                      117           74          174        171          208 
                                                           --------     --------     --------   --------     -------- 
   Net cash provided by (used in) financing activities          942       (1,338)          (3)        12          411 
                                                           --------     --------     --------   --------     -------- 
NET INCREASE (DECREASE) IN CASH AND                                                                                   
EQUIVALENTS                                                       3          692          (34)       854        3,451 
CASH AND EQUIVALENTS AT BEGINNING OF                                                                                  
PERIOD                                                          110          113          805        805          771 
                                                           --------     --------     --------   --------     -------- 
CASH AND EQUIVALENTS AT END OF                                                                                        
PERIOD                                                     $    113     $    805     $    771   $  1,659     $  4,222 
                                                           ========     ========     ========   ========     ======== 
   Cash paid for interest                                  $     58     $     76     $     12   $     10     $     18 
   Cash paid for income taxes                              $     59     $    170     $    166   $    166     $    185 

              The accompanying notes are an integral part of these                                                    
                             financial statements.                                                                    

 F-6

424B1
85th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 85th
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS

1.   The Company                                                                

Applied Intelligent Systems, Inc. (the Company) provides industrial machine     
vision solutions for automated process control and visual inspection throughout 
a wide range of manufacturing processes. The Company provides solutions for the 
enhancement, analysis and understanding of digital imagery, replacing human     
vision on the factory floor.                                                    

2.   Significant Accounting Policies                                            

The accompanying financial statements reflect the application of certain        
accounting policies described in this and other notes to financial statements.  

Cash Equivalents                                                                

The Company considers all highly liquid financial instruments purchased with    
maturities of less than three months to be cash equivalents.                    

Inventories                                                                     

Inventories are stated at the lower of cost (determined using the first-in,     
first-out method) or market.                                                    

Other Current Assets                                                            

Other current assets at September 30, 1997 included a receivable of $235,265    
(unaudited) resulting from a cost reimbursement from a customer and a $135,934  
(unaudited) receivable resulting from the sale of a portion of the Company's    
inventory to the Company's contract manufacturer.                               

Property and Equipment                                                          

Additions to property and equipment are recorded at cost. Depreciation is       
provided using the straight-line method over the respective estimated useful    
lives of the related assets, which range from three to seven years. Amortization
of leasehold improvements is provided over the term of the related lease or the 
estimated useful life of the improvement, whichever is shorter. Maintenance and 
repairs are expensed as incurred.                                               

Investment                                                                      

In 1992, the Company acquired an ownership interest in a Korean company for     
$102,633. This investment has been accounted for using the cost method. During  
1996, the Company established a valuation allowance against the entire          
investment balance.                                                             

Revenue Recognition                                                             

Revenue from system sales is recognized at the point of shipment. Revenue from  
software and engineering development is recognized as the Company performs the  
services in accordance with the contract terms.                                 

 F-7

424B1
86th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 86th
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

2.   Significant Accounting Policies (continued)                                

During 1993, the Company entered into a product development and sales agreement 
with a Korean customer. Under the terms of the agreement, the Company provided  
certain product development services and sold certain systems to the customer.  
During 1994 the Company recognized revenue of $2,100,000 pursuant to this       
agreement.                                                                      

The Company enters into certain agreements with customers, from time to time,   
which may include multiple phases and can include multiple products and/or      
services. Cash may be received or billings may be made prior to the completion  
of these projects, requiring the Company to defer some portion of revenue in    
accordance with the provisions of Statement of Position 91-1.                   

Net Income (Loss) Per Share                                                     

Net income (loss) per share is based on the weighted average number of shares   
outstanding during the period after considering the dilutive effect of          
outstanding stock options.                                                      

Software Development Costs                                                      

Software development costs incurred prior to the establishment of technological 
feasibility are expensed as incurred. Software development costs incurred       
subsequent to the establishment of technological feasibility are capitalized, if
material. To date, no significant software development costs have been incurred 
subsequent to the establishment of technological feasibility.                   

Income Taxes                                                                    

The Company accounts for income taxes under Statement of Financial Accounting   
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires  
an asset and liability approach that recognizes deferred tax assets and         
liabilities for the expected future tax consequences of events that have been   
recognized in the Company's financial statements or tax returns. In estimating  
future tax consequences, SFAS 109 generally considers all expected future events
other than enactments of changes in the tax law or tax rates.                   

Concentration of Credit Risk                                                    

Financial instruments, which potentially subject the Company to concentration of
credit risk, consist principally of trade receivables. A majority of the        
Company's trade receivables are derived from sales in various geographic areas  
to companies within the semiconductor and electronics manufacturing industries. 
The Company performs ongoing credit evaluations of its customers' financial     
condition but generally does not require collateral. Management believes the    
carrying value of trade receivables approximates fair value.                    

Fair Value of Financial Instruments                                             

The carrying values of all financial instruments in the accompanying financial  
statements approximate fair value.                                              

 F-8

424B1
87th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 87th
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

Management Estimates                                                            

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

Reclassifications                                                               

Certain amounts in the 1994 and 1995 financial statements have been reclassified
to conform with the 1996 presentation.                                          

Newly Released Accounting Pronouncements                                        

The Financial Accounting Standards Board has recently issued the following      
pronouncements: Statement of Financial Accounting Standards (SFAS) No. 128,     
Earnings per Share, SFAS No. 129, Disclosure of Information about Capital       
Structure, SFAS No. 130, Reporting Comprehensive Income and SFAS No. 131,       
Reporting Disaggrated Information about a Business Enterprise. SFAS No. 128 and 
129 are effective for periods ending after December 15, 1997. SFAS No. 130 and  
131 are effective for periods beginning after December 15, 1997. SFAS No. 128   
will have an impact on future earnings per share calculations as it modifies the
underlying variables in the calculation. The impact will depend on the status of
potentially dilutive securities in the future. SFAS No. 129, 130 and 131 are not
expected to have a significant impact on the Company's future financial         
statements.                                                                     

3.   Inventories                                                                

Inventories consist of the following:                                           

                                                                [Download Table]

                          December 31,          September 30,
                       1995               1996          1997 
                 ----------         ----------  ------------ 
                                                  (unaudited)
                                                             
Raw materials    $1,162,338         $1,018,110    $1,835,049 
Work-in-process   2,800,781            669,162       215,548 
Finished goods       56,942            191,616       177,028 
                 ----------         ----------    ---------- 
                 $4,020,061         $1,878,888    $2,227,625 
                 ==========         ==========    ========== 

Work-in-process and finished goods inventories include materials and the direct 
costs of assembly.                                                              

During 1996 the Company recorded a charge against inventory of approximately    
$1.2 million related to the discontinuation of two product lines which has been 
included in costs of system sales in the accompanying statement of operations   
for the year ended December 31, 1996.                                           

 F-9

424B1
88th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 88th
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

4.   Property and Equipment                                                     

Property and equipment consists of the following:                               

                                                                [Download Table]

                                         December 31,           September 30,
                                       1995               1996          1997 
                                -----------        -----------  ------------ 
                                                                  (unaudited)
                                                                             
Computers and test equipment    $ 3,437,575        $ 3,152,078   $ 3,688,422 
Furniture and fixtures              460,757            690,172       690,269 
Leasehold Improvements              339,548            528,314       663,803 
Equipment under capital leases      221,257            211,829       211,829 
Office equipment                    177,887            209,016       229,215 
                                -----------        -----------   ----------- 
                                  4,637,024          4,791,409     5,483,538 
Accumulated depreciation and                                                 
amortization                      2,364,621          2,172,830     2,876,272 
                                -----------        -----------   ----------- 
Property and equipment - net    $ 2,272,403        $ 2,618,579   $ 2,607,266 
                                ===========        ===========   =========== 

5.   Stock-Based Compensation Plans                                             

Incentive Stock Option Plans                                                    

The 1995 Incentive Stock Option Plan (the 1995 Plan), the 1992 Incentive Stock  
Option Plan (the 1992 Plan) and the 1991 Incentive Stock Option Plan (the 1991  
Plan) were approved by the Company's stockholders, as successor plans to the    
Company's 1989 Incentive Stock Option Plan (the 1989 Plan). All options         
available under the 1992 Plan, 1991 Plan and 1989 Plan have been granted. These 
plans cover substantially all employees. Options to purchase the Company's      
common stock are exercisable at a price equal to the fair market value of the   
stock at the date of grant, as determined by the Company's board of directors,  
and become exercisable over a period of one to five years following the date of 
grant. All options expire ten years after the date of grant. There are 650,000  
shares reserved for issuance under the 1995 Plan, of which options on 579,050   
shares have been granted.                                                       

The Company accounts for these plans under APB Opinion No. 25, under which no   
compensation expense has been recognized. Had compensation expense for these    
plans been determined consistent with FASB Statement No. 123 (SFAS 123),        
Accounting for Stock-Based Compensation, the Company's net income (loss) and    
earnings (loss) per share would have been as follows:                           

                                                                [Download Table]

                                                                       September 30,
                                                  1995          1996           1997 
                                           -----------  ------------   ------------ 
                                                                        (unaudited) 
                                                                                    
Net income (loss):            As Reported  $ 2,864,018  $ (3,172,366)   $ 3,642,397 
                              Pro Forma      2,473,822    (3,411,994)     3,525,185 
Net income (loss) per share:  As Reported      $.70         $(.90)          $.92    
                              Pro Forma         .60          (.82)           .89    

F-10

424B1
89th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 89th
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

SFAS 123 requirements are not applicable to options granted prior to January 1, 
1995. The above pro forma results may not be representative of that to be       
expected in future years. The fair value of stock options has been determined   
using the minimum value method. In applying this method, the Company assumed no 
future dividends, an expected life of each option of 7.5 years and a risk-free  
rate of return that is based on United States Treasury notes. Forfeitures are   
recognized as they occur. The weighted average risk-free interest rate used by  
the Company was approximately 6.5% and 6.0% for the years ended December 31,    
1996 and 1995, respectively.                                                    

Information concerning incentive stock options for the years ended December 31, 
1994, 1995 and 1996 and for the nine months ended September 30, 1997 is as      
follows:                                                                        

                                                                [Download Table]

                                                Number of            Price Per
                                                   Shares                Share
                                                ---------            ---------
                                                                              
Outstanding at December 31, 1993                  985,480             $ 1 - 4 
Exercisable at December 31, 1993                  684,960             $ 1 - 4 
1994 Activity:                                                                
  Options granted                                  96,500             $ 4 - 6 
  Options terminated                              (26,410)            $ 1 - 4 
  Options exercised                               (62,610)            $ 1 - 4 
                                                ---------                     
Outstanding at December 31, 1994                  992,960             $ 1 - 6 
                                                =========                     
Exercisable at December 31, 1994                  728,067             $ 1 - 4 

F-11

424B1
90th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 90th
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

5.   Stock-Based Compensation Plans (continued)                                 

                                                                [Download Table]

                                                              Weighted
                                                      Price    Average
                                        Number of       Per   Exercise
                                           Shares     Share      Price
                                        ---------   -------  ---------
                                                                      
1995 Activity:                                                        
      Options granted                     271,200   $ 6 - 8  $    7.54
      Options terminated                  (24,201)  $ 1 - 6       1.75
      Options exercised                   (61,424)  $ 1 - 4       1.69
                                        ---------                     
Outstanding at December 31, 1995        1,178,535   $ 1 - 8           
                                        =========                     
Exercisable at December 31, 1995          908,213   $ 1 - 8           

Weighted average fair value of options                                
granted                                 $    2.66                     

1996 Activity:                                                        
      Options granted                     338,550   $ 4 - 8  $    4.22
      Options terminated                 (402,625)  $ 1 - 8       6.39
      Options exercised                  (114,234)  $ 1 - 8       2.46
                                        ---------                     
Outstanding at December 31, 1996        1,000,226   $ 1 - 4           
                                        =========                     
Exercisable at December 31, 1996          806,462   $ 1 - 4           
Weighted average fair value of options                                
granted                                    $ 3.69                     
1997 Activity (unaudited):                                            
      Options granted                      37,300   $ 4      $    4.00
      Options terminated                  (34,953)  $ 2 - 4  $    3.89
      Options exercised                  (116,038)  $ 1 - 4       1.79
                                        ---------                     
Outstanding at September 30, 1997         886,535                     
                                        =========                     
Exercisable at September 30, 1997         726,811                     
Weighted average fair value of options                                
granted                                 $    1.45                     

Related to the options outstanding at December 31, 1996, the following table    
provides additional information:                                                

                                                                [Download Table]

                                            Weighted Average Remaining
                         Weighted Average  Contractual Life of Options
Range  Number of Shares   Exercise Price           Outstanding        
-----  ----------------  ----------------  ---------------------------
                                                                      
$   1       312,490            $    1                 2.0 years       
    2       298,286                 2                 4.0 years       
    4       389,450                 4                 8.7 years       
         ---------                                                    
         1,000,226                                                    
         =========                                                    

F-12

424B1
91st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 91st
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

During 1994, 1995 and 1996 and for the nine months ended September 30, 1997,    
69,860 shares, 64,424 shares, 114,234 shares and 116,038 shares (unaudited),    
respectively, were issued due to the exercise of stock options, the net proceeds
of which were $116,515, $73,566, $173,933 and $207,466 (unaudited),             
respectively.                                                                   

Non-Qualified Stock Option Plans                                                

The Company has granted options to certain directors of the Company to purchase 
shares of common stock at prices ranging from $1 to $4 per share, pursuant to   
previously established Non-Qualified Stock Option Plans. Options to purchase the
Company's common stock are exercisable at a price equal to the fair market value
of the stock at the date of grant, as determined by the Company's board of      
directors, and become exercisable over a period of one to five years following  
the date of grant. All options expire ten years after the date of grant. Options
to purchase 15,000 shares of common stock were outstanding as of December 31,   
1996. During 1996, 1995 and 1994, 10,000 options were exercised at $2 per share,
3,000 options were exercised at $1 per share, and 7,250 options were exercised  
at a range of $1 to $4 per share, respectively. No non-qualified stock options  
were exercised during the nine months ended September 30, 1997.                 

6.   Income Taxes                                                               

The components of the provision for income taxes in the accompanying statements 
of operations consist of the following:                                         

                                                        [Enlarge/Download Table]

                                                                         Nine months ended       
                             For the years ended December 31,               September 30,        
                            1994             1995             1996         1996             1997 
                      ----------       ----------       ----------   ----------       ---------- 
                                                                              (unaudited)        
                                                                                                 
Current tax expense:                                                                             
    Federal           $   93,200       $   97,800       $       --   $       --       $  121,000 
    State                     --          338,700           52,500       52,500          194,000 
Deferred tax expense     488,300          961,900       (1,079,000)    (809,000)       1,277,300 
Change in valuation                                                                              
allowance               (488,300)        (961,900)       1,079,000      809,000       (1,277,300)
                      ----------       ----------       ----------   ----------       ---------- 
Total provision       $   93,200       $  436,500       $   52,500   $   52,500       $  315,000 
                      ==========       ==========       ==========   ==========       ========== 

In 1994, 1995 and 1996, the Company's effective tax rates differ from the       
Federal statutory tax rate of 34% primarily due to the change in the deferred   
tax valuation allowance net of state tax expense.                               

Deferred income taxes and benefits are provided for significant income and      
expense items recognized in different years for tax and financial reporting     
purposes. Temporary differences which give rise to deferred taxes are as        
follows:                                                                        

F-13

424B1
92nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 92nd
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

                                                                [Download Table]

                                             December 31,           September 30,
                                          1995               1996           1997 
                                    ----------         ----------   ------------ 
                                                                      (unaudited)
                                                                                 
Deferred tax assets                                                              
   Net operating loss carryforward  $4,482,000         $4,829,300     $2,953,000 
   Inventory and accounts                                                        
   receivable reserves                 338,000            726,300        668,500 
   Business credit carryforward        463,200            470,000        470,000 
   Accrued expenses                    533,600            519,000      1,059,600 
   Property and equipment               44,600            197,100        302,800 
   Alternative minimum tax credit                                                
   carryforward                        135,400            157,000        162,200 
   Note receivable reserve                  --            139,400        144,700 
   Other deferred tax assets                --             37,700         37,700 
                                    ----------         ----------     ---------- 
                                     5,996,800          7,075,800      5,798,500 
Valuation allowance                 (5,996,800)        (7,075,800)    (5,798,500)
                                    ----------         ----------     ---------- 
Net deferred taxes                  $       --         $       --     $       -- 
                                    ==========         ==========     ========== 

The Company has assessed its past earnings history and trends, sales backlog,   
budgeted sales, and the expiration dates of the carryforwards and is unable to  
conclude that it is more likely than not that they will realize the benefit of  
the net operating loss carryforwards. Valuation allowances of $5,996,800,       
$7,075,800 and $5,798,500 (unaudited) have been recorded to reserve the related 
deferred tax assets at December 31, 1995 and 1996 and September 30, 1997,       
respectively.                                                                   

The Company has available net operating loss carryforwards to reduce future     
taxable income and general business credit carryforwards to offset future taxes 
payable. As of September 30, 1997 net operating loss carryforwards of           
$14,146,800 exist which expire over the period from 1999 through 2011. The      
general business and alternative minimum tax credit carryforwards approximate   
$632,200. The general business credits expire over the period from 1997 through 
2002.                                                                           

7.   Significant Customers and Export Sales                                     

Significant Customers                                                           

The following summarizes significant customers from which the Company earned 10%
or more of its annual revenues:                                                 

F-14

424B1
93rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 93rd
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

                                                        [Enlarge/Download Table]

                                        Number of                          Percentage
                                      Significant  Significant  Revenues     of Total
                                        Customers     Customer    (000's)    Revenues
                                      -----------  -----------  --------   ----------
                                                                                     
Nine months ended September 30, 1997       2            A        $14,694       66%   
(unaudited)                                             B          4,322       20    
Year ended December 31, 1996               2            A        $ 8,584       52%   
                                                        B          4,127       25    
Year ended December 31, 1995               2            A        $12,439       55%   
                                                        B          4,917       22    
Year ended December 31, 1994               3            A        $ 6,061       41%   
                                                        B          3,029       21    
                                                        C          2,100       14    

Export Sales                                                                    

Export sales, primarily to Asia and Europe, in 1994, 1995, 1996 and the nine    
months ended September 30, 1997, were approximately $4,002,000, $2,908,000,     
$2,485,000 and $2,353,000 (unaudited), respectively.                            

8.   Line of Credit                                                             

The Company had a $3,000,000 revolving unsecured bank line of credit agreement  
which expired on September 30, 1997. Interest was charged at the bank's prime   
rate. Renewal of the agreement has been approved by the bank, but has not yet   
been executed by AISI.                                                          

The maximum amounts outstanding during 1994, 1995 and 1996 under the Company's  
line of credit agreement were $1,700,000, $2,075,000 and $100,000, respectively.
The average amounts outstanding and the weighted average interest rates for     
1994, 1995 and 1996 were approximately $917,000, $744,000 and $8,000, and 7.6%, 
9.1% and 8.5%, respectively. No amounts were borrowed during 1997.              

The line of credit agreement contained a minimum tangible net worth requirement 
and provided for certain other non-financial conditions. In addition, the       
Company was required to maintain working capital of not less than $750,000, and 
a ratio of total liabilities to tangible net worth not to exceed 1.5 to 1.0.    

9.   Leases and Notes Payable                                                   

The Company has entered into noncancelable operating and capital lease          
agreements for its office, engineering and manufacturing facilities and certain 
equipment. The facility leases require that the Company pay for insurance,      
taxes, maintenance and repairs. Rent expense under the operating leases was     
approximately $512,000, $619,000, $690,000 and $517,000 (unaudited) in 1994,    
1995, 1996, and the nine months ended September 30, 1997, respectively. Minimum 
future rental commitments under noncancelable operating and capital leases at   
December 31, 1996 are as follows:                                               

F-15

424B1
94th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 94th
 APPLIED INTELLIGENT SYSTEMS, INC.

 NOTES TO FINANCIAL STATEMENTS (Continued)

                                                                [Download Table]

                                      Capital Lease   Operating
                                        Obligations      Leases
                                      -------------   ---------
                                                               
   1997                                 $  78,914    $  590,720
   1998                                    39,874       473,288
   1999                                        --       465,900
   2000                                        --       429,547
   2001                                        --       435,696
   Thereafter                                  --     2,372,748
                                        ---------    ----------
Total minimum payments                    118,788    $4,767,899
                                        =========    ==========
Less amounts representing interest          6,725              
                                        ---------              
Total present value of minimum lease                           
   payments at December 31, 1996          112,063              
Less current portion                       73,196              
                                        ---------              
Long-term portion                       $  38,867              
                                        =========              

Subsequent to December 31, 1996, the Company entered into an installment note   
payable to a bank to finance the purchase of certain equipment. Interest on the 
note is at the bank's prime rate plus 1/2%. The outstanding balance of the note 
is approximately $258,000 (unaudited) as of September 30, 1997.                 

10.  Related Party Transactions                                                 

During 1994 the Company loaned $500,000 to an officer of the Company under the  
terms of a demand note. During January 1995, the officer repaid to the Company  
all of the accrued interest and $460,920 of the principal on this note. During  
August 1995, the Company loaned $308,792 to an officer of the Company under the 
terms of a demand note which bears interest at the Company's effective borrowing
rate. During August 1996, the Company loaned $30,000 to an officer of the       
Company under the terms of a demand note which bears interest at the Company's  
effective borrowing rate. The outstanding notes are secured by the officer's    
options to purchase the Company's common stock. Beginning in 1996, the Company  
established valuation allowances against the entire note and interest receivable
balances.                                                                       

11.  Employee Benefit Plan                                                      

The Company has a 401(k) plan covering all eligible employees. Participants may 
elect to defer a certain percentage of qualified compensation through voluntary 
contributions to the plan and the Company may make discretionary contributions  
to the plan based on the gross compensation of qualified participants. The      
Company made no contributions to the plan in 1994, 1995 or 1996.                

12.  Contingencies                                                              

The Company is party to litigation and legal proceedings arising in the ordinary
course of business. In the opinion of the Company's management, these matters   
will not have a material adverse effect on the financial condition and the      
results of operations of the Company.                                           

F-16

424B1
95th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 95th
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Shareholders of                                   
Electro Scientific Industries, Inc.:                                            

 We have audited the accompanying consolidated balance sheets of Electro
Scientific Industries, Inc. (an Oregon corporation) and subsidiaries as of May  
31, 1997 and 1996, and the related consolidated statements of income,           
shareholders' equity and cash flows for each of the three years in the period   
ended May 31, 1997. These financial statements are the responsibility of the    
Company's management. Our responsibility is to express an opinion on these      
financial statements based on our audits.                                       

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain 
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting 
the amounts and disclosures in the financial statements. An audit also includes 
assessing the accounting principles used and significant estimates made by      
management, as well as evaluating the overall financial statement presentation. 
We believe that our audits provide a reasonable basis for our opinion.          

 In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Electro     
Scientific Industries, Inc. and subsidiaries as of May 31, 1997 and 1996, and   
the results of their operations and their cash flows for each of the three years
in the period ended May 31, 1997 in conformity with generally accepted          
accounting principles.                                                          

                 ARTHUR ANDERSEN LLP

Portland, Oregon                                                                
August 15, 1997                                                                 

F-17

424B1
96th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 96th
                                                        [Enlarge/Download Table]

              ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES                                                      

                           CONSOLIDATED BALANCE SHEETS                                                                  
                                     ASSETS                                                                             

                                                                                          May 31,                       
                                                                                 -----------------------      August 31,
                                                                                      1996          1997           1997 
                                                                                 ---------     ---------      --------- 
                                                                                            (in thousands)              
CURRENT ASSETS:                                                                                             (unaudited) 
                                                                                                                        
Cash and cash equivalents....................................................... $  19,600     $  17,801      $  14,242 
Securities available for sale...................................................    18,363        27,860         30,332 
                                                                                 ---------     ---------      --------- 
Total cash and securities.......................................................    37,963        45,661         44,574 
Trade receivables, less allowance for doubtful accounts of $314 and                                                     
$230 at May 31, 1996 and 1997 and $412 at August 31, 1997.......................    40,411        50,869         49,910 
Inventories                                                                                                             
Finished goods..................................................................     2,979         4,322          5,655 
Work-in-process.................................................................     6,188         6,757         10,229 
Raw materials and purchased parts...............................................    21,906        21,772         23,064 
                                                                                 ---------     ---------      --------- 
Total inventories...............................................................    31,073        32,851         38,948 
Deferred income taxes...........................................................     2,747         2,366          2,366 
Other current assets............................................................       819           580          1,530 
                                                                                 ---------     ---------      --------- 
Total current assets............................................................   113,013       132,327        137,328 

PROPERTY AND EQUIPMENT, AT COST.................................................    39,086        40,963         43,467 
Less-Accumulated depreciation...................................................  (22,265)      (24,559)       (25,347) 
                                                                                 ---------     ---------      --------- 
    Net property and equipment..................................................    16,821        16,404         18,120 

DEFERRED INCOME TAXES...........................................................     1,137         1,042          4,042 

OTHER ASSETS....................................................................     4,487         5,040          9,807 
                                                                                 ---------     ---------      --------- 
                                                                                 $ 135,458     $ 154,813      $ 169,297 
                                                                                 =========     =========      ========= 
                      LIABILITIES AND SHAREHOLDERS' EQUITY                                                              

CURRENT LIABILITIES:                                                                                                    
  Accounts payable.............................................................. $   5,170     $   6,494        $ 7,516 
  Accrued liabilities -                                                                                                 
      Payroll related...........................................................     3,792         4,126          4,338 
      Commissions...............................................................     1,961         2,189          2,326 
   Income taxes.................................................................     2,930           811          3,163 
   Other........................................................................     4,484         2,001          2,424 
                                                                                 ---------     ---------      --------- 
      Total accrued liabilities.................................................    13,167         9,127         12,251 
  Deferred revenue..............................................................       276            78             -- 
                                                                                 ---------     ---------      --------- 
      Total current liabilities.................................................    18,613        15,699         19,767 

SHAREHOLDERS' EQUITY                                                                                                    
Preferred stock, without par value; 1,000 shares authorized; no shares issued...        --            --             -- 
Common stock, without par value; 40,000 shares authorized; 9,355, 9,468 and                                             
9,922 shares issued and outstanding at May 31, 1996 and 1997 and August 31,                                             
1997, respectively..............................................................    55,940        57,736         72,093 
Retained earnings...............................................................    60,905        81,378         77,437 
                                                                                 ---------     ---------      --------- 

  Total shareholders' equity                                                       116,845       139,114        149,530 
                                                                                 ---------     ---------      --------- 

                                                                                 $ 135,458     $ 154,813      $ 169,297 
                                                                                 =========     =========      ========= 

                 The accompanying notes are an integral part of                                                         
                               these statements.                                                                        

F-18

424B1
97th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 97th
                                                        [Enlarge/Download Table]

              ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES                                                              

                        CONSOLIDATED STATEMENTS OF INCOME                                                                       

                                                                                                          Three months ended    
                                                                        Year ended May 31,                    August 31,        
                                                              -------------------------------------     ----------------------- 
                                                                   1995          1996          1997          1996          1997 
                                                              ---------     ---------     ---------     ---------     --------- 
                                                                                                              (unaudited)       
                                                                            (in thousands, except per share data)               
                                                                                                                                
Net sales                                                     $ 112,900     $ 166,310     $ 160,149     $  36,199     $  48,356 

Cost of sales                                                    53,238        75,167        73,097        15,509        21,291 
                                                              ---------     ---------     ---------     ---------     --------- 

  Gross margin                                                   59,662        91,143        87,052        20,690       27,065  

 Operating expenses:                                                                                                            

  Selling, service and administrative                            29,094        41,564        38,974         9,242        12,249 

  Research, development and engineering                          13,483        16,743        17,038         4,326         5,034 

   Acquired in-process research and development                      --         6,000            --            --        11,124 
                                                              ---------     ---------     ---------     ---------     --------- 

  Total operating expenses                                       42,577        64,307        56,012        13,568        28,407 

Operating income (loss)                                          17,085        26,836        31,040         7,122        (1,342)

Interest income                                                     565         1,210         1,523           392           453 

Other income (expense), net                                       (167)         (719)          (75)          (276)           57 
                                                              ---------     ---------     ---------     ---------     --------- 

Income (loss) before income taxes                                17,483        27,327        32,488         7,238          (832)

Provision for income taxes                                        5,266        10,028        11,238         2,635         3,029 
                                                              ---------     ---------     ---------     ---------     --------- 

Net income (loss)                                             $  12,217     $  17,299     $  21,250     $   4,603     $  (3,861)
                                                              =========     =========     =========     =========     ========= 

Net income (loss) per share                                  $     1.49    $     1.86    $     2.27      $   0.49       $ (0.39)

Weighted average number of shares used in                         8,210         9,306         9,373         9,355          9,842
computing per share amounts                                                                                                     

                 The accompanying notes are an integral part of                                                                 
                               these statements.                                                                                

F-19

424B1
98th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 98th
                                                        [Enlarge/Download Table]

              ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES                                                    

                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY                                                      

                 For the years ended May 31, 1995, 1996 and 1997                                                      
                     and three months ended August 31, 1997                                                           

                                                                         Common Stock                                 
                                                                    -----------------------                           
                                                                       Number                    Retained             
                                                                    of Shares        Amount      Earnings       Total 
                                                                    ---------     ---------     ---------   --------- 
                                                                                  (in thousands)                      
                                                                                                                      
BALANCE AT MAY 31, 1994, as previously reported                         6,420     $  22,097     $  31,450   $  53,547 

   Adjustments for Chip Star, Inc. Pooling-of-Interests                   700           150          (138)         12 
                                                                          ---           ---                           

BALANCE AT MAY 31, 1994, adjusted                                       7,120        22,247        31,312      53,559 
   Net income                                                              --            --        12,217      12,217 
   Non-employee directors stock incentive plan                             --            19            --          19 
   Stock plans:                                                                                                       
       Employee stock plans                                               241         2,104            --       2,104 
       Tax benefit of stock options exercised                              --         1,068            --       1,068 
   Shares issued for acquisition of Chicago Laser                         333         1,939            --       1,939 
   Shares issued in stock offering                                      1,380        22,535            --      22,535 
   Unrealized gain on securities                                           --            --            60          60 
   Cumulative translation adjustment                                       --            --         1,655       1,655 
                                                                    ---------     ---------     ---------   --------- 

BALANCE AT MAY 31, 1995                                                 9,074        49,912        45,244      95,156 
   Net income                                                              --            --        17,299      17,299 
   Stock plans:                                                                                                       
       Employee stock plans                                                85           706            --         706 
       Tax benefit of stock options exercised                              --           540            --         540 
   Shares issued for acquisitions                                         196         4,782            --       4,782 
   Unrealized loss on securities                                           --            --           (42)        (42)
   Cumulative translation adjustment                                       --            --        (1,596)     (1,596)
                                                                    ---------     ---------     ---------   --------- 

BALANCE AT MAY 31, 1996                                                 9,355        55,940        60,905     116,845 
   Net income                                                              --            --        21,250      21,250 
   Adjustment to align Chip Star, Inc. fiscal year with May 31             --            --          (325)       (325)
   Stock plans:                                                                                                       
       Employee stock plans                                               113         1,235            --       1,235 
       Tax benefit of stock options exercised                              --           561            --         561 
   Unrealized loss on securities                                           --            --           (19)        (19)
   Cumulative translation adjustment                                       --            --          (433)       (433)
                                                                    ---------     ---------     ---------   --------- 

BALANCE AT MAY 31, 1997                                                 9,468     $  57,736     $  81,378   $ 139,114 
Net income                                                                 --            --        (3,861)     (3,861)
Stock plans                                                               107         2,407            --       2,407 
Shares issued for acquisition of Dynamotion                               347        11,950            --      11,950 
Cumulative translation adjustment                                          --            --           (80)        (80)
                                                                    ---------     ---------     ---------   --------- 
Balance at August 31, 1997 (unaudited)                                  9,922     $  72,093     $  77,437   $ 149,530 
                                                                    =========     =========     =========   ========= 

                 The accompanying notes are an integral part of                                                       
                               these statements.                                                                      

F-20

424B1
99th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 99th
                                                        [Enlarge/Download Table]

              ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES                                                             

                      CONSOLIDATED STATEMENTS OF CASH FLOWS                                                                    
                                 (in thousands)                                                                                

                                                                                                             Three months      
                                                                              Year ended May 31,            ended August 31,   
                                                                    ----------------------------------   --------------------- 
                                                                        1995         1996         1997       1996         1997 
                                                                    --------     --------     --------   --------     -------- 
                                                                                                              (unaudited)      
                                                                                                                               
 CASH FLOWS FROM OPERATING ACTIVITIES                                                                                          
   Net income (loss)                                                $ 12,217     $ 17,299     $ 21,250   $  4,603     $ (3,861)
   Adjustment to align Chip Star, Inc. fiscal year with May 31            --          --          (325)        --           -- 
   Adjustments to reconcile net income to cash provided by                                                                     
     (used in) operating activities:                                                                                           
         Acquired in-process research and development and                 --        6,000           --         --       11,124 
            merger related expenses                                                                                            
         Depreciation and amortization                                 2,646        2,803        3,109      1,034        1,186 
         Other non-cash charges (credits)                               (414)          --           --         --           -- 
         Deferred income taxes                                        (1,626)        (770)         476         --           -- 
   Changes in operating accounts:                                                                                              
         (Decrease) Increase in trade receivables                    (15,198)      (6,010)     (11,599)    (2,276)       3,317 
         Increase in inventories                                      (3,014)      (3,563)      (1,012)    (3,102)      (1,268)
         Decrease (increase) in other current assets                    (368)          43          239       (208)        (909)
         (Decrease) increase in accounts payable and accrued                                                                   
            liabilities                                                6,268       (3,987)      (2,028)      (813)      (4,040)
                                                                    --------     --------     --------   --------     -------- 
   Net cash provided by (used in) operating activities                   511       11,815       10,110       (762)       5,549 
                                                                    --------     --------     --------   --------     -------- 
CASH FLOWS FROM INVESTING ACTIVITIES                                                                                           
   Purchase of XRL subsidiary, net of cash acquired (1)                   --         (492)          --         --           -- 
   Purchase of Chicago Laser subsidiary, net of cash                    (707)          --           --         --           -- 
     acquired (2)                                                                                                              
   Purchase of property and equipment                                 (3,070)      (3,755)      (3,469)      (683)      (1,919)
   Proceeds from the sale of property and equipment                      648           --           --         --           -- 
   Purchase of securities                                            (20,950)     (30,986)     (42,316)    (7,563)      (9,972)
   Proceeds from sales of securities and maturing securities           4,000       29,850       32,800      8,800        7,500 
   (Increase) decrease in other assets                                (1,458)         366         (720)        41         (145)
                                                                    --------     --------     --------   --------     -------- 
   Net cash (provided by) used in investing activities               (21,537)      (5,017)     (13,705)       595       (4,536)
                                                                    --------     --------     --------   --------     -------- 
CASH FLOWS FROM FINANCING ACTIVITIES                                                                                           
   Payments to retire debt                                            (1,383)          --           --         --           -- 
   Repayment of Dynamotion subsidiary debt (3)                            --           --           --         --       (6,979)
   Proceeds from secondary stock offering                             22,535           --           --         --           -- 
   Proceeds from exercise of stock options and stock plans                                                                     
     and related tax benefits                                          3,172        1,246        1,796        129        2,407 
                                                                    --------     --------     --------   --------     -------- 
Net cash provided by (used in) financing activities                   24,324        1,246        1,796        129       (4,572)
                                                                    --------     --------     --------   --------     -------- 
NET CHANGE IN CASH AND CASH EQUIVALENTS                                3,298        8,044       (1,799)       (38)      (3,559)
CASH AND CASH EQUIVALENTS AT BEGINNING OF                                                                                      
PERIOD                                                                 8,258       11,556       19,600     19,600       17,801 
                                                                    --------     --------     --------   --------     -------- 
CASH AND CASH EQUIVALENTS AT END OF PERIOD                          $ 11,556     $ 19,600     $ 17,801   $ 19,562     $ 14,242 
                                                                    ========     ========     ========   ========     ======== 

                   The accompanying notes are an integral part                                                                 
                              of these statements.                                                                             

F-21

424B1
100th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 100th
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

(1)  Acquisition of XRL subsidiary:                                             

Assets less liabilities acquired, net of cash acquired             $   (5,073)  
Issuance of common stock                                                4,581   
                                                                ----------
Net cash used to acquire business                                  $     (492)  
                                                                ==========

(2)  Acquisition of Chicago Laser subsidiary:                                   

Assets less liabilities acquired, net of cash acquired             $   (2,646)  
Issuance of common stock                                                1,939   
                                                                ----------
Net cash used to acquire business                                  $     (707)  
                                                                ==========

(3)  Acquisition of Dynamotion subsidiary:                                      

   Assets less liabilities acquired, net of cash                 $  (11,950)
  Issuance of common stock and common stock options                 11,950
                                                                ----------
  Net cash used to acquire Dynamotion:                          $        0
                                                                ==========

Cash payments for interest were not significant in 1997, 1996 or 1995.          

F-22

424B1
101st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 101st
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                      

Business Environment                                                            

    The accompanying consolidated financial statements include the accounts of
Electro Scientific Industries, Inc. and its subsidiaries (the Company), all of  
which are wholly owned. The Company designs and manufactures sophisticated      
products used around the world in electronics manufacturing including: laser    
manufacturing systems for semiconductor yield improvement, production and test  
equipment for the manufacture of surface mount ceramic capacitors, circuit fine 
tuning systems, precision laser and mechanical electronic packaging production  
systems and machine vision systems. The Company serves the global electronics   
market from its headquarters in Portland, Oregon and through subsidiaries       
located in the United States, Europe and Asia.                                  

Concentrations of Credit Risk                                                   

The Company uses financial instruments that potentially subject it to 
concentrations of credit risk. Such instruments include cash equivalents,       
securities held for sale, trade receivables and financial instruments used in   
hedging activities. The Company invests its cash in cash deposits, money market 
funds, commercial paper, certificates of deposit and readily marketable debt    
securities. The Company places its investments with high credit quality         
financial institutions and limits the credit exposure from any one institution  
or instrument. To date, the Company has not experienced losses on any of these  
investments. The Company sells a significant portion of its products to a small 
number of electronics manufacturers: 47.1% of fiscal 1997 revenues were derived 
from ten customers. The Company's operating results could be adversely affected 
if the financial condition and operations of these key customers decline.       

Concentrations of Other Risks                                                   

    The Company's operations involve a number of other risks and uncertainties
including but not limited to the cyclicality of the electronics market, rapidly 
changing technology, international operations and hedging exposures.            

Basis of Presentation                                                           

     In June 1997, ESI merged with Chip Star, Inc. (Chip Star), a privately-held
company based in San Marcos, California. Chip Star provides capital equipment   
for producers of surface mount ceramic capacitors. Consideration paid to Chip   
Star was 700 shares of ESI stock. The merger was accounted for as a             
pooling-of-interests. Accordingly, all financial statements and footnote data   
have been restated. The following is a reconciliation of certain restated       
amounts with amounts previously reported.                                       

F-23

424B1
102nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 102nd
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

                                                                [Download Table]

                                                             Three Months
                            Year Ended May 31,                      Ended
                      1995          1996            1997  August 31, 1996
                  --------      --------        --------  ---------------
                                                                         
Sales:                                                                   
  ESI             $108,215      $159,705        $150,159         $ 34,856
  Chip Star          4,685         6,605           9,990            1,343
                  --------      --------        --------         --------
     As restated  $112,900      $166,310        $160,149         $ 36,199

Net income:                                                              
  ESI              $11,517       $16,082         $18,952          $ 4,347
  Chip Star            700         1,217           2,298              224
                  --------      --------        --------         --------
    As restated     12,217        17,299         $21,250           $4,603

Summary of Significant Accounting Policies                                      

Principles of Consolidation                                                     

   All material intercompany accounts and transactions have been eliminated.

Use of Estimates                                                                

The preparation of financial statements in conformity with generally  
accepted accounting principles requires management to make estimates and        
assumptions that affect the reported amounts of assets and liabilities and      
disclosure of contingent assets and liabilities at the date of the financial    
statements and the reported amounts of revenues and expenses during the         
reporting period. Actual results may differ from those estimates and such       
differences could be material to the financial statements.                      

Reclassifications                                                               

   Certain reclassifications have been made in the accompanying consolidated
financial statements for 1995 and 1996 to conform with the 1997 presentation.   

Interim Financial Information                                                   

 The interim consolidated financial statements included herein have been
prepared, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally  
included in financial statements prepared in accordance with generally accepted 
accounting principles have been condensed or omitted pursuant to such rules and 
regulations, although the management of the Company believes that the           
disclosures are adequate to make the information presented not misleading.      
Interim financial statements are by necessity somewhat tentative; judgments are 
used to estimate interim amounts for items that are normally determinable only  
on an annual basis. For example, the effective income tax rate is based on      
estimates of annual amounts of taxable income, tax credits and other factors.   

 The interim period information included herein reflects all adjustments
which are, in the opinion of the management of the company, necessary for a fair
statement of the results of the respective interim periods. Results of          
operations for interim periods are not necessarily indicative of results to be  
expected for an entire year.                                                    

F-24

424B1
103rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 103rd
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Revenue Recognition                                                             

The Company generally recognizes revenue at the time of shipment.     

Product Warranty                                                                

    The Company generally warrants its systems for a period of up to 12 months
for material and labor to repair and service the system. A provision for the    
estimated cost related to warranty is recorded upon shipment.                   

Research and Development                                                        

Research and development costs are expensed as incurred.              

F-25

424B1
104th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 104th
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Taxes on Income                                                                 

Deferred income taxes have not been provided on unremitted earnings of
foreign subsidiaries as the Company believes any U.S. tax on such earnings would
be substantially offset by associated foreign tax credits.                      

Net Income Per Share                                                            

Net income per share is computed using the weighted average number of 
common shares and common stock equivalents (stock options) outstanding, if      
significant.                                                                    

Cash Equivalents                                                                

The Company considers all highly liquid investments with a maturity of
three months or less at date of purchase to be cash equivalents.                

Inventories                                                                     

    Inventories are principally valued at standard costs which approximate the
lower of cost (first-in, first-out) or market. Costs utilized for inventory     
valuation purposes include material, labor and manufacturing overhead.          

Depreciation and Capitalization Policies                                        

Depreciation is determined on the declining balance and straight-line 
methods based on the following useful lives: buildings: 25 to 40 years; building
improvements: 5 to 15 years; and machinery and equipment: 3 to 10 years.        

     Expenditures for maintenance, repairs and minor improvements are charged to
expense. Major improvements and additions are capitalized. When property is sold
or retired, the cost and related accumulated depreciation are removed from the  
accounts and the resulting gain or loss is included in other expense.           

Foreign Currency Translation                                                    

  The Company accounts for foreign currency translation in accordance with
Statement of Financial Accounting Standards No. 52. The total cumulative        
translation adjustment included in retained earnings is $(4), $429 and $2,025 at
May 31, 1997, 1996 and 1995, respectively. Foreign currency transaction losses  
were $176 and $227 for the years ended May 31, 1997 and 1995, respectively, with
a gain of $380 for the year ended May 31, 1996. These amounts are included in   
other expense in the accompanying Consolidated Statements of Income.            

Property and Equipment                                                          

Major classes of property and equipment consist of the following:     

                                                         May 31,
                                                        1996        1997
                                                   ---------   ---------
Land...................................................$   3,419   $   3,419    
Buildings and improvements.............................   13,004      13,143    
Machinery and equipment................................   22,321      24,132    
Construction in progress...............................      342         269    
                                                   ---------   ---------
                                                   $  39,086   $  40,963

F-26

424B1
105th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 105th
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Line of Credit                                                                  

    The Company has a short-term revolving line of credit with a large foreign
bank totaling $7,000. At the Company's option, the interest rate is either prime
or LIBOR plus 1.25 percent. There were no borrowings outstanding under the line 
at anytime during fiscal 1997 or the three months ended August 31, 1997 and     
subsequent to May 31, 1997 the expiration date for the line was extended to     
September 1998.                                                                 

Employee Benefit Plans                                                          

  The Company has an employee savings plan under the provisions of section
401(k) of the Internal Revenue Code. The Company contributed $406, $462 and $334
to the plan for the years ended May 31, 1997, 1996 and 1995, respectively.      

Income Taxes                                                                    

The Company accounts for income taxes in accordance with Statement of 
Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS     
109). Under the liability method specified by SFAS 109, the deferred tax assets 
and liabilities are determined based on the temporary differences between the   
financial statement and tax bases of assets and liabilities as measured by the  
enacted tax rates for the years in which the taxes are expected to be paid.     

    The net deferred tax asset as of May 31, 1996 and May 31, 1997 consists of
the following tax effects relating to temporary differences and carryforwards:  

                                                         May 31,
                                                        1996        1997
                                                   ---------   ---------
Deferred tax assets:                                                          
Inventory valuation                                  $   1,129   $   1,385  
Vacation pay                                              560         629 
Warranty costs                                            350         440 
Accrued compensation                                      392         443 

                                                       2,431       2,897
Tax loss and credit carryforwards                        1,874       1,405  

 Total deferred tax assets                             4,305       4,302

Deferred tax liabilities                                    (421)       (894)   
                                                   ---------   ---------
Net deferred tax asset                                 $   3,884   $   3,408    
                                                   =========   =========

At May 31, 1997, there was a net operating loss carryforward of $4,015
available for U.S. federal income tax purposes. These losses were acquired as   
part of the XRL acquisition and expire through 2008.                            

   The components of income before income taxes and the provision for income
taxes are as follows:                                                           

                                                        [Enlarge/Download Table]

                                                              Year Ended May 31,          
                                                        1995           1996           1997
                                                    --------       --------       --------
                                                                                          
Income before income taxes:                                                               
   Domestic                                         $ 14,395       $ 25,690       $ 27,976
   Foreign                                             3,088          1,637          4,512
                                                    --------       --------       --------

                                                     $17,483        $27,327        $32,488
                                                     =======        =======        =======

                                      F-27                                                

424B1
106th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 106th
              ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES                        

Provision for income taxes:                                                               
   Current:                                                                               
   U.S. Federal and State                           $  4,088       $  9,371       $  8,298
   Foreign                                             1,736            887          1,903
                                                    --------       --------       --------
                                                       5,824         10,258         10,201

Deferred                                              (1,626)          (770)           476
   Income tax effect of stock options exercised        1,068            540            561
                                                    --------       --------       --------

                                                    $  5,266       $ 10,028       $ 11,238
                                                    ========       ========       ========

In accordance with SFAS 109, the tax benefit related to stock option  
exercises has been recorded as an increase to Common Stock rather than a        
reduction to the provision for income taxes.                                    

     A reconciliation of the provision for income taxes at the federal statutory
income tax rate to the provision for income taxes as reported is as follows:    

                                                        [Enlarge/Download Table]

                                                                         Year ended May 31,          
                                                                  1995          1996            1997 
                                                              --------      --------        -------- 
                                                                                                     
Provision computed at federal statutory rate                    $6,119      $  9,564        $ 11,371 
Higher than U.S. tax rates in foreign jurisdictions                753           314             323 
Impact of U.S. tax loss and credit carryforwards utilization    (1,236)         (434)             -- 
Impact of state taxes                                              334           876           1,156 
Benefit of foreign sales corporation (FSC)                        (217)         (137)         (1,468)
Other, net                                                        (487)         (155)           (144)
                                                              --------      --------        -------- 
                                                              $  5,266      $ 10,028        $ 11,238 
                                                              ========      ========        ======== 

     Consolidated income tax payments amounted to $4,715, $8,762 and $12,276 for
the years ended May 31, 1995, 1996 and 1997, respectively.                      

Earnings Per Share                                                              

  In March 1997, the Financial Accounting Standards Board issued Statement
128, Earnings per Share ("SFAS 128"), superseding APB Opinion 15. SFAS 128 is   
required to be adopted for periods ending after December 15, 1997. When adopted,
all prior earnings per share ("EPS") calculations will be restated to conform to
SFAS 128. The pro forma effects of applying SFAS 128 to EPS are as follows:     

                                                        [Enlarge/Download Table]

                                                                                  Three months       
                                       Year ended May 31,                       ended August 31,     
                               --------------------------------------      ------------------------- 
                                                                                  (unaudited)        
                                 1995           1996            1997          1996               1997
                               --------------------------------------------------------------------- 
                                                                                                     
Primary EPS as reported        $ 1.49         $ 1.86          $ 2.27       $ 0.49            $ (0.39)
Effect of SFAS 128               0.00           0.00            0.00         0.00               0.00 
                               ------         ------          ------       ------            ------- 
Basic EPS as restated          $ 1.49         $ 1.86          $ 2.27       $ 0.49            $ (0.39)
                               ======         ======          ======       ======            ======= 

Fully diluted EPS as reported  $ 1.49         $ 1.86          $ 2.27       $ 0.49            $ (0.39)
Effect of SFAS 128              (0.04)         (0.04)          (0.05)       (0.01)               0.00
                               ------         ------          ------       ------            ------- 
Diluted EPS as restated        $ 1.45         $ 1.82          $ 2.22       $ 0.48            $ (0.39)
                               ======         ======          ======       ======            ======= 

F-28

424B1
107th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 107th
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

Commitments and Contingencies                                                   

   The Company has limited involvement with derivative financial instruments
and does not use them for trading purposes. Derivatives are used to manage well 
defined foreign currency risks: the Company enters into forward exchange        
contracts to hedge the value of accounts receivable denominated in a foreign    
currency. Foreign exchange contracts have gains and losses that are recognized  
at the settlement date. At May 31, 1996 and 1997, the Company had forward       
exchange contracts totaling $7,460 and $5,470, respectively. These contracts    
generally mature in less than one year and the counter party is a large, widely 
recognized international bank; therefore, risk of credit loss as a result of    
nonperformance by the bank is minimal. The use of derivatives does not have a   
significant effect on the Company's results of operations or its financial      
position.                                                                       

    The Company leases equipment and office space under operating leases which
are non-cancelable and expire on various dates through 2002. The aggregate      
minimum commitment for rentals under operating leases beyond May 31, 1997 is not
significant.                                                                    

  The Company is a party to various legal proceedings. Management believes
that the outcome of such proceedings will not have a material effect on the     
business, financial position or results of operations of the Company.           

Securities Available for Sale                                                   

The Company accounts for securities in accordance with Statement of   
Financial Accounting Standards No. 115, "Accounting for Certain Investments in  
Debt and Equity Securities" (SFAS 115). The Company classifies its marketable   
debt securities as Securities Available for Sale in the accompanying            
Consolidated Balance Sheets. The fair market value of these securities at May   
31, 1996 and 1997 is $18,363 and $27,860, respectively. All of the Company's    
marketable debt securities are invested in high-credit quality tax advantaged   
securities with maturities of less than one year from the date of purchase; the 
amortized cost of these securities approximates fair market value.              

     During fiscal 1996 and 1997, proceeds of $29,850 and $32,800, respectively,
resulted from the sales or maturities of securities; there were no realized     
gains or losses associated with these sales or maturities.                      

Shareholder Rights Plan                                                         

   In May 1989, the Company adopted a Shareholder Rights Plan and declared a
dividend distribution of one Right for each outstanding share of Common Stock,  
payable to holders of record on June 23, 1989. Under certain conditions, each   
Right may be exercised to purchase 1/100 of a share of Series A No Par Preferred
Stock at a purchase price of $55, subject to adjustment. The Rights are not     
presently exercisable and will only become exercisable following the occurrence 
of certain specified events. If these specified events occur, each Right will be
adjusted to entitle its holder to receive, upon exercise, Common Stock (or, in  
certain circumstances, other assets of the Company) having a value equal to two 
times the exercise price of the Right or each Right will be adjusted to entitle 
its holder to receive, upon exercise, common stock of the acquiring company     
having a value equal to two times the exercise price of the Right, depending on 
the circumstances. The Rights expire on May 12, 1999 and may be redeemed by the 
Company for $0.01 per Right. The Rights do not have voting or dividend rights,  
and until they become exercisable, have no dilutive effect on the earnings of   
the Company.                                                                    

Stock Plans                                                                     

    The Company has stock option and restricted stock grant plans for officers
and employees. During fiscal 1997, ESI recorded $475 of compensation expense    
related to stock grants earned in April 1997. Awards under these                

F-29

424B1
108th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 108th
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

plans are determined by the Compensation Committee of the Board of Directors.   
Stock appreciation rights may be granted in connection with options, although no
options have been granted that include stock appreciation rights. Option prices 
are at fair market value at the date of the grant and all expire ten years from 
the date of grant.                                                              

The Company has an employee stock purchase plan which allows qualified
employees to direct up to 15% of base pay for purchases of stock. The purchase  
price for shares purchased under the Plan is the lower of 85% of the fair market
value of stock on January 8, 1997 or January 7, 1998.                           

The Company accounts for its stock option plans and its employee stock
purchase plan in accordance with the provisions of the Accounting Principles    
Board's Opinion No. 25 (APB 25), "Accounting For Stock Issued to Employees." In 
1995, the Financial Accounting Standards Board released Statement of Financial  
Accounting Standard No. 123 (SFAS 123), "Accounting For Stock Based             
Compensation." SFAS 123 provides an alternative to APB 25 and was effective     
beginning with the Company's 1996 fiscal year. The Company will continue to     
account for its employee stock plans in accordance with the provisions of APB   
25. Accordingly, the Company has elected to provide pro forma disclosures as    
required by SFAS 123.                                                           

   The Company has computed, for pro forma disclosure purposes, the value of
all options granted under the stock option plan to be $16.04 and $13.26 for 1997
and 1996. The pro forma value of options granted under the employee stock       
purchase plan is immaterial for both 1997 and 1996. These computations were made
using the Black-Scholes option-pricing model, as prescribed by SFAS 123, with   
the following weighted average assumptions for grants in 1997 and 1996:         

  Risk-free interest rate                           7.5%
  Expected dividend yield                             0%
  Expected life stock option plan                7 years
  Expected volatility                              48.5%

   The total value of options granted would be amortized on a pro rata basis
over the vesting period of the options. Options generally vest equally over four
years. If the Company had accounted for these plans in accordance with SFAS 123,
the Company's net income and net income per share would have decreased as       
reflected in the following pro forma amounts:                                   

                                                      Year ended May 31,
                                                        1996          1997
                                                    --------      --------
Net income:                                                                     
As reported                                         $ 17,299      $ 21,250
Pro forma                                             17,048        20,514

Net income per share:                                                           
As reported                                         $   1.86      $   2.27
Pro forma                                               1.85          2.22

F-30

424B1
109th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 109th
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

    The following table summarizes activity in stock plans for the years ended
May 31, 1997 and 1996:                                                          

                                                        [Enlarge/Download Table]

                                                                               Year ended May 31,                        
                                                                     1996                               1997             
                                                        -----------------------------      ----------------------------- 
                                                                             Weighted-                          Weighted-
                                                                     Average Exercise                   Average Exercise 
                                                        Shares                  Price      Shares                  Price 
                                                                                                                         
Options outstanding at beginning of year                   675                 $17.61         835                 $20.60 
   Granted.............................................    277                  22.20         230                  25.95 
   Exercised...........................................     73                   9.05          93                  16.47 
   Canceled   .........................................     44                  20.35          55                  20.93 
                                                        ------                 ------      ------                 ------ 
Options outstanding at end of year.....................    835                  20.60         917                  22.83 
                                                        ======                 ======      ======                 ====== 
Exercisable at end of year.............................    260                 $15.03         355                 $18.27 
                                                        ======                 ======      ======                 ====== 

   The following table sets forth the exercise price range, number of shares
outstanding at May 31, 1997, weighted average remaining contractual life,       
weighted average exercise price, number of exercisable shares and weighted      
average exercise price of exercisable options by groups of similar price and    
grant date:                                                                     

                                                        [Enlarge/Download Table]

                             Options Outstanding                                           Options Exercisable         
----------------------------------------------------------------------------------  ---------------------------------- 

                                               Weighted-                                                               
                                                Average                                                                
                         Outstanding           Remaining             Weighted-      Exercisable            Weighted-   
Range of Exercise            as of         Contractual Life       Average Exercise     as of           Average Exercise
     Prices              May 31, 1997           (Years)                Price        May 31, 1997             Price     
                                                                                                                       
$  2.63-$9.88                267                 5.76                 $ 8.86            217                 $ 8.53     
   9.89-18.00                210                 8.60                  17.46             51                  16.58     
  18.01-24.00                183                 7.96                  23.62             75                  23.75     
  24.01-33.00                243                 9.59                  28.22              9                  32.80     
  33.01-39.38                 14                 8.25                  38.36              3                  38.36     
                             ---                                                        ---                            

                             917                 8.18                 $22.83            355                 $18.27     
                             ===                                                        ===                            

Geographic Reporting                                                            

  The Company operates in the capital equipment segment of the electronics
industry with geographic operations in the United States, Europe and Asia.      
Transfers between geographic areas are made at prevailing market prices.        
Operating income is total revenue less operating expenses. In computing         
operating income, none of the following items have been added or deducted:      
interest income, other expense or the provision for income taxes. Identifiable  
assets are those assets of the Company that are identified with the operations  
in each geographic location. Corporate assets are primarily cash and cash       
equivalents and securities available for sale.                                  

    Export sales included in United States sales to unaffiliated customers for
the years ended May 31, 1995, 1996 and 1997 were as follows:                    

                                                                [Download Table]

                                                  Europe     Asia    Total
                                                                          
May 31, 1995.....................................  3,889   36,605   40,494
May 31, 1996.....................................  1,926   68,192   70,118
May 31, 1997..................................... $4,282  $59,053  $63,335

F-31

424B1
110th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 110th
    In fiscal 1997 and 1996, there were no sales to any one customer in excess
of 10% of consolidated net sales. During fiscal 1995, one customer accounted for
11.9% of consolidated net sales.                                                

    The following data represents segment information for the years ending May
31:                                                                             

                                                        [Enlarge/Download Table]

                                                                                               Adjustments               
                                                    United                                             and               
1995                                                States            Europe         Asia     Eliminations   Consolidated
                                                 ---------        ----------     --------  ---------------   ------------
                                                                                                                         
Sales to unaffiliated customers                  $  73,853        $   15,869     $ 23,178     $         --      $ 112,900
Transfers between geographic areas                  24,631                 9          434          (25,074)            --
                                                 ---------        ----------     --------     ------------      ---------
Total revenue                                    $  98,484        $   15,878     $ 23,612     $    (25,074)     $ 112,900
Operating income                                 $  13,441        $      791     $  2,605     $        248      $  17,085
Identifiable assets at May 31, 1995              $  84,926        $    7,994     $ 10,922     $    (19,746)     $  84,096
Corporate assets                                                                                                   28,825
                                                                                                                ---------
Total assets at May 31, 1995                                                                                    $ 112,921

1996                                                                                                                     

Sales to unaffiliated customers                  $ 125,669        $   18,329     $ 22,312     $         --      $ 166,310
Transfers between geographic areas                  28,009                 8          543          (28,560)            --
                                                 ---------        ----------     --------     ------------      ---------
Total revenue                                    $ 153,678        $   18,337     $ 22,855     $    (28,560)     $ 166,310
Operating income 1                               $  24,847        $      260     $  1,965     $       (236)     $  26,836
Identifiable assets at May 31, 1996              $ 101,397        $    8,624     $  8,049     $    (20,575)     $  97,495
Corporate assets                                                                                                   37,963
                                                                                                                ---------
Total assets at May 31, 1996                                                                                    $ 135,458

1997                                                                                                                     

Sales to unaffiliated customers                  $ 110,318        $   28,872     $ 20,959     $         --      $ 160,149
Transfers between geographic areas                  35,986                --          427          (36,413)            --
                                                 ---------        ----------    ---------     ------------      ---------
Total revenue                                    $ 146,304        $   28,872     $ 21,386     $    (36,413)     $ 160,149
Operating income                                 $  26,656        $    2,899     $  1,623     $       (138)     $  31,040
Identifiable assets at May 31, 1997              $  96,299        $   11,374     $  9,480     $     (8,001)     $ 109,152
Corporate assets                                                                                                   45,661
                                                                                                                ---------
Total assets at May 31, 1997                                                                                    $ 154,813

1    Includes the $6,000 in-process research and development charge associated                                           
     with the acquisition of XRL, Inc.                                                                                   

Acquisitions                                                                    

XRL, Inc.                                                                       

 In July 1995, the Company acquired all of the outstanding stock of XRL,
Inc., a privately held company based in Canton, Massachusetts. XRL provides     
capital equipment for semiconductor yield improvement. The purchase             
consideration consisted of 179 shares of ESI stock. The transaction was         
accounted for as a purchase.                                                    

   In connection with the purchase price allocation, an analysis of the fair
value of the intangible assets acquired indicated that substantially all of the 
acquired intangible assets consisted of research and development                

F-32

424B1
111th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 111th
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

projects in process. The development of these projects had not reached          
technological feasibility and the technology has no alternative future use. In  
accordance with generally accepted accounting principles, the acquired          
in-process research and development of $6,000 was charged to expense during the 
quarter ended August 31, 1995 and is reflected in the accompanying Consolidated 
Statements of Income.                                                           

   Pro forma combined income statement data for the years ended May 31, 1996
and 1995 was not materially different from results presented in the accompanying
Consolidated Statements of Income.                                              

Subsequent Event - Dynamotion Corp.                                             

In June 1997, ESI acquired all of the equity of Dynamotion/ATI Corp.  
(Dynamotion), a publicly-held company based in Santa Ana, California. Dynamotion
provides mechanical drilling equipment for printed circuit board manufacturers. 
The preliminary purchase consideration was $11,950 (347 shares of ESI stock) and
assumption of $14,352 of liabilities. The purchase consideration includes the   
fair market value of all Dynamotion stock options. The purchase price allocation
includes $2,229 of goodwill which will be amortized over seven years. The       
Company is still obtaining certain data related to the acquisition, and         
accordingly, the purchase price allocation remains open. The transaction was    
accounted for as a purchase.                                                    

   In connection with the purchase price allocation, an analysis of the fair
value of the intangible assets acquired indicated that substantially all of the 
acquired intangible assets consisted of research and development projects in    
process. The development of these projects had not reached technological        
feasibility and the technology has no alternative future use. In accordance with
generally accepted accounting principles, the acquired in-process research and  
development of $9,000 will be charged to expense during the quarter ended August
31, 1997. The Company currently believes that the research and development      
efforts will result in commercially feasible products in the next 24 months at  
an estimated additional cost of $2,000.                                         

    Unaudited pro forma combined income statement data for the years ended May
31, 1996 and 1997 and for the three months ended August 31, 1996 are as follows:

                                                                [Download Table]

                                                                        Three
                                                                 months ended
                                         Year ended                August 31,
                                   ----------------------------  ------------
                                          1996             1997          1996
                                   -----------      -----------  ------------
                                                                             
Sales                              $   179,813      $   172,787  $     39,530
Income from continuing operations  $    13,915      $    15,256  $      3,385
Net income per share                     $1.44            $1.57         $0.35

Quarterly Financial Information                                                 
(Unaudited)                                                                     

                                                        [Enlarge/Download Table]

Year ended May 31, 1996                                   1st              2nd        3rd        4th           
                                                      Quarter          Quarter    Quarter    Quarter      Total
                                                    ---------        ---------  ---------  ---------  ---------
                                                                                                               
Net sales                                           $  38,721        $  43,089  $  42,119  $  42,381  $ 166,310
Gross margin                                           20,951           23,541     22,840     23,811     91,143
Net income                                              1,226/1          5,393      5,122      5,558     17,299
Net income per share                                $    0.13/1      $    0.58  $    0.55  $    0.60  $    1.86

/1   Includes the $6,000 in-process research and development charge associated                                 
     with the acquisition of XRL, Inc.                                                                         

F-33

424B1
112th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 112th
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

                                                                [Download Table]

Year ended May 31, 1997        1st        2nd        3rd        4th           
                           Quarter    Quarter    Quarter    Quarter      Total
                         ---------  ---------  ---------  ---------  ---------
                                                                              
Net sales                $  36,199  $  37,415  $  40,347  $  46,188  $ 160,149
Gross margin                20,690     20,932     22,160     23,270     87,052
Net income                   4,603      5,103      5,758      5,786     21,250
Net income per share     $    0.49  $    0.55  $    0.61  $    0.62  $    2.27

F-34

424B1
113th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 113th
                                                                         ANNEX A

 AGREEMENT
OF
 REORGANIZATION AND MERGER

 among

 Electro Scientific Industries, Inc.
an Oregon corporation,

 Applied Intelligent Systems, Inc.
 a Michigan corporation,

 and

Asteroid Merger Corp.,
an Oregon corporation.

September 29, 1997

424B1
114th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 114th
 TABLE OF CONTENTS

 ARTICLE I
THE MERGER

1.1    The Merger..............................................................2
1.2    Effect of Merger........................................................2
       1.2.1    The Surviving Corporation......................................2
       1.2.2    Directors and Officers.........................................3
1.3    Merger Consideration....................................................3
       1.3.1    AISI Stock.....................................................3
       1.3.2    Stock Splits, Etc..............................................4
       1.3.3    Merger Corp. Stock.............................................4
       1.3.4    Options........................................................5
1.4    Surrender and Cancellation of Certificates..............................6
       1.4.1    Surrender of Certificates......................................6
       1.4.2    Option Agreements..............................................7
       1.4.3    No Fractional Shares...........................................7
       1.4.4    Cancellation...................................................8
       1.4.5    Treasury Shares................................................8
       1.4.6    Escheat........................................................8
       1.4.7    Withholding Rights.............................................8
1.5    Dissenters' Rights......................................................9
       1.5.1    Notice.........................................................9
       1.5.2    Rights of Dissenting Shares....................................9
1.6    Stock Transfer Books...................................................10
1.7    Closing................................................................10
1.8    Subsequent Actions.....................................................10

ARTICLE II
FURTHER AGREEMENTS

2.1    Noncompetition and Confidentiality Agreements..........................11
2.2    Escrow Agreement.......................................................11

 ARTICLE III
REPRESENTATIONS AND WARRANTIES

3.1    Representations and Warranties of AISI.................................12
       3.1.1    Organization and Status.......................................12
       3.1.2    Capitalization................................................12

 i

424B1
115th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 115th
       3.1.3    Corporate Authority...........................................13
       3.1.4    Governmental Filings..........................................14
       3.1.5    Investments; Subsidiaries.....................................14
       3.1.6    No Adverse Consequences.......................................14
       3.1.7    Financial Statements..........................................15
       3.1.8    Undisclosed Liabilities; Returns..............................15
       3.1.9    Absence of Certain Changes or Events..........................16
       3.1.10   Prohibited Payments...........................................18
       3.1.11   Litigation....................................................18
       3.1.12   Compliance with Laws; Judgments...............................18
       3.1.13   Employment Matters............................................19
                3.1.13.1 Labor Matters........................................19
                3.1.13.2 Employee Benefits....................................19
                3.1.13.3 Employment Agreements................................21
                3.1.13.4 Compensation.........................................21
                3.1.13.5 Confidentiality and Inventions Agreements............22
       3.1.14   Title to and Condition of Real Property.......................22
       3.1.15   Title to and Condition of Fixed Assets........................23
       3.1.16   Intellectual Property.........................................23
       3.1.17   Certain Contracts and Arrangements............................24
       3.1.18   Status of Contracts...........................................25
       3.1.19   Insurance.....................................................26
       3.1.20   Permits and Licenses..........................................26
       3.1.21   Taxes.........................................................27
                3.1.21.1 Returns..............................................27
                3.1.21.2 Taxes Paid or Reserved...............................28
                3.1.21.3 Definition...........................................28
       3.1.22   Related Party Interests.......................................29
       3.1.23   No Powers of Attorney or Restrictions.........................29
       3.1.24   Environmental Conditions......................................30
                3.1.24.1 Compliance...........................................30
                3.1.24.2 Hazardous Substances.................................30
                3.1.24.3 Filings and Notices..................................31
                3.1.24.4 Definitions..........................................31
       3.1.25   Consents and Approvals........................................32
       3.1.26   Records.......................................................32
       3.1.27   Receivables...................................................32
       3.1.28   Bank Accounts.................................................32
       3.1.29   Product Warranties............................................33
       3.1.30   Inventories...................................................33
       3.1.31   Product Liability.............................................34
       3.1.32   Backlog and Customer Information..............................34
       3.1.33   Accounting Controls...........................................34

ii

424B1
116th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 116th
       3.1.34   Brokers and Finders...........................................34
       3.1.35   Reliance......................................................35
       3.1.36   Accuracy of Representations and Warranties....................35
       3.1.37   Prospectus/Information Statement..............................35
       3.1.38   Continuity of Business Enterprise.............................36
       3.1.39   1998 Forecast.................................................36
3.2    Representations and Warranties of ESI..................................36
       3.2.1    Organization and Status.......................................36
       3.2.2    Capitalization................................................36
       3.2.3    Corporate Authority...........................................37
       3.2.4    Governmental Filings..........................................37
       3.2.5    SEC Reports and Financial Statements..........................37
       3.2.6    Litigation....................................................38
       3.2.7    No Adverse Consequences.......................................38
       3.2.8    Brokers and Finders...........................................38
       3.2.9    Prospectus/Information Statement..............................39
3.3    Representations and Warranties Relating to Merger Corp.................39
       3.3.1    Organization and Status.......................................39
       3.3.2    Capitalization................................................39
       3.3.3    Corporate Authority...........................................40
       3.3.4    Governmental Filings..........................................40
       3.3.5    Litigation....................................................40
       3.3.6    No Operations.................................................40

ARTICLE IV
 COVENANTS

4.1    Mutual Covenants.......................................................41
       4.1.1    Consents and Approvals........................................41
       4.1.2    Best Efforts..................................................41
       4.1.3    Publicity.....................................................41
       4.1.4    Confidentiality...............................................41
4.2    Covenants of AISI......................................................41
       4.2.1    Conduct of Business...........................................42
       4.2.2    Acquisition Proposals.........................................44
       4.2.3    Investigations................................................45
       4.2.4    Antitrust Improvements Act....................................45
       4.2.5    AISI Shareholders Approval....................................46
4.2.6    Information for Prospectus/Information Statement and     
                Registration Statement........................................46
4.3    Covenants of ESI.......................................................46
       4.3.1    Conduct of Business...........................................47
       4.3.2    Registration Statement........................................47

 iii

424B1
117th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 117th
       4.3.3    Listing of ESI Common Stock...................................47
       4.3.4    Antitrust Improvements Act....................................47
       4.3.5    Issuance of Certificates......................................47
       4.3.6    Registration of Option Shares.................................48
       4.3.7    Directors & Officers Insurance................................48
4.4    Covenants of Merger Corp...............................................48

 ARTICLE V
CONDITIONS

5.1    Conditions to the Obligations of All Parties...........................49
       5.1.1    Regulatory Approvals..........................................49
       5.1.2    Litigation....................................................49
                5.1.3    Section 368(a)(2)(E) of the Code Requirement.........49
5.2    Conditions to the Obligations of AISI..................................50
       5.2.1    Representations, Warranties and Covenants.....................50
       5.2.2    No Material Adverse Change....................................51
       5.2.3    Opinion of Counsel............................................51
       5.2.4    Registration of Securities; Listing...........................51
       5.2.5    Shareholders' Approval; Dissenters............................51
       5.2.6    Accountants Opinion...........................................51
5.3    Conditions to the Obligations of ESI and Merger Corp...................52
       5.3.1    Representations, Warranties and Covenants.....................52
       5.3.2    Opinion of Counsel............................................52
       5.3.3    Consents and Approvals........................................52
       5.3.4    No Material Adverse Change; Completion of Inspection..........52
                5.3.4.1  No Material Adverse Change...........................53
                5.3.4.2  Completion of Investigation..........................53
       5.3.5    Accountants Opinion...........................................53
       5.3.6    Registration of Securities; Listing...........................53
       5.3.7    Affiliate Representation Letters..............................54
       5.3.8    Continuity of Interests Letter................................54
       5.3.9    Other Agreements..............................................54
       5.3.10   Physical Count of Assets......................................54
       5.3.11   Tax Clearance Certificate.....................................55
       5.3.12   Related Party Agreements......................................55
       5.3.13   Confidentiality Agreements....................................55
       5.3.14   Updated Financial and Other Information.......................55
       5.3.15   Environmental Report..........................................55
       5.3.16   Fairness Opinion..............................................55

iv

424B1
118th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 118th
ARTICLE VI
SURVIVAL AND INDEMNIFICATION

6.1    Survival...............................................................56
6.2    Scope of Indemnification...............................................56
6.3    Escrow.................................................................57
6.4    Limitations............................................................57
       6.4.1    Minor Claims..................................................57
       6.4.2    Escrowed Property.............................................57
6.5    Claim Procedure for Indemnification....................................58
       6.5.1    Notice........................................................58
       6.5.2    Response to Third Party Claim.................................58
       6.5.3    Diligent Conduct..............................................58

 ARTICLE VII
 TERMINATION

7.1    Termination by Mutual Consent..........................................59
7.2    Termination by Either AISI or ESI......................................59
7.3    Effect of Termination and Abandonment..................................60
7.4    Termination Fees.......................................................60

ARTICLE VIII
 MISCELLANEOUS AND GENERAL

8.1    Payment of Expenses....................................................62
8.2    Entire Agreement.......................................................62
8.3    Assignment.............................................................62
8.4    Binding Effect; No Third Party Benefit.................................62
8.5    Amendment and Modification.............................................63
8.6    Waiver of Conditions...................................................63
8.7    Counterparts...........................................................63
8.8    Captions...............................................................63
8.9    Subsidiary.............................................................63
8.10   Notices................................................................64
8.11   Choice of Law..........................................................65
8.12   Attorneys' Fees........................................................65
8.13   Separability...........................................................65

 v

424B1
119th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 119th
EXHIBITS

A  -  Plan of Merger                                                            
B  -  Form of ESI Confidentiality Agreement                                     
C  -  Form of Escrow Agreement                                                  
D  -  Form(s) of Confidentiality and Inventions Agreements                      
E  -  Form of Counsel Opinion for ESI                                           
F  -  Form of Counsel Opinion for AISI                                          
G  -  Form of Affiliate Representation Letter                                   
H  -  Form of Continuity of Interests Letter                                    

vi

424B1
120th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 120th
 SCHEDULES

             Schedule                                                       Page

3.1          AISI Disclosure Schedule                                         12
3.1.2        AISI Shareholders and Option Holders                             13
3.1.5        AISI Investments                                                 14
3.1.13.2     Employee Benefits                                                19
3.1.13.3     Employment Manuals                                               21
3.1.13.4     Compensation                                                     21
3.1.14       Leased Real Property                                             22
3.1.15       Tangible Personal Property                                       23
3.1.16       Intellectual Property                                            23
3.1.17       Other Agreements                                                 24
3.1.19       Insurance Policies                                               26
3.1.20       Permits                                                          26
3.1.21       Audits                                                           27
3.1.22       Related Parties                                                  29
3.1.28       Bank Accounts                                                    32
3.1.29       Product Warranty                                                 33
3.1.30       Inventory                                                        33
3.1.32       Backlog                                                          34
3.2          ESI Disclosure Schedule                                          36
5.3.7        Signatories to Affiliate Representation Letter                   54
5.3.8        Signatories to Continuity of Interest Letter                     54

vii 

424B1
121st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 121st
INDEX OF TERMS

Term                                    Section                             Page
----                                    -------                             ----

1998 Forecast                           Section 3.1.39                        36
Acquisition Transaction                 Section 4.2.2                         44
Agreement                               Preamble                               1
AISI                                    Preamble                               1
AISI Common Stock                       Section 1.1                            2
AISI Disclosure Schedule                Section 3.1                           12
AISI Stock Plans                        Section 3.1.2                         13
Cash Election Shares                    Section 1.3.3(b)                       4
Claim Notice                            Section 6.5.1                         58
Closing                                 Section 1.7                           10
Closing Date                            Section 1.7                           10
Code                                    Recital B                              1
Confidentiality Agreements              Section 4.1.4                         41
Contracts                               Section 3.1.18                        25
Conversion Ratio                        Section 1.3                            3
Current Balance Sheet                   Section 3.1.7                         15
Damages                                 Section 6.2                           56
Disclosed Litigation                    Section 6.2                           56
Dissenters' Rights                      Section 1.5.1                          9
Dissenting Shareholder                  Section 1.5.2                          9
Dissenting Shares                       Section 1.5.2                          9
Effective Time                          Section 1.1                            2
Environmental Law                       Section 3.1.24.4                      31
ERISA                                   Section 3.1.13.2                      20
ERISA Plans                             Section 3.1.13.2                      20
Escrow Agreement                        Section 2.2                           10
Escrowed Property                       Section 6.3                           57
ESI                                     Preamble                               1
ESI Common Stock                        Section 1.1                            2
ESI Disclosure Schedule                 Section 3.2                           36
ESI SEC Reports                         Section 3.2.5                         38
Financial Statements                    Section 3.1.7                         15
Governmental Entity                     Section 3.1.4                         14
Hazardous Substance                     Section 3.1.24.4                      31
HSR Filing                              Section 4.2.4                         45
Indemnified Parties                     Section 6.2                           56
Intellectual Property                   Section 3.1.16                        23
Leased Real Property                    Section 3.1.14                        22

viii

424B1
122nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 122nd
INDEX OF TERMS (continued)

Term                                    Section                             Page
----                                    -------                             ----

MBCA                                    Section 1.2.1                          2
Merger                                  Section 1.1                            2
Merger Consideration                    Section 1.3                            3
Merger Corp.                            Preamble                               1
OBCA                                    Section 1.2                            2
Permits                                 Section 3.1.20                        26
Policies                                Section 3.1.19                        26
Previously Leased Real Property         Section 3.1.14                        22
Prospectus/Information Statement        Section 4.2.5                         46
Reserves or Reserved                    Section 3.1.8                         15
Returns                                 Section 3.1.21.1                      27
SEC                                     Section 3.2.5                         38
Shareholder Representatives             Section 2.2                           11
Subsidiary                              Section 8.9                           63
Surviving Corporation                   Section 1.2.1                          2
Tangible Personal Property              Section 3.1.15                        23
Taxes                                   Section 3.1.21.3                      28
Third Party Claims                      Section 6.5.2                         58

ix

424B1
123rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 123rd
 AGREEMENT

OF

 REORGANIZATION AND MERGER

   THIS AGREEMENT OF REORGANIZATION AND MERGER (this "Agreement") is entered
into as of September 29, 1997 among Electro Scientific Industries, Inc., an     
Oregon corporation ("ESI"), Applied Intelligent Systems, Inc., a Michigan       
corporation ("AISI"), and Asteroid Merger Corp., an Oregon corporation ("Merger 
Corp.").                                                                        

RECITALS

  A. The Boards of Directors of ESI and AISI have determined that it is in
the best interests of their respective shareholders for ESI to acquire AISI upon
the terms and subject to the conditions set forth herein.                       

B. It is intended that the Merger (as defined below) qualify as a     
reorganization under the provisions of Section 368(a) of the United States      
Internal Revenue Code of 1986, as amended (the "Code").                         

 AGREEMENT

In consideration of the mutual representations, warranties, covenants,
agreements and conditions contained herein, the parties agree as follows:       

1 

424B1
124th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 124th
 ARTICLE I

THE MERGER

    1.1 The Merger. Pursuant to the laws of the States of Michigan and Oregon,
and subject to and in accordance with the terms and conditions of this Agreement
and the Plan of Merger attached hereto as Exhibit A, Merger Corp. shall be      
merged with and into AISI, and the outstanding shares of AISI Common Stock, no  
par value (the "AISI Common Stock") shall be converted into the right to receive
shares of ESI Common Stock, without par value (the "ESI Common Stock"), in a    
transaction intended to qualify as a tax-free reorganization under Section      
368(a)(1)(A) and (a)(2)(E) of the Code. AISI and Merger Corp. shall execute     
Articles of Merger, to be filed with the Secretaries of State of the States of  
Michigan and Oregon on the Closing Date, as defined in Section 1.7, or as soon  
thereafter as practicable. The merger of Merger Corp. with and into AISI (the   
"Merger") shall take effect (the "Effective Time") upon the later of the time   
when the Articles of Merger are duly filed with the Secretary of State of the   
State of Michigan, and the time when the Articles of Merger are duly filed with 
the Corporation Division of the Secretary of State of the State of Oregon, or at
such other time as the parties may agree upon in writing pursuant to applicable 
law.                                                                            

1.2 Effect of Merger.                                                 

        1.2.1 The Surviving Corporation. At the Effective Time, Merger Corp.
shall be merged with and into AISI in the manner and with the effect provided by
the Michigan Business Corporation Act (the "MBCA") and the Oregon Business      
Corporation Act (the "OBCA"), the separate corporate existence of Merger Corp.  
shall cease and AISI shall be the surviving corporation (the "Surviving         
Corporation"). The outstanding shares of AISI Common Stock shall                

2 

424B1
125th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 125th
be converted into shares of ESI Common Stock, and the outstanding shares of     
capital stock of Merger Corp. shall be converted into shares of capital stock of
the Surviving Corporation, all on the basis, terms and conditions described in  
Section 1.3.                                                                    

      1.2.2 Directors and Officers. At and as of the Effective Time, the
directors and officers of the Surviving Corporation shall be as follows:        

Directors                                             

Donald R. VanLuvanee                                  
Barry L. Harmon                                       
Larry T. Rapp                                         

Officers                                              

        Donald R. VanLuvanee     President and Chief Executive Officer
             Barry L. Harmon          Vice President and Chief Financial Officer
Larry T. Rapp            Secretary                    

1.3 Merger Consideration. Each share of AISI Common Stock outstanding 
immediately before the Effective Time (excluding each Dissenting Share as       
defined in Section 1.5.2) shall be converted into the right to receive the      
number of shares of ESI Common Stock (the "Merger Consideration") that          
corresponds to a ratio (the "Conversion Ratio") determined by dividing 1,400,000
by the sum of the total shares of AISI Common Stock outstanding on the Closing  
Date plus the total number of AISI shares subject to the Options (as defined in 
Section 1.3.4) on the Closing Date. The manner and basis of converting the      
shares of AISI Common Stock shall be as follows:                                

          1.3.1 AISI Stock. Each share of AISI Common Stock which is outstanding
immediately before the Effective Time and which is not a Dissenting Share shall,
by virtue of the Merger and without any action on the part of the holder        
thereof, cease to exist and be converted                                        

3 

424B1
126th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 126th
into the right to receive the number of shares of ESI Common Stock that         
corresponds to one multiplied by the Conversion Ratio (i.e., 1 x Conversion     
Ratio).                                                                         

       1.3.2 Stock Splits, Etc. If, between the date of this Agreement and
the Effective Time, the outstanding shares of either AISI Common Stock or ESI   
Common Stock shall have been changed into a different number of shares or a     
different class by reason of any reclassification, combination,                 
recapitalization, stock split, stock dividend, subdivision, exchange of shares, 
or other extraordinary transaction, the Conversion Ratio shall be adjusted      
proportionately.                                                                

        1.3.3 Merger Corp. Stock. Each share of Common Stock of Merger Corp.
issued and outstanding immediately prior to the Effective Time shall by virtue  
of the Merger and without any action on the part of the holder thereof, cease to
exist and be converted into and become one share of common stock of the         
Surviving Corporation. After the Effective Time, ESI, the sole holder of shares 
of Merger Corp. common stock outstanding immediately prior to the Effective     
Time, shall, upon surrender for cancellation of a certificate representing such 
shares to the Surviving Corporation, be entitled to receive in exchange         
therefore a certificate representing the number of shares of common stock of the
Surviving Corporation into which such shares of Merger Corp. common stock have  
been converted pursuant to this Section 1.3.3. Until so surrendered, the        
certificates which prior to the Merger represented shares of Merger Corp. common
stock shall be deemed, for all corporate purposes, including voting entitlement,
to evidence ownership of the shares of the Surviving Corporation common stock   
into which such shares of Merger Corp. common stock shall have been converted.  

4 

424B1
127th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 127th
          1.3.4 Options. Except as otherwise provided in this Section 1.3.4, the
terms and provisions of the stock options (the "Options") held by those AISI    
option holders identified in Schedule 3.1.2 shall continue in full force and    
effect following the Merger. By virtue of the Merger and at the Effective Time, 
and without any further action on the part of any holder thereof, each Option   
shall be assumed by ESI and shall be converted into an option to purchase the   
whole number of shares of ESI Common Stock corresponding to the number of shares
of AISI Common Stock which the holder of the Option would have been entitled to 
receive had such holder exercised the Option in full immediately prior to the   
Effective Time (whether or not such Option shall then have been exercisable),   
which number of shares shall be equal to the product (rounded to the nearest    
whole number) of (x) the number of shares of AISI Common Stock for which such   
Option is exercisable multiplied by (y) the Conversion Ratio. The exercise price
per share shall be redetermined by dividing the per share exercise price        
immediately prior to the Effective Time by the Conversion Ratio. The term,      
exercisability, vesting schedule, status as an "Incentive Stock Option" under   
Section 422 of the Code, if applicable, and all other terms and conditions of   
the Options will to the extent permitted by law and otherwise reasonably        
practicable be unchanged; each Option which is an Incentive Stock Option shall  
be adjusted in accordance with the requirements of Section 424(a) of the Code so
as not to constitute a modification, renewal or extension of the Option within  
the meaning of Section 424(h) of the Code. Continuous employment with AISI shall
be credited to the optionee for purposes of determining the vesting of the      
number of shares of ESI Common Stock subject to exercise under the optionee's   
converted Option after the Effective Time.                                      

5 

424B1
128th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 128th
1.4 Surrender and Cancellation of Certificates.                       

          1.4.1 Surrender of Certificates. After the Effective Time, each holder
of shares of AISI Common Stock outstanding immediately prior to the Effective   
Time (other than Dissenting Shares), upon surrender to ESI or its agent         
designated for such purpose of a certificate or certificates representing such  
shares, along with a transmittal letter in the form described below and stock   
powers duly endorsed in blank, shall be entitled to receive (x) a certificate   
representing the number of shares of ESI Common Stock into which such shares of 
AISI Common Stock shall have been converted pursuant to the provisions of       
Section 1.3 less the number of such shares determined to be Escrowed Property   
(as defined in Section 6.3) and (y) subject to Section 6.3 and the provisions of
the Escrow Agreement, a certificate representing the shares of ESI Common Stock 
determined to be Escrowed Property. If any certificate for shares of ESI Common 
Stock is to be issued in a name other than that in which the certificate for    
AISI Common Stock surrendered in exchange therefor is registered, it shall be a 
condition of the issuance thereof that the certificate so surrendered shall be  
properly endorsed and otherwise in proper form for transfer, and that the person
requesting such exchange pay to ESI or its agent designated for such purpose any
transfer or other taxes required, or establish to the satisfaction of ESI or its
agent that such tax has been paid or is not payable. If any holder of AISI      
Common Stock canceled and retired in accordance with this Agreement is unable to
deliver a certificate or certificates representing such shares of the holder,   
ESI, in the absence of actual notice that any shares theretofore represented by 
any such certificate have been acquired by a bona fide purchaser, shall deliver 
to such holder the number of shares of Common Stock to which such holder is     
entitled in accordance with the provisions of this Agreement upon the           
presentation of the following: (i) evidence satisfactory to                     

6 

424B1
129th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 129th
ESI (a) that such person is the owner of the shares theretofore represented by  
each certificate claimed by him to be lost, wrongfully taken or destroyed and   
(b) that he is the person who would be entitled to present each such certificate
for conversion pursuant to this Agreement; and (ii) such security or indemnity  
as may be reasonably requested by ESI to indemnify and hold ESI and the transfer
agent harmless. Promptly following the Closing, ESI's transfer agent shall      
deliver to AISI shareholders (i) a form of transmittal letter to be signed by   
each AISI shareholder providing for, among other things, transmittal of such    
shareholder's shares of AISI Common Stock to ESI's transfer agent, agreement to 
indemnification provisions contained in this Agreement, agreement to the escrow 
of shares of ESI Common Stock on behalf of such shareholder, to the extent      
provided for in Section 6.3, and the appointment of the Shareholder             
Representatives (as defined in Section 2.2); and (ii) a form of stock power to  
be endorsed in blank by each AISI Shareholder with respect to the shares of ESI 
Common Stock escrowed on behalf of such shareholder.                            

        1.4.2 Option Agreements. After the Effective Time, each holder of an
Option outstanding immediately prior to the Effective Time shall be deemed to   
hold an option exercisable for ESI Common Stock in accordance with the          
provisions of Section 1.3.4.                                                    

   1.4.3 No Fractional Shares. No certificates or scrip evidencing
fractional shares of ESI Common Stock shall be issued in the Merger, and such   
fractional share interests will not entitle the owner thereof to any rights as a
shareholder of ESI. In lieu of fractional shares, ESI shall pay each holder of  
shares of AISI Common Stock who would otherwise have been entitled to a fraction
of a share of ESI Common Stock upon surrender of stock certificates an amount of
cash (without interest) determined by multiplying (a) the Average Sale Price by 
(b) the fractional share interest in ESI Common Stock to which such holder would
otherwise be entitled. The                                                      

7 

424B1
130th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 130th
"Average Sale Price" shall mean the average of the high and low prices of ESI   
Common Stock, as reported in The Wall Street Journal, for the trading day       
immediately preceding the Closing Date.                                         

        1.4.4 Cancellation. At the Effective Time, all shares of AISI Common
Stock outstanding immediately before the Effective Time shall no longer be      
outstanding and shall automatically be canceled and retired and shall cease to  
exist, and each certificate previously evidencing any such shares shall         
thereafter represent only the right to receive the Merger Consideration. The    
holders of such certificates previously evidencing such shares of AISI Common   
Stock outstanding immediately before the Effective Time shall cease to have any 
rights with respect to such shares of AISI Common Stock, except for Dissenters  
Rights as provided in Section 1.5.                                              

      1.4.5 Treasury Shares. Each share of AISI Common Stock held in the
treasury of AISI immediately prior to the Effective Time shall be canceled and  
extinguished without any conversion thereof and no payment shall be made with   
respect thereto.                                                                

      1.4.6 Escheat. Neither ESI nor Merger Corp. shall be liable to any
holder of shares of AISI Common Stock for any such shares of ESI Common Stock   
(or dividends or distributions with respect thereto) or cash delivered to a     
public official pursuant to any applicable abandoned property, escheat or       
similar law.                                                                    

          1.4.7 Withholding Rights. ESI shall be entitled to deduct and withhold
from the Merger Consideration such amounts as ESI is required to deduct and     
withhold with respect to the making of such payment under the Code, or any      
provision of state, local or foreign tax law. To the extent that amounts are so 
withheld by ESI, such withheld amounts shall be treated for all                 

8 

424B1
131st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 131st
purposes of this Agreement as having been paid by the holder of the shares of   
AISI Common Stock in respect of which such deduction and withholding was made by
ESI.                                                                            

1.5 Dissenters' Rights.                                               

       1.5.1 Notice. AISI shareholders desiring to dissent from the Merger
and obtain payment of the fair value of their shares of AISI Common Stock       
immediately before the consummation of the Merger in lieu of the Merger         
Consideration may exercise their dissenters' rights under the provisions set    
forth at Sections 761 through 774 of the MBCA ("Dissenters' Rights"). Consistent
with Sections 764(2) and 766 of the MBCA, AISI shall notify in writing each     
shareholder entitled to assert Dissenters' Rights that action by written consent
has been taken to approve the Merger and shall provide each such shareholder the
dissenters' notice described in Section 766 of the MBCA. The date specified in  
such notice for receipt by AISI of payment demand from any shareholder          
exercising rights of dissent shall be the earliest date permitted by Section    
766(d) of the MBCA.                                                             

        1.5.2 Rights of Dissenting Shares. Shares of AISI Common Stock which
are issued and outstanding as of the Effective Time and held by any shareholder 
who has, in accordance with Section 767 of the MBCA, delivered a payment demand 
accompanied by the required certification and deposit of shares ("Dissenting    
Shares") shall not be converted as described in Section 1.3 but shall from and  
after the Effective Time represent only the right to receive such consideration 
as may be determined to be due under the MBCA. AISI shall give ESI prompt notice
upon receipt by AISI of any payment demand from any such shareholder of AISI (a 
"Dissenting Shareholder"). AISI agrees that prior to the Effective Time, it will
not, except with prior written consent of ESI, voluntarily make any payment with
respect to, or settle or offer to                                               

9 

424B1
132nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 132nd
settle, any request pursuant to the exercise of Dissenters' Rights. Each        
Dissenting Shareholder who becomes entitled, pursuant to the MBCA, to payment   
for his Dissenting Shares shall receive payment therefor in accordance with the 
MBCA. Notwithstanding the foregoing, if any Dissenting Shareholder shall        
rescind, fail to perfect or otherwise lose such rights either before or after   
the Effective Time, such shareholder's shares of AISI Common Stock shall be     
converted into ESI Common Stock or cash, as of the Effective Time, in accordance
with the provisions of Section 1.3.                                             

   1.6 Stock Transfer Books. At the Effective Time, the stock transfer books
of AISI shall be closed and there shall be no further registration of transfers 
of shares of AISI Common Stock thereafter on the records of the AISI. On or     
after the Effective Time, any certificates for AISI Common Stock presented to   
ESI or its agent for any reason shall be converted into the Merger              
Consideration.                                                                  

    1.7 Closing. The closing of the Merger (the "Closing") shall take place at
the offices of Stoel Rives LLP, 900 SW Fifth Avenue, Suite 2300, Portland,      
Oregon 97204 on the Condition Completion Date (as hereinafter defined), or on   
such other date and/or at such other place and time as AISI, ESI and Merger     
Corp. may agree (the "Closing Date"). The "Condition Completion Date" shall be  
the day on which the last of the conditions set forth in Article V hereof shall 
have been fulfilled or waived (other than those conditions which, by their      
terms, are to occur at Closing).                                                

1.8 Subsequent Actions. If, at any time after the Effective Time, the 
Surviving Corporation shall consider or be advised that any deeds, bills of     
sale, assignments, assurances or any other actions or things are necessary or   
desirable to vest, perfect or confirm of record or                              

10

424B1
133rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 133rd
otherwise in the Surviving Corporation its right, title or interest in, to, or  
under any of the rights, properties or assets of AISI or Merger Corp. acquired  
or to be acquired by the Surviving Corporation as a result of, or in connection 
with, the Merger or otherwise to carry out this Agreement, the officers and     
directors of the Surviving Corporation shall be authorized to execute and       
deliver, in the name and on behalf of AISI or Merger Corp. or otherwise, all    
such deeds, bills of sale, assignments and assurances, and to take and do, in   
the name and on behalf of AISI or Merger Corp, or otherwise, all such other     
actions and things as may be necessary or desirable to vest, perfect or confirm 
any and all right, title and interest in, to and under such rights, properties  
or assets in the Surviving Corporation or otherwise to carry out the purposes of
this Agreement.                                                                 

ARTICLE II

FURTHER AGREEMENTS

     2.1 Noncompetition and Confidentiality Agreements. AISI shall cause each of
its employees who will become employees of the Surviving Corporation to sign a  
noncompetition and confidentiality agreement (the "ESI Confidentiality          
Agreement") substantially in the form of Exhibit B.                             

2.2 Escrow Agreement. Prior to or at the Closing, ESI, the three      
representatives appointed to act for and on behalf of the AISI shareholders (the
"Shareholder Representatives"), and the AISI shareholders otherwise listed as   
signatories thereto shall execute and deliver an Escrow Agreement ("Escrow      
Agreement") substantially in the form attached as Exhibit C, and shall cause the
Escrow Agent, as such term is defined in the Escrow Agreement, to execute the   
Escrow Agreement.                                                               

11

424B1
134th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 134th
 ARTICLE III

REPRESENTATIONS AND WARRANTIES

3.1 Representations and Warranties of AISI. AISI hereby represents and
warrants to ESI and Merger Corp. that, except as specifically set forth in      
Schedule 3.1 (the "AISI Disclosure Schedule") in a numbered paragraph that      
corresponds to the section for which disclosure is made:                        

        3.1.1 Organization and Status. AISI is a corporation duly organized,
validly existing and in good standing under the laws of its jurisdiction of     
incorporation and is duly qualified and in good standing as a foreign           
corporation in each jurisdiction where its properties (whether owned, leased or 
operated) or its business conducted require such qualification, except where the
failure to so qualify or be in good standing, when taken together with all such 
failures, would not have a material adverse effect on AISI. AISI has all        
requisite corporate power and authority to own, operate and lease its property  
and to carry on its businesses as they are now being conducted. AISI has        
delivered to ESI complete and accurate copies of the Amended and Restated       
Articles of Incorporation ("Articles of Incorporation") and the Amended Bylaws  
of AISI ("Bylaws"), each as amended to the date hereof.                         

         3.1.2 Capitalization. AISI has authorized capital stock consisting of
10,000,000 shares of AISI Common Stock, of which 3,581,391 shares were          
outstanding on June 30, 1997 and options to purchase 1,010,210 shares were      
outstanding on June 30, 1997 under grants made pursuant to AISI's 1989 Incentive
Stock Option Plan, its 1991 Incentive Stock Option Plan, its 1992 Incentive     
Stock Option Plan, and its 1995 Incentive Stock Option Plan, and the three      
non-qualified stock option agreements identified in Schedule 3.1.2              
(collectively, the "AISI Stock                                                  

12

424B1
135th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 135th
Plans"). All of the outstanding shares of capital stock of AISI have been duly  
authorized and are validly issued, fully paid and nonassessable, and no shares  
were issued in violation of preemptive or similar rights of any shareholder or  
in violation of any applicable securities laws. Except as set forth above, there
are no shares of capital stock of AISI authorized, issued or outstanding, and,  
except for options granted pursuant to the AISI Stock Plans, there are no       
preemptive rights or any outstanding subscriptions, options, warrants, rights,  
convertible securities or other agreements or commitments of AISI of any        
character relating to the issued or unissued capital stock or other securities  
of AISI. There are no outstanding obligations of AISI to repurchase, redeem or  
otherwise acquire any of its outstanding shares of capital stock. The list of   
shareholders and option holders attached hereto as Schedule 3.1.2 sets forth a  
complete and accurate list of the shareholders and option holders of AISI as of 
the date hereof, indicating the number of shares of AISI Common Stock held by   
each shareholder, or subject to options in the case of option holders, and the  
percentage of the shares of all the AISI Common Stock outstanding represented by
the shares so held in the case of shareholders.                                 

         3.1.3 Corporate Authority. AISI has the corporate power and authority
and has taken all corporate action necessary to execute and deliver this        
Agreement and to consummate the transactions contemplated hereby. This Agreement
has been duly and validly authorized by the Board of Directors of AISI, validly 
executed and delivered by AISI and, as of the Closing Date, will have been duly 
and validly approved by the shareholders of AISI. This Agreement constitutes the
valid and binding obligation of AISI, enforceable in accordance with its terms, 
except as enforcement may be limited by applicable bankruptcy, insolvency,      
reorganization, moratorium or similar laws affecting the enforcement of         
creditors' rights generally and except that                                     

13

424B1
136th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 136th
the availability of the equitable remedy of specific performance or injunctive  
relief is subject to the discretion of the court before which any proceeding may
be brought.                                                                     

        3.1.4 Governmental Filings. Other than (a) the filing of Articles of
Merger contemplated by Article I and (b) the HSR Filing described in Section    
4.2.4, no notices, reports or other filings are required to be made by AISI     
with, nor are any consents, registrations, approvals, permits or authorizations 
required to be obtained by AISI from, any domestic or foreign governmental or   
regulatory authority, agency, court, commission or other entity ("Governmental  
Entity") in connection with the execution and delivery of this Agreement by AISI
and the consummation by AISI of the transactions contemplated hereby.           

          3.1.5 Investments; Subsidiaries. All direct or indirect investments of
AISI in any corporation, partnership, association, joint venture or other entity
are listed in Schedule 3.1.5. AISI has no subsidiaries.                         

        3.1.6 No Adverse Consequences. Neither the execution and delivery of
this Agreement by AISI nor the consummation of the transactions contemplated by 
this Agreement will (a) result in the creation or imposition of any lien,       
charge, encumbrance or restriction on any of the assets or properties of AISI,  
(b) violate any provision of the Articles of Incorporation or Bylaws of AISI,   
(c) violate any statute, judgment, order, injunction, decree, rule, regulation  
or ruling of any governmental authority applicable to AISI, or (d) either alone 
or with the giving of notice or the passage of time or both, conflict with,     
constitute grounds for termination of, accelerate the performance required by,  
accelerate the maturity of any indebtedness or obligation under, result in the  
breach of the terms, conditions or provisions of or constitute a default under  

14

424B1
137th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 137th
any mortgage, deed of trust, indenture, note, bond, lease, license, permit or   
other agreement, instrument or obligation to which AISI is a party or by which  
it is bound.                                                                    

    3.1.7 Financial Statements. AISI has furnished to ESI an audited
balance sheet of AISI as of December 31, 1996, and the related statements of    
income, stockholders' equity and cash flows for the period then ended, and the  
unaudited balance sheet of AISI as of June 30, 1997 (the "Current Balance       
Sheet") and the related statements of income and stockholders' equity for the   
six months then ended, and the financial statements delivered at or before the  
Closing pursuant to Section 5.3.16 (all such balance sheets and statements      
collectively, the "Financial Statements"). The Financial Statements are complete
and accurate in all material respects and present fairly the financial position 
and operating results of AISI as of the dates and for the periods indicated     
therein, and have been prepared in accordance with generally accepted accounting
principles.                                                                     

          3.1.8 Undisclosed Liabilities; Returns. Except for current liabilities
which were incurred after June 30, 1997 in the ordinary course of business and  
of a type and in an amount both consistent with past practices and not material 
(either individually or in the aggregate), AISI has no liability or obligation  
(whether absolute, accrued, contingent or otherwise, and whether due or to      
become due) which is not accrued, Reserved against, or identified in the Current
Balance Sheet. "Reserves" or "Reserved" in this Agreement shall mean the        
aggregate amount of AISI reserves for the specific item or matter referred to,  
as the context requires, plus the amount of the undifferentiated AISI reserve   
recorded in AISI's general ledger Account No. 2390 as of June 30, 1997, but only
to the extent such reserves are not otherwise used in complying with any other  
representation or warranty. There are no rights of return or other agreements   
between AISI and any customer which would cause any sales reflected in the      
Financial Statements                                                            

15

424B1
138th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 138th
to fail to qualify as sales in accordance with generally accepted accounting    
principles and AISI's revenue recognition policy as reflected in the Financial  
Statements.                                                                     

       3.1.9 Absence of Certain Changes or Events. Since December 31, 1996
there has not been:                                                             

(a) Any material adverse change in the business, results of 
operations, financial condition, properties, assets or prospects of AISI;       

         (b) Any material damage, destruction, requisition, taking or casualty
loss, whether or not covered by insurance, of or to any of the assets or        
properties of AISI;                                                             

       (c) Any direct or indirect declaration, setting aside or payment of
any dividend or other distribution (whether in cash, stock, property or any     
combination thereof) in respect of the AISI Common Stock, or any direct or      
indirect repurchase, redemption or other acquisition by AISI of any shares of   
its stock;                                                                      

          (d) Other than as disclosed pursuant to Section 3.1.13.4, any increase
in the rate or terms of compensation payable or to become payable by AISI to its
directors, officers or employees; any change in the rate or terms of any bonus, 
insurance, pension or other employee benefit plan, payment or arrangement made  
to, for or with any employees of AISI; any special bonus or remuneration paid;  
any written employment contract executed or amended; or any change in personnel 
policies;                                                                       

(e) Any entry into any agreement, commitment or transaction 
(including, without limitation, any license of intellectual property, any       
borrowing, capital expenditure or capital financing, any purchase, acquisition, 
sale or other disposition of assets (other than inventory in the ordinary course
of business), any lease or sublease, any guaranty, assumption or                

16

424B1
139th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 139th
endorsement of payment or performance of any loan or obligation of another, or  
any amendment, modification or termination of any existing agreement, commitment
or transaction) by AISI as contemplated in this Agreement;                      

          (f) Any change by AISI in accounting methods, principles or practices;

       (g) Any issuance or sale of any stock of AISI (other than issuances
pursuant to the exercise of options outstanding on June 30, 1997) or any        
issuance or granting of any option, warrant or right to purchase any stock of   
AISI (other than options granted under the AISI Stock Plans on or before June   
30, 1997) or any commitment to do any of the foregoing;                         

         (h) Any amendment to the Articles of Incorporation or Bylaws of AISI;

       (i) Any conduct of business which is outside the ordinary course of
business or not substantially in the manner that AISI previously conducted its  
business;                                                                       

    (j) Any encumbrance or consent to encumbrance of any property or
assets;                                                                         

(k) Any pending or threatened labor disputes, organizational
activities or disturbances;                                                     

         (l) Any indication from any customer of AISI which purchased $500,000
or more of products or services from AISI in the year ended December 31, 1996   
that such customer intends to, is desirous of, or is actively considering       
terminating or reducing its purchases from AISI for any reason; or              

  (m) Any change not described above in the assets, liabilities,
licenses, permits or franchises of AISI, or in any agreement to which AISI is a 
party or is bound, which, either individually or in the aggregate, has had or   
reasonably could be expected to have a material                                 

17

424B1
140th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 140th
adverse effect on the business, results of operations, financial condition,     
properties, assets or prospects of AISI.                                        

          3.1.10 Prohibited Payments. Neither AISI nor any shareholder, officer,
director or other person or entity has, directly or indirectly, on behalf of or 
with respect to the business or operations of AISI, (a) made any payment outside
the ordinary course of business to any purchasing or selling agent or person    
charged with similar duties of any entity to which AISI sells or from which AISI
buys products, for the purpose of influencing such agent or person to buy       
products from or sell products to AISI; or (b) otherwise made or received any   
payment that was not legal to make or receive under any applicable law or       
regulation of the United States or any other country or territory; or (c)       
engaged in any transaction, maintained any bank account, or used any corporate  
funds or assets except for transactions, bank accounts, funds, and assets which 
have been and are reflected in the normally maintained books and records of     
AISI.                                                                           

3.1.11 Litigation. No litigation, proceeding or governmental
investigation is pending or, to the knowledge of AISI, threatened against or    
relating to AISI, its officers or directors in their capacities as such, or any 
of AISI's properties or businesses.                                             

          3.1.12 Compliance with Laws; Judgments. AISI has at all relevant times
conducted its business in compliance with the provisions of its Articles of     
Incorporation, Bylaws, and all applicable laws, regulations and standards,      
including without limitation the United States Export Control Act and all       
applicable regulations promulgated by the U.S. Department of Health and Human   
Services and the Federal Communications Commission and foreign counterparts to  
such laws and regulations. AISI is not in violation of any applicable laws or   
regulations, other than violations which individually or in the aggregate do    
not, and, with the passage of time will                                         

18

424B1
141st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 141st
not, have a material adverse effect on its business, financial condition,       
results of operations, properties, assets or prospects. AISI is not subject to  
any outstanding judgment, order, writ, injunction or decree and has not been    
charged with, or threatened with a charge of, a violation of any provision of   
any applicable law or regulation.                                               

3.1.13 Employment Matters.                                  

              3.1.13.1 Labor Matters. AISI is not a party or otherwise subject
to any collective bargaining or other agreement governing the wages, hours or   
terms of employment of its employees. AISI is and has been in compliance with   
all applicable laws regarding employment and employment practices, terms and    
conditions of employment, wages and hours and is not and has not been engaged in
any unfair labor practice. There is no (a) unfair labor practice complaint      
against AISI pending before the National Labor Relations Board or any other     
Governmental Entity, (b) labor strike, slowdown or work stoppage actually       
occurring or, to the knowledge of AISI, threatened against AISI, (c)            
representation petition respecting the employees of AISI pending before the     
National Labor Relations Board or similar agency, or (d) grievance or any       
arbitration proceeding pending arising out of or under collective bargaining    
agreements applicable to AISI. AISI has not experienced any primary work        
stoppage or other organized work stoppage involving its employees in the past   
two years. AISI is not aware of any labor strike, slowdown, or work stoppage    
occurring or, to the knowledge of AISI, threatened against any of its principal 
suppliers that might be expected to have a material adverse effect on the       
business, financial condition, results of operations, properties, or assets of  
AISI.                                                                           

              3.1.13.2 Employee Benefits. Schedule 3.1.13.2 lists all pension,
retirement, profit sharing, deferred compensation, bonus, commission, incentive 
compensation                                                                    

19

424B1
142nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 142nd
(including cash, stock and option plans or arrangements), life insurance, health
and disability insurance, hospitalization and all other employee benefit plans  
or arrangements (including, without limitation, any contracts or agreements with
trustees, insurance companies or others relating to any such employee benefit   
plans or arrangements) established or maintained by AISI, and complete and      
accurate copies of all those plans or arrangements have been provided to ESI.   
The employee pension benefit plans (within the meaning of Section 3(2) of the   
Employee Retirement Income Security Act of 1974, as amended ("ERISA"))          
established and maintained by AISI that are subject to ERISA (the "ERISA Plans")
are listed separately as ERISA Plans on Schedule 3.1.13.2. The ERISA Plans      
comply in all material respects with the applicable requirements of ERISA. AISI 
has received from the Internal Revenue Service a favorable determination for    
each of the ERISA Plans and their related trusts that each of the ERISA Plans is
qualified under Section 401(a) of the Code and the related trust is tax-exempt  
under Section 501(a) of the Code. There has been no event subsequent to that    
determination that has adversely affected the tax qualified status of the ERISA 
Plans or the exemption of the related trusts other than changes in the Code that
are not effective as of the Closing Date. None of the ERISA Plans, its related  
trusts or any trustee, investment manager or administrator thereof has engaged  
in a nonexempt "prohibited transaction," as such term is defined in Section 406 
of ERISA and Section 4975 of the Code. There are not and have not been any      
excess deferrals or excess contributions under any ERISA Plan. Each ERISA Plan  
is and has been operated and administered in conformity with the requirements of
all applicable laws and regulations, whether or not the ERISA Plan documents    
have been amended to reflect such requirements. AISI has no obligation of any   
kind (whether under the terms of the ERISA Plans or under any understanding with
employees) to make payments under, or to pay                                    

20

424B1
143rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 143rd
contributions to, any plan, agreement or other arrangement for deferred         
compensation of employees, whether or not tax qualified, including, without     
limitation, a single employer tax qualified plan, a tax qualified plan of a     
controlled group of corporations, a multiemployer pension plan, a "defined      
benefit" plan, a nonqualified deferred compensation plan, an individual         
employment or compensation agreement or a commitment to provide medical benefits
to retirees.                                                                    

         3.1.13.3 Employment Agreements. Each employee of AISI is an
"at-will" employee and there are no written employment, commission or           
compensation agreements of any kind between AISI and any of its employees.      
Schedule 3.1.13.3 lists all AISI's employment or supervisory manuals, employment
or supervisory policies, and written information generally provided to employees
(such as applications or notices), and complete and accurate copies of those    
manuals, policies and written information have been provided to ESI. AISI does  
not have any agreements or understandings with its employees, including without 
limitation any agreements or understandings regarding compensation of any       
nature, severance payments or retirement benefits, except as reflected in the   
items listed in Schedules 3.1.13.2 and 3.1.13.4.                                

              3.1.13.4 Compensation. Schedule 3.1.13.4 contains a complete and
accurate list of all current directors, officers, employees or consultants of   
AISI, specifying their names and job designations, the total amount paid or     
payable as cash and noncash compensation to each such person, and the basis of  
such compensation, whether fixed or commission or a combination thereof, and the
total amount of accrued benefits (including without limitation vacation, sick or
wellness pay) for such persons as of December 31, 1996 and as of August 31,     
1997. Except as set forth in Schedules 3.1.13.2, 3.1.13.3 or the agreements     
described in Section 3.1.13.5, AISI is not a party to any employment contract or
agreement and has not made any other                                            

21

424B1
144th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 144th
commitment entitling any employee to any payment in the event of termination or 
resignation that would constitute a "parachute payment" within the meaning of   
Section 280G of the Code or would in the aggregate exceed 100 percent of such   
person's annual base cash compensation. The provisions for wages and salaries   
accrued on the Current Balance Sheet are adequate for salaries and wages,       
including accrued vacation pay and sick or wellness pay, and AISI has accrued on
its books and records all obligations for wages and salaries and other          
compensation to its employees, including but not limited to, vacation pay and   
sick or wellness pay, and all commissions and other fees payable to agents,     
salesmen, and representatives.                                                  

               3.1.13.5 Confidentiality and Inventions Agreements. Each employee
or consultant of AISI has previously signed a confidentiality and invention     
agreement in the form or forms attached hereto as Exhibit D.                    

         3.1.14 Title to and Condition of Real Property. AISI does not own any
real property. Schedule 3.1.14 contains a list of all real property currently   
leased or occupied by AISI (the "Leased Real Property"), including the dates of 
and parties to all leases and any amendments thereof and a list of all real     
property previously leased or occupied by AISI (the "Previously Leased Real     
Property"). To the knowledge of AISI, all Leased Real Property (including       
improvements thereon) is in satisfactory condition and repair consistent with   
its present use, and is available for immediate use in the conduct of AISI's    
business. To the knowledge of AISI, neither the operations of AISI on any Leased
Real Property, nor any improvements on the Leased Real Property, violates any   
applicable building or zoning code or regulation of any governmental authority  
having jurisdiction. The Leased Real Property includes all such property        
necessary to conduct the business of AISI.                                      

22

424B1
145th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 145th
  3.1.15 Title to and Condition of Fixed Assets. Schedule 3.1.15
contains a complete and accurate list of all tangible personal property         
(excluding inventory) owned or leased by AISI (the "Tangible Personal           
Property"), including the dates of and parties to all leases and any amendments 
thereof. AISI has good and marketable title to all of the Tangible Personal     
Property listed in Schedule 3.1.15, free and clear of all liens, mortgages,     
pledges, leases, restrictions and other claims and encumbrances of any nature   
whatsoever. The Tangible Personal Property is in good operating condition and   
repair (ordinary wear and tear excepted), is performing satisfactorily, and is  
adequate for the conduct of the business of AISI. All Tangible Personal Property
and the state of maintenance thereof are in compliance with all applicable laws 
and regulations.                                                                

      3.1.16 Intellectual Property. AISI owns, or has a valid license to
use, all patents, trademarks, service marks, trade names, copyrights, trade     
secrets, technology, know-how and other intellectual property (the "Intellectual
Property") necessary to or used in the conduct of the business of AISI as now   
conducted and as proposed to be conducted. Schedule 3.1.16 contains a complete  
and accurate list of all patents, patent applications, trademarks and service   
marks and related applications, trade names and copyrights owned by or licensed 
to AISI. Schedule 3.1.16 also contains a description of all agreements or       
licenses relating to the acquisition by or license to AISI of such Intellectual 
Property or under which AISI has sold or granted a right to use any Intellectual
Property. All Intellectual Property owned by AISI is owned by it free and clear 
of all liens, claims, encumbrances or adverse claims of any third party (other  
than infringement claims). The conduct of AISI's business does not, to the      
knowledge of AISI, conflict with or infringe upon                               

23

424B1
146th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 146th
any Intellectual Property rights of any other person and no claims of conflict  
or infringement are pending or threatened against AISI.                         

        3.1.17 Certain Contracts and Arrangements. Schedule 3.1.17, which is
organized by type of agreement, contains a complete and accurate list of each of
the following types of agreements or arrangements, including any amendments     
thereto, to which AISI is a party or by which it is bound:                      

       (a) any mortgage, note or other instrument or agreement relating to
the borrowing of money or the incurrence of indebtedness or the guaranty of any 
obligation for the borrowing of money;                                          

          (b) any contract, agreement, purchase order or acknowledgment form for
the purchase, sale, lease or other disposition of equipment, products, materials
or capital assets, or for the performance of services (including without        
limitation consulting services), with respect to which the annual aggregate     
dollar amount either due to or payable by AISI exceeds $20,000;                 

    (c) contracts or agreements for the joint performance of work or
services, and all other joint venture agreements;                               

       (d) contracts or agreements with agents, brokers, consignees, sales
representatives or distributors relating to the sale of products or services;   

        (e) confidentiality or inventions assignment agreements with parties
other than employees of AISI; and                                               

   (f) any other contract, instrument, agreement or obligation not
described in any other Schedule which contains unfulfilled obligations, is not  
terminable without payment of                                                   

24

424B1
147th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 147th
premium or penalty upon 30 days' notice or less and the annual amount either due
to or payable by AISI exceeds $20,000 for any single contract or $50,000 in the 
aggregate.                                                                      

  3.1.18 Status of Contracts. Each of the contracts, agreements,
commitments and instruments listed on Schedules 3.1.14, 3.1.15, 3.1.16, and     
3.1.17 and the agreements described in Section 3.1.13.5 (collectively, the      
"Contracts") is in full force and effect and is valid, binding and enforceable  
by AISI in accordance with its terms, except as enforcement may be limited by   
applicable bankruptcy, insolvency, reorganization, moratorium or similar laws   
affecting the enforcement of creditors' rights generally and except that the    
availability of the equitable remedy of specific performance or injunctive      
relief is subject to the discretion of the court before which any proceeding may
be brought. There is no existing material default or violation by AISI under any
Contract and no event has occurred which (whether with or without notice, lapse 
of time or both) would constitute a material default of AISI under any Contract.
There is no pending or threatened proceeding which would interfere with the     
quiet enjoyment of any leasehold of which AISI is lessee or sublessee. All other
parties to the Contracts have consented or prior to the Closing will have       
consented (where such consent is necessary) to the consummation of the          
transactions contemplated by this Agreement without modification of the rights  
or obligations of AISI under any Contract. Complete and accurate copies of all  
Contracts have been delivered to ESI. AISI is not aware of any default by any   
other party to any Contract or of any event which (whether with or without      
notice, lapse of time or both) would constitute a material default by any other 
party with respect to obligations of that party under any Contract, and, to the 
knowledge of AISI, there are no facts that exist indicating that any of the     
Contracts may be totally or partially terminated or suspended by the other      
parties. AISI has not granted any waiver or forbearance with                    

25

424B1
148th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 148th
respect to any of the Contracts. AISI is not a party to, or bound by, any       
Contract that AISI can reasonably foresee will result in any material loss to   
AISI upon the performance thereof (including any liability for penalties or     
damages, whether liquidated, direct, indirect, incidental or consequential).    

      3.1.19 Insurance. Schedule 3.1.19 contains a complete and accurate
list of all policies of fire, liability, worker's compensation and other forms  
of insurance insuring AISI, its officers or directors, its assets or its        
operations (the "Policies"), setting forth the applicable deductible amounts.   
All the Policies are valid, enforceable and in full force and effect, all       
premiums with respect to the Policies covering all periods up to and including  
the date as of which this representation is being made have been paid and no    
notice of cancellation or termination has been received with respect to any     
Policy. The Policies are sufficient for compliance with all requirements of law 
and agreements to which AISI is a party and provide insurance for the risks and 
in the amounts and types of coverage usually obtained by persons using or       
holding similar properties in similar businesses. There have been no claims made
for insurance payment under any of the Policies in the three years preceding the
date of this Agreement. Complete and accurate copies of the Policies and all    
endorsements thereto have been delivered to ESI. AISI has not been refused any  
insurance coverage and no insurance coverage has been canceled during the three 
years preceding the date of this Agreement.                                     

        3.1.20 Permits and Licenses. Schedule 3.1.20 contains a complete and
accurate list of all governmental licenses, permits, franchises, easements and  
authorizations (collectively, "Permits") held by AISI, listed by governmental   
entity. AISI holds, and at all times has held, all material Permits necessary   
for the lawful conduct of its business pursuant to all applicable statutes,     

26

424B1
149th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 149th
laws, ordinances, rules and regulations of all governmental bodies, agencies and
other authorities having jurisdiction over it or any part of its operations.    
AISI is in compliance with each of the terms of the Permits listed on Schedule  
3.1.20, and there are no claims of violation by AISI of any of such Permits     
except where any such failure so to comply or violation, individually or in the 
aggregate with any other failures to comply or violations, either with or       
without the giving of notice or the passage of time or both, would not have a   
material adverse effect on the business, results of operation, financial        
condition, properties, assets or prospects of AISI. Complete and accurate copies
of all Permits held by AISI have been delivered to ESI. All governmental        
entities and agencies that have issued any Permits to or with respect to AISI or
its business have consented or prior to the Closing will have consented (where  
such consent is necessary) to the consummation of the transactions contemplated 
by this Agreement without requiring modification of the rights or obligations of
AISI under any of such Permits.                                                 

3.1.21 Taxes.                                               

             3.1.21.1 Returns. AISI has filed on a timely basis all federal,
state, foreign and other returns, reports, forms, declarations and information  
returns required to be filed by it with respect to Taxes (as defined below)     
which relate to the business, results of operations, financial condition,       
properties or assets of AISI (collectively, the "Returns") and has paid on a    
timely basis all Taxes shown to be due on the Returns. AISI is not part of an   
affiliated group of corporations that files or has the privilege of filing      
consolidated tax returns pursuant to Section 1501 of the Code or any similar    
provisions of state, local or foreign law, and AISI is not a party to any       
tax-sharing or tax-allocation agreement. No extensions of time have been        
requested for Returns which have not been filed except as set forth on Schedule 
3.1.21. No Returns have been                                                    

27

424B1
150th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 150th
examined by the applicable taxing authorities for all periods to and including  
the fiscal year ended December 31, 1996 and, except as set forth on Schedule    
3.1.21, AISI has not received any notice of audit and there are no outstanding  
agreements or waivers extending the applicable statutory periods of limitation  
for such Taxes for any period. All Returns filed are complete and accurate in   
all respects and no additional Taxes are owed by AISI with respect to the       
periods covered by the Returns. AISI has provided ESI with complete and accurate
copies of Returns for each of AISI's fiscal years 1991 through 1996 and the     
Forms 1139 related to any loss or credit or carryback claim for those years.    

            3.1.21.2 Taxes Paid or Reserved. The Reserves reflected in the
Current Balance Sheet are adequate for payment of Taxes in respect of periods   
ending on or before the date of the Current Balance Sheet. All reserves for     
Taxes have been determined in accordance with generally accepted accounting     
principles consistently applied throughout the periods involved and with prior  
periods. All Taxes which AISI has been required to collect or withhold have been
withheld or collected and, to the extent required, have been paid to the proper 
taxing authority. AISI has not elected to be treated as a consenting corporation
pursuant to Section 341(f) of the Code.                                         

           3.1.21.3 Definition. The term "Taxes" shall mean all federal,
state, local or foreign taxes, charges, fees, levies or other assessments,      
including, without limitation, all net income, gross income, gross receipts,    
premium, sales, use, ad valorem, transfer, franchise, profits, license,         
withholding, payroll, employment, excise, estimated severance, stamp,           
occupation, property or other taxes, fees, assessments or charges of any kind   
whatsoever, together                                                            

28

424B1
151st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 151st
with any interest and any penalties (including penalties for failure to file in 
accordance with applicable information reporting requirements), and additions to
tax.                                                                            

        3.1.22 Related Party Interests. Except as listed in Schedule 3.1.22,
no shareholder, officer or director of AISI (or any entity owned or controlled  
by one or more of such parties) (a) has any interest in any property, real or   
personal, tangible or intangible, used in or pertaining to AISI's business, (b) 
is indebted to AISI, or (c) has any material financial interest, direct or      
indirect, in any supplier or customer of, or other outside business which has   
significant transactions with AISI. True and complete copies of all agreements  
listed on Schedule 3.1.22 have been provided to ESI. AISI is not indebted to any
of its shareholders, directors or officers (or any entity owned or controlled by
one or more of such parties) except for amounts due under normal salary         
arrangements and for reimbursement of ordinary business expenses. The           
consummation of the transactions contemplated by this Agreement will not (either
alone or upon the occurrence of any act or event, or with the lapse of time, or 
both) result in any payment (severance or other) becoming due from AISI to any  
of its shareholders, officers, directors or employees (or any entity owned or   
controlled by one or more of such parties).                                     

         3.1.23 No Powers of Attorney or Restrictions. No power of attorney or
similar authorization given by AISI is presently in effect or outstanding. No   
contract or agreement to which AISI is a party or is bound or to which any of   
its properties or assets is subject limits the freedom of AISI to compete in any
line of business or with any person. None of the employees of AISI is obligated 
under any contract (including licenses, covenants or commitments of any nature),
or subject to any judgment, decree or order of any court or administrative      
agency, that                                                                    

29

424B1
152nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 152nd
would interfere with the use of his or her best efforts to promote the interests
of AISI or that would conflict with the business of AISI as now conducted or    
proposed to be conducted.                                                       

3.1.24 Environmental Conditions.                            

             3.1.24.1 Compliance. The business and assets of AISI, including
without limitation the Leased Real Property and the Previously Leased Real      
Property (during the period of AISI's use only), are and have been in compliance
with all Environmental Laws and all Permits required under any Environmental Law
are listed separately in Schedule 3.1.20. There are no pending or, to the       
knowledge of AISI, threatened claims, actions or proceedings against AISI under 
any Environmental Law or related Permit. All wastes generated in connection with
AISI's business are and have been transported and disposed of off-site in       
compliance with all Environmental Laws, and true and correct logs of such       
transportation and disposal have been made available to ESI.                    

            3.1.24.2 Hazardous Substances. No Hazardous Substance has been
disposed of, spilled, leaked or otherwise released on, in, under or from the    
Leased Real Property or the Previously Leased Real Property (during the period  
of AISI's use only) or has otherwise come to be located in the soil or water    
(including surface and ground water) on or under the Leased Real Property or the
Previously Leased Real Property (during the period of AISI's use only). None of 
the assets of AISI or the improvements on the Leased Real Property or the       
Previously Leased Real Property (attributable to AISI) have incorporated into   
them any asbestos, urea formaldehyde foam insulation, polychlorinated biphenyls 
(including in any electrical transformer or capacitor located on such property),
or any other Hazardous Substance which is prohibited, restricted or regulated   
when present in buildings, structures, fixtures or equipment.                   

30

424B1
153rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 153rd
No Hazardous Substance is or has been generated, manufactured, treated, stored, 
transported, used or otherwise handled on the Leased Real Property or the       
Previously Leased Real Property (during the period of AISI's use only) or in    
connection with the business of AISI. There are no underground storage tanks on 
the Real Property (whether or not regulated and whether or not out of service,  
closed or decommissioned), other than a septic tank previously used only for    
sanitary waste, the use of which has been discontinued in compliance with       
Michigan law.                                                                   

              3.1.24.3 Filings and Notices. AISI has timely filed all required
reports, obtained all required approvals and permits, and generated and         
maintained all required data, documentation and records under all applicable    
Environmental Laws. All notifications required by any Environmental Law in      
respect of any discharge, release or emission, including any notices required to
be provided under applicable Michigan law, if any, have been made within the    
time prescribed by such Environmental Law, and copies of all such notifications 
have been provided to ESI. No part of the Leased Real Property or, to the       
knowledge of AISI, the Previously Leased Real Property is listed as a site      
contaminated by Hazardous Substances pursuant to any Environmental Law.         

  3.1.24.4 Definitions. As used in this Agreement, (a)
"Environmental Law" means any federal, state, foreign or local statute,         
ordinance or regulation pertaining to the protection of human health or the     
environment and any applicable orders, judgments, decrees, permits, licenses or 
other authorizations or mandates under such statutes, ordinances or regulations,
and (b) "Hazardous Substance" means any hazardous, toxic, radioactive or        
infectious substance, material or waste as defined, listed or regulated under   
any Environmental Law, and includes without limitation radioactive material.    

31

424B1
154th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 154th
        3.1.25 Consents and Approvals. Except as set forth in Sections 3.1.4
and 5.2.5, no consent, approval, or authorization of, or filing or registration 
with, any court, regulatory authority, governmental body, or any other entity or
person not a party to this Agreement is required to be obtained by AISI for the 
consummation of the transactions described in this Agreement.                   

         3.1.26 Records. The books of account, minute books, stock certificate
books and stock transfer ledgers of AISI are complete and accurate in all       
material respects, and there has been no transaction involving the business or  
stock ownership of AISI, or action of AISI's board of directors or shareholders,
which properly should have been set forth therein and which has not been        
accurately so set forth. Complete and accurate copies of such books, records and
ledgers have been made available to ESI.                                        

  3.1.27 Receivables. Each of the receivables of AISI (including
accounts receivable, loans receivable and advances) that is reflected in the    
Current Balance Sheet, and each of the receivables that has arisen since that   
date, has arisen only from bona fide transactions in the ordinary course of     
AISI's business and shall be fully collected when due, or in the case of each   
account receivable, within 90 days after it arose, without resort to litigation 
and without offset or counterclaim, except to the extent of the normal allowance
for doubtful accounts with respect to accounts receivable, consistent with      
AISI's prior practices, as reflected in the Current Balance Sheet.              

          3.1.28 Bank Accounts. Schedule 3.1.28 contains a complete and accurate
list of all the banks or other financial institutions at which AISI maintains   
accounts or safe deposit boxes, together with numbers of such accounts and boxes
and the names of the persons authorized                                         

32

424B1
155th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 155th
to draw thereon or permitted access thereto. All cash in such accounts is held  
in demand deposits and is not subject to any restriction or limitation as to    
withdrawal.                                                                     

       3.1.29 Product Warranties. Schedule 3.1.29 contains AISI's standard
form of product warranty, infringement indemnity and limitation of liability    
provisions and a copy of each negotiated warranty, indemnity and limitations    
provision that differs materially from the standard form. AISI has not          
undertaken any performance obligations or made any warranties or guarantees with
respect to its products other than those disclosed in Schedule 3.1.29, or sold  
any products or services without the limitation of liability provisions         
disclosed in Schedule 3.1.29. The aggregate cost to AISI to comply with its     
product warranties has not and is not anticipated to exceed 2.0 percent of total
revenue, as reported in AISI's audited financial statements, for any fiscal     
year. All products under warranty as of the date of this Agreement, serviced,   
distributed or sold by AISI, and the delivery thereof, have been in conformity  
with AISI's warranty commitments.                                               

         3.1.30 Inventories. Schedule 3.1.30 contains a true and complete list
and summary of all inventory of AISI as of June 30, 1997. All inventories,      
whether finished goods, work in process or raw materials, reflected on the      
Current Balance Sheet or thereafter acquired, are all items of a quality usable 
or saleable in the ordinary and usual course of AISI's business, except for     
inventory items that have been written down to an amount not in excess of       
realizable market value or for which adequate Reserves or allowances have been  
provided on the Current Balance Sheet. The values at which inventories are      
carried reflect an inventory valuation policy consistent with AISI's past       
practice and in accordance with generally accepted accounting principles. AISI  
has good and marketable title to all its inventories, free and clear of all     
liens,                                                                          

33

424B1
156th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 156th
mortgages, pledges, leases, restrictions and other claims and encumbrances of   
any nature whatsoever.                                                          

3.1.31 Product Liability. AISI has not recalled any products
manufactured, serviced, distributed, leased, or sold by AISI, and there is no   
reasonable basis known to AISI for any such recall on or after the Closing Date.

          3.1.32 Backlog and Customer Information. Schedule 3.1.32 shows (a) the
aggregate backlog, including sales price, product cost and gross margin, and the
backlog by customer and product, for AISI as of August 31, 1997 and (b) a list  
of the top ten AISI customers for each of the last two fiscal years, with       
aggregate annual revenue for each customer for each year.                       

   3.1.33 Accounting Controls. AISI maintains a system of internal
accounting controls sufficient to provide reasonable assurances that (i)        
transactions are executed in accordance with management's general or specific   
authorizations, (ii) transactions are recorded as necessary to permit           
preparation of financial statements in conformity with generally accepted       
accounting principles and to maintain accountability for assets, (iii) access to
assets is permitted only in accordance with management's general or specific    
authorization, and (iv) the recorded accountability for assets is compared with 
existing assets at reasonable intervals and appropriate action is taken with    
respect to any differences.                                                     

       3.1.34 Brokers and Finders. AISI has not incurred any liability for
any brokerage or investment banking fees, commissions or finders' fees in       
connection with the Merger.                                                     

34

424B1
157th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 157th
         3.1.35 Reliance. AISI recognizes and agrees that, notwithstanding any
investigation by ESI, ESI is relying upon the representations and warranties    
made by AISI in this Agreement.                                                 

  3.1.36 Accuracy of Representations and Warranties. None of the
representations or warranties of AISI contained in this Agreement contains or   
will contain any untrue statement of any material fact or omits or misstates a  
material fact necessary to make the statements contained in this Agreement not  
misleading. AISI knows of no fact that has resulted or that, in the reasonable  
judgment of AISI may result, in any material adverse change in AISI's business, 
results of operation, financial condition, properties, assets or prospects that 
has not been set forth in this Agreement.                                       

        3.1.37 Prospectus/Information Statement. The information provided in
writing by AISI (or its representatives) regarding AISI specifically to be      
contained in the Prospectus/Information Statement (as defined in Section 4.2.5) 
to be mailed to shareholders of AISI pursuant to Section 4.2.5 hereof and such  
AISI information supplemented or reviewed by AISI (or its representatives)      
without objection prior to the mailing of such Prospectus/Information Statement,
will be correct in all material respects and will not omit any material fact    
required to be stated therein or necessary in order to make the statements      
therein not misleading; provided, however, that no representation is made by    
AISI with respect to information supplied by ESI specifically for inclusion     
therein or relating to and reviewed by ESI (or its representatives) without     
objection. AISI will promptly inform ESI of the happening of any event prior to 
the Effective Time which would render such information regarding AISI, incorrect
in any material respect or require the amendment of the Prospectus/Information  
Statement.                                                                      

35

424B1
158th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 158th
        3.1.38 Continuity of Business Enterprise. AISI operates at least one
significant historic business line, or owns at least a significant portion of   
its historic business assets, in each case within the meaning of Treasury       
Regulation ss. 1.368-1(d).                                                      

         3.1.39 1998 Forecast. The AISI 1998 forecast dated September 19, 1997
(the "1998 Forecast") provided to ESI was prepared by AISI in good faith, is    
based on reasonable assumptions and represents AISI's best estimate of its      
future results. To the best of AISI's knowledge, no assumption underlying the   
1998 Forecast has changed.                                                      

3.2 Representations and Warranties of ESI. ESI hereby represents and  
warrants to AISI that, except as specifically set forth in Schedule 3.2 (the    
"ESI Disclosure Schedule") in a numbered paragraph that corresponds to the      
section for which disclosure is made:                                           

        3.2.1 Organization and Status. Each of ESI and its subsidiaries is a
corporation duly organized and validly existing under the laws of its           
jurisdiction of incorporation and is duly qualified and in good standing as a   
foreign corporation in each jurisdiction where the properties owned, leased or  
operated, or the business conducted, by it require such qualification, except   
where the failure to so qualify or be in good standing, when taken together with
all such failures, would not have a material adverse effect on ESI. Each of ESI 
and its subsidiaries has all requisite corporate power and authority to own,    
operate and lease its property and to carry on its businesses as they are now   
being conducted.                                                                

        3.2.2 Capitalization. ESI has authorized capital stock consisting of
40,000,000 shares of Common Stock, without par value, of which 9,853,000 shares 
were outstanding on July 15, 1997 and 1,000,000 shares of Preferred Stock, of   
which no shares were outstanding on July 15, 1997. All of the outstanding shares
of capital stock of ESI have been duly authorized and are                       

36

424B1
159th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 159th
validly issued, fully paid and nonassessable, and no shares were issued in      
violation of preemptive or similar rights of any shareholder. Except under the  
terms of the various ESI employee or director benefit plans, or as disclosed in 
the ESI SEC Reports (defined in Section 3.2.5) there are no subscriptions,      
options, warrants, rights, convertible securities or other agreements or        
commitments of any character obligating ESI to issue any shares of capital      
stock.                                                                          

        3.2.3 Corporate Authority. ESI has the corporate power and authority
and has taken all corporate action necessary to execute and deliver this        
Agreement and to consummate the transactions contemplated hereby. This Agreement
has been duly and validly authorized by the Board of Directors of ESI and duly  
and validly executed and delivered by ESI. This Agreement constitutes the valid 
and binding obligation of ESI, enforceable in accordance with its terms, except 
as enforcement may be limited by applicable bankruptcy, insolvency,             
reorganization, moratorium or similar laws affecting the enforcement of         
creditors' rights generally and except that the availability of the equitable   
remedy of specific performance or injunctive relief is subject to the discretion
of the court before which any proceeding may be brought.                        

        3.2.4 Governmental Filings. Other than the filing of (a) Articles of
Merger contemplated by Article I, (b) the HSR Filing described in Section 4.2.4,
and (c) the Registration Statement described in Section 4.3.2, no notices,      
reports or other filings are required to be made by ESI with, nor are any       
consents, registrations, approvals, permits or authorizations required to be    
obtained by ESI from, any Governmental Entity in connection with the execution  
and delivery of this Agreement by ESI and the consummation by ESI of the        
transactions contemplated hereby.                                               

  3.2.5 SEC Reports and Financial Statements. ESI has heretofore
furnished AISI with complete copies of all registration statements, reports and 
proxy statements, including                                                     

37

424B1
160th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 160th
amendments thereto, filed with the Securities and Exchange Commission (the      
"SEC") since May 31, 1997 and prior to the date of this Agreement (collectively,
the "ESI SEC Reports").                                                         

    3.2.6 Litigation. Except as set forth in the ESI SEC Reports, no
litigation, proceeding or governmental investigation is pending or, to the      
knowledge of ESI, threatened against or relating to ESI, its officers or        
directors in their capacities as such or any of its subsidiaries, or their      
respective properties or businesses.                                            

        3.2.7 No Adverse Consequences. Neither the execution and delivery of
this Agreement by ESI nor the consummation of the transactions contemplated by  
this Agreement will (a) result in the creation or imposition of any lien,       
charge, encumbrance or restriction on any of the assets or properties of ESI or 
any subsidiary, (b) violate any provision of the Articles of Incorporation or   
Bylaws of ESI or any subsidiary, (c) to the knowledge of ESI, violate any       
statute, judgment, order, injunction, decree, rule, regulation or ruling of any 
governmental authority applicable to ESI or any subsidiary, or (d) either alone 
or with the giving of notice or the passage of time or both, conflict with,     
constitute grounds for termination of, accelerate the performance required by,  
accelerate the maturity of any indebtedness or obligation under, result in the  
breach of the terms, conditions or provisions of or constitute a default under  
any mortgage, deed of trust, indenture, note, bond, lease, license, permit or   
other agreement, instrument or obligation to which either ESI or any subsidiary 
is a party or by which any of them is bound.                                    

          3.2.8 Brokers and Finders. Neither ESI nor any of its subsidiaries has
incurred any liability for any brokerage or investment banking fees, commissions
or finders' fees in connection with the Merger.                                 

38

424B1
161st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 161st
         3.2.9 Prospectus/Information Statement. The information regarding ESI
contained in the Prospectus/Information Statement (as defined in Section 4.2.5) 
to be mailed to AISI shareholders pursuant to Section 4.2.5 will be correct in  
all material respects and will not omit any material fact required to be stated 
therein or necessary in order to make the statement therein not misleading;     
provided, however, that no representation or warranty is made hereby with       
respect to information contained in such Prospectus/Information Statement which 
is furnished in writing by AISI (or its representatives) expressly for use in   
such Prospectus/Information Statement or information relating to AISI which is  
reviewed by AISI with the knowledge that it will be so used and without         
objecting to such use. ESI will promptly inform AISI of the happening of any    
event prior to the Effective Time which would render such information regarding 
ESI incorrect in any material respect or require the amendment of the           
Prospectus/Information Statement.                                               

    3.3 Representations and Warranties Relating to Merger Corp. ESI and Merger
Corp. hereby represent and warrant to AISI that:                                

     3.3.1 Organization and Status. Merger Corp. is a corporation duly
organized and validly existing under the laws of the State of Oregon. Merger    
Corp. does not own any properties (other than the initial cash subscription for 
shares) nor has it commenced any business or operations.                        

      3.3.2 Capitalization. Merger Corp. has an authorized capital stock
consisting of 100 shares of Common Stock, of which 100 shares were issued and   
outstanding on the date of this Agreement. All of the issued and outstanding    
shares of capital stock of Merging Corp are owned by ESI.                       

39

424B1
162nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 162nd
       3.3.3 Corporate Authority. Merger Corp. has the corporate power and
authority and has taken all corporate action necessary to execute and deliver   
this Agreement and to consummate the transactions contemplated hereby. The      
Agreement has been duly and validly authorized by the Board of Directors and    
sole shareholder of Merger Corp., duly and validly executed and delivered by    
Merger Corp. and constitutes the valid and binding obligation of Merger Corp.,  
enforceable in accordance with its terms, except as enforcement may be limited  
by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws
affecting the enforcement of creditors' rights generally and except that the    
availability of the equitable remedy of specific performance or injunctive      
relief is subject to the discretion of the court before which any proceeding may
be brought.                                                                     

        3.3.4 Governmental Filings. Other than (a) the filing of Articles of
Merger contemplated by Article I and (b) the HSR Filing described in Section    
4.2.4, no notices, reports or other filings are required to be made by Merger   
Corp. with, nor are any consents, registrations, approvals, permits or          
authorizations required to be obtained by Merger Corp. from, any Governmental   
Entity in connection with the execution and delivery of this Agreement by Merger
Corp. and the consummation by Merger Corp. of the transactions contemplated     
hereby.                                                                         

3.3.5 Litigation. No litigation, proceeding or governmental 
investigation is pending or, to the knowledge of Merger Corp., threatened       
against or relating to Merger Corp., or its officers or directors in their      
capacities as such.                                                             

         3.3.6 No Operations. Merger Corp. has not conducted active operations
and has no assets or liabilities other than in accordance with this Agreement.  

40

424B1
163rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 163rd
ARTICLE IV

 COVENANTS

    4.1 Mutual Covenants. AISI and ESI mutually covenant and agree as follows:

4.1.1 Consents and Approvals. AISI and ESI each will use its
reasonable best efforts to secure, and ESI will cause Merger Corp. to use its   
reasonable best efforts to secure, all consents, approvals, licenses or permits 
which may be required in connection with the Merger, and each will cooperate    
with the other to secure all such consents, approvals, licenses or permits in a 
form mutually satisfactory to AISI and ESI.                                     

        4.1.2 Best Efforts. Subject to the terms of this Agreement, AISI and
ESI each will use its reasonable best efforts, and ESI will cause Merger Corp.  
to use its reasonable best efforts, to effectuate the transactions contemplated 
hereby and to fulfill the conditions of their respective obligations under this 
Agreement.                                                                      

       4.1.3 Publicity. Except as required by law, no party will issue any
press releases or otherwise make any public statements with respect to the      
transactions contemplated hereby without the prior written consent of ESI and   
AISI, in each case not to be unreasonably withheld.                             

4.1.4 Confidentiality. The provisions of the Confidentiality
Agreements dated December 7, 1995 (in favor of AISI) and March 1, 1996 (in favor
of ESI) (collectively, the "Confidentiality Agreements") shall apply to all     
"Confidential Information" (as defined in the Confidentiality Agreements)       
obtained by any party pursuant to this Agreement.                               

4.2 Covenants of AISI. AISI covenants and agrees as follows:          

41

424B1
164th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 164th
     4.2.1 Conduct of Business. Prior to the Effective Time, AISI will
carry on its business in the ordinary and usual manner and maintain its existing
relationships with suppliers, customers, employees and business associates, and 
will not, without the prior written consent of ESI:                             

(a) amend its Articles of Incorporation or Bylaws;          

(b) enter into any new agreements respecting an increase in 
compensation or benefits payable to its officers or employees, except that AISI 
may enter into indemnification agreements with its officers and directors on    
terms consistent with the provisions of AISI's Articles of Incorporation and    
Bylaws;                                                                         

       (c) split, combine, reclassify any of the outstanding shares of its
capital stock or otherwise change its authorized capitalization;                

         (d) declare, set aside or pay any dividends payable in cash, stock or
property with respect to shares of its capital stock;                           

         (e) issue, sell, pledge, dispose of or encumber any additional shares
of, or securities convertible into or exchangeable for, or options, warrants,   
calls, commitments or rights of any kind to acquire, any shares of its capital  
stock of any class other than pursuant to exercise of outstanding stock options 
outstanding on June 30, 1997;                                                   

       (f) redeem, purchase or otherwise acquire any shares of its capital
stock, merge into or consolidate with any other corporation or permit any other 
corporation to merge into or consolidate with it, liquidate or sell or dispose  
of any of its assets, or close any plant or business operation;                 

42

424B1
165th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 165th
    (g) except for short-term indebtedness and indebtedness incurred
pursuant to AISI's revolving credit agreement and renewals, replacements and    
amendments thereof not in excess of the current maximum under such credit       
agreement incurred in the ordinary course of business, incur, assume or         
guarantee any indebtedness, or modify or repay any existing indebtedness;       

       (h) enter into any transaction, make any commitment (whether or not
subject to the approval of the Board of Directors of AISI) or modify any        
Contracts, except as otherwise contemplated or permitted by this Agreement, or  
take or omit to take any action which could be reasonably anticipated to have a 
material adverse effect on the business, properties, financial condition or     
results of operations of AISI;                                                  

       (i) transfer, lease, license, guarantee, sell, mortgage, pledge, or
dispose of, any property or assets (including without limitation any            
intellectual property), encumber any property or assets or incur or modify any  
liability, other than the sale of inventory in the ordinary and usual course of 
business;                                                                       

        (j) authorize capital expenditures other than in the ordinary course
of business, form any subsidiary, or make any acquisition of, or investment in, 
assets or stock of any other person or entity;                                  

(k) make any tax election;                                  

        (l) permit any insurance policy naming it as a beneficiary or a loss
payable payee to be canceled, terminated or renewed without prior notice to ESI;

43

424B1
166th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 166th
          (m) change its method of accounting as in effect at December 31, 1996,
except as required by changes in generally accepted accounting principles as    
concurred with by the AISI's independent auditors, or change its fiscal year;   

       (n) conduct any transactions which, in the opinion of ESI or Arthur
Andersen LLP, could disqualify the Merger for pooling of interests accounting;  
or                                                                              

     (o) authorize or enter into an agreement to do any of the actions
referred to in paragraphs (a) through (n) above.                                

      4.2.2 Acquisition Proposals. Unless and until this Agreement shall
have been terminated pursuant to Section 7.1 or Section 7.2, AISI shall not     
directly, or indirectly through any officer, director, agent, employee or       
representative (i) encourage, initiate or solicit, on or after the date hereof, 
any inquiries or the submission of any proposals or offers from any person      
relating to any merger, consolidation, sale of all or substantially all of its  
assets or similar business transaction involving AISI (each, an "Acquisition    
Transaction"); (ii) participate in any negotiations regarding, furnish to any   
other person any information with respect to, or otherwise assist or participate
in, any attempt by any third party to propose or offer any Acquisition          
Transaction; (iii) enter into or execute any agreement relating to an           
Acquisition Transaction; or (iv) make or authorize any public statement,        
recommendation or solicitation in support of any Acquisition Transaction or any 
proposal or offer relating to an Acquisition Transaction, in each case other    
than with respect to the Merger. Notwithstanding the foregoing, nothing         
contained herein shall prohibit AISI from taking the actions described above in 
connection with an unsolicited third-party proposal or offer of an Acquisition  
Transaction if and to the extent that (a) the Board of Directors of AISI        
determines in good faith, upon advice of legal counsel, that such action is     
required for the                                                                

44

424B1
167th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 167th
directors of AISI to fulfill their fiduciary duties and obligations under       
Michigan law and (b) prior to furnishing such information to or entering into   
discussions or negotiations with such third-party, AISI provides immediate      
written notice to ESI of such proposal or offer and, to the extent not          
inconsistent with the fiduciary duties of AISI's officers and directors,        
provides material information concerning such proposal or offer (including      
proposed terms and the identity of the person or entity making such proposal or 
offer) and thereafter continues to cooperate with ESI by informing ESI of       
additional material facts as they arise and furnishing to ESI any additional    
information furnished in connection with such proposal or offer.                

         4.2.3 Investigations. AISI agrees to give ESI and its representatives
and agents full access to all its premises, books and records and agreements and
files and to cause its officers of AISI to furnish ESI with such financial and  
operating data and other information with respect to its business and properties
as ESI shall from time to time request. Without limitation of the foregoing,    
AISI shall permit ESI to conduct an operations review at the plant level during 
which ESI shall have access to the plant managers, sales and marketing managers,
finance officers, and technology, environmental and human resource managers of  
each AISI operating facility. Any such investigations (a) shall be conducted in 
such manner as not to interfere unreasonably with the operation of AISI's       
business; and (b) shall not diminish any of the representations and warranties  
hereunder.                                                                      

        4.2.4 Antitrust Improvements Act. AISI will timely and promptly make
all filings which are required under the Antitrust Improvements Act of 1976, as 
amended (the "HSR Filing"). AISI will furnish to ESI such information and       
assistance as ESI may request in connection with its preparation of filings or  
submissions to any governmental agency, including,                              

45

424B1
168th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 168th
without limitation, the HSR Filing. AISI will supply ESI with copies of all     
correspondence, filings or communications (or memoranda setting forth the       
substance thereof) between AISI or its representatives, on the one hand, and the
Federal Trade Commission, the Antitrust Division of the United States Department
of Justice or any other governmental agency or authority or members of their    
respective staffs, on the other hand, with respect to this Agreement or the     
transaction contemplated hereby.                                                

          4.2.5 AISI Shareholders Approval. AISI shall obtain by written consent
of at least a majority of the holders of AISI Common Stock, approval of this    
Agreement, approval of the Merger and the other transactions contemplated       
hereunder, and appointment of the Shareholder Representatives. Upon receipt from
ESI of a master copy of the Prospectus/Information Statement relating to this   
Agreement ("Prospectus/Information Statement") in the form declared effective by
the Securities and Exchange Commission, AISI will immediately cause a copy of   
the Prospectus/Information Statement to be distributed to each of its           
shareholders, together with (i) a copy of the written consent to the Merger by  
the holders of at least a majority of the outstanding shares of AISI's common   
stock, and (ii) the Dissenters' Rights notice required by Section 766 of the    
MBCA to be delivered to any shareholder who did not execute the written consent.

4.2.6 Information for Prospectus/Information Statement and  
Registration Statement. AISI will promptly provide to ESI for inclusion within  
the Prospectus/Information Statement and in the Registration Statement described
in Section 4.3.2, in form reasonably satisfactory to ESI, such information      
concerning AISI's operations, capitalization, technology and share ownership,   
and such other information as ESI may reasonably request.                       

4.3 Covenants of ESI. ESI covenants and agrees as follows:            

46

424B1
169th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 169th
        4.3.1 Conduct of Business. Prior to the Effective Time, ESI will not
take or omit to take any action which could be reasonably anticipated to have a 
material adverse effect on the business, properties, financial condition or     
results of operations of ESI.                                                   

 4.3.2 Registration Statement. ESI will promptly file with the
Securities and Exchange Commission a Registration Statement complying in all    
respects with Form S-4 for the purpose of registering the ESI Common Stock into 
which the AISI Common Stock will be converted pursuant to Section 1.3, and ESI  
will use its best efforts to cause such Registration Statement to be declared   
effective.                                                                      

        4.3.3 Listing of ESI Common Stock. ESI will promptly list the shares
of ESI Common Stock into which the AISI Common Stock will be converted pursuant 
to the provisions of this Agreement in the Nasdaq National Market System.       

       4.3.4 Antitrust Improvements Act. ESI will timely and promptly make
its HSR Filing. ESI will furnish to AISI such information and assistance as AISI
may request in connection with its preparation of filings or submissions to any 
governmental agency, including, without limitation, any HSR Filing under the    
provisions of the Antitrust Improvements Act. ESI will supply AISI with copies  
of all correspondence, filings or communications (or memoranda setting forth the
substance thereof) between it or its representatives, on the one hand, and the  
Federal Trade Commission, the Antitrust Division of the United States Department
of Justice or any other governmental agency or authority or members of their    
respective staffs, on the other hand, with respect to this Agreement or the     
transactions contemplated hereby.                                               

       4.3.5 Issuance of Certificates. After the Effective Time, ESI shall
issue and deliver, or shall cause to be issued and delivered, in accordance with
the provisions of Article I                                                     

47

424B1
170th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 170th
hereto, stock certificates representing the number of shares of ESI Common Stock
to be issued in the Merger.                                                     

          4.3.6 Registration of Option Shares. ESI shall use its best efforts to
cause the shares of ESI Common Stock issuable upon exercise of the Options      
(assumed pursuant to Section 1.3.4 of this Agreement) to be issued pursuant to a
then effective registration statement or otherwise to be registered after the   
Effective Time on SEC Form S-8, filed no later than 30 days after the Effective 
Time, and shall use its best efforts to maintain the effectiveness of such      
registration statement or registration statements for so long as such assumed   
Options remain outstanding.                                                     

      4.3.7 Directors & Officers Insurance. For a period of at least two
years following the Effective Time, ESI shall, or shall cause the Surviving     
Corporation to, continue in effect the directors and officers insurance policies
currently maintained by AISI (or substitute policies with substantially the same
coverage and terms); provided that each AISI officer and director covered by    
such policies represents and warrants that such person has no knowledge of any  
claims covered by such policies. It is intended that such insurance shall be the
primary source of funding AISI's obligation to indemnify its directors and      
officers against liability arising from acts in their official capacities prior 
to the Effective Time.                                                          

4.4 Covenants of Merger Corp. Merger Corp. covenants and agrees that, 
except as is contemplated by this Agreement, prior to the Effective Time, Merger
Corp. will not engage in any business activities or liquidate, merge into or    
consolidate with any other corporation or permit any other corporation to merge 
into or consolidate with it; or increase its authorized capital stock; or issue 
options, rights or warrants to purchase any of its capital stock.               

48

424B1
171st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 171st
 ARTICLE V

CONDITIONS

    5.1 Conditions to the Obligations of All Parties. The obligations of AISI,
ESI and Merger Corp. to consummate the transactions contemplated by this        
Agreement are subject to the fulfillment at or before the Closing of each of the
following conditions:                                                           

       5.1.1 Regulatory Approvals. The parties shall have made all filings
and received all approvals of any governmental or regulatory agency of competent
jurisdiction necessary in order to consummate the Merger, including without     
limitation, expiration or termination of the waiting period for the HSR Filing, 
and each of such approvals shall be in full force and effect at the Closing and 
not subject to any condition which requires the taking or refraining from taking
of any action which would have a material adverse effect on AISI or on ESI and  
its subsidiaries.                                                               

       5.1.2 Litigation. There shall not be in effect any order, decree or
injunction of a Federal or State court of competent jurisdiction restraining,   
enjoining or prohibiting the consummation of the transactions contemplated by   
this Agreement (each party agreeing to use its best efforts, including appeals  
to higher courts, to have any such non-final, appealable order, decree or       
injunction set aside or lifted), and no action shall have been taken, and no    
statute, rule or regulation shall have been enacted, by any state or federal    
government or governmental agency in the United States which would prevent the  
consummation of the Merger.                                                     

        5.1.3 Section 368(a)(2)(E) of the Code Requirement. The parties will
be satisfied that AISI will hold, after the Merger at least 90 percent of the   
fair market value of the net assets and at least 70 percent of the fair market  
value of the gross assets held by Merger Corp.                                  

49

424B1
172nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 172nd
immediately prior to the Merger and will retain at least 90 percent of the fair 
market value of the net assets and at least 70 percent of the fair market value 
of the gross assets held by AISI immediately prior to the Merger. For purposes  
of this condition, amounts paid by AISI to dissenters, amounts paid by AISI to  
its shareholders who receive cash or other property, assets of AISI used to pay 
its reorganization expenses, and all redemptions and distributions (except for  
normal dividends) made by AISI immediately preceding the Merger, will be        
included as assets of AISI held immediately prior to the Merger.                

5.2 Conditions to the Obligations of AISI. The obligations of AISI to 
consummate the transactions contemplated by this Agreement are subject to the   
fulfillment at or before the Closing of each of the following conditions:       

        5.2.1 Representations, Warranties and Covenants. The representations
and warranties of ESI and Merger Corp. contained in this Agreement shall be     
correct (a) at the date of this Agreement and (b) as of the Closing, with the   
same effect as though made on and as of such date, except for representations   
and warranties made as of a specific date, which representations and warranties 
need only be true and correct as of such date and for changes specifically      
contemplated by this Agreement, and ESI and Merger Corp. shall have performed   
all of their respective covenants and obligations hereunder to be performed as  
of the Closing. AISI shall have received at the Closing certificates to the     
foregoing effect, dated the Closing Date, and executed on behalf of ESI by an   
executive officer of ESI and on behalf of Merger Corp. by an executive officer  
of Merger Corp. For purposes of affirming the accuracy of the representations   
and warranties of ESI made as of the Closing, the term "ESI SEC Reports" shall  
be deemed to include all registration statements, reports and proxy and         
information statements, including all                                           

50

424B1
173rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 173rd
amendments thereto, filed by ESI with the SEC after the date of this Agreement  
and prior to Closing.                                                           

         5.2.2 No Material Adverse Change. Since May 31, 1997 there shall have
been no material adverse change, or discovery of a condition or occurrence of an
event which has resulted or reasonably can be expected to result in a material  
adverse change, in the business, properties, financial condition or results of  
operations of ESI and its subsidiaries taken as a whole, other than changes     
permitted or contemplated by this Agreement.                                    

       5.2.3 Opinion of Counsel. AISI shall have received from Stoel Rives
LLP, counsel to ESI, an opinion dated the Closing Date substantially in the form
of Exhibit E attached hereto.                                                   

       5.2.4 Registration of Securities; Listing. The shares of ESI Common
Stock to be issued by ESI pursuant to this Agreement shall have been registered 
under the Securities Act of 1933, as amended, and listed in the Nasdaq National 
Market System.                                                                  

5.2.5 Shareholders' Approval; Dissenters. In accordance with
applicable provisions of the MBCA and the Articles of Incorporation and Bylaws  
of AISI, the holders of at least a majority of the issued and outstanding shares
of Common Stock of AISI shall have approved this Agreement and the Agreement of 
Merger and the condition set forth in Section 5.3.7 shall have been satisfied.  

       5.2.6 Accountants Opinion. The condition set forth in Section 5.3.5
shall have been satisfied.                                                      

51

424B1
174th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 174th
   5.3 Conditions to the Obligations of ESI and Merger Corp. The obligations
of ESI and Merger Corp. to consummate the transactions contemplated by this     
Agreement are subject to the fulfillment at or before the Closing of each of the
following conditions:                                                           

        5.3.1 Representations, Warranties and Covenants. The representations
and warranties of AISI contained in this Agreement shall be correct (a) at the  
date of this Agreement and (b) as of the Closing Date, with the same effect as  
though made on and as of such date, except for representations and warranties   
made as of a specific date which representations and warranties need only be    
true and correct as of such date and for changes specifically contemplated by   
this Agreement and AISI shall have performed in all material respects all of its
covenants and obligations hereunder to be performed as of the Closing. ESI shall
have received at the Closing a certificate to the foregoing effect, dated the   
Closing Date, and executed on behalf of AISI by an executive officer of AISI.   

   5.3.2 Opinion of Counsel. ESI shall have received from Brouse &
McDowell, A Legal Professional Association ("Brouse & McDowell"), counsel to    
AISI, an opinion dated the Closing Date substantially in the form of Exhibit F  
attached hereto. ESI also shall have received from Brouse & McDowell an opinion 
satisfactory to ESI and its counsel that the Merger will be tax free pursuant to
Section 368 of the Code.                                                        

  5.3.3 Consents and Approvals. All nongovernmental consents and
approvals required to be obtained by AISI for consummation of the Merger shall  
have been obtained, other than those which, if not obtained, would not, either  
singly or in the aggregate, have a material adverse effect on AISI.             

5.3.4 No Material Adverse Change; Completion of Inspection. 

52

424B1
175th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 175th
           5.3.4.1 No Material Adverse Change. Since June 30, 1997 there
shall have been no material adverse change, or discovery of a condition or      
occurrence of an event which has resulted or reasonably can be expected to      
result in such change, in the business, properties, financial condition or      
results of operations of AISI, other than changes permitted under or            
contemplated by this Agreement.                                                 

              5.3.4.2 Completion of Investigation. ESI shall have completed to
its satisfaction its investigation of AISI's business, including without        
limitation, the investigation referred to in Section 4.2.3, and such            
investigation shall have not revealed (1) any facts or circumstances (including 
those arising as a result of the acquisition contemplated hereby) that ESI      
believes are reasonably likely to have a material adverse effect on the         
business, properties, financial condition, or results of operations of AISI or  
the 1998 Forecast, or (2) any facts or circumstances (including those arising as
a result of the acquisition contemplated hereby) indicating that the Merger is  
reasonably likely to dilute ESI's earnings per share for its fiscal quarter     
ending November 30, 1997 or its fiscal quarter ending February 28, 1998 or its  
fiscal year ending May 31, 1998.                                                

          5.3.5 Accountants Opinion. ESI and AISI shall have received an opinion
of Arthur Andersen LLP in form satisfactory to ESI and AISI that the Merger may 
be accounted for as a pooling of interests.                                     

       5.3.6 Registration of Securities; Listing. The shares of ESI Common
Stock to be issued by ESI pursuant to this Agreement shall have been registered 
under the Securities Act of 1933, as amended, and under the securities laws of  
such states as counsel for ESI shall deem                                       

53

424B1
176th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 176th
necessary or exemptions from such state registration or qualification shall have
been determined by such counsel to be available, and shall have been listed in  
the Nasdaq National Market System.                                              

        5.3.7 Affiliate Representation Letters. ESI shall have received from
each of the persons or entities listed on Schedule 5.3.7 a duly executed        
representation letter, substantially in the form of Exhibit G, containing       
certain representations and warranties with respect to the ownership of capital 
stock of AISI by such person or entity and certain representations, warranties, 
covenants and acknowledgments with respect to the shares of ESI Common Stock to 
be acquired hereby and the transfer of such shares.                             

      5.3.8 Continuity of Interests Letter. ESI shall have received from
each of the persons or entities listed on Schedule 5.3.8 a duly executed        
representation letter, substantially in the form of Exhibit H, containing       
certain representations and warranties with respect to the ownership of capital 
stock of AISI by such person or entity and certain representations, warranties, 
covenants and acknowledgments with respect to the shares of ESI Common Stock to 
be acquired hereby and the transfer of such shares.                             

     5.3.9 Other Agreements. The ESI Confidentiality Agreement and the
Escrow Agreement to be delivered under Article II shall have been signed and    
delivered by the parties to such agreements other than ESI or Merger Corp.      

    5.3.10 Physical Count of Assets. At a mutually agreeable time, a
physical count of all AISI tangible assets shall have been conducted to the     
reasonable satisfaction of ESI and the aggregate value of the tangible assets   
shown by such count shall not be less than the value for such assets reflected  
on the AISI books and records as of the date of such count.                     

54

424B1
177th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 177th
     5.3.11 Tax Clearance Certificate. AISI shall deliver to ESI a tax
clearance certificate from the applicable agencies of the State of Michigan.    

   5.3.12 Related Party Agreements. All agreements or arrangements
described on Schedule 3.1.22 (Related Parties), if requested by ESI, shall have 
been terminated or amended to the reasonable satisfaction of ESI.               

       5.3.13 Confidentiality Agreements. All employees of AISI shall have
signed a confidentiality and inventions assignment agreement in a form          
reasonably satisfactory to ESI, as provided in Section 2.1.                     

  5.3.14 Updated Financial and Other Information. ESI shall have
received (a) the unaudited balance sheet of AISI and the related statements of  
income and stockholder's equity for the most recent accounting period of AISI   
ended prior to the Closing Date, and (b) schedules of accounts receivable       
(including an aging analysis), inventories (organized by category), and backlog 
(by customer and product), in each case as of immediately prior to Closing and  
in each case with an officer's certificate as to accuracy and completeness of   
such schedule.                                                                  

  5.3.15 Environmental Report. ESI shall have received a Phase I
environmental audit report with respect to the Leased Real Property, prepared by
an environmental audit firm selected by ESI, the results of which audit shall be
reasonably satisfactory to ESI.                                                 

       5.3.16 Fairness Opinion. ESI shall have received from Alex. Brown &
Sons an opinion that the Conversion Ratio is fair, from a financial point of    
view, to the holders of ESI Common Stock.                                       

55

424B1
178th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 178th
ARTICLE VI

SURVIVAL AND INDEMNIFICATION

    6.1 Survival. All representations and warranties of any party contained in
this Agreement shall survive the execution and delivery of this Agreement and   
the consummation of the transactions contemplated hereby, but shall be          
extinguished and be of no further force or effect nine months after the Closing 
Date, except with respect to any claim for which a Claim Notice (as defined in  
Section 6.4) is delivered pursuant to Section 6.4 prior to the expiration of the
nine-month period. No Claim Notice shall be effective if delivered after the    
time periods referred to above in this Section 6.1.                             

     6.2 Scope of Indemnification. From and after the Effective Time and subject
to the limitations of this Article VI, each AISI shareholder will, pro rata and 
to the extent of his, her or its ESI Common Stock delivered to the Escrow Agent 
pursuant to Section 6.3, indemnify and hold harmless ESI, Merger Corp. and the  
Surviving Corporation and their respective officers, directors and shareholders 
(collectively, the "Indemnified Parties") from, for and against any (a) losses, 
costs, expenses, damages and liabilities, including reasonable attorneys' fees  
(collectively, "Damages"), incurred by an Indemnified Party by reason of or     
arising out of any inaccuracy in any representation or warranty or the breach of
any covenant of AISI made in this Agreement, and (b) Damages (excluding, in this
instance, attorneys fees) incurred by an Indemnified Party in connection with   
the prosecution, defense of counterclaim or settlement of the litigation        
described in Section 3.1.11 of the Disclosure Schedule (the "Disclosed          
Litigation").                                                                   

56

424B1
179th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 179th
   6.3 Escrow. On the Closing Date, ESI shall, on behalf of each of the AISI
shareholders, deliver to the Escrow Agent 10 percent of such AISI shareholder's 
shares of the ESI Common Stock to be received by such AISI shareholder pursuant 
to Section 1.3, provided, that, the shares to be delivered on behalf of each    
AISI shareholder shall be rounded downward to the nearest whole share of ESI    
Common Stock (such deposited shares shall be referred to as the "Escrowed       
Property"). The Escrowed Property will be deposited with the Escrow Agent       
pursuant to the terms of the Escrow Agreement. The escrow and the Escrow        
Agreement shall terminate and the Escrowed Property shall be distributed to the 
former AISI shareholders at the earliest time provided for in the Escrow        
Agreement, but not later than the first anniversary of the Closing Date.        

     6.4 Limitations. The liability of the AISI shareholders pursuant to Section
6.2 shall be subject to the following limitations:                              

          6.4.1 Minor Claims. The AISI shareholders shall not have any liability
or indemnity obligation under Section 6.2 with respect to the first $100,000 of 
Damages of the Indemnified Parties. In addition, to the extent not applied to   
any specific item or matter, the Reserves will be generally available to satisfy
any liability of AISI in connection with any representation, warranty or        
covenant of AISI set forth in this Agreement other than the representations     
regarding taxes in Section 3.1.21.                                              

 6.4.2 Escrowed Property. The indemnity obligation of the AISI
shareholders under Section 6.2 shall be satisfied exclusively out of the        
Escrowed Property in accordance with the Escrow Agreement.                      

57

424B1
180th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 180th
     6.5 Claim Procedure for Indemnification. The obligations and liabilities of
the AISI shareholders in connection with claims for indemnification for Damages 
by an Indemnified Party shall be subject to the following terms and conditions: 

        6.5.1 Notice. The Indemnified Party shall give written notice to the
Shareholder Representatives and the Escrow Agent of its claim for               
indemnification as promptly as practicable whenever the Indemnified Party shall 
have determined that there are facts or circumstances which entitle ESI to      
indemnification under this Article VI; provided, however, that the failure to   
give a timely notice of a claim for indemnification shall not diminish the      
indemnification obligations hereunder except to the extent that the delay in    
giving such notice materially adversely affects the ability of the Shareholder  
Representatives to mitigate Damages with respect to any claim. The notice       
("Claim Notice") shall set forth in reasonable detail the basis for the claim,  
the nature of the Damages and the amount thereof, to the extent known.          

          6.5.2 Response to Third Party Claim. If the Claim Notice states that a
claim has been asserted by a third party against the Indemnified Party (a "Third
Party Claim"), ESI shall undertake, conduct and control, through counsel of its 
choosing, the good faith settlement or defense of the Third Party Claim and the 
Disclosed Litigation.                                                           

          6.5.3 Diligent Conduct. If, within five days after receipt by ESI from
the Shareholder Representatives of written notice that ESI is not diligently    
conducting the defense or attempted settlement in good faith, ESI does not      
provide reasonably sufficient evidence to the Shareholder Representatives that  
ESI is diligently conducting the defense or attempting settlement               

58

424B1
181st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 181st
in good faith, the Shareholder Representatives shall thereafter have the right  
to contest, settle or compromise the Third Party Claim.                         

 ARTICLE VII

 TERMINATION

     7.1 Termination by Mutual Consent. This Agreement may be terminated and the
Merger may be abandoned at any time prior to the Effective Time by the mutual   
consent of AISI and ESI.                                                        

     7.2 Termination by Either AISI or ESI. This Agreement may be terminated and
the Merger may be abandoned at any time prior to the Effective Time:            

          (a) by ESI or AISI if the Merger shall not have become effective on or
prior to November 1, 1997, provided, however, that the right to terminate this  
Agreement pursuant to this Section 7.2(a) shall not be available to any party   
whose breach of this Agreement has been the cause of, or resulted in, the       
failure of the Merger to occur on or before such date;                          

     (b) by ESI or AISI if the requisite approval of the Merger by the
shareholders of AISI shall not have been obtained by November 1, 1997;          

    (c) by ESI or AISI if any court of competent jurisdiction in the
United States or any state shall have issued an order, judgment or decree (other
than a temporary restraining order) restraining, enjoining or otherwise         
prohibiting the Merger and such order, judgment or decree shall have become     
final and nonappealable;                                                        

59

424B1
182nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 182nd
     (d) by ESI if the AISI Board of Directors shall have withdrawn or
modified in a manner adverse to ESI approval of the Merger, this Agreement or   
the transactions contemplated hereby;                                           

     (e) by ESI if AISI or any of the persons or entities described in
Section 4.2.2 of this Agreement shall have taken any of the actions that would  
be proscribed by Section 4.2.2, other than actions taken in the exercise of the 
fiduciary duties of AISI's Board of Directors and satisfying all the conditions 
of Section 4.2.2; or                                                            

    (f) by AISI if the Board of Directors of AISI determines in good
faith, upon advice of legal counsel, that such termination of this Agreement is 
required for the directors of AISI to fulfill their fiduciary duties and        
obligations under Michigan law.                                                 

   7.3 Effect of Termination and Abandonment. In the event of termination of
this Agreement and abandonment of the Merger pursuant to this Article VII, (i)  
this Agreement immediately will become void and of no effect, except that       
Sections 4.1.4, 7.3, 7.4 and 8.1 will survive the event of termination; and (ii)
no party hereto (or any of its directors of officers) shall have any liability  
or further obligation to any other party to this Agreement, except as provided  
in Section 7.4 of this Agreement.                                               

7.4 Termination Fees and Expenses.                                    

         (a) AISI agrees to pay ESI (provided that ESI is not then in material
breach of any representation, warranty, covenant or agreement contained in this 
Agreement) promptly upon the termination of this Agreement (or such later date  
as may apply in the case of (iii) below) by                                     

60

424B1
183rd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 183rd
wire transfer, the sum of $3 Million in immediately available funds in the event
that any of the following shall have occurred:                                  

     (i) this Agreement shall have been terminated pursuant to Section
     7.2(b) hereof on the basis of failure of approval of the Merger by the AISI
shareholders;                                                         

      (ii) this Agreement shall have been terminated pursuant to Section
7.2(d) or Section 7.2(e) hereof; or                                   

      (iii) AISI shall have terminated the Agreement pursuant to Section
 7.2(f) hereof and shall have agreed to an Acquisition Transaction which
 results in a change in the beneficial owners of more than fifty percent
(50%) of the voting power of the capital stock of AISI within one year
   after termination of this Agreement with any person other than ESI or any
of its affiliates.                                                    

          (b) ESI agrees to pay AISI (provided that AISI is not then in material
breach of any representation, warranty, covenant or agreement contained in this 
Agreement) promptly upon the termination of this Agreement by wire transfer, the
sum of $3 Million in immediately available funds in the event this Agreement    
shall have been terminated by ESI (other than pursuant to Section 7.1 and 7.2)  
and all conditions to the obligations of ESI and Merger Corp. in Sections 5.1   
and 5.3 have been fulfilled.                                                    

          (c) The right to the payment of the fees set forth in this Section 7.3
shall be the exclusive remedy at law or in equity to which ESI or AISI shall be 
entitled upon termination of this Agreement under the conditions described in   
Section 7.3; provided, however, nothing in                                      

61

424B1
184th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 184th
Sections 7.2 or 7.3 of this Agreement shall be deemed to limit a party's        
remedies in the event of breach of this Agreement by the other party.           

ARTICLE VIII

 MISCELLANEOUS AND GENERAL

8.1 Payment of Expenses. Other than in the event of breach of this    
Agreement by the other party, and except as provided in Section 7.3, each party 
shall be responsible for the costs and expenses incurred by it in connection    
with the transactions contemplated by this Agreement. The fees to be paid in the
circumstances described in Section 7.3 are intended by the parties to compensate
for expenses and other damages incurred by the party entitled to the fee. Other 
than in the circumstances described in Section 7.3, nothing in this Agreement is
meant to limit the right of a non-breaching party to obtain reimbursement of    
expenses and other damages, including attorneys fees, incurred as a result      
breach of this Agreement by the other party.                                    

8.2 Entire Agreement. This Agreement, including the schedules and the 
exhibits hereto, and the Confidentiality Agreements constitute the entire       
agreement between the parties hereto and supersede all prior agreements and     
understandings, oral and written, among the parties hereto with respect to the  
subject matter hereof.                                                          

8.3 Assignment. This Agreement shall not be assignable by any of the  
parties hereto without the prior written consent of each of ESI and AISI.       

   8.4 Binding Effect; No Third Party Benefit. This Agreement shall inure to
the benefit of and be binding upon the parties hereto and their respective      
successors and assigns, subject to the restrictions on assignment contained in  
Section 8.3. Nothing express or implied in                                      

62

424B1
185th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 185th
this Agreement is intended or shall be construed to confer upon or give to a    
person, firm or corporation other than the parties hereto any rights or remedies
under or by reason of this Agreement or any transaction contemplated hereby.    

   8.5 Amendment and Modification. Subject to applicable law, this Agreement
may be amended, modified and supplemented at any time prior to or at the        
Closing, whether before or after the votes of shareholders of AISI, by written  
agreement executed and delivered by the duly authorized officers of AISI and    
ESI.                                                                            

8.6 Waiver of Conditions. The conditions to each of the parties'      
obligations to consummate the Merger are for the sole benefit of such party and 
may be waived by such party in whole or in part to the extent permitted by      
applicable law; provided, however, that any waiver by a party must be in        
writing.                                                                        

     8.7 Counterparts. For the convenience of the parties hereto, this Agreement
may be executed in any number of counterparts, each such counterpart being      
deemed to be an original instrument, and all such counterparts shall together   
constitute the same agreement.                                                  

  8.8 Captions. The article, section and paragraph captions herein are for
convenience of reference only, do not constitute a part of this Agreement and   
shall not be deemed to limit or otherwise affect any of the provisions hereof.  

    8.9 Subsidiary. When a reference is made in this Agreement to a subsidiary
of a party, the term "subsidiary" means any corporation or other organization,  
whether incorporated or unincorporated, of which at least a majority of the     
securities or interests having by the terms thereof ordinary voting power to    
elect a majority of the board of directors or others performing                 

63

424B1
186th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 186th
similar functions with respect to such corporation or other organization is     
directly or indirectly owned or controlled by such party or by any one or more  
of its subsidiaries, or by such party and one or more of its subsidiaries.      

8.10 Notices. All notices, requests, demands, waivers and other       
communications required or permitted to be given under this Agreement shall be  
in writing and shall be deemed to have been duly given if delivered personally  
or mailed, certified or registered mail with postage prepaid, or sent by telex, 
telegram or facsimile (in each case with evidence of confirmed transmission) as 
follows:                                                                        

If to AISI, to it at:                                       

3923 Ranchero Drive                               
Ann Arbor, Michigan  48108                        
Attention:  President                             
Fax: (313) 995-2138                               

with copies to:                                             

Brouse & McDowell                                 
500 First National Tower                          
Akron, Ohio 44308-1471                            
Attention: Stanley E. Everett                     
Fax: (330) 253-8601                               

If to ESI or Merger Corp., to it at:                        

13900 NW Science Park Drive                       
Portland, Oregon 97229                            
Attention:  President and Chief                   
Executive Officer         
Fax:  (503) 671-5698                              

64

424B1
187th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 187th
with copies to:                                             

Stoel Rives LLP                                   
900 SW Fifth Avenue                               
Portland, Oregon  97204                           
Attention:  Annette M. Mulee                      
Fax:  (503) 220-2480                              

or to such other person or address as any party shall specify by notice in      
writing. All such notices, requests, demands, waivers and communications shall  
be deemed to have been received on the date of delivery or on the third business
day after the mailing thereof.                                                  

  8.11 Choice of Law. This Agreement shall be governed by and construed in
accordance with the laws of the State of Oregon, exclusive of choice of law     
rules, except that the provisions of this Agreement relating to the Merger shall
also be governed by the merger provisions of the MBCA.                          

  8.12 Attorneys' Fees. If suit or action is filed by any party to enforce
the provisions of this Agreement or otherwise with respect to the subject matter
of this Agreement, the prevailing party shall be entitled to recover reasonable 
attorneys' fees as fixed by final order of the trial court and, if any appeal is
taken from the decision of the trial court, reasonable attorneys' fees as fixed 
by final order of the appellate court.                                          

     8.13 Separability. Any term or provision of this Agreement which is invalid
or unenforceable in any jurisdiction shall, as to such jurisdiction, be         
ineffective to the extent of such invalidity or unenforceability without        
rendering invalid or unenforceable the remaining terms and provisions of this   
Agreement or affecting the validity or enforceability of any of the terms or    
provisions of this Agreement in any other jurisdiction. If any provision of this

65

424B1
188th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 188th
Agreement is so broad as to be unenforceable, such provision shall be           
interpreted to be only so broad as is enforceable.                              

    IN WITNESS WHEREOF, this Agreement has been duly executed and delivered by
the duly authorized officers of the parties hereto as of the date first         
hereinabove written.                                                            

                                 Electro Scientific Industries, Inc.

                By BARRY L. HARMON
                                          --------------------------------------
                         Name: Barry L. Harmon
                             Title: Sr. Vice President

                               Applied Intelligent Systems, Inc.

              By J.E. ANDERSON
                                          --------------------------------------
                           Name: James E. Anderson
                          Title: President & CEO

                   Asteroid Merger Corp.

                By BARRY L. HARMON
                                          --------------------------------------
                         Name: Barry L. Harmon
                             Title: Sr. Vice President

66

424B1
189th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 189th
 AMENDMENT NO. 1
AGREEMENT OF REORGANIZATION AND MERGER

   This Amendment No. 1 to the Agreement of Reorganization and Merger, dated
September 29, 1997 (the "Agreement"), is entered into by and among Electro      
Scientific Industries, Inc. ("ESI"), Applied Intelligent Systems, Inc. ("AISI") 
and Asteroid Merger Corp. ("Merger Corp.") effective as of October 8, 1997.     

   1. Amendment of Section 1.7 (Closing). Section 1.7 of the Agreement shall
be amended to read in its entirety as follows:                                  

"The closing of the Merger (the "Closing") shall take place 
at the offices of Stoel Rives LLP, 900 SW Fifth Avenue,     
Suite 2300, Portland, Oregon 97204 on November 30, 1997, or 
as soon as is practicable following the Condition Completion
Date (as hereinafter defined), or on such other date and/or 
at such other place and time as AISI, ESI and Merger Corp.  
may agree (the "Closing Date"). The "Condition Completion   
Date" shall be the day on which the last of the conditions  
set forth in Article V hereof shall have been fulfilled or  
waived (other than those conditions which, by their terms,  
are to occur at Closing)." (new language underscored)       

     2. Amendment of Section 7.2(a) and (b) (Termination by Either AISI or ESI).
Sections 7.2(a) and 7.2(b) of the Agreement shall be amended to read in their   
entirety as follows:                                                            

"(a) by ESI or AISI if the Merger shall not have become     
effective on or prior to December 31, 1997, provided,       
however, that the right to terminate this Agreement pursuant
to this Section 7.2(a) shall not be available to any party  
whose breach of this Agreement has been the cause of, or    
resulted in, the failure of the Merger to occur on or before
such date;                                                  

(b) by ESI or AISI if the requisite approval of the Merger  
by the shareholders of AISI shall not have been obtained by 
December 31, 1997;" (new language underscored)              

3. Deletion of Section 5.3.4.2 (Completion of Investigation). Section 
5.3.4.2 of the Agreement is deleted in its entirety.                            

424B1
190th Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 190th
 4. Deletion of Section 5.3.16 (Fairness Opinion). Section 5.3.16 of the
Agreement, requiring that ESI receive a fairness opinion as a condition to      
Closing, is deleted in its entirety.                                            

  IN WITNESS WHEREOF, this Amendment to the Agreement has been executed by
the undersigned as of the date written above.                                   

  Electro Scientific Industries, Inc.    Applied Intelligent Systems, Inc.

By: BARRY L. HARMON                    By: JAMES E. ANDERSON          
       ------------------------------         ------------------------------
Name: Barry L. Harmon                  Name: James E. Anderson        
         ----------------------------           ----------------------------
Title: Senior Vice President           Title: President & CEO         
          ---------------------------            ---------------------------

Asteroid Merger Corp.                                                 

By: BARRY L. HARMON                                                   
------------------------------                                
Name: Barry L. Harmon                                                 
----------------------------                              
Title: Vice President                                                 
---------------------------                             

424B1
191st Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 191st
 AMENDMENT NO. 2
AGREEMENT OF REORGANIZATION AND MERGER

   This Amendment No. 2 to the Agreement of Reorganization and Merger, dated
September 29, 1997 (the "Agreement"), is entered into by and among Electro      
Scientific Industries, Inc. ("ESI"), Applied Intelligent Systems, Inc. ("AISI") 
and Asteroid Merger Corp. ("Merger Corp.") effective as of November 13, 1997.   

In recognition of amendments made to the Michigan statutes governing  
dissenters' rights following the execution of the Agreement, Section 1.5 of the 
Agreement, describing dissenters' rights, is hereby deleted. In addition, all   
other references to dissenters' rights in the Agreement are hereby deleted.     

  IN WITNESS WHEREOF, this Amendment to the Agreement has been executed by
the undersigned as of the date written above.                                   

  Electro Scientific Industries, Inc.    Applied Intelligent Systems, Inc.

By: LARRY T. RAPP                      By: JON G. EHRMANN             
        -------------------------------        -------------------------------
Name: Larry T. Rapp                Name: Jon G. Ehrmann       
              -------------------------          -----------------------------
Title: Vice President and          Title: VP - Finance & CFO  
               Corporate Secretary                ----------------------------
------------------------                        

Asteroid Merger Corp.                                                 

By: LARRY T. RAPP                                                     
-------------------------------                               
Name: Larry T. Rapp                                           
-------------------------                         
Title: Corporate Secretary                                    
------------------------                        

424B1
192nd Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 192nd
                                                                         ANNEX B

September 29, 1997                                                              

Board of Directors                                                              
Applied Intelligent Systems, Inc.                                               
3923 Ranchero Drive                                                             
Ann Arbor, MI  48108                                                            

Attention:  James Anderson - President and Chief Executive Officer              

Gentlemen:                                                                      

Applied Intelligent Systems, Inc. ("AISI" or the "Company") has entered into an 
Agreement of Reorganization and Merger (the "Agreement") dated as of September  
29, 1997, by and among the Company, Electro Scientific Industries, Inc. ("ESIO")
and Asteroid Merger Corp., a wholly-owned subsidiary of ESIO (the "Merger").    
Pursuant to the Merger, we understand that each outstanding share of common     
stock of AISI (the "AISI Common Stock") will be converted into and represent the
right to receive 0.305 shares of ESIO (the "Consideration"). The terms and      
conditions of the Merger, and the Consideration to be received by the AISI      
shareholders pursuant to the Merger, are set forth in more detail in the        
Agreement.                                                                      

You have asked Adams, Harkness & Hill, Inc. ("AH&H") for its opinion as to the  
fairness to the current stockholders of AISI from a financial point of view of  
the Consideration to be received by AISI in the Merger (the "Opinion"). AH&H, as
part of its investment banking business, is continually engaged in the valuation
of businesses and their securities in connection with mergers and acquisitions, 
negotiated underwritings, secondary distributions of listed and unlisted        
securities, private placements, and valuations for estate, corporate and other  
purposes.                                                                       

In rendering its opinion, AH&H, among other things: (i) analyzed certain        
publicly available financial statements and other information concerning ESIO;  
(ii) analyzed certain internal financial statements and forecasts and other     
financial and operating data concerning AISI prepared by the management of AISI;
(iii) analyzed certain forecasts and related assumptions pertaining to ESIO     
obtained from third party research analysts; (iv) discussed the past and current
operations and financial condition and the prospects of AISI and ESIO with the  
management of AISI and ESIO, respectively, and analyzed the pro forma impact of 
the Merger on ESIO's earnings per share; (v) reviewed certain of the reported   
prices and trading activity of ESIO's Common Stock over the past 33 months; (vi)
compared the financial performance of ESIO and certain of the prices and trading
activity of ESIO's Common Stock with that of certain other comparable publicly  
traded companies and their securities; (vii) reviewed the financial terms, to   
the extent publicly available, of certain comparable acquisition transactions;  
(viii) reviewed and                                                             

424B1
Last Page of 193
TOC
1st
Previous
Next
↓Bottom
Just 193rd
Applied Intelligent Systems, Inc.                                               
September 29, 1997                                                              
Page 2                                                                          

discussed with the senior management of AISI the strategic rationale for the    
Merger and the benefits of the Merger to AISI; (ix) reviewed a draft of the     
Agreement dated as of September 29, 1997; (x) discussed with senior management  
of AISI the impact of its customer concentration on its financial and operating 
results; and (xi) performed such other studies, analyses and inquiries and      
considered such other information as AH&H deemed relevant.                      

In connection with our review, we have not independently verified any of the    
foregoing information provided to us and have relied, with your consent, on its 
being complete and accurate in all material respects. With respect to any       
financial forecasts reviewed relating to the prospects of AISI and ESIO, we have
assumed that they have been reasonably prepared on bases reflecting the best    
currently available estimates and judgments of AISI's and ESIO's management as  
to the future financial performance of AISI and ESIO. Our Opinion is rendered on
the basis of securities market conditions prevailing as of the date hereof and  
on the conditions and prospects, financial and otherwise, of AISI and ESIO as   
known to us on the date hereof. We have not conducted, nor have we received     
copies of, any independent evaluation or appraisal of any of the assets of AISI 
and ESIO.                                                                       

The Opinion rendered by us pursuant hereto may be referred to in the minutes of 
the meetings of your Board of Directors.                                        

You acknowledge that our Opinion and any oral advice given by us to you in      
connection with our engagement are intended solely for your use in connection   
with the Merger, and your evaluation of the Consideration to be received in the 
Merger, but does not constitute a recommendation to any stockholder or          
shareholder to approve the Merger, and you agree that, except as provided in the
preceding paragraph, no such opinion or advice shall be reproduced,             
disseminated, quoted or referred to at any time, in any manner, or for any      
purpose, without our prior written consent (except to the extent otherwise      
required by law).                                                               

We agree that any confidential or non-public information furnished to us by you 
or at your direction in connection with our rendering services hereunder will be
used solely for the purpose of performing our services hereunder and that such  
information will be kept confidential by us (except to the extent otherwise     
required by law).                                                               

Based on the above factors considered by AH&H and subject to the foregoing, it  
is our opinion that as of the date hereof, the consideration to be received in  
the Merger by AISI is fair to the stockholders of AISI from a financial point of
view.                                                                           

Very truly yours,                                                               

ADAMS, HARKNESS & HILL, INC.                                                    

By: THEODORE L. STEBBINS                                                        
------------------------------                                          
Theodore L. Stebbins                                                    
Managing Director                                                       

TLS:pal