**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q/A**

 

**(MarkOne)**
| **ý**                                                                                                                                                                                                                                                                                                                                                                                                                                 | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                 | ** **                                                                                          |
| **For the  quarterly period ended September 30,  2004**                                                                                                                                                                                                                                                                                                                                                                               |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                 | ** **                                                                                          |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                 | ** **                                                                                          |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                                      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                 | ** **                                                                                          |
| **For the  transition period from                                   to                                  ** |

 

**Commission File Number 000-30637**

 

 

**AUGUST TECHNOLOGY CORPORATION**

(Exact name of Registrant as specified inits charter)

 
| **Minnesota**                                                                         | ** ** | **41-1729485**                        |
|---------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State of incorporation)                                                              |       | (I.R.S. Employer  Identification No.) |
|                                                                                  |       |                                  |
| **4900 West 78th  Street  Bloomington, MN**                                           | ** ** | **55435**                             |
| (Address of principal  executive offices)                                             |       | (Zip Code)                            |
|                                                                                  |       |                                  |
| **(952) 820-0080**                                                                    |
| (Registrant’s telephone  number, including area code)                            |
|                                                                                  |       |                                  |
| **N/A**                                                                               |
| (Former name, former address, and former fiscal  year, if changed since last report.) |

 

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.    Yes  ý  No  o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined by Exchange ActRule 12b-2).  Yes  ý  No  o

 

As of October 29,2004, there were 17,810,778 shares of common stock outstanding.

 

 

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**AUGUST TECHNOLOGY CORPORATION**

**TABLE OF CONTENTS**

 
| ** **     | **Description**                                                                                                          | ** ** | ** ** |
|----------------|--------------------------------------------------------------------------------------------------------------------------|------------|------------|
|           |                                                                                                                     |       |
| PART I         | FINANCIAL INFORMATION                                                                                                    |       |
|           |                                                                                                                     |       |
| Item  1.       | Financial Statements                                                                                                     |       |
|           |                                                                                                                     |       |
|           | Consolidated Balance Sheets  as of September 30, 2004 and December 31, 2003 (unaudited)                        |       |
|           |                                                                                                                     |       |
|           | Consolidated  Statements of Operations for the three and nine months ended September 30,  2004 and 2003 (unaudited) |       |
|           |                                                                                                                     |       |
|           | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2004  and 2003 (unaudited)           |       |
|           |                                                                                                                     |       |
|           | Notes to  Consolidated Financial Statements (unaudited)                                                                  |       |
|           |                                                                                                                     |       |
| Item  2.       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                              |       |
|           |                                                                                                                     |       |
| Item  3.       | Quantitative and Qualitative Disclosures about  Market Risk                                                              |       |
|           |                                                                                                                     |       |
| Item  4.       | Controls and Procedures                                                                                                  |       |
|           |                                                                                                                     |       |
| PART II        | OTHER INFORMATION                                                                                                        |       |
|           |                                                                                                                     |       |
| Item  6.       | Exhibits                                                                                                                 |       |
|           |                                                                                                                     |       |
| SIGNATURES     |                                                                                                                     |
|           |                                                                                                                     |       |
| EXHIBIT  INDEX |                                                                                                                     |

 

2

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**PART I****        FINANCIAL INFORMATION**

 

**Item1****.  Financial Statements**

**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share amounts)**

**(Unaudited)**

 
| ** **                                                                                                                       | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                       |       |                         |       |                        |       |
|                                                                                                                             |       |                         |       |                        |       |
| Current assets:                                                                                                                  |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                        |       | $                            | 3,432      |                        | $          | 10,027 |   |
| Short-term marketable debt securities                                                                                            |       | 42,060                       |       | 43,528                      |       |
| Accounts receivable, net                                                                                                         |       | 11,315                       |       | 4,094                       |       |
| Inventories                                                                                                                      |       | 20,135                       |       | 11,651                      |       |
| Inventories at customers under purchase orders                                                                                   |       | 4,741                        |       | 2,293                       |       |
| Prepaid expenses and other current assets                                                                                        |       | 2,011                        |       | 1,631                       |       |
| Total current assets                                                                                                             |       | 83,694                       |       | 73,224                      |       |
|                                                                                                                             |       |                         |       |                        |       |
| Property and equipment, net                                                                                                      |       | 6,449                        |       | 3,141                       |       |
| Long-term marketable debt securities                                                                                             |       | 5,362                        |       | 10,295                      |       |
| Purchased technology, net                                                                                                        |       | 3,314                        |       | 1,179                       |       |
| Goodwill                                                                                                                         |       | 498                          |       | 498                         |       |
| Other assets                                                                                                                     |       | 515                          |       | 610                         |       |
| Total assets                                                                                                                     |       | $                            | 99,832     |                        | $          | 88,947 |   |
|                                                                                                                             |       |                         |       |                        |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                   |       |                         |       |                        |       |
|                                                                                                                             |       |                         |       |                        |       |
| Current liabilities:                                                                                                             |       |                         |       |                        |       |
| Accounts payable                                                                                                                 |       | $                            | 6,461      |                        | $          | 5,409 |   |
| Accrued compensation                                                                                                             |       | 2,431                        |       | 1,146                       |       |
| Accrued liabilities                                                                                                              |       | 1,778                        |       | 1,414                       |       |
| Customer deposits and deferred revenue                                                                                           |       | 7,489                        |       | 2,436                       |       |
| Total current liabilities                                                                                                        |       | 18,159                       |       | 10,405                      |       |
|                                                                                                                             |       |                         |       |                        |       |
| Other non-current liabilities                                                                                                    |       | 82                           |       | 65                          |       |
| Total liabilities                                                                                                                |       | 18,241                       |       | 10,470                      |       |
|                                                                                                                             |       |                         |       |                        |       |
| Commitments and contingencies                                                                                                    |       | —                       |       | —                      |       |
|                                                                                                                             |       |                         |       |                        |       |
| Shareholders’ equity:                                                                                                       |       |                         |       |                        |       |
| Common stock, no par value, 42,000,000 shares authorized,  17,804,696 and 17,382,538 shares issued and outstanding, respectively |       | 90,090                       |       | 88,086                      |       |
| Undesignated capital stock, no par value, 3,000,000  shares authorized, no shares issued or outstanding                          |       | —                       |       | —                      |       |
| Deferred compensation related to stock options                                                                                   |       | (12                          | )          | (49                         | )          |
| Accumulated deficit                                                                                                              |       | (8,404                       | )          | (9,578                      | )          |
| Accumulated other comprehensive income (loss)                                                                                    |       | (83                          | )          | 18                          |       |
| Total shareholders’ equity                                                                                                  |       | 81,591                       |       | 78,477                      |       |
| Total liabilities and shareholders’ equity                                                                                  |       | $                            | 99,832     |                        | $          | 88,947 |   |

 

See accompanyingnotes to consolidated financial statements.

 

3

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**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Inthousands, except per share amounts)**

**(Unaudited)**

 
| ** **                                      | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                      | ** ** | ** **                                | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                                    |       | $                                         | 15,516     |                                     | $          | 11,685 |   | $ | 51,771 |   | $ | 26,005 |   |
| Cost of revenues                                |       | 8,187                                     |       | 5,100                                    |       | 24,304 |   | 11,603 |   |
| Gross profit                                    |       | 7,329                                     |       | 6,585                                    |       | 27,467 |   | 14,402 |   |
|                                            |       |                                      |       |                                     |       |   |   |   |   |
| Selling, general and administrative expenses    |       | 6,202                                     |       | 3,808                                    |       | 16,781 |   | 10,228 |   |
| Research and development expenses               |       | 3,822                                     |       | 2,595                                    |       | 10,052 |   | 7,797 |   |
| Operating income (loss)                         |       | (2,695                                    | )          | 182                                      |       | 634 |   | (3,623 | ) |
|                                            |       |                                      |       |                                     |       |   |   |   |   |
| Interest income                                 |       | 204                                       |       | 71                                       |       | 594 |   | 247 |   |
| Other income                                    |       | 46                                        |       | —                                   |       | 46 |   | — |   |
|                                            |       |                                      |       |                                     |       |   |   |   |   |
| Income (loss) before provision for income taxes |       | (2,445                                    | )     | 253                                      |       | 1,274 |   | (3,376 | )  |
| Provision for income taxes                      |       | —                                    |       | —                                   |       | 100 |   | — |   |
| Net income (loss)                               |       | $                                         | (2,445     | )                                        | $          | 253 |   | $ | 1,174 |   | $ | (3,376 | ) |
|                                            |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss) per share:                    |       |                                      |       |                                     |       |   |   |   |   |
| Basic                                           |       | $                                         | (0.14      | )                                        | $          | 0.02 |   | $ | 0.07 |   | $ | (0.25 | ) |
| Diluted                                         |       | $                                         | (0.14      | )                                        | $          | 0.02 |   | $ | 0.06 |   | $ | (0.25 | ) |

 

Seeaccompanying notes to consolidated financial statements.

 

4

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** **

**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                                          | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| Cash flows from operating activities:                                                               |       |                                     |       |   |   |
| Net income (loss)                                                                                   |       | $                                        | 1,174      |   | $ | (3,376 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                                     |       |   |   |
| Depreciation and amortization                                                                       |       | 1,890                                    |       | 1,368 |   |
| Provision for doubtful accounts                                                                     |       | 115                                      |       | 134 |   |
| Amortization of deferred compensation related to  stock options                                     |       | 37                                       |       | 43 |   |
| Issuances of stock options to nonemployees                                                          |       | 3                                        |       | 2 |   |
| Changes in operating assets and liabilities, net of  affects of acquisitions:                       |       |                                     |       |   |   |
| Accounts receivable                                                                                 |       | (7,213                                   | )          | 1,829 |   |
| Inventories                                                                                         |       | (8,484                                   | )          | (967 | ) |
| Inventories at customers under purchase orders                                                      |       | (2,448                                   | )          | (746 | ) |
| Prepaid expenses and other current assets                                                           |       | (397                                     | )          | (141 | ) |
| Accounts payable                                                                                    |       | 1,052                                    |       | 1,696 |   |
| Accrued compensation                                                                                |       | 1,285                                    |       | 745 |   |
| Accrued liabilities                                                                                 |       | 304                                      |       | 572 |   |
| Customer deposits and deferred revenue                                                              |       | 4,804                                    |       | 919 |   |
| Net cash provided by (used in) operating activities                                                 |       | (7,878                                   | )          | 2,078 |   |
|                                                                                                |       |                                     |       |   |   |
| Cash flows from investing activities:                                                               |       |                                     |       |   |   |
| Purchases of marketable securities                                                                  |       | (166,391                                 | )          | (62,539 | ) |
| Maturities of marketable securities                                                                 |       | 172,710                                  |       | 29,161 |   |
| Purchases of property and equipment                                                                 |       | (4,703                                   | )          | (739 | ) |
| Cash paid for acquisitions                                                                          |       | (2,300                                   | )          | (1,485 | ) |
| Investments in other assets                                                                         |       | (14                                      | )          | — |   |
| Net cash used in investing activities                                                               |       | (698                                     | )          | (35,602 | ) |
|                                                                                                |       |                                     |       |   |   |
| Cash flows from financing activities:                                                               |       |                                     |       |   |   |
| Net proceeds from follow on common stock offering                                                   |       | —                                   |       | 36,122 |   |
| Net proceeds from issuances of common stock to  employees                                           |       | 2,001                                    |       | 604 |   |
| Net cash provided by financing activities                                                           |       | 2,001                                    |       | 36,726 |   |
|                                                                                                |       |                                     |       |   |   |
| Effect of exchange rates on cash and cash  equivalents                                              |       | (20                                      | )          | — |   |
|                                                                                                |       |                                     |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                                |       | (6,595                                   | )          | 3,202 |   |
| Cash and cash equivalents at beginning of period                                                    |       | 10,027                                   |       | 1,895 |   |
| Cash and cash equivalents at end of period                                                          |       | $                                        | 3,432      |   | $ | 5,097 |   |
|                                                                                                |       |                                     |       |   |   |
| Supplemental cash flow information:                                                                 |       |                                     |       |   |   |
| Cash refunds (payments) of income taxes, net                                                        |       | $                                        | (83        | ) | $ | 227 |   |
| Common stock issued for acquisitions                                                                |       | $                                        | —     |   | $ | 2,160 |   |

 

See accompanying notes to consolidated financialstatements.

 

5

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**AUGUST TECHNOLOGY CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2004**

**(In thousands, except per share amounts)**

** **

**(Unaudited)**

** **

**Note****1 –****Basis of Presentation**

 

The accompanyingunaudited consolidated financial statements have been prepared pursuant to therules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures,normally included in consolidated financial statements prepared in accordancewith accounting principles generally accepted in the United States of America,have been condensed or omitted pursuant to such rules and regulations.  In the opinion of the management of August TechnologyCorporation (collectively with its subsidiaries, the “Company”), alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation have been included in the consolidated balance sheet atSeptember 30, 2004, the consolidated results of operations for the threeand nine months ended September 30, 2004 and 2003, and the consolidatedstatements of cash flows for the nine months ended September 30, 2004 and2003.  The results of operations of theinterim periods are not necessarily indicative of the results of operationsthat may be expected for any other period or for the year as a whole.  These consolidated financial statements andnotes hereto should be read in conjunction with the audited consolidatedfinancial statements and notes thereto included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2003, filed with theSecurities and Exchange Commission on March 1, 2004.

 

The accompanyingconsolidated financial statements include the accounts of August TechnologyCorporation and its wholly owned subsidiaries. All significant intercompany balances and transactions are eliminated inconsolidation.

 

**Note 2****–****Business Combination**

 

On July 27, 2004,the Company purchased certain assets relating to the DMSVision softwaredivision (“DMS”) of Inspex, Inc.  Thepurchase was made pursuant to an Asset Purchase Agreement between the Companyand Inspex, Inc. dated June 23, 2004. DMS develops and marketsproduct characterization software solutions that allow customers to collect andanalyze process information from a broad range of applications.   The total consideration paid for DMS,including direct acquisition costs, was $2,288. In addition, the Company may owe additional future consideration basedon new orders for DMS software licenses received in the twelve months after thepurchase (See note 9).

 

6

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The allocation of thepurchase price to the net assets acquired and liabilities assumed based upontheir estimated fair market values was as follows:

 
| Accounts  receivable | ** ** | $     | 123    | ** ** |
|----------------------|------------|-------|--------|------------|
| Purchased technology |       | 2,435 |   |
| Accrued liabilities  |       | (21   | )      |
| Deferred revenue     |       | (249  | )      |
|                 |       | $     | 2,288  |       |

 

Thefollowing unaudited pro forma consolidated financial information presents thecombined results of operations of the Company and DMS as if the acquisitionoccurred at the beginning of the periods presented, after giving effect to certainadjustments, including amortization expense.  The unaudited pro formaconsolidated financial information does not necessarily reflect the results ofoperations that would have occurred had the acquisition been completed as ofthe dates indicated or the results that may be obtained in the future.

 
| ** **                   | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                   | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenues                 |       | $                                         | 15,590     |                                     | $          | 12,095 |   | $ | 52,289 |   | $ | 27,387 |   |
| Net income (loss)            |       | (2,587                                    | )          | (99                                      | )          | 179 |   | (4,280 | ) |
|                         |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss) per share: |       |                                      |       |                                     |       |   |   |   |   |
| Basic                        |       | $                                         | (0.15      | )                                        | $          | (0.01 | ) | $ | 0.01 |   | $ | (0.32 | ) |
| Diluted                      |       | (0.15                                     | )          | (0.01                                    | )          | 0.01 |   | (0.32 | ) |

 

**Note 3– Marketable Debt Securities**

 

Theamortized cost and estimated fair value of available-for-sale marketable debtsecurities were as follows:

 
| ** **      | ** ** | **September 30, 2004** | ** ** |
|-----------------|------------|-----------------------------|------------|
| ** **      | ** ** | **Amortized   Cost**        | ** ** | **Gross   Unrealized   Gains** | ** ** | **Gross   Unrealized   Losses** | ** ** | **Fair   Value** | ** ** |
| Corporate bonds |       | $                           | 13,196     |   | $ | 1 |   | $ | (31 | ) | $ | 13,166 |   |
| Municipal bonds |       | 34,270                      |       | 1 |   | (15 | ) | 34,256 |   |
|            |       | $                           | 47,466     |   | $ | 2 |   | $ | (46 | ) | $ | 47,422 |   |

 
| ** **      | ** ** | **December 31, 2003** | ** ** |
|-----------------|------------|----------------------------|------------|
| ** **      | ** ** | **Amortized   Cost**       | ** ** | **Gross   Unrealized   Gains** | ** ** | **Gross   Unrealized   Losses** | ** ** | **Fair   Value** | ** ** |
| Corporate bonds |       | $                          | 12,484     |   | $ | 35 |   | $ | (2 | ) | $ | 12,517 |   |
| Municipal bonds |       | 41,301                     |       | 7 |   | (2 | ) | 41,306 |   |
|            |       | $                          | 53,785     |   | $ | 42 |   | $ | (4 | ) | $ | 53,823 |   |

 

7

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Thematurities of available-for-sale marketable debt securities were as follows:

 
| ** **                             | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | **Amortized   Cost**        | ** ** | **Fair   Value**           | ** ** | **Amortized   Cost** | ** ** | **Fair   Value** | ** ** |
| Due within one year                    |       | $                           | 42,092     |                       | $          | 42,060 |   | $ | 43,524 |   | $ | 43,528 |   |
| Due after one year through three years |       | 5,374                       |       | 5,362                      |       | 10,261 |   | 10,295 |   |
|                                   |       | $                           | 47,466     |                       | $          | 47,422 |   | $ | 53,785 |   | $ | 53,823 |   |

 

Netrealized gains and losses were not material for the nine months ended September 30,2004 and the year ended December 31, 2003.

 

**Note 4 –Accounts Receivable**

 

Accountsreceivable consisted of the following:

 
| ** **                      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                            |       |                         |       |                        |       |
| Billed receivables              |       | $                            | 10,246     |                        | $          | 3,837 |   |
| Unbilled revenue                |       | 1,739                        |       | 812                         |       |
|                            |       | 11,985                       |       | 4,649                       |       |
| Allowance for doubtful accounts |       | (670                         | )          | (555                        | )          |
| Accounts receivable, net        |       | $                            | 11,315     |                        | $          | 4,094 |   |

 

**Note 5 –Inventories**

 

Inventoriesconsisted of the following:

 
| ** **              | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                    |       |                         |       |                        |       |
| Raw materials           |       | $                            | 6,859      |                        | $          | 4,645 |   |
| Work in process         |       | 4,640                        |       | 2,305                       |       |
| Demonstration equipment |       | 4,554                        |       | 1,603                       |       |
| Finished goods          |       | 4,082                        |       | 3,098                       |       |
| Inventories             |       | $                            | 20,135     |                        | $          | 11,651 |   |

 

**Note 6 – Purchased Technology**

 

As of September 30,2004, purchased technology was $3,865 and related accumulated amortization of $551. Purchased technology is amortized on a straight-line basis over anestimated useful life of four years. Amortization expense for the three months ended September 30, 2004and 2003 was $187 and $84, respectively.  Amortization expense for thenine months ended September 30, 2004 and 2003 was $361 and $103,respectively.  Assuming no change in the gross carrying value of purchasedtechnology, the estimated amortization expense for the twelve months ending December 31,2004 is $648 and for each of the next four years is $953, $953, $761 and $304.

 

8

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**Note 7 – Accumulated OtherComprehensive Income (Loss)**

 

Theaccumulated balances for each classification of accumulated other comprehensiveincome (loss) are as follows:

 
| ** **                                          | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                                |       |                         |       |                        |       |
| Currency translation adjustments                    |       | $                            | (39        | )                           | $          | (20 | ) |
| Net unrealized gain (loss) on marketable securities |       | (44                          | )          | 38                          |       |
| Accumulated other comprehensive income (loss)       |       | $                            | (83        | )                           | $          | 18 |   |

 

**Note 8 –Shareholders’ Equity**

 

Changes in shareholders’equity during the nine months ended September 30, 2004 were as follows:

 
| Shareholders’ equity balance at December 31,  2003    |   | $      | 78,477 |   |
|-----------------------------------------------------------------|--------|--------|--------|--------|
| Net income                                                      |   | 1,174  |   |
| Accumulated other comprehensive loss:                           |   |   |   |
| Foreign currency translation adjustment                         |   | (19    | )      |
| Net unrealized loss on marketable debt securities               |   | (82    | )      |
| Comprehensive income                                            |   | 1,073  |   |
| Issuances of common stock in conjunction with:                  |   |   |   |
| Exercises of employee stock options and warrants                |   | 1,864  |   |
| Employee stock purchase plan                                    |   | 137    |   |
| Amortization of deferred compensation related to  stock options |   | 37     |   |
| Issuances of stock options to nonemployees                      |   | 3      |   |
| Shareholders’ equity balance at September 30,  2004   |   | $      | 81,591 |   |

 

On September 23,2003, the Company sold 3,000 shares of its Common Stock at a price of $13.00per share in a follow-on public offering (the “Offering”).  In conjunction with the Offering, on October 21,2003, the underwriters exercised their over-allotment option to acquire anadditional 490 shares of Common Stock at the same price to the public and withthe same underwriting discount as the Offering. The net proceeds from the Offering, including the exercise of theunderwriters over-allotment, after deducting the underwriting discount andoffering expenses, was $42,049.

 

9

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***Net Income (Loss)Per Share***

 

The components of basicand diluted net income (loss) per share were as follows:

 
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                    | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                          |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss)                             |       | $                                         | (2,445     | )                                        | $          | 253 |   | $ | 1,174 |   | $ | (3,376 | ) |
|                                          |       |                                      |       |                                     |       |   |   |   |   |
| Weighted average common shares:               |       |                                      |       |                                     |       |   |   |   |   |
| Basic                                         |       | 17,803                                    |       | 13,844                                   |       | 17,735 |   | 13,451 |   |
| Effect of dilutive stock options and warrants |       | —                                    |       | 734                                      |       | 610 |   | — |   |
| Diluted                                       |       | 17,803                                    |       | 14,578                                   |       | 18,345 |   | 13,451 |   |
|                                          |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss) per share:                  |       |                                      |       |                                     |       |   |   |   |   |
| Basic                                         |       | $                                         | (0.14      | )                                        | $          | 0.02 |   | $ | 0.07 |   | $ | (0.25 | ) |
| Diluted                                       |       | $                                         | (0.14      | )                                        | $          | 0.02 |   | $ | 0.06 |   | $ | (0.25 | ) |

 

The total weightedaverage number of stock options and warrants excluded from the calculation ofpotentially dilutive securities either due to the exercise price exceeding theaverage market price or the inclusion of such securities in a calculation of netincome (loss) per share would have been anti-dilutive for the three monthsended September 30, 2004 and 2003 were 1,710 and 517, respectively, andfor the nine months ended September 30, 2004 and 2003 were 296 and 1,887, respectively.

 

***Stock-based Compensation***

 

The Company appliesAccounting Principles Board Opinion (“APB”) No. 25, *“Accountingfor Stock Issued to Employees,”* and related interpretations inaccounting for stock-based compensation. The exercise price of the Company’s stock options equals the marketprice of the underlying stock on the date of grant for all options granted, andthus, under APB 25, no compensation expense is recognized in the consolidatedstatements of operations.

 

The estimated per shareweighted average fair value of all stock options granted during the threemonths ended September 30, 2004 and 2003 was $6.01 and $6.11, respectively, and forthe nine months ended September 30, 2004 and 2003 was $8.10 and $3.82, respectively. Thefair value of each option grant was estimated using the Black-Scholes optionpricing model with the following weighted average assumptions:

 
| ** **              | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **              | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|                    |       |                                      |       |                                     |       |   |   |   |   |
| Expected life           |       | 4.7 years                                 |       | 5.9 years                                |       | 4.5 years |   | 5.6 years |   |
| Risk free interest rate |       | 3.0                                       | %          | 3.2                                      | %          | 2.9 | % | 3.0 | % |
| Volatility              |       | 73.8                                      | %          | 75.1                                     | %          | 74.0 | % | 75.1 | % |
| Dividend yield          |       | —                                    |       | —                                   |       | — |   | — |   |

 

10

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Had the Company recordedcompensation cost based on the estimated fair value on the date of grant, asdefined by SFAS 123, the Company’s pro forma net income (loss) would havebeen as follows:

 
| ** **                                                                                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                         | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                               |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss), as reported                                                                     |       | $                                         | (2,445     | )                                        | $          | 253 |   | $ | 1,174 |   | $ | (3,376 | ) |
| Stock-based employee compensation expense determined  under fair value based method for all awards |       | (629                                      | )          | (377                                     | )          | (2,303 | ) | (1,053 | ) |
| Net loss, pro forma                                                                                |       | $                                         | (3,074     | )                                        | $          | (124 | ) | $ | (1,129 | ) | $ | (4,429 | ) |
|                                                                                               |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss) per share:                                                                       |       |                                      |       |                                     |       |   |   |   |   |
| As reported:                                                                                       |       |                                      |       |                                     |       |   |   |   |   |
| Basic                                                                                              |       | $                                         | (0.14      | )                                        | $          | 0.02 |   | $ | 0.07 |   | $ | (0.25 | ) |
| Diluted                                                                                            |       | $                                         | (0.14      | )                                        | $          | 0.02 |   | $ | 0.06 |   | $ | (0.25 | ) |
|                                                                                               |       |                                      |       |                                     |       |   |   |   |   |
| Pro forma:                                                                                         |       |                                      |       |                                     |       |   |   |   |   |
| Basic                                                                                              |       | $                                         | (0.17      | )                                        | $          | (0.01 | ) | $ | (0.06 | ) | $ | (0.33 | ) |
| Diluted                                                                                            |       | $                                         | (0.17      | )                                        | $          | (0.01 | ) | $ | (0.06 | ) | $ | (0.33 | ) |

 

**Note 9 –Commitments and Contingencies**

 

***Warranties***

 

The Company provideswarranty coverage for its systems for a period of one year, including parts andlabor necessary to repair the systems during the warranty period.  The estimated warranty cost is based on ourhistorical experience rate of incurred expenses to corresponding systemrevenues.

 

The following tablesummarizes the activity related to the warranty liability during the ninemonths ended September 30, 2004 and 2003:

 
| ** **                   | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------|------------|------------------------------------------|------------|
| ** **                   | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
|                         |       |                                     |       |   |   |
| Accrual at beginning of year |       | $                                        | 239        |   | $ | 111 |   |
| Warranties issued            |       | 955                                      |       | 267 |   |
| Costs incurred               |       | (553                                     | )          | (148 | ) |
| Accrual at end of period     |       | $                                        | 641        |   | $ | 230 |   |

 

***Contingent Consideration***

 

In connection with theacquisition of DMS, the Company is subject to certain contingent considerationarrangements at September 30, 2004. This arrangement is based upon new orders for DMS software licensesreceived in the twelve months after the purchase.  The payment of the contingency will result inan increase in the allocation of purchase price to purchased technology.  As a result, amortization expense related tothis asset will increase.  Amounts paidunder this arrangement are not expected to have a material effect on theCompany’s consolidated financial condition or results of operations.  The Company currently estimates the totalcontingent consideration to be paid will be between $250 and $750.

 

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***Legal Proceedings***

 

The Company fully settledthe commercial litigation between the Company and Rudolph Technologies, Inc.(“Rudolph”).  On September 23, 2003,the Company and its subsidiary, Semiconductor Technologies & Instruments,Inc. (“STI”), filed a complaint against Rudolph and its subsidiary ISOA, Inc.(“ISOA”).  In the complaint, the Companyand STI sought a declaratory judgment that the Company and STI were not usingISOA technology in their products.  STIalso asserted a claim for breach of contract to recover amounts STI paid toISOA in connection with a joint development agreement between STI andISOA.  Rudolph and ISOA filed an answerand counterclaim, denying the allegations set forth in the complaint andclaiming that ISOA was entitled to damages for STI’s alleged breach of thejoint development agreement.  ISOA alsosought a declaratory judgment that STI and/or the Company were wrongfully usingISOA’s technology without compensating ISOA and that ISOA was entitled toroyalty payments for use of its technology.

 

The Company acquired STIfrom ASTI Holdings, Ltd. (“ASTI”) in April 2003.  In connection with the acquisition, ASTIagreed to indemnify the Company for claims relating to STI’s dispute withRudolph and ISOA, up to a maximum value of $670.  To secure ASTI’s performance of ASTI’sindemnification obligations, ASTI and August created an escrow.

 

OnJuly 22, 2004, the Company, STI, Rudolph, ISOA agreed to settle all claimsbetween the parties.  On August 6, 2004 the Company entered intoa final settlement agreement with Rudolph.  Under the terms of theconfidential settlement, ASTI made a one-time payment out of the escrow toRudolph in the amount of $503.  The Company, STI, Rudolph and ISOA agreedto release any and all claims against each other relating to the jointdevelopment agreement and to dismiss all claims asserted in the litigation withprejudice.

 

**Note 10– Geographic, Product Line and Significant Customer Information**

 

All of the Company’stangible long-lived assets are located in the United States, except for a smallamount of property and equipment in Taiwan. The Company derives revenues from shipments to customers outside of theUnited States.  The percentage of netrevenues by geographical region was as follows:

 
| ** **    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **    | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenues: |       |                                      |       |                                     |       |   |   |   |   |
| United States |       | 21                                        | %          | 17                                       | %          | 27 | % | 25 | % |
| Asia          |       | 68                                        | %          | 72                                       | %          | 69 | % | 64 | % |
| Europe        |       | 11                                        | %          | 11                                       | %          | 4 | % | 11 | % |
|          |       | 100                                       | %          | 100                                      | %          | 100 | % | 100 | % |

 

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The percentage of netrevenues by major product line was as follows:

 
| ** **          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **          | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenues:       |       |                                      |       |                                     |       |   |   |   |   |
| NSX Series          |       | 39                                        | %          | 36                                       | %          | 50 | % | 53 | % |
| All Surface Modules |       | 40                                        | %          | 14                                       | %          | 25 | % | 6 | % |
| 3Di Series          |       | 4                                         | %          | 25                                       | %          | 7 | % | 16 | % |
| Other               |       | 17                                        | %          | 25                                       | %          | 18 | % | 25 | % |
|                |       | 100                                       | %          | 100                                      | %          | 100 | % | 100 | % |

 

The percentage of netrevenues derived from major customers, which include distributors, were asfollows:

 
| ** **    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **    | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenues: |       |                                      |       |                                     |       |   |   |   |   |
| Customer A    |       | 29                                        | %          | 15                                       | %          | 19 | % | 7 | % |
| Customer B    |       | 11                                        | %          | 4                                        | %          | 10 | % | 2 | % |
| Customer C    |       | 10                                        | %          | 1                                        | %          | 9 | % | 5 | % |
| Customer D    |       | 1                                         | %          | 20                                       | %          | 5 | % | 12 | % |
| Customer E    |       | 4                                         | %          | 18                                       | %          | 5 | % | 16 | % |
| Customer F    |       | —                                    |       | 8                                        | %          | 2 | % | 16 | % |
|          |       | 55                                        | %          | 66                                       | %          | 50 | % | 58 | % |

 

**Note 11– Recently Issued Accounting Pronouncements**

 

In December 2003,the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation(“FIN”) No. 46R, “*Consolidation of VariableInterest Entities,”* which addresses how a business enterprise shouldevaluate whether it has a controlling financial interest in an entity throughmeans other than voting rights and accordingly should consolidate theentity.  FIN 46R replaces FASB InterpretationNo. 46, “*Consolidation of Variable InterestEntities,”* which was issued in January 2003. The Company isrequired to apply FIN 46R to variable interests in variable interest entities(“VIE”) created after December 31, 2003. For variable interests in VIEscreated before January 1, 2004, the Interpretation will be appliedbeginning on January 1, 2005. For any VIEs that must be consolidated underFIN 46R that were created before January 1, 2004, the assets, liabilitiesand noncontrolling interests of the VIE initially would be measured at theircarrying amounts with any difference between the net amount added to thebalance sheet and any previously recognized interest being recognized as thecumulative effect of an accounting change. If determining the carrying amountsis not practicable, fair value at the date FIN 46R first applies may be used tomeasure the assets, liabilities and noncontrolling interest of the VIE. TheCompany believes it has no variable interest entities and, therefore, FIN 46Rdid not have an impact on the Company’s consolidated financial statements.

 

In May 2003, the FASBissued SFAS No. 150, “*Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity.”* The Statement establishes standards for theclassification and measurement of certain financial instruments withcharacteristics of both liabilities and equity. The Statement also includes required disclosures for financialinstruments

 

13

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within its scope.  For the Company, the Statement was effectivefor instruments entered into or modified after May 31, 2003, and otherwise willbe effective as of January 1, 2004, except for mandatorily redeemablefinancial instruments.  For certainmandatorily redeemable financial instruments, the Statement will be effectivefor the Company on January 1, 2005. The effective date has been deferred indefinitely for certain othertypes of mandatorily redeemable financial instruments.  The Company currently does not have anyfinancial instruments that are within the scope of the Statement.

 

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**Item2**.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

** **

**Cautionary Factors That May Affect Future Results**

** **

Certain statements madein this Quarterly Report on Form 10-Q, as well as oral statements made by usfrom time to time, which are prefaced with words such as “expects,”“anticipates,” “believes,” “projects,” “intends,” “plans” and similar words andother statements of similar sense, are forward-looking statements.  Our forward-looking statements generallyrelate to our growth strategies, financial results, future financialprojections, product development activities and sales efforts.  Our actualresults could differ materially from those projected in the forward-lookingstatements as a result of a number of factors, including but not limited tomarket acceptance of our products, our ability to successfully develop newproducts, our ability to protect our intellectual property, our dependence uponinternational customers and suppliers, our dependence on a small number ofcustomers that account for a significant portion of revenues, availability ofproducts from our suppliers, cyclicality in the microelectronic manufacturingequipment and other industries, management of growth, integration of acquiredbusinesses, and the other risk factors detailed below and in our Annual Reporton Form 10-K for the year ended December 31, 2003, as filed with the SECon March 1, 2004.  We disclaim anyobligation to revise forward-looking statements, or to update the reasonsactual results could differ materially from those anticipated, to reflectevents or circumstances after the date of such statements or to reflect theoccurrence of anticipated or unanticipated events. Because many factors areunforeseeable, the foregoing should not be considered an exhaustive list.

 

**Introduction**

 

The following discussion of our results ofoperations and financial condition should be read together with the otherfinancial information and consolidated financial statements and related notesincluded in this Form 10-Q. This discussion contains forward-looking statementsthat involve risks and uncertainties. Our actual results could differmaterially from those anticipated in the forward-looking statements as a resultof a variety of factors.

 

**Critical Accounting Policies**

 

Thepreparation of our consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities.  We based these estimates andassumptions on historical experience and evaluate them on an on-going basis tohelp ensure they remain reasonable under current conditions.  Actualresults could differ from those estimates. We discuss the development andselection of the critical accounting estimates with the audit committee of ourboard of directors on a quarterly basis, and the audit committee has reviewedthe Company’s critical accounting policies as described in Item 7,“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” in our Annual Report on Form 10-K for the year ended December 31,2003.   For the nine months ended September 30, 2004, there wereno changes to these critical accounting policies.

 

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**Overview**

 

We are a world-classprovider of automated defect detection and product characterization systems formicroelectronic device manufacturers. Our systems provide manufacturers withinformation that enables process-enhancing decisions, ultimately loweringmanufacturing costs and decreasing time-to-market. We sell our systems to manyof the leading microelectronic device manufacturers throughout the world forinspecting semiconductors, advanced packaging applications, optoelectronicsdevices, MEMS, data storage devices and micro displays.  We have traditionally provided systems toaddress the automated inspection needs of the early stages of the finalmanufacturing or back-end of the microelectronic device manufacturing process.These needs were met primarily with our NSX Series and 3Di Series of products.

 

We recently introducedthe AXi Series and the E20 and B20 inspection modules (collectively, the “AllSurface Inspection System”) for advanced macro detection primarily in thefront-end of the wafer manufacturing process. When used in conjunction with oneanother these systems allow a manufacturer to inspect the top, edge and back ofa wafer’s surface.  We believe we are thefirst to offer all surface wafer inspection. During 2004, we have made a significant investment supporting AllSurface Inspection System demonstrations at many large semiconductormanufacturers, which allows these customers to evaluate the benefits thesesystems provide.  We expect thesedemonstrations will lead to increased revenues six to nine months afterinstallation.

 

We complement this broadinspection capability with an expanding suite of software tools designed toenhance the speed and effectiveness of the process by which devicemanufacturers analyze defects, and make decisions regarding their manufacturingprocess to reduce or eliminate such defects. We refer to this process as the “detection-to-decision” process.

 

Inaddition to internal development, we look to expand through strategic mergersand acquisitions of complementary products and technologies. In April 2003we completed the acquisition of Semiconductor Technologies & Instruments,Inc. (“STI”), enhancing our probe mark inspection and metrology capabilities.In July 2003 we acquired the assets of Counterpoint Solutions, Inc.(“CSI”), including the design for the VersaScope a defect review system foradvanced microscope-based imaging and analysis. The VersaScope provides us the ability to serve our customers earlier intheir device development process and to more quickly analyze defects andunderstand their manufacturing process once they initiate high volumeproduction.  In July 2004 weacquired certain assets of the DMSVision software division of Inspex, Inc.  We plan to use the DMSVision software tofurther expand and enhance our current defect analysis software offerings.

 

Our business is subjectto the highly cyclical nature of the microelectronic device manufacturingmarkets we serve. These cycles are caused by significant, and often rapid,fluctuations in the supply and demand of microelectronic devices driven by suchfactors as changes in technology and global economic conditions. As a result ofthese fluctuations, our quarterly orders and revenues have fluctuateddramatically.  After a three year industrydownturn we began toexperience signs of an industry recovery during the second half of 2003 andcontinued through the first half of 2004. This resulted in a significant increase in the level of orders andrevenues during this period, and a record level of backlog at June 30,2004.  In response to the increasedactivity level we added additional staff in all functional areas and increasedour manufacturing levels.  Near the endof the third quarter of 2004, as a result of a slowdown in the microelectronicdevice manufacturing market, we encountered a slowdown in the rate of ordersbeing received, and a delay in shipments of certain systems under previouslyreceived orders.  This resulted in asequential decrease in quarterly revenues and a lower level of orders inbacklog, as compared to the end of the second quarter.

 

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Althoughwe currently believe this slowdown may only be temporary in nature, we haveimplemented cost cutting initiatives during the fourth quarter of 2004.  These initiatives include staffing reductions, reductions in managementcompensation, cuts in discretionary spending and mandatory time-off foremployees (the “Cost Cutting Initiatives”). We expect the Cost Cutting Initiatives will result in a reduction inoperating expenses of between 4% and 7% as compared to the third quarter of2004.

 

Managementfocuses on several key financial metrics in evaluating our financialcondition and operating performance.  Although we do not believe backlogis always a meaningful or accurate indication of future revenues andperformance, since only a portion of our revenues for any quarter includesystems that were in backlog as of the beginning of that quarter, we do closelymonitor the level of orders both geographically and by product line and inrelation to the level of revenues, referred to as the book-to-bill ratio.  During the third quarter of 2004 ourbook-to-bill ratio was below parity for the first time in nine consecutivequarters.  A book-to-bill ratio greaterthan parity indicates a growing level of backlog.  In addition to monitoring our level oforders and backlog, we focus on revenues by product family compared toprior-period and current-year plans, year-over-year revenue growth compared tothe overall semiconductor equipment industry, operating profit or lossperformance compared with prior-period and current-year plans and the level ofoperating cash flow.

 

Future quarterly andannual results will continue to be impacted by fluctuations in supply anddemand of microelectronic devices, the timing of new product announcements andreleases by us or our competitors, market acceptance of new or enhancedversions of our products, changes in the pricing of our products and the timingand level of our research and development expenditures.  We cannot predict the sustainability or depth of these fluctuations andtheir impact on our business, and/or the overall industry’s rate of growth. Ifwe are unable to effectively manage our resources and production capacityduring an industry cycle, there could be a material adverse effect on ourbusiness, financial condition and results of operations.

 

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**Results of Operations**

 
| ** **                                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                |       |                                      |       |                                     |       |   |   |   |   |
| Net revenues                                        |       | 100.0                                     | %          | 100.0                                    | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                    |       | 52.8                                      |       | 43.6                                     |       | 46.9 |   | 44.6 |   |
| Gross profit                                        |       | 47.2                                      |       | 56.4                                     |       | 53.1 |   | 55.4 |   |
|                                                |       |                                      |       |                                     |       |   |   |   |   |
| Selling, general and administrative expenses        |       | 40.0                                      |       | 32.6                                     |       | 32.4 |   | 39.4 |   |
| Research and development expenses                   |       | 24.6                                      |       | 22.2                                     |       | 19.4 |   | 30.0 |   |
| Operating income (loss)                             |       | (17.4                                     | )          | 1.6                                      |       | 1.3 |   | (14.0 | ) |
|                                                |       |                                      |       |                                     |       |   |   |   |   |
| Interest income                                     |       | 1.3                                       |       | 0.6                                      |       | 1.1 |   | 1.0 |   |
| Other income                                        |       | 0.3                                       |       | —                                   |       | 0.1 |   | — |   |
|                                                |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss) before provision for income taxes |       | (15.8                                     | )          | 2.2                                      |       | 2.5 |   | (13.0 | ) |
| Provision for income taxes                          |       | —                                    |       | —                                   |       | 0.2 |   | — |   |
| Net income (loss)                                   |       | (15.8                                     | )%         | 2.2                                      | %          | 2.3 | % | (13.0 | )% |

** **

*Three and nine months ended September 30, 2004 compared to thethree and nine months ended September 30, 2003*

 

*Net Revenues.*  Net revenues increased $3.8 million, or32.8%, to $15.5 million for the three months ended September 30, 2004,from $11.7 million for the same period in 2003. Net revenues increased $25.8 million, or 99.1%, to $51.8 million for thenine months ended September 30, 2004, from $26.0 million for the sameperiod in 2003.  The increase in netrevenues was primarily due to increased sales of higher throughput NSX Seriessystems installed in a broader array of wafer and device fabrication processesand sales related to the AXi Series, for which we began to recognize revenueduring the third quarter of 2003.  Inaddition, during the three months ended September 30, 2004, we recognizedthe first revenues from the E20 edge inspection modules.  Revenues from these product lines increasedprimarily as a result of higher sales of systems into the front end of thewafer fabrication process and an overall increase in demand due to the industryrecovery that began in the second half of 2003 and continued through the firsthalf of 2004.  Revenues are expected tobe relatively flat, as compared to third quarter of 2004, due to the industryslowdown described above.

 

Netrevenues from international sales represented 79% and 83% of total net revenuesfor the three months ended September 30, 2004 and 2003.  International revenues during these periodswere primarily the result of sales to Asia, which comprised 68% and 72% oftotal net revenues, respectively.  Net revenuesfrom international sales represented 73% and 75% of net revenues for the ninemonths ended September 30, 2004 and 2003, and were primarily the result ofsales to Asia, which comprised 69% and 64% of total net revenues.

 

*Gross Margin.*  Gross margin decreased to 47.2% for the threemonths ended September 30, 2004, from 56.4% for the same period in2003.  Gross margin decreased to 53.1% for the nine months ended September 30,2004, from 55.4% for the same period in 2003. Gross margins decreasedprimarily as a result of the write-off of $870,000 of inventory related to theWAV Series product line, as the WAV’s functionality is being integrated intothe NSX Series product line.  Thiswrite-off caused margins to decrease by 5.6 and 1.7 percentage points, duringthe three and nine months ended September 30, 2004, respectively.   Gross margins in the third quarter of 2004were also negatively impacted by 1.7 percentage points due to under-absorptionof fixed overhead costs due to a decrease in the number of systemsmanufactured.  The remaining decrease isdue to lower gross margins on sales of our AXi Series and NSX Series productlines due to an increase in the number 

 

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of systems sold thatincluded higher cost automated material handling subsystem options thatincorporate more third party supplied components.  In addition, we have experienced pricingpressure primarily related to our inspection systems sold into final manufacturingapplications as competitors have continued to enter this market.  These decreases were offset by increasedrevenue from our Yield*Pilot* productline.  We expect future gross margins tobe between 53% and 56%.

 

*Selling,General and Administrative Expenses.*  Selling, general and administrative(“SG&A”) expenses consist primarily of employee salaries and relatedbenefits, travel expenses and occupancy related costs.  SG&A expenses were $6.2 million and $16.8million for the three and nine months ended September 30, 2004, comparedto $3.8 million and $10.2 million for the same periods in 2003.  SG&A expenses as a percentage of netrevenues were 40.0% and 32.4% for the three and nine months ended September 30,2004, compared to 32.6% and 39.4% ofnet revenues for the same periods in 2003. The increase in expense dollars was primarily the result of costsassociated with both new hires and contractors in our field service and salesgroups to support increased revenues and customer demonstrations, and ourdirect sales and service office in South Korea, which opened in February 2004,and expenses associated with the ongoing operations of three acquisitionscompleted subsequent to the first quarter of 2003.  The quarterly SG&A expense dollars, andas a percentage of revenues, are expected to decrease in the fourth quarter of2004, as compared to the third quarter of 2004, primarily as a result of theCost Cutting Initiatives.

 

*Research and Development Expenses.* Research and development (“R&D”) expenses consist primarily ofemployee salaries and related benefits and consulting fees for individualsengaged in the research, design and development of new products.  R&D expenses were $3.8 million and $10.1million for the three and nine months ended September 30, 2004, comparedto $2.6 million and $7.8 million for the same periods in 2003.  R&D expenses as a percentage of netrevenues were 24.6% and 19.4% for thethree and nine months ended September 30, 2004, compared to 22.2% and30.0% for the same periods in 2003.  Theincrease in expense dollars was primarily due to employee compensation and related benefits associated with thehiring of additional staff and an increase in the use of outside contractors tocomplete certain stages of development of the E20 edge and B20 back-sideinspection options and VersaScope, and further enhancements to both the NSXSeries and AXi Series.  In addition,expenses increased due to three acquisitions completed subsequent to the firstquarter of 2003.  The savings from theCost Cutting Initiatives will be offset by our commitment to continuing toinvest in the continued expansion ofour business in the front-end of the wafer manufacturing process and expansionof our suite of software solutions.  Asa result, we currently anticipate that researchand development expenses, both in dollars and as a percentage of revenues, willremain relatively flat in the fourth quarter of 2004, as compared to the thirdquarter of 2004.

 

*Interest Income.* Interest income was $204,000 and $594,000 for the three and nine monthsended September 30, 2004, compared to $71,000 and $247,000 for the sameperiods in 2003.  The increase ininterest income was primarily due to an increase in overall investmentbalances, as a result of the proceeds received from a follow-on public offeringof our Common Stock that was completed on September 23, 2003 and theunderwriters’ exercise of the over-allotment option on October 21, 2003(the “Offering”).

 

***Income Taxes. ***As a result of historical operating losses and uncertaintyas to the extent of profitability in future periods, we began to record avaluation allowance against our deferred tax assets in the second quarter of2002 and continue to do so at September 30, 2004.  As a result, we did not reflect a provisionfor income taxes during 2003, and have recorded a provision for income taxes of$100,000 for the nine months ended September 30, 2004, primarily toreflect foreign

 

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income tax owed and stateregistration fees.  Statement ofFinancial Accounting Standards (“SFAS”)No. 109 “Accounting for Income Taxes,” requires the establishment of avaluation allowance to reflect the likelihood of the realization of deferredtax assets.  We do not expect to record aprovision for income taxes during the fourth quarter of 2004.  As of December 31, 2003 the valuationallowance was $7.5 million.

** **

**Liquidity and CapitalResources**

** **

At September 30,2004 our principal sources of liquidity consisted of cash, cash equivalents andmarketable debt securities of $50.9 million, compared to $63.9 million at December 31,2003, a decrease of $13.0 million.  During the nine months ended September 30,2004, working capital increased to $65.5 million as compared to $62.8 millionat December 31, 2003.  Theincrease was primarily due to an increase in both accounts receivable andinventories, partially offset by an increase in customer deposits and deferredrevenues.  During the next twelve months,and beyond, we intend to utilize our current sources of liquidity to fundoperations, specifically to enhance our position in the front-end waferfabrication process.  We have no outstanding debt at September 30, 2004.  Our liquidity is affected by many factors,some of which are based on the normal ongoing operations of our business, themost significant of which includes the timing of the collection of receivables,the level of inventories, capital expenditures and acquisitions.

 

*Accounts Receivable.*  Ouraccounts receivable increased $7.2 million from December 31, 2003 to September 30,2004.  Our days sales outstanding (“DSO”)during the three months ended September 30, 2004 was 79 days.  This compares to a DSO of 59 days in thesecond quarter of 2004.  The increase inthe DSO during the third quarter is primarily due to the high mix of internationalrevenues during current and prior quarters, which generally require a longertime for collection.  This increase hasresulted in a use of cash of $7.2 million during the nine months ended September 30,2004, as we have funded shipments for increased revenues prior to receivingpayments from customers.  We believe ourDSO will be between 60 and 70 days in future quarters.

 

*Inventories.*  Inventories increased$8.5 million from December 31, 2003 to September 30, 2004.  The increase is primarily due to the need tosupport new product introductions, increased backlog and increaseddemonstration equipment at customers under evaluation, primarily in waferprocessing applications.

 

*Inventories at Customers under Purchase Orders.*  Inventoriesat customers under purchase orders increased $2.4 million from December 31,2003 to September 30, 2004, primarily due to shipments of newer models ofour NSX Series that have not yet qualified for revenue recognition. Weanticipate that a portion of this inventory will be recognized as revenueduring the fourth quarter of 2004.  Weanticipate that this inventory will increase as shipments of newly introducedproducts increase.

 

*Capital Expenditures.*  Ourcapital expenditures during the first nine months of 2004 were $4.7 million,consisting primarily of the capitalization of finished goods that have beentransferred to engineering for test and characterization, to customer servicefor training and to sales for customer application studies.  This equipment is expected to be utilized forthese purposes for its estimated life, generally three years.  Our total capital expenditures, including thecapitalization of finished goods, are expected to be between $5.0 million and $5.5 million in 2004, as we continue to

 

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expandthe use of internal test and development equipment and facilities to meetcustomer demand and better serve our customers.

 

Our liquidity is also affected by factors beyond ourcontrol related to the uncertainties of global economies and the cyclicalnature of the semiconductor and microelectronic industries.  Although liquidity requirements willfluctuate based on the timing and extent of all of these factors and others, managementbelieves that existing cash and investment balances will be adequate to satisfyour existing liquidity requirements for at least the next twelve months.

 

*CashFlows*

 

Netcash used in operating activities for the nine months ended September 30,2004 was $7.9 million, which resulted primarily from increased accountsreceivable and inventories partially offset by our net income and increasedcustomer deposits and deferred revenues. Net cash used in investing activities was $698,000, primarily due to $4.7million used for purchases of property and equipment and $2.3 million used forthe purchase of the DMSVision division of Inspex, partially offset by $6.3million of net proceeds from sales of marketable debt securities.  Net cash provided by financing activities was$2.0 million from the proceeds received from issuances of common stock,primarily related to exercises of stock options by employees.   We currently do not expect to generate cashflow from operating activities during the remainder of 2004.

 

Netcash provided by operating activities for the nine months ended September 30,2003 was $2.1 million, which resulted primarily from decreased accountsreceivable and increased customer deposits and accounts payable partiallyoffset by our net loss and increased inventory during the period.  Net cash used in investing activities was$35.6 million, primarily due to $33.4 million of net purchases of marketable debtsecurities resulting from the proceeds of the Offering, $1.4 million paid toacquire STI and $739,000 of purchases of property and equipment.  Net cash provided by financing activities was$36.7 million, including $36.1 million of net proceeds received from theOffering.

 

**New Accounting Pronouncements**

 

In December 2003,the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation(“FIN”) No. 46R, “*Consolidation of VariableInterest Entities,”* which addresses how a business enterprise shouldevaluate whether it has a controlling financial interest in an entity throughmeans other than voting rights and accordingly should consolidate theentity.  FIN 46R replaces FASBInterpretation No. 46, “*Consolidation ofVariable Interest Entities,”* which was issued in January 2003.We are required to apply FIN 46R to variable interests in variable interestentities (“VIE”) created after December 31, 2003. For variable interestsin VIEs created before January 1, 2004, the Interpretation will be appliedbeginning on January 1, 2005. For any VIEs that must be consolidated underFIN 46R that were created before January 1, 2004, the assets, liabilitiesand noncontrolling interests of the VIE initially would be measured at theircarrying amounts with any difference between the net amount added to thebalance sheet and any previously recognized interest being recognized as thecumulative effect of an accounting change. If determining the carrying amountsis not practicable, fair value at the date FIN 46R first applies may be used tomeasure the assets, liabilities and noncontrolling interest of the VIE. Webelieve that we have no variable interest entities and, therefore, FIN 46R didnot have an impact on our consolidated financial statements.

 

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In May2003, the FASB issued SFAS No. 150, “Accounting*for Certain Financial Instruments with Characteristics of both Liabilities andEquity.”* The Statement establishes standards for the classificationand measurement of certain financial instruments with characteristics of bothliabilities and equity.  The Statementalso includes required disclosures for financial instruments within itsscope.  For us, the Statement waseffective for instruments entered into or modified after May 31, 2003, andotherwise will be effective as of January 1, 2004, except for mandatorilyredeemable financial instruments.  For certainmandatorily redeemable financial instruments, the Statement will be effectivefor us on January 1, 2005.  Theeffective date has been deferred indefinitely for certain other types ofmandatorily redeemable financial instruments. We currently do not have any financial instruments that are within thescope of the Statement and, therefore, SFAS 150 did not have an effect on ourconsolidated financial statements.

 

**Item 3****.****                                                           Quantitativeand Qualitative Disclosures about Market Risk**

 

*MarketRisk*

 

We areexposed to market risk primarily from changes in interest rates and creditrisk.  We do not have material exposureto market risk from fluctuations in foreign currency exchange rates because allsales are made in U.S. dollars.

 

*InterestRate Risk*

 

We areexposed to interest rate risk primarily from investments in cash equivalentsand short-term and long-term marketable debt securities (the “InvestmentPortfolio”).  The entire InvestmentPortfolio, classified as available-for-sale, is recorded on the balance sheetat fair market value with unrealized gains or losses excluded from earnings andincluded in “Accumulated other comprehensive income (loss)” untilrealized.  The entire InvestmentPortfolio is denominated in U.S. dollars. We do not use derivative financial instruments in the InvestmentPortfolio.  Due to the short duration ofour Investment Portfolio, an immediate 100 percent change in interest rates isnot expected to have a material adverse effect on our near-term financialcondition or results of operations.

 

*CreditRisk*

 

Financialinstruments which potentially subject us to credit risk consist principally ofsecurities in the Investment Portfolio and trade receivables.  We limit credit risk related to theInvestment Portfolio by placing all investments with high quality creditissuers and limit the amount of investments with any one issuer.  As of September 30, 2004, 88.7% of theInvestment Portfolio consisted of government securities and corporatecommercial paper and bonds with maturities of one year or less.  We limit credit risk associated with tradereceivables by performing ongoing credit evaluations and believe that there isno additional risk beyond amounts provided for collection losses to be inherentin trade receivables.

 

**Item 4****.****                                                           Controlsand Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

As ofthe end of the period covered by this report, the Company conducted anevaluation under the supervision and with the participation of the Company’smanagement, including the Company’s

 

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Acting PrincipalExecutive Officer and Chief Financial Officer, regarding the effectiveness ofthe design and operation of the Company’s disclosure controls and procedurespursuant to Rules 13a-15(b) of the Securities Exchange Act of 1934 (the“Exchange Act”).  Based upon thatevaluation, the Acting Principal Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures are effectiveto ensure that information that is required to be disclosed by the Company inreports that it files under the Exchange Act is recorded, processed, summarizedand reported within the time periods specified in the rules of the Securitiesand Exchange Commission.

 

*Changesin Internal Controls*

 

Therewere no changes in the Company’s internal controls over financial reportingthat occurred during the period covered by this report that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

**PART II****– OTHERINFORMATION**

 

**Item 6****.****                                                           Exhibits**

 

Theexhibits listed on the Exhibit Index are filed herewith.

 

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                         | AUGUST TECHNOLOGY  CORPORATION    |
|------------------------------|----------------------------------------|
|                         |                                   |
|                         |                                   |
| Date: November 1,  2004 | By:                                    | /s/ DAVID L.  KLENK |   |
|                         | David L. Klenk                         |
|                         | President and  Chief Operating Officer |
|                         | (Acting  Principal Executive Officer)  |
|                         |                                   |
|                         |                                   |
| Date: November 1,  2004 | By:                                    | /s/ STANLEY D.  PIEKOS |   |
|                         | Stanley D.  Piekos                     |
|                         | Chief Financial  Officer               |
|                         | (Principal  Financial Officer)         |
|                         |                                   |
|                         |                                   |
| Date: November 1,  2004 | By:                                    | /s/ SCOTT A.  GABBARD |   |
|                         | Scott A. Gabbard                       |
|                         | Chief Accounting  Officer and          |
|                         | Vice President,  Finance               |
|                         | (Principal  Accounting Officer)        |
|                              |                                        |  |  |  |  |

 

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**SECURITIES AND EXCHANGE COMMISSION**

Washington, D.C.  20549

 

EXHIBIT INDEX TO FORM 10-Q/A

 
| For the  quarter ended:  |   | Commission  File No.: 000-30637 |
|--------------------------|--------|---------------------------------|
| September 30,  2004 |   |                            |

 

**AUGUST TECHNOLOGYCORPORATION**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                           |
| 31.1                |       | Certification  pursuant to Exchange Act Rules 13a-14(a) of the Acting Principal Executive  Officer             |
|                |       |                                                                                                           |
| 31.2                |       | Certification  pursuant to Exchange Act Rules 13a-14(a) of the Chief Financial Officer                         |
|                |       |                                                                                                           |
| 32.1                |       | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to the  Sarbanes-Oxley Act of 2002 |

 

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