**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

| **(Mark  One)**                                                                                                                                                                                                                                                |                                                                                               |   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------|--------|--------|
| **ý**                                                                                                                                                                                                                                                     | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                                                                                                                           |                                                                                               |   |   |   |
| **For  the quarterly period ended June 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** |

 

**CommissionFile Number 000-30637**

 

 

**AUGUST TECHNOLOGYCORPORATION**

(Exact name of Registrantas specified in its 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**

(Formername, former address, and former fiscal year, if changed since last report.)

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 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 check mark whether the registrant is anaccelerated filer (as defined by Exchange Act Rule 12b-2).  Yes  ý  No  o

 

As of July 31, 2004,there were 17,802,646 shares of common stock outstanding.

 

 

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**AUGUST TECHNOLOGYCORPORATION****TABLE OF CONTENTS**

 
|          | **Description**                                                                                                    | ** ** |
|---------------|--------------------------------------------------------------------------------------------------------------------|------------|
|          |                                                                                                               |       |
| PART I        | FINANCIAL INFORMATION                                                                                              |       |
|          |                                                                                                               |       |
| Item 1.       | Financial Statements                                                                                               |       |
|          |                                                                                                               |       |
|          | Consolidated Balance Sheets  as of June 30, 2004 and December 31, 2003 (unaudited)                       |       |
|          |                                                                                                               |       |
|          | Consolidated  Statements of Operations for the three and six months ended June 30,  2004 and 2003 (unaudited) |       |
|          |                                                                                                               |       |
|          | Consolidated  Statements of Cash Flows for the six months ended June 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  1.      | Legal  Proceedings                                                                                                 |       |
|          |                                                                                                               |       |
| Item  2.      | Unregistered  Sales of Equity Securities and Use of Proceeds                                                       |       |
|          |                                                                                                               |       |
| Item  4.      | Submission  of Matters to a Vote of Security Holders                                                               |       |
|          |                                                                                                               |       |
| Item 6.       | Exhibits and  Reports on Form 8-K                                                                                  |       |
|          |                                                                                                               |       |
| SIGNATURES    |                                                                                                               |
|          |                                                                                                               |       |
| EXHIBIT INDEX |                                                                                                               |
|               |                                                                                                                    |            |  |

 

2

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**PART I****                               FINANCIALINFORMATION**

 

**Item1.****  FinancialStatements**

**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                        | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                        |       |                    |       |                        |       |
|                                                                                                                              |       |                    |       |                        |       |
| Current  assets:                                                                                                                  |       |                    |       |                        |       |
| Cash  and cash equivalents                                                                                                        |       | $                       | 1,592      |                        | $          | 10,027 |   |
| Short-term  marketable debt securities                                                                                            |       | 44,888                  |       | 43,528                      |       |
| Accounts  receivable, net                                                                                                         |       | 15,200                  |       | 4,094                       |       |
| Inventories                                                                                                                       |       | 18,699                  |       | 11,651                      |       |
| Inventories  at customers under purchase orders                                                                                   |       | 5,072                   |       | 2,293                       |       |
| Prepaid  expenses and other current assets                                                                                        |       | 2,035                   |       | 1,631                       |       |
| Total  current assets                                                                                                             |       | 87,486                  |       | 73,224                      |       |
|                                                                                                                              |       |                    |       |                        |       |
| Property  and equipment, net                                                                                                      |       | 4,798                   |       | 3,141                       |       |
| Long-term  marketable debt securities                                                                                             |       | 5,980                   |       | 10,295                      |       |
| Purchased  technology, net                                                                                                        |       | 1,013                   |       | 1,179                       |       |
| Goodwill                                                                                                                          |       | 498                     |       | 498                         |       |
| Other  assets                                                                                                                     |       | 648                     |       | 610                         |       |
| Total  assets                                                                                                                     |       | $                       | 100,423    |                        | $          | 88,947 |   |
|                                                                                                                              |       |                    |       |                        |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                    |       |                    |       |                        |       |
|                                                                                                                              |       |                    |       |                        |       |
| Current  liabilities:                                                                                                             |       |                    |       |                        |       |
| Accounts  payable                                                                                                                 |       | $                       | 7,629      |                        | $          | 5,409 |   |
| Accrued  compensation                                                                                                             |       | 1,842                   |       | 1,146                       |       |
| Accrued  liabilities                                                                                                              |       | 1,368                   |       | 1,414                       |       |
| Customer  deposits and deferred revenue                                                                                           |       | 5,463                   |       | 2,436                       |       |
| Total  current liabilities                                                                                                        |       | 16,302                  |       | 10,405                      |       |
|                                                                                                                              |       |                    |       |                        |       |
| Other  non-current liabilities                                                                                                    |       | 118                     |       | 65                          |       |
| Total  liabilities                                                                                                                |       | 16,420                  |       | 10,470                      |       |
|                                                                                                                              |       |                    |       |                        |       |
| Commitments  and contingencies                                                                                                    |       | —                  |       | —                      |       |
|                                                                                                                              |       |                    |       |                        |       |
| Shareholders’  equity:                                                                                                       |       |                    |       |                        |       |
| Common  stock, no par value, 42,000,000 shares authorized, 17,801,946 and 17,382,538  shares issued and outstanding, respectively |       | 90,076                  |       | 88,086                      |       |
| Undesignated  capital stock, no par value, 3,000,000 shares authorized, no shares issued or  outstanding                          |       | —                  |       | —                      |       |
| Deferred  compensation related to stock options                                                                                   |       | (24                     | )          | (49                         | )          |
| Accumulated  deficit                                                                                                              |       | (5,959                  | )          | (9,578                      | )          |
| Accumulated  other comprehensive income (loss)                                                                                    |       | (90                     | )          | 18                          |       |
| Total  shareholders’ equity                                                                                                  |       | 84,003                  |       | 78,477                      |       |
| Total  liabilities and shareholders’ equity                                                                                  |       | $                       | 100,423    |                        | $          | 88,947 |   |

 

See accompanyingnotes to consolidated financial statements.

 

3

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**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Net  revenues                                    |       | $                                    | 19,855     |                               | $          | 7,757 |   | $ | 36,255 |   | $ | 14,320 |   |
| Cost  of revenues                                |       | 9,059                                |       | 3,548                              |       | 16,117 |   | 6,503 |   |
| Gross  profit                                    |       | 10,796                               |       | 4,209                              |       | 20,138 |   | 7,817 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Selling,  general and administrative expenses    |       | 5,390                                |       | 3,213                              |       | 10,579 |   | 6,420 |   |
| Research  and development expenses               |       | 3,322                                |       | 2,434                              |       | 6,230 |   | 5,202 |   |
| Operating  income (loss)                         |       | 2,084                                |       | (1,438                             | )          | 3,329 |   | (3,805 | ) |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Interest  income                                 |       | 189                                  |       | 78                                 |       | 390 |   | 176 |   |
| Income  (loss) before provision for income taxes |       | 2,273                                |       | (1,360                             | )          | 3,719 |   | (3,629 | ) |
| Provision  for income taxes                      |       | 100                                  |       | —                             |       | 100 |   | — |   |
| Net  income (loss)                               |       | $                                    | 2,173      |                               | $          | (1,360 | ) | $ | 3,619 |   | $ | (3,629 | ) |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Net  income (loss) per share:                    |       |                                 |       |                               |       |   |   |   |   |
| Basic                                            |       | $                                    | 0.12       |                               | $          | (0.10 | ) | $ | 0.20 |   | $ | (0.27 | ) |
| Diluted                                          |       | $                                    | 0.12       |                               | $          | (0.10 | ) | $ | 0.20 |   | $ | (0.27 | ) |

 

Seeaccompanying notes to consolidated financial statements.

 

4

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**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                           | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| Cash  flows from operating activities:                                                               |       |                               |       |   |   |
| Net  income (loss)                                                                                   |       | $                                  | 3,619      |   | $ | (3,629 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                               |       |   |   |
| Depreciation  and amortization                                                                       |       | 1,019                              |       | 816 |   |
| Provision  for doubtful accounts                                                                     |       | 79                                 |       | 81 |   |
| Amortization  of deferred compensation related to stock options                                      |       | 27                                 |       | 27 |   |
| Changes  in operating assets and liabilities, net of affects of acquisition:                         |       |                               |       |   |   |
| Accounts  receivable                                                                                 |       | (11,185                            | )          | 2,120 |   |
| Inventories                                                                                          |       | (7,048                             | )          | 1,098 |   |
| Inventories  at customers under purchase orders                                                      |       | (2,779                             | )          | (2,383 | ) |
| Prepaid  expenses and other current assets                                                           |       | (402                               | )          | (114 | ) |
| Accounts  payable                                                                                    |       | 2,220                              |       | 1,378 |   |
| Accrued  compensation                                                                                |       | 696                                |       | 156 |   |
| Accrued  liabilities                                                                                 |       | 9                                  |       | 94 |   |
| Customer  deposits and deferred revenue                                                              |       | 3,027                              |       | 3,605 |   |
| Net  cash provided by (used in) operating activities                                                 |       | (10,718                            | )          | 3,249 |   |
|                                                                                                 |       |                               |       |   |   |
| Cash  flows from investing activities:                                                               |       |                               |       |   |   |
| Purchases  of marketable securities                                                                  |       | (91,499                            | )          | (18,097 | ) |
| Maturities  of marketable securities                                                                 |       | 94,356                             |       | 16,245 |   |
| Purchases  of property and equipment                                                                 |       | (2,455                             | )          | (588 | ) |
| Cash  paid for acquisitions                                                                          |       | (17                                | )          | (1,370 | ) |
| Investments  in other assets                                                                         |       | (77                                | )          | — |   |
| Net  cash provided by (used in) investing activities                                                 |       | 308                                |       | (3,810 | ) |
|                                                                                                 |       |                               |       |   |   |
| Cash  flows from financing activities:                                                               |       |                               |       |   |   |
| Net  proceeds from issuances of common stock                                                         |       | 1,988                              |       | 176 |   |
| Net  cash provided by financing activities                                                           |       | 1,988                              |       | 176 |   |
|                                                                                                 |       |                               |       |   |   |
| Effect  of exchange rates on cash and cash equivalents                                               |       | (13                                | )          | 2 |   |
|                                                                                                 |       |                               |       |   |   |
| Net  decrease in cash and cash equivalents                                                           |       | (8,435                             | )          | (383 | ) |
| Cash  and cash equivalents at beginning of period                                                    |       | 10,027                             |       | 1,895 |   |
| Cash  and cash equivalents at end of period                                                          |       | $                                  | 1,592      |   | $ | 1,512 |   |
|                                                                                                 |       |                               |       |   |   |
| Supplemental  cash flow information:                                                                 |       |                               |       |   |   |
| Cash  refunds (payments) of income taxes, net                                                        |       | $                                  | (78        | ) | $ | 250 |   |
| Common  stock issued for acquisition                                                                 |       | $                                  | —     |   | $ | 756 |   |

 

See accompanying notes toconsolidated financial statements.

 

5

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**AUGUST TECHNOLOGYCORPORATION**

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**JUNE 30, 2004**

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

**(Unaudited)**

 

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

 

The accompanying unaudited consolidated financialstatements have been prepared pursuant to the rules and regulations of theSecurities and Exchange Commission. Certain information and footnote disclosures, normally included inconsolidated financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America, have beencondensed or omitted pursuant to such rules and regulations.  In the opinion of the management ofAugust Technology Corporation (collectively with its subsidiaries, the“Company”), all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included in theconsolidated balance sheet at June 30, 2004, the consolidated results ofoperations for the three and six months ended June 30, 2004 and 2003, andthe consolidated statements of cash flows for the six months endedJune 30, 2004 and 2003.  The resultsof operations of the interim periods are not necessarily indicative of theresults of operations that may be expected for any other period or for the yearas a whole.  These consolidated financialstatements and notes hereto should be read in conjunction with the auditedconsolidated financial statements and notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2003, filedwith the Securities and Exchange Commission on March 1, 2004.

 

The accompanying consolidated financial statementsinclude the accounts of August Technology Corporation and its wholly ownedsubsidiaries.  All significantintercompany balances and transactions are eliminated in consolidation.

 

**Note 2****–****Business Combinations**

 

On July 27, 2004, the Company purchased certainassets relating to the DMSVision Software business of Inspex, Inc. for apurchase price of $2.1 million plus future consideration based on DMSVisionsoftware revenues resulting from new orders received in the twelve months afterthe purchase.  The purchase was madepursuant to an Asset Purchase Agreement between the Company and Inspex Incdated June 23, 2004 and was approved by the United States Bankruptcy Courtfor the District of Massachusetts.

 

6

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**Note 3 – MarketableSecurities**

 

The amortized cost and estimated fair value ofavailable-for-sale marketable debt securities were as follows:

 
| ** **       | ** ** | **June 30, 2004** | ** ** |
|------------------|------------|------------------------|------------|
| ** **       | ** ** | **Amortized  Cost**    | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Corporate  bonds |       | $                      | 13,846     |   | $ | 2 |   | $ | (47 | ) | $ | 13,801 |   |
| Municipal  bonds |       | 37,082                 |       | 1 |   | (16 | ) | 37,067 |   |
|             |       | $                      | 50,928     |   | $ | 3 |   | $ | (63 | ) | $ | 50,868 |   |

 
|             |   | **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 |   |

 

The maturities of available-for-sale marketable debtsecurities were as follows:

 
| ** **                                    | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **Amortized  Cost**    | ** ** | **Fair  Value**            | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
| Due  within one year                          |       | $                      | 44,919     |                       | $          | 44,888 |   | $ | 43,524 |   | $ | 43,528 |   |
| Due  after one year  through three years |       | 6,009                  |       | 5,980                      |       | 10,261 |   | 10,295 |   |
|                                          |       | $                      | 50,928     |                       | $          | 50,868 |   | $ | 53,785 |   | $ | 53,823 |   |

 

Net realized gains and losses were not material forthe six months ended June 30, 2004 and the year ended December 31,2003.

 

7

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**Note 4 – Accounts Receivable**

 

Accounts receivable consisted of the following:

 
| ** **                       | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                             |       |                    |       |                        |       |
| Billed  receivables              |       | $                       | 13,303     |                        | $          | 3,837 |   |
| Unbilled  revenue                |       | 2,550                   |       | 812                         |       |
|                             |       | 15,853                  |       | 4,649                       |       |
| Allowance  for doubtful accounts |       | (653                    | )          | (555                        | )          |
| Accounts  receivable, net        |       | $                       | 15,200     |                        | $          | 4,094 |   |

 

**Note 5 – Inventories**

 

Inventories consisted of the following:

 
| ** **               | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                     |       |                    |       |                        |       |
| Raw  materials           |       | $                       | 6,909      |                        | $          | 4,645 |   |
| Work  in process         |       | 3,017                   |       | 2,305                       |       |
| Demonstration  equipment |       | 2,550                   |       | 1,603                       |       |
| Finished  goods          |       | 6,223                   |       | 3,098                       |       |
| Inventories              |       | $                       | 18,699     |                        | $          | 11,651 |   |

 

**Note 6 – Purchased Technology**

 

As of June 30, 2004, purchased technology was $1,377 and related accumulatedamortization of $364.  Purchased technology is amortized on astraight-line basis over an estimated useful life of four years.  Amortization expense for the six months endedJune 30, 2004 and 2003 was $174 and $18, respectively.  Assuming nochange in the gross carrying value of purchased technology, the estimatedamortization expense for the twelve months ending December 31, 2004 is$342 and for each of the next four years is $342, $342, $155 and nonethereafter.

 

**Note 7 – Accumulated Other Comprehensive Income(Loss)**

 

The accumulated balances foreach classification of accumulated other comprehensive income (loss) are asfollows:

 
| ** **                                           | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Currency  translation adjustments                    |       | $                       | (30        | )                           | $          | (20 | ) |
| Net  unrealized gain (loss) on marketable securities |       | (60                     | )          | 38                          |       |
| Accumulated  other comprehensive income (loss)       |       | $                       | (90        | )                           | $          | 18 |   |

 

8

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**Note 8 –Shareholders’ Equity**

 

Changes in shareholders’ equity during the six monthsended June 30, 2004 were as follows:

 
| Shareholders’  equity balance at December 31, 2003    |   | $      | 78,477 |   |
|-----------------------------------------------------------------|--------|--------|--------|--------|
| Net  income                                                     |   | 3,619  |   |
| Accumulated  other comprehensive loss:                          |   |   |   |
| Foreign  currency translation adjustment                        |   | (10    | )      |
| Net  unrealized loss on marketable debt securities              |   | (98    | )      |
| Comprehensive  income                                           |   | 3,511  |   |
| Issuances  of common stock in conjunction with:                 |   |   |   |
| Exercises  of employee stock options and warrants               |   | 1,851  |   |
| Employee  stock purchase plan                                   |   | 137    |   |
| Amortization  of deferred compensation related to stock options |   | 27     |   |
| Shareholders’ equity  balance at June 30, 2004        |   | $      | 84,003 |   |

 

On September 23, 2003, the Company sold 3,000shares of its Common Stock at a price of $13.00 per share in a follow-on publicoffering (the “Offering”).  Inconjunction with the Offering, on October 21, 2003, the underwritersexercised their over-allotment option to acquire an additional 490 shares ofCommon Stock at the same price to the public and with the same underwritingdiscount as the Offering.  The netproceeds from the Offering, including the exercise of the underwritersover-allotment, after deducting the underwriting discount and offeringexpenses, was $42,049.

 

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

 

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

 
| ** **                                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                           |       |                                 |       |                               |       |   |   |   |   |
| Net  income (loss)                             |       | $                                    | 2,173      |                               | $          | (1,360 | ) | $ | 3,619 |   | $ | (3,629 | ) |
|                                           |       |                                 |       |                               |       |   |   |   |   |
| Weighted  average common shares:               |       |                                 |       |                               |       |   |   |   |   |
| Basic                                          |       | 17,778                               |       | 13,352                             |       | 17,700 |   | 13,255 |   |
| Effect  of dilutive stock options and warrants |       | 571                                  |       | —                             |       | 721 |   | — |   |
| Diluted                                        |       | 18,349                               |       | 13,352                             |       | 18,421 |   | 13,255 |   |
|                                           |       |                                 |       |                               |       |   |   |   |   |
| Net  income (loss) per share:                  |       |                                 |       |                               |       |   |   |   |   |
| Basic                                          |       | $                                    | 0.12       |                               | $          | (0.10 | ) | $ | 0.20 |   | $ | (0.27 | ) |
| Diluted                                        |       | $                                    | 0.12       |                               | $          | (0.10 | ) | $ | 0.20 |   | $ | (0.27 | ) |

 

The total weighted average number of stock options andwarrants excluded from the calculation of potentially dilutive securitieseither due to the exercise price exceeding the average market price or theinclusion of such securities in a calculation of net income (loss) per sharewould have been anti-dilutive for the three months ended June 30, 2004 and2003 were 330 and1,886, respectively, and for the six months ended June 30, 2004 and 2003were 218 and 1,851,respectively.

 

9

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***Stock-based Compensation***

 

The Company applies Accounting Principles BoardOpinion (“APB”) No. 25, *“Accounting for StockIssued to Employees”*, and related interpretations in accounting forstock-based compensation.  The exerciseprice of the Company’s stock options equals the market price of the underlyingstock on the date of grant for all options granted, and thus, under APB 25, nocompensation expense is recognized in the consolidated statements ofoperations.

 

The estimated per share weighted average fair value ofall stock options granted during the three months ended June 30, 2004 and2003 was $9.53 and$2.79, respectively, and for the six months ended June 30, 2004 and 2003was $9.91 and $2.72,respectively. The fair value of each option grant was estimated using theBlack-Scholes option pricing model with the following weighted averageassumptions:

 
| ** **               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                     |       |                                 |       |                               |       |   |   |   |   |
| Expected  life           |       | 5.5 years                            |       | 5.8 years                          |       | 4.3 years |   | 5.5 years |   |
| Risk  free interest rate |       | 3.6                                  | %          | 3.0                                | %          | 2.8 | % | 2.9 | % |
| Volatility               |       | 73.7                                 | %          | 75.1                               | %          | 74.1 | % | 75.2 | % |
| Dividend  yield          |       | —                               |       | —                             |       | — |   | — |   |

 

Had the Company recorded compensation cost based onthe estimated fair value on the date of grant, as defined by SFAS 123, theCompany’s pro forma net income (loss) would have been as follows:

 
| ** **                                                                                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                |       |                                 |       |                               |       |   |   |   |   |
| Net  income (loss), as reported                                                                     |       | $                                    | 2,173      |                               | $          | (1,360 | ) | $ | 3,619 |   | $ | (3,629 | ) |
| Stock-based  employee compensation expense determined under fair value based method for  all awards |       | (521                                 | )          | (377                               | )          | (1,674 | ) | (675 | ) |
| Net  income (loss), pro forma                                                                       |       | $                                    | 1,652      |                               | $          | (1,737 | ) | $ | 1,945 |   | $ | (4,304 | ) |
|                                                                                                |       |                                 |       |                               |       |   |   |   |   |
| Net  income (loss) per share:                                                                       |       |                                 |       |                               |       |   |   |   |   |
| As  reported:                                                                                       |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                               |       | $                                    | 0.12       |                               | $          | (0.10 | ) | $ | 0.20 |   | $ | (0.27 | ) |
| Diluted                                                                                             |       | $                                    | 0.12       |                               | $          | (0.10 | ) | $ | 0.20 |   | $ | (0.27 | ) |
|                                                                                                |       |                                 |       |                               |       |   |   |   |   |
| Pro  forma:                                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                               |       | $                                    | 0.09       |                               | $          | (0.13 | ) | $ | 0.11 |   | $ | (0.32 | ) |
| Diluted                                                                                             |       | $                                    | 0.09       |                               | $          | (0.13 | ) | $ | 0.11 |   | $ | (0.32 | ) |

 

**Note 9 – Commitments andContingencies**

 

***Warranties***

The Company provides warranty coverage for its systemsfor a period of one year, including parts and labor necessary to repair thesystems during the warranty period.  Theestimated warranty cost is based on our historical experience rate of incurredexpenses to corresponding system revenues.

 

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The following table summarizes the activity related tothe warranty liability during the six months ended June 30, 2004 and 2003:

 
| ** **                    | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------|------------|------------------------------------|------------|
| ** **                    | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| Accrual  at beginning of year |       | $                                  | 239        |   | $ | 111 |   |
| Warranties  issued            |       | 415                                |       | 137 |   |
| Costs  incurred               |       | (271                               | )          | (79 | ) |
| Accrual  at end of period     |       | $                                  | 383        |   | $ | 169 |   |

 

***Legal Proceedings***

The Company has fully settled the commerciallitigation between the Company and Rudolph Technologies, Inc. (“Rudolph”).  On September 23, 2003, the Company andits subsidiary, Semiconductor Technologies & Instruments, Inc. (“STI”),filed a complaint against Rudolph and its subsidiary ISOA, Inc. (“ISOA”).  In the complaint, the Company and STI soughta declaratory judgment that the Company and STI were not using ISOA technologyin their products.  STI also asserted aclaim for breach of contract to recover amounts STI paid to ISOA in connectionwith a joint development agreement between STI and ISOA.  Rudolph and ISOA filed an answer andcounterclaim, denying the allegations set forth in the complaint and claimingthat ISOA was entitled to damages for STI’s alleged breach of the jointdevelopment agreement.  ISOA also soughta declaratory judgment that STI and/or the Company were wrongfully using ISOA’stechnology without compensating ISOA and that ISOA was entitled to royaltypayments 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.

 

On July 22, 2004,the Company, STI, Rudolph, ISOA agreed to settle all claims between theparties.  Under the terms of theconfidential settlement, ASTI will make a one-time payment out of the escrow toRudolph in the amount of $503.  TheCompany, STI, Rudolph and ISOA agreed to release any and all claims againsteach other relating to the joint development agreement and to dismiss allclaims asserted in the litigation with prejudice.

 

**Note 10 – Recently Issued AccountingPronouncements**

 

In December 2003, the Financial AccountingStandards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 46R, “*Consolidation of Variable Interest Entities”*,which addresses how a business enterprise should evaluate whether it has acontrolling financial interest in an entity through means other than votingrights and accordingly should consolidate the entity.  FIN 46R replaces FASB Interpretation No. 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

 

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amountswith any difference between the net amount added to the balance sheet and anypreviously recognized interest being recognized as the cumulative effect of anaccounting change. If determining the carrying amounts is not practicable, fairvalue at the date FIN 46R first applies may be used to measure the assets, liabilitiesand noncontrolling interest of the VIE. The Company believes it has no variableinterest entities and, therefore, FIN 46R did not have an impact on theCompany’s consolidated financial statements.

 

In May 2003, the FASB issued SFAS No. 150, “*Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity”.* The Statementestablishes standards for the classification and measurement of certainfinancial instruments with characteristics of both liabilities and equity.  The Statement also includes requireddisclosures for financial instruments 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 other typesof mandatorily redeemable financial instruments.  The Company currently does not have anyfinancial instruments that are within the scope of the Statement.

 

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**Item 2.****  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**CautionaryFactors That May Affect Future Results**

 

Certain statements made in this Quarterly Report onForm 10-Q, as well as oral statements made by us from time to time, which areprefaced with words such as “expects,” “anticipates,” “believes,” “projects,”“intends,” “plans” and similar words and other statements of similar sense, areforward-looking statements.  Ourforward-looking statements generally relate to our growth strategies, financialresults, future financial projections, product development activities and salesefforts.  Our actual results could differ materially from those projectedin the forward-looking statements as a result of a number of factors, includingbut not limited to market acceptance of our products, our ability tosuccessfully develop new products, our ability to protect our intellectualproperty, our dependence upon international customers and suppliers, ourdependence on a small number of customers that account for a significantportion of revenues, availability of products from our suppliers, cyclicalityin the microelectronic manufacturing equipment and other industries, managementof growth, integration of acquired businesses, and the other risk factorsdetailed below and in our Annual Report on Form 10-K for the year endedDecember 31, 2003, as filed with the SEC on March 1, 2004.  We disclaim any obligation to reviseforward-looking statements, or to update the reasons actual results coulddiffer materially from those anticipated, to reflect events or circumstancesafter the date of such statements or to reflect the occurrence of anticipatedor unanticipated events. Because many factors are unforeseeable, the foregoingshould not be considered an exhaustive list.

 

**Introduction**

 

Thefollowing discussion of our results of operations and financial conditionshould be read together with the other financial information and consolidatedfinancial statements and related notes included in this Form 10-Q. Thisdiscussion contains forward-looking statements that involve risks anduncertainties. Our actual results could differ materially from thoseanticipated in the forward-looking statements as a result of a variety offactors.

 

**CriticalAccounting Policies**

 

The preparation of our consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues and expenses, and related disclosure of contingent assets andliabilities.  We based these estimates and assumptions on historicalexperience and evaluate them on an on-going basis to help ensure they remainreasonable under current conditions.  Actual results could differ fromthose estimates. We discuss the development and selection of the criticalaccounting estimates with the audit committee of our board of directors on aquarterly basis, and the audit committee has reviewed the Company’s criticalaccounting policies as described in Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” in our Annual Reporton Form 10-K for the year ended December 31, 2003.   For the sixmonths ended June 30, 2004, there were no changes to these criticalaccounting policies.

 

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**Overview**

 

We are a world-class provider of automated defectdetection and product characterization systems for microelectronic devicemanufacturers. Our systems provide manufacturers with information that enablesprocess-enhancing decisions, ultimately lowering manufacturing costs anddecreasing time-to-market. We sell our systems to many of the leadingmicroelectronic device manufacturers throughout the world for inspectingsemiconductors, advanced packaging applications, optoelectronics devices, MEMS,data storage devices and micro displays. We have traditionally provided systems to address the automatedinspection needs of the early stages of the final manufacturing or back-end ofthe microelectronic device manufacturing process. These needs were metprimarily with our NSX Series and 3Di Series of products.  We recently introduced the AXi Series, E20and B20 inspection options for advanced macro detection in the front-end of thewafer manufacturing process. When used in conjunction with one another thesesystems allow a manufacturer to inspect the top, edge and back of a wafer’ssurface.  We believe we are the first tooffer all surface wafer inspection.  Wecomplement this broad inspection capability with an expanding suite of softwaretools designed to enhance the speed and effectiveness of the process by whichdevice manufacturers analyze defects, and make decisions regarding theirmanufacturing process to reduce or eliminate such defects.  We refer to this process as the“detection-to-decision” process.  Webelieve a key to our success in establishing and maintaining a leadershipposition in our served markets has been our ability to introduce innovativeinspection and defect review solutions that provide microelectronic devicemanufacturers yield improving information about their increasingly complexmanufacturing processes.

 

In addition to internaldevelopment, we look to expand through strategic acquisitions of complementaryproducts and technologies. In April 2003 we completed the acquisition ofSTI, adding the WAV Series for high speed wafer probe mark inspection andmetrology. In July 2003 we acquired the assets of CSI, including thedesign for the VersaScope, a recently introduced 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 business of Inspex, Inc.  We plan to use the DMSVision Software tofurther expand and enhance our current defect analysis software offerings.

 

Our business is subject to the highly cyclical natureof the microelectronic device manufacturing markets we serve. These cycles arecaused by significant fluctuations in the supply and demand of microelectronicdevices driven by such factors as changes in technology and global economicconditions. As a result of these fluctuations, our quarterly orders andrevenues have fluctuated dramatically. After a three year industry downturn we began to experience signs of an industryrecovery during the second half of 2003. The recovery has continued through the first half of 2004.  This has resulted in a significant increasein the level of orders and revenues during this period, and a record level ofbacklog at June 30, 2004.  Althoughwe do not believe backlog is always a meaningful or accurate indication offuture revenues and performance, since only a portion of our revenues for anyquarter represents systems in backlog, we do closely monitor the level oforders both geographically and by product line and in relation to the level ofrevenues, referred to as the book-to-bill ratio.  During the second quarter of 2004 ourbook-to-bill ratio was above parity for the eighth consecutive quarter.  A book-to-bill ratiogreater than parity indicates a growing level of backlog.

 

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In addition to monitoring our level of orders andbacklog, we focus on several key financial metrics in evaluating our financialcondition and operating performance, most importantly revenues by productfamily compared to prior-period and current-year plans, year-over-year revenuegrowth compared to the overall semiconductor equipment industry, operatingprofit or loss performance compared with prior-period and current-year plansand the level of operating cash flow.

 

In response to the currentincrease in activity we have added and continue to recruit additional staff inall functional areas and increased our manufacturing levels to meet theincreased demand.  However, we cannotpredict the sustainability of the current recovery, and/or the industry’s rateof growth. If we are unable to effectively manage our resources and productioncapacity during an industry cycle, there could be a material adverse effect onour business, financial condition and results of operations.

 

We anticipate that futurequarterly and annual results will continue to be impacted by fluctuations insupply and demand of microelectronic devices, the timing of new productannouncements and releases by us or our competitors, market acceptance of newor enhanced versions of our products, changes in the pricing of our productsand the timing and level of our research and development expenditures.

 

**Resultsof Operations**

 
| ** **                                           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                           | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Net  revenues                                        |       | 100.0                                | %          | 100.0                              | %          | 100.0 | % | 100.0 | % |
| Cost  of revenues                                    |       | 45.6                                 |       | 45.7                               |       | 44.5 |   | 45.4 |   |
| Gross  profit                                        |       | 54.4                                 |       | 54.3                               |       | 55.5 |   | 54.6 |   |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Selling,  general and administrative expenses        |       | 27.2                                 |       | 41.4                               |       | 29.2 |   | 44.9 |   |
| Research  and development expenses                   |       | 16.7                                 |       | 31.4                               |       | 17.1 |   | 36.3 |   |
| Operating  income (loss)                             |       | 10.5                                 |       | (18.5                              | )          | 9.2 |   | (26.6 | ) |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Interest  income                                     |       | 0.9                                  |       | 1.0                                |       | 1.1 |   | 1.2 |   |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Net  income (loss) before provision for income taxes |       | 11.4                                 |       | (17.5                              | )          | 10.3 |   | (25.4 | ) |
| Provision  for income taxes                          |       | 0.5                                  |       | —                             |       | 0.3 |   | — |   |
| Net  income (loss)                                   |       | 10.9                                 | %          | (17.5                              | )%         | 10.0 | % | (25.4 | )% |

 

*Threeand six months ended June 30, 2004 compared to the three and six monthsended June 30, 2003*

 

*Net Revenues.*  Netrevenues increased $12.1 million, or 156.0%, to $19.9 million for the threemonths ended June 30, 2004, from $7.8 million for the same period in2003.  Net revenues increased $21.9million, or 153.2%, to $36.3 million for the six months ended June 30,2004, from $14.3 million for the same period in 2003.  The increase in net revenues was primarilydue to increased sales of higher throughput NSX Series systems installed in abroader array of wafer and device fabrication processes and sales related tothe AXi Series, for which we began to recognize revenue during the thirdquarter of 2003.  Net revenues alsoincreased as a result of the recognition revenues from the sale of the firstVersaScope systems.  Sales of theseproduct lines increased primarily as a result of higher sales of systems intothe front end of the wafer fabrication process and an overall increase indemand due to the industry recovery that began in the second half of 2003.  Revenues are expected to continue to increaseduring the second half of 2004 due to the

 

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recognition of revenues currently in backlog as ofJune 30, 2004 and anticipated continued strength of the overallmicroelectronic industry.

 

Netrevenues from international sales represented 71% and 69% of total net revenuesfor the three months ended June 30, 2004 and 2003.  International revenues during the threemonths ended June 30, 2004 consisted entirely of sales to customers inAsia.  The increase in the percentage ofnet revenues from Asia was partially offset by a decrease in net revenues fromEurope, which comprised 11% of net revenues in the prior year.  Net revenues from international salesrepresented 71% and 68% of net revenues for the six months ended June 30,2004 and 2003, and were primarily the result of sales to Asia, which comprised69% and 57% of total net revenues.

 

*Gross Margin.*  Grossmargin increased slightly to 54.4% for the three months ended June 30,2004, from 54.3% for the same period in 2003.  Gross margin increased to 55.5% for the six months ended June 30,2004, from 54.6 % for the same period in 2003. Gross margins increaseddue to an increase in the numberof systems manufactured, which resulted in higher manufacturing utilization anddecreased labor and overhead per system sold, and increased revenue from ourYield*Pilot* product line.  This increase was offset by lower grossmargins on sales of our AXi Series and NSX Series product lines due to anincrease in the number of systems sold that included automated materialhandling subsystem options, which have lower gross margins than our coreinspection systems, and lower margins on revenues from the first VersaScopesystems due to the higher costs of the initial systems manufactured.  In addition, we have experienced pricingpressure primarily related to our inspection systems sold into finalmanufacturing applications as competitors have continued to enter this market.

 

*Selling, General and Administrative Expenses.*  Selling, general and administrative expensesconsist primarily of employee salaries and related benefits, travel expensesand occupancy related costs.  Selling,general and administrative expenses were $5.4 million and $10.6 million for thethree and six months ended June 30, 2004, compared to $3.2 million and$6.4 million for the same periods in 2003. Selling, general and administrative expenses as a percentage of netrevenues were 27.2% and 29.2% for the three and six months ended June 30,2004, compared to 41.4% and 44.9% ofnet revenues for the same periods in 2003. The increase in expense dollars was primarily the result of increasedvariable costs associated with the increased level of revenues, employeecompensation costs, including salaries related to the hiring of additionalfield service and sales personnel to support the increased revenues and ourdirect sales and service office in Korea, which opened in February 2004,and expenses associated with the ongoing operations of two acquisitionscompleted during the second and third quarters of 2003.  The quarterly selling, general andadministrative expense dollars are expected to increase in the third quarter of2004, as compared to the first quarter, primarily as a result of variable expensesassociated with the expected higher level of revenues, and increased headcountto support the increased revenues and further develop our organization to meetincreased customer demands.  However,selling, general and administrative expenses as a percentage of revenues areexpected to decrease, as revenues are expected to increase at a higher ratethan the increase in selling, general and administrative expenses.

 

*Research and DevelopmentExpenses.*  Research and development expenses consistprimarily of employee salaries and related benefits and consulting fees forindividuals engaged in the research, design and development of newproducts.  Research and developmentexpenses were $3.3 million and $6.2 million for the three and six months endedJune 30, 2004, compared to $2.4 million and $5.2 million for thesame periods in 2003.  Research anddevelopment expenses as a percentage of net revenues were 16.7% and 17.1% for the three and six monthsended June 30, 2004, compared to 31.4% and 36.3% for the same periods in2003.  The increase in expense dollarswas primarily due

 

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to employee compensation and related benefits associatedwith the hiring of additional staff and an increase in the use of outsidecontractors to complete certain stages of development of the B20 back-sideinspection option and VersaScope, and further enhancements to both the NSXSeries and AXi Series.  In addition,expenses increased due to two acquisitions completed during the second andthird quarters of 2003.  We anticipatethat research and development expenses,both in dollars and as a percentage of revenues, will increase in the thirdquarter of 2004, as compared to the second quarter of 2004 due to developmentprojects related to the continued expansion of our business in the front-end ofthe wafer manufacturing process and expansion of our suite of softwaresolutions.

 

*Interest Income.* Interest income was $189,000 and $390,000 for the three and six monthsended June 30, 2004, compared to $78,000 and $176,000 for the same periodsin 2003.  The increase in interest incomewas primarily due to an increase in overall investment balances, as a result ofthe proceeds received from a follow-on public offering of our Common Stock thatwas completed on September 23, 2003 and the underwriters’ exercise of theover-allotment option on October 21, 2003 (the “Offering”).

 

***Income Taxes.**** *As a result of historical operating losses and uncertainty as to theextent of profitability in future periods, we began to record a valuation allowanceagainst our deferred tax assets in the second quarter of 2002 and continue todo so at June 30, 2004.  As aresult, we did not reflect a provision for income taxes during the three andsix months ended June 30, 2003, and have recorded a provision for incometaxes of $100,000 during the three and six months ended June 30, 2004,primarily to reflect alternative minimum tax owed on our pretax income.   Statement of Financial Accounting Standards (“SFAS”)No. 109 “Accountingfor Income Taxes,” requires the establishment of a valuation allowance toreflect the likelihood of the realization of deferred tax assets.  We expect to record a similar provision forincome taxes during the second half of 2004. As of December 31, 2003 the valuation allowance was $7.5 million.

 

**Liquidity and Capital Resources**

 

Duringthe six months ended June 30, 2004, working capital increased to $71.2million as compared to $62.8 million at December 31, 2003.  The increase was primarily due to an increasein both accounts receivable and inventories. At June 30, 2004 our principal sources of liquidity consisted ofcash, cash equivalents and marketable debt securities of $52.5 million.  We have no outstanding debt at June 30,2004.  Our liquidity is affected by manyfactors, some of which are based on the normal ongoing operations of ourbusiness, the most significant of which includes the timing of the collectionof receivables, the level of inventories, capital expenditures andacquisitions.

 

*Accounts Receivable.*  Ouraccounts receivable increased $11.1 million from December 31, 2003 toJune 30, 2004.  Our days salesoutstanding (“DSO”) during the three months ended June 30, 2004 was 59days.  This compares to a DSO of 41 daysin the first quarter of 2004.  Due to thehigh mix of international revenues during a given quarter, which generallyrequire a longer time for collection, we believe our DSO will be between 60 and70 days in future quarters.

 

*Inventories.* Inventories increased $7.0 million fromDecember 31, 2003 to June 30, 2004. The increase is primarily due to the need to support new productintroductions, increased backlog and increased demonstration equipment atcustomers under evaluation.

 

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*Inventoriesat Customers under Purchase Orders.*  Inventoriesat customers under purchase orders increased $2.8 million fromDecember 31, 2003 to June 30, 2004, primarily due to shipments ofnewer models of our NSX Series that have not yet qualified for revenuerecognition. We anticipate that a portion of this inventory will be recognizedas revenue during the third quarter of 2004. We anticipate that this inventory will increase as shipments of newlyintroduced products increase.

 

*Capital Expenditures.*  Ourcapital expenditures during the first six months of 2004 were $2.5 million,consisting primarily of the capitalization of finished goods used to supportour engineering, sales and service efforts. Our total capital expenditures are expected to be between $4.0 million and $5.0 million in 2004 as we expand the use ofinternal test and development equipment and facilities to meet increasedcustomer demand.

 

Our liquidity is alsoaffected by factors beyond our control related to the uncertainties of globaleconomies and the cyclical nature of the semiconductor and microelectronicindustries.  Although liquidityrequirements will fluctuate based on the timing and extent of all of thesefactors and others, management believes that existing cash and investmentbalances will be adequate to satisfy our existing liquidity requirements for atleast the next twelve months.

 

*CashFlows*

 

Net cash used inoperating activities for the six months ended June 30, 2004 was $10.7million, which resulted primarily from increased accounts receivable and inventoriespartially offset by our net income and increased accounts payable and customerdeposits.  Net cash provided by investingactivities was $308,000, primarily due to $2.9 million of net proceeds fromsales of marketable securities and partially offset by $2.5 million forpurchases of property and equipment.  Netcash provided by financing activities was $2.0 million from the proceedsreceived from issuances of common stock.  We currently expect to generate cash flow from operating activitiesduring the second half of 2004.  Cashflows used in investing activities will include the $2.1 million purchase pricefor the DMSVision software acquisition and capital expenditures to be between  $1.5 million and $2.5 million during thesecond half 2004.

 

Net cash provided byoperating activities for the six months ended June 30, 2003 was $3.2million, which resulted primarily from decreased accounts receivable andincreased customer deposits and accounts payable partially offset by our netloss and increased inventory during the period. Net cash used in investing activities was $3.8 million, primarily due to$1.8 million of net purchases of marketable securities, $1.4 million of cashpaid to acquire STI and $588,000 for purchases of property and equipment.  Net cash provided by financing activities was$176,000 proceeds received from issuances of common stock.

 

**NewAccounting Pronouncements**

 

In December 2003, the Financial Accounting Standards Board(“FASB”) issued FASB Interpretation (“FIN”) No. 46R, “*Consolidation of Variable Interest Entities”*,which addresses how a business enterprise should evaluate whether it has acontrolling financial interest in an entity through means other than votingrights and accordingly should consolidate the entity.  FIN 46R replaces FASB Interpretation No. 46,“*Consolidation of Variable InterestEntities”*, which was issued in January 2003. We are required toapply FIN 46R to variable interests in variable interest entities (“VIE”)created after December 31, 2003. For variable interests in VIEs createdbefore January 1, 2004, the Interpretation will be applied beginning onJanuary 1, 2005. For any VIEs that

 

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must beconsolidated under FIN 46R that were created before January 1, 2004, theassets, liabilities and noncontrolling interests of the VIE initially would bemeasured at their carrying amounts with any difference between the net amountadded to the balance sheet and any previously recognized interest beingrecognized as the cumulative effect of an accounting change. If determining thecarrying amounts is not practicable, fair value at the date FIN 46R firstapplies may be used to measure the assets, liabilities and noncontrollinginterest of the VIE. We believe that we have no variable interest entities and,therefore, FIN 46R did not have an impact on our consolidated financialstatements.

 

In May 2003, the FASB issued SFAS No. 150, “*Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity”.* The Statement establishes standardsfor the classification and measurement of certain financial instruments withcharacteristics of both liabilities and equity. The Statement also includes required disclosures for financialinstruments within its scope.  For us,the Statement was effective for instruments entered into or modified after May31, 2003, and otherwise will be effective as of January 1, 2004, exceptfor mandatorily redeemable financial instruments.  For certain mandatorily redeemable financialinstruments, the Statement will be effective for us on January 1,2005.  The effective date has beendeferred indefinitely for certain other types of mandatorily redeemablefinancial instruments.  We currently donot have any financial instruments that are within the scope of the Statementand, therefore, SFAS 150 did not have an effect on our consolidated financialstatements.

 

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

 

*Market Risk*

 

We are exposed to marketrisk primarily from changes in interest rates and credit risk.  We do not have material exposure to marketrisk from fluctuations in foreign currency exchange rates because all sales aremade in U.S. dollars.

 

*Interest Rate Risk*

 

We are exposed to interest rate risk primarily frominvestments in cash equivalents and short-term and long-term marketable debtsecurities (the “Investment Portfolio”). The entire Investment Portfolio, classified as available-for-sale, isrecorded on the balance sheet at fair market value with unrealized gains orlosses excluded from earnings and included in “Accumulated other comprehensiveincome (loss)” until realized.  Theentire Investment Portfolio is denominated in U.S. dollars.  We do not use derivative financialinstruments in the Investment Portfolio. Due to the short duration of our Investment Portfolio, an immediate 100percent change in interest rates is not expected to have a material adverseeffect on our near-term financial condition or results of operations.

 

*Credit Risk*

 

Financial instruments which potentially subject us tocredit risk consist principally of securities in the Investment Portfolio andtrade receivables.  We limit credit riskrelated to the Investment Portfolio by placing all investments with highquality credit issuers and limit the amount of investments with any oneissuer.  As of June 30, 2004, 88.2%of the Investment 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.

 

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**Item4.****                                   Controlsand Procedures**

 

*Evaluation of Disclosure Controls and Procedures*

 

As of the end of theperiod covered by this report, the Company conducted an evaluation under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, regardingthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures pursuant to Rules 13a-15(b) of the Securities ExchangeAct of 1934 (the “Exchange Act”).  Basedupon that evaluation, the Chief 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*

 

There were no changes inthe Company’s internal controls over financial reporting that occurred duringthe period covered by this report that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PART II— OTHER INFORMATION**

 

**Item 1.****                                   LegalProceedings**

 

The Company has fullysettled the 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 $670,000.  To secure ASTI’s performance of ASTI’sindemnification obligations, ASTI and August created an escrow.

 

On July 22, 2004,the Company, STI, Rudolph, ISOA agreed to settle all claims between theparties.  Under the terms of theconfidential settlement, ASTI will make a one-time payment out of the escrow toRudolph in the amount of $502,500.  TheCompany, STI, Rudolph and ISOA agreed to release any and all claims againsteach other relating to the joint development agreement and to dismiss all claimsasserted in the litigation with prejudice.

 

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**Item 2.****                                   UnregisteredSales of Equity Securities and Use of Proceeds**

 

On April 29, 2004and May 19, 2004, theCompany sold an aggregate of 9,375 shares of common stock at $1.20 per shareupon the exercise of warrants by two holders. The issuances were exempt from registration under Section 4(2) ofthe Securities Act of 1933, as amended, which provides an exemption fortransactions not involving a public offering.

 

# **Item4.**                                   Submission of Matters to a Vote of Security Holders

 

The Company held itsAnnual Meeting of Shareholders on April 28, 2004 at the Company’s worldheadquarters at 4900 West 78th Street, Bloomington, Minnesota.  Of the 17,695,930 shares of Common Stockoutstanding as of March 4, 2004 (the record date),  16,105,956 shares (91%) were presentor represented by proxy at the meeting.

 

1.               Theshareholders approved the Board of Director’s recommendation for setting thenumber of directorships at five.  Thisproposal received 15,998,581 votes for and 82,186 votes against, with 25,189votes abstaining.

 

2.               Theshareholders elected Jeff L. O’Dell and Michael W. Wright as Class I Directors,pursuant to the following votes:

 

| ** **           | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|----------------------|------------|---------------|------------|--------------------|------------|
|                 |       |          |       |               |       |
| Jeff  L. O’Dell |       | 15,404,397    |       | 701,559            |       |
|                 |       |          |       |               |       |
| Michael  W. Wright   |       | 15,644,174    |       | 461,782            |       |

 

The terms of LindaWhitman, as a Class II director and James A, Bernards and Roger E. Gower asClass III directors of the Company, were not subject to reelection at thismeeting and thus their terms continued after the meeting.

 

3.               Theshareholders approved an amendment to the Company’s Restated 1997 StockIncentive Plan (the “Plan) to increase the number of shares of Common Stockreserved for issuance from 3,050,000 to 4,250,000 shares.  In addition, the amendment added restrictedstock awards, performance awards, and stock appreciation rights to theincentives offered under the Plan.  Thisproposal received 9,888,302 votes for and 2,611,455 votes against, with 3,606,199votes abstaining.

 

4.               Theshareholders ratified the appointment of KPMG LLP as the Company’s independentauditors for the 2004 fiscal year.  Thisproposal received 16,015,829 votesfor and 61,539 votes against, with 28,588 votes abstaining.

 

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**Item6.****                                   Exhibitsand Reports on Form 8-K**

 

(a)                                  Exhibits:

 

The exhibits listed onthe Exhibit Index are filed herewith.

 

(b)                                 Reportson Form 8-K:

 

Current Report on Form8-K dated April 28, 2004 and furnished April 28, 2004, was furnishedpursuant to Item 9 (Regulation FD Disclosure) in satisfaction of Item 12(Disclosure of Results of Operations and Financial Condition) to report thepress release announcing the Company’s first quarter 2004 financial results.

 

Current Report on Form8-K dated May 12, 2004 and filed May 13, 2004, was filed pursuant to Item 5(Other Events) and Item 7 (Financial Statements and Exhibits) to report theadoption of a trading plan under Rule10b5-1 by a director of the Company.

 

Current Report on Form8-K dated June 23, 2004 and filed June 24, 2004, was filed pursuantto Item 5 (Other Events) to report the entering of a purchase agreement withInspex Inc. for the purchase of certain assets used by Inspex Inc. inconnection with its DMSVision software.

 

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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: August 3, 2004 | By:                                 | /s/ JEFF L. O’DELL |   |
|                 | Jeff L. O’Dell                 |
|                 | Chief Executive Officer             |
|                 | (Principal Executive  Officer)      |
|                 |                                |
|                 |                                |
| Date: August 3, 2004 | By:                                 | /s/ STANLEY D. PIEKOS |   |
|                 | Stanley D. Piekos                   |
|                 | Chief Financial Officer             |
|                 | (Principal Financial  Officer)      |
|                 |                                |
|                 |                                |
| Date: August 3, 2004 | By:                                 | /s/ SCOTT A. GABBARD |   |
|                 | Scott A. Gabbard                    |
|                 | Chief Accounting  Officer and       |
|                 | Vice President, Finance             |
|                 | (Principal Accounting  Officer)     |
|                      |                                     |  |  |  |  |  |  |

 

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**SECURITIESAND EXCHANGE COMMISSION**

Washington, D.C.  20549

 

EXHIBITINDEX TO FORM 10-Q

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

 

**AUGUST TECHNOLOGYCORPORATION**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                        | ** ** |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|
|                |       |                                                                                                                                   |       |
| 10.1                |       | Fifth  Amendment to Lease Agreement between the Company and 4900 West 78th Street  Bloomington Associates, LLC dated May 27, 2004 |       |
|                |       |                                                                                                                                   |       |
| 31.1                |       | Certification pursuant  to Exchange Act Rules 13a-14(a) of the Chief 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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