**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q/A**

**(Amendment No. 1)**

 

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

 

**For thequarterly period ended June 30, 2005**

 

**OR**

 
| **o** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

 

**For thetransition period from                               to                               **

 

**Commission File Number 000-30637**

 

 

**AUGUST TECHNOLOGY CORPORATION**

(Exact name of Registrant as 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**                                                                               |
| (Former name, former address, and former fiscal  year, if changed since last report.) |

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.     Yes  ý   No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined byExchange Act Rule 12b-2).  Yes  ý  No  o

 

As of July 31,2005, there were 18,122,976 shares of common stock outstanding.

 

 

----

 

**AUGUST TECHNOLOGY CORPORATION**

**EXPLANATORY NOTE**

 

As previously disclosed, August TechnologyCorporation (the “Company”) has restated its consolidated financial statementsfor the year 2004 and for the first two quarters of 2005. The determination torestate these financial statements was made as a result of a correction of theCompany’s application of revenue recognition principles contained in theFinancial Accounting Standard Board’s Emerging Issues Task Force Issue No. 00-21,“*Revenue Arrangements with Multiple Deliverables*”(“EITF 00-21”).  As a result ofsubsequently reviewing our revenue recognition policies and procedures, weadditionally noted that beginning in the fourth quarter of 2002 certaindeferred software revenue should have been fully recognized upon delivery or customeracceptance rather than ratably over a twelve-month period.  As a result, the Company has restated itsconsolidated financial statements for the years 2004, 2003 and 2002 and for thefirst two quarters of 2005 (the “Restatement”). Our restated consolidated financial statements also include disclosureof restated unaudited quarterly results for 2004 and 2003.  The Audit Committee of the Company’s Board ofDirectors (the “Audit Committee”) worked closely with the Company’s managementto review the Restatement and the Company’s policies and practices for therecognition of revenue.  Furtherinformation on the adjustments can be found in Note 2, “Restatement ofFinancial Statements” to the accompanying consolidated financial statements.

 

This Amendment No. 1 onForm 10-Q/A (the “Form 10-Q/A”) to the Company’s Quarterly Report on Form 10-Qfor the quarterly period ended June 30, 2005, initially filed with theSecurities and Exchange Commission (the “SEC”) on August 5, 2005 (the “OriginalFiling”), is being filed to reflect restatements of the Company’s consolidatedbalance sheet as of June 30, 2005, the Company’s consolidated statementsof cash flows for the six-month periods ended June 30, 2005 and 2004, andthe Company’s consolidated statements of operations for the three-month andsix-month periods ended June 30, 2005 and June 30, 2004 and the notesrelated thereto.  Certain adjustmentswere recorded to each quarter in 2004 and the first two quarters of 2005 tocorrect other miscellaneous items identified in prior external audits orquarterly reviews but were previously passed, none of which were individuallysignificant.  For a more detaileddescription of the restatement, see Note 2, “Restatement of FinancialStatements” to the accompanying consolidated financial statements and the section entitled“Restatement” in Management’s Discussion and Analysis of Financial Conditionand Results of Operations contained in this Form 10-Q/A.

 

Concurrent with the filingof this Form 10-Q/A we are filing an Amendment No. 1 on Form 10-K/A(the “Form 10-K/A”) to the Company’s Annual Report on Form 10-K forthe year ended December 31, 2004 to reflect restatements of the Company’sconsolidated balance sheets as of December 31, 2004 and 2003 and theCompany’s consolidated statements of operations, cash flows and stockholders’equity for the years ended December 31, 2004, 2003 and 2002 and the notesrelated thereto.

 

For the convenience of thereader, this Form 10-Q/A sets forth the Original Filing in its entirety.However, this Form 10-Q/A only amends and restates Items 1, 2 and 4of Part I of the Original Filing, in each case, solely as a result of, andto reflect, the Restatement, and no other information in the Original Filing isamended hereby. The foregoing items have not been updated to reflect otherevents occurring after the Original Filing or to modify or update thosedisclosures affected by subsequent events. In addition, pursuant to the rules ofthe SEC, Item 6 of Part II of the Original Filing has been amended tocontain currently-dated certifications from the Company’s Chief ExecutiveOfficer and Chief Financial Officer, as required by Sections 302 and 906of the Sarbanes-Oxley Act of 2002. The certifications of the Company’s ChiefExecutive Officer and Chief Financial Officer are attached to this Form 10-Q/Aas Exhibits 31.1, 31.2 and 32.1.

 

Except for the foregoingamended information, this Form 10-Q/A continues to speak as of the date ofthe Original Filing, and the Company has not updated the disclosures containedherein to reflect events that occurred at a later date.  Other events occurring after the filing of theOriginal Filing or other disclosures

 

2

----

 

necessary to reflect subsequent events have been orwill be addressed in the Company’s Quarterly Report on Form 10-Q for thequarterly period ended September 30, 2005 which is being filedconcurrently with the filing of this Form 10-Q/A, and any reports filedwith the SEC subsequent to the date of this filing.

 

The Company has not amendedand does not intend to amend its previously filed Quarterly Reports on Form 10-Qfor the periods affected by the Restatement prior to December 31, 2004.For this reason, the consolidated financial statements and related financial informationfor the affected periods contained in such reports should no longer be reliedupon.

 

3

----

 

**AUGUST TECHNOLOGY CORPORATION**

 

**TABLE OF CONTENTS**

 
| ** **         | **Description**                                                                                       | ** **                                                                                   |
|--------------------|-------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------|
|               |                                                                                                  |
| PART I        | FINANCIAL INFORMATION                                                                                 |                                                                                         |
|               |                                                                                                  |
|               | Item 1.                                                                                               | Financial Statements (unaudited)                                                             |   |
|               |                                                                                                  |
|               | Consolidated Balance Sheets as of June 30,  2005 and December 31, 2004                      |                                                                                         |
|               |                                                                                                  |                                                                                         |
|               | Consolidated Statements of  Operations for the three and six months ended June 30, 2005 and 2004 |                                                                                         |
|               |                                                                                                  |                                                                                         |
|               | Consolidated Statements of  Cash Flows for the six months ended June 30, 2005 and 2004           |                                                                                         |
|               |                                                                                                  |                                                                                         |
|               | Notes to Consolidated  Financial Statements                                                           |                                                                                         |
|               |                                                                                                  |
|               | 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                                                                                     |   |
|               |                                                                                                  |                                                                                         |
| SIGNATURES         |                                                                                                  |
|               |                                                                                                  |                                                                                         |
| EXHIBIT INDEX |                                                                                                  |
|                    |                                                                                                       |                                                                                              |  |  |

 

4

----

 

**PART I– FINANCIAL INFORMATION**

**Item1.  Financial Statements**

**AUGUST TECHNOLOGYCORPORATION**

 

**CONSOLIDATEDBALANCE SHEETS**

**(Inthousands, except share amounts)**

**(Unaudited)**

 
| ** **                                                                                                                        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                        | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **                                                                                                                        | ** ** | **(Restated)**    | ** ** | **(Restated)**        | ** ** |
| **ASSETS**                                                                                                                        |       |              |       |                  |       |
|                                                                                                                              |       |              |       |                  |       |
| Current assets:                                                                                                                   |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                         |       | $                 | 10,313     |                  | $          | 5,518 |   |
| Short-term marketable debt securities                                                                                             |       | 22,583            |       | 28,615                |       |
| Accounts receivable, net                                                                                                          |       | 10,389            |       | 8,328                 |       |
| Inventories                                                                                                                       |       | 21,393            |       | 20,106                |       |
| Inventories at customers under purchase orders                                                                                    |       | 9,294             |       | 6,704                 |       |
| Prepaid expenses and other current assets                                                                                         |       | 1,951             |       | 2,517                 |       |
| Total current assets                                                                                                              |       | 75,923            |       | 71,788                |       |
|                                                                                                                              |       |              |       |                  |       |
| Property and  equipment, net                                                                                                      |       | 5,342             |       | 5,994                 |       |
| Long-term  marketable debt securities                                                                                             |       | 9,034             |       | 16,289                |       |
| Purchased  technology, net                                                                                                        |       | 3,098             |       | 3,703                 |       |
| Goodwill                                                                                                                          |       | 498               |       | 498                   |       |
| Other assets                                                                                                                      |       | 162               |       | 150                   |       |
| Total assets                                                                                                                      |       | $                 | 94,057     |                  | $          | 98,422 |   |
|                                                                                                                              |       |              |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                     |       |              |       |                  |       |
|                                                                                                                              |       |              |       |                  |       |
| Current liabilities:                                                                                                              |       |              |       |                  |       |
| Accounts payable                                                                                                                  |       | $                 | 6,747      |                  | $          | 3,291 |   |
| Accrued compensation                                                                                                              |       | 2,952             |       | 1,636                 |       |
| Other accrued liabilities                                                                                                         |       | 2,294             |       | 2,322                 |       |
| Customer deposits and deferred revenues                                                                                           |       | 17,051            |       | 11,973                |       |
| Total current liabilities                                                                                                         |       | 29,044            |       | 19,222                |       |
|                                                                                                                              |       |              |       |                  |       |
| Other  non-current liabilities                                                                                                    |       | 108               |       | 131                   |       |
| Total liabilities                                                                                                                 |       | 29,152            |       | 19,353                |       |
|                                                                                                                              |       |              |       |                  |       |
| Commitments and  contingencies (note 9)                                                                                           |       | —            |       | —                |       |
|                                                                                                                              |       |              |       |                  |       |
| Shareholders’  equity:                                                                                                       |       |              |       |                  |       |
| Common stock, no par value, 42,000,000 shares  authorized, 18,064,032 and 17,839,298 shares issued and outstanding,  respectively |       | 91,447            |       | 90,363                |       |
| Undesignated capital stock, no par value, 3,000,000  shares authorized, no shares issued or outstanding                           |       | —            |       | —                |       |
| Accumulated deficit                                                                                                               |       | (26,446           | )          | (11,188               | )          |
| Accumulated other comprehensive loss                                                                                              |       | (96               | )          | (106                  | )          |
| Total shareholders’ equity                                                                                                   |       | 64,905            |       | 79,069                |       |
| Total liabilities and shareholders’ equity                                                                                   |       | $                 | 94,057     |                  | $          | 98,422 |   |

 

See accompanying notes toconsolidated financial statements.

 

5

----

 

**AUGUST TECHNOLOGYCORPORATION**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(Restated)**                       | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Net revenues                                     |       | $                                    | 16,749     |                               | $          | 18,024 |   | $ | 31,785 |   | $ | 34,869 |   |
| Cost of revenues                                 |       | 6,953                                |       | 8,159                              |       | 13,777 |   | 15,217 |   |
| Gross profit                                     |       | 9,796                                |       | 9,865                              |       | 18,008 |   | 19,652 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Selling, general  and administrative expenses    |       | 7,236                                |       | 5,390                              |       | 13,574 |   | 10,579 |   |
| Research and  development expenses               |       | 3,324                                |       | 3,322                              |       | 6,990 |   | 6,230 |   |
| Operating income (loss)                          |       | (764                                 | )          | 1,153                              |       | (2,556 | ) | 2,843 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Merger expenses                                  |       | (11,991                              | )          | —                             |       | (13,225 | ) | — |   |
| Interest income                                  |       | 334                                  |       | 189                                |       | 623 |   | 390 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Income (loss)  before provision for income taxes |       | (12,421                              | )          | 1,342                              |       | (15,158 | ) | 3,233 |   |
| Provision for  income taxes                      |       | 50                                   |       | 59                                 |       | 100 |   | 100 |   |
| Net income  (loss)                               |       | $                                    | (12,471    | )                                  | $          | 1,283 |   | $ | (15,258 | ) | $ | 3,133 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss) per share:                    |       |                                 |       |                               |       |   |   |   |   |
| Basic                                            |       | $                                    | (0.69      | )                                  | $          | 0.07 |   | $ | (0.85 | ) | $ | 0.18 |   |
| Diluted                                          |       | $                                    | (0.69      | )                                  | $          | 0.07 |   | $ | (0.85 | ) | $ | 0.17 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Weighted average  number of shares:              |       |                                 |       |                               |       |   |   |   |   |
| Basic                                            |       | 18,005                               |       | 17,778                             |       | 17,936 |   | 17,700 |   |
| Diluted                                          |       | 18,005                               |       | 18,349                             |       | 17,936 |   | 18,421 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

6

----

 

**AUGUST TECHNOLOGY CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                            | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                                                            | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** |
| Cash flows from  operating activities:                                                |       |                               |       |   |   |
| Net income (loss)                                                                     |       | $                                  | (15,258    | ) | $ | 3,133 |   |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                               |       |   |   |
| Depreciation and amortization                                                         |       | 2,115                              |       | 1,019 |   |
| Provision for (recovery of) doubtful accounts                                         |       | (57                                | )          | 79 |   |
| Tax benefit from employee stock options                                               |       | 13                                 |       | — |   |
| Deferred income taxes                                                                 |       | 6                                  |       | — |   |
| Stock based compensation                                                              |       | 30                                 |       | — |   |
| Amortization of deferred compensation related to  stock options                       |       | —                             |       | 27 |   |
| Changes in operating assets and liabilities:                                          |       |                               |       |   |   |
| Accounts receivable                                                                   |       | (1,998                             | )          | (8,874 | ) |
| Inventories                                                                           |       | (1,142                             | )          | (7,048 | ) |
| Inventories at customers under purchase orders                                        |       | (2,590                             | )          | (3,679 | ) |
| Prepaid expenses and other current assets                                             |       | 575                                |       | (402 | ) |
| Accounts payable                                                                      |       | 3,456                              |       | 2,120 |   |
| Accrued compensation                                                                  |       | 1,312                              |       | 696 |   |
| Accrued liabilities                                                                   |       | —                             |       | 9 |   |
| Customer deposits and deferred revenues                                               |       | 5,076                              |       | 2,202 |   |
| Net cash used in operating activities                                                 |       | (8,462                             | )          | (10,718 | ) |
|                                                                                  |       |                               |       |   |   |
| Cash flows from  investing activities:                                                |       |                               |       |   |   |
| Proceeds from maturities of marketable debt  securities                               |       | 45,389                             |       | 94,356 |   |
| Purchases of marketable debt securities                                               |       | (32,119                            | )          | (91,499 | ) |
| Purchases of property and equipment                                                   |       | (843                               | )          | (2,455 | ) |
| Investment in other assets                                                            |       | (186                               | )          | (77 | ) |
| Cash paid for acquisitions                                                            |       | (28                                | )          | (17 | ) |
| Proceeds from disposition of property and equipment                                   |       | 4                                  |       | — |   |
| Net cash provided by investing activities                                             |       | 12,217                             |       | 308 |   |
|                                                                                  |       |                               |       |   |   |
| Cash flows from  financing activities:                                                |       |                               |       |   |   |
| Net proceeds from issuances of common stock to  employees                             |       | 1,161                              |       | 1,988 |   |
| Redemption of common stock                                                            |       | (120                               | )          | — |   |
| Net cash provided by financing activities                                             |       | 1,041                              |       | 1,988 |   |
|                                                                                  |       |                               |       |   |   |
| Effect of  exchange rates on cash and cash equivalents                                |       | (1                                 | )          | (13 | ) |
|                                                                                  |       |                               |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                 |       | 4,795                              |       | (8,435 | ) |
| Cash and cash  equivalents at beginning of period                                     |       | 5,518                              |       | 10,027 |   |
| Cash and cash  equivalents at end of period                                           |       | $                                  | 10,313     |   | $ | 1,592 |   |
|                                                                                  |       |                               |       |   |   |
| Supplemental  cash flow information:                                                  |       |                               |       |   |   |
| Cash payments of income taxes                                                         |       | $                                  | (209       | ) | $ | (78 | ) |
| Cash payments for merger expenses                                                     |       | $                                  | (12,342    | ) | $ | — |   |

 

See accompanying notes to consolidated financialstatements.

 

7

----

 

**AUGUST TECHNOLOGY CORPORATION**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**JUNE 30, 2005**

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

**(Unaudited)**

 

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

 

The accompanyingunaudited consolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission.  Certain information and footnote disclosures,normally included in consolidated financial statements prepared in accordancewith accounting principles generally accepted in the United States of America,have been condensed or omitted pursuant to such rules and regulations.  In the opinion of the management of August TechnologyCorporation (collectively with its subsidiaries, the “Company”), alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation have been included in the consolidated balance sheet atJune 30, 2005, the consolidated statements of operations for the three andsix months ended June 30, 2005 and 2004, and the consolidated statementsof cash flows for the six months ended June 30, 2005 and 2004.  The statements of operations of the interimperiods are not necessarily indicative of the results of operations that may beexpected for any other period or for the year as a whole.  These consolidated financial statements andnotes hereto should be read in conjunction with the audited restated consolidatedfinancial statements and notes thereto included in the Company’s Amendment No. 1on Form 10-K/A for the year ended December 31, 2004, which is being filedwith the Securities and Exchange Commission concurrently with the filing of this Form 10-Q/A..

 

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

 

Management uses estimatesand assumptions in preparing consolidated financial statements in accordancewith accounting principles generally accepted in the United States ofAmerica.  Those estimates and assumptionsaffect the reported amounts of assets and liabilities and the disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported revenues and expenses during the reportingperiods.  Actual results could differfrom those estimates.

 

**Note 2 – Restatement of Financial Statements**

 

We have restated our consolidated financial statements for the years2004, 2003 and 2002 and for the first two quarters of 2005.  In addition, certain disclosures in Notes 4,6, 7, 10, 12 and 13 to the consolidated financial statements contained in thisreport have been restated to reflect the Restatement adjustments.  Our restated consolidated financial statementsalso include disclosure of restated unaudited quarterly results for 2004 and2003.  The initial determination torestate the 2004 and first half 2005 consolidated financial statements was madeas a result of a correction of the Company’s application of revenue recognitionprinciples, as contained in the Financial Accounting Standard Board’s EmergingIssues Task Force Issue No. 00-21, “*Revenue Arrangements withMultiple Deliverables*” (“EITF 00-21”).  As a result of subsequently reviewing ourrevenue recognition policies and procedures, we additionally noted thatbeginning in the fourth quarter of 2002 certain deferred software revenueshould have been fully recognized upon delivery or customer acceptance ratherthan ratably over a twelve-month period. This created the need to restate our2002 and 2003 consolidated financial statements.  Certain adjustments were recorded to eachquarter in 2004 and first two quarters of 2005 to correct other miscellaneousitems identified in prior external audits or quarterly reviews but werepreviously passed, none of which were individually significant.

 

8

----

 

In 2004 and the first half of 2005, the Company sold AXi 930 systems toa customer for an aggregate amount of approximately $12.2 million ($6.7 millionin 2004, $3.1 million in the first quarter of 2005 and $2.4 million in thesecond quarter of 2005) and recognized the revenue for these sales.  The cost of revenues related to these saleswas $2.7 million in 2004, $1.5 million in the first quarter of 2005 and $1.2million in the second quarter of 2005.  Forthe three and six months ended June 30, 2004, the Company originallyrecognized $2.2 million in revenue and $0.9 million in cost of revenue forthese AXi 930 sales.  During the sametime periods, the Company accepted orders from the same customer forenhancement packages to the AXi 930 system but had not yet delivered theenhancement packages.  In connection withpreparing to finalize its results for the quarter ended September 30,2005, the Company determined that recognition of the $12.2 million of revenuefrom the AXi 930 systems should have been deferred until the delivery of theenhancement packages, according to EITF 00-21. The customer cancelled its orders for the enhancement packages on September 27,2005, which allowed the Company to recognize the entire $12.2 million of AXi930 deferred revenue in the quarter ended September 30, 2005.

 

In the fourth quarter of 2002, the Company began deferring Yield Pilotsoftware revenue and recognizing it over a twelve-month period whichrepresented the Company’s obligation to provide warranty and support.  The Company determined based on a subsequentreview of Statement of Position 97-2, “*Software Revenue Recognition*” that YieldPilot software revenues should have been recognized upon delivery or customeracceptance.  The correction of this errorhad no significant impact on revenues for the three months ended June 30,2005 and decreased revenue by $0.3 million for the three months ended March 31,2005. The correction increased revenue by $0.4 million for each of the firsttwo quarters in 2004 and had no impact on cost of revenues.  The correction increased revenue by $0.9million, $0.5 million and $0.2 million for 2004, 2003 and 2002, respectivelyand had no impact on costs of revenues.

 

In the second quarter of 2005, the Companyrecognized $0.6 million in revenue and $0.2 million in cost of revenue relatedto the sale of an NSX 105 inspection system. It was subsequently determined that this revenue should have beendeferred until the newly introduced software component of this bundled transactionwas completed and delivered.  This errorwas corrected as part of the restatement of the second quarter of 2005.  The Company expects to realize revenue on the completedtransaction in the fourth quarter of 2005 when all elements will be deliveredand accepted and fair value has been established for the newly introducedsoftware component.

 

The impact of the Restatement on the consolidated statements ofoperations for the three-month and six-month periods ended June 30, 2005and 2004 is shown in the accompanying tables. The primary impact of the Restatement on the consolidated balance sheetat June 30, 2005 was to increase inventory at customers under purchaseorders related to the deferral of the cost of revenue and to increase customerdeposits and deferred revenues related to cash collected for revenue deferredin the Restatement.  The Restatement hadno impact on cash balances or net cash flows from operating, investing, orfinancing activities.  The impact of theRestatement on the consolidated balance sheet and consolidated statements ofcash flows is shown in the accompanying tables.

 

9

----

 

**The following table presents theeffect of the Restatement on the consolidated balance sheet:**

 
| ** **                                      | ** ** | **June 30, 2005** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **As**                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Previously**         | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                      | ** ** | **Reported**           | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| **ASSETS**                                      |       |                   |       |   |   |   |   |
|                                            |       |                   |       |   |   |   |   |
| Current assets:                                 |       |                   |       |   |   |   |   |
| Cash and cash equivalents                       |       | $                      | 10,313     |   | $ | — |   | $ | 10,313 |   |
| Short-term marketable debt securities           |       | 22,583                 |       | — |   | 22,583 |   |
| Accounts receivable, net                        |       | 12,035                 |       | (1,646 | ) | 10,389 |   |
| Inventories                                     |       | 21,393                 |       | — |   | 21,393 |   |
| Inventories at customers under purchase orders  |       | 3,646                  |       | 5,648 |   | 9,294 |   |
| Prepaid expenses and other current assets       |       | 1,651                  |       | 300 |   | 1,951 |   |
| Total current assets                            |       | 71,621                 |       | 4,302 |   | 75,923 |   |
|                                            |       |                   |       |   |   |   |   |
| Property and  equipment, net                    |       | 5,342                  |       | — |   | 5,342 |   |
| Long-term  marketable debt securities           |       | 9,034                  |       | — |   | 9,034 |   |
| Purchased  technology, net                      |       | 3,098                  |       | — |   | 3,098 |   |
| Goodwill                                        |       | 498                    |       | — |   | 498 |   |
| Other assets                                    |       | 162                    |       | — |   | 162 |   |
| Total assets                                    |       | $                      | 89,755     |   | $ | 4,302 |   | $ | 94,057 |   |
|                                            |       |                   |       |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**   |       |                   |       |   |   |   |   |
|                                            |       |                   |       |   |   |   |   |
| Current  liabilities:                           |       |                   |       |   |   |   |   |
| Accounts payable                                |       | $                      | 6,947      |   | $ | (200 | ) | $ | 6,747 |   |
| Accrued compensation                            |       | 2,952                  |       | — |   | 2,952 |   |
| Other accrued liabilities                       |       | 2,353                  |       | (59 | ) | 2,294 |   |
| Customer deposits and deferred revenues         |       | 6,769                  |       | 10,282 |   | 17,051 |   |
| Total current liabilities                       |       | 19,021                 |       | 10,023 |   | 29,044 |   |
|                                            |       |                   |       |   |   |   |   |
| Other  non-current liabilities                  |       | 108                    |       | — |   | 108 |   |
| Total liabilities                               |       | 19,129                 |       | 10,023 |   | 29,152 |   |
|                                            |       |                   |       |   |   |   |   |
| Shareholders’  equity:                     |       |                   |       |   |   |   |   |
| Common stock, no par value                      |       | 91,437                 |       | 10 |   | 91,447 |   |
| Undesignated capital stock, no par value        |       | —                 |       | — |   | — |   |
| Accumulated deficit                             |       | (20,715                | )          | (5,731 | ) | (26,446 | ) |
| Accumulated other comprehensive loss            |       | (96                    | )          | — |   | (96 | ) |
| Total shareholders’ equity                 |       | 70,626                 |       | (5,721 | ) | 64,905 |   |
| Total liabilities and shareholders’ equity |       | $                      | 89,755     |   | $ | 4,302 |   | $ | 94,057 |   |

 

10

----

 

**The following table presents the effect of theRestatement on the consolidated statements of operations:**

 
| ** **                                                                          | ** ** | **Three Months Ended June 30,  2005** | ** ** | **Three Months Ended June 30,  2004** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                          | ** ** | **As  Previously  Reported**               | ** ** | **Adjustments**                            | ** ** | **As  Restated** | ** ** | **As  Previously  Reported** | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
|                                                                                |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Net revenues                                                                        |       | $                                          | 19,688     |                                       | $          | (2,939 | ) | $ | 16,749 |   | $ | 19,855 |   | $ | (1,831 | ) | $ | 18,024 |   |
| Cost of revenues                                                                    |       | 8,403                                      |       | (1,450                                     | )          | 6,953 |   | 9,059 |   | (900 | ) | 8,159 |   |
| Gross profit                                                                        |       | 11,285                                     |       | (1,489                                     | )          | 9,796 |   | 10,796 |   | (931 | ) | 9,865 |   |
|                                                                                |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative expenses                                        |       | 7,237                                      |       | (1                                         | )          | 7,236 |   | 5,390 |   | — |   | 5,390 |   |
| Research and development expenses                                                   |       | 3,324                                      |       | —                                     |       | 3,324 |   | 3,322 |   | — |   | 3,322 |   |
| Operating income (loss)                                                             |       | 724                                        |       | (1,488                                     | )          | (764 | ) | 2,084 |   | (931 | ) | 1,153 |   |
|                                                                                |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Merger expenses                                                                     |       | (11,991                                    | )          | —                                     |       | (11,991 | ) | — |   | — |   | — |   |
| Interest income                                                                     |       | 335                                        |       | (1                                         | )          | 334 |   | 189 |   | — |   | 189 |   |
|                                                                                |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Income (loss) before provision for income taxes                                     |       | (10,932                                    | )          | (1,489                                     | )          | (12,421 | ) | 2,273 |   | (931 | ) | 1,342 |   |
| Provision for  income taxes                                                         |       | 109                                        |       | (59                                        | )          | 50 |   | 100 |   | (41 | ) | 59 |   |
| Net income (loss)                                                                   |       | $                                          | (11,041    | )                                          | $          | (1,430 | ) | $ | (12,471 | ) | $ | 2,173 |   | $ | (890 | ) | $ | 1,283 |   |
|                                                                                |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income  (loss) per share:                                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Basic                                                                               |       | $                                          | (0.61      | )                                          | (0.08      | ) | $ | (0.69 | ) | $ | 0.12 |   | (0.05 | ) | $ | 0.07 |   |
| Diluted                                                                             |       | $                                          | (0.61      | )                                          | (0.08      | ) | $ | (0.69 | ) | $ | 0.12 |   | (0.05 | ) | $ | 0.07 |   |
|                                                                                |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding used to  calculate net income (loss) per share: |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Basic                                                                               |       | 18,005                                     |       |                                       |       | 18,005 |   | 17,778 |   |   |   | 17,778 |   |
| Diluted                                                                             |       | 18,005                                     |       |                                       |       | 18,005 |   | 18,349 |   |   |   | 18,349 |   |

 

11

----

 

**Thefollowing table presents the effect of the Restatement on the consolidatedstatements of operations:**

 
| ** **                                                                          | ** ** | **Six Months Ended June 30,  2005** | ** ** | **Six Months Ended June 30,  2004** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                          | ** ** | **As**                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | **As** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                          | ** ** | **Previously**                           | ** ** | ** **                               | ** ** | **As** | ** ** | **Previously** | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                          | ** ** | **Reported**                             | ** ** | **Adjustments**                          | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                                                                |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Net revenues                                                                        |       | $                                        | 38,105     |                                     | $          | (6,320 | ) | $ | 31,785 |   | $ | 36,255 |   | $ | (1,386 | ) | $ | 34,869 |   |
| Cost of revenues                                                                    |       | 16,762                                   |       | (2,985                                   | )          | 13,777 |   | 16,117 |   | (900 | ) | 15,217 |   |
| Gross profit                                                                        |       | 21,343                                   |       | (3,335                                   | )          | 18,008 |   | 20,138 |   | (486 | ) | 19,652 |   |
|                                                                                |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative expenses                                        |       | 13,526                                   |       | 48                                       |       | 13,574 |   | 10,579 |   | — |   | 10,579 |   |
| Research and development expenses                                                   |       | 6,990                                    |       | —                                   |       | 6,990 |   | 6,230 |   | — |   | 6,230 |   |
| Operating income (loss)                                                             |       | 827                                      |       | (3,383                                   | )          | (2,556 | ) | 3,329 |   | (486 | ) | 2,843 |   |
|                                                                                |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Merger expenses                                                                     |       | (13,225                                  | )          | —                                   |       | (13,225 | ) | — |   | — |   | — |   |
| Interest income                                                                     |       | 623                                      |       | —                                   |       | 623 |   | 390 |   | — |   | 390 |   |
|                                                                                |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Income (loss) before provision for income taxes                                     |       | (11,775                                  | )          | (3,383                                   | )          | (15,158 | ) | 3,719 |   | (486 | ) | 3,233 |   |
| Provision for  income taxes                                                         |       | 164                                      |       | (64                                      | )          | 100 |   | 100 |   | — |   | 100 |   |
| Net income  (loss)                                                                  |       | $                                        | (11,939    | )                                        | $          | (3,319 | ) | $ | (15,258 | ) | $ | 3,619 |   | $ | (486 | ) | $ | 3,133 |   |
|                                                                                |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Net income  (loss) per share:                                                       |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                               |       | $                                        | (0.67      | )                                        | (0.18      | ) | $ | (0.85 | ) | $ | 0.20 |   | (0.02 | ) | $ | 0.18 |   |
| Diluted                                                                             |       | $                                        | (0.67      | )                                        | (0.18      | ) | $ | (0.85 | ) | $ | 0.20 |   | (0.03 | ) | $ | 0.17 |   |
|                                                                                |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding used to  calculate net income (loss) per share: |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                               |       | 17,936                                   |       |                                     |       | 17,936 |   | 17,700 |   |   |   | 17,700 |   |
| Diluted                                                                             |       | 17,936                                   |       |                                     |       | 17,936 |   | 18,421 |   |   |   | 18,421 |   |

 

12

----

 

**Thefollowing table presents the effect of the Restatement on the consolidatedstatement of cash flows:**

 
| ** **                                                                   | ** ** | **Six Months Ended June 30,  2005** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                   | ** ** | **As Previously**                        | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                   | ** ** | **Reported**                             | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                       |       |                                     |       |   |   |   |   |
| Net loss                                                                     |       | $                                        | (11,939    | ) | $ | (3,319 | ) | $ | (15,258 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                     |       |   |   |   |   |
| Depreciation and amortization                                                |       | 2,115                                    |       | — |   | 2,115 |   |
| Recovery of doubtful accounts                                                |       | (57                                      | )          | — |   | (57 | ) |
| Tax benefit from stock options exercised                                     |       | 19                                       |       | (6 | ) | 13 |   |
| Deferred income taxes                                                        |       | 6                                        |       | — |   | 6 |   |
| Stock based compensation                                                     |       | 30                                       |       |   |   | 30 |   |
| Changes in operating assets and liabilities, net of  effect of acquisitions: |       |                                     |       |   |   |   |   |
| Accounts receivable                                                          |       | (3,369                                   | )          | 1,371 |   | (1,998 | ) |
| Inventories                                                                  |       | (1,117                                   | )          | (25 | ) | (1,142 | ) |
| Inventories at customers under purchase orders                               |       | 347                                      |       | (2,937 | ) | (2,590 | ) |
| Prepaid expenses and other current assets                                    |       | 664                                      |       | (89 | ) | 575 |   |
| Accounts payable                                                             |       | 3,581                                    |       | (125 | ) | 3,456 |   |
| Accrued compensation                                                         |       | 1,257                                    |       | 55 |   | 1,312 |   |
| Other accrued liabilities                                                    |       | 73                                       |       | (73 | ) | — |   |
| Customer deposits and deferred revenues                                      |       | (72                                      | )          | 5,148 |   | 5,076 |   |
| Net cash used in operating activities                                        |       | (8,462                                   | )          | — |   | (8,462 | ) |
|                                                                         |       |                                     |       |   |   |   |   |
| Cash flows from  investing activities:                                       |       |                                     |       |   |   |   |   |
| Proceeds from maturities of marketable debt  securities                      |       | 45,389                                   |       | — |   | 45,389 |   |
| Purchases of marketable debt securities                                      |       | (32,119                                  | )          | — |   | (32,119 | ) |
| Purchases of property and equipment                                          |       | (843                                     | )          | — |   | (843 | ) |
| Investments in other assets                                                  |       | (186                                     | )          | — |   | (186 | ) |
| Proceeds from disposition of property and equipment                          |       | 4                                        |       | — |   | 4 |   |
| Cash paid for acquistions                                                    |       | (28                                      | )          | — |   | (28 | ) |
| Net cash provided by investing activities                                    |       | 12,217                                   |       | — |   | 12,217 |   |
|                                                                         |       |                                     |       |   |   |   |   |
| Cash flows from  financing activities:                                       |       |                                     |       |   |   |   |   |
| Net proceeds from issuances of common stock                                  |       | 1,161                                    |       | — |   | 1,161 |   |
| Redemption of common stock                                                   |       | (120                                     | )          | — |   | (120 | ) |
| Net cash provided by financing activities                                    |       | 1,041                                    |       | — |   | 1,041 |   |
|                                                                         |       |                                     |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                       |       | (1                                       | )          | — |   | (1 | ) |
| Net increase in  cash and cash equivalents                                   |       | 4,795                                    |       | — |   | 4,795 |   |
| Cash and cash  equivalents at beginning of year                              |       | 5,518                                    |       | — |   | 5,518 |   |
| Cash and cash  equivalents at end of year                                    |       | $                                        | 10,313     |   | $ | — |   | $ | 10,313 |   |

 

13

----

 
| ** **                                                                     | ** ** | **Six Months Ended June 30,  2004** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                     | ** ** | **As**                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                     | ** ** | **Previously**                           | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                     | ** ** | **Reported**                             | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                         |       |                                     |       |   |   |   |   |
| Net income                                                                     |       | $                                        | 3,619      |   | $ | (486 | ) | $ | 3,133 |   |
| Adjustments to reconcile net income to net cash used  in operating activities: |       |                                     |       |   |   |   |   |
| Depreciation and amortization                                                  |       | 1,019                                    |       | — |   | 1,019 |   |
| Provision for doubtful accounts                                                |       | 79                                       |       | — |   | 79 |   |
| Stock based compensation                                                       |       | 27                                       |       | — |   | 27 |   |
| Changes in operating assets and liabilities, net of  effect of acquisitions:   |       |                                     |       |   |   |   |   |
| Accounts receivable                                                            |       | (11,185                                  | )          | 2,311 |   | (8,874 | ) |
| Inventories                                                                    |       | (7,048                                   | )          | — |   | (7,048 | ) |
| Inventories at customers under purchase orders                                 |       | (2,779                                   | )          | (900 | ) | (3,679 | ) |
| Prepaid expenses and other current assets                                      |       | (402                                     | )          | — |   | (402 | ) |
| Accounts payable                                                               |       | 2,220                                    |       | (100 | ) | 2,120 |   |
| Accrued compensation                                                           |       | 696                                      |       | — |   | 696 |   |
| Other accrued liabilities                                                      |       | 9                                        |       | — |   | 9 |   |
| Customer deposits and deferred revenues                                        |       | 3,027                                    |       | (825 | ) | 2,202 |   |
| Net cash used in operating activities                                          |       | (10,718                                  | )          | — |   | (10,718 | ) |
|                                                                           |       |                                     |       |   |   |   |   |
| Cash flows from  investing activities:                                         |       |                                     |       |   |   |   |   |
| Proceeds from maturities of marketable debt  securities                        |       | 94,356                                   |       | — |   | 94,356 |   |
| Purchases of marketable debt securities                                        |       | (91,499                                  | )          | — |   | (91,499 | ) |
| Purchases of property and equipment                                            |       | (2,455                                   | )          | — |   | (2,455 | ) |
| Investments in other assets                                                    |       | (77                                      | )          | — |   | (77 | ) |
| Cash paid for acquisitions                                                     |       | (17                                      | )          | — |   | (17 | ) |
| Net cash provided by investing activities                                      |       | 308                                      |       | — |   | 308 |   |
|                                                                           |       |                                     |       |   |   |   |   |
| Cash flows from  financing activities:                                         |       |                                     |       |   |   |   |   |
| Net proceeds from issuances of common stock                                    |       | 1,988                                    |       | — |   | 1,988 |   |
| Net cash provided by financing activities                                      |       | 1,988                                    |       | — |   | 1,988 |   |
|                                                                           |       |                                     |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                         |       | (13                                      | )          | — |   | (13 | ) |
| Net decrease in  cash and cash equivalents                                     |       | (8,435                                   | )          | — |   | (8,435 | ) |
| Cash and cash  equivalents at beginning of year                                |       | 10,027                                   |       | — |   | 10,027 |   |
| Cash and cash  equivalents at end of year                                      |       | $                                        | 1,592      |   | $ | — |   | $ | 1,592 |   |

 

 

14

----

 

**Note 3 – BusinessCombinations**

 

On January 21,2005, the Company entered into an Agreement and Plan of Merger andReorganization (the “Nanometrics Merger Agreement”) with Nanometrics,Incorporated (“Nanometrics”), Major League Merger Corporation and Minor LeagueMerger Corporation.    Under the terms ofthe Nanometrics Merger Agreement each share of the Company’s common stock wasto be converted into the right to receive 0.6401 of a share of August Nanometricscommon stock.  On June 27, 2005, theCompany and Nanometricsterminated the Nanometrics Merger Agreement. In accordance with the terms of the Nanometrics Merger Agreement, theCompany paid Nanometrics a termination fee of $8,300, and reimbursed $2,600 ofmerger related expenses.

 

On June 27, 2005, the Company enteredinto an Agreement and Plan of Merger (the “Rudolph Merger Agreement”) withRudolph Technologies, Inc. (“Rudolph”) and NS Merger Sub, Inc.  Underthe terms of the Rudolph Merger Agreement each of the Company’s shareholderswill have the option to elect to receive either $10.50 per share in cash or 0.7625of a share of Rudolph common stock, subject to proration and allocation, basedon the total cash and shares available in the merger. The agreement requiresthat the total consideration for the transaction will include a minimum of $37,200and a maximum of $60,000 of cash subject to shareholder election.  The aggregate consideration was approximately$193,000 as of June 27, 2005.

 

**Note 4– Stock-Based Compensation**

 

TheCompany applies Accounting Principles Board Opinion (“APB”) No. 25, *“Accounting for Stock Issued to Employees,”* and relatedinterpretations in accounting for stock-based compensation.  The exercise price of the Company’s stockoptions equals the market price of the underlying stock on the date of grantfor all options granted, and thus, under APB 25, no compensation expense isrecognized in the consolidated statements of operations.

 

Theestimated per share weighted average fair value of all stock options grantedduring the three months ended June 30, 2005 and 2004 was $7.15 and $9.53, respectively, and forthe six months ended June 30, 2005 and 2004 was $6.78 and $9.91,respectively.  The fair value of eachoption grant was estimated using the Black-Scholes option pricing model withthe following weighted average assumptions:

 
| ** **               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                     |       |                                 |       |                               |       |   |   |   |   |
| Expected life            |       | 4.9 years                            |       | 5.5 years                          |       | 4.7 years |   | 4.3 years |   |
| Risk free  interest rate |       | 3.9                                  | %          | 3.6                                | %          | 3.8 | % | 2.8 | % |
| Volatility               |       | 72.5                                 | %          | 73.7                               | %          | 73.3 | % | 74.1 | % |
| Dividend yield           |       | —                               |       | —                             |       | — |   | — |   |

 

Hadthe Company recorded compensation cost based on the estimated fair value on thedate of grant, as defined by Statement of Financial Accounting Standards (“SFAS”)123, *“Accounting for Stock-Based Compensation,”*the Company’s pro forma net income (loss) would have been as follows:

 

15

----

 
| ** **                                                                                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                         | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                         | ** ** | **(Restated)**                       | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss), as reported                                                                    |       | $                                    | (12,471    | )                                  | 1,283      |   | (15,258 | ) | 3,133 |   |
|                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Add:                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Stock-based employee compensation expense included  in net income (loss), as reported              |       | 30                                   |       | —                             |       | 30 |   | — |   |
| Deduct:                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Stock-based employee compensation expense determined  under fair value based method for all awards |       | (541                                 | )          | (521                               | )          | (1,342 | ) | (1,674 | ) |
| Net income  (loss), pro forma                                                                      |       | $                                    | (12,982    | )                                  | $          | 762 |   | $ | (16,570 | ) | $ | 1,459 |   |
|                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss) per share:                                                                      |       |                                 |       |                               |       |   |   |   |   |
| As reported:                                                                                       |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                              |       | $                                    | (0.69      | )                                  | 0.07       |   | (0.85 | ) | 0.18 |   |
| Diluted                                                                                            |       | $                                    | (0.69      | )                                  | 0.07       |   | (0.85 | ) | 0.17 |   |
|                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Pro forma:                                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                              |       | $                                    | (0.72      | )                                  | 0.04       |   | (0.92 | ) | 0.08 |   |
| Diluted                                                                                            |       | $                                    | (0.72      | )                                  | 0.04       |   | (0.92 | ) | 0.08 |   |
|                                                                                                    |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

On March 30, 2005, the board of directorsauthorized the Company to enter into an agreement to grant 175,000 nonqualifiedstock options to the Company’s President and Chief Operating Officer uponacceptance of the position.  The grant is not part of the Company’s 1997Stock Incentive Plan, and was not approved by the Company’s shareholders. The options were granted at fair market value on the date of grant, and vestratably over five years from the date of grant. In the event of a change in control, the board of directors may providefor the acceleration of vesting of the options.

 

**Note 5– Marketable Debt Securities**

 

The amortized cost andestimated fair value of available-for-sale marketable debt securities were asfollows:

 
| ** **      | ** ** | **June 30, 2005** | ** ** |
|-----------------|------------|------------------------|------------|
| ** **      | ** ** | ** **             | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **      | ** ** | **Amortized**          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **      | ** ** | **Cost**               | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Corporate bonds |       | $                      | 10,454     |   | $ | 5 |   | $ | (57 | ) | $ | 10,402 |   |
| Municipal bonds |       | 21,287                 |       | 1 |   | (73 | ) | 21,215 |   |
|            |       | $                      | 31,741     |   | $ | 6 |   | $ | (130 | ) | $ | 31,617 |   |

 
| ** **      | ** ** | **December 31, 2004** | ** ** |
|-----------------|------------|----------------------------|------------|
| ** **      | ** ** | ** **                 | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **      | ** ** | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **      | ** ** | **Cost**                   | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Corporate bonds |       | $                          | 12,611     |   | $ | 1 |   | $ | (55 | ) | $ | 12,557 |   |
| Municipal bonds |       | 32,400                     |       | 3 |   | (56 | ) | 32,347 |   |
|            |       | $                          | 45,011     |   | $ | 4 |   | $ | (111 | ) | $ | 44,904 |   |

 

16

----

 

The maturities ofavailable-for-sale marketable debt securities were as follows:

 
| ** **                              | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | **Amortized**          | ** ** | **Fair**                   | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                              | ** ** | **Cost**               | ** ** | **Value**                  | ** ** | **Cost** | ** ** | **Value** | ** ** |
| Due within one  year                    |       | $                      | 22,652     |                       | $          | 22,583 |   | $ | 28,662 |   | $ | 28,615 |   |
| Due after one  year through three years |       | 7,789                  |       | 7,742                      |       | 13,349 |   | 13,289 |   |
| Due after three  years                  |       | 1,300                  |       | 1,292                      |       | 3,000 |   | 3,000 |   |
|                                    |       | $                      | 31,741     |                       | $          | 31,617 |   | $ | 45,011 |   | $ | 44,904 |   |

 

Net realized gains andlosses were not material for the six months ended June 30, 2005 and 2004.

 

**Note 6 –Accounts Receivable**

 

Accounts receivableconsisted of the following:

 
| ** **                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **                       | ** ** | **(Restated)**    | ** ** | **(Restated)**        | ** ** |
|                             |       |              |       |                  |       |
| Billed  receivables              |       | $                 | 9,264      |                  | $          | 7,994 |   |
| Unbilled revenue                 |       | 1,815             |       | 1,024                 |       |
|                             |       | 11,079            |       | 9,018                 |       |
| Allowance for  doubtful accounts |       | (690              | )          | (690                  | )          |
| Accounts receivable, net         |       | $                 | 10,389     |                  | $          | 8,328 |   |

 

**Note 7 –Inventories**

 

Inventories consisted ofthe following:

 
| ** **               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **               | ** ** | ** **        | ** ** | **(Restated)**        | ** ** |
|                     |       |              |       |                  |       |
| Raw materials            |       | $                 | 10,220     |                  | $          | 8,449 |   |
| Work in process          |       | 4,065             |       | 3,558                 |       |
| Demonstration  equipment |       | 4,312             |       | 4,152                 |       |
| Finished goods           |       | 2,796             |       | 3,947                 |       |
| Inventories              |       | $                 | 21,393     |                  | $          | 20,106 |   |

 

**Note 8 – Purchased Technology**

 

Purchased technology wasas follows:

 
| ** **                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| Purchased  technology           |       | $                 | 4,769      |                  | $          | 4,651 |   |
| Less:  accumulated amortization |       | (1,671            | )          | (948                  | )          |
| Purchased technology, net       |       | $                 | 3,098      |                  | $          | 3,703 |   |

 

Purchased technologyincreased $118 for the six months ended June 30, 2005 due to contingentconsideration paid for the DMSVision acquisition discussed in Note 9 below.  Amortization expense for the six months endedJune 30, 2005 and 2004 was $724 and $174, respectively.  Assuming no additionalchange in the gross carrying value of purchased technology, the estimatedamortization expense for the twelve months ending December 31, 2005 is $1,435and for each of the next four years is $1,208, $800, $378 and none.

 

17

----

 

In December 2004,the Company purchased certain technology from Excelerate Technologies, Inc.(“Excelerate”).  The total considerationpaid was $800, which included the forgiveness of a $500 convertible notereceivable from Excelerate and $300 of cash, of which $150 was paid in January 2005.

 

**Note 9 –Commitments and Contingencies**

 

***Warranties***

 

TheCompany provides warranty coverage for its systems for a period of one year,including parts and labor necessary to repair the systems during the warrantyperiod.  The estimated warranty cost isbased on the Company’s historical experience rate of incurred expenses tocorresponding system revenues.

 

Thefollowing table summarizes the activity related to the warranty liabilityduring the six months ended June 30, 2005 and 2004:

 
| ** **                    | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------|------------|------------------------------------|------------|
| ** **                    | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Accrual at  beginning of year |       | $                                  | 942        |   | $ | 239 |   |
| Warranties issued             |       | 395                                |       | 415 |   |
| Costs incurred                |       | (188                               | )          | (271 | ) |
| Accrual at end  of period     |       | $                                  | 1,149      |   | $ | 383 |   |

 

***Separation Agreements***

 

In thesecond quarter of 2005, the Company entered into separation agreements withcertain executives and other employees that resulted in an expense of $920, ofwhich $29 was paid as of June 30, 2005. The separation agreements require substantially all of the severance benefits to be paid by June 30,2006.

 

***Contingent Consideration***

 

Inconnection with the July 27, 2004 acquisition of the DMSVision software division of Inspex, Inc (“DMSVision”),the Company is subject to a contingent consideration arrangement at June 30,2005.  This arrangement is based upon neworders for DMSVision software licenses received in the twelve months after theacquisition.  The payment of thecontingency results in an increase in the allocation of purchase price to purchasedtechnology.  As a result, amortizationexpense related to this asset increases. Amounts paid under this arrangement are not expected to have a materialeffect on the Company’s consolidated financial condition or results ofoperations.  The total contingentconsideration the Company expects to pay related to the twelve months after theacquisition is $142, of which $24 and $118 was added to purchased technology in2004 and 2005, respectively.  As of June 30,2005, $90 remained unpaid.

 

***Legal Proceedings***

 

From time totime in the ordinary course of business, the Company is subject to claims,asserted or unasserted, or named as a party to lawsuits or investigations.  Litigation, in general, and intellectualproperty and securities litigation in particular, can be expensive anddisruptive to normal business operations. Moreover, the results of legal proceedings cannot be predicted with anycertainty and in the case of more complex legal proceedings such asintellectual property and securities litigation, the results are difficult topredict at all.

 

The Company and each of its board of directors,Jeff O’Dell, James Bernards, Roger Gower, Michael Wright and Linda HallWhitman, were named as defendants in two separate lawsuits that purported to beclass

 

18

----

 

action claims on behalf of the Company’s shareholders.  The Company received a summons and complaintwith respect to the first of these proceedings on February 4, 2005 and thesecond on February 14, 2005.  Bothlawsuits were brought in Minnesota State Court and claimed that the directorshad breached their fiduciary duties to the Company’s shareholders in connectionwith their actions in agreeing to the proposed merger with NanometricsIncorporated.  The plaintiffs in bothactions sought various forms of injunctive relief including an order enjoining theCompany and its board of directors from consummating the merger withNanometrics.

 

The two proceedings were consolidated andheard as one case.  On April 19,2005, the Court issued a 30 day stay of all proceedings.  On April 27, 2005, the plaintiffsscheduled a hearing on a motion to amend the complaint.  The hearing was scheduled for June 9,2005.  On May 10, 2005 the Courtissued an order dismissing the complaint for asserting derivative claimswithout complying with the rules governing derivative actions.  Thereafter the Court removed the hearing fromthe calendar.

 

On July 18,2005, a purported shareholder class action lawsuit asserting derivative claims wasfiled in Minnesota state court against the Company and the individual membersof the board named above as well as Lynn J. Davis, who joined the board on March 30,2005 (the “Board”).  The lawsuit claimsthe directors have breached their fiduciary duties to the Company’sshareholders in connection with their actions in approving the merger agreementwith Nanometrics, Inc. and subsequently terminating that merger agreementand entering into a new merger agreement with Rudolph Technologies, Inc.  The plaintiff seeks various forms ofinjunctive relief including an order enjoining the Company and the Board fromconsummating the proposed merger with Rudolph.

 

The plaintiffin the lawsuit filed on July 18, 2005 is Robert Etem, the owner of 4,200shares of the Company’s common stock.  Mr. Etemwas also a plaintiff in the lawsuit described above filed on February 14,2005.

 

On July 14, 2005, the Company filed apatent infringement lawsuit against Camtek, Ltd. of Migdal Haemek, Israel.  The patent infringement lawsuit, filed inU.S. federal court in Minneapolis, alleges that Camtek’s line of inspectionequipment sold under the “Falcon” trademark infringes on the Company’s U.S.patent no. 6,826,298.

 

19

----

 

**Note 10 –Net Income (Loss) Per Share**

 

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

 
| ** **                                    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **(Restated)**                       | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                                          |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss)                            |       | $                                    | (12,471    | )                                  | $          | 1,283 |   | $ | (15,258 | ) | $ | 3,133 |   |
|                                          |       |                                 |       |                               |       |   |   |   |   |
| Weighted average  common shares:              |       |                                 |       |                               |       |   |   |   |   |
| Basic                                         |       | 18,005                               |       | 17,778                             |       | 17,936 |   | 17,700 |   |
| Effect of dilutive stock options and warrants |       | —                               |       | 571                                |       | — |   | 721 |   |
| Diluted                                       |       | 18,005                               |       | 18,349                             |       | 17,936 |   | 18,421 |   |
|                                          |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss) per share:                 |       |                                 |       |                               |       |   |   |   |   |
| Basic                                         |       | $                                    | (0.69      | )                                  | $          | 0.07 |   | $ | (0.85 | ) | $ | 0.18 |   |
| Diluted                                       |       | $                                    | (0.69      | )                                  | $          | 0.07 |   | $ | (0.85 | ) | $ | 0.17 |   |
|                                               |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

The total weightedaverage number of stock options and warrants excluded from the calculation ofpotentially dilutive securities either due to the exercise price exceeding theaverage market price or the inclusion of such securities in a calculation ofnet income (loss) per share would have been anti-dilutive for the three monthsended June 30, 2005 and 2004 were 2,106 and 330, respectively, and for thesix months ended June 30, 2005 and 2004 were 2,053 and 218, respectively.

 

**Note 11 – Accumulated OtherComprehensive Loss**

 

Theaccumulated balances for each classification of accumulated other comprehensiveloss are as follows:

 
| ** **                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2005**          | ** ** | **2004**              | ** ** |
|                                                 |       |              |       |                  |       |
| Currency  translation adjustments                    |       | $                 | 28         |                  | $          | 1 |   |
| Net unrealized  losses on marketable debt securities |       | (124              | )          | (107                  | )          |
| Accumulated other comprehensive loss                 |       | $                 | (96        | )                     | $          | (106 | ) |

 

20

----

 

 

**Note 12– Shareholders’ Equity**

 

Changes in shareholders’equity during the six months ended June 30, 2005 were as follows:

 
| Shareholders’ equity balance at December 31,  2004 (Restated) |   | $       | 79,069 |   |
|-------------------------------------------------------------------------|--------|---------|--------|--------|
| Net loss (Restated)                                                     |   | (15,258 | )      |
| Accumulated other comprehensive loss:                                   |   |    |   |
| Foreign currency translation adjustment                                 |   | 27      |   |
| Net unrealized loss on marketable debt securities                       |   | (17     | )      |
| Comprehensive loss (Restated)                                           |   | (15,248 | )      |
| Issuances of common stock in conjunction with:                          |   |    |   |
| Exercises of employee stock options                                     |   | 1,038   |   |
| Employee stock purchase plan                                            |   | 123     |   |
| Redemption of common stock                                              |   | (120    | )      |
| Tax benefit from stock options exercised (Restated)                     |   | 13      |   |
| Stock-based compensation                                                |   | 30      |   |
| Shareholders’ equity balance at June 30, 2005  (Restated)     |   | $       | 64,905 |   |

 

In May 2005,the Company purchased 11,614 common shares from an executive officer for $120,which represented 90% of the market value on the date of purchase.  There are currently no plans to repurchaseadditional shares.

 

***Shareholder Rights Plan***

 

On June 27, 2005, the Boardadopted a Shareholder Rights Plan to protect shareholders from coercive orotherwise unfair takeover tactics and to protect the interests of the Company’sshareholders.  Pursuant to the RightsAgreement relating to the Shareholder Rights Plan, the Board has declared adividend of one preferred share purchase right (a “Right”) for each share ofcommon stock outstanding at the close of business on June 27, 2005.  In general terms, the Rights Agreement worksby imposing a significant penalty upon any person or group that acquires 10% ormore of the Company’s outstanding common stock without the approval of theBoard.  The Company does not believe theRights Agreement will interfere with any merger or other business combinationapproved by the Board.

 

Each Rightwill allow its holder to purchase from the Company one one-thousandth of ashare of Series A Junior Participating Preferred Stock for $27.00 once theRights become exercisable.  The Rightswill not be exercisable until fifteen days after the public announcement that aperson or group has become an “Acquiring Person” by obtaining beneficialownership of 10% or more of the Company’s outstanding common stock, or, ifearlier, fifteen business days after a person or group begins a tender orexchange offer which, if completed, would result in that person or groupbecoming an Acquiring Person.  If aperson or group becomes an Acquiring Person, all holders of Rights except theAcquiring Person, may, for $27.00 purchase shares of the Company’s common stockwith a market value of $54.00, based on the market price of the common stockprior to such acquisition.  In addition,if the Company is later acquired in a merger or similar transaction after theRights have become exercisable and a person or group is, or becomes, anAcquiring Person, all holders of Rights except the Acquiring Person may, for$27.00, purchase shares of the acquiring corporation with a market value of $54.00based on the market price of the acquiring corporation’s stock, prior to suchmerger.  The Board may redeem the Rightsfor $.0005 per Right at any time before any person or group becomes anAcquiring Person.

 

21

----

 

**Note 13– Significant Customer, Product Line and Geographic Information**

 

The percentageof net revenues derived from major customers was as follows:

 
| ** **    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **    | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **    | ** ** | **(Restated)**                       | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net revenues: |       |                                 |       |                               |       |   |   |   |   |
| Customer A    |       | 18                                   | %          | 12                                 | %          | 10 | % | 10 | % |
| Customer B    |       |                                 | *          | 20                                 | %          |   | * | 11 | % |
| Customer C    |       |                                 | *          | 14                                 | %          |   | * |   | * |
| Customer D    |       |                                 | *          | 11                                 | %          |   | * |   | * |
| Customer E    |       |                                 | *          | 11                                 | %          |   | * |   | * |
|          |       | 18                                   | %          | 68                                 | %          | 10 | % | 21 | % |

 

----

*                                         Customerrepresented less than 10% of net revenues during the period.

 

Thepercentage of net revenues by major product line was as follows:

 
| ** **          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **          | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **          | ** ** | **(Restated)**                       | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net revenues:       |       |                                 |       |                               |       |   |   |   |   |
| NSX Series          |       | 65                                   | %          | 62                                 | %          | 57 | % | 57 | % |
| All Surface Systems |       | 7                                    | %          | 6                                  | %          | 14 | % | 13 | % |
| 3Di Series          |       | 3                                    | %          | 8                                  | %          | 6 | % | 9 | % |
| Other               |       | 25                                   | %          | 24                                 | %          | 23 | % | 21 | % |
|                |       | 100                                  | %          | 100                                | %          | 100 | % | 100 | % |

 

All ofthe Company’s tangible long-lived assets are located in the United States,except for an insignificant amount of property and equipment in Taiwan andSouth Korea.  The Company derivesrevenues from shipments to customers outside of the United States.  The percentage of net revenues by thegeographic region in which the customer is located was as follows:

 
| ** **    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **    | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **    | ** ** | **(Restated)**                       | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net revenues: |       |                                 |       |                               |       |   |   |   |   |
| United States |       | 13                                   | %          | 32                                 | %          | 17 | % | 30 | % |
| Taiwan        |       | 45                                   | %          | 50                                 | %          | 48 | % | 36 | % |
| South Korea   |       | 4                                    | %          | 1                                  | %          | 6 | % | 12 | % |
| Europe        |       | 27                                   | %          | 0                                  | %          | 22 | % | 2 | % |
| Japan         |       | 2                                    | %          | 3                                  | %          | 2 | % | 5 | % |
| Rest of Asia  |       | 9                                    | %          | 14                                 | %          | 5 | % | 15 | % |
|          |       | 100                                  | %          | 100                                | %          | 100 | % | 100 | % |

 

22

----

 

**Note 14– Recent Accounting Pronouncements **

 

In June 2005,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 154, “*AccountingChanges and Error Corrections—a replacement of APB No. 20 and FAS No. 3.*”  SFAS 154 provides guidance on the accountingfor and reporting of accounting changes and error corrections.  It establishes, unless impracticable,retrospective application as the required method for reporting a change inaccounting principle in the absence of explicit transition requirementsspecific to the newly adopted accounting principle.  SFAS 154 also provides guidance fordetermining whether retrospective application of a change in accountingprinciple is impracticable and for reporting a change when retrospectiveapplication is impracticable.  Thecorrection of an error in previously issued financial statements is not anaccounting change.  However, thereporting of an error correction involves adjustments to previously issuedfinancial statements similar to those generally applicable to reporting anaccounting change retrospectively.  Therefore,the reporting of a correction of an error by restating previously issuedfinancial statements is also addressed by SFAS 154.  SFAS 154 is required to be adopted in fiscalyears beginning after December 15, 2005.  Adoption of SFAS No. 154 is not expectedto have a material effect on the Company’s financial position, results ofoperations or cash flows.

 

In March 2005,the FASB issued FASB Interpretation No. 47, “*Accountingfor Conditional Asset Retirement Obligations*,” which is aninterpretation of SFAS No. 143, “*Accounting for AssetRetirement Obligations*.”  The interpretation requires aliability for the fair value of a conditional asset retirement obligation berecognized if the fair value of the liability can be reasonably estimated.  The interpretation is effective no later thanthe end of fiscal years ending after December 15, 2005.  The interpretation is not expected to have amaterial impact on the Company’s financial position, results of operations orcash flows.

 

In December 2004, the FASB issued SFAS No. 123(Revised 2004), “*Share-Based Payment.”*  SFAS No. 123R is a revision of SFAS No. 123,*“Accounting for Stock-Based Compensation”*and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “*Accounting for Stock Issued to Employees*” and its relatedimplementation guidance.  SFAS No. 123Rfocuses primarily on accounting for transactions in which an entity obtainsemployee services through share-based payment transactions.  SFAS No. 123R requires a public entityto measure the cost of employee services received in exchange for the award ofequity instruments based on the fair value of the award at the date of grant.  The cost will be recognized over the periodduring which an employee is required to provide services in exchange for theaward.  The SEC issued guidance in April 2005announcing that public companies will be required to adopt SFAS No. 123Rby their first fiscal year beginning after June 15, 2005.  While the Company cannot precisely determinethe impact on net earnings as a result of the adoption of SFAS No. 123R,estimated compensation expense related to prior periods can be found in Note 4,“Stock-Based Compensation.”  The ultimateamount of increased compensation expense will be dependent on whether theCompany adopts SFAS No. 123R using the modified prospective orretrospective method, the number of option shares granted during the year,their timing and vesting period, and the method used to calculate the fairvalue of the awards, among other factors the Company is currently assessing.

 

In November 2004, the FASB issued SFAS No. 151,“*Inventory Costs - an amendment of ARB No. 43,Chapter 4*.”  SFAS No. 151 clarifies the accountingfor abnormal amounts of idle facility expenses, freight, handling costs, andspoilage.  It also requires thatallocation of fixed production overheads to inventory be based on the normalcapacity of production facilities.  SFAS No. 151is effective for inventory costs incurred during fiscal years beginning after June 15,2005.  Adoption of SFAS No. 151 isnot expected to have a material effect on the Company’s financial position,results of operations or cash flows.

 

23

----

 

**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

**Cautionary Factors That May Affect FutureResults**

 

Certainstatements made in this Form 10-Q/A, as well as oral statements made by usfrom time to time, which are prefaced with words such as “expects,” “anticipates,”“believes,” “projects,” “intends,” “plans” and similar words and otherstatements of similar sense, are forward-looking statements.  Our forward-looking statements generallyrelate to our growth strategies, financial results, future financialprojections, product development activities and sales efforts.  Our actualresults could differ materially from those projected in the forward-lookingstatements as a result of a number of factors, including but not limited tomarket acceptance of our products, our ability to successfully develop newproducts, our ability to protect our intellectual property, our dependence uponinternational customers and suppliers, our dependence on a small number ofcustomers that account for a significant portion of revenues, availability ofproducts from our suppliers, cyclicality in the microelectronic manufacturingequipment and other industries, management of growth, integration of acquiredbusinesses, and the other risk factors detailed below and in our Amendment No. 1on Form 10-K/A for the year ended December 31, 2004, which is beingfiled with the SEC concurrently with this Form 10-Q/A.  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 manyfactors are unforeseeable, the foregoing should not be considered an exhaustivelist.

 

**Introduction**

 

The following discussionof our results of operations and financial condition should be read togetherwith the other financial information and consolidated financial statements andrelated notes included in this Form 10-Q/A.  All applicable disclosures in the following discussion have beenmodified to reflect the Restatement, as described below.  This discussion contains forward-looking statementsthat involve risks and uncertainties. Our actual results could differmaterially from those anticipated in the forward-looking statements as a resultof a variety of factors.

 

**Restatement**

 

We have restated our consolidated financial statements for the years2004, 2003 and 2002 and for the first two quarters of 2005. Our restatedconsolidated financial statements also include disclosure of restated unauditedquarterly results for 2004 and 2003.  Theinitial determination to restate the 2004 and first half 2005 consolidatedfinancial statements was made as a result of a correction of the Company’sapplication of revenue recognition principles, as contained in the FinancialAccounting Standard Board’s Emerging Issues Task Force Issue No. 00-21, “*Revenue Arrangements with Multiple Deliverables*” (“EITF 00-21”).  As a result of subsequently reviewing ourrevenue recognition policies and procedures, we additionally noted thatbeginning in the fourth quarter of 2002 certain deferred software revenueshould have been fully recognized upon delivery or customer acceptance ratherthan ratably over a twelve-month period. This created the need to restate our2002 and 2003 consolidated financial statements.  Certain adjustments were recorded to eachquarter in 2004 and first two quarters of 2005 to correct other miscellaneousitems identified in prior external audits or quarterly reviews but werepreviously passed, none of which were individually significant.

 

In 2004 and the first half of 2005, the Company sold AXi 930 systems toa customer for an aggregate amount of approximately $12.2 million ($6.7 millionin 2004, $3.1 million in the first quarter of 2005 and $2.4 million in thesecond quarter of 2005) and recognized the revenue for these sales.  The cost of revenues related to these saleswas $2.7 million in 2004, $1.5 million in the first quarter of 2005 and $1.2million in the second quarter of 2005.  Forthe three and six months ended June 30, 2004, the Company originallyrecognized $2.2 million in revenue and $0.9 million in cost of revenue forthese AXi 930 sales.  During the sametime periods, the Company accepted orders from the same customer for

 

24

----

 

enhancementpackages to the AXi 930 system but had not yet delivered the enhancementpackages.  In connection with preparingto finalize its results for the quarter ended September 30, 2005, theCompany determined that recognition of the $12.2 million of revenue from theAXi 930 systems should have been deferred until the delivery of the enhancementpackages, according to EITF 00-21.  Thecustomer cancelled its orders for the enhancement packages on September 27,2005, which allowed the Company to recognize the entire $12.2 million of AXi930 deferred revenue in the quarter ended September 30, 2005.

 

In the fourth quarter of 2002, the Company began deferring Yield Pilotsoftware revenue and recognizing it over a twelve-month period whichrepresented the Company’s obligation to provide warranty and support.  The Company determined based on a subsequentreview of Statement of Position 97-2, “*Software Revenue Recognition*” that YieldPilot software revenues should have been recognized upon delivery or customeracceptance.  The correction of this errorhad no significant impact on revenues for the three months ended June 30,2005 and decreased revenue by $0.3 million for the three months ended March 31,2005.  The correction increased revenueby $0.4 million for each of the first two quarters in 2004 and had no impact oncost of revenues.  The correctionincreased revenue by $0.9 million, $0.5 million and $0.2 million for 2004, 2003and 2002, respectively and had no impact on costs of revenues.

 

In the second quarter of 2005, the Companyrecognized $0.6 million in revenue and $0.2 million in cost of revenue relatedto the sale of an NSX 105 inspection system. It was subsequently determined that this revenue should have beendeferred until the newly introduced software component of this bundledtransaction was completed and delivered. This error was corrected as part of the restatement of the secondquarter of 2005.  The Company expects to realize revenue on the completedtransaction in the fourth quarter of 2005 when all elements will be deliveredand accepted and fair value has been established for the newly introducedsoftware component.

 

The Audit Committee worked closely with the Company’s management toreview the Restatement and the Company’s policies and practices for therecognition of revenue.

 

The Restatement impacted the timing of revenue recognition as the AXi930 enhancement packages have been deferred into the third quarter of 2005 andthe Yield Pilot software revenue is recognized upon delivery or customeracceptance rather than ratably over a twelve-month period.  The impact of the Restatement on theconsolidated statements of operations for the three-month and six-month periodsended June 30, 2005 and 2004 is shown in Note 2 to our consolidatedfinancial statements included in this Form 10-Q/A.

 

The primary impact of the Restatement on the consolidated balance sheetat June 30, 2005 was to increase inventory at customers under purchaseorders related to the deferral of the cost of revenue and to increase customerdeposits and deferred revenues related to cash collected for revenue deferredin the Restatement.  The Restatement hadno impact on cash balances or net cash flows from operating, investing, orfinancing activities.  The impact of theRestatement on the consolidated balance sheet and consolidated statements ofcash flows is shown in Note 2 to our consolidated financial statements includedin this Form 10-Q/A.

 

**Critical Accounting Policies**

 

The preparation of our consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets, liabilities, revenues and expenses,and related disclosure of contingent assets and liabilities.  We basedthese estimates and assumptions on historical experience and evaluate them onan on-going basis to help ensure they remain reasonable under currentconditions.  Actual results could differ from those estimates. We discussthe development and selection of the critical accounting estimates with theaudit committee of our board of directors on a quarterly basis, and the auditcommittee has reviewed our critical accounting policies as described in Item 7,“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” in our Amendement No. 1 on Form 10-K/A for the year endedDecember 31, 2004.   For the six months ended June 30,2005, there were no changes to these critical accounting policies.

 

25

----

 

**Overview**

 

We are a world-class provider of automated defectdetection and product characterization systems for microelectronic devicemanufacturers.  Our systems providemanufacturers with information that enables process-enhancing decisions,ultimately lowering manufacturing costs and decreasing time-to-market.  We have traditionally provided systems toaddress the automated inspection needs of the early stages of the final manufacturingor back-end of the microelectronic device manufacturing process.  These needs were met primarily with our NSX Series and3Di Series of products.  We haveintroduced the AXi Series and the E20 for edge and B20 for backsideinspection systems (collectively, the “All Surface Inspection System”) foradvanced macro defect detection primarily in the front-end of the wafermanufacturing process.  When used inconjunction with one another these systems allow a manufacturer to inspect thetop, edge and back of a wafer’s surface. We believe we are the first to offer all surface wafer inspection.  We continued to support front-end systemdemonstrations at many large semiconductor manufacturers during thequarter.  These demonstrations allowthese customers to evaluate the benefits these systems provide.  We expect these demonstrations will lead toincreased revenues six to nine months after shipment.

 

We complementthis broad inspection capability with an expanding suite of software toolsdesigned to enhance the speed and effectiveness of the process by which devicemanufacturers analyze defects, and make decisions regarding their manufacturingprocess to reduce or eliminate such defects. We refer to this process as the “detection-to-decision” process.

 

Ourbusiness has been, and will continue to be, subject to the highly cyclicalnature of the microelectronic device manufacturing markets we serve.  These cycles are caused by significant, andoften rapid, fluctuations in the supply and demand of microelectronic devicesdriven by such factors as changes in technology and global economic conditions.  As a result of these fluctuations, and due tothe fact that our quarterly revenues are comprised of systems with sellingprices of between $150,000 and $1,000,000, a small change in the number ofsystems we sell may also cause significant changes in our operatingresults.  Because fluctuations in thetiming of orders from our major customers or in the number of individualsystems we sell could cause our revenues to fluctuate significantly in anygiven quarter or year, we do not believe that period-to-period comparisons ofour financial results are necessarily meaningful, and they should not be reliedupon as an indication of our future performance.  Additionally, the rate and timing of customerorders may vary significantly from month to month.  Accordingly, if sales of our products do notoccur when we expect, and we are unable to adjust our estimates on a timelybasis, our expenses and inventory levels may increase relative to revenues andtotal assets.

 

We have sold our systems to many of the leadingmicroelectronic device manufacturers throughout the world.  Historically, a significant portion of ourrevenues in each quarter and year has been derived from sales to relatively fewcustomers, and we expect this trend to continue.   In the six months endedJune 30, 2005 and 2004 sales to customers that individually represented atleast ten percent of our revenues accounted for 10% and 21% of our netrevenues, respectively.

 

Management focuses on several key financial metricsin evaluating our financial condition and operating performance.  Although we do not believe backlog is alwaysan accurate indication of future revenues and performance, since only a portionof our revenues for any quarter include systems that were in backlog as of thebeginning of that quarter, we do closely monitor the level of orders bothgeographically and by product line and in relation to the level of revenues,referred to as the book-to-bill ratio. During the second quarter of 2005, our book-to-bill ratio was above parity.  A book-to-bill ratio above parity indicates anincreasing level of backlog.  In additionto monitoring our level of orders and backlog, we focus on revenues by productfamily compared to prior-period and current-year plans, year-over-year revenuegrowth compared to the overall semiconductor

 

26

----

 

equipmentindustry, operating profit or loss performance compared with prior-period and current-yearplans and the level of operating cash flow.

 

**Merger Activities**

 

On January 21,2005, we entered into an Agreement and Plan of Merger and Reorganization (the “NanometricsMerger Agreement”) with Nanometrics, Incorporated (“Nanometrics”), Major LeagueMerger Corporation and Minor League Merger Corporation.    Under the terms of the Nanometrics MergerAgreement each share of our common stock was to be converted into the right toreceive 0.6401 of a share of August Nanometrics common stock.  On June 27, 2005, we and Nanometricsterminated the Nanometrics Merger Agreement. In accordance with the terms of the Nanometrics Merger Agreement, wepaid Nanometrics a termination fee of $8,300, and reimbursed $2,600 of mergerrelated expenses.

 

On June 27,2005, we entered into an Agreement and Plan of Merger (the “Rudolph MergerAgreement”) with Rudolph Technologies, Inc. (“Rudolph”) and NS Merger Sub, Inc.  Under the terms of the Rudolph MergerAgreement each of our shareholders will have the option to elect to receiveeither $10.50 per share in cash or 0.7625 of a share of Rudolph common stock,subject to proration and allocation, based on the total cash and sharesavailable in the merger.  The agreementrequires that the total consideration for the transaction will include aminimum of $37,200 and a maximum of $60,000 of cash subject to shareholderelection.  The aggregate considerationwas approximately $193,000 as of June 27, 2005.

 

On February 9,2005, we received a letter from Kenneth Schroeder, President and ChiefExecutive Officer of KLA-Tencor Corporation (“KLA”), regarding KLA’s interestin pursuing a merger with us.  The letterstated that KLA proposed to acquire us in a transaction in which ourshareholders would receive $11.50 per share. KLA also stated that it would be willing to consider using stock asconsideration.  Since the February 9letter, KLA has made various public statements and additional communications tous (including a press release issued on July 13, 2005) stating that KLAcontinues to be interested in acquiring August Technology.  As of the date of this filing, KLA has beenunwilling to execute a confidentiality agreement in a form acceptable to us andwe have had no discussions with KLA regarding their proposal.

 

**Results of Operations**

 
| ** **                                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                          | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                          | ** ** | **(Restated)**                       | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                                                |       |                                 |       |                               |       |   |   |   |   |
| Net revenues                                        |       | 100.0                                | %          | 100.0                              | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                    |       | 41.5                                 |       | 45.3                               |       | 43.3 |   | 43.6 |   |
| Gross profit                                        |       | 58.5                                 |       | 54.7                               |       | 56.7 |   | 56.4 |   |
|                                                |       |                                 |       |                               |       |   |   |   |   |
| Selling, general and administrative expenses        |       | 43.2                                 |       | 29.9                               |       | 42.7 |   | 30.3 |   |
| Research and development expenses                   |       | 19.8                                 |       | 18.4                               |       | 22.0 |   | 17.9 |   |
| Operating income (loss)                             |       | (4.5                                 | )          | 6.4                                |       | (8.0 | ) | 8.2 |   |
|                                                |       |                                 |       |                               |       |   |   |   |   |
| Merger expenses                                     |       | (71.6                                | )          | —                             |       | (41.6 | ) | — |   |
| Interest income                                     |       | 2.0                                  |       | 1.0                                |       | 2.0 |   | 1.1 |   |
| Net income (loss) before provision for income taxes |       | (74.1                                | )          | 7.4                                |       | (47.6 | ) | 9.3 |   |
| Provision for income taxes                          |       | 0.3                                  |       | 0.3                                |       | 0.3 |   | 0.3 |   |
| Net income (loss)                                   |       | (74.4                                | )%         | 7.1                                | %          | (47.9 | )% | 9.0 | % |

 

*Three and six months ended June 30, 2005 compared to the three andsix months ended June 30, 2004*

 

*Net Revenues.*  Net revenues decreased $1.3 million, or 7.1%,to $16.7 million for the three months ended June 30, 2005, from $18.0million for the same period in 2004.  Netrevenues decreased $3.1 million, or

 

27

----

 

8.8%,to $31.8 million for the six months ended June 30, 2005, from $34.9million for the same period in 2004.  Thedecrease in net revenues during the six months ended June 30, 2005 wasprimarily due to a decrease in sales to the NSX/3Di and AXi series system salespartially offset by the revenues from DMS Vision which was acquired in July 2004.  Revenues derived from systems sold forfront-end wafer fab applications accounted for 31.7% and 49.0% of total netrevenues in the first half of 2005 and the first half of 2004, respectively.  Revenues in the third quarter of 2005 areexpected to range from flat to an increase of 10%, as compared to the secondquarter of 2005.

 

Net revenues from international sales represented 87%and 68% of total net revenues for the three months ended June 30, 2005 and2004, respectively.  Internationalrevenues during these periods were primarily the result of sales to Asia, whichcomprised 60% and 68% of total net revenues for the three months ended June 30,2005 and 2004, respectively.  Sales toEurope for the three months ended June 30, 2005 represented the nexthighest concentration with 27% of net revenues, which is the highest three-monthrevenue ever from that continent.  Netrevenues from international sales represented 83% and 70% of total net revenuesfor the six months ended June 30, 2005 and 2004, respectively, and wereprimarily the result of sales to Asia, which comprised 61% and 68% of total netrevenues.

 

*Gross Profit.*  Gross profit as a percent of net revenues increasedto 58.5% for the three months ended June 30, 2005, from 54.7% for the sameperiod in 2004.  Gross profit aspercentage of net revenues increased to 56.7% for the six months ended June 30,2005, from 56.4% for the same period in 2004. Gross profit percentage increased primarily as a result of revenues fromDMSVision software sales and improved margins within the NSX Series, partiallyoffset by higher rework costs related to certain systems and the recording oflower of cost or market adjustments related to certain component parts thatbecame obsolete due to engineering design changes.  We expectto continue to experience pricing pressure primarily related to our inspectionsystems sold into final manufacturing applications as competitors havecontinued to enter this market.  Theimpact of these reductions in gross profit is expected to be offset by highermargin products sold into front end applications.  We expect future gross profit as a percentageof net revenues to be between 54% and 57%.

 

*Selling,General and Administrative Expenses.*  Selling, general and administrative (“SG&A”)expenses consist primarily of employee salaries and related benefits,depreciation and amortization, and travel expenses.  SG&A expenses were $7.2 million and $13.6million for the three and six months ended June 30, 2005, compared to $5.4million and $10.6 million for the same periods in 2004.  SG&A expenses as a percentage of netrevenues were 43.2% and 42.7% for the three and six months ended June 30,2005, compared to 29.9% and 30.3% ofnet revenues for the same periods in 2004. The increase in expense dollars was primarily the result of severance costs,amortization of purchased technology resulting from the DMSVision acquisition andtechnology purchased from Excelerate, and expenses associated with both increased personnel and support costsassociated with an increased number of demo systems.  We expect SG&A expense dollars to decreasein the third quarter of 2005, as compared to the second quarter of 2005, due toa reduction in severance expenses, partially offset by increased marketingcosts related to tradeshows.

 

*Research and Development Expenses.* Research and development (“R&D”) expenses consist primarily ofemployee salaries and related benefits for individuals engaged in the research,design and development of new products. R&D expenses were $3.3 million and $7.0 million for the three andsix months ended June 30, 2005, compared to $3.3 million and $6.2 millionfor the same periods in 2004. R&D expenses as a percentage of net revenues were 19.8% and 22.0% for the three and six monthsended June 30, 2005, compared to 18.4% and 17.9% for the same periods in2004.  The increase in expense dollars duringthe six months ended June 30, 2005 was primarily due to employee compensation and related benefits associatedwith the hiring of additional staff to complete certain stages of developmentof the all surface inspection systems. In addition, expenses increased due to the DMSVision acquisitioncompleted in July 2004.  Wecurrently anticipate that research anddevelopment expense dollars will increase in the third quarter of 2005 as wecontinue to expand our suite of software solutions.

 

28

----

 

*Interest Income.* Interest income was $0.3 million and $0.6 million for the three and six monthsended June 30, 2005, compared to $0.2 million and $0.4 million for thesame periods in 2004.  The increase ininterest income was primarily due to an increase in the rate of return on ourinvestment balances.

 

*Merger Expenses.*  Merger expenses were $12.0million and $13.2 million for the three and six months ended June 30, 2005,compared to none in 2004.  The mergerexpenses included a $10.9 million termination fee paid to Nanometrics forterminating the Nanometrics Merger Agreement, legal and investment banker feesincurred prior to terminating the proposed merger with Nanometrics, and legaland investment banker fees incurred in conjunction with the proposed mergerwith Rudolph Technologies, Inc.

 

***Income Taxes. ***We currently anticipate a pretax profit in 2005 for incometax purposes, as compared to a pretax loss under generally accepted accountingprinciples, due to the fact that the merger expenses are primarilynondeductible for income tax purposes.  Inaddition, as a result of historical operating losses and uncertainty as to theextent of profitability in future periods, we began to record a valuationallowance against our deferred tax assets in the second quarter of 2002 andcontinue to do so at June 30, 2005. Statement of Financial Accounting Standards (“SFAS”)No. 109 “*Accounting for Income Taxes*,” requires the establishment ofa valuation allowance to reflect the likelihood of the realization of deferredtax assets.  As of December 31, 2004,the valuation allowance was $9.3 million. The above factors have resulted in the recording of a provision forincome taxes for the three and six months ended June 30, 2005 and 2004,primarily to reflect foreign income taxes and federal alternative minimum taxesowed.

 

**Liquidity and CapitalResources**

 

At June 30,2005, our principal sources of liquidity consisted of cash, cash equivalentsand investments in marketable debt securities of $41.9 million, compared to $50.4million at December 31, 2004, a decrease of $8.5 million.  Thedecrease was primarily due to $12.3 million in cash paid for merger expensesand an increase in accounts receivable, partially offset by increases in accountspayable and accrued compensation.  Duringthe next twelve months, and beyond, we intend to utilize our current sources ofliquidity to fund operations, specifically to enhance our position in the front-endwafer fabrication process.  We have no outstanding debt at June 30, 2005. Our liquidity is affected by many factors, some of which are based onthe normal ongoing operations of our business, the most significant of whichincludes the timing of the collection of receivables, the level of inventories,capital expenditures and acquisitions.

 

*Accounts Receivable.*  Accountsreceivable increased $2.1 million from December 31, 2004 to June 30,2005.  Our days sales outstanding (“DSO”)during the three months ended June 30, 2005 was 54 days.  This compares to a DSO of 53 days in the firstquarter of 2005.  The increase in the DSOduring the second quarter is primarily due to the timing of revenues during thequarter.  The increase in accountsreceivable resulted in a use of cash during the six months ended June 30,2005, as we have funded shipments for increased revenues prior to receivingpayments from customers.  We believe ourDSO will be between 50 and 65 days in future quarters.

 

*Inventories.* Inventories increased $1.3 million fromDecember 31, 2004 to June 30, 2005. The increase is primarily due to an increase in raw material to support ananticipated increase in revenues during the second half of 2005 and new productintroductions.  This increase was partiallyoffset by a decrease in finished goods due to the transfer of certain systemsto property and equipment for internal use and sales to third parties.

 

*Inventoriesat Customers under Purchase Orders.*  Inventories at customersunder purchase orders increased from $6.7 million at December 31, 2004 to$9.3 million at June 30, 2005.  Weanticipate that a portion of this inventory will be recognized as revenueduring 2005.  We anticipate that thisinventory will increase as shipments of newly introduced products increase.

 

29

----

 

*Capital Expenditures.*  Ourcapital expenditures during the first six months of 2005 were $843,000,consisting primarily of the capitalization of finished goods that have beentransferred to engineering for test and characterization, and to sales forcustomer application studies.  Thisequipment is expected to be utilized for these purposes for its estimated life,generally three years.  Our total capitalexpenditures, including the capitalization of finished goods for internal use,are expected to be between $3.0 million and $4.0 million in 2005, as we continue to expand the use of internal test anddevelopment equipment and facilities to meet customer demand and better serveour customers.

 

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

 

*CashFlows*

 

Netcash used in operating activities for the six months ended June 30, 2005was $8.5 million, primarily due to $12.3 million in cash paid for mergerexpenses, an increase in accounts receivable, inventories, and inventories atcustomers under purchase orders, partially offset by increases in accountspayable, accrued compensation, and customer deposits and deferred revenues.  Excluding cash payments for merger expenses,cash generated from operating activities was $3.9 million for the six monthsended June 30, 2005.  Net cashprovided by investing activities was $12.2 million, primarily due to $13.3million of net proceeds from maturities of marketable debt securities,partially offset by $1.0 million of additions to property and equipment, andother assets.  Net cash provided by financingactivities was $1.0 million, primarily related to proceeds received fromexercises of stock options.  We currentlyexpect to generate cash from operating activities during the remainder of 2005.

 

Netcash used in operating activities for the six months ended June 30, 2004was $10.7 million, which resulted primarily from increased accounts receivableand inventories partially offset by our net income and increased accountspayable, accrued compensation and customer deposits.  Net cash provided by investing activities was$308,000, primarily due to $2.9 million of net proceeds from sales ofmarketable securities and partially offset by $2.5 million for purchases ofproperty and equipment.  Net cashprovided by financing activities was $2.0 million from the proceeds receivedfrom issuances of common stock.

 

**New Accounting Pronouncements**

 

In June 2005,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 154, “*AccountingChanges and Error Corrections—a replacement of APB No. 20 and FAS No. 3.*”  SFAS 154 provides guidance on the accountingfor and reporting of accounting changes and error corrections.  It establishes, unless impracticable,retrospective application as the required method for reporting a change inaccounting principle in the absence of explicit transition requirementsspecific to the newly adopted accounting principle. SFAS 154 also providesguidance for determining whether retrospective application of a change inaccounting principle is impracticable and for reporting a change whenretrospective application is impracticable. The correction of an error in previously issued financial statements isnot an accounting change.  However, thereporting of an error correction involves adjustments to previously issuedfinancial statements similar to those generally applicable to reporting anaccounting change retrospectively.  Therefore,the reporting of a correction of an error by restating previously issuedfinancial statements is also addressed by SFAS 154.  SFAS 154 is required to be adopted in fiscalyears beginning after

 

30

----

 

December 15, 2005.  Adoption of SFAS No. 154 is not expectedto have a material effect on our financial position, results of operations orcash flows.

 

In March 2005,the FASB issued FASB Interpretation No. 47, “*Accountingfor Conditional Asset Retirement Obligations*,” which is aninterpretation of SFAS No. 143, “*Accounting for AssetRetirement Obligations*.”  The interpretation requires aliability for the fair value of a conditional asset retirement obligation berecognized if the fair value of the liability can be reasonably estimated.  The interpretation is effective no later thanthe end of fiscal years ending after December 15, 2005.  The interpretation is not expected to have a materialimpact on our financial position, results of operations or cash flows.

 

In December 2004, the FASB issued SFAS No. 123(Revised 2004), “*Share-Based Payment.”*  SFAS No. 123R is a revision of SFAS No. 123,“*Accounting for Stock-Based Compensation*”and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “*Accounting for Stock Issued to Employees*” and its relatedimplementation guidance.  SFAS No. 123Rfocuses primarily on accounting for transactions in which an entity obtainsemployee services through share-based payment transactions.  SFAS No. 123R requires a public entity tomeasure the cost of employee services received in exchange for the award ofequity instruments based on the fair value of the award at the date of grant.  The cost will be recognized over the periodduring which an employee is required to provide services in exchange for theaward.  The SEC issued guidance in April 2005announcing that public companies will be required to adopt SFAS No. 123Rby their first fiscal year beginning after June 15, 2005.  While we cannot precisely determine the impacton net earnings as a result of the adoption of SFAS No. 123R, estimatedcompensation expense related to prior periods can be found in Note 4, “Stock-BasedCompensation.”  The ultimate amount ofincreased compensation expense will be dependent on whether we adopt SFAS No. 123Rusing the modified prospective or retrospective method, the number of optionshares granted during the year, their timing and vesting period, and the methodused to calculate the fair value of the awards, among other factors we arecurrently assessing.

 

In November 2004, the FASB issued SFAS No. 151,“*Inventory Costs - an amendment of ARB No. 43,Chapter 4*.”  SFAS No. 151 clarifies the accountingfor abnormal amounts of idle facility expenses, freight, handling costs, andspoilage.  It also requires thatallocation of fixed production overheads to inventory be based on the normalcapacity of production facilities.  SFAS No. 151is effective for inventory costs incurred during fiscal years beginning after June 15,2005.  Adoption of SFAS No. 151 isnot expected to have a material effect on our financial position, results ofoperations or cash flows.

 

31

----

 

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

 

*MarketRisk*

 

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

 

*InterestRate Risk*

 

We are exposed tointerest rate risk primarily from investments in cash equivalents andshort-term and long-term marketable debt securities (the “Investment Portfolio”).  The entire Investment Portfolio, classifiedas available-for-sale, is recorded on the balance sheet at fair market valuewith unrealized gains or losses excluded from earnings and included in “Accumulatedother comprehensive income (loss)” until realized.  The entire Investment Portfolio isdenominated in U.S. dollars.  We do notuse derivative financial instruments in the Investment Portfolio.  Due to the short duration of our InvestmentPortfolio, an immediate 10 percent change in interest rates is not expected tohave a material adverse effect on our near-term financial condition or resultsof operations.

 

*CreditRisk*

 

Financialinstruments which potentially subject us to credit risk consist principally ofsecurities in the Investment Portfolio and trade receivables.  We limit credit risk related to theInvestment Portfolio by placing all investments with high quality creditissuers and limit the amount of investments with any one issuer.  As of June 30, 2005, 71.4% of theInvestment Portfolio consisted of government securities and corporate bondswith maturities of one year or less.  Welimit credit risk associated with trade receivables by performing ongoingcredit evaluations and believe that there is no additional risk beyond amountsprovided for collection losses to be inherent in trade receivables.

 

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

 

**Overview**

 

As previously disclosed in a Current Report on Form 8-Kwhich we filed on September 29, 2005 and as described in our ExplanatoryNote to this Form 10-Q/A and Note 2 to our accompanying consolidatedfinancial statements, in connection with preparing to finalize our results forthe quarter ended September 30, 2005, we determined that certain revenuerecognized in 2004 and the first half of 2005 should have been deferred untillater periods.  As a result ofsubsequently reviewing our revenue recognition policies and procedures, weadditionally noted that beginning in the fourth quarter of 2002 certaindeferred software revenue should have been fully recognized upon delivery orcustomer acceptance rather than ratably over a twelve-month period.  We also have determined that an internalcontrol deficiency existed related to the knowledge and application of revenuerecognition methods in accordance with U.S. generally accepted accountingprinciples.  Based on the impact of theaforementioned accounting errors, we determined to restate our financialstatements as of December 31, 2004 and 2003 and for each of the years inthe three-year period ended December 31, 2004, as well as interimfinancial statements for the quarters ended March 31, 2005 and June 30,2005.  Our restated consolidated financialstatements also include disclosure of restated unaudited quarterly results for2004 and 2003.

 

Management has determined that the internal controldeficiency that resulted in the aforementioned accounting errors is a materialweakness, as defined by the Public Company Accounting Oversight Board’sAuditing Standard No. 2.  We havedetermined that the material weakness was that we did not maintain adequate controls and procedures to assurethat multi-element arrangements and related software revenue components wereaccounted for in accordance with generally accepted accounting principles.  The Public Company AccountingOversight Board has defined a material weakness as “a significant deficiency,or combination of significant deficiencies, that results in more than a remotelikelihood that a

 

32

----

 

materialmisstatement of the annual or interim financial statements will not beprevented or detected.” Management has reviewed the internal control deficiencywith our Audit Committee, has discussed it with our independent registeredpublic accounting firm, KPMG LLP, and has advised our Audit Committee that thedeficiency is a material weakness in our internal control over financialreporting.

 

**(a)   Conclusion Regarding the Effectiveness ofDisclosure Controls and Procedures**

 

The effectiveness of our orany system of disclosure controls and procedures is subject to certainlimitations, including the exercise of judgment in designing, implementing andevaluating the controls and procedures, the assumptions used in identifying thelikelihood of future events, and the inability to eliminate misconductcompletely. As a result, there can be no assurance that our disclosure controlsand procedures will detect all errors or fraud. By their nature, our, or any,system of disclosure controls and procedures can provide only reasonableassurance regarding management’s control objectives.

 

Under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, we evaluated the design and operation of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) ofthe Securities Exchange Act of 1934, or the “Exchange Act”) as of June 30,2005. At the time of the initial filing of our Quarterly Report on Form 10-Qfor the quarter ended June 30, 2005, on the basis of that evaluation, ourmanagement, including our Chief Executive Officer and Chief Financial Officer,concluded that our disclosure controls and procedures were effective, to givereasonable assurance that the information required to be disclosed by us inreports that we file under the Exchange Act is recorded, processed, summarizedand reported within the time periods specified in the rules and forms ofthe SEC and to ensure that information required to be disclosed in the reportsfiled or submitted under the Exchange Act is accumulated and communicated toour management, including our Chief Executive Officer and Chief FinancialOfficer, in a manner that allows timely decisions regarding requireddisclosure.

 

In light of the materialweakness in internal control over financial reporting referenced above, ourChief Executive Officer and Chief Financial Officer now believe that ourdisclosure controls and procedures were not effective at a reasonable assurancelevel as of June 30, 2005.

 

In response to this materialweakness, management performed additional analyses and other post-closingprocedures to ensure our restated consolidated financial statements wereprepared in accordance with generally accepted accounting principles. Accordingly,management, including our Chief Executive Officer and Chief Financial Officer,believes the restated consolidated financial statements included in this reportand our Form 10-K/A fairly present, in all material respects, ourfinancial condition, results of operations and cash flows for the periodspresented.

 

**(b)****                                 ****Changes in Internal ControlOver Financial Reporting**

 

There were no changes in ourinternal control over financial reporting that occurred in the second quarterof 2005 that materially affected, or were reasonably likely to materiallyaffect, our internal control over financial reporting.

 

During October 2005, weimplemented the remedial measures outlined below to address the identifiedmaterial weakness in connection with the preparation of our restated financialstatements included in our Form 10-K/A for the year ended December 31,2004.  We have recently dedicatedadditional resources to the review of our control processes and proceduressurrounding revenue recognition. Furthermore, we have been conducting a thorough review and evaluation ofour internal controls over revenue recognition as part of our compliance withthe requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

 

In order to remediate theweakness in our internal control over financial reporting, management hasimplemented the following measures as of the date of filing of this report andour Form 10-K/A:

 

33

----

 

•                  Enhanced our revenue recognition proceduresby updating our contract evaluation criteria and decision processflowcharts.  These evaluation and processupdates were developed as a result of performing a thorough review ofapplicable accounting literature related to revenue recognition, particularlyEITF No. 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables.”

 

•                  Modified our revenue recognition procedureson software contracts requiring postcontractcustomer support in accordance with the guidelines of SOP 97-2, “SoftwareRevenue Recognition” and subsequent interpretations.

 

•                  Enhanced our revenue recognition proceduresto assure vendor-specific objective evidence is obtained to establish fairvalue for undelivered software elements prior to recognizing revenue.

 

•                  Implemented additional training foraccounting personnel to enhance their understanding of the applicable revenuerecognition principles.

 

•                  Implemented additional training for our salespersonnel to enhance communications of pertinent revenue information to ouraccounting department that would impact accounting for agreements containingmultiple deliverables.

 

34

----

 

**PART II – OTHER INFORMATION**

 

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

 

TheCompany and each of its directors, Jeff O’Dell, James Bernards, Roger Gower,Michael Wright and Linda Hall Whitman, were named as defendants in two separatelawsuits that purported to be class action claims on behalf of the Company’sshareholders.  The Company received asummons and complaint with respect to the first of these proceedings on February 4,2005 and the second on February 14, 2005. Both lawsuits were brought in Minnesota State Court and claimed that thedirectors had breached their fiduciary duties to the Company’s shareholders inconnection with their actions in agreeing to the proposed merger withNanometrics Incorporated.  The plaintiffsin both actions sought various forms of injunctive relief including an orderenjoining the Company and its board of directors from consummating the mergerwith Nanometrics.

 

The two proceedings wereconsolidated and heard as one case.  On April 19,2005, the Court issued a 30 day stay of all proceedings.  On April 27, 2005, the plaintiffsscheduled a hearing on a motion to amend the complaint.  The hearing was scheduled for June 9,2005.  On May 10, 2005 the Courtissued an order dismissing the complaint for asserting derivative claimswithout complying with the rules governing derivative actions.  Thereafter the Court removed the hearing fromthe calendar.

 

On July 18,2005, a purported shareholder class action lawsuit asserting derivative claims wasfiled in Minnesota state court against the Company and the individual membersof the board named above as well as Lynn J. Davis, who joined the board on March 30,2005 (the “Board”).  The lawsuit claimsthe directors have breached their fiduciary duties to Company’s shareholders inconnection with their actions in approving the merger agreement withNanometrics, Inc. and subsequently terminating that merger agreement andentering into a new merger agreement with Rudolph Technologies, Inc.  The plaintiff seeks various forms ofinjunctive relief including an order enjoining the Company and the Board fromconsummating the proposed merger with Rudolph.

 

The plaintiffin the lawsuit filed on July 18, 2005 is Robert Etem, the owner of 4,200shares of the Company’s common stock.  Mr. Etemwas also a plaintiff in the lawsuit described above filed on February 14,2005.

 

On July 14, 2005, the Companyfiled a patent infringement lawsuit against Camtek, Ltd. of Migdal Haemek,Israel.  The patent infringement lawsuit,filed in U.S. federal court in Minneapolis, alleges that Camtek’s line ofinspection equipment sold under the “Falcon” trademark infringes on the Company’sU.S. patent no. 6,826,298.

 

35

----

 

**Item 2.****                                  ****Unregistered Sales of EquitySecurities and Use of Proceeds**

 

The following table sets forth therepurchase of stock by the Company in the second quarter:

 
| **Period**         | ** ** | **(a) Total  Number of  Shares  Purchased** | ** ** | **(b) Average  Price Paid per  Share** | ** ** | **(c) Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **(d) Maximum Number (or  Approximate Dollar  Value) of Shares that May  Yet be Purchased Under  the Plans or Programs** | ** ** |
|--------------------|------------|--------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| May 19,  2005 |       | 11,614                                           | (1)        | $                                           | 10.332     |                                                                                                   | 0          |                                                                                                                          | 0          |   |
|                    |            |                                                  |            |                                             |            |                                                                                                        |            |                                                                                                                               |            |  |

 

(1)                  Pursuant to a RedemptionAgreement between the Company and Michael Plisinski, Vice President ofEngineering, the Company repurchased the shares at a price equal to 90% of theclosing price of the Company’s stock on the day preceding the repurchasedate.  There is no agreement torepurchase additional shares.

 

**Item 4.****                                   Submissionof Matters to a Vote of Security Holders**

 

TheCompany held its Annual Meeting of Shareholders on May 25, 2005 at theCompany’s world headquarters at 4900 West 78th Street, Bloomington,Minnesota.  Of the 17,970,496 shares ofCommon Stock outstanding as of April 13, 2005 (the record date), 16,476,676(92%) were present or represented by proxy at the meeting.

 

1.                 Theshareholders approved the Board of Director’s recommendation for setting thenumber of directorships at six.  Thisproposal received 14,704,125 votes for and 867,318 votes against, with 905,233votes abstaining.

 

2.                 Theshareholders elected Lynn J. Davis and Linda Hall Whitman as Class IIDirectors, pursuant to the following votes:

 
| ** **         | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|--------------------|------------|---------------|------------|--------------------|------------|
| Lynn J. Davis      |       | 14,604,115    |       | 1,872,561          |       |
| Linda Hall Whitman |       | 14,283,713    |       | 2,192,963          |       |

 

JamesA. Bernards and Roger E. Gower as Class III directors and Jeff O’Dell andMichael Wright as a Class I directors of the Company were not subject toreelection at this meeting, and thus their terms continued after the meeting.

 

3.                 Theshareholders ratified the appointment of KPMG LLP as the Company’s independentauditors for the 2005 fiscal year.  Thisproposal received 14,728,283 votesfor and 834,143 votes against, with 914,250 votes abstaining.

 

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

 

The exhibitslisted on the Exhibit Index are filed herewith.

 

36

----

 

## SIGNATURES

 

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

 

 
|                         | AUGUST TECHNOLOGY CORPORATION            |
|------------------------------|-----------------------------------------------|
|                         |                                          |
|                         |                                          |
| Date: November 9,  2005 | By:                                           | /s/ JEFF L. O’DELL |   |
|                         | Jeff L. O’Dell                           |
|                         | Chief Executive Officer                       |
|                         | (Principal Executive  Officer)                |
|                         |                                          |
|                         |                                          |
| Date: November 9,  2005 | By:                                           | /s/ STANLEY D.  PIEKOS |   |
|                         | Stanley D. Piekos                             |
|                         | Chief Financial Officer                       |
|                         | (Principal  Financial and Accounting Officer) |
|                              |                                               |  |  |  |  |

 

37

----

 

**SECURITIES AND EXCHANGE COMMISSION**

Washington, D.C.  20549

 

EXHIBIT INDEX TO FORM 10-Q/A

 
| For the  quarter ended: |   | Commission  File No.: 000-30637 |
|-------------------------|--------|---------------------------------|

June 30, 2005

 

**AUGUST TECHNOLOGYCORPORATION**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                |
|-------------------------|------------|----------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                           |
| 10.1*                   |       | Amendment to  Employment Agreement between the Company and David Klenk, dated May 5,  2005                |
|                    |       |                                                                                                           |
| 10.2*                   |       | Separation  Agreement and Release between the Company and David Klenk, dated May 5,  2005                 |
|                    |       |                                                                                                           |
| 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 |

 

----

*                 Previouslyfiled with the Original Filing

**          Filedherewith

 

38

----