**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

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

(Exact name of Registrant as specified inits charter)

 
| **Minnesota**                             | ** ** | **41-1729485**      |
|-------------------------------------------|------------|---------------------|
| (State of incorporation)                  |       | (I.R.S. Employer    |
|                                      |       | Identification No.) |
|                                      |       |                |
| **4900 West 78th Street**                 | ** ** | ** **          |
| **Bloomington, MN**                       | ** ** | **55435**           |
| (Address of principal  executive offices) |       | (Zip Code)          |

 

**(952) 820-0080**

(Registrant’s telephone number, includingarea 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

 

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

 

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

 

 

----

 

**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 |                                                                                                   |

 

2

----

 

**PART I– FINANCIAL INFORMATION**

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

 

**AUGUST TECHNOLOGYCORPORATION**

** **

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share amounts)**

**(Unaudited)**

 
| ** **                                                                                                                        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                        | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| **ASSETS**                                                                                                                        |       |              |       |                  |       |
|                                                                                                                              |       |              |       |                  |       |
| Current assets:                                                                                                                   |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                        |       | $                 | 10,313     |                  | $          | 5,518 |   |
| Short-term  marketable debt securities                                                                                            |       | 22,583            |       | 28,615                |       |
| Accounts  receivable, net                                                                                                         |       | 12,035            |       | 8,603                 |       |
| Inventories                                                                                                                       |       | 21,393            |       | 20,131                |       |
| Inventories at  customers under purchase orders                                                                                   |       | 3,646             |       | 3,993                 |       |
| Prepaid expenses  and other current assets                                                                                        |       | 1,651             |       | 2,306                 |       |
| Total current  assets                                                                                                             |       | 71,621            |       | 69,166                |       |
|                                                                                                                              |       |              |       |                  |       |
| 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                                                                                                                      |       | $                 | 89,755     |                  | $          | 95,800 |   |
|                                                                                                                              |       |              |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                     |       |              |       |                  |       |
|                                                                                                                              |       |              |       |                  |       |
| Current  liabilities:                                                                                                             |       |              |       |                  |       |
| Accounts payable                                                                                                                  |       | $                 | 6,947      |                  | $          | 3,366 |   |
| Accrued  compensation                                                                                                             |       | 2,952             |       | 1,691                 |       |
| Other accrued  liabilities                                                                                                        |       | 2,353             |       | 2,306                 |       |
| Customer  deposits and deferred revenues                                                                                          |       | 6,769             |       | 6,841                 |       |
| Total current  liabilities                                                                                                        |       | 19,021            |       | 14,204                |       |
|                                                                                                                              |       |              |       |                  |       |
| Other  non-current liabilities                                                                                                    |       | 108               |       | 131                   |       |
| Total  liabilities                                                                                                                |       | 19,129            |       | 14,335                |       |
|                                                                                                                              |       |              |       |                  |       |
| Commitments and  contingencies (note 8)                                                                                           |       | —            |       | —                |       |
|                                                                                                                              |       |              |       |                  |       |
| Shareholders’  equity:                                                                                                       |       |              |       |                  |       |
| Common stock, no  par value, 42,000,000 shares authorized, 18,064,032 and 17,839,298 shares  issued and outstanding, respectively |       | 91,437            |       | 90,347                |       |
| Undesignated  capital stock, no par value, 3,000,000 shares authorized, no shares issued or  outstanding                          |       | —            |       | —                |       |
| Accumulated  deficit                                                                                                              |       | (20,715           | )          | (8,776                | )          |
| Accumulated  other comprehensive loss                                                                                             |       | (96               | )          | (106                  | )          |
| Total  shareholders’ equity                                                                                                  |       | 70,626            |       | 81,465                |       |
| Total  liabilities and shareholders’ equity                                                                                  |       | $                 | 89,755     |                  | $          | 95,800 |   |

 

See accompanyingnotes to consolidated financial statements.

 

3

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**AUGUST TECHNOLOGYCORPORATION**

** **

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Net revenues                                     |       | $                                    | 19,688     |                               | $          | 19,855 |   | $ | 38,105 |   | $ | 36,255 |   |
| Cost of revenues                                 |       | 8,403                                |       | 9,059                              |       | 16,762 |   | 16,117 |   |
| Gross profit                                     |       | 11,285                               |       | 10,796                             |       | 21,343 |   | 20,138 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Selling, general  and administrative expenses    |       | 7,237                                |       | 5,390                              |       | 13,526 |   | 10,579 |   |
| Research and  development expenses               |       | 3,324                                |       | 3,322                              |       | 6,990 |   | 6,230 |   |
| Operating income                                 |       | 724                                  |       | 2,084                              |       | 827 |   | 3,329 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Merger expenses                                  |       | (11,991                              | )          | —                             |       | (13,225 | ) | — |   |
| Interest income                                  |       | 335                                  |       | 189                                |       | 623 |   | 390 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Income (loss)  before provision for income taxes |       | (10,932                              | )          | 2,273                              |       | (11,775 | ) | 3,719 |   |
| Provision for  income taxes                      |       | 109                                  |       | 100                                |       | 164 |   | 100 |   |
| Net income  (loss)                               |       | $                                    | (11,041    | )                                  | $          | 2,173 |   | $ | (11,939 | ) | $ | 3,619 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss) per share:                    |       |                                 |       |                               |       |   |   |   |   |
| Basic                                            |       | $                                    | (0.61      | )                                  | $          | 0.12 |   | $ | (0.67 | ) | $ | 0.20 |   |
| Diluted                                          |       | $                                    | (0.61      | )                                  | $          | 0.12 |   | $ | (0.67 | ) | $ | 0.20 |   |
|                                             |       |                                 |       |                               |       |   |   |   |   |
| Weighted average  number of shares:              |       |                                 |       |                               |       |   |   |   |   |
| Basic                                            |       | 18,005                               |       | 17,778                             |       | 17,936 |   | 17,700 |   |
| Diluted                                          |       | 18,005                               |       | 18,349                             |       | 17,936 |   | 18,421 |   |

 

See accompanyingnotes to consolidated financial statements.

 

4

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**AUGUST TECHNOLOGY CORPORATION**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                            | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                                |       |                               |       |   |   |
| Net income  (loss)                                                                    |       | $                                  | (11,939    | ) | $ | 3,619 |   |
| Adjustments to  reconcile net income (loss) to net cash used in operating activities: |       |                               |       |   |   |
| Depreciation and  amortization                                                        |       | 2,115                              |       | 1,019 |   |
| Stock-based  compensation                                                             |       | 30                                 |       | 27 |   |
| Provision for  (recovery of) doubtful accounts                                        |       | (57                                | )          | 79 |   |
| Tax benefit from  stock options exercised                                             |       | 19                                 |       | — |   |
| Deferred income  taxes                                                                |       | 6                                  |       | — |   |
| Changes in  operating assets and liabilities:                                         |       |                               |       |   |   |
| Accounts  receivable                                                                  |       | (3,369                             | )          | (11,185 | ) |
| Inventories                                                                           |       | (1,117                             | )          | (7,048 | ) |
| Inventories at  customers under purchase orders                                       |       | 347                                |       | (2,779 | ) |
| Prepaid expenses  and other current assets                                            |       | 664                                |       | (402 | ) |
| Accounts payable                                                                      |       | 3,581                              |       | 2,220 |   |
| Accrued  compensation                                                                 |       | 1,257                              |       | 696 |   |
| Other accrued  liabilities                                                            |       | 73                                 |       | 9 |   |
| Customer  deposits and deferred revenues                                              |       | (72                                | )          | 3,027 |   |
| 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 | ) |
| Proceeds from  disposition of property and equipment                                  |       | 4                                  |       | — |   |
| Cash paid for  acquisitions                                                           |       | (28                                | )          | (17 | ) |
| Net cash  provided by investing activities                                            |       | 12,217                             |       | 308 |   |
|                                                                                  |       |                               |       |   |   |
| Cash flows from  financing activities:                                                |       |                               |       |   |   |
| Net proceeds  from issuances of common stock                                          |       | 1,161                              |       | 1,988 |   |
| Redemption of  common stock                                                           |       | (120                               | )          | — |   |
| Net cash  provided by financing activities                                            |       | 1,041                              |       | 1,988 |   |
|                                                                                  |       |                               |       |   |   |
| Effect of  exchange rate changes 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 accompanyingnotes to consolidated financial statements.

 

5

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**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 andregulations.  In the opinion of themanagement of August Technology Corporation (collectively with itssubsidiaries, the “Company”), all adjustments (consisting of normal recurringadjustments) considered necessary for a fair presentation have been included inthe consolidated balance sheet at June 30, 2005, the consolidated statementsof operations for the three and six months ended June 30, 2005 and 2004,and the consolidated statements of cash flows for the six months ended June 30,2005 and 2004.  The statements ofoperations of the interim periods are not necessarily indicative of the resultsof operations that may be expected for any other period or for the year as awhole.  These consolidated financialstatements and notes hereto should be read in conjunction with the auditedconsolidated financial statements and notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004,filed with the Securities and Exchange Commission on March 16, 2005.

 

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 – 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.

 

6

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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 3– 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 with thefollowing 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           |       | —                               |       | —                             |       | — |   | — |   |

 

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

 

7

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| ** **                                                                                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                         | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss), as reported                                                                    |       | $                                    | (11,041    | )                                  | $          | 2,173 |   | $ | (11,939 | ) | $ | 3,619 |   |
|                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Add:                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Stock-based  employee compensation expense included in net income (loss), as reported              |       | 29                                   |       | —                             |       | 29 |   | — |   |
| 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                                                                      |       | $                                    | (11,553    | )                                  | $          | 1,652 |   | $ | (13,252 | ) | $ | 1,945 |   |
|                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss) per share:                                                                      |       |                                 |       |                               |       |   |   |   |   |
| As reported:                                                                                       |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                              |       | $                                    | (0.61      | )                                  | $          | 0.12 |   | $ | (0.67 | ) | $ | 0.20 |   |
| Diluted                                                                                            |       | $                                    | (0.61      | )                                  | $          | 0.12 |   | $ | (0.67 | ) | $ | 0.20 |   |
|                                                                                               |       |                                 |       |                               |       |   |   |   |   |
| Pro forma:                                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                              |       | $                                    | (0.64      | )                                  | $          | 0.09 |   | $ | (0.74 | ) | $ | 0.11 |   |
| Diluted                                                                                            |       | $                                    | (0.64      | )                                  | $          | 0.09 |   | $ | (0.74 | ) | $ | 0.11 |   |

 

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 4– 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 |   |

 

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

 

8

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| ** **                              | ** ** | **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 5 –Accounts Receivable**

 

Accounts receivableconsisted of the following:

 
| ** **                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2005**          | ** ** | **2004**              | ** ** |
|                             |       |              |       |                  |       |
| Billed  receivables              |       | $                 | 10,470     |                  | $          | 8,150 |   |
| Unbilled revenue                 |       | 2,255             |       | 1,143                 |       |
|                             |       | 12,725            |       | 9,293                 |       |
| Allowance for  doubtful accounts |       | (690              | )          | (690                  | )          |
| Accounts  receivable, net        |       | $                 | 12,035     |                  | $          | 8,603 |   |

 

**Note 6 –Inventories**

 

Inventories consisted ofthe following:

 
| ** **               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2005**          | ** ** | **2004**              | ** ** |
|                     |       |              |       |                  |       |
| Raw materials            |       | $                 | 10,220     |                  | $          | 8,474 |   |
| Work in process          |       | 4,065             |       | 3,558                 |       |
| Demonstration  equipment |       | 4,312             |       | 4,152                 |       |
| Finished goods           |       | 2,796             |       | 3,947                 |       |
| Inventories              |       | $                 | 21,393     |                  | $          | 20,131 |   |

 

**Note 7 – 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 8 below.

 

9

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Amortization expense forthe six months ended June 30, 2005 and 2004 was $724 and $174,respectively.  Assuming no additional change in the gross carrying valueof purchased technology, the estimated amortization expense for the twelvemonths ending December 31, 2005 is $1,435 and for each of the next fouryears is $1,208, $800, $378 and none.

 

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 8 –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 topurchased technology.  As a result,amortization expense related to this asset increases.  Amounts paid under this arrangement are notexpected to have a material effect on the Company’s consolidated financialcondition or results of operations.  The totalcontingent consideration the Company expects to pay related to the twelvemonths after the acquisition is $142, of which $24 and $118 was added to purchased technology in 2004 and 2005, respectively.  As of June 30, 2005, $90 remained unpaid.

 

10

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***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, JamesBernards, Roger Gower, Michael Wright and Linda Hall Whitman, were named asdefendants in two separate lawsuits that purported to be class action claims onbehalf of the Company’s shareholders.  TheCompany received a summons and complaint with respect to the first of theseproceedings on February 4, 2005 and the second on February 14,2005.  Both lawsuits were brought inMinnesota State Court and claimed that the directors had breached theirfiduciary duties to the Company’s shareholders in connection with their actionsin agreeing to the proposed merger with Nanometrics Incorporated.  The plaintiffs in both actions sought variousforms of injunctive relief including an order enjoining the Company and itsboard of directors from consummating the merger with Nanometrics.

 

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 onMarch 30, 2005 (the “Board”).  Thelawsuit claims the directors have breached their fiduciary duties to theCompany’s shareholders in connection with their actions in approving the mergeragreement with Nanometrics, Inc. and subsequently terminating that mergeragreement and 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.

 

**Note 9 –Net Income (Loss) Per Share**

 

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

 

11

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| ** **                                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                           |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss)                             |       | $                                    | (11,041    | )                                  | $          | 2,173 |   | $ | (11,939 | ) | $ | 3,619 |   |
|                                           |       |                                 |       |                               |       |   |   |   |   |
| 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                                          |       | $                                    | (0.61      | )                                  | $          | 0.12 |   | $ | (0.67 | ) | $ | 0.20 |   |
| Diluted                                        |       | $                                    | (0.61      | )                                  | $          | 0.12 |   | $ | (0.67 | ) | $ | 0.20 |   |

 

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 10 – 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 | ) |

 

12

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**Note 11– Shareholders’ Equity**

 

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

 
| Shareholders’  equity balance at December 31, 2004 |   | $       | 81,465 |   |
|--------------------------------------------------------------|--------|---------|--------|--------|
| Net loss                                                     |   | (11,939 | )      |
| Accumulated  other comprehensive loss:                       |   |    |   |
| Foreign currency  translation adjustment                     |   | 27      |   |
| Net unrealized  loss on marketable debt securities           |   | (17     | )      |
| Comprehensive  loss                                          |   | (11,929 | )      |
| Issuances of  common stock in conjunction with:              |   |    |   |
| Exercises of  stock options                                  |   | 1,038   |   |
| Employee stock  purchase plan                                |   | 123     |   |
| Redemption of  common stock                                  |   | (120    | )      |
| Tax benefit from  stock options exercised                    |   | 19      |   |
| Stock-based  compensation                                    |   | 30      |   |
| Shareholders’  equity balance at June 30, 2005     |   | $       | 70,626 |   |

 

In May 2005, the Company purchased 11,614 common shares from anexecutive officer for $120, which represented 90% of the market value on the dateof purchase.  There are currently noplans to repurchase additional shares.

 

***Shareholder Rights Plan***

 

On June 27, 2005, the Board adopted aShareholder Rights Plan to protect shareholders from coercive or otherwiseunfair 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, theRights Agreement works by imposing a significant penalty upon any person orgroup that acquires 10% or more of the Company’s outstanding common stockwithout the approval of the Board.  The Company does not believe the RightsAgreement will interfere with any merger or other business combination approvedby the Board.

 

Each Rightwill allow its holder to purchase from the Company one one-thousandth of ashare of Series A Junior Participating PreferredStock for $27.00 once the Rights become exercisable.  The Rights will not be exercisable untilfifteen days after the public announcement that a person or group has become an“Acquiring Person” by obtaining beneficial ownership of 10% or more of theCompany’s outstanding common stock, or, if earlier, fifteen business days aftera person or group begins a tender or exchange offer which, if completed, wouldresult in that person or group becoming an Acquiring Person.  If a person or group becomes an AcquiringPerson, all holders of Rights except the Acquiring Person, may,for $27.00 purchase shares of the Company’s common stock with a market value of$54.00, based on the market price of the common stock prior to such acquisition.  In addition, if the Company is later acquiredin a merger or similar transaction after the Rights have become exercisable anda person or group is, or becomes, an Acquiring Person, all holders of Rightsexcept the Acquiring Person may, for $27.00, purchase shares of the

 

13

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acquiringcorporation with a market value of $54.00 based on the market price of theacquiring corporation’s stock, prior to such merger.  The Board may redeem the Rights for $.0005per Right at any time before any person or group becomes an Acquiring Person.

 

**Note 12– Significant Customer, Product Line and Geographic Information**

 

Thepercentage of net revenues derived from major customers was as follows:

 
| ** **    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **    | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenues: |       |                                 |       |                               |       |   |   |   |   |
| Customer A    |       | 15                                   | %          | 10                                 | %          |   | * |   | * |
| Customer B    |       | 13                                   | %          | 12                                 | %          | 18 | % | 15 | % |
| Customer C    |       |                                 | *          | 17                                 | %          |   | * | 10 | % |
| Customer D    |       |                                 | *          | 12                                 | %          |   | * |   | * |
| Customer E    |       |                                 | *          | 10                                 | %          |   | * |   | * |
| Customer F    |       |                                 | *          | 10                                 | %          |   | * |   | * |
|          |       | 28                                   | %          | 71                                 | %          | 18 | % | 25 | % |

 

----

*       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** | ** ** |
| Net revenues:        |       |                                 |       |                               |       |   |   |   |   |
| NSX Series           |       | 58                                   | %          | 56                                 | %          | 49 | % | 55 | % |
| All Surface  Systems |       | 18                                   | %          | 16                                 | %          | 26 | % | 18 | % |
| 3Di Series           |       | 2                                    | %          | 8                                  | %          | 5 | % | 9 | % |
| Other                |       | 22                                   | %          | 20                                 | %          | 20 | % | 18 | % |
|                 |       | 100                                  | %          | 100                                | %          | 100 | % | 100 | % |

 

All ofthe Company’s tangible long-lived assets are located in the United States, exceptfor an insignificant amount of property and equipment in Taiwan and SouthKorea.  The Company derives revenues fromshipments 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** | ** ** |
| Net revenues: |       |                                 |       |                               |       |   |   |   |   |
| United States |       | 14                                   | %          | 29                                 | %          | 16 | % | 29 | % |
| Taiwan        |       | 38                                   | %          | 44                                 | %          | 40 | % | 33 | % |
| South Korea   |       | 16                                   | %          | 12                                 | %          | 20 | % | 18 | % |
| Europe        |       | 23                                   | %          | 0                                  | %          | 18 | % | 2 | % |
| Japan         |       | 2                                    | %          | 3                                  | %          | 2 | % | 4 | % |
| Rest of Asia  |       | 7                                    | %          | 12                                 | %          | 4 | % | 14 | % |
|          |       | 100                                  | %          | 100                                | %          | 100 | % | 100 | % |

 

14

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**Note 13– 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 3,“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.

 

15

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

** **

**Cautionary Factors That May Affect FutureResults**

** **

Certainstatements made in this Quarterly Report on Form 10-Q, as well as oralstatements made by us from time to time, which are prefaced with words such as “expects,”“anticipates,” “believes,” “projects,” “intends,” “plans” and similar words andother statements of similar sense, are forward-looking statements.  Our forward-looking statements generallyrelate to our growth strategies, financial results, future financialprojections, product development activities and sales efforts.  Our actualresults could differ materially from those projected in the forward-lookingstatements as a result of a number of factors, including but not limited tomarket acceptance of our products, our ability to successfully develop newproducts, our ability to protect our intellectual property, our dependence uponinternational customers and suppliers, our dependence on a small number ofcustomers that account for a significant portion of revenues, availability ofproducts from our suppliers, cyclicality in the microelectronic manufacturingequipment and other industries, management of growth, integration of acquiredbusinesses, and the other risk factors detailed below and in our Annual Reporton Form 10-K for the year ended December 31, 2004, as filed with theSEC on March 16, 2005.  We disclaimany obligation to revise forward-looking statements, or to update the reasonsactual results could differ materially from those anticipated, to reflectevents or circumstances after the date of such statements or to reflect theoccurrence of anticipated or unanticipated events.  Because many factors are unforeseeable, theforegoing should not be considered an exhaustive list.

 

**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. This discussion contains forward-looking statements that involve risksand uncertainties. Our actual results could differ materially from thoseanticipated in the forward-looking statements as a result of a variety offactors.

 

**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 Annual Report on Form 10-K for the year ended December 31,2004.  For the six months ended June 30, 2005, there were no changesto these critical accounting policies.

 

16

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**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 finalmanufacturing or 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 the quarter.  These demonstrations allow these customers toevaluate the benefits these systems provide. We expect these demonstrations will lead to increased revenues six tonine months after shipment.

 

We complement this broad inspection capability with an expanding suiteof software tools designed to enhance the speed and effectiveness of theprocess by which device manufacturers analyze defects, and make decisionsregarding their manufacturing process to reduce or eliminate such defects.  We refer to this process as the “detection-to-decision”process.

 

Our business has been, and will continue to be, subjectto the highly cyclical nature of the microelectronic device manufacturingmarkets we serve.  These cycles arecaused by significant, and often rapid, fluctuations in the supply and demandof microelectronic devices driven by such factors as changes in technology andglobal economic conditions.  As a resultof these fluctuations, and due to the fact that our quarterly revenues arecomprised of systems with selling prices of between $150,000 and $1,000,000, asmall change in the number of systems we sell may also cause significantchanges in our operating results. Because fluctuations in the timing of orders from our major customers orin the number of individual systems we sell could cause our revenues tofluctuate significantly in any given quarter or year, we do not believe thatperiod-to-period comparisons of our financial results are necessarilymeaningful, and they should not be relied upon as an indication of our futureperformance.  Additionally, the rate andtiming of customer orders 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 tomany of the leading microelectronic 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 ended June 30, 2005and 2004 sales to customers that individually represented at least ten percentof our revenues accounted for 18% and 25% of our net revenues, respectively.

 

Management focuses onseveral key financial metrics in evaluating our financial condition andoperating performance.  Although we donot believe backlog is always an accurate indication of future revenues andperformance, since only a portion of our revenues for any quarter includesystems that were in backlog as of the beginning of that quarter, we do closelymonitor the level of orders both geographically and by product line and inrelation to the level of revenues, referred to as the book-to-bill ratio.  During the second quarter of 2005, ourbook-to-bill ratio was above parity.  Abook-to-bill ratio above parity indicates an increasing level of backlog.  In addition to monitoring

 

17

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our level of orders and backlog, we focus onrevenues by product family compared to prior-period and current-year plans,year-over-year revenue growth compared to the overall semiconductor equipmentindustry, operating profit or loss performance compared with prior-period andcurrent-year plans and the level of operating cash flow.

 

**Merger Activities**

 

On January 21, 2005, we entered into anAgreement and Plan of Merger and Reorganization (the “Nanometrics MergerAgreement”) with Nanometrics, Incorporated (“Nanometrics”), Major League MergerCorporation 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 Agreementand Plan of Merger (the “Rudolph Merger Agreement”) with Rudolph Technologies, Inc.(“Rudolph”) and NS Merger Sub, Inc. Under the terms of the Rudolph Merger Agreement each of our shareholderswill have the option to elect to receive either $10.50 per share in cash or0.7625 of a share of Rudolph common stock, subject to proration and allocation,based on the total cash and shares available in the merger.  The agreement requires that the totalconsideration for the transaction will include a minimum of $37,200 and amaximum of $60,000 of cash subject to shareholder election.  The aggregate consideration was 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 our shareholderswould receive $11.50 per share.  KLA alsostated that it would be willing to consider using stock as consideration.  Since the February 9 letter, KLA hasmade various public statements and additional communications to us (including apress release issued on July 13, 2005) stating that KLA continues to beinterested in acquiring August Technology. As of the date of this filing, KLA has been unwilling to execute aconfidentiality agreement in a form acceptable to us and we have had nodiscussions with KLA regarding their proposal.

 

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**Results of Operations**

 
| ** **                                           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                           | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Net revenues                                         |       | 100.0                                | %          | 100.0                              | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                     |       | 42.7                                 |       | 45.6                               |       | 44.0 |   | 44.5 |   |
| Gross profit                                         |       | 57.3                                 |       | 54.4                               |       | 56.0 |   | 55.5 |   |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Selling, general  and administrative expenses        |       | 36.8                                 |       | 27.2                               |       | 35.5 |   | 29.2 |   |
| Research and  development expenses                   |       | 16.9                                 |       | 16.7                               |       | 18.3 |   | 17.1 |   |
| Operating income                                     |       | 3.6                                  |       | 10.5                               |       | 2.2 |   | 9.2 |   |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Merger expenses                                      |       | (60.9                                | )          | —                             |       | (34.7 | ) | — |   |
| Interest income                                      |       | 1.7                                  |       | 0.9                                |       | 1.6 |   | 1.1 |   |
| Net income  (loss) before provision for income taxes |       | (55.6                                | )          | 11.4                               |       | (30.9 | ) | 10.3 |   |
| Provision for  income taxes                          |       | 0.6                                  |       | 0.5                                |       | 0.4 |   | 0.3 |   |
| Net income  (loss)                                   |       | (56.2                                | )%         | 10.9                               | %          | (31.3 | )% | 10.0 | % |

** **

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

 

*Net Revenues.*  Netrevenues decreased $0.2 million, or 0.8%, to $19.7 million for the three monthsended June 30, 2005, from the record revenues of $19.9 million for thesame period in 2004.  Strong growth inrevenues from systems sold into final manufacturing assembly and packagingapplications were the largest contributors in the three months ended June 30,2005.  Net revenues increased $1.9million, or 5.1%, to $38.1 million for the six months ended June 30, 2005,from $36.3 million for the same period in 2004. The increase in net revenues during the six months ended June 30,2005 was primarily due to increased sales of all surface inspection systemsinto front-end wafer fabrication processes, and revenues from DMSVision, whichwas acquired in July 2004.  Thisincrease during the first half of 2005 was partially offset by lower NSX Series salesinto front-end wafer fabrication processes and 3Di Series sales.  Revenues derived from systems sold forfront-end wafer fab applications accounted for 42.9% and 51.1% 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 86%and 71% 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 63% and 71% 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 23% of net revenues, which is the highestthree-month revenue ever from that continent. Net revenues from international sales represented 84% and 71% of totalnet revenues for the six months ended June 30, 2005 and 2004, respectively,and were primarily the result of sales to Asia, which comprised 66% and 69% oftotal net revenues.

 

*Gross Profit.*  Grossprofit as a percent of net revenues increased to 57.3% for the three monthsended June 30, 2005, from 54.4% for the same period in 2004.  Gross profit as percentage of net revenuesincreased to 56.0% for the six months ended June 30, 2005, from 55.5% forthe same period in 2004.  Gross profit percentageincreased primarily as a result of revenues from DMSVision software sales andimproved margins within the NSX Series, partially offset by higher rework costsrelated to certain systems and the recording of lower of cost or marketadjustments related to certain component parts that became obsolete due toengineering design changes.  We expect to continue to experience pricingpressure primarily related to our inspection systems sold

 

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into final manufacturing applications as competitors have continued to enterthis market.  The impact of these reductionsin gross profit is expected to be offset by higher margin products sold intofront end applications.  We expect futuregross profit as a percentage of 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 $13.5million 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 36.8% and 35.5% for the three and six months ended June 30,2005, compared to 27.2% and 29.2% 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 DevelopmentExpenses.*  Research and development (“R&D”) expensesconsist primarily of employee salaries and related benefits for individualsengaged in the research, design and development of new products.  R&D expenses were $3.3 million and $7.0million for the three and six months ended June 30, 2005, compared to $3.3million and $6.2 million for the same periods in 2004.  R&D expenses as a percentage of netrevenues were 16.9% and 18.3% for thethree and six months ended June 30, 2005, compared to 16.7% and 17.1% forthe same periods in 2004.  The increasein expense dollars during the six months ended June 30, 2005 was primarilydue to employee compensation andrelated benefits associated with the hiring of additional staff tocomplete certain stages of development of the all surface inspectionsystems.  In addition, expenses increaseddue to the DMSVision acquisition completed in July 2004.  We currently anticipate that research and development expense dollars willincrease in the third quarter of 2005 as we continue to expand our suite ofsoftware solutions.

 

*InterestIncome.*  Interest income was $0.3 million and $0.6 millionfor the three and six months ended June 30, 2005, compared to $0.2 millionand $0.4 million for the same periods in 2004. The increase in interest income was primarily due to an increase in therate of return on our investment balances.

 

*Merger Expenses.* Merger expenses were $12.0 million and $13.2 million for the three andsix months ended June 30, 2005, compared to none in 2004.  The merger expenses included a $10.9 milliontermination fee paid to Nanometrics for terminating the Nanometrics Merger Agreement,legal and investment banker fees incurred prior to terminating the proposedmerger with Nanometrics, and legal and investment banker fees incurred inconjunction with the proposed merger with Rudolph Technologies, Inc.

 

***Income Taxes.**** *Wecurrently anticipate a pretax profit in 2005 for income tax purposes, ascompared to a pretax loss under generally accepted accounting principles, dueto the fact that the merger expenses are primarily nondeductible for income taxpurposes.  In addition, as a result ofhistorical operating losses and uncertainty as to the extent of profitabilityin future periods, we began to record a valuation allowance against ourdeferred tax assets in the second quarter of 2002 and continue to do so at June 30,2005.  Statement of Financial AccountingStandards (“SFAS”)No. 109 “*Accounting for Income Taxes*,” requires the establishment ofa valuation allowance to reflect

 

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**the** likelihood of the realization of deferred tax assets.  As of December 31, 2004, the valuationallowance was $8.5 million.  The abovefactors have resulted in the recording of a provision for income taxes for thethree and six months ended June 30, 2005 and 2004, primarily to reflectforeign income taxes and federal alternative minimum taxes owed.

** **

**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 thefront-end wafer 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 $3.4 million from December 31, 2004 to June 30,2005.  Our days sales outstanding (“DSO”)during the three months ended June 30, 2005 was 50 days.  This compares to a DSO of 45 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 waspartially offset by a decrease in finished goods due to the transfer of certainsystems to property and equipment for internal use and sales to third parties.

 

*Inventoriesat Customers under Purchase Orders.*  Inventoriesat customers under purchase orders decreased from $4.0 million at December 31,2004 to $3.6 million at June 30, 2005. We anticipate that a portion of this inventory will be recognized asrevenue during 2005.  We anticipate thatthis inventory will increase as shipments of newly introduced productsincrease.

 

*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

 

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and others, management believes that existing cash and investment balanceswill be adequate to satisfy our existing liquidity requirements for at leastthe next twelve months.

 

*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 and an increase in accounts receivable, partially offset by increasesin accounts payable and accrued compensation. Excluding cash payments for merger expenses, cash generated fromoperating activities was $3.9 million for the six months ended June 30,2005.  Net cash provided by investingactivities was $12.2 million, primarily due to $13.3 million of net proceedsfrom maturities of marketable debt securities, partially offset by $1.0 millionof additions to property and equipment, and other assets.  Net cash provided by financing activities was$1.0 million, primarily related to proceeds received from exercises of stockoptions.  We currently expect to generatecash 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 and customer deposits.  Net cashprovided by investing activities was $308,000, primarily due to $2.9 million ofnet proceeds from sales of marketable securities and partially offset by $2.5million for purchases of property and equipment.  Net cash provided by financing activities was$2.0 million from the proceeds received from 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 issued financialstatements is also addressed by SFAS 154. SFAS 154 is required to be adopted in fiscal years beginning after December 15,2005.  Adoption of SFAS No. 154 isnot expected to have a material effect on our 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 a liabilityfor the fair value of a conditional asset retirement obligation be recognizedif 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.

 

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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 of equityinstruments 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 3, “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.

 

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**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 and short-termand 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**

 

*Evaluationof Disclosure Controls and Procedures*

 

As ofthe end of the period covered by this report, the Company conducted anevaluation under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, regarding the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Rules 13a-15(b) of theSecurities Exchange Act of 1934 (the “Exchange Act”).  Based upon that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that the Company’s disclosurecontrols and procedures are effective to ensure that information that isrequired to be disclosed by the Company in reports that it files under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the rules of the Securities and Exchange Commission.

 

*Changesin Internal Controls*

 

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

 

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**PART II – OTHER INFORMATION**

 

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

 

The Company and each of its 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 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 onMarch 30, 2005 (the “Board”).  Thelawsuit claims the directors have breached their fiduciary duties to 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. patentno. 6,826,298.

 

# **Item2.**            Unregistered Sales of Equity Securities 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          |   |

 

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(1)      Pursuant to a Redemption Agreement between the Company andMichael Plisinski, Vice President of Engineering, the Company repurchased theshares at a price equal to 90% of the closing price of the Company’s stock onthe day preceding the repurchase date. There is no agreement to repurchase additional shares.

 

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

 

The Company held its Annual Meeting of Shareholders onMay 25, 2005 at the Company’s world headquarters at 4900 West 78thStreet, Bloomington, Minnesota.  Of the 17,970,496shares of Common Stock outstanding as of April 13, 2005 (the record date),16,476,676 (92%) were present or represented by proxy at the meeting.

 

1.     The shareholdersapproved the Board of Director’s recommendation for setting the number ofdirectorships at six.  This proposalreceived 14,704,125 votes for and 867,318 votes against, with 905,233 votesabstaining.

 

2.     The shareholderselected Lynn J. Davis and Linda Hall Whitman as Class II Directors,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.     The shareholdersratified the appointment of KPMG LLP as the Company’s independent auditors forthe 2005 fiscal year.  This proposalreceived 14,728,283 votes forand 834,143 votes against, with 914,250 votes abstaining.

 

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

 

The exhibitslisted on the Exhibit Index are filed herewith.

 

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## SIGNATURES

 

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

 

 
|                       | AUGUST TECHNOLOGY CORPORATION |
|----------------------------|------------------------------------|
|                       |                               |
|                       |                               |
| Date:  August 5, 2005 | By:                                | /s/ JEFF L.  O’DELL |   |
|                       | Jeff L. O’Dell                |
|                       | Chief Executive Officer            |
|                       | (Principal Executive  Officer)     |
|                       |                               |
|                       |                               |
| Date:  August 5, 2005 | By:                                | /s/ STANLEY D.  PIEKOS |   |
|                       | Stanley D. Piekos                  |
|                       | Chief Financial Officer            |
|                       | (Principal  Financial Officer)     |
|                       |                               |
|                       |                               |
| Date:  August 5, 2005 | By:                                | /s/ SCOTT A.  GABBARD |   |
|                       | Scott A. Gabbard                   |
|                       | Chief Accounting Officer and       |
|                       | Vice President, Finance            |
|                       | (Principal  Accounting Officer)    |
|                            |                                    |  |  |  |  |  |  |

 

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**SECURITIES AND EXCHANGE COMMISSION**

Washington, D.C.  20549

 

EXHIBIT INDEX TO FORM 10-Q

 
| 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 |

 

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