**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**
| **ý**                                                                                                                                                                                        | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                              |       |                                                                                          |
| **For the quarterly period ended  September 30, 2005**                                                                                                                                            |
|                                                                                                                                                                                              |       |                                                                                          |
| **OR**                                                                                                                                                                                            |
|                                                                                                                                                                                              |       |                                                                                          |
| **o**                                                                                                                                                                                             | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                              |       |                                                                                          |
| **For the transition period from              to             ** |

 

**CommissionFile Number 000-30637**

** **

**(insertcolor logo)**

 

**AUGUSTTECHNOLOGY CORPORATION**

(Exactname of Registrant as specified in its charter)

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

 

**(952) 820-0080**

(Registrant’s telephone number, including area code)

 

**N/A**

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

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.     Yes  ý  No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined by Exchange Act Rule12b-2).  Yes ý  No o

 

As of October 31, 2005,there were 18,294,438 shares of common stock outstanding.

 

 

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**AUGUSTTECHNOLOGY CORPORATION**

 

**TABLE OFCONTENTS**

 
| ** **     | **Description**                                                                                        | ** ** |
|----------------|--------------------------------------------------------------------------------------------------------|------------|
|           |                                                                                                   |       |
| PART I         | FINANCIAL INFORMATION                                                                                  |       |
|           |                                                                                                   |       |
| Item 1.        | Financial  Statements (unaudited)                                                                      |       |
|           |                                                                                                   |       |
|           | Consolidated Balance Sheets as of  September 30, 2005 and December 31, 2004                            |       |
|           |                                                                                                   |       |
|           | Consolidated Statements of  Operations for the three and nine months ended September 30, 2005 and 2004 |       |
|           |                                                                                                   |       |
|           | Consolidated Statements of  Cash Flows for the nine months ended September 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 6.        | Exhibits                                                                                               |       |
|           |                                                                                                   |       |
| SIGNATURES     |                                                                                                   |
|           |                                                                                                   |       |
| EXHIBIT  INDEX |                                                                                                   |

 

2

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**PART I –FINANCIAL INFORMATION**

**Item1.  Financial Statements**

** **

**AUGUSTTECHNOLOGY CORPORATION**

** **

**CONSOLIDATEDBALANCE SHEETS**

**(Inthousands, except share amounts)**

**(Unaudited)**

 
| ** **                                                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                        | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                                                                                                                        | ** ** | ** **        | ** ** | **(Restated)**   | ** ** |
| **ASSETS**                                                                                                                        |       |              |       |             |       |
|                                                                                                                              |       |              |       |             |       |
| Current assets:                                                                                                                   |       |              |       |             |       |
| Cash and cash  equivalents                                                                                                        |       | $                 | 5,866      |             | $          | 5,518 |   |
| Short-term  marketable debt securities                                                                                            |       | 23,391            |       | 28,615           |       |
| Accounts  receivable, net                                                                                                         |       | 13,788            |       | 8,328            |       |
| Inventories                                                                                                                       |       | 21,800            |       | 20,106           |       |
| Inventories at  customers under purchase orders                                                                                   |       | 5,205             |       | 6,704            |       |
| Prepaid expenses  and other current assets                                                                                        |       | 1,474             |       | 2,517            |       |
| Total current  assets                                                                                                             |       | 71,524            |       | 71,788           |       |
|                                                                                                                              |       |              |       |             |       |
| Property and  equipment, net                                                                                                      |       | 6,158             |       | 5,994            |       |
| Long-term  marketable debt securities                                                                                             |       | 10,228            |       | 16,289           |       |
| Purchased  technology, net                                                                                                        |       | 2,742             |       | 3,703            |       |
| Goodwill                                                                                                                          |       | 498               |       | 498              |       |
| Other assets                                                                                                                      |       | 180               |       | 150              |       |
| Total assets                                                                                                                      |       | $                 | 91,330     |             | $          | 98,422 |   |
|                                                                                                                              |       |              |       |             |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                    |       |              |       |             |       |
|                                                                                                                              |       |              |       |             |       |
| Current  liabilities:                                                                                                             |       |              |       |             |       |
| Accounts payable                                                                                                                  |       | $                 | 7,167      |             | $          | 3,291 |   |
| Accrued  compensation                                                                                                             |       | 3,018             |       | 1,636            |       |
| Other accrued  liabilities                                                                                                        |       | 2,240             |       | 2,322            |       |
| Customer  deposits and deferred revenues                                                                                          |       | 4,457             |       | 11,973           |       |
| Total current  liabilities                                                                                                        |       | 16,882            |       | 19,222           |       |
|                                                                                                                              |       |              |       |             |       |
| Other  non-current liabilities                                                                                                    |       | 112               |       | 131              |       |
| Total  liabilities                                                                                                                |       | 16,994            |       | 19,353           |       |
|                                                                                                                              |       |              |       |             |       |
| Commitments and  contingencies (note 9)                                                                                           |       | —            |       | —           |       |
|                                                                                                                              |       |              |       |             |       |
| Shareholders’  equity:                                                                                                       |       |              |       |             |       |
| Common stock, no  par value, 42,000,000 shares authorized, 18,291,638 and 17,839,298 shares  issued and outstanding, respectively |       | 93,023            |       | 90,363           |       |
| Undesignated  capital stock, no par value, 3,000,000 shares authorized, no shares issued or  outstanding                          |       | —            |       | —           |       |
| Accumulated  deficit                                                                                                              |       | (18,449           | )          | (11,188          | )          |
| Accumulated  other comprehensive loss                                                                                             |       | (238              | )          | (106             | )          |
| Total shareholders’  equity                                                                                                  |       | 74,336            |       | 79,069           |       |
| Total  liabilities and shareholders’ equity                                                                                  |       | $                 | 91,330     |             | $          | 98,422 |   |

 

See accompanyingnotes to consolidated financial statements.

 

3

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**AUGUSTTECHNOLOGY CORPORATION**

** **

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                      | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                      | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | ** **                           | ** ** | **(Restated)**                      | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
|                                            |       |                                 |       |                                |       |   |   |   |   |
| Net revenues                                    |       | $                                    | 33,622     |                                | $          | 11,101 |   | $ | 65,407 |   | $ | 45,970 |   |
| Cost of revenues                                |       | 15,174                               |       | 6,376                               |       | 28,951 |   | 21,593 |   |
| Gross profit                                    |       | 18,448                               |       | 4,725                               |       | 36,456 |   | 24,377 |   |
|                                            |       |                                 |       |                                |       |   |   |   |   |
| Selling, general and administrative expenses    |       | 6,268                                |       | 6,202                               |       | 19,842 |   | 16,781 |   |
| Research and development expenses               |       | 3,604                                |       | 3,822                               |       | 10,594 |   | 10,052 |   |
| Operating income (loss)                         |       | 8,576                                |       | (5,299                              | )          | 6,020 |   | (2,456 | ) |
|                                            |       |                                 |       |                                |       |   |   |   |   |
| Merger expenses                                 |       | (734                                 | )          | —                              |       | (13,959 | ) | — |   |
| Interest income                                 |       | 317                                  |       | 204                                 |       | 940 |   | 594 |   |
| Other income                                    |       | —                               |       | 46                                  |       | — |   | 46 |   |
|                                            |       |                                 |       |                                |       |   |   |   |   |
| Income (loss) before provision for income taxes |       | 8,159                                |       | (5,049                              | )          | (6,999 | ) | (1,816 | ) |
| Provision for income taxes                      |       | 162                                  |       | 60                                  |       | 262 |   | 160 |   |
| Net income (loss)                               |       | $                                    | 7,997      |                                | $          | (5,109 | ) | $ | (7,261 | ) | $ | (1,976 | ) |
|                                            |       |                                 |       |                                |       |   |   |   |   |
| Net income (loss) per share:                    |       |                                 |       |                                |       |   |   |   |   |
| Basic                                           |       | $                                    | 0.44       |                                | $          | (0.29 | ) | $ | (0.40 | ) | $ | (0.11 | ) |
| Diluted                                         |       | $                                    | 0.43       |                                | $          | (0.29 | ) | $ | (0.40 | ) | $ | (0.11 | ) |
|                                            |       |                                 |       |                                |       |   |   |   |   |
| Weighted average number of shares:              |       |                                 |       |                                |       |   |   |   |   |
| Basic                                           |       | 18,161                               |       | 17,803                              |       | 18,011 |   | 17,735 |   |
| Diluted                                         |       | 18,567                               |       | 17,803                              |       | 18,011 |   | 17,735 |   |

 

See accompanying notes to consolidated financial statements.

 

4

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**AUGUSTTECHNOLOGY CORPORATION**

** **

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                   | ** ** | ** **                          | ** ** | **(Restated)** | ** ** |
| Cash flows from  operating activities:                                       |       |                                |       |   |   |
| Net loss                                                                     |       | $                                   | (7,261     | ) | $ | (1,976 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                |       |   |   |
| Depreciation and  amortization                                               |       | 3,133                               |       | 1,890 |   |
| Stock-based  compensation                                                    |       | 30                                  |       | 40 |   |
| Provision for  (recovery of) doubtful accounts                               |       | (93                                 | )          | 115 |   |
| Tax benefit from  stock options exercised                                    |       | 37                                  |       | — |   |
| Deferred income  taxes                                                       |       | 9                                   |       | — |   |
| Changes in  operating assets and liabilities:                                |       |                                |       |   |   |
| Accounts  receivable                                                         |       | (5,352                              | )          | (4,914 | ) |
| Inventories                                                                  |       | (1,609                              | )          | (8,484 | ) |
| Inventories at  customers under purchase orders                              |       | 1,499                               |       | (5,158 | ) |
| Prepaid expenses  and other current assets                                   |       | 1,044                               |       | (397 | ) |
| Accounts payable                                                             |       | 2,970                               |       | 752 |   |
| Accrued  compensation                                                        |       | 1,387                               |       | 1,285 |   |
| Other accrued  liabilities                                                   |       | 40                                  |       | 364 |   |
| Customer  deposits and deferred revenues                                     |       | (7,517                              | )          | 8,605 |   |
| Net cash used in  operating activities                                       |       | (11,683                             | )          | (7,878 | ) |
|                                                                         |       |                                |       |   |   |
| Cash flows from  investing activities:                                       |       |                                |       |   |   |
| Proceeds from  maturities of marketable debt securities                      |       | 55,266                              |       | 172,710 |   |
| Purchases of  marketable debt securities                                     |       | (44,053                             | )          | (166,391 | ) |
| Purchases of  property and equipment                                         |       | (1,400                              | )          | (4,703 | ) |
| Investment in  other assets                                                  |       | (217                                | )          | (14 | ) |
| Proceeds from  disposition of property and equipment                         |       | 4                                   |       | — |   |
| Cash paid for  acquisitions                                                  |       | (118                                | )          | (2,300 | ) |
| Net cash  provided by (used in) investing activities                         |       | 9,482                               |       | (698 | ) |
|                                                                         |       |                                |       |   |   |
| Cash flows from  financing activities:                                       |       |                                |       |   |   |
| Net proceeds  from issuances of common stock                                 |       | 2,712                               |       | 2,001 |   |
| Redemption of  common stock                                                  |       | (120                                | )          | — |   |
| Net cash  provided by financing activities                                   |       | 2,592                               |       | 2,001 |   |
|                                                                         |       |                                |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                |       | (43                                 | )          | (20 | ) |
|                                                                         |       |                                |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | 348                                 |       | (6,595 | ) |
| Cash and cash  equivalents at beginning of period                            |       | 5,518                               |       | 10,027 |   |
| Cash and cash  equivalents at end of period                                  |       | $                                   | 5,866      |   | $ | 3,432 |   |
|                                                                         |       |                                |       |   |   |
| Supplemental  cash flow information:                                         |       |                                |       |   |   |
| Cash payments of  income taxes                                               |       | $                                   | (310       | ) | $ | (83 | ) |
| Cash payments  for merger expenses                                           |       | $                                   | (13,553    | ) | $ | — |   |

 

See accompanyingnotes to consolidated financial statements.

 

5

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**AUGUSTTECHNOLOGY CORPORATION**

** **

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER30, 2005**

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

**(Unaudited)**

 

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

 

The accompanying unaudited consolidated financialstatements have been prepared pursuant to the rules and regulations of theSecurities and Exchange Commission. Certain information and footnote disclosures, normally included inconsolidated financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America, have beencondensed or omitted pursuant to such rules and regulations.  In the opinion of the management of AugustTechnology Corporation (collectively with its subsidiaries, the “Company” or “AugustTechnology”), all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included in theconsolidated balance sheet at September 30, 2005, the consolidated statements ofoperations for the three and nine months ended September 30, 2005 and 2004, andthe consolidated statements of cash flows for the nine months ended September30, 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 audited restatedconsolidated financial statements and notes thereto included in the Company’s AmendmentNo. 1 on Form 10-K/A for the year ended December 31, 2004, which is being filedwith the Securities and Exchange Commission concurrently with the filing of this Form10-Q .

 

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

 

Management uses estimates and assumptions in preparingconsolidated financial statements in accordance with accounting principlesgenerally accepted in the United States of America.  Those estimates and assumptions affect thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the consolidated financial statements andthe reported revenues and expenses during the reporting periods.  Actual results could differ from thoseestimates.

 

**Note 2 – Restatement of Prior Period FinancialStatements**

 

We have restated ourconsolidated financial statements for the years 2004, 2003 and 2002 and for thefirst two quarters of 2005 (the “Restatement”). In addition, certaindisclosures in Notes 4, 6, 7, 10, 12 and 13 to the consolidated financialstatements contained in this report have been restated to reflect theRestatement adjustments.  Our restatedconsolidated financial statements also include disclosure of restated unauditedquarterly results for 2004 and 2003.  Theinitial determination to restate the 2004 and first half 2005 consolidatedfinancial statements was made as a result of a correction of the Company’sapplication of revenue recognition principles, as contained in the FinancialAccounting Standard Board’s Emerging Issues Task Force Issue No. 00-21, “*Revenue Arrangements with Multiple Deliverables*” (“EITF00-21”).  As a result of subsequentlyreviewing our revenue recognition policies and procedures, we additionallynoted that beginning in the fourth quarter of 2002 certain deferred softwarerevenue should have been fully recognized upon delivery or customer acceptancerather than ratably over a twelve-month period. This created the need 

 

6

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to restate our 2002 and 2003 consolidatedfinancial statements.  Certainadjustments were recorded to each quarter in 2004 and first two quarters of2005 to correct other miscellaneous items identified in prior external auditsor quarterly reviews but were previously passed, none of which wereindividually significant.

 

In 2004 and the first halfof 2005, the Company sold AXi 930 systems to a customer for an aggregate amountof approximately $12.2 million ($6.7 million in 2004, $3.1 million in the firstquarter of 2005 and $2.4 million in the second quarter of 2005) and recognizedthe revenue for these sales.  The cost ofrevenues related to these sales was $2.7 million in 2004, $1.5 million in thefirst quarter of 2005 and $1.2 million in the second quarter of 2005.  For the first nine months of 2004, therevenue from these sales was $2.2 million in the second quarter and $4.4million in the third quarter.  Relatedcosts of revenues in 2004 were $0.9 million in the second quarter and $1.8million in the third quarter.  During thesame time periods, the Company accepted orders from the same customer forenhancement packages to the AXi 930 system but had not yet delivered theenhancement packages.  In connection withpreparing to finalize its results for the quarter ended September 30, 2005, theCompany determined that recognition of the $12.2 million of revenue from theAXi 930 systems should have been deferred until the delivery of the enhancementpackages, according to EITF 00-21.  Thecustomer cancelled its orders for the enhancement packages on September 27,2005, which allowed the Company to recognize the entire $12.2 million of AXi930 deferred revenue in the quarter ended September 30, 2005.

 

In the fourth quarter of2002, the Company began deferring Yield Pilot software revenue and recognizingit over a twelve-month period which represented the Company’s obligation toprovide warranty and support.  TheCompany determined based on a subsequent review of Statement of Position 97-2, “*SoftwareRevenue Recognition*” that Yield Pilot software revenues should havebeen recognized upon delivery or customer acceptance.  The correction of this error had nosignificant impact on revenues for the three months ended June 30, 2005 anddecreased revenue by $0.3 million for the three months ended March 31, 2005. Thecorrection increased revenue by $0.4 million for each of the first two quartersin 2004 and had no impact on cost of revenues. The correction increased revenue by $0.9 million, $0.5 million and $0.2million for 2004, 2003 and 2002, respectively and had no impact on costs ofrevenues.

 

Inthe second quarter of 2005, the Company recognized $0.6 million in revenue and$0.2 million in cost of revenue related to the sale of an NSX 105 inspectionsystem.  It was subsequently determinedthat this revenue should have been deferred until the newly introduced softwarecomponent of this bundled transaction was completed and delivered.  This revenue and related cost of revenue hasbeen corrected as part of the restatement of the second quarter of 2005.  The Company expects to realize revenue on the completedtransaction in the fourth quarter of 2005 when all elements will be deliveredand accepted and fair value has been established for the newly introducedsoftware component.

 

The impact of theRestatement on the consolidated statements of operations for the three-monthand nine-month periods ended September 30, 2004 is shown in an accompanyingtable.  The primary impact of theRestatement on the consolidated balance sheet at December 31, 2004 was toincrease inventory at customers under purchase orders related to the deferralof the cost of revenue and to increase customer deposits and deferred revenuesrelated to cash collected for revenue deferred in the Restatement.  The Restatement had no impact on cash balancesor net cash flows from operating, investing, or financing activities.  The impact of the Restatement on theconsolidated statement of cash flows for the nine months ended September 30,2004 is shown in an accompanying table.

 

7

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**The following table presents the effect of the Restatement onthe consolidated statements of operations:**

 
| ** **                                                                          | ** ** | **Three Months Ended September 30, 2004** | ** ** | **Nine Months Ended September 30, 2004** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                          | ** ** | **As**                                    | ** ** | ** **                               | ** ** | ** ** | ** ** | **As** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                          | ** ** | **Previously**                            | ** ** | ** **                               | ** ** | **As** | ** ** | **Previously** | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                          | ** ** | **Reported**                              | ** ** | **Adjustments**                          | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Net revenues                                                                        |       | $                                         | 15,516     |                                     | $          | (4,415 | ) | $ | 11,101 |   | $ | 51,771 |   | $ | (5,801 | ) | $ | 45,970 |   |
| Cost of revenues                                                                    |       | 8,187                                     |       | (1,811                                   | )          | 6,376 |   | 24,304 |   | (2,711 | ) | 21,593 |   |
| Gross profit                                                                        |       | 7,329                                     |       | (2,604                                   | )          | 4,725 |   | 27,467 |   | (3,090 | ) | 24,377 |   |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Selling, general  and administrative expenses                                       |       | 6,202                                     |       | —                                   |       | 6,202 |   | 16,781 |   | — |   | 16,781 |   |
| Research and  development expenses                                                  |       | 3,822                                     |       | —                                   |       | 3,822 |   | 10,052 |   | — |   | 10,052 |   |
| Operating income  (loss)                                                            |       | (2,695                                    | )          | (2,604                                   | )          | (5,299 | ) | 634 |   | (3,090 | ) | (2,456 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest income                                                                     |       | 204                                       |       | —                                   |       | 204 |   | 594 |   | — |   | 594 |   |
| Other income                                                                        |       | 46                                        |       | —                                   |       | 46 |   | 46 |   | — |   | 46 |   |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Income (loss)  before provision for income taxes                                    |       | (2,445                                    | )          | (2,604                                   | )          | (5,049 | ) | 1,274 |   | (3,090 | ) | (1,816 | ) |
| Provision for  income taxes                                                         |       | —                                    |       | 60                                       |       | 60 |   | 100 |   | 60 |   | 160 |   |
| Net income  (loss)                                                                  |       | $                                         | (2,445     | )                                        | $          | (2,664 | ) | $ | (5,109 | ) | $ | 1,174 |   | $ | (3,150 | ) | $ | (1,976 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Net income  (loss) per share:                                                       |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                               |       | $                                         | (0.14      | )                                        | (0.15      | ) | $ | (0.29 | ) | $ | 0.07 |   | (0.18 | ) | $ | (0.11 | ) |
| Diluted                                                                             |       | $                                         | (0.14      | )                                        | (0.15      | ) | $ | (0.29 | ) | $ | 0.06 |   | (0.17 | ) | $ | (0.11 | ) |
|                                                                                |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Weighted average  shares outstanding used to calculate net income (loss) per share: |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                               |       | 17,803                                    |       | —                                   |       | 17,803 |   | 17,735 |   | — |   | 17,735 |   |
| Diluted                                                                             |       | 17,803                                    |       | —                                   |       | 17,803 |   | 18,345 |   | (610 | ) | 17,735 |   |

 

8

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

 
| ** **                                                                            | ** ** | **Nine Months Ended September 30, 2004** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                            | ** ** | **As Previously**                        | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                            | ** ** | **Reported**                             | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                                |       |                                     |       |   |   |   |   |
| Net income  (loss)                                                                    |       | $                                        | 1,174      |   | $ | (3,150 | ) | $ | (1,976 | ) |
| Adjustments to  reconcile net income (loss) to net cash used in operating activities: |       |                                     |       |   |   |   |   |
| Depreciation and  amortization                                                        |       | 1,890                                    |       | — |   | 1,890 |   |
| Stock based  compensation                                                             |       | 40                                       |       | — |   | 40 |   |
| Provision for  doubtful accounts                                                      |       | 115                                      |       | — |   | 115 |   |
| Changes in  operating assets and liabilities, net of effect of acquisitions:          |       |                                     |       |   |   |   |   |
| Accounts  receivable                                                                  |       | (7,213                                   | )          | 2,299 |   | (4,914 | ) |
| Inventories                                                                           |       | (8,484                                   | )          | — |   | (8,484 | ) |
| Inventories at  customers under purchase orders                                       |       | (2,448                                   | )          | (2,710 | ) | (5,158 | ) |
| Prepaid expenses  and other current assets                                            |       | (397                                     | )          | — |   | (397 | ) |
| Accounts payable                                                                      |       | 1,052                                    |       | (300 | ) | 752 |   |
| Accrued  compensation                                                                 |       | 1,285                                    |       | — |   | 1,285 |   |
| Other accrued  liabilities                                                            |       | 304                                      |       | 60 |   | 364 |   |
| Customer  deposits and deferred revenues                                              |       | 4,804                                    |       | 3,801 |   | 8,605 |   |
| Net cash used in  operating activities                                                |       | (7,878                                   | )          | — |   | (7,878 | ) |
|                                                                                  |       |                                     |       |   |   |   |   |
| Cash flows from  investing activities:                                                |       |                                     |       |   |   |   |   |
| Proceeds from  maturities of marketable debt securities                               |       | 172,710                                  |       | — |   | 172,710 |   |
| Purchases of  marketable debt securities                                              |       | (166,391                                 | )          | — |   | (166,391 | ) |
| Purchases of  property and equipment                                                  |       | (4,703                                   | )          | — |   | (4,703 | ) |
| Investments in  other assets                                                          |       | (14                                      | )          | — |   | (14 | ) |
| Cash paid for  acquistions                                                            |       | (2,300                                   | )          | — |   | (2,300 | ) |
| Net cash used in  investing activities                                                |       | (698                                     | )          | — |   | (698 | ) |
|                                                                                  |       |                                     |       |   |   |   |   |
| Cash flows from  financing activities:                                                |       |                                     |       |   |   |   |   |
| Net proceeds  from issuances of common stock                                          |       | 2,001                                    |       | — |   | 2,001 |   |
| Net cash  provided by financing activities                                            |       | 2,001                                    |       | — |   | 2,001 |   |
|                                                                                  |       |                                     |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                                |       | (20                                      | )          | — |   | (20 | ) |
| Net decrease in  cash and cash equivalents                                            |       | (6,595                                   | )          | — |   | (6,595 | ) |
| Cash and cash  equivalents at beginning of year                                       |       | 10,027                                   |       | — |   | 10,027 |   |
| Cash and cash  equivalents at end of year                                             |       | $                                        | 3,432      |   | $ | — |   | $ | 3,432 |   |

 

9

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**Note 3 – Business Combinations**

 

On January 21, 2005, the Company 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 the Company’s common stock was to be converted into theright to receive 0.6401 of a share of August Nanometrics common stock.  On June 27, 2005, the Company and Nanometricsterminated the Nanometrics Merger Agreement. In accordance with the terms of the Nanometrics Merger Agreement, theCompany paid Nanometrics a termination fee of $8.3 million, and reimbursed $2.6million of merger related expenses.

 

On June 27, 2005, the Company entered into anAgreement and Plan of Merger (the “Rudolph Merger Agreement”) with RudolphTechnologies, Inc. (“Rudolph”) and NS Merger Sub, Inc.  Under the terms of the Rudolph MergerAgreement each of the Company’s shareholders will have the option to elect toreceive either $10.50 per share in cash or 0.7625 of a share of Rudolph commonstock, subject to proration and allocation, based on the total cash and sharesavailable in the merger. The agreement requires that the total considerationfor the transaction will include a minimum of $37,200 and a maximum of $60,000of cash subject to shareholder election. The aggregate consideration was approximately $193,000 as of June 27,2005.

 

**Note 4 – Stock-BasedCompensation**

 

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

 

The estimated per shareweighted average fair value of all stock options granted during the threemonths ended September 30, 2005 and 2004 was $7.50 and $6.01, respectively, and forthe nine months ended September 30, 2005 and 2004 was $6.86 and $8.10, respectively. The fair value of each option grant was estimated using the Black-Scholesoption pricing model with the following weighted average assumptions:

 
| ** **               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **               | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                     |       |                                 |       |                                |       |   |   |   |   |
| Expected life            |       | 4.8 years                            |       | 4.7 years                           |       | 4.7 years |   | 4.5 years |   |
| Risk free  interest rate |       | 4.1                                  | %          | 3.0                                 | %          | 3.9 | % | 2.9 | % |
| Volatility               |       | 71.7                                 | %          | 73.8                                | %          | 73.1 | % | 74.0 | % |
| 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:

 

10

----

 
| ** **                                                                                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                          | ** ** | ** **                           | ** ** | **(Restated)**                      | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
|                                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Net income  (loss), as reported                                                                     |       | $                                    | 7,997      |                                | $          | (5,109 | ) | $ | (7,261 | ) | $ | (1,976 | ) |
|                                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Add:                                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Stock-based  employee compensation expense included in net income (loss), as reported               |       | —                               |       | —                              |       | 30 |   | — |   |
| Deduct:                                                                                             |       |                                 |       |                                |       |   |   |   |   |
| Stock-based  employee compensation expense determined under fair value based method for  all awards |       | (406                                 | )          | (629                                | )          | (1,748 | ) | (2,303 | ) |
| Net income  (loss), pro forma                                                                       |       | $                                    | 7,591      |                                | $          | (5,738 | ) | $ | (8,979 | ) | $ | (4,279 | ) |
|                                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Net income  (loss) per share:                                                                       |       |                                 |       |                                |       |   |   |   |   |
| As reported:                                                                                        |       |                                 |       |                                |       |   |   |   |   |
| Basic                                                                                               |       | $                                    | 0.44       |                                | $          | (0.29 | ) | $ | (0.40 | ) | $ | (0.11 | ) |
| Diluted                                                                                             |       | $                                    | 0.43       |                                | $          | (0.29 | ) | $ | (0.40 | ) | $ | (0.11 | ) |
|                                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Pro forma:                                                                                          |       |                                 |       |                                |       |   |   |   |   |
| Basic                                                                                               |       | $                                    | 0.42       |                                | $          | (0.32 | ) | $ | (0.50 | ) | $ | (0.24 | ) |
| Diluted                                                                                             |       | $                                    | 0.41       |                                | $          | (0.32 | ) | $ | (0.50 | ) | $ | (0.24 | ) |

 

On March 30, 2005, theboard of directors authorized the Company to enter into an agreement to grant175,000 nonqualified stock options to the Company’s President and ChiefOperating Officer upon acceptance 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 valueon the date of grant, and vest ratably over five years from the date ofgrant.  In the event of a change incontrol, the board of directors may provide for the acceleration of vesting ofthe options.

 

**Note 5 – Marketable DebtSecurities**

 

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

 
| ** **      | ** ** | **September 30, 2005** | ** ** |
|-----------------|------------|------------------------|------------|
| ** **      | ** ** | ** **             | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **      | ** ** | **Amortized**          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **      | ** ** | **Cost**               | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Corporate bonds |       | $                      | 11,024     |   | $ | 1 |   | $ | (66 | ) | $ | 10,959 |   |
| Municipal bonds |       | 22,772                 |       | 1 |   | (113 | ) | 22,660 |   |
|            |       | $                      | 33,796     |   | $ | 2 |   | $ | (179 | ) | $ | 33,619 |   |

 
| ** **      | ** ** | **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 |   |

 

11

----

 

The maturities of available-for-sale marketable debt securities were asfollows:

 
| ** **                              | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **Amortized**          | ** ** | **Fair**              | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                              | ** ** | **Cost**               | ** ** | **Value**             | ** ** | **Cost** | ** ** | **Value** | ** ** |
| Due within one  year                    |       | $                      | 23,454     |                  | $          | 23,391 |   | $ | 28,662 |   | $ | 28,615 |   |
| Due after one  year through three years |       | 9,442                  |       | 9,343                 |       | 13,349 |   | 13,289 |   |
| Due after three  years                  |       | 900                    |       | 885                   |       | 3,000 |   | 3,000 |   |
|                                    |       | $                      | 33,796     |                  | $          | 33,619 |   | $ | 45,011 |   | $ | 44,904 |   |

 

Net realized gains and losses were not material forthe nine months ended September 30, 2005 and 2004.

 

**Note 6 – Accounts Receivable**

 

Accounts receivable consisted of the following:

 
| ** **                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                       | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                       | ** ** | ** **        | ** ** | **(Restated)**   | ** ** |
| Billed  receivables              |       | $                 | 11,626     |             | $          | 7,994 |   |
| Unbilled revenue                 |       | 2,857             |       | 1,024            |       |
|                             |       | 14,483            |       | 9,018            |       |
| Allowance for  doubtful accounts |       | (695              | )          | (690             | )          |
| Accounts  receivable, net        |       | $                 | 13,788     |             | $          | 8,328 |   |

 

**Note 7 – Inventories**

 

Inventories consisted of the following:

 
| ** **               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-------------------|------------|------------------|------------|
| ** **               | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **               | ** ** | ** **        | ** ** | **(Restated)**   | ** ** |
| Raw materials            |       | $                 | 11,154     |             | $          | 8,449 |   |
| Work in process          |       | 4,089             |       | 3,558            |       |
| Demonstration  equipment |       | 4,361             |       | 4,152            |       |
| Finished Goods           |       | 2,196             |       | 3,947            |       |
| Inventories              |       | $                 | 21,800     |             | $          | 20,106 |   |

 

**Note 8 – Purchased Technology**

 

Purchased technology was as follows:

 
| ** **                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                      | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Purchased  technology           |       | $                 | 4,769      |             | $          | 4,651 |   |
| Less:  accumulated amortization |       | (2,027            | )          | (948             | )          |
| Purchased  technology, net      |       | $                 | 2,742      |             | $          | 3,703 |   |

 

Purchased technology increased $118 for the ninemonths ended September 30, 2005 due to contingent consideration paid for theDMSVision acquisition discussed in Note 9 below.

 

12

----

 

Amortization expense for the nine months ended September 30, 2005 and 2004was $1,079 and $361, respectively.  Assuming no additional change in thegross carrying value of purchased technology, the estimated amortizationexpense for the twelve months ending December 31, 2005 is $1,435 and for eachof the next four fiscal years is $1,208, $800, $378 and none.

 

In December 2004, the Company purchased certaintechnology from Excelerate Technologies, Inc. (“Excelerate”).  The total consideration paid was $800, whichincluded the forgiveness of a $500 convertible note receivable from Excelerateand $300 of cash, of which $150 was paid in January 2005.

 

**Note 9 – Commitments andContingencies**

 

***Warranties***

 

The Company provideswarranty coverage for its systems for a period of one year, including parts andlabor necessary to repair the systems during the warranty period.  The estimated warranty cost is based on theCompany’s historical experience rate of incurred expenses to correspondingsystem revenues.

 

The following tablesummarizes the activity related to the warranty liability during the ninemonths ended September 30, 2005 and 2004:

 
| ** **                    | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| Accrual at  beginning of year |       | $                                   | 942        |   | $ | 239 |   |
| Warranties  issued            |       | 702                                 |       | 955 |   |
| Costs incurred                |       | (498                                | )          | (553 | ) |
| Accrual at end  of period     |       | $                                   | 1,146      |   | $ | 641 |   |

 

***Separation Agreements***

 

During the nine monthsended September 30, 2005 the Company entered into separation agreements withcertain executives and other employees that resulted in an expense of $1,062,of which $141 was paid as of September 30, 2005.  The separation agreements require substantially all of the severancebenefits to be paid by September 30, 2006.

 

***Contingent Consideration***

 

In connection with theJuly 27, 2004 acquisition of the DMSVision software division of Inspex, Inc (“DMSVision”), theCompany is subject to a contingent consideration arrangement at September 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 topurchased technology in 2004 and 2005, respectively, all of which was paid asof September 30, 2005.

 

13

----

 

***Legal Proceedings***

 

From time to time in the ordinary course ofbusiness, the Company is subject to claims, asserted or unasserted, or named asa party to lawsuits or investigations.  Litigation,in general, and intellectual property and securities litigation in particular,can be expensive and disruptive to normal business operations.  Moreover, the results of legal proceedingscannot be predicted with any certainty and in the case of more complex legalproceedings such as intellectual property and securities litigation, theresults are difficult to predict at all.

 

***Shareholder actions.******   ***On February 4, 2005, AugustTechnology received a summons and complaint with respect to a purported classaction lawsuit naming Robert Etem as the plaintiff and on February 14, 2005August Technology received a summons and complaint with respect to a similarpurported class action lawsuit naming John Silliman as the plaintiff.  Mr. Etem is the owner of 4,200 shares of theCompany’s common stock.  The Company doesnot know how many shares Mr. Silliman owns. Both lawsuits named as defendants August Technology Corporation and eachof its directors, Jeff O’Dell, James Bernards, Roger Gower, Michael Wright andLinda Hall Whitman.  Both lawsuits werebrought in Minnesota State Court and claimed that the directors had breachedtheir fiduciary duties to our shareholders in connection with their actions inagreeing to the proposed merger with Nanometrics Incorporated.  The plaintiffs in both actions sought variousforms of injunctive relief including an order enjoining the Company and itsdirectors from consummating the merger with Nanometrics.

 

The two proceedings were consolidated and heard as one case.  On April 19, 2005, the Court issued a 30 daystay of all proceedings.  On April 27,2005, the plaintiffs scheduled a hearing on a motion to amend the complaint.  The hearing was scheduled for June 9,2005.  On May 10, 2005 the Court issuedan order dismissing the complaint for asserting derivative claims withoutcomplying with the rules governing derivative actions.  Thereafter the Court removed the hearing fromthe calendar.  Although the February 2005claims initiated by Mr. Etem and Mr. Silliman were dismissed, both Mr. Etem andMr. Silliman have filed more recent claims as described below.

 

On July 18, 2005, a purported shareholder class actionnaming Mr. Etem as plaintiff and asserting derivative claims was filed inMinnesota state court against the Company and the individual members of theAugust Technology board of directors named above, as well as Lynn J. Davis, whojoined the board on March 30, 2005.  Thelawsuit claims the directors have breached their fiduciary duties to the Company’sshareholders in connection with their actions in approving the merger agreementwith Nanometrics, Inc. and subsequently terminating that merger agreement andentering into a new merger agreement with Rudolph Technologies, Inc.  Mr. Etem seeks various forms of injunctiverelief including an order enjoining the Company and the directors fromconsummating the proposed merger with Rudolph.

 

On August 1, 2005, a second purported shareholderclass action naming Mr. Silliman as plaintiff and asserting derivative claimswas filed in Minnesota state court against the Company and the individualmembers of the August Technology board of directors. This second lawsuit alsoclaims the directors have breached their fiduciary duties to the Company’sshareholders in connection with their actions in approving the merger agreementwith Nanometrics, Inc. and subsequently terminating that merger agreement andentering into a new merger agreement with Rudolph Technologies, Inc.  Mr. Silliman likewise seeks various forms of injunctiverelief including an order enjoining the Company and the directors fromconsummating the proposed merger with Rudolph.

 

14

----

 

Mr. Silliman served the Company with an amendedcomplaint on August 31, 2005, and changed the case from a derivative actionbrought on the Company’s behalf, to a class action asserting direct claimsagainst the Company and the individual members of the August Technology Boardof Directors.  Mr. Etem also served theCompany with an amended complaint on August 31, 2005, but his allegations remain derivative in nature.  Both the Silliman claims and the Etem claimswill be heard by the same judge.  Thedefendants’ motions to dismiss both cases are scheduled to be heard on November8, 2005.  August Technology and itsdirectors believe the lawsuits are without merit and plan to vigorously defendagainst the claims. The Company does not believe these lawsuits will have amaterial impact on the Company’s consolidated financial position orconsolidated results of operations.

 

***Patent protection lawsuit.   ***On July 14, 2005, theCompany filed a patent infringement lawsuit against Camtek, Ltd. of MigdalHaemek, Israel.  The patent infringementlawsuit, filed in U.S. federal court in Minneapolis, alleges that Camtek’s lineof inspection equipment sold under the “Falcon” trademark infringes on theCompany’s U.S. patent no. 6,826,298. The Company does not believe this claimwill have a material impact on the Company’s consolidated financial position orconsolidated results of operations.

 

***Compensation claim.   ***OnAugust 22, 2005, a claim was filed in Massachusetts State Court by three formeremployees of Excelerate Technologies, LLC against the Company and six otherdefendants unrelated to the Company seeking unpaid wages and othercompensation.  The Company is a party toa Software License Agreement with Excelerate Technologies, LLC but has neveremployed the plaintiffs in the lawsuit and denies any liability for the unpaidwages of the plaintiffs.  The plaintiffsseek treble damages for an aggregate amount of $220,774 in unpaid wages as wellas compensatory and punitive damages and attorney’s fees.The Company does notbelieve this claim will have a material impact on the Company’s consolidatedfinancial position or consolidated results of operations.

 

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

 

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

 
| ** **                                     | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | ** **                           | ** ** | **(Restated)**                      | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| Net income  (loss)                             |       | $                                    | 7,997      |                                | $          | (5,109 | ) | $ | (7,261 | ) | $ | (1,976 | ) |
|                                           |       |                                 |       |                                |       |   |   |   |   |
| Weighted average  common shares:               |       |                                 |       |                                |       |   |   |   |   |
| Basic                                          |       | 18,161                               |       | 17,803                              |       | 18,011 |   | 17,735 |   |
| Effect of  dilutive stock options and warrants |       | 406                                  |       | —                              |       | — |   | — |   |
| Diluted                                        |       | 18,567                               |       | 17,803                              |       | 18,011 |   | 17,735 |   |
|                                           |       |                                 |       |                                |       |   |   |   |   |
| Net income  (loss) per share:                  |       |                                 |       |                                |       |   |   |   |   |
| Basic                                          |       | $                                    | 0.44       |                                | $          | (0.29 | ) | $ | (0.40 | ) | $ | (0.11 | ) |
| Diluted                                        |       | $                                    | 0.43       |                                | $          | (0.29 | ) | $ | (0.40 | ) | $ | (0.11 | ) |

 

The total weighted average number of stock options andwarrants excluded from the calculation of potentially dilutive securitieseither due to the exercise price exceeding the average market price or theinclusion of such securities in a calculation of net income (loss) per share wouldhave been anti-dilutive for the three months ended September 30, 2005 and 2004were 456 and 1,710, respectively, and for the nine months ended September 30,2005 and 2004 were 1,882 and 1,652, respectively.

 

15

----

 

**Note 11 – Accumulated Other Comprehensive Loss**

 

The accumulated balances foreach classification of accumulated other comprehensive loss are as follows:

 
| ** **                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                           | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Currency  translation adjustments                    |       | $                 | (61        | )                | $          | 1 |   |
| Net unrealized  losses on marketable debt securities |       | (177              | )          | (107             | )          |
| Accumulated  other comprehensive loss                |       | $                 | (238       | )                | $          | (106 | ) |

 

16

----

 

**Note 12 – Shareholders’ Equity**

 

Changes in shareholders’ equity during the nine monthsended September 30, 2005 were as follows:

 
| Shareholders’  equity balance at December 31, 2004 (Restated) |   | $      | 79,069 |   |
|--------------------------------------------------------------------|--------|--------|--------|--------|
| Net loss                                                           |   | (7,261 | )      |
| Accumulated  other comprehensive loss:                             |   |   |   |
| Foreign currency  translation adjustment                           |   | (62    | )      |
| Net unrealized  loss on marketable debt securities                 |   | (70    | )      |
| Comprehensive  loss                                                |   | (7,393 | )      |
| Issuances of  common stock in conjunction with:                    |   |   |   |
| Exercises of  stock options                                        |   | 2,590  |   |
| Employee stock  purchase plan                                      |   | 123    |   |
| Redemption of  common stock                                        |   | (120   | )      |
| Tax benefit from  stock options exercised                          |   | 37     |   |
| Stock-based  compensation                                          |   | 30     |   |
| Shareholders’  equity balance at September 30, 2005           |   | $      | 74,336 |   |

 

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 a Shareholder Rights Plan to protect shareholders fromcoercive or otherwise unfair takeover tactics and to protect the interests ofthe Company’s shareholders.  Pursuant tothe Rights Agreement relating to the Shareholder Rights Plan, the Board hasdeclared a dividend of one preferred share purchase right (a “Right”) for eachshare of common stock outstanding at the close of business on June 27,2005.  In general terms, the RightsAgreement works by imposing a significant penalty upon any person or group thatacquires 10% or more of the Company’s outstanding common stock without theapproval of the Board.  The Company doesnot believe the Rights Agreement will interfere with any merger or otherbusiness combination approved by the Board.

 

Each Right will allow its holder to purchase from the Company oneone-thousandth of a share of Series A Junior Participating Preferred Stock for$27.00 once the Rights become exercisable. The Rights will not be exercisable until fifteen days after the publicannouncement that a person or group has become an “Acquiring Person” byobtaining beneficial ownership of 10% or more of the Company’s outstandingcommon stock, or, if earlier, fifteen business days after a person or groupbegins a tender or exchange offer which, if completed, would result in thatperson or group becoming an Acquiring Person. If a person or group becomes an Acquiring Person, all holders of Rightsexcept the Acquiring Person, may, for $27.00 purchase shares of the Company’s commonstock with a market value of $54.00, based on the market price of the commonstock prior to such acquisition.  Inaddition, if the Company is later acquired in a merger or similar transactionafter the Rights have become exercisable and a person or group is, or becomes,an Acquiring Person, all holders of Rights except the Acquiring Person may, for$27.00, purchase shares of the

 

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

 

The percentage of netrevenues derived from major customers was as follows:

 
| ** **    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **    | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **    | ** ** | ** **                           | ** ** | **(Restated)**                      | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| Net revenues: |       |                                 |       |                                |       |   |   |   |   |
| Customer A    |       | 40                                   | %          |                                | *          | 23 | % |   | *  |
| Customer B    |       |                                 | *     | 15                                  | %          |   | * | 11 | % |
| Customer C    |       |                                 | *     | 14                                  | %          |   | *  | 10 | % |
| Customer D    |       |                                 | *     | 11                                  | %          |   | *  | 11 | % |
|          |       | 40                                   | %          | 40                                  | %          | 23 | % | 32 | % |

 

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

 

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

 
| ** **           | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **           | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **           | ** ** | ** **                           | ** ** | **(Restated)**                      | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| Net revenues:        |       |                                 |       |                                |       |   |   |   |   |
| NSX Series           |       | 41                                   | %          | 55                                  | %          | 49 | % | 56 | % |
| All Surface  Systems |       | 46                                   | %          | 17                                  | %          | 31 | % | 14 | % |
| 3Di Series           |       | 2                                    | %          | 5                                   | %          | 4 | % | 8 | % |
| Other                |       | 11                                   | %          | 23                                  | %          | 16 | % | 22 | % |
|                 |       | 100                                  | %          | 100                                 | %          | 100 | % | 100 | % |

 

All of the Company’stangible long-lived assets are located in the United States, except for aninsignificant amount of property and equipment in Taiwan and South Korea.  The Company derives revenues from shipmentsto customers outside of the United States. The percentage of net revenues by the geographic region in which thecustomer is located was as follows:

 
| ** **    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **    | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **    | ** ** | ** **                           | ** ** | **(Restated)**                      | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| Net revenues: |       |                                 |       |                                |       |   |   |   |   |
| United States |       | 8                                    | %          | 30                                  | %          | 12 | % | 30 | % |
| Taiwan        |       | 26                                   | %          | 39                                  | %          | 36 | % | 37 | % |
| South Korea   |       | 40                                   | %          | 2                                   | %          | 24 | % | 10 | % |
| Europe        |       | 6                                    | %          | 16                                  | %          | 14 | % | 5 | % |
| Japan         |       | 3                                    | %          | 6                                   | %          | 3 | % | 5 | % |
| Rest of Asia  |       | 17                                   | %          | 7                                   | %          | 11 | % | 13 | % |
|          |       | 100                                  | %          | 100                                 | %          | 100 | % | 100 | % |

 

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**Note 14 – Recent AccountingPronouncements **

 

In June 2005, the Financial Accounting Standards Board (“FASB”) issued Statementof Financial Accounting 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 expected tohave a material effect on the Company’s financial position, results ofoperations or cash flows.

 

In March 2005, the FASB issued FASB Interpretation No. 47, “*Accounting for Conditional Asset Retirement Obligations*,”which is an interpretation of SFAS No. 143, “*Accountingfor Asset Retirement Obligations*.”  The interpretation requiresa liability 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 FASBissued SFAS No. 123 (Revised 2004), “*Share-Based Payment.”*  SFAS No. 123R is a revision of SFAS No. 123, *“Accounting for Stock-Based Compensation”* and supersedesAccounting Principles Board (“APB”) Opinion No. 25, “*Accountingfor Stock Issued to Employees*” and its related implementationguidance.  SFAS No. 123R focusesprimarily on accounting for transactions in which an entity obtains employeeservices through share-based payment transactions.  SFAS No. 123R requires a public entity tomeasure the cost of employee services received in exchange for the award ofequity instruments based on the fair value of the award at the date of grant.  The cost will be recognized over the periodduring which an employee is required to provide services in exchange for theaward.  The SEC issued guidance in April2005 announcing that public companies will be required to adopt SFAS No. 123Rby their first fiscal year beginning after June 15, 2005.  While the Company cannot precisely determinethe impact on net earnings as a result of the adoption of SFAS No. 123R,estimated compensation expense related to prior periods can be found in Note 4,“Stock-Based Compensation.”  The ultimateamount of increased compensation expense will be dependent on whether theCompany adopts SFAS No. 123R using the modified prospective or retrospectivemethod, the number of option shares granted during the year, their timing andvesting period, and the method used to calculate the fair value of the awards,among other factors the Company is currently assessing.

 

In November 2004, the FASBissued SFAS No. 151, “*Inventory Costs - anamendment of ARB No. 43, Chapter 4*.”  SFAS No. 151 clarifiesthe accounting for abnormal amounts of idle facility expenses, freight,handling costs, and spoilage.  It alsorequires that allocation of fixed production overheads to inventory be based onthe normal capacity of production facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005.  Adoptionof SFAS No. 151 is not expected to have a material effect on the Company’sfinancial position, results of operations or cash flows.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial 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 Amendment No. 1on Form 10-K/A for the year ended December 31, 2004, which is beingfiled with the SEC concurrently with this Form 10-Q.  We disclaim any obligation to reviseforward-looking statements, or to update the reasons actual results coulddiffer materially from those anticipated, to reflect events or circumstancesafter the date of such statements or to reflect the occurrence of anticipatedor unanticipated events.  Because manyfactors are unforeseeable, the foregoing should not be considered an exhaustivelist.

 

**Introduction**

 

The following discussionof our results of operations and financial condition should be read togetherwith the other financial information and consolidated financial statements andrelated notes included in this Form 10-Q. 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.

 

**Restatement of Prior PeriodFinancial Statements**

 

We have restated our consolidated financial statements for the years2004, 2003 and 2002 and for the first two quarters of 2005 (the “Restatement”).Our restated consolidated financial statements also include disclosure ofrestated unaudited quarterly results for 2004 and 2003.  The initial determination to restate the 2004and first half 2005 consolidated financial statements was made as a result of acorrection of the Company’s application of revenue recognition principles, ascontained in the Financial Accounting Standard Board’s Emerging Issues TaskForce Issue No. 00-21, “*Revenue Arrangements withMultiple Deliverables*” (“EITF 00-21”).  As a result of subsequently reviewing our revenuerecognition policies and procedures, we additionally noted that beginning inthe fourth quarter of 2002 certain deferred software revenue should have beenfully recognized upon delivery or customer acceptance rather than ratably overa twelve-month period.  This created theneed to restate our 2002 and 2003 consolidated financial statements.  Certain adjustments were recorded to eachquarter in 2004 and first two quarters of 2005 to correct other miscellaneousitems identified in prior external audits or quarterly reviews but werepreviously passed, none of which were individually significant.

 

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In 2004 and the first half of 2005, the Company sold AXi 930 systems toa customer for an aggregate amount of approximately $12.2 million ($6.7 millionin 2004, $3.1 million in the first quarter of 2005 and $2.4 million in thesecond quarter of 2005) and recognized the revenue for these sales.  The cost of revenues related to these saleswas $2.7 million in 2004, $1.5 million in the first quarter of 2005 and $1.2million in the second quarter of 2005.  Forthe first nine months of 2004, the revenue from these sales was $2.2 million inthe second quarter and $4.4 million in the third quarter.  Related costs of revenues in 2004 were $0.9million in the second quarter and $1.8 million in the third quarter.  During the same time periods, the Companyaccepted orders from the same customer for enhancement packages to the AXi 930system but had not yet delivered the enhancement packages.  In connection with preparing to finalize itsresults for the quarter ended September 30, 2005, the Company determinedthat recognition of the $12.2 million of revenue from the AXi 930 systemsshould have been deferred until the delivery of the enhancement packages,according to EITF 00-21.  The customercancelled its orders for the enhancement packages on September 27, 2005,which allowed the Company to recognize the entire $12.2 million of AXi 930deferred revenue in the quarter ended September 30, 2005.

 

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

 

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

 

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

 

The impact of the Restatement on the consolidated statements ofoperations for the three-month and nine-month periods ended September 30,2004 is shown in Note 2 to our consolidated financial statements.

 

The primary impact of the Restatement on the consolidated balance sheetat December 31, 2004 was to increase inventory at customers under purchaseorders related to the deferral of the cost of revenue and to increase customerdeposits and deferred revenues related to cash collected for revenue deferredin the Restatement.  The Restatement hadno impact on cash balances or net cash flows from operating, investing, orfinancing activities.  The impact of theRestatement on the consolidated statement of cash flows for the nine monthsended September 30, 2004 is shown in Note 2 to our consolidated financialstatements.

 

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**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 Amendment No. 1 on Form 10-K/A for the year ended December 31,2004.   For the nine months ended September 30, 2005, there wereno changes to these critical accounting policies.

 

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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 thequarter.  These demonstrations allowthese customers to evaluate the benefits these systems provide.  We expect these demonstrations will lead toincreased revenues six to nine months after shipment.

 

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

 

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

 

We have sold our systems to many of the leadingmicroelectronic device manufacturers throughout the world.  Historically, a significant portion of ourrevenues in each quarter and year has been derived from sales to relatively fewcustomers, and we expect this trend to continue.   In the nine monthsended September 30, 2005 and 2004 sales to customers that individuallyrepresented at least ten percent of our revenues accounted for 23% and 32% ofour net revenues, respectively.

 

Management focuses on several key financial metricsin evaluating our financial condition and operating performance.  Although we do not believe backlog is alwaysan accurate indication of future revenues and performance, since only a portionof our revenues for any quarter include systems that were in backlog as of thebeginning of that quarter, we do closely monitor the level of orders bothgeographically and by product line and in relation to the level of revenues,referred to as the book-to-bill ratio. During the third quarter of 2005, our book-to-bill ratio was below parity.  A 

 

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book-to-billratio below parity indicates a decreasing level of backlog.  In addition to monitoring our level of ordersand backlog, we focus on revenues by product family compared to prior-periodand current-year plans, year-over-year revenue growth compared to the overallsemiconductor equipment industry, operating profit or loss performance comparedwith prior-period and current-year plans and the level of operating cash flow.

 

**Merger Activities**

 

OnJanuary 21, 2005, we 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 our common stock was to beconverted into the right to receive 0.6401 of a share of August Nanometricscommon stock.  On June 27, 2005, we andNanometrics terminated the Nanometrics Merger Agreement.  In accordance with the terms of theNanometrics Merger Agreement, we paid Nanometrics a termination fee of $8.3million, and reimbursed $2.6 million of merger related expenses.

 

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

 

OnFebruary 9, 2005, we received a letter from Kenneth Schroeder, President andChief Executive Officer of KLA-Tencor Corporation (“KLA”), regarding KLA’sinterest in pursuing a merger with us. The letter stated that KLA proposed to acquire us in a transaction inwhich our shareholders would receive $11.50 per share.  KLA also stated that it would be willing toconsider using stock as consideration. Since the February 9 letter, KLA has made various public statements andadditional communications to us (including a press release issued on July 13,2005) stating that KLA continues to be interested in acquiring AugustTechnology.  As of the date of thisfiling, KLA has been unwilling to execute a confidentiality agreement in a formacceptable to us and we have had no discussions with KLA regarding theirproposal.

** **

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** **

**Results of Operations**

 
| ** **                                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                          | ** ** | ** **                                | ** ** | **(Restated)**                           | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
|                                                |       |                                      |       |                                     |       |   |   |   |   |
| Net revenues                                        |       | 100.0                                     | %          | 100.0                                    | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                    |       | 45.1                                      |       | 57.4                                     |       | 44.3 |   | 47.0 |   |
| Gross profit                                        |       | 54.9                                      |       | 42.6                                     |       | 55.7 |   | 53.0 |   |
|                                                |       |                                      |       |                                     |       |   |   |   |   |
| Selling, general and administrative expenses        |       | 18.7                                      |       | 55.9                                     |       | 30.3 |   | 36.5 |   |
| Research and development expenses                   |       | 10.7                                      |       | 34.4                                     |       | 16.2 |   | 21.8 |   |
| Operating income (loss)                             |       | 25.5                                      |       | (47.7                                    | )          | 9.2 |   | (5.3 | ) |
|                                                |       |                                      |       |                                     |       |   |   |   |   |
| Merger expenses                                     |       | (2.2                                      | )          | —                                   |       | (21.3 | ) | — |   |
| Interest income                                     |       | 1.0                                       |       | 1.8                                      |       | 1.4 |   | 1.3 |   |
| Other income                                        |       | —                                    |       | 0.4                                      |       | — |   | — |   |
| Net income (loss) before provision for income taxes |       | 24.3                                      |       | (45.5                                    | )          | (10.7 | ) | (4.0 | ) |
| Provision for income taxes                          |       | 0.5                                       |       | 0.5                                      |       | 0.4 |   | 0.3 |   |
| Net income (loss)                                   |       | 23.8                                      | %          | (46.0                                    | )%         | (11.1 | )% | (4.3 | )% |

 

*Three and nine months ended September 30, 2005 compared to thethree and nine months ended September 30, 2004*

 

NetRevenues.  Net revenues increased $22.5 million to $33.6 million for thethree months ended September 30, 2005, from revenues of $11.1 million forthe same period in 2004. Current period revenues included $12.2 million of AXi930 system sales shipped and installed at one customer during the period April 2004through June 2005 for which the Company accepted additional orders forenhancement packages.  The customercancelled the orders for the enhancement packages in September 2005,allowing the Company to recognize revenues on the AXi 930 systems previously deliveredand installed at this customer.  The AXi930 system is the core offering in the Company’s all surface inspection systemssold primarily into front-end wafer fabrication processes.  Revenuesderived from systems sold for front-end wafer fab applications accounted for45% and 48% of total net revenues in the nine months of 2005 and 2004,respectively.  Total all surfaceinspection systems revenues grew $13.5 million compared with the same quarterin the prior year as a result of the $12.2 million AXi 930 transactionsdescribed above and an increase of $1.3 million all surface inspection systemrevenues from increased sales into front end wafer processing applications.  Revenues in the fourth quarter of 2005 areexpected to be between $22 and $24 million.

 

NSX Series systemrevenues grew $7.9 million or 132% to $13.9 million for the three months ended September 30,2005 from revenues of $6.0 million for the same period in 2004.  NSX systems are installed in a broader arrayof wafer and device manufacturing processes from front-end wafer manufacturingto back end assembly. Higher NSX revenues in the current three-month periodrepresent significantly higher sales in final assembly and packaging (“back end”)applications.

 

Netrevenues from international sales represented 92% and 70% of total net revenuesfor the three months ended September 30, 2005 and 2004, respectively.  International revenues during these periodswere primarily the result of sales to Asia, which comprised 86% and 54% oftotal net revenues for the three months ended September 30, 2005 and 2004,respectively.  Sales in South Korea forthe three months ended September 30, 2005 represented the next highestconcentration with 40% of net revenues, which is the highest three-monthrevenue ever from that country, primarily due to the impact of recognizing$12.2 million in revenue from one customer. Net revenues from international sales represented 88% and 70% of totalnet revenues for the nine months ended September 30, 2005 and 2004,respectively, and were primarily the result of sales to Asia, which comprised74% and 65% of total net revenues.

 

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GrossProfit.  Gross profit as a percent of net revenues increased to 54.9% forthe three months ended September 30, 2005, from 42.6% for the same periodin 2004.  Gross profit as percentage of net revenues increased to 55.7%for the nine months ended September 30, 2005, from 53.0% for the sameperiod in 2004.  Gross profit for the three months ended September 30,2004 was adversely impacted by the provision for obsolete WAV inventory whichreduced gross profit percentage by 7.8 percentage points.  We expect to continue to experience pricingpressure primarily related to our inspection systems sold into finalmanufacturing applications as competitors enter this market.  We expectfuture gross 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 $6.3 million and $19.8million for the three and nine months ended September 30, 2005, comparedto $6.2 million and $16.8 million for the same periods in 2004.  SG&A expenses as a percentage of netrevenues were 18.7% and 30.3% for the three and nine months ended September 30,2005, compared to 55.9% and 36.5% ofnet revenues for the same periods in 2004.  The large decrease as a percentage of revenueis primarily due to the recognition of $12.2 million of revenue from onecustomer.   The increase in expense dollars for the ninemonths ended September 30, 2005 was primarily the result of severancecosts, amortization of purchased technology resulting from the DMSVision acquisition,technology 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 remainrelatively flat in the fourth quarter of 2005, as compared to the third quarterof 2005.

 

*Research and Development Expenses.* Research and development (“R&D”) expenses consist primarily ofemployee salaries and related benefits for individuals engaged in the research,design and development of new products. R&D expenses were $3.6 million and $10.6 million for the three andnine months ended September 30, 2005, compared to $3.8 million and $10.1million for the same periods in 2004. R&D expenses as a percentage of net revenues were 10.7% and 16.2% for the three and nine monthsended September 30, 2005, compared to 34.4% and 21.8% for the same periodsin 2004.  The large decrease as apercentage of revenue is primarily due to the recognition of $12.2 million ofrevenue from one customer.  The increasein expense dollars during the nine months ended September 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 inspection systems.  We currently anticipate that research and development expense dollars willincrease in the fourth quarter of 2005 as we continue to expand our suite ofsoftware solutions.

 

*Interest Income.* Interest income was $317,000 and $940,000 for the three and nine monthsended September 30, 2005, compared to $204,000 and $594,000 for the sameperiods in 2004.  The increase ininterest income was primarily due to an increase in the rate of return on ourinvestment balances.

 

*Merger Expenses.*  Merger expenses were $734,000 and$14.0 million for the three and nine months ended September 30, 2005,compared to none in 2004.  The mergerexpenses included a $10.9 million termination fee paid to Nanometrics in June 2005for terminating the Nanometrics Merger Agreement, legal and investment bankerfees incurred prior to terminating the proposed merger with Nanometrics, andlegal and investment banker fees incurred in conjunction with the proposedmerger with Rudolph Technologies, Inc.

 

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***Income Taxes. ***We currently anticipate a pretax profit in 2005 for incometax purposes, as compared to a pretax loss under generally accepted accountingprinciples, due to our current assumption that the merger expenses areprimarily nondeductible for income tax purposes.  In addition, as a result of historicaloperating losses and uncertainty as to the extent of profitability in futureperiods, we began to record a valuation allowance against our deferred taxassets in the second quarter of 2002 and continue to do so at September 30,2005.  Statement of Financial AccountingStandards (“SFAS”)No. 109 “*Accounting for Income Taxes*,” requires the establishment ofa valuation allowance to reflect the likelihood of the realization of deferredtax assets.  As of December 31,2004, the valuation allowance was $9.3 million. The above factors have resulted in the recording of a provision forincome taxes for the three and nine months ended September 30, 2005 and2004, primarily to reflect foreign income taxes and federal alternative minimumtaxes owed.  We calculate our taxprovision both with and without the benefit of stock option exercises, whichare deductible for taxable income but not for income under generally acceptedaccounting principles.  In the fourth quarter of 2005, we anticipate thatthe year-to-date taxable income may exceed cumulative tax net operating lossesexcluding the stock option benefit, which could generate a significant non-cashtax provision for the fourth quarter, with an offset to common stock.  Dueto the potential offset related to the tax deductibility of merger expenses for2005, we continued to use the cut-off method for the calculation of federalincome taxes as of September 30, 2005, rather than utilize an annualized projectedtax rate method.

** **

**Liquidity and CapitalResources**

 

At September 30,2005, our principal sources of liquidity consisted of cash, cash equivalentsand investments in marketable debt securities of $39.5 million, compared to$50.4 million at December 31, 2004, a decrease of $10.9 million.  Thedecrease was primarily due to $13.6 million in cash paid for merger expensesand an increase in accounts receivable, partially offset by increases inaccounts payable related to raw material purchases and increased accruedcompensation related to separation agreements. During the next twelve months, and beyond, we intend to utilize ourcurrent sources of liquidity to fund operations, specifically to enhance ourposition in the front-end wafer fabrication process.  Wehave no outstanding debt at September 30,2005.  Our liquidity is affected by manyfactors, some of which are based on the normal ongoing operations of ourbusiness, the most significant of which includes the timing of the collectionof receivables, the level of inventories, capital expenditures and acquisitionexpenses.

 

*Accounts Receivable.*  Accounts receivable increased $5.5 millionfrom December 31, 2004 to September 30, 2005. The increase resulted in a use of cash during the nine months ended September30, 2005, as we have funded shipments for increased revenues prior to receivingpayments from customers. As restated, our days sales outstanding (“DSO”) duringthe three months ended September 30, 2005 was 33 days, compared to a DSO of 54days in the second quarter of 2005. Excluding the impact of the $12.2 million deferral of AXi 930 netrevenues, the DSO would have been 55 days for the third quarter of 2005,compared to 51 days for the second quarter of 2005.  We believe our DSO will be between 50 and 65days in future quarters.

 

*Inventories.*  Inventories increased$1.7 million from December 31, 2004 to September 30, 2005.  The increase is primarily due to an increasein raw material to support an anticipated increase in shipments in fourthquarter 2005 and first quarter of 2006.

 

*Inventories at Customers under Purchase Orders.*  Inventoriesat customers under purchase orders decreased from $6.7 million at December 31,2004 to $5.2 million at September 30, 2005. The balance decreased $2.7million related to the recognition of revenue triggered by the 

 

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cancellation of the AXi930 enhancement option for one customer, partially offset by an increase inshipments to customers. We anticipate that a portion of this inventory will berecognized as revenue during fourth quarter 2005.

 

*Capital Expenditures.*  Our additionsto property and equipment during the first nine months of 2005 were $2.3million, consisting primarily of the clean room manufacturing expansionproject.  Approximately $0.9 million ofthese additions remained unpaid asof September 30, 2005.  As we expand into the front end waferfabrication processes, it is essential that our manufacturing process iscompliant with the needs of our customers.

 

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

 

*CashFlows*

 

Netcash used in operating activities for the nine months ended September 30,2005 was $11.7 million, primarily due to $13.6 million in cash paid for mergerexpenses, an increase in accounts receivable and a decrease in customerdeposits and deferred revenue, partially offset by increases in accountspayable and accrued compensation. Excluding cash payments for merger expenses, cash generated fromoperating activities was $1.9 million for the nine months ended September 30,2005.  Net cash provided by investingactivities was $9.5 million, primarily due to $11.2 million of net proceedsfrom maturities of marketable debt securities, partially offset by $1.6 millionof additions to property and equipment, and other assets.  Net cash provided by financing activities was$2.6 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 nine months ended September 30,2004 was $7.9 million, which resulted primarily from increased accountsreceivable and inventories partially offset by our net loss and increasedcustomer deposits and deferred revenues. Net cash used in investing activities was $698,000, primarily due to$4.7 million used for purchases of property and equipment and $2.3 million usedfor the purchase of the DMSVision division of Inspex, partially offset by $6.3million of net proceeds from sales of marketable debt securities.  Net cash provided by financing activities was$2.0 million from the proceeds received from issuances of common stock,primarily related to exercises of stock options by employees.

 

**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 

 

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previously issued financial statementssimilar to those generally applicable to reporting an accounting changeretrospectively.  Therefore, thereporting 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 an interpretationof SFAS No. 143, “*Accounting for AssetRetirement Obligations*.”  The interpretation requires aliability for the fair value of a conditional asset retirement obligation berecognized if the fair value of the liability can be reasonably estimated.  The interpretation is effective no later thanthe end of fiscal years ending after December 15, 2005.  The interpretation is not expected to have a materialimpact on our financial position, results of operations or cash flows.

 

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

 

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

 

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

 

*CreditRisk*

 

Financialinstruments which potentially subject us to credit risk consist principally ofsecurities in the Investment Portfolio and trade receivables.  We limit credit risk related to theInvestment Portfolio by placing all investments with high quality credit issuersand limit the amount of investments with any one issuer.  As of September 30, 2005, 69.6% of theInvestment Portfolio consisted of government securities and corporate bondswith maturities of one year or less.  Welimit credit risk associated with trade receivables by performing ongoingcredit evaluations and believe that there is no additional risk beyond amountsprovided for collection losses to be inherent in trade receivables.

 

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

 

**Overview**

 

As previously disclosed in a Current Report on Form 8-Kwhich we filed on September 29, 2005 and as described Note 2 to ouraccompanying consolidated financial statements, in connection with preparing tofinalize our results for the quarter ended September 30, 2005, wedetermined that certain revenue recognized in 2004 and the first half of 2005should have been deferred until later periods. As a result of subsequently reviewing our revenue recognition policiesand procedures, we additionally noted that beginning in the fourth quarter of2002 certain deferred software revenue should have been fully recognized upondelivery or customer acceptance rather than ratably over a twelve-monthperiod.  We also have determined that aninternal control deficiency existed related to the knowledge and application ofrevenue recognition methods in accordance with U.S. generally acceptedaccounting principles.  Based on theimpact of the aforementioned accounting errors, we determined to restate ourfinancial statements as of December 31, 2004 and 2003 and for each of theyears in the three-year period ended December 31, 2004, as well as interimfinancial statements for the quarters ended March 31, 2005 and June 30,2005.  Our restated consolidated financialstatements also include disclosure of restated unaudited quarterly results for2004 and 2003.

 

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Management has determined that the internal controldeficiency that resulted in the aforementioned accounting errors is a materialweakness, as defined by the Public Company Accounting Oversight Board’sAuditing Standard No. 2.  We havedetermined that the material weakness was that we did not maintain adequate controls and procedures to ensurethat multi-element arrangements and related software revenue components wereaccounted for in accordance with generally accepted accounting principles.  The Public Company AccountingOversight Board has defined a material weakness as “a significant deficiency,or combination of significant deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected.” Management has reviewed theinternal control deficiency with our Audit Committee, has discussed it with ourindependent registered public accounting firm, KPMG LLP, and has advised ourAudit Committee that the deficiency is a material weakness in our internalcontrol over financial reporting.

 

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

 

Theeffectiveness of our or any system of disclosure controls and procedures issubject to certain limitations, including the exercise of judgment indesigning, implementing and evaluating the controls and procedures, theassumptions used in identifying the likelihood of future events, and theinability to eliminate misconduct completely. As a result, there can be no assurance that our disclosure controls andprocedures will detect all errors or fraud. By their nature, our, or any, system of disclosure controls andprocedures can provide only reasonable assurance regarding management’s controlobjectives.

 

Under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, we evaluated the design andoperation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, or the “Exchange Act”)as of September 30, 2005.

 

In light ofthe material weakness in internal control over financial reporting referencedabove, our management, including our Chief Executive Officer and ChiefFinancial Officer, concluded that our disclosure controls and procedures were noteffective as of September 30, 2005, to give reasonable assurance that theinformation required to be disclosed by us in reports that we file under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the rules and forms of the SEC and to ensure thatinformation required to be disclosed in the reports filed or submitted underthe Exchange Act is accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, in a manner thatallows timely decisions regarding required disclosure.

 

In response tothis material weakness, management performed additional analyses and otherpost-closing procedures to ensure our restated consolidated financialstatements were prepared in accordance with generally accepted accountingprinciples. Accordingly, management, including our Chief Executive Officer andChief Financial Officer, believes the restated consolidated financialstatements included in this report and our Form 10-K/A fairly present, inall material respects, our financial condition, results of operations and cashflows for the periods presented.

 

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**(b)   Changes in Internal Control Over FinancialReporting**

 

There were nochanges in our internal control over financial reporting that occurred in thethird quarter of 2005 that materially affected, or were reasonably likely tomaterially affect, our internal control over financial reporting.

 

During October 2005,we implemented the remedial measures outlined below to address the identifiedmaterial weakness in connection with the preparation of our restated financialstatements included in our Form 10-K/A for the year ended December 31,2004 and on our Form 10-Q/As for the quarters ended March 31, 2005and June 30, 2005.  We have recentlydedicated additional resources to the review of our control processes andprocedures surrounding revenue recognition. Furthermore, we have been conducting a thorough review and evaluation ofour internal controls over revenue recognition as part of our compliance withthe requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

 

In order toremediate the weakness in our internal control over financial reporting,management has implemented the following measures as of the date of filing ofthis report and our Form 10-K/A:

 

•                  Enhanced ourrevenue recognition procedures by updating our contract evaluation criteria anddecision process flowcharts.  Theseevaluation and process updates were developed as a result of performing athorough review of applicable accounting literature related to revenuerecognition, particularly EITF No. 00-21, “Accounting for RevenueArrangements with Multiple Deliverables.”

 

•                  Modified ourrevenue recognition procedures on software contracts requiring postcontract customer support in accordancewith the guidelines of SOP 97-2, “Software Revenue Recognition” and subsequentinterpretations.

 

•                  Enhanced ourrevenue recognition procedures to assure vendor-specific objectiveevidence is obtained to establish fair value for undelivered software elementsprior to recognizing revenue.

 

•                  Implementedadditional training for accounting personnel to enhance their understanding ofthe applicable revenue recognition principles.

 

•                  Implementedadditional training for our sales personnel to enhance communications ofpertinent revenue information to our accounting department that would impactaccounting for agreements containing multiple deliverables.

 

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**PART II – OTHER INFORMATION**

 

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

 

***Shareholder actions.******   ***On February 4, 2005, August Technologyreceived a summons and complaint with respect to a purported class actionlawsuit naming Robert Etem as the plaintiff and on February 14, 2005 August Technologyreceived a summons and complaint with respect to a similar purported classaction lawsuit naming John Silliman as the plaintiff.  Mr. Etem is the owner of 4,200 shares ofthe Company’s common stock.  The Companydoes not know how many shares Mr. Silliman owns.  Both lawsuits named as defendants August TechnologyCorporation and each of its directors, Jeff O’Dell, James Bernards, RogerGower, Michael Wright and Linda Hall Whitman. Both lawsuits were brought in Minnesota State Court and claimed that thedirectors had breached their fiduciary duties to our 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 enjoiningthe Company and its directors from consummating the merger with Nanometrics.

 

The twoproceedings were consolidated and heard as one case.  On April 19, 2005, the Court issued a 30day stay of all proceedings.  On April 27,2005, the plaintiffs scheduled a hearing on a motion to amend thecomplaint.  The hearing was scheduled forJune 9, 2005.  On May 10, 2005the Court issued an order dismissing the complaint for asserting derivativeclaims without complying with the rules governing derivative actions.  Thereafter the Court removed the hearing fromthe calendar.  Although the February 2005claims initiated by Mr. Etem and Mr. Silliman were dismissed, both Mr. Etemand Mr. Silliman have filed more recent claims as described below.

 

On July 18,2005, a purported shareholder class action naming Mr. Etem as plaintiffand asserting derivative claims was filed in Minnesota state court against theCompany and the individual members of the August Technology board ofdirectors named above, as well as Lynn J. Davis, who joined the board on March 30,2005.  The lawsuit claims the directorshave breached their fiduciary duties to the Company’s shareholders inconnection with their actions in approving the merger agreement withNanometrics, Inc. and subsequently terminating that merger agreement andentering into a new merger agreement with Rudolph Technologies, Inc.  Mr. Etem seeks various forms ofinjunctive relief including an order enjoining the Company and the directorsfrom consummating the proposed merger with Rudolph.

 

On August 1,2005, a second purported shareholder class action naming Mr. Silliman asplaintiff and asserting derivative claims was filed in Minnesota state courtagainst the Company and the individual members of the August Technologyboard of directors. This second lawsuit also claims the directors have breachedtheir fiduciary duties to the Company’s shareholders in connection with theiractions in approving the merger agreement with Nanometrics, Inc. andsubsequently terminating that merger agreement and entering into a new mergeragreement with Rudolph Technologies, Inc. Mr. Silliman likewise seeks various forms of injunctive reliefincluding an order enjoining the Company and the directors from consummatingthe proposed merger with Rudolph.

 

Mr. Sillimanserved the Company with an amended complaint on August 31, 2005, andchanged the case from a derivative action brought on the Company’s behalf, to aclass action asserting direct claims against the Company and the individualmembers of the August Technology Board of Directors.  Mr. Etem also served the Company with anamended complaint on August 31, 2005, but his allegations remainderivative in nature.  Both the Sillimanclaims and the Etem claims 

 

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will be heard by the samejudge.  The defendants’ motions to dismiss both casesare scheduled to be heard on November 8, 2005.  August Technology and its directorsbelieve the lawsuits are without merit and plan to vigorously defend againstthe claims. The Company does not believe these lawsuits will have a materialimpact on the Company’s consolidated financial position or consolidated resultsof operations.

 

***Patent protection lawsuit.***    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.

 

***Compensation claim.***    On August 22, 2005, a claim was filedin Massachusetts State Court by three former employees of ExcelerateTechnologies, LLC against the Company and six other defendants unrelated to theCompany seeking unpaid wages and other compensation.  The Company is a party to a Software LicenseAgreement with Excelerate Technologies, LLC but has never employed theplaintiffs in the lawsuit and denies any liability for the unpaid wages of theplaintiffs.  The plaintiffs seek trebledamages for an aggregate amount of $220,774 in unpaid wages as well ascompensatory and punitive damages and attorney’s fees. The Company does notbelieve this claim will have a material impact on the Company’s consolidatedfinancial position or consolidated results of operations.

 

**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 duly causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

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

 

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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 |
|--------------------------|---------------------------------|
| September 30,  2005 |                            |

 

**AUGUST TECHNOLOGYCORPORATION**

** **
| **Exhibit Number** | ** ** | **Description**                                                                                                |
|-------------------------|------------|----------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                           |
| 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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