**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q/A**

**(Amendment No. 1)**

 

**(MarkOne)**

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

 

**For thequarterly period ended March 31, 2005**

 

**OR**

 

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

 

**For thetransition period from                           to**

 

**Commission File Number 000-30637**

 

 

**AUGUST TECHNOLOGY CORPORATION**

(Exact name of Registrant as specified inits charter)

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

 

**(952) 820-0080**

(Registrant’s telephone number, includingarea code)

 

**N/A**

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

 

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

 

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

 

As of May 3,2005, there were 17,980,484 shares of common stock outstanding.

 

 

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**AUGUST TECHNOLOGY CORPORATION**

**EXPLANATORY NOTE**

 

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

 

This Amendment No. 1 onForm 10-Q/A (the “Form 10-Q/A”) to the Company’s Quarterly Report on Form 10-Qfor the quarterly period ended March 31, 2005, initially filed with theSecurities and Exchange Commission (the “SEC”) on May 10, 2005 (the “OriginalFiling”), is being filed to reflect restatements of the Company’s consolidatedbalance sheet as of March 31, 2005 and the Company’s consolidatedstatements of operations and cash flows for the three-month periods ended March 31,2005 and March 31, 2004 and the notes related thereto.  Certain adjustments were recorded to each quarterin 2004 and the first two quarters of 2005 to correct other miscellaneous itemsidentified in prior external audits or quarterly reviews but were previouslypassed, none of which were individually significant.  For a more detailed description of therestatement, see Note 2, “Restatement of Financial Statements” to theaccompanying consolidated financial statements and the section entitled “Restatement”in Management’s Discussion and Analysis of Financial Condition and Results ofOperations contained in this Form 10-Q/A.

 

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

 

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

 

Except for the foregoing amendedinformation, this Form 10-Q/A continues to speak as of the date of theOriginal Filing, and the Company has not updated the disclosures containedherein to reflect events that occurred at a later date. Other events occurringafter the filing of the Original Filing or other disclosures necessary to reflectsubsequent events have been or will be addressed in the Company’s amendedQuarterly

 

2

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Report on Form 10-Q/A for the quarterly periodended June 30, 2005 and/or the Company’s Quarterly Report on Form 10-Qfor the quarterly period ended September 30, 2005 which are being filedconcurrently with the filing of this Form 10-Q/A, and any reports filedwith the SEC subsequent to the date of this filing.

 

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

 

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**AUGUST TECHNOLOGY CORPORATION**

**TABLE OF CONTENTS**

 
|               | Description                                                                                                 |   |
|--------------------|-------------------------------------------------------------------------------------------------------------|--------|
|               |                                                                                                        |   |
| PART I        | FINANCIAL INFORMATION                                                                                       |   |
|               |                                                                                                        |   |
| Item 1.            | Financial Statements                                                                                        |   |
|               |                                                                                                        |   |
|               | Consolidated  Balance Sheets as of March 31, 2005 and December 31, 2004  (unaudited)              |   |
|               |                                                                                                        |   |
|               | Consolidated  Statements of Operations for the three months ended March 31, 2005 and  2004 (unaudited) |   |
|               |                                                                                                        |   |
|               | Consolidated  Statements of Cash Flows for the three months ended March 31, 2005 and  2004 (unaudited) |   |
|               |                                                                                                        |   |
|               | Notes  to Consolidated Financial Statements (unaudited)                                                     |   |
|               |                                                                                                        |   |
| Item 2.            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                 |   |
|               |                                                                                                        |   |
| Item 3.            | Quantitative  and Qualitative Disclosures about Market Risk                                                 |   |
|               |                                                                                                        |   |
| Item 4.            | Controls and  Procedures                                                                                    |   |
|               |                                                                                                        |   |
| PART II       | OTHER INFORMATION                                                                                           |   |
|               |                                                                                                        |   |
| Item 1.            | Legal Proceedings                                                                                           |   |
|               |                                                                                                        |   |
| Item  6.           | Exhibits                                                                                                    |   |
|               |                                                                                                        |   |
| SIGNATURES         |                                                                                                        |
|               |                                                                                                        |   |
| EXHIBIT INDEX |                                                                                                        |
|                    |                                                                                                             |        |  |

 

4

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**PART I         FINANCIAL INFORMATION**

**Item1.  Financial Statements**

**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

**(Inthousands, except share amounts)**

**(Unaudited)**

 
| ** **                                                                                                                       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                       | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **                                                                                                                       | ** ** | **(Restated)**     | ** ** | **(Restated)**        | ** ** |
| **ASSETS**                                                                                                                       |       |               |       |                  |       |
|                                                                                                                             |       |               |       |                  |       |
| Current assets:                                                                                                                  |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                        |       | $                  | 11,518     |                  | $          | 5,518 |   |
| Short-term marketable debt securities                                                                                            |       | 25,265             |       | 28,615                |       |
| Accounts receivable, net                                                                                                         |       | 9,359              |       | 8,328                 |       |
| Inventories                                                                                                                      |       | 20,948             |       | 20,106                |       |
| Inventories at customers under purchase orders                                                                                   |       | 7,989              |       | 6,704                 |       |
| Prepaid expenses and other current assets                                                                                        |       | 2,180              |       | 2,517                 |       |
| Total current assets                                                                                                             |       | 77,259             |       | 71,788                |       |
|                                                                                                                             |       |               |       |                  |       |
| Property and  equipment, net                                                                                                     |       | 5,531              |       | 5,994                 |       |
| Long-term  marketable debt securities                                                                                            |       | 15,439             |       | 16,289                |       |
| Purchased  technology, net                                                                                                       |       | 3,355              |       | 3,703                 |       |
| Goodwill                                                                                                                         |       | 498                |       | 498                   |       |
| Other assets                                                                                                                     |       | 139                |       | 150                   |       |
| Total assets                                                                                                                     |       | $                  | 102,221    |                  | $          | 98,422 |   |
|                                                                                                                             |       |               |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                    |       |               |       |                  |       |
|                                                                                                                             |       |               |       |                  |       |
| Current  liabilities:                                                                                                            |       |               |       |                  |       |
| Accounts payable                                                                                                                 |       | $                  | 5,800      |                  | $          | 3,291 |   |
| Accrued compensation                                                                                                             |       | 2,051              |       | 1,636                 |       |
| Other accrued liabilities                                                                                                        |       | 2,222              |       | 2,322                 |       |
| Customer deposits and deferred revenues                                                                                          |       | 15,397             |       | 11,973                |       |
| Total current liabilities                                                                                                        |       | 25,470             |       | 19,222                |       |
|                                                                                                                             |       |               |       |                  |       |
| Other  non-current liabilities                                                                                                   |       | 112                |       | 131                   |       |
| Total liabilities                                                                                                                |       | 25,582             |       | 19,353                |       |
|                                                                                                                             |       |               |       |                  |       |
| Commitments and  contingencies (note 9)                                                                                          |       | —             |       | —                |       |
|                                                                                                                             |       |               |       |                  |       |
| Shareholders’  equity:                                                                                                      |       |               |       |                  |       |
| Common stock, no par value, 42,000,000 shares authorized,  17,925,793 and 17,839,298 shares issued and outstanding, respectively |       | 90,826             |       | 90,363                |       |
| Undesignated capital stock, no par value, 3,000,000  shares authorized, no shares issued or outstanding                          |       | —             |       | —                |       |
| Accumulated deficit                                                                                                              |       | (13,975            | )          | (11,188               | )          |
| Accumulated other comprehensive loss                                                                                             |       | (212               | )          | (106                  | )          |
| Total shareholders’ equity                                                                                                  |       | 76,639             |       | 79,069                |       |
|                                                                                                                             |       |               |       |                  |       |
| Total liabilities and shareholders’ equity                                                                                  |       | $                  | 102,221    |                  | $          | 98,422 |   |

 

See accompanying notes toconsolidated financial statements.

 

5

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**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                       | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** |
|                                             |       |                                  |       |   |   |
| Net revenues                                     |       | $                                     | 15,036     |   | $ | 16,845 |   |
| Cost of revenues                                 |       | 6,824                                 |       | 7,058 |   |
| Gross profit                                     |       | 8,212                                 |       | 9,787 |   |
|                                             |       |                                  |       |   |   |
| Selling, general  and administrative expenses    |       | 6,338                                 |       | 5,189 |   |
| Research and  development expenses               |       | 3,666                                 |       | 2,908 |   |
| Operating income (loss)                          |       | (1,792                                | )          | 1,690 |   |
|                                             |       |                                  |       |   |   |
| Merger expenses                                  |       | (1,234                                | )          | — |   |
| Interest income                                  |       | 289                                   |       | 201 |   |
|                                             |       |                                  |       |   |   |
| Income (loss)  before provision for income taxes |       | (2,737                                | )          | 1,891 |   |
| Provision for  income taxes                      |       | 50                                    |       | 41 |   |
| Net income  (loss)                               |       | $                                     | (2,787     | ) | $ | 1,850 |   |
|                                             |       |                                  |       |   |   |
| Net income  (loss) per share:                    |       |                                  |       |   |   |
| Basic                                            |       | $                                     | (0.16      | ) | $ | 0.10 |   |
| Diluted                                          |       | $                                     | (0.16      | ) | $ | 0.10 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**AUGUST TECHNOLOGY CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                                                                          | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** |
| Cash flows from  operating activities:                                                              |       |                                  |       |   |   |
| Net income (loss)                                                                                   |       | $                                     | (2,787     | ) | $ | 1,850 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                                       |       | 1,039                                 |       | 518 |   |
| Provision for (recovery of) doubtful accounts                                                       |       | (57                                   | )          | 46 |   |
| Tax benefit from employee stock options                                                             |       | —                                |       | — |   |
| Deferred income taxes                                                                               |       | 3                                     |       | — |   |
| Amortization of deferred compensation related to  stock options                                     |       | —                                |       | 14 |   |
| Changes in operating assets and liabilities:                                                        |       |                                  |       |   |   |
| Accounts receivable                                                                                 |       | (968                                  | )          | (6,644 | ) |
| Inventories                                                                                         |       | (696                                  | )          | (3,835 | ) |
| Inventories at customers under purchase orders                                                      |       | (1,285                                | )          | (2,291 | ) |
| Prepaid expenses and other current assets                                                           |       | 345                                   |       | (601 | ) |
| Accounts payable                                                                                    |       | 2,509                                 |       | 1,978 |   |
| Accrued compensation                                                                                |       | 396                                   |       | 503 |   |
| Accrued liabilities                                                                                 |       | 39                                    |       | 166 |   |
| Customer deposits and deferred revenues                                                             |       | 3,424                                 |       | 1,517 |   |
| Net cash provided by (used in) operating activities                                                 |       | 1,962                                 |       | (6,779 | ) |
|                                                                                                |       |                                  |       |   |   |
| Cash flows from  investing activities:                                                              |       |                                  |       |   |   |
| Proceeds from maturities of marketable debt  securities                                             |       | 22,415                                |       | 53,872 |   |
| Purchases of marketable debt securities                                                             |       | (18,354                               | )          | (53,218 | ) |
| Purchases of property and equipment                                                                 |       | (344                                  | )          | (542 | ) |
| Investment in other assets                                                                          |       | (150                                  | )          | (62 | ) |
| Proceeds from disposition of property and equipment                                                 |       | 4                                     |       | — |   |
| Net cash provided by investing activities                                                           |       | 3,571                                 |       | 50 |   |
|                                                                                                |       |                                  |       |   |   |
| Cash flows from  financing activities:                                                              |       |                                  |       |   |   |
| Net proceeds from issuances of common stock to employees                                            |       | 462                                   |       | 1,548 |   |
| Net cash provided by financing activities                                                           |       | 462                                   |       | 1,548 |   |
|                                                                                                |       |                                  |       |   |   |
| Effect of  exchange rates on cash and cash equivalents                                              |       | 5                                     |       | (3 | ) |
|                                                                                                |       |                                  |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                               |       | 6,000                                 |       | (5,184 | ) |
| Cash and cash  equivalents at beginning of period                                                   |       | 5,518                                 |       | 10,027 |   |
| Cash and cash  equivalents at end of period                                                         |       | $                                     | 11,518     |   | $ | 4,843 |   |
|                                                                                                |       |                                  |       |   |   |
| Supplemental  cash flow information:                                                                |       |                                  |       |   |   |
| Cash payments of income taxes                                                                       |       | $                                     | (61        | ) | $ | (18 | ) |

 

See accompanying notes to consolidated financialstatements.

 

7

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**AUGUST TECHNOLOGY CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**MARCH 31, 2005**

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

**(Unaudited)**

** **

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

 

The accompanyingunaudited consolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission.  Certain information and footnote disclosures,normally included in consolidated financial statements prepared in accordancewith accounting principles generally accepted in the United States of America,have been condensed or omitted pursuant to such rules andregulations.  In the opinion of themanagement of August Technology Corporation (collectively with itssubsidiaries, the “Company”), all adjustments (consisting of normal recurringadjustments) considered necessary for a fair presentation have been included inthe consolidated balance sheet at March 31, 2005, the consolidated statementsof operations for the three months ended March 31, 2005 and 2004, and theconsolidated statements of cash flows for the three months ended March 31,2005 and 2004.  The statements ofoperations of the interim periods are not necessarily indicative of the results of operations that may beexpected for any other period or for the year as a whole.  These consolidated financial statements andnotes hereto should be read in conjunction with the audited restated consolidatedfinancial statements and notes thereto included in the Company’s Amendment No. 1on Form 10-K/A for the year ended December 31, 2004, which is being filedwith the Securities and Exchange Commission concurrently with the filing ofthis Form 10-Q/A .

 

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

 

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

 

8

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**Note 2 – Restatement of Financial Statements**

 

We have restated our consolidated financial statements for the years2004, 2003 and 2002 and for the first two quarters of 2005. In addition,certain disclosures in Notes 4, 5, 8 and 10 to the consolidated financialstatements contained in this report have been restated to reflect theRestatement adjustments. Our restated consolidated financial statements willalso include disclosure of restated unaudited quarterly results for 2004 and2003.  The initial determination torestate the 2004 and first half 2005 consolidated financial statements was madeas a result of a correction of the Company’s application of revenue recognitionprinciples, as contained in the Financial Accounting Standard Board’s EmergingIssues Task Force Issue No. 00-21, “*Revenue Arrangements withMultiple Deliverables*” (“EITF 00-21”).  As a result of subsequently reviewing ourrevenue recognition policies and procedures, we additionally noted thatbeginning in the fourth quarter of 2002 certain deferred software revenueshould have been fully recognized upon delivery or customer acceptance ratherthan ratably over a twelve-month period. This created the need to restate our 2003 and 2002 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 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.  Therewere no sales of AXi 930 systems to this customer that should have beendeferred in the quarter ended March 31, 2004.  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 errordecreased revenue by $0.3 million for the three months ended March 31,2005 and increased revenue by $0.4 million for the three months ended March 31,2004. 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.

 

The Restatement impacted the timing of revenue recognition as the AXi930 enhancement packages have been deferred into the third quarter of 2005 andthe Yield Pilot software revenue is recognized upon delivery or customeracceptance rather than ratably over a twelve-month period.  The impact of the Restatement on the consolidatedstatements of operations for the three months ended March 31, 2005 and 2004is shown in the accompanying tables.

 

The primary impact of the Restatement on the consolidated balance sheetat March 31, 2005 was to increase inventory at customers under purchaseorders related to the deferral of the cost of revenue and to increase customerdeposits and deferred revenues related to cash collected for revenue deferredin the Restatement.  The Restatement hadno impact on cash balances or net cash flows from operating, investing, orfinancing activities.  The impact of theRestatement on the consolidated balance sheet and consolidated statements ofcash flows is shown in the accompanying tables.

 

9

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

 
| ** **                                      | ** ** | **March 31, 2005** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **As**                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Previously**          | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                      | ** ** | **Reported**            | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| **ASSETS**                                      |       |                    |       |   |   |   |   |
|                                            |       |                    |       |   |   |   |   |
| Current assets:                                 |       |                    |       |   |   |   |   |
| Cash and cash equivalents                       |       | $                       | 11,518     |   | $ | — |   | $ | 11,518 |   |
| Short-term marketable debt securities           |       | 25,265                  |       | — |   | 25,265 |   |
| Accounts receivable, net                        |       | 9,618                   |       | (259 | ) | 9,359 |   |
| Inventories                                     |       | 20,948                  |       | — |   | 20,948 |   |
| Inventories at customers under purchase orders  |       | 3,791                   |       | 4,198 |   | 7,989 |   |
| Prepaid expenses and other current assets       |       | 1,954                   |       | 226 |   | 2,180 |   |
| Total current assets                            |       | 73,094                  |       | 4,165 |   | 77,259 |   |
|                                            |       |                    |       |   |   |   |   |
| Property and  equipment, net                    |       | 5,531                   |       | — |   | 5,531 |   |
| Long-term  marketable debt securities           |       | 15,439                  |       | — |   | 15,439 |   |
| Purchased  technology, net                      |       | 3,355                   |       | — |   | 3,355 |   |
| Goodwill                                        |       | 498                     |       | — |   | 498 |   |
| Other assets                                    |       | 139                     |       | — |   | 139 |   |
| Total assets                                    |       | $                       | 98,056     |   | $ | 4,165 |   | $ | 102,221 |   |
|                                            |       |                    |       |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**   |       |                    |       |   |   |   |   |
|                                            |       |                    |       |   |   |   |   |
| Current  liabilities:                           |       |                    |       |   |   |   |   |
| Accounts payable                                |       | $                       | 5,975      |   | $ | (175 | ) | $ | 5,800 |   |
| Accrued compensation                            |       | 2,051                   |       | — |   | 2,051 |   |
| Other accrued liabilities                       |       | 2,222                   |       | — |   | 2,222 |   |
| Customer deposits and deferred revenues         |       | 6,767                   |       | 8,630 |   | 15,397 |   |
| Total current liabilities                       |       | 17,015                  |       | 8,455 |   | 25,470 |   |
|                                            |       |                    |       |   |   |   |   |
| Other  non-current liabilities                  |       | 112                     |       | — |   | 112 |   |
| Total liabilities                               |       | 17,127                  |       | 8,455 |   | 25,582 |   |
|                                            |       |                    |       |   |   |   |   |
| Shareholders’  equity:                     |       |                    |       |   |   |   |   |
| Common stock, no par value                      |       | 90,815                  |       | 11 |   | 90,826 |   |
| Undesignated capital stock, no par value        |       | —                  |       | — |   | — |   |
| Accumulated deficit                             |       | (9,674                  | )          | (4,301 | ) | (13,975 | ) |
| Accumulated other comprehensive loss            |       | (212                    | )          | — |   | (212 | ) |
| Total shareholders’ equity                 |       | 80,929                  |       | (4,290 | ) | 76,639 |   |
| Total liabilities and shareholders’ equity |       | $                       | 98,056     |   | $ | 4,165 |   | $ | 102,221 |   |

 

10

----

 

**The following table presents theeffect of the Restatement on the consolidated statements of operations:**

 
| ** **                                                                          | ** ** | **Three Months Ended March 31,  2005** | ** ** | **Three Months Ended March 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                          | ** ** | **As**                                      | ** ** | ** **                                  | ** ** | ** ** | ** ** | **As** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                          | ** ** | **Previously**                              | ** ** | ** **                                  | ** ** | **As** | ** ** | **Previously** | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                          | ** ** | **Reported**                                | ** ** | **Adjustments**                             | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                                                                |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Net revenues                                                                        |       | $                                           | 18,417     |                                        | $          | (3,381 | ) | $ | 15,036 |   | $ | 16,400 |   | $ | 445 |   | $ | 16,845 |   |
| Cost of revenues                                                                    |       | 8,359                                       |       | (1,535                                      | )          | 6,824 |   | 7,058 |   | — |   | 7,058 |   |
| Gross profit                                                                        |       | 10,058                                      |       | (1,846                                      | )          | 8,212 |   | 9,342 |   | 445 |   | 9,787 |   |
|                                                                                |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Selling, general  and administrative expenses                                       |       | 6,290                                       |       | 48                                          |       | 6,338 |   | 5,189 |   | — |   | 5,189 |   |
| Research and  development expenses                                                  |       | 3,666                                       |       | —                                      |       | 3,666 |   | 2,908 |   | — |   | 2,908 |   |
| Operating income (loss)                                                             |       | 102                                         |       | (1,894                                      | )          | (1,792 | ) | 1,245 |   | 445 |   | 1,690 |   |
|                                                                                |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Merger expenses                                                                     |       | (1,234                                      | )          | —                                      |       | (1,234 | ) | — |   | — |   | — |   |
| Interest income                                                                     |       | 289                                         |       | —                                      |       | 289 |   | 201 |   | — |   | 201 |   |
|                                                                                |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Income (loss)  before provision for income taxes                                    |       | (843                                        | )          | (1,894                                      | )          | (2,737 | ) | 1,446 |   | 445 |   | 1,891 |   |
| Provision for  income taxes                                                         |       | 55                                          |       | (5                                          | )          | 50 |   | — |   | 41 |   | 41 |   |
| Net income  (loss)                                                                  |       | $                                           | (898       | )                                           | $          | (1,889 | ) | $ | (2,787 | ) | $ | 1,446 |   | $ | 404 |   | $ | 1,850 |   |
|                                                                                |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Net income  (loss) per share:                                                       |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                                               |       | $                                           | (0.05      | )                                           | (0.11      | ) | $ | (0.16 | ) | $ | 0.08 |   | 0.02 |   | $ | 0.10 |   |
| Diluted                                                                             |       | $                                           | (0.05      | )                                           | (0.11      | ) | $ | (0.16 | ) | $ | 0.08 |   | 0.02 |   | $ | 0.10 |   |
|                                                                                |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding used to  calculate net income (loss) per share: |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                                               |       | 17,867                                      |       |                                        |       | 17,867 |   | 17,622 |   |   |   | 17,622 |   |
| Diluted                                                                             |       | 17,867                                      |       |                                        |       | 17,867 |   | 18,486 |   |   |   | 18,486 |   |

 

11

----

 

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

 
| ** **                                                                       | ** ** | **Three Months Ended March 31,  2005** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                       | ** ** | **As Previously**                           | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                       | ** ** | **Reported**                                | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                           |       |                                        |       |   |   |   |   |
| Net loss                                                                         |       | $                                           | (898       | ) | $ | (1,889 | ) | $ | (2,787 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                    |       | 1,039                                       |       | — |   | 1,039 |   |
| Recovery of doubtful accounts                                                    |       | (57                                         | )          | — |   | (57 | ) |
| Tax benefit from stock options exercised                                         |       | 5                                           |       | (5 | ) | — |   |
| Deferred income taxes                                                            |       | 3                                           |       | — |   | 3 |   |
| Changes in operating assets and liabilities, net of  effect of acquisitions:     |       |                                        |       |   |   |   |   |
| Accounts receivable                                                              |       | (952                                        | )          | (16 | ) | (968 | ) |
| Inventories                                                                      |       | (671                                        | )          | (25 | ) | (696 | ) |
| Inventories at customers under purchase orders                                   |       | 202                                         |       | (1,487 | ) | (1,285 | ) |
| Prepaid expenses and other current assets                                        |       | 361                                         |       | (16 | ) | 345 |   |
| Accounts payable                                                                 |       | 2,609                                       |       | (100 | ) | 2,509 |   |
| Accrued compensation                                                             |       | 356                                         |       | 40 |   | 396 |   |
| Other accrued liabilities                                                        |       | 39                                          |       | — |   | 39 |   |
| Customer deposits and deferred revenues                                          |       | (74                                         | )          | 3,498 |   | 3,424 |   |
| Net cash provided by operating activities                                        |       | 1,962                                       |       | — |   | 1,962 |   |
|                                                                             |       |                                        |       |   |   |   |   |
| Cash flows from  investing activities:                                           |       |                                        |       |   |   |   |   |
| Proceeds from maturities of marketable debt  securities                          |       | 22,415                                      |       | — |   | 22,415 |   |
| Purchases of marketable debt securities                                          |       | (18,354                                     | )          | — |   | (18,354 | ) |
| Proceeds from disposition of property and equipment                              |       | 4                                           |       | — |   | 4 |   |
| Purchases of property and equipment                                              |       | (344                                        | )          | — |   | (344 | ) |
| Investments in other assets                                                      |       | (150                                        | )          | — |   | (150 | ) |
| Net cash provided by investing activities                                        |       | 3,571                                       |       | — |   | 3,571 |   |
|                                                                             |       |                                        |       |   |   |   |   |
| Cash flows from  financing activities:                                           |       |                                        |       |   |   |   |   |
| Net proceeds from issuances of common stock                                      |       | 462                                         |       | — |   | 462 |   |
| Net cash provided by financing activities                                        |       | 462                                         |       | — |   | 462 |   |
|                                                                             |       |                                        |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                           |       | 5                                           |       | — |   | 5 |   |
| Net increase in  cash and cash equivalents                                       |       | 6,000                                       |       | — |   | 6,000 |   |
| Cash and cash  equivalents at beginning of year                                  |       | 5,518                                       |       | — |   | 5,518 |   |
| Cash and cash  equivalents at end of year                                        |       | $                                           | 11,518     |   | $ | — |   | $ | 11,518 |   |

 

12

----

 

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

 
| ** **                                                                     | ** ** | **Three Months Ended March 31,  2004** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                     | ** ** | **As**                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                     | ** ** | **Previously**                              | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                     | ** ** | **Reported**                                | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                         |       |                                        |       |   |   |   |   |
| Net income                                                                     |       | $                                           | 1,446      |   | $ | 404 |   | $ | 1,850 |   |
| Adjustments to  reconcile net income to net cash used in operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                  |       | 518                                         |       | — |   | 518 |   |
| Provision for doubtful accounts                                                |       | 46                                          |       | — |   | 46 |   |
| Amortization of deferred compensation related to  stock options                |       | 14                                          |       | — |   | 14 |   |
| Changes in operating assets and liabilities, net of  effect of acquisitions:   |       |                                        |       |   |   |   |   |
| Accounts receivable                                                            |       | (6,644                                      | )          | — |   | (6,644 | ) |
| Inventories                                                                    |       | (3,835                                      | )          | — |   | (3,835 | ) |
| Inventories at customers under purchase orders                                 |       | (2,291                                      | )          | — |   | (2,291 | ) |
| Prepaid expenses and other current assets                                      |       | (601                                        | )          | — |   | (601 | ) |
| Accounts payable                                                               |       | 1,978                                       |       | — |   | 1,978 |   |
| Accrued compensation                                                           |       | 503                                         |       | — |   | 503 |   |
| Other accrued liabilities                                                      |       | 125                                         |       | 41 |   | 166 |   |
| Customer deposits and deferred revenues                                        |       | 1,962                                       |       | (445 | ) | 1,517 |   |
| Net cash used in operating activities                                          |       | (6,779                                      | )          | — |   | (6,779 | ) |
|                                                                           |       |                                        |       |   |   |   |   |
| Cash flows from  investing activities:                                         |       |                                        |       |   |   |   |   |
| Proceeds from maturities of marketable debt  securities                        |       | 53,872                                      |       | — |   | 53,872 |   |
| Purchases of marketable debt securities                                        |       | (53,218                                     | )          | — |   | (53,218 | ) |
| Purchases of property and equipment                                            |       | (542                                        | )          | — |   | (542 | ) |
| Investments in other assets                                                    |       | (62                                         | )          | — |   | (62 | ) |
| Net cash provided by investing activities                                      |       | 50                                          |       | — |   | 50 |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Cash flows from  financing activities:                                         |       |                                        |       |   |   |   |   |
| Net proceeds from issuances of common stock                                    |       | 1,548                                       |       | — |   | 1,548 |   |
| Net cash provided by financing activities                                      |       | 1,548                                       |       | — |   | 1,548 |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                         |       | (3                                          | )          | — |   | (3 | ) |
| Net decrease in  cash and cash equivalents                                     |       | (5,184                                      | )          | — |   | (5,184 | ) |
| Cash and cash  equivalents at beginning of year                                |       | 10,027                                      |       | — |   | 10,027 |   |
| Cash and cash  equivalents at end of year                                      |       | $                                           | 4,843      |   | $ | — |   | $ | 4,843 |   |

 

13

----

 

**Note 3– Marketable Debt Securities**

 

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

 
| ** **      | ** ** | **March 31, 2005** | ** ** |
|-----------------|------------|-------------------------|------------|
| ** **      | ** ** | ** **              | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **      | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **      | ** ** | **Cost**                | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Corporate bonds |       | $                       | 12,670     |   | $ | 2 |   | $ | (87 | ) | $ | 12,585 |   |
| Municipal bonds |       | 28,280                  |       | 1 |   | (162 | ) | 28,119 |   |
|            |       | $                       | 40,950     |   | $ | 3 |   | $ | (249 | ) | $ | 40,704 |   |

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

 

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

 
| ** **                              | ** ** | **March 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | **Amortized**           | ** ** | **Fair**                   | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                              | ** ** | **Cost**                | ** ** | **Value**                  | ** ** | **Cost** | ** ** | **Value** | ** ** |
| Due within one  year                    |       | $                       | 25,352     |                       | $          | 25,265 |   | $ | 28,662 |   | $ | 28,615 |   |
| Due after one  year through three years |       | 13,098                  |       | 12,939                     |       | 13,349 |   | 13,289 |   |
| Due after three  years                  |       | 2,500                   |       | 2,500                      |       | 3,000 |   | 3,000 |   |
|                                    |       | $                       | 40,950     |                       | $          | 40,704 |   | $ | 45,011 |   | $ | 44,904 |   |

 

Net realized gains andlosses were not material for the three months ended March 31, 2005 and theyear ended December 31, 2004.

 

**Note 4 –Accounts Receivable**

 

Accounts receivableconsisted of the following:

 
| ** **                       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **                       | ** ** | **(Restated)**     | ** ** | **(Restated)**        | ** ** |
|                             |       |               |       |                  |       |
| Billed  receivables              |       | $                  | 8,531      |                  | $          | 7,994 |   |
| Unbilled revenue                 |       | 1,518              |       | 1,024                 |       |
|                             |       | 10,049             |       | 9,018                 |       |
| Allowance for  doubtful accounts |       | (690               | )          | (690                  | )          |
| Accounts receivable, net         |       | $                  | 9,359      |                  | $          | 8,328 |   |

 

14

----

 

**Note 5 –Inventories**

 

Inventories consisted ofthe following:

 
| ** **               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **               | ** ** | ** **         | ** ** | **(Restated)**        | ** ** |
|                     |       |               |       |                  |       |
| Raw materials            |       | $                  | 9,245      |                  | $          | 8,449 |   |
| Work in process          |       | 3,900              |       | 3,558                 |       |
| Demonstration  equipment |       | 5,048              |       | 4,152                 |       |
| Finished goods           |       | 2,755              |       | 3,947                 |       |
| Inventories              |       | $                  | 20,948     |                  | $          | 20,106 |   |

 

**Note 6 – Purchased Technology**

 

Purchased technology wasas follows:

 
| ** **                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2005**           | ** ** | **2004**              | ** ** |
|                            |       |               |       |                  |       |
| Purchased  technology           |       | $                  | 4,651      |                  | $          | 4,651 |   |
| Less:  Accumulated amortization |       | (1,296             | )          | (948                  | )          |
| Purchased technology, net       |       | $                  | 3,355      |                  | $          | 3,703 |   |

 

Amortization expense forthe three months ended March 31, 2005 and 2004 was $348 and $85,respectively.  Assuming no change in the gross carrying value of purchasedtechnology, the estimated amortization expense for the twelve months ending December 31,2005 is $1,393 and for each of the next four years is $1,178, $771, $361 andnone.

 

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

 

**Note 7 – Accumulated OtherComprehensive Loss**

 

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

 
| ** **                                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2005**           | ** ** | **2004**              | ** ** |
|                                                 |       |               |       |                  |       |
| Currency  translation adjustments                    |       | $                  | 34         |                  | $          | 1 |   |
| Net unrealized  losses on marketable debt securities |       | (246               | )          | (107                  | )          |
| Accumulated other comprehensive loss                 |       | $                  | (212       | )                     | $          | (106 | ) |

 

15

----

 

**Note 8 –Shareholders’ Equity**

 

Changes in shareholders’equity during the three months ended March 31, 2005 were as follows:

 
| Shareholders’ equity balance at December 31,  2004 (Restated) |   | $      | 79,069 |   |
|-------------------------------------------------------------------------|--------|--------|--------|--------|
| Net loss (Restated)                                                     |   | (2,787 | )      |
| Accumulated other comprehensive loss:                                   |   |   |   |
| Foreign currency translation adjustment                                 |   | 33     |   |
| Net unrealized loss on marketable debt securities                       |   | (139   | )      |
| Comprehensive loss                                                      |   | (2,893 | )      |
| Issuances of common stock in conjunction with:                          |   |   |   |
| Exercises of employee stock options                                     |   | 462    |   |
| Tax benefit from stock options exercised (Restated)                     |   | — |   |
| Expense related to issuances of stock options to  nonemployees          |   | 1      |   |
| Shareholders’  equity balance at March 31, 2005 (Restated)    |   | $      | 76,639 |   |

 

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

 

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

 
| ** **                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** |
|                                          |       |                                  |       |   |   |
| Net income  (loss)                            |       | $                                     | (2,787     | ) | $ | 1,850 |   |
|                                          |       |                                  |       |   |   |
| Weighted average  common shares:              |       |                                  |       |   |   |
| Basic                                         |       | 17,867                                |       | 17,622 |   |
| Effect of dilutive stock options and warrants |       | —                                |       | 864 |   |
| Diluted                                       |       | 17,867                                |       | 18,486 |   |
|                                          |       |                                  |       |   |   |
| Net income  (loss) per share:                 |       |                                  |       |   |   |
| Basic                                         |       | $                                     | (0.16      | ) | $ | 0.10 |   |
| Diluted                                       |       | $                                     | (0.16      | ) | $ | 0.10 |   |

 

The total weightedaverage number of stock options and warrants excluded from the calculation ofpotentially dilutive securities either due to the exercise price exceeding theaverage market price or the inclusion of such securities in a calculation ofnet loss per share would have been anti-dilutive for the three months ended March 31,2005 and 2004 were 1,999 and 143, respectively.

 

***Stock-based Compensation***

 

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

 

16

----

 

 

Theestimated per share weighted average fair value of all stock options grantedduring the three months ended March 31, 2005 and 2004 was $6.69 and $10.04. The fair value ofeach option grant was estimated using the Black-Scholes option pricing modelwith the following weighted average assumptions:

 
| ** **               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|
| ** **               | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                     |       |                                  |       |   |   |
| Expected life            |       | 4.7 years                             |       | 3.9 years |   |
| Risk free  interest rate |       | 3.8                                   | %          | 2.5 | % |
| Volatility               |       | 73.5                                  | %          | 74.3 | % |
| Dividend yield           |       | —                                |       | — |   |

 

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

 
| ** **                                                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                         | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                                                                         | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** |
|                                                                                               |       |                                  |       |   |   |
| Net income  (loss), as reported                                                                    |       | $                                     | (2,787     | ) | $ | 1,850 |   |
| Add:                                                                                               |       |                                  |       |   |   |
| Stock-based employee compensation expense included  in net income (loss), as reported              |       | —                                |       | — |   |
| Deduct:                                                                                            |       |                                  |       |   |   |
| Stock-based employee compensation expense determined  under fair value based method for all awards |       | (800                                  | )          | (1,153 | ) |
| Net income  (loss), pro forma                                                                      |       | $                                     | (3,587     | ) | $ | 697 |   |
|                                                                                               |       |                                  |       |   |   |
| Net income  (loss) per share:                                                                      |       |                                  |       |   |   |
| As reported:                                                                                       |       |                                  |       |   |   |
| Basic                                                                                              |       | $                                     | (0.16      | ) | $ | 0.10 |   |
| Diluted                                                                                            |       | $                                     | (0.16      | ) | $ | 0.10 |   |
|                                                                                               |       |                                  |       |   |   |
| Pro forma:                                                                                         |       |                                  |       |   |   |
| Basic                                                                                              |       | $                                     | (0.20      | ) | $ | 0.04 |   |
| Diluted                                                                                            |       | $                                     | (0.20      | ) | $ | 0.04 |   |

 

On March 30, 2005, the board of directorsauthorized the Company to enter into an agreement to grant 175,000 options tothe Company’s President and Chief Operating Officer upon acceptance of theposition.  The grant is not part of the Company’s 1997 Stock IncentivePlan, and was not approved by the Company’s shareholders.  The optionswere granted at fair market value on the date of grant, and vest ratably overfive years from the date of grant.

 

**Note 9 –Commitments and Contingencies**

 

***Warranties***

 

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

 

17

----

 

Thefollowing table summarizes the activity related to the warranty liabilityduring the three months ended March 31, 2005 and 2004:

 
| ** **                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|
| ** **                    | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Accrual at  beginning of year |       | $                                     | 942        |   | $ | 239 |   |
| Warranties issued             |       | 312                                   |       | 160 |   |
| Costs incurred                |       | (141                                  | )          | (137 | ) |
| Accrual at end  of period     |       | $                                     | 1,113      |   | $ | 262 |   |

 

***Contingent Consideration***

 

Inconnection with the acquisition of DMSVision software division of Inspex, Inc (“DMSVision”), theCompany is subject to a contingent consideration arrangement at March 31,2005.  This arrangement is based upon neworders for DMSVision software licenses received in the twelve months after the acquisition.  The payment of the contingency will result inan increase in the allocation of purchase price to purchased technology.  As a result, amortization expense related tothis asset will increase.  Amounts paidunder this arrangement are not expected to have a material effect on theCompany’s consolidated financial condition or results of operations.  The Company currently estimates the totalcontingent consideration to be paid will be between $150 and $300.

 

***Legal Proceedings***

 

From time totime in the ordinary course of business, we are subject to claims, asserted orunasserted, or named as a party to lawsuits or investigations. Litigation, ingeneral, and intellectual property and securities litigation in particular, canbe expensive and disruptive to normal business operations. Moreover, theresults of legal proceedings cannot be predicted with any certainty and in thecase of more complex legal proceedings such as intellectual property andsecurities litigation, the results are difficult to predict at all.

 

August TechnologyCorporation and each of its directors, Jeff O’Dell, James Bernards, RogerGower, Michael Wright and Linda Hall Whitman, have been named as defendants intwo separate lawsuits that purport to be class actions claims on behalf of ourshareholders.  We received a summons andcomplaint with respect to the first of these proceedings on February 4,2005 and the second on February 14, 2005. Both lawsuits are brought in Minnesota State Court and claim that thedirectors have breached their fiduciary duties to our shareholders inconnection with their actions in agreeing to the proposed merger withNanometrics Incorporated.  The plaintiffsin both actions seek various forms of injunctive relief including an orderenjoining us and our directors from consummating the merger withNanometrics.  August Technology andits directors believe the lawsuits are without merit and plan to vigorouslydefend against the claims.

 

The twoproceedings have been consolidated and are being heard as one case.  On April 19, 2005, the Court issued a 30day stay of all proceedings.  Inaddition, the Court stated that it would issue an order on motions to dismissfiled by August Technology Corporation and the individual directordefendants within that 30 day period.

 

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

 

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

 
| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|---------------------------------------|------------|
| ** **    | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **    | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** |
| Net revenues: |       |                                  |       |   |   |
| Customer A    |       | 14                                    | %          |   | * |
| Customer B    |       | 13                                    | %          |   | * |
| Customer C    |       | 11                                    | %          |   | * |
| Customer D    |       |                                  | *          | 18 | % |
|          |       | 38                                    | %          | 18 | % |

 

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

 
| ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **          | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** |
| Net revenues:       |       |                                  |       |   |   |
| NSX Series          |       | 49                                    | %          | 52 | % |
| All Surface Systems |       | 23                                    | %          | 20 | % |
| 3Di Series          |       | 9                                     | %          | 9 | % |
| Other               |       | 19                                    | %          | 19 | % |
|                |       | 100                                   | %          | 100 | % |

 

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

 
| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|---------------------------------------|------------|
| ** **    | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **    | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** |
| Net revenues: |       |                                  |       |   |   |
| United States |       | 21                                    | %          | 29 | % |
| Taiwan        |       | 51                                    | %          | 21 | % |
| South Korea   |       | 9                                     | %          | 24 | % |
| Europe        |       | 17                                    | %          | 3 | % |
| Japan         |       | 2                                     | %          | 6 | % |
| Rest of Asia  |       | 0                                     | %          | 17 | % |
|          |       | 100                                   | %          | 100 | % |

 

**Note 11– Recently Issued Accounting Pronouncements**

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“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. 123R focuses primarily on

 

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accountingfor transactions in which an entity obtains employee services throughshare-based payment transactions. SFAS No. 123R requires a public entityto measure the cost of employee services received in exchange for the award ofequity instruments based on the fair value of the award at the date of grant.The cost will be recognized over the period during which an employee isrequired to provide services in exchange for the award. The SEC issued guidancein April 2005 announcing that public companies will be required to adoptSFAS No. 123R by their first fiscal year beginning after June 15,2005. While the Company cannot precisely determine the impact on net earningsas a result of the adoption of SFAS No. 123R, estimated compensationexpense related to prior periods can be found in Note 8, see “Stock-basedCompensation”. The ultimate amount of increased compensation expense will bedependent on whether the Company adopts SFAS No. 123R using the modifiedprospective or retrospective method, the number of option shares granted duringthe year, their timing and vesting period, and the method used to calculate thefair value of the awards, among other factors the Company is currentlyassessing.

 

In November 2004, the FASB issued SFAS No. 151,“*Inventory Costs - an amendment of ARB No. 43,Chapter 4*.” SFAS No. 151clarifies the accounting for abnormal amounts of idle facility expenses,freight, handling costs, and spoilage. It also requires that allocation offixed production overheads to inventory be based on the normal capacity ofproduction facilities. SFAS No. 151 is effective for inventory costsincurred during fiscal years beginning after June 15, 2005. Adoption ofSFAS 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 Form 10-Q/A, as well as oral statements made by usfrom time to time, which are prefaced with words such as “expects,” “anticipates,”“believes,” “projects,” “intends,” “plans” and similar words and otherstatements of similar sense, are forward-looking statements.  Our forward-looking statements generallyrelate to our growth strategies, financial results, future financialprojections, product development activities and sales efforts.  Our actualresults could differ materially from those projected in the forward-lookingstatements as a result of a number of factors, including but not limited tomarket acceptance of our products, our ability to successfully develop newproducts, our ability to protect our intellectual property, our dependence uponinternational customers and suppliers, our dependence on a small number ofcustomers that account for a significant portion of revenues, availability ofproducts from our suppliers, cyclicality in the microelectronic manufacturingequipment and other industries, management of growth, integration of acquiredbusinesses, and the other risk factors detailed below and in our Amendment No. 1on Form 10-K/A for the year ended December 31, 2004, which is being filedwith the SEC concurrently with this Form 10-Q/A.  We disclaim any obligation to reviseforward-looking statements, or to update the reasons actual results coulddiffer materially from those anticipated, to reflect events or circumstancesafter the date of such statements or to reflect the occurrence of anticipatedor unanticipated events. Because many factors are unforeseeable, the foregoingshould not be considered an exhaustive list.

 

**Introduction**

 

The following discussion of our results ofoperations and financial condition should be read together with the otherfinancial information and consolidated financial statements and related notesincluded in this Form 10-Q/A. All applicable disclosures in the following discussion have been modifiedto reflect the Restatement, as described below. Thisdiscussion contains forward-looking statements that involve risks anduncertainties. Our actual results could differ materially from thoseanticipated in the forward-looking statements as a result of a variety offactors.

 

**Restatement**

 

We have restated our consolidated financial statements for the years2004, 2003 and 2002 and for the first two quarters of 2005. Our restatedconsolidated financial statements also include disclosure of restated unauditedquarterly results for 2004 and 2003.  Theinitial determination to restate the 2004 and first half 2005 consolidatedfinancial statements was made as a result of a correction of the Company’sapplication of revenue recognition principles, as contained in the FinancialAccounting Standard Board’s Emerging Issues Task Force Issue No. 00-21, “*Revenue Arrangements with Multiple Deliverables*” (“EITF 00-21”).  As a result of subsequently reviewing ourrevenue recognition policies and procedures, we additionally noted thatbeginning in the fourth quarter of 2002 certain deferred software revenueshould have been fully recognized upon delivery or customer acceptance ratherthan ratably over a twelve-month period. This created the need to restate 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 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

 

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$2.4million in the second quarter of 2005) and recognized the revenue for thesesales.  The cost of revenues related tothese sales was $2.7 million in 2004, $1.5 million in the first quarter of 2005and $1.2 million in the second quarter of 2005. There were no sales of AXi 930 systems to this customer that should havebeen deferred in the quarter ended March 31, 2004.  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 errordecreased revenue by $0.3 million for the three months ended March 31,2005 and increased revenue by $0.4 million for the three months ended March 31,2004. 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.

 

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

 

The Restatement impacted the timing of revenue recognition as the AXi930 enhancement packages have been deferred into the third quarter of 2005 andthe Yield Pilot software revenue is recognized upon delivery or customeracceptance rather than ratably over a twelve-month period.  The impact of the Restatement on theconsolidated statements of operations for the three months ended March 31,2005 and 2004 is shown in Note 2 to our consolidated financial statementsincluded in this Form 10-Q/A.

 

The primary impact of the Restatement on the consolidated balance sheetat March 31, 2005 was to increase inventory at customers under purchaseorders related to the deferral of the cost of revenue and to increase customerdeposits and deferred revenues related to cash collected for revenue deferredin the Restatement.  The Restatement hadno impact on cash balances or net cash flows from operating, investing, orfinancing activities.  The impact of theRestatement on the consolidated balance sheet and consolidated statements ofcash flows is shown in Note 2 to our consolidated financial statements includedin this Form 10-Q/A.

 

**Critical Accounting Policies**

 

The preparation of our consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets, liabilities, revenues and expenses,and related disclosure of contingent assets and liabilities.  We basedthese estimates and assumptions on historical experience and evaluate them onan on-going basis to help ensure they remain reasonable under currentconditions.  Actual results could differ from those estimates. We discussthe development and selection of the critical accounting estimates with theaudit committee of our board of directors on a quarterly basis, and the auditcommittee has reviewed the Company’s critical accounting policies as describedin Item 7, “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in our Amendment No. 1 on Form 10-K/A for theyear ended December 31, 2004.   For the three months ended March 31,2005, there were no 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 provide manufacturers with information that enablesprocess-enhancing decisions, ultimately lowering manufacturing costs anddecreasing time-to-market. We have traditionally provided systems to addressthe automated inspection needs of the early stages of the final manufacturingor back-end of the microelectronic device manufacturing process. These needswere met primarily with our NSX Series and 3Di Series ofproducts.  We have introduced the AXi Series andthe E20 for edge and B20 for backside inspection systems (collectively, the “AllSurface Inspection System”) for advanced macro defect detection primarily inthe front-end of the wafer manufacturing process. When used in conjunction withone another these systems allow a manufacturer to inspect the top, edge andback of a wafer’s surface.  We believe weare the first to offer all surface wafer inspection.  We continue 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.

 

In addition to internal development, we look toexpand through strategic mergers and acquisitions of complementary products andtechnologies. In April 2003 we completed the acquisition of SemiconductorTechnologies & Instruments, Inc. (“STI”), enhancing our probemark inspection and metrology capabilities. In July 2003 we acquired theassets of Counterpoint Solutions, Inc. (“CSI”), including the design forthe VersaScope a defect review system for advanced microscope-based imaging andanalysis.  In July 2004 we acquiredcertain assets of the DMSVision software division of Inspex, Inc (“DMSVision”).  We have used the DMSVision software tofurther expand and enhance our defect analysis software offerings with therelease of our DMS Decision product during the quarter.

 

Ourbusiness has been, and will continue to be, subject to the highly cyclicalnature of the microelectronic device manufacturing markets we serve. Thesecycles are caused by significant, and often rapid, fluctuations in the supplyand demand of microelectronic devices driven by such factors as changes intechnology and global economic conditions. As a result of these fluctuations, anddue to the fact that our quarterly revenues are comprised of systems withaverage selling prices of between $150,000 and $1,000,000, a small change inthe number of systems we sell may also cause significant changes in ouroperating results.  Because fluctuationsin the timing 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 ourproducts do not occur when we expect, and we are unable to adjust our estimateson a timely basis, our expenses and inventory levels may increase relative torevenues and total assets.

 

We have sold our systems to many of the leadingmicroelectronic device manufacturers throughout the world. Historically, asignificant portion of our revenues in each quarter and year has been derivedfrom sales to relatively few customers, and we expect this trend to continue.  In the

 

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threemonths ended March 31, 2005 and 2004 sales to customers that individuallyrepresented at least ten percent of our revenues accounted for 38% and 18% 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.  Duringthe first quarter of 2005 our book-to-bill ratio was below parity.  A book-to-bill ratio below parity indicates adecreasing level of backlog.  In additionto monitoring our level of orders and backlog, we focus on revenues by productfamily compared to prior-period and current-year plans, year-over-year revenuegrowth compared to the overall semiconductor equipment industry, operatingprofit or loss performance compared with prior-period and current-year plansand the level of operating cash flow.

 

**Merger Activities**

 

On January 21, 2005, we entered into a MergerAgreement with Nanometrics, Incorporated (“Nanometrics”), pursuant towhich Nanometrics will reincorporate under Delaware law and August TechnologyCorporation will become a wholly-owned subsidiary of Nanometrics.  In connection with this transaction,Nanometric’s name will be changed to August Nanometrics.  Each share of our common stock will beconverted into the right to receive 0.6401 of a share of August Nanometricscommon stock.  August Nanometricswill make a cash payment to our shareholders for any fractional shares of August Nanometricscommon stock they would otherwise be entitled to receive instead of issuingfractional shares.  On March 28,2005, Nanometrics filed a registration statement on Form S-4 with theSecurities and Exchange Commission containing a Joint ProxyStatement/Prospectus of Nanometrics and August Technology with respect tothe Merger Agreement and related transactions.

 

On January 27, 2005, we received a letter from PaulF. McLaughlin, Chairman and Chief Executive Officer of Rudolph Technologies, Inc.(“Rudolph”), stating that Rudolph is prepared to enter into a merger with usbased on a share exchange ratio of 0.6239 share of Rudolph stock for each shareof our common stock (equivalent to $10.50 per share of our common stock basedon the closing price of Rudolph stock on January 27, 2005).  The letter stated that each of ourshareholders may elect to receive all cash, stock or a combination of cash andstock, subject to proration based on total cash consideration of $40 million.

 

Also on January 27, 2005, Rudolph issued apress release with proposed terms slightly different from those described inthe letter.  The press release statedthat Rudolph is prepared to enter into a merger with us whereby each of ourshareholders will receive the value of $2.16 per share in cash and 0.4955 pershare in Rudolph common stock (equivalent to $10.50 per share of our CommonStock, based on the closing price of Rudolph stock on January 27,2005).  The press release stated thateach of our shareholders would have the option to elect to receive all cash,stock or a combination of cash and stock, subject to proration based on totalcash consideration of $40 million.

 

On April 4, 2005, we entered into aconfidentiality agreement with Rudolph and are currently engaged in discussionsand exchanging information with Rudolph to consider and evaluate itsoffer.  We remain subject to our January 21,2005 Merger Agreement with Nanometrics

 

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andare conducting the discussions with Rudolph as permitted by the terms of theMerger Agreement.

 

On February 9, 2005, we received a letter fromKenneth Schroeder, President and Chief Executive Officer of KLA-TencorCorporation (“KLA”), regarding KLA’s interest in pursuing a merger withus.  The letter stated that KLA proposedto acquire us in a transaction in which our shareholders would receive $11.50per share.  KLA also stated that it wouldbe willing to consider using stock as consideration.  As of the date of this filing, we have beenunable to reach agreement with KLA on a confidentiality agreement and nodiscussions regarding KLA’s offer have taken place.

 

Under the terms of our Merger Agreement with Nanometrics,we may be obligated to pay to Nanometrics a fee of $8.3 million, plusNanometrics’ expenses, if (i) we accept an acquisition proposal fromRudolph or KLA or any other party; or (ii) change our recommendation toshareholders with respect to the proposed merger with Nanometrics in order topursue an alternative acquisition proposal.

 

**Results of Operations**

 
| ** **                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                           | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** |
| Net revenues                                         |       | 100.0                                 | %          | 100.0 | % |
| Cost of revenues                                     |       | 45.4                                  |       | 41.9 |   |
| Gross profit                                         |       | 54.6                                  |       | 58.1 |   |
|                                                 |       |                                  |       |   |   |
| Selling, general  and administrative expenses        |       | 42.1                                  |       | 30.8 |   |
| Research and  development expenses                   |       | 24.4                                  |       | 17.3 |   |
| Operating income (loss)                              |       | (11.9                                 | )          | 10.0 |   |
|                                                 |       |                                  |       |   |   |
| Merger expenses                                      |       | (8.2                                  | )          | — |   |
| Interest income                                      |       | 1.9                                   |       | 1.2 |   |
| Net income  (loss) before provision for income taxes |       | (18.2                                 | )          | 11.2 |   |
| Provision for  income taxes                          |       | 0.3                                   |       | 0.2 |   |
| Net income  (loss)                                   |       | (18.5                                 | )%         | 11.0 | % |

** **

*Three months ended March 31, 2005 compared to the three monthsended March 31, 2004*

 

*Net Revenues.*  Net revenues decreased $1.8 million, or 10.7%,to $15.0 million for the three months ended March 31, 2005, from $16.8million for the same period in 2004.  The decrease in net revenues was primarily due to decreased sales of ourNSX and AXi inspection systems.  Revenuesderived from systems sold for front-end wafer fab applications accounted for 42%and 52% of total net revenues for the three months ended March 31, 2005and 2004, respectively. Revenues in the second quarter of 2005 are expected to rangefrom -5% to +5%, as compared to the first quarter of 2005.

 

Net revenues from international sales represented 79%and 71% of total net revenues for the three months ended March 31, 2005and 2004, respectively.  Internationalrevenues during these

 

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periodswere primarily the result of sales to Asia, which comprised 62% and 68% oftotal net revenues for the three months ended March 31, 2005 and 2004,respectively.

 

*Gross Margin.*  Gross margin decreased to 54.6% for the threemonths ended March 31, 2005, from 58.1% for the same period in 2004.  Gross margins decreased in the first quarterof 2005 primarily as a result of rework costs related to certain systems, therecording of a lower of cost or market adjustments related to certain componentparts that became obsolete due to engineering design changes during thequarter, and additional reserves related to slow moving inventories.  Inaddition, we have experienced pricing pressure primarily related to ourinspection systems sold into final manufacturing applications as competitorshave continued to enter this market.  Theimpact of these lower margins has been offset by higher margin products soldinto front end applications.  We expectfuture gross margins 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 for thethree months ended March 31, 2005, compared to $5.2 million for the sameperiod in 2004.  SG&A expenses as apercentage of net revenues were 42.1% for the three months ended March 31,2005, compared to 30.8% of net revenuesfor the same period in 2004.  Theincrease in expense dollars was primarily the result of costs associated withboth new hires and contractors in our field service and sales groups to supportincreased revenues and customer demonstrations, an increased number of demosystems and amortization expense related to technology acquired with thepurchase of DMSVision. We expect SG&A expense dollars to remain relativelyflat in future quarters, as compared to the first quarter of 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 $3.7 million for the three months ended March 31,2005, compared to $2.9 million for the same period in 2004.  R&D expenses as a percentage of netrevenues were 24.4% for the threemonths ended March 31, 2005, compared to 17.3% for the same period in2004.  The increase in expense dollarswas primarily due to employeecompensation and related benefits associated with the hiring ofadditional staff to complete certain stages of development of the all surfaceinspection systems.  In addition,expenses increased due to the DMSVision acquisition completed in July 2004.  We currently anticipate that research and development expense dollars willincrease in the second quarter of 2005 as we continue to expand our suite ofsoftware solutions.

 

*Interest Income.* Interest income was $289,000 for the three months ended March 31,2005, compared to $201,000 for the same period in 2004.  The increase in interest income was primarilydue to an increase in the rate of return on our investment balances.

 

*Merger Expenses.*  Merger expenses were $1.2million, or 8.2% of net revenues, for the three months ended March 31,2005, compared to none for the same period in 2004.  The merger expenses were primarily legal andinvestment banker fees incurred for the proposed merger with Nanometrics,Incorporated, and the evaluation of the KLA-Tencor Corporation and RudolphTechologies, Inc. offers.

 

***Income Taxes. ***As a result of historical operating losses and uncertaintyas to the extent of profitability in future periods, we began to record avaluation allowance against our deferred tax assets in the second quarter of2002 and continue to do so at March 31, 2005.  As a result, we have recorded a provision forincome taxes of $50,000 and $41,000 for the three months ended

 

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**March 31, 2005, and 2004, respectively, primarily toreflect foreign income taxes owed.  Statement of Financial Accounting Standards**(“SFAS”)No. 109 “Accounting forIncome Taxes,” requires the establishment of a valuation allowance to reflectthe likelihood of the realization of deferred tax assets.  As of December 31, 2004 the valuationallowance was $9.3 million.

** **

**Liquidity and CapitalResources**

** **

At March 31,2005 our principal sources of liquidity consisted of cash, cash equivalents andinvestments in marketable debt securities of $52.2 million, compared to $50.4million at December 31, 2004, an increase of $1.8 million.  Theincrease was primarily due to an increase in accounts payable and accruedcompensation, and cash collected upon the exercise of stock options partiallyoffset by an increase in both accounts receivable and inventories.  During the next twelve months, and beyond, weintend to utilize our current sources of liquidity to fund operations,specifically to enhance our position in the front-end wafer fabricationprocess.  We have no outstandingdebt at March 31, 2005.  Ourliquidity is affected by many factors, some of which are based on the normalongoing operations of our business, the most significant of which includes thetiming of the collection of receivables, the level of inventories, capitalexpenditures and acquisitions.

 

*Accounts Receivable.*  Accountsreceivable increased $1.0 million from December 31, 2004 to March 31,2005.  Our days sales outstanding (“DSO”)during the three months ended March 31, 2005 was 53 days.  This compares to a DSO of 48 days in thefourth quarter of 2004.  The increase inthe DSO during the first quarter is primarily due to the decrease in netrevenues as compared with fourth quarter 2004. The increase in accounts receivable resulted in a use of cash during thethree months ended March 31, 2005, as we have funded shipments forincreased revenues prior to receiving payments from customers.  We believe our DSO will be between 50 and 65days in future quarters.

 

*Inventories.* Inventories increased $842,000 from December 31,2004 to March 31, 2005.  Theincrease is primarily due to the need to support new product introductions andincreased demonstration equipment under evaluation at customer locations.  This increase was partially offset by a decreasein finished goods due to the capitalization and sales of finished goodsinventory.

 

*Inventoriesat Customers under Purchase Orders.*  Inventories at customersunder purchase orders increased from $6.7 million at December 31, 2004 to$8.0 million at March 31, 2005.  Weanticipate that a portion of this inventory will be recognized as revenueduring 2005.  We anticipate that thisinventory will increase as shipments of newly introduced products increase.

 

*Capital Expenditures.*  Ourcapital expenditures during the first quarter of 2005 were $344,000, consistingprimarily of the capitalization of finished goods that have been transferred toengineering for test and characterization, and to sales for customerapplication studies.  This equipment isexpected to be utilized for these purposes for its estimated life, generallythree years.  Our total capitalexpenditures, including the capitalization of finished goods, are expected tobe between $3.0 million and $4.0 million in 2005, as we continue to expand the use of internal test anddevelopment equipment and facilities to meet customer demand and better serveour customers.

 

Ourliquidity is also affected by factors beyond our control related to theuncertainties of global economies and the cyclical nature of the semiconductorand microelectronic industries.  Althoughliquidity requirements will fluctuate based on the timing and extent of all ofthese factors and others, management believes that existing cash and investmentbalances will be adequate to satisfy our existing liquidity requirements for atleast the next twelve months.

 

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*CashFlows*

 

Netcash provided by operating activities for the three months ended March 31,2005 was $2.0 million, which resulted primarily from increased accounts payableand customer deposits partially offset by an increase in accounts receivableand inventories.  Net cash provided byinvesting activities was $3.6 million, primarily due to $4.1 million of netproceeds from maturities of marketable debt securities, partially offset by$494,000 of additions to property and equipment, and other assets.  Net cash provided by financing activities was$462,000 from proceeds received from the exercises of stock options.   We currently expect to generate cash fromoperating activities during the remainder of 2005.

 

Netcash used in operating activities for the three months ended March 31,2004 was $6.8 million, which resulted primarily from increased accountsreceivable and inventories partially offset by our net income and increasedaccounts payable and customer deposits. Net cash provided by investing activities was $50,000, primarily from$654,000 of net proceeds from maturities of marketable debt securities,partially offset by $604,000 of purchases of property and equipment, and otherassets.  Net cash provided by financingactivities was $1.5 million from proceeds received from issuances of commonstock in conjunction with exercises of stock options.

 

**New Accounting Pronouncements**

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“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. 123R focuses primarily on accounting fortransactions in which an entity obtains employee services through share-basedpayment transactions. SFAS No. 123R requires a public entity to measurethe cost of employee services received in exchange for the award of equityinstruments based on the fair value of the award at the date of grant. The costwill be recognized over the period during which an employee is required toprovide 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 cannotprecisely determine the impact on net earnings as a result of the adoption ofSFAS No. 123R, estimated compensation expense related to prior periods canbe found in Note 8, see “Stock-based Compensation”. 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. 151clarifies the accounting for abnormal amounts of idle facility expenses,freight, handling costs, and spoilage. It also requires that allocation offixed production overheads to inventory be based on the normal capacity ofproduction facilities. SFAS No. 151 is effective for inventory costsincurred during fiscal years beginning after June 15, 2005. Adoption ofSFAS No. 151 is not expected to have a material effect on our financialposition, results of operations 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 creditissuers and limit the amount of investments with any one issuer.  As of March 31, 2005, 62% of theInvestment Portfolio consisted of government securities and corporate bondswith maturities of one year or less.  Welimit credit risk associated with trade receivables by performing ongoingcredit evaluations and believe that there is no additional risk beyond amountsprovided for collection losses to be inherent in trade receivables.

 

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

 

**Overview**

 

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

 

Management has determined that the internal control deficiencythat resulted in the aforementioned accounting errors is a material weakness,as defined by the Public Company Accounting Oversight Board’s Auditing StandardNo. 2.  We have determined that thematerial weakness was that we did not maintain adequate controls and procedures to assure that multi-elementarrangements and related software revenue

 

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components were accounted for in accordance withgenerally accepted accounting principles. The Public CompanyAccounting Oversight Board has defined a material weakness as “a significantdeficiency, or combination of significant deficiencies, that results in morethan a remote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected.” Management hasreviewed the internal control deficiency with our Audit Committee, hasdiscussed it with our independent registered public accounting firm, KPMG LLP,and has advised our Audit Committee that the deficiency is a material weaknessin our internal control over financial reporting.

 

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

 

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

 

Under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, we evaluated the design and operation of ourdisclosure 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 March 31, 2005. At the time of the initial filing of our QuarterlyReport on Form 10-Q for the quarter ended March 31, 2005, on thebasis of that evaluation, our management, including our Chief Executive Officerand Chief Financial Officer, concluded that our disclosure controls andprocedures were effective, to give reasonable assurance that the informationrequired to be disclosed by us in reports that we file under the Exchange Actis recorded, processed, summarized and reported within the time periodsspecified in the rules and forms of the SEC and to ensure that informationrequired to be disclosed in the reports filed or submitted under the ExchangeAct is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, in a manner that allows timelydecisions regarding required disclosure.

 

In light of the materialweakness in internal control over financial reporting referenced above, ourChief Executive Officer and Chief Financial Officer now believe that ourdisclosure controls and procedures were not effective at a reasonable assurancelevel as of March 31, 2005.

 

In response to this materialweakness, management performed additional analyses and other post-closingprocedures to ensure our restated consolidated financial statements wereprepared in accordance with generally accepted accounting principles.Accordingly, management, including our Chief Executive Officer and ChiefFinancial Officer, believes the restated consolidated financial statementsincluded in this report and our Form 10-K/A fairly present, in allmaterial respects, our financial condition, results of operations and cashflows for the periods presented.

 

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

 

There were no changes in ourinternal control over financial reporting that occurred in the first quarter of2005 that materially affected, or were reasonably likely to materially affect,our internal control over financial reporting.

 

During October 2005, weimplemented the remedial measures outlined below to address the identifiedmaterial weakness in connection with the preparation of our restated financialstatements included in our Form 10-K/A for the year ended December 31,2004.  We have recently dedicatedadditional resources to the review of our control processes and proceduressurrounding revenue recognition. Furthermore, we have

 

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been conducting a thorough review and evaluation ofour internal controls over revenue recognition as part of our compliance withthe requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

 

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

 

•                  Enhanced our revenue recognition proceduresby updating our contract evaluation criteria and decision process flowcharts.  These evaluation and process updates weredeveloped as a result of performing a thorough review of applicable accountingliterature related to revenue recognition, particularly EITF No. 00-21, “Accountingfor Revenue Arrangements with Multiple Deliverables.”

 

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

 

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

 

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

 

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

 

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**PART II – OTHER INFORMATION**

 

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

 

August TechnologyCorporation and each of its directors, Jeff O’Dell, James Bernards, RogerGower, Michael Wright and Linda Hall Whitman, have been named as defendants intwo separate lawsuits that purport to be class actions claims on behalf of ourshareholders.  We received a summons andcomplaint with respect to the first of these proceedings on February 4,2005 and the second on February 14, 2005. Both lawsuits are brought in Minnesota State Court and claim that thedirectors have breached their fiduciary duties to our shareholders inconnection with their actions in agreeing to the proposed merger withNanometrics Incorporated.  The plaintiffsin both actions seek various forms of injunctive relief including an orderenjoining us and our directors from consummating the merger withNanometrics.  August Technology andits directors believe the lawsuits are without merit and plan to vigorouslydefend against the claims.

 

The twoproceedings have been consolidated and are being heard as one case.  On April 19, 2005, the Court issued a 30day stay of all proceedings.  Inaddition, the Court stated that it would issue an order on motions to dismissfiled by August Technology Corporation and the individual directordefendants within that 30 day period.

 

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

 

The exhibitslisted on the Exhibit Index are filed herewith.

 

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## SIGNATURES

 

 

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

 

 
|                         | AUGUST TECHNOLOGY CORPORATION            |
|------------------------------|-----------------------------------------------|
|                         |                                          |
|                         |                                          |
| Date: 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/A

 
| For the  quarter ended: |   | Commission  File No.: 000-30637 |
|-------------------------|--------|---------------------------------|
| March 31,  2005    |   |                            |

 

**AUGUST TECHNOLOGYCORPORATION**

** **
| **Exhibit Number** | ** ** | **Description**                                                                                                |
|-------------------------|------------|----------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                           |
| 10.1*                   |       | Executive  Employment Contract between the Company and Lynn Davis dated March 30,  2005                   |
|                    |       |                                                                                                           |
| 10.2*                   |       | Non-Statutory  Stock Option Agreement between the Company and Lynn Davis dated March 30,  2005            |
|                    |       |                                                                                                           |
| 31.1**                  |       | Certification  pursuant to Exchange Act Rules 13a-14(a) of the Chief Executive  Officer              |
|                    |       |                                                                                                           |
| 31.2**                  |       | Certification  pursuant to Exchange Act Rules 13a-14(a) of the Chief Financial  Officer              |
|                    |       |                                                                                                           |
| 32.1**                  |       | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to the Sarbanes-Oxley  Act of 2002 |

 

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*                 Previouslyfiled with the Original Filing

**          Filedherewith

 

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