**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

 

**FORM 10-Q**

 

 

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

**EXCHANGE  ACT OF 1934** |
|------------|------------|----------------------------------------------------------------------------------------------------|

** **

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

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

**EXCHANGE  ACT OF 1934** |

 

**For thetransition period from                         to                         **

 

 

**Commission File Number 000-30637**

 

 

**AUGUST TECHNOLOGY CORPORATION**

(Exact name of Registrantas specified in its charter)

 

| **Minnesota**  | ** ** | **41-1729485**      |
|----------------|------------|---------------------|
| (State of      |       | (I.R.S. Employer    |
| incorporation) |       | Identification No.) |

 

| **4900  West 78th Street**               | ** ** | ** ** |
|------------------------------------------|------------|------------|
| **Bloomington, MN**                      | ** ** | **55435**  |
| (Address of principal executive offices) |       | (Zip Code) |

 

**(952)820-0080**

(Registrant’s telephonenumber, including area code)

 

**N/A**

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

 

    Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

 

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

 

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

 

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**AUGUSTTECHNOLOGY CORPORATION**

**TABLE OFCONTENTS**

 

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

 

2

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**PART I****     FINANCIALINFORMATION**

**Item 1****.  Financial Statements**

**AUGUST TECHNOLOGY CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

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

**(Unaudited)**
| ** **                                                                                                                        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                                                                                                        | ** ** | **2005**      | ** ** | **2004**         | ** ** |
|                                                                                                                              |       |          |       |             |       |
| **ASSETS**                                                                                                                        |       |          |       |             |       |
| Current assets:                                                                                                                   |       |          |       |             |       |
| Cash and cash equivalents                                                                                                         |       | $             | 11,518     |             | $          | 5,518 |   |
| Short-term  marketable debt securities                                                                                            |       | 25,265        |       | 28,615           |       |
| Accounts  receivable, net                                                                                                         |       | 9,618         |       | 8,603            |       |
| Inventories                                                                                                                       |       | 20,948        |       | 20,131           |       |
| Inventories at  customers under purchase orders                                                                                   |       | 3,791         |       | 3,993            |       |
| Prepaid expenses  and other current assets                                                                                        |       | 1,954         |       | 2,306            |       |
| Total current  assets                                                                                                             |       | 73,094        |       | 69,166           |       |
|                                                                                                                              |       |          |       |             |       |
| 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                                                                                                                      |       | $             | 98,056     |             | $          | 95,800 |   |
|                                                                                                                              |       |          |       |             |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                     |       |          |       |             |       |
| Current  liabilities:                                                                                                             |       |          |       |             |       |
| Accounts payable                                                                                                                  |       | $             | 5,975      |             | $          | 3,366 |   |
| Accrued  compensation                                                                                                             |       | 2,051         |       | 1,691            |       |
| Other accrued  liabilities                                                                                                        |       | 2,222         |       | 2,306            |       |
| Customer  deposits and deferred revenues                                                                                          |       | 6,767         |       | 6,841            |       |
| Total current  liabilities                                                                                                        |       | 17,015        |       | 14,204           |       |
|                                                                                                                              |       |          |       |             |       |
| Other  non-current liabilities                                                                                                    |       | 112           |       | 131              |       |
| Total  liabilities                                                                                                                |       | 17,127        |       | 14,335           |       |
|                                                                                                                              |       |          |       |             |       |
| Commitments and  contingencies (note 8)                                                                                           |       | —        |       | —           |       |
|                                                                                                                              |       |          |       |             |       |
| Shareholders’  equity:                                                                                                       |       |          |       |             |       |
| Common stock, no  par value, 42,000,000 shares authorized, 17,925,793 and 17,839,298 shares  issued and outstanding, respectively |       | 90,815        |       | 90,347           |       |
| Undesignated  capital stock, no par value, 3,000,000 shares authorized, no shares issued or  outstanding                          |       | —        |       | —           |       |
| Accumulated  deficit                                                                                                              |       | (9,674        | )          | (8,776           | )          |
| Accumulated  other comprehensive loss                                                                                             |       | (212          | )          | (106             | )          |
| Total  shareholders’ equity                                                                                                  |       | 80,929        |       | 81,465           |       |
| Total  liabilities and shareholders’ equity                                                                                  |       | $             | 98,056     |             | $          | 95,800 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

3

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**AUGUST TECHNOLOGY CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Net revenues                                     |       | $                                | 18,417     |   | $ | 16,400 |   |
| Cost of revenues                                 |       | 8,359                            |       | 7,058 |   |
| Gross profit                                     |       | 10,058                           |       | 9,342 |   |
|                                             |       |                             |       |   |   |
| Selling, general  and administrative expenses    |       | 6,290                            |       | 5,189 |   |
| Research and  development expenses               |       | 3,666                            |       | 2,908 |   |
| Operating income                                 |       | 102                              |       | 1,245 |   |
|                                             |       |                             |       |   |   |
| Merger expenses                                  |       | (1,234                           | )          | — |   |
| Interest income                                  |       | 289                              |       | 201 |   |
|                                             |       |                             |       |   |   |
| Income (loss)  before provision for income taxes |       | (843                             | )          | 1,446 |   |
| Provision for  income taxes                      |       | 55                               |       | — |   |
| Net income  (loss)                               |       | $                                | (898       | ) | $ | 1,446 |   |
|                                             |       |                             |       |   |   |
| Net income  (loss) per share:                    |       |                             |       |   |   |
| Basic                                            |       | $                                | (0.05      | ) | $ | 0.08 |   |
| Diluted                                          |       | $                                | (0.05      | ) | $ | 0.08 |   |

 

See accompanying notes to consolidated financial statements.

** **

**4**

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** **

**AUGUST TECHNOLOGY CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                           | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                                               |       |                             |       |   |   |
| Net income  (loss)                                                                                   |       | $                                | (898       | ) | $ | 1,446 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                             |       |   |   |
| Depreciation and  amortization                                                                       |       | 1,039                            |       | 518 |   |
| Provision for  doubtful accounts                                                                     |       | (57                              | )          | 46 |   |
| Tax benefit from  employee stock options                                                             |       | 5                                |       | — |   |
| Deferred income  taxes                                                                               |       | 3                                |       | — |   |
| Amortization of  deferred compensation related to stock options                                      |       | —                           |       | 14 |   |
| Changes in  operating assets and liabilities:                                                        |       |                             |       |   |   |
| Accounts  receivable                                                                                 |       | (952                             | )          | (6,644 | ) |
| Inventories                                                                                          |       | (671                             | )          | (3,835 | ) |
| Inventories at  customers under purchase orders                                                      |       | 202                              |       | (2,291 | ) |
| Prepaid expenses  and other current assets                                                           |       | 361                              |       | (601 | ) |
| Accounts payable                                                                                     |       | 2,609                            |       | 1,978 |   |
| Accrued  compensation                                                                                |       | 356                              |       | 503 |   |
| Accrued  liabilities                                                                                 |       | 39                               |       | 125 |   |
| Customer  deposits and deferred revenues                                                             |       | (74                              | )          | 1,962 |   |
| 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 financial statements.

 

5

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**AUGUST TECHNOLOGY CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**MARCH 31, 2005**

**(In thousands, except per shareamounts)**

**(Unaudited)**

 

**Note****1 —****Basisof Presentation**

 

                The accompanying unaudited consolidatedfinancial statements have been prepared pursuant to the rules and regulationsof the Securities and Exchange Commission. Certain information and footnotedisclosures, normally included in consolidated financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America, have been condensed or omitted pursuant to such rules andregulations. In the opinion of the management of August Technology Corporation(collectively with its subsidiaries, the “Company”), all adjustments(consisting of normal recurring adjustments) considered necessary for a fairpresentation have been included in the consolidated balance sheet at March 31,2005, the consolidated statements of operations for the three months endedMarch 31, 2005 and 2004, and the consolidated statements of cash flows for thethree months ended March 31, 2005 and 2004. The statements of operations of theinterim periods are not necessarily indicative of the results of operationsthat may be expected for any other period or for the year as a whole. Theseconsolidated financial statements and notes hereto should be read inconjunction with the audited consolidated financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2004, filed with the Securities and Exchange Commission on March16, 2005.

 

                The accompanying consolidatedfinancial statements include the accounts of August Technology Corporation andits wholly owned subsidiaries. All significant intercompany balances andtransactions are eliminated in consolidation.

 

                Management usesestimates and assumptions in preparing consolidated financial statements inaccordance with accounting principles generally accepted in the United Statesof America. Those estimates and assumptions affect the reported amounts ofassets and liabilities and the disclosure of contingent assets and liabilitiesat the date of the consolidated financial statements and the reported revenuesand expenses during the reporting periods. Actual results could differ fromthose estimates.

 

6

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**Note 2 — Marketable Debt Securities**

 

                The amortized cost and estimatedfair value of available-for-sale marketable debt securities were as follows:

 
| ** **      | ** ** | **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 and losseswere not material for the three months ended March 31, 2005 and the year endedDecember 31, 2004.

 

**Note 3 — Accounts Receivable**

 

                Accounts receivable consisted ofthe following:

 
| ** **                       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|---------------|------------|------------------|------------|
| ** **                       | ** ** | **2005**      | ** ** | **2004**         | ** ** |
| Billed  receivables              |       | $             | 8,531      |             | $          | 8,150 |   |
| Unbilled revenue                 |       | 1,777         |       | 1,143            |       |
|                             |       | 10,308        |       | 9,293            |       |
| Allowance for  doubtful accounts |       | (690          | )          | (690             | )          |
| Accounts  receivable, net        |       | $             | 9,618      |             | $          | 8,603 |   |

 

7

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**Note 4 — Inventories**

 

                Inventories consisted of thefollowing:

 
| ** **               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------|------------|---------------|------------|------------------|------------|
| ** **               | ** ** | **2005**      | ** ** | **2004**         | ** ** |
|                     |       |          |       |             |       |
| Raw materials            |       | $             | 9,245      |             | $          | 8,474 |   |
| Work in process          |       | 3,900         |       | 3,558            |       |
| Demonstration  equipment |       | 5,048         |       | 4,152            |       |
| Finished goods           |       | 2,755         |       | 3,947            |       |
| Inventories              |       | $             | 20,948     |             | $          | 20,131 |   |

 

**Note 5****— Purchased Technology**

 

                Purchasedtechnology was as 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 for thethree months ended March 31, 2005 and 2004was $348 and $85, respectively.  Assuming no change in the grosscarrying value of purchased technology, the estimated amortization expense forthe twelve months ending December 31, 2005 is $1,393 and for each of the nextfour years is $1,178, $771, $361 and none.

 

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

 

**Note 6 — Accumulated Other Comprehensive 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 | ) |

 

8

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**Note 7 — Shareholders’ Equity**

 

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

 

 
| Shareholders’  equity balance at December 31, 2004        |   | $      | 81,465 |   |
|----------------------------------------------------------------|--------|--------|--------|--------|
| Net loss                                                       |   | (898   | )      |
| Accumulated  other comprehensive loss:                         |   |   |   |
| Foreign currency  translation adjustment                       |   | 33     |   |
| Net unrealized  loss on marketable debt securities             |   | (139   | )      |
| Comprehensive  loss                                            |   | (1,004 | )      |
| Issuances of  common stock in conjunction with:                |   |   |   |
| Exercises of  employee stock options                           |   | 462    |   |
| Tax benefit from  stock options exercised                      |   | 5      |   |
| Expense related  to issuances of stock options to nonemployees |   | 1      |   |
| Shareholders’  equity balance at March 31, 2005           |   | $      | 80,929 |   |

 

 

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

 

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

 
| ** **                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Net income  (loss)                             |       | $                                | (898       | ) | $ | 1,446 |   |
|                                           |       |                             |       |   |   |
| 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                                          |       | $                                | (0.05      | ) | $ | 0.08 |   |
| Diluted                                        |       | $                                | (0.05      | ) | $ | 0.08 |   |

 

                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 endedMarch 31, 2005 and 2004 were 1,310 and 143, respectively.

 

***Stock-based Compensation***

 

                The Company applies AccountingPrinciples Board Opinion (“APB”) No. 25, *“Accounting for StockIssued to Employees,”* and related interpretations in accounting forstock-based compensation. The exercise price of the Company’s stock optionsequals the market price of the underlying stock on the date of grant for alloptions granted, and thus, under APB 25, no compensation expense is recognizedin the consolidated statements of operations.

 

9

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                The estimated per share weightedaverage fair value of all stock options granted during the three months endedMarch 31, 2005 and 2004 was $6.69 and $10.04. Thefair value of each option grant was estimated using the Black-Scholesoption pricing model with 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           |       | —                           |       | — |   |

 

                Hadthe Company recorded compensation cost based on the estimated fair value on thedate of grant, 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** | ** ** |
| Net income  (loss), as reported                                                                     |       | $                                | (898       | ) | $ | 1,446 |   |
| 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                                                                       |       | $                                | (1,698     | ) | $ | 293 |   |
|                                                                                                |       |                             |       |   |   |
| Net income  (loss) per share:                                                                       |       |                             |       |   |   |
| As reported:                                                                                        |       |                             |       |   |   |
| Basic                                                                                               |       | $                                | (0.05      | ) | $ | 0.08 |   |
| Diluted                                                                                             |       | $                                | (0.05      | ) | $ | 0.08 |   |
|                                                                                                |       |                             |       |   |   |
| Pro forma:                                                                                          |       |                             |       |   |   |
| Basic                                                                                               |       | $                                | (0.10      | ) | $ | 0.02 |   |
| Diluted                                                                                             |       | $                                | (0.10      | ) | $ | 0.02 |   |

 

                On March 30, 2005, the board ofdirectors authorized the Company to enter into an agreement to grant 175,000options to the Company’s President and Chief Operating Officer upon acceptanceof the position.  The grant is not part of the Company’s 1997 StockIncentive Plan, and was not approved by the Company’s shareholders.  Theoptions were granted at fair market value on the date of grant, and vestratably over five years from the date of grant.

 

**Note 8 — Commitments andContingencies**

 

***Warranties***

 

                The Company provides warranty coverage for itssystems for a period of one year, including parts and labor necessary to repairthe systems during the warranty period. The estimated warranty cost is based onour historical experience rate of incurred expenses to corresponding systemrevenues.

 

10

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                The following table summarizes the activity relatedto the warranty liability during the threemonths 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***

 

                In connection with the acquisition of DMSVisionsoftware division of Inspex, Inc (“DMSVision”), the Company is subject to a contingent considerationarrangement at March 31, 2005. This arrangement is based upon new orders forDMSVision software licenses received in the twelve months after the acquisition.The payment of the contingency will result in an increase in the allocation ofpurchase price to purchased technology. As a result, amortization expenserelated to this asset will increase. Amounts paid under this arrangement arenot expected to have a material effect on the Company’s consolidated financialcondition or results of operations. The Company currently estimates the totalcontingent consideration to be paid will be between $150 and $300.

 

***Legal Proceedings***

 

                From time to time in the ordinary course of business,we are subject to claims, asserted or unasserted, or named as a party tolawsuits or investigations. Litigation, in general, and intellectual propertyand securities litigation in particular, can be expensive and disruptive tonormal business operations. Moreover, the results of legal proceedings cannotbe predicted with any certainty and in the case of more complex legalproceedings such as intellectual property and securities litigation, theresults are difficult to predict at all.

 

                August Technology Corporation andeach of its directors, Jeff O’Dell, James Bernards, Roger Gower, Michael Wrightand Linda Hall Whitman, have been named as defendants in two separate lawsuitsthat purport to be class actions claims on behalf of our shareholders. Wereceived a summons and complaint with respect to the first of these proceedingson February 4, 2005 and the second on February 14, 2005. Both lawsuits arebrought in Minnesota State Court and claim that the directors have breachedtheir fiduciary duties to our shareholders in connection with their actions inagreeing to the proposed merger with Nanometrics Incorporated. The plaintiffsin both actions seek various forms of injunctive relief including an orderenjoining us and our directors from consummating the merger with Nanometrics. AugustTechnology and its directors believe the lawsuits are without merit and plan tovigorously defend against the claims.

                Thetwo proceedings have been consolidated and are being heard as one case. OnApril 19, 2005, the Court issued a 30 day stay of all proceedings. In addition,the Court stated that it would issue an order on motions to dismiss filed byAugust Technology Corporation and the individual director defendants withinthat 30 day period.

 

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**Note 9 — Significant Customer,Product Line and Geographic Information**

 

                The percentage of net revenuesderived from major customers were as follows:

 
| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Net revenues: |       |                             |       |   |   |
| Customer A    |       | 24                               | %          | 19 | % |
| Customer B    |       | 12                               | %          | * |   |
| Customer C    |       | 10                               | %          | * |   |
|          |       | 46                               | %          | 19 | % |

----

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

 

                The percentage of net revenuesby major product line was as follows:
| ** **           | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------|------------|----------------------------------|------------|
| ** **           | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Net revenues:        |       |                             |       |   |   |
| NSX Series           |       | 40                               | %          | 53 | % |
| All Surface  Systems |       | 34                               | %          | 20 | % |
| 3Di Series           |       | 8                                | %          | 10 | % |
| Other                |       | 18                               | %          | 17 | % |
|                 |       | 100                              | %          | 100 | % |

 

                All of the Company’s tangiblelong-lived assets are located in the United States, except for an insignificantamount of property and equipment in Taiwan and South Korea. The Company derivesrevenues from shipments to customers outside of the United States. Thepercentage of net revenues by the geographic region in which the customer islocated was as follows:

 
| ** **    | ** ** | **Three Months Ended March31,** | ** ** |
|---------------|------------|---------------------------------|------------|
| ** **    | ** ** | **2005**                        | ** ** | **2004** | ** ** |
| Net revenues: |       |                            |       |   |   |
| United States |       | 18                              | %          | 30 | % |
| Taiwan        |       | 42                              | %          | 21 | % |
| South Korea   |       | 24                              | %          | 24 | % |
| Europe        |       | 14                              | %          | 2 | % |
| Japan         |       | 2                               | %          | 6 | % |
| Rest of Asia  |       | —                          |       | 17 | % |
|          |       | 100                             | %          | 100 | % |

 

**Note 10 — Recently Issued AccountingPronouncements**

 

                In December 2004, the Financial Accounting StandardsBoard (“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, *“Accountingfor Stock-Based Compensation”* and supersedes Accounting PrinciplesBoard (“APB”) Opinion No. 25, “*Accounting for StockIssued to Employees*” and its related implementation guidance. SFASNo. 123R focuses primarily on accounting for transactions in which an entityobtains employee services through share-based payment transactions. SFAS No.123R requires a public entity to measure the cost of employee services receivedin exchange for the award of equity instruments based on the fair value of the 

 

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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 adopt SFASNo. 123R by their first fiscal year beginning after June 15, 2005. Whilethe Company cannot precisely determine the impact on net earnings as a resultof the adoption of SFAS No. 123R, estimated compensation expense related toprior periods can be found in Note 7, see “Stock-based Compensation”. Theultimate amount of increased compensation expense will be dependent on whetherthe Company adopts SFAS No. 123R using the modified prospective orretrospective method, the number of option shares granted during the year,their timing and vesting period, and the method used to calculate the fairvalue of the awards, among other factors the Company is currently assessing.

 

                In November 2004, the FASB issued SFAS No. 151, “*Inventory Costs - an amendment of ARB No. 43, Chapter4*.” 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 of productionfacilities. SFAS No. 151 is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. Adoption of SFAS No. 151 is notexpected to have a material effect on the Company’s financial position, resultsof operations or cash flows.

 

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**Item2**.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

** **

**Cautionary Factors That May Affect Future Results**

 

                Certainstatements made in this Quarterly Report on Form 10-Q, as well as oralstatements made by us from time to time, which are prefaced with words such as “expects,”“anticipates,” “believes,” “projects,” “intends,” “plans” and similar words andother statements of similar sense, are forward-looking statements. Ourforward-looking statements generally relate to our growth strategies, financialresults, future financial projections, product development activities and salesefforts.  Our actual results could differ materially from those projectedin the forward-looking statements as a result of a number of factors, includingbut not limited to market acceptance of our products, our ability tosuccessfully develop new products, our ability to protect our intellectualproperty, our dependence upon international customers and suppliers, ourdependence on a small number of customers that account for a significantportion of revenues, availability of products from our suppliers, cyclicalityin the microelectronic manufacturing equipment and other industries, managementof growth, integration of acquired businesses, and the other risk factorsdetailed below and in our Annual Report on Form 10-K for the year endedDecember 31, 2004, as filed with the SEC on March 16, 2005. We disclaim anyobligation to revise forward-looking statements, or to update the reasonsactual results could differ materially from those anticipated, to reflectevents or circumstances after the date of such statements or to reflect theoccurrence of anticipated or unanticipated events. Because many factors areunforeseeable, the foregoing should not be considered an exhaustive list.

 

**Introduction**

 

                The following discussion of ourresults of operations and financial condition should be read together with theother financial information and consolidated financial statements and relatednotes included in this Form 10-Q. This discussion contains forward-lookingstatements that involve risks and uncertainties. Our actual results could differ materially from thoseanticipated in the forward-looking statements as a result of a variety offactors.

 

**Critical Accounting Policies**

 

                The preparationof our consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  We based these estimates andassumptions on historical experience and evaluate them on an on-going basis tohelp ensure they remain reasonable under current conditions.  Actualresults could differ from those estimates. We discuss the development andselection of the critical accounting estimates with the audit committee of ourboard of directors on a quarterly basis, and the audit committee has reviewedthe Company’s critical accounting policies as described in Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inour Annual Report on Form 10-K for the year ended December 31,2004.   For the three months ended March 31, 2005, there were nochanges to these critical accounting policies.

 

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**Overview**

 

We are a world-classprovider of automated defect detection and product characterization systems formicroelectronic device manufacturers. Our systems provide manufacturers withinformation that enables process-enhancing decisions, ultimately loweringmanufacturing costs and decreasing time-to-market. We have traditionallyprovided systems to address the automated inspection needs of the early stagesof the final manufacturing or back-end of the microelectronic devicemanufacturing process. These needs were met primarily with our NSX Series and3Di Series of products. We have introduced the AXi Series and the E20 for edgeand B20 for backside inspection systems (collectively, the “All SurfaceInspection System”) for advanced macro defect detection primarily in thefront-end of the wafer manufacturing process. When used in conjunction with oneanother these systems allow a manufacturer to inspect the top, edge and back ofa wafer’s surface. We believe we are the first to offer all surface waferinspection. We continue to support front-end system demonstrations at manylarge semiconductor manufacturers during the quarter. These demonstrationsallow these customers to evaluate the benefits these systems provide. We expectthese demonstrations will lead to increased revenues six to nine months aftershipment.

 

We complement this broad inspection capability with anexpanding suite of software tools designed to enhance the speed andeffectiveness of the process by which device manufacturers analyze defects, andmake decisions regarding their manufacturing process to reduce or eliminatesuch 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 probe markinspection and metrology capabilities. In July 2003 we acquired the assetsof Counterpoint Solutions, Inc. (“CSI”), including the design for theVersaScope a defect review system for advanced microscope-based imaging andanalysis. In July 2004 we acquired certain assets of the DMSVision softwaredivision 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.

 

Our business has been, and will continue to be, subjectto the highly cyclical nature of the microelectronic device manufacturingmarkets we serve. These cycles are caused by significant, and often rapid,fluctuations in the supply and demand of microelectronic devices driven by suchfactors as changes in technology and global economic conditions. As a result ofthese fluctuations, and due to the fact that our quarterly revenues arecomprised of systems with average selling prices of between $150,000 and$1,000,000, a small change in the number of systems we sell may also causesignificant changes in our operating results. Because fluctuations in thetiming of orders from our major customers or in the number of individualsystems we sell could cause our revenues to fluctuate significantly in anygiven quarter or year, we do not believe that period-to-period comparisons ofour financial results are necessarily meaningful, and they should not be reliedupon as an indication of our future performance. Additionally, the rate andtiming of customer orders may vary significantly from month to month.Accordingly, if sales of our products do not occur when we expect, and we areunable to adjust our estimates on a timely basis, our expenses and inventorylevels may increase relative to revenues and total assets.

 

We have sold our systems tomany of the leading microelectronic device manufacturers throughout the world. Historically,a significant 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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three months ended March 31,2005 and 2004 sales to customers that individually represented at least ten percentof our revenues accounted for 46% and 19% of our net revenues, respectively.

 

Management focuses onseveral key financial metrics in evaluating our financial condition andoperating performance. Although we do not believe backlog is always an accurateindication of future revenues and performance, since only a portion of ourrevenues for any quarter include systems that were in backlog as of thebeginning of that quarter, we do closely monitor the level of orders bothgeographically and by product line and in relation to the level of revenues,referred to as the book-to-bill ratio. During the first quarter of 2005 ourbook-to-bill ratio was below parity. A book-to-bill ratio below parityindicates a decreasing level of backlog. In addition to monitoring our level oforders and backlog, we focus on revenues by product family compared toprior-period and current-year plans, year-over-year revenue growth compared tothe overall semiconductor equipment industry, operating profit or lossperformance compared with prior-period and current-year plans and the level ofoperating cash flow.

 

**Merger Activities**

 

On January 21, 2005, weentered into a Merger Agreement with Nanometrics, Incorporated (“Nanometrics”),pursuant to which Nanometrics will reincorporate under Delaware law andAugust Technology Corporation will become a wholly-owned subsidiary ofNanometrics. In connection with this transaction, Nanometric’s name will bechanged to August Nanometrics. Each share of our common stock will be convertedinto the right to receive 0.6401 of a share of August Nanometrics common stock.August Nanometrics will make a cash payment to our shareholders for anyfractional shares of August Nanometrics common stock they would otherwise beentitled to receive instead of issuing fractional shares. On March 28, 2005,Nanometrics filed a registration statement on Form S-4 with the Securities andExchange Commission containing a Joint Proxy Statement/Prospectus ofNanometrics and August Technology with respect to the Merger Agreement andrelated transactions.

 

On January 27, 2005, wereceived a letter from Paul F. McLaughlin, Chairman and Chief Executive Officerof Rudolph Technologies, Inc. (“Rudolph”), stating that Rudolph is prepared toenter into a merger with us based on a share exchange ratio of 0.6239 share ofRudolph stock for each share of our common stock (equivalent to $10.50 pershare of our common stock based on the closing price of Rudolph stock onJanuary 27, 2005). The letter stated that each of our shareholders may elect toreceive all cash, stock or a combination of cash and stock, subject toproration based on total cash consideration of $40 million.

 

Also on January 27, 2005,Rudolph issued a press release with proposed terms slightly different fromthose described in the letter. The press release stated that Rudolph isprepared to enter into a merger with us whereby each of our shareholders willreceive the value of $2.16 per share in cash and 0.4955 per share in Rudolphcommon stock (equivalent to $10.50 per share of our Common Stock, based on theclosing price of Rudolph stock on January 27, 2005). The press release statedthat each of our shareholders would have the option to elect to receive allcash, stock or a combination of cash and stock, subject to proration based ontotal cash consideration of $40 million.

 

On April 4, 2005, we enteredinto a confidentiality agreement with Rudolph and are currently engaged in discussionsand exchanging information with Rudolph to consider and evaluate its offer. Weremain subject to our January 21, 2005 Merger Agreement with Nanometrics 

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and are conducting the discussions with Rudolphas permitted by the terms of the Merger Agreement.

 

On February 9, 2005, wereceived a letter from Kenneth Schroeder, President and Chief Executive Officerof KLA-Tencor Corporation (“KLA”), regarding KLA’s interest in pursuing amerger with us. The letter stated that KLA proposed to acquire us in atransaction in which our shareholders would receive $11.50 per share. KLA alsostated that it would be willing to consider using stock as consideration. As ofthe date of this filing, we have been unable to reach agreement with KLA on aconfidentiality agreement and no discussions regarding KLA’s offer have takenplace.

 

Under the terms of ourMerger Agreement with Nanometrics, we may be obligated to pay to Nanometrics afee of $8.3 million, plus Nanometrics’ expenses, if (i) we accept anacquisition proposal from Rudolph or KLA or any other party; or (ii) change ourrecommendation to shareholders with respect to the proposed merger withNanometrics in order to pursue an alternative acquisition proposal.

** **

**Results of Operations**

 
| ** **                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Net revenue                                          |       | 100.0                            | %          | 100.0 | % |
| Cost of revenues                                     |       | 45.4                             |       | 43.0 |   |
| Gross profit                                         |       | 54.6                             |       | 57.0 |   |
|                                                 |       |                             |       |   |   |
| Selling, general  and administrative expenses        |       | 34.1                             |       | 31.7 |   |
| Research and  development expenses                   |       | 19.9                             |       | 17.7 |   |
| Operating income                                     |       | 0.6                              |       | 7.6 |   |
|                                                 |       |                             |       |   |   |
| Merger expenses                                      |       | (6.7                             | )          | — |   |
| Interest income                                      |       | 1.5                              |       | 1.2 |   |
| Net income  (loss) before provision for income taxes |       | (4.6                             | )          | 8.8 |   |
| Provision for  income taxes                          |       | 0.3                              |       | — |   |
| Net income  (loss)                                   |       | (4.9                             | )%         | 8.8 | % |

* *

* *

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

 

*                Net Revenues.* Net revenuesincreased $2.0 million, or 12.3%, to $18.4 million for the three months endedMarch 31, 2005, from $16.4 million for the same period in 2004. The increase innet revenues was primarily due to increased sales of all surface inspectionsystems into front-end wafer fabrication processes, partially offset by lowerNSX Series sales into the same processes. Revenues derived from systems soldfor front-end wafer fab applications accounted for 52% of total net revenues inthe first quarter of 2005 and 2004. Revenues in the second quarter of 2005 areexpected to range from -5% to +5%, as compared to the first quarter of 2005.

 

                Net revenues frominternational sales represented 82% and 70% of total net revenues for the threemonths ended March 31, 2005 and 2004, respectively. International revenuesduring these periods were primarily the result of sales to Asia, whichcomprised 68% of total net revenues for the three months ended March 31, 2005and 2004.

 

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                *GrossMargin.* Gross margin decreased to 54.6% for the three months ended March 31,2005, from 57.0% for the same period in 2004. Gross margins decreased in thefirst quarter of 2005 primarily as a result of rework costs related to certainsystems, the recording of a lower of cost or market adjustments related tocertain component parts that became obsolete due to engineering design changesduring the quarter, and additional reserves related to slow moving inventories. In addition,we have experienced pricing pressure primarily related to our inspectionsystems sold into final manufacturing applications as competitors havecontinued to enter this market. The impact of these lower margins has beenoffset by higher margin products sold into front end applications. We expectfuture gross margins to be between 54% and 57%.

 

*                Selling, General andAdministrative Expenses.* Selling, general and administrative (“SG&A”) expenses consistprimarily of employee salaries and related benefits, depreciation andamortization, and travel expenses. SG&A expenses were $6.3 million for thethree months ended March 31, 2005, compared to $5.2 million for the same periodin 2004. SG&A expenses as a percentage of net revenues were 34.1% for thethree months ended March 31, 2005, compared to 31.7% of net revenues for the same period in 2004. The increase in expensedollars was primarily the result of costs associated with both new hires andcontractors in our field service and sales groups to support increased revenuesand customer demonstrations, an increased number of demo systems andamortization expense related to technology acquired with the purchase ofDMSVision. We expect SG&A expense dollars to remain relatively flat infuture quarters, as compared to the first quarter of 2005.

 

*                Research andDevelopment Expenses.* Research and development (“R&D”)expenses consist primarily of employee salaries and related benefits forindividuals engaged in the research, design and development of new products. R&Dexpenses were $3.7 million for the three months ended March 31, 2005, comparedto $2.9 million for thesame period in 2004. R&D expenses as a percentage of net revenues were 19.9% for the three months ended March 31, 2005,compared to 17.7% for the same period in 2004. 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 DMSVisionacquisition 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 forthe same period in 2004. The increase in interest income was primarily due to anincrease in the rate of return on our investment balances.

 

                *MergerExpenses.* Merger expenses were $1.2 million, or 6.7% of netrevenues, for the three months ended March 31, 2005, compared to none for thesame period in 2004. The merger expenses were primarily legal and investmentbanker fees incurred for the proposed merger with Nanometrics, Incorporated,and the evaluation of the KLA-Tencor Corporation and Rudolph Techologies, Inc.offers.

 

***                IncomeTaxes.***As aresult of historical operating losses and uncertainty as to the extent ofprofitability in future periods, we began to record a valuation allowanceagainst our deferred tax assets in the second quarter of 2002 and continue todo so at March 31, 2005. As a result, we did not reflect a provision for incometaxes for the three months ended March 31, 2004, and have recorded a provisionfor income taxes of $55,000 on the pretax loss for the three months ended March31, 2005, primarily to reflect foreign income taxes owed. Statement ofFinancial 

** **

**18**

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** **

**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, 2004the valuation allowance was $8.5 million.

** **

**Liquidity and CapitalResources**

 

                At March 31, 2005 our principal sourcesof liquidity consisted of cash, cash equivalents and investments in marketabledebt securities of $52.2 million, compared to $50.4 million 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 thenext twelve months, and beyond, we intend to utilize our current sources ofliquidity to fund operations, specifically to enhance our position in thefront-end wafer fabrication process. Wehave no outstanding debt atMarch 31, 2005. Our liquidity is affected by many factors, some of which arebased on the normal ongoing operations of our business, the most significant ofwhich includes the timing of the collection of receivables, the level ofinventories, capital expenditures and acquisitions.

 

*                AccountsReceivable.*Accounts receivable increased $1.0 million from December 31, 2004 toMarch 31, 2005. Our days sales outstanding (“DSO”) during the three monthsended March 31, 2005 was 45 days. This compares to a DSO of 55 days in thefourth quarter of 2004. The decrease in the DSO during the first quarter isprimarily due to timely collections. The increase in accounts receivableresulted in a use of cash during the three months ended March 31, 2005, as wehave funded shipments for increased revenues prior to receiving payments fromcustomers. We believe our DSO will be between 50 and 65 days in futurequarters.

 

*                Inventories.* Inventoriesincreased $817,000 from December 31, 2004 to March 31, 2005. The increase isprimarily due to the need to support new product introductions and increaseddemonstration equipment under evaluation at customer locations. This increasewas partially offset by a decrease in finished goods due to the capitalizationand sales of finished goods inventory.

 

*                Inventoriesat Customers under Purchase Orders.* Inventories at customers under purchaseorders decreased from $4.0 million at December 31, 2004 to $3.8 million atMarch 31, 2005. We anticipate that a portion of this inventory will berecognized as revenue during 2005. We anticipate that this inventory willincrease as shipments of newly introduced products increase.

 

*                CapitalExpenditures.* Our capital expenditures during the first quarterof 2005 were $344,000, consisting primarily of the capitalization of finishedgoods that have been transferred to engineering for test and characterization,and to sales for customer application studies. This equipment is expected to beutilized for these purposes for its estimated life, generally three years. Ourtotal capital expenditures, including the capitalization of finished goods, areexpected to be between $3.0 million and$4.0 million in 2005, as we continue to expand the use of internal test anddevelopment equipment and facilities to meet customer demand and better serveour customers.

 

                Ourliquidity is also affected by factors beyond our control related to theuncertainties of global economies and the cyclical nature of the semiconductorand microelectronic industries. Although liquidity requirements will fluctuatebased on the timing and extent of all of these factors and others, managementbelieves that existing cash and investment balances will be adequate to satisfyour existing liquidity requirements for at least the next twelve months.

 

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*CashFlows*

 

                Net cash provided by operatingactivities for the three months ended March 31, 2005 was $2.0 million, whichresulted primarily from increased accounts payable and depreciation andamortization partially offset by an increase in accounts receivable andinventories. Net cash provided by investing activities was $3.6 million,primarily due to $4.1 million of net proceeds from maturities of marketabledebt securities, partially offset by $494,000 of additions to property andequipment, and other assets. Net cash provided by financing activities was$462,000 from proceeds received from the exercises of stock options. Wecurrently expect to generate cash from operating activities during theremainder of 2005.

 

                Net cash used in operatingactivities for the three months ended March 31, 2004 was $6.8 million, whichresulted primarily from increased accounts receivable and inventories partiallyoffset by our net income and increased accounts payable and customer deposits. Netcash provided by investing activities was $50,000, primarily from $654,000 ofnet proceeds from maturities of marketable debt securities, partially offset by$604,000 of purchases of property and equipment, and other assets. Net cashprovided by financing activities was $1.5 million from proceeds received fromissuances of common stock in conjunction with exercises of stock options.

 

**NewAccounting Pronouncements**

 

                In December 2004, the Financial Accounting StandardsBoard (“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-BasedCompensation” and supersedes Accounting Principles Board (“APB”) Opinion No.25, “*Accounting for Stock Issued to Employees*”and its related implementation guidance. SFAS No. 123R focuses primarily onaccounting for transactions in which an entity obtains employee servicesthrough share-based payment transactions. SFAS No. 123R requires a public entityto measure the cost of employee services received in exchange for the award ofequity instruments based on the fair value of the award at the date of grant.The cost will be recognized over the 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 adopt SFASNo. 123R by their first fiscal year beginning after June 15, 2005. Whilewe cannot precisely determine the impact on net earnings as a result of theadoption of SFAS No. 123R, estimated compensation expense related to priorperiods can be found in Note 7, see “Stock-based Compensation”. The ultimateamount of increased compensation expense will be dependent on whether we adoptSFAS No. 123R using the modified prospective or retrospective method, thenumber of option shares granted during the year, their timing and vestingperiod, and the method used to calculate the fair value of the awards, amongother factors we are currently assessing.

 

                In November 2004, the FASB issued SFAS No. 151, “*Inventory Costs - an amendment of ARB No. 43, Chapter4*.” 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 costs incurredduring fiscal years beginning after June 15, 2005. Adoption of SFAS No. 151 isnot expected to have a material effect on our financial position, results ofoperations or cash flows.

 

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**Item3****.                    Quantitativeand Qualitative Disclosures about Market Risk**

 

*Market Risk*

 

                We are exposed tomarket risk primarily from changes in interest rates and credit risk. We do nothave material exposure to market risk from fluctuations in foreign currencyexchange rates because all sales are made in U.S. dollars.

 

*Interest Rate 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, classified as available-for-sale, is recordedon the balance sheet at fair market value with unrealized gains or lossesexcluded from earnings and included in “Accumulated other comprehensive income(loss)” until realized. The entire Investment Portfolio is denominated in U.S.dollars. We do not use derivative financial instruments in the InvestmentPortfolio. Due to the short duration of our Investment Portfolio, an immediate10 percent change in interest rates is not expected to have a material adverseeffect on our near-term financial condition or results of operations.

 

*Credit Risk*

 

                Financialinstruments which potentially subject us to credit risk consist principally ofsecurities in the Investment Portfolio and trade receivables. We limit creditrisk related to the Investment Portfolio by placing all investments with highquality credit issuers and limit the amount of investments with any one issuer.As of March 31, 2005, 62% of the Investment Portfolio consisted of governmentsecurities and corporate bonds with maturities of one year or less. We limitcredit risk associated with trade receivables by performing ongoing creditevaluations and believe that there is no additional risk beyond amountsprovided for collection losses to be inherent in trade receivables.

 

**Item 4****.                    Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

                Asof the end of the period covered by this report, the Company conducted anevaluation under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, regarding the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Rules 13a-15(b) of theSecurities Exchange Act of 1934 (the “Exchange Act”). Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures are effective to ensurethat information that is required to be disclosed by the Company in reportsthat it files under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the rules of the Securities andExchange Commission.

 

*Changes in Internal Controls*

 

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

 

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**PART II****— OTHERINFORMATION**

 

**Item 1****.                    Legal Proceedings**

                AugustTechnology Corporation and each of its directors, Jeff O’Dell, James Bernards,Roger Gower, Michael Wright and Linda Hall Whitman, have been named asdefendants in two separate lawsuits that purport to be class actions claims onbehalf of our shareholders. We received a summons and complaint with respect tothe first of these proceedings on February 4, 2005 and the second on February14, 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 plaintiffs in both actions seek various forms ofinjunctive relief including an order enjoining us and our directors fromconsummating the merger with Nanometrics. August Technology and its directorsbelieve the lawsuits are without merit and plan to vigorously defend againstthe claims.

                Thetwo proceedings have been consolidated and are being heard as one case. OnApril 19, 2005, the Court issued a 30 day stay of all proceedings. In addition,the Court stated that it would issue an order on motions to dismiss filed byAugust Technology Corporation and the individual director defendants withinthat 30 day period.

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

 

                The exhibitslisted on the Exhibit Index are filed herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                | AUGUST TECHNOLOGY  CORPORATION  |
|---------------------|---------------------------------|
|                |                            |
| Date:  May 10, 2005 | By:                        | /s/  JEFF L. O’DELL |   |
|                | Jeff L. O’Dell             |
|                | Chief Executive Officer         |
|                | (Principal Executive Officer)   |
|                |                            |
| Date:  May 10, 2005 | By:                        | /s/  STANLEY D. PIEKOS |   |
|                | Stanley D. Piekos               |
|                | Chief Financial  Officer        |
|                | (Principal  Financial Officer)  |
|                |                            |
| Date:  May 10, 2005 | By:                        | /s/  SCOTT A. GABBARD |   |
|                | Scott A. Gabbard                |
|                | Chief Accounting  Officer and   |
|                | Vice President,  Finance        |
|                | (Principal  Accounting Officer) |
|                     |                                 |  |  |  |

 

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**SECURITIES AND EXCHANGECOMMISSION**

Washington, D.C. 20549

 

EXHIBIT INDEX TO FORM 10-Q

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

 

 

**AUGUST TECHNOLOGY CORPORATION**

** **

 
| **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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