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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                               -------------------

                                    FORM 10-K

                               -------------------


(MARK ONE)

              [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1999*

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

          FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .

                         COMMISSION FILE NUMBER: 0-11348

                           SILICON VALLEY GROUP, INC.
             ------------------------------------------------------
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                DELAWARE                                    94-2264681
    (STATE OR OTHER JURISDICTION OF                        (IRS EMPLOYER
     INCORPORATION OR ORGANIZATION)                   IDENTIFICATION NUMBER)

             101 METRO DRIVE, SUITE 400, SAN JOSE, CALIFORNIA 95110
               (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 441-6700

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                          COMMON STOCK, $.01 PAR VALUE

    Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for 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 [X] No [ ]

    Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

    The aggregate market value of the voting stock held by persons other than
those who may be deemed affiliates of the Registrant, as of November 26, 1999,
was approximately $386,227,325. Shares of common stock held by each executive
officer and director and by each person who owns 5% or more of the outstanding
common stock have been excluded in that such persons may under certain
circumstances be deemed to be affiliates. This determination of executive
officer or affiliate status is not necessarily a conclusive determination for
other purposes.

    The number of shares outstanding of the Registrant's Common Stock as of
November 26, 1999 was 33,336,829.

    * See Part II, Item 8A. of this report for information regarding
Registrant's fiscal year.

                       DOCUMENTS INCORPORATED BY REFERENCE

    Portions of the following documents are incorporated by reference into the
parts of this Form 10-K as indicated herein:

        Proxy Statement for Annual Meeting of Stockholders to be held on
        February 23, 2000........................................    Part III

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                                     PART I

    The information in this report contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, as amended. Such statements are subject to
certain risks and uncertainties, including those discussed below that could
cause actual results to differ materially from those described herein. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date hereof. Forward-looking statements are indicated
by an asterisk (*) following the sentence in which such statement is made. The
Company undertakes no obligation to publicly release the results of any
revisions to these forward-looking statements which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.

ITEM 1. BUSINESS.

    Silicon Valley Group, Inc. (the "Company" or "SVG") primarily designs,
manufactures, markets and services semiconductor processing equipment used in
the fabrication of integrated circuits. The fabrication of integrated circuits
involves repeating a complex series of process steps to a semiconductor wafer.
The three broad categories of wafer processing steps are deposition,
photolithography and etching. SVG has three principal product groups which focus
primarily on photolithography, photoresist processing, and deposition for
oxidation/diffusion and low-pressure chemical vapor deposition ("LPCVD") and
with the acquisition of the Semiconductor Equipment Group of Watkins-Johnson
Company, thermal processing products which address atmospheric pressure chemical
vapor deposition ("APCVD"). In addition, a precision optics group supplies
certain components for the Company's photolithography products, government
markets and lens systems to the cinematography industry. The Company's products
incorporate proprietary technologies and unique processes, and focus on
providing process and product technologies and productivity enhancements to its
customers. SVG works closely with its existing and potential customers in the
development of new systems and technologies and supports its products through a
network of worldwide service and technical support organizations.

    Herein the Company refers to its photolithography exposure products as SVG
Lithography Systems, Inc. "SVGL" products, its photoresist processing products
as "Track" products and its oxidation/diffusion, LPCVD and its newly acquired
APCVD products from Watkins-Johnson Company as "Thermal" products.

INDUSTRY BACKGROUND

    Continuous improvements in semiconductor process and design technologies
have led to the production of smaller, more complex and more reliable
semiconductor devices at a lower cost per function. As performance has increased
and size and cost have decreased, the demand for semiconductors has expanded in
computer systems, telecommunications systems, automotive products, consumer
goods and industrial automation and control systems. Semiconductor content as a
percentage of system cost has also increased. The Company believes that these
long-term trends will continue and will be accompanied by a growing demand for
semiconductor production equipment that can produce advanced integrated circuits
in high volumes with a low cost of ownership.*

    The rapid development of advanced semiconductor applications requires
semiconductor manufacturers to continually improve their core technology and
manufacturing capabilities to remain competitive within the industry. As a
consequence, semiconductor manufacturers demand increasingly sophisticated,
highly productive and cost effective processing equipment from semiconductor
equipment suppliers. The increasing diversity and complexity of semiconductor
products, the demands of technological change and the costs associated with
keeping pace with industry developments have contributed to the emergence of
cooperative development and manufacturing alliances both amongst semiconductor
manufacturers and between semiconductor manufacturers and semiconductor
equipment suppliers. The Company believes it is essential to have customer
alliances to provide access to valuable product and process technologies. These
factors result in customers concentrating their business with a small number of
key suppliers.

    The semiconductor industry into which the Company sells its products is
highly cyclical and has, historically, experienced periodic downturns that have
had a severe effect on the semiconductor industry's demand for semiconductor
processing equipment. As a result of the Asian economic crisis which began in
1997, an oversupply of certain semiconductor products, the impact of low cost
personal computers, and various other factors, semiconductor manufacturers
reduced planned expenditures and cancelled or delayed the construction of new
fabrication facilities. This slowdown in demand began to impact the Company
during the first quarter of fiscal 1998 and continued to impact the Company
throughout fiscal 1999. The slowdown in demand resulted in the Company
experiencing lower new customer orders, customer deferrals of scheduled
equipment delivery dates and, to a lesser extent, customer order cancellations.
Last



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year's lower bookings, order rescheduling and cancellations, have caused sales
and net income during fiscal 1999 to decline from prior years amounts. Although,
the Company has experienced a modest improvement in new bookings, as during the
second half of fiscal 1999 the Company recorded new bookings of $324,213,000 up
from new bookings of $254,444,000 and $237,451,000 during the first half of
fiscal 1999 and the second half of fiscal 1998, respectively. There can be no
assurance that the dollar amount of new bookings will continue to increase.*
There can be no assurance that the Company will not experience further customer
delivery deferrals, additional order cancellations or a prolonged period of
customer orders at reduced levels, any or a combination of which would have a
material adverse effect on the Company's business and results of operations.*

STRATEGY

    The Company's objective is to strengthen its position as a leading worldwide
semiconductor equipment supplier that offers a broad line of technologically
advanced products. The Company's strategy incorporates the following key
elements:

    -   Future Technological Innovation. The Company is committed to developing
        new products, improving processes and enhancing existing products
        through substantial investment in research and development. In this
        regard, the Company has developed a roadmap for the development of next
        generation lithography technology well into the next decade. The
        Company's products incorporate proprietary technologies in
        photolithography, control software, optics and particulate control and
        unique processes focusing on providing process and product technologies
        and productivity enhancements to customers. Additionally, the Company
        works with universities and laboratories to leverage new concepts for
        its advanced projects.

    -   Customer Commitment. The Company's objective is to strengthen its
        position as a leading worldwide semiconductor equipment supplier by
        offering a broad line of technologically advanced products. The Company
        works closely with its existing and potential customers, industry
        consortia and research institutions to improve current products and
        processes and to define new product development opportunities. These
        efforts enable the Company to participate in the development of new
        technologies, to influence the design of new fabrication processes and
        to position it as a principal supplier for volume equipment orders. The
        Company believes that cooperative working relationships with leading
        semiconductor manufacturers are critical to ensuring that its products
        are designed in conjunction with the development of the semiconductor
        manufacturers' advanced process requirements.

    -   Continued Operational Efficiency and Improvement. The industry requires
        that equipment suppliers provide cost-effective products that are based
        on extendible technology. Cost of ownership and the ability to satisfy
        customer delivery requirements are critical ingredients in the selection
        process for advanced equipment. To address these issues, the Company has
        in the past and is continuing to respond to this issue by expanding
        certain of its facilities and deploying capital for manufacturing and
        test equipment to respond to the long term requirements of the
        semiconductor industry. The Company continues to implement programs to
        improve operational efficiency to improve the effectiveness of its
        material procurement, reduce manufacturing cycle times and improve
        production methods and processes to gain additional efficiencies.

    -   Expansion of Its Customer Base. The Company is committed to expanding
        its worldwide customer base to address the needs of the global
        semiconductor market. Continuous improvement programs and timely
        introduction of new technology tools are key elements of the Company's
        strategy. The Company remains focused on leveraging the strength of its
        products and customer base to satisfy the diverse requirements of the
        Logic, Memory and ASIC markets on a worldwide basis.

SVG LITHOGRAPHY SYSTEMS, INC. (SVGL)

    SVGL designs, manufactures, markets and services advanced photolithography
exposure systems. Photolithography is one of the most critical and expensive
steps in integrated circuit fabrication, representing approximately one-third or
more of the fabrication cost. Consequently, integrated circuit manufacturers
focus on obtaining advanced photolithography equipment to help them produce
critical layers for increasingly complex devices reliably, efficiently and
cost-effectively.

    In the photolithography step of the fabrication process, the integrated
circuit patterns are projected through masks, or reticles, onto the silicon
wafers. As semiconductors have become more complex, the patterns have become
finer, with line widths as narrow as 0.15 micron and below in many of today's
more advanced integrated circuits. As the patterns become finer,
photolithography exposure systems must be capable of projecting the patterns
through the masks with ever-finer resolution. The resolution capability of a
photolithography exposure system is a function of numerical aperture (a measure
of its light gathering characteristics) and the



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wavelength of the light used in exposure. With the advancement of
photolithography technology there has come a trend toward the reduction in
wavelength from G-line (436-nanometer) to I-line (365-nanometer) to DUV (248 and
193-nanometer) and the increase in numerical aperture from 0.2 to approximately
0.7. During fiscal 1999, the Company entered into an agreement with Intel
Corporation for the development of 157-nanometer lithography technology capable
of producing line widths as fine as .10 microns.

    Historically, there have been two major approaches to photolithography
exposure systems: full field scanning projection aligners ("scanners") and
refractive steppers ("steppers"). Scanners project a full scale mask image onto
a moving full wafer, while steppers sequentially expose a small section of a
wafer in a stepped sequence of exposures, but do so by reducing the size of a
mask image by several fold (typically 5 times). Thus, scanners offer large
exposure fields while steppers offer masks that are easier to make and have a
lower cost. These strengths are combined in the step-and-scan system, a
technology pioneered by SVGL.

    Micrascan. The Company believes that its Micrascan photolithography
step-and-scan exposure system provides the increased resolution required for
current advanced logic and memory devices and for succeeding generations of
complex, fine geometry integrated circuits through its use of DUV lamp or laser
light source and unique projection optics design. Micrascan overcomes the line
width limitations of steppers over a large exposure field by combining the
elements of both steppers and scanners into the Micrascan's step-and-scan
technology.*

    The Micrascan combines advantages of scanning projection aligners and
steppers by projecting a light through a very narrow slit and scanning a portion
of the wafer, then "stepping" to another portion of the wafer and repeating the
process as necessary. Each scan has the capability to expose a large segment of
the wafer. The large exposure field enables Micrascan to fabricate larger
devices in a single scan than steppers, thus avoiding the necessity of
"stitching" a circuit together through two different exposures, and depending on
the size of the chip provides the ability to expose more than one device in an
exposure field. In addition, Micrascan continuously modifies the position of the
wafer surface during the scan, using its on-the-fly focus system to keep the
wafer in the optimal focal plane, thus providing a larger usable depth of focus.
The larger the usable depth of focus field is, the more tolerant of variations
in the wafer surface the equipment will be. The Company believes Micrascan's
greater tolerance of wafer surface variations can reduce the number of defective
devices on a wafer, thereby contributing to higher yields.* It further believes
that scanning across the field instead of exposing the entire field at one time
also enables Micrascan to achieve greater uniformity of resolution across the
entire exposure field and contributes to higher yields of faster devices.*

    The Company believes that SVGL has substantial technological expertise and
process knowledge in developing deep ultraviolet ("DUV") step-and-scan
photolithography systems.* SVGL has developed internal capability to design and
fabricate optical lenses, mirrors and coatings. This includes a combination of
purchased and proprietary optical metrology using phase measuring interferometry
to precisely measure and test the optical elements it produces. Micrascan
incorporates both mirrors and lenses in its optical system, which the Company
believes allows for an optical projection system that is less sensitive to
environmental variants and accommodates the use of light sources with broader
spectral bandwidth (than refractive optics), with the additional benefits of
reduced operational cost and increased reliability.*

    In addition to the optical system technology described above, SVGL has
developed certain proprietary mechanical systems incorporated in the Micrascan
to control the position of the wafer and the reticules prior to and during the
wafer exposure step. The Company believes that these servo controlled systems
contribute to the Micrascan's ability to scan the exposure field at high speeds
with no substantial loss of resolution, thereby increasing the throughput
capability of the machine.*

    The Company believes that the photolithography exposure equipment market is
one of the largest segments of the semiconductor processing equipment industry
and that SVGL's Micrascan family of photolithography systems are currently the
most technically advanced step-and-scan machines shipping in multiple quantities
to global semiconductor manufacturers.* The Micrascan QML lamp-based systems and
Micrascan III laser-based systems, each capable of printing sub .30 micron line
widths, sell for up to approximately $4,300,000, depending upon configuration.
Micrascan III+ capable of producing line widths of sub .18 micron sells for
approximately $6,000,000. The Micrascan 193-nanometer system capable of
producing line widths of sub .15 micron sells for approximately $10,500,000
depending on configuration. Although the Company specifies that its systems
produce certain line widths, it is commonplace that the combination of the
tool's robustness and the customer's process technology achieves finer line
widths than those specified.

    Uncertain Market for Micrascan Products. The Company believes that the
photolithography exposure equipment market is one of the largest segments of the
semiconductor processing equipment industry.* To address the market for advanced
photolithography exposure systems, the Company has invested and expects to
continue to invest substantial resources in SVGL's Micrascan technology and its
family of Micrascan DUV step-and-scan photolithography systems, which is
currently capable of producing line widths of .15



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micron and below and which the Company believes eventually will be capable of
producing line widths of .10 micron and below.* The development of a market for
the Company's Micrascan step-and-scan photolithography products will be highly
dependent on the continued trend towards finer line widths in integrated
circuits and the ability of other lithography manufacturers to keep pace with
this trend through either enhanced technologies or improved processes.* The
Company believes DUV lithography is required to fabricate devices with line
widths below 0.3 micron.* Semiconductor manufacturers can purchase DUV steppers
to produce product at .25 micron line widths. However, the Company believes that
as devices increase in complexity and size and require finer line widths, the
technical advantages of DUV step-and-scan systems, as compared to DUV steppers,
will enable semiconductor manufacturers to achieve finer line widths with
improved critical dimension control which will result in higher yields of faster
devices.* The Company also believes that the industry transition to DUV
step-and-scan systems has accelerated in calendar 1999 and that advanced
semiconductor manufacturers are beginning to require volume quantities of
production equipment as advanced as the current and pending versions of
Micrascan to produce both critical and to some degree sub-critical layers of
semiconductor devices.* Currently, competitive DUV step-and-scan equipment
capable of producing .25 micron line widths and below is available in limited
quantities from three competitors.* Further, if manufacturers of DUV steppers
are able to further enhance existing technology to achieve finer line widths
sufficiently to erode the competitive and technological advantages of DUV
step-and-scan systems, or other manufacturers of step-and-scan systems are
successful in supplying sufficient quantities of product in a timely manner that
are technically equal to or better than the Micrascan, demand for the Micrascan
technology may not develop as the Company expects.*

   The Company believes that advanced logic devices, DRAMs and ASICs will
require increasingly finer line widths.* Consequently, SVGL must continue to
develop advanced technology equipment capable of meeting its customers' current
and future requirements while offering those customers a progressively lower
cost of ownership.* In particular, the Company believes that it must continue
its development of future systems capable of printing line widths finer than .10
micron and processing 300mm wafers.* Any failure by the Company to develop the
advanced technology required by its customers at progressively lower costs of
ownership and supply sufficient quantities to a worldwide customer base could
have a material adverse impact on the Company's financial condition and results
of operations.*

   The Company believes that for SVGL to succeed in the long term, it must sell
its Micrascan products on a global basis.* The Japanese and Pacific Rim markets
(including fabrication plants located in other parts of the world which are
operated by Japanese and Pacific Rim semiconductor manufacturers as well as
foundries located primarily in Taiwan) represent a substantial portion of the
overall market for photolithography exposure equipment. To date, the Company has
not been successful in penetrating either of these markets. (See "Importance of
the Japanese and Pacific Rim Markets").

    Micralign. SVGL also sells a family of scanning projection aligners known as
"Micralign." The most advanced product in this family, the Micralign 700, is
used primarily in the production of semiconductor devices with minimum feature
sizes above 1.25 microns, or in the fabrication of less critical layers within
more sophisticated semiconductor devices. Micralign products are a mature
product family and sales of Micralign products have declined in recent years as
steppers have supplanted scanning projection aligners. The Company anticipates
that such sales will continue to decline.* A large installed base of Micralign
systems exists throughout the world and a majority of SVGL's Micralign related
revenues is derived from servicing that installed base and the sales of spare
parts. The list price of the Micralign 700 is approximately $1,350,000.

TRACK SYSTEMS (TRACK)

    Track designs, manufactures, markets and services photoresist processing
equipment which performs all the steps necessary to process semiconductor wafers
prior to photolithography exposure, including cleaning, adhesion promotion and
photoresist coating, and which performs all the steps required to treat wafers
after photolithography exposure prior to etching, including developing and
baking. As photoresist processing technology has evolved, the Company has
developed increasingly advanced products for this market, which are capable of
handling integrated circuits with line widths as narrow as 0.18 micron. Each
product line includes the principal processing capabilities described above and
is generally sold in customer-specified configurations that can include
specially engineered features and capabilities. All Track products are available
in fully automated cassette-to-cassette configurations either as stand-alone
processing stations or as in-line integrated manufacturing systems. The
equipment is modular in design to allow configuration to customer requirements.
Each semiconductor manufacturer may require certain of the processing stations
to effect its proprietary or specialized processes.

    As a result of being able to supply its customers with both SVGL's Micrascan
photolithography systems and Track's photoresist processing products, the
Company believes it offers the only clustered solution manufactured by a single
supplier. Additionally, Track's 90 Series is designed to interface with all
other lithography exposure products, regardless of the manufacturer.



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    Track's product lines correspond to the development of successive
generations of wafer processing technologies. In general, it has been the
Company's experience that introduction of new Track products has been followed
by lower order levels for older products.

    ProCell. Announced in June 1999, the ProCell is designed for 200-mm advanced
fabrication processes with line widths of .18 micron and beyond. The ProCell,
which can process more than 40 wafers simultaneously offers scalability from
200-mm to-300-mm wafers and significant productivity improvement for the coat
and develop process through the use of ProCell's symmetrical cluster
configuration. The ProCell has enhanced reliability, uniformity in process
results and serviceability due to the use of a single software platform, cell
based design and the use of isolated process and coat environments. Prices for
the ProCell range from approximately $2,200,000 to $3,500,000.

    90 Series. The 90 Series, the 90-S and the 90-SE photoresist processing
systems are designed for use in fabrication processes for integrated circuits
with line widths as narrow as 0.25 micron, such as is required for 64 megabit
DRAMs. The 90 Series incorporates a proprietary wafer transfer system to
increase throughput and provides features allowing it to interface with factory
automation systems, such as those using automated guided vehicles. The 90 Series
can process wafers up to eight inches in diameter. The 90-S and the more recent
90-SE offer improved cost of ownership through increased productivity and a
smaller floor space requirement. Prices of the 90 Series range from
approximately $650,000 to $1,700,000.

    8800 Series. The 8800 Series is designed to meet market needs for
photoresist contamination control and photoresist processing down to 0.8 micron
line widths. The 8800 Series incorporates such automation features as beltless
wafer handling, compatibility with low contamination wafer storage and movement
techniques, advanced software and communications capabilities and certain
process control improvements. The 8800 Series can process wafers from three to
six inches in diameter. The 8800 series is a mature product and sales have
declined in recent years. The Company anticipates that such sales will continue
to decline.* Prices of the 8800 Series range from approximately $200,000 to
$550,000.

THERMAL SYSTEMS (THERMAL)

    Thermal Systems product line includes large batch thermal processing
products which address the oxidation/diffusion and LPCVD steps of the
semiconductor fabrication process, and with the acquisition of the Semiconductor
Equipment Group of Watkins-Johnson Company, thermal processing products that
deposit thin dielectric films by using the process of atmospheric-pressure
chemical-vapor-deposition ("APCVD"). Thermal products are used for a broad range
of processing applications required in the fabrication of most semiconductor
devices, including growing insulating layers on the wafers, diffusing dopants
into the silicon structure and depositing insulating or conducting films on the
wafer surface. Thermal's products incorporate proprietary technology the Company
has developed or acquired in the areas of thermal control, gas handling,
particle control and automated wafer handling.

    There are two major configurations of oxidation/diffusion and LPCVD
processing equipment, commonly referred to as vertical and horizontal,
corresponding to the orientation of their reaction chamber(s). Vertical
processing systems represent an increasing portion of the market for
oxidation/diffusion and LPCVD processing equipment. Vertical reactors generally
consist of a single, fully automated cylindrical reaction chamber, individually
controlled by a dedicated computer control system. Vertical systems generally
provide greater process uniformity and lower particle contamination than do
horizontal systems, due to improved thermal control and an increased ability to
maintain environmental integrity, thereby achieving higher yields in wafer
processing. Additionally, vertical systems provide more flexibility in
manufacturing configurations. Horizontal thermal processing systems, which are
typically much larger and less automated than vertical reactors, were the
standard of the semiconductor processing equipment industry and are still used
for a broad range of processes.

    Rapid Vertical Processor -- 300 ("RVP-300"). Announced in 1997, the RVP-300
is the latest addition to the vertical furnace product line. RVP-300 is designed
for processing of 300mm (12 inch) wafers addressing requirements for 0.18 micron
technology and beyond. The design of RVP-300 focuses on maximizing productivity
and throughput. This is done by utilizing features such as fast temperature ramp
up and ramp down capability, Model Based Temperature Control (MBTC) for
optimized temperature control across the wafer, and a dual boat configuration.
Initial shipments of the RVP-300 occurred in the second quarter of fiscal 1998.
Prices of the RVP-300 range from $900,000 to $1,500,000, depending on
configuration.

    Series 9000 Rapid Vertical Processor ("RVP"). Introduced in 1996, the RVP is
based on the Advanced Vertical Processor ("AVP") platform, processes both
eight-inch and six-inch wafers and meets .25 micron technology requirements. The
RVP features a proprietary and patented design that enables it to ramp up and
ramp down temperatures anywhere between twice and ten times as fast



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as the AVP and offers faster throughput and tighter junction depth control for
critical anneals. By utilizing the AVP platform, the Company believes that the
RVP, which incorporates key features of the AVP, such as 16-cassette wafer
handling and model based temperature control (MBTC), offers the high reliability
of the established AVP product line. The typical price range of an RVP system is
$1,000,000 to $1,200,000, depending on process configuration.

    Series 8000 Advanced Vertical Processor ("AVP"). Initially shipped in
September 1992, the AVP is a vertical furnace designed to meet the eight and six
inch wafer requirements of sub-.50 micron processing. The Series 8000 single
tube systems include advanced process control, data acquisition software,
advanced automation, a proprietary process chamber design and an option for
atmospheric control within the wafer handling area. Key features of the AVP
system include storage capacity for sixteen 25-wafer cassettes (400 wafers), and
model based temperature control (MBTC) for accurate wafer temperature
regulation. The AVP system is designed to offer customers a low cost of
ownership, through high productivity and a low square footage requirement. The
typical price range of an AVP system is $500,000 to $1,200,000, depending on
process configuration.

    Vertical Thermal Reactor ("VTR"). Thermal's VTR processes wafers from 100mm
to 200mm in diameter. It operates under computer control, providing specialized
process recipe introduction, cassette-to-cassette automation, monitoring of
critical system functions and automated loading of wafers into the reaction
chamber. In general, the VTR offers comparable reliability, lower contamination
and better process uniformity than horizontal reactors. The VTR can be installed
through-the-wall in a customer's clean room facility and is compatible with
industry standard software interfaces. The VTR 7000PLUS, in comparison to
earlier versions of VTR's, offers improved process control, uniformity, reduced
particle levels, higher throughput, internal storage capabilities and the
industry's standard mechanical interface (SMIF). Typical prices for the
Company's VTR products range from approximately $600,000 to $900,000.

    Horizontal Processing Systems. The typical horizontal system consists of
four separately controlled cylindrical reaction chambers which are mounted
horizontally, one directly above the other. Horizontal systems are a mature
product family. Sales of these systems have been declining in recent years, as
semiconductor manufacturers have increasingly installed vertical reactors in
their newer fabrication facilities and the Company expects this trend to
continue.* However, the Company believes that manufacturers of less complex
devices will continue to have some need for horizontal processing systems for
the foreseeable future, but at successively declining rates.* In addition, the
existing installed base of horizontal processing systems enables the Company to
generate revenues through the sale of spare parts and upgrades. Prices for
horizontal systems range from approximately $400,000 to $900,000.

    The Company's ("APCVD") products acquired from Watkins-Johnson Company
utilize a propriety approach to the APCVD process. The substrates are
transported under injectors on a continuously moving conveyor belt through a
resistance heated muffle. This approach allows high deposition rates with a
simpler reactor design yielding higher reliability operations and high wafer
throughput.

    1500 System. The 1500 APCVD system processes 200mm wafers addressing
design-rule fabrication capability of 0.15 micron. It offers low cost of
ownership with a new process muffle design and an improved MonoBlok injector
assembly resulting in improved reliability, performance and serviceability
through enhanced film uniformity, reduced consumables, improved system
availability and ultra-low film metal levels. The 1500 system provides both
doped and undoped deposition of TEOS based silicon dioxide and can be utilized
in a broad range of dielectric film applications for both Logic and Memory
manufacturing requirements. Typical prices for the 1500 System range from
approximately $2,200,000 to $2,500,000 depending on process configuration.

    1000 System. The 1000 APCVD system offers either hybrid or TEOS reactant
processes and is specifically designed for high-productivity on 200mm wafer
processing lines. The 1000 system provides both doped and undoped deposition of
TEOS based silicon dioxide and can be utilized in a broad range of dielectric
film applications for both Logic and Memory manufacturing requirements. Typical
prices for the 1000 System range from approximately $1,500,000 to $2,200,000
depending on process configuration.

    999 Systems. The 999 and TEOS999 APCVD systems are for production lines
utilizing between 100mm to 150mm wafers and are capable of simultaneous
processing two wafers in parallel. Both systems offer doped and undoped silicon
dioxide. Typical prices for the 999 System range from approximately $1,500,000
to $2,300,000 depending on process configuration.



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CUSTOMERS

    The Company's customer base includes companies that manufacture
semiconductor devices primarily for sale to others and companies that
manufacture semiconductor devices primarily for internal use. Repeat sales to
existing customers represent a significant portion of the Company's processing
equipment sales. The Company believes that its installed customer base
represents a significant competitive advantage.* By working closely with its
established customer base, the Company is able to identify new product
development opportunities. The Company's customers during fiscal 1999 included
the following:

        IBM                              Microchip Technology
        Intel                            Motorola
        LSI Logic                        Philips Semiconductor
        Maxim                            ST Microelectronics

    The Company relies on a limited number of customers for a substantial
percentage of its sales. In fiscal 1999, Intel represented 56% of the Company's
net sales with the Company's five largest customers accounting for 74% of net
sales. For fiscal 1998, Intel, IBM and Motorola represented 40%, 17% and 13%,
respectively, of sales and the Company's largest five customers represented 76%
of sales. During fiscal years 1999 and 1998, no other customer represented more
than 10% of net sales for the Company. In fiscal 1999 and 1998, Intel
represented a substantial portion of the total sales of both Track and SVGL
products with Intel representing approximately 78% of SVGL's fiscal 1999 net
sales. The loss of a significant customer (and in particular the loss of Intel
as a Track or SVGL customer -- See "Manufacturing and Raw Materials"), a delay
in shipment due to customer rescheduling or any substantial reduction in orders
by a significant customer, including reductions in orders due to market,
economic or competitive conditions in the semiconductor industry, would
adversely affect the Company's business and results of operations.*

MARKETING, SALES AND SERVICE

    The Company markets and sells its products primarily to independent
manufacturers of semiconductor devices and computer, telecommunications and
other companies that manufacture semiconductor devices for their own use. The
market for the Company's products is worldwide. The Company sells its products
in the United States principally through its direct sales organization. The
Company sells its products overseas through a direct sales staff, independent
distributors and independent representatives. The following table sets forth the
Company's revenues by geographic area as a percentage of net sales for the three
fiscal years ended September 30:

<TABLE>
<CAPTION>
                                             YEARS ENDED SEPTEMBER 30,
                                             -------------------------
                                             1997       1998      1999
                                             ----       ----      ----
<S>                                          <C>        <C>       <C>
          United States..................     72%        65%       68%
          Europe.........................     18         31        26
          Pacific Rim....................     10          4         6
</TABLE>

    Reliability, which is commonly measured in up-time and mean time between
failure, and performance are increasingly important factors by which customers
evaluate the potential suppliers of sophisticated processing systems. The
Company believes that its field service and process support capabilities are
major factors in its selection as an equipment supplier. Increasingly,
semiconductor manufacturers are requiring seven-day, around the clock, on site
or on call support. To meet this need, the Company continues to enhance its
training programs and deploy spare part inventories at both customer sites and
regional field depots. Service personnel are based in field offices throughout
the United States, Western Europe, Japan and the Pacific Rim and increasingly on
site at particularly large customer locations.

    The Company warrants its products against defects in design, materials and
workmanship, generally for periods ranging from one to two years.

BACKLOG

At September 30, 1999 and 1998, the Company had a backlog of approximately
$357,455,000 and $254,129,000, respectively. The Company includes in backlog
only those orders to which a purchase order number has been assigned by the
customer and for which delivery has been specified within 12 months. Such orders
are subject to cancellation by the customer with limited charges. Because of the
possibility of customer changes in delivery schedules, cancellation of orders
and potential delays in product shipments, the



                                       8
<PAGE>   9

Company's backlog as of any particular date may not be representative of actual
sales for any succeeding period. As a result of the slow down in demand which
began to impact the Company during the first quarter of fiscal 1998 and
continued to impact the Company through out fiscal 1999, the Company has
received customer deferrals and order cancellations of product with scheduled
delivery dates which resulted in reduced levels of shipments during these
periods. There can be no assurance that the Company will not in the future
continue to experience customer delivery deferrals, order cancellations or a
prolonged period of customer orders at reduced levels, any or a combination of
which would have an adverse effect on its operating results.*

RESEARCH, DEVELOPMENT AND RELATED ENGINEERING

    The market served by the Company is characterized by rapid technological
change. Accordingly, the Company's product and process development programs are
devoted to the development of new systems and processes, including new
generations of products for existing markets, enhancements and extensions of
existing products and custom engineering for specific customers. The Company
believes that its future success will depend upon its ability to continue to
enhance its existing products and their process capabilities and to successfully
develop, introduce and manufacture new and enhanced products and processes which
satisfy a broad range of customer needs and achieve market acceptance.*
Accordingly, the Company works closely with semiconductor manufacturers,
industry consortia, and research institutions to respond to the industry's
evolving product and process requirements. The Company's research staff
collaborates with key customers in order to evaluate designs, specifications and
prototypes of the Company's new products.

    The Company believes that in selecting a photolithography equipment
manufacturer, customers look for a supplier with a long-term product development
strategy and the ability to fund that development since photolithography
exposure equipment can represent a substantial portion of the equipment cost of
a fabrication facility. Semiconductor manufacturers may be unwilling to rely on
a relatively small supplier, such as the Company, for a critical element of the
fabrication process if they believe that the Company does not have sufficient
capital to implement its product development strategy. The Company depends in
part on external sources to fund its photolithography development efforts.

    During fiscal 1996, the Company entered into agreements with certain
customers (the "Participants") whereby each agreed to assist in funding the
Company's development of an advanced technology 193-nanometer Micrascan system.
In exchange for such funding, each Participant received the right to purchase
one such system and, in addition, received a right of first refusal (ratable
among such Participants) to all such machines manufactured during the first two
years following the initial system shipments. For each initial system ordered,
each Participant agreed to fund $5,000,000 in such development costs. The
agreements call for each Participant to pay $1,000,000 of initial development
funding and four subsequent payments of $1,000,000 upon the completion of
certain development milestones. The Participants may withdraw from the
development program without penalty, but payments made against completed
development milestones are not refundable and all rights to future equipment are
forfeited. At September 30, 1999, the Company had received and recognized
$20,000,000 in funding from program Participants against research and
development expenditures. Three competitors of the Company have either announced
the development of, or have shipped 193-nanometer products. In June 1999,
certain Participants decided that their product needs have changed for initial
193-nanometer machines and have withdrawn from the program and chosen to use or
are evaluating other solutions. At September 30, 1999, the Company's obligations
under these agreements are complete and no additional funding is expected or
required from the Participants.* As a result, the Company expects to use its own
funds to continue development of an advanced technology 193-nanometer Micrascan
system, which will result in an increase in the Company's research and
development expenses and a decrease in the Company's operating income.*

    In May 1999, the Company entered into an agreement with Intel Corporation
("Intel") for the development of 157-nanometer lithography technology. This
agreement obligates the Company among other things to develop and sell to Intel
a predetermined number of initial tools. Intel has agreed to provide advanced
payments for the development and manufacture of these machines, based upon
predetermined milestones. Separately, Intel has invested approximately
$15,000,000 in the Company in the form of a purchase of Series 1 Convertible
Preferred Stock (see Note 11 to the Consolidated Financial Statements). The
Company is obligated to dedicate a certain amount of its 157-nanometer unit
production output to Intel. The Company is required to use the proceeds from the
Series 1 Preferred investment and funds received under the agreement for the
development of technology for use on 157-nanometer lithography equipment. There
can be no assurance that the Company will be successful in developing
157-nanometer technology or will be able to manufacture significant quantities
of machines to satisfy its obligations to Intel or other customers.* There is no
assurance that the Company will receive all funding which it currently
anticipates under its agreement with Intel.* If the Company were required to use
its own funds, its research and development expenses would increase and its
operating income would be reduced correspondingly.*



                                       9
<PAGE>   10

    The Company anticipates that it will need to continue to make substantial
research and development expenditures, particularly in its photolithography
products, in order to remain competitive in the semiconductor equipment
industry. There is no assurance that the Company will receive all funding which
it currently anticipates or that it will be able to obtain future outside
funding beyond that which it is currently receiving. If the Company were not
able to secure additional external funding, its new product development and
product enhancement efforts would either be impaired or would have a material
adverse effect on the Company's results of operations.*

    In connection with the Company's acquisition of SVGL in 1990, SVGL received
an equity investment and research and development funding commitments for
Micrascan from IBM. Under the terms of the related research and development
agreement, SVGL owed IBM certain royalties based on future operating results.
During the second quarter of fiscal 1997, the Company satisfied its obligation,
recognized an expense of $32,582,000, which represented royalties related to
products currently under development, and recorded a prepayment of $5,418,000,
which represented royalties related to existing products which are being
amortized through fiscal 2000.

    The Company has historically devoted a significant portion of its personnel
and financial resources to research and development programs. For fiscal years
1999, 1998, and 1997, total research and development expenditures were
approximately $98,000,000, $99,000,000, and $82,000,000, respectively, of which
approximately $3,000,000, $12,000,000, and $8,000,000, respectively, was funded
by outside parties. Substantially all development funding received by SVGL has
been for the development of its Micrascan technology and systems. During prior
years, the majority of development funding was received from the industry
consortium of semiconductor manufacturers, SEMATECH. In fiscal 1999, 1998 and
1997 the funding was received primarily from the Participants for the
development of the advanced technology 193-nanometer system.

COMPETITION

    The semiconductor equipment industry is intensely competitive. The Company
faces substantial competition both in the United States and other countries in
all of its products. The Company's competitors include Tokyo Electron, Ltd.
("TEL") and DaiNippon Screen Mfg. Co., Ltd. in photoresist processing equipment;
TEL and Kokusai Electric Co., Ltd. in oxidation/diffusion, LPCVD equipment;
Applied Materials and Quester in its newly acquired APCVD products from
Watkins-Johnson; and Nikon, Canon, ASM Lithography and other suppliers in
photolithography exposure equipment, and projection aligners. The trend toward
consolidation in the semiconductor processing equipment industry has made it
increasingly important to have the financial resources necessary to compete
effectively across a broad range of product offerings, to fund customer service
and support on a worldwide basis and to invest in both product and process
research and development. Significant competitive factors include technology and
cost of ownership, a formula which includes such data as initial price, system
throughput and reliability, use of consumables and time to maintain or repair.
Other competitive factors include familiarity with particular manufacturers'
products, established relationships between suppliers and customers, product
availability and technological differentiation. Occasionally, the Company has
encountered intense price competition with respect to particular orders and has
had difficulty establishing new relationships with certain customers who have
long-standing relationships with other suppliers. The Company believes that
outside Japan and the Pacific Rim it competes favorably with respect to most of
these factors.* (See "Importance of Japanese and Pacific Rim Markets".)

    Many of the Company's competitors are Japanese corporations. Although the
economic conditions in Asia are improving, the Company believes that an
oversupply of equipment from certain Japanese competitors may continue to cause
more severe price competition in its non-Asian markets.* To compete effectively
in these markets, the Company may be forced to reduce prices, which could cause
further reduction in net sales and gross margins and, consequently, have a
material adverse effect on the Company's financial condition and results of
operations.*

    Certain of the Company's existing and potential competitors have
substantially greater name recognition, financial, engineering, manufacturing
and marketing resources and customer service and support capabilities than the
Company. Additionally, the Company is a relative newcomer in the commercial
photolithography exposure market. Nikon, and to a lesser extent Canon, have long
established relationships as suppliers of photolithography equipment to most of
the semiconductor manufacturers. Although the Company has supplied Track and
Thermal equipment to many of these customers, it has not previously sold
meaningful quantities of Micrascan photolithography equipment to most of them.

    The Company's competitors can be expected to continue to improve the design
and performance of their current products and processes and to introduce new
products and processes with improved price/performance characteristics.



                                       10
<PAGE>   11

The Micralign products manufactured by SVGL are generally not competitive with
steppers for fabrication of semiconductor devices with line widths smaller than
1.25 micron. In marketing Micrascan systems, SVGL continues to face competition
from suppliers employing other technologies, principally I-Line and DUV
steppers, including Nikon Corp., Canon and ASM Lithography who have begun
shipping initial quantities of .25 micron step-and-scan photolithography systems
which utilize DUV light sources. The Company believes DUV lithography is
required to fabricate devices with line widths below 0.3 micron.* Semiconductor
manufacturers can purchase DUV steppers to produce product at .25 micron line
widths. However, the Company believes that as devices increase in complexity and
size and require finer line widths, the technical advantages of DUV
step-and-scan systems, as compared to DUV steppers, will enable semiconductor
manufacturers to achieve finer line widths with improved critical dimension
control which will result in higher yields of faster devices.* The Company also
believes that the industry transition to DUV step-and-scan systems has
accelerated in calendar 1999 and that advanced semiconductor manufacturers are
beginning to require volume quantities of production equipment as advanced as
the current and pending versions of Micrascan to produce both critical and to
some degree sub-critical layers of semiconductor devices.* Currently,
competitive DUV step-and-scan equipment capable of producing .25 micron line
widths and below is available in limited quantities from Nikon, Canon and ASM
Lithography. There can be no assurance that the Company will be successful in
competing with such systems.* Further, if manufacturers of DUV steppers are able
to further enhance existing technology to achieve finer line widths sufficiently
to erode the competitive and technological advantages of DUV step-and-scan
systems, or other manufacturers of step-and-scan systems are successful in
supplying sufficient quantities of product in a timely manner that are
technically equal to or better than the Micrascan, demand for the Micrascan
technology may not develop as the Company expects.*

IMPORTANCE OF THE JAPANESE AND PACIFIC RIM MARKETS

    The Company's customers are heavily concentrated in the United States and
Europe. The Japanese and Pacific Rim markets (including fabrication plants
located in other parts of the world which are operated by Japanese and Pacific
Rim semiconductor manufacturers) represent a substantial portion of the overall
market for semiconductor manufacturing equipment. To date, neither the Company's
shipments into Japan nor the Pacific Rim have been significant. The Company
believes that the Japanese companies with which it competes have a competitive
advantage because their dominance of the Japanese and Pacific Rim semiconductor
equipment market provides them with the sales and technology base to compete
more effectively throughout the rest of the world.* The Company is not engaged
in any significant collaborative effort with any Japanese or Pacific Rim
semiconductor manufacturers. As a result, the Company may be at a competitive
disadvantage to the Japanese equipment suppliers that are engaged in such
collaborative efforts with Japanese and Pacific Rim semiconductor manufacturers.
The Company believes that it must substantially increase its share of these
markets if it is to compete as a global supplier.* Further, in many instances,
Japanese and Pacific Rim semiconductor manufacturers fabricate devices such as
dynamic random access memory devices ("DRAMs"), with potentially different
economic cycles than those affecting the sales of devices manufactured by the
majority of the Company's U.S. and European customers. Failure to secure
customers in these markets may limit the global market share available to the
Company and may increase the Company's vulnerability to industry or geographic
downturns.*

    In the past, several of the Company's larger customers have entered into
joint ventures ("JV") with European, Japanese or Pacific Rim semiconductor
manufacturers. In such cases, the Company has encountered intense price
competition from foreign competitors who are suppliers to the non-U.S. member of
the JV. Further, in certain instances the Company has not secured the equipment
order when the non-U.S. member has had the responsibility for selecting the
equipment to be used by the JV in its U.S. operations. There can be no assurance
that as the Company's customers form additional alliances, whether in the U.S.
or in other parts of the world, that the Company will be successful in obtaining
equipment orders or that it will be able to obtain orders with sufficient gross
margin to generate profitable transactions, either of which could have an
adverse effect on the Company's results of operations.*

    Throughout the Pacific Rim, the Company is attempting to compete with major
equipment suppliers having significant market share and established service and
support infrastructures in place. The Company has invested in the staffing and
facilities that it believes are necessary to sell, service and support customers
in the Pacific Rim and with the acquisition of SEG, the Company acquired from
Watkins-Johnson Company a 36,000 square foot customer demonstration facility in
Kawasaki City, Japan. However, the Company anticipates that it will continue to
encounter significant price competition as well as competition based on
technological ability.* There can be no assurance that the Company's Pacific Rim
operations will be profitable, even if it is successful in obtaining significant
sales into this region.* Further, due to recent economic issues in certain Asian
countries, particularly Korea, the Company's ability to penetrate such markets
has been more difficult. Failure to secure customers in these markets would have
an adverse effect on the Company's business and results of operations.*



                                       11
<PAGE>   12

MANUFACTURING AND RAW MATERIALS

    The Company manufactures its products from standard components and from
components manufactured by others according to the Company's design
specifications. Track products are manufactured in San Jose, California. Thermal
products are primarily manufactured in Orange and Scotts Valley, California.
Tinsley manufactures optical components in Richmond and North Hollywood,
California. SVGL photolithography exposure products are manufactured in Wilton
and Ridgefield, Connecticut.

    From time-to-time, the Company has experienced delays in the introduction of
its products and product enhancements due to technical, manufacturing and other
difficulties and may experience similar delays in the future.* For example,
during fiscal 1996, the Company announced the subsequently terminated 200-APS
Track product. Initial shipments of the 200-APS were scheduled to commence
during the second quarter of fiscal 1997, and were delayed until the second
quarter of fiscal 1998. This delay, as well as industry developments, caused the
Company to implement a plan, which was announced on September 30, 1998, to
terminate future development and shipments of its 200-APS products, and to
concentrate its efforts on completing the ProCell product which had been in
development for approximately one year. There can be no assurance that the
Company will not experience delays in completing the development or
manufacturing problems related to the ProCell product as a result of instability
of the design of either the hardware or software elements of the new technology,
or be able to efficiently manufacture the new product or other products.* In
June of 1999 the Company introduced the ProCell product for shipment in fiscal
2000. The Company believes that protracted delays in delivering initial
quantities of this newly introduced product or any new product to multiple
customers could result in semiconductor manufacturers electing to install
competitive equipment and could preclude industry acceptance of the ProCell
product or any of the Company's products.* The inability to produce such
products or any failure to achieve market acceptance could have a material
effect on the Company's business, results of operations and could result in a
subsequent loss of future sales.*

    In June of 1999, five participants in the 193 Development Program decided
that their product needs have changed for initial 193-nanometer machines and
have withdrawn from the development program and declined delivery of initial
tools. These participants withdrew in part due to delays in product introduction
and changes in participant's technical requirements. As the Lithography demands
continue, the Company is responding by accelerating the development of a very
high numerical aperture ("VHNA") version of its 193 product. In order to address
a broader market with this tool, the Company is also redesigning its stage
technology to optimize cost of ownership. Although the Company believes that the
timing of the introduction of the product will be sufficient to meet volume
production requirements of .13 micron, there can be no assurance that the
product will be introduced on time or that customers will wait for the product
to commit for their production needs.* The absence of a successful
implementation of the product or obtaining sufficient orders for this product
could have a material adverse impact on the future profitability of the
Company.*

    Semiconductor manufacturers tend to select either a single supplier or a
primary supplier for a certain type of equipment. The Company believes that
prolonged delays in delivering initial quantities of newly developed products to
multiple customers, whether due to the protracted release of product from
engineering into manufacturing or due to manufacturing difficulties, could
result in semiconductor manufacturers electing to install competitive equipment
in their fabrication facilities and could preclude industry acceptance of the
Company's products.* For example, the Company's largest Track customer has
decided to secure deliveries from another source, a decision the Company
believes is primarily due to the delay and subsequent termination of the
200-APS. Initial shipments into the market of a new technology Track product,
the ProCell, is not expected until fiscal 2000.* As a result, competitors will
increase their market share, and it will be increasingly more difficult for the
Company to regain market position.* The Company's inability to effect the timely
production of new products or any failure of these products to achieve market
acceptance could have a material adverse effect on the Company's business and
results of operations.*

Historically, the unit cost of the Company's products has been the highest when
they are newly introduced into production and cost reductions have come over
time through engineering improvements, economies of scale and improvements in
the manufacturing process.* As a result, new products have, at times, had an
unfavorable impact on the Company's gross margins and results of operations.
There can be no assurance that the initial shipments of new products will not
have an adverse effect on the Company's profitability or that the Company will
be able to attain design improvements, manufacturing efficiencies or
manufacturing process improvements over time.* Further, the potential
unfavorable effect of newly introduced products on profitability can be
exacerbated when there is intense price competition in the marketplace.

    The time required to build a Micrascan system is significant. If SVGL is to
be successful in supplying increased quantities of Micrascan systems, it will
not only need to be able to build more systems, it will need to build them
faster.* SVGL will require additional trained personnel, additional raw
materials and components and improved manufacturing and testing techniques to
both facilitate volume increases and shorten manufacturing cycle time.* To that
end, SVGL is continuing to develop its vendor supply infrastructure, and
implement manufacturing improvements.* Additionally, the Company believes that
as it increases its penetration



                                       12
<PAGE>   13

of the Micrascan product, it must resume increasing its factory, field service
and technical support organization staffing and infrastructure to support the
anticipated customer requirements.* There can be no assurance that the Company
will successfully increase its penetration of the Micrascan product or that the
Company will not experience manufacturing difficulties or encounter problems in
its attempt to increase production and upgrade or expand existing operations.*

    One of the most critical components of the Micrascan systems is the
projection optics, which are primarily manufactured by SVGL. As part of its
overall investment in capacity, the Company has increased SVGL's optical
manufacturing floor space. The Company believes that in order for SVGL to be a
viable supplier of advanced lithography systems in the future, it must
successfully reduce the cycle times required to build projection optics.*

    In November 1997, the Company acquired Tinsley Laboratories, Inc. ("TLI") in
exchange for approximately 1,091,000 shares of Company common stock. TLI
designs, manufactures and sells precision optical components, assemblies and
systems to customers in a variety of industries and research endeavors. The
primary reasons for the acquisition were TLI's technology and expertise relating
to aspherical lenses, a key component of SVGL's photolithography products, the
adaptation of certain of TLI's manufacturing processes by SVGL and TLI's
commencement of the fabrication of non-aspherical lenses which are currently
produced by SVGL. However, there can be no assurance that TLI's manufacturing
technology is scaleable, or that such expertise can be transferred without
substantial time or expense, if at all.* The inability of SVGL to transfer this
production technology for use in processes of a substantially larger scale or
the inability of TLI to manufacture non-aspherical lenses for SVGL in sufficient
quantities to realize efficiencies of scale could adversely affect the Company's
ability to realize any significant benefits from the acquisition of TLI.*

    The Company believes that protracted delays in delivering quantities of both
current and future generations of Micrascan products to multiple worldwide
customers could result in semiconductor manufacturers electing to install
competitive equipment in their advanced fabrication facilities, and could
preclude industry acceptance of the Micrascan technology and products.* In
addition, the Company's operating results could also be adversely affected by
the increase in fixed costs and operating expenses related to increases in
production capacity and field service and technical support activities if net
sales do not increase commensurately.*

    Most raw materials and components not produced by the Company are available
from more than one supplier. However, certain raw materials, components and
subassemblies are obtained from single sources or a limited group of suppliers.
Although the Company seeks to reduce its dependence on these sole and limited
source suppliers, and the Company has not experienced significant production
delays due to unavailability or delay in procurement of component parts or raw
materials to date, disruption or termination of certain of these sources could
occur and such disruptions could have at least a temporary adverse effect on the
Company's business and results of operations.* Moreover, a prolonged inability
to obtain certain components could have a material adverse effect on the
Company's business and results of operations and could result in damage to
customer relationships.*

    The raw material for a proprietary component of the optical system for the
Micrascan is available from only one supplier. The supplier has expanded its
capacity to meet SVGL's projected long-term requirements and has created and
stored agreed upon quantities of safety stock. There can be no assurance that
the supplier will be able to provide acceptable quantities of material required
by SVGL.* Additionally, a version of the Company's Micrascan III
photolithography system utilizes an Excimer laser that is manufactured in volume
by only one supplier. In fiscal 1999 SVGL qualified an additional source of
lasers for its current and future versions of Micrascan products, allowing the
potential for the integration of such lasers into its system configurations.*
However, there can be no assurance that its customers will be receptive to
procuring products with lasers from this supplier, or the supplier will be able
to provide product of sufficient quantity and quality.* If these suppliers were
unable to meet their commitments, SVGL would be unable to manufacture the
quantity of products required to meet the anticipated future demand, which would
have a material adverse effect on the Company's business and results of
operations.*

    It is anticipated that a critical component of the optical system for the
157-nanometer lithography product, which is currently under development, will
utilize Calcium Fluoride.* Calcium Fluoride is a raw material that has been
known to be in short supply and is integral to the production of optics capable
of producing quality line widths of .10 and below. The Company has or expects to
shortly qualify three suppliers who could be sources of this raw material for
the Company.* There can be no assurance that these suppliers will be able to
supply the quality or quantity of the product necessary for the Company to meet
expected future demand, which could have a material adverse effect on the
Company's business and results of operations.*



                                       13
<PAGE>   14

PATENTS AND LICENSES

    The Company owns several domestic and foreign patents relating to the
businesses of Track, Thermal and SVGL products. Although the Company has
historically relied and continues to rely on the technical and marketing
competence and creative ability of its personnel, rather than patents, to
maintain its competitive position, it has begun to pursue both domestic and
foreign patent protection more aggressively.

    As is typical in the semiconductor equipment industry, the Company has from
time to time received, and may in the future receive, communications from third
parties asserting patents or copyrights on certain of the Company's products and
technologies. Two of the Company's customers have notified the Company that they
have received a notice of infringement from Jerome H. Lemelson, alleging that
equipment used in the manufacture of electronic devices infringes patents issued
to Mr. Lemelson relating to "machine vision" or "barcode reader" technologies.
The customers have put the Company on notice that it intends to seek
indemnification from the Company for any damages and expenses resulting from
this matter if found liable or if the customer settles the claim. The Company
cannot predict the outcome of this or any similar claim or its effect upon the
Company, and there can be no assurance that any such litigation or claim would
not have a material adverse effect upon the Company's financial condition or
results of operations.*

EMPLOYEES

    At September 30, 1999, the Company had 2,815 full-time employees and 263
part-time employees and contract personnel, including 782 in research and
development, 1,315 in manufacturing, 833 in marketing, sales and customer
service and support and 148 in administration. None of the Company's employees
are represented by a union. Management considers its relations with its
employees to be good.

    The Company's future success will continue to depend to a large extent on
the continued contributions of its executive officers and key management and
technical personnel. In particular, SVGL's future growth is very dependent on
the Company's ability to attract and retain key skilled employees, particularly
those related to the optical segment of its business. The Company is a party to
agreements with each of its executive officers to help ensure the officers'
continual service to the Company in the event of a change-in-control. Each of
the Company's executive officers, and key management and technical personnel
would be difficult to replace. The loss of the services of one or more of the
Company's executive officers or key personnel, or the inability to continue to
attract qualified personnel could delay product development cycles or otherwise
have a material adverse effect on the Company's business, financial condition
and results of operations.*

EXECUTIVE OFFICERS OF THE REGISTRANT

    The executive officers of the Company are as follows:

<TABLE>
<CAPTION>
                NAME                    AGE                     POSITION
                ----                    ---                     --------
<S>                                     <C>   <C>
       Papken S. Der Torossian.......   60    Chairman of the Board and Chief Executive Officer
       William A. Hightower..........   56    President and Chief Operating Officer
       Russell G. Weinstock..........   56    Vice President, Finance and Chief Financial Officer
       Steven L. Jensen..............   50    Vice President, Worldwide Sales and Marketing
       Jeffrey M. Kowalski...........   46    Vice President, President, Thermal Systems
       Boris Lipkin..................   52    Vice President, Corporate
       Larry W. Sonsini..............   58    Secretary
</TABLE>

    Mr. Der Torossian became Chairman of the Board and Chief Executive Officer
in July 1991, and has been a director of the Company since October 1984.

    Mr. Hightower became President and Chief Operating Officer in August 1997.
He has been a member of the Board of Directors of the Company since 1994. From
January 1996 to August 1997, Mr. Hightower was the Chairman of the Board of
Directors and Chief Executive Officer of Cadnet Corporation and from August 1989
to December 1995, he was the President and Chief Executive Officer of Telematics
International, Inc.

    Mr. Weinstock has been Vice President of Finance and Chief Financial Officer
of the Company since July 1990.

    Mr. Jensen became a Vice President of the Company in July 1992 and Vice
President, Worldwide Sales in April 1992.



                                       14
<PAGE>   15

    Mr. Kowalski became a Vice President of the Company and President of Thermal
Systems in January 1995. From November 1992 to January 1995 he was the Vice
President of Marketing of Thermal Systems, as well as its Vice President of
Technology from November 1993.

    Mr. Lipkin became a Vice President of the Company in March 1995. From August
1992 to March 1995 he was the Vice President and General Manager of the Thin
Film Systems business unit of Varian Associates.

    Mr. Sonsini has been Secretary since November 1988. He was a member of the
Board of Directors of the Company from 1991 to 1997. Mr. Sonsini is a member of
the law firm of Wilson Sonsini Goodrich & Rosati, Professional Corporation,
counsel to the Company, and is the Chairman of the firm's Executive Committee.
Mr. Sonsini serves on the boards of directors of Lattice Semiconductor
Corporation, Novell, Inc., and PIXAR.

ITEM 2. PROPERTIES.

    The Company's corporate headquarters are located in San Jose, California in
36,000 square feet of office space. This space is under a lease that expires in
2006 and has a current base rental of approximately $69,000 per month.

    The Company's Track Systems Division has two leased facilities in San Jose,
California. The first is a 90,000 square foot, two-story building with a current
monthly base rental of approximately $95,000 and a lease expiration of 2004. The
second is also a two-story building consisting of approximately 83,000 square
feet. The monthly base rental for this facility is approximately $53,000 under a
lease expiring in 2003.

    In March 1996, the Company purchased approximately nine acres of land
adjacent to one of the Track facilities in San Jose, California. Although the
Company currently has no plans to develop the parcel, it provides the
flexibility for future expansion of the Company's Track operations and its
thermal processing lab.

    The Thermal Systems Division has two facilities in Orange and one nine
building facility in Scotts Valley, California. The first Orange facility
consists of approximately 92,000 square feet with a base monthly rent expense of
approximately $53,000 under a lease expiring in 2004. The second facility
consists of approximately 77,000 square feet with a base monthly rental expense
of approximately $46,000 under a lease expiring in 2000. The Scotts Valley
facility consists of nine buildings comprising approximately 205,000 square feet
with a base monthly rent expense of approximately $100,000 under a lease
expiring in 2004.

    SVGL owns two facilities in Fairfield County, Connecticut. The first
consists of approximately 29 acres of land and buildings totaling approximately
276,000 square feet, located in Wilton, Connecticut. The second consists of
approximately 50 acres of land and a 201,000 square foot building located in
Ridgefield, Connecticut

    The Company acquired a facility in Kawasaki, Japan from the Semiconductor
Equipment Group of Watkins-Johnson Company. The facility consists of a 36,000
square foot, two-story building on approximately one acre of land.

    Tinsley owns two facilities in Richmond, California. The first consists of
approximately three acres of land and buildings totaling 64,000 square feet.
The second consists of two acres of land with a 32,000 square foot facility.

    Tinsley, which owns Century Precision Optics, has two facilities in North
Hollywood, California. The first facility consists of approximately 21,000
square feet with a base monthly rent expense of approximately $21,300 under a
lease expiring in 2004. The second facility consists of approximately 5,000
square feet with a base monthly rent expense of approximately $4,500. This lease
is on a month to month basis.

    The Company also leases storage and warehouse space near its headquarters in
San Jose, office and warehouse space near its Thermal facilities in Orange and
Scotts Valley, sales and service offices in key locations throughout the United
States, Western Europe and the Pacific Rim.



                                       15
<PAGE>   16

ITEM 3. LEGAL PROCEEDINGS.

    On or about August 12, 1998, Fullman International Inc. and Fullman Company
LLC (collectively, "Fullman") initiated a lawsuit in the United States District
Court for the District of Oregon alleging claims for fraudulent conveyance,
constructive trust and declaratory relief in connection with a settlement the
Company had previously entered into resolving its claims against a Thailand
purchaser of the Company's equipment. In its complaint against the Company,
Fullman, allegedly another creditor of the Thailand purchaser, alleges damages
of approximately $11,500,000 plus interest. The Company has successfully moved
to transfer the case to the United States District Court for the Northern
District of California. The trail is tentatively scheduled for July 2000.

    While the outcome of such litigation is uncertain, the Company believes it
has meritorious defenses to the claims and intends to conduct a vigorous
defense. However, an unfavorable outcome in this matter could have a material
adverse effect on the Company's financial condition.*

    On July 8, 1999, the Company filed a complaint for copyright infringement to
protect its investment and intellectual property from six third party vendors
("the Defendants"), subsequently, complaints against two of the Defendants were
withdrawn by the Company. The complaint was filed against the Defendants
alleging that the named defendants have infringed upon certain copyrights owned
by the Company on its 8X series equipment by duplicating or modifying software
in the refurbishment and sale of replacement boards. The complaint further asks
for preliminary and permanent injunction against the Defendants' further
infringement of the Company's copyrights and sale of infringing systems and
boards, and for an award of damages. One of the Defendants has filed a
counterclaim against the Company in response to the Company's complaint.

    In addition to the above, the Company, from time to time, is party to
various legal actions arising out of the normal course of business, none of
which is expected to have a material effect on the Company's financial position
or operating results.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

    No matter was submitted to a vote of the Company's security holders during
the fiscal quarter ended September 30, 1999.



                                       16
<PAGE>   17

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

    The Company's common stock is traded in the over-the-counter market on the
Nasdaq National Market System under the symbol SVGI. The following table sets
forth the range of high and low sales prices of the stock during fiscal years
1998 and 1999 as reported by Nasdaq-NMS.

<TABLE>
<CAPTION>
                                 FISCAL 1998               FISCAL 1999
                            --------------------     -----------------------
                             HIGH         LOW          HIGH           LOW
                            -------      -------     ---------      --------
<S>                         <C>          <C>         <C>            <C>
        First Quarter       $36-1/4      $18-3/8     $13-5/16       $ 6-5/8
        Second Quarter       27-7/8       19          17-5/16        10-3/8
        Third Quarter        21-1/2       15-3/4      16-13/16       12-1/16
        Fourth Quarter       16-1/2        8          17-11/16       11
</TABLE>

    To date, the Company has not declared or paid dividends on its common stock.
The Board of Directors of the Company presently intends to retain all earnings
for use in the Company's business and therefore does not anticipate declaring or
paying any cash dividends in the foreseeable future. The Company's revolving
credit facility prohibits the payment of cash dividends on common stock.

As of November 26, 1999, there were 806 holders of record of the common stock.

ITEM 6. SELECTED FINANCIAL DATA.

    The following selected consolidated financial data concerning the Company
for and as of the end of each of the years in the five year period ended
September 30, 1999, are derived from the audited consolidated financial
statements of the Company. The selected financial data are qualified in their
entirety by the more detailed information and financial statements, including
the notes thereto. The financial statements of the Company as of September 30,
1999, and for each of the three years in the period ended September 30, 1999,
and the report of Deloitte and Touche LLP thereon, are included elsewhere in
this report.

<TABLE>
<CAPTION>
        YEARS ENDED SEPTEMBER 30,
        (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)    1995         1996         1997         1998          1999
                                                  --------     --------     --------     --------      --------
<S>                                               <C>          <C>          <C>          <C>           <C>
        Statement of operations data:
          Net sales                               $475,141     $657,337     $614,226     $608,625      $473,690
          Income (loss) before income
           taxes and minority interest              61,696       99,809        4,198      (27,157)      (37,436)
          Net income (loss)                         39,263       64,099        2,592      (13,577)      (25,456)
          Preferred stock dividend                     537           --           --           --            --
          Net income (loss)
           per share--basic                       $   1.66     $   2.09     $   0.08     $  (0.42)     $  (0.77)
          Shares used in per share
           computations--basic                      23,627       30,657       31,635       32,438        32,926
          Net income (loss)
           per share--diluted                     $   1.61     $   2.06     $   0.08     $  (0.42)     $  (0.77)
          Shares used in per share
           computations--diluted                    24,326       31,122       32,414       32,438        32,926

        Balance Sheet Data:

          Working capital                         $328,128     $466,637     $420,486     $371,960      $382,155
          Total assets                             513,665      744,257      756,017      730,590       754,773
          Long-term debt and capital leases          2,015        1,718        6,515        5,865        26,790

          Stockholders' equity                     358,614      551,242      573,110      561,530       557,537

        Other Data:
          Backlog                                 $400,324     $404,889     $437,668     $254,129      $357,455
          Number of employees                        2,757        3,185        3,515        2,660         3,078
</TABLE>



                                       17
<PAGE>   18

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.

    The information in this discussion contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, as amended. Such statements are subject
to certain risks and uncertainties, including those discussed below that could
cause actual results to differ materially from those projected. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. Forward-looking statements are indicated by an
asterisk (*) following the sentence in which such statement is made. The Company
undertakes no obligation to publicly release the results of any revisions to
these forward-looking statements which may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.

RESULTS OF OPERATIONS

    The Company primarily designs, manufactures, markets and services
semiconductor processing equipment used in the fabrication of integrated
circuits. The Company's products are used in photolithography for exposure and
photoresist processing, and in deposition for oxidation/diffusion and low
pressure chemical vapor deposition ("LPCVD"), and with the acquisition of the
Semiconductor Equipment Group of Watkins-Johnson, thermal processing products
which address atmospheric pressure chemical vapor deposition ("APCVD"). The
Company manufactures and markets photolithography exposure SVGL products,
photoresist processing Track products, oxidation/diffusion, chemical vapor
deposition and LPCVD, APCVD Thermal products and certain precision optical
components.

    On July 6, 1999, the Company acquired the business of the Semiconductor
Equipment Group of Watkins-Johnson Company ("SEG"). The acquisition was
accounted under the purchase method of accounting for financial reporting
purposes. The results of the Company for fiscal 1999 include the operating
results of SEG from the date of acquisition.

On November 26, 1997, the Company acquired Tinsley Laboratories, Inc. ("TLI").
The transaction has been accounted for as a pooling of interests for financial
reporting purposes. All amounts discussed below have been retroactively restated
to reflect the inclusion of TLI.

    The semiconductor industry into which the Company sells its products is
highly cyclical and has, historically, experienced periodic downturns that have
had a severe effect on the semiconductor industry's demand for semiconductor
processing equipment. As a result of the Asian economic crisis which began in
1997, an oversupply of certain semiconductor products, the impact of low cost
personal computers, and various other factors, semiconductor manufacturers
reduced planned expenditures and cancelled or delayed the construction of new
fabrication facilities. This slowdown in demand began to impact the Company
during the first quarter of fiscal 1998 and continued to impact the Company
through out fiscal 1999. The slowdown in demand resulted in the Company
experiencing lower new customer orders, customer deferrals of scheduled
equipment delivery dates and, to a lesser extent, customer order cancellations.
Customer orders with scheduled delivery dates are referred to by the Company as
bookings. Last year's lower bookings, order rescheduling and cancellations, have
caused sales and net income during fiscal 1999 to decline from prior years
amounts. Although the Company has experienced a modest improvement in new
bookings as during the second half of fiscal 1999 the Company recorded new
bookings of $324,213,000 up from new bookings of $254,444,000 and $237,451,000
during the first half of fiscal 1999 and the second half of fiscal 1998,
respectively, there can be no assurance that the dollar amount of new bookings
will continue to increase. There can be no assurance that the Company will not
in the future experience further customer delivery deferrals, additional order
cancellations or a prolonged period of customer orders at reduced levels, any or
a combination of which would have a material adverse effect on the Company's
business and results of operations.*

    During fiscal 1998 in an effort to lessen the impact of these lower sales
volumes, the Company took several steps to reduce operating expenses including a
reduction in workforce, temporary shutdowns and the restructuring of certain
portions of the Company's business. During the second half of fiscal 1998, the
Company shut down the majority of its operations for 15 days and recorded
restructuring and related charges of $33,680,000. The restructuring and related
charges include costs of $28,521,000 resulting from the termination of the
Company's previously announced 200-APS photoresist processing system and a
provision of $5,159,000 for 1998 reductions in the Company's workforce for
approximately 1,150 employees.

    Historically, the Company has relied on a limited number of customers for a
substantial percentage of its net sales. In fiscal 1999, the Company's largest
customer accounted for 56% of net sales. The Company believes that, for the
foreseeable future, it will continue to rely on a limited number of major
customers for a substantial percentage of its net sales.*



                                       18
<PAGE>   19

FISCAL 1999 COMPARED TO FISCAL 1998

    Net sales for fiscal 1999 were $473,690,000, 22% below fiscal 1998 net sales
of $608,625,000. The decrease in net sales was due to lower shipments of Track,
Thermal and Lithography products during fiscal 1999, offset in part by sales of
APCVD products during the fourth quarter of fiscal 1999 resulting from the SEG
acquisition. The decrease in net sales occurred across all geographies except
Israel where sales increased by $40,298,000 reflecting continued expansion of
customer manufacturing operations in Israel.

    The Company's fiscal 1999 net bookings were $545,709,000, representing a
book to bill ratio of 1.15 to 1, significantly above fiscal 1998 net bookings of
427,272,000, representing a book to bill ratio of .70 to 1. At September 30,
1999, the Company had a backlog of $357,455,000, a 41% increase over September
30, 1998 backlog of $254,129,000. The Company includes in backlog only those
orders to which a purchase order number has been assigned by the customer, with
substantially all of the terms and conditions agreed upon, and for which
delivery has been specified within twelve months. During the third quarter of
fiscal 1999, the Company reduced its 193-nanometer orders by approximately
$53,000,000; of this amount, customer orders for three machines totaling
$31,500,000 were cancelled and removed from the Company's backlog due to
customer requirements having changed. (See "SVGL- Research and Development
Funding"). Backlog at September 30, 1999, included orders for 47 Micrascan
photolithography products.

    During the first quarter of fiscal 1999, the Company recognized net sales of
approximately $20,000,000 from one customer who accepted and took title to the
related equipment and agreed to normal payment terms, but requested that the
Company store the equipment until predetermined shipment dates. During fiscal
1998 approximately $58,000,000 in net sales to two such customers was
recognized. At September 30, 1999, the Company was storing approximately
$1,500,000 of such equipment with a scheduled shipment date of March 2000.

    Fiscal 1999 gross margin was 34%, slightly above fiscal 1998 gross margin of
33%. Fiscal 1998 cost of sales includes $19,117,000 in restructuring charges for
the write-off of 200-APS inventory. Excluding the impact of the 200-APS
inventory charge, the fiscal 1998 adjusted gross margin was 36%. The decrease in
fiscal 1999 gross margin when compared to fiscal 1998 adjusted gross margin was
primarily the result of the impact associated with the fourth quarter fiscal
1999 inventory provision due to the cancellation of orders (discussed above)
under the Low NA 193nm Lithography program, higher per unit costs resulting from
lower shipment volumes of Thermal products, partially offset by higher margin
shipments of the Company's newly acquired APCVD products.

    Research, development and related engineering ("R&D") expenses are net of
funding received from outside parties under various development agreements. Such
funding is typically payable upon the attainment of one or more development
milestones that are specified in the agreements. During fiscal years 1997, 1998
and 1999 funding was primarily related to agreements between the Company and
certain customers for the development of a 193-nanometer Micrascan system ("193
Development Program"). During June 1999 certain participants in the 193
Development Program decided that their product needs have changed for initial
193-nanometer machines and have withdrawn from the development program and
chosen to use or are evaluating other solutions. (See "SVGL-Research and
Development Funding.")

    During fiscal 1999, R&D expenses were $94,698,000 (20% of net sales),
compared to $87,272,000 (14% of net sales) during fiscal 1998. Such R&D amounts
are net of funding recognized under joint development agreements of $2,902,000
and $11,997,000 during fiscal 1999 and fiscal 1998, respectively. R&D expense
increased over fiscal 1998 primarily due to increased spending on the
157-nanometer development program, reduced development funding, offset in part
by reduced spending on the 200-APS Track product resulting from its fiscal 1998
cancellation. The increase in R&D as a percentage of net sales reflects the
significant year-to-year decrease in net sales.

    Fiscal 1999, marketing, general and administrative ("MG&A") expenses were
$109,819,000 (23% of net sales), lower than fiscal 1998 MG&A of $130,615,000
(21% of net sales). The decrease in MG&A from the preceding year was primarily
due to reduced product support costs. The increase in MG&A as a percentage of
net sales reflects the significant year-to-year decrease in net sales.

    As discussed above, during the fourth quarter of fiscal 1998, the Company
recorded restructuring and related charges of $33,680,000, of which $14,563,000
was classified as operating expenses. During the fourth quarter of fiscal 1999,
the Company revised its estimate primarily relating to severance and benefits
and reversed approximately $506,000 of the fiscal 1998 restructuring and related
charges accrued against operating expenses.



                                       19
<PAGE>   20

    For fiscal 1999, the Company had an operating loss of $42,640,000, compared
to an operating loss of $32,221,000 during fiscal 1998. In comparison to the
preceding year, the increase in the operating loss is primarily from reduced
gross margin resulting from reduced net sales, increased R&D expenses offset in
part by the absence of restructuring charges in fiscal 1999 and lower MG&A
expenses.

    Interest and other income was $6,509,000 during fiscal 1999 compared to
$6,082,000 for fiscal 1998. The year to year increase in interest and other
income was primarily the result of foreign currency translation and exchange
gains offset in part by lower interest income due to lower average cash balances
available for investment.

    Interest expense in fiscal 1999 was $1,305,000 compared to fiscal 1998
interest expense of $1,018,000. The increase in interest expense between periods
is primarily due to the three Japanese bank loans assumed in connection with the
acquisition of SEG. (See Note 8 to the Consolidated Financial Statements).

    The Company recorded a 32% benefit for income taxes for fiscal 1999,
compared to a 50% benefit for fiscal 1998. Variations in the Company's effective
tax rate relate primarily to changes in the geographic distribution of its
pretax income and certain tax-free interest income. (See Note 10 to the
Consolidated Financial Statements).

    For fiscal 1999 the Company had a net loss of $25,456,000 ($0.77 loss per
share--diluted), compared to a net loss of $13,577,000 ($0.42 loss per
share--diluted) for fiscal 1998.

FISCAL 1998 COMPARED TO FISCAL 1997

    For fiscal 1998, net sales were $608,625,000, slightly below fiscal 1997 net
sales of $614,226,000. The decrease in net sales was due to lower shipments of
Thermal and Track products during fiscal 1998, offset in part by increased
shipments of the SVGL Micrascan photolithography product. The decrease in net
sales occurred across all geographies except Ireland and Israel where sales
increased by $83,285,000 and $11,118,000, respectively. These increases
reflected expansions of customer manufacturing operations in these countries.

    The Company's fiscal 1998 net bookings were $427,272,000, which represented
a book to bill ratio of 0.70 to 1, significantly below fiscal 1997 net bookings
of $648,001,000, which represented a book to bill ratio of 1.05 to 1. At
September 30, 1998, the Company had a backlog of $254,129,000, a 42% decrease
from the September 30, 1997 backlog of $437,668,000.

    For fiscal 1998, the Company's gross margin was 33%, significantly below the
fiscal 1997 gross margin of 38%. Fiscal 1998 included a restructuring charge of
$19,117,000 for the write-off of 200-APS inventory, which has been included in
cost of sales. This restructuring charge accounted for 3% of the year to year
decrease in gross margin. Without taking into account the 200-APS inventory
charge, the fiscal 1998 gross margin was 36%, a decrease of 2% from the fiscal
1997 gross margin. This decrease was primarily the result of lower volumes and
higher fixed costs for SVGL products during the second half of fiscal 1998 and
the overall effect of lower volumes of Thermal and to a lesser degree, Track
products.

    R&D expenses were $87,272,000 (14% of net sales) during fiscal 1998,
compared to $74,311,000 (12% of net sales) during fiscal 1997. Such R&D amounts
are net of funding recognized under joint development agreements of $11,997,000
and $7,968,000 during fiscal 1998 and fiscal 1997, respectively. The year to
year increase in R&D was primarily due to new product and process development,
particularly for SVGL products, the design and development of equipment capable
of processing the next generation 300mm wafer and costs associated with Track's
subsequently terminated 200-APS program.

    During late fiscal 1996 and early fiscal 1997, the Company sold
approximately $20,000,000 in product to SubMicron Technology PCL ("SMT"), a
newly established semiconductor foundry in Thailand. SMT paid the Company
approximately $14,000,000 before encountering severe financial difficulties.
During the third quarter of fiscal 1997, the Company determined that the
remaining receivable from SMT was uncollectible. After reversing costs accrued
for the installation and warranty of the products sold to SMT, the Company
recorded a net charge against its fiscal 1997 operating results of approximately
$4,000,000 (the "SMT Charge").



                                       20
<PAGE>   21

    During fiscal 1998, marketing, general and administrative ("MG&A") expenses
were $130,615,000 (21% of net sales), lower than fiscal 1997 MG&A of
$134,642,000 (22% of net sales). The decrease in MG&A from the preceding year
was primarily due to the effect of the SMT Charge on fiscal 1997 MG&A.

    As discussed above, during the fourth quarter of fiscal 1998, the Company
recorded restructuring and related charges of $33,680,000, of which $14,563,000
was classified as operating expenses.

    Under the terms of a research and development agreement, SVGL owed IBM
certain royalties based on future operating results. During the second quarter
of fiscal 1997, the Company satisfied its obligation to IBM, recognized an
expense of $32,582,000, which represented royalties related to products
currently under development, and recorded a prepayment of $5,418,000, which
represented royalties related to existing products which are being amortized
through fiscal 2000.

    For fiscal 1998, the Company had an operating loss of $32,221,000, compared
to an operating loss of $5,423,000 during fiscal 1997. In comparison to the
preceding year, the fiscal 1998 operating loss was the result of the
restructuring charges, lower gross margins on lower net sales and increased R&D
expenses, offset in part by the non-recurring royalty settlement during fiscal
1997.

    Interest and other income was $6,082,000 during fiscal 1998 compared to
$10,639,000 for fiscal 1997. The year to year decrease in interest and other
income was primarily the result of lower interest income due to lower average
cash balances available for investment, foreign currency translation and
exchange losses, in large part due to the strength of the U.S. dollar during
fiscal 1998, and the absence of certain royalty income under an agreement which
expired during the fourth quarter of fiscal 1997.

    Interest expense of $1,018,000 in fiscal 1998 was equivalent to fiscal 1997
interest expense of $1,018,000. Interest expense in fiscal 1998 and 1997 was
primarily associated with a $6,500,000 loan received from the Connecticut
Development Authority. (See Note 8 to the Consolidated Financial Statements).

    The Company recorded a 50% benefit for income taxes for fiscal 1998,
compared to a 36% provision for fiscal 1997. Variations in the Company's
effective tax rate relate primarily to changes in the geographic distribution of
its pretax income, settlement of royalty obligations and certain tax-free
interest income. (See Note 10 to the Consolidated Financial Statements).

    The minority interest reflected in the Company's 1997 financial statements
represents that share of SVGL's operating results attributable at the time to
its minority stockholder, IBM. In March 1997, the Company purchased IBM's
interest in SVGL for $3,000,000. The Company now accounts for SVGL as a wholly
owned subsidiary and there is no longer a minority interest. In fiscal 1997,
minority interest was recorded from the beginning of the fiscal year through the
date the Company purchased IBM's interest and represented a reduction from
income of $92,000.

    For fiscal 1998 the Company had a net loss of $13,577,000 ($0.42 loss per
share--diluted), compared to net income of $2,592,000 ($0.08 per share--diluted)
for fiscal 1997.

LIQUIDITY AND CAPITAL RESOURCES

    At September 30, 1999, cash and cash equivalents and short-term investments
totaled $142,246,000, a decrease of $7,754,000 from the September 30, 1998
balance of $150,000,000 and a decrease of $64,415,000 from the September 30,
1997 balance of $206,661,000.

    During fiscal years 1999 and 1998 the Company generated $2,933,000 and
$22,422,000, respectively, in cash from operating activities. Contributors to
positive cash from operations during fiscal 1999 include non-cash depreciation
and amortization, reduced inventories and refundable income taxes offset in part
by increased accounts receivable resulting from increased fourth quarter sales,
a net loss of $25,456,000 for the fiscal year and reduced accrued liabilities.

    Net cash used for investing activities for fiscal years 1999 and 1998 was
$45,996,000 and $30,661,000, respectively. During fiscal 1999 purchases of
capital equipment were $30,937,000 and net purchases of temporary investments
were $15,198,000.

    Net cash provided by financing activities was $19,056,000 in fiscal 1999
compared to $2,941,000 during fiscal 1998. During fiscal 1999 the Company
received $14,976,000 from the sale of preferred stock and $4,940,000 from the
exercise of stock options and issuance of stock under the Company's Employee
stock purchase plan.



                                       21
<PAGE>   22

    In connection with the acquisition of SEG (See Note 2 to the Consolidated
Financial Statements) the Company assumed three Yen-denominated bank loans
totaling approximately $22,700,000 bearing interest at rates of between 2.2% and
3.1%.

    On June 30, 1998, the Company entered into an unsecured $150,000,000 bank
revolving line of credit agreement that expires June 30, 2001. Advances under
the line bear interest at the bank's prime rate or 0.65% to 1.50% over LIBOR.
The agreement includes covenants regarding liquidity, profitability, leverage,
and coverage of certain charges and minimum net worth and prohibits the payment
of cash dividends. On October 23, 1998 and May 14, 1999, certain of the
covenants were amended, in part to reflect the acquisition of SEG and change
quarterly profitability covenants. The Company is in compliance with the
covenants as amended. At September 30, 1999, there were no borrowings
outstanding under the facility.

    The Company believes that it has sufficient working capital and available
bank credit to sustain operations and research and development activities, to
the extent such activities are not funded by third parties, and provide for the
expansion of its business for the next twelve months.*

YEAR 2000

    As the Year 2000 approaches, a universal issue has emerged regarding how
existing application software programs and operating systems can accommodate
date values. The Company has evaluated and continues to evaluate its Year 2000
risk as it exists in three areas: information technology infrastructure,
including reviewing what actions are necessary to bring all software tools used
internally to Year 2000 compliance; Year 2000 readiness of critical suppliers;
and Year 2000 compliance of the products the Company supplies to its customers.

    The Company evaluated its information technology infrastructure for Year
2000 compliance, which included reviewing what actions were required to make all
internal-use software systems Year 2000 compliant. The Company has completed the
modification of its internal-use computer software for the Year 2000. The third
party costs associated with such modifications were $124,000 and were expensed
in fiscal 1998. Although the Company believes that the solutions, which were
extensively tested, have resulted in its internal-use systems being Year 2000
compliant, there can be no assurance that unforeseen problems that could disrupt
operations will not arise, or that the Company will not be required to expend
further cost and effort to solve such problems.*

    The Company has contacted its critical suppliers and service providers to
ascertain their state of readiness and compliance for Year 2000 issues.
Responses have generally indicated substantial remediation, or documented plans
to remediate the Year 2000 issue. Some suppliers have given written
certification of internal and product compliance. Substantially all critical
suppliers have indicated compliance of their products or service. The Company
will continue to monitor their progress and compliance for these issues. There
can be no assurance, however, that the Company's suppliers and service providers
will timely provide the Company with products or services which are Year 2000
compliant. Any failure to do so by such third parties could have a material
adverse impact on the Company's results of operations.*

    The Company has evaluated its products and identified those areas containing
date sensitive Year 2000 issues. The Company adheres to Year 2000 test case
scenarios established by SEMATECH, an industry group comprised of U.S.
semiconductor manufacturers. The Company's compliance efforts and review and
identification of corrective measures are substantially complete. Based on this
review, the Company believes that all products currently being shipped are Year
2000 compliant. The Company has made available for potential sale the necessary
modifications to bring previously shipped products into compliance. As all
customer events cannot be anticipated, the Company may see an increase in
product warranty and other claims.* In the event that any of the Company's
products ultimately are not Year 2000 compliant, or there are customer claims
made against the Company, the Company's business, financial condition and
results of operations could be adversely affected.*

    The total cost to address the Year 2000 issue has not been and is not
expected to be material to the Company's financial condition.* The Company is
using both internal and external resources in its Year 2000 project.* The
Company does not segregate internal costs incurred to assess and remedy
deficiencies related to the Year 2000 problem or modifications to its products.

    At this time, the Company does not feel it is necessary to develop a
contingency plan.* As risks are identified, plans will be developed and
implemented as required.



                                       22
<PAGE>   23

    Although the Company believes its Year 2000 plans will be successful, there
can be no assurance that unforeseen problems will not happen which could have a
material adverse effect on the Company.*

RISKS INHERENT IN THE COMPANY'S BUSINESS

    Fluctuations in Quarterly Results. The Company has, at times during its
existence, experienced quarterly fluctuations in its operating results. Due to
the relatively small number of systems sold during each fiscal quarter and the
relatively high revenue per system, customer order rescheduling or
cancellations, or production or shipping delays can significantly affect
quarterly revenues and profitability. The Company has experienced, and may again
experience, quarters during which a substantial portion of the Company's net
sales are realized near the end of the quarter.* Accordingly, shipments
scheduled near the end of a quarter, which are delayed for any reason, can cause
quarterly net sales to fall short of anticipated levels. Since most of the
Company's expenses are fixed in the short term, such shortfalls in net sales
could have an adverse effect on the Company's business and results of
operations.* The Company's operating results may also vary from quarter to
quarter based upon numerous factors including the timing of new product
introductions, product mix, level of sales, the relative proportion of domestic
and international sales, activities of competitors, acquisitions, international
events, currency exchange fluctuations, and difficulties obtaining materials or
components on a timely basis.* In light of these factors, the Company may again
experience variability in its quarterly operating results.*

    Rapid Technological Change; Dependence on New Product Development.
Semiconductor manufacturing equipment and processes are subject to rapid
technological change. The Company believes that its future success will depend
upon its ability to continue to enhance its existing products and their process
capabilities and to develop and manufacture new products with improved process
capabilities that enable semiconductor manufacturers to fabricate more advanced
semiconductors with increased efficiency.* The Company is developing Track and
Lithography products, and has shipped limited quantities of Thermal products,
capable of processing 300mm wafers in anticipation of the industry's transition
to this larger wafer standard.* Failure to successfully introduce these or any
other new products in a timely manner would result in the loss of competitive
position and could reduce sales of existing products.* In addition, new product
introductions could contribute to quarterly fluctuations in operating results as
orders for new products commence and increase the potential for a decline in
orders of existing products, particularly if new products are delayed.*

    From time-to-time, the Company has experienced delays in the introduction of
its products and product enhancements due to technical, manufacturing and other
difficulties and may experience similar delays in the future.* For example,
during fiscal 1996, the Company announced the subsequently terminated 200-APS
Track product. Initial shipments of the 200-APS were scheduled to commence
during the second quarter of fiscal 1997, and were delayed until the second
quarter of fiscal 1998. This delay, as well as industry developments, caused the
Company to implement a plan, which was announced on September 30, 1998, to
terminate future development and shipments of its 200-APS products, and to
concentrate its efforts on completing the ProCell product which had been in
development for approximately one year. There can be no assurance that the
Company will not experience delays in completing the development or
manufacturing problems related to the ProCell product as a result of instability
of the design of either the hardware or software elements of the new technology,
or be able to efficiently manufacture the new product or other products.* During
June of 1999 the Company introduced the ProCell product for shipment in fiscal
2000. The Company believes that protracted delays in delivering initial
quantities of this newly introduced product or any new product to multiple
customers could result in semiconductor manufacturers electing to install
competitive equipment and could preclude industry acceptance of the ProCell
product or any of the Company's products.* The inability to produce such
products or any failure to achieve market acceptance could have a material
effect on the Company's business, results of operations and could result in a
subsequent loss of future sales.*

    In June of 1999, five participants in the 193-nanometer Development Program
decided that their product needs have changed for initial 193-nanometer machines
and have withdrawn from the development program and declined delivery of initial
tools. These participants withdrew in part due to delays in product introduction
and changes in participant's technical requirements. As the Lithography demands
continue, the Company is responding by accelerating the development of a very
high numerical aperture ("VHNA") version of its 193-nanometer product. In order
to address a broader market with this tool, the Company is also redesigning its
stage technology to optimize cost of ownership. Although the Company believes
that the timing of the introduction of the product will be sufficient to meet
volume production requirements of .13 micron, there can be no assurance that the
product will be introduced on time or that customers will wait for the product
to commit for their production needs.* The absence of a successful
implementation of the product or obtaining sufficient orders for this product
could have a material adverse impact on the future profitability of the
Company.*

    Semiconductor manufacturers tend to select either a single supplier or a
primary supplier for a certain type of equipment. The Company believes that
prolonged delays in delivering initial quantities of newly developed products to
multiple customers, whether



                                       23
<PAGE>   24

due to the protracted release of product from engineering into manufacturing or
due to manufacturing difficulties, could result in semiconductor manufacturers
electing to install competitive equipment in their fabrication facilities and
could preclude industry acceptance of the Company's products.* For example, the
Company's largest Track customer has decided to secure deliveries from another
source, a decision the Company believes is primarily due to the delay and
subsequent termination of the 200-APS. Initial shipments into the market of a
new technology Track product, the ProCell, is not expected until fiscal 2000.*
As a result, competitors will increase their market share, and it will be
increasingly more difficult for the Company to regain market position.* The
Company's inability to effect the timely production of new products or any
failure of these products to achieve market acceptance could have a material
adverse effect on the Company's business and results of operations.*

    Historically, the unit cost of the Company's products has been the highest
when they are newly introduced into production and cost reductions have come
over time through engineering improvements, economies of scale and improvements
in the manufacturing process.* As a result, new products have, at times, had an
unfavorable impact on the Company's gross margins and results of operations.
There can be no assurance that the initial shipments of new products will not
have an adverse effect on the Company's profitability or that the Company will
be able to attain design improvements, manufacturing efficiencies or
manufacturing process improvements over time.* Further, the potential
unfavorable effect of newly introduced products on profitability can be
exacerbated when there is intense price competition in the marketplace.*

    Competition. The semiconductor equipment industry is intensely competitive.
The Company faces substantial competition both in the United States and other
countries in all of its products. The Company's competitors include Tokyo
Electron, Ltd. ("TEL") and DaiNippon Screen Mfg. Co., Ltd. in photoresist
processing equipment; TEL and Kokusai Electric Co., Ltd. in oxidation/diffusion,
LPCVD equipment; in its newly acquired APCVD products from Watkins-Johnson the
Company's competitors include Applied Materials and Quester; and Nikon, Canon,
ASM Lithography and other suppliers of photolithography exposure equipment, and
projection aligners. The trend toward consolidation in the semiconductor
processing equipment industry has made it increasingly important to have the
financial resources necessary to compete effectively across a broad range of
product offerings, to fund customer service and support on a worldwide basis and
to invest in both product and process research and development. Significant
competitive factors include technology and cost of ownership, a formula which
includes such data as initial price, system throughput and reliability and time
to maintain or repair. Other competitive factors include familiarity with
particular manufacturers' products, established relationships between suppliers
and customers, product availability and technological differentiation.
Occasionally, the Company has encountered intense price competition with respect
to particular orders and has had difficulty establishing new relationships with
certain customers who have long-standing relationships with other suppliers. The
Company believes that outside Japan and the Pacific Rim it competes favorably
with respect to most of these factors.* (See "Importance of Japanese and Pacific
Rim Markets".)

    Many of the Company's competitors are Japanese corporations. Although the
economic conditions in Asia are improving, the Company believes that an
oversupply of equipment from certain Japanese competitors may continue to cause
more severe price competition in its non-Asian markets.* To compete effectively
in these markets, the Company may be forced to reduce prices, which could cause
further reduction in net sales and gross margins and, consequently, have a
material adverse effect on the Company's financial condition and results of
operations.*

    Customer Concentration. Historically, the Company has relied on a limited
number of customers for a substantial percentage of its net sales. In fiscal
1999, the Company's largest customer accounted for 56% of net sales and no other
single customer accounted for 10% or more of net sales. In fiscal 1998, the
Company's three largest customers accounted for 40%, 17% and 13% of net sales.
The Company believes that, for the foreseeable future, it will continue to rely
on a limited number of major customers for a substantial percentage of its net
sales.* As a result of delays in delivering initial quantities of the
subsequently terminated 200-APS Track product, one of the Company's largest
Track customers has decided to purchase systems with similar capabilities from
another supplier. We expect that the decision by such customer to purchase
systems from other suppliers and the cancellation of the 200-APS Track product
will continue to have an adverse effect on Track product sales in future
periods.* (See "Risks Inherent in the Company's Business - Rapid Technological
Change; Dependence on New Product Development"). The loss of any other
significant customer or additional reductions in orders by a significant
customer, including reductions in orders due to market, economic or competitive
conditions in the semiconductor industry, or delays in the introduction of newly
developed products and product enhancements will further exacerbate the adverse
effect the customer order rescheduling and cancellations discussed above will
have on the Company's business and results of operations.*

    Importance of the Japanese and Pacific Rim Markets. The Company's customers
are heavily concentrated in the United States and Europe. The Japanese and
Pacific Rim markets (including fabrication plants located in other parts of the
world which are operated by Japanese and Pacific Rim semiconductor
manufacturers) represent a substantial portion of the overall market for
semiconductor manufacturing equipment. To date, neither the Company's shipments
into Japan nor the Pacific Rim have been significant. The



                                       24
<PAGE>   25

Company believes that the Japanese companies with which it competes have a
competitive advantage because their dominance of the Japanese and Pacific Rim
semiconductor equipment market provides them with the sales and technology base
to compete more effectively throughout the rest of the world. The Company is not
engaged in any significant collaborative effort with any Japanese or Pacific Rim
semiconductor manufacturers. As a result, the Company may be at a competitive
disadvantage to the Japanese equipment suppliers that are engaged in such
collaborative efforts with Japanese and Pacific Rim semiconductor manufacturers.
The Company believes that it must substantially increase its share of these
markets if it is to compete as a global supplier.* Further, in many instances,
Japanese and Pacific Rim semiconductor manufacturers fabricate devices such as
dynamic random access memory devices ("DRAMs"), with potentially different
economic cycles than those affecting the sales of devices manufactured by the
majority of the Company's U.S. and European customers. Failure to secure
customers in these markets may limit the global market share available to the
Company and may increase the Company's vulnerability to industry or geographic
downturns.*

    In the past, several of the Company's larger customers have entered into
joint ventures ("JV") with European, Japanese or Pacific Rim semiconductor
manufacturers. In such cases, the Company has encountered intense price
competition from foreign competitors who are suppliers to the non-U.S. member of
the JV. Further, in certain instances the Company has not secured the equipment
order when the non-U.S. member has had the responsibility for selecting the
equipment to be used by the JV in its U.S. operations. There can be no assurance
that as the Company's customers form additional alliances, whether in the U.S.
or in other parts of the world, that the Company will be successful in obtaining
equipment orders or that it will be able to obtain orders with sufficient gross
margin to generate profitable transactions, either of which could have an
adverse effect on the Company's results of operations.*

    Throughout the Pacific Rim, the Company is attempting to compete with major
equipment suppliers having significant market share and established service and
support infrastructures in place. The Company has invested in the staffing and
facilities that it believes are necessary to sell, service and support customers
in the Pacific Rim and with the acquisition of SEG, the Company acquired from
Watkins-Johnson Company a 36,000 square foot customer demonstration facility in
Kawasaki City, Japan. However, the Company anticipates that it will continue to
encounter significant price competition as well as competition based on
technological ability.* There can be no assurance that the Company's Pacific Rim
operations will be profitable, even if it is successful in obtaining significant
sales into this region.* Further, due to recent economic issues in certain Asian
countries, particularly Korea, the Company's ability to penetrate such markets
has been more difficult. Failure to secure customers in these markets would have
an adverse effect on the Company's business and results of operations.*

    Due to the high cost of building, equipping and maintaining fabrication
facilities, many customers are outsourcing their manufacturing to foundries,
many of which are located in Taiwan. Although the Company is focused on
increasing its penetration into Taiwan, it has had limited success in securing
volume orders from companies in this area, which have long standing
relationships with the Company's competitors. If the Company is not successful
in penetrating this market, it could have an adverse effect on the Company's net
sales and results of operations.*

    Risks Associated with Acquisition of Watkins-Johnson Company's Semiconductor
Equipment Group. On July 6, 1999, the Company completed the acquisition of the
Semiconductor Equipment Group ("SEG") of Watkins-Johnson. The acquisition of the
assets of SEG is accompanied by a variety of risks, which could prevent the
Company from realizing any significant benefits from the transaction. The
Company may experience difficulty with integrating the operations and personnel
of the business acquired from Watkins-Johnson, need additional financial
resources to fund the operations of the acquired business, be unable to maximize
the Company's financial and strategic position by the incorporation or
development of the acquired technology and products or lose key employees of the
acquired business. In particular, the Company believes it must successfully
transition the acquired technology of SEG to incorporate process improvements
such as single wafer processing and scalability from 200mm to 300mm wafer
processing capability.* There can be no assurance that the Company will not
experience difficulties or delays in transitioning this technology which could
have a material adverse effect on the Company.*

    The acquisition of SEG also included the assumption of certain liabilities
of SEG, which may prove more costly than the Company anticipates. For example,
certain environmental remediation steps have been put in place at the site,
there can be no assurance that additional environmental hazards or liabilities
will not surface which may have an adverse impact on the Company's business.* In
order to successfully integrate SEG, the Company must, among other things,
continue to attract and retain key personnel, integrate the acquired products,
technology and information systems from engineering, sales, product development
and marketing perspectives, and consolidate functions and facilities, which may
result in future charges to streamline the combined operations. Difficulties
encountered in the integration of SEG may have a material adverse effect on the
Company.*

    Business Interruption. The Company manufactures its Track products in San
Jose, California and substantially all of its Thermal products in Orange and
Scotts Valley, California. Tinsley's optical components are manufactured in
Richmond and North Hollywood,



                                       25
<PAGE>   26

California. These California facilities are located in seismically active
regions. SVGL's photolithography exposure products are manufactured in Wilton
and Ridgefield, Connecticut. If the Company were to lose the use of one of its
facilities as a result of an earthquake, flood or other natural disaster, the
resultant interruptions in operations would have a material adverse effect on
the Company's results of operations and financial condition.*

    Euro Conversion. On January 1, 1999, 11 of the 15 member countries of the
European Union established fixed conversion rates between each of their existing
sovereign currencies and the Single European Currency. The participating
countries adopted the Euro as their common legal currency on that date, with a
transition period through January 2002 regarding certain elements of the Euro
change. In January 1999, the Company implemented changes to its internal systems
to make them Euro capable. The cost of system modifications to date has not been
material, nor are future system modifications expected to be material.* The
Company does not expect the transition to, or use of, the Euro to have a
material adverse effect on the Company's results of operations and financial
condition.*

    Environmental Matters. The Company is subject to a number of governmental
regulations related to the discharge or disposal of toxic and hazardous
chemicals used in the manufacture of certain of the Company's products. The
Company believes that it is in general compliance with these regulations and
that it has obtained or expects to obtain shortly all necessary environmental
permits to conduct its business.* The failure to comply with present or future
regulations could result in fines or penalties being assessed against the
Company, interruption of production or reduction in the Company's customers
accepting its products.*

    The Scotts Valley, California facility is subject to an environmental
remediation plan being monitored by various governmental agencies.
Watkins-Johnson Company purchased a guaranteed fixed price remediation contract
from a third party environmental consultant to remediate the groundwater
contamination at the facility. The remediation agreement (which includes
insurance policies covering performance of the environmental consultant and
coverage for undiscovered contamination) obligates the third party to perform
all of the obligations and responsibilities of Watkins-Johnson Company. There
can be no assurance that the third party consultant will have the financial
resources or technical expertise to execute under the remediation agreement.* It
is not inconceivable that environmental regulatory agencies could ultimately
look to the Company to remediate the groundwater contamination at the site.*

    In August 1996, the Company purchased from Perkin-Elmer, approximately 50
acres of land and a 201,000 square foot building thereon (the "Property")
located in Ridgefield, Connecticut. At the time the Company purchased the
Property, it was aware that certain groundwater and soil contamination was
present and that the Property was subject to a clean-up order being performed by
Perkin-Elmer under the jurisdiction of the Connecticut Department of
Environmental Protection. Agreements between the Company and Perkin-Elmer
provide that Perkin-Elmer has sole responsibility for all obligations or
liabilities related to the clean-up order. While the Company believes that it
has been adequately indemnified, if for some reason Perkin-Elmer was unable to
comply or did not comply with the clean-up order, the Company could be required
to do so.*

    The Company does not anticipate any material capital expenditures for
environmental control facilities in 2000.*

    SVGL - Uncertain Market for Micrascan Products. The Company believes that
the photolithography exposure equipment market is one of the largest segments of
the semiconductor processing equipment industry.* To address the market for
advanced photolithography exposure systems, the Company has invested and expects
to continue to invest substantial resources in SVGL's Micrascan technology and
its family of Micrascan DUV step-and-scan photolithography systems, eventually
capable of producing line widths of .10 micron and below. The development of a
market for the Company's Micrascan step-and-scan photolithography products will
be highly dependent on the continued trend towards finer line widths in
integrated circuits and the ability of other lithography manufacturers to keep
pace with this trend through either enhanced technologies or improved
processes.* The Company believes DUV lithography is required to fabricate
devices with line widths below 0.3 micron.* Semiconductor manufacturers can
purchase DUV steppers to produce product at .25 micron line widths. However, the
Company believes that as devices increase in complexity and size and require
finer line widths, the technical advantages of DUV step-and-scan systems, as
compared to DUV steppers, will enable semiconductor manufacturers to achieve
finer line widths with improved critical dimension control which will result in
higher yields of faster devices.* The Company also believes that the industry
transition to DUV step-and-scan systems has accelerated in calendar 1999 and
that advanced semiconductor manufacturers are beginning to require volume
quantities of production equipment as advanced as the current and pending
versions of Micrascan to produce both critical and to some degree sub-critical
layers of semiconductor devices.* Currently, competitive DUV step-and-scan
equipment capable of producing .25 micron line widths and below is available in
limited quantities from three competitors.* Further, if manufacturers of DUV
steppers are able to further enhance existing technology to achieve finer line
widths sufficiently to erode the competitive and technological advantages of DUV
step-and-scan systems, or other manufacturers of step-and-scan systems are
successful in supplying sufficient quantities of product in a timely



                                       26
<PAGE>   27

manner that are technically equal to or better than the Micrascan, demand for
the Micrascan technology may not develop as the Company expects.*

    The Company believes that advanced logic devices, DRAMs and ASICs will
require increasingly finer line widths.* Consequently, SVGL must continue to
develop advanced technology equipment capable of meeting its customers' current
and future requirements while offering those customers a progressively lower
cost of ownership.* In particular, the Company believes that it must continue
its development of future systems capable of printing line widths finer than .10
micron and processing 300mm wafers.* Any failure by the Company to develop the
advanced technology required by its customers at progressively lower costs of
ownership and supply sufficient quantities to a worldwide customer base could
have a material adverse impact on the Company's financial condition and results
of operations.*

    The Company believes that for SVGL to succeed in the long term, it must sell
its Micrascan products on a global basis. The Japanese and Pacific Rim markets
(including fabrication plants located in other parts of the world which are
operated by Japanese and Pacific Rim semiconductor manufacturers as well as
foundries located primarily in Taiwan) represent a substantial portion of the
overall market for photolithography exposure equipment. To date, the Company has
not been successful in penetrating either of these markets. (See "Importance of
the Japanese and Pacific Rim Markets").

    SVGL - Need to Increase Manufacturing Capacity and System Output. The
Company believes that its ability to supply systems in volume to multiple
customers will be a major factor in customer decisions to commit to the
Micrascan technology.* Based upon the expected transition from steppers to
step-and-scan equipment for photolithography equipment, and potential future
demand for advanced lithography products, the Company has been in the process of
increasing SVGL's production capacity. In August 1996, as part of this
expansion, the Company purchased from The Perkin-Elmer Corporation a 243,000
square foot facility (subsequently increased by the Company to 276,000 square
feet) occupied by SVGL in Wilton, Connecticut and an additional 201,000 square
foot building, which SVGL now occupies, in Ridgefield, Connecticut. The Company
has invested in significant capital improvements related to the buildings
purchased and the equipment required to expand the production capabilities of
SVGL. While the Company has essentially completed its facility expansion
activities, it has not invested in all of the metrology and other equipment
required to maximize manufacturing capacity. However, the Company plans to
continue increasing capacity to produce optical components, thus enabling it to
quickly respond to customer requirements.* Once demand recovers, the timely
equipping of facilities to successfully complete the increase in capacity will
require the continued recruitment, training and retention of a high quality
workforce, as well as the achievement of satisfactory manufacturing results on a
scale greater than SVGL has attempted in the past. There can be no assurance
that demand will recover or, that if it does, that the Company can manage these
efforts successfully. Any failure to successfully manage such efforts could
result in product delivery delays and a subsequent loss of future revenues. In
particular, the Company believes that protracted delays in delivery quantities
of current and future Micrascan products could result in semiconductor
manufacturers electing to install competitive equipment in their advanced
fabrication facilities, which could impede acceptance of the Micrascan products
on an industry-wide basis.* This could result in the Company's operating results
being adversely affected by the increase in fixed costs and operating expenses
related to increases in production capacity if net sales, for any reason, do not
increase commensurately.*

    The time required to build a Micrascan system is significant. If SVGL is to
be successful in supplying increased quantities of Micrascan systems, it will
not only need to be able to build more systems, it will need to build them
faster.* SVGL will require additional trained personnel, additional raw
materials and components and improved manufacturing and testing techniques to
both facilitate volume increases and shorten manufacturing cycle time.* To that
end, SVGL is continuing to develop its vendor supply infrastructure, and
implement manufacturing improvements.* Additionally, the Company believes that
as it increases its penetration of the Micrascan product, it must resume
increasing its factory, field service and technical support organization
staffing and infrastructure to support the anticipated customer requirements.*
There can be no assurance that the Company will not experience manufacturing
difficulties or encounter problems in its attempt to increase production and
upgrade or expand existing operations.*

    One of the most critical components of the Micrascan systems is the
projection optics, which are primarily manufactured by SVGL. As part of its
overall investment in capacity, the Company has increased SVGL's optical
manufacturing floor space. The Company believes that in order for SVGL to be a
viable supplier of advanced lithography systems in the future, it must
successfully reduce the cycle times required to build projection optics.*

    In November 1997, the Company acquired Tinsley Laboratories, Inc. ("TLI") in
exchange for approximately 1,091,000 shares of Company common stock. TLI
designs, manufactures and sells precision optical components, assemblies and
systems to customers in a variety of industries and research endeavors. The
primary reasons for the acquisition were TLI's technology and expertise relating
to aspherical lenses, a key component of SVGL's photolithography products, the
adaptation of certain of TLI's manufacturing



                                       27
<PAGE>   28

processes by SVGL and TLI's commencement of the fabrication of non-aspherical
lenses which are currently produced by SVGL. However, there can be no assurance
that TLI's manufacturing technology is scaleable, or that such expertise can be
transferred without substantial time or expense, if at all.* The inability of
SVGL to transfer this production technology for use in processes of a
substantially larger scale or the inability of TLI to manufacture non-aspherical
lenses for SVGL in sufficient quantities to realize efficiencies of scale could
adversely affect the Company's ability to realize any significant benefits from
the acquisition of TLI.*

    The Company believes that protracted delays in delivering quantities of both
current and future generations of Micrascan products to multiple worldwide
customers could result in semiconductor manufacturers electing to install
competitive equipment in their advanced fabrication facilities, and could
preclude industry acceptance of the Micrascan technology and products.* In
addition, the Company's operating results could also be adversely affected by
the increase in fixed costs and operating expenses related to increases in
production capacity and field service and technical support activities if net
sales do not increase commensurately.*

    SVGL - Sole Source Materials and Components. Most raw materials and
components not produced by the Company are available from more than one
supplier. However, certain raw materials, components and subassemblies are
obtained from single sources or a limited group of suppliers. Although the
Company seeks to reduce its dependence on these sole and limited source
suppliers, and the Company has not experienced significant production delays due
to unavailability or delay in procurement of component parts or raw materials to
date, disruption or termination of certain of these sources could occur and such
disruptions could have at least a temporary adverse effect on the Company's
business and results of operations.* Moreover, a prolonged inability to obtain
certain components could have a material adverse effect on the Company's
business and results of operations and could result in damage to customer
relationships.*

    The raw material for a proprietary component of the optical system for the
Micrascan is available from only one supplier. The supplier has expanded its
capacity to meet SVGL's projected long-term requirements and has created and
stored agreed upon quantities of safety stock. There can be no assurance that
the supplier will be able to provide acceptable quantities of material required
by SVGL.* Additionally, a version of the Company's Micrascan III
photolithography system utilizes an Excimer laser that is manufactured in volume
by only one supplier. In fiscal 1999 SVGL qualified an additional source of
lasers for its current and future versions of Micrascan products, allowing the
potential for the integration of such lasers into its system configurations.*
However, there can be no assurance that its customers will be receptive to
procuring products with lasers from this supplier, or the supplier will be able
to provide product of sufficient quantity and quality.* If these suppliers were
unable to meet their commitments, SVGL would be unable to manufacture the
quantity of products required to meet the anticipated future demand, which would
have a material adverse effect on the Company's business and results of
operations.*

    It is anticipated that a critical component of the optical system for the
157-nanometer lithography product, which is currently under development, will
utilize Calcium Fluoride.* Calcium Fluoride is a raw material that has been
known to be in short supply and is integral to the production of optics capable
of producing quality line widths of .10 and below. The Company has or will
shortly qualify three suppliers who could be sources of this raw material for
the Company.* There can be no assurance that these suppliers will be able to
supply the quality or quantity of the product necessary for the Company to meet
expected future demand, which could have a material adverse effect on the
Company's business and results on operations.

    SVGL - Research and Development Funding. Historically, the Company has
depended on external funding to assist in the high cost of development in its
photolithography operation. Beginning in fiscal 1996, the Company entered into
agreements with certain customers (the "Participants") whereby each agreed to
assist in funding the Company's development of an advanced technology
193-nanometer Micrascan system. In exchange for such funding, each Participant
received the right to purchase one such system and, in addition, received a
right of first refusal (ratable among such Participants) to all such machines
manufactured during the first two years following the initial system shipments.
For each initial system ordered, each Participant agreed to fund $5,000,000 in
such development costs. The agreements call for each Participant to pay
$1,000,000 of initial development funding and four subsequent payments of
$1,000,000 upon the completion of certain development milestones. The
Participants may withdraw from the development program without penalty, but
payments made against completed development milestones are not refundable and
all rights to future equipment are forfeited. At September 30, 1999, the Company
had received and recognized $20,000,000 in funding from program Participants
against research and development expenditures. Three competitors of the Company
have either announced the development of, or have shipped 193-nanometer
products. In June 1999, certain Participants decided that their product needs
have changed for initial 193-nanometer machines and have withdrawn from the
program and chosen to use or are evaluating other solutions. At September 30,
1999, the Company's obligations under these agreements are complete and no
additional funding is expected or required from the Participants.*



                                       28
<PAGE>   29

    In May 1999, the Company entered into an agreement with Intel Corporation
("Intel") for the development of 157-nanometer lithography technology. This
agreement obligates the Company among other things to develop and sell to Intel
a predetermined number of initial tools. Intel has agreed to provide advanced
payments for the development and manufacture of these machines, based upon
predetermined milestones. Separately, Intel has invested approximately
$15,000,000 in the Company in the form of a purchase of Series 1 Convertible
Preferred Stock (see Note 11 to the Consolidated Financial Statements). The
Company is obligated to dedicate a certain amount of its 157-nanometer unit
production output to Intel. The Company is required to use the proceeds from the
Series 1 Preferred investment and funds received under the agreement for the
development of technology for use on 157-nanometer lithography equipment. There
can be no assurance that the Company will be successful in developing
157-nanometer technology or will be able to manufacture significant quantities
of machines to satisfy its obligations to Intel or other customers.* There is no
assurance that the Company will receive all funding which it currently
anticipates or that it will be able to obtain future outside funding beyond that
which it is currently receiving, and any failure to do so could have a material
adverse impact on the Company's results of operations.* If the Company were
required to use its own funds, its research and development expenses would
increase and its operating income would be reduced correspondingly.

    SVGL - Market Penetration. The Company believes that for SVGL to succeed in
the long term, it must expand its customer base and sell its Micrascan products
on a global basis.* The Japanese market (including fabrication plants operated
outside Japan by Japanese semiconductor manufacturers), the Taiwanese market and
the Korean market represent a substantial portion of the overall market for
photolithography exposure equipment. To date, the Company has not been
successful penetrating any of these markets. Economic difficulties in certain
Asian economies, particularly Korea, may adversely effect the Company's ability
to penetrate such markets.*

    SVGL - Future Profitability. If SVGL is to attain its objective of being a
volume supplier of advanced photolithography products to multiple customers, the
Company believes that it must expand its customer base to include additional
customers from whom it secures and successfully fulfills orders for
production-quantities of Micrascan products.* The Company believes that in light
of the recent downturn in industry demand, costs associated with the continued
development of the Micrascan technology, the expansion of SVGL's manufacturing
capacity, the related increase in manpower and customer support, increased
competition and the potential difficulties inherent in developing and
manufacturing sub-.25 micron Micrascan products, in particular the projection
optics required for these products, there can be no assurance that SVGL will be
able to operate profitably in the future.*

    Dependence on Key Personnel. The Company's future success will continue to
depend to a large extent on the continued contributions of its executive
officers and key management and technical personnel. In particular, SVGL's
future growth is very dependent on the Company's ability to attract and retain
key skilled employees, particularly those related to the optical segment of its
business. The Company is a party to agreements with each of its executive
officers to help ensure the officers' continual service to the Company in the
event of a change-in-control. Each of the Company's executive officers, and key
management and technical personnel would be difficult to replace. The loss of
the services of one or more of the Company's executive officers or key
personnel, or the inability to continue to attract qualified personnel could
delay product development cycles or otherwise have a material adverse effect on
the Company's business, financial condition and results of operations.*

    Legal Proceedings. On or about August 12, 1998, Fullman International Inc.
and Fullman Company LLC (collectively, "Fullman") initiated a lawsuit in the
United States District Court for the District of Oregon alleging claims for
fraudulent conveyance, constructive trust and declaratory relief in connection
with a settlement the Company had previously entered into resolving its claims
against a Thailand purchaser of the Company's equipment. In its complaint
against the Company, Fullman, allegedly another creditor of the Thailand
purchaser, alleges damages of approximately $11,500,000 plus interest. The
Company has successfully moved to transfer the case to the United States
District Court for the Northern District of California. The trial is tentatively
scheduled for July 2000.

    While the outcome of such litigation is uncertain, the Company believes it
has meritorious defenses to the claims and intends to conduct a vigorous
defense. However, an unfavorable outcome in this matter could have a material
adverse effect on the Company's financial condition.*

    On July 8, 1999, the Company filed a complaint for copyright infringement to
protect its investment and intellectual property from six third party vendors
("the Defendants") subsequently complaints against two of the Defendants were
withdrawn by the Company. The complaint was filed against the Defendants
alleging that the named defendants have infringed upon certain copyrights owned
by the Company on its 8X series equipment by duplicating or modifying software
in the refurbishment and sale of replacement boards. The complaint further asks
for preliminary and permanent injunction against the Defendants' further
infringement of the Company's copyrights and sale of infringing systems and
boards, and for an award of damages. One of the Defendants has filed a
counterclaim against the Company in response to the Company's complaint.



                                       29
<PAGE>   30

    In addition to the above, the Company, from time to time, is party to
various legal actions arising out of the normal course of business, none of
which is expected to have a material effect on the Company's financial position
or operating results.*

    Recently Issued Accounting Pronouncements. In June 1998 and June 1999, the
Financial Accounting Standards Board (FASB) issued SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities" and SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133." These statements require companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting. The Company is required to adopt SFAS 133 for
the fiscal year ending September 30, 2002. Although the Company has not fully
assessed the impact of adoption, management believes that the adoption of these
statements will not have a significant impact on its financial results.*

    In December 1999, the Securities and Exchange Commission (SEC) released
Staff Accounting Bulletin No. 101 (SAB101). SAB 101 summarizes certain
interpretations and practices followed by the Division of Corporation finance
and the Office of the Chief Accountant of the SEC in administering the
disclosure requirements of the Federal securities laws in applying generally
accepted accounting principles to revenue recognition in financial statements.
Although the company has not fully assessed the impact of adoption, management
believes that applying the guidance in this bulletin will not have a significant
impact on its financial statements.*

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    The Company is exposed to financial market risks, including changes in
foreign currency exchange rates and interest rates. The Company attempts to
minimize its currency fluctuation risk by actively managing the balances of
current assets and liabilities denominated in foreign currencies. A 10% change
in the foreign currency exchange rates would not have a material impact on the
Company's results of operations. During fiscal 1999 the Company did not use
foreign currency hedging transactions, however it is the Company's intent during
fiscal 2000 to sell forward contracts in Japanese Yen in order to hedge foreign
currency exposures.*

    At September 30, 1999 the Company had investments in marketable debt
securities that are subject to interest rate risk (See Note 4 to the
Consolidated Financial Statements). However, due to the short-term nature of the
Company's debt investments and the Company's ability to hold it's fixed income
investments to maturity the impact of a 10% interest rate change would not have
a material impact on the value of such investments.*

    At September 30, 1999 fixed rate debt obligations totaled $28,410,000 (See
Note 8 to the Consolidated Financial Statements). The fixed rate obligations
range between 2.2% to 12% with a weighted average of 3.93% and maturity dates
through February 2011. Certain of the Company's manufacturing facilities are
leased under operating lease agreements under which the monthly rent payments
adjust based on LIBOR. Monthly rent payments are variable at 0.75% to 2.0% over
LIBOR. For one of the leases, the Company has entered into an interest rate swap
contract to fix the interest rate and therefore, the lease payment. For the
other lease, the Company has income and cash flow exposure to the extent that
LIBOR changes. The impact of a 10% change in interest rates would not have a
material impact on the amount of lease payment.



                                       30
<PAGE>   31

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Consolidated Financial Statements Included in Item 8:

<TABLE>
<CAPTION>
                                                                                                               Page
                                                                                                               ----
<S>                                                                                                             <C>
Independent Auditors' Report................................................................................    32

Consolidated Balance Sheets at September 30, 1998 and 1999..................................................    33

Consolidated Statements of Operations for the Years Ended September 30, 1997, 1998 and 1999.................    34

Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for the Years Ended
September 30, 1997, 1998 and 1999...........................................................................    35

Consolidated Statements of Cash Flows for the Years Ended September 30, 1997, 1998 and 1999.................    36

Notes to Consolidated Financial Statements..................................................................    37

Schedule for each of the three years in the period ended September 30, 1999 included in Item 14(a):

II--Valuation and Qualifying Accounts and Reserves..........................................................    53
</TABLE>


    Schedules other than those listed above have been omitted since the required
information is not present or not present in amounts sufficient to require
submission of the schedule, or because the information required is included in
the consolidated financial statements or the notes thereto.



                                       31
<PAGE>   32

INDEPENDENT AUDITORS' REPORT

Board of Directors and Stockholders of
    Silicon Valley Group, Inc.:

We have audited the accompanying consolidated balance sheets of Silicon Valley
Group, Inc. and its subsidiaries as of September 30, 1998 and 1999 and the
related consolidated statements of operations, stockholders' equity and
comprehensive income (loss), and cash flows for each of the three years in the
period ended September 30, 1999. Our audits also included the consolidated
financial statement schedule listed in Item 14.(a)2. These financial statements
and the financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Silicon Valley Group, Inc. and its
subsidiaries at September 30, 1998 and 1999, and the results of their operations
and their cash flows for each of the three years in the period ended September
30, 1999, in conformity with generally accepted accounting principles. Also, in
our opinion, such consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.


/s/ DELOITTE & TOUCHE LLP
-------------------------------------
Deloitte & Touche LLP

San Jose, California
October 25, 1999



                                       32
<PAGE>   33



SILICON VALLEY GROUP, INC.
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
SEPTEMBER 30 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)       1998           1999
                                                                    --------       --------
<S>                                                                 <C>            <C>
ASSETS

Current Assets:
    Cash and equivalents                                            $121,575       $ 98,278
    Short-term investments                                            28,425         43,968
    Accounts receivable (net of allowance for doubtful
        accounts of $8,232 and $5,038, respectively)                 121,562        153,981
    Refundable income taxes                                           15,000          2,500
    Inventories                                                      212,975        200,769
    Prepaid expenses and other assets                                  7,485          9,826
    Deferred income taxes                                             22,740         35,489
                                                                    --------       --------
        Total current assets                                         529,762        544,811

Property and equipment, net                                          191,022        198,403
Deposits and other assets                                              6,070          8,299
Intangible assets, net                                                 3,736          3,260
                                                                    --------       --------
Total                                                               $730,590       $754,773
                                                                    ========       ========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
    Accounts payable                                               $  25,346       $ 34,202
    Accrued liabilities                                              130,532        123,266
    Current portion of long-term debt                                    640          1,620
    Income taxes payable                                               1,284          3,568
                                                                    --------       --------
        Total current liabilities                                    157,802        162,656
                                                                    --------       --------

Long-term debt                                                         5,865         26,790
                                                                    --------       --------
Deferred and other liabilities                                         5,393          7,790
                                                                    --------       --------
Commitments (See Notes 9, 13, 14 and 17)                                  --             --
Stockholders' Equity:
    Convertible preferred stock--$0.01 par value,
        Shares authorized: 1,000,000; shares outstanding:
        1998: none; 1999: 15,000                                          --         14,976
    Common stock--$0.01 par value, shares authorized:
        100,000,000; shares outstanding: 1998: 32,696,394;
        1999: 33,333,884                                             404,462        410,068
    Retained earnings                                                160,384        134,928
    Accumulated other comprehensive loss                              (3,316)        (2,435)
                                                                    --------       --------
        Total stockholders' equity                                   561,530        557,537
                                                                    --------       --------
Total                                                               $730,590       $754,773
                                                                    ========       ========
</TABLE>

See Notes to Consolidated Financial Statements.



                                       33
<PAGE>   34



SILICON VALLEY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)                  1997            1998            1999
                                                        --------        --------        --------
<S>                                                     <C>             <C>             <C>
Net sales                                               $614,226        $608,625        $473,690

Cost of sales:
    Cost of net sales                                    378,114         389,279         312,319
    Restructuring charges                                     --          19,117              --
                                                        --------        --------        --------
Gross profit                                             236,112         200,229         161,371

Operating expenses:
    Research, development and related engineering         74,311          87,272          94,698
    Marketing, general and administrative                134,642         130,615         109,819
    Settlement of royalty obligation                      32,582              --              --
    Restructuring and related charges                         --          14,563            (506)
                                                        --------        --------        --------

Operating loss                                            (5,423)        (32,221)        (42,640)

Interest and other income                                 10,639           6,082           6,509

Interest expense                                          (1,018)         (1,018)         (1,305)
                                                        --------        --------        --------

Income (loss) before income taxes and
    minority interest                                      4,198         (27,157)        (37,436)

Provision (benefit) for income taxes                       1,514         (13,580)        (11,980)

Minority interest                                             92              --              --
                                                        --------        --------        --------

Net income (loss)                                       $  2,592        $(13,577)       $(25,456)
                                                        ========        ========        ========

Net income (loss) per share--basic                      $   0.08        $  (0.42)       $  (0.77)
                                                        ========        ========        ========

 Shares used in per share computations--basic             31,635          32,438          32,926
                                                        ========        ========        ========

Net income (loss) per share--diluted                    $   0.08        $  (0.42)       $  (0.77)
                                                        ========        ========        ========

 Shares used in per share computations--diluted           32,414          32,438          32,926
                                                        ========        ========        ========
</TABLE>

See Notes to Consolidated Financial Statements.



                                       34
<PAGE>   35



SILICON VALLEY GROUP, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)

<TABLE>
<CAPTION>
                                                   CONVERTIBLE                                            ACCUMULATED
                                                 PREFERRED STOCK         COMMON STOCK                        OTHER
                                                -----------------   ----------------------    RETAINED   COMPREHENSIVE
(IN THOUSANDS EXCEPT SHARES)                    SHARES     AMOUNT     SHARES       AMOUNT     EARNINGS    INCOME(LOSS)     TOTAL
                                                ------    -------   ----------    --------    --------   -------------    --------
<S>                                             <C>       <C>       <C>           <C>         <C>           <C>           <C>
Balances, October 1, 1996                           --         --   31,199,148    $379,553    $171,817      $  (128)      $551,242
                                                ------    -------   ----------    --------    --------      -------       --------
Stock issued in settlement of
    royalty obligation                                                 489,296       9,994                                   9,994
Stock options exercised                                                372,464       3,853                                   3,853
Employee stock purchase plan                                           216,709       3,753                                   3,753
Tax benefit of stock option
    transactions                                                                     2,532                                   2,532
Adjustment to conform TLI fiscal year                                   (5,275)        (22)                                    (22)
Components of comprehensive income:
   Net income                                                                                    2,592                       2,592
   Cumulative translation adjustment                                                                           (240)          (240)
   Pension liability                                                                                           (146)          (146)
   Adjustment to conform TLI
        fiscal year                                                                               (448)                       (448)
                                                                                                                          --------
        Total comprehensive income                                                                                           1,758
                                                ------    -------   ----------    --------    --------      -------       --------
Balances, September 30, 1997                        --         --   32,272,342     399,663     173,961         (514)       573,110
                                                ------    -------   ----------    --------    --------      -------       --------

Stock options exercised                                                158,254         866                                     866
Employee stock purchase plan                                           265,798       3,196                                   3,196
Tax benefit of stock option transactions                                               737                                     737
Components of comprehensive loss:
   Net loss                                                                                    (13,577)                    (13,577)
   Cumulative translation adjustment                                                                         (2,802)        (2,802)
                                                                                                                          --------
        Total comprehensive loss                                                                                           (16,379)
                                                ------    -------   ----------    --------    --------      -------       --------

Balances, September 30, 1998                        --         --   32,696,394     404,462     160,384       (3,316)       561,530
                                                ------    -------   ----------    --------    --------      -------       --------

Stock options exercised                                                214,659       1,444                                   1,444
Employee stock purchase plan                                           422,831       3,496                                   3,496
Tax benefit of stock option
    transactions                                                                       357                                     357
Stock compensation                                                                     309                                     309
Sale of convertible preferred stock, net
    of $24 in issuance costs                    15,000    $14,976                                                           14,976
Components of comprehensive loss:
    Net loss                                                                                   (25,456)                    (25,456)
    Cumulative translation adjustment                                                                           574            574
    Change in unrealized gain
        on investments                                                                                          345            345
    Pension liability                                                                                           (38)           (38)
                                                                                                                          --------
     Total comprehensive loss                                                                                              (24,575)
                                                ------    -------   ----------    --------    --------      -------       --------
Balances, September 30, 1999                    15,000    $14,976   33,333,884    $410,068    $134,928      $(2,435)      $557,537
                                                ======    =======   ==========    ========    ========      ========      ========
</TABLE>

See Notes to Consolidated Financial Statements.



                                       35
<PAGE>   36



SILICON VALLEY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30 (IN THOUSANDS)                                  1997             1998             1999
                                                                       ---------        ---------        ---------
<S>                                                                    <C>              <C>              <C>
Cash Flows from Operating Activities:
    Net income (loss)                                                  $   2,592        $ (13,577)       $ (25,456)
    Reconciliation to net cash provided by operating activities:
        Depreciation and amortization                                     27,605           39,171           48,690
        Settlement of royalty obligation                                  27,582               --               --
        Amortization of intangibles                                          751              848              476
        Deferred income taxes                                                948          (17,150)         (11,620)
        Stock compensation                                                    --               --              309
        Adjustment to conform TLI fiscal year                               (470)              --               --
        Minority interest                                                     92               --               --
        Changes in assets and liabilities:
            Accounts receivable                                          (14,250)          24,232          (32,419)
            Refundable income taxes                                           --          (15,000)          12,500
            Inventories                                                  (13,249)          15,478           26,318
            Prepaid expenses and other assets                               (120)              22             (819)
            Deposits and other assets                                     (1,159)             373           (2,502)
            Accounts payable                                               7,481          (18,361)           3,507
            Accrued liabilities                                           (9,350)           5,617          (16,366)
            Income taxes payable                                          (3,416)             769              315
                                                                       ---------        ---------        ---------
    Net cash provided by operating activities                             25,037           22,422            2,933
                                                                       ---------        ---------        ---------

Cash Flows from Investing Activities:
    Purchases of short-term investments, available for sale             (109,872)         (10,190)         (54,773)
    Maturities of short-term investments, available for sale              76,120           58,737           39,575
    Purchases of property and equipment                                  (89,932)         (79,208)         (30,937)
    Net cash received from SEG acquisition (See Note 2)                       --               --              139
    Purchase of minority interest in subsidiary                           (3,000)              --               --
                                                                       ---------        ---------        ---------
    Net cash used for investing activities                              (126,684)         (30,661)         (45,996)
                                                                       ---------        ---------        ---------

Cash Flows from Financing Activities:
    Sale of preferred stock                                                   --               --           14,976
    Sale of common stock                                                   7,332            4,799            4,940
    Proceeds from borrowings                                               6,462              250               --
    Repayment of debt                                                     (1,406)          (2,108)            (860)
                                                                       ---------        ---------        ---------
    Net cash provided by financing activities                             12,388            2,941           19,056
                                                                       ---------        ---------        ---------
Effect of Exchange Rate Changes on Cash                                     (839)          (2,816)             710
                                                                       ---------        ---------        ---------

Decrease in cash and equivalents                                         (90,098)          (8,114)         (23,297)
Cash and equivalents:
    Beginning of year                                                    219,787          129,689          121,575
                                                                       ---------        ---------        ---------
    End of year                                                        $ 129,689        $ 121,575        $  98,278
                                                                       =========        =========        =========

Non-Cash Investing and Financing Activities:

    Common stock issued in settlement of royalty obligation            $   9,994        $      --        $      --
                                                                       =========        =========        =========
    Tax benefit of stock option transactions                           $   2,532        $     737        $     357
                                                                       =========        =========        =========
</TABLE>


See Notes to Consolidated Financial Statements.



                                       36
<PAGE>   37



SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES

LINE OF BUSINESS. Silicon Valley Group, Inc. (the Company) primarily designs,
manufactures, markets and services semiconductor wafer processing equipment used
in the fabrication of integrated circuits.

CERTAIN RISKS AND UNCERTAINTIES. The semiconductor industry is highly cyclical
and has, historically, experienced periodic downturns that have had a severe
effect on the industry's demand for semiconductor wafer processing equipment.
Any future such downturns are likely to have an adverse effect on the Company's
results of operations.

The Company relies on a limited number of major customers for a substantial
percentage of its net sales. The loss of or any substantial reduction or
rescheduling of orders by any such customer could adversely affect the Company's
business and results of operations.

CONCENTRATION OF CREDIT RISK. Financial instruments that potentially subject the
Company to concentrations of credit risk consist principally of investments and
trade receivables. The Company places its cash equivalents and short-term
investments in high-grade instruments, which it places for safe keeping with
high-quality financial institutions. Further, by policy, it limits the amount of
credit exposure with any one counterparty and the amount of total investment
through any one financial institution or in any one type of investment.

The Company sells its systems to both domestic and international semiconductor
manufacturers. The Company performs ongoing credit evaluations of its customers'
financial condition and, generally, requires no collateral from its customers.
The Company maintains an allowance for uncollectible accounts receivable. The
combined receivables at September 30, 1999 for the Company's top five
revenue-generating customers in fiscal 1999 total approximately $108,000,000.

USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The Company regularly assesses those estimates and, while
actual results may differ, management believes that the estimates are
reasonable.

PRINCIPLES OF CONSOLIDATION. The Consolidated Financial Statements include the
accounts of the Company and its wholly-owned subsidiaries, after elimination of
significant intercompany transactions and balances.

The functional currency for the majority of the Company's subsidiaries is the
U.S. dollar, and for such subsidiaries, foreign exchange gains and losses are
included in net income (loss) and were not significant in any of the periods
presented. For two subsidiaries, the functional currency is the local currency,
and for these subsidiaries, remeasurement gains and losses are included in a
separate component of stockholders' equity. Certain intercompany receivables
from two subsidiaries have been classified as long term and the cumulative
translation adjustments related to these receivables are presented as a separate
component of stockholders' equity.

CASH EQUIVALENTS. Cash and equivalents consist of highly liquid investments with
a maturity date at acquisition of three months or less. Cash and equivalents are
stated at cost, plus any accrued interest, which approximates fair value.

INVENTORIES. Inventories are stated at the lower of cost (which approximates
first-in, first-out) or market.

PROPERTY AND EQUIPMENT. Property and equipment are stated at cost. Depreciation
is computed on the straight-line method over the estimated useful lives of the
assets. Estimated useful lives are as follows:

<TABLE>
<CAPTION>
                                                            YEARS
<S>                                              <C>
          Land improvements                                                 15
          Buildings and improvements                                  35 to 40
          Machinery and equipment                                      2 to 10
          Furniture and fixtures                                       2 to 10
          Leasehold improvements                      Shorter of the estimated
                                                 useful life or the lease term
</TABLE>



                                       37
<PAGE>   38

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

INTANGIBLE ASSETS. Intangible assets are amortized on a straight-line basis over
their estimated lives as follows: goodwill, twenty-five years; purchased
technology, six years.

REVENUE RECOGNITION. The Company generally recognizes revenue from the sale of
equipment upon shipment and transfer of title. During fiscal 1999, the Company
recognized net sales of approximately $20,000,000 from a customer who accepted
and took title to the related equipment and agreed to normal payment terms, but
requested that the Company store the equipment until predetermined shipment
dates. Approximately $58,000,000 in revenue to two such customers was recognized
in fiscal 1998. At September 30, 1999 the Company was storing $1,500,000 of such
equipment with a scheduled shipment date of March 2000.

Product liability and installation costs are accrued in the period that sales
are recognized.

RESEARCH, DEVELOPMENT AND RELATED ENGINEERING. Research, development and related
engineering costs are expensed as incurred. Funds received under development
funding arrangements are recorded as a reduction to such expenses as earned (See
Note 14). The Company's products include certain software applications that are
integral to the operation of the product. The costs to develop such software
have not been capitalized as the Company believes its current software
development process is essentially completed concurrent with the establishment
of technological feasibility of the software and/or development of the related
hardware.

NET INCOME (LOSS) PER SHARE. Effective October 1, 1997, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share"
(EPS), which requires a dual presentation of basic and diluted EPS. Basic net
income (loss) per common share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding for the period. Diluted net
income (loss) per share reflects the potential dilution that could occur if
securities to issue common stock (convertible preferred stock and common stock
options) were exercised or converted into common stock. Common stock equivalents
are excluded from the computation in loss periods, as their effect is
antidilutive.

The following table sets forth the computation of basic and diluted earnings
(loss) per share (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                                          1997        1998         1999
                                                                          ----        ----         ----
<S>                                                                      <C>        <C>          <C>
          Numerator:
              Net income (loss)                                          $ 2,592    $(13,577)    $(25,456)
                                                                         -------    --------     --------

          Denominator:
              Denominator for basic earnings (loss) per share
                --weighted average shares outstanding                     31,635      32,438       32,926
              Employee stock options                                         779          --           --
                                                                         -------    --------     --------
          Denominator for diluted earnings (loss) per
                share--adjusted weighted average shares outstanding       32,414      32,438       32,926
                                                                         -------    --------     --------

          Basic earnings (loss) per share                                $  0.08    $  (0.42)    $  (0.77)
                                                                         =======    ========     ========

          Diluted earnings (loss) per share                              $  0.08    $  (0.42)    $  (0.77)
                                                                         =======    ========     ========
</TABLE>

Weighted average options to purchase approximately 3,700,000 shares in 1999 and
2,800,000 shares in 1998 of common stock at weighted average exercise prices of
$18.22 and $18.59 per share, respectively, were excluded from the computation of
diluted earnings per common share because their effect was antidilutive.
Weighted average preferred stock convertible into approximately 461,000 common
shares was excluded from the computation of diluted earnings per share in 1999
because its effect was antidilutive. In 1997, 475,000 options with a weighted
average price of $20.61 per share were outstanding but excluded from the
computation of diluted earnings per share because their exercise price exceeded
the average market price and therefore, the effect would be anitdilutive.



                                       38
<PAGE>   39

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

EMPLOYEE STOCK PLANS. The Company accounts for its stock option and employee
stock purchase plans in accordance with the provisions of the Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees." In accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company continues to apply the provisions of APB No. 25 for
purposes of determining net income or loss and has adopted the pro forma
disclosure requirements of SFAS No. 123 (see Note 12).

COMPREHENSIVE INCOME. In the first quarter of fiscal 1999, the Company adopted
SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes
standards for the reporting and display of comprehensive income. Components of
comprehensive income (loss) include net income (loss), unrealized gains (losses)
on investments, foreign currency translation adjustments, and pension liability
changes (See Note 9). The adoption of SFAS No. 130 required additional
disclosure in the consolidated statement of stockholders' equity and
comprehensive income (loss), but did not impact the Company's consolidated
financial position, results of operations or cash flows.

SEGMENT INFORMATION. The Company adopted SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information," for the year ended September
30, 1999. SFAS No. 131 establishes annual and interim reporting standards for a
Company's business segments and related disclosures about its products,
services, geographic areas and major customers.

The Company primarily designs, manufactures, markets and services semiconductor
wafer processing equipment used in the fabrication of integrated circuits. All
operating units are aggregated into one segment because of their similarities in
the nature of products and services, production processes, types of customers,
and distribution method.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS. In June 1998 and June 1999, the FASB
issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" and SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133." These
statements require companies to record all derivatives on the balance sheet as
assets or liabilities measured at fair value. Gains or losses resulting from
changes in the values of those derivatives would be accounted for depending on
the use of the derivative and whether it qualifies for hedge accounting. SFAS
No. 133 is effective for the Company's fiscal year ending September 30, 2002.
Although the Company has not fully assessed the impact of the adoption,
management believes that the adoption of these statements will not have a
material effect on the Company's financial results.

RECLASSIFICATIONS. Certain reclassifications have been made to the prior years'
Consolidated Financial Statements to conform to the fiscal 1999 presentation.
Such reclassifications had no impact on the Company's financial position or
results of operations.

FISCAL YEAR. The Company uses a 52-53 week fiscal year ending on the Friday
closest to September 30. The accompanying financial statements have been shown
as ending on September 30. Fiscal 1997 included 53 weeks, fiscal 1998 and fiscal
1999 each included 52 weeks.

NOTE 2. ACQUISITION OF THE SEMICONDUCTOR EQUIPMENT GROUP OF WATKINS-JOHNSON.

On July 6, 1999, the Company acquired the business of the Semiconductor
Equipment Group of Watkins-Johnson Company ("SEG"), a California corporation,
pursuant to a Securities Purchase Agreement dated April 30, 1999 by and between
the Company and Watkins-Johnson, as amended by Amendment No. 1 to the Securities
Purchase Agreement dated July 2, 1999 by and between the Company and
Watkins-Johnson (as so amended, the "Purchase Agreement").

Under the terms of the Purchase Agreement, the Company acquired from
Watkins-Johnson all of its limited liability company interests in Semiconductor
Equipment Group, LLC and the outstanding capital stock of certain foreign
subsidiaries. The acquisition was accounted for as a purchase. The Company made
preliminary payments to Watkins-Johnson of approximately $9,000,000 based upon
certain values of assets and liabilities at December 31, 1998. The purchase
price was adjusted to $2,700,000 based upon the final closing Balance Sheet of
July 2, 1999. The $6,300,000 excess payment to Watkins-Johnson appears in
prepaid expenses and other assets at September 30, 1999 and was refunded in
October 1999. The total purchase price of $3,750,000 included approximately
$1,050,000 in costs directly attributable to the acquisition and was allocated
to the assets acquired and liabilities assumed based on



                                       39
<PAGE>   40

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

their respective fair values. The excess of the net SEG assets over the total
purchase price was used to proportionately reduce the value of material
noncurrent assets acquired.

Also, in connection with the acquisition, $3,450,000 was placed in escrow by
Watkins-Johnson to cover potential claims by the Company. The Company has up to
twelve months from the closing date to file claims for indemnification against
this escrow fund. At the end of this period, the remaining funds, interest and
earnings accrued revert to Watkins-Johnson.

The operating results of SEG have been included in the consolidated statements
of operations since the date of acquisition. Had the acquisition taken place at
the beginning of the periods presented, unaudited pro forma results of
operations would have been as follows (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                        1998        1999
                                                        ----        ----
<S>                                                   <C>        <C>
                Net sales                             $705,606   $ 570,636
                Net loss                               (64,728)    (22,170)
                Diluted loss per share                   (2.00)      (0.67)
</TABLE>

Pro forma financial information is presented for illustrative purposes only and
does not purport to be indicative of the operating results that would have
occurred had the acquisition been effected as of the periods indicated, nor is
it indicative of the future operating results of the Company.

NOTE 3. RESTRUCTURING AND RELATED CHARGES

During the fourth quarter of fiscal 1998, the Company recorded restructuring and
related charges of $33,680,000. The charge includes costs of $28,521,000
resulting from the termination of the Company's previously announced 200-APS
photoresist processing system (the 200-APS charge) and a provision of $5,159,000
for reductions in the Company's workforce that includes severance compensation
and benefit costs for workforce reductions announced in July 1998 ($2,696,000)
and September 1998 ($2,463,000). These workforce reductions were implemented in
response to global weakness in the demand for semiconductor capital equipment as
well as the decision to terminate the 200-APS product.

The 200-APS charge consisted of: the write-off of 200-APS inventory and purchase
commitments, which has been classified as cost of sales; the write-off of fixed
assets that were employed in the 200-APS effort; costs to fulfill obligations to
customers utilizing 200-APS systems, including the cancellation of certain
receivables and the support of such systems through fiscal 2000; and certain
other costs related to exiting the 200-APS program.

Changes to the restructuring accrual in fiscal 1999 are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                               200-APS
                                                              INVENTORY
                                              SEVERANCE      AND PURCHASE    CUSTOMER      OTHER EXIT
                                             AND BENEFITS    COMMITMENTS    OBLIGATIONS       COSTS        TOTAL
                                             ------------    -----------    -----------    ----------      -----
<S>                                          <C>             <C>            <C>            <C>            <C>
          Balance at September 30, 1998        $ 3,006         $ 1,832        $ 2,293         $ 201       $ 7,332
          Incurred to date                      (1,761)         (1,832)        (2,037)         (201)       (5,831)
          Adjustments                             (506)             --             --            --          (506)
                                               -------         -------        -------         -----       -------
          Balance at September 30, 1999        $   739         $    --        $   256         $  --       $   995
                                               =======         =======        =======         =====       =======
</TABLE>

The Company revised its estimate related to severance and benefits in fiscal
1999. Substantially all employee terminations have been effected as of September
30, 1999, although benefits will continue to be paid during fiscal 2000.
Customer obligations will be concluded in fiscal 2000.


                                       40
<PAGE>   41

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4.  INVESTMENTS

Investments in debt and equity securities are classified as available for sale
and measured at fair value. Material unrealized gains and losses, net of tax,
are recorded as a separate component of stockholders' equity until realized. At
September 30, 1999 net unrealized gains on investments totaled $435,000.

Investments at September 30 are comprised of the following:

<TABLE>
<CAPTION>
                                                             1998                      1999
                                                             ----                      ----
                                                                   MARKET                    MARKET
       (IN THOUSANDS)                                  COST        VALUE         COST        VALUE
                                                       ----        -----         ----        -----
<S>                                                  <C>          <C>          <C>          <C>
       Available for sale:
       Institutional money market funds
           included in cash and cash equivalents     $101,123     $101,123     $ 64,652     $ 64,652
                                                     --------     --------     --------     --------
       Municipal bonds                                 25,425       25,425          256          251
       Municipal notes                                     --           --       13,833       13,806
       Auction rate preferreds                          3,000        3,000           --           --
       Market auction preferreds                           --           --        4,000        4,000
       Certificates of deposit                             --           --        5,030        4,985
       Foreign debt securities                             --           --        2,036        2,000
       Corporate bonds                                     --           --        1,003        1,003
       U.S. government agencies                            --           --       17,995       17,923
                                                     --------     --------     --------     --------
       Total included in short-term investments        28,425       28,425       44,153       43,968
                                                     --------     --------     --------     --------
       Institutional mutual funds
           included in deposits and other assets        2,487        2,487        4,610        5,230
                                                     --------     --------     --------     --------
       Total available for sale                      $132,035     $132,035     $113,415     $113,850
                                                     ========     ========     ========     ========
</TABLE>

All of the Company's investments at September 30, 1999 mature within one year.

NOTE 5. BALANCE SHEET COMPONENTS

<TABLE>
<CAPTION>
              SEPTEMBER 30 (IN THOUSANDS)                       1998           1999
                                                              ---------      ---------
<S>                                                           <C>            <C>
              Inventories:
                 Raw materials                                $ 103,738      $  83,080
                 Work-in-process                                103,362        115,172
                 Finished goods                                   5,875          2,517
                                                              ---------      ---------
              Total                                           $ 212,975      $ 200,769
                                                              =========      =========

              Property and equipment:
                 Land and improvements                        $  11,494      $  19,351
                 Buildings and improvements                      74,822         87,645
                 Machinery and equipment                        172,584        195,944
                 Furniture and fixtures                          36,114         41,554
                 Leasehold improvements                          24,220         26,611
                                                              ---------      ---------
              Total                                             319,234        371,105
                                                              ---------      ---------
                Accumulated depreciation and amortization      (128,212)      (172,702)
                                                              ---------      ---------
               Property and equipment, net                    $ 191,022      $ 198,403
                                                              =========      =========
</TABLE>


                                       41
<PAGE>   42


SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<S>                                                    <C>           <C>
              Intangible assets:
                 Goodwill                              $  6,019      $  5,705
                 Purchased technology                     1,000            --
                                                          7,019         5,705
                                                       --------      --------
                 Accumulated amortization                (3,283)       (2,445)
                                                       --------      --------
              Total                                    $  3,736      $  3,260
                                                       ========      ========

              Accrued liabilities:
                 Compensation                          $ 28,792      $ 23,853
                 Product warranty                        48,943        53,746
                 Customer deposits and advances          31,452        23,131
                 Restructuring and related charges        7,332           995
                 Other                                   14,013        21,541
                                                       --------      --------
              Total                                    $130,532      $123,266
                                                       ========      ========
</TABLE>


NOTE 6. SVG LITHOGRAPHY SYSTEMS, INC.

Through March 17, 1997, the Company owned 94% of SVG Lithography Systems, Inc.
(SVGL) and International Business Machines, Inc. (IBM) owned the remaining 6%.
The minority interest reflected in the Consolidated Statement of Operations
represented that share of SVGL's operating results which were attributable to
IBM. On March 18, 1997, the Company purchased IBM's 6% interest in SVGL for
$3,000,000. As a result, the Company now accounts for SVGL as a wholly-owned
subsidiary.

NOTE 7. SETTLEMENT OF ROYALTY OBLIGATION

Under the terms of a research and development agreement, SVGL owed IBM certain
royalties based on future operating results. On March 18, 1997, the Company
satisfied this royalty obligation to IBM in exchange for $5,000,000 in cash,
489,296 shares of common stock valued at $10,000,000 and $23,000,000 in SVGL
product. Of the $38,000,000 total, $32,582,000 related to products currently
under development and was recognized as an expense in the second quarter of
fiscal 1997, and $5,418,000 related to existing products and was recorded as a
prepayment which is being amortized to expense through fiscal year 2000.

NOTE 8. DEBT ARRANGEMENTS

On June 30, 1998, the Company entered into an unsecured $150,000,000 bank
revolving line of credit agreement, which expires June 30, 2001. Advances under
the line bear interest at the bank's prime rate (8.25% at September 30, 1999) or
0.65% to 1.50% over LIBOR (6.13% at September 30, 1999). The agreement includes
covenants regarding liquidity, profitability, leverage, coverage of certain
charges and minimum net worth and prohibits the payment of cash dividends. On
October 23, 1998 and May 14, 1999, certain of the covenants were amended to
reflect the effects of the acquisition of SEG (See Note 2) and change quarterly
profitability covenants. The Company is in compliance with the covenants as
amended and there were no outstanding borrowings under this facility at
September 30, 1999.

In February 1997, the Company received a $6,500,000 loan from the Connecticut
Development Authority. The loan has a ten year term, bears interest at 8.25%,
and is secured by the Company's Wilton, Connecticut facility which houses
certain operations of SVGL.

Tinsley Laboratories, Inc. (TLI) has two loans and one special assessment bond
outstanding, which bear interest at rates between 8.5% and 12% with maturity
dates through April 2007.

In 1999, the Company assumed three Yen-denominated loans in connection with the
acquisition of SEG (See Note 2). Approximately $7,700,000 (Y804.6 million),
which is secured by land and buildings in Japan, is payable in monthly
installments through the year 2011, bearing interest at 2.5%. Approximately
$13,000,000 (Y1,350.0 million) and $2,000,000 (Y200.0 million) are unsecured and
require a payment in 2006 and 2007, respectively, bearing interest at 3.1% and
2.2%, respectively, payable semiannually.



                                       42
<PAGE>   43

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Interest rates on substantially all of the Company's debt reflect current market
rates, therefore the carrying value of the Company's debt approximates fair
value.

Long-term debt balances at September 30, consist of the following (in
thousands):

<TABLE>
<CAPTION>
                                                    1998          1999
                                                    ----          ----
<S>                                               <C>           <C>
       Connecticut Development Authority loan     $  5,791      $  5,294
       TLI loans and special assessment bonds          714           512
       Japanese Yen-denominated bank loans              --        22,604
                                                  --------      --------
                                                     6,505        28,410
       Less current portion                           (640)       (1,620)
                                                  --------      --------
                                                  $  5,865      $ 26,790
                                                  ========      ========
</TABLE>


Interest payments were $488,000 in 1997, $655,000 in 1998 and $662,000 in 1999.
At September 30, 1999, aggregate debt maturities were approximately: $1,620,000
in fiscal 2000; $1,309,000 in fiscal 2001; $1,354,000 fiscal 2002; $1,384,000 in
fiscal 2003; $1,443,000 in 2004; and $21,300,000 thereafter.

NOTE 9. EMPLOYEE BENEFIT PLANS

The Company's profit-sharing plan provides quarterly distributions to eligible
employees as determined by the Board of Directors. Profit-sharing distributions
were $1,172,000 in 1997, and $1,623,000 in 1998. No profit-sharing distributions
were made in fiscal 1999.

Under the Company's Cash or Deferred Profit Sharing Plan (401(k) Plan), the
Company may make contributions, depending on the amount of the employee's
contribution, up to a maximum of 3% of compensation. The Company's contributions
were $3,135,000 in 1997, $3,407,000 in 1998 and $3,432,000 in 1999.

In February 1997, the Company adopted a non-qualified deferred compensation plan
that allows a select group of management or highly compensated Employees and
Directors to defer a portion of their salary, bonus and other benefits. The plan
is unfunded and amounts due participants represent general obligations of the
Company. The Company may credit additional amounts to participants' account
balances, depending on the amount of the employee's contribution, up to a
maximum of 5% of an employee's annual salary and bonus. In addition, interest is
credited to the participants' account balances at 120% of the average Moody's
corporate bond rate. For 1999, participants' accounts will be credited at 7.18%.
Company contributions and related interest become 100% vested five years after
the plan year in which the contribution was made. During fiscal 1997, 1998 and
1999, the Company's expense was $609,000, $878,000 and $774,000, respectively,
and at September 30, 1999, the Company's liability under the deferred
compensation plan was $5,227,000.

Additionally, the Company assumed unfunded salary continuation agreements with
certain key executives and employees of TLI. Under the terms of the agreement,
the Company has agreed to pay certain fixed amounts over a ten year period after
the employees reach the age of 65. Payments began vesting December 1990 and
become fully vested only if the participants remain employed by the Company
through the age of 65. The present value of these payments, calculated using a
discount rate of 6% is being charged ratably to expense over the vesting period.
During fiscal 1997, 1998, and 1999 the Company had related expenses of $32,000,
$14,000, and $21,000, respectively, and at September 30, 1999, the Company's
liability under these agreements was $532,000.

At September 30, 1999, four officers of the Company had employment agreements
that provide, in the event of disability, death, or termination meeting certain
criteria, for severance payments based on a multiple of their then-current
compensation. At September 30, 1999, the aggregate potential payments under
these agreements would have been approximately $5,500,000.

The Company also assumed the defined benefit pension plan of TLI. The plan had
previously been terminated during 1995 and the Company is currently in the
process of finalizing the termination process. At September 30, 1998 and 1999,
the Company had recorded a minimum pension liability of $274,000 and $312,000,
respectively, within stockholders' equity, net of income taxes, which is based
upon the excess of the estimated accumulated benefit obligation of $1,705,000
and $2,174,000, respectively, over the fair



                                       43
<PAGE>   44

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

market value of plan assets (primarily corporate bond mutual funds) of
$1,510,000 and $1,513,000, respectively. Upon finalization of the plan
termination, the minimum pension liability will be charged to the statement of
operations.

NOTE 10. INCOME TAXES

The provision (benefit) for income taxes consists of (in thousands):

<TABLE>
<CAPTION>
       YEARS ENDED SEPTEMBER 30,      1997            1998            1999
                                     -------        --------        --------
<S>                                  <C>            <C>             <C>
           Current:
              Federal                $(1,218)       $    478        $ (2,500)
              State                    1,433           1,252              --
              Foreign                    351           1,840           2,140
                                     -------        --------        --------
           Total current                 566           3,570            (360)
                                     -------        --------        --------

           Deferred:
              Federal                   (293)        (14,720)         (9,921)
              State                    1,241          (2,430)         (1,699)
                                     -------        --------        --------
           Total Deferred                948         (17,150)        (11,620)
                                     -------        --------        --------
                                     $ 1,514        $(13,580)       $(11,980)
                                     =======        ========        ========
</TABLE>

Domestic and foreign income (loss) before income taxes and minority interest is
as follows (in thousands):

<TABLE>
<CAPTION>
       YEARS ENDED SEPTEMBER 30,       1997            1998            1999
                                     --------        --------        --------
<S>                                  <C>             <C>             <C>
       Domestic                      $  3,898        $(30,925)       $(43,762)
       Foreign                            300           3,768           6,326
                                     --------        --------        --------
                                     $  4,198        $(27,157)       $(37,436)
                                     ========        ========        ========
</TABLE>

The effective tax rate differs from the Federal statutory rate as follows (in
thousands):

<TABLE>
<CAPTION>
       YEARS ENDED SEPTEMBER 30,               1997         1998         1999
                                              -------     --------     --------
<S>                                           <C>         <C>          <C>
       Statutory rate                         $ 1,469     $ (9,505)    $(13,103)
       State taxes, net of Federal effect         200       (1,178)        (486)
       Foreign taxes at differing rates           268          (51)         395
       FSC commission                            (464)      (1,437)          --
       Tax exempt interest                     (2,284)      (1,799)        (360)
       Settlement of royalty obligation         1,500           --           --
       Other                                      825          390        1,574
                                              -------     --------     --------
         Total                                $ 1,514     $(13,580)    $(11,980)
                                              =======     ========     ========
</TABLE>

The items giving rise to deferred taxes were as follows (in thousands):

<TABLE>
<CAPTION>
       SEPTEMBER 30,                                      1998          1999
                                                        --------      --------
<S>                                                     <C>           <C>
       Deferred tax assets:
         Reserves not recognized for tax purposes       $ 28,907      $ 37,256
         Net operating loss carryforwards                  3,130         7,530

         Accelerated depreciation                            273          (497)
                                                        --------      --------
         Total deferred tax assets                        32,310        44,289
       Valuation allowance                                (9,297)       (9,297)
                                                        --------      --------
       Total                                            $ 23,013      $ 34,992
                                                        ========      ========
</TABLE>



                                       44
<PAGE>   45

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The components giving rise to the net deferred tax asset described above have
been included in the accompanying consolidated balance sheet as follows:

<TABLE>
<CAPTION>
       SEPTEMBER 30,                            1998          1999
                                               -------       -------
<S>                                            <C>           <C>
       Current assets                          $22,740       $35,489
       Deposits and other assets                   273            --
       Deferred and other liabilities               --          (497)
</TABLE>

At September 30, 1999, the Company had approximately $11,300,000 and $4,200,000
of federal and state loss carryforwards available to offset future income. These
losses begin to expire in year 2004. Additionally, approximately $7,900,000 of
federal loss carryforwards were available to offset future federal taxable
income generated by SVGL, through the year 2007, subject to certain limitations.
The valuation allowance relates to the net deferred tax assets of SVGL.

In 1997 and 1998, the Company made income tax payments of $2,882,000, and
$16,878,000 respectively. In 1999, income tax refunds were $13,207,000.

NOTE 11. STOCKHOLDERS' EQUITY

CONVERTIBLE PREFERRED STOCK. On May 5, 1999 Intel Corporation (Intel) made a
$15,000,000 equity investment in the Company in the form of a purchase of 15,000
shares of newly issued non-voting Series 1 Convertible Preferred Stock (Series 1
Preferred). The Series 1 Preferred investment is convertible into 1,111,111
shares of the Company's common stock subject to adjustments for events of
dilution in certain circumstances such as stock splits or dividends. Intel has
the option to convert, at any time, it's Series 1 Preferred into shares of the
Company's common stock.

In connection with the Series 1 Preferred investment, Intel and the Company
entered into an agreement for the development of 157-nanometer lithography
technology. This agreement obligates the Company, among other things, to develop
and sell to Intel a predetermined number of initial development tools. Intel has
agreed to provide advance payments for the development and manufacture of these
machines based on predetermined milestones. Under certain conditions, the
Company is obligated to dedicate a certain amount of 157-nanometer unit
production output to Intel. The Company is required to use the proceeds from the
Series 1 Preferred investment and funds received under this development
agreement for the development of technology for use on 157-nanometer lithography
equipment.

PREFERRED SHARES PURCHASE RIGHTS. In September 1996, the Company's Board of
Directors adopted a plan for the distribution of one Preferred Shares Purchase
Right (the Rights) to the holder of each outstanding share of the Company's
common stock. The rights expire in September 2006 and are not exercisable until
a person or group announces the acquisition of 15% or more of the Company's
outstanding common stock, or the commencement of a tender or exchange offer for
15% or more of the Company's common stock. Each Right entitles its holder to
purchase 1/1000 of one new share of the Company's Series A Participating
Preferred Stock at an exercise price of $125, subject to certain antidilution
adjustments. Additionally, a holder would be entitled, under certain
circumstances, to purchase shares of common stock of the Company or, in other
cases, of the acquiring company, having a market value of twice the exercise
price of the Right. Under certain conditions, the Company may redeem the Rights
for a price of $0.01 per Right or exchange each Right not held by the acquirer
for one share of the Company's common stock.

NOTE 12. STOCK OPTION AND PURCHASE PLANS

Under the Company's stock option plans, the Board of Directors may, at its
discretion, grant incentive or nonqualified stock options to employees and
directors, and options are automatically granted annually to directors who are
not employees of the Company. Options may be granted with a period not to exceed
ten years from the date of grant, at prices at least equal to the fair market
value of common stock at the grant date, and vest and become exercisable
generally over a period of up to five years.



                                       45
<PAGE>   46

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Activity under the plans is as follows (shares in thousands):

<TABLE>
<CAPTION>
                                                                 WEIGHTED
                                                  SHARES          AVERAGE
                                               UNDER OPTION   EXERCISE PRICE
                                               ------------   --------------
<S>                                            <C>            <C>
              Balances, October 1, 1996           2,127           $13.02
                Granted                             823            25.03
                Exercised                          (372)           10.34
                Canceled                           (117)           17.94
                                                  -----           ------

              Balances, September 30, 1997        2,461            16.97
                Granted                           1,121            21.64
                Exercised                          (158)            5.47
                Canceled                           (218)           20.24
                                                  -----           ------

              Balances, September 30, 1998        3,206            18.93
                Granted                           1,502            13.35
                Exercised                          (215)            6.73
                Canceled                           (173)           19.34
                                                  -----           ------
              Balances, September 30, 1999        4,320           $17.60
                                                  =====           ======
</TABLE>

The following table summarizes information concerning options outstanding and
exercisable as of September 30, 1999:

<TABLE>
<CAPTION>
                                                    OPTIONS OUTSTANDING                 OPTIONS EXERCISABLE
                                             ----------------------------------    -----------------------------
                                             WEIGHTED AVERAGE       WEIGHTED                         WEIGHTED
     RANGE OF                   NUMBER       CONTRACTUAL LIFE        AVERAGE         NUMBER           AVERAGE
     EXERCISE PRICES          OUTSTANDING       (IN YEARS)       EXERCISE PRICE    EXERCISABLE    EXERCISE PRICE
     ---------------          -----------    ----------------    --------------    -----------    --------------
<S>                           <C>            <C>                 <C>               <C>            <C>
     $ 4.66 - $15.00           1,965,754          6.53               $12.88           644,823         $11.61
          16.13                  717,212          3.79                16.13           524,515          16.13
      16.63 -  20.63             653,527          7.97                20.25           215,825          19.90
     $21.25 - $32.69             983,051          6.30                26.36           418,665          26.26
                               ---------          ----               ------         ---------         ------
     Total                     4,319,544          6.24               $17.60         1,803,828         $17.31
                               =========          ====               ======         =========         ======
</TABLE>

At September 30, 1999, approximately 5,567,120 options to purchase common stock
were authorized, with 1,247,576 options available for future grant.

Under the Company's Employee Stock Purchase Plan, 2,950,000 shares of common
stock were reserved for issuance of which 1,915,354 had been issued at September
30, 1999. The plan permits eligible employees to purchase, through payroll
deductions, common stock at 85% of the lower of the fair market value of the
common stock on the first or last day of the offering period. The plan has
offering periods of twelve months, with a new twelve-month period beginning each
April 1 and October 1.

PRO FORMA NET INCOME AND EARNINGS PER SHARE. The Company has elected to continue
following APB No. 25, in accounting for its employee stock options. Under APB
No. 25, because the exercise price of the Company's employee options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized in the Company's financial statements.

Pro forma information regarding net income and earnings per share is required by
SFAS No. 123. This information is required to be determined as if the Company
had accounted for its employee stock options (including shares under the
Employee Stock Purchase Plan) granted subsequent to September 30, 1995 under the
fair value method of that statement.

The fair value of options was estimated at the date of grant using the
Black-Scholes option pricing model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options which have no
vesting restrictions and which are



                                       46
<PAGE>   47

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

fully transferable. In addition, the Black-Scholes model requires the input of
highly subjective assumptions, including the expected stock price volatility.
Because the Company's employee stock option and stock purchase plans have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of the Company's
stock-based awards to employees. The fair value of the stock option plan and the
stock purchase plan was estimated assuming no expected dividends and the
following weighted average assumptions

<TABLE>
<CAPTION>
                                                              1997         1998          1999
                                                            --------    ----------    ----------
<S>                                                         <C>         <C>           <C>
             Stock option plan:
             Expected stock price volatility                     56%           64%           69%
             Risk free interest rate                            6.4%          6.0%          4.9%
             Expected life of options after vesting:
                 Officers and directors                      2 years    7.2 months       1 month
                 All others                                 9 months    7.3 months    1.7 months

             Stock purchase plan:
             Expected stock price volatility                     56%           60%           67%
             Risk free interest rate                            5.8%          6.0%          5.3%
             Expected life of options                         1 year        1 year        1 year
</TABLE>

The Company's calculations are based on a multiple option valuation approach and
recognition of forfeitures as they occur. The weighted average fair value of
options granted during the fiscal 1997, 1998 and 1999 was approximately $12.57,
$9.85 and $4.18 per share, respectively. The weighted average fair value of
purchase rights granted in fiscal 1997, 1998 and 1999 was approximately $8.76,
$7.68 and $5.94 per share, respectively.

For purposes of pro forma disclosures required by SFAS No. 123, the estimated
fair value of the options is amortized to expense over the options' vesting
period. The Company's pro forma information follows (in thousands except for
earnings per share information):

<TABLE>
<CAPTION>
                                                              1997        1998         1999
                                                            -------     --------     --------
<S>                                                         <C>         <C>          <C>
             Proforma net loss                              $(3,738)    $(21,116)    $(34,006)
             Proforma loss per share--basic                   (0.12)       (0.65)       (1.03)
             Proforma loss per share--diluted                 (0.12)       (0.65)       (1.03)
</TABLE>

For pro forma purposes in accordance with SFAS No. 123, the repricing of
employee stock options during 1996 is treated as a modification of the
stock-based award, with the original options being repurchased and new options
granted. Any additional compensation arising from the modification is recognized
over the remaining vesting period of the new grant. SFAS 123 is effective for
stock-based awards granted by the Company commencing October 1, 1995. All
stock-based awards granted before October 1, 1995, have not been valued and no
pro forma compensation expense has been recognized. However, any option granted
before October 1, 1995 that was repriced in 1996 is treated as a new grant
within 1996 and valued accordingly. In addition, because compensation expense is
recognized over the vesting period of the option, the initial impact on pro
forma income may not be representative of pro forma compensation expense in
future years.



                                       47
<PAGE>   48

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13. COMMITMENTS

Future minimum lease payments for operating leases for the years ended September
30 (primarily facilities) are as follows (in thousands):

<TABLE>
<S>                                              <C>
                   2000                          $ 7,149
                   2001                            5,948
                   2002                            5,604
                   2003                            5,201
                   2004                           24,250
                   Thereafter through 2010         1,196
                                                 -------
                   Total                         $49,348
                                                 =======
</TABLE>

Rent expense was $7,009,000, $7,006,000 and $7,360,000 in 1997, 1998 and 1999,
respectively.

During 1999, the Company entered into two synthetic lease agreements for
facilities in San Jose and for the Scotts Valley facility (See Note 2). Both
leases are for a five-year term. Monthly rent payments are variable at 0.61% to
2.0% over LIBOR. For the Scotts Valley facility, the Company entered into an
interest rate swap contract to fix the interest rate and, therefore, the lease
payment. Under the terms of the leases, the Company, at its option, can acquire
the properties at their original cost or arrange for properties to be acquired.
If the Company does not purchase the properties by the end of the lease terms,
the Company will be contingently liable to the lessors for residual value
guarantees of approximately $8,400,000 and $12,125,000 respectively (included in
future minimum lease payments above). In addition, under the terms of the
leases, the Company must maintain compliance with certain financial covenants.
As of September 30, 1999, the Company was in compliance with all of its
covenants. Management believes that the contingent liability related to the
residual value guarantees does not currently have a material adverse effect on
the Company's financial position or results of operations.

NOTE 14. RESEARCH AND DEVELOPMENT AGREEMENTS

The Company, primarily through SVGL, has obtained research and development
funding from outside parties. Under the research and development agreements, the
Company receives payments based on meeting specified product development
milestones and retains ownership of the developed technology and products. The
Company does not anticipate that such funding will cover the entire cost of the
development efforts to which it pertains. Therefore, it is recorded as a
reduction of research, development, and related engineering, in amounts
approximating the percentage of costs incurred to date to the total estimated
costs of such development efforts.

The Company incurred costs of $40,227,000 in 1997, $12,842,000 in 1998 and
$9,231,000 in 1999 relating to such product development and recognized
$7,968,000, $11,997,000 and $2,902,000, respectively, in related funding.

During fiscal 1996, the Company entered into agreements with certain customers
(the Participants) whereby each agreed to assist in funding the Company's
development of an advanced technology 193-nanometer Micrascan system. In
exchange for such funding the Participants receive the right to purchase one
such system and in addition, receive a right of first refusal (ratable among
such participants) to all such machines manufactured during the first two years
following the initial system shipments. For each initial system ordered, each
Participant agreed to fund $5,000,000 in such development costs. The agreements
call for each Participant to pay $1,000,000 of initial development funding and
four subsequent payments of $1,000,000 upon the completion of certain
development milestones. The participants may withdraw from the development
program without penalty but payments made against completed development
milestones are not refundable and all preferential rights to future equipment
are forfeited. As of September 30, 1999, the Company had received $20,000,000 in
funding from six Participants, all of which had been recognized and offset
against research and development expenditures. During fiscal 1999 all but one of
the Participants withdrew from the development program and the Company shipped a
193-nanometer Micrascan system to the remaining Participant. The Company's
obligations under these agreements are complete, and no additional funding is
expected from the Participants.



                                       48
<PAGE>   49

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15. GEOGRAPHIC SEGMENTS

The Company's products are manufactured in the United States and are sold
worldwide. The Company designs, manufactures, markets and services semiconductor
wafer processing equipment used in the fabrication of integrated circuits. All
operating units are aggregated into one segment because of their similarities in
the nature of products and services, production processes, types of customers,
and distribution method. The Company markets internationally through both its
foreign-based sales and service operations and through outside distributors and
sales representatives.

One customer accounted for 36% of sales in 1997, 40% of sales in 1998, and 56%
of sales in 1999; a second customer accounted for 22% of sales in 1997, 17% of
sales in 1998 and 7% of sales in 1999; and a third customer accounted for 6% of
sales in 1997, 13% of sales in 1998 and 6% of sales in 1999.

The following table summarizes total net sales and long-lived assets attributed
to significant countries as of and for the years ended September 30 (in
thousands):

<TABLE>
<CAPTION>
                                                  1997        1998      1999
                                               --------    --------    --------
<S>                                            <C>         <C>         <C>
             Net sales:
                 United States                 $442,314    $393,375    $322,095
                 France                          53,600      44,240      13,059
                 Ireland                          3,180      86,465      20,641
                 Israel                              65      11,183      51,481
                 Other                          115,067      73,362      66,414
                                               --------    --------    --------
             Total net sales                   $614,226    $608,625    $473,690
                                               ========    =========   ========

             Long-lived assets:
                 United States                 $157,289    $195,272    $185,187
                 Japan                              536         489      18,341
                 Other                            2,548       2,307       1,477
                                               --------    --------    --------
             Total long-lived assets           $160,373    $198,068    $205,005
                                               ========    ========    ========
</TABLE>

Net sales are attributed to countries based upon the shipment destinations and
service locations of systems. Long-lived assets consist of net property and
equipment, deposits and other assets, and net intangible assets, excluding
long-term investments and long-term deferred tax assets. Export sales were 23%
of net sales in 1997, 29% of net sales in 1998, and 20% of net sales in 1999.

NOTE 16. ACQUISITION OF TINSLEY LABORATORIES, INC.

On November 26, 1997, the Company acquired Tinsley Laboratories, Inc. (TLI) in a
stock for stock transaction whereby approximately 1,091,000 shares of the
Company's common stock were exchanged for all outstanding shares of TLI common
stock. TLI designs, manufacturers and sells precision optical components,
assemblies and systems to customers in a variety of industries and research
endeavors. The transaction was accounted for as a pooling of interests for
financial reporting purposes. All prior periods have been restated to include
TLI financial results.



                                       49
<PAGE>   50

SILICON VALLEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17. LEGAL MATTERS

On or about August 12, 1998, Fullman International Inc. and Fullman Company LLC
(collectively, Fullman) initiated a lawsuit in the United States District
Court for the District of Oregon alleging claims for fraudulent conveyance,
constructive trust and declaratory relief in connection with a settlement the
Company had previously entered into resolving its claims against a Thailand
purchaser of the Company's equipment. In its complaint against the Company,
Fullman, allegedly another creditor of the Thailand purchaser, alleges damages
of approximately $11,500,000 plus interest. The Company has successfully moved
to transfer the case to the United States District Court for the Northern
District of California. The trial is tentatively scheduled for July 2000.

While the outcome of such litigation is uncertain, the Company believes it has
meritorious defenses to the claims and intends to conduct a vigorous defense.
However, an unfavorable outcome in this matter could have a material adverse
effect on the Company's financial condition.

In addition to the above, the Company, from time to time, is party to various
legal actions arising out of the normal course of business. The resolution of
such matters, and the Fullman litigation, are not expected to have a material
adverse effect on the Company's financial position or operating results.

NOTE 18. SUMMARIZED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
                                                           FIRST       SECOND      THIRD       FOURTH
              (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)    QUARTER     QUARTER     QUARTER     QUARTER
                                                          --------    --------    --------    --------
<S>                                                       <C>         <C>         <C>         <C>
              1999
                Net sales                                 $ 85,487    $ 61,496    $136,894    $189,813
                Gross profit                                24,030      14,170      47,860      75,311
                Income (loss) before income taxes          (10,353)    (26,450)     (3,037)      2,404
                Net income (loss)                           (7,032)    (17,994)     (2,065)      1,635
                Net income (loss) per share--basic           (0.21)      (0.55)      (0.06)        .05
                Net income (loss) per share--diluted         (0.21)      (0.55)      (0.06)        .05
              1998
                Net sales                                 $188,707    $195,872    $116,385    $107,661
                Gross profit                                74,388      77,514      38,088      10,239
                Income (loss) before income taxes           17,860      14,059     (11,357)    (47,719)
                Net income (loss)                           12,145       9,560      (6,817)    (28,465)
                Net income (loss) per share--basic            0.38        0.30       (0.21)      (0.87)
                Net income (loss) per share--diluted          0.37        0.29       (0.21)      (0.87)
</TABLE>







                                       50
<PAGE>   51

ITEM 8A. THE COMPANY'S FISCAL YEAR

    The Company observes a 52-53 week fiscal year ending on the Friday closest
to September 30. Under this practice, the Company's last three fiscal years
ended October 3, 1997, October 2, 1998 and October 1, 1999. For convenience,
this Report and the Company's Consolidated Financial Statements refer to all
such fiscal years as ending at September 30. Fiscal 1998 and fiscal 1999 each
included 52 weeks. Fiscal 1997 included 53 weeks.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS.

    Not applicable.

                                    PART III

    Certain information required by Part III is omitted from this Report in that
the Registrant will file its definitive Proxy Statement for the Annual Meeting
of Stockholders to be held on February 23, 2000, pursuant to Regulation 14A of
the Securities Exchange Act of 1934 (the "Proxy Statement"), not later than 120
days after the end of the fiscal year covered by this Report, and certain
information included in the Proxy Statement is incorporated herein by reference.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

    (a) Executive Officers. See the section entitled "Executive Officers of the
Registrant" in Part I, Item 1 of this Report.

    (b) Directors. The information required by this Item is incorporated by
reference to the section entitled "Election of Directors" in the Proxy
Statement.

ITEM 11. EXECUTIVE COMPENSATION.

    The information required by this Item is incorporated by reference to the
section entitled "Executive Compensation" in the Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

    The information required by this Item is incorporated by reference to the
section entitled "Stock Ownership of Certain Beneficial Owners and Management"
in the Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

    The information required by this Item is incorporated by reference to the
section entitled "Certain Transactions" in the Proxy Statement.

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K.

(a) 1. FINANCIAL STATEMENTS.

    The financial statements (including the notes thereto) listed in the Index
to Consolidated Financial Statements and Financial Statements Schedule (set
forth in Item 8 of Part II of this Form 10-K) are filed within this Annual
Report on Form 10-K.

    2. SUPPLEMENTAL SCHEDULE.

    The financial statement schedule listed in the Index to Consolidated
Financial Statements and Financial Statements Schedule (set forth in Item 8 of
Part II of this Form 10-K) is filed within this Annual Report on Form 10-K.



                                       51
<PAGE>   52

3.  EXHIBITS.

<TABLE>
<CAPTION>
EXHIBIT NO.                            EXHIBIT
-----------                            -------
<S>            <C>
  10.50        Amendment to Employment Agreement between the Registrant and
               Papken S. Der Torossian dated June 7, 1999.*

  10.51        Amendment to Employment Agreement between the Registrant and
               William A. Hightower dated June 7, 1999.*

  10.52        Amendment to Employment Agreement between the Registrant and
               Russell G. Weinstock dated June 7, 1999.*

  10.53        Amendment to Employment Agreement between the Registrant and
               Boris Lipkin dated June 7, 1999.*

  10.54        Participation Agreement by and among SELCO Service Corporation,
               the Registrant and KeyBank National Association, as agent for the
               participants named therein, dated June 30, 1999.

  10.55        Purchase Agreement between SELCO Service Corporation and the
               Registrant, dated June 30, 1999.

  10.56        Lease Agreement, Deed of Trust with Assignment of Rents, Security
               Agreement and Fixture Filing between SELCO Service Corporation
               and the Registrant, dated June 30, 1999.

  10.57        Loan Agreement dated as of February 9, 1996 (English Translation)
               between Watkins-Johnson International Japan K.K. and The Bank of
               Yokoyama Ltd., including Loan Guaranty Agreement by the
               Registrant effective July 6, 1999.

  10.58        Loan Agreement dated as of June 12, 1996 (English Translation)
               between Watkins-Johnson International Japan K.K. and The Japan
               Development Bank, including Loan Guaranty Agreement by the
               Registrant effective July 6, 1999.

  10.59        Loan and Relocation Agreement between the Registrant and Jeffrey
               Kowalski dated August 31, 1999.*

  21.1         Registrant's wholly-owned subsidiaries.

  23.1         Consent of Deloitte & Touche LLP, independent auditors.

  24.1         Power of Attorney (see page 54)

  27           Financial Data Schedule.
</TABLE>

----------------

* Management contract or compensatory plans or arrangements

(b) REPORTS ON FORM 8-K.

        The Company filed reports on Form 8-K on July 16, 1999 and an amended
        Form 8-KA on September 17, 1999 in connection with the acquisition of
        the Semiconductor Equipment Group of Watkins-Johnson Company. Included
        in the Form 8-K are financial statements for the Company and for the
        Semiconductor Equipment Group of Watkins-Johnson Company.

(c) EXHIBITS. See (a) above.

(d) FINANCIAL STATEMENT SCHEDULES. See (a) above.



                                       52
<PAGE>   53


                              SILICON VALLEY GROUP

                                   SCHEDULE II
                        VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                        BALANCE AT     CHARGED                    BALANCE AT
                                                         BEGINNING  TO COSTS AND                      END
DESCRIPTION                                              OF PERIOD    EXPENSES      DEDUCTIONS(1)  OF PERIOD
                                                         ---------    --------      -------------  ---------
<S>                                                       <C>          <C>            <C>           <C>
YEAR ENDED 9/30/97:
  Allowance for Doubtful Accounts..................       $ 6,078      $ 7,725        $ (7,009)     $ 6,794
  Product Warranty Reserves........................        42,899       42,320         (41,685)      43,534
YEAR ENDED 9/30/98:
  Allowance for Doubtful Accounts..................         6,794        3,273          (1,835)       8,232
  Product Warranty Reserves........................        43,534       64,138         (58,729)      48,943
YEAR ENDED 9/30/99:
  Allowance for Doubtful Accounts..................         8,232       (2,579)(3)        (615)       5,038
  Product Warranty Reserves........................        48,943       46,371 (2)     (41,568)      53,746
</TABLE>

----------

(1)  Write-offs of uncollectible accounts and costs incurred for warranty
     repairs.

(2)  Includes $7,076,000 in product warranty reserves acquired from
     Watkins-Johnson Company's Semiconductor Equipment Group (See Note 2 of the
     Consolidated Financial Statements included in Item 8).

(3)  Includes approximately $2,800,000 of recoveries of previously reserved
     amounts.









                                       53
<PAGE>   54



                                   SIGNATURES

    Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

December 22, 1999

                                       SILICON VALLEY GROUP, INC.

                                       By: /s/  PAPKEN S. DER TOROSSIAN
                                           -------------------------------------
                                                Papken S. Der Torossian
                                                Chairman of the Board and
                                                Chief Executive Officer

                                POWER OF ATTORNEY

    KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Papken S. Der Torossian and Russell G. Weinstock,
and each of them, as his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments to this report
on Form 10-K, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in connection therewith and about the premises, as fully to
all intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or any of them, or their
or his substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.

    Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been duly signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
          SIGNATURES                                TITLE                                   DATE
          ----------                                -----                                   ----
<S>                                      <C>                                         <C>

  /s/ PAPKEN S. DER TOROSSIAN            Chairman of the Board,                      December 22, 1999
-----------------------------------      Chief Executive Officer
      Papken S. Der Torossian            And Director (Principal
                                         Executive Officer)

   /s/ WILLIAM A. HIGHTOWER              President Chief                             December 22, 1999
-----------------------------------      Operating Officer and Director
       William A. Hightower

   /s/ RUSSELL G. WEINSTOCK              Vice President, Finance                     December 22, 1999
-----------------------------------      And Chief Financial
       Russell G. Weinstock              Officer (Principal Financial
                                         And Accounting Officer)

    /s/ MICHAEL J. ATTARDO               Director                                    December 22, 1999
-----------------------------------
      Michael J. Attardo

     /s/ WILLIAM L. MARTIN               Director                                    December 22, 1999
-----------------------------------
       William L. Martin

        /s/ NAM P. SUH                   Director                                    December 22, 1999
-------------------------------------
          Nam P. Suh

                                         Director
-------------------------------------
      Kenneth M. Thompson

    /s/ LAWRENCE TOMLINSON               Director                                    December 22, 1999
-------------------------------------
      Lawrence Tomlinson
</TABLE>


                                       54
<PAGE>   55


                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NO.                            EXHIBIT
-----------                            -------
<S>            <C>
  10.50        Amendment to Employment Agreement between the Registrant and
               Papken S. Der Torossian dated June 7, 1999.*

  10.51        Amendment to Employment Agreement between the Registrant and
               William A. Hightower dated June 7, 1999.*

  10.52        Amendment to Employment Agreement between the Registrant and
               Russell G. Weinstock dated June 7, 1999.*

  10.53        Amendment to Employment Agreement between the Registrant and
               Boris Lipkin dated June 7, 1999.*

  10.54        Participation Agreement by and among SELCO Service Corporation,
               the Registrant and KeyBank National Association, as agent for the
               participants named therein, dated June 30, 1999.

  10.55        Purchase Agreement between SELCO Service Corporation and the
               Registrant, dated June 30, 1999.

  10.56        Lease Agreement, Deed of Trust with Assignment of Rents, Security
               Agreement and Fixture Filing between SELCO Service Corporation
               and the Registrant, dated June 30, 1999.

  10.57        Loan Agreement dated as of February 9, 1996 (English Translation)
               between Watkins-Johnson International Japan K.K. and The Bank of
               Yokoyama Ltd., including Loan Guaranty Agreement by the
               Registrant effective July 6, 1999.

  10.58        Loan Agreement dated as of June 12, 1996 (English Translation)
               between Watkins-Johnson International Japan K.K. and The Japan
               Development Bank, including Loan Guaranty Agreement by the
               Registrant effective July 6, 1999.

  10.59        Loan and Relocation Agreement between the Registrant and Jeffrey
               Kowalski dated August 31, 1999.*

  21.1         Registrant's wholly-owned subsidiaries.

  23.1         Consent of Deloitte & Touche LLP, independent auditors.

  24.1         Power of Attorney (see page 54)

  27           Financial Data Schedule.
</TABLE>

----------------

* Management contract or compensatory plans or arrangements