United
States 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 1934For
      the Fiscal Year Ended May 31, 2008[   ]
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR
              15(d)
      OF THE SECURITIES EXCHANGE ACT OF 1934For
      The Transition Period From ____ To
_______




Commission
File Number: 0-21626


Electroglas,
Inc.


(Exact
Name of Registrant as Specified in its Charter)





Delaware
            77-0336101(State
      of Incorporation)
            (I.R.S.
      Employer Identification No.)





5729
      Fontanoso Way,San
      Jose, California 95138
            (408)
      528-3000(Address
      of Principal Executive Offices) (Zip Code)
            (Registrant’s
      Telephone Number Including Area
Code)


Securities
registered pursuant to Section 12(b) of the Act:




Common
Stock, $0.01 par value




(Title
of Class)




Securities
registered pursuant to Section 12(g) of the Act: None




Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act of 1933, as amended.  Yes
[    ]     No [ X ]





Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Securities Act of 1934, as amended.  Yes
[    ]     No [ X ]







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.  [  ]




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):




Large
accelerated filer   [
]         Accelerated filer
  [ ]        Non-accelerated filer
  [ ]        Smaller reporting
company [X]




Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).  Yes __     NoX




As of
December 1, 2007, the aggregate market value of the voting and non-voting common
equity held by non-affiliates of the Registrant was approximately $38,000,000
based on the closing sale price as reported on the Nasdaq Global Market on such
date. This calculation does not reflect a determination that certain persons are
affiliates of the Registrant for any other purposes.




1


As of
July 28, 2008, the Registrant had 26,718,000 outstanding shares of Common
Stock.







DOCUMENTS
INCORPORATED BY REFERENCE




Portions
of the Registrant’s Proxy Statement in connection with the Annual Meeting of
Stockholders, to be held on October 15, 2008, are incorporated by reference into
Part III of this Form 10-K.







2


Electroglas,
Inc.





Form
10K
 For
the Year Ended May 31, 2008
 INDEX
              PagesFORWARD-LOOKING
      STATEMENTS...................................................................................................................................................................................................................................................................................................................
              4PART
      I............................................................................................................................................................................................................................................................................................................................................................................
              6Item
      1.  Business..................................................................................................................................................................................................................................................................................................................
              6Item
      1A.  Risk
      Factors.....................................................................................................................................................................................................................................................................................................
              11Item
      1B.  Unresolved Staff
      Comments..................................................................................................................................................................................................................................................................................
              15Item
      2.  Properties.............................................................................................................................................................................................................................................................................................................
              15Item
      3.  LegalProceedings..................................................................................................................................................................................................................................................................................................
              15Item
      4.  Submission of Matters to a Vote of Security
      Holders...................................................................................................................................................................................................................................................
              15PART
      II............................................................................................................................................................................................................................................................................................................................
              15Item
      5.  Market for the Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities............................................................................................................................................................
              15Item
      6.  Selected Financial
      Data........................................................................................................................................................................................................................................................................................
              17Item
      7.  Management’s Discussion and Analysis of Financial Condition
      and Results of
      Operations...............................................................................................................................................................................................
              18Item
      7A.  Quantitative and Qualitative Disclosures about Market
      Risk......................................................................................................................................................................................................................................
              27Item
      8.  Financial Statements and Supplementary
      Data...........................................................................................................................................................................................................................................................
              28Item
      9.  Changes in and Disagreements with Accountants on Accounting
      and Financial
      Disclosure..............................................................................................................................................................................................
              52Item
      9A(T).  Controls and
      Procedures...................................................................................................................................................................................................................................................................................
              53Item
      9B.  Other
      Information.................................................................................................................................................................................................................................................................................................
              53PART
      III...........................................................................................................................................................................................................................................................................................................................
              53Item
      10.  Directors and Executive Officers of the Registrant and
      Corporate
      Governance...................................................................................................................................................................................................................
              53Item
      11.  Executive
      Compensation.......................................................................................................................................................................................................................................................................................
              53Item
      12.  Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder
      Matters.................................................................................................................................................................................
              53Item
      13.  Certain Relationships and Related Transactions and Director
      Independence...................................................................................................................................................................................................................
              53Item
      14.  Principal Accountant Fees and Services.
      ..................................................................................................................................................................................................................................................................
              53PART
      IV............................................................................................................................................................................................................................................................................................................................
              54Item
      15.  Exhibits and Financial Statement
      Schedules.............................................................................................................................................................................................................................................................
              54SIGNATURES.....................................................................................................................................................................................................................................................................................................................
              56
 
    3




Forward-Looking Statements




The
following discussion should be read in conjunction with our accompanying
Financial Statements and the related notes thereto.  This Annual
Report on Form 10-K contains forward-looking statements within the “safe harbor”
provisions of the Private Securities Litigation Reform Act of
1995.  All statements included or incorporated by reference in this
Annual Report, other than statements that are purely historical are
forward-looking statements.  Words such as “anticipates,” “expects,”
“intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions
also identify forward-looking statements.  The forward-looking
statements include, without limitation, statements regarding:





•
            Our
      expectation that we will continue to invest in research and development of
      our wafer prober products and software to anticipate and address
      technological advances;


•
            Our
      belief that continued, rapid development of new products and enhancements
      to existing products is necessary to maintain our competitive
      position;


•
            Our
      belief that alternative sources of components and subassemblies included
      in our products that are obtained from a single source exist or can be
      developed, if required;


•
            Our
      belief that our products compete favorably with respect to product
      performance, reliability, price, service and technical support, product
      improvements, established relationships with customers, and product
      familiarity;


•
            Our
      intention to retain any future earnings to fund the development and growth
      of our business;


•
            Our
      statements relating to our efforts to market our existing technologies to
      other industries;


•
            Our
      belief that to stay competitive, grow our business over the long term,
      improve our gross margins, and generate operating cash flows, we must
      continue to invest in new technologies and product enhancements and at the
      same time, as necessary, rapidly adjust our expense structure during the
      hard to predict cyclical semiconductor equipment demand
      cycles;


•
            Our
      expectation that the semiconductor test markets will remain highly
      cyclical and difficult to forecast;


•
            Our
      expectation that international sales will continue to represent a
      significant percentage of net sales and fluctuate as a percentage of total
      sales;


•
            Our
      intention not to repatriate earnings from foreign subsidiaries and the
      effect of any repatriation of foreign earnings on income
      taxes;


•
            Our
      cash contractual obligations as of  May 31,
  2008;


•
            Our
      anticipation that our future cash from operations, available cash and cash
      equivalents, and proceeds from our line of credit at May 31, 2008 should
      be sufficient to meet our anticipated needs for working capital and
      capital expenditures to support planned activities for the next twelve
      months;


•
            Our
      expectation that external financing vehicles will continue to be available
      to us;


•
            Our
      expectation that the holders of the 6.25% Notes will convert the Notes
      into Common Stock at some time prior to March 2011 or if not converted
      prior to that date the note holders will require us to purchase the Notes
      at that time;


•
            Our
      belief that future sales will be impacted by our ability to succeed in new
      product evaluations;


•
            Our
      belief that we have and can maintain certain technological and other
      advantages over our competitors;


•
            Our
      belief that our success depends in significant part on our intellectual
      property, innovation, technological expertise, distribution strength, and
      our ability to manage our
suppliers;


•
            Our
      belief that our future success partly depends on our ability to hire and
      retain key personnel and the ability to attract additional skilled
      personnel in all areas to grow our
business;


•
            Our
      current intention not to issue any preferred
  stock;


•
            Our
      belief that our current foreign exchange exposure in all international
      operations is not material to our consolidated financial statements
      because we primarily transact business in United States
      dollars;


•
            Our
      belief that the impact of a 10% change in exchange rates would not be
      material to our financial condition and results of
    operations;


•
            Our
      belief that it is improbable that we will be required to pay any amounts
      for indemnification under our software license
  agreements;


•
            Our
      statements relating to outstanding restructuring charges and the timing of
      payment of such charges;


•
            Our
      assertion that sales often reflect orders shipped in the same quarter as
      they are received;


•
            Our
      intention to emphasize outsourcing in functional areas where it is cost
      effective and increases the Company’s competitive
  position;


•
            Our
      belief that in order to become profitable, our market share for our
      products must improve;


•
            Our
      intention to continue to emphasize reduction of our utilization of cash,
      improving gross margins on sales, and maintaining spending
      controls;


•
            Our
      intention to record a full valuation allowance on domestic tax benefits
      until we can sustain an appropriate level of profitability;
      and


4


•
            Our
      belief that we have adequately accrued for any foreseeable outcome related
      to any foreign and domestic tax issues on a more likely than not
      basis.




The
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those stated or implied by the
forward-looking statements.






These
risks and uncertainties include but are not limited to:


•    An
unanticipated lack of resources to continue to make investments in technolgical
advances necessary to maintain competitive advantages and fund new development
programs;


•   
Unanticipated product performance failures and the lack of market acceptance of
our EG6000 products;


•    Unanticipated
problems encountered in our manufacturing outsourcing and other outsourcing
efforts;


•    Unanticipated
problems with foreign and domestic tax authorities;


•    Continued
cyclicality in the semiconductor industry;


•    The
ability to secure additional funding, if needed;


•    The
ability to achieve broad market acceptance of existing and future products;
and


•    The
loss of one or more of our customers.







For a
detailed description of these and other risks associated with our business that
could cause actual results to differ from those stated or implied in such
forward-looking statements, see the disclosure contained under the heading “Risk
Factors” in this Annual Report on Form 10-K.  All forward-looking
statements included in this document are made as of the date hereof, based on
information available to us as of the date hereof, and we assume no obligation
to update any forward-looking statement or statements. The reader should also
consult the cautionary statements and risk factors listed in our other reports
filed from time to time with the Securities and Exchange
Commission.







5


PartI





Item
1.  Business





Overview




We are a
supplier of semiconductor manufacturing equipment and software to the global
semiconductor industry. We were incorporated in Delaware in April 1993, to
succeed the wafer prober business conducted by the Electroglas division of
General Signal Corporation, our former parent. Immediately prior to the closing
of the initial public offering of our Common Stock in July 1993, we assumed the
assets and liabilities of the Electroglas division in an asset transfer. We have
been in the semiconductor equipment business for more than 40 years and our
installed base is one of the largest in the industry, with over 16,500 wafer
probers sold.




Our
primary product line is automated wafer probing equipment and related network
software to manage information from that equipment. In conjunction with
automated test systems from other suppliers, our semiconductor manufacturing
customers use our wafer probers and network software to quality test
semiconductor wafers.




In January 2001, we acquired Statware Inc., of Corvallis, Oregon, to
      further expand our network software product offerings in the test
      management area. Today, the Statware technology is the basis for our
      web-based applications that allow our customers to monitor and control
      probers from any location, as well as collect, analyze, and report
      critical test process information and automatically direct corrective
      action.
              
              Starting in 2003, we changed our
      corporate strategy and refocused the Company back to its core competency
      of wafer probing and extending wafer probing technologies throughout the
      back-end of the semiconductor manufacturing process. In 2003 we sold our
      Design for Manufacturing (“DFM”) and Fab Solutions software product lines
      and our Optical Inspection product line. In 2004, we introduced a new
      extended performance 200mm wafer prober, the 4090μ+, and in January 2005 a
      new 300mm prober, the EG6000, that represents a major advancement in
      prober design and automation.
              
              Beginning
      in fiscal 2007, we began to market our existing EG6000 technologies to
      other equipment manufacturers in other application areas such as micro
      assembly and inspection.  These companies, in addition to
      semiconductor, sell into the medical and solar
    fields.
            
            4090uAdditional
      information about Electroglas is available on our web site (www.electroglas.com).
      Electroglas makes available free of charge on our website Reports filed
      pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934,
      as amended, as soon as reasonably practicable after we electronically file
      them with or furnish them to the SEC. The public may read and copy any
      materials that we file with the SEC at the SEC’s Public Reference Room at
      100 F Street, N.E., Washington, D.C. 20549. The public may obtain
      information by calling the SEC at 1-800-SEC-0330. Our filings also are
      available at the SEC’s website at http://www.sec.gov
      .
            
            Introduced in
      2004, the 4090μ+ addresses the demands of testing fine pitch devices,
      semiconductors with copper interconnects and low k dielectric processes
      and other advanced applications, while simultaneously reducing test costs
      by increasing throughput.




Industry
Background






Semiconductor
devices are fabricated by repeating a series of complex process steps on a
substrate, or wafer, which is usually made of silicon. Wafers are typically sent
through a series of 100 to 400 process steps. A finished wafer consists of many
integrated circuits, each referred to as a “device” or “die” or “chip”, the
number of which depends on the area of the circuits and the size of the wafer.
These wafers measure from 75mm to 300mm, or 3 to 12 inches, in diameter.
Manufacturers have increasingly utilized larger diameter wafers to achieve more
cost-effective production. The move to 300mm (12-inch) wafers, a significant
trend for equipment manufacturers, began in 2000. The manufacture of
semiconductor devices is very capital intensive. A typical state of the art
facility, usually called a “wafer fab”, can cost more than $2.0 billion. The
purchase of semiconductor manufacturing equipment and spare parts, the
integration of such equipment into production lines, and the training of
employees on a particular supplier’s equipment requires significant expenditures
by semiconductor manufacturers.




6




Wafer
Probing






A wafer
prober successively positions each die on the wafer so that the electrical
contact points, or pads, on the die align under and make contact with probe
pins, which are located on a probe card mounted on the wafer prober. The probe
card, which is generally custom-made by other suppliers for the specific device
being tested, is connected to a test system, also supplied by other suppliers,
which performs the required parametric or functional test. Parametric testing is
typically performed during the wafer fabrication process, referred to as
“in-line testing,” to measure electrical parameters of the device being
fabricated. Functional testing is performed after the completion of wafer
fabrication to identify devices that do not conform to particular electrical
specifications or performance criteria. This process is commonly called “wafer
sort.” Wafers often go through several wafer probing steps during the
manufacturing process.







Wafer
probing requires sophisticated machine vision and software capabilities to align
each die on a wafer — often to accuracies as tight as 2.5μm — to pins on a probe
card connected to a tester that measures electrical
performance.







Automatic
wafer probers are primarily used during this “wafer sort” process, which occurs
after the fabrication steps are completed and before the separation and
packaging of each individual device. Positioning accuracy is a key requirement
of an automatic wafer prober.  As manufacturers continue to shrink
their device sizes, the manufacturing equipment accuracy must continue to keep
pace with reduced feature sizes.  Throughput is another key prober
feature, because allowing more devices to be tested in a given amount of time
reduces the overall cost of test.  Similarly, wafer probers are
required to be reliable, easy to use, portable, and very robust at handling the
test process without failure or interruption, since these cause loss of
throughput for the entire test cell. Recently, new device manufacturing
processes, such as the use of copper for the metal layers and the use of very
soft, delicate dielectric layers, have required a new level of control over the
speed and accuracy with which probes are brought into contact with the pads to
prevent damage and yield loss. Also, many devices must be designed to operate in
severe conditions requiring cold testing to -55C and hot testing to
+200C.






Wafer
probers are also used during in-line parametric testing. In-line testing
requires special equipment features such as clean room compatibility and
low-noise electrical measurement capability, as tests are carried out during the
fabrication process. This testing is done to verify the quality of the
manufacturing process while wafers are in an unfinished state where corrective
action can occur. A small number of probers are also used for research and
development, and quality and process control applications. We estimate based
upon our experience that wafer sort applications represent as much as 85%-90% of
the market for automatic wafer probers. The remainder is divided between in-line
and laboratory applications.






There is
a growing trend for semiconductor manufacturers to contract with other companies
to perform their wafer sort operations. These contract test companies, commonly
called “test houses”, perform the wafer testing service and often provide
assembly and packaging services as well.






A
semiconductor manufacturer typically purchases wafer probers when outfitting a
new wafer fabrication facility or expanding an existing facility. Wafer probers
are also purchased to replace equipment in response to major changes in
technology such as larger wafer sizes and greater device complexity. A
semiconductor fabrication facility may require from 20 to over 100 probers to
meet testing requirements on a timely basis. A test house may require hundreds
of wafer probe systems to support the testing requirements of the companies that
contract with them.




7




Test
Floor Management






Process
management software plays an important role in Integrated Circuit (IC)
manufacturing. Capital and operating costs of a fabrication facility are very
high so semiconductor manufacturers seek ways to improve overall equipment
efficiency (OEE) and optimize their processes. Test houses and Integrated Device
Manufacturers look to reduce the cost of test and improve quality through
software monitoring, analysis, and the automation of their test
floors.  In wafer sort, network software is increasingly being used to
manage wafer information to speed the identification of yield shortfalls and to
reduce reprobe rates by collecting wafer maps from multiple passes for all
systems and storing the files in a common database for viewing, analyzing and
archiving. Other uses include prior step verification to insure that wafers
accurately flow through a pre-defined set of steps and are not tested if they
have not completed the previous step in the process and, product file management
capabilities that allow the user to save a master template for product file
set-up that can be accessed by all test systems on the test floor.






Our
Strategy






We are a
major supplier of wafer probers due to a combination of strengths, including a
large installed base, advanced technical capabilities, close relationships with
the leading manufacturers of integrated circuits, a broad line of high quality
products, and a well-established, highly qualified distribution organization.
Building on these capabilities, our strategy is comprised of the following key
elements:






•
            Focus on supplying high-speed
      testing tools that meet our customers’ requirements for accuracy,
      reliability, and production-worthiness. We have refocused our
      efforts on our core technology, wafer probing. We have invested in
      research and development to add features and functionality to our 200mm
      wafer prober products, as well as to improve and expand our advanced 300mm
      wafer probing platform. Beginning in 2007, we began to market our existing
      EG6000 technologies to other equipment manufacturers in other application
      areas such as micro assembly and inspection. We expect to continue to
      invest in research and development of our wafer prober products and
      software to anticipate and address technological
  advances.






•
            Maintain customer
      relationships based on trust and dependability and good service. We
      have long-standing relationships with our customers and we seek to
      strengthen our existing customer relationships by providing high levels of
      service and support. Our development of products and product enhancements
      is market-driven. Marketing, engineering, sales and management personnel
      collaborate with our customers to determine their needs and
      specifications.






•
            Emphasize quality
      products.  We believe in providing high-quality products
      that are dependable tools for our customer’s manufacturing
      processes.






•
            Emphasize outsourcing in
      functional areas where we believe it is cost effective and increases the
      Company’s competitive position.We have outsourced our
      manufacturing to Flextronics Industrial, Ltd. In
      China.   We also have engaged with a number of distributors
      in Asia to sell our products.






Products






Wafer
Probers






Horizon 4000
Series:The 4090μ+ (4090 Micro Plus) was introduced in Q4 2004
and is our new extended performance wafer prober system for 200mm wafers. The
4090μ+ addresses the demands of testing fine pitch devices, semiconductors with
copper interconnects and low k dielectric processes, and other advanced
applications. Employing MicroTouchTM, a feature that decreases the impact force
as the probe pins contact the bond pads, the 4090μ+ reduces touchdown damage
that can occur when testing fragile copper and low k devices or when pads are
located over active circuit geometry. The 4090μ+ increases test cell
availability and throughput while simultaneously reducing test cost by making
improvements in how probe-to-pad alignment is maintained in varying temperature
environments. In addition, the 4090μ+ has simplified and fully automated
operations for high volume manufacturing applications, such as those that exist
in integrated device manufacturer (IDM) and contract test
facilities.  Customers who want to use the latest high productivity
200mm probing solution from Electroglas can also cost-effectively upgrade
existing Electroglas 4080, 4090 and 4090μ prober systems with 4090μ+
technology.






8


The
EG6000:Developed in 2004 and introduced in January 2005, the
new EG6000 300mm probing system from Electroglas is the only 300mm prober that
employs precision direct-drive technology to enable it to achieve the highest
positioning accuracy currently available. Designed for advanced applications
such as copper and low k dielectrics, the system employs a proprietary stage and
control technology enabling highly accurate positioning of the test devices
while moving devices into contact with the probes for test. MicroTouch adds the
ability to control the impact forces while probing on delicate devices. In
addition, patented active vibration cancellation technology reduces internally
and externally generated vibrations while maintaining the integrity of the
connection between devices under test and the probe pins, which can improve test
yield.  It also allows the prober to have higher throughput in typical
test applications with raised test floors that are subject to vibration. The
EG6000 features the new Advanced Vision System for better accuracy, robustness
and speed in aligning devices to the probe card for test. It also features a
sophisticated system for automatically measuring and compensating for thermal
changes in the system components while testing at hot or cold temperatures. The
EG6000 features a broader range of application capabilities as well as many
refinements and improvements in accuracy, throughput, automation, portability,
and reliability. This allows the EG6000 to address customer’s needs for high
volume production wafer test which is the majority of the 300mm prober
market.  During 2007 and 2008, the Company has successfully completed
a number of customer evaluations against its competition, particularly in the
SOC area.




The EG6000t:Introduced in July of 2008, the new EG6000t
      is the second generation of our flagship 300mm wafer prober product line
      that fuses automation and reliability requirements of high volume
      manufacturing environments with the highest caliber of prober technology,
      producing the world’s most accurate 300mm production wafer
      probers.  The EG6000t
      combines improved probe card finding optics, increased wafer pre-align,
      cassette loading and mapping speeds together with increased loader
      pre-alignment accuracy to produce smooth, fast and precise
      operation.  The EG6000t
      also provides a new generation of overall z accuracy with proprietary
      grid-based wafer surface mapping and advanced probe-to-pad alignment
      optics and algorithms.  Along with increased z accuracy, when
      implemented with the MicroTouch feature that allows for precise control of
      z-stage velocities, it enables the EG6000t
      to reduce overall damage to aluminum capped copper pads, low k
      dielectrics, circuitry under pads, in addition to extending the life of
      probe cards used on the tool during production.  These advanced
      features of the EG6000tare
      critical elements when probing advanced device technologies.
              
              Parametric Probers:  The EG6000e,
      introduced in December 2005 is targeted at the parametric test ("e-test")
      segment of the wafer probe market.  This system incorporates patented
      technologiy licensed from Cascade Microtech, Inc. This technology allows
      extremely precise, low-leve electrical measurements to be made at the
      wafer level. This typ of electrical measurement performance is becoming
      increasingly critical for advanced sub-micron semiconductor
      processes.
            
            eg6000t





Test
Floor Management Software Products





SORTmanager: Bridging the gap
between raw data and genuine process improvement is the difference between data
overload and real productivity gains. Electroglas’ SORTmanager provides that
bridge, enabling a secure, web-based environment for the analysis, reporting and
control of sort-floor processes. Data about test results, binning, prober
performance and throughput can be collected from all SORTmanager-connected wafer
probers, and this information can then be delivered via dynamic and interactive
web pages that allow users to view the underlying data or perform additional
analysis.  Powerful web publishing capabilities allow web reports to
be created and distributed throughout an enterprise.  SORTmanager’s flexible
data-access and information viewing capabilities, combined with a comprehensive
suite of pre-built applications and a scripting language for fine tuning
applications to customer needs, makes SORTmanager a unique and
powerful test floor management tool.





Engineering,
Research and Development





The
market for semiconductor manufacturing equipment is characterized by continuous
technological development and a high rate of product innovation. We believe that
continued, rapid development of new products and enhancements to existing
products is necessary to maintain our competitive position. For example, we
devote a significant portion of our personnel and financial resources to
engineering, research and development programs to continue development of our
EG6000 300mm platform. We use our close relationships with our key customers to
make product improvements that respond to our customers’ needs. Engineering,
research and development expenses were $9.1 million, $11.1 million and $11.5
million, for the fiscal years ended May 31, 2008, 2007 and 2006, respectively,
or 20%, 25% and 26% of net sales.





9


Marketing,
Sales and Service





We sell
our products directly to end-users through a direct sales force and
distributors. We generally sell products to customers on net 30 to 60 day terms
from shipment or acceptance. Other, primarily Asian customers are required to
deliver a letter of credit typically payable upon product delivery. We generally
warrant our products for a period of 13 months from the date of shipment for
material and labor repair. Installation and certain training are customarily
included in the price of the product. Customers may enter into repair and
maintenance service contracts covering our products. Our field engineers provide
customers (with products not under warranty or service contracts) with call out
repair and maintenance services. We also train our customers, for a fee, to
perform routine service.





We
maintain sales and service personnel throughout the United States and Europe in
strategic locations to meet our customers’ needs. In Asia we maintain sales and
service offices in the People’s Republic of China, Singapore and
Taiwan.





Customers





We sell
our products to leading semiconductor manufacturers and contract test companies
throughout the world. Customers that accounted for more than 10% of our net
sales were Texas Instruments and ST Microelectronics for the fiscal year ended
May 31, 2008, NXP Semiconductors for the fiscal year ended May 31, 2007, and ST
Microelectronics for the fiscal year ended May 31, 2006. International sales
represented 55%, 56% and 58% of our net sales for the fiscal years ended May 31,
2008, 2007 and 2006, respectively. These sales represent the combined total of
export sales made by United States operations and all sales made by foreign
operations.





Manufacturing
and Suppliers





Our
manufacturing activities consist primarily of integrating components and
subassemblies to create finished probers and spares and upgrades configured to
customer specifications. We schedule production based on firm customer
commitments and anticipated orders during the planning cycle. In December 2002,
we completed our move of equipment manufacturing from San Jose, California to
Singapore to reduce production costs. In September 2007, we signed a five year
Manufacturing Services Agreement (“Agreement”) with Flextronics Industrial, Ltd.
to outsource our Singapore manufacturing to Flextronics in China. As part of
this Agreement, Flextronics accepts purchase orders and forecasts from the
Company which constitute authorization for Flextronics to procure inventory
based on lead times and to procure certain special inventory such as long
lead-time items. This transition from Singapore to China has been completed and
our Singapore factory was closed in April 2008. We believe through outsourcing
our manufacturing we can achieve cost efficiencies and volume
flexibility.  However, we cannot assure you that we will achieve the
expected cost efficiencies and volume flexibility.  In addition to
rapid product innovation, the wafer prober market is subject to significant
price competition and product cost reductions are required. Certain of our
components and subassemblies included in our products are obtained from a single
source. We believe that alternative sources exist or can be developed, if
required. Quality control is maintained throughout the assembly, test, and final
inspection process, with documented instructions and test
procedures.





Backlog





Our
backlog was $13.7 million, $7.6 million and $9.1 million as of May 31, 2008,
2007 and 2006, respectively. Our backlog consists of product orders for which a
customer purchase order has been received and which is scheduled for shipment or
is to be earned within the next twenty-four months. Orders are subject to
cancellation or rescheduling by the customer, sometimes with a cancellation
charge. Due to timing of order placement and product lead times, changes in
product delivery schedules and cancellations, and because sales will often
reflect orders shipped in the same quarter received, our backlog at any
particular date is not necessarily indicative of sales for any succeeding
period. Backlog also includes deferred revenue comprised of products shipped
(but not recognizable as revenue in accordance with our revenue recognition
policy), maintenance revenue that is being amortized over twenty-four months or
less, and services earned or to be performed within the next year.





Competition





The
semiconductor equipment industry is highly competitive. The principal
competitive factors in the industry are product performance, reliability, price,
service and technical support, product improvements, established relationships
with customers, and product familiarity. We believe that our products compete
favorably with respect to these factors. Our major competitors in the prober
market are Tokyo Electron Limited (“TEL”) and Tokyo Seimitsu (“TSK”), both of
which are based in Japan. In this market, these competitors have greater
financial, engineering and manufacturing resources than we have, as well as
larger service organizations and long-standing customer relationships. We cannot
assure you that levels of competition will not intensify or that our
technological advantages will be reduced or lost as a result of technological
advances by competitors or changes in semiconductor processing technology. For a
more detailed discussion of the competition we face, see “Risk
Factors.”





10


Patents,
Trademarks, Copyrights and Other Intellectual Property





We
believe that the success of our business depends more on the technical
competence, creativity and marketing abilities of our employees, rather than on
patents, trademarks and copyrights. Nevertheless, we have a policy of seeking
patents when appropriate on inventions concerning new products and improvements
as part of our ongoing research, development and manufacturing activities. We
own over 30 patents, including five granted in fiscal year 2008 and currently
have three filed and pending. These fiscal year 2008 patents include: Active
Vibration Control (AVC), Dual Loop Controls for improved z accuracy, and
MicroTouch – all key technologies in our EG6000 prober. We also have several
registered United States and international trademarks. We maintain unregistered
copyrights on our software and typically maintain the source code for our
products as a trade secret. We also rely on trade secret protection for our
confidential and proprietary information. We routinely enter into
confidentiality agreements with our employees. There can be no assurance;
however, that others will not independently gain information and techniques or
otherwise gain access to our trade secrets or that we can meaningfully protect
our trade secrets. For a more detailed discussion regarding risks related to our
intellectual property, see “Risk Factors.”





Employees





As of May
31, 2008, we employed 155 people. Many of our employees are highly skilled, and
our success will depend in part upon our ability to attract and retain such
employees, who are in great demand. We have never had a work stoppage or strike,
and there are no employees represented by a labor union or covered by a
collective bargaining agreement. We consider our employee relations to be
good.





Item 1A.  Risk Factors




Semiconductor industry downturns
adversely affect our revenues and operating results. Our business largely
depends on capital expenditures by semiconductor manufacturers and semiconductor
test companies, which in turn depend on the current and anticipated market
demand for integrated circuits and products that use integrated circuits. The
semiconductor industry is highly cyclical and has historically experienced
periods of oversupply resulting in significantly reduced demand for capital
equipment. During a down cycle, we must be in a position to adjust our cost and
expense structure to prevailing market conditions. Our ability to reduce
expenses may be limited by our need to invest in the engineering, research and
development and marketing required to penetrate targeted markets and maintain
customer service and support. During periods of rapid growth, we must be able to
rapidly increase our outsourcing manufacturing capacity and other personnel to
meet customer demand. We cannot assure our investors that these objectives can
be met, which would likely have a material and adverse effect on our business
and operating results.






Our historical financial results
have been, and our future financial results are anticipated to be, subject to
substantial fluctuations.If we do not meet our forecasts and
additional capital is unavailable, we may have insufficient capital available to
us to support our business activities andcontinue to operate our business
pursuant to our current business plan.Total revenues were $45.4 million,
$44.6 million, and $44.3 million, respectively, for the years ended May 31,
2008, 2007 and 2006. We incurred operating losses of $13.1 million, $17.9
million, and $15.7 million for the same periods, respectively. The demand for
our products follows the semiconductor test markets, which remain highly
cyclical and difficult to forecast. Another economic slowdown and/or changes in
demand for our products and services and other factors could continue to
adversely affect our business in the near term, and we may experience additional
declines in revenue and increases in operating losses. We cannot assure our
investors that we will be able to return to operating profitability or that, if
we do, we will be able to sustain it. Our cash, cash equivalents and short-term
investments totaled $16.5 million at May 31, 2008.  Our cash used in
operating activities was $5.3 million during the year ended May 31, 2008.We currently anticipate
that our future cash from operations, available cash and cash equivalents, and
our available credit facilities at May 31, 2008 should be sufficient to meet our
anticipated needs for working capital and capital expenditures through the next
twelve months. Although we are committed to the successful execution of our
operating plan and will take further action as necessary to align our operations
and reduce expenses, there can be no assurance that our cash utilization will
remain at or be reduced below its current level or that we will have sufficient
capital available to us to support our business activities andcontinue to operate our
business pursuant to our current business plan. We cannot assure you that
additional financing,if needed,will be available on terms
favorable to us, or at all. If adequate funds are not
available or are not available on terms favorable to us, we may not be able to
continue to operate our business pursuant to our current business plan and our
ability to run our business would be negatively impacted.






11


Our operating results are subject to
variability and uncertainty, which could negatively impact our stock
price.  We have experienced and expect to continue to
experience significant fluctuations in our results.  Our backlog at
the beginning of each period does not necessarily determine actual sales for any
succeeding period.  Our sales have often reflected orders shipped in
the same period that they were received.  Customers may cancel or
reschedule shipments, and production difficulties could delay
shipments.  For the years ended May 31, 2008, 2007 and 2006 five of
our customers accounted for 51%, 42%, and 51%, respectively, of our net
sales.  If one or more of our major customers delayed, ceased or
significantly curtailed its purchases, it could cause our quarterly results to
fluctuate and would likely have a material adverse effect on our results of
operations.  Other factors that may influence our operating results in
a particular quarter include the timing of the receipt of orders from major
customers, product mix, competitive pricing pressures, the relative proportions
of domestic and international sales, our ability to design, manufacture and
introduce new products on a cost-effective and timely basis, the delay between
expenses to further develop marketing and service capabilities and the
realization of benefits from those improved capabilities, and the introduction
of new products by our competitors.  Accordingly, our results of
operations are subject to significant variability and uncertainty from quarter
to quarter, which could adversely affect our stock price.






If we do not continue to develop and
successfully market our existing products and new products, our business will be
negatively affected.We believe that our future success will
depend in part upon our ability to continue to enhance existing products and to
develop and manufacture new products. As a result, we expect to continue
investing in selective new development programs. There can be no assurance that
we will be successful in the introduction, marketing and cost effective
manufacture of any of our new products; that we will be able to develop and
introduce new products in a timely manner; enhance our existing products and
processes to satisfy customer needs or achieve market acceptance; or that the
new markets for which we are developing new products or expect to sell current
products will develop sufficiently. To develop new products successfully, we
depend on close relationships with our customers and the willingness of those
customers to share information with us. The failure to develop products and
introduce them successfully and in a timely manner could adversely affect our
competitive position and results of operations. Additionally, the customer
evaluation process for our new 300mm prober products can be lengthy and can
consume significant Company resources.  Our future sales will be
impacted by our ability to successfully complete these new product evaluations.
Further, we have begun to market our existing technologies to other industries.
However, there can be no assurance that we will be successful in these efforts,
or that our efforts will result in a significant increase in revenues.






If we do not successfully compete in
the markets in which we do business, our business and results of operations will
be negatively affected.  Our major competitors in the prober
market are Tokyo Electron Limited (“TEL”) and Tokyo Seimitsu (“TSK”), both of
which are based in Japan. In the prober market, these competitors have greater
financial, engineering and manufacturing resources than we do as well as larger
service organizations and long-standing customer relationships. Our competitors
can be expected to continue to improve the design and performance of their
products and to introduce new products with competitive price/performance
characteristics. Competitive pressures may force price reductions that could
adversely affect our operating results. Although we believe we have certain
technological and other advantages over our competitors, maintaining and
capitalizing on these advantages will require us to continue a high level of
investment in engineering, research and development, marketing, and customer
service. We cannot assure you that we will have sufficient resources to continue
to make these investments or that we will be able to make the technological
advances necessary to maintain such competitive advantages.






We have incurred substantial
indebtedness as a result of the sale of convertible Notes.As
of May 31, 2007 the Company had $8.5 million of 5.25% Notes which became due on
June 15, 2007. In March 2007, the Company completed a $25.75 million private
placement of 6.25% Notes. The Company used part of the 6.25% Notes proceeds to
repay in June 2007 the $8.5 million of 5.25% Notes which matured. These 6.25%
Notes are due in 2027; however, the holders have the right in March 2011 and on
various other dates prior to maturity to demand repayment in full. Additionally,
one of the covenants of our debenture agreement with respect to the 6.25% Notes
can be interpreted such that if we are late with any of our required filings
under the Securities Act of 1934, as amended (“1934 Act”), and if we fail to
effect a cure within 60 days, the holders of the 6.25% Notes can put the
6.25% Notes back to the Company, whereby the 6.25% Notes become immediately due
and payable. As a result of our restructuring efforts, the Company has fewer
employees to perform the day-to-day controls, processes and activities which
increases the risk that we will be unable to make timely filings in accordance
with the 1934 Act. These 6.25% Notes could materially and adversely affect our
ability to obtain additional debt financing for working capital, acquisitions or
other purposes, limit our flexibility in planning for or reacting to changes in
our business, reduce funds available for use in our operations and could make us
more vulnerable to industry downturns and competitive pressures. We expect
holders of the 6.25% Notes to convert their notes or require us to purchase our
outstanding 6.25% Notes in March, 2011, the earliest date allowed by the terms
of the 6.25% Notes. Our ability to meet our debt service obligations will be
dependent upon our future performance, which will be subject to financial,
business and other factors affecting our operations, some of which are beyond
our control.




12




If we do not successfully protect
our intellectual property, our business could be negatively
impacted.  Our success depends in significant part on our
intellectual property. While we attempt to protect our intellectual property
through patents, copyrights and trade secrets, we believe that our success will
depend more upon innovation, technological expertise and distribution strength.
There can be no assurance that we will successfully protect our technology or
that competitors will not be able to develop similar technology. No assurance
can be given that the claims allowed on any patents we hold will be sufficiently
broad to protect our technology. In addition, we cannot assure you that any
patents issued to us will not be challenged, invalidated or circumvented, or
that the rights granted thereunder will provide us with competitive
advantages.






Our dependence on contract
manufacturers and sole source suppliers may prevent us from delivering our
products on time, may damage our customer relations, and may harm our
business.  On September 18, 2007, we signed a five year
Manufacturing Services Agreement (“Agreement”) with Flextronics Industrial Ltd.
to outsource our Singapore manufacturing to China.  This agreement requires
us to submit rolling unit forecasts, allows us to reschedule and modify the
forecasts within certain period guidelines, and in certain circumstances allows
us to share the benefits of cost reduction projects.  We believe through
outsourcing our manufacturing we can achieve cost efficiencies, volume
flexibility, and better lead times.  We cannot assure you that we will not
experience short term manufacturing challenges such as delays in shipping or
that we will achieve the expected cost efficiencies and volume
flexibility.  Further, reliance on a single third-party manufacturer
exposes us to significant risks, especially inadequate capacity, late delivery,
substandard quality and high costs. We cannot be certain that existing or future
contract manufacturers will be able to manufacture our products on a timely and
cost-effective basis, or to our quality and performance specifications. Should
our contract manufacturer be unable to meet our manufacturing requirements in a
timely manner, whether as a result of transitional issues or otherwise, our
ability to ship orders and to realize the related revenues when anticipated
could be materially impacted.






We also
use numerous suppliers to supply components and subassemblies for the
manufacture and support of our products and systems. While we make reasonable
efforts to ensure that such components and subassemblies are available from
multiple suppliers, this is not always possible.  Although we seek to
reduce our dependence on these limited source suppliers, disruption or
termination of certain of these sources could occur and such disruptions could
have at least a temporary adverse effect on our results of operations and damage
our customer relationships. Moreover, a prolonged inability to obtain certain
components, or a significant increase in the price of one or more of these
components, could have a material adverse effect on our business, financial
condition and results of operations.




As part
of our Agreement with Flextronics, Flextronics accepts purchase orders and
forecasts from the Company which constitute authorization for Flextronics to
procure inventory based on lead times and to procure certain special inventory
such as long lead-time items. The Company does not take ownership of these
Flextronics orders until the finished products are ready to be shipped on behalf
of  the Company.  Flextronics open commitments and inventory
on hand at May 31, 2008, based on the Company’s forecasts, were valued at $18.6
million.  If the Flextronics inventory goes unused, the Company may be
assessed carrying charges or obsolete charges which could have a negative impact
on our results of operations.




Ifwe do not successfully address the
challenges inherent in conducting international sales and operations, our
business and results of operations will be negatively
impacted.  We have experienced fluctuations in our
international sales and operations.  International sales accounted for
55%, 56%, and 58% of our net sales for the years ended May 31, 2008, 2007 and
2006, respectively.  We expect international sales to continue to
represent a significant percentage of net sales.  We are subject to
certain risks inherent in doing business in international markets, one or more
of which could adversely affect our international sales and operations,
including:




•          the
imposition of government controls on our business and/or business
partners;


•          fluctuations
in the United States dollar, which could increase our foreign sales prices in
local currencies;


•          export
license requirements;


•          restrictions
on the export of technology;


•          changes
in tariffs;


•          legal
and cultural differences in the conduct of business;


•          difficulties
in staffing and managing international operations;


•          strikes;


•          longer
payment cycles;


•          difficulties
in collecting accounts receivable in foreign countries;


•          withholding
taxes that limit the repatriation of earnings;


•          trade
barriers and restrictions;


•          immigration
regulations that limit our ability to deploy employees;


•          political
instability;


•          war
and acts of terrorism;


•          natural
disasters; and


•          variations
in effective income tax rates among countries where we conduct
business.




13


Although
these and similar regulatory, geopolitical and global economic factors have not
yet had a material adverse effect on our operations, there can be no assurance
that such factors will not adversely impact our operations in the future or
require us to modify our current business practices. In addition, the laws of
certain foreign countries where we do business may not protect our intellectual
property rights to the same extent as do the laws of the United States. Further,
we have found it difficult to penetrate the large Japanese market, which
represents a significant percentage of the worldwide wafer prober
market.  Our past sales in Japan have not been
significant.






In
addition, an increasing portion of our products and the products we purchase
from our suppliers are sourced or manufactured in foreign locations, including
Singapore and China, and a large portion of the devices our products test are
fabricated and tested by foundries and subcontractors in Taiwan, Singapore,
China and other parts of Asia. As a result, we are subject to a number of
economic and other risks, particularly during times of political or financial
instability in these regions. Disruption of manufacturing or supply sources in
these international locations could have a material adverse impact on our
ability to fill customer orders and potentially result in lost
business.






Our business will be harmed if we
cannot hire and retain key personnel.  Our future success
partly depends on our ability to hire and retain key personnel. We also need to
attract additional skilled personnel in all areas to grow our business. While
many of our current employees have many years of service with us, there can be
no assurance that we will be able to retain our existing personnel or attract
additional qualified employees in the future. We deem stock options to be an
important part of our employees’ compensation.  With our Common Stock
trading at a price below the exercise price of most of our outstanding stock
options, this may impact our ability to hire and retain key
personnel.




Our outsource providers and
distributors may fail to perform as we expect.Outsource
providers have played and will play key roles in our manufacturing operations
and in many of our transactional and administrative functions, such as
information technology, facilities management, and certain elements of our
finance organization.  Also, we rely on distributors in certain
geographies to sell our products.  Although we aim at selecting
reputable providers and secure their performance on terms documented in written
contracts, it is possible that one or more of these providers could fail to
perform as we expect and such failure could have an adverse impact on our
business.  In addition, the expansive role of outsource providers has
required and will continue to require us to implement changes to our existing
operations and to adopt new procedures to deal with and manage the performance
of the outsource providers.  Any delay or failure in the
implementation of our operational changes and new procedures could adversely
affect our customer relationships and/or have a negative effect on our operating
results.




Material weaknesses or deficiencies
in our internal control over financial reporting could harm stockholder and
business confidence in our financial reporting. Maintaining an effective system of internal control
over financial reporting is necessary for us to provide reliable financial
reports.  Further, Section 404 of the Sarbanes-Oxley Act of 2002 requires
our management to report on the effectiveness of our internal control structure
and procedures for financial reporting each year.  As described in
Item 9A(T) — Controls and Procedures, management, under the
supervision of the Chief Executive Officer (CEO) and Chief Financial Officer
(CFO), conducted an evaluation of our disclosure controls and procedures and
internal control over financial reporting. Based on those evaluations, the CEO
and CFO identified material weaknesses in internal control over financial
reporting related to revenue recognition and inventory reserves.  More
specifically, appropriate evidence documenting persuasive evidence of an
arrangement was lacking resulting in year-end audit adjustments to reverse
revenue and inventory reserves were incorrectly adjusted in a manner which was
not consistent with the Company’s policies or in accordance with generally
accepted accounting principles.  A material weakness is a deficiency,
or a combination of deficiencies, in internal control over financial reporting,
such that there is a reasonable possibility that a material misstatement of the
company’s annual or interim financial statements will not be prevented or
detected on a timely basis.  As a result of these material weaknesses in
revenue recognition procedures and inventory reserves, our management concluded
that our disclosure controls and procedures and internal control over financial
reporting were not effective as of May 31, 2008.  We plan to remediate
these material weaknesses by: improving training of our sales force and
accounting personnel on our revenue and inventory reserve policies and
procedures, ensuring that appropriate evidence of an arrangement exists for
revenue transactions, reviewing shipping terms to ensure proper revenue
recognition under current arrangements, and adding controls around changes in
shipping terms from other than EXWorks which is the standard commercial shipping
terms used by the Company.  We cannot assure you however that the
measures we have taken will remediate these material weaknesses identified or
that any additional material weaknesses will not arise in the future due to our
failure to implement and maintain adequate internal controls over financial
reporting. In addition, even if we are successful in strengthening our controls
and procedures, those controls and procedures may not be adequate to prevent or
identify irregularities or ensure the fair presentation of our financial
statements included in our periodic reports filed with the
Commission.


Our business may be harmed if we
cannot maintain our listing on the NASDAQ Capital Market.To maintain our listing
on the NASDAQ Capital Market we must satisfy certain minimum financial and other
continued listing standards, including, among other requirements, (i) a $1.00
minimum bid price requirement and (ii) a $2.5 million minimum stockholder’s
equity requirement, $500,000 minimum net income requirement or $35 million
minimum market value of listed securities requirement. As of July 24, 2008, the
bid price of our common stock was $1.30 per share and our approximate market
value for listed securities was $34.5 million.  Further, as of May 31, 2008
our stockholders' equity was $3.9 million and our net loss was $15.9 million for
fiscal year ended May 31, 2008.  There can be no assurance we will
continue to meet the continued listing requirements for the NASDAQ Capital
Market, or that we will not be delisted from the NASDAQ Capital Market in the
future.  The delisting of our Common Stock could have a material
adverse effect on the trading price, liquidity, value and marketability of our
Common Stock.




14


Item
1B.  Unresolved Staff
Comments





None.





Item 2.  Properties





In
February 2005, we entered into an agreement with 5729 Fontanoso Way, LLC to
lease 78,000 square feet for our corporate headquarters. This facility includes
most of the Company’s engineering, marketing, and general and administrative
functions. The term of this lease is five years with an option to renew for an
additional five years.





Item 3.Legal
Proceedings





We are
not currently involved in any legal actions that we believe are material. From
time to time, however, we may be subject to various claims and lawsuits by
customers, suppliers, competitors, and employees arising in the normal course of
business, including suits charging infringement or violations of antitrust laws.
Such suits may seek substantial damages and, in certain instances, any damages
awarded could be trebled.





Item 4.  Submission of Matters
to a Vote of Security Holders





No
matters were submitted to a vote of our security holders during the fourth
quarter ended May 31, 2008.





Part II





Item 5.  Market for the Registrant’s Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities





Market
Prices for Common Stock





Our
common stock is traded on the Nasdaq Capital Market under the symbol “EGLS”. The
following table sets forth for the periods indicated the closing high and low
sales prices per share.





Quarter
            
            Year
      2008
            
            Year
      2007High
            Low
            
            High
            Low1st
            
            $2.75
            $1.95
            
            $3.81
            $2.292nd
            
            $2.70
            $1.27
            
            $3.22
            $2.393rd
            
            $1.94
            $1.23
            
            $2.99
            $2.294th
            
            $2.06
            $1.12
            
            $2.55
            $1.92








On July
24, 2008, the closing price of our common stock was $1.30. We have never
declared or paid cash dividends and we do not anticipate paying cash dividends
in the foreseeable future. Also, the terms of the Company’s 6.25% Notes restrict
the Company from paying dividends. We currently intend to retain any future
earnings to fund the development and growth of our business. As of July 24,
2008, we had approximately 2,600 stockholders of record.





15


The
following graph compares the cumulative 53-month total return of holders of
Electroglas, Inc.'s common stock relative to the cumulative total returns of the
NASDAQ Composite index and the RDG Semiconductor Composite index. The graph
tracks the performance of a $100 investment in our Common Stock and in each
of the indexes (with the reinvestment of all dividends) from December 31, 2003
to May 31, 2008.





12/03
            12/04
            5/05
            5/06
            5/07
            5/08Electroglas,
      Inc.
            
            100.00
            129.04
            95.62
            95.34
            59.45
            51.51NASDAQ
      Composite
            
            100.00
            110.06
            104.45
            112.16
            135.12
            130.67RDG
      Semiconductor Composite
            
            100.00
            79.75
            83.34
            82.92
            91.63
            89.54





The stock
price performance included in this graph is not necessarily indicative of future
stock price performance.


16








Item 6.  Selected Financial Data








Years
      ended May 31,
            
            
            Five
      months ended
            
            
            Years
      ended December 31,In
      thousands, except per share data
            
            2008
            
            
            2007
            
            
            2006
            
            
            May
      31, 2005
            
            
            2004
            
            
            2003Net
      sales
            
            $
            45,421
            
            
            $
            44,624
            
            
            $
            44,317
            
            
            $
            11,223
            
            
            $
            63,004
            
            
            $
            44,967Gross
      profit (1)
            
            
            12,414
            
            
            
            9,483
            
            
            
            12,303
            
            
            
            1,109
            
            
            
            22,810
            
            
            
            220Engineering,
      research and development
            
            
            9,102
            
            
            
            11,073
            
            
            
            11,510
            
            
            
            5,524
            
            
            
            16,194
            
            
            
            21,785Sales,
      general and administrative
            
            
            14,475
            
            
            
            16,593
            
            
            
            16,153
            
            
            
            7,038
            
            
            
            17,182
            
            
            
            33,559Restructuring
      charges
            
            
            1,580
            
            
            
            129
            
            
            
            239
            
            
            
            -
            
            
            
            979
            
            
            
            3,909Impairment
      charges
            
            
            359
            
            
            
            -
            
            
            
            89
            
            
            
            86
            
            
            
            4,251
            
            
            
            6,254Indemnification
      release
            
            
            -
            
            
            
            (459
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Gains
      on sales of product lines
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (7,872
            )Operating
      loss
            
            
            (13,102
            )
            
            
            (17,853
            )
            
            
            (15,688
            )
            
            
            (11,539
            )
            
            
            (15,796
            )
            
            
            (57,415
            )Interest
      expense, net
            
            
            (1,410
            )
            
            
            (487
            )
            
            
            (982
            )
            
            
            (499
            )
            
            
            (2,077
            )
            
            
            (2,822
            )Gain
      on sale of long term investment
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,545
            
            
            
            -Gain
      on settlement of long term liability
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            8,273
            
            
            
            -Debt
      conversion expense
            
            
            -
            
            
            
            -
            
            
            
            (17,603
            )
            
            
            -
            
            
            
            -
            
            
            
            -Gain
      (loss) on mark to market of financial instrumentrelated
      to convertible debt
            
            
            85
            
            
            
            (154
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Other
      income (expense), net
            
            
            (855
            )
            
            
            (280
            )
            
            
            (385
            )
            
            
            (350
            )
            
            
            (260
            )
            
            
            112Net
      loss before income taxes
            
            
            (15,282
            )
            
            
            (18,774
            )
            
            
            (34,658
            )
            
            
            (12,388
            )
            
            
            (6,315
            )
            
            
            (60,125
            )Provision
      (benefit) for income taxes
            
            
            651
            
            
            
            9
            
            
            
            (628
            )
            
            
            5
            
            
            
            57
            
            
            
            (1,153
            )Net
      loss
            
            $
            (15,933
            )
            
            $
            (18,783
            )
            
            $
            (34,030
            )
            
            $
            (12,393
            )
            
            $
            (6,372
            )
            
            $
            (58,972
            )Basic
      and diluted net loss per share
            
            $
            (0.60
            )
            
            $
            (0.71
            )
            
            $
            (1.53
            )
            
            $
            (0.57
            )
            
            $
            (0.30
            )
            
            $
            (2.76
            )Shares
      used in basic and diluted calculations
            
            
            26,395
            
            
            
            26,285
            
            
            
            22,178
            
            
            
            21,762
            
            
            
            21,534
            
            
            
            21,343Working
      capital
            
            $
            22,498
            
            
            $
            33,814
            
            
            $
            32,524
            
            
            $
            54,433
            
            
            $
            69,865
            
            
            $
            43,463Total
      assets
            
            $
            43,361
            
            
            $
            65,834
            
            
            $
            62,672
            
            
            $
            83,990
            
            
            $
            95,619
            
            
            $
            110,155Convertible
      notes
            
            $
            23,610
            
            
            $
            31,337
            
            
            $
            8,330
            
            
            $
            32,413
            
            
            $
            34,123
            
            
            $
            33,630Total
      stockholders' equity
            
            $
            3,918
            
            
            $
            15,503
            
            
            $
            33,182
            
            
            $
            32,432
            
            
            $
            44,662
            
            
            $
            50,265





(1)
            Gross
      profit for 2007 includes a $2.8 million inventory provision due to a
      reduced forecast for the strip handler product line, net of $0.6 million
      of that reserved inventory which was subsequently sold. The Company also
      recorded, during 2007, a $0.7 million provision for excess inventory
      related to its 2001 product line and $0.4 million for other inventory
      provisions. Gross profit for 2003 includes $3.2 million for inventory
      provisions, $3.7 million in write-offs of unreserved inventories, and $2.7
      million in warranty charges.


17





Quarterly
Consolidated Financial Data (Unaudited)





Quarters
      endedIn
      thousands, expect per share data
              
              May
      31, 2008
              
              
              March
      1, 2008
              
              
              December
      1, 2007
              
              
              September
      1, 2007Net
      Sales
              
              $
              11,996
              
              
              $
              11,553
              
              
              $
              11,381
              
              
              $
              10,491Gross
      profit
              
              $
              2,802
              
              
              $
              2,918
              
              
              $
              3,098
              
              
              $
              3,596Net
      loss
              
              $
              (5,554
              )
              
              $
              (3,748
              )
              
              $
              (3,333
              )
              
              $
              (3,298
              )Basic
      and diluted net loss per share
              
              $
              (0.21
              )
              
              $
              (0.14
              )
              
              $
              (0.13
              )
              
              $
              (0.13
              )Quarters
      endedIn
      thousands, expect per share data
              
              May
      31, 2007
              
              
              March
      3, 2007
              
              
              December
      2, 2006
              
              
              September
      2, 2006Net
      Sales
              
              $
              8,701
              
              
              $
              9,809
              
              
              $
              12,581
              
              
              $
              13,533Gross
      profit (1)
              
              $
              529
              
              
              $
              3,080
              
              
              $
              3,891
              
              
              $
              1,983Net
      loss
              
              $
              (6,609
              )
              
              $
              (3,123
              )
              
              $
              (3,226
              )
              
              $
              (5,825
              )Basic
      and diluted net loss per share
              
              $
              (0.25
              )
              
              $
              (0.12
              )
              
              $
              (0.12
              )
              
              $
              (0.22
              )
 
 (1)
              Gross
      profit for 2007 includes: in the first quarter – a $3.4 million inventory
      provision due to a reduced forecast for the strip handler product line; in
      the second quarter - $0.6 million of a reversal of inventory reserves from
      the sale of strip handler products. During Q4 2007, the Company recorded a
      $0.7 million provision for excess inventory related to its 2001 product
      line and $0.4 million for other inventory
  provisions.


Item 7.Management’s Discussion
and Analysis of Financial Condition and Results of
Operations





Executive
Overview




We are a
supplier of semiconductor manufacturing equipment and software to the global
semiconductor industry. Our primary product line is automated wafer probing
equipment.  In conjunction with automated test systems from other
suppliers, our semiconductor manufacturing customers use our wafer probers to
quality test semiconductor wafers. Electroglas has sold over 16,500 wafer
probers and its installed base is one of the largest in the industry.
Beginning in 2007, we began to market our existing EG6000 technologies to other
equipment manufacturers in other application areas such as micro assembly and
inspection.  These companies, in addition to semiconductor, sell into
the medical and solar fields.






Our
customers consist primarily of chip manufacturers and contract test companies.
The demand for our products follows the semiconductor test markets, which remain
highly cyclical and difficult to forecast. The EG6000, which represents a major
advancement in prober design and automation and is focused on providing better
performance than currently available from competitors’ products,was developed to serve
this much larger production test market.






To stay
competitive, grow our business over the long term, improve our gross margins,
and generate operating cash flows, we must continue to invest in new
technologies and product enhancements and at the same time, as necessary,
rapidly adjust our expense structure during the hard to predict cyclical
semiconductor equipment demand cycles.  Due to the cyclicality of the
semiconductor equipment industry and the resulting market pressures, we are
focusing our efforts in the following areas:




•
            Controlling
      and aligning our costs, through outsourcing and streamlining to move to
      break-even and then profitable levels of operation, including positive
      operating cash flows;


•
            Developing
      successful products and services to meet market windows in our target
      markets, and marketing our existing technologies to other
      industries;


•
            Working
      with our manufacturing outsourcing vendor, Flextronics, to achieve a more
      variable cost model and to cost reduce our
  products;


•
            Completing
      new customer evaluations of our 300mm products;
  and


•
            Preparing
      ourselves for increases in customer demand while at the same time
      maintaining expense control and limiting increases in our cost
      structure.




There can
be no assurances that these efforts will be successful. In order to become
profitable, our market share for our products must improve.




18




Additional
information about Electroglas is available on our website (www.electroglas.com).
Electroglas makes available free of charge on our website our Reports filed
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as
amended, as soon as reasonably practicable after we electronically file them
with the Securities Exchange Commission (“SEC”). The public may read and copy
any materials that we file with the SEC at the SEC’s Public Reference Room
(1-800-SEC-0330) at 100 F Street, NE, Washington, D.C. 20549. Our filings are
also available at the SEC’s website at http://www.sec.gov.




Critical
Accounting Policies and Estimates




General:Our
discussion and analysis of our financial condition and results of operations are
based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United
States.






Use of Estimates: The
preparation of our financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and
liabilities.  On an on-going basis, we evaluate our estimates,
including those related to revenue recognition, inventory valuation, warranties,
allowance for doubtful accounts, tax allowances and reserves, stock based
compensation, valuation of long-lived assets, and accruals for such items as
restructuring reserves.  We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for our judgments
about the carrying values of assets and liabilities.  Actual results
may differ materially from these estimates under different assumptions or
conditions.






We
believe the following critical accounting policies involve more significant
judgments or estimates used in the preparation of our consolidated financial
statements. Senior management has discussed the development and selection of
these critical accounting policies and estimates with the Company’s audit
committee.






Revenue recognition:Revenue
is recognized on the sale of the Company’s equipment when a customer purchase
order or contract has been received, when the products or services have been
delivered, when the total purchase price can be assured without making
significant concessions, and when the Company’s ability to collect from its
customer has been assured.  In recognizing revenue the Company makes
certain assumptions and estimates, namely: (i) the Company considers a new
system routinely accepted in the marketplace when three to five successful
installations, based on our acceptance criteria, have been put into customer
production; (ii) the Company considers systems, delivered separately from
options, to have value to our customers on a stand alone basis if we have fair
value of the options and the options are not significant to the total amount of
the order and the options are not essential to the functionality of the system;
(iii) the Company considers systems, delivered separately from installation, to
have value to its  customers on a stand-alone basis because the
equipment can readily be sold by the customer, customers are capable of
installing the systems without the support of our installers, installation is
routine and inconsequential to the total value of the transaction, we have fair
value and routinely sold on a stand-alone basis; and (iv) for most customers the
Company assumes that, based on past history, it will continue to collect its
receivables from them without payment or product concessions, despite the fact
that they have larger financial size relative to the Company and despite its
dependence on them in a heavily concentrated industry. In an arrangement with
multiple deliverables, such as installation and services, the delivered items
are considered a separate unit of accounting if all of the following criteria
are met: (i) the delivered items have value to the customer on a stand-alone
basis, (ii) vendor specific objective evidence (VSOE) of fair value exists,
which is based on the average price charged when each element is sold
separately, for the undelivered elements, and (iii) if the arrangement does not
include a general right of return relative to a delivered item, or if
performance of the undelivered item is considered probable and substantially in
the control of the Company.  If the Company cannot objectively
determine the fair value of any undelivered element included in a multiple
element arrangement, the Company defers revenue until all elements are delivered
and the service has been performed, or until fair value can be objectively
determined for any remaining undelivered elements.  Where the Company
sells to distributors, revenue is deferred until resale to the
end-customers.  Sales to distributors do not represent a material amount of
the Company's sales.  Revenue related to maintenance and service contracts
is recognized ratably over the duration of the contracts.






Inventory valuation:
Inventories are stated at lower of cost or market (estimated net realizable
value) using the FIFO method.  We periodically review the carrying
value of inventories and non-cancelable purchase commitments, including
inventories at Flextronics, by reviewing sales forecasts, material usage
requirements, and by reviewing the impact of changes in technology on our
products (including engineering design changes). These forecasts of changes in
technology, future sales and pricing are estimates. We may record charges to
write down inventories based on these reviews and forecasts. If there is weak
demand in the semiconductor equipment markets and orders fall below our
forecasts, additional write downs of inventories may be required which will
negatively impact gross margins. Inventory impairment charges are considered to
permanently establish a new cost basis for inventory and are not subsequently
reversed to income even if circumstances later suggest that increased carrying
amounts are recoverable, except when the associated inventory is disposed of or
sold. Inventory purchase commitments considered excess or losses on purchase
commitments above market prices are accrued in the period in which such
determinations are made.




19




Warranty:We generally
warrant our products for a period of thirteen months from the date of shipment
and we accrue a liability for the estimated cost of warranty.  For our
established products, this accrual is based on historical experience; and for
our newer products, this accrual is based on estimates from similar
products.  In addition, from time to time, specific warranty accruals
are made for specific technical problems.  If we experience unforeseen
technical problems with our products in future periods to meet our product
warranty requirements, revisions to our estimated cost of warranty may be
required, and our gross margins will be negatively
impacted.  Estimates have historically approximated actual
results.






Allowance for doubtful
accounts:We closely monitor the collection of our accounts
receivable and record a general allowance based on the age of the receivables
and a specific reserve for identified amounts that we believe are not
recoverable. We sell primarily to large, well-established semiconductor
manufacturers and semiconductor test companies and we have not experienced
significant accounts receivable losses in the past. We have, however, from time
to time experienced slowdowns in receivable collections, especially during
semiconductor equipment down cycles, as customers extend their payment schedules
to conserve their cash balances. If our customers continue to experience down
cycles or if their financial conditions deteriorate, we may be required to
increase our allowance for doubtful accounts. If a customer demonstrates a
pattern of renegotiating terms or requesting concessions prior to payment, we
would defer revenue until the price was considered fixed and determinable.
Estimates have historically approximated actual results.






Accounting for Income
Taxes:The Company adopted FIN 48 “Accounting for Uncertainty
in Income Taxes – An Interpretation of FASB Statement No. 109” on June 1, 2007,
the first day of the first quarter of fiscal 2008.  FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return that results in a tax benefit. Additionally, FIN 48 provides guidance
on de-recognition of deferred tax assets and liabilities, statement of
operations classification of interest and penalties, accounting in interim
periods, disclosure, and transition.  In connection with our implementation
of FIN 48, we reevaluated all of our significant tax positions and based upon
this evaluation we concluded that our deferred tax assets and liabilities did
not differ significantly from our recorded deferred tax assets and liabilities
prior to adoption.  Therefore, we did not record any adjustments as of
the adoption date.  At the adoption date of June 1, 2007, we had
approximately $7.7 million of total gross unrecognized tax benefits, all of
which would impact our effective tax rate if recognized. We continue to
recognize interest and penalties related to uncertain tax positions in income
tax expense.






As part
of the process of preparing our consolidated financial statements, we are
required to estimate our income taxes. This process involves estimating our
actual current tax liability together with assessing temporary differences that
may result in deferred tax assets. Management judgment is required in
determining any valuation allowance recorded against our net deferred tax
assets. We establish estimates for these allowances and reserves based on
historical experience and other assumptions.  It is our policy to
accrue for tax exposures or to release tax reserves in the period in which the
facts and circumstances arise that suggest that the valuation allowances or
reserves should be modified. We will continue to record a full valuation
allowance on domestic tax benefits until we can sustain an appropriate level of
profitability. The amount of income taxes we pay is subject to ongoing audits by
federal, state and foreign tax authorities which might result in proposed
assessments. Our estimate for the potential outcome for any uncertain tax issue
is judgmental in nature. However, we believe we have adequately provided for any
reasonable foreseeable outcome related to those matters. Our future results may
include favorable or unfavorable adjustments to our estimated tax liabilities in
the period the assessments are made or resolved or when statutes of limitation
on potential assessments expire.






Long-lived
assets:  We evaluate the carrying value of long-lived assets,
consisting primarily of equipment and leasehold improvements, whenever certain
events or changes in circumstances indicate that the carrying amount of these
assets may not be recoverable.  Charges related to asset impairments
are recorded in accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets”.






Restructuring
charges:We recognize a liability for restructuring costs at
fair value only when the liability is incurred. The three main components of our
restructuring charges are workforce reductions, consolidating facilities and
asset impairments. Workforce-related charges are accrued when it is determined
that a liability has been incurred, which is generally when individuals have
been notified of their termination dates and expected severance payments. Plans
to eliminate excess facilities result in charges for lease termination fees and
future commitments to pay lease charges, net of estimated future sublease
income. We recognize charges for elimination of excess facilities when we have
vacated the premises. Asset impairments primarily consist of property, plant and
equipment associated with excess facilities being eliminated, and are based on
an estimate of the amounts and timing of future cash flows related to the
expected future remaining use and ultimate sale or disposal of the property,
plant and equipment.  These estimates were derived using the guidance
of Statement of Financial Accounting Standards ("SFAS") No.  146
"Accounting for Exit or Disposal Activities" ("SFAS No. 146") which was
effective for exit and disposal activities initiated after December 31,
2002. If the amounts and timing of cash flows from restructuring activities are
significantly different from what we have estimated, the actual amount of
restructuring and asset impairment charges could be materially different, either
higher or lower, than those we have recorded.




20




Stock based compensation expense:We estimate the value of employee stock based awards on the date of grant
using the Black-Sholes model and amortize these costs on a straight-line basis
over the requisite service periods of the awards.  Under SFAS 123(R)
“Share-Based Payment”, the determination of fair value of share-based payment
awards on the date of grant using an option-pricing model is affected by our
stock price as well as assumptions regarding a number of highly complex and
subjective variables, such as:




Expected
volatility – historical volatility of the Company’s stock price.


Expected
term – historical data on employee exercises and post-vesting employment
termination behavior.


Risk free
interest rate – an implied yield currently based on United States Treasury
rates.


Estimated
forfeitures – historical option forfeitures over a given period.


Dividend
yield – historical rate of dividend payments




Results
of Operations





YearsPercentage
      of net sales
            
            2008
            
            
            2007
            
            
            2006Net
      sales
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of sales
            
            
            72.7
            
            
            
            78.7
            
            
            
            72.2Gross
      profit
            
            
            27.3
            
            
            
            21.3
            
            
            
            27.8Operating
      expenses:Engineering,
      research and development
            
            
            20.0
            
            
            
            24.8
            
            
            
            26.0Sales,
      general and administrative
            
            
            31.9
            
            
            
            37.2
            
            
            
            36.5Restructuring
      charges
            
            
            3.5
            
            
            
            0.3
            
            
            
            0.5Impairment
      charges
            
            
            0.8
            
            
            
            -
            
            
            
            0.2Indemnification
      release
            
            
            -
            
            
            
            (1.0
            )
            
            
            -Total
      operating expenses
            
            
            56.2
            
            
            
            61.3
            
            
            
            63.2Operating
      loss
            
            
            (28.9
            )
            
            
            (40.0
            )
            
            
            (35.4
            )Interest
      income
            
            
            2.3
            
            
            
            1.4
            
            
            
            2.7Interest
      expense
            
            
            (5.4
            )
            
            
            (2.5
            )
            
            
            (4.9
            )Debt
      conversion expense
            
            
            -
            
            
            
            -
            
            
            
            (39.7
            )Gain
      (loss) on mark to market of financial instrumentrelated
      to convertible debt
            
            
            0.2
            
            
            
            (0.4
            )
            
            
            -Other
      expense, net
            
            
            (1.9
            )
            
            
            (0.6
            )
            
            
            (0.9
            )Loss
      before income taxes
            
            
            (33.7
            )
            
            
            (42.1
            )
            
            
            (78.2
            )Provision
      (benefit) for income taxes
            
            
            1.4
            
            
            
            -
            
            
            
            (1.4
            )Net
      loss
            
            
            (35.1
            )
      %
            
            
            (42.1
            )
      %
            
            
            (76.8
            )
      %





21


Net
Sales




Net sales
are comprised of systems and aftermarket products and services sales, consisting
primarily of services, spare parts, upgrades, and refurbished systems. Service
revenue, included in aftermarket prober products and service was 10%, 11% and
10% of net sales for the years ended May 31, 2008, 2007, and 2006,
respectively.  Net sales of our products are as follows:







YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Systems
            
            $
            27,595
            
            
            $
            26,084
            
            
            $
            27,074Aftermarket
      products and service
            
            
            17,826
            
            
            
            18,540
            
            
            
            17,243$
            45,421
            
            
            $
            44,624
            
            
            $
            44,317







Net sales
increased 2% in 2008 as compared to 2007 because of increased EG6000 and 4090
system sales ($2.9 million), and software royalties ($0.3 million), offset by
lower sales of aftermarket products ($1.7 million) and Sidewinder, strip test
handler ($0.6 million).  Net sales were up slightly in 2007 as
compared to 2006.  The demand for our products follows the
semiconductor test markets, which remain highly cyclical and difficult to
forecast.  As a result of uncertainties in this market environment,
any rescheduling or cancellation of planned capital purchases by our customers
will cause our sales to fluctuate.






Net
sales amounts and as a percentage of sales were as follows:




YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Asia
            
            $
            16,056
            
            
            
            35
            %
            
            $
            13,704
            
            
            
            31
            %
            
            $
            15,924
            
            
            
            36
            %Europe
            
            
            8,885
            
            
            
            20
            
            
            
            11,355
            
            
            
            25
            
            
            
            9,804
            
            
            
            22International
            
            
            24,941
            
            
            
            55
            %
            
            
            25,059
            
            
            
            56
            %
            
            
            25,728
            
            
            
            58
            %North
      America
            
            
            20,480
            
            
            
            45
            
            
            
            19,565
            
            
            
            44
            
            
            
            18,589
            
            
            
            42$
            45,421
            
            
            
            100
            %
            
            $
            44,624
            
            
            
            100
            %
            
            $
            44,317
            
            
            
            100
            %





We expect
international sales to continue to represent a significant percentage of net
sales and fluctuate as individual manufacturers and semiconductor test companies
address their capacity needs at differing stages of the semiconductor demand
cycle. During 2006 through 2008, we experienced weakness in sales across all of
our major geographic regions due to industry conditions and slow customer
acceptance of our 300mm products.





Gross
Profit





YearsIn thousands
            
            2008
            
            
            2007
            
            
            2006Gross
      Profit
            
            $
            12,414
            
            
            $
            9,483
            
            
            $
            12,303Gross
      profit as a % of net sales
            
            
            27.3
            %
            
            
            21.3
            %
            
            
            27.8
            %





The
increase in gross profit in 2008 compared to 2007 was primarily due to higher
systems sales with higher average ASP’s ($0.9 million), and lower net inventory
provisions in 2007 related to the strip handler product compared to the prior
year ($2.8 million), offset by higher period costs due to duplicate factories,
Singapore and Flextronics in China ($1.6 million).  The decline in
gross profit


in
2007 compared to 2006 was primarily due to higher inventory provisions of $2.8
million due to a reduced forecast for the strip test handler product line in
2007.





We
periodically review the carrying value of our inventories and noncancelable
inventory purchase commitments by evaluating material usage and manufacturing
requirements to determine inventory obsolescence and excess quantities, and we
reduce the carrying value of these inventories when appropriate.





We
believe that our gross profit will continue to be affected by a number of
factors, including changes in demand for semiconductors, competitive pressures
on average selling prices and product mix. Continued weak demand and changes in
market conditions may cause orders to be below forecasts, which may result in
additional excess inventory, which would cause additional write-downs of
inventories and would negatively impact our gross profit margins.





22


Engineering,
Research and Development Expenses (ER&D)





YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006ER&D
            
            $
            9,102
            
            
            $
            11,073
            
            
            $
            11,510ER&D
      as a % of net sales
            
            
            20.0
            %
            
            
            24.8
            %
            
            
            26.0
            %




In 2008
versus 2007, the decrease in ER&D was mainly due to a reduction in headcount
and related personnel expenses of $0.9 million and reduced development and
evaluation costs of $1.1 million as part of our cost containment
measures.  In 2007 versus 2006, the decrease in ER&D was mainly
due to reduced payroll and related personnel charges of $0.6 million as well as
lower infrastructure and facility costs of $0.3 million, partially offset by
higher development and evaluation costs for the EG6000 product line of $0.6
million. Engineering, research and development expenses consist primarily of
salaries, project materials, consultant fees, and other costs associated with
our ongoing efforts in product development and enhancement.




Selling,
General and Administrative Expenses (SG&A)





YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006SG&A
            
            $
            14,475
            
            
            $
            16,593
            
            
            $
            16,153SG&A
      as a % of net sales
            
            
            31.9
            %
            
            
            37.2
            %
            
            
            36.5
            %




In 2008
versus 2007, the decrease was primarily due to a decrease in headcount and
related personnel costs of $1.1 million and reduced product evaluation costs,
audit fees, and discretionary costs of $0.4 million, $0.2 million, and $0.3
million, respectively.  In 2007 versus 2006, the increase in absolute
dollars was primarily due to increased new product evaluation costs of $0.9
million and audit fees of $0.4 million, offset by lower payroll and related
personnel charges of $0.6 million and decreased infrastructure and facility
costs of $0.2 million. SG&A expenses consist primarily of employee salaries
and benefits, travel expenses, advertising and other promotion expenses,
facilities expenses, legal expenses and other infrastructure costs.




Restructuring
Charges





During
2008 we recorded a restructuring charge of $1.6 million related to
reductions in the workforce in our foreign offices and the closing of our
manufacturing facility in Singapore. During 2007 the net restructuring amount
was $0.1 million. We recorded a restructuring charge of $0.3 million related to
a reduction in workforce. This was offset by a favorable $0.2
million benefit related to the early termination of a facility lease
previously restructured in 2004. During 2006, we recorded a $0.2 million
restructuring charge related to workforce reductions.


23


Impairment
Charges




We
performed impairment tests as of December 31, 2007 and 2006, which compared
currently utilized property and equipment and non-current assets net book values
with the expected undiscounted cash flows from these assets. The estimated
undiscounted cash flows of the assets were sufficient to recover the net book
value of these assets. In 2008, we recorded a $0.4 million impairment charge on
the carrying value of the company’s MRP system due to the closure of our
manufacturing facility in Singapore as well an impairment of furniture and
fixtures in under utilized facilities.  In 2006, we recorded a $0.1
million impairment charge on fixed assets no longer in use.





The
semiconductor industry is highly cyclical and the severity of these cycles is
difficult to predict. During a down cycle, we must be in a position to adjust
our cost and expense structure to prevailing market conditions, which could
affect our net sales and the sufficiency of estimated future cash
flows.  If the estimated cash flows are not sufficient to recover the
net book value of our assets we would be required to record additional
impairment charges.





Indemnification
release





In
January 2005, the Company sold its San Jose campus facility. The agreement
covering this sale included a provision that allowed for a two year period for
the buyer to make indemnification claims up to a maximum amount of $3.5 million
for breaches of the agreement’s representations and warranties. At that time,
the Company recorded a $0.5 million reserve for the net present value of the
Company’s guarantee obligations under these indemnification provisions. In
January 2007, after the expiration of the two year period specified in the
agreement, the Company reversed this reserve as no claims had been
made.





Interest
Income





YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Interest
      income
            
            $
            1,037
            
            
            $
            604
            
            
            $
            1,195




The
increase in interest income in 2008 over 2007 was related to increased cash due
to the issuance of $25.75 million in 6.25% Notes offset by the repayment of $8.5
million of our 5.25% bonds and cash used to fund operations.  The
decrease in interest income in 2007 over 2006 was primarily due to the use of
cash for operations as well as the $7.5 million in cash used as partial
consideration in the repurchase of $25.0 million of our 5.25%
Notes.




Interest
Expense





YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Interest
      expense
            
            $
            2,447
            
            
            $
            1,091
            
            
            $
            2,177





Interest
expense is comprised primarily of interest on our Notes. The increase in 2008
over 2007 is primarily due to increased convertible debt and discount
amortization of our 6.25% Notes.  The decrease in 2007 over 2006 is
primarily due to the repurchase of $25.0 million of the Notes in
2006.  (see Notes 8 and 9).






Debt
Conversion Expense






During
May 2006, we exchanged $25.0 million of our 5.25% Notes for 4,268,000 shares of
common stock and $7.5 million in cash in privately negotiated transactions with
Note holders. At the conversion price of $10.2465 per share, the $25.0 million
of Notes exchanged would have been convertible into 2,440,000 shares of common
stock.  For accounting purposes, the additional 1,828,000 shares of
common stock, valued at $8.6 million, and the $7.5 million cash paid was
considered an inducement for the holders to convert their Notes, which combined
with unamortized bond costs of $1.1 million and transaction costs of $0.4
million, required us to record a non-operating debt conversion expense of $17.6
million during the year ended May 31, 2006.




24






Provision
(Benefit) for Income Taxes




YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Provision
      (benefit) for income taxes
            
            $
            651
            
            
            $
            9
            
            
            $
            (628
            )





The 2008
provision reflects the amount of the tax settlement totaling $0.4 million
reached with the Singapore government to end our tax holiday (see Note 16) and a
reduction in our deferred tax assets due to changes in estimates of $0.2
million.  The 2007 provision resulted from taxes accrued on the income
of various foreign branches and subsidiaries.  The 2006 income tax
benefit resulted primarily from a $0.6 million release of tax reserves related
to transfer pricing issues. Realization of our deferred tax assets depends on us
generating sufficient taxable income in future years in appropriate tax
jurisdictions to obtain benefit from the reversal of temporary differences and
from net operating loss and credit carryforwards. Due to the uncertainty of the
timing and amount of such realization, management concluded that a valuation
allowance of $122.0 million was required at May 31, 2008.





In
October of 2004, the American Jobs Protection Act was signed into
law.  Certain provisions of this Act allow multinational companies to
repatriate cash related foreign earnings at a favorable rate if used to create
or maintain jobs in the United States. At May 31, 2008, there are no plans to
repatriate earnings from foreign subsidiaries as the only cash maintained in
these entities is for working capital purposes.  Any repatriation of
foreign earnings would have an immaterial effect on income taxes.





Liquidity
and Capital Resources





YearsIn thousands
            
            2008
            
            
            2007
            
            
            2006Cash
      used in operating activities
            
            $
            (5,333
            )
            
            $
            (11,251
            )
            
            $
            (20,525
            )Cash
      (used in) provided by investing activities
            
            $
            (505
            )
            
            $
            1,191
            
            
            $
            13,377Cash
      (used in) provided by financing activities
            
            $
            (8,444
            )
            
            $
            23,547
            
            
            $
            (7,051
            )





Operating activities:Cash
used in operating activities was $5.3 million for the period ended May 31,
2008.  The primary uses of cash were to fund operational losses offset
by cash received from Flextronics for transfer of inventories of $6.7
million in connection with its outsourcing agreement.





Cash used in operating
activities was $11.3 million for the period ended May 31, 2007.  The
primary uses of cash were to fund operational lossesand a
reduction in accounts payable and accrued liabilities offset by reduced accounts
receivable due to improved collection efforts.





Cash used
in operating activities was $20.5 million for the period ended May 31,
2006.  The primary uses of cash was to fund operational losses and
fund increases in working capital levels, including accounts receivable and
inventories, due to increased sales in the last half of 2006.





Investing activities:Cash
used in investing activities in 2008 was $0.5 million due to purchases of fixed
assets. Cash provided by investing activities in 2007 was $1.2 million due to
the maturity of investments offset by purchases of fixed assets.  Cash
provided by investing activities in 2006 was $13.4 million, an increase of $5.3
million over the prior fiscal year largely due to liquidation of investments due
to our increased use of cash in operations as a result of larger accounts
receivables and inventory balances.





Financing activities:Cash
used in financing activities in 2008 was $8.4 million, primarily due to the
repayment of $8.5 million of our 5.25% Notes.Cash provided by
financing activities in 2007 was $23.5 million, largely from the proceeds
received from the issuance of our 6.25% Notes in March 2007.  Cash
used in financing activities in 2006 was $7.1 million, largely from $7.5 million
paid in the exchange of $25.0 million of our 5.25% Notes in May 2006 for
4,268,000 shares of our common stock and cash in privately negotiated
transactions with Note holders.


25


Cash
contractual obligations are as follows as of May 31, 2008:





Payments
      Due by Fiscal YearIn
      thousands
            
            Total
            
            
            2009
            
            
            2010
            
            
            2011Operating
      leases
            
            $
            3,345
            
            
            $
            1,712
            
            
            $
            1,545
            
            
            $
            88Inventory
      purchase commitments
            
            
            20,069
            
            
            
            20,069
            
            
            
            -
            
            
            
            -Interest
      payments on convertible subordinated notes
            
            
            5,279
            
            
            
            1,609
            
            
            
            1,609
            
            
            
            2,061Principal
      payment on convertible subordinated notes
            
            
            25,750
            
            
            
            -
            
            
            
            -
            
            
            
            25,750Total
            
            $
            54,443
            
            
            $
            23,390
            
            
            $
            3,154
            
            
            $
            27,899





Purchase
commitments include $1.0 million of purchase orders that are
cancelable.





On
September 18, 2007, the Company signed a five year Manufacturing Services
Agreement (“Agreement”) with Flextronics Industrial Ltd. to outsource its
Singapore manufacturing to Flextronics in China. As part of this Agreement,
Flextronics accepts purchase orders and forecasts from the Company which
constitute authorization for Flextronics to procure inventory based on lead
times and to procure certain special inventory such as long lead-time items. The
Company does not take ownership of these Flextronics orders until the finished
products are ready to be shipped to our customers.  Flextronics open
commitments and inventory on hand at May 31, 2008, based on the Company’s
forecasts, were valued at $18.6 million and are included in the above table as
inventory purchase commitments.




In
February 2005, we entered into a five-year operating lease for a 78,000 square
foot corporate headquarters building in San Jose, California. Payments due under
this new lease are $2.7 million for fiscal years 2009 through 2010.




Line of credit:In June 2008,
we renewed and amended our revolving line of credit with Comerica Bank. Under
this amended agreement, we may borrow up to $7.5 million based upon eligible
accounts receivable balances. This amended line of credit, which has a maturity
date of August 31, 2010, is secured by substantially all of our assets and
requires that we maintain certain financial covenants. We currently maintain
cash deposits of $3.0 million that will be considered restricted as compensating
balances to the extent we borrow against this credit line.  There were
no borrowings from the credit line as of May 31, 2008 and 2007,
respectively.





Liquidity: Our principal
source of liquidity as of May 31, 2008 consisted of $16.5 million of cash and
cash equivalents.  As of May 31, 2008, we had net working capital of $22.5
million.  During 2009, we will continue to emphasize reduction of our
utilization of cash, including improving gross margins on sales, maintaining
spending controls and additional headcount reductions.  In March 2007, the
Company completed a $25.75 million private placement of 6.25% fixed rate
convertible subordinated secured notes (the “6.25% Notes Offering”). We
currently anticipate that our available cash and amounts available under our
line of credit at May 31, 2008 should be sufficient to meet our anticipated
needs for working capital and capital expenditures to support planned activities
for the next 12 months.





Impact
of Recently Issued Accounting Pronouncements




In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements.” SFAS No. 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and expands
disclosures about fair value measurements. This Statement applies to other
accounting pronouncements that require or permit fair value measurements, the
FASB having previously concluded in those accounting pronouncements that fair
value is the relevant measurement attribute. SFAS No. 157 is effective for
financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. This Statement is required
to be adopted by us in the first quarter of our fiscal year 2009.  On
February 12, 2008, the FASB issued FASB Staff Position (FSP) No. 157-2,
"Effective Date of FASB Statement No. 157".  FSP 157-2 delays the effective
date for nonfinancial assets and liabilities to fiscal years beginning
after November 15, 2008. Management is currently assessing the impact of the
adoption of this Statement.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
statement No. 115”.  SFAS No. 159 permits companies to choose to
measure certain financial instruments and other items at fair value. The
standard requires that unrealized gains and losses are reported in earnings for
items measured using the fair value option. SFAS No. 159 is effective for
fiscal years beginning after November 15, 2007. The fair value option under
SFAS No 159 becomes available to us in the first quarter of our fiscal year
2009. Management is currently assessing the impact of the adoption of this
Statement.


26


In
December 2007, the FASB issued SFAS No. 141R, “Business
Combinations”.  SFAS 141R establishes principles and requirements for
how the acquirer shall recognize and measure in its financial statements the
identifiable assets acquired, liabilities assumed, any noncontrolling interest
in the acquiree and goodwill acquired in the business combination. SFAS 141R is
effective for business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. This Statement is required to be adopted by us in the
first quarter of our fiscal year 2010. This statement will have no impact on the
Company unless management enters into a business combination after May 31,
2009.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests
in Consolidated Financial Statements — an Amendment of Accounting Research
Bulletin, or ARB No. 51”.  SFAS 160 establishes and expands
accounting and reporting standards for the noncontrolling interest in a
subsidiary. SFAS 160 is effective for business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. This Statement is required
to be adopted by us in the first quarter of our fiscal year 2010. This statement
will have no impact on the Company unless management enters into a business
combination after May 31, 2009.




In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and
Hedging Activities”.  SFAS 161 requires additional disclosures about
the objectives of using derivative instruments, the method by which the
derivative instruments and related hedged items are accounted for under FASB
Statement No.133 and its related interpretations, and the effect of derivative
instruments and related hedged items on financial position, financial
performance, and cash flows. SFAS 161 also requires the disclosure of the fair
values of derivative instruments and their gains and losses in a tabular format.
SFAS 161 is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, with early adoption
encouraged.  This Statement is required to be adopted by us in the
first quarter of our fiscal year 2010. This statement will have no impact on the
Company unless management enters into derivative instruments or hedging
activities after May 31, 2009.







Item 7A.  Quantitative and
Qualitative Disclosures about Market Risk





Interest
Rate Risk





At May
31, 2008, our cash equivalents consisted primarily of fixed income securities.
We maintain an investment policy, which ensures the safety and the preservation
of our invested funds by limiting default risk, market risk and reinvestment
risk. The portfolio includes only cash equivalents with active secondary or
resale markets. These securities are subject to interest rate risk and may
decline in value when interest rates change. If a 100 basis point change
occurred in the value of our portfolio, the impact on our financial statements
would be less than $0.1 million. The table below presents notional amounts and
related weighted-average interest rates by year of maturity for our investment
portfolios:





In
      thousands, except percentages
            
            Within
      One Year
            
            
            Fair
      Value at
              May
      31, 2008Interest
      bearing cash accounts and cash equivalents
            
            $
            14,042
            
            
            $
            14,042Average
      rate
            
            
            2.6
            %
            
            
            2.6
            %





Foreign
Currency Exchange Rate Risk





We
believe that our current foreign exchange exposure in all international
operations is not material to our consolidated financial statements because we
primarily transact business in United States dollars.  Accordingly, we
do not use derivative financial instruments to hedge our current foreign
exchange exposure.  We believe the impact of a 10% change in exchange
rates would not be material to our financial condition and results of
operations.  (see Note 2 – Business and Summary of Significant
Accounting Policies)  There have been no significant changes in our
market risk from the prior year.





27


Item 8.  Financial Statements
and Supplementary Data





Report
of Independent Registered Public Accounting Firm






Board of
Directors and Stockholders


Electroglas,
Inc.


San Jose,
CA




We have
audited the accompanying consolidated balance sheets of Electroglas, Inc. as of
May 31, 2008 and 2007 and the related consolidated statements of operations,
stockholders’ equity and comprehensive loss, and cash flows for each of the
three years in the period ended May 31, 2008. These financial statements are the
responsibility of the Company’s management.  Our responsibility is to
express an opinion on these financial statements based on our
audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting.  Our audits included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion.  An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall presentation of the financial statements.  We believe that our
audits provide a reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Electroglas, Inc. at May 31,
2008 and 2007, and the results of its operations and its cash flows for each of
the three years in the period ended May 31, 2008, in conformity with
accounting principles generally accepted in the United States of
America.





As
discussed in Note 13, effective June 1, 2006, the Company adopted Statement
of Financial Accounting Standards No. 123(R) “Share-Based
Payment”.




As
discussed in Note 14, effective May 31, 2007, the Company adopted Statement of
Financial Accounting Standards No. 158 “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements
No. 87, 88, 106, and 132(R)”.




As
discussed in Note 16, effective June 1, 2007, the Company adopted Financial
Accounting Standards Board (FASB) Interpretation No. 48 “Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No.
109”.













San Jose,
California


August
12, 2008












28





Electroglas,
Inc


Consolidated
Statements of Operations











Years
      ended May 31,In
      thousands, except per share data
            
            2008
            
            
            2007
            
            
            2006Net
      sales
            
            $
            45,421
            
            
            $
            44,624
            
            
            $
            44,317Cost
      of sales
            
            
            33,007
            
            
            
            35,141
            
            
            
            32,014Gross
      profit
            
            
            12,414
            
            
            
            9,483
            
            
            
            12,303Operating
      expenses:Engineering,
      research and development
            
            
            9,102
            
            
            
            11,073
            
            
            
            11,510Sales,
      general and administrative
            
            
            14,475
            
            
            
            16,593
            
            
            
            16,153Restructuring
      charges
            
            
            1,580
            
            
            
            129
            
            
            
            239Impairment
      charges
            
            
            359
            
            
            
            -
            
            
            
            89Indemnification
      release
            
            
            -
            
            
            
            (459
            )
            
            
            -Total
      operating expenses
            
            
            25,516
            
            
            
            27,336
            
            
            
            27,991Operating
      loss
            
            
            (13,102
            )
            
            
            (17,853
            )
            
            
            (15,688
            )Interest
      income
            
            
            1,037
            
            
            
            604
            
            
            
            1,195Interest
      expense
            
            
            (2,447
            )
            
            
            (1,091
            )
            
            
            (2,177
            )Debt
      conversion expense
            
            
            -
            
            
            
            -
            
            
            
            (17,603
            )Loss
      on mark to market of financial instrumentsrelated
      to convertible debt
            
            
            85
            
            
            
            (154
            )
            
            
            -Other
      expense, net
            
            
            (855
            )
            
            
            (280
            )
            
            
            (385
            )Loss
      before income taxes
            
            
            (15,282
            )
            
            
            (18,774
            )
            
            
            (34,658
            )Provision
      (benefit) for income taxes
            
            
            651
            
            
            
            9
            
            
            
            (628
            )Net
      loss
            
            $
            (15,933
            )
            
            $
            (18,783
            )
            
            $
            (34,030
            )Basic
      and diluted net loss per share
            
            $
            (0.60
            )
            
            $
            (0.71
            )
            
            $
            (1.53
            )Shares
      used in basic and diluted calculations
            
            
            26,395
            
            
            
            26,285
            
            
            
            22,178








See
accompanying notes to consolidated financial statements.











29


Electroglas,
Inc


Consolidated
Balance Sheets








May
      31,In
      thousands, except share data
            
            2008
            
            
            2007ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            16,541
            
            
            $
            30,788Accounts
      receivable, net of allowances of $329 and $392
            
            
            9,419
            
            
            
            9,855Inventories
            
            
            5,533
            
            
            
            11,883Restricted
      cash
            
            
            -
            
            
            
            500Receivable
      from Flextronics Industrial Ltd.
            
            
            1,644
            
            
            
            -Prepaid
      expenses and other current assets
            
            
            2,752
            
            
            
            2,355Total
      current assets
            
            
            35,889
            
            
            
            55,381Equipment
      and leasehold improvements, net
            
            
            2,724
            
            
            
            4,779Goodwill
            
            
            1,942
            
            
            
            1,942Other
      assets
            
            
            2,806
            
            
            
            3,732Total
      assets
            
            $
            43,361
            
            
            $
            65,834LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            6,848
            
            
            $
            5,953Accrued
      liabilities
            
            
            5,717
            
            
            
            5,456Deferred
      revenue - current
            
            
            826
            
            
            
            1,036Accrued
      losses on inventory purchase commitments
            
            
            -
            
            
            
            636Convertible
      subordinated notes - short term
            
            
            -
            
            
            
            8,486Total
      current liabilities
            
            
            13,391
            
            
            
            21,567Convertible
      subordinated notes - long term
            
            
            23,610
            
            
            
            22,851Financial
      instrument related to convertible debt
            
            
            -
            
            
            
            3,192Non-current
      liabilities
            
            
            2,442
            
            
            
            2,721Total
      liabilities
            
            
            39,443
            
            
            
            50,331Commitments
      and contingencies (see Note 12)Stockholders’
      equity:Preferred
      stock, $0.01 par value; 1,000,000 shares authorized; none
      outstanding
            
            
            -
            
            
            
            -Common
      stock, $0.01 par value; 60,000,000 shares authorized; 26,681,000 and
      26,466,000shares
      issued; 26,526,000 and 26,311,000 outstanding
            
            
            267
            
            
            
            265Additional
      paid-in capital
            
            
            199,932
            
            
            
            195,586Accumulated
      deficit
            
            
            (193,985
            )
            
            
            (178,052
            )Cost
      of common stock in treasury; 155,000 shares
            
            
            (2,296
            )
            
            
            (2,296
            )Total
      stockholders’ equity
            
            
            3,918
            
            
            
            15,503Total
      liabilities and stockholders’ equity
            
            $
            43,361
            
            
            $
            65,834








See
accompanying notes to consolidated financial statements.


30


Electroglas,
Inc.


Consolidated
Statements of Stockholders’ Equity and Comprehensive Loss





AccumulatedAdditional
            
            
            Retained
            
            
            Other
            
            
            
            
            
            
            
            
            TotalCommon
      Stock
            
            
            Paid-in
            
            
            Earnings
            
            
            Comprehensive
            
            
            Treasury
      Stock
            
            
            Stockholders’In
      thousands
            
            Shares
            
            
            Amount
            
            
            Capital
            
            
            (Deficit)
            
            
            Income/(Loss)
            
            
            Shares
            
            
            Amount
            
            
            EquityBalance
      at June 1, 2005
            
            
            21,957
            
            
            $
            219
            
            
            $
            159,734
            
            
            $
            (125,239
            )
            
            $
            14
            
            
            
            (155
            )
            
            $
            (2,296
            )
            
            $
            32,432Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (34,030
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (34,030
            )Net
      unrealized loss on investments
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (39
            )
            
            
            -
            
            
            
            -
            
            
            
            (39
            )Total
      comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (34,069
            )Issuance
      of common stock underemployee
      stock plans
            
            
            177
            
            
            
            2
            
            
            
            447
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            449Issuance
      of common stock throughconversion
      of notes
            
            
            4,268
            
            
            
            43
            
            
            
            33,533
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            33,576Stock-based
      compensation expense
            
            
            -
            
            
            
            -
            
            
            
            794
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            794Balance
      at May 31, 2006
            
            
            26,402
            
            
            
            264
            
            
            
            194,508
            
            
            
            (159,269
            )
            
            
            (25
            )
            
            
            (155
            )
            
            
            (2,296
            )
            
            
            33,182Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (18,783
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (18,783
            )Net
      unrealized loss on investments
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            25
            
            
            
            -
            
            
            
            -
            
            
            
            25Total
      comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (18,758
            )Issuance
      of common stock underemployee
      stock plans
            
            
            64
            
            
            
            1
            
            
            
            143
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            144Stock-based
      compensation expense
            
            
            -
            
            
            
            -
            
            
            
            935
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            935Balance
      at May 31, 2007
            
            
            26,466
            
            
            
            265
            
            
            
            195,586
            
            
            
            (178,052
            )
            
            
            -
            
            
            
            (155
            )
            
            
            (2,296
            )
            
            
            15,503Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (15,608
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (15,933
            )Net
      unrealized loss on investments
            
            
            -
            
            
            
            -
            
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (15,933
            )Reclassification
      of financial instrument relatedto
      convertible debt
            
            
            -
            
            
            
            -
            
            
            
            3,107
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,107Issuance
      of common stock underemployee
      stock plans
            
            
            215
            
            
            
            2
            
            
            
            106
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            108Stock-based
      compensation expense
            
            
            -
            
            
            
            -
            
            
            
            1,133
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,133Balance
      at May 31, 2008
            
            
            26,681
            
            
            $
            267
            
            
            $
            199,932
            
            
            $
            (193,660
            )
            
            $
            -
            
            
            
            (155
            )
            
            $
            (2,296
            )
            
            $
            3,918

















See
accompanying notes to consolidated financial statements.








31


Electroglas,
Inc.


consolidated
Statements of Cash Flows











Years
      ended May 31,In
      thousands
            
            2008
            
            
            2007
            
            
            2006Cash
      flows used in operating activitiesNet
      loss
            
            $
            (15,933
            )
            
            $
            (18,783
            )
            
            $
            (34,030
            )Adjustments
      to reconcile net loss to net cash used inoperating
      activities:Depreciation
            
            
            1,908
            
            
            
            1,952
            
            
            
            2,220Amortization
            
            
            632
            
            
            
            294
            
            
            
            589Provision
      for inventory reserves and amortizationof
      loaner equipment
            
            
            1,859
            
            
            
            6,872
            
            
            
            988Stock
      based compensation charges
            
            
            1,133
            
            
            
            935
            
            
            
            794Interest
      expense on convertible notes
            
            
            773
            
            
            
            295
            
            
            
            424Loss
      on mark to market of financial instrument related toconvertible
      debt
            
            
            (85
            )
            
            
            154
            
            
            
            -Indemnification
      release
            
            
            -
            
            
            
            (459
            )
            
            
            -Impairment
      charges
            
            
            359
            
            
            
            -
            
            
            
            89(Gain)
      loss on translation of foreign currency
            
            
            (152
            )
            
            
            37
            
            
            
            (65
            )Debt
      conversion expense
            
            
            -
            
            
            
            -
            
            
            
            17,603Loss
      (gain) on disposal of fixed assets
            
            
            404
            
            
            
            14
            
            
            
            (15
            )Change
      in estimate on tax reserves
            
            
            -
            
            
            
            -
            
            
            
            (865
            )Changes
      in current assets and liabilities:Accounts
      receivable
            
            
            (285
            )
            
            
            2,761
            
            
            
            (6,939
            )Inventories
            
            
            3,870
            
            
            
            422
            
            
            
            (4,033
            )Prepaid
      expenses and other current and long-term assets
            
            
            606
            
            
            
            (49
            )
            
            
            1,438Accounts
      payable
            
            
            (220
            )
            
            
            (3,781
            )
            
            
            2,565Accrued
      and other current and long-term liabilities
            
            
            (202
            )
            
            
            (1,915
            )
            
            
            (1,288
            )(5,333
            )
            
            
            (11,251
            )
            
            
            (20,525
            )Cash
      flows (used in) provided by investing activitiesCapital
      expenditures
            
            
            (505
            )
            
            
            (808
            )
            
            
            (624
            )Proceeds
      from disposal of property, plant and equipment
            
            
            -
            
            
            
            -
            
            
            
            16Purchases
      of investments, available-for-sale
            
            
            -
            
            
            
            -
            
            
            
            (10,000
            )Maturities
      of investments, available-for-sale
            
            
            -
            
            
            
            1,999
            
            
            
            23,985(505
            )
            
            
            1,191
            
            
            
            13,377Cash
      flows (used in) provided by financing activitiesPurchase
      of convertible notes
            
            
            (8,500
            )
            
            
            -
            
            
            
            (7,500
            )Proceeds
      from issuance of convertible notes
            
            
            -
            
            
            
            25,750
            
            
            
            -Debt
      issuance cost related to the  issuance of convertible
      notes
            
            
            (52
            )
            
            
            (2,347
            )Sales
      of common stock to employees
            
            
            108
            
            
            
            144
            
            
            
            449(8,444
            )
            
            
            23,547
            
            
            
            (7,051
            )Effect
      of exchange rate changes on cash
            
            
            35
            
            
            
            8
            
            
            
            7Net
      (decrease) increase in cash and cash equivalents
            
            
            (14,247
            )
            
            
            13,495
            
            
            
            (14,192
            )Cash
      and cash equivalents at beginning of year
            
            
            30,788
            
            
            
            17,293
            
            
            
            31,485Cash
      and cash equivalents at end of year
            
            $
            16,541
            
            
            $
            30,788
            
            
            $
            17,293Supplemental
      cash flow disclosures:Interest
      paid on convertible subordinated notes
            
            $
            (1,381
            )
            
            $
            (446
            )
            
            $
            (2,271
            )Cash
      (paid) received during the period for income taxes
            
            $
            (676
            )
            
            $
            (31
            )
            
            $
            170Supplemental
      non-cash investing and financing activities:Conversion
      of subordinated debt
            
            $
            -
            
            
            $
            -
            
            
            $
            33,532Reclassification
      of financial instrument related to convertible debt
            
            $
            3,107
            
            
            $
            -
            
            
            $
            -See
      accompanying notes to consolidated financial statements.


32


Electroglas,
Inc.


Notes
to Consolidated Financial Statements





Note
1.  Change in Fiscal Year







Effective
July 2005, Electroglas, Inc. (“the Company”)changed its fiscal
year-end from December 31 to May 31 retroactive to May 31, 2005. The Company’s
fiscal quarters are every 13 weeks and end on a Saturday.






Note
2.  Business and Summary of Significant Accounting
Policies




Business: Electroglas Inc. is
a supplier of semiconductor manufacturing equipment and software to the global
semiconductor industry. The Company was incorporated in Delaware in April 1993,
to succeed the wafer prober business conducted by the Electroglas division of
General Signal Corporation, our former parent. Immediately prior to the closing
of the initial public offering of our Common Stock in July 1993, the Company
assumed the assets and liabilities of the Electroglas division in an asset
transfer. The Company has been in the semiconductor equipment business for more
than 40 years. The Company’s primary product line is automated wafer probing
equipment and related network software to manage information from that
equipment. In conjunction with automated test systems from other suppliers, the
Company’s  semiconductor manufacturing customers use its wafer probers
and network software to quality test semiconductor wafers.





Principles of consolidation and
basis of presentation:The consolidated financial statements
include the accounts of the domestic and foreign business operations of the
Company for all periods. Intercompany balances and transactions have been
eliminated in consolidation.





Use of
estimates:The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions for such items as revenue
recognition, inventory valuation, warranty reserves, allowances for doubtful
accounts, guarantee obligations, tax valuation allowances, stock based
compensation, valuation of long-lived assets, and accruals such as restructuring
reserves.  These estimates and assumptions affect the amounts reported
in the financial statements. Actual results could differ materially from these
estimates.





Cash and cash
equivalents:The Company considers all highly liquid
investments with minimum yield risks and maturities of 90 days or less from the
date of purchase to be cash equivalents.





Reclassifications:Certain prior period
amounts have been reclassified to conform to the current period presentation.
These reclassifications have no effect on previously reported net loss or
accumulated deficit.





Investments:The
Company invests its excess cash in investment grade debt and equity instruments.
Management determines the appropriate classification of the debt securities at
the time of the purchase as either held-to-maturity or available-for-sale and
re-evaluates such designation as of each balance sheet date. Available-for-sale
securities are stated at fair market value, with unrealized gains and losses
reported in a separate component of stockholders’ equity. Amortization of
premiums and accretion of discounts, as well as any interest on the securities,
is included in interest income.  At May 31, 2008 and 2007, the Company
did not have any marketable securities.





Inventories:Inventories
are stated at the lower of cost or market (estimated net realizable value) using
the first-in, first-out (FIFO) method. The Company may record charges to
inventory reserves due to excess, obsolete and slow moving inventories,
including those held by Flextronics. The Company’s reserve analysis is based on
the estimated impact of changes in technology on the Company’s products
(including engineering design changes) and the timing of these changes. The
Company also considers future sales forecasts, product order history, and
backlog to assess its inventory requirements as well as outstanding purchase
commitments. Inventory on loan to customers is included in finished goods
inventory. Loaner inventory is reserved beginning in the ninth month after
shipment through the twentieth month to a 10% residual value and is charged to
the organization responsible for the inventory, either Engineering or Sales. If
there is weak demand in the semiconductor equipment markets and orders fall
below forecasts, additional reserves of inventories may be required which will
negatively impact gross margins. Inventory reserves are considered to
permanently establish a new basis for inventory and are not subsequently
reversed to income even if circumstances later suggest that increased carrying
amounts are recoverable, except when the associated inventory balances decline
due to disposition or sale. As a result of these analyses, the Company recorded
inventory provisions and amortization of loaned inventory of $1.9 million, $6.9
million and $1.0 million, for the years ended May 31, 2008, 2007 and 2006,
respectively.


33


The
following is a summary of the major categories of inventory as of:





May
      31,In
      thousands
            
            2008
            
            
            2007Raw
      materials
            
            $
            2,578
            
            
            $
            7,807Work-in
      process
            
            
            143
            
            
            
            2,327Finished
      goods
            
            
            2,812
            
            
            
            1,749$
            5,533
            
            
            $
            11,883





Equipment and leasehold
improvements:  Equipment and leasehold improvements are stated
at cost less accumulated depreciation and amortization using the straight-line
method over the estimated useful lives of the assets or the life of the lease,
whichever is shorter. The following is a summary by major category as
of:





Estimated
            
            
            May
      31,Dollars
      in thousands
            
            Useful
      Lives
            
            
            2008
            
            
            2007Equipment
            
            
            3-5
            
            
            $
            5,220
            
            
            $
            5,999Leasehold
      improvements
            
            Term
      of lease
            
            
            
            1,737
            
            
            
            3,657Office
      furniture and equipment
            
            
            3-10
            
            
            
            5,463
            
            
            
            7,37712,420
            
            
            
            17,033Accumulated
      depreciation and amortization
            
            
            
            
            
            
            (9,696
            )
            
            
            (12,254
            )$
            2,724
            
            
            $
            4,779





Accounting for long-lived
assets:  In accordance with Statement of Financial Accounting
Standards No. No.144, “Accounting for the Impairment or Disposal of Long-Lived
Assets” (SFAS 144), the Company reviews long-lived assets held and used by the
Company for impairment whenever events or changes in circumstances indicate that
assets may be impaired and the undiscounted cash flows estimated to be generated
by those assets are less than the carrying amounts of those
assets.  Measurement of impairment charges for long-lived assets to be
held and used are based on the excess of the carrying amount of those assets
over the fair value. The fair value of the assets then becomes the assets’ new
carrying value, which is depreciated over the remaining estimated useful lives
of the assets.





Goodwill:The Company accounts for goodwill in accordance with Statement of
Financial Accounting Standard No. 142, “Goodwill and Intangible Assets” (SFAS
142). The Company performed its annual impairment test of goodwill as of
December 31, 2007 and 2006 and has concluded that no impairment exists. The
Company performs impairment tests on an annual basis and between annual tests if
an event occurs or circumstances change that would indicate that a potential
impairment in the value of the asset has occurred.





Revenue recognition:Revenue
is recognized on the sale of the Company’s equipment when a customer purchase
order or fully executed contract has been received, when the products or
services have been delivered, when the total purchase price can be assured
without making significant concessions, and when the Company’s ability to
collect from its customer has been assured.  In recognizing revenue
the Company makes certain assumptions and estimates, namely: (i) the Company
considers a new system routinely accepted in the marketplace when three to five
successful installations, based on our acceptance criteria, have been put into
customer production; (ii) the Company considers systems delivered separately
from options to have value to our customers on a stand alone basis if we have
fair value of the options and the options are not significant to the total
amount of the order and the options are not essential to the functionality of
the system; (iii) the Company considers systems delivered separately from
installation to have value to its  customers on a stand-alone basis
because the equipment can readily be sold by the customer, customers are capable
of installing the systems without the support of our installers, installation is
routine and inconsequential to the total value of the transaction, we have fair
value, and these services are routinely sold on a stand-alone basis; and (iv)
for most customers the Company assumes that, based on past history, it will
continue to collect its receivables from them without payment or product
concessions, despite the fact that they have larger financial size relative to
the Company and despite its dependence on them in a heavily concentrated
industry. In an arrangement with multiple deliverables, such as installation and
services, the delivered items are considered a separate unit of accounting if
all of the following criteria are met: (i) the delivered items have value to the
customer on a stand-alone basis, (ii) vendor specific objective evidence (VSOE)
of fair value exists, which is based on the average price charged when each
element is sold separately, for the undelivered elements, and (iii) if the
arrangement does not include a general right of return relative to a delivered
item, or if performance of the undelivered item is considered probable and
substantially in the control of the Company.  If the Company cannot
objectively determine the fair value of any undelivered element include in a
multiple element arrangement, the Company defers revenue until all elements are
delivered and service have been performed, or until fair value can
objectively  be determined for any remaining undelivered
elements.  Where the Company sells to distributors, revenue is
deferred until resale to the end-customers.  Sales to distributors do not
represent a material amount of the Company's sales. Revenue related to
maintenance and service contracts is recognized ratably over the duration of the
contracts.





34


Deferred
revenue consisted of the following as of:





May
      31,In
      thousands
            
            2008
            
            
            2007Systems
      products
            
            $
            70
            
            
            $
            96Prober
      maintenance revenue
            
            
            612
            
            
            
            617Prober
      services recognized upon future delivery
            
            
            72
            
            
            
            276Software
      licenses
            
            
            72
            
            
            
            47Deferred
      revenue - current
            
            $
            826
            
            
            $
            1,036Prober
      maintenance revenue - non current
            
            $
            191
            
            
            $
            194





Warranty: The Company
generally warrants its products for a period of thirteen months from the date of
shipment and accrues a current liability for the estimated cost of warranty upon
shipment. For established products, this accrual is based on historical
experience; and for the Company’s newer products, this accrual is based on
estimates from similar products.  In addition, from time to time,
specific warranty accruals are made for specific technical
problems.





Allowance for doubtful
accounts:The Company closely monitors the collection of its
accounts receivables and records a reserve for doubtful accounts against aged
accounts and for specifically identified amounts that it believes are not
recoverable. When receivable balances are determined to be uncollectible, these
balances are written off.  The Company sells primarily to large,
well-established semiconductor manufacturers and semiconductor test companies
and has not experienced significant accounts receivable losses in the
past.





Engineering, research and
development expenses:The Company is actively engaged in basic
technology and applied research programs designed to develop new products and
product applications. In addition, ongoing product and process improvement, and
engineering, and support programs relating to existing products are conducted.
Engineering, research and development costs are expensed to operations as
incurred.





Foreign currency
accounting:The United States dollar is the functional
currency for all foreign operations. The effect on the consolidated statements
of operations of transaction and translation gains and losses is insignificant
for all periods presented.




Stock basedcompensationexpense: We estimate the value
of employee stock options on the date of grant using the Black-Sholes model and
amortize these costs on a straight-line basis over the requisite service periods
of the awards.  Under SFAS 123(R) “Share-Based Payment”, the
determination of fair value of share-based payment awards on the date of grant
using an option-pricing model is affected by our stock price as well as
assumptions regarding a number of highly complex and subjective
variables.




Expected
volatility – historical volatility of the Company’s stock
price


Expected
term – historical data on employee exercises and post-vesting
employment termination behavior


Risk free
interest rate – an implied yield currently based on United States Treasury
rates


Estimated
forfeitures – historical option forfeitures over a given period


Dividend
yield – historical rate of dividend payments




Shipping and
handling:The cost of shipping the Company’s products to
customers is included in SG&A expenses. The cost of shipping related to
material purchases is included in cost of sales. Shipping costs are not
material.  The Company recognizes billings to customers related to
shipping costs as Sales.  Shipping revenues are not
material.





Comprehensive
loss:This includes net loss as well as additional other
comprehensive items such as unrealized losses on investments.  The
Consolidated Statement of Stockholders’ Equity and Comprehensive Loss summarizes
the activity in comprehensive loss.  As of May 31, 2008 and 2007,
there was no items of accumulated other comprehensive income or
loss.




Income taxes:The
Company recognizes income taxes in accordance with SFAS 109, using an asset
and liability approach. This approach requires the recognition of taxes payable
or refundable for the current year and deferred tax assets and liabilities for
the expected future tax consequences of events that have been recognized in the
Company’s consolidated financial statements or tax returns. The measurement of
current and deferred taxes is based on provisions of the enacted tax law. SFAS 109
provides for recognition of deferred tax assets if the realization of such
assets is more likely than not to occur. Otherwise, a valuation allowance is
established for the deferred tax assets which may not be
realized.
 35
  The
Company is subject to income tax audits by the respective tax authorities in all
of the jurisdictions in which it operates. The determination of tax liabilities
in each of these jurisdictions requires the interpretation and application of
complex and sometimes uncertain tax laws and regulations. The recognition and
measurement of current taxes payable or refundable and deferred tax assets and
liabilities requires that the Company make certain estimates and judgments.
Changes to these estimates or a change in judgment may have a material impact on
the Company’s tax provision in a future period.
  Effective
June 1, 2007, the Company adopted FIN 48, which requires a
more-likely-than-not threshold for financial statement recognition and
measurement of tax positions taken or expected to be taken in a tax return. The
Company records a liability for the difference between the benefit recognized
and measured pursuant to FIN 48 and the tax position taken or expected to
be taken on its tax return. To the extent that the Company’s assessment of such
tax positions changes, the change in estimate is recorded in the period in which
the determination is made. With the adoption of FIN 48, the Company also
began reporting tax-related interest and penalties as a component of income tax
expense.




Impact of recently issued accounting
pronouncements:  In September 2006, the FASB issued SFAS
No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements.
This Statement applies to other accounting pronouncements that require or permit
fair value measurements, the FASB having previously concluded in those
accounting pronouncements that fair value is the relevant measurement attribute.
SFAS No. 157 is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. This Statement is required to be adopted by us in the first quarter of
our fiscal year 2009. On February 12, 2008, the FASB issued FASB Staff
Position (FSP) No. 157-2, "Effective date of FASB Statement No. 157". 
FAS157-2 delays the effective date for nonfinancial assets and liabilities to
fiscal years beginning after November 15, 2008.  Management is currently
assessing the impact of the adoption of this Statement.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
statement No. 115”.  SFAS No. 159 permits companies to choose to
measure certain financial instruments and other items at fair value. The
standard requires that unrealized gains and losses are reported in earnings for
items measured using the fair value option. SFAS No. 159 is effective for
fiscal years beginning after November 15, 2007. This Statement is required
to be adopted by us in the first quarter of our fiscal year 2009. Management is
currently assessing the impact of the adoption of this Statement.





In
December 2007, the FASB issued SFAS No. 141R, “Business
Combinations”.  SFAS 141R establishes principles and requirements for
how the acquirer shall recognize and measure in its financial statements the
identifiable assets acquired, liabilities assumed, any noncontrolling interest
in the acquiree and goodwill acquired in the business combination. SFAS 141R is
effective for business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. This Statement is required to be adopted by us in the
first quarter of our fiscal year 2010. This statement will have no impact on The
Company unless management enters into a business combination after May 31,
2009.




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests
in Consolidated Financial Statements — an Amendment of Accounting Research
Bulletin, or ARB No. 51”.  SFAS 160 establishes and expands
accounting and reporting standards for the noncontrolling interest in a
subsidiary. SFAS 160 is effective for business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. This Statement is required
to be adopted by us in the first quarter of our fiscal year 2010. This statement
will have no impact on The Company unless management enters into a business
combination after May 31, 2009.




In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and
Hedging Activities”.  SFAS 161 requires additional disclosures about
the objectives of using derivative instruments, the method by which the
derivative instruments and related hedged items are accounted for under FASB
Statement No.133 and its related interpretations, and the effect of derivative
instruments and related hedged items on financial position, financial
performance, and cash flows. SFAS 161 also requires the disclosure of the fair
values of derivative instruments and their gains and losses in a tabular format.
SFAS 161 is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, with early adoption
encouraged.  This Statement is required to be adopted by us in the
first quarter of our fiscal year 2010. This statement will have no impact on the
Company unless management enters into derivative instruments or hedging
activities after May 31, 2009.




Note 3.  Financial Instruments





Concentration of credit
risk:Financial instruments that potentially subject the
Company to concentration of credit risk consist principally of cash equivalents,
investments and trade receivables. The Company places its cash equivalents and
investments with high credit-quality financial institutions. The Company invests
its excess cash in commercial paper, readily marketable debt and equity
instruments, and collateralized funds of United States and state government
entities. The Company has established guidelines relative to credit ratings,
diversification and maturities that seek to maintain safety and
liquidity.  With respect to accounts receivable, the Company sells its
systems to semiconductor manufacturers and contract test companies throughout
the world. The Company performs ongoing credit evaluations of its customers’
financial condition and requires collateral such as letters of credit whenever
deemed necessary. The write-off of uncollectible amounts historically has been
within management’s expectations. Accounts receivable from customers in Asia
were $3.3 million and $3.4 million at May 31, 2008 and 2007, respectively (see
Note 15 – Segment Information). For the years ended May 31, 2008, 2007 and 2006
five of our customers accounted for 51%, 42%, and 51%, respectively, of our net
sales.





Fair value of financial
instruments:The Company estimated the fair value of financial
instruments and concluded the amounts reported for cash equivalents approximate
fair value due to their short maturities.  Convertible subordinated
notes are stated at cost which approximates fair value due to the recent March
2007 issue of the 6.25% Notes and the expectation that they will convert by
March 2011.




36


Note
4.  Non-Current Liabilities and Other Assets





The
following is a summary of non-current liabilities by major category as
of:





May
      31,In
      thousands
            
            2008
            
            
            2007Deferred
      revenue
            
            $
            191
            
            
            $
            194Deferred
      rent liability - long term
            
            
            570
            
            
            
            1,148Projected
      benefit obligation - German pension
            
            
            929
            
            
            
            908Post-retirement
      medical plan
            
            
            548
            
            
            
            255Other
            
            
            204
            
            
            
            216$
            2,442
            
            
            $
            2,721





The
following is a summary of other assets by major category as of:





May
      31,In
      thousands
            
            2008
            
            
            2007Cash
      surrender value of Company owned life insurance
            
            $
            414
            
            
            $
            395Cash
      surrender value of Company owned reinsurance policies
            
            
            1,200
            
            
            
            1,009Foreign
      income tax receivable
            
            
            -
            
            
            
            523Deferred
      financing costs on convertible subordinated notes,net
      of current portion
            
            
            1,100
            
            
            
            1,663Other
            
            
            92
            
            
            
            142$
            2,806
            
            
            $
            3,732





Note
5.  Accrued Liabilities





The
following is a summary of accrued liabilities by major category as
of:





May
      31,In
      thousands
            
            2008
            
            
            2007Accrued
      compensation and related liabilities
            
            $
            1,755
            
            
            $
            1,550Warranty
      reserves
            
            
            1,110
            
            
            
            1,242Accrued
      audit and compliance fees
            
            
            459
            
            
            
            523Restructuring
      charges
            
            
            147
            
            
            
            321Deferred
      rent liability - current
            
            
            578
            
            
            
            532Taxes
      other than on income
            
            
            483
            
            
            
            319Interest
      payable on convertible subordinated notes
            
            
            738
            
            
            
            491Other
            
            
            447
            
            
            
            478$
            5,717
            
            
            $
            5,456





Note
6.  Warranty Reserves and Guarantees





The
Company’s warranty liability is included in accrued liabilities and changes
during the reporting periods are as follow:





In
      thousands
            
            Balance
      at Beginning of Period
            
            
            Additions
      Charged to Costs of Sales
            
            
            Warranty
      Reserve Utilized
            
            
            Balance
      at End of PeriodYear
      2008
            
            $
            1,242
            
            
            $
            1,400
            
            
            $
            (1,532
            )
            
            $
            1,110Year
      2007
            
            $
            1,518
            
            
            $
            2,106
            
            
            $
            (2,382
            )
            
            $
            1,242







The
Company’ssoftware
license agreements generally include certain provisions for indemnifying
customers against liabilities if the Company’s software products infringe a
third party’s intellectual property rights. Further, the Company also provides
guarantee instruments to certain third parties as required for certain
transactions. To date, the Company has not incurred any material costs as a
result of such indemnifications and has not accrued any liabilities related to
such obligations.  The Company does not believe, based on historical
experience and information currently available, that it is probable that any
amounts will be required to be paid under these arrangements.




In
January 2005, the Company sold its corporate campus to Integrated Device
Technology (“IDT”). In the sales agreement the Company had indemnified IDT for
two years with respect to representations and warranties made by the Company
related to the sale. The limit of the Company’s liability for breach of the
representations and warranties was $3.5 million in the sale agreement, and a
$0.5 million reserve was recorded for the net present value of the Company’s
guarantee obligations under the indemnification provisions. In January 2007,
after the expiration of the two year period specified in the agreement, the
Company reversed this reserve as no claims had been made nor have any been made
to date.




37


Note
7.  Restructuring Charges






For the
year ended May 31, 2008, the Company recorded restructuring charges of $1.6
million consisting of $0.6 million related to retention incentives during the
shut down of our Singapore factory, $0.8 million related to our Singapore
factory closure and $0.2 million for headcount reductions in our European
offices.  During 2007, the Company recorded a $0.1 million net
restructuring charge.  A $0.3 million charge related to a reduction of
workforce in foreign offices, offset by a $0.2 million reversal for the
early termination of a facility lease previously restructured in
2004.  In 2006, the Company recorded $0.2 million in restructuring
charges for workforce reductions of three employees in the United States and
Europe.  Restructuring accruals are included in accrued
liabilities.






Details
of the 2008 Plan were as follows and are expected to be fully paid by the end of
fiscal 2009:




Year 2008In
      thousands
            
            Severance
            
            
            Other
      Costs
            
            
            TotalBeginning
      balance
            
            $
            -
            
            
            $
            -
            
            
            $
            -Restructuring
      charges
            
            
            
            
            
            
            1,371
            
            
            
            1,371Cash
      payments
            
            
            -
            
            
            
            (1,224
            )
            
            
            (1,224
            )Ending
      balance
            
            $
            -
            
            
            $
            147
            
            
            $
            147





Details
of the 2007 Plan were as follows:





Year
      2008
            
            
            Year 2007In
      thousands
            
            Severance
            
            
            Other
      Costs
            
            
            Total
            
            
            Severance
            
            
            Other
      Costs
            
            
            TotalBeginning
      balance
            
            $
            227
            
            
            $
            94
            
            
            $
            321
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Restructuring
      charges
            
            
            197
            
            
            
            12
            
            
            
            209
            
            
            
            227
            
            
            
            94
            
            
            
            321Asset
      write offs
            
            
            -
            
            
            
            (80
            )
            
            
            (80
            )
            
            
            -
            
            
            
            -
            
            
            
            -Cash
      payments
            
            
            (424
            )
            
            
            (26
            )
            
            
            (450
            )
            
            
            -
            
            
            
            -
            
            
            
            -Ending
      balance
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            227
            
            
            $
            94
            
            
            $
            321





Details
of the 2004 Plan were as follows:





Year 2007In
      thousands
            
            Severance
            
            
            Other
      Costs
            
            
            TotalBeginning
      balance
            
            $
            -
            
            
            $
            365
            
            
            $
            365Restructuring
      charges
            
            
            -
            
            
            
            (167
            )
            
            
            (167
            )Cash
      payments
            
            
            -
            
            
            
            (198
            )
            
            
            (198
            )Ending
      balance
            
            $
            -
            
            
            $
            -
            
            
            $
            -





Details
of the 2003 and 2002 Plan were as follows:





Year
      2007In
      thousands
            
            Severance
            
            
            Other
      Costs
            
            
            TotalBeginning
      balance
            
            $
            17
            
            
            $
            20
            
            
            $
            37Restructuring
      charges
            
            
            (15
            )
            
            
            (10
            )
            
            
            (25
            )Cash
      payments
            
            
            (2
            )
            
            
            (10
            )
            
            
            (12
            )Ending
      balance
            
            $
            -
            
            
            $
            -
            
            
            $
            -





38


Note
8. Convertible Subordinated Notes (“5.25% Notes”), Debt Conversion Expense and
Warrants




In June
2002, the Company completed a $35.5 million private placement of 5.25% fixed
rate convertible subordinated notes (the “5.25% Notes”) due in June 2007.
Interest on the 5.25% Notes was payable each year on the fifteenth of June and
December and was charged to interest expense. In the transition period ended May
31, 2005, the Company repurchased a total of $2.0 million of the 5.25% Notes.
During May 2006, the Company exchanged $25.0 million of 5.25% Notes for
4,268,000 shares of Common Stock and $7.5 million in cash in privately
negotiated transactions incurring debt conversion expense of $17.6 million. The
Company repaid the $8.5 million balance of the 5.25% Notes plus accrued interest
on the June 15, 2007 maturity date.




Note
9.  Subordinated Secured Notes (“6.25% Notes”)




In March
2007, the Company completed a $25.75 million private placement of 6.25% (payable
semi-annually in June and December) fixed rate subordinated secured notes (the
“6.25% Notes”). The Company incurred debt issuance costs totaling $2.4 million
and these costs are being amortized to other expense using a method that
approximates the effective interest method over the estimated four year life of
the 6.25% Notes, which coincides with the earliest date upon which the note
holders can require the Company to repurchase the Notes. For the years ended May
31, 2008 and 2007, the Company recognized other expense related to the
amortization of the debt issuance costs of $0.6 million and $0.1 million,
respectively.  The 6.25% Notes are due in March 2027; however, the
holders may require the Company to repurchase for cash on March 26, 2011 and
various future dates at a price equal to 100% of the principal amount plus
accrued interest, if any, to the applicable repurchase date. The 6.25% Note
terms restrict the Company from transferring capital to certain of its
subsidiaries, restrict the payment of dividends, and contain certain other
restrictions. Additionally, one of the covenants of our debenture agreement can
be interpreted such that if we are late with any of our required filings under
the Securities Act of 1934, as amended, and if we fail to effect a cure within
60 days, the holders of the 6.25% Notes can put the 6.25% Notes back to the
Company, whereby the 6.25% Notes become immediately due and
payable.






The 6.25%
Notes are convertible at any time prior to maturity at the election of the bond
holders into shares of Common Stock at a conversion price of $2.295, which
represented a 12.5% premium over the Company’s stock price on the date of the
private placement’s closing. If fully converted, the 6.25% Notes would convert
into approximately 11.22 million shares of Common Stock. At any time prior to
maturity, subject to certain limitations, the Company may elect to automatically
convert (“Auto Convert”) the 6.25% Notes into Common Stock if the closing price
of the Common Stock has exceeded 150% (above $3.44 per share) of the conversion
price for at least 20 trading days during any 30-day period prior to the Company
giving notice to the bond holders. If the Company elects to Auto Convert within
the first three years, the Company will be required to pay the bond holders
interest for the three year period (make-whole), less any interest paid to that
date. The Company considers this interest make-whole provision to be an embedded
derivative and determined the value of it to be negligible.  The
Company can also after three years redeem the 6.25% Notes for cash at 100%
of the principal amount plus accrued interest. The 6.25% Notes are ranked
junior to the Company’s Comerica bank line borrowings and are collateralized by
a second priority lien on substantially all of the Company’s
assets.






Prior to
October 17, 2007, the 6.25% Notes were deemed to contain an
additional embedded derivative (described below) requiring bifurcation and
valuation in accordance with the guidance in SFAS 133 “Accounting for Derivative
Instruments and Hedging Activities”.  Furthermore, in analyzing the
terms of the 6.25% Notes, the Company determined that the notes represent
non-conventional convertible debt as defined in EITF Issue 05-2, “The Meaning of
‘Conventional Convertible Debt Instrument’ in Issue No. 00-19” due to the fact
that the 6.25% Notes contain provisions that provide for adjustment to the
number of shares into which the notes are convertible and, therefore, the number
of shares issuable upon conversion is not fixed. Under the provisions of EITF
00-19 “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock”  this conversion feature would be classified as a
liability if it were a freestanding financial instrument, due to the fact that
at issuance and through the remainder of the year ended May 31, 2007, the
Company did not have enough authorized and unissued shares available to fully
settle the maximum potential number of shares that could be required to be
delivered under the terms of all of  the Company’s existing financial
instruments.  As a result, to the extent that a shortfall existed
between the maximum potential shares issuable under the conversion feature of
approximately 13,365,000 shares and the minimum number of shares the Company has
available for issuance of approximately 10,091,000 (resulting in a shortfall of
approximately 3,274,000 shares), the Company had calculated the relative portion
of the fair value of the conversion feature that pertains to this shortfall to
be $3.0 million (see discussion of valuation methodology and assumptions below)
and had recognized this amount as a separate derivative liability with an
offsetting discount to  the carrying value of the 6.25%
Notes.  The resultant discount is being amortized to interest expense
over the estimated four year life of the 6.25% Notes. Discount amortization
recorded to interest expense during the years ended May 31, 2008 and 2007 was
$0.8 million and $0.1 million, respectively.




39




On
October 17, 2007, at the annual meeting of stockholders, the stockholders
approved an amendment to the Company’s certificate of incorporation to increase
the number of authorized shares of the Company’s Common Stock from 40,000,000 to
60,000,000. This increase in authorized common shares eliminated the shortfall
that existed between the maximum potential shares issuable under the conversion
feature and the number of authorized shares, and thereby eliminated the embedded
derivative liability established in accordance with SFAS 133 when the 6.25%
Notes were issued. On October 17, 2007 the conversion feature derivative
liability was remeasured at its estimated fair value and the increase in value
of $0.1 million was recognized as a gain on mark to market financial instrument
in the statement of operations and the financial instrument liability of $3.1
million was reclassified to additional paid-in capital.






The
following table outlines the assumptions the Company used in the Black-Scholes
model to value the conversion feature at the dates presented:




Conversion
      FeatureOctober
      17, 2007
            
            
            May
      31, 2007Contractual
      term in years
            
            
            3.4
            
            
            
            3.8Volatility
            
            
            59.9
            %
            
            
            66.8
            %Risk-free
      interest rate
            
            
            4.7
            %
            
            
            4.9
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %





The
following is a summary of the 6.25% Notes value, as of:





May 31,In thousands
            
            2008
            
            
            2007Face
      value of Notes
            
            $
            25,750
            
            
            $
            25,750Notes
      discount
            
            
            (2,140
            )
            
            
            (2,899
            )$
            23,610
            
            
            $
            22,851





Note
10.  Long Term Liability – Deferred Rent





The
Company leases facilities for its corporate headquarters under a five year
agreement that includes tenant concessions such as tenant improvement allowances
of $1.0 million and eighteen months of "free rent”. The Company records rent
expense using the effective average net rent over the lease term after taking
into consideration the value of these tenant rent concessions. This accounting
resulted in long term deferred rent liabilities of $0.6 million and $1.1 million
as of May 31, 2008 and 2007, respectively.





Note
11.  Line of Credit





In June
2008, the Company renewed and amended its revolving line of credit with Comerica
Bank. Under this amended agreement, the Company may borrow up to $7.5 million at
a rate of prime plus 0.25% based upon eligible accounts receivable balances.
This bank line, which has a maturity date of August 31, 2010, is secured by
substantially all of the Company’s assets and requires that the Company maintain
certain financial covenants. At May 31, 2008, the Company met all financial
covenants and currently maintains cash deposits of $3.0 million that will be
considered restricted as compensating balances to the extent the Company borrows
against this bank line.  There were no borrowings outstanding as of
May 31, 2008 and May 31, 2007, respectively.





40


Note
12.  Commitments and Contingencies





The
Company’s lease agreement with 5729 Fontanoso Way, LLC for its new corporate
headquarters commenced on May 1, 2005 for sixty months.  The Company
has an option to extend this lease agreement for an additional five year
period.  The Company’s rent expense was $1.6 million, $1.6 million,
and $1.7 million for the years ended May 31, 2008, 2007, and 2006,
respectively.





The
following table summarizes our contractual obligations and estimated commercial
commitments as of May 31, 2008 and the effect such obligations are expected to
have on liquidity in future periods:





Payments
      Due by Fiscal PeriodIn
      thousands
            
            2009
            
            
            2010
            
            
            2011
            
            
            TotalOperating
      leases
            
            $
            1,712
            
            
            $
            1,545
            
            
            $
            88
            
            
            $
            3,345Inventory
      purchase commitments
            
            
            20,069
            
            
            
            -
            
            
            
            -
            
            
            
            20,069Interest
      payments on convertible notes
            
            
            1,609
            
            
            
            1,609
            
            
            
            2,061
            
            
            
            5,279Principal
      payment on convertible notes
            
            
            -
            
            
            
            -
            
            
            
            25,750
            
            
            
            25,750Total
      cash obligations
            
            $
            23,390
            
            
            $
            3,154
            
            
            $
            27,899
            
            
            $
            54,443





On
September 18, 2007, the Company signed a five year Manufacturing Services
Agreement (“Agreement”) with Flextronics Industrial Ltd. to outsource its
Singapore manufacturing to Flextronics in China. As part of this Agreement,
Flextronics accepts purchase orders and forecasts from the Company which
constitute authorization for Flextronics to procure inventory based on lead
times and to procure certain special inventory such as long lead-time items. The
Company does not take ownership of these Flextronics orders until the finished
products are ready to be shipped to our customers.  Flextronics open
commitments and inventory on hand at May 31, 2008, based on the Company’s
forecasts, were valued at $18.6 million and are included in the above table as
inventory purchase commitments.  If the Flextronics inventory goes
unused, the Company may be assessed carrying charges or obsolete
charges.  During the fiscal year ended May 31, 2008, the Company
billed Flextronics $8.3 million for inventory purchases of which $6.7 million
was paid leaving a $1.6 million “Receivable from Flextronics Industrial
Ltd”.





The
Company is not currently involved in any legal actions that management believes
are material.  From time-to-time, however, the Company may be subject
to various claims and lawsuits by customers, suppliers, competitors, and
employees arising in the normal course of business, including suits charging
infringement or violations of antitrust laws.  Such suits may seek
substantial damages and in certain instances, any damages awarded could be
trebled.




Note
13.  Stockholders’ Equity




Preferred stock: The Board of
Directors has the authority, without any further vote or action by the
stockholders, to provide for the issuance of 1,000,000 shares of preferred stock
from time to time in one or more series with such designation, rights
preferences and limitations as the Board of Directors may determine, including
the consideration received therefrom, the number of shares comprising each
series, dividend rates, redemption provisions, liquidation preferences,
redemption fund provisions, conversion rights, and voting rights, all without
the approval of the holders of common stock.




Stock option plans:The Company has a
stock-based compensation program that provides its Board of Directors with broad
discretion in creating employee equity incentives. In October 2006, the
Company’s stockholders approved a new stock incentive plan (the “2006 Plan”) to
replace the Company’s 1997 Stock Incentive Plan (the “1997 Plan”) and the
Company’s 2001 Non-Officer Employee Stock Incentive Plan (the “2001 Plan”). The
stockholders approved a total of 4.0 million shares of Common Stock (2.0 million
of which may be restricted shares) reserved for issuance under the 2006 Plan,
plus the number of shares of Common Stock that remained available for grants of
awards under the 1997 and 2001 Plans (1.4 million shares), plus any shares of
Common Stock that would otherwise return to these plans as a result of
forfeiture, termination or expiration of awards previously granted under these
plans. Stock options are generally time-based, vesting on each annual
anniversary of the grant date over three to four years and expire no more than
seven years from the grant date.  At May 31, 2008, there were 7.5
million shares reserved of which 3.9 million shares were available for
grant.




41


The
following table summarizes stock option activity and related information for the
years ended May 31:




Years2008
            
            
            2007
            
            
            2006Shares
      in thousands
            
            Options
      Outstanding
            
            
            Weighted
      Average Exercise Price
            
            
            Options
      Outstanding
            
            
            Weighted
      Average Exercise Price
            
            
            Options
      Outstanding
            
            
            Weighted
      Average Exercise PriceBeginning
            
            
            3,077
            
            
            $
            6.53
            
            
            
            3,480
            
            
            $
            6.88
            
            
            
            3,582
            
            
            $
            6.63Granted
            
            
            1,909
            
            
            $
            2.06
            
            
            
            375
            
            
            $
            2.83
            
            
            
            1,614
            
            
            $
            3.75Exercised
            
            
            (14
            )
            
            $
            1.66
            
            
            
            (3
            )
            
            $
            2.44
            
            
            
            (118
            )
            
            $
            2.20Forfeited
            
            
            (1,393
            )
            
            $
            6.43
            
            
            
            (775
            )
            
            $
            6.33
            
            
            
            (1,598
            )
            
            $
            3.49Ending
            
            
            3,579
            
            
            $
            4.21
            
            
            
            3,077
            
            
            $
            6.53
            
            
            
            3,480
            
            
            $
            6.88




Additional
disclosures for options outstanding as of May 31, 2008 at various ranges of
exercise prices are as follows (shares in thousands):
  Options
      outstanding
                    
                    
                    Options
      exercisableRange
      of exercise prices
                    
                    
                    Shares
                    
                    
                    Weighted
      average exercise price
                    
                    
                    Weighted
      average contractual life
                    
                    
                    Shares
                    
                    
                    Weighted
      average exercise price$
                    1.59
                    
                    to
                    
                    $
                    1.99
                    
                    
                    
                    952
                    
                    
                    $
                    1.83
                    
                    
                    
                    6.2
                    
                    
                    
                    122
                    
                    
                    $
                    1.72$
                    2.00
                    
                    to
                    
                    $
                    2.39
                    
                    
                    
                    883
                    
                    
                    $
                    2.26
                    
                    
                    
                    5.1
                    
                    
                    
                    80
                    
                    
                    $
                    2.20$
                    2.40
                    
                    to
                    
                    $
                    4.45
                    
                    
                    
                    896
                    
                    
                    $
                    3.37
                    
                    
                    
                    2.3
                    
                    
                    
                    766
                    
                    
                    $
                    3.44$
                    4.46
                    
                    to
                    
                    $
                    32.94
                    
                    
                    
                    848
                    
                    
                    $
                    9.81
                    
                    
                    
                    3.2
                    
                    
                    
                    497
                    
                    
                    $
                    13.313,579
                    
                    
                    $
                    4.21
                    
                    
                    
                    4.3
                    
                    
                    
                    1,465
                    
                    
                    $
                    6.58


Aggregate
intrinsic value represents the excess of the Company’s closing stock price on
the last trading day of the fiscal period, which was $1.88 as of May 31, 2008,
over the option exercise price of the shares multiplied by the number of options
outstanding.  Additional information on the status of options as of
May 31, 2008 is as follows:




Shares
      and aggregate intrinsic value, in thousands
            
            Shares
            
            
            Aggregate
      intrinsic value
            
            
            Weighted
      average exercise price
            
            
            Weighted
      average remaining contractual life (years)Outstanding
            
            
            3,579
            
            
            $
            70
            
            
            $
            4.21
            
            
            
            4.3Vested
      and expected to vest
            
            
            3,409
            
            
            $
            66
            
            
            $
            4.27
            
            
            
            4.2Exercisable
            
            
            1,465
            
            
            $
            19
            
            
            $
            6.58
            
            
            
            2.3




The
following table summarizes stock option exercises for:




YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Net
      cash proceeds
            
            $
            22
            
            
            $
            8
            
            
            $
            260Intrinsic
      value of options exercised
            
            $
            9
            
            
            $
            2
            
            
            $
            225Income
      tax benefits
            
            $
            -
            
            
            $
            -
            
            
            $
            -




In
accordance with FAS 123(R), the Company presents excess tax benefits from the
exercise of stock options, if any, as financing cash flows rather than operating
cash flows.




42


Restricted Stock Units:Restricted stock units
are converted into shares of Common Stock upon vesting on a one-for-one basis.
Vesting of restricted stock units is subject to the employee’s continuing
service with the Company. The compensation expense related to these awards was
determined using the fair value of Common Stock on the date of the grant, and
compensation is recognized over the service period. Restricted stock units
generally vest over three years.   The following table summarizes
restricted stock unit activity and related information for the period
indicated:








Year
      2008Outstanding
      restricted stock unitsShares
      in thousands
            
            Restriced
      stock units outsanding
            
            
            Weighted
      average grant date fair valueUnvested
      awards beginning of period
            
            
            521
            
            
            $
            2.43Awards
            
            
            -
            
            
            $
            -Vested
            
            
            (156
            )
            
            $
            2.43Forfeitures
            
            
            (108
            )
            
            $
            2.43Unvested
      awards end of period
            
            
            257
            
            
            $
            2.43




Employee Stock Purchase
Plan:In May
2002, the Company’s stockholders approved the 2002 Employee Stock Purchase Plan
(the “2002 Plan”) and reserved 2,000,000 shares for issuance under the Plan. The
Company’s 2002 Plan provides that eligible employees may purchase stock at
85% of its fair value on specified dates through payroll deductions. At May 31,
2008, the Company had 1.5 million shares reserved for future
issuance.





YearsIn
      thousands, except per share data
            
            2008
            
            
            2007
            
            
            2006Shares
      issued
            
            
            46
            
            
            
            60
            
            
            
            59Average
      purchase price
            
            $
            1.81
            
            
            $
            2.24
            
            
            $
            3.20Net
      cash proceeds
            
            $
            84
            
            
            $
            135
            
            
            $
            189Intrinsic
      value
            
            $
            15
            
            
            $
            24
            
            
            $
            53Income
      tax benefits
            
            $
            -
            
            
            $
            -
            
            
            $
            -





Adoption of Statementof Financial Accounting Standard No.
123(revised) “Share-Based Payment”:On June 1, 2006, the
Company adopted the provisions of FAS 123(R), and started
recognizing compensation expense related to the fair value of its employee
stock-based compensation awards. The Company elected to use the modified
prospective transition method as permitted by FAS 123(R) and therefore financial
results for prior periods were not restated. Under this transition method,
stock-based compensation expense for the year ended May 31, 2007 includes
compensation expense for all employee stock-based compensation awards granted
prior to, but not yet vested as of June 1, 2006 based on the grant date fair
value estimated in accordance with the original provisions of FAS 123, adjusted
for awards not expected to vest. Stock-based compensation expense for all
stock-based compensation awards granted subsequent to June 1, 2006 was based on
the grant-date fair value estimated in accordance with the provisions of FAS
123(R), adjusted for awards not expected to vest. Upon adoption of SFAS 123(R),
the Company recognizes compensation expense for stock option awards granted
subsequent to June 1, 2006 on a straight-line basis over the requisite service
period of the award while prior grants continue to be recognized on an
accelerated basis.




The
Company estimates the fair value of stock options using a Black-Scholes
valuation model.  The fair value assumptions and weighted average
grant date fair values for the plans are as follows:





43


YearsStock
      Option Plans
            
            2008
            
            
            2007
            
            
            2006Expected
      dividend yield
            
            
            -
            
            
            
            -
            
            
            
            -Expected
      stock price volatility
            
            
            60.7
            %
            
            
            66.8
            %
            
            
            67.4
            %Risk-free
      interest rate
            
            
            4.2
            %
            
            
            4.9
            %
            
            
            4.9
            %Expected
      life (years)
            
            
            3.8
            
            
            
            3.1
            
            
            
            2.9Weighted
      average grant date fair values
            
            $
            1.00
            
            
            $
            1.36
            
            
            $
            2.42YearsEmployee
      stock purchase plans
            
            2008
            
            
            2007
            
            
            2006Expected
      dividend yield
            
            
            -
            
            
            
            -
            
            
            
            -Expected
      stock price volatility
            
            
            49.4
            %
            
            
            55.9
            %
            
            
            71.8
            %Risk-free
      interest rate
            
            
            3.8
            %
            
            
            5.1
            %
            
            
            3.6
            %Expected
      life (years)
            
            
            1.3
            
            
            
            1.3
            
            
            
            1.2Weighted
      average purchase date fair values
            
            $
            0.05
            
            
            $
            1.05
            
            
            $
            1.85




The
Company’s computation of expected volatility for all periods presented was based
on historical volatility and the computation of expected life was based on
historical exercise patterns. The interest rate for periods within the
contractual life of the award was based on the U.S. Treasury yield curve in
effect at the time of grant.  The Company pays no dividends and does
not expect to pay any for the foreseeable future. FAS 123(R) requires
forfeitures to be estimated at the time of grant and these estimates are revised
if necessary in subsequent periods if actual forfeitures differ.




FAS
123(R) requires the Company to calculate the pool of excess tax benefits that
are available as of June 1, 2006 to absorb tax deficiencies recognized in
subsequent periods, assuming the Company had applied the provisions of the
standard in prior periods. The Company has elected to use the regular or long
method of determining tax effects of share-based compensation. The choice of
approach will have no impact on the tax benefit pool or tax expense to be
recognized for the current period, due to the Company’s net operating loss
position.




The total
stock-based compensation expense for stock options, restricted stock units, and
ESPP was as follows:




YearsIn
      thousands
            
            2008
            
            
            2007Cost
      of sales
            
            $
            70
            
            
            $
            79Research
      and development
            
            
            306
            
            
            
            177Selling,
      general and administrative
            
            
            757
            
            
            
            679$
            1,133
            
            
            $
            935




As of May
31, 2008, the unamortized stock-based compensation balance related to stock
options, restricted stock units, and the ESPP was $1.9 million and will be
recognized over an estimated weighted average amortization period of three
years.




Prior to the adoption of FAS
123(R):Prior to
the adoption of FAS 123(R), the Company applied FAS 123, amended by FAS 148,
“Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS
148), which allowed companies to apply the existing accounting rules under
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
Employees”and related
interpretations. In general, as the exercise price of options granted under
these plans was equal to the market price of the underlying common stock on the
grant date, no stock-based employee compensation cost was recognized in the
Company’s net loss.  As required by FAS 148 prior to the adoption
of FAS 123(R), the Company provided pro forma net loss and pro forma net loss
per common share disclosures for stock-based awards, as if the fair-value-based
method defined in FAS 123 had been applied.




44




The
following table illustrates the pro forma net loss after tax and net loss per
common share as if the Company had applied the fair value recognition provisions
of FAS 123 to stock-based compensation:




Year
      endedIn thousands, except per share data
      (unaudited)
            
            May
      31, 2006Net
      loss - as reported
            
            $
            (34,030
            )Add:
      Stock-based employee compensation expenseincluded
      in reported net loss
            
            
            794Deduct:  stock-based
      employee compensationexpense
      net of related tax effects
            
            
            (1,565
            )Pro
      forma net loss
            
            $
            (34,801
            )Net
      loss per share:Basic
      and Diluted - as reported
            
            $
            (1.53
            )Basic
      and Diluted - pro forma
            
            $
            (1.57
            )




Warrants:In
connection with the issuance of the 5.25% Notes, the Company also issued
warrants for the purchase of 715,000 shares.  (see Note 8 –
Convertible Subordinated Notes (“5.25% Notes”) Conversion Expense and
Warrants)  These warrants expired June 15, 2007.




Note
14.  Employee Benefit Plans




Incentive
plans:The Company has adopted an Employee Incentive Plan and
a Savings Plan covering substantially all of its employees who reside in the
United States. The Board of Directors determines annually a formula to set aside
amounts into a profit sharing pool based upon performance targets to pay bonuses
to employees. There were no charges to operations for these plans during 2008,
2007 and 2006.




Post-retirement medical plan:
Effective July 23, 1996 the Board of Directors approved a plan for medical and
dental coverage for certain executive retirees meeting certain age and service
eligibility requirements. At May 31, 2008, three retirees and their spouses were
in the plan. The retirees and their spouses pay their share of the coverage
costs at the same percentage rate as an active Company employee. The Company’s
future obligation under this plan, which is accrued and included in accrued
liabilities, is estimated to be $0.5 million using the following medical
assumptions:




YearPost-retirement
      medical plan
            
            2008Premium
      inflation factor
            
            
            7.6
            %Present
      value rate
            
            
            7.0
            %Expected
      life (years)
            
            
            17.8




Pensionplans: The majority of
employees in the United States are covered by 401K type defined contribution
plans. In Germany, employees are covered by a defined benefit pension plan (“The
Plan”) in accordance with local legal requirements.




In
September 2006, the FASB issued Statement No. 158,Employers’Accounting for Defined Benefit
Pension and Other Postretirement Plans (“SFAS No. 158”). SFAS No. 158
amends SFAS No. 87,Employers’Accounting for Pensions,
SFAS No. 88, Employers’Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination
Benefits, SFAS No. 106,Employers’Accounting for Postretirement
Benefits Other Than Pensions, SFAS No. 132−R,Employers’Disclosures about Pensions and
Other Postretirement Benefits, and other related accounting literature.
SFAS No. 158 requires employers to recognize the funded status of a benefit
plan, measured as the difference between plan assets at fair value and the
benefit obligation, in their balance sheet. The recognition of the funded status
on the balance sheet requires employers to recognize actuarial items (such as
actuarial gains and losses, prior service costs, and transition obligations) as
a component of other comprehensive income, net of tax. The adoption of SFAS No.
158 on May 31, 2007 had no impact on our Consolidated Statement of Operations,
Consolidated Balance Sheets or Consolidated Statement of Stockholder's Equity
and Comprehensive Loss.  The Company has purchased insurance policies
to cover the payment risk of The Plan.  These insurance policies have
not been segregated and restricted to provide for pension benefits and are
therefore not considered plan assets  The cash surrender value of
these insurance policies as of May 31, 2008 and 2007 was $1.2 million
and $1.0 million, respectively, and have been included in non-current
assets.




45


The
projected benefit obligations of the Plan are as follows and are classified as
non-current liabilities:




YearsIn
      thousands
            
            2008
            
            
            2007Projected
      benefit obligation at beginning of year
            
            $
            908
            
            
            $
            826Interest
      costs
            
            
            48
            
            
            
            40Actuarial
      loss
            
            
            (150
            )
            
            
            (20
            )Service
      costs
            
            
            8
            
            
            
            8Benefits
      paid
            
            
            (28
            )
            
            
            (25
            )Effect
      of foreign currency
            
            
            143
            
            
            
            79Projected
      benefit obligation at the end of the year
            
            $
            929
            
            
            $
            908




The net
periodic pension costs are as follows for the periods presented:




YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Interest
      on projected benefit obligation
            
            $
            48
            
            
            $
            40
            
            
            $
            37Service
      cost
            
            
            8
            
            
            
            8
            
            
            
            7Net
      periodic pension cost
            
            $
            56
            
            
            $
            48
            
            
            $
            44




The
weighted-average assumptions used in computing the projected benefit obligation
and net periodic pension costs are as follows:




Years2008
            
            
            2007
            
            
            2006Assumed
      discount rate
            
            
            5.8
            %
            
            
            4.9
            %
            
            
            4.6
            %Rate
      of compensation increase
            
            
            1.5
            %
            
            
            1.5
            %
            
            
            1.5
            %




The Plan
benefit payments, which reflect expected future service, are expected to be paid
as follows:




In
      thousands2009
            $
            302010
            
            312011
            
            312012
            
            322013-2017
            
            185Total
            $
            309




46


Note
15.  Segment Information




FASB
Statement No. 131, “Disclosures about Segments of an Enterprise and Related
Information”, establishes standards for reporting information about operating
segments.  Operating segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker, or decision making
group, in deciding how to allocate resources and in assessing performance. The
Company’s chief operating decision maker is the Chief Executive
Officer.  The Company operates as a single operating unit and has one
reportable unit and is a United States, Delaware Corporation.




The
Company’s net sales by geography are as follows:




YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Asia
            
            $
            16,056
            
            
            
            35
            %
            
            $
            13,704
            
            
            
            31
            %
            
            $
            15,924
            
            
            
            36
            %Europe
            
            
            8,885
            
            
            
            20
            
            
            
            11,355
            
            
            
            25
            
            
            
            9,804
            
            
            
            22International
            
            
            24,941
            
            
            
            55
            
            
            
            25,059
            
            
            
            56
            
            
            
            25,728
            
            
            
            58North
      America
            
            
            20,480
            
            
            
            45
            
            
            
            19,565
            
            
            
            44
            
            
            
            18,589
            
            
            
            42$
            45,421
            
            
            
            100
            %
            
            $
            44,624
            
            
            
            100
            %
            
            $
            44,317
            
            
            
            100
            %




Sales
between geographic areas are at prices that the Company believes are at arm’s
length and are eliminated in the consolidated financial statements.
International sales represent the combined total of export sales made by United
States operations and all sales made by foreign operations.




Sales to
customers in the United States represented 45% of the Company’s sales in 2008.
Sales to customers in the United States represented 44% of the Company’s sales
in 2007.  Sales to customers in the United States, Singapore and
France represented 41%, 11% and 10% of the Company’s sales in 2006,
respectively.




Service
revenue, included in aftermarket prober products and services was 10%, 11% and
10% of net sales for the year ended May 31, 2008, 2007 and 2006, respectively.
Revenues from after-sale services have traditionally totaled less than 10% of
the Company’s total revenues and are not shown separately.The following is a summary
of the Company’s net sales by product category, although the Company manages its
business as a single operating unit:




YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Prober
      systems and software
            
            $
            27,595
            
            
            $
            26,084
            
            
            $
            27,074Aftermarket
      prober products and services
            
            
            17,826
            
            
            
            18,540
            
            
            
            17,243$
            45,421
            
            
            $
            44,624
            
            
            $
            44,317




47


The
following table presents summary customer concentration information as a
percentage of sales:




YearsCustomers
            
            2008
            
            
            2007
            
            
            2006Customer
      A
            
            
            24
            %
            
            
            9
            %
            
            
            5
            %Customer
      B
            
            
            11
            %
            
            
            8
            %
            
            
            28
            %Customer
      C
            
            
            7
            %
            
            
            11
            %
            
            
            8
            %




The
following table presents summary customer concentration information as a
percentage of accounts receivable:




Years
      endedCustomers
            
            2008
            
            
            2007Customer
      C
            
            
            11
            %
            
            
            8
            %Customer
      D
            
            
            10
            %
            
            
            9
            %




Identifiable
long-lived assets by geography are as follows:




Years
      endedIn
      thousands
            
            2008
            
            
            2007Europe
            
            $
            13
            
            
            $
            111Asia
            
            
            405
            
            
            
            690International
            
            
            418
            
            
            
            801United
      States
            
            
            2,306
            
            
            
            3,978$
            2,724
            
            
            $
            4,779






The
majority of the Company’s long-lived assets in Asia consist of fixed assets
located at the Company’s Singapore and Taiwan offices.




Note
16.  Income Taxes




Significant
components of the provision (benefit) for income taxes are as follows
for:




YearsIn
      thousands
            
            2008
            
            
            2007
            
            
            2006Federal:Current
            
            $
            -
            
            
            $
            -
            
            
            $
            -Deferred
            
            
            -
            
            
            
            -
            
            
            
            --
            
            
            
            -
            
            
            
            -State:Current
            
            
            -
            
            
            
            -
            
            
            
            -Deferred
            
            
            -
            
            
            
            -
            
            
            
            --
            
            
            
            -
            
            
            
            -Foreign:Current
            
            
            463
            
            
            
            297
            
            
            
            (628
            )Deferred
            
            
            188
            
            
            
            (288
            )
            
            
            -651
            
            
            
            9
            
            
            
            (628
            )$
            651
            
            
            $
            9
            
            
            $
            (628
            )




No tax
benefits were realized from exercises of nonqualified stock options or
disqualifying dispositions of stock acquired through incentive stock option or
the employee stock purchase plan during the years ended May 31, 2008, 2007 and
2006, respectively.  Pre-tax income (loss) from foreign operations was
$1.3 million, $0.6 million and $2.1 million, for the same periods.




48


The
Company uses estimates based on historical experience and various other
assumptions in the area of income tax accounting that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of tax assets and
liabilities.  It is the Company’s policy to accrue for income tax
exposures or to release such tax reserves in the period in which facts and
circumstances arise that suggest that the valuation allowances or reserves
should be adjusted.  As of May 31, 2008 and 2007, income tax related
reserves totaled approximately $1.2 million and $1.0 million,
respectively.




When
establishing the manufacturing facility in Singapore, the Company received a
five-year exemption from Singapore income taxes beginning March 1, 2003 under
the condition that certain capital investment and expenditure milestones would
be reached by March 1, 2008.  As a result of the Company’s strategic
initiative of moving the Company’s manufacturing function from Singapore to
China, the Company was exposed to a liability for the taxes that otherwise would
have been due during the tax exemption period. During 2007, the Company
initiated negotiations with the Singapore government, which were concluded in
September 2007 to end the tax exemption period retroactively, and eliminate the
remaining investment milestones, in exchange for a three-year tax exemption
ending February 28, 2006. The Singapore government agreed to shorten the
exemption period and waive the remaining investment
milestones.  During 2008, the Company accrued $0.4 million to reflect
the tax amounts owed as part of this negotiated settlement.




The
reconciliation of income tax computed at the United States federal statutory
rates to income tax expense is as follows for the periods ended:




YearsIn
      thousands,
            
            2008
            
            
            2007
            
            
            2006except
      percentages
            
            Amount
            
            
            Percent
            
            
            Amount
            
            
            Percent
            
            
            Amount
            
            
            PercentTax
      computedat
      U.S. statutory rate
            
            $
            (5,349
            )
            
            
            (35.0
            )
      %
            
            $
            (6,571
            )
            
            
            (35.0
            )
      %
            
            $
            (12,131
            )
            
            
            (35.0
            )
      %Research
      and development
              credits
            
            
            (45
            )
            
            
            (0.3
            )
            
            
            (296
            )
            
            
            (1.6
            )
            
            
            (554
            )
            
            
            (1.6
            )Foreign
      taxes
            
            
            234
            
            
            
            1.5
            
            
            
            (16
            )
            
            
            (0.1
            )
            
            
            13
            
            
            
            -Debt
      conversion expenses
            
            
            217
            
            
            
            1.4
            
            
            
            -
            
            
            
            -
            
            
            
            6,023
            
            
            
            17.4Unbenefitted
      losses
            
            
            2,488
            
            
            
            16.3
            
            
            
            6,496
            
            
            
            34.6
            
            
            
            5,857
            
            
            
            16.9Changes
      in valuation
              allowance
            
            
            63
            
            
            
            0.4
            
            
            
            296
            
            
            
            1.6
            
            
            
            554
            
            
            
            1.6Reversal
      of tax reserves
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (647
            )
            
            
            (1.9
            )956
      inclusion
            
            
            2,544
            
            
            
            16.7
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Other,
      net
            
            
            499
            
            
            
            3.3
            
            
            
            100
            
            
            
            0.5
            
            
            
            257
            
            
            
            0.8Provision
      (benefit) for income taxes
            
            $
            651
            
            
            
            4.3
            %
            
            $
            9
            
            
            
            (0.0
            )
      %
            
            $
            (628
            )
            
            
            (1.8
            )
      %





Deferred
income taxes reflect the net tax effects of temporary timing differences between
the carrying amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company’s deferred tax accounts are as follows for:





YearsIn
      thousands
            
            2008
            
            
            2007Deferred
      tax assets:Intangible
      assets
            
            $
            65
            
            
            $
            2,099Warranty
      reserves
            
            
            430
            
            
            
            470Inventories
            
            
            1,777
            
            
            
            2,090Depreciable
      assets
            
            
            (136
            )
            
            
            (222
            )Deferred
      revenue
            
            
            328
            
            
            
            361Net
      operating losses
            
            
            106,540
            
            
            
            104,562Tax
      credit carryforwards
            
            
            9,378
            
            
            
            13,893Other
            
            
            3,873
            
            
            
            3,346Total
      deferred tax assets
            
            
            122,255
            
            
            
            126,599Less:
      valuation allowance
            
            
            (122,155
            )
            
            
            (126,311
            )Net
      deferred tax assets
            
            $
            100
            
            
            $
            288




Realization
of the deferred tax assets is dependent on the Company generating sufficient
taxable income in future years in appropriate tax jurisdictions to obtain
benefit from the reversal of temporary differences and from net operating losses
and tax credit carryforwards. The Company has provided a valuation allowance
against deferred tax assets of $122.0 million to reflect management’s estimation
that, as of May 31, 2008, it is more likely than not that only $ 0.1 million of
deferred tax assets will be utilized.  The valuation allowance
decreased by $4.2 million and increased by $9.7 million in 2008 and 2007,
respectively.




49




The
Company’s tax attributes were as follows as of May 31, 2008:




Federal
            
            
            StateIn
      thousands
            
            Amount
            
            
            Expiration
            
            
            Amount
            
            
            ExpirationAcquisition
      related net operating losses
            
            $
            230
            
            
            
            2018-2020
            
            
            $
            -
            
            
            
            -Acquisition
      related tax credits
            
            $
            139
            
            
            
            2010-2019
            
            
            $
            -
            
            
            
            -Non-acquisition
      related net operating losses
            
            $
            302,066
            
            
            
            2021-2028
            
            
            $
            128,389
            
            
            
            2013-2017Non-acquisition
      related tax credits
            
            $
            6,838
            
            
            
            2018-2028
            
            
            $
            6,588
            
            
            
            2009-2014




As of May
31, 2008, the Company had federal and state net operating losses and tax credits
that will expire in varying amounts if unutilized as indicated
above.  Due to change of ownership rules, net operating losses and tax
credits attributable to the Company’s acquisitions are significantly limited and
will expire if not utilized.  The California research and development
credit of $6.3 million does not expire under the current law, whereas the
manufacturer’s investment credit of $0.3 million will expire if not used in
2014.




The
Company may have had an ownership change as defined in Section 382 of the
Internal Revenue Code and similar state law.  The Company's ability to
utilize the net operating losses and tax credit carryforwards in the future may
be subject to substantial restriction in the event of past or future ownership
changes.  No determination has been made at this point.  A formal
Section 382 study will be performed in order to make a
determination.




Effective
June 1, 2007, the Company adopted the provisions of Financial Accounting
Standards Board Interpretation No. 48 (“FIN No. 48”), “Accounting for
Uncertainty in Income Taxes,” which provisions included a two-step approach to
recognizing, de-recognizing and measuring uncertain tax positions accounted for
in accordance with SFAS No. 109 (“SFAS No. 109”), “Accounting for
Income Taxes.” As a result of the implementation of FIN No. 48, the Company
recognized no increase in the liability for unrecognized tax
benefits.




The
Company adopted a policy to classify accrued interest and penalties as part of
the accrued FIN No. 48 liability in the provision for income taxes. For the
year beginning June 1, 2007, the Company has recognized interest or penalties of
approximately $9,000 related to unrecognized tax benefits.As of May 31,
2008, the Company had approximately $12,000 of accrued interest and penalties
related to uncertain tax matters.





The
Company’s unrecognized tax benefits:





In
      thousands
            
            AmountBalance
      at May 31, 2007
            
            $
            7,688Additions
      for tax positions of prior years
            
            
            23Reductions
      for tax positions of prior years
            
            
            (276
            )Additions
      based on tax positions related to the current year
            
            
            6Balance
      at May 31, 2008
            
            $
            7,441





All of
these unrecognized tax benefits would affect the effective tax rate if
recognized.





During
the next fiscal year, the Company has no material uncertain tax positions that
would be reduced as a result of a lapse of the applicable statute of
limitations.  We do not anticipate the adjustments would result in a
material change to our financial position.





We file
income tax returns in the U.S. federal jurisdictions, and various states
jurisdictions.  The 1997 through 2008 tax years are open and may be
subject to potential examination in one or more jurisdictions. The Company is
not currently under federal or state income tax examination.


50




Note
17.  Allowances for Doubtful Accounts and Sales Returns







In
      thousands
            
            Balance
      at Beginning of Period
            
            
            Charged
      to costs and expenses
            
            
            Deductions
            
            
            Balance
      at End of PeriodAllowance
      for doubtful accounts
            
            $
            331
            
            
            $
            (1
            )
            
            $
            (62
            )
            
            $
            268Allowance
      for sales returns
            
            
            61
            
            
            
            -
            
            
            
            -
            
            
            
            61Total
      at May 31, 2008
            
            $
            392
            
            
            $
            (1
            )
            
            $
            (62
            )
            
            $
            329Allowance
      for doubtful accounts
            
            $
            418
            
            
            $
            29
            
            
            $
            (116
            )
            
            $
            331Allowance
      for sales returns
            
            
            61
            
            
            
            -
            
            
            
            -
            
            
            
            61Total
      at May 31, 2007
            
            $
            479
            
            
            $
            29
            
            
            $
            (116
            )
            
            $
            392Allowance
      for doubtful accounts
            
            $
            513
            
            
            $
            (79
            )
            
            $
            (16
            )
            
            $
            418Allowance
      for sales returns
            
            
            81
            
            
            
            (20
            )
            
            
            -
            
            
            
            61Total
      at May 31, 2006
            
            $
            594
            
            
            $
            (99
            )
            
            $
            (16
            )
            
            $
            479





51




Item 9.Changes in and
Disagreements with Accountants on Accounting and Financial
Disclosure






Not
applicable.






Item9A(T).Controls and
Procedures






Controls
and Procedures






Evaluation of
disclosure controls and procedures:We conducted an evaluation
of the effectiveness of the design and operation of our “disclosure controls and
procedures” (Disclosure Controls) as of May 31, 2008, the end of the period
covered by this Form 10−K. The controls evaluation was conducted under the
supervision and with the participation of management, including our CEO and CFO.
Disclosure Controls are controls and procedures designed to reasonably assure
that information required to be disclosed in our reports filed under the
Exchange Act, such as this Form 10−K, is recorded, processed, summarized and
reported within the time periods specified in the U.S. Securities and Exchange
Commission’s (SEC’s) rules and forms. Disclosure Controls are also designed to
reasonably assure that such information is accumulated and communicated to our
management, including the CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure. Our quarterly evaluation of Disclosure Controls
includes an evaluation of some components of our internal control over financial
reporting, and internal control over financial reporting is also separately
evaluated on an annual basis for purposes of providing the management report
which is set forth below.




The
evaluation of our Disclosure Controls included a review of the controls’
objectives and design, the Company’s implementation of the controls and the
effect of the controls on the information generated for use in this Form 10−K.
In the course of the controls evaluation, we sought to identify any past
instances of data errors, control problems or acts of fraud and sought to
confirm that appropriate corrective actions, including process improvements, had
been undertaken.




This type
of evaluation is performed on a quarterly basis so that the conclusions of
management, including the CEO and CFO, concerning the effectiveness of the
Disclosure Controls can be reported in our periodic reports on Form 10−Q and
Form 10−K. Many of the components of our Disclosure Controls are also evaluated
on an ongoing basis by our finance organization. The goals of these various
evaluation activities are to monitor our Disclosure Controls, and to modify them
as necessary. Our intent is to maintain the Disclosure Controls as dynamic
systems that change as conditions warrant.


Based
upon the controls evaluation, our CEO and CFO have identified material
weaknesses related to controls surrounding revenue recognition and
inventory reserves. More specifically, appropriate evidence documenting
persuasive evidence of an arrangement was lacking resulting in year-end audit
adjustments to reverse revenue.  Also, inventory reserves were
incorrectly adjusted in a manner which was not consistent with the Company’s
policies or in accordance with generally accepted accounting principles. Based
on the results of this controls evaluation, our management has concluded as a
result of the material weaknesses in our controls surrounding revenue
recognition and inventory reserves that the Company’s disclosure controls and
procedures were not effective as of May 31, 2008, the end of the period covered
by this Form 10−K.  We plan to remediate these material
weaknesses by: improving training of our sales force and accounting personnel on
our revenue and inventory reserve policies and procedures,
ensuring that appropriate evidence of an arrangement exists for revenue
transactions, reviewing shipping terms to ensure proper revenue recognition
under current arrangements, and adding controls around changes in shipping terms
from other than EXWorks which is the standard commercial shipping terms used by
the Company.
  Changes
Internal Control over Financial Reporting: There were no changes in
our internal controls over financial reporting during the quarter ended May 31,
2008 that have materially affected, or are reasonably likely to materially
affect, our internal controls over financial
reporting.
   Management’s
Report on Internal Control over Financial Reporting
   Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a−15(f) and 15d−15(f). Under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
we conducted an evaluation of the effectiveness of our internal control over
financial reporting as of May 31, 2008 based on the guidelines established in
Internal Control—Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on the results of this controls evaluation,
our management has concluded solely as a result of the material weaknesses in
controls surrounding revenue recognition and inventory reserves that our
internal control over financial reporting was not effective as of as of May 31,
2008, the end of the period covered by this Form 10−K.
  This
annual report does not include an attestation report of the company’s registered
public accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the company’s registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the company to provide only management’s report
in this annual report.
   52




Item 9B.Other
Information






Not
applicable.




PartIII





Item 10.  Directors and Executive
Officers of the Registrantand Corporate
Governance





The
information required by this item, including the independence of the audit
committee and the audit committee’s financial expert, is included under the
heading “Election of Director” and “Other Matters” in the Company’s Proxy
Statement to be filed in connection with the Annual Meeting of Stockholders to
be held on October 15, 2008 and is incorporated herein by
reference.





We
adopted a code of business conduct and ethics, or code of conduct, in 2003. The
code of conduct has been designed to qualify as a “code of ethics” within the
meaning of Section 406 of the Sarbanes-Oxley Act of 2002 and the rules
promulgated thereunder.  The code is available on our website (www.electroglas.com).
To the extent required by law, any amendments to, or waivers from, any provision
of the code will be promptly disclosed publicly. To the extent permitted by such
requirements, we intend to make such public disclosure by posting the relevant
material on our website in accordance with SEC rules.





Item 11.  Executive
Compensation





The
information required by this item is included under the heading “Executive
Compensation and Other Information” in the Company’s Proxy Statement to be filed
in connection with the Annual Meeting of Stockholders to be held on October 15,
2008, and is incorporated herein by reference.





Item 12.  Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder
Matters





The
information required by this item is included under the heading “Security
Ownership of Certain Beneficial Owners and Management” in the Company’s Proxy
Statement to be filed in connection with the Annual Meeting of Stockholders to
be held on October 15, 2008, and is incorporated herein by
reference.





Item 13.  Certain Relationships
and Related Transactions and Director Independence





The
information required by this item is included under the heading “Certain
Relationships and Related Transactions” in the Company’s Proxy Statement to be
filed in connection with the Annual Meeting of Stockholders to be held on
October 15, 2008, and is incorporated herein by reference.





Item 14.Principal Accountant
Fees and Services.





The
information required by this item is included under the heading “Principal
Accountant Fees and Services” in the Company’s Proxy Statement to be filed in
connection with the Annual Meeting of Stockholders to be held on October 15,
2008, and is incorporated herein by reference.


53


Part IV




Item 15.Exhibits and Financial
Statement Schedules






(a)
            Documents filed as a part of
      this Report:




(1) Index to Financial Consolidated
Statements


Report
      of Independent Registered Public Accounting Firm, BDO Seidman
      LLP
            28Consolidated
      statements of operations - years ended May 31, 2008, 2007 and
      2006
            29Consolidated
      balance sheets - May 31, 2008 and 2007
            30Consolidated
      statements of stockholders’ equity and comprehensive loss - years ended
      May 31, 2008, 2007  and 2006
            31Consolidated
      statements of cash flows - years ended May 31, 2008, 2007 and
      2006
            32Notes
      to consolidated financial statements
            33





(2) Index to Financial Statement
Schedules– All schedules have been omitted because the required
information is included in the consolidated financial statements or the notes
thereto, or are not applicable or required.




54


(3) Exhibit Index


Exhibit
      Number
              
              
              
              Incorporated
      by Reference
              
              FiledExhibit
      Description
              
              Form
              
              File
      No.
              
              Exhibit
              
              Filing
      Date
              
              Herewith3.1
              
              Certificate
      of Incorporation of Electroglas, Inc., as amended.
              
              S-1
              
              33-61528
              
              
              
              6/23/19933.2
              
              By-laws
      of Electroglas, Inc., as amended.
              
              10-K
              
              
              
              3.2
              
              3/12/19993.3
              
              Certificate
      of Designation for Electroglas, Inc.
              
              10-K
              
              
              
              3.3
              
              3/30/19984.1
              
              Reference
      is made to Exhibits 3.1, 3.2 and 3.3.4.2
              
              Specimen
      Common Stock Certificate of Electroglas, Inc., a Delaware
      Corporation.
              
              S-1
              
              33-61528
              
              
              
              6/23/199310.1*
              
              Electroglas,
      Inc. 1993 Long-Term Incentive Plan.
              
              S-1
              
              33-74860
              
              10.1
              
              2/23/199410.2*
              
              Change
      in Control Agreement between Electroglas, Inc. and Armand J. Stegall dated
      as of June 9, 1995.
              
              10-K
              
              
              
              10.2
              
              3/31/199610.3*
              
              Electroglas,
      Inc. Restricted Stock Bonus Agreement Between Electroglas, Inc. and Curtis
      S. Wozniak.
              
              10-Q
              
              
              
              10.10
              
              6/30/199610.4*
              
              Change
      of Control Agreement between Electroglas, Inc. and Curtis S. Wozniak dated
      as of April 4, 1996.
              
              10-Q
              
              
              
              10.11
              
              6/30/199710.5*
              
              Electroglas
      Officers' Retirement Medical and Dental Coverage Policy.
              
              10-Q
              
              
              
              10.12
              
              9/31/199610.7
              
              Rights
      Agreement between Electroglas, Inc., and BankBoston, N.A., as rights agent
      dated as of November 18, 1997
              
              8-A12G
              
              0-21626
              
              1.0
              
              11/19/199710.8*
              
              Electroglas,
      Inc. 1997 Stock Incentive Plan.
              
              10-K
              
              
              
              10.18
              
              3/30/199810.9*
              
              Form
      of change of Control Agreement between the company and each of Timothy J.
      Boyle, Wayne E. Woodward, Thomas E. Brunton, and Richard J. Casler as of
      June 9, 1995, April 5, 1999, December 22, 2000, and March 14, 2004,
      respectively.
              
              10-K
              
              
              
              10.18
              
              3/30/199810.11*
              
              Electroglas,
      Inc. 1998 Employee Stock Purchase Plan.
              
              10-Q
              
              
              
              10.2
              
              6/30/199810.12*
              
              Electroglas,
      Inc. 2001 Non-Officer Employee Stock Incentive Plan.
              
              10-K
              
              
              
              10.12
              
              3/13/200210.13*
              
              Executive
      Employment Agreement between Electroglas, Inc. and Keith Barnes dated
      October 22, 2003.
              
              10-K
              
              
              
              10.13
              
              9/30/200310.14*
              
              Electroglas,
      Inc. Stock Option Agreement between Electroglas, Inc. and Keith Barnes
      dated October 28, 2003.
              
              10-K
              
              
              
              10.14
              
              9/30/200310.15*
              
              Resignation
      letter from Curt Wozniak to Electroglas, Inc. dated October 28,
      2003.
              
              10-K
              
              
              
              10.15
              
              9/30/200310.16
              
              Lease
      agreement between 5729 fontanoso Way, LLC and Electroglas, Inc. dated
      February 7, 2005.
              
              10-K
              
              
              
              10.16
              
              3/14/200510.17*
              
              Form
      of Board of Directors consulting and Indemnity Agreement, dated December
      19, 2005, by ad between Electrogals, Inc. and each of Robert J.
      Frankenberg, Mel Friedman, C. Scott Gibson, John F. Osborne, Thomas M.
      Rohrs, and Edward M. Saliba.
              
              8-K
              
              
              
              10.1
              
              12/23/200510.18*
              
              Board
      of Directors Consulting and Indemnity Agreement, dated February 2, 2006 by
      and between Electroglas, Inc. and Fusen E. Chen.
              
              8-K
              
              
              
              10.1
              
              2/8/200610.19*
              
              Board
      of Directors consulting and Indemnity Agreement, dated April 12.2006, by
      and between Electrogals, Inc. and Keith L. Barnes.
              
              8-K
              
              
              
              10.1
              
              4/14/200610.20*
              
              Offer
      letter, effective April 7, 2006 by and between the Company and Thomas M.
      Rohrs
              
              10-Q
              
              
              
              10.2
              
              3/4/200610.19
              
              Exchange
      Agreement with Certain holder of the Company's 5.25% convertible
      Subordinated Notes Due 2007.
              
              8-K
              
              
              
              10.1
              
              5/3/200610.20*
              
              Clarification
      of Consulting Agreement by and Between Electroglas, Inc., and Keith L.
      Barnes dated July 6, 2006.
              
              8-K
              
              
              
              
              
              7/10/200610.21*
              
              Amended
      and Restated Change of Control Agreement, dated March 31, 2006, by and
      between Electrogals, Inc. and Thomas E. Brunton.
              
              8-K
              
              
              
              10.1
              
              5/3/200610.22*
              
              Board
      of Directors consulting and Indemnity Agreement, dated March 30, 2007, by
      and between Electroglas, Inc. and Jack G. Wilborn.
              
              8-K
              
              
              
              10.1
              
              3/31/200712.1
              
              Statement
      of Computation of Ratios
              
              
              
              
              
              
              
              
              
              X21.1
              
              List
      of subsidiaries of registrant.
              
              
              
              
              
              
              
              
              
              X23.1
              
              Consent
      of BDO Seidman LLP, Independent Registered Public Accounting
      Firm.
              
              
              
              
              
              
              
              
              
              X31.1
              
              Certification
      of Thomas M. Rohrs, Chief Executive Officer, pursuant to Rules 13a-14(a)
      and 15d-14(a) of the Securities Exchange Act, as amended.
              
              
              
              
              
              
              
              
              
              X31.2
              
              Certification
      of Thomas E. Brunton, Chief Financial Officer, pursuant to Rules 13a-14(a)
      and 15d-14(a) of the Securities Exchange Act, as amended.
              
              
              
              
              
              
              
              
              
              X32.1
              
              Certification
      of Thomas M. Rohrs, Chief Executive Officer, pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.
              
              
              
              
              
              
              
              
              
              X32.2
              
              Certification
      of Thomas E. Brunton, Chief Financial Officer, pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.
              
              
              
              
              
              
              
              
              
              X*
              
              Management
      contracts, or Company compensatory planos or arrangements.


55


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.





Electroglas, Inc.








By:/s/THOMAS
M.
ROHRS


Thomas
M. Rohrs


Chairman
and Chief Executive Officer





Date:
August 12, 2008





Power
of Attorney




KNOW ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Thomas M. Rohrs and Thomas E. Brunton, and each of
them, his attorneys-in-fact, each with power of substitution, for him in any and
all capacities, to sign any amendments to this Annual Report on Form 10-K and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact, or his substitute or
substitutes may do or cause to be done by virtue hereof.





Pursuant
to the requirements of the Securities Exchange Act of 1934, this Annual Report
on Form 10-K has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.





Signature
            Title
            Date/s/               Thomas M.
      Rohrs
            Chairman
      and Chief Executive Officer
            August 12,
      2008Thomas M. Rohrs
            (Principal
      Executive Officer)/s/             Thomas E.
      Brunton
            Senior
      Vice President, Finance, Chief Financial Officer,
            August 12,
      2008Thomas E.
    Brunton
            Treasurer
      and Secretary(Principal
      Financial and Accounting Officer)/s/                  Mel
      Friedman
            Director
            August 12,
      2008Mel Friedman/s/                 C. Scott
      Gibson
            Director
            August 12,
      2008C. Scott Gibson/s/                   John
      Osborne
            Director
            August 12,
      2008John Osborne/s/                  Jorge
      Titinger
            Director
            August 12,
      2008Jorge Titinger/s/                  jack g.
      wilborn
            Director
            August 12,
      2008Jack G. Wilborn











56