##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




---

Form 10-K

FOR ANNUAL AND TRANSITION REPORTS


PURSUANT TO SECTIONS 13 OR 15(d) OF


THE SECURITIES EXCHANGE ACT OF 1934


|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                 
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended March 28,
    2004                                                    
|          
|OR        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | FOR THE TRANSITION PERIOD
    FROM           TO                                                 

Commission file number 000-26911

Therma-Wave, Inc.


(Exact Name of Registrant as Specified in Its
Charter)


|                                                                                      |  |                                                      
|------------------------------------------------------------------------------------- |  | -----------------------------------------------------
|Delaware(State or Other Jurisdiction of
    Incorporation or Organization)            |  | 94-3000561(I.R.S. Employer Identification
    Number)
|                                                                                     
|1250 Reliance Way
    Fremont, California(Address of Principal Executive
    Offices) |  | 94539(Zip Code)                                      

(510) 668-2200

(Registrants Telephone Number, Including
Area Code)


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

None


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

Common Stock, par value $0.01 per
share


(Title of Class)


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 þ          No o

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.     o

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).     Yes þ          No o

The aggregate market value of the common equity
held by non-affiliates of the registrant, based upon the closing
price as of the last business day of the registrants most
recently completed second fiscal quarter (September 28,
2003) as reported by the Nasdaq National Market, was
approximately $122 million.

As of June 1, 2004, the registrant had
35,652,190 shares of common stock outstanding.

Portions of the Proxy Statement for the 2004
annual stockholders meeting are incorporated by reference into
Part III.



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THERMA-WAVE, INC.

Form 10-K

TABLE OF CONTENTS

|              |  |                                                                                                                          |    |      |    | 
|------------- |  | ------------------------------------------------------------------------------------------------------------------------ | -- | ---- | -- | 
|              |  |                                                                                                                          |    | Page
|              |  |                                                                                                                          |    |     
|Part I.      
|Item 1.       |  | Business                                                                                                                 |    |      | 2  | 
|Item 2.       |  | Properties                                                                                                               |    |      | 14 | 
|Item 3.       |  | Legal Proceedings                                                                                                        |    |      | 14 | 
|Item 4.       |  | Submission of Matters to a
    Vote of Security Holders                                                                  |    |      | 15 | 
|Part II.     
|Item 5.       |  | Market for the
    Registrants Common Equity, Related Stockholder Matters and
    Issuer Purchases of Equity Securities |    |      | 15 | 
|Item 6.       |  | Selected Financial Data                                                                                                  |    |      | 17 | 
|Item 7.       |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations                                |    |      | 19 | 
|Item 7A.      |  | Quantitative and Qualitative
    Disclosures About Market Risks                                                          |    |      | 38 | 
|Item 8.       |  | Financial Statements and
    Supplementary Data                                                                          |    |      | 40 | 
|Item 9.       |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure                                 |    |      | 70 | 
|Item 9A.      |  | Controls and Procedures                                                                                                  |    |      | 70 | 
|Part III.    
|Item 10.      |  | Directors and Executive
    Officers of the Registrant                                                                   |    |      | 70 | 
|Item 11.      |  | Executive Compensation                                                                                                   |    |      | 70 | 
|Item 12.      |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters                   |    |      | 71 | 
|Item 13.      |  | Certain Relationships and
    Related Transactions                                                                       |    |      | 71 | 
|Item 14.      |  | Principal Accountant Fees
    and Services                                                                               |    |      | 71 | 
|Part IV.     
|Item 15.      |  | Exhibits, Consolidated
    Financial Statement Schedules and Reports on Form 8-K                                         |    |      | 72 | 
|Signatures    |  |                                                                                                                          | 76 |     
|EXHIBIT 10.9 
|EXHIBIT 10.16
|EXHIBIT 10.31
|EXHIBIT 14.1 
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 
|EXHIBIT 99.1 



1



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PART I






|        |         
|------- | --------
|Item 1. | Business

This annual report on Form 10-K contains
forward-looking statements, including, without limitation,
statements concerning the conditions in the semiconductor and
semiconductor capital equipment industries, our operations,
economic performance and financial condition, including in
particular statements relating to our business and growth
strategy and product development efforts. The words
believe, expect, anticipate,
intend and other similar expressions generally
identify forward-looking statements. Potential investors are
cautioned not to place undue reliance on these forward-looking
statements, which speak only as of their dates. These
forward-looking statements are based largely on our current
expectations and are subject to a number of risks and
uncertainties, including, without limitation, those identified
under Exhibit 99.1, Risk Factors, and elsewhere
in this annual report and other risks and uncertainties
indicated from time to time in our filings with the SEC. Actual
results could differ materially from these forward-looking
statements. In addition, important factors to consider in
evaluating such forward-looking statements include changes in
external market factors, changes in our business or growth
strategy, an inability to raise additional funds if necessary,
an inability to execute our strategy due to changes in our
industry or the economy generally, the emergence of new or
growing competitors, an inability to develop or introduce new
products as planned, or the acceptance of those products by our
customers and various other competitive factors. In light of
these risks and uncertainties, there can be no assurance that
the matters referred to in the forward-looking statements
contained in this annual report will in fact occur.

Overview

Therma-Wave develops, manufactures, markets and
services process control metrology systems used in the
manufacture of semiconductors and controls significant market
share in the metrology industry. Process control metrology is
used to monitor process parameters in order to enable
semiconductor manufacturers to maintain high overall
manufacturing yield, reduce the size of the circuit features
imprinted on the semiconductor to improve the performance of the
semiconductor device and increase their equipment productivity.
Our current product families, Therma-Probe®,
Opti-Probe®, Opti-Probe CD and
RT/CD®, Integra® integrated
metrology products, use proprietary and patented technology to
provide precise, non-contact, non-destructive measurements for
the basic building blocks, or process modules, in the
manufacture of integrated circuits, or ICs:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Ion Implantation  implanting ions,
    usually boron, phosphorus or arsenic, into selected areas of the
    silicon wafer to alter its electrical properties. Ion
    implantation may be performed typically ten to 24 times in
    the manufacture of ICs. For example, ion implantation creates
    the positively- and negatively-doped regions used to create each
    of the millions of transistors on each integrated circuit. It
    also is used to adjust the voltage (threshold voltage) at which
    the transistors will turn on. Our Therma-Probe
    product is used as a standard metrology tool for these ion
    implantation processes.                                                                                                          
|
| |  | Dielectric Film Deposition and
    Etching  depositing and selectively removing layers
    of dielectric films on the silicon wafer in order to provide
    electrical insulation for each layer of the semiconductor IC.
    Film deposition is typically done by Chemical Vapor Deposition,
    or CVD, and film removal is typically done by plasma etching.
    Our Opti-Probe is used as a standard, in-line metrology tool for
    film thickness in these processes. Our Opti-Probe CD and RT/CD,
    or Real-Time Critical Dimensions, and Integra integrated
    metrology products, are newly introduced products which provide
    rapid, non-destructive wafer-state information for control of
    the critical dimensions, or CDs, of the etch processes.
|
| |  | Conductor Film Deposition and Etching 
    depositing and selectively removing layers of metal,
    polysilicon, and metal barrier films used to interconnect the
    transistors within a semiconductor device. Film deposition is
    typically done by Ppysical vapor deposition, or PVD,
    electrochemical deposition, or ECD, or by CVD. Film removal is
    typically done by plasma etching or chemical mechanical
    planarization. Our Opti-Probe is used as a standard metrology
    tool for the non-opaque conductor films.                                                                                                                                                                                                                             

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | Our Opti-Probe CD and RT/CD, and Integra
    integrated metrology products provide rapid, non-destructive
    wafer-state information for control of the CDs of the etch
    processes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Chemical Mechanical Planarization, or
    CMP  leveling the top surface of the
    wafer after each layer of device features is added. The leveling
    is done by mechanical polishing in a chemical solution, and is
    required to maintain flatness of the wafer throughout the
    sequence of hundreds of process steps. Our Opti-Probe is used as
    a standard, in-line metrology tool for film thickness in these
    processes.                                                                                                                                                                                                                                     
|
| |  | Wafer Patterning  using
    photolithographic techniques to create the fine (sub-micron)
    structures that define the integrated circuit. The wafer
    patterning is typically done by stepper exposure
    systems and the photoresist developing and removal is done by
    coater/developer track systems and
    asher/strip systems. Our Opti-Probe is used as a
    standard, in-line metrology tool for film thickness and
    reflectivity in these processes. Our Opti-Probe CD and RT/ CD,
    and Integra integrated metrology products provide rapid,
    non-destructive wafer-state information for control of the CDs
    of the wafer patterning process.

Industry Background

The demand for semiconductors has increased as
the use of semiconductors has expanded beyond personal computers
and computer systems to a wide array of additional applications,
including telecommunication and data communication systems,
automotive systems, consumer electronics, medical products and
household appliances. Additionally, the Internet has stimulated
the need for more high performance semiconductor devices. As a
result, semiconductors have become more complex, requiring:



| |   |                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | successive decreases in feature line width, for
    example, from 150 nanometers, or nm to 130 nm, from 130 nm to
    110 nm, and from 110 nm to 90 nm;
|
| |  | as many as 500 process steps; and                                                                                                                      
|
| |  | an increase in the number of metal or
    interconnect layers.                                                                                       

Additionally, the life cycle for these
semiconductor device processes has been compressed from four
years in the early 1990s to approximately two years today. The
increase in device complexity and reduction in product life
cycles have led to a more costly and complex manufacturing
process. At the same time, semiconductor manufacturers have
continued to face significant price pressure due to competition
in the industry. These factors have led semiconductor
manufacturers to intensify efforts to improve fab productivity,
including the increased use of process control metrology.

Process control metrology is used to monitor
process parameters in order to enable semiconductor
manufacturers to reduce costs and improve device performance.
Historically, semiconductor manufacturers have achieved annual
reductions in cost per chip function through productivity
improvements including reduced feature size, increased wafer
size and increased equipment productivity. Although increasing
wafer size and yield (percentage of good ICs per
wafer) will continue to be sources of productivity gains by
semiconductor manufacturers, increasingly, we believe, gains
will come from reduced feature size and non-yield-derived
manufacturing productivity enhancements. This important last
category includes increased equipment uptime, reduced
manufacturing space requirements, reduced use of wafers for
testing purposes and lower tool maintenance costs.

Therma-Wave Metrology Solutions

Our family of metrology products currently
consists of the following product lines:



| |                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------
| | Therma-Probe and Opti-Probe
    systems  two well-established, major product families
    of in-line process control metrology equipment.

The Therma-Probe product family was introduced in
1985 as our initial product line, and the Opti-Probe product
family was introduced in 1992. Both product families feature
proprietary and patented measurement technologies and offer
robotic wafer handling, advanced vision processing,
sophisticated but user-friendly

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software and high throughput and reliability. The
modular design of the hardware and software enables continuous
product enhancement as new advances are made.




| |                                                                                            
| | -------------------------------------------------------------------------------------------
| | Opti-Probe RT/CD and Integra 
    two additional recently-introduced product
    families.

Opti-Probe CD and RT/ CD (Real-Time Critical
Dimension):The Opti-Probe CD is a
spectroscopic ellipsometer-based system that provides
nondestructive Critical Dimension metrology for the smallest
features of the next generations of ICs. This product employs
our new RT/CD analysis software that provides real-time CD and
profile results, and solutions based on a previously generated
and stored library. During this fiscal year, we continued our
expansion from being a hardware system supplier to a more
complete CD system supplier (Opti-Probe CD plus RT/CD analysis
software).

Integra integrated metrology
products:Integrated Metrology, or IM,
is based on compact metrology modules which are
installed and function inside an IC process system such as an
etcher or coater/developer track system to provide metrology on
each wafer before it exits the process tool. Originating as a
means to further boost IC fab productivity, we believe IM is a
growing trend in the semiconductor industry and that our Integra
IM product offering is one of the most diverse in the
semiconductor metrology industry.

These products represent a substantial expansion
of our fab productivity enhancement offerings to the
semiconductor industry, and represent a growth in our addressed
market by over 100%.

For the years ended March 31, 2004, 2003 and
2002, revenues from the Opti-Probe product family accounted for
approximately 44%, 41% and 62%, respectively, of our total net
revenues. Revenues from the Therma-Probe product family
accounted for approximately 8%, 11% and 13%, respectively, of
our total net revenues in fiscal 2004, 2003 and 2002.

Therma-Probe Ion Implant Monitoring
Products



| |                      
| | ---------------------
| | Ion Implant Metrology

A key process step in the fabrication of
semiconductor devices is the implantation of ions of boron,
phosphorous, arsenic, antimony, and indium into selective areas
of the silicon wafer to alter its electrical properties. Control
of the accuracy and uniformity of the ion implant dose is
critical to device performance and yield. Ion implantation is
generally performed several (typically ten to 24) times during
the early phases of the fabrication cycle. As a result, there is
typically a time lag of several weeks between these implant
steps and the first electrical measurements that indicate
whether the ion implantation process was properly executed.
Failure to identify improper ion implantation can be extremely
costly to a semiconductor manufacturer if the wafer production
is permitted to continue in error. To test on a more timely
basis whether the ion implantation was properly executed,
semiconductor manufacturers historically used a four-point
probe, which required physical contact between the probe and the
silicon wafer surface. Because the physical contact with the
wafer surface produces silicon particles (defects), which can
kill IC yield, the four-point probe method can only be used on
monitor wafers (non-production blank wafers that have no IC
devices on them). In contrast to that method,
Therma-Probes ability to measure nondestructively on
actual production IC wafers decreases manufacturing costs by
reducing the need for test wafers. In addition, Therma-Probe
systems detect implant processing problems that only affect the
product wafers and which are not revealed by utilizing test
wafer monitoring alone.



| |                                     
| | ------------------------------------
| | Ultra-Shallow Junction
    Metrology

As semiconductor devices decrease in size,
demands for the formation of Ultra-Shallow-Junctions, or USJs,
for source/drain formation are increasing. One of the main
challenges in the scaling of complementary metal oxide
semiconductor, or CMOS, devices is the formation, control and
monitoring of these USJs. The Therma-Probe system performs
nondestructive evaluation of USJs for junction depth and
junction abruptness simultaneously. These measurements are
enabled by our proprietary USJ software. This Therma-Probe
capability allows engineers to monitor and contol the formation
of USJs in CMOS device fabrication.

4



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| |                            
| | ---------------------------
| | Therma-Probe Product Family

The Therma-Probe systems employ proprietary
thermal wave technology that uses highly focused but low power
laser beams to generate and detect thermal and plasma wave
signals in the silicon wafer. Proprietary software correlates
the signals to the ion implant dose. Unlike previous ion implant
metrology systems, the Therma-Probe systems utilize a
non-contact, non-damaging technology and thus can be used to
monitor product wafers immediately after the ion implantation
process. These features have been integrated into an easy-to-use
and reliable package with automated wafer handling and
statistical data processing.

In 2003, we introduced the Therma-Probe XP Series
for 200 and 300 mm ion implantation metrology applications. With
the introduction of the XP-Series, the dose detectability and
long term stability of the original Therma-Probe products have
been further improved to provide more robust and repeatable
measurement capability for the 90-nm technology node and beyond.



| |                      
| | ---------------------
| | Therma-Probe Benefits

We believe that our Therma-Probe systems offer
the following technological advantages and benefits:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Proprietary
    Technology.To provide non-contact,
    non-contaminating ion implant measurements on product wafers,
    Therma-Probe systems employ proprietary thermal wave technology,
    which uses highly focused but low power laser beams to generate
    and detect thermal wave signals in the silicon wafer that can be
    correlated to the ion implant dose. The thermal wave technology
    used to measure these signals is an extensively patented
    technology owned by our company.
|
| |  | Ease of Use and
    Reliability.The Therma-Probe systems
    are configured specifically for use by semiconductor device
    manufacturers and feature automated wafer handling, automated
    data collection, statistical data processing and data management
    for 200 and 300 mm wafer applications.                                                                                                                                                                                              
|
| |  | Continuous
    Improvement.We continue to develop,
    manufacture and market new and improved Therma-Probe systems to
    enhance system capability and to lower the cost of ownership to
    the customer. For example, the most recent generation TP-630XP
    Series possesses state-of-the-art ion implant measurement
    technology with enhanced dose detectability, long-term
    stability, and USJ capabilities for wafer sizes up to 300
    millimeters.                                   

The following table summarizes the Therma-Probe
product history:

|         |  |            |      |                                       |  |                                                                                                                                                                                               
|-------- |  | ---------- | ---- | ------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         |  | Year       |      |                                      
|System   |  | Introduced |      | Description of Innovation/Advancement
|         |  |            |      |                                      
|TP-200   |  |            | 1985 |                                       |  | Introduced first non-destructive process control
    metrology system to measure ion implantation.                                                                                            
|TP-300   |  |            | 1987 |                                       |  | Added cassette-to-cassette wafer handling and
    automation software.                                                                                                                        
|TP-400   |  |            | 1992 |                                       |  | Improved repeatability of the ion implantation
    dose measurement and added second wafer cassette station for
    improved tool calibration.                                                
|TP-500   |  |            | 1996 |                                       |  | Improved product reliability by employing the
    modernized and field-proven platform of the Therma-Wave
    Opti-Probe 2600 and added pattern recognition and improved wafer
    throughput.
|TP-630   |  |            | 1998 |                                       |  | Expanded wafer measurement capability to handle
    300-mm wafers.                                                                                                                            
|TP-500   |  |            | 2000 |                                       |  | Initiated application research for ultra-shallow
    junction depth metrology.                                                                                                                
|TP-630   |  |            | 2001 |                                       |  | Integrated new 300 mm Automation SEMI Standards
    (E87, E90, E40, E94).                                                                                                                     
|TP-630XP |  |            | 2003 |                                       |  | Increased repeatability of ion implantation dose
    measurement and released the application for ultra-shallow
    junction depth metrology.                                                 

Opti-Probe Thin-Film Metrology
Systems

The majority of the 200 to 500 process steps
required to fabricate semiconductors on a silicon wafer involve
the deposition and selective removal of a variety of insulating
and conducting thin films. Thin-film metrology systems measure
the thickness and material properties of these thin films and,
because they are

5



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used to measure a large number of process steps,
they are one of the most important and pervasive metrology
systems utilized at semiconductor fabrication facilities. The
most widely used technologies to measure the thickness and
properties of thin films have historically been reflection
spectrometry and ellipsometry. Reflection spectrometers obtain
an optical spectrum as a function of wavelength for light
reflected from the surface of a wafer. This spectrum is then
analyzed with appropriate physics-based algorithms to obtain
film thickness and, in some cases, other properties of the film.
In ellipsometry, the change of polarization of the reflected
light is measured. The polarization change is analyzed with
appropriate algorithms to obtain film thickness and, in some
cases, other properties of the film.


Increasingly, traditional, single-technology film
metrology systems have been unable to meet the process control
metrology demands of the semiconductor industry. The continual
demand for improved precision and repeatability requires the
ability to measure thicknesses that range from extremely thin
films, which generally measure below 20 angstroms, to films that
are hundreds of thousands times thicker. Reflection
spectrometers are most suitable for measuring thicker films,
whereas ellipsometers are most suitable for measuring very thin
films. Furthermore, the industry is now using film stacks
composed of several layers of different films and the optical
properties of many films are functions of the actual deposition
conditions. Generally spectrometers or ellipsometers alone
generate insufficient data to simultaneously determine the
thicknesses and properties of these film stacks and new films
with the precision and accuracy that semiconductor manufacturers
require. Reflection spectrometer and most ellipsometer have
limited capabilities for such simultaneous measurements of both
thickness and optical parameters when used as independent
standalone measurement technologies.



| |                          
| | -------------------------
| | Opti-Probe Product Family

Opti-Probe systems improve upon existing
thin-film metrology systems with the integration of up to five
distinct film measurement technologies, three of which are
patented by our company. By combining the measured data from
these multiple technologies, Opti-Probe systems provide
increased measurement capability leading to higher yields, less
misprocessing, less rework, faster production ramp-up and
increased productivity on both test and product wafers.



| |                    
| | -------------------
| | Opti-Probe Benefits

Several technological advantages and benefits of
Opti-Probe systems including the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Proprietary Measurement
    Technology.Opti-Probe systems combine
    up to five complementary measurement technologies: Beam Profile
    Reflectometry, or BPR®, Beam Profile
    Ellipsometry, or BPE®, Deep Ultra Violet
    Reflectometery, or DUV, Absolute Ellipsometery, or
    AE® and Rotating Compensator Spectroscopic
    Ellipsometery, or RCSE. Each technology addresses specific film
    measurement applications. The integration of these multiple
    technologies on a single tool allows for a wide range of
    capabilities on a single tool. Additionally, due to the amount
    of data that can be obtained by combining these optical
    technologies, it is possible to determine the thickness and
    optical parameters of multiple films simultaneously. We hold
    patents on the use of many of the combinations of these
    thin-film measurement technologies.
|
| |  | Proprietary
    Software.The use of proprietary
    software algorithms in conjunction with the spectral information
    collected by the Opti-Probe measurement hardware enables the
    calculation of the film thickness and optical properties.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Ease of Use and
    Reliability.Opti-Probe systems are
    configured specifically for semiconductor device manufacturers
    and feature automated wafer handling, advanced image processing,
    automated data collection, statistical data processing and data
    management.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Continuous
    Improvement.We continue to develop,
    manufacture and market new and improved systems. We strive to
    provide the semiconductor industry with thin-film metrology
    systems that meet the precision, repeatability and matching
    requirements for each new technology node.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

In 1992, we introduced the first Opti-Probe
system based on our patented BPR measurement technology to meet
the film measurement needs for the 250-nm technology node. Over
the years the Opti-Probe products

6



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have evolved to keep pace with the increasing
film measurement precision, repeatability and matching
requirements driven by technology advances. In 2002, we
introduced our latest generation of film thickness metrology,
the Opti-Probe Series 7. Integrating all five measurement
technologies, the Opti-Probe Series 7 addresses the wide
range of film measurements of 90 nm production as well as
supporting films process development of 65 nm and below
technology nodes.


The following table summarizes the Opti-Probe
product history:

|               |  |            |           |                                       |  |                                                                                                                                                                                                                                                                                                                           
|-------------- |  | ---------- | --------- | ------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|               |  | Year       |           |                                      
|System         |  | Introduced |           | Description of Innovation/Advancement
|               |  |            |           |                                      
|OP-1000        |  |            | 1992      |                                       |  | Introduced a new, patented optical technology,
    BPR, to measure thin-film deposition and removal.                                                                                                                                                                                                                      
|OP-2000        |  |            | 1993      |                                       |  | Integrated BPR with a newly patented optical
    technology, BPE, to enhance measurement capabilities for very
    thin-films.                                                                                                                                                                                            
|OP-2600        |  |            | 1994      |                                       |  | Integrated BPR, BPE and spectrometry to further
    expand the measurement capabilities.                                                                                                                                                                                                                                  
|OP-2600 DUV    |  |            | 1996      |                                       |  | Integrated DUV with the existing system to expand
    measurement range.                                                                                                                                                                                                                                                  
|OP-3260 DUV    |  |            | 1996      |                                       |  | Significantly increased throughput of Opti-Probe.                                                                                                                                                                                                                                                                         
|OP-5200 Series |  |            | 1998      |                                       |  | Integrated up to five measurement technologies
    (BPR, BPE, DUV reflectance, spectroscopic ellipsometry, or SE,
    and AE).                                                                                                                                                                                            
|OP-5300 Series |  |            | 1998      |                                       |  | Expanded OP-5200 series wafer measurement
    capability to 300 millimeters.                                                                                                                                                                                                                                              
|OP-5300 Series |  |            | 2000-2001 |                                       |  | Released new applications for advanced
    semiconductor manufacturing processes, including ultra-thin gate
    stacks, advanced 193 nanometer organic and inorganic
    antireflective layers, silicon on insulator, and
    silicon-germanium.                                                                          
|OP-5300 Series |  |            | 2001      |                                       |  | Windows NT became the standard operating
    system for 300 millimeter Opti-Probes, replacing DOS.                                                                                                                                                                                                                        
|OP-5200 Series |  |            | 2000-2001 |                                       |  | Desorber option introduced, enabling the
    Opti-Probe to meet industry requirements for thin gate
    dielectric metrology by removing environmental contaminants from
    the wafer surface that may otherwise interfere with the
    measurement precision.                                                           
|OP-5300 Series |  |            | 2000-2001 |                                       |  | Wafer Bow/ Warp/ Stress, or
    WBWS®, product option introduced, incorporating
    measurement capability of additional wafer properties on a
    single tool at overall reduced cost for the customer. Integrated
    new 300mm Automation SEMI Standards (E87, E90, E40, E94).                                         
|OP Series-7    |  |            | 2002      |                                       |  | Series-7; a 200/ 300 mm platform, builds on the
    OP-5000 technologies. Delivering higher productivity and
    enhanced optics to address advanced thin-film applications, it
    improves upon industry requirements for on-product wafer
    measurement resulting in lower COO and extendibility to the
    customer.

Opti-Probe CD and RT/ CD Products



| |                        
| | -----------------------
| | New Market Requirements

In January 2002, we introduced Opti-Probe CD with
Real Time CD processing, or RT/ CD, a product designed to
measure the lateral Critical Dimensions and cross-sectional
shape, or profile, of fine IC features. As semiconductor device
manufacturers continue to shrink feature sizes to the 90 nm
technology node and smaller, traditional CD metrology techniques
such as critical dimension scanning electron microscopy, or
CD-SEM, lack the resolution and stability required to provide
accurate data about feature critical dimensions and profiles. A
significant limitation is that these methods provide only a
top-down view of features and provide little or no data about
characteristics of the sides or bottom of a structure.

7



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Semiconductor manufacturers are often confronted
with problems involving variations in profile and sidewall
angle. Detailed knowledge of profile shape is of high
importance. In shallow trench isolation, or STI, or damascene
integration schemes, etched trenches to be filled by downstream
process steps may have problematic re-entrant angles, notching,
t-topping or other artifacts. These feature artifacts can lead
to yield-killing conditions such as voiding and cracking of
deposited films in later deposition fill process steps.

For the critical gate patterning process, tight
control of the gate CD correlates to improved device performance
and better bin sort yields (and revenues/chip). Furthermore,
shape anomalies such as undercut, microtrenching or notching,
can have a detrimental effect on device speed and reliability.
In these and other applications, precise shape profiling is
crucial.



| |                                      
| | -------------------------------------
| | Opti-Probe CD and RT/ CD
    Products

Our Opti-Probe RT/ CD is the first optical CD
scatterometry system that combines high-information content SE,
optical measurement with ultra-fast calculation (real-time
regression) to analyze and display results without the use
of off-line modeling and solution libraries. Complex CD profiles
can be calculated in seconds with precision and repeatability
with structural information not available with standard CD-SEM
technologies.

The Opti-Probe CD system leverages our
established Opti-Probe thin-film metrology platform for optical
data acquisition. The Opti-Probes patented RCSE provides
rich spectral data, ensuring detail and accuracy in the results.
This non-destructive CD measurement technology is beneficial for
the current prevalent microelectronics technology node (130 nm),
and is extendable to the 65 nm technology node and beyond for a
wide range of process applications.

Integrated Metrology Products



| |                    
| | -------------------
| | Market Requirements

In 2000, we committed to a program of developing
a broad family of IM, modules under the product family name
Integra. We have at this time both spectrometer and
spectroscopic ellipsometer based IM units available in the
marketplace. These are compact metrology units that contain a
single measurement technology matched to the specific metrology
need of a particular semiconductor process tool (etch,
coater/developer, CVD, CMP, stepper, etc.) Each IM unit is
installed directly into a semiconductor process tool, and can
measure each wafer immediately after processing. In this manner,
processing variations can be detected at the earliest possible
moment, as opposed to the conventional procedure in which a
25-wafer lot is typically completed before metrology is first
done, thereby leaving the entire lot at risk of becoming scrap.
With 300 mm wafers, this economic loss becomes increasingly
large due to the additional product value of each processed
wafer.



| |                                                                  
| | -----------------------------------------------------------------
| | Benefits of Integrated Metrology and
    Advanced Process Control

IM is becoming increasingly accepted as a means
to reach greater productivity. Advanced semiconductor
manufacturing today is under great pressure to deliver greater
levels of process performance, production availability and
process repeatability in order to minimize risk of product loss,
improve manufacturing efficiencies and improve device yields.
The transition towards 300 mm wafers, continuing device shrinks
and the mixed foundry manufacturing models are key contributors
to these trends. To successfully meet these challenges, device
manufacturers and process tool equipment manufacturers are
actively engaged in developing technologies for advanced process
control, or APC. We believe that APC implementation requires the
integration of metrology capabilities directly onboard the
process tool.

Device manufacturers can derive a wide range of
benefits by implementing integrated metrology and APC strategies
in their fabs. By integrating the measurement directly onto the
process tool, they can greatly increase the rate of sampling and
decrease the delay between the process step and measurement.
Increasing the measurement frequency to every single wafer
allows for rapid fault detection and correction. This reduces

8



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##### Table of Contents



potential for scrap due to excursions in the
process tool. In addition, the data collected can be input into
realtime process control models to correct minor drifts in the
processing conditions.




| |                                                
| | -----------------------------------------------
| | Sensys Acquisition and Business
    Integration

To strengthen our position as a leader in
integrated metrology, we acquired Sensys Instruments Corporation
in January 2002 and Sensys became a wholly owned subsidiary of
our company focusing on integrated metrology applications and
developing business with process tool equipment suppliers.
Subsequent to the acquisition, all of the integrated metrology
development and business operations have been consolidated into
a single integrated metrology business focus team concentrating
on providing optical CD, thin-film, and overlay integrated
metrology solutions to semiconductor process equipment makers.



| |                       
| | ----------------------
| | INTEGRA Product Family

All of our integrated metrology products,
including the products originally developed by Sensys, are
grouped into a family of products with the INTEGRA name. These
include:



| |   |                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | INTEGRA CCD-i  a second-generation
    reflectometer unit for high throughput thin-film, CMP and OCD
    applications based on the CD-i product, and
|
| |  | INTEGRA iX-SE  a spectroscopic
    ellipsometer unit for high performance thin-film and OCD
    applications.                                       

During fiscal 2004, multiple CCD-i units were
installed at key development and pilot production fabs in
Europe, North America, Taiwan and Japan by a major
coater/developer equipment supplier to the semiconductor
industry. Additional end-user installations for advanced
technology development and production lines are planned during
fiscal 2005.

During fiscal 2004, iX-SE units were installed at
key development and pilot production fabs in North America and
Taiwan by a major etcher equipment supplier to the semiconductor
industry. These units and technology are currently under
development and evaluation as metrology systems to enable future
Advanced Process Control (APC) in etch module applications.



| |          
| | ---------
| | Employees

As of March 31, 2004, we employed
349 people, including 89 in engineering, research and
development, 55 in manufacturing, 131 in customer support, 44 in
sales and marketing and 30 in executive and administrative
functions. Many of our employees are highly trained and hold
advanced post-graduate degrees in science and engineering. None
of our employees are represented by a labor union or covered by
a collective bargaining agreement. We consider our employee
relations to be good. We believe we have been able to attract
and retain a highly talented group of managers, designers and
engineers that enables us to continually improve our products
and customer support. Due to reduction in force programs, we
have terminated the employment of approximately 61 persons since
March 31, 2003.



| |                    
| | -------------------
| | Sales and Marketing

We maintain sales offices and regional sales
representatives throughout the world. In the United States, we
maintain sales offices in California. We also utilize
manufacturers sales representatives to cover those regions
of the United States with too few customers to support a direct
sales effort. In Asia, we maintain sales offices in Japan,
China, Korea, Singapore and Taiwan. The Japan and Singapore
offices work with manufacturers sales representatives to
sell our products to customers in Japan, Singapore and Malaysia,
while the China, Taiwan and Korea offices sell to customers
directly. We also have sales representatives in the United
Kingdom working with manufacturers sales representatives
throughout the rest of Europe.

9



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Sales to Taiwan Semiconductor Manufacturing
Corporation, Intel Corporation, Tokyo Electon Limited, and Seki
Technotron Corp. each accounted for more than 10% of net
revenues in fiscal 2004. The following chart indicates the
percentage of net revenues from each of these customers for
fiscal years 2004, 2003 and 2002, respectively.

|                                           |       |                    |    |      |   |      |    |    |   |  |    |    |  
|------------------------------------------ | ----- | ------------------ | -- | ---- | - | ---- | -- | -- | - |  | -- | -- | -
|                                           |       |                   
|                                           |       | Percentage of     
|                                           |       | Net Revenues      
|                                           |       |                   
|                                           |       |                   
|                                           |       | Fiscal Years Ended
|                                           |       | March 31,         
|                                           |       |                   
|                                           |       | 2004               |    | 2003 |   | 2002
|                                           |       |                    |    |      |   |     
|Customers:                                 |       |                    |    |      |   |      |    |    |   |  |    |   
|Taiwan Semiconductor Manufacturing Company |       |                    | 16 | %    |   |      |   | %  |   |  | 13 | % 
|Intel Corporation                          |       |                    | 14 | %    |   |      | 13 | %  |   |  | 24 | % 
|Tokyo Electron, Ltd.                       |       |                    | 12 | %    |   |      |   | %  |   |  |   | % 
|Seki Technotron Corp.                      |       |                    | 10 | %    |   |      |   | %  |   |  | 12 | % 
|                                           |       |                    |    |      |   |      |    |    |   |  |    |   
|                                           | Total |                    |    | 52   | % |      |    | 13 | % |  |    | 49 | %
|                                           |       |                    |    |      |   |      |    |    |   |  |    |   

International revenues in fiscal 2004, 2003 and
2002 accounted for approximately 72%, 72% and 62% of net
revenues in each of these periods, respectively. We anticipate
that international sales will continue to account for a
significant portion of our net revenues in the foreseeable
future. The following chart indicates the percentage of net
revenues that we derived from our sales to Taiwan and Japan, our
two largest overseas markets:

|       |  |                              |    |      |  |      |    |   |  |  |    |  
|------ |  | ---------------------------- | -- | ---- |  | ---- | -- | - |  |  | -- | -
|       |  |                             
|       |  | Percentage of Net Revenues  
|       |  |                             
|       |  |                             
|       |  | Fiscal Years Ended March 31,
|       |  |                             
|       |  | 2004                         |    | 2003 |  | 2002
|       |  |                              |    |      |  |     
|Taiwan |  |                              | 23 | %    |  |      | 24 | % |  |  | 23 | %
|Japan  |  |                              | 22 | %    |  |      | 14 | % |  |  | 13 | %

In addition, we provide direct customer support
in most parts of the world. In some locations, field service is
still provided by the same manufacturers sales
representative that handles the sales function, but applications
support is provided by our employees in that territory. In the
United States, we have field service and applications engineers
located in Arizona, California, Florida, Idaho, Massachusetts,
New Mexico, Oregon, Tennessee, Texas and Washington. Customers
contract for dedicated site-specific field service and
applications engineers. In Asia, we provide direct customer
support in Japan, China, Taiwan, Korea and Singapore. In Europe
and the Middle East, our service and applications personnel,
located in France, the United Kingdom, Italy, Ireland and Israel
provide direct customer support to customers in Europe and the
Middle East and to our European manufacturers sales
representatives. We provide our customers with comprehensive
support before, during and after delivery of our products. Prior
to shipment, our support personnel typically assist the customer
in site preparation and inspection, and provide customers with
training at our facilities and at the customers location.
Our customer training programs include instructions in the
maintenance of our systems and in system hardware and software
tools for optimizing the performance of our systems. Our field
support personnel work with the customers employees to
install the equipment and demonstrate equipment readiness. In
addition, we maintain a group of highly skilled applications
scientists to respond to customers process needs worldwide
when a higher level of technical expertise is required.

We generally warrant our products for a period of
up to 12 months from system acceptance, although this can,
at times, be extended according to the terms of a particular
contract. Installation and initial training are customarily
included in the price of the system. After the expiration of the
warranty period, customers may enter into support agreements
covering both field service and field applications support. Our
field service engineers may also provide customers with repair
and maintenance services on a fee basis. Our applications
engineers and scientists are also available to work with the
customers on recipe development. Additionally, for a fee, we
train customers to perform routine maintenance on their
purchased tools. We also provide a 24-hour telephone help-line.

10



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Our backlog consists of orders not yet shipped,
deferred revenues for products that have been shipped and
invoiced but have not yet been recognized as revenue in
accordance with SAB 104, recurring fees payable under
support contracts with our customers and orders for spare parts
and billable services, such as non-recurring engineering
services. Orders that are scheduled for shipment beyond the
twelve-month window are not included in backlog until they fall
within the twelve-month window. Orders are subject to
rescheduling or cancellation by the customer, usually without
penalty. Because of possible changes in product delivery
schedules and cancellation of product orders and because our
sales will sometimes reflect orders shipped in the same quarter
that they are received, our backlog at any particular date is
not necessarily indicative of actual sales for any succeeding
period. At March 31, 2004, our backlog was
$27.5 million, compared to $19.0 million at
March 31, 2003.



| |                                             
| | --------------------------------------------
| | Research and Development and
    Engineering

The process control metrology market is
characterized by continuous technological development and
product innovations. We believe that continued and timely
development of new products and enhancements to existing
products is necessary to maintain our competitive position.
Accordingly, we devote a significant portion of our personnel
and financial resources to engineering and research and
development programs. As of March 31, 2004, our research,
development and engineering staff comprised 89 people. We
seek to maintain our close relationships with customers to make
improvements in our products that respond to customers
needs. For example, several of the improvements relating to the
Opti-Probe and RT/ CD product families were developed in
cooperation with some of our major customers to address their
needs for more capable thin-film measurement systems.

Software development accounts for a significant
portion of our research and development efforts. We are
currently transitioning all of our software applications from
DOS to the Microsoft NT operating system in order to better
serve our customers. NT is now the standard operating system
used by our Opti-Probe customers for 300 millimeter wafer
production.

Our ongoing engineering and research and
development efforts can be classified into three categories: new
products; feature enhancements, such as features to improve
precision, speed and automation; and customer-driven product
enhancements, such as new measurement recipes or algorithms. We
have research and development and engineering staffs working
both on developing new products and features and on responding
to the particular needs of customers. As a result of these
efforts, we introduced a new Opti-Probe thin-film measurement
family and a new Critical Dimension measurement product in
fiscal year 2003.

Engineering and research and development expenses
were $18.7 million, $29.2 million and
$29.1 million, in fiscal 2004, 2003 and 2002, respectively,
or 29%, 59% and 36% of net revenues for those periods,
respectively. We expect engineering and research and development
expenditures will continue to represent a substantial percentage
of our net revenues for the foreseeable future. The decrease in
the percentage of research and development expenses to net
revenues for fiscal year 2004 compared to 2003 reflects
increased net revenues and decreased spending in 2004. We expect
research and development expenditures to increase gradually but
to decrease as a percentage of net revenues over time as
industry conditions and our net revenues improve.



| |              
| | -------------
| | Manufacturing

Our manufacturing strategy is to produce
technologically advanced and high quality metrology systems. We
currently perform the majority of our system assembly activities
in-house. In order to lower production costs in the future, we
intend to perform in-house only those manufacturing activities
that add significant value or that require unique technology or
specialized knowledge. As a result, we expect to rely
increasingly on subcontractors and turnkey suppliers to
fabricate components, build assemblies and perform other
activities in a cost effective manner.

Our principal manufacturing activities include
assembly and test work, both of which are conducted at our
facility in Fremont, California. Assembly activities include
inspection, subassembly and final assembly. Test activities
include modular testing, system integration and final testing.
Components and subassemblies,

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such as lasers, robots and stages, are acquired
from third party vendors and integrated into our finished
systems. These components and subassemblies are obtained from a
limited group of suppliers, and occasionally from a single
source supplier. While we use standard components and
subassemblies wherever possible, most mechanical parts, metal
fabrications and critical components are engineered and
manufactured to our specifications. We have not entered into any
formal agreements with limited source suppliers, other than
long-term purchase orders and, in some cases, volume pricing
agreements. Those parts coming from a limited group of suppliers
are monitored by management to ensure that adequate supplies are
available to maintain manufacturing schedules and to reduce our
dependence on these suppliers should supply lines become
interrupted. The partial or complete loss of such suppliers
could increase our manufacturing costs or delay product
shipments while we qualify new suppliers. Additionally, any such
loss could require us to redesign products, thereby having a
material adverse effect on our business or customer
relationships. Furthermore, a significant increase in the price
of one or more of these components could adversely affect our
financial condition or results of operations.


We schedule production based upon firm customer
commitments and anticipated orders. We have structured our
production process and facility to be driven by both orders and
forecasts and have adopted a modular system architecture to
increase assembly efficiency and test flexibility. Cycle times
for our products vary significantly. We believe these cycle
times will improve as we continue to emphasize manufacturability
in our new product designs.

We conduct the assembly of some optical
components and final testing of our systems in clean-room
environments. This procedure is intended to reduce the amount of
particulates and other contaminants in the final assembled
system, and test our products against our customers
acceptance criteria prior to shipment. Following the final test,
the completed system is packaged within triple vacuum-sealed
bags to maintain a high level of cleanliness during shipment and
installation.



| |            
| | -----------
| | Competition

The market for semiconductor capital equipment is
highly competitive. We face substantial competition in each of
the markets that we serve. Some of our competitors have greater
financial, engineering, manufacturing and marketing resources
and broader product offerings than we have. Significant
competitive factors in the market for metrology systems include
system performance, ease of use, reliability, cost of ownership
to the customer, technical support and customer relationships.
We believe we compete favorably on the basis of these factors in
each of our served markets. We compete with both larger and
smaller companies in the markets we serve.

Our Therma-Probe systems compete primarily with
other metrology systems designed to measure ion implant dose in
some alternative fashion, such as contact and destructive
four-point probe measurement systems, including those
manufactured by KLA-Tencor Corporation, Applied Materials, Inc.
and Kokusai Electric Ltd. Our Therma-Probe systems are
non-contact, nondestructive ion implant metrology systems for
product wafers and have a major share of the market. Several
years ago, Jenoptik GmbH introduced a competitive product to our
Therma-Probe systems, which utilized thermal wave technology. In
November 1997, a jury found that Jenoptiks product
infringed on a number of our United States patents. As a result
of the settlement of this litigation, Jenoptik has agreed not to
sell any of its metrology products in the United States until
the patents expire and to pay us a royalty fee for systems sold
in Japan. To date, the sale of these products by Jenoptik (or
TePla AG, who has purchased these rights from Jenoptik) has not
had a material impact on our market position.

On April 22, 2002, we filed a patent
infringement suit against Boxer Cross Inc. We believe the Boxer
Cross BX-10 product infringed certain patents held by us related
to ion implant monitoring. More recently, Boxer Cross introduced
a competitive product to our Therma-Probe systems that utilizes
a similar technology. In July 2003, we settled this lawsuit and
dismissed our claims.

Our Opti-Probe film thickness metrology systems
primarily compete with systems manufactured by KLA-Tencor
Corporation, Rudolph Technologies, Inc., Nanometrics, Inc. and
Dai Nippon Screen, Mfg. Co., Ltd. Our Opti-Probe CD and RT/ CD
systems participate in a newly developing market of optical CD

12



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##### Table of Contents



metrology. We expect competition primarily from
several of the same companies that compete with the Opti-Probe
for film thickness metrology business. In addition, Accent
Optical Technologies is an early participant in this market.


Suppliers of integrated metrology with whom we
compete include most of the companies listed above regarding the
Opti-Probe, in addition to Nova Instruments.

In recent years, there has been merger and
acquisition activity among our competitors and potential
competitors, as well as by us. Acquisitions by our competitors
and potential competitors could allow them to expand their
product offerings, which could afford such competitors and
potential competitors an advantage in meeting customers
demands. The greater resources, including financial, marketing
and support resources, of competitors potentially engaged in
these acquisitions could permit them to accelerate the
development and commercialization of new products and the
marketing of existing products to their larger installed bases.
Accordingly, such business combinations and acquisitions could
have a detrimental impact on both our market share and the
pricing of our products, which could result in a material
adverse effect on our business and results of operations.

Patents and Proprietary Rights

We believe the success of our business depends as
much on the technical competence, creativity and marketing
abilities of our employees as on the protection derived from our
patents and other proprietary rights. Nevertheless, our success
will depend, at least in part, on our ability to obtain and
maintain patents and proprietary rights to protect our
technology.

We have a policy of seeking patents where
appropriate on inventions concerning new products and
improvements as part of our ongoing engineering and research and
development activities. We have acquired a number of patents
relating to our two key product families, the Therma-Probe and
the Opti-Probe systems. As of March 28, 2004, we owned
106 patents. Of these, we owned 88 U.S. patents
with expiration dates ranging from 2004 to 2022 and we had filed
applications for 100 additional U.S. patents. In
addition, we owned 11 foreign patents with expiration dates
ranging from 2004 to 2019 and had filed applications for 35
additional foreign patents.

In May 2004, nine U.S. and six foreign patents
expired. All these patents relate to our older Therma-Probe
products and technologies that have since been upgraded or
replaced with new technologies and more recent patents. The
expiration of these patents is not expected to have a material
impact on our operations.

There can be no assurance that any of our pending
patent applications will be approved, that we will develop
additional proprietary technology that is patentable, that any
patents owned by or issued to us will provide us with
competitive advantages or that these patents will not be
challenged by any third parties. Furthermore, there can be no
assurance that third parties will not design around our patents.
Any of the foregoing results could have a material adverse
effect on our business, financial condition or results of
operations.

In addition to patent protection, we rely upon
trade secret protection for our confidential and proprietary
information and technology. We routinely enter into
confidentiality agreements with our employees. However, there
can be no assurance that these agreements will not be breached,
that we will have adequate remedies for any breach or that our
confidential and proprietary information and technology will not
be independently developed by, or become otherwise known, to
third parties.

As of March 28, 2004, we owned
21 registered trademarks in the U.S. and two in Japan and
had filed five trademark registration applications in the U.S.

SEC Reports

Our annual reports on Form 10-K, quarterly
reports on Form l0-Q, current reports on Form 8-K, and
all amendments to these reports filed with the
U.S. Securities and Exchange Commission, are available
for review free of charge on the SECs website which
you can access through our website at

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www.thermawave.com as soon as reasonably
practicable after such material is electronically filed or
furnished to the SEC. In addition, you may read and copy any
materials we file with the SEC at the SECs Public
Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. You may obtain information on the
operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC also maintains a website at
www.sec.gov that contains reports, proxy and information
statements and other information that we file with the SEC.







|        |           
|------- | ----------
|Item 2. | Properties

Our executive and manufacturing, engineering,
marketing, research and development operations are located in a
102,000 square foot building at 1250 Reliance Way in
Fremont, California. The facility has approximately
800 square feet of Class 10 clean rooms for customer
demonstrations and approximately 20,000 square feet of
Class 1000 clean rooms for manufacturing. This facility is
occupied under a lease expiring in 2006 at an aggregate annual
rental expense of approximately $1.2 million. We have the
option of extending this lease for another 15 years after
2006. We own substantially all of the equipment used in our
facilities. We also lease a building of approximately
28,000 square feet on Kato Road in Fremont, California, and
two buildings of approximately 24,574 square feet in
Santa Clara, California. During March 2003, we moved all
our employees out of the Kato Road and Santa Clara
facilities and into our Reliance Way facility. We are attempting
to sublet these buildings to reduce our costs. We have partially
sublet one of the buildings in Santa Clara. We believe that
our existing facilities, capital equipment and anticipated
capital expenditures will be adequate to meet our requirements
for at least the next two years and that suitable additional or
substitute space will be readily available if needed.

We also lease sales and customer support offices
in Texas, Japan, China, Korea, Taiwan, Singapore, and the United
Kingdom.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

On April 22, 2002, we filed a patent
infringement suit against Boxer Cross Inc. in the United States
District Court, Northern District of California. The suit
alleged that Boxer Cross BX-10 product infringed certain
patents held by Therma-Wave related to ion implant monitoring.
On June 7, 2002, Boxer Cross filed its amended answer and
counterclaims to our complaint and asserted various affirmative
defenses to our claims of patent infringement. The pleading also
contained various counterclaims including allegations that
Therma-Waves Therma-Probe product infringed upon certain
patents owned by Boxer Cross and also raised claims of
misappropriation of trade secrets, tortious interference with
contract, unfair competition and unfair business practices. We
replied to Boxer Crosss counterclaims, denying the
material allegations and asserting declaratory judgment
counterclaims. On April 29, 2003, Applied Materials
announced that it had acquired all of the outstanding stock of
Boxer Cross. We settled this lawsuit with Boxer Cross and
Applied Materials on July 7, 2003. Pursuant to the
settlement, Therma-Wave dismissed its pending patent
infringement claims with prejudice. Boxer Cross dismissed its
pending patent infringement claims without prejudice and
dismissed its pending state law claims with prejudice.

There are currently no other material legal
proceedings pending against us. We may be required to initiate
additional litigation in order to enforce any patents issued to
or licensed to us or to determine the scope and/or validity of a
third partys patent or other proprietary rights. In
addition, we may be subject to additional lawsuits by third
parties seeking to enforce their own intellectual property
rights. Any such litigation, regardless of outcome, could be
expensive and time consuming and, as discussed above in the
prior risk factor, could subject us to significant liabilities
or require us to cease using proprietary third party technology
and, consequently, could have a material adverse effect on our
business, financial condition, results of operations or cash
flows.

14



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

No matters were submitted to a vote of security
holders during the quarter ended March 31, 2004.




PART II






|        |                                                                                                                     
|------- | --------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity,
    Related Stockholder Matters and Issuer Purchases of Equity
    Securities

Our common stock is traded on The NASDAQ National
Market. As of June 1, 2004, there were 183 holders of
record of common stock. The following table sets forth, for the
periods indicated, the high and low closing prices per share of
our common stock as reported on The NASDAQ National Market.

|                      |  |      |       |     |  |   |      | 
|--------------------- |  | ---- | ----- | --- |  | - | ---- | 
|Quarter               |  | High |       | Low
|                      |  |      |       |    
|Fiscal Year 2003:     |  |      |       |     |  |   |      | 
|First Fiscal Quarter  |  | $    | 15.42 |     |  | $ | 8.52 | 
|Second Fiscal Quarter |  | $    | 10.00 |     |  | $ | 0.90 | 
|Third Fiscal Quarter  |  | $    | 1.82  |     |  | $ | 0.35 | 
|Fourth Fiscal Quarter |  | $    | 1.40  |     |  | $ | 0.39 | 
|Fiscal Year 2004:     |  |      |       |     |  |   |      | 
|First Fiscal Quarter  |  | $    | 2.59  |     |  | $ | 0.43 | 
|Second Fiscal Quarter |  | $    | 3.73  |     |  | $ | 1.59 | 
|Third Fiscal Quarter  |  | $    | 6.78  |     |  | $ | 3.36 | 
|Fourth Fiscal Quarter |  | $    | 6.26  |     |  | $ | 3.45 | 

To date, we have not declared or paid cash
dividends to our stockholders. We have no plans to declare or
pay cash dividends in the near future. Any future determination
to pay dividends will be at the discretion of the board of
directors and will depend upon, among other factors, our results
of operations, financial conditions, capital requirements and
contractual restrictions.

Shares Authorized for Issuance Under Equity
Compensation Plans

The following table summarizes the total shares
of our common stock that may be received by holders upon the
exercise of currently outstanding options, the weighted average
exercise price of those outstanding options and the number of
shares of our common stock that are still available for future
issuance under our equity compensation plans after considering
the stock options currently outstanding as of March 31,
2004. All of the options described below have been or can be
issued pursuant to our 1997 Stock Purchase and Option Plan, our
1997 Employee Stock Purchase and Option Plan, our 1997 Special
Employee Stock Purchase and Option Plan, our 2000 Equity
Incentive Plan and our 2000 Employee Stock Purchase Plan as of
March 31, 2004. All of these plans have been approved by
our stockholders.

15



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The information in the table below takes into
account our recent employee stock option exchange offer which
expired on September 10, 2003. The voluntary program
allowed Therma-Wave employees, excluding officers and directors,
to return to us existing options issued before July 1, 2002
with an exercise price greater than $2.00 per share and
exchange them for new options that were granted on
September 10, 2003. The number of new options granted in
the employee stock option exchange program was equal to 75% of
the number of options canceled in the exchange. The new option
grants have a different vesting schedule from the original
option grants and have an exercise price equal to $2.38, the
fair market value of our common stock on September 10,
2003. Of the 1,366,570 options eligible for exchange, 1,352,108
options, or 99%, were exchanged for 1,014,144 new options with
an exercise price of $2.38. The replacement options vest 50% on
June 11, 2004, and 50% on April 11, 2005 or according
to the performance vesting schedules of specific option grants.

|                                                  |                                 |                  |  |                |  |                 |   |      |  |  |  |           |           | 
|------------------------------------------------- | ------------------------------- | ---------------- |  | -------------- |  | --------------- | - | ---- |  |  |  | --------- | --------- | 
|                                                  |                                 | Number of        |  | Weighted       |  |                
|                                                  |                                 | Shares           |  | Average        |  | Number of      
|                                                  |                                 | to be Issued     |  | Exercise Price |  | Shares         
|                                                  |                                 | Under Exercise   |  | of Outstanding |  | Remaining      
|                                                  |                                 | of Outstanding   |  | Stock          |  | Available for  
|Plan Category:                                    |                                 | Stock Options(1) |  | Options(1)     |  | Future Issuance
|                                                  |                                 |                  |  |                |  |                
|Equity compensation plan approved by stockholders |                                 |                  |  |                |  |                 |   |      |  |  |  |          
|                                                  | Stock option plans              |                  |  | 5,532,067      |  |                 | $ | 3.81 |  |  |  | 2,305,500 | (2)      
|                                                  | Employee Stock Purchase Plan(1) |                  |  |                |  |                 |   |      |  |  |  | 1,070,616 |          
|                                                  |                                 |                  |  |                |  |                 |   |      |  |  |  |          
|                                                  |                                 | Total            |  |                |  |                 |   |      |  |  |  |           | 3,376,116 | 
|                                                  |                                 |                  |  |                |  |                 |   |      |  |  |  |          



---



|    |                                                                                                                                                                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The number of securities to be issued upon the
    exercise of outstanding options and the weighted average
    exercise price of outstanding options under our Employee Stock
    Purchase Plan cannot be determined prior to the actual purchase
    dates under the plan.
|   
|(2) | The number of shares available for issuance under
    our 2000 Equity Incentive Plan increases each year by one
    percent of the total shares of our outstanding common stock
    pursuant to the terms of the plan.                                                      

16



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##### Table of Contents








|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The selected financial data should be read in
conjunction with Managements Discussion and Analysis
of Financial Condition and Results of Operations and the
Consolidated Financial Statements and accompanying notes thereto
included elsewhere in this annual report on Form 10-K.

|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |        |        |  
|------------------------------------------------------------------------------- | --------------------------------------------------------- | ------------------------------------- | ------- | ------- | ------ | ------- | -------- | ------- | ------- | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | -
|                                                                                |                                                           |                                      
|                                                                                |                                                           | Fiscal Years Ended March 31,         
|                                                                                |                                                           |                                      
|                                                                                |                                                           | 2004                                  |         | 2003(3) |        | 2002(3) |          | 2001(1) |         | 2000
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |     
|                                                                                |                                                           |                                      
|                                                                                |                                                           | (In thousands, except per share data)
|Statement of Operations Data:                                                   |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Net revenues                                                                    |                                                           | $                                     | 65,309  |         |        | $       | 49,220   |         |         | $    | 81,937  |        |        | $ | 198,199 |        |        | $ | 115,679 |       
|Cost of revenues                                                                |                                                           |                                       | 38,500  |         |        |         | 55,061   |         |         |      | 65,414  |        |        |   | 101,421 |        |        |   | 60,320  |       
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Gross profit (loss)                                                             |                                                           |                                       | 26,809  |         |        |         | (5,841   | )       |         |      | 16,523  |        |        |   | 96,778  |        |        |   | 55,359  |       
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Operating expenses:                                                             |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|                                                                                | Research and development                                  |                                       |         | 18,710  |        |         |          | 29,230  |         |      |         | 29,122 |        |   |         | 33,881 |        |   |         | 21,748 |       
|                                                                                | Selling, general and administrative                       |                                       |         | 22,958  |        |         |          | 26,071  |         |      |         | 21,713 |        |   |         | 28,239 |        |   |         | 20,829 |       
|                                                                                | In-process research and development                       |                                       |         |        |        |         |          |         |         |      |         | 16,340 |        |   |         |       |        |   |         |       |       
|                                                                                | Impairment of goodwill and other intangible
    assets(4) |                                       |         |        |        |         |          | 67,408  |         |      |         |       |        |   |         |       |        |   |         |       |       
|                                                                                | Restructuring, severance and other                        |                                       |         | 1,938   |        |         |          | 4,293   |         |      |         | 1,470  |        |   |         | 1,700  |        |   |         |       |       
|                                                                                | Stock-based compensation                                  |                                       |         | 1,150   |        |         |          | 1,684   |         |      |         | 536    |        |   |         |       |        |   |         |       |       
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|                                                                                |                                                           | Total operating expenses              |         |         | 44,756 |         |          |         | 128,686 |      |         |        | 69,181 |   |         |        | 63,820 |   |         |        | 42,577 |  
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Operating income (loss)                                                         |                                                           |                                       | (17,947 | )       |        |         | (134,527 | )       |         |      | (52,658 | )      |        |   | 32,958  |        |        |   | 12,782  |       
|Other income (expense), net                                                     |                                                           |                                       | (146    | )       |        |         | 923      |         |         |      | 2,342   |        |        |   | 1,196   |        |        |   | (14,933 | )     
|Loss from early extinguishment of debt(2)                                       |                                                           |                                       |        |         |        |         |         |         |         |      |        |        |        |   |        |        |        |   | (18,404 | )     
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Income (loss) before provision (benefit) for
    income taxes                   |                                                           |                                       | (18,093 | )       |        |         | (133,604 | )       |         |      | (50,316 | )      |        |   | 34,154  |        |        |   | (20,555 | )     
|Provision (benefit) for income taxes                                            |                                                           |                                       |        |         |        |         |         |         |         |      | (1,120  | )      |        |   | 2,025   |        |        |   |        |       
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Income (loss) before cumulative effect of change
    in accounting principle    |                                                           |                                       | (18,093 | )       |        |         | (133,604 | )       |         |      | (49,196 | )      |        |   | 32,129  |        |        |   | (20,555 | )     
|Cumulative effect of change in accounting
    principle, net of income taxes(1) |                                                           |                                       |        |         |        |         |         |         |         |      |        |        |        |   | (6,287  | )      |        |   |        |       
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Net income (loss)                                                               |                                                           |                                       | (18,093 | )       |        |         | (133,604 | )       |         |      | (49,196 | )      |        |   | 25,842  |        |        |   | (20,555 | )     
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Net income (loss) available to common stockholders                              |                                                           | $                                     | (18,093 | )       |        | $       | (133,604 | )       |         | $    | (49,196 | )      |        | $ | 25,842  |        |        | $ | (21,497 | )     
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Basic net income (loss) per share:                                              |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Income (loss) before cumulative effect of change
    in accounting principle    |                                                           | $                                     | (0.56   | )       |        | $       | (4.69    | )       |         | $    | (1.98   | )      |        | $ | 1.37    |        |        | $ | (1.72   | )     
|Cumulative effect of change in accounting
    principle, net of income taxes(1) |                                                           |                                       |        |         |        |         |         |         |         |      |        |        |        |   | (0.27   | )      |        |   |        |       
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|                                                                                |                                                           | Basic net income (loss) per share     |         | $       | (0.56  | )       |          | $       | (4.69   | )    |         | $      | (1.98  | ) |         | $      | 1.10   |   |         | $      | (1.72  | )
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Diluted net income (loss) per share:                                            |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Income (loss) before cumulative effect of change
    in accounting principle    |                                                           | $                                     | (0.56   | )       |        | $       | (4.69    | )       |         | $    | (1.98   | )      |        | $ | 1.27    |        |        | $ | (1.72   | )     
|Cumulative effect of change in accounting
    principle, net of income taxes(1) |                                                           |                                       |        |         |        |         |         |         |         |      |        |        |        |   | (0.25   | )      |        |   |        |       
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|                                                                                |                                                           | Diluted net income (loss) per share   |         | $       | (0.56  | )       |          | $       | (4.69   | )    |         | $      | (1.98  | ) |         | $      | 1.02   |   |         | $      | (1.72  | )
|                                                                                |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|Weighted average common shares outstanding:                                     |                                                           |                                       |         |         |        |         |          |         |         |      |         |        |        |   |         |        |        |   |         |       
|                                                                                | Basic                                                     |                                       |         | 32,387  |        |         |          | 28,500  |         |      |         | 24,894 |        |   |         | 23,444 |        |   |         | 12,511 |       
|                                                                                | Diluted                                                   |                                       |         | 32,387  |        |         |          | 28,500  |         |      |         | 24,894 |        |   |         | 25,277 |        |   |         | 12,511 |       

|                                                                              |  |                              |        |         |  |         |         |         |  |      |         |   |  |   |         |   |  |   |        |  
|----------------------------------------------------------------------------- |  | ---------------------------- | ------ | ------- |  | ------- | ------- | ------- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------ | -
|                                                                              |  |                             
|                                                                              |  | Fiscal Years Ended March 31,
|                                                                              |  |                             
|                                                                              |  | 2004                         |        | 2003(3) |  | 2002(3) |         | 2001(1) |  | 2000
|                                                                              |  |                              |        |         |  |         |         |         |  |     
|Other Financial Data:                                                         |  |                              |        |         |  |         |         |         |  |      |         |   |  |   |         |   |  |   |        |  
|Cash provided by (used in) operating activities                               |  | $                            | (2,884 | )       |  | $       | (42,550 | )       |  | $    | (17,289 | ) |  | $ | 9,600   |   |  | $ | (6,258 | )
|Cash provided by (used in) investing activities                               |  |                              | 387    |         |  |         | 9,101   |         |  |      | 4,039   |   |  |   | (32,316 | ) |  |   | (3,627 | )
|Cash provided by financing activities and effect
    of exchange rate on cash |  |                              | 12,701 |         |  |         | 660     |         |  |      | 4,009   |   |  |   | 3,241   |   |  |   | 64,840 |  
|Capital expenditures                                                          |  |                              | 254    |         |  |         | 1,464   |         |  |      | 4,364   |   |  |   | 11,988  |   |  |   | 3,261  |  

|                                |  |           |        |         |  |         |        |         |  |      |         |  |  |   |         |  |  |   |         | 
|------------------------------- |  | --------- | ------ | ------- |  | ------- | ------ | ------- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                |  |          
|                                |  | March 31,
|                                |  |          
|                                |  | 2004      |        | 2003(3) |  | 2002(3) |        | 2001(1) |  | 2000
|                                |  |           |        |         |  |         |        |         |  |     
|Balance Sheet Data:             |  |           |        |         |  |         |        |         |  |      |         |  |  |   |         |  |  |   |         | 
|Cash and short-term investments |  | $         | 23,899 |         |  | $       | 13,695 |         |  | $    | 59,059  |  |  | $ | 75,575  |  |  | $ | 75,200  | 
|Working capital                 |  |           | 27,878 |         |  |         | 23,509 |         |  |      | 81,013  |  |  |   | 109,849 |  |  |   | 94,109  | 
|Total assets                    |  |           | 65,189 |         |  |         | 67,703 |         |  |      | 201,646 |  |  |   | 191,191 |  |  |   | 133,694 | 
|Long-term debt                  |  |           |       |         |  |         |       |         |  |      | 16      |  |  |   | 16      |  |  |   | 16      | 
|Stockholders equity            |  |           | 32,264 |         |  |         | 36,338 |         |  |      | 167,499 |  |  |   | 129,082 |  |  |   | 99,485  | 

17



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---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Effective April 1, 2000, we changed our
    method of accounting for revenue recognition in accordance with
    Securities and Exchange Staff Accounting Bulletin Number 101
    (SAB 101). In December 2003, the Securities Exchange
    Commission issued Staff Accounting Bulletin Number 104
    (SAB 104), which supercedes SAB 101. We are in
    compliance with SAB 104.                                                                                                                                                                                                                      
|   
|(2) | On May 16, 1997, we effected the
    recapitalization. We issued $115.0 million in aggregate
    principal amount of 10 5/8% senior notes in connection
    with the recapitalization. In March 2000, we used approximately
    $130.5 million of net proceeds from our initial public
    offering of common stock to redeem or repurchase substantially
    all of the outstanding senior notes issued with our
    recapitalization in 1997. Approximately $18.4 million costs
    were associated with this early extinguishment of debt.                                                         
|   
|(3) | The consolidated financial statements for the
    years ended March 31, 2003 and 2002 were restated as a
    result of an investigation and revenue recognition review
    conducted by our Audit Committee with the assistance of outside
    legal counsel, independent forensic accountants, and our
    independent registered public accounting firm.                                                                                                                                                                                                                                            
|   
|(4) | During fiscal year ended March 31, 2003, we
    conducted impairment reviews of goodwill and other intangible
    assets in accordance with Statement of Financial Accounting
    Standards No. 142, Goodwill and Other Intangible
    Assets, and Statement of Financial Accounting Standards
    No. 144, Accounting for the Impairment or Disposal of
    Long-Lived Assets. As a result of the reviews, we wrote
    off $65.9 million for goodwill, $0.6 million for
    developed technology, $0.2 million for a development
    contract and $0.8 million for trade name intangible assets.

18



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##### Table of Contents








|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

General

We develop, manufacture, market and service
process control metrology systems for use in the manufacture of
semiconductors and control significant market share in the
metrology industry. Process control metrology is used to monitor
process parameters in order to enable semiconductor
manufacturers to maintain high yields on the production lines,
reduce feature size, increase wafer size, increase equipment
productivity and improve device performance. Our metrology
systems are used in all sections of the semiconductor
fabrication plant, or fab, to control the wafer
fabrication processes. Examples of wafer fab processes, in which
our metrology systems supply key information, are photoresist
processing to support lithography, deposition of insulator and
conductor films, patterned removal, or etching, of
insulator and conductor films, ion implantation and chemical
mechanical planarization. We currently sell four product
families of process control metrology systems: Therma-Probe
systems, Opti-Probe systems, Opti-Probe CD systems, and Integra
integrated metrology systems.

Therma-Probe Product
Family.Therma-Probe systems utilize
our proprietary thermal wave technology and are non-destructive
process control metrology systems used to measure the critical
ion implantation process on product wafers in the fabrication of
semiconductors. Therma-Probe systems have a major share of the
market.

Opti-Probe Product
Family.Opti-Probe Film Metrology
systems provide the industrys most powerful capability to
control and diagnose non-opaque films for semiconductor
production. This unsurpassed metrology power is achieved by
successfully integrating different measurement technologies,
including optical technologies that are proprietary to our
company, into each Opti-Probe system.

Opti-Probe CD Product
Family.Opti-Probe CD systems measure
the critical dimensions, or CD, representing the device
structures, using a revolutionary, nondestructive technique
based on spectroscopic ellipsometry. These systems are capable
of providing CD metrology for the smallest features of the next
several generations of ICs.

Integra Product
Family.The Integra line of integrated
metrology products is a broad-based family of compact metrology
modules which are installed on and function in
conjunction with an IC process system, such as an etching system
or CVD deposition system, to provide metrology on each wafer
before it exits the process tool.

Management Overview



| |            
| | -----------
| | Our Mission

Our mission can be stated in simple
terms  we want to help our customers achieve their
goals, which will in turn help us achieve ours. Therma-Wave
develops, manufactures, markets and services process control
metrology systems for use in the manufacture of semiconductors.
Our customers must have metrology equipment to improve their
yields, an essential element to improving their profits. A
significant number of our customers are now expanding their
wafer production capacity while moving from 200 millimeter
to new 300 millimeter technology. The industry is also
advancing to smaller geometries for semiconductor device
production, currently at the 130 nm technology node and
advancing to 90 nm and in the future advancing to the
65 nm technology node. These technology advances will
significantly increase the requirement to improve yields.



| |             
| | ------------
| | Our Products

Our core products include the latest generations
of our Therma-Probe and Opti-Probe metrology systems. Our core
markets, remain the thin film and ion implant measurement
markets that we successfully addressed for nearly
$200 million of revenue during the peak year of the last
semiconductor industry cycle. Our new products include our
optical RT/ CD product family and our integrated product line,
Integra. All of our new and latest generation products, which
taken together accounted for approximately 60% of our total
systems

19



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##### Table of Contents



new order bookings in fiscal year 2004, are in
keeping with our objective to stay at the forefront of
technology leadership in metrology for the semiconductor
industry. Our new products and technologies for critical
dimension and integrated metrology substantially expand our
target markets going forward.


Therma-Wave introduced its Opti-Probe Real Time
Critical Dimension system, Opti-Probe RT/CD, in 2002. This
product combines a powerful computer and Therma-Wave proprietary
software with our standard 7000 series Opti-Probe and
has moved Therma-Wave into a market not previously served by the
company. Opti-Probe RT/CD has positioned us to compete for
business previously served by manufacturers of scanning
electronic microscopes, known as CD SEM. CD SEM is becoming
non-competitive in certain advanced technologies of 90 nm
and smaller. We believe that our Opti-Probe RT/ CD product can
address some CD requirements faster, better and at a
substantially lower cost of ownership to the customer. Where CD
SEM is an expensive low throughput technology, Opti-Probe RT/ CD
can do the same thing faster and with more precision. We believe
the superiority of Opti-Probe RT/ CD will become even greater as
fabs move to 90 nm and then to 65 nm. We believe the
total critical dimension market could be as much as
$500 million to $700 million in calendar year 2005
based on Gartner/ Dataquest market information. Optical products
may take an increasing share of this market as technology nodes
decrease in size.

Also in 2002, we introduced our first integrated
critical dimension metrology product, Integra, which we sell
primarily to an original equipment manufacturer of integrated
circuit process systems. This product is a family of compact
metrology modules that are installed on and function in
conjunction with the IC process system. We are rated by Tokyo
Electron as their Class 1 supplier for integrated CD
metrology on their market leading photoresist track system.

Therma-Wave has an installed base of more than
1,650 systems and has systems located at nearly every major
semiconductor manufacturer in the world. Therma-Wave has never
been a low price competitor. Our strength has been technology
from the beginning of the company, when the Therma-Probe product
dominated a market niche. We have protected our technology with
106 U.S. and foreign patents as of the end of fiscal 2004.
We have a broad range of applications, with products that are
reliable and have a low cost of ownership due to their
capabilities, not necessarily due to their price.

We also have a reputation for excellent customer
support and we again last year ranked ahead of our top
competitor in VLSIs Customer Support Survey. We have a
worldwide customer support organization of approximately
131 people located very close to all our major customers.
We have subsidiaries in Japan, the UK and China and branch
locations or offices in Taiwan, Hong Kong, Israel, and Ireland,
as well as several locations in the U.S. We also have
representatives or distributors in Germany, France, Italy,
Singapore and Japan.

To be competitive, our products must be
extendable, provide low cost of ownership and help our customers
to continuously meet the ever-advancing technology nodes
challenge. Some of our customers are currently moving or
planning to move from 130 nm to 90 nm and will begin
moving to 65 nm as the next step. They will not purchase
products from a supplier who they believe cannot continue to
enable them to advance and meet those technology changes.
Therma-Wave products have demonstrated the capability to be
extendable and meet those challenges in the past and we believe
our products are well positioned to meet those requirements for
the future.



| |                            
| | ---------------------------
| | Our Market and Market Share

Based on the Gartner/ Dataquest January 2004
industry survey information, it is estimated that the total
process control market will grow to approximately
$5.2 billion by calendar year 2005. Of that, approximately
$2.3 billion is expected to be the metrology segment.
Therma-Wave is targeting the transparent thin film, critical
dimension and overlay segments of this market, which is
estimated to be approximately $1.3 billion by 2005. Our
goal is to capture a minimum of 15% of this market, plus a major
share of the ion implant process measurement market, and plus
normal upgrades and service and support. The ion implant market
is actually included as a small part of the opaque film market
by Gartner/ Dataquest, and we believe this market will be
between $25 million and $30 million in calendar year
2005, most of which we expect to capture. If achieved,

20



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##### Table of Contents



this could provide Therma-Wave with
$250 million or more of total revenues in our fiscal year
2006. If not achieved, we will not see the benefits of such
revenue growth.


As reported by the Gartner/ Dataquest industry
survey, our Opti-Probe products in the standalone non-metal thin
film metrology market increased market share from 15% in
calendar 2002 to 19% in calendar 2003. Our Opti-Probe RT/ CD
product also made strong market share gains, improving from 22%
in 2002 to 50% in calendar 2003. This product was introduced in
the second half of 2002. It is also noteworthy that the total
market for optical critical dimension measurement equipment more
than doubled, from $7.6 million in 2002 to $18 million
in 2003. We believe this growth will continue and even
accelerate further.



| |           
| | ----------
| | New Orders

The semiconductor industry has just gone through
its longest and deepest downturn in its history. Therma-Wave was
severely impacted. However, our orders and order activity
increased during our fiscal third and fourth quarters of 2004.
In our fiscal third quarter, we reported an 89% increase in
orders from the previous quarter, which resulted in shipments
increasing by over 28% in the fiscal fourth quarter. Our order
rates for the last two quarters of our fiscal year 2004 were at
the highest level they have reached since our fiscal year 2001.
Although the industry orders picture is still somewhat unclear,
we believe that business overall in the semiconductor industry
is improving.

In fiscal 2004, we also substantially increased
our total number of customers worldwide to whom we sold systems
to 39 customers worldwide, up from 29 the previous year. We sold
products to eight of the top ten capital spending companies in
the world in semiconductor manufacturing capital facilities and
equipment, up from seven of the top ten in the previous year. We
more than doubled our metrology systems orders to approximately
$48 million in fiscal year 2004, up from approximately
$21 million the previous year.

In addition to the overall growth in orders, it
is important to note that our new leading edge products grew as
a percentage of our product mix. The advanced Therma-Probe
systems grew from 3%, or $0.7 million, of total systems
orders in fiscal 2003 to 16%, or $8.0 million, of total
systems orders in fiscal 2004. The advanced Opti-Probe systems
grew from 16%, or $3.5 million, to 31%, or
$15.2 million, of total systems orders. Also, 60% of total
systems booked during the year were for 300 millimeter
business, which we feel is significant because it demonstrates
that customers are accepting our more advanced products.

Geographically, in our fiscal 2004, European
business strengthened and we recaptured business in Korea. We
opened a new subsidiary in Shanghai to service the new business
in China. Overall for the fiscal year 2004, 56% of systems
orders came from Asia excluding Japan, 19% came from Japan, 12%
from Europe and 13% from the United States. This compared to 54%
of systems orders from Asia excluding Japan, 12% from Japan, 4%
from Europe and 29% from the United States for the fiscal year
2003. We believe the distribution of new orders in fiscal fourth
quarter of 2004 is significant, indicating a broad market
penetration, particularly the strong growth in Europe, Korea and
Taiwan.



| |             
| | ------------
| | Net Revenues

During fiscal 2003, quarterly net revenues
bottomed at between $10 and $11 million per quarter in the
fiscal second and third quarters, then turned up to
$13.1 million in the fiscal fourth quarter of 2003. We
continued to make progress during fiscal year 2004, and net
revenues for the fiscal fourth quarter of 2004 were
$19.5 million. Sequentially, net revenues in the fiscal
fourth quarter 2004 decreased by $0.4 million from the
fiscal third quarter 2004, however fiscal third quarter included
$15.2 million of our standard products and services and
$4.7 million of revenue related to a development program
that ended during the fiscal third quarter. Therefore, fiscal
fourth quarter net revenues from standard products and services
actually increased by $4.3 million or 28.5%. Net revenues
for the fiscal year ended March 28, 2004 totaled
$65.3 million compared to $49.2 million for fiscal
year 2003, an increase of $16.1 million or 32.7%. This
reflects the industry-wide upturn in purchases of semiconductor
metrology capital equipment.

21



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| |        
| | -------
| | Margins

Gross margins improved steadily throughout fiscal
year 2004 and continued this improvement in the fiscal fourth
quarter, benefiting both from the higher volume and from cost
reduction efforts. Our gross margins averaged 50.1% for our
fiscal third quarter, including $3.7 million of margin from
a development program that ended during the quarter and averaged
41.6% for our standard products and services in addition to
$3.7 million from the conclusion of the development program
mentioned above. Our third fiscal quarter gross margin from
standard products and services benefited from the sale of
$2.5 million, or 12% of revenues, of inventory that had
previously been written off, and was reduced by new inventory
charges of $0.6 million, or 3% of revenues. We improved
gross margins for standard products and services to 43.4% in the
fiscal fourth quarter of 2004, which includes the benefit of
$2.5 million, or 13% of revenues, from the sale of
previously written off inventory and the reduction of
$2.2 million, or 11% of revenues, due to new charges to
inventory in the fourth fiscal quarter.

We ended fiscal year 2003 with average gross
margins of negative 12%, including new inventory charges of
$9.6 million, or 20% of net revenues, and the benefit from
the sale of $1.0 million, or 2% of net revenues, of
inventory that had previously been written off. We improved
gross margins in fiscal year 2004 to over 41%, including the
benefit from the sale of $10.6 million, or 16% of net
revenues, of inventory previously written off and the reduction
due to new inventory charges of $5.2 million, or 8% of net
revenues. Net revenues from our 300 millimeter standalone
tools increased to 57% of total net revenues for our fiscal
fourth quarter, up 34% from the fiscal third quarter 2004. In
addition, 60% of our new orders for the same period were for
300 millimeter products indicating that this trend should
continue. The significance of this product mix to margins is
that our 300 millimeter products are less mature and
therefore margins on these systems are lower than on older, more
mature 200 millimeter products. Cost reduction programs are
under way to improve our 300 millimeter product margins.

For the fiscal fourth quarter 2004, we fully
absorbed our factory overhead for the first time in more than
two years due to higher production volumes. This is important
because it means that any additional volume growth begins to
reduce the average overhead cost per tool produced, thereby
reducing the average total cost per tool. However, our margins
continued to be unfavorably impacted by lower than optimum
production levels.



| |                   
| | ------------------
| | Operating Expenses

During fiscal 2004, our efforts were directed
toward managing our operating expenses to be in line with
business conditions. Total operating expenses for the fiscal
fourth quarter 2004 decreased by approximately $0.7 million
from the fiscal third quarter. This decrease was due primarily
to non-cash charges for variable accounting treatment for stock
options of approximately $0.7 million that were incurred in
the fiscal third quarter, compared to a credit of
$0.1 million recorded for the variable accounting treatment
for stock options in the fiscal fourth quarter. The credit
occurred because our stock price decreased from quarter to
quarter. Operating expenses for all costs other than the
variable accounting treatment for stock options were up about
$0.4 million from our fiscal third quarter, an increase of
approximately 4%.

For fiscal 2004, operating expenses were
$44.8 million, down from $128.7 million in fiscal
2003. Fiscal 2003 included charges of $67.4 million for the
impairment of goodwill and other intangible assets related to
the Sensys acquisition. Excluding the $67.4 million
impairment charges, fiscal 2003 expenses were
$61.3 million. The reduction in operating expenses other
than impairment charges in fiscal 2004 compared to fiscal 2003
reflects an 18% labor savings due to reductions in force, 54%
lower direct material charges due to the timing of development
activities, a 42% reduction in spending on outside services, and
lower costs for marketing programs, travel, and facilities and
information systems support. In fiscal 2005, we expect to manage
operating expenses in line with revenues, increasing over time
as the business grows, but declining as a percentage of
revenues, thereby improving profitability.

22



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##### Table of Contents





| |         
| | --------
| | Net Loss

Our net loss for the fiscal fourth quarter 2004
was $1.8 million or $0.05 per diluted share, including
the sale of inventory with an original cost of
$2.5 million, or $0.07 per share that had previously
been written off, and was reduced by new inventory charges of
$2.2 million, or $0.06 per share. This compared to a
net loss for the fiscal third quarter of $1.0 million, or
$0.03 per diluted share, that benefited from the sale of
inventory with an original cost of $2.5 million that had
previously been written off, and that was reduced by new
inventory charges of $0.6 million, or $0.02 per share.
However, our fiscal third quarter also benefited from
approximately $3.7 million of net income, or approximately
$0.10 per diluted share, recognized from the ending of a
development program. The net loss from the sale of our standard
products and services for the fiscal third quarter was
$4.7 million or $0.13 per diluted share.

Our net loss for the fiscal year 2004 was
$18.1 million or $0.56 per diluted share compared to a
loss of $133.6 million or $4.69 per diluted share for
fiscal year 2003. However, our fiscal year 2004 benefited from
approximately $3.7 million of net income, or approximately
$0.10 per diluted share, recognized from the ending of the
development program mentioned earlier. Our fiscal year 2004 also
benefited from the sale of inventory that originally had cost
$10.6 million, or $0.33 per share that had previously
been written off, and was reduced by $5.2 million, or
$0.16 per share, in new inventory charges. The fiscal year
2003 results included non-cash charges of $67.4 million, or
$2.37 per share, for the impairment of goodwill and other
intangible assets originating from the January 2002 acquisition
of Sensys. The fiscal year 2003 net loss also benefited
from the sale of inventory that originally cost
$1.0 million, or $0.04 per share, that had previously
been written off, and was reduced by $9.6 million, or
$0.34 per share, in new inventory charges.



| |              
| | -------------
| | Balance Sheet

Our balance sheet was strengthened significantly
during our last two quarters of fiscal 2004. Cash and short-term
investments totaled $23.9 million at March 28, 2004 an
increase of $1.4 million from the $22.5 million
reported as of December 28, 2004 and $22.6 million
reported at September 28, 2003. This compares to cash and
restricted cash as of the end of fiscal 2003 of
$14.8 million. Cash improvements were due primarily to
$11.7 million in net proceeds raised in a private offering
completed on September 16, 2003, increased accounts
receivable collections due to improved net revenues and reduced
receivables days sales outstanding and sale of inventory,
including the sale of inventory that had originally cost
$10.6 million but that had later been written off prior to
sale. Our receivables days sales outstanding, or DSO, ended the
fiscal fourth quarter of 2003 at 106 days and was improved
to 52 days for our fiscal fourth quarter of 2004. We have
no long-term debt, and we have access to $15 million in
credit facilities that are unused other than for supporting
standby letters of credit.

In previous communications to shareholders and
the investment community, we identified inventory controls as a
key component for the success of the company. In the fiscal
fourth quarter inventory increased by approximately
$0.2 million, the first increase in more than a year due
primarily to increased purchasing of parts to accommodate the
shift in product mix from 200 millimeter products to
300 millimeter products and also due to the increased
manufacturing and sales volume. We also continued to sell
previously written off 200 millimeter inventory.



| |        
| | -------
| | Summary

Our financial performance has significantly
improved in the past year and we expect that improvement to
continue. Our goal is that this improvement will bring us back
to profitability during the current fiscal year. Our management
team is lead by Boris Lipkin, who joined Therma-Wave as our CEO
in February 2003. Mr. Lipkin has brought together a new
team, most of which was assembled during fiscal year 2004. We
have a new chairman, Papken Der Torossian, former chairman and
CEO of Silicon Valley Group, who joined the board in March 2003.
And in March of 2004 we added three new board members: Peter
Handley, recently retired as President of Novellus, Larry
Tomlinson, recently retired Treasurer of Hewlett Packard and Nam
Pyo Suh, professor and Director of the Manufacturing Institute
at MIT. Mr. Tomlinson is also now chairman of our audit
committee.

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By far our most important goal for fiscal year
2005 is to return the company to profitability. We undertook a
course of action at the beginning of our fiscal year 2004 that
started producing the expected results. During the year, our
orders activity continued to improve, gross margins continued to
improve and our losses were substantially reduced. In total our
fiscal year 2004 was a substantial improvement over the previous
year and confirms that our company is headed in the right
direction. This does not mean that we are satisfied, but we are
pleased with our fiscal year 2004 performance.



| |                
| | ---------------
| | Looking Forward

The timing of orders and shipments continues to
be difficult to predict, but we expect both orders and net
revenues to steadily increase quarter by quarter during our
fiscal year 2005. At least in the fiscal first quarter we expect
gross margins to be influenced by the continued mix shift from
200 millimeter products to 300 millimeter products,
and pricing pressures, though lessening to continue, slowing
margin improvement, possibly offsetting potential margin
improvements from higher volume. Operating expenses are expected
to be higher due to higher research and development project
costs, higher sales commissions that result from the increased
new orders, and from expenses related to Sarbanes-Oxley Act
compliance. We expect a net loss in the fiscal first quarter
2005. However, we continue to believe that our profitability
will improve during fiscal year 2005, aided by expected further
improvements in orders and shipments and a growing benefit from
ongoing cost reduction efforts.

As mentioned earlier, cash and short-term
investments totaled $23.9 million at March 28, 2004 an
increase of $1.4 million from the $22.5 million
reported as of December 28, 2004. Our inventory increased
in our fiscal fourth quarter 2004 for the first time in more
than a year. We believe that growth in new orders and revenues
and continued change in product mix, going toward more
300 millimeter products will increase inventories further
and that trade receivables will also begin to increase in our
fiscal first quarter of 2005. We expect this trend to continue
at least through the first two quarters of our fiscal year 2005
and to require an investment in net working capital in our
fiscal first quarter and possibly in the fiscal second quarter.
We believe that we have adequate cash to fund this working
capital growth. However, if required, we have access to
$15 million in credit facilities available through our bank.

Critical Accounting Policies and
Estimates

Our consolidated financial statements have been
prepared in accordance with accounting principles generally
accepted in the United States. The methods, estimates and
judgments we use in applying our accounting policies has a
significant impact on the results we report in our consolidated
financial statements. On an on-going basis, management evaluates
its estimates and judgments, including those related to revenue
recognition, inventory, allowance for doubtful accounts
receivable, valuation of long-lived assets and intangible
assets, income taxes and warranty. Management bases its
estimates and judgments on historical experience and on various
other factors that are believed to be reasonable under the
circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or
conditions.

An accounting policy is considered to be critical
if it requires an accounting estimate to be made based on
assumptions about matters that are highly uncertain at the time
the estimate is made, and if different estimates that reasonably
could have been used, or changes in the accounting estimates
that are reasonably likely to occur periodically, could
materially impact the financial statements. Management believes
the following critical accounting policies affect its
significant judgments and estimates used in the preparation of
its consolidated financial statements. The following
descriptions of critical accounting policies, judgments and
estimates should be read in conjunction with our consolidated
financial statements and other disclosures included in this
report.

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| |                    
| | -------------------
| | Revenue Recognition

Effective April 1, 2000, we changed our
method of accounting for revenue recognition in accordance with
Securities and Exchange Commission Staff Accounting Bulletin
No. 101, or SAB 101, Revenue Recognition in
Financial Statements. In December 2003, the Securities
Exchange Commission issued Staff Accounting Bulletin
No. 104, or SAB 104, Revenue Recognition,
which superceded SAB 101. SAB 104 is a codification of
other revenue recognition pronouncements and in substance does
not change SAB 101. Revenues are recognized when the
contractual obligations have been performed, title and risk of
ownership have passed to the customer, collectibility of the
sales price has been reasonably assured and customer final
acceptance has been obtained, if applicable. Freight terms of
sales are FOB shipping point unless otherwise negotiated and
agreed in written form between our customers and us. Shipments
typically are made in compliance with shipment requirements
specified in our customers purchase order.

Systems Revenues.Equipment sales are accounted for as
multiple-element arrangement sales that require the deferral of
a significant portion of revenues in the amount of the greater
of fair market value of installation and a percentage of payment
subject to final acceptance. Systems revenues are allocated to
each component of the multiple-element arrangement. Revenues on
each element are recognized when the contractual obligations
have been performed, title and risk of ownership have passed to
the customer, collectibility of the sales price has been
reasonably assured and customer final acceptance has been
obtained, if applicable. Estimated contractual warranty
obligations are recorded when related systems sales are shipped.

Systems revenues on newly introduced products are
deferred at shipment and recognized upon customer final
acceptance. Systems revenues are also deferred when the customer
has the right to return the product for credit. In such cases,
systems revenues are not recognized until all of the following
conditions have been evidenced after the customers
purchase order has been fulfilled: the right of return has
expired and any potential returns would require authorization by
our company under warranty provisions; the price of the sales is
fixed or determinable; the payment terms are fixed and
enforceable and collectibility is reasonably assured.

In accordance with SAB 104, we evaluate our
systems sales to determine the appropriate timing for revenue
recognition for each of the multiple elements involved in each
sale. This sometimes results in deferrals of revenues from the
period in which the tool is shipped to future periods.

Services Revenues.We derive services revenues from three
primary sources: sale of spare parts, service contracts and
service labor. Revenues on the sale of spare parts are
recognized when title and risk of ownership have transferred to
the customer and collectibility of the sales price has been
reasonably assured. Revenues on service contracts are deferred
and recognized on a straight-line basis over the period of the
contract. Revenues on time and material services performed are
recognized when the services are completed, collectibility of
the sales price has been reasonably assured and customer final
acceptance has been obtained, if applicable.



| |          
| | ---------
| | Inventory

We value our inventory at the lower of cost
(first-in, first-out method) or market. Due to changing market
conditions, estimated future requirements, age of the
inventories on hand and our production of new products, we
regularly review inventory quantities on hand and record a
provision to write down excess and obsolete inventory to its
estimated net realizable value. A significant increase in the
demand for our product could result in a short-term increase of
inventory purchases while a significant decrease in demand could
result in an increase in the charges for excess inventory
quantities on hand. In addition, our industry is subject to
technological change, new product development, and product
technological obsolescence that could result in an increase in
the amount of obsolete inventory quantities on hand. Therefore,
any significant unanticipated changes in demand or technological
developments could have a significant impact on the value of our
inventory and reported operating results. When we record
additional reserves for excess and obsolete inventory, we create
a new cost basis for the inventory. The reserve is only released
if and when the reserved inventory is sold or scrapped, which is
in accordance with SAB 100. The inventory charge in fiscal
2004 was $5.2 million, and was $9.6 million in fiscal
2003.

25



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##### Table of Contents





| |                                                
| | -----------------------------------------------
| | Allowance for Doubtful Accounts
    Receivables

We utilize estimates in determining our allowance
for doubtful accounts receivable and reserve for potential
returns for credit. We continuously monitor collections and
payments from our customers and maintain a provision for
estimated credit losses based upon our historical experience,
any specific customer collection issues that we have identified,
and the aging of the accounts receivable. While such credit
losses have historically been within our expectations and the
provisions established, there is no assurance that we will
continue to experience the same credit loss rates that we have
in the past. A significant change in the liquidity or financial
position of our customers could have a material adverse impact
on the collectibility of our accounts receivable and our future
operating results.



| |                                                  
| | -------------------------------------------------
| | Valuation of Long-Lived and Intangible
    Assets

We have adopted Statement of Financial Accounting
Standards No. 142, or SFAS No. 142,
Goodwill and Other Intangible Assets and
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. We assess the impairment of
identifiable intangibles and long-lived assets whenever events
or changes in circumstances indicate that the carrying value may
not be recoverable. Factors we consider important which could
trigger an impairment review of such assets include the
following:



| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| |  | significant under-performance relative to
    expected historical or projected future operating results;             
|
| |  | significant changes in the manner of our use of
    the acquired assets or the strategy for our overall business; and
|
| |  | significant negative industry or economic trends.                                                                    

When we determine that the carrying value of
intangibles and long-lived assets may not be recoverable based
upon the existence of one or more of the above indicators of
impairment, we measure the impairment based on a projected
discounted cash flow method using a discount rate determined by
our management to be commensurate with the risk inherent in our
business model. While we believe that our estimates of future
cash flows are reasonable, different assumptions regarding such
cash flows could materially affect our evaluations. In fiscal
year 2003 we wrote off $67.4 million in regards to the
impairment of goodwill and other intangibles associated with the
Sensys acquisition.



| |             
| | ------------
| | Income Taxes

We account for income taxes using the asset and
liability approach, which requires recognition of deferred tax
assets and liabilities for the expected future tax consequences
of events that have been recognized in our financial statements,
but have not been reflected in our taxable income. A valuation
allowance is established to reduce deferred tax assets to their
estimated realizable value. We provide a valuation allowance to
the extent we cannot conclude, based on available objective
evidence, that it is more likely than not we will generate
sufficient taxable income in future periods to realize the
benefit of our deferred tax assets. Predicting future taxable
income is difficult, and requires the use of significant
judgment.



| |         
| | --------
| | Warranty

We provide warranty coverage for a predetermined
amount of time, on systems and parts for material and labor to
repair and maintain the equipment. We record the estimated cost
of systems and parts warranty upon shipment of tools, based on
the average historical warranty expense for a specific tool.
Should actual costs or material usage differ from our estimates,
revisions to the estimated warranty liability may be required.

26



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##### Table of Contents



Results of Operations

The following table summarizes our historical
results of operations as a percentage of net revenues for the
periods indicated.

|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |      |      | 
|------------------------------------ | -------------------------------------------------- | --------------------------------- | ----- | ---- | ---- | ---- | ------ | ----- | ----- |  | ----- | ---- | ---- | 
|                                     |                                                    |                                  
|                                     |                                                    | Fiscal Year                      
|                                     |                                                    |                                  
|                                     |                                                    | 2004                              |       | 2003 |      | 2002
|                                     |                                                    |                                   |       |      |      |     
|Net revenues                         |                                                    |                                   | 100.0 | %    |      |      | 100.0  | %     |       |  | 100.0 | %   
|Cost of revenues                     |                                                    |                                   | 59.0  |      |      |      | 111.9  |       |       |  | 79.8  |     
|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|Gross profit (loss)                  |                                                    |                                   | 41.0  |      |      |      | (11.9  | )     |       |  | 20.2  |     
|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|Operating expenses:                  |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|                                     | Research and development                           |                                   |       | 28.5 |      |      |        | 59.4  |       |  |       | 35.5 |     
|                                     | Selling, general and administrative                |                                   |       | 35.2 |      |      |        | 53.0  |       |  |       | 26.5 |     
|                                     | In-process research and development                |                                   |       | 0.0  |      |      |        | 0.0   |       |  |       | 19.9 |     
|                                     | Impairment of goodwill and other intangible assets |                                   |       | 0.0  |      |      |        | 136.9 |       |  |       | 0.0  |     
|                                     | Restructuring, severance and other                 |                                   |       | 3.0  |      |      |        | 8.7   |       |  |       | 1.8  |     
|                                     | Stock-based compensation                           |                                   |       | 1.8  |      |      |        | 3.4   |       |  |       | 0.7  |     
|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|                                     |                                                    | Total operating expenses          |       |      | 68.5 |      |        |       | 261.4 |  |       |      | 84.4 | 
|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|Operating loss:                      |                                                    |                                   | (27.5 | )    |      |      | (273.3 | )     |       |  | (64.2 | )   
|Other income (expense), net:         |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|                                     | Interest expense                                   |                                   |       | (0.1 | )    |      |        | (0.3  | )     |  |       | (0.3 | )   
|                                     | Interest income                                    |                                   |       | 0.2  |      |      |        | 1.9   |       |  |       | 3.0  |     
|                                     | Other income (expense), net                        |                                   |       | (0.3 | )    |      |        | 0.3   |       |  |       | 0.1  |     
|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|                                     |                                                    | Total other income (expense), net |       |      | (0.2 | )    |        |       | 1.9   |  |       |      | 2.8  | 
|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|Loss before benefit for income taxes |                                                    |                                   | (27.7 | )    |      |      | (271.4 | )     |       |  | (61.4 | )   
|Benefit for income taxes             |                                                    |                                   | 0.0   |      |      |      | 0.0    |       |       |  | (1.4  | )   
|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |     
|Net loss                             |                                                    |                                   | (27.7 | )%   |      |      | (271.4 | )%    |       |  | (60.0 | )%  
|                                     |                                                    |                                   |       |      |      |      |        |       |       |  |       |     

Due to the 33% increase in net revenues in fiscal
2004 compared to fiscal 2003, cost of net revenues and operating
expense as a percentage of net revenues declined, reducing the
net loss as a percentage of revenues. Included in the changes
from fiscal 2004 compared to fiscal 2003, among other changes,
are (in millions):

|                                                                                                 |  |              |     |          |  |              |    |          |  |          |      |  |  |   |      |  |  |  |     |  
|------------------------------------------------------------------------------------------------ |  | ------------ | --- | -------- |  | ------------ | -- | -------- |  | -------- | ---- |  |  | - | ---- |  |  |  | --- | -
|                                                                                                 |  |              |     | % of Net |  |              |    |          |  | % of Net
|                                                                                                 |  | Net Revenues |     | Revenues |  | Gross Profit |    | Net Loss |  | Revenues
|                                                                                                 |  |              |     |          |  |              |    |          |  |         
|The conclusion of a development contract                                                         |  | $            | 4.7 |          |  |              | 7% |          |  | $        | 3.7  |  |  | $ | 3.7  |  |  |  | 6   | %
|Lower operating expenses due to the fiscal 2003
    impairment of goodwill and other intangibles |  |              |     |          |  |              |    |          |  |          | 67.4 |  |  |   | 67.4 |  |  |  | 137 | %
|Increase in the sale of inventory that had been
    previously written off                       |  |              |     |          |  |              |    |          |  |          | 9.6  |  |  |   | 9.6  |  |  |  | 15  | %
|Increase in new charges to inventory for excess
    and obsolescence                             |  |              |     |          |  |              |    |          |  |          | 4.4  |  |  |   | 4.4  |  |  |  | 7   | %

Due to a 40% decline in net revenues in fiscal
2003 compared to fiscal 2002, cost of net revenues increased as
a percentage of net revenues, as did operating expenses,
increasing the net loss as a percentage of net revenues in
fiscal 2003 compared to fiscal 2002. Fiscal 2003 results
included (in millions):



| |   |                                                                                      
| | - | -------------------------------------------------------------------------------------
| |  | a charge of $9.6 million, or 20% of net
    revenues, for the write down of inventory

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| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | a benefit from the sale of $1.0 million, or
    2% of net revenues, of inventory previously written off                    
|
| |  | a $67.4 million charge for the impairment of
    goodwill and other intangible assets related to the Sensys
    acquisition



| |                                                                                  
| | ---------------------------------------------------------------------------------
| | Fiscal Year Ended March 31, 2004
    Compared to Fiscal Year Ended March 31, 2003

Net Revenues.Net
revenues for the fiscal years ended March 31, 2004 and 2003
were $65.3 million and $49.2 million, respectively.
Compared to fiscal 2003, net revenues in fiscal 2004 increased
$16.1 million or 32.7% primarily as a result of capital
spending increases in the semiconductor industry. We sold 40%
more units of our Therma-Probe and Opti-Probe products in fiscal
2004 and the average selling price increased 55% in fiscal 2004
due to a shift in business towards newer, more expensive models.
We experienced strong price competition during both fiscal 2004
and fiscal 2003.

The following table summarizes our revenues in
different categories as a percentage of total net revenues for
the periods indicated.

|                   |                    |                    |     |      |  |      |     |      |  |  |     |      | 
|------------------ | ------------------ | ------------------ | --- | ---- |  | ---- | --- | ---- |  |  | --- | ---- | 
|                   |                    |                   
|                   |                    | Fiscal Years Ended
|                   |                    | March 31,         
|                   |                    |                   
|                   |                    | 2004               |     | 2003 |  | 2002
|                   |                    |                    |     |      |  |     
|Products           |                    |                    | 72% |      |  |      | 58% |      |  |  | 78% |     
|Services and parts |                    |                    | 28% |      |  |      | 42% |      |  |  | 22% |     
|                   |                    |                    |     |      |  |      |     |      |  |  |     |     
|                   | Total net revenues |                    |     | 100% |  |      |     | 100% |  |  |     | 100% | 
|                   |                    |                    |     |      |  |      |     |      |  |  |     |     

The fluctuations in these percentages are related
primarily to the changes in the amount of metrology capital
equipment being purchased by the semiconductor industry from one
year to the next. Sales of service contracts and parts tend to
reflect the installed base of systems previously sold rather
than current system sales. As a result, the dollars of such
sales do not fluctuate as widely as systems sales, and therefore
represent a higher percentage of net revenues when product sales
are lower.

Net revenues attributable to international sales
for the fiscal years ended March 31, 2004 and 2003
accounted for 72% of our total revenues for each of these two
periods. We anticipate that international sales will continue to
account for a significant portion of our revenues in the
foreseeable future, because of the concentration of large
customers in Asia. A substantial portion of our international
sales is denominated in U.S. dollars. As a result, changes
in the values of foreign currencies relative to the value of the
U.S. dollar can render our products comparatively more
expensive. Although we have not been negatively impacted in the
past by foreign currency changes in Japan, Korea, China, Taiwan,
Singapore, Israel and Europe, such conditions could negatively
impact our international sales in future periods.

Demand for semiconductors and semiconductor
equipment increased during our fiscal year 2004. As a result, we
increased the number of our customers and experienced higher
order booking rates than in the previous fiscal year. The
increased orders resulted in higher revenues for systems
shipments and an increase in our ending backlog. The increased
revenues materially improved our financial position and results
of operations in fiscal 2004 compared to the previous year. We
expect that the revenues for the first quarter of fiscal year
2005 will increase 8% to 12% from the fiscal fourth quarter of
2004 and that both orders and revenues will improve gradually by
quarter in fiscal year 2005. However, due to the uncertainty of
economic conditions, the market response to our newly introduced
products and the timing of revenue recognition of our new
products, we can give no assurance that we will be able to meet
our revenue expectations.

Gross Profit (Loss).Gross profit increased to $26.8 million in fiscal 2004 from
a $5.8 million gross loss in fiscal 2003, a total change of
$32.7 million. As a percentage of net revenues, gross
profit increased from

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(12)% in fiscal 2003 to 41% in fiscal 2004. Key
contributors to this improvement in gross profits can be
summarized as follows:


|                                                   |       |              |       |         |  |  |     |      | 
|-------------------------------------------------- | ----- | ------------ | ----- | ------- |  |  | --- | ---- | 
|                                                   |       | Gross Profit |       |        
|Key Contributors to Cost of Sales Improvement:     |       | Improvement  |       | Percent
|                                                   |       |              |       |        
|Increased systems revenues                         |       | $            | 7,647 |         |  |  | 23% |     
|Increased sale of inventory previously written off |       |              | 9,563 |         |  |  | 29% |     
|Decreased in new inventory charges                 |       |              | 4,400 |         |  |  | 14% |     
|Overhead spending reductions                       |       |              | 6,118 |         |  |  | 19% |     
|Termination of a development contract              |       |              | 3,675 |         |  |  | 11% |     
|Favorable resolution of accrued tax exposure       |       |              | 1,247 |         |  |  | 4%  |     
|                                                   |       |              |       |         |  |  |     |     
|                                                   | Total |              | $     | 32,650  |  |  |     | 100% | 
|                                                   |       |              |       |         |  |  |     |     

Roughly one quarter of the improvement in gross
profit reflects systems revenue increases in absolute dollars
and as a percentage of total net revenues. Systems revenues,
which contribute relatively higher gross margins, grew by 39% in
fiscal 2004 compared to fiscal 2003, while service revenues,
which contribute relatively lower gross margins, declined by 13%
in fiscal 2004 compared to fiscal 2003. Increased demand for
systems improved the margins in several others ways,
specifically by enabling the sale of inventory that had been
previously reserved ($10.6 million), facilitating sales of
systems that had been used internally for demonstration and
testing purposes, which generally have a lower cost basis than
new systems ($2.5 million), and improving overhead
absorption of fixed costs ($0.8 million).

Overhead spending was reduced by over
$6.1 million dollars, due to reductions in labor and
discretionary spending in fiscal 2004 compared to fiscal 2003.
These spending reductions contributed approximately 19% to the
improvement in gross profit. Approximately 11% of the gross
margin improvement is due to the termination of a development
agreement in the third fiscal quarter of 2004, in which we
recognized $4.7 million of previously deferred revenues and
gross profit of $3.7 million. Approximately 4% of the
improvement is due to the favorable resolution in the third
fiscal quarter of 2004 of a potential tax exposure in Korea that
we accrued in fiscal 2003.

During fiscal 2004, as a result of favorable
economic conditions and increasing demand for semiconductor
products, our gross profits included $10.6 million for
sales of previously reserved inventory and charges of
$5.2 million in new inventory reserves. We also scrapped
$3.1 million of previously reserved inventory. This
compares to our gross loss in fiscal year 2003 in which we
experienced a decline in sales and recorded an inventory charge
of $9.6 million related to excess and obsolete inventories,
partially offset by the sale of $1.0 million of inventory
previously written off. Inventory charges recorded in fiscal
2003 have substantially lowered the net value of our 200 mm
inventory on hand and will have a significant impact on our
gross margin if we are able to continue to sell our excess
200 mm inventory in the future.

We have implemented or are in the process of
implementing a number of cost reduction measures to improve our
overall gross margin financial performance. These cost reduction
measures include, but are not limited to, sourcing and design
initiatives to lower cost and improve product performance, tight
controls on discretionary overhead spending, renegotiation of
equipment maintenance contracts with vendors and so on. We
expect these cost reduction measures will contribute to gross
margin improvements in fiscal 2005.

Research and Development, or R&D,
Expenses.R&D expenses were
$18.7 million and $29.2 million for fiscal years 2004
and 2003, respectively, a reduction of $10.5 million, or
36%. R&D expenses as a percentage of net revenues for fiscal
2004 decreased to 29% from 59% for fiscal 2003 due to both lower
R&D spending and the increase of net revenues in fiscal
2004. During fiscal year 2004, in part due to reductions in
force, labor and benefits costs were lower by $3.9 million,
or 27%. We also reduced the use of outside services by
$3.9 million, or 73%. Spending on project materials
declined by $1.4 million, or 54%. Other discretionary
spending and allocations for facilities and information systems
support declined by $1.3 million, or 18%. We maintained the
resources for our critical programs such as our real-time
critical dimension product, or RT/ CD. We believe that
technological leadership is essential to strengthen our market
position in the next economic upturn and

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expect to continue to commit significant
resources to the development of new products and the continuous
improvement of existing products. Therefore, we will continue to
invest in R&D during 2005 at levels similar to fiscal 2004
levels. R&D expenditures as a percentage of net revenues are
expected to decrease gradually in fiscal 2005 as net revenues
increase with improving industry conditions.


Selling, General and Administrative, or
SG&A, Expenses.SG&A expenses
were $23.0 million and $26.1 million for fiscal years
2004 and 2003, respectively. Compared to fiscal 2003, SG&A
expenses in fiscal 2003 decreased $3.1 million, or 12%. The
decrease in fiscal 2004 SG&A expenses reflects lower
headcount, partially due to reductions in force, resulting in
savings of $1.3 million, or 9%. Spending on outside
services declined by $1.9 million, or 22%. Commissions,
however, increased by $0.5 million in 2004 compared to 2003
reflecting increased orders and revenues. Other discretionary
spending, such as travel and entertainment and allocations for
facilities and information systems support declined by
$0.4 million, or 14%. SG&A expenses as a percentage of
net revenues decreased to 35% in fiscal 2004 from 53% in fiscal
2003 primarily due to significantly higher net revenues in
fiscal 2004. We expect SG&A expenses will increase in fiscal
2005 primarily due to the costs related to compliance with
Section 404 of The Sarbanes-Oxley Act and to expansion of
our selling, general and administrative activities as our
business grows. However, SG&A expenditures as a percentage
of net revenues may decrease gradually in fiscal 2005 as net
revenues increase with improving industry conditions.

Impairment of Goodwill and Other Intangible
Assets.Due to operating losses, the
absence of positive cash flows, significant declines in our
common stock price and uncertainties resulting from the duration
and severity of the industry downturn, we assessed the
recoverability of the intangible assets related to the Sensys
acquisition subject to amortization in accordance with
SFAS No. 144 and tested goodwill related to the Sensys
acquisition for impairment in accordance with
SFAS No. 142 during the quarter ended
September 30, 2002. In assessing the recoverability of the
intangible assets related to the Sensys acquisition in
accordance with SFAS No. 144 we projected
significantly reduced future cash flows related to Sensys
products and therefore we recognized an impairment expense of
$0.6 million for developed technology, $0.2 million
for a development contract and $0.4 million for trade name
intangible assets in the quarter ended September 30, 2002.
In addition, during the fourth quarter ended March 31,
2003, we recognized an additional impairment charge of
$0.4 million related to trade name intangible assets.

The impairment test under SFAS No. 142
was based on a two-step process involving comparing the
estimated fair value of the related reporting unit to its net
book value, and comparing the estimated implied fair value of
goodwill to its carrying value. As a result of the test, we
wrote down goodwill assets by $65.9 million in the quarter
ended September 30, 2002.

During the quarter ended December 31, 2003,
due to the termination of a development agreement, we
accelerated the amortization of $1.5 million of the related
development contract intangible assets.

Restructuring, Severance and
Other.The following table summarizes
the changes in restructuring, severance and other costs during
the twelve months ended March 31, 2004 and 2003 (in
thousands):

|                                   |  |                 |       |           |  |             |       |            |  |                 |        |   |  |   |   |  |  |   |     | 
|---------------------------------- |  | --------------- | ----- | --------- |  | ----------- | ----- | ---------- |  | --------------- | ------ | - |  | - | - |  |  | - | --- | 
|                                   |  | Liability as of |       |           |  |             |       |            |  | Liability as of
|                                   |  | March 31,       |       |           |  |             |       | Non-Cash   |  | March 31,      
|                                   |  | 2003            |       | Provision |  | Utilization |       | Settlement |  | 2004           
|                                   |  |                 |       |           |  |             |       |            |  |                
|Severance and workforce reduction  |  | $               | 558   |           |  | $           | 1,772 |            |  | $               | (2,330 | ) |  | $ |  |  |  | $ |    | 
|Consolidation of excess facilities |  |                 | 662   |           |  |             | 82    |            |  |                 | (524   | ) |  |   |  |  |  |   | 220 | 
|Other costs                        |  |                 | 134   |           |  |             | 84    |            |  |                 | (218   | ) |  |   |  |  |  |   |    | 
|                                   |  |                 |       |           |  |             |       |            |  |                 |        |   |  |   |   |  |  |   |     | 
|Total                              |  | $               | 1,354 |           |  | $           | 1,938 |            |  | $               | (3,072 | ) |  | $ |  |  |  | $ | 220 | 
|                                   |  |                 |       |           |  |             |       |            |  |                 |        |   |  |   |   |  |  |   |     | 

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|                                   |  |                 |     |           |  |             |       |            |  |                 |        |   |  |   |      |   |  |   |       | 
|---------------------------------- |  | --------------- | --- | --------- |  | ----------- | ----- | ---------- |  | --------------- | ------ | - |  | - | ---- | - |  | - | ----- | 
|                                   |  | Liability as of |     |           |  |             |       |            |  | Liability as of
|                                   |  | March 31,       |     |           |  |             |       | Non-Cash   |  | March 31,      
|                                   |  | 2002            |     | Provision |  | Utilization |       | Settlement |  | 2003           
|                                   |  |                 |     |           |  |             |       |            |  |                
|Severance and workforce reduction  |  | $               | 184 |           |  | $           | 2,936 |            |  | $               | (2,562 | ) |  | $ |     |   |  | $ | 558   | 
|Consolidation of excess facilities |  |                 |    |           |  |             | 673   |            |  |                 | (11    | ) |  |   |     |   |  |   | 662   | 
|Fixed assets                       |  |                 |    |           |  |             | 513   |            |  |                 |       |   |  |   | (513 | ) |  |   |      | 
|Other costs                        |  |                 | 117 |           |  |             | 171   |            |  |                 | (154   | ) |  |   |     |   |  |   | 134   | 
|                                   |  |                 |     |           |  |             |       |            |  |                 |        |   |  |   |      |   |  |   |       | 
|Total                              |  | $               | 301 |           |  | $           | 4,293 |            |  | $               | (2,727 | ) |  | $ | (513 | ) |  | $ | 1,354 | 
|                                   |  |                 |     |           |  |             |       |            |  |                 |        |   |  |   |      |   |  |   |       | 

During fiscal 2004, we recorded $1.9 million
in charges related to restructuring, severance and other costs.
Of this amount, $1.8 million relates to reductions in force
in April 2003 and October 2003 of approximately 39 and 22
employees, respectively. An additional $0.1 million was
recorded as leased facility charges during the second quarter of
2004 when we entered into a sublease on a previously vacated
facility. The $0.1 million charge reflects the difference
between the estimated sublease income and the actual sublease
income for this facility. As of the end of fiscal 2004,
liabilities that we had accrued for severance and other costs
had been paid out in full. During fiscal 2003, we recorded
$4.3 million in charges related to restructuring, severance
and other costs. We closed down two facilities in
Santa Clara, California to reduce operating expenses and
recorded a $1.2 million charge associated with the
abandonment of leased facilities and write-off of fixed assets.
We also implemented two reduction-in-force programs affecting
approximately 190 people and recorded $2.9 million of
severance and workforce reduction and $0.2 million of other
severance-related costs.

Stock-Based
Compensation.Stock-based compensation
charges reflect options assumed as part of the Sensys
acquisition in January 2002 and charges for options issued
September 10, 2003 in the employee stock option exchange
offer.

As part of the Sensys acquisition, we assumed
$3.5 million of stock-based compensation to be amortized
over the vesting period of the options. The amortization expense
was $0.6 million or 1% of net revenues in fiscal 2004 and
$1.7 million or 3% of net revenues in fiscal 2003, of which
$168,000 and $33,000, respectively, was included in cost of
revenues. We expect that the stock-based compensation for
options assumed in the Sensys acquisition in fiscal 2005 will be
lower than that of fiscal 2004 due to the forfeitures of options
held by the Sensys employees who left the company in fiscal 2004.

During the second quarter of fiscal 2004, we
commenced and completed an employee stock option exchange
program. The voluntary program allowed Therma-Wave employees,
excluding officers and directors, to return to us existing
options issued before July 1, 2002 with an exercise price
greater than $2.00 per share and exchange them for new
options that were granted on September 10, 2003. The number
of new options granted in the employee stock option exchange
program was equal to 75% of the number of options canceled in
the exchange. The new option grants have a different vesting
schedule from the original option grants and have an exercise
price equal to $2.38, the fair market value of our common stock
on September 10, 2003. Of the 1,366,570 options eligible
for exchange, 1,352,108 options, or 99%, were exchanged for
1,014,144 new options with an exercise price of $2.38. None of
these replacement options vests before June 11, 2004.

As a result of the modification to the exercise
price of the stock options, the replacement options are
accounted for as variable from the date of modification until
the option is either exercised, forfeited, canceled or expired.
As of March 31, 2004, we have recorded approximately
$0.7 million in compensation expense related to the
employee option exchange program. This charge reflects three
groups of options:



| |   |                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------
| |  | the new options issued in the exchange which were
    outstanding since September 10, 2003                 
|
| |  | options eligible for exchange that were not
    exchanged (about 1% of eligible options)                   
|
| |  | options issued to eligible participants within
    the six months prior to or following September 10, 2003.

Due to the options requiring variable accounting
treatment, the expense is being recorded for the vesting of
these options over time based on increases in the stock price
over and above the exercise price of the new

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options. In future quarters, the expense could
increase as the vesting over time of these options increases and
if the stock price increases. Reductions to expense may also be
recorded if the stock price decreases, but such reductions will
be limited to the net expense previously reported.


During fiscal 2004, charges related to the
variable accounting treatment of options were $0.7 million.
However, on a quarterly basis these costs varied based on the
amount of time the options were outstanding and on the
quarter-end closing stock price as follows:

|                                    |  |                  |        |    |  |    |         |             |  |   |          |   |  |   |         | 
|----------------------------------- |  | ---------------- | ------ | -- |  | -- | ------- | ----------- |  | - | -------- | - |  | - | ------- | 
|                                    |  |                 
|                                    |  | Fiscal Year 2004
|                                    |  |                 
|                                    |  | Q2               |        | Q3 |  | Q4 |         | Fiscal Year
|                                    |  |                  |        |    |  |    |         |            
|Days outstanding                    |  |                  | 18     |    |  |    | 90      |             |  |   | 90       |   |  |   | 198     | 
|Ending stock price                  |  | $                | 3.48   |    |  | $  | 5.37    |             |  | $ | 3.67     |   |  | $ | 3.67    | 
|                                    |  |                  |        |    |  |    |         |             |  |   |          |   |  |   |         | 
|Variable accounting charge (credit) |  | $                | 61,000 |    |  | $  | 889,000 |             |  | $ | (213,000 | ) |  | $ | 737,000 | 
|                                    |  |                  |        |    |  |    |         |             |  |   |          |   |  |   |         | 

We anticipate that expense amounts relating to
the employee stock option exchange program will continue to vary
from quarter to quarter reflecting both the vesting schedules of
the options and the fluctuations in the quarter-ending stock
price. Our time vesting percentage calculations reflect the
vesting schedules of the newly issued replacement options, which
will vest 50% on June 11, 2004, with the remaining 50%
vesting on April 11, 2005 or according to the specific
performance vesting schedules of particular stock option grants.

Other Income
(Expense).Other income
(expense) includes interest expense, interest income, and
other non-operating income, net. Total other income
(expense) for fiscal 2004 was $(0.1) million, compared
to $0.9 million in fiscal 2003. The decrease in fiscal 2004
compared to fiscal 2003 was attributable to lower interest
income of $0.8 million resulting from lower average
interest rates as well as lower average investment balances that
declined approximately $17.6 million from fiscal 2003 to
fiscal 2004, offset by $0.3 million in interest refunded
from the Internal Revenue Service in fiscal 2003. Other expense
recorded in fiscal 2004 includes a loss on the sale of an
investment in the first quarter of fiscal 2004 in the amount of
$0.1 million. We expect that other income in fiscal 2005
will be similar to that of fiscal 2004 due to continued low
interest rates and a relatively steady average investment
balance.

Net Loss.The
combination of all the factors discussed above contributed to a
net loss of $18.1 million for fiscal 2004 compared with a
net loss of $133.6 million in the prior fiscal year. We
expect that with our cost reduction programs and expense
controls in place and with expected revenue increases in fiscal
2005, we will continue to reduce our net loss amounts in the
coming quarters of fiscal 2005. This forward-looking statement
excludes the impact of amounts relating to the variable
accounting treatment of the employee stock option exchange
program, which may either increase or decrease our net loss.

Fiscal Year
Ended March 31, 2003 Compared to Fiscal Year Ended
March 31, 2002

Net Revenues.Net
revenues for the fiscal year ended March 31, 2003 and 2002
were $49.2 million and $81.9 million, respectively.
Both fiscal 2003 and fiscal 2002 results reflect our adoption of
SAB 101. Under SAB 101, a portion of revenues are
deferred until installation is complete and the customer accepts
the system. Deferred revenues relative to service contracts are
recognized over of the life of the related service contract.

Compared to fiscal 2002, net revenues in fiscal
2003 decreased $32.7 million or 39.9%. The decrease in
fiscal 2003 revenues was primarily attributable to the capital
spending reductions in the semiconductor industry during fiscal
2003, which were primarily related to the cyclical downturn of
semiconductor manufacturers and the weakness of the global
economy. Compared to fiscal 2002, we sold 42% fewer units of our
Therma-Probe and Opti-Probe products in fiscal 2003 and the
average selling price decreased 17% in fiscal 2003 due to
increased price competition.

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The following table summarizes our revenues in
different categories as a percentage of total net revenues for
the periods indicated.

|                   |  |                    |     |      |  |      |     |   |  |  |     |  
|------------------ |  | ------------------ | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                   |  |                   
|                   |  | Fiscal Years Ended
|                   |  | March 31,         
|                   |  |                   
|                   |  | 2004               |     | 2003 |  | 2002
|                   |  |                    |     |      |  |     
|Net revenues       |  |                    |     |      |  |      |     |   |  |  |     |  
|Product            |  |                    | 72  | %    |  |      | 58  | % |  |  | 78  | %
|Service and parts  |  |                    | 28  | %    |  |      | 42  | % |  |  | 22  | %
|                   |  |                    |     |      |  |      |     |   |  |  |     |  
|Total net revenues |  |                    | 100 | %    |  |      | 100 | % |  |  | 100 | %
|                   |  |                    |     |      |  |      |     |   |  |  |     |  

Net revenues attributable to product sales in the
fiscal years ended March 31, 2003 and 2002 accounted for
58% and 78% of our total revenues for such periods, respectively.

Gross Profit/(Loss).Gross profit (loss) decreased 135% from a $16.5 million
gross profit in fiscal 2002 to a $5.8 million gross loss in
fiscal 2003. As a percentage of net revenues, gross profit
decreased from 20% in fiscal 2003 to (12)% in fiscal 2003. Lower
gross profit was primarily because of lower revenues and lower
average selling price of products due to increased price
competition in fiscal 2003. During fiscal 2003, as a result of
unfavorable economic conditions and diminished demand for
semiconductor products, we experienced a decline in sales and
recorded an inventory charge of $9.6 million related to
excess and obsolete inventories. This $9.6 million charge
was offset by the reserve release of $1.0 million for sales
of previously reserved inventory. This charge has been included
in cost of revenues in our consolidated statement of operations.
At March 31, 2002, we had written down inventories on hand
by $12.2 million. These charges were in addition to our
normal inventory reserve and were primarily caused by a
significant reduction in demand including reduced demand for our
older technology products. Inventory charges recorded in fiscal
2003 and 2002 have substantially lowered the net value of our
200 mm inventory on hand and will have a significant impact
on our gross margin if we are able to sell our excess 200 mm
inventory in the future. We implemented a number of cost
reductions measures to improve our overall financial
performance. These cost reduction measures included, but are not
limited to, reductions in workforce in all functional areas,
restrictions in discretionary spending, renegotiation of
equipment maintenance contracts with vendors.

Research and Development, or R&D,
Expenses.R&D expenses were
$29.2 million and $29.1 million for fiscal years 2003
and 2002. R&D expenses as a percentage of net revenues for
fiscal 2003 increased to 59% from 36% for fiscal 2002 primarily
due to the decrease of net revenues in fiscal 2003. During
fiscal year 2003 we continued to reduce contract labor costs and
other discretionary expenses but maintained the resources for
our critical programs such as our real-time critical dimension
product, or RT/ CD.

Selling, General and Administrative, or
SG&A, Expenses.SG&A expenses
were $26.1 million and $21.7 million for fiscal years
2003 and 2002, respectively. Compared to fiscal 2002, SG&A
expenses in fiscal 2003 increased $4.4 million, or 20%. The
increase in fiscal 2003 SG&A expenses was due primarily to
the legal and accounting fees associated with the investigation
of a revenue recognition issue that we identified in fiscal
2003, and the inclusion of a full year of SG&A expense for
Sensys Instruments Corporation, which represented
$3.2 million. In fiscal 2002, two and half months of
SG&A expenses of Sensys were included, which amounted to
$616,000. The acquisition of Sensys is discussed in Note 6
of Notes to Consolidated Financial Statements. SG&A expenses
as a percentage of net revenues increased to 53% in fiscal 2003
from 27% in fiscal 2002 primarily due to significantly lower
revenue levels in fiscal 2003.

In-Process Research and
Development.In January 2002, we
acquired Sensys in a transaction accounted for as a purchase.
The purchase price was allocated to the assets acquired,
including intangible assets, based on their estimated fair
values. The intangible assets included approximately
$16.3 million for acquired in-process technology for
various projects that did not have future alternative uses. The
value of the purchased in-process technology was determined
using the income approach, which discounts expected future cash
flows from projects under development to their net present
value. Each project was analyzed to determine the technological
innovations included; the utilization of core technology; the
complexity, cost and time to complete development; any
alternative future use or current technological feasibility; and
the stage of

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completion. The cash flows derived from the
in-process technology projects were discounted at a rate of 40%.
We believe this rate was appropriate given the risks associated
with the technologies for which commercial feasibility had not
been established. The percentage of completion for each
in-process project was determined by identifying the elapsed
time invested in the project as a ratio of the total time
required to bring the project to technological and commercial
feasibility. At the date of the acquisition, the development of
these projects had not yet reached technological feasibility,
and the technology in process had no alternative future uses.
Accordingly, these costs were expensed in the fourth quarter of
fiscal 2002.


Impairment of Goodwill and Other Intangible
Assets.During the quarter ended
September 30, 2002, due to operating losses, the absence of
positive cash flows, significant declines in our common stock
price and uncertainties resulting from the duration and severity
of the industry downturn, we assessed the recoverability of the
intangible assets related to the Sensys acquisition subject to
amortization in accordance with SFAS No. 144 and
tested goodwill related to the Sensys acquisition for impairment
in accordance with SFAS No. 142. In assessing the
recoverability of the intangible assets related to the Sensys
acquisition in accordance with SFAS No. 144 we
projected significantly reduced future cash flows related to
Sensys products and therefore we recognized an impairment
expense of $0.6 million for developed technology,
$0.2 million for development contract and $0.4 million
for trade name intangible assets in the quarter ended
September 30, 2002. In addition, during the quarter ended
March 31, 2003, we recognized an additional impairment
charge of $0.4 million related to trade name intangible
assets.

The impairment test under SFAS No. 142
was based on a two-step process involving: 1) comparing the
estimated fair value of the related reporting unit to its net
book value, and 2) comparing the estimated implied fair
value of goodwill to its carrying value. As a result of the
test, we wrote down goodwill by $65.9 million in the
quarter ended September 30, 2002.

Restructuring, Severance and
Other.During fiscal 2003, we recorded
$4.3 million charges related to restructuring, severance
and other costs. We closed down two facilities in
Santa Clara, California to reduce operating expenses and
recorded a $1.2 million charge associated with the
abandonment of these leased facilities and the write-off of
fixed assets. We also implemented two reduction-in-force
programs affecting approximately 190 people and recorded
$3.1 million of severance and related costs. During fiscal
2002, we recorded $1.5 million in severance charges as we
reduced our workforce by approximately 130 people to reduce
operating costs.

Stock-Based
Compensation.As part of the
acquisition of Sensys, we assumed $3.5 million of
stock-based compensation to be amortized over the vesting period
of the options. The amortization expense was $1.7 million
or 3% of net revenues in fiscal 2003 and $0.6 million or 1%
of net revenues in fiscal 2002.

Other Income
(Expense).Other income
(expense) includes interest expense, interest income, and
other non-operating income (expense), net. Total other income
for fiscal 2003 was $0.9 million, compared to
$2.3 million of total other income in fiscal 2002. The
decrease from fiscal 2002 to fiscal 2003 was primarily due to
lower investment balances.

Benefit for Income
Taxes.The effective tax rate of 0%
for fiscal year 2003 was based upon our net tax loss for fiscal
2003. For fiscal 2002, we recorded a $1.1 million benefit
for income taxes due to a change in the tax law that allowed us
to carry back net operating losses for five years instead of two
years under the previous law.

Net Loss.Net loss
for fiscal 2003 was $133.6 million, as compared to net loss
of $49.2 million for the prior fiscal year. The loss in
fiscal 2003 was primarily a result of decreased revenue, lower
gross profit margin and charges recorded in the fiscal 2003 of
$67.4 million of goodwill and other intangible assets
impairment, $9.6 million of additional reserves for
obsolete and excess inventories and $4.3 million of
restructuring, severance and other costs. The loss in fiscal
2002 included charges of $16.3 million for the write-off of
acquired IPR&D and $12.2 million additional reserves
for obsolete and excess inventories.

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Recently Issued Accounting
Pronouncements

In May 2003, the Financial Accounting Standard
Board, or FASB, issued SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity. SFAS No. 150 establishes
standards for how companies classify and measure certain
financial instruments with characteristics of both liabilities
and equity. It requires companies to classify a financial
instrument that is within its scope as a liability (or an asset
in some circumstances). SFAS No. 150 was effective
beginning the second quarter of fiscal 2004. We believe that the
adoption of this standard has had and will continue to have no
material impact on our consolidated financial statements.

In January 2003, the FASB issued FASB
Interpretation No. 46, Consolidation of Variable
Interest Entities  An Interpretation of ARB
No. 51. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have
the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. FIN 46 was effective immediately for
all new variable interest entities created or acquired after
January 31, 2003. In December 2003, the FASB issued a
revision of FIN 46, or FIN 46R, that delayed the
implementation date for certain interests created or acquired
prior to January 31, 2003 until the first interim or annual
period ending after March 15, 2004.

FIN 46R is effective immediately for all new
variable interest entities created or acquired after
January 31, 2003. Since January 31, 2003, we have not
invested in any entities we believe are variable interest
entities. For those arrangements entered into prior to
February 1, 2003, we were required to adopt the provisions
of FIN 46R (as revised December 2003) at the end of the
first quarter of fiscal 2004. Therma-Waves adoption of
FIN 46R did not result in consolidation of any entities.

On March 31, 2004, the Financial Accounting
Standards Board issued a proposed Statement, Share-Based
Payment, that addresses the accounting for share-based
payment transactions in which an enterprise receives employee
services in exchange for equity instruments of the enterprise or
liabilities that are based on the fair value of the
enterprises equity instruments or that may be settled by
the issuance of such equity instruments. The proposed Statement
would eliminate the ability to account for share-based
compensation transactions using APB Opinion No. 25,
Accounting for Stock Issued to Employees, and
generally would require instead that such transactions be
accounted for using a fair-value-based method. It is anticipated
that this exposure draft would be finalized during the summer of
2004 and would be required to be applied by public companies for
years ended subsequent to December 15, 2004.

Backlog

At March 31, 2004 and 2003, our backlog was
$27.5 million and $19.0 million, respectively. Our
backlog consists of orders not yet shipped, deferred revenues
for products that have been shipped and invoiced but have not
yet been recognized as revenue in accordance with SAB 104,
recurring fees payable under support contracts with our
customers and orders for spare parts and billable services, such
as non-recurring engineering services. Orders that are scheduled
for shipment beyond the twelve-month window are not included in
backlog until they fall within the twelve-month window. Orders
are subject to rescheduling or cancellation by the customer,
usually without penalty. Because of possible changes in product
delivery schedules and cancellation of product orders and
because our sales will sometimes reflect orders shipped in the
same quarter that they are received, our backlog at any
particular date is not necessarily indicative of actual sales
for any succeeding period.

Liquidity and Capital Resources

Our principal liquidity requirements are for
working capital. Over the last three fiscal years, we have
funded our operating activities principally from proceeds from
the sale of common stock. Our cash and restricted cash balances
increased by $9.1 million during fiscal year 2004 to
$23.9 million as of March 31, 2004 from
$14.8 million as of March 31, 2003. The increase is
primarily attributable to the $11.7 million in net proceeds
from a private placement in September 2003. In the offering, we
raised $12.7 million of gross

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proceeds and incurred $1.0 million of
issuance costs, $0.9 million of which were payable to
Needham & Company who acted as placement agent. We are
using these funds for general corporate purposes.


Cash flows used in operating activities was
$2.9 million and $42.6 million for the years ended
March 31, 2004 and 2003, respectively. The cash used in
operating activities in fiscal years 2004 and 2003 was mainly
due to the net loss in these two fiscal years of
$18.1 million and $133.6 million, respectively.
Included in the net loss for these two fiscal years were
non-cash charges of $13.2 million and $87.0 million,
which include $8.1 million and $9.1 million for the
two years, respectively, of non-cash charges for depreciation
and amortization of property, intangibles and deferred stock
compensation, inventory charges of $5.2 million and
$9.6 million for the two years respectively, and in fiscal
2003, non-cash charges of $67.4 million for the impairment
of goodwill and intangible assets, among other charges detailed
in our consolidated statements of cash flows. In addition to the
cash flow impact of these non-cash charges to net loss, changes
in operating assets and liabilities generated $2.0 million
and $4.1 million of cash flows from operations in fiscal
2004 and 2003, respectively.

During fiscal 2004, $2.0 million cash was
generated by changes in operating assets and liabilities.
Accounts receivable increased by only $0.3 million even
though net revenues increased 33% in fiscal 2004 compared to
fiscal 2003, resulting in a decrease in DSO from 106 at the end
of fiscal 2003 to 52 at the end of fiscal 2004. Changes in
inventories excluding the $5.2 million non-cash charges
noted above were an increase of $0.2 million. Inventory
receipts were approximately equal to inventory reductions due to
the sale, scrap and internal usage of inventory. The sale of
inventory included those inventories that had previously been
fully written off but that had originally cost
$10.6 million. We also scrapped inventories that had
originally cost $3.1 million but that had been previously
fully written off. Accounts payable increased $5.3 million
in fiscal year 2004. Accounts payable increases reflect that our
purchases of new parts have increased due to increased net
revenues and declining inventory. Deferred revenues decreased by
$2.4 million reflecting the termination of a development
contract for which $4.7 million in deferred revenues were
recognized. Reductions in other assets contributed
$0.9 million in cash, and decreases in accrued and other
liabilities used $1.3 million in cash.

During fiscal year 2003, cash generated from
changes in assets and liabilities was $4.1 million, and
included reductions in accounts receivable of $2.3 million
reflecting declining revenues, inventory reductions of
$2.9 million, reductions in other assets of
$2.3 million, and an increase in deferred revenues of
$1.6 million, offset by cash used to reduce accounts
payable by $4.1 million. Decreases in accrued and other
liabilities used $0.9 million of cash.

During the year ended March 31, 2004, net
cash provided by investing activities was $0.4 million.
Cash generated from investing activities includes a decrease in
restricted cash of $1.1 million and the sale of an
investment for $0.4 million. At the beginning of fiscal
2003, $1.1 million cash was restricted due to the
requirement of our insurance premium financing agreement. This
restriction was removed in late June 2003, when the security for
the insurance premiums was converted from restricted cash to a
standby letter of credit under our new loan and security
agreement with Silicon Valley Bank. In March 2004, we renewed
our annual insurance policies without re-accessing the available
insurance premium financing; so the letter of credit has expired
as of the end of fiscal year 2004. Cash used in investing
activities includes investments in property and equipment of
$0.3 million and investments in our patent portfolio of
$0.8 million.

During the year ended March 31, 2003, net
cash provided by investing activities was $9.1 million, due
primarily to the sale of short-term investments of
$12.6 million offset by investments in restricted cash of
$1.1 million, $1.5 million in purchases of property
and equipment, and $0.9 million invested in our patent
portfolio. Cash used in investing activities includes
investments in property and equipment and investments in our
patent portfolio. Investments in property and equipment amounted
to $0.3 million and $1.5 million for the years ended
March 31, 2004 and 2003, respectively. Our requirements for
new capital investment have been relatively low in recent years,
reflecting the industry downturn, in which we reduced our
headcount and consolidated facilities. Investments in our patent
portfolio were $0.8 million and $0.9 million for the
years ended March 31, 2004 and 2003, respectively,
reflecting our ongoing commitment to technology inventions and
patent protection. For fiscal year 2005, we expect investments
in patents and property and equipment, consisting primarily of
computer and test equipment, to continue at the relatively low
levels of recent years.

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Cash generated from financing activities was
$12.1 million and $0.2 million during the fiscal years
ended March 31, 2004 and 2003, respectively. The increase
is primarily due to the $11.7 million, net of
$1.0 million of issuance costs, raised in a private
placement during fiscal 2004. We also raised $0.4 million
cash from the issuance of common stock including the sale of
treasury shares under our 2000 Employee Stock Purchase Plan and
2000 Equity Incentive Plan. In fiscal 2004, we did not
repurchase stock pursuant to the stock repurchase program
discussed in Note 10 of Notes to Consolidated Financial
Statements entitled Treasury Stock.

Cash generated in financing activities in fiscal
2003 was $0.2 million, of which $1.1 million was
generated from the issuance of common stock under our 2000
Employee Stock Purchase Plan and 2000 Equity Incentive Plan and
for the exercise of warrants in connection with the Sensys
acquisition and $0.9 million was used to repurchase stock
pursuant to the stock repurchase program discussed in
Note 10 of Notes to Consolidated Financial Statements
entitled Treasury Stock.

Off-Balance
Sheet Commitments

Our off-balance sheet commitments are limited to
equipment operating leases, leases on office and manufacturing
space and certain software license agreements, and commitments
to vendors related to non-cancelable purchase orders. Future
payments due under these obligations as of March 31, 2004
are as follows (in thousands):

|                            |       |                       |       |           |  |       |       |        |  |           |       |       |  |   |     |     |  |   |   |   | 
|--------------------------- | ----- | --------------------- | ----- | --------- |  | ----- | ----- | ------ |  | --------- | ----- | ----- |  | - | --- | --- |  | - | - | - | 
|                            |       |                      
|                            |       | Payment Due by Period
|                            |       |                      
|                            |       |                       |       | Less than |  | 1-3   |       | 3-5    |  | More than
|Contractual Obligations     |       | Total                 |       | 1 Year    |  | Years |       | Years  |  | 5 Years  
|                            |       |                       |       |           |  |       |       |        |  |          
|Operating lease obligations |       | $                     | 5,786 |           |  | $     | 2,621 |        |  | $         | 2,514 |       |  | $ | 651 |     |  | $ |  |  
|Purchase obligations        |       |                       | 8,727 |           |  |       | 8,424 |        |  |           | 303   |       |  |   |    |     |  |   |  |  
|Minimum royalty payments    |       |                       | 120   |           |  |       | 40    |        |  |           | 80    |       |  |   |    |     |  |   |  |  
|Cancellation fees           |       |                       | 350   |           |  |       | 350   |        |  |           |      |       |  |   |    |     |  |   |  |  
|                            |       |                       |       |           |  |       |       |        |  |           |       |       |  |   |     |     |  |   |   |  
|                            | Total |                       | $     | 14,983    |  |       | $     | 11,435 |  |           | $     | 2,897 |  |   | $   | 651 |  |   | $ |  | 
|                            |       |                       |       |           |  |       |       |        |  |           |       |       |  |   |     |     |  |   |   |  

We indemnify some of our suppliers and customers
for specified intellectual property rights pursuant to certain
parameters and restrictions. The scope of these indemnities
varies, but in some instances includes indemnification for
damages and expenses (including reasonable attorney fees)
related to any misuse by us of the intellectual property. No
amounts have been accrued in respect of the indemnification
provisions at March 31, 2004.

Credit Facilities

In June 2003, we entered into a new loan and
security agreement with Silicon Valley Bank, or SVB. The new
agreement includes a $5.0 million domestic line of credit,
including a sub-limit of $5.0 million for letters of
credit, and a $10.0 million Export-Import Bank of the
United States, or EXIM, guaranteed revolving line of credit. The
bank credit facilities allow us to borrow money under the
domestic line bearing interest at the SVB prime rate plus 1.50%
floating. The EXIM revolving line allows us to borrow money at
SVB prime rate plus 1.75% floating. We may request advances in
an aggregate outstanding amount not to exceed the lesser of
$15.0 million total under the two lines or the borrowing
base, in each case minus the aggregate face amount of
outstanding letters of credit, including any drawn but
unreimbursed letters of credit. Our borrowings under the SVB and
EXIM guaranteed credit facilities are secured by substantially
all of our assets. As of March 31, 2004, we had
$4.6 million in outstanding letters of credit under this
agreement. The credit facilities originally matured on
June 13, 2004, but we have recently extended these
facilities for one additional year. As of March 31, 2004,
we were in compliance with all the covenants in the agreement.
We believe that we have adequate cash on hand to fund our
operations for at least the next twelve months. However, if
required, we also have access to these $15 million of
credit facilities.

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Inflation

The impact of inflation on our business has not
been material for the fiscal years ended March 31, 2004,
2003 and 2002.

Liquidity

Our principal sources of funds have been and are
anticipated to be cash on hand ($23.9 million unrestricted
as of March 28, 2004), cash flows from operating activities
(if any), borrowings under our bank credit facilities and the
sale of common stock. We have implemented various cost reduction
programs during and subsequent to the end of fiscal 2003 to
bring operating expenses in line with revenue projections. We
believe that with these cost reduction programs in place, we
will reduce operating expenses significantly enough so that we
will have adequate liquidity and capital resources to meet our
current and future financial obligations for the next twelve
months. No assurance can be given, however, that this will be
the case. We may require additional equity or debt financing to
meet our working capital requirements or to fund our research
and development activities. There can be no assurance that
additional financing will be available, if required or, if
available, will be on terms satisfactory to us.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    about Market Risk

The following discussion about market risk
disclosures involves forward-looking statements. Actual results
could differ materially from those projected in the
forward-looking statements. We do not have any derivative
financial instruments. See also the discussion of
forward-looking statements in the first paragraph of Item 1
above.

Market Risk Related to Interest Rates and
Foreign Currency

We are exposed to market risks related to changes
in interest rates and foreign currency exchange rates, however,
we believe those risks to be not material in relation to our
operations. We do not have any derivative financial instruments.

Interest Rate Risk

As of March 31, 2004, our cash and cash
equivalents included money market securities and investment
grade commercial paper. Our exposure to market risk for changes
in interest rates relates to our investment portfolio. We do not
use derivative financial instruments in our investment
portfolio. We place our investments with high credit quality
issuers. The portfolio includes only marketable securities with
active secondary or resale markets to ensure portfolio
liquidity. We have no cash flow exposure due to rate changes for
cash equivalents and short-term investments, as all of these
investments are at market interest rates. Due to the short-term
duration of our investment portfolio, an immediate 10% change in
interest rates would not have a material effect on the fair
market value of the portfolio. Therefore, we would not expect
our operating results or cash flows to be affected to any
significant degree by the effect of a sudden change in market
interest rates on our securities portfolio.

Foreign Currency Exchange Risk

We are primarily a U.S. dollar functional
currency entity. A substantial portion of our international
sales are denominated in U.S. dollars and, as a result, we
have relatively little exposure to foreign currency exchange
risk with respect to sales. We have determined that the
functional currency of our foreign operations is the local
currency in our international operations, which incur most of
their expenses in the local currency. The transactions
denominated in currencies other than our functional currencies
create gains and losses that are reflected in our consolidated
statement of income. Foreign currency transaction gains (losses)
are included in other income (expense) in our consolidated
statements of operations and amounted to $19,000, $(5,000), and
$(31,000) for the years ended March 31, 2004, 2003, and
2002, respectively.

We convert the financial statements of our
foreign subsidiaries into U.S. dollars. When there is a
change in foreign currency exchange rates, the conversion of the
foreign subsidiaries financial statements into

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U.S. dollars leads to a translation gain or
loss. The accumulated effects of foreign translation rate
changes related to net assets located outside the U.S. are
included as a component of stockholders equity. As of
March 31, 2004 we have an accumulated comprehensive loss of
$0.7 million consisting of foreign currency translation
adjustments, down from $1.3 million as of March 31,
2003.


We do not use forward exchange contracts to hedge
exposures denominated in foreign currencies or any other
derivative financial instruments for trading or speculative
purposes. The effect of an immediate 10% change in exchange
rates would not have a material impact on our future operating
results or cash flows.

The following table illustrates net assets and
costs and expenses for fiscal 2004 exposed to foreign currency
risk (in thousands):

|                                       |  |       |       |    |  |           |       |   |  |   |       |  
|-------------------------------------- |  | ----- | ----- | -- |  | --------- | ----- | - |  | - | ----- | -
|                                       |  |       |       |    |  | Other    
|                                       |  |       |       |    |  | Foreign  
|                                       |  | Japan |       | UK |  | Locations
|                                       |  |       |       |    |  |          
|Net assets                             |  | $     | 2,616 |    |  | $         | 629   |   |  | $ | 3,113 |  
|Costs and expenses                     |  | $     | 3,129 |    |  | $         | 2,124 |   |  | $ | 5,362 |  
|Percentage of total costs and expenses |  |       | 4     | %  |  |           | 3     | % |  |   | 6     | %

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|        |                                               
|------- | ----------------------------------------------
|Item 8. | Financial Statements and Supplemental
    Data

|                                                                                                      |  |      |    | 
|----------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                      |  | Page
|                                                                                                      |  |     
|Report of Independent Registered Public
    Accounting Firm                                           |  |      | 41 | 
|Consolidated Balance Sheets as of March 31,
    2004 and 2003                                         |  |      | 42 | 
|Consolidated Statements of Operations for the
    years ended March 31, 2004, 2003 and 2002           |  |      | 43 | 
|Consolidated Statements of Stockholders
    Equity for the years ended March 31, 2004, 2003 and 2002 |  |      | 44 | 
|Consolidated Statements of Cash Flows for the
    years ended March 31, 2004, 2003 and 2002           |  |      | 46 | 
|Notes to Consolidated Financial Statements                                                            |  |      | 47 | 

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REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Therma-Wave, Inc.


In our opinion, the consolidated financial
statements listed in the accompanying index present fairly, in
all material respects, the financial position of Therma-Wave,
Inc. and its subsidiaries at March 28, 2004 and
March 30, 2003, and the results of their operations and
their cash flows for each of the three years in the period ended
March 28, 2004 in conformity with the accounting principles
generally accepted in the United States of America. In addition,
in our opinion, the financial statement schedule listed in the
index appearing under Item 15(a)2 presents fairly, in all
material respects, the information set forth therein when read
in conjunction with the related consolidated financial
statements. These financial statements and the financial
statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on
our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

San Jose, California

June 10, 2004


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THERMA-WAVE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share
data)


|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |          |        | 
|---------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | -------- | ------ |  | ----- | -------- | ------ | 
|                                         |                                                                                                                                                                                                                       |                                           
|                                         |                                                                                                                                                                                                                       | March 31,                                 
|                                         |                                                                                                                                                                                                                       |                                           
|                                         |                                                                                                                                                                                                                       | 2004                                       |       | 2003    
|                                         |                                                                                                                                                                                                                       |                                            |       |         
|ASSETS                                  
|Current assets:                          |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         | Cash and cash equivalents                                                                                                                                                                                             |                                            | $     | 23,899   |        |  | $     | 13,695   |       
|                                         | Restricted cash                                                                                                                                                                                                       |                                            |       |         |        |  |       | 1,064    |       
|                                         | Accounts receivable, net of allowance for
    doubtful accounts of $907 and $1,553 at March 31, 2004 and
    2003, respectively                                                                                       |                                            |       | 14,772   |        |  |       | 13,822   |       
|                                         | Inventories                                                                                                                                                                                                           |                                            |       | 17,169   |        |  |       | 22,146   |       
|                                         | Other current assets                                                                                                                                                                                                  |                                            |       | 2,075    |        |  |       | 1,657    |       
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         |                                                                                                                                                                                                                       | Total current assets                       |       |          | 57,915 |  |       |          | 52,384 | 
|Property and equipment, net              |                                                                                                                                                                                                                       |                                            | 4,564 |          |        |  | 9,004 |         
|Intangible assets, net                   |                                                                                                                                                                                                                       |                                            |      |          |        |  | 1,811 |         
|Other assets                             |                                                                                                                                                                                                                       |                                            | 2,710 |          |        |  | 4,504 |         
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         |                                                                                                                                                                                                                       | Total assets                               |       | $        | 65,189 |  |       | $        | 67,703 | 
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         | Accounts payable                                                                                                                                                                                                      |                                            | $     | 7,420    |        |  | $     | 2,148    |       
|                                         | Accrued liabilities                                                                                                                                                                                                   |                                            |       | 15,730   |        |  |       | 15,589   |       
|                                         | Deferred revenues                                                                                                                                                                                                     |                                            |       | 6,887    |        |  |       | 11,138   |       
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         |                                                                                                                                                                                                                       | Total current liabilities                  |       |          | 30,037 |  |       |          | 28,875 | 
|Non-current deferred revenues            |                                                                                                                                                                                                                       |                                            | 1,815 |          |        |  |      |         
|Other long-term liabilities              |                                                                                                                                                                                                                       |                                            | 1,073 |          |        |  | 2,490 |         
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         |                                                                                                                                                                                                                       | Total liabilities                          |       |          | 32,925 |  |       |          | 31,365 | 
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|Commitments and contingencies (Note 7)   |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|Stockholders equity:                    |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         | Common stock, $0.01 par value;
    75,000,000 shares authorized; 35,498,025 shares issued
    and outstanding at March 31, 2004; 29,360,026 shares
    issued and 29,090,515 shares outstanding at March 31,
    2003 |                                            |       | 355      |        |  |       | 293      |       
|                                         | Additional paid-in capital                                                                                                                                                                                            |                                            |       | 335,012  |        |  |       | 322,048  |       
|                                         | Treasury stock, 269,511 shares at
    March 31, 2003 at cost                                                                                                                                                          |                                            |       |         |        |  |       | (437     | )     
|                                         | Notes receivable from stockholders                                                                                                                                                                                    |                                            |       | (174     | )      |  |       | (196     | )     
|                                         | Accumulated other comprehensive loss                                                                                                                                                                                  |                                            |       | (735     | )      |  |       | (1,334   | )     
|                                         | Deferred stock-based compensation                                                                                                                                                                                     |                                            |       | (1,172   | )      |  |       | (1,107   | )     
|                                         | Accumulated deficit                                                                                                                                                                                                   |                                            |       | (301,022 | )      |  |       | (282,929 | )     
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         |                                                                                                                                                                                                                       | Total stockholders equity                 |       |          | 32,264 |  |       |          | 36,338 | 
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         
|                                         |                                                                                                                                                                                                                       | Total liabilities and stockholders equity |       | $        | 65,189 |  |       | $        | 67,703 | 
|                                         |                                                                                                                                                                                                                       |                                            |       |          |        |  |       |         

The accompanying notes are an integral part of
these consolidated financial statements.

42



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##### Table of Contents



THERMA-WAVE, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except per share
data)


|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |        |        | 
|------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------- | --------------------------------- | ------- | ------ | ------ | ---- | -------- | ------ | ------- | - | ------- | ------ | ------ | 
|                                                                               |                                                                                                     |                                  
|                                                                               |                                                                                                     | Fiscal Years Ended March 31,     
|                                                                               |                                                                                                     |                                  
|                                                                               |                                                                                                     | 2004                              |         | 2003   |        | 2002
|                                                                               |                                                                                                     |                                   |         |        |        |     
|Net revenues                                                                   |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|                                                                               | Product                                                                                             |                                   | $       | 46,938 |        |      | $        | 28,515 |         |   | $       | 63,793 |       
|                                                                               | Service and parts                                                                                   |                                   |         | 18,371 |        |      |          | 20,705 |         |   |         | 18,144 |       
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|                                                                               |                                                                                                     | Total net revenues                |         |        | 65,309 |      |          |        | 49,220  |   |         |        | 81,937 | 
|Cost of revenues (including stock-based
    compensation of $168, $33 and $16) |                                                                                                     |                                   | 38,500  |        |        |      | 55,061   |        |         |   | 65,414  |       
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|Gross profit (loss)                                                            |                                                                                                     |                                   | 26,809  |        |        |      | (5,841   | )      |         |   | 16,523  |       
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|Operating expenses:                                                            |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|                                                                               | Research and development (excluding stock-based
    compensation of $706, $967 and $297)            |                                   |         | 18,710 |        |      |          | 29,230 |         |   |         | 29,122 |       
|                                                                               | Selling, general and administrative (excluding
    stock-based compensation of $444, $717 and $239) |                                   |         | 22,958 |        |      |          | 26,071 |         |   |         | 21,713 |       
|                                                                               | In-process research and development                                                                 |                                   |         |       |        |      |          |       |         |   |         | 16,340 |       
|                                                                               | Impairment of goodwill and other intangible assets                                                  |                                   |         |       |        |      |          | 67,408 |         |   |         |       |       
|                                                                               | Restructuring, severance and other                                                                  |                                   |         | 1,938  |        |      |          | 4,293  |         |   |         | 1,470  |       
|                                                                               | Stock-based compensation                                                                            |                                   |         | 1,150  |        |      |          | 1,684  |         |   |         | 536    |       
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|                                                                               |                                                                                                     | Total operating expenses          |         |        | 44,756 |      |          |        | 128,686 |   |         |        | 69,181 | 
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|Operating loss                                                                 |                                                                                                     |                                   | (17,947 | )      |        |      | (134,527 | )      |         |   | (52,658 | )     
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|Other income (expense):                                                        |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|                                                                               | Interest expense                                                                                    |                                   |         | (76    | )      |      |          | (161   | )       |   |         | (204   | )     
|                                                                               | Interest income                                                                                     |                                   |         | 160    |        |      |          | 946    |         |   |         | 2,436  |       
|                                                                               | Other, net                                                                                          |                                   |         | (230   | )      |      |          | 138    |         |   |         | 110    |       
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|                                                                               |                                                                                                     | Total other income (expense), net |         |        | (146   | )    |          |        | 923     |   |         |        | 2,342  | 
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|Loss before benefit for income taxes                                           |                                                                                                     |                                   | (18,093 | )      |        |      | (133,604 | )      |         |   | (50,316 | )     
|Benefit for income taxes                                                       |                                                                                                     |                                   |        |        |        |      |         |        |         |   | (1,120  | )     
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|Net Loss                                                                       |                                                                                                     | $                                 | (18,093 | )      |        | $    | (133,604 | )      |         | $ | (49,196 | )     
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|Net loss per share:                                                            |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|                                                                               | Basic and Diluted                                                                                   |                                   | $       | (0.56  | )      |      | $        | (4.69  | )       |   | $       | (1.98  | )     
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|Weighted average common shares outstanding:                                    |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       
|                                                                               | Basic and Diluted                                                                                   |                                   |         | 32,387 |        |      |          | 28,500 |         |   |         | 24,894 |       
|                                                                               |                                                                                                     |                                   |         |        |        |      |          |        |         |   |         |       

The accompanying notes are an integral part of
these consolidated financial statements.

43



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##### Table of Contents



THERMA-WAVE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

(In thousands, except per share
data)


|                                                                              |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  |   |          |  
|----------------------------------------------------------------------------- |  | ------------ | ---------- | ---------- |  | -------------- | --- | ---------- |  | ------------- | ------- | ------------ |  | ----------- | -------- | ------------ |  | ------------- | ---- | ----- |  | ------ | ---- | - |  | - | ------ | - |  | - | ------ | - |  | - | -------- | - |  | - | -------- | - |  | - | -------- | -
|                                                                              |  |              |            |            |  |                |     | Notes      |  | Accumulated   |         |              |  |             |          |              |  |              
|                                                                              |  | Common Stock |            | Additional |  | Treasury Stock |     | Receivable |  | Other         |         | Deferred     |  |             |          |              |  |              
|                                                                              |  |              |            | Paid-In    |  |                |     | from       |  | Comprehensive |         | Stock        |  | Accumulated |          |              |  | Comprehensive
|                                                                              |  | Shares       |            | Amount     |  | Capital        |     | Shares     |  | Amount        |         | Stockholders |  | Loss        |          | Compensation |  | Deficit       |      | Total |  | (Loss)
|                                                                              |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |       
|Balance at March 31, 2001                                                     |  |              | 23,994,699 |            |  | $              | 240 |            |  | $             | 230,646 |              |  |             |         |              |  | $             |     |       |  | $      | (212 | ) |  | $ | (1,463 | ) |  | $ |       |   |  | $ | (100,129 | ) |  | $ | 129,082  |   |  |   |          |  
|Net income                                                                    |  |              |           |            |  |                |    |            |  |               |        |              |  |             |          |              |  |               |      |       |  |        |     |   |  |   |       |   |  |   |       |   |  |   | (49,196  | ) |  |   | (49,196  | ) |  | $ | (49,196  | )
|Currency translation adjustments, net of tax                                  |  |              |           |            |  |                |    |            |  |               |        |              |  |             |          |              |  |               |      |       |  |        |     |   |  |   | (327   | ) |  |   |       |   |  |   |         |   |  |   | (327     | ) |  |   | (327     | )
|                                                                              |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  |   |          |  
|Comprehensive income                                                          |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  | $ | (49,523  | )
|                                                                              |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  |   |          |  
|Receipts from stockholders                                                    |  |              |           |            |  |                |    |            |  |               |        |              |  |             |          |              |  |               |      |       |  |        | 12   |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   | 12       |   |  |   |          |  
|Issuance of common stock under ESPP                                           |  |              | 295,199    |            |  |                | 3   |            |  |               | 2,740   |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | 2,743    |   |  |   |          |  
|Issuance of common stock under stock option plans                             |  |              | 132,434    |            |  |                | 1   |            |  |               | 875     |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | 876      |   |  |   |          |  
|Cancellation of time-vesting shares                                           |  |              | (13,742    | )          |  |                |    |            |  |               | (6      | )            |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | (6       | ) |  |   |          |  
|Issuance of common stock for acquisition of Sensys                            |  |              | 4,470,510  |            |  |                | 45  |            |  |               | 82,941  |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | 82,986   |   |  |   |          |  
|Issuance of common stock for the exercise of
    warrants                     |  |              | 211,018    |            |  |                | 2   |            |  |               | 775     |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | 777      |   |  |   |          |  
|Deferred stock- based compensation                                            |  |              |           |            |  |                |    |            |  |               | 3,495   |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   | (3,495 | ) |  |   |          |   |  |   |         |   |  |   |          |  
|Amortization of deferred stock-based compensation                             |  |              |           |            |  |                |    |            |  |               |        |              |  |             |          |              |  |               |      |       |  |        |     |   |  |   |       |   |  |   | 552    |   |  |   |         |   |  |   | 552      |   |  |   |          |  
|                                                                              |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  |   |          |  
|Balance at March 31, 2002                                                     |  |              | 29,090,118 |            |  |                | 291 |            |  |               | 321,466 |              |  |             |         |              |  |               |     |       |  |        | (200 | ) |  |   | (1,790 | ) |  |   | (2,943 | ) |  |   | (149,325 | ) |  |   | 167,499  |   |  |   |          |  
|Net loss                                                                      |  |              |           |            |  |                |    |            |  |               |        |              |  |             |         |              |  |               |     |       |  |        |     |   |  |   |       |   |  |   |       |   |  |   | (133,604 | ) |  |   | (133,604 | ) |  | $ | (133,604 | )
|Currency translation adjustments, net of tax                                  |  |              |           |            |  |                |    |            |  |               |        |              |  |             |          |              |  |               |      |       |  |        |     |   |  |   | 456    |   |  |   |       |   |  |   |         |   |  |   | 456      |   |  |   | 456      |  
|                                                                              |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  |   |          |  
|Comprehensive loss                                                            |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  | $ | (133,148 | )
|                                                                              |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  |   |          |  
|Receipts from stockholders                                                    |  |              |           |            |  |                |    |            |  |               |        |              |  |             |          |              |  |               |      |       |  |        | 4    |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   | 4        |   |  |   |          |  
|Repurchase of common stock                                                    |  |              |           |            |  |                |    |            |  |               |        |              |  |             | (447,500 | )            |  |               | (938 | )     |  |        |     |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   | (938     | ) |  |   |          |  
|Issuance of common stock under ESPP                                           |  |              | 205,706    |            |  |                | 2   |            |  |               | 455     |              |  |             | 147,314  |              |  |               | 411  |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | 868      |   |  |   |          |  
|Issuance of common stock under stock option plans                             |  |              | 24,246     |            |  |                |    |            |  |               | 136     |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | 136      |   |  |   |          |  
|Issuance of treasury stock for payment of
    consulting service              |  |              |           |            |  |                |    |            |  |               | (40     | )            |  |             | 30,675   |              |  |               | 90   |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | 50       |   |  |   |          |  
|Issuance of common stock for the exercise of
    warrants                     |  |              | 39,956     |            |  |                |    |            |  |               | 150     |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   | 150      |   |  |   |          |  
|Adjustment to deferred stock-based compensation
    due to reduction in force |  |              |           |            |  |                |    |            |  |               | (119    | )            |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   | 119    |   |  |   |          |   |  |   |         |   |  |   |          |  
|Amortization of deferred stock-based compensation                             |  |              |           |            |  |                |    |            |  |               |        |              |  |             |          |              |  |               |      |       |  |        |     |   |  |   |       |   |  |   | 1,717  |   |  |   |         |   |  |   | 1,717    |   |  |   |          |  
|                                                                              |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |          |   |  |   |          |  

44



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##### Table of Contents



|                                                                                                                     |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------ | ---------- | ---------- |  | -------------- | --- | ---------- |  | ------------- | ------- | ------------ |  | ----------- | -------- | ------------ |  | ------------- | ---- | ----- |  | ------ | ---- | - |  | - | ------ | - |  | - | ------ | - |  | - | -------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                                                                     |  |              |            |            |  |                |     | Notes      |  | Accumulated   |         |              |  |             |          |              |  |              
|                                                                                                                     |  | Common Stock |            | Additional |  | Treasury Stock |     | Receivable |  | Other         |         | Deferred     |  |             |          |              |  |              
|                                                                                                                     |  |              |            | Paid-In    |  |                |     | from       |  | Comprehensive |         | Stock        |  | Accumulated |          |              |  | Comprehensive
|                                                                                                                     |  | Shares       |            | Amount     |  | Capital        |     | Shares     |  | Amount        |         | Stockholders |  | Loss        |          | Compensation |  | Deficit       |      | Total |  | (Loss)
|                                                                                                                     |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |       
|Balance at March 31, 2003                                                                                            |  |              | 29,360,026 |            |  |                | 293 |            |  |               | 322,048 |              |  |             | (269,511 | )            |  |               | (437 | )     |  |        | (196 | ) |  |   | (1,334 | ) |  |   | (1,107 | ) |  |   | (282,929 | ) |  |   | 36,338  |   |  |   |         |  
|Net loss                                                                                                             |  |              |           |            |  |                |    |            |  |               |        |              |  |             |         |              |  |               |     |       |  |        |     |   |  |   |       |   |  |   |       |   |  |   | (18,093  | ) |  |   | (18,093 | ) |  | $ | (18,093 | )
|Currency translation adjustments, net of tax                                                                         |  |              |           |            |  |                |    |            |  |               |        |              |  |             |         |              |  |               |     |       |  |        |     |   |  |   | 599    |   |  |   |       |   |  |   |         |   |  |   | 599     |   |  |   | 599     |  
|                                                                                                                     |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |         |   |  |   |         |  
|Comprehensive loss                                                                                                   |  |              |           |            |  |                |    |            |  |               |        |              |  |             |         |              |  |               |     |       |  |        |      |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   |        |   |  | $ | (17,494 | )
|                                                                                                                     |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |         |   |  |   |         |  
|Receipts from stockholders                                                                                           |  |              |           |            |  |                |    |            |  |               |        |              |  |             |         |              |  |               |     |       |  |        | 22   |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   | 22      |   |  |   |         |  
|Issuance of common stock under private offering                                                                      |  |              | 5,800,000  |            |  |                | 58  |            |  |               | 11,670  |              |  |             |         |              |  |               |     |       |  |        |     |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   | 11,728  |   |  |   |         |  
|Issuance of common stock under ESPP                                                                                  |  |              | 244,098    |            |  |                | 3   |            |  |               | (223    | )            |  |             | 266,854  |              |  |               | 434  |       |  |        |     |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   | 214     |   |  |   |         |  
|Issuance of common stock under stock option plans                                                                    |  |              | 93,901     |            |  |                | 1   |            |  |               | 134     |              |  |             | 2,657    |              |  |               | 3    |       |  |        |     |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   | 138     |   |  |   |         |  
|Issuance of common stock for the exercise of
    warrants                                                            |  |              |           |            |  |                |    |            |  |               |        |              |  |             |         |              |  |               |     |       |  |        |     |   |  |   |       |   |  |   |       |   |  |   |         |   |  |   |        |   |  |   |         |  
|Adjustment to deferred stock-based compensation
    due to reduction in force                                        |  |              |           |            |  |                |    |            |  |               | (260    | )            |  |             |         |              |  |               |     |       |  |        |     |   |  |   |       |   |  |   | 260    |   |  |   |         |   |  |   |        |   |  |   |         |  
|Deferred stock- based compensation resulting from
    the variable accounting treatment for stock options            |  |              |           |            |  |                |    |            |  |               | 1,643   |              |  |             |         |              |  |               |     |       |  |        |     |   |  |   |       |   |  |   | (1,643 | ) |  |   |         |   |  |   |        |   |  |   |         |  
|Amortization of deferred stock-based compensation
    related to the variable accounting treatment for stock options |  |              |           |            |  |                |    |            |  |               |         |              |  |             |         |              |  |               |     |       |  |        |     |   |  |   |       |   |  |   | 737    |   |  |   |         |   |  |   | 737     |   |  |   |         |  
|Amortization of deferred stock-based compensation
    related to Sensys acquisition                                  |  |              |           |            |  |                |    |            |  |               |        |              |  |             |         |              |  |               |     |       |  |        |     |   |  |   |       |   |  |   | 581    |   |  |   |         |   |  |   | 581     |   |  |   |         |  
|                                                                                                                     |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |         |   |  |   |         |  
|Balance at March 28, 2004                                                                                            |  |              | 35,498,025 |            |  | $              | 355 |            |  | $             | 335,012 |              |  |             |         |              |  | $             |     |       |  | $      | (174 | ) |  | $ | (735   | ) |  | $ | (1,172 | ) |  | $ | (301,022 | ) |  | $ | 32,264  |   |  |   |         |  
|                                                                                                                     |  |              |            |            |  |                |     |            |  |               |         |              |  |             |          |              |  |               |      |       |  |        |      |   |  |   |        |   |  |   |        |   |  |   |          |   |  |   |         |   |  |   |         |  

The accompanying notes are an integral part of
these consolidated financial statements.

45



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##### Table of Contents



THERMA-WAVE, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |         |         |  
|------------------------------------------------------------------------------- | -------------------------------------------------------------------------------- | ----------------------------------------- | ------- | ------ | ------ | ---- | -------- | ------ | ------- | - | ------- | ------- | ------- | -
|                                                                                |                                                                                  |                                          
|                                                                                |                                                                                  | Fiscal Years Ended March 31,             
|                                                                                |                                                                                  |                                          
|                                                                                |                                                                                  | 2004                                      |         | 2003   |        | 2002
|                                                                                |                                                                                  |                                           |         |        |        |     
|Operating activities:                                                           |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Net loss                                                                        |                                                                                  | $                                         | (18,093 | )      |        | $    | (133,604 | )      |         | $ | (49,196 | )      
|Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|                                                                                | Depreciation and amortization of property and
    equipment                      |                                           |         | 4,221  |        |      |          | 5,913  |         |   |         | 5,251   |        
|                                                                                | Amortization of intangible assets                                                |                                           |         | 2,548  |        |      |          | 1,497  |         |   |         | 682     |        
|                                                                                | Amortization of deferred stock-based compensation                                |                                           |         | 1,318  |        |      |          | 1,717  |         |   |         | 552     |        
|                                                                                | In-process research and development                                              |                                           |         |       |        |      |          |       |         |   |         | 16,340  |        
|                                                                                | Deferred income taxes                                                            |                                           |         |       |        |      |          |       |         |   |         | 5,459   |        
|                                                                                | Impairment of goodwill and other intangible assets                               |                                           |         |       |        |      |          | 67,409 |         |   |         |        |        
|                                                                                | Provision for doubtful accounts receivable                                       |                                           |         | (646   | )      |      |          | (471   | )       |   |         | 928     |        
|                                                                                | Inventory charge                                                                 |                                           |         | 5,200  |        |      |          | 9,605  |         |   |         | 12,217  |        
|                                                                                | Loss on disposal of property and equipment                                       |                                           |         | 473    |        |      |          | 588    |         |   |         |        |        
|                                                                                | Loss on abandonment of leased facilities                                         |                                           |         |       |        |      |          | 651    |         |   |         |        |        
|                                                                                | Loss on sale of an investment                                                    |                                           |         | 125    |        |      |          |       |         |   |         |         |        
|                                                                                | Issuance of treasury stock in connection with
    payment of consulting services |                                           |         |       |        |      |          | 50     |         |   |         |        |        
|Changes in operating assets and liabilities:                                    |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|                                                                                | Accounts receivable                                                              |                                           |         | (304   | )      |      |          | 2,284  |         |   |         | 26,788  |        
|                                                                                | Inventories                                                                      |                                           |         | (223   | )      |      |          | 2,926  |         |   |         | 1,166   |        
|                                                                                | Other assets                                                                     |                                           |         | 937    |        |      |          | 2,302  |         |   |         | (2,110  | )      
|                                                                                | Accounts payable                                                                 |                                           |         | 5,272  |        |      |          | (4,149 | )       |   |         | (6,983  | )      
|                                                                                | Accrued and other liabilities                                                    |                                           |         | (1,276 | )      |      |          | (913   | )       |   |         | (20,780 | )      
|                                                                                | Deferred revenues                                                                |                                           |         | (2,436 | )      |      |          | 1,645  |         |   |         | (7,603  | )      
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|                                                                                |                                                                                  | Net cash used in operating activities     |         |        | (2,884 | )    |          |        | (42,550 | ) |         |         | (17,289 | )
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Investing activities:                                                           |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|                                                                                | Purchases of property and equipment                                              |                                           |         | (254   | )      |      |          | (1,464 | )       |   |         | (4,364  | )      
|                                                                                | Sales of short-term investments                                                  |                                           |         |       |        |      |          | 12,575 |         |   |         | 7,275   |        
|                                                                                | Cash acquired upon Sensys acquisition                                            |                                           |         |       |        |      |          |       |         |   |         | 2,055   |        
|                                                                                | Proceeds from sale of an investment                                              |                                           |         | 375    |        |      |          |       |         |   |         |        |        
|                                                                                | Purchase of patents                                                              |                                           |         | (798   | )      |      |          | (946   | )       |   |         | (927    | )      
|                                                                                | Restricted cash                                                                  |                                           |         | 1,064  |        |      |          | (1,064 | )       |   |         |        |        
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|                                                                                |                                                                                  | Net cash provided by investing activities |         |        | 387    |      |          |        | 9,101   |   |         |         | 4,039   |  
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Financing activities:                                                           |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|                                                                                | Principal payments under capital lease obligations                               |                                           |         |       |        |      |          |       |         |   |         | (66     | )      
|                                                                                | Proceeds from issuance of common stock                                           |                                           |         | 12,080 |        |      |          | 1,154  |         |   |         | 4,390   |        
|                                                                                | Proceeds from note receivable from stockholders                                  |                                           |         | 22     |        |      |          | 4      |         |   |         | 12      |        
|                                                                                | Purchase of treasury stock                                                       |                                           |         |       |        |      |          | (938   | )       |   |         |        |        
|                                                                                | Repayment of long-term debt                                                      |                                           |         |       |        |      |          | (16    | )       |   |         |        |        
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|                                                                                |                                                                                  | Net cash provided by financing activities |         |        | 12,102 |      |          |        | 204     |   |         |         | 4,336   |  
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Effect of exchange rates on cash                                                |                                                                                  |                                           | 599     |        |        |      | 456      |        |         |   | (327    | )      
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Net increase (decrease) in cash and cash
    equivalents                        |                                                                                  |                                           | 10,204  |        |        |      | (32,789  | )      |         |   | (9,241  | )      
|Cash and cash equivalents at beginning of year                                  |                                                                                  |                                           | 13,695  |        |        |      | 46,484   |        |         |   | 55,725  |        
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Cash and cash equivalents at end of year                                        |                                                                                  | $                                         | 23,899  |        |        | $    | 13,695   |        |         | $ | 46,484  |        
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Supplementary disclosures:                                                      |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Cash paid for interest                                                          |                                                                                  | $                                         | 4       |        |        | $    | 75       |        |         | $ | 134     |        
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        
|Cash paid for taxes                                                             |                                                                                  | $                                         | 9       |        |        | $    | 124      |        |         | $ | 577     |        
|                                                                                |                                                                                  |                                           |         |        |        |      |          |        |         |   |         |        

The accompanying notes are an integral part of
these consolidated financial statements.

46



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##### Table of Contents



THERMA-WAVE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|   |                                                                
|-- | ---------------------------------------------------------------
|1. | Organization and Summary of Significant
    Accounting Policies



| |                        
| | -----------------------
| | Description of Business

Therma-Wave, Inc. (the Company), a
Delaware corporation, develops, manufactures, and markets
process control metrology systems for use in the manufacture of
semiconductors. These systems are based on our proprietary
thermal wave and optical technologies. We market and sell our
products worldwide to major semiconductor manufacturers.



| |                      
| | ---------------------
| | Basis of Presentation

The consolidated financial statements include the
accounts of Therma-Wave, Inc. and its wholly owned subsidiaries.
All significant inter-company transactions and balances have
been eliminated. Our fiscal year is a 52 to 53 week year
ending on the Sunday closest to March 31 of each year.
Fiscal years 2004, 2003 and 2002 ended on March 28, 2004,
March 30, 2003 and March 31, 2002, respectively. For
convenience, the accompanying financial statements have been
presented as March 31 of each fiscal year.



| |                    
| | -------------------
| | Revenue Recognition

Effective April 1, 2000, we changed our
method of accounting for revenue recognition in accordance with
Securities and Exchange Commission Staff Accounting
Bulletin No. 101, or SAB 101, Revenue
Recognition in Financial Statements. In December 2003, the
SEC issued Staff Accounting Bulletin No. 104, or
SAB 104, Revenue Recognition, which superceded
SAB 101. SAB 104 is a codification of other revenue
recognition pronouncements and in substance does not change
SAB 101. The adoption of SAB 104 did not have a
material effect on our revenue recognition policy. Revenues are
recognized when the contractual obligations have been performed,
title and risk of ownership have passed to the customer,
collectibility of the sales price has been reasonably assured
and customer final acceptance has been obtained, if applicable.

Freight terms of sales are FOB shipping
point unless otherwise negotiated and agreed in written form
between our customers and us. Shipments typically are made in
compliance with shipment requirements specified in our
customers purchase order.

Systems Revenues.Equipment sales are accounted for as multiple-element
arrangement sales that require the deferral of a significant
portion of revenues in the amount of the greater of fair market
value of installation and a percentage of payment subject to
final acceptance. Systems revenues are allocated to each
component of the multiple-element arrangement. Revenues on each
element are recognized when the contractual obligations have
been performed, title and risk of ownership have passed to the
customer, collectibility of the sales price has been reasonably
assured and customer final acceptance has been obtained if
applicable. Estimated contractual warranty obligations are
recorded when related systems sales are shipped.

In accordance with SAB 104, we evaluate our
systems sales to determine the appropriate timing for revenue
recognition for each of the multiple elements involved in each
sale. This sometimes results in deferrals of revenues from the
period in which the tool is shipped to future periods.

Systems revenues are also deferred when the
customer has the right to return the product for credit. In such
cases, systems revenues are not recognized until all of the
following conditions have been evidenced after the
customers purchase order has been fulfilled: the
right of return has expired and any potential returns would
require authorization by our company under warranty provisions;
the price of the sales is fixed or determinable; the payment
terms are fixed and enforceable; and collectibility is
reasonably assured.

Services Revenues.We derive service revenues from three primary
sources  sale of spare parts, service contracts and
service labor. Revenues on the sale of spare parts are
recognized when title and risk of ownership have transferred to
the customer and collectibility of the sales price has been
reasonably assured. Revenues on service contracts are deferred
and recognized on a straight-line basis over the period of the
contract. Revenues

47



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

on time and material services performed are
recognized when the services are completed, collectibility of
the sales price has been reasonably assured and customer final
acceptance has been obtained, if applicable.



| |                                                
| | -----------------------------------------------
| | Allowance for Doubtful Accounts and
    Returns

We utilize estimates in determining our allowance
for doubtful accounts and potential returns for credit. We
continuously monitor collections and payments from our customers
and maintain a provision for estimated credit losses based upon
our historical experience, any specific customer collection
issues that we have identified, and the aging of the accounts
receivable. While such credit losses have historically been
within our expectations and the provisions established, there is
no assurance that we will continue to experience the same credit
loss rates that we have in the past. A significant change in the
liquidity or financial position of our customers could have a
material adverse impact on the collectibility of our accounts
receivable and our future operating results.



| |          
| | ---------
| | Liquidity

Our principal sources of funds have been and are
anticipated to be cash on hand ($23.9 million unrestricted
as of March 28, 2004), cash flows from operating activities
(if any), borrowings under our bank credit facility and the sale
of common stock. We have implemented various cost reduction
programs during and subsequent to the end of fiscal 2003 to
bring operating expenses in line with revenue projections. We
believe that with these cost reduction programs in place, we
will reduce operating expenses significantly enough so that we
will have adequate liquidity and capital resources to meet our
current and future financial obligations for the next twelve
months. No assurance can be given, however, that this will be
the case. We may require additional equity or debt financing to
meet our working capital requirements or to fund our research
and development activities. There can be no assurance that
additional financing will be available, if required or, if
available, will be on terms satisfactory to us.



| |                                                  
| | -------------------------------------------------
| | Concentration of Credit Risk/ Major
    Customers

We sell our products to major semiconductor
manufacturing companies throughout the world. We perform
continuing credit evaluations of our customers and, generally,
do not require collateral. Letters of credit may be required
from our customers in certain circumstances. Sales to customers
representing 10% or more of net revenues were as follows:

|           |       |                    |     |      |  |      |     |     |  |  |     |     | 
|---------- | ----- | ------------------ | --- | ---- |  | ---- | --- | --- |  |  | --- | --- | 
|           |       |                   
|           |       | Percentage of Net 
|           |       | Revenues          
|           |       |                   
|           |       |                   
|           |       | Fiscal Years Ended
|           |       | March 31,         
|           |       |                   
|Customers: |       | 2004               |     | 2003 |  | 2002
|           |       |                    |     |      |  |     
|A          |       |                    | 16% |      |  |      | %  |     |  |  | 13% |    
|B          |       |                    | 14% |      |  |      | 13% |     |  |  | 24% |    
|C          |       |                    | 12% |      |  |      | %  |     |  |  | %  |    
|D          |       |                    | 10% |      |  |      | %  |     |  |  | 12% |    
|           |       |                    |     |      |  |      |     |     |  |  |     |    
|           | Total |                    |     | 52%  |  |      |     | 13% |  |  |     | 49% | 
|           |       |                    |     |      |  |      |     |     |  |  |     |    

Accounts receivable from two customers accounted
for approximately 35% and 15%, respectively, of total accounts
receivable at March 31, 2004. Accounts receivable from two
customers accounted for approximately 16% and 10%, respectively,
of total accounts receivable at March 31, 2003.

Certain of the components and subassemblies
included in our systems are obtained from a single source or a
limited group of suppliers. Although we seek to reduce
dependence on those sole and limited source

48



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

suppliers, the partial or complete loss of
certain of these sources could have at least a temporary adverse
effect on our results of operations and damage customer
relationships. Further, a significant increase in the price of
one or more of these components could adversely affect our
results of operations.



| |                 
| | ----------------
| | Use of Estimates

The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities,
disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues
and expenses during the reported period. Actual results could
differ from those estimates, and such differences could affect
the results of operations reported in future periods.



| |                                                   
| | --------------------------------------------------
| | Foreign Currency Translations and
    Transactions

We are primarily a U.S. dollar functional
currency entity. A substantial portion of our international
sales are denominated in U.S. dollars and, as a result, we
have relatively little exposure to foreign currency exchange
risk with respect to sales. We have determined that the
functional currency of our foreign operations is the local
currency. The transactions denominated in currencies other than
our functional currencies create gains and losses that are
reflected in our consolidated statement of operations. Foreign
currency transaction gains (losses) are included in other income
(expense) in our consolidated statements of operations and
amounted to $19,000, $(5,000), and $(31,000) for the years ended
March 31, 2004, 2003, and 2002, respectively.

We convert the financial statements of our
foreign subsidiaries into U.S. dollars. When there is a
change in foreign currency exchange rates, the conversion of the
foreign subsidiaries financial statements into
U.S. dollars leads to a translation gain or loss. The
accumulated effects of foreign translation rate changes related
to net assets located outside the U.S. are included as a
component of stockholders equity. As of March 31,
2004 and 2003 we have accumulated comprehensive losses of
$735,000 and $1,334,000, respectively, consisting of
foreign currency translation adjustments.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

We maintain our cash in depository accounts,
money market accounts and commercial paper with several
financial institutions. We consider all highly liquid
investments purchased with original maturities of three months
or less to be cash equivalents.



| |                       
| | ----------------------
| | Short-Term Investments

In fiscal year 2004, we had no short-term
investments. Our cash balances were held in cash and cash
equivalents. In fiscal year 2003, all investments were made in
commercial paper or municipal bonds and were held to maturity.
In 2003, we also had certain money market and mutual fund
investments classified as trading securities included in other
assets that are part of a deferred executive compensation plan.
Trading securities were reported at fair value with unrealized
gains and losses, interest and dividends included in interest
income.



| |                
| | ---------------
| | Restricted Cash

At March 31, 2003, the Company had
$1.1 million restricted cash invested in a certificate of
deposit. This restricted cash was pledged as a deposit for
financed insurance premiums. We have no restricted cash as of
March 31, 2004.



| |            
| | -----------
| | Inventories

Inventories are stated at the lower of cost or
market. Cost is determined by the first-in, first-out method.
During the years ended March 31, 2004, 2003 and 2002,
respectively, we recorded charges of $5.2 million,

49



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

$9.6 million, and $12.2 million,
respectively, to write off the value of obsolete and excess
inventory. The charges were included in cost of revenues. In
fiscal 2003, we sold $1.0 million of inventory that had
been previously written off and in fiscal 2004, we sold
$10.6 million of inventory that had been previously written
off.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost, net of
accumulated depreciation and amortization. Depreciation and
amortization are provided on a straight-line basis over the
estimated useful lives of the respective assets, generally three
to five years. Unless a different specific life is appropriate
to a particular asset, the companys policy is to
depreciate machinery, laboratory and test equipment over three
years, and to depreciate office furniture and fixtures and
capitalized software over five years. Leasehold improvements are
amortized on a straight-line basis over the shorter of the
assets useful lives or lease terms. Depreciation and
amortization expense on property and equipment for fiscal years
2004, 2003, and 2002 was $4.2 million, $5.9 million,
and $5.3 million, respectively.



| |             
| | ------------
| | Other Assets

Included in other assets is the value of our
patent portfolio, stated at cost, net of accumulated
amortization. Amortization is provided on a straight-line basis
over the estimated useful lives of the patents, generally five
years. Amortization on our patent portfolio for fiscal years,
2004, 2003, and 2002 was $0.7 million, $0.6 million,
and $0.4 million respectively. We expect investments in our
patent portfolio and patent amortization expenses in fiscal 2005
to be similar to prior years.



| |                                         
| | ----------------------------------------
| | Goodwill and Other Intangible
    Assets

We obtained certain intangible assets in the
acquisition of Sensys Instruments Corporation, or Sensys. These
intangible assets include developed technology, development
contract and trade name and are being amortized on a
straight-line basis over the estimated useful lives of two to
five years. We have adopted Statement of Financial Accounting
Standards No. 142, or SFAS No. 142,
Goodwill and Other Intangible Assets. We conducted
impairment reviews of goodwill and other intangible assets in
fiscal 2004 and fiscal 2003. As a result of the fiscal 2003
reviews, we wrote off $65.9 million for goodwill,
$0.6 million for developed technology, $0.2 million
for a development contract and $0.8 million for trade name
intangible assets in fiscal 2003. For fiscal 2003 we recorded
intangible asset amortization expense of $0.9 million. For
fiscal 2004 we recorded intangible asset amortization expense of
$1.8 million.



| |                  
| | -----------------
| | Long-Lived Assets

We review for the impairment of long-lived assets
whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. An
impairment loss would be recognized when estimated future cash
flows expected to result from the use of the asset and its
eventual disposition is less than its carrying amount. As part
of the cost reduction efforts in fiscal 2003, the Company
abandoned two of its leased facilities. Leasehold improvements
for the abandoned facilities and fixed assets disposed along
with the restructuring totaling $0.5 million were written
off in the fourth quarter of fiscal 2003 as it was determined
that the carrying amount of these assets exceeded the estimated
future cash flows from the use of these assets.



| |                                         
| | ----------------------------------------
| | Deferred Executive Compensation
    Plan

In fiscal 2000, we established a deferred
executive compensation plan. The company recognizes the amounts
payable to participants as non-current liabilities. As of
March 31, 2004, 17 participants held $0.5 million
in our deferred executive compensation plan. Investment returns
of the participants increase or decrease the companys
liability to the participants, thereby impacting our results of
operations.

50



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                      
| | -------------------------------------
| | Research and Development
    Expenses

Expenditures for research and development are
expensed as incurred. Research and development expenses include
employee compensation costs, project materials, consulting,
equipment costs, including charges for the use of the
companys own products for design verification and test
purposes, patent defense expenses and the amortization of
capitalized patents, facilities and information systems
allocations, and other spending such as travel and office
supplies.



| |                         
| | ------------------------
| | Stock-Based Compensation

In October 1995, the Financial Accounting
Standards Board issued SFAS No. 123, Accounting
for Stock-Based Compensation. As allowed by the provisions
of SFAS No. 123, the Company has continued to apply
Accounting Principles Board Opinion No. 25 in
accounting for its stock option plans and, accordingly, does not
recognize compensation cost because the exercise price of stock
options equals the market price of the underlying stock at the
date of option grant. The Company adopted the disclosure
provisions of SFAS No. 123. In April 2000, the
Financial Accounting Standards Board issued FASB
Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation: An
Interpretation of APB No. 25. The Company has
adopted the provisions of FIN 44, and such adoption did not
materially impact the Companys results of operations. In
December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based Compensation Transition and
Disclosure. The statement amends SFAS No. 123 to
provide alternative methods of transition for a voluntary change
to the fair value based method of accounting for stock-based
employee compensation. The Company has adopted the disclosure
provisions of SFAS No. 148.

Had compensation costs been determined based upon
the fair value at the grant date for awards under the stock
option plans and employee stock purchase plans, consistent with
the methodology prescribed under SFAS No. 123, our pro
forma net loss and pro forma net loss per share under
SFAS No. 123 would have been:

|                                 |                                                                                                           |                                       |   |         |   |      |   |          |   |  |   |         |  
|-------------------------------- | --------------------------------------------------------------------------------------------------------- | ------------------------------------- | - | ------- | - | ---- | - | -------- | - |  | - | ------- | -
|                                 |                                                                                                           |                                      
|                                 |                                                                                                           | Fiscal Years Ended March 31,         
|                                 |                                                                                                           |                                      
|                                 |                                                                                                           | 2004                                  |   | 2003    |   | 2002
|                                 |                                                                                                           |                                       |   |         |   |     
|                                 |                                                                                                           |                                      
|                                 |                                                                                                           | (In thousands, except per share data)
|Net loss (in thousands)          |                                                                                                           |                                       |   |         |   |      |   |          |   |  |   |        
|                                 | As reported                                                                                               |                                       | $ | (18,093 | ) |      | $ | (133,604 | ) |  | $ | (49,196 | )
|                                 | Add: Stock-based employee compensation
    expense included in the determination of net loss, as reported |                                       |   | 1,318   |   |      |   | 1,717    |   |  |   | 552     |  
|                                 | Deduct: Stock-based employee compensation
    expense as determined using the fair value method           |                                       |   | (4,459  | ) |      |   | (6,233   | ) |  |   | (7,508  | )
|                                 |                                                                                                           |                                       |   |         |   |      |   |          |   |  |   |        
|                                 | Pro forma net loss                                                                                        |                                       | $ | (21,234 | ) |      | $ | (138,120 | ) |  | $ | (56,152 | )
|                                 |                                                                                                           |                                       |   |         |   |      |   |          |   |  |   |        
|Basic and diluted loss per share |                                                                                                           |                                       |   |         |   |      |   |          |   |  |   |        
|                                 | As reported                                                                                               |                                       | $ | (0.56   | ) |      | $ | (4.69    | ) |  | $ | (1.98   | )
|                                 | Pro forma                                                                                                 |                                       | $ | (0.66   | ) |      | $ | (4.85    | ) |  | $ | (2.26   | )



| |             
| | ------------
| | Income Taxes

We account for income taxes under the asset and
liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
temporary differences between the financial statement carrying
amounts and the tax basis of existing assets and liabilities
measured using enacted tax rates expected to apply to taxable
income in the years in which the temporary differences are
expected to be recovered or settled. The measurement of deferred
tax assets is reduced, if necessary, by the amount of any tax
benefits that, based on available evidence, are not expected to
be realized.

51



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                  
| | -----------------
| | Advertising Costs

We expense advertising and promotional costs as
they are incurred.



| |                  
| | -----------------
| | Reclassifications

Certain prior year amounts have been reclassified
to conform to the current period presentation.



| |                                              
| | ---------------------------------------------
| | Recently Issued Accounting
    Pronouncements

In May 2003, the Financial Accounting Standard
Board, or FASB, issued SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity. SFAS No. 150 establishes
standards for how companies classify and measure certain
financial instruments with characteristics of both liabilities
and equity. It requires companies to classify a financial
instrument that is within its scope as a liability (or an asset
in some circumstances). SFAS No. 150 was effective
beginning the second quarter of fiscal 2004. We believe that the
adoption of this standard has had and will continue to have no
material impact on our consolidated financial statements.

In January 2003, the FASB issued
FASB Interpretation No. 46, Consolidation
of Variable Interest Entities  An Interpretation of
ARB No. 51. FIN 46 requires certain
variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated
financial support from other parties. FIN 46 was effective
immediately for all new variable interest entities created or
acquired after January 31, 2003. In December 2003, the FASB
issued a revision of FIN 46, or FIN 46R, that delayed
the implementation date for certain interests created or
acquired prior to January 31, 2003 until the first interim
or annual period ending after March 15, 2004.

FIN 46R is effective immediately for all new
variable interest entities created or acquired after
January 31, 2003. Since January 31, 2003, we have not
invested in any entities we believe are variable interest
entities. For those arrangements entered into prior to
February 1, 2003, we were required to adopt the provisions
of FIN 46R (as revised December 2003) at the end of the
first quarter of fiscal 2004. Therma-Waves adoption of
FIN 46R did not result in consolidation of any entities.

On March 31, 2004, the Financial Accounting
Standards Board issued a proposed Statement, Share-Based
Payment, that addresses the accounting for share-based
payment transactions in which an enterprise receives employee
services in exchange for equity instruments of the enterprise or
liabilities that are based on the fair value of the
enterprises equity instruments or that may be settled by
the issuance of such equity instruments. The proposed Statement
would eliminate the ability to account for share-based
compensation transactions using APB Opinion No. 25,
Accounting for Stock Issued to Employees, and
generally would require instead that such transactions be
accounted for using a fair-value-based method. It is anticipated
that this exposure draft would be finalized during the summer of
2004 and would be required to be applied by public companies for
years ended subsequent to December 15, 2004.

52



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THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                         
|-- | ------------------------
|2. | Balance Sheet Components

|           |                     |                 |   |       |        |  |   |        |        | 
|---------- | ------------------- | --------------- | - | ----- | ------ |  | - | ------ | ------ | 
|           |                     |                
|           |                     | March 31,      
|           |                     |                
|           |                     | 2004            |   | 2003 
|           |                     |                 |   |      
|           |                     |                
|           |                     | (In thousands) 
|Inventory: |                     |                 |   |       |        |  |   |       
|           | Purchased materials |                 | $ | 6,066 |        |  | $ | 2,459  |       
|           | Systems in process  |                 |   | 8,158 |        |  |   | 11,340 |       
|           | Finished systems    |                 |   | 2,945 |        |  |   | 8,347  |       
|           |                     |                 |   |       |        |  |   |       
|           |                     | Total inventory |   | $     | 17,169 |  |   | $      | 22,146 | 
|           |                     |                 |   |       |        |  |   |       

|                        |                                |                                           |                                   |        |         |       |   |        |         |       | 
|----------------------- | ------------------------------ | ----------------------------------------- | --------------------------------- | ------ | ------- | ----- | - | ------ | ------- | ----- | 
|                        |                                |                                          
|                        |                                | March 31,                                
|                        |                                |                                          
|                        |                                | 2004                                      |                                   | 2003  
|                        |                                |                                           |                                   |       
|                        |                                |                                          
|                        |                                | (In thousands)                           
|Property and equipment: |                                |                                           |                                   |        |         |       |   |       
|                        | Laboratory and test equipment  |                                           | $                                 | 6,014  |         |       | $ | 9,220  |        
|                        | Office furniture and equipment |                                           |                                   | 10,100 |         |       |   | 10,536 |        
|                        | Machinery and equipment        |                                           |                                   | 819    |         |       |   | 1,729  |        
|                        | Leasehold improvements         |                                           |                                   | 8,612  |         |       |   | 8,414  |        
|                        |                                |                                           |                                   |        |         |       |   |       
|                        |                                | Total property and equipment              |                                   |        | 25,545  |       |   |        | 29,899  |      
|                        |                                | Accumulated depreciation and amortization |                                   |        | (20,981 | )     |   |        | (20,895 | )    
|                        |                                |                                           |                                   |        |         |       |   |       
|                        |                                |                                           | Total property and equipment, net |        | $       | 4,564 |   |        | $       | 9,004 | 
|                        |                                |                                           |                                   |        |         |       |   |       

|                     |                                           |                           |   |       |        |  |   |       |        | 
|-------------------- | ----------------------------------------- | ------------------------- | - | ----- | ------ |  | - | ----- | ------ | 
|                     |                                           |                          
|                     |                                           | March 31,                
|                     |                                           |                          
|                     |                                           | 2004                      |   | 2003 
|                     |                                           |                           |   |      
|                     |                                           |                          
|                     |                                           | (In thousands)           
|Accrued liabilities: |                                           |                           |   |       |        |  |   |      
|                     | Accrued compensation and related expenses |                           | $ | 2,368 |        |  | $ | 3,417 |       
|                     | Accrued warranty costs                    |                           |   | 1,731 |        |  |   | 983   |       
|                     | Commissions payable                       |                           |   | 893   |        |  |   | 354   |       
|                     | Income tax payable                        |                           |   | 4,870 |        |  |   | 4,890 |       
|                     | Other accrued liabilities                 |                           |   | 5,868 |        |  |   | 5,945 |       
|                     |                                           |                           |   |       |        |  |   |      
|                     |                                           | Total accrued liabilities |   | $     | 15,730 |  |   | $     | 15,589 | 
|                     |                                           |                           |   |       |        |  |   |      



|   |                   
|-- | ------------------
|3. | Net Loss Per Share

We have adopted the provisions of Statement of
Financial Accounting Standards No. 128, Earnings per
Share (SFAS No. 128).
SFAS No. 128 requires us to report both basic net
income (loss) per share, which is based on the weighted-average
number of common shares outstanding excluding contingently
issuable or returnable shares such as unvested common stock or
shares that contingently convert into common stock upon certain
events, and diluted net income (loss) per share, which is based
on the weighted average number of common shares outstanding and
dilutive potential common shares outstanding.

53



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following tables set forth the computation of
net loss per share of common stock:

|                                                                          |          |                              |        |         |   |      |        |          |   |  |        |         |  
|------------------------------------------------------------------------- | -------- | ---------------------------- | ------ | ------- | - | ---- | ------ | -------- | - |  | ------ | ------- | -
|                                                                          |          |                             
|                                                                          |          | Fiscal Years Ended March 31,
|                                                                          |          |                             
|                                                                          |          | 2004                         |        | 2003    |   | 2002
|                                                                          |          |                              |        |         |   |     
|                                                                          |          |                             
|                                                                          |          | (In thousands)              
|Numerator:                                                                |          |                              |        |         |   |      |        |          |   |  |        |        
|                                                                          | Net loss |                              | $      | (18,093 | ) |      | $      | (133,604 | ) |  | $      | (49,196 | )
|                                                                          |          |                              |        |         |   |      |        |          |   |  |        |        
|Denominator:                                                              |          |                              |        |         |   |      |        |          |   |  |        |        
|Weighted shares outstanding used for basic and
    diluted loss per share |          |                              | 32,387 |         |   |      | 28,500 |          |   |  | 24,894 |        
|                                                                          |          |                              |        |         |   |      |        |          |   |  |        |        

The following table summarizes securities
outstanding (in thousands), in absolute number, as of each
period end which were not included in the calculation of diluted
net loss per share since their inclusion would be anti-dilutive.

|                                   |  |                |       |      |  |      |       |  |  |  |       | 
|---------------------------------- |  | -------------- | ----- | ---- |  | ---- | ----- |  |  |  | ----- | 
|                                   |  |               
|                                   |  | March 31,     
|                                   |  |               
|                                   |  | 2004           |       | 2003 |  | 2002
|                                   |  |                |       |      |  |     
|                                   |  |               
|                                   |  | (In thousands)
|Common stock subject to repurchase |  |                |      |      |  |      |      |  |  |  | 105   | 
|Common stock held in escrow        |  |                |      |      |  |      | 541   |  |  |  | 541   | 
|Stock options                      |  |                | 5,532 |      |  |      | 5,756 |  |  |  | 5,016 | 
|Warrants                           |  |                | 79    |      |  |      | 79    |  |  |  | 118   | 

The stock options outstanding at March 31,
2004, 2003 and 2002 that we excluded from the above calculation,
had a weighted average exercise price of $3.81, $8.27, and
$11.46, respectively. The warrants outstanding at March 31,
2004 that we excluded from the above calculation, had a weighted
average exercise price of $3.68.



|   |                       
|-- | ----------------------
|4. | Financing Arrangements

In June 2003, we entered into a loan and security
agreement with Silicon Valley Bank, or SVB. The agreement
includes a $5.0 million domestic line of credit, including
a sub-limit of $5.0 million for letters of credit, and a
$10.0 million Export-Import Bank of the United States, or
EXIM, guaranteed revolving line of credit. The new bank credit
facilities allow us to borrow money under the domestic line
bearing a floating interest rate equal to the SVB prime rate
plus 1.50%. The EXIM revolving line allows us to borrow money at
a floating interest rate equal to the SVB prime rate plus 1.75%.
We may request advances in an aggregate outstanding amount not
to exceed the lesser of $15.0 million total under the two
lines or the borrowing base, in each case minus the aggregate
face amount of outstanding letters of credit, including any
drawn but un-reimbursed letters of credit. Our borrowings under
the SVB and EXIM guaranteed credit facilities are secured by
substantially all of our assets. As of March 31, 2004, we
had $4.6 million in outstanding letters of credit under
this agreement. The credit facilities originally matured on
June 13, 2004, but we have recently extended these credit
facilities for one additional year. As of March 31, 2004,
we were in compliance with all the covenants in the agreement.

54



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THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |             
|-- | ------------
|5. | Income Taxes

The domestic and foreign components of loss
before benefit for income taxes are as follows (in thousands):

|         |       |                              |         |         |   |      |          |          |   |   |         |         |  
|-------- | ----- | ---------------------------- | ------- | ------- | - | ---- | -------- | -------- | - | - | ------- | ------- | -
|         |       |                             
|         |       | Fiscal Years Ended March 31,
|         |       |                             
|         |       | 2004                         |         | 2003    |   | 2002
|         |       |                              |         |         |   |     
|         |       |                             
|         |       | (In thousands)              
|Domestic |       | $                            | (16,999 | )       |   | $    | (133,142 | )        |   | $ | (47,829 | )      
|Foreign  |       |                              | (1,094  | )       |   |      | (462     | )        |   |   | (1,367  | )      
|         |       |                              |         |         |   |      |          |          |   |   |         |        
|         | Total |                              | $       | (18,093 | ) |      | $        | (133,604 | ) |   | $       | (49,196 | )
|         |       |                              |         |         |   |      |          |          |   |   |         |        

The components of the provision (benefit) for
income taxes are as follows (in thousands):

|          |         |                    |   |      |  |      |   |   |  |   |        |        |  
|--------- | ------- | ------------------ | - | ---- |  | ---- | - | - |  | - | ------ | ------ | -
|          |         |                   
|          |         | Fiscal Years Ended
|          |         | March 31,         
|          |         |                   
|          |         | 2004               |   | 2003 |  | 2002
|          |         |                    |   |      |  |     
|          |         |                   
|          |         | (In thousands)    
|Current:  |         |                    |   |      |  |      |   |   |  |   |        |       
|          | Federal |                    | $ |     |  |      | $ |  |  |   | $      | (6,579 | )
|          |         |                    |   |      |  |      |   |   |  |   |        |       
|          |         |                    |  |      |  |      |  |   |  |   | (6,579 | )     
|          |         |                    |   |      |  |      |   |   |  |   |        |       
|Deferred: |         |                    |   |      |  |      |   |   |  |   |        |       
|          | Federal |                    | $ |     |  |      | $ |  |  |   | $      | 5,459  |  
|          |         |                    |   |      |  |      |   |   |  |   |        |       
|          |         |                    |  |      |  |      |  |   |  |   | 5,459  |       
|          |         |                    |   |      |  |      |   |   |  |   |        |       
|Total     |         | $                  |  |      |  | $    |  |   |  | $ | (1,120 | )     
|          |         |                    |   |      |  |      |   |   |  |   |        |       

A reconciliation between the U.S. federal
statutory rate and the effective tax rate reflected in the
statements of operations is as follows:

|                                    |       |                    |       |      |   |      |       |     |   |  |       |     |  
|----------------------------------- | ----- | ------------------ | ----- | ---- | - | ---- | ----- | --- | - |  | ----- | --- | -
|                                    |       |                   
|                                    |       | Fiscal Years Ended
|                                    |       | March 31,         
|                                    |       |                   
|                                    |       | 2004               |       | 2003 |   | 2002
|                                    |       |                    |       |      |   |     
|Provision at federal statutory rate |       |                    | 35.0  | %    |   |      | 35.0  | %   |   |  | 35.0  | %  
|State taxes                         |       |                    | 2.8   |      |   |      | 2.8   |     |   |  | 0.4   |    
|Change in valuation allowance       |       |                    | (30.7 | )    |   |      | (19.5 | )   |   |  | (25.7 | )  
|Non-deductible expenses             |       |                    | (3.0  | )    |   |      | (18.1 | )   |   |  | (11.3 | )  
|Other                               |       |                    | (4.1  | )    |   |      | (0.2  | )   |   |  | 3.8   |    
|                                    |       |                    |       |      |   |      |       |     |   |  |       |    
|                                    | Total |                    |       | 0.0  | % |      |       | 0.0 | % |  |       | 2.2 | %
|                                    |       |                    |       |      |   |      |       |     |   |  |       |    

55



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THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The tax effects of temporary differences that
give rise to significant portions of the deferred tax assets and
deferred tax liabilities are presented below (in thousands):

|                                |                                                 |                    |         |        |  |   |         |        |  
|------------------------------- | ----------------------------------------------- | ------------------ | ------- | ------ |  | - | ------- | ------ | -
|                                |                                                 |                   
|                                |                                                 | Fiscal Years Ended
|                                |                                                 | March 31,         
|                                |                                                 |                   
|                                |                                                 | 2004               |         | 2003  
|                                |                                                 |                    |         |       
|Deferred tax assets:            |                                                 |                    |         |        |  |   |         |       
|                                | Accrued costs and expenses                      |                    | $       | 14,875 |  |   | $       | 18,361 |  
|                                | Depreciation and amortization                   |                    |         | 2,337  |  |   |         | 1,033  |  
|                                | Other                                           |                    |         | 743    |  |   |         | 1,367  |  
|                                | Net operating loss and tax credit carryforwards |                    |         | 34,653 |  |   |         | 27,982 |  
|                                |                                                 |                    |         |        |  |   |         |       
|Total gross deferred tax assets |                                                 |                    | 52,607  |        |  |   | 48,743  |       
|Less: valuation allowance       |                                                 |                    | (52,607 | )      |  |   | (47,055 | )     
|                                |                                                 |                    |         |        |  |   |         |       
|Total deferred tax assets       |                                                 |                    |        |        |  |   | 1,688   |       
|                                |                                                 |                    |         |        |  |   |         |       
|Deferred tax liabilities:       |                                                 |                    |         |        |  |   |         |       
|                                | Non-goodwill intangibles                        |                    |         |       |  |   |         | (1,688 | )
|                                | Other                                           |                    |         |        |  |   |         |       |  
|                                |                                                 |                    |         |        |  |   |         |       
|Net deferred tax liabilities    |                                                 |                    |        |        |  |   | (1,688  | )     
|                                |                                                 |                    |         |        |  |   |         |       
|Total net deferred tax assets   |                                                 | $                  |        |        |  | $ |        |       
|                                |                                                 |                    |         |        |  |   |         |       

The net changes in the total valuation allowance
for the years ended March 31, 2004 and 2003 were $5.5 and
$22.9 million, respectively. At March 31, 2002,
management has recognized deferred tax assets equal to the
deferred tax liability related to acquired non-goodwill
tangibles.

At March 31, 2004, we had federal and state
net operating losses of $93.1 million and
$18.8 million, respectively. The federal and state net
operating losses will expire at various dates through 2024 and
2014, respectively.

Under the Internal Revenue Code Section 382,
the amounts of and benefits from net operating loss
carryforwards may be impaired or limited in certain
circumstances. Events which cause limitations in the amount of
net operating losses that the Company may utilize in any one
year include, but are not limited to, a cumulative ownership
change of more than 50%, as defined, over a three year period.

At March 31, 2004, we had federal and state
research and development tax credits of $558,000 and $800,000,
respectively. The federal research and development tax credits
will expire at various dates through 2024, while the state
research tax credits may be carried forward indefinitely.



|   |                      
|-- | ---------------------
|6. | Business Combinations

On January 16, 2002, we issued approximately
4.47 million shares of our common stock in exchange for all
outstanding common and preferred shares of Sensys. The results
of Sensys operations have been included in the
consolidated financial statements since that date. Sensys was
founded in 1996 to develop and market advanced process control
metrology products that can be integrated into semiconductor
processing equipment. These products are aimed at improving the
productivity of this equipment in semiconductor fabs. Sensys has
established positions at several leading process equipment
suppliers for lithography, CMP, etch and CD-SEM equipment. The
Sensys acquisition further strengthens our position in this
important emerging market segment. Sensys business
operations have been fully integrated with Therma-Waves
Integra product lines, including the iX-SE, to form our
integrated metrology offering.

56



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The total purchase price for this acquisition was
$88.3 million, consisting of approximately
4.47 million shares of common stock with a fair value of
$72.8 million, assumed stock options to
purchase 608,151 shares of common stock with a fair
value of $9.1 million, assumed warrants to acquire
329,490 shares of common stock with a fair value of
$4.6 million, and transaction costs, consisting of
investment advisory, legal and other professional service fees,
of $1.85 million. Common stock was valued at
$16.28 per share using the Companys average stock
price for the five-day period around January 15, 2002.
Stock options were valued using the Black-Scholes option pricing
model, applying a weighted average expected life of five years,
a weighted average risk-free rate of 4.5%, an expected dividend
yield of zero percent, a volatility of 90% and a deemed fair
value of $16.28 per share. The intrinsic value of these
options, totaling approximately $3.5 million, has been
recorded as deferred stock-based compensation. Warrants were
valued using the Black-Scholes option pricing model, applying
the remaining contractual life of 3.6 years, a weighted
average risk-free rate of 4.5%, an expected dividend yield of
zero percent, a volatility of 90% and a deemed fair value of
$16.28 per share.

The purchase price allocation is as follows (in
thousands):

|                                      |                                     |                      |        |             |        |  |   |         |  | 
|------------------------------------- | ----------------------------------- | -------------------- | ------ | ----------- | ------ |  | - | ------- |  | 
|                                      |                                     | Amount               |        | Useful Life
|                                      |                                     |                      |        |            
|Fair value of net liabilities assumed |                                     | $                    | (1,840 | )           |        |  |  |        
|                                      | In-process research and development |                      |        | 16,340      |        |  |   |        | 
|                                      | Developed technology                |                      |        | 890         |        |  |   | 2 years | 
|                                      | Development contract                |                      |        | 2,590       |        |  |   | 5 years | 
|                                      | Trade name                          |                      |        | 990         |        |  |   | 5 years | 
|                                      | Unearned stock compensation         |                      |        | 3,495       |        |  |   | 4 years | 
|                                      | Goodwill                            |                      |        | 65,865      |        |  |   |        | 
|                                      |                                     |                      |        |             |        |  |   |        
|                                      |                                     | Total purchase price |        | $           | 88,330 |  |   |         |  | 
|                                      |                                     |                      |        |             |        |  |   |        

The fair values of Sensys net assets as of
the acquisition date were (in thousands):

|                          |  |        |        |  
|------------------------- |  | ------ | ------ | -
|                          |  | Amount
|                          |  |       
|Cash                      |  | $      | 2,055  |  
|Accounts receivable, net  |  |        | 2      |  
|Inventory                 |  |        | 879    |  
|Other current assets      |  |        | 394    |  
|Fixed assets              |  |        | 450    |  
|Accounts payable          |  |        | (733   | )
|Other current liabilities |  |        | (4,879 | )
|Long-term liabilities     |  |        | (8     | )
|                          |  |        |        |  
|                          |  | $      | (1,840 | )
|                          |  |        |        |  

The allocation of the consideration for the
acquisition of Sensys to its individual assets and liabilities
was based on managements analysis and estimates of the
fair values of the acquired assets and liabilities. In addition
to the value assigned to IPR&D projects, and Sensys
tangible assets, specific intangible assets were identified and
valued. The identifiable assets included a development contract,
trade name, and then-existing developed technology.

IPR&D consisted of those products not yet
proven to be technologically feasible but developed to a point
where there was value associated with them in relation to
potential future revenue. Because technological feasibility was
not yet proven and no alternative future uses were believed to
exist for the in-process technologies, the assigned value was
expensed immediately upon the closing date of the acquisition.

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THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The value of IPR&D was determined by
estimating the expected cash flows from the projects once
commercially viable, discounting the net cash flows back to
their present value and then applying a percentage of completion
to the calculated value as defined below. A discount rate of 40%
was used which is higher than the industry average due to
inherent uncertainties surrounding the successful development of
the IPR&D, market acceptance of the technology, the useful
life of such technology and the uncertainty of technological
advances which could potentially impact the estimates described
above. The percentage of completion for each project was
determined using costs incurred to date on each project as
compared to the remaining research and development to be
completed to bring each project to technological feasibility.

The projects included in purchased IPR&D, the
percent completed and the value assigned to each project were as
follows (in thousands):

|                        |  |                   |    |          |  |   |        | 
|----------------------- |  | ----------------- | -- | -------- |  | - | ------ | 
|                        |  | Estimate of       |    | Value   
|                        |  | Percent Completed |    | Assigned
|                        |  |                   |    |         
|IPR&D:                  |  |                   |    |          |  |   |        | 
|Compact CD-i            |  |                   | 22 | %        |  | $ | 14,180 | 
|Standalone Capabilities |  |                   | 30 | %        |  |   | 2,160  | 
|                        |  |                   |    |          |  |   |        | 
|Total IPR&D             |  |                   |    |          |  | $ | 16,340 | 
|                        |  |                   |    |          |  |   |        | 

During fiscal 2003, we invested about
$1 million in the above IPR&D projects. We shipped
several units of both CCD-I and standalone tools to TEL and
other leading semiconductor equipment suppliers. We also
received multiple unit orders from TEL for shipment in fiscal
2004.

The following unaudited pro forma information is
presented to illustrate the effects of the acquisition on the
historical financial position and operating results of
Therma-Wave and Sensys using the purchase method of accounting
in accordance with accounting principles generally accepted in
the United States of America. The unaudited pro forma
information is based upon the historical financial statements of
the respective companies. The unaudited pro forma information
for the twelve months ended March 31, 2002 assumes the
acquisition took place as of April 1, 2001 and combines
results from Therma-Waves consolidated statement of
operations for the twelve months ended March 31, 2002 and
Sensys unaudited statement of operations for the period
from April 1, 2001 through January 16, 2002, the date
of completion of the acquisition.

|                                                                                 |         |                     |         |             |   |   |         |        |  
|-------------------------------------------------------------------------------- | ------- | ------------------- | ------- | ----------- | - | - | ------- | ------ | -
|                                                                                 |         |                    
|                                                                                 |         | Twelve Months Ended
|                                                                                 |         | March 31, 2002     
|                                                                                 |         |                    
|                                                                                 |         | Pro Forma           |         | As Reported
|                                                                                 |         |                     |         |            
|Net revenues                                                                     |         | $                   | 84,234  |             |   | $ | 81,937  |       
|Gross profit                                                                     |         |                     | 16,729  |             |   |   | 16,523  |       
|Operating income (loss)                                                          |         |                     | (62,365 | )           |   |   | (52,658 | )     
|Net income (loss) before cumulative effect of
    change in accounting principle |         |                     | (59,399 | )           |   |   | (49,196 | )     
|Net income (loss)                                                                |         | $                   | (59,399 | )           |   | $ | (49,196 | )     
|                                                                                 |         |                     |         |             |   |   |         |       
|Net income (loss) per share:                                                     |         |                     |         |             |   |   |         |       
|                                                                                 | Basic   |                     | $       | (2.12       | ) |   | $       | (1.98  | )
|                                                                                 | Diluted |                     | $       | (2.12       | ) |   | $       | (1.98  | )
|Weighted average common shares outstanding:                                      |         |                     |         |             |   |   |         |       
|                                                                                 | Basic   |                     |         | 28,024      |   |   |         | 24,894 |  
|                                                                                 | Diluted |                     |         | 28,024      |   |   |         | 24,894 |  

58



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THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The unaudited pro forma information is provided
for illustrative purposes only and does not purport to represent
what the actual consolidated results of operations or the
consolidated financial position of Therma-Wave would have been
had the acquisition occurred on the dates assumed, nor is it
necessarily indicative of future consolidated results of
operations or financial position.



|   |                              
|-- | -----------------------------
|7. | Commitments and Contingencies

We lease our facilities under non-cancelable
operating leases that require us to pay maintenance and
operating expenses, such as taxes, insurance and utilities. We
are required pursuant to the terms of facility leases to
maintain two standby letters of credit totaling
$2.6 million.

Rent expense was approximately $2.2 million,
$2.7 million, and $2.3 million for the fiscal years
ended March 31, 2004, 2003 and 2002, respectively. At
March 31, 2004, future minimum lease payments under
non-cancelable operating leases (facilities and equipment
leases) are as follows (in thousands):

|                            |  |      |       |      |  |      |       |      |  |      |     |            |  |       |     |  |  |   |    |  |  |   |   |  |  |   |       | 
|--------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | --- | ---------- |  | ----- | --- |  |  | - | -- |  |  | - | - |  |  | - | ----- | 
|Contractual Obligations     |  | 2005 |       | 2006 |  | 2007 |       | 2008 |  | 2009 |     | Thereafter |  | Total
|                            |  |      |       |      |  |      |       |      |  |      |     |            |  |      
|Operating lease obligations |  | $    | 2,621 |      |  | $    | 1,935 |      |  | $    | 579 |            |  | $     | 558 |  |  | $ | 93 |  |  | $ |  |  |  | $ | 5,786 | 



| |                
| | ---------------
| | Indemnification

We indemnify some of our suppliers and customers
for specified intellectual property rights pursuant to certain
parameters and restrictions. The scope of these indemnities
varies, but in some instances includes indemnification for
damages and expenses (including reasonable attorney fees)
related to any misuse by us of the intellectual property. No
amounts have been accrued in respect of the indemnification
provisions at March 31, 2004, nor have we incurred any
losses under such indemnification during the periods covered in
this report.



| |                  
| | -----------------
| | Legal Proceedings

On April 22, 2002, we filed a patent
infringement suit against Boxer Cross Inc. in the United States
District Court, Northern District of California. The suit
alleged that Boxer Cross BX-10 product infringed certain
patents held by Therma-Wave related to ion implant monitoring.
On June 7, 2002, Boxer Cross filed its amended answer and
counterclaims to our complaint and asserted various affirmative
defenses to our claims of patent infringement. The pleading also
contained various counterclaims including allegations that
Therma-Waves Therma-Probe product infringed upon certain
patents owned by Boxer Cross and also raised claims of
misappropriation of trade secrets, tortious interference with
contract, unfair competition and unfair business practices. We
replied to Boxer Crosss counterclaims, denying the
material allegations and asserting declaratory judgment
counterclaims. On April 29, 2003, Applied Materials
announced that it had acquired all of the outstanding stock of
Boxer Cross. We settled this lawsuit with Boxer Cross and
Applied Materials on July 7, 2003. Pursuant to the
settlement, Therma-Wave dismissed its pending patent
infringement claims with prejudice. Boxer Cross dismissed its
pending patent infringement claims without prejudice and
dismissed its pending state law claims with prejudice.

There are currently no other material legal
proceedings pending against us. We may be required to initiate
additional litigation in order to enforce any patents issued to
or licensed to us or to determine the scope and/or validity of a
third partys patent or other proprietary rights. In
addition, we may be subject to additional lawsuits by third
parties seeking to enforce their own intellectual property
rights. Any such litigation, regardless of outcome, could be
expensive and time consuming and, as discussed above in the
prior risk factor, could subject us to significant liabilities
or require us to cease using proprietary third party technology
and, consequently, could have a material adverse effect on our
business, financial condition, results of operations or cash
flows.

59



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THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                             
|-- | --------------------------------------------
|8. | Restructuring, Severance and Other
    Costs

The following table summarizes the changes in
restructuring, severance and other costs during fiscal 2004 and
2003 (in thousands):

|                                   |  |                 |       |           |  |             |       |            |  |                 |        |   |  |   |   |  |  |   |     | 
|---------------------------------- |  | --------------- | ----- | --------- |  | ----------- | ----- | ---------- |  | --------------- | ------ | - |  | - | - |  |  | - | --- | 
|                                   |  | Liability as of |       |           |  |             |       |            |  | Liability as of
|                                   |  | March 31,       |       |           |  |             |       | Non-Cash   |  | March 31,      
|                                   |  | 2003            |       | Provision |  | Utilization |       | Settlement |  | 2004           
|                                   |  |                 |       |           |  |             |       |            |  |                
|Severance and workforce reduction  |  | $               | 558   |           |  | $           | 1,772 |            |  | $               | (2,330 | ) |  | $ |  |  |  | $ |    | 
|Consolidation of excess facilities |  |                 | 662   |           |  |             | 82    |            |  |                 | (524   | ) |  |   |  |  |  |   | 220 | 
|Other costs                        |  |                 | 134   |           |  |             | 84    |            |  |                 | (218   | ) |  |   |  |  |  |   |    | 
|                                   |  |                 |       |           |  |             |       |            |  |                 |        |   |  |   |   |  |  |   |     | 
|Total                              |  | $               | 1,354 |           |  | $           | 1,938 |            |  | $               | (3,072 | ) |  | $ |  |  |  | $ | 220 | 
|                                   |  |                 |       |           |  |             |       |            |  |                 |        |   |  |   |   |  |  |   |     | 

|                                   |  |                 |     |           |  |             |       |            |  |                 |        |   |  |   |      |   |  |   |       | 
|---------------------------------- |  | --------------- | --- | --------- |  | ----------- | ----- | ---------- |  | --------------- | ------ | - |  | - | ---- | - |  | - | ----- | 
|                                   |  | Liability as of |     |           |  |             |       |            |  | Liability as of
|                                   |  | March 31,       |     |           |  |             |       | Non-Cash   |  | March 31,      
|                                   |  | 2002            |     | Provision |  | Utilization |       | Settlement |  | 2003           
|                                   |  |                 |     |           |  |             |       |            |  |                
|Severance and workforce reduction  |  | $               | 184 |           |  | $           | 2,936 |            |  | $               | (2,562 | ) |  | $ |     |   |  | $ | 558   | 
|Consolidation of excess facilities |  |                 |    |           |  |             | 673   |            |  |                 | (11    | ) |  |   |     |   |  |   | 662   | 
|Fixed assets                       |  |                 |    |           |  |             | 513   |            |  |                 |       |   |  |   | (513 | ) |  |   |      | 
|Other costs                        |  |                 | 117 |           |  |             | 171   |            |  |                 | (154   | ) |  |   |     |   |  |   | 134   | 
|                                   |  |                 |     |           |  |             |       |            |  |                 |        |   |  |   |      |   |  |   |       | 
|Total                              |  | $               | 301 |           |  | $           | 4,293 |            |  | $               | (2,727 | ) |  | $ | (513 | ) |  | $ | 1,354 | 
|                                   |  |                 |     |           |  |             |       |            |  |                 |        |   |  |   |      |   |  |   |       | 

During fiscal 2004, we recorded $1.9 million
in charges related to restructuring, severance and other costs.
Of this amount, $1.8 million relates to reductions in force
in April 2003 and October 2003 of approximately 39 and 22
employees, respectively. An additional $0.1 million was
recorded as leased facility charges during the second quarter of
2004 when we entered into a sublease on a previously vacated
facility. The $0.1 million charge reflects the difference
between the estimated sublease income and the actual sublease
income for this facility. As of the end of fiscal 2004,
liabilities that we had accrued for severance and other costs
had been paid out in full. During fiscal 2003, we recorded
$4.3 million in charges related to restructuring, severance
and other costs. We closed down two facilities in
Santa Clara, California to reduce operating expenses and
recorded a $1.2 million charge associated with the
abandonment of leased facilities and write-off of fixed assets.
We also implemented two reduction-in-force programs affecting
approximately 190 people and recorded $2.9 million of
severance and $0.2 million of other severance-related costs.



| |                                      
| | -------------------------------------
| | Severance and Workforce
    Reduction

In April 2003 and October 2003, the Company
reduced its workforce by approximately 39 and 22 employees,
respectively, across all functional areas. Severance and related
employee benefit costs related to the reduction in force
amounted to $1.8 million, including severance paid to
employees at the time of their separation, related taxes and
benefits, and third party outplacement costs. The Company had
paid out all funds due under its workforce reduction program as
of the end of the fiscal year 2004.

In September 2002, the Company reduced its
workforce by approximately 115 employees across all functional
areas. Severance and related employee benefit costs amounted to
$2.9 million. Included in the severance charge were
approximately $0.4 million of severance expenses related to
the change of the Companys executive team and the
management in its Taiwan branch.

During fiscal year 2002, we announced and
implemented reduction in force programs aimed at bringing
operating expenses in line with our operating environment during
the period. All terminated employees were notified of their
severance and related benefits at the time the programs were
announced. The programs

60



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THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

resulted in a reduction of approximately 130
employees primarily involved in customer service and
manufacturing positions.

In the last quarter of fiscal year 2001, we
recorded a $1.7 million severance charge in connection with
the retirement of our former Chairman and Chief Technical
Officer. All obligations were fulfilled in the fiscal year ended
March 31, 2003.



| |                                       
| | --------------------------------------
| | Consolidation of Excess
    Facilities

The Company incurred a $0.7 million
restructuring charge in fiscal 2003 for two excess facilities
leased by Sensys in Santa Clara, California. The Company
also vacated a third facility on Kato Road for which it did not
incur a restructuring charge due to ongoing use of the facility
for storage purposes. The remaining lease obligations on vacated
facilities in Santa Clara that are non-cancelable, net of
the income from subleasing these facilities, are estimated to be
approximately $0.7 million. The income from subleasing
these facilities is estimated based upon current comparable
rates for leases in the applicable market. If facilities rental
rates decrease in the market, or if it takes longer than
expected to sublease these facilities, the actual loss could
exceed this estimate. During fiscal 2004, $0.1 million was
recorded as additional leased facility charges when we entered
into a sublease on one of the two excess facilities. The
$0.1 million charge reflects the difference between the
estimated sublease income and the actual sublease income for
this facility.

During fiscal 2003, restructuring costs related
to abandoned property and equipment amounted to
$0.5 million, which represented the net book value of fixed
assets as of March 31, 2003 relating to the consolidation
of Sensys operations into the Companys Fremont,
California facility. The fixed assets included in the
restructuring charges were removed from service prior to
March 31, 2003.



| |            
| | -----------
| | Other Costs

At March 31, 2003, other costs of
$0.1 million relate to reduction in force programs such as
security service, hotel, counseling services and COBRA. As of
the end of fiscal 2004, all accrued liabilities related to other
costs of workforce reduction have been paid.



|   |                 
|-- | ----------------
|9. | Warranty Accrual

Under its warranty obligations, the Company is
required to repair or replace defective products or parts,
generally at a customers site, during the warranty period
at no cost to the customer. At the time of systems shipment, we
provide an accrual for estimated costs to be incurred pursuant
to our warranty obligation. Our estimate is based primarily on
historical experience. The actual warranty costs may differ from
historical experience, and in those cases, the Company adjusts
its warranty accrual accordingly. Changes in the warranty
accrual during fiscal 2004 and 2003 are summarized as follows
(in thousands):

|                                                            |  |           |       |                |  |                |       |         |  |   |        |   |  |   |       | 
|----------------------------------------------------------- |  | --------- | ----- | -------------- |  | -------------- | ----- | ------- |  | - | ------ | - |  | - | ----- | 
|                                                            |  |           |       | Provisions for |  |                |       |        
|                                                            |  |           |       | Warranties     |  | Settlements of |       |        
|                                                            |  | Beginning |       | Issued During  |  | Pre-Existing   |       | Ending 
|                                                            |  | Balance   |       | the Period     |  | Warranties     |       | Balance
|                                                            |  |           |       |                |  |                |       |        
|Fiscal year as of and for the year ended
    March 31, 2004 |  | $         | 983   |                |  | $              | 2,417 |         |  | $ | (1,669 | ) |  | $ | 1,731 | 
|                                                            |  |           |       |                |  |                |       |         |  |   |        |   |  |   |       | 
|Fiscal year as of and for the year ended
    March 31, 2003 |  | $         | 1,777 |                |  | $              | 937   |         |  | $ | (1,731 | ) |  | $ | 983   | 
|                                                            |  |           |       |                |  |                |       |         |  |   |        |   |  |   |       | 



|    |               
|--- | --------------
|10. | Treasury Stock

On August 1, 2002, the Companys Board
of Directors announced a stock repurchase program for the
repurchase of up to one million shares of Therma-Waves
common stock. As of March 31, 2004, the Company

61



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

repurchased 447,500 shares of common stock
at an average price of $2.10 per share, of which
414,168 shares were reissued under our Employee Stock
Purchase Plan, 30,675 shares were reissued to pay for
consulting services and 2,657 shares were reissued upon
exercise of stock options. These shares are to be used for
various purposes, including, without limitation, satisfying
stock option exercises and employee stock purchase plan
requirements. The repurchase program is currently suspended but
at any time and from time to time may be reactivated without
prior notice.



|    |                                     
|--- | ------------------------------------
|11. | Goodwill and Other Intangible Assets

In connection with our acquisition of Sensys
Instruments Corporation, effective January 16, 2002, the
Company recorded $65.9 million of goodwill and
$4.5 million of intangible assets, consisting of developed
technology, development contract and trade name. The intangible
assets were being amortized on a straight-line basis over the
original estimated lives of two to five years.

The following table summarizes the components of
other intangible assets and the related accumulated amortization
balances (in thousands):

|                       |                      |                |       |                |  |          |        |          |   |              |   |          |  |   |       |       |  |   |        |      |   |   |       |       | 
|---------------------- | -------------------- | -------------- | ----- | -------------- |  | -------- | ------ | -------- | - | ------------ | - | -------- |  | - | ----- | ----- |  | - | ------ | ---- | - | - | ----- | ----- | 
|                       |                      |                |       |               
|                       |                      | March 31, 2004 |       | March 31, 2003
|                       |                      |                |       |               
|                       |                      | Gross          |       |                |  | Net      |        | Gross    |   |              |   | Net     
|                       |                      | Carrying       |       | Accumulated    |  | Carrying |        | Carrying |   | Accumulated  |   | Carrying
|                       |                      | Amount         |       | Amortization   |  | Amount   |        | Amount   |   | Amortization |   | Amount  
|                       |                      |                |       |                |  |          |        |          |   |              |   |         
|Intangible assets      |                      |                |       |                |  |          |        |          |   |              |   |          |  |   |       |       |  |   |        |      |   |   |       |      
|                       | Developed technology |                | $     | 314            |  |          | $      | (314     | ) |              | $ |         |  |   | $     | 314   |  |   | $      | (314 | ) |   | $     |      | 
|                       | Development contract |                |       | 2,415          |  |          |        | (2,415   | ) |              |   |         |  |   |       | 2,415 |  |   |        | (604 | ) |   |       | 1,811 | 
|                       | Trade name           |                |       | 197            |  |          |        | (197     | ) |              |   |         |  |   |       | 197   |  |   |        | (197 | ) |   |       |      | 
|                       |                      |                |       |                |  |          |        |          |   |              |   |          |  |   |       |       |  |   |        |      |   |   |       |      
|Intangible assets, net |                      | $              | 2,926 |                |  | $        | (2,926 | )        |   | $            |  |          |  | $ | 2,926 |       |  | $ | (1,115 | )    |   | $ | 1,811 |      
|                       |                      |                |       |                |  |          |        |          |   |              |   |          |  |   |       |       |  |   |        |      |   |   |       |      

During the quarter ended September 30, 2002,
due to operating losses, the absence of positive cash flows,
significant declines in our common stock price and uncertainties
resulting from the duration and severity of the industry
downturn, we assessed the recoverability of the intangible
assets related to the Sensys acquisition subject to amortization
in accordance with SFAS No. 144 and tested goodwill
related to the Sensys acquisition for impairment in accordance
with SFAS No. 142. In assessing the recoverability of
the intangible assets related to the Sensys acquisition in
accordance SFAS No. 144 we projected significantly
reduced future cash flows related to Sensys products and
therefore we recognized an impairment expense of
$0.6 million for developed technology, $0.2 million
for a development contract and $0.4 million for trade name
intangible assets in the quarter ended September 30, 2002.
In addition, during the quarter ended March 31, 2003, we
recognized an additional impairment charge of $0.4 million
related to trade name intangible assets.

The goodwill acquisition impairment test under
SFAS No. 142 was based on a two-step process involving
comparing the estimated fair value of the related reporting unit
to its net book value, and comparing the estimated implied fair
value of goodwill to its carrying value. As a result of the
impairment test, we wrote down goodwill assets by
$65.9 million in the quarter ended September 30, 2002.

During the quarter ended December 31, 2003,
due to the termination of a development agreement, we
accelerated the amortization on $1.5 million of the related
development contract intangible assets.

Amortization of these acquisition-related
intangible assets was $1.8 million, $0.9, and $0.2 for the
fiscal years ended March 31, 2004, 2003 and 2002,
respectively.

Capitalized patent acquisition costs are included
in non-current other assets, net. Capitalized patent acquisition
costs are amortized over the estimated useful life of the
patent, generally five years. Amortization

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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

of patent assets was $0.7 million,
$0.6 million and $0.4 million for the fiscal years
ended March 31, 2004, 2003 and 2002, respectively.



|    |                                             
|--- | --------------------------------------------
|12. | Stock Options, Common Stock and
    Warrants



| |             
| | ------------
| | Common Stock

On January 16, 2002, we issued approximately
4.47 million shares of common stock to the former
shareholders of Sensys in connection with the Sensys
acquisition, of which 540,724 shares were being held in
escrow for a period of 18 months and during that time were
to be used to satisfy certain working capital adjustments and
indemnification claims, as necessary. At the end of the
18 month escrow holding period, the 540,724 escrow shares
were distributed to the former shareholders of Sensys.



| |                         
| | ------------------------
| | Stock-Based Compensation

Stock Options.During fiscal year 1998, we adopted several stock option plans
(the 1997 Plans) whereby the Board of Directors may
have granted incentive stock options and non-statutory stock
options to employees, directors or consultants.

In connection with our initial public offering,
we adopted the 2000 Equity Incentive Plan, whereby the Board of
Directors may grant incentive stock options and non-statutory
stock options to employees, directors or consultants. No future
grants became available under the 1997 Plans upon the
effectiveness of the 2000 Equity Incentive Plan. We have
reserved (1) 3,300,000 shares of common stock
(2) any shares returned to the 1997 Plans as a result of
termination of options and (3) annual increases to be added
on the date of each annual meeting of stockholders commencing in
2000 equal to 1.0% of the outstanding shares of common stock, or
such lesser amount as may be determined by the Board of
Directors, for issuance under the 2000 Equity Incentive Plan.

Vesting provisions for stock options granted
under our stock option plans are determined by the Board of
Directors. Generally, unless the Board of Directors specifically
determines otherwise at the time of the grant, the options shall
vest 25% on first anniversary of the grant and then vest monthly
thereafter for the remaining thirty-six months, i.e., one
forty-eighth (2.083%) per month from the date of grant,
beginning with stock options granted on April 30, 2002.
Prior to April 30, 2002, options vested 25% on each of the
first four anniversaries from the date of grant. Stock options
expire ten years from the date of grant, except for stock
options issued September 10, 2003 in the employee stock
option exchange program which expire four years from the date of
grant. Common shares issued on exercise of options prior to
vesting are subject to repurchase if the holder is no longer
employed by us.

63



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

A summary of our stock option activity, and
related information for the years ended March 31, 2004,
2003 and 2002 is as follows:

|                          |  |                       |            |                   |  |                  |            |   |  |   |       | 
|------------------------- |  | --------------------- | ---------- | ----------------- |  | ---------------- | ---------- | - |  | - | ----- | 
|                          |  |                      
|                          |  | Stock Options        
|                          |  |                      
|                          |  |                       |            | Weighted         
|                          |  | Options Available for |            | Number of Options |  | Average Exercise
|                          |  | Future Issuance       |            | Outstanding       |  | Price Per Option
|                          |  |                       |            |                   |  |                 
|Balance at March 31, 2001 |  |                       | 2,579,735  |                   |  |                  | 3,683,967  |   |  | $ | 12.48 | 
|Authorized                |  |                       | 241,241    |                   |  |                  |           |   |  |   |       | 
|Granted                   |  |                       | (2,036,810 | )                 |  |                  | 2,036,810  |   |  |   | 10.00 | 
|Exercised                 |  |                       |           |                   |  |                  | (132,434   | ) |  |   | 6.62  | 
|Forfeited                 |  |                       | 572,250    |                   |  |                  | (572,250   | ) |  |   | 13.95 | 
|                          |  |                       |            |                   |  |                  |            |   |  |   |       | 
|Balance at March 31, 2002 |  |                       | 1,356,416  |                   |  |                  | 5,016,093  |   |  | $ | 11.46 | 
|Authorized                |  |                       | 292,107    |                   |  |                  |           |   |  |   |       | 
|Granted                   |  |                       | (1,790,828 | )                 |  |                  | 1,790,828  |   |  |   | 1.39  | 
|Exercised                 |  |                       |           |                   |  |                  | (24,246    | ) |  |   | 5.42  | 
|Forfeited                 |  |                       | 1,026,318  |                   |  |                  | (1,026,318 | ) |  |   | 11.82 | 
|                          |  |                       |            |                   |  |                  |            |   |  |   |       | 
|Balance at March 31, 2003 |  |                       | 884,013    |                   |  |                  | 5,756,357  |   |  | $ | 8.27  | 
|Authorized                |  |                       | 1,293,755  |                   |  |                  |           |   |  |   |      | 
|Granted                   |  |                       | (3,174,844 | )                 |  |                  | 3,174,844  |   |  |   | 2.45  | 
|Exercised                 |  |                       |           |                   |  |                  | (96,558    | ) |  |   | 1.44  | 
|Forfeited                 |  |                       | 3,302,576  |                   |  |                  | (3,302,576 | ) |  |   | 10.35 | 
|                          |  |                       |            |                   |  |                  |            |   |  |   |       | 
|Balance at March 31, 2004 |  |                       | 2,305,500  |                   |  |                  | 5,532,067  |   |  | $ | 3.81  | 
|                          |  |                       |            |                   |  |                  |            |   |  |   |       | 

The following table summarizes information about
stock options outstanding as of March 31, 2004:

|                          |  |                                 |      |                         |  |           |           |           |  |           |       |  |  |  |           |  |  |   |       | 
|------------------------- |  | ------------------------------- | ---- | ----------------------- |  | --------- | --------- | --------- |  | --------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|                          |  |                                 |      |                         |  |           |           |          
|                          |  |                                 |      | Total Exercisable Stock
|                          |  | Total Stock Options Outstanding |      | Options                
|                          |  |                                 |      |                        
|                          |  | Weighted                        |      |                         |  | Weighted  |           |           |  | Weighted 
|                          |  | Average                         |      |                         |  | Average   |           |           |  | Average  
|                          |  | Remaining                       |      |                         |  | Exercise  |           |           |  | Exercise 
|                          |  | Contractual Life                |      | Stock Options           |  | Price Per |           | Number of |  | Price Per
|                          |  | (Years)                         |      | Outstanding             |  | Option    |           | Options   |  | Option   
|                          |  |                                 |      |                         |  |           |           |           |  |          
|Range of exercise prices: |  |                                 |      |                         |  |           |           |           |  |           |       |  |  |  |           |  |  |   |       | 
|$0.42 - $0.42             |  |                                 | 8.96 |                         |  |           | 400,000   |           |  | $         | 0.42  |  |  |  | 100,000   |  |  | $ | 0.42  | 
|$0.47 - $0.47             |  |                                 | 9.07 |                         |  |           | 831,050   |           |  | $         | 0.47  |  |  |  |          |  |  | $ |      | 
|$0.60 - $0.66             |  |                                 | 8.83 |                         |  |           | 565,800   |           |  | $         | 0.65  |  |  |  | 151,557   |  |  | $ | 0.65  | 
|$0.82 - $1.37             |  |                                 | 3.42 |                         |  |           | 78,565    |           |  | $         | 1.12  |  |  |  | 78,565    |  |  | $ | 1.12  | 
|$1.64 - $2.35             |  |                                 | 8.51 |                         |  |           | 575,897   |           |  | $         | 2.01  |  |  |  | 128,894   |  |  | $ | 1.57  | 
|$2.38 - $2.38             |  |                                 | 3.45 |                         |  |           | 935,638   |           |  | $         | 2.38  |  |  |  |          |  |  | $ |      | 
|$2.48 - $3.51             |  |                                 | 8.94 |                         |  |           | 431,809   |           |  | $         | 2.84  |  |  |  | 109,134   |  |  | $ | 2.48  | 
|$4.00 - $4.70             |  |                                 | 8.91 |                         |  |           | 569,007   |           |  | $         | 4.24  |  |  |  | 82,526    |  |  | $ | 4.08  | 
|$6.37 - $8.93             |  |                                 | 6.70 |                         |  |           | 400,168   |           |  | $         | 7.50  |  |  |  | 194,077   |  |  | $ | 8.64  | 
|$10.68 - $15.89           |  |                                 | 5.03 |                         |  |           | 657,318   |           |  | $         | 12.28 |  |  |  | 491,608   |  |  | $ | 12.30 | 
|$18.25 - $27.50           |  |                                 | 6.27 |                         |  |           | 86,815    |           |  | $         | 22.74 |  |  |  | 70,112    |  |  | $ | 22.64 | 
|                          |  |                                 |      |                         |  |           |           |           |  |           |       |  |  |  |           |  |  |   |       | 
|TOTAL                     |  |                                 | 7.23 |                         |  |           | 5,532,067 |           |  | $         | 3.81  |  |  |  | 1,406,473 |  |  | $ | 7.36  | 
|                          |  |                                 |      |                         |  |           |           |           |  |           |       |  |  |  |           |  |  |   |       | 

64



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Pro forma information regarding net loss and net
loss per share is required by SFAS No. 123, which also
requires that the information be determined as if we have
accounted for our employee stock options granted subsequent to
March 31, 1996 under the fair value method. The fair value
for these options was estimated using the Black-Scholes option
pricing model.

For the years ended March 31, 2004, 2003 and
2002, the fair value of each option grant was estimated on the
date of the grant using the Black-Scholes option-pricing model
with the following assumptions:

|                        |  |                    |       |      |  |      |     |   |  |  |     |  
|----------------------- |  | ------------------ | ----- | ---- |  | ---- | --- | - |  |  | --- | -
|                        |  |                   
|                        |  | Fiscal Years Ended
|                        |  | March 31,         
|                        |  |                   
|                        |  | 2004               |       | 2003 |  | 2002
|                        |  |                    |       |      |  |     
|Risk-free interest rate |  |                    | 3.985 | %    |  |      | 3.6 | % |  |  | 4.5 | %
|Expected dividend yield |  |                    |      |      |  |      |    |   |  |  |    |  
|Expected volatility     |  |                    | 118   | %    |  |      | 116 | % |  |  | 90  | %
|Expected life in years  |  |                    | 3.87  |      |  |      | 4.5 |   |  |  | 5   |  

Employee Stock Purchase
Plan.In connection with our initial
public offering, we adopted the 2000 Employee Stock Purchase
Plan, whereby employees may purchase shares of common stock, at
a discounted price through payroll deductions or lump sum cash
payments. We have reserved 2,500,000 shares of common stock
for issuance under the 2000 Employee Stock Purchase Plan. A
total of 510,952, 353,020 and 295,199 shares, respectively,
of common stock have been issued under the 2000 Employee Stock
Purchase Plan for the years ended March 31, 2004, 2003 and
2002, respectively.

For the years ended March 31, 2004, 2003 and
2002, the following weighted-average assumptions were used to
determine the fair value of purchase rights under the 2000
Employee Stock Purchase Plan:

|                        |  |                    |      |      |  |      |      |   |  |  |     |  
|----------------------- |  | ------------------ | ---- | ---- |  | ---- | ---- | - |  |  | --- | -
|                        |  |                   
|                        |  | Fiscal Years Ended
|                        |  | March 31,         
|                        |  |                   
|                        |  | 2004               |      | 2003 |  | 2002
|                        |  |                    |      |      |  |     
|Risk-free interest rate |  |                    | 0.86 | %    |  |      | 1.75 | % |  |  | 4.5 | %
|Expected dividend yield |  |                    |     |      |  |      |     |   |  |  |    |  
|Expected volatility     |  |                    | 125  | %    |  |      | 136  | % |  |  | 90  | %
|Expected life in years  |  |                    | 1    |      |  |      | 1    |   |  |  | 1   |  

Deferred Stock-Based
Compensation.In connection with the
Sensys acquisition, we recognized unearned compensation of
$3.5 million for stock options granted. Deferred
stock-based compensation is amortized to expense over the
vesting period using an accelerated method, and may decrease if
employees terminate service prior to vesting. We recognized
stock-based compensation of $0.6 million,
$1.7 million, and $0.6 million in fiscal 2004, 2003
and 2002, respectively, relating to stock-based compensation
with respect to the Sensys acquisition.

During the second quarter of fiscal 2004, we
commenced and completed an employee stock option exchange
program. The voluntary program allowed Therma-Wave employees,
excluding officers and directors, to return to the Company
existing options issued before July 1, 2002 with an
exercise price greater than $2.00 per share and exchange
them for new options that were granted on September 10,
2003. The number of new options granted in the employee stock
option exchange program was equal to 75% of the number of
options canceled in the exchange. The new option grants have a
different vesting schedule from the original option grants and
have an exercise price equal to $2.38, the fair market value of
our common stock on September 10, 2003. Of the 1,366,570
options eligible for exchange, 1,352,108 options, or 99%, were
exchanged for 1,014,144 new options with an exercise price of
$2.38. The replacement options are unvested as of March 31,
2004. These replacement options vest 50% on June 11, 2004,
and 50% on April 11, 2005 or according to the performance
vesting schedules of specific option grants.

65



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

As a result of the modification to the exercise
price of the stock options, the replacement options are
accounted for as variable from the date of modification until
the option is either exercised, forfeited, canceled or expired.
As of March 31, 2004, the Company has recorded
approximately $0.7 million in compensation expense. This
charge reflects the new options eligible for exchange which were
outstanding since September 10, 2003 and reflects options
issued to eligible participants within the six months prior to
or following September 10, 2003. Due to the options
requiring variable accounting treatment, expense is being
recorded for the pro-rata vesting over time of these options
based on increases in the stock price over and above the
exercise price of the new options. In future quarters, the
expense could increase as the pro-rata vesting over time for
these shares increases and if the stock price increases.
Reductions to expense may also be recorded if the stock price
decreases, but such reductions will be limited to the net
expense previously reported.

Warrants.In
connection with the Sensys acquisition in January 2002, we
assumed warrants to purchase 329,490 shares of our
common stock. These warrants were fully exercisable in January
2003. Of the 329,490 warrants, 78,516 warrants were still
outstanding as of March 31, 2004 and March 31, 2003,
respectively. These 78,516 warrants are exercisable at a
weighted average exercise price of $3.68 per share for an
aggregate purchase value of $0.3 million.



|    |                           
|--- | --------------------------
|13. | Related Party Transactions

Ms. Talat Hasan, a former member of our
Board of Directors and former Senior Vice President of
Therma-Wave and President and Chief Executive Officer of Sensys,
is a general partner of Hitek Venture Partners Limited
Partnership, or Hitek. Sensys, a wholly owned subsidiary of
Therma-Wave, leases from Hitek certain facilities occupied by
Sensys in Santa Clara, California. For each of the years
ended March 31, 2004, 2003 and 2002, Hitek received
$0.3 million, $0.3 million and $45,000, respectively,
from the lease of such facilities.

Mr. David Aspnes, a member of our Board of
Directors, is also an owner of Aspnes Associates, Inc. We use
Aspnes Associates, Inc. for consulting service on various
engineering projects and have paid $5,000, $59,000 and $40,000
to Aspnes Associates, Inc. during fiscal 2004, 2003 and 2002,
respectively. Accounts payable to Aspnes Associates, Inc. were
$3,000, $6,000 and $4,000 as of March 31, 2004,
March 31, 2003 and March 31, 2002, respectively.

John DErrico, a member of our Board of
Directors, is also Executive Vice President, Storage Components
of LSI Logic Corporation. Our revenues from sales to LSI Logic
in fiscal 2004 and 2003 were $1,163,000 and $252,000,
respectively. As of March 31, 2004 and 2003, the accounts
receivable from LSI Logic were $98,000 and $12,000, respectively.

As of March 31, 2004 and 2003, we had an
aggregate $1.1 million in outstanding loans to former
members of management. During fiscal 2004, one former executive
repaid in full two loans worth $58,000 combined. As of
March 31, 2004 loans of approximately $0.2 million
that were used by former management to acquire our capital stock
are reported in stockholders equity as notes receivable
from stockholders. Loans of approximately $0.9 million that
were used to pay certain tax liabilities incurred by former
executives are included in non-current other assets. The
$0.2 million in loans used to acquire our capital stock
bear interest at the applicable federal rate in effect at the
time. The $0.9 million in loans used to pay certain tax
liabilities do not bear interest. The individuals who owe us
$0.9 million have pledged their Therma-Wave stock as
security for these amounts. We have $0.9 million in
reserves against the realizeable value of the $0.9 million
in loans used to pay certain tax liabilities.

66



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                 
|--- | ----------------
|14. | Retirement Plans

We have a retirement plan under
Section 401(k) of the Internal Revenue Code covering
substantially all employees. Discretionary company contributions
accrued, which are based on achieving certain operating profit
goals, were $0 in each of fiscal 2004, 2003 and 2002,
respectively.

We allow our U.S.-based officers and
director-level employees to defer a portion of their
compensation under the Deferred Executive Compensation Plan.
Plan participants self-direct their investments deferred under
the plan. In the event the Company becomes insolvent, plan
assets are subject to the claims of the general creditors. Since
the inception of the plan, we have not made any matching or
discretionary contributions to the plan. There are no plan
provisions that provide for any guarantees or minimum return on
investments. At March 31, 2004, there were approximately 17
participants in the plan and plan assets were approximately
$0.5 million. Investment returns of the participants
increase or decrease the companys liability to the
participants, thereby impacting our results of operations.



|    |                    
|--- | -------------------
|15. | Segment Information

We operate in one segment as we manufacture,
market and service process control metrology systems within the
semiconductor equipment market. All products and services are
marketed in each geographic region in which we operate. Our
current product offerings qualify for aggregation under
SFAS No. 131 as our products are manufactured and
distributed in the same manner, have similar long-term gross
margins and are sold to the same customer base.

Revenues in each geographic area are recognized
according to our revenue recognition policy as described in
Note 1 of these Notes to Consolidated Financial Statements.
Transfers and commission arrangements between geographic areas
are at prices sufficient to recover a reasonable profit. Export
sales were $47.2 million, $35.4 million, and
$50.6 million in fiscal 2004, 2003 and 2002, respectively.

67



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##### Table of Contents



THERMA-WAVE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following is a summary of operations in
geographic areas. Other foreign areas include China, Taiwan,
Israel and Korea, each of which is individually not material for
separate disclosure (in thousands).

|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|------------------------------------ |  | ---- | -------- | ----- |  | -- | ----- | ------------- |  | ------------ | ----- | ------------ |  | - | ----- | - |  | - | ------- | - |  | - | -------- | -
|                                     |  |      |          |       |  |    |       | Other Foreign |  |              |       |             
|                                     |  | U.S. |          | Japan |  | UK |       | Locations     |  | Eliminations |       | Consolidated
|                                     |  |      |          |       |  |    |       |               |  |              |       |             
|Fiscal Year Ended March 31, 2002     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Sales to unaffiliated customers      |  | $    | 75,377   |       |  | $  | 2,192 |               |  | $            | 1,534 |              |  | $ | 2,834 |   |  | $ |        |   |  | $ | 81,937   |  
|Transfers between geographic regions |  |      | (1,945   | )     |  |    | 1,981 |               |  |              | 940   |              |  |   | 2,159 |   |  |   | (3,135  | ) |  |   |         |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Total net revenues                   |  | $    | 73,432   |       |  | $  | 4,173 |               |  | $            | 2,474 |              |  | $ | 4,993 |   |  | $ | (3,135  | ) |  | $ | 81,937   |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Operating income (loss)              |  | $    | (50,465  | )     |  | $  | (58   | )             |  | $            | 242   |              |  | $ | (95   | ) |  | $ | (2,282  | ) |  | $ | (52,658  | )
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Long-lived assets                    |  | $    | 94,535   |       |  | $  | 330   |               |  | $            | 64    |              |  | $ | 647   |   |  | $ | (6,716  | ) |  | $ | 88,860   |  
|All other identifiable assets        |  |      | 109,553  |       |  |    | 2,802 |               |  |              | 3,022 |              |  |   | 2,503 |   |  |   | (5,094  | ) |  |   | 112,786  |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Total assets                         |  | $    | 204,088  |       |  | $  | 3,132 |               |  | $            | 3,086 |              |  | $ | 3,150 |   |  | $ | (11,810 | ) |  | $ | 201,646  |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Fiscal Year Ended March 31, 2003     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Sales to unaffiliated customers      |  | $    | 41,039   |       |  | $  | 2,181 |               |  | $            | 2,220 |              |  | $ | 3,780 |   |  | $ |        |   |  | $ | 49,220   |  
|Transfers between geographic regions |  |      | (1,460   | )     |  |    | 986   |               |  |              | 800   |              |  |   | 1,588 |   |  |   | (1,914  | ) |  |   |         |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Total net revenues                   |  | $    | 39,579   |       |  | $  | 3,167 |               |  | $            | 3,020 |              |  | $ | 5,368 |   |  | $ | (1,914  | ) |  | $ | 49,220   |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Operating income (loss)              |  | $    | (134,042 | )     |  | $  | (116  | )             |  | $            | (955  | )            |  | $ | (21   | ) |  | $ | 607     |   |  | $ | (134,527 | )
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Long-lived assets                    |  | $    | 21,350   |       |  | $  | 303   |               |  | $            | 44    |              |  | $ | 518   |   |  | $ | (6,896  | ) |  | $ | 15,319   |  
|All other identifiable assets        |  |      | 60,183   |       |  |    | 2,333 |               |  |              | 1,430 |              |  |   | 2,749 |   |  |   | (14,311 | ) |  |   | 52,384   |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Total assets                         |  | $    | 81,533   |       |  | $  | 2,636 |               |  | $            | 1,474 |              |  | $ | 3,267 |   |  | $ | (21,207 | ) |  | $ | 67,703   |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Fiscal Year Ended March 31, 2004     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Sales to unaffiliated customers      |  | $    | 57,778   |       |  | $  | 2,355 |               |  | $            | 1,787 |              |  | $ | 3,389 |   |  | $ |        |   |  | $ | 65,309   |  
|Transfers between geographic regions |  |      | (574     | )     |  |    | 556   |               |  |              | 655   |              |  |   | 1,585 |   |  |   | (2,222  | ) |  |   |         |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Total net revenues                   |  | $    | 57,204   |       |  | $  | 2,911 |               |  | $            | 2,442 |              |  | $ | 4,974 |   |  | $ | (2,222  | ) |  | $ | 65,309   |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Operating income (loss)              |  | $    | (16,776  | )     |  | $  | (218  | )             |  | $            | 381   |              |  | $ | (388  | ) |  | $ | (946    | ) |  | $ | (17,947  | )
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Long-lived assets                    |  | $    | 13,505   |       |  | $  | 233   |               |  | $            |      |              |  | $ | 456   |   |  | $ | (6,920  | ) |  | $ | 7,274    |  
|All other identifiable assets        |  |      | 54,391   |       |  |    | 2,383 |               |  |              | 629   |              |  |   | 2,657 |   |  |   | (2,145  | ) |  | $ | 57,915   |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  
|Total assets                         |  | $    | 67,896   |       |  | $  | 2,616 |               |  | $            | 629   |              |  | $ | 3,113 |   |  | $ | (9,065  | ) |  | $ | 65,189   |  
|                                     |  |      |          |       |  |    |       |               |  |              |       |              |  |   |       |   |  |   |         |   |  |   |          |  

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THERMA-WAVE, INC.

QUARTERLY FINANCIAL DATA (UNAUDITED)

|                    |                   |                  |        |                  |   |    |        |       |   |      |        |       |   |    |        |       |   |    |         |       |   |   |         |       |   |   |         |       |   |   |         |       |   |   |         |       |   |   |          |       |  
|------------------- | ----------------- | ---------------- | ------ | ---------------- | - | -- | ------ | ----- | - | ---- | ------ | ----- | - | -- | ------ | ----- | - | -- | ------- | ----- | - | - | ------- | ----- | - | - | ------- | ----- | - | - | ------- | ----- | - | - | ------- | ----- | - | - | -------- | ----- | -
|                    |                   |                  |        |                 
|                    |                   | Fiscal Year 2004 |        | Fiscal Year 2003
|                    |                   |                  |        |                 
|                    |                   | Q1               |        | Q2               |   | Q3 |        | Q4    |   | Year |        | Q1    |   | Q2 |        | Q3    |   | Q4 |         | Year 
|                    |                   |                  |        |                  |   |    |        |       |   |      |        |       |   |    |        |       |   |    |         |      
|Net revenues        |                   | $                | 11,903 |                  |   | $  | 14,066 |       |   | $    | 19,866 |       |   | $  | 19,474 |       |   | $  | 65,309  |       |   | $ | 14,949  |       |   | $ | 10,945  |       |   | $ | 10,249  |       |   | $ | 13,077  |       |   | $ | 49,220   |      
|Gross profit (loss) |                   | $                | 2,832  |                  |   | $  | 5,567  |       |   | $    | 9,962  |       |   | $  | 8,448  |       |   | $  | 26,809  |       |   | $ | 3,078   |       |   | $ | (7,024  | )     |   | $ | 16      |       |   | $ | (1,911  | )     |   | $ | (5,841   | )    
|Operating loss      |                   | $                | (9,339 | )                |   | $  | (5,782 | )     |   | $    | (1,027 | )     |   | $  | (1,799 | )     |   | $  | (17,947 | )     |   | $ | (11,624 | )     |   | $ | (90,399 | )     |   | $ | (13,347 | )     |   | $ | (19,157 | )     |   | $ | (134,527 | )    
|Net loss            |                   | $                | (9,534 | )                |   | $  | (5,728 | )     |   | $    | (1,031 | )     |   | $  | (1,800 | )     |   | $  | (18,093 | )     |   | $ | (11,303 | )     |   | $ | (89,886 | )     |   | $ | (13,290 | )     |   | $ | (19,125 | )     |   | $ | (133,604 | )    
|Net loss per share: |                   |                  |        |                  |   |    |        |       |   |      |        |       |   |    |        |       |   |    |         |       |   |   |         |       |   |   |         |       |   |   |         |       |   |   |         |       |   |   |          |      
|                    | Basic and diluted |                  | $      | (0.33            | ) |    | $      | (0.19 | ) |      | $      | (0.03 | ) |    | $      | (0.05 | ) |    | $       | (0.56 | ) |   | $       | (0.40 | ) |   | $       | (3.16 | ) |   | $       | (0.47 | ) |   | $       | (0.66 | ) |   | $        | (4.69 | )

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|        |                                                                           
|------- | --------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants and Financial Disclosure

Not applicable.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

We maintain disclosure controls and
procedures, as this term is defined in Rule 13a-15(e)
under the Securities Exchange Act of 1934, or the Exchange Act,
that are designated to ensure that information required to be
disclosed by us in reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange
Commission rules and forms, and that this information is
accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosure.

In designing and evaluating our disclosure
controls and procedures, management recognized that disclosure
controls and procedures, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance
that the objectives of the disclosure controls and procedures
are met. Additionally, in designing disclosure controls and
procedures, our management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible
disclosure controls and procedures. The design of any disclosure
controls and procedures also is based in part upon certain
assumptions about the likelihood of future events, and there can
be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions.

During fiscal year 2003, we identified two
material weaknesses related to controls surrounding evaluating
and reporting revenue transactions, particularly in the Asia/
Pacific region, and our processes relating to account analysis
and reconciliations, including lack of timely management review.
As a result, in fiscal 2004, we implemented several changes and
additions to our internal controls and procedures. We have not
identified similar material weaknesses or any other material
weaknesses during fiscal year 2004.

Based on their evaluation as of the end of the
period covered by this annual report on Form 10-K, our
Chief Executive Officer and Chief Financial Officer have
concluded that, subject to the limitations noted above, our
disclosure controls and procedures were effective to ensure that
material information relating to us, including our consolidated
subsidiaries, is made known to them by others within those
entities, particularly during the period in which this annual
report on Form 10-K was being prepared.

There was no change in our internal control over
financial reporting that occurred during our fourth fiscal
quarter of fiscal 2004 that has materially affected, or is
reasonably likely to materially affect, our internal control
over financial reporting, except as noted above.




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

Information concerning directors and executive
officers of Therma-Wave, Inc. will appear in the proxy statement
for our 2004 annual stockholders meeting, under the
Management section. This portion of the proxy
statement is incorporated herein by reference.

We have adopted a Code of Ethics that applies to
all of our officers, directors and employees. The Code of Ethics
is filed as an exhibit to this annual report on Form 10-K.






|         |                                       
|-------- | --------------------------------------
|Item 11. | Compensation of Executive
    Officers

Information concerning compensation of executive
officers of Therma-Wave, Inc. will appear in the proxy statement
for our 2004 annual stockholders meeting, under the
Management section. This portion of the proxy
statement is incorporated herein by reference.

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|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

Information concerning the security ownership of
certain beneficial owners and management will appear in
Therma-Waves proxy statement for our 2004 annual
stockholders meeting, under the Principle
Stockholders section. This portion of the proxy statement
is incorporated herein by reference.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

Information concerning certain relationships and
related transactions will appear in the proxy statement for our
2004 annual stockholders meeting, under the Certain
Relationships and Related Transactions section. This
portion of the proxy statement is incorporated herein by
reference.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

PricewaterhouseCoopers LLP, who have been our
independent registered public accounting firm for the past
fiscal year, have again been selected by the audit committee to
be Therma-Waves independent public accountants for fiscal
year 2005.

The following table sets forth the aggregate fees
billed or to be billed by PricewaterhouseCoopers for the
following services during fiscal years 2004, 2003 and 2002.
Under the SECs new rule on auditor independence, which is
effective for the first fiscal year ending after
December 15, 2003 and was adopted as a result of
implementing the Sarbanes-Oxley Act of 2002, the fees are
categorized as follows:

|                   |       |      |         |         |  |   |         |         | 
|------------------ | ----- | ---- | ------- | ------- |  | - | ------- | ------- | 
|Category of Fees   |       | 2004 |         | 2003   
|                   |       |      |         |        
|Audit fees         |       | $    | 440,034 |         |  | $ | 216,260 |        
|Audit-related fees |       |      | 365,000 |         |  |   | 161,450 |        
|Tax fees           |       |      | 7,391   |         |  |   | 140,499 |        
|                   |       |      |         |         |  |   |         |        
|                   | Total |      | $       | 812,425 |  |   | $       | 518,209 | 

Audit fees.Aggregate fees for the years ended March 31, 2004 and
March 31, 2003, respectively, were for professional
services rendered for the audits of our consolidated financial
statements and limited reviews of our unaudited condensed
consolidated interim financial statements, issuance of consents
and assistance with review of documents filed with the SEC,
including filings related to the private placement of common
stock that we completed in September 2003.

Audit-related fees.Audit-related fees for the years ended March 31, 2004 and
2003, respectively, included services related to investigation
work in connection with the review of certain of our financial
statements and quarterly reports for fiscal year 2004 and 2003
and services related to due diligence of a potential acquisition
in fiscal 2003.

Tax fees.Aggregate
fees for the years ended March 31, 2004 and March 31,
2003, respectively, were for services related to tax compliance,
including the preparation of tax returns and claims for refunds,
tax planning and tax advice, including assistance with tax
audits, assistance with ex-patriot tax return calculations for
employee compensation purposes, assistance with documentation
and filing for certain tax credits and advice related to mergers
and acquisitions.

Our audit committee has considered the role of
PricewaterhouseCoopers LLP in providing tax and audit services
and other non-audit services to Therma-Wave and has concluded
that such services are compatible with PricewaterhouseCoopers
LLPs independence as our accountants.

Our audit committee must now pre-approve all
non-audit services provided to us by our independent
accountants. According to our revised audit committee charter, a
copy of which will be filed as an appendix to our proxy
statement for the 2004 annual stockholders meeting, this
pre-approval authority may be delegated to a single member of
the audit committee and then reviewed by the entire audit
committee at the committees next meeting. Approvals of
non-audit services will be publicly disclosed in our periodic
reports filed with the SEC. For the fiscal year 2004, all
non-audit services were pre-approved by the audit committee.

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PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a) The following documents are filed as
part of this report:

1. Consolidated Financial
Statements  See Item 8. Financial
Statements and Supplementary Data

2. Financial Statement Schedules:

THERMA-WAVE, INC.

SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

(In thousands)


|                           |                                                           |                                               |  |           |       |               |  |               |       |  |  |   |       |  |  |   |       | 
|-------------------------- | --------------------------------------------------------- | --------------------------------------------- |  | --------- | ----- | ------------- |  | ------------- | ----- |  |  | - | ----- |  |  | - | ----- | 
|                           |                                                           | Balance at                                    |  |           |       |               |  |              
|                           |                                                           | Beginning of                                  |  |           |       |               |  | Balance at   
|Description                |                                                           | Period                                        |  | Additions |       | Deductions(1) |  | End of Period
|                           |                                                           |                                               |  |           |       |               |  |              
|Year Ended March 31, 2004: |                                                           |                                               |  |           |       |               |  |               |       |  |  |   |       |  |  |  
|                           | Reserves and allowances deducted from asset
    accounts: |                                               |  |           |       |               |  |               |       |  |  |   |       |  |  |   |      
|                           |                                                           | Allowance for doubtful accounts receivable    |  | $         | 1,553 |               |  | $             | 658   |  |  | $ | 1,304 |  |  | $ | 907   | 
|Year Ended March 31, 2003: |                                                           |                                               |  |           |       |               |  |               |       |  |  |   |       |  |  |  
|                           | Reserves and allowances deducted from asset
    accounts: |                                               |  |           |       |               |  |               |       |  |  |   |       |  |  |   |      
|                           |                                                           | Allowance for doubtful accounts receivable    |  | $         | 2,024 |               |  | $             | 222   |  |  | $ | 693   |  |  | $ | 1,553 | 
|Year Ended March 31, 2002: |                                                           |                                               |  |           |       |               |  |               |       |  |  |   |       |  |  |  
|                           | Reserves and allowances deducted from asset
    accounts: |                                               |  |           |       |               |  |               |       |  |  |   |       |  |  |   |      
|                           |                                                           | Allowance for doubtful accounts receivable(2) |  | $         | 1,096 |               |  | $             | 1,295 |  |  | $ | 367   |  |  | $ | 2,024 | 

All other schedules for which provision is made
in the applicable accounting regulations of the Commission are
not required under the related instructions, are inapplicable or
not material, or the information called for thereby is otherwise
included in the financial statements and therefore has been
omitted.

3. Exhibits

|        |   |             |  |                                                                                                                                                                                                                                                                                                                                                                        
|------- | - | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |   |            
|Number  |   | Description
|        |   |            
|        | 3 | .1          |  | Restated Certificate of Incorporation of
    Therma-Wave, Inc. (Incorporated herein by reference to the
    Exhibit 3.1 to Therma-Waves annual report on
    Form 10-K for the period ended April 2, 2000.)                                                                                                                                                           
|        | 3 | .2          |  | Certificate of Amendment to Restated Certificate
    of Incorporation of Therma-Wave, Inc. (Incorporated herein by
    reference to Exhibit 3.1 in Therma-Waves quarterly
    report on Form 10-Q for the period ended September 29,
    2002.)                                                                                                                       
|        | 3 | .3          |  | Amended and Restated By-Laws of Therma-Wave.
    (Incorporated herein by reference to Exhibit 3.2 in
    Therma-Waves annual report on Form 10-K for the
    period ended April 1, 2001.)                                                                                                                                                                             
|        | 4 | .1          |  | Form of Registration Rights Agreement, dated as
    of January 16, 2002, among Therma-Wave, Inc., Sensys
    Instruments Corporation and each holder of Sensys Instruments
    Corporation capital stock. (Incorporated herein by reference to
    Exhibit 4.1 in Therma-Waves current report on
    Form 8-K, as filed with the Commission on December 19,
    2001.)
|        | 4 | .2          |  | Form of certificate representing shares of Common
    Stock. (Incorporated herein by reference to Exhibit 4.6 to
    Therma-Waves Registration Statement on Form S-1
    (Registration No. 333-76019).)                                                                                                                                                               

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|        |    |             |  |                                                                                                                                                                                                                                                                                                              
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 4  | .3          |  | Registration Rights Agreement, dated as of
    September 15, 2003, by and among Therma-Wave, Inc. and the
    holders named therein. (Incorporated herein by reference to
    Exhibit 4.6 to Therma-Waves Registration Statement on
    Form S-1 (Registration No. 333-110162.)                             
|        | 10 | .1#         |  | Employment Agreement, dated as of
    January 16, 2002, by and between Therma-Wave, Inc. and
    Rodney Smedt. (Incorporated herein by reference to
    Exhibit 10.1 in Therma-Waves annual report for the
    year ended March 30, 2003.)                                                                  
|        | 10 | .2          |  | Loan and Security Agreement, dated June 13,
    2003, by and between Therma-Wave, Inc. and Silicon Valley Bank.
    (Incorporated herein by reference to Exhibit 10.2 in
    Therma-Waves annual report for the year ended
    March 30, 2003.)                                                             
|        | 10 | .3#         |  | Stock Option Agreement, dated as of
    March 15, 2003, by and between Therma-Wave, Inc. and Papken
    S. Der Torossian. (Incorporated herein by reference to
    Exhibit 10.46 in Therma-Waves quarterly report on
    Form 10-Q for the period ended December 29, 2002.)                                 
|        | 10 | .4#         |  | Employment Agreement, dated as of May 16,
    1997, by and between Therma-Wave and Jon L. Opsal. (Incorporated
    herein by reference to Exhibit 10.4 to Therma-Waves
    Registration Statement on Form S-4 (Registration
    No. 333-29871).)                                                            
|        | 10 | .5#         |  | Stock Option Agreement, dated as of
    February 5, 2003, by and between Therma-Wave, Inc. and
    Boris Lipkin. (Incorporated herein by reference to
    Exhibit 10.44 in Therma-Waves quarterly report on
    Form 10-Q for the period ended December 29, 2002.)                                          
|        | 10 | .6#         |  | Offer Letter, Board Services, dated as of
    March 12, 2003, from Therma-Wave, Inc. to Papken S. Der
    Torossian. (Incorporated herein by reference to
    Exhibit 10.45 in Therma-Waves quarterly report on
    Form 10-Q for the period ended December 29, 2002.)                                      
|        | 10 | .7#         |  | Executive Stock Agreement, dated as of
    May 16, 1997, by and between Therma-Wave, Inc. and Jon L.
    Opsal. (Incorporated herein by reference to Exhibit 10.9 to
    Therma-Waves Registration Statement on Form S-4
    (Registration No. 333-29871).)                                                 
|        | 10 | .8#         |  | Employment Agreement dated as of February 5,
    2003, by and between Therma-Wave, Inc. and Boris Lipkin.
    (Incorporated herein by reference to Exhibit 10.43 in
    Therma-Waves quarterly report on Form 10-Q for the
    period ended December 29, 2002.)                                             
|        | 10 | .9#         |  | Amendment No. 2, dated as of March 25,
    2004, to the Employment Agreement by and between Therma-Wave,
    Inc. and Boris Lipkin.                                                                                                                                                                          
|        | 10 | .10         |  | Development License Agreement, dated
    June 12, 1992, by and among Therma-Wave and Therma-Wave
    K.K., Toray Industries, Inc. and Shimadzu Corporation.
    (Incorporated herein by reference to Exhibit 10.12 to
    Therma-Waves Registration Statement on Form S-4
    (Registration No. 333-29871).)
|        | 10 | .11         |  | New Development Agreement, dated
    December 22, 1995, by and between Therma-Wave and Toray
    Industries, Inc. (Incorporated herein by reference to
    Exhibit 10.13 to Therma-Waves Registration Statement
    on Form S-4 (Registration No. 333-29871).)                                              
|        | 10 | .12         |  | Lease Agreement, dated as of May 26, 1995,
    by and between Therma-Wave and Sobrato Interests. (Incorporated
    herein by reference to Exhibit 10.14 to Therma-Waves
    Registration Statement on Form S-4 (Registration
    No. 333-29871).)                                                           
|        | 10 | .13#        |  | Therma-Wave, Inc. 2000 Equity Incentive Plan.
    (Incorporated herein by reference to Exhibit 10.22 to
    Therma-Waves annual report on Form 10-K for the
    period ended March 31, 2000.)                                                                                                               
|        | 10 | .14#        |  | Amendment No. 1 to Therma-Wave, Inc. 2000
    Equity Incentive Plan. (Incorporated herein by reference to
    Exhibit 99.2 in Therma-Waves Registration Statement
    on Form S-8 (Registration No. 333-83282).)                                                                                            
|        | 10 | .15         |  | Loan Modification Agreement, dated as of
    July 24, 2003, by and between Therma-Wave, Inc. and Silicon
    Valley Bank. (Incorporated herein by reference to
    Exhibit 10.39 to Therma-Waves quarterly report for
    the quarter ended June 29, 2003.)                                                 
|        | 10 | .16         |  | Loan Modification Agreement, dated as of
    May 4, 2004, by and between Therma-Wave, Inc. and Silicon
    Valley Bank.                                                                                                                                                                                      

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|        |    |             |  |                                                                                                                                                                                                                                                                    
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .17#        |  | Therma-Wave, Inc. 1997 Stock Purchase and Option
    Plan. (Incorporated herein by reference to Exhibit 10.20 to
    Therma-Waves Registration Statement on Form S-4
    (Registration No. 333-29871).)                                                           
|        | 10 | .18#        |  | Form of Stock Option Agreement under the 2000
    Equity Incentive Plan. (Incorporated herein by reference to
    Exhibit 10.39 to Therma-Waves quarterly report on
    Form 10-Q for the period ended June 30, 2002.)                                            
|        | 10 | .19#        |  | Employment Agreement, dated as of August 10,
    1998, by and between Therma-Wave and L. Ray Christie.
    (Incorporated herein by reference to Exhibit 10.27 to
    Therma-Waves Registration Statement on Form S-1
    (Registration No. 333-76019).)           
|        | 10 | .20#        |  | Amended and Restated Therma-Wave 2000 Employee
    Stock Purchase Plan. (Incorporate herein by reference to
    Exhibit 10.26 to Therma-Waves annual report on
    Form 10-K for the period ended March 31, 2000.)                                                
|        | 10 | .21#        |  | Amendment No. 1 to Therma-Wave, Inc. 2000
    Employee Stock Purchase Plan. (Incorporated herein by reference
    to Exhibit 10.26.1 to Therma-Waves quarterly report
    on Form 10-Q for the period ended July 1, 2001.)                                        
|        | 10 | .22#        |  | Amendment No. 2 to the 2000 Employee Stock
    Purchase Plan. (Incorporated herein by reference to
    Exhibit 10.26.2 to Therma-Waves amended quarterly
    report on Form 10-Q/ A for the period ended
    September 29, 2002.)                                 
|        | 10 | .23#        |  | Amendment No. 3 to the 2000 Employee Stock
    Purchase Plan. (Incorporated herein by reference to
    Exhibit 10.29 in Therma-Waves annual report for the
    year ended March 30, 2003.)                                                                        
|        | 10 | .24#        |  | 1997 Employee Stock Purchase and Option Plan.
    (Incorporated herein by reference to Exhibit 10.30 to
    Therma-Waves Registration Statement on Form S-1
    (Registration No. 333-76019).                                                                     
|        | 10 | .25#        |  | Therma-Wave Executive Deferred Compensation Plan,
    effective January 1, 2000. (Incorporated herein by
    reference to Exhibit 10.31 to Therma-Waves annual
    report on Form 10-K for the period ended April 2,
    2000.)                                   
|        | 10 | .26         |  | Lease between Minos Management, Inc. as Landlord,
    and Therma-Wave as Tenant, dated May 31, 2000.
    (Incorporated herein by reference to Exhibit 10.32 to
    Therma-Waves annual report on Form 10-K for the
    period ended April 2, 2000.)               
|        | 10 | .27#        |  | Form of Indemnification Agreement with directors
    and executive officers. (Incorporated herein by reference to
    Exhibit 10.33 to Therma-Waves annual report on
    Form 10-K for the period ended April 2, 2000.)                                           
|        | 10 | .28#        |  | 1997 Special Employee Stock Purchase and Option
    Plan. (Incorporated herein by reference to Exhibit 10.31 to
    Therma-Waves Registration Statement on Form S-1
    (Registration No. 333-76019).)                                                            
|        | 10 | .29#        |  | Amendment No. 1 to Employment Agreement,
    dated as of August 21, 2003, between Boris Lipkin and
    Therma-Wave, Inc. (Incorporated herein by reference to
    Exhibit 10.39 to Therma-Waves quarterly report for
    the quarter ended September 28, 2003.)   
|        | 10 | .30#        |  | Amendment No. 1 to Employment Agreement,
    dated as of August 21, 2003, between L. Ray Christie and
    Therma-Wave, Inc. (Incorporated herein by reference to
    Exhibit 10.40 to Therma-Waves quarterly report for
    the quarter ended September 28, 2003.)
|        | 10 | .31         |  | Borrower Agreement, dated as of June 4,
    2004, by and between Therma-Wave, Inc. and the Export-Import
    Bank of the United States.                                                                                                                            
|        | 14 | .1          |  | Code of Ethics applicable to all employees.                                                                                                                                                                                                                        
|        | 21 | .1          |  | Subsidiaries of Therma-Wave. (Incorporated herein
    by reference to Exhibit 21.1 to Therma-Waves annual
    report on Form 10-K for the year ended March 30, 2003.)                                                                                             
|        | 23 | .1          |  | Consent of Independent Registered Public
    Accounting Firm.                                                                                                                                                                                                      
|        | 31 | .1          |  | Certification of the Chief Executive Officer
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                        

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|        |    |             |  |                                                                                                            
|------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 31 | .2          |  | Certification of the Chief Financial Officer
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|        | 32 | .1          |  | Certification of the Chief Executive Officer
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|        | 32 | .2          |  | Certification of the Chief Financial Officer
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|        | 99 | .1          |  | Risk Factors.                                                                                              



---



|  |                                                                            
|- | ---------------------------------------------------------------------------
|* | Confidential treatment has been granted for
    portions of this agreement.
| 
|# | Denotes management contract or compensatory plan.                          

(b) Reports on Form 8-K

On January 28, 2004 we furnished a current
report on Form 8-K, item 12, announcing our results
for the quarter ended December 28, 2003.

75



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##### Table of Contents






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.



| |                  
| | -----------------
| | THERMA-WAVE, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/     BORIS LIPKIN

| |                                                    
| | ---------------------------------------------------
| |                                                    
| | Boris Lipkin                                       
| | President, Chief Executive Officer and
    Director

Dated: June 14, 2004

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person
whose signature appears below constitutes and appoints Boris
Lipkin and L. Ray Christie, and each of them, his true and
lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign any or all
amendments to this annual report on Form 10-K under the
Securities Exchange Act of 1934, as amended, and to file the
same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and
each of them, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as
he might or could do in person, hereby ratifying and confirming
all that said attorneys-in-fact and agents or any of them, or
their or his substitute or substitutes, may lawfully do or cause
to be done by virtue hereof.

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

|                                                   |  |                                                                                                            |  |               |  | 
|-------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------- |  | ------------- |  | 
|                                                   |  |                                                                                                            |  |              
|Signature                                          |  | Title                                                                                                      |  | Date         
|                                                   |  |                                                                                                            |  |              
|                                                  
|/s/ PAPKEN S. DER TOROSSIANPapken S. Der Torossian |  | Chairman of the Board                                                                                      |  | June 14, 2004
|                                                  
|/s/ BORIS LIPKINBoris Lipkin                       |  | President, Chief Executive Officer and
    Director
    (Principal Executive Officer)                      |  | June 14, 2004
|                                                  
|/s/ L. RAY CHRISTIEL. Ray Christie                 |  | Vice President, Chief Financial Officer and
    Secretary
    (Principal Financial and Accounting Officer) |  | June 14, 2004
|                                                  
|/s/ DAVID ASPNESDavid Aspnes                       |  | Director                                                                                                   |  | June 14, 2004
|                                                  
|/s/ G. LEONARD BAKERG. Leonard Baker               |  | Director                                                                                                   |  | June 14, 2004

76



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##### Table of Contents



|                                         |  |          |  |               |  | 
|---------------------------------------- |  | -------- |  | ------------- |  | 
|                                         |  |          |  |              
|Signature                                |  | Title    |  | Date         
|                                         |  |          |  |              
|                                        
|/s/ DAVID DOMINIKDavid Dominik           |  | Director |  | June 14, 2004
|                                        
|/s/ JOHN DERRICOJohn DErrico           |  | Director |  | June 14, 2004
|                                        
|/s/ PETER R. HANLEYPeter R. Hanley       |  | Director |  | June 14, 2004
|                                        
|/s/ NAM PYO SUHNam Pyo Suh               |  | Director |  | June 14, 2004
|                                        
|/s/ LAWRENCE TOMLINSONLawrence Tomlinson |  | Director |  | June 14, 2004

77



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##### Table of Contents



Exhibit Index

|        |    |             |  |                                                                                                                                                                                                                                                                                                                                                                        
|------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 3  | .1          |  | Restated Certificate of Incorporation of
    Therma-Wave, Inc. (Incorporated herein by reference to the
    Exhibit 3.1 to Therma-Waves annual report on
    Form 10-K for the period ended April 2, 2000.)                                                                                                                                                           
|        | 3  | .2          |  | Certificate of Amendment to Restated Certificate
    of Incorporation of Therma-Wave, Inc. (Incorporated herein by
    reference to Exhibit 3.1 in Therma-Waves quarterly
    report on Form 10-Q for the period ended September 29,
    2002.)                                                                                                                       
|        | 3  | .3          |  | Amended and Restated By-Laws of Therma-Wave.
    (Incorporated herein by reference to Exhibit 3.2 in
    Therma-Waves annual report on Form 10-K for the
    period ended April 1, 2001.)                                                                                                                                                                             
|        | 4  | .1          |  | Form of Registration Rights Agreement, dated as
    of January 16, 2002, among Therma-Wave, Inc., Sensys
    Instruments Corporation and each holder of Sensys Instruments
    Corporation capital stock. (Incorporated herein by reference to
    Exhibit 4.1 in Therma-Waves current report on
    Form 8-K, as filed with the Commission on December 19,
    2001.)
|        | 4  | .2          |  | Form of certificate representing shares of Common
    Stock. (Incorporated herein by reference to Exhibit 4.6 to
    Therma-Waves Registration Statement on Form S-1
    (Registration No. 333-76019).)                                                                                                                                                               
|        | 4  | .3          |  | Registration Rights Agreement, dated as of
    September 15, 2003, by and among Therma-Wave, Inc. and the
    holders named therein. (Incorporated herein by reference to
    Exhibit 4.6 to Therma-Waves Registration Statement on
    Form S-1 (Registration No. 333-110162.)                                                                                       
|        | 10 | .1#         |  | Employment Agreement, dated as of
    January 16, 2002, by and between Therma-Wave, Inc. and
    Rodney Smedt. (Incorporated herein by reference to
    Exhibit 10.1 in Therma-Waves annual report for the
    year ended March 30, 2003.)                                                                                                                            
|        | 10 | .2          |  | Loan and Security Agreement, dated June 13,
    2003, by and between Therma-Wave, Inc. and Silicon Valley Bank.
    (Incorporated herein by reference to Exhibit 10.2 in
    Therma-Waves annual report for the year ended
    March 30, 2003.)                                                                                                                       
|        | 10 | .3#         |  | Stock Option Agreement, dated as of
    March 15, 2003, by and between Therma-Wave, Inc. and Papken
    S. Der Torossian. (Incorporated herein by reference to
    Exhibit 10.46 in Therma-Waves quarterly report on
    Form 10-Q for the period ended December 29, 2002.)                                                                                           
|        | 10 | .4#         |  | Employment Agreement, dated as of May 16,
    1997, by and between Therma-Wave and Jon L. Opsal. (Incorporated
    herein by reference to Exhibit 10.4 to Therma-Waves
    Registration Statement on Form S-4 (Registration
    No. 333-29871).)                                                                                                                      
|        | 10 | .5#         |  | Stock Option Agreement, dated as of
    February 5, 2003, by and between Therma-Wave, Inc. and
    Boris Lipkin. (Incorporated herein by reference to
    Exhibit 10.44 in Therma-Waves quarterly report on
    Form 10-Q for the period ended December 29, 2002.)                                                                                                    
|        | 10 | .6#         |  | Offer Letter, Board Services, dated as of
    March 12, 2003, from Therma-Wave, Inc. to Papken S. Der
    Torossian. (Incorporated herein by reference to
    Exhibit 10.45 in Therma-Waves quarterly report on
    Form 10-Q for the period ended December 29, 2002.)                                                                                                
|        | 10 | .7#         |  | Executive Stock Agreement, dated as of
    May 16, 1997, by and between Therma-Wave, Inc. and Jon L.
    Opsal. (Incorporated herein by reference to Exhibit 10.9 to
    Therma-Waves Registration Statement on Form S-4
    (Registration No. 333-29871).)                                                                                                           
|        | 10 | .8#         |  | Employment Agreement dated as of February 5,
    2003, by and between Therma-Wave, Inc. and Boris Lipkin.
    (Incorporated herein by reference to Exhibit 10.43 in
    Therma-Waves quarterly report on Form 10-Q for the
    period ended December 29, 2002.)                                                                                                       
|        | 10 | .9#         |  | Amendment No. 2, dated as of March 25,
    2004, to the Employment Agreement by and between Therma-Wave,
    Inc. and Boris Lipkin.                                                                                                                                                                                                                                    
|        | 10 | .10         |  | Development License Agreement, dated
    June 12, 1992, by and among Therma-Wave and Therma-Wave
    K.K., Toray Industries, Inc. and Shimadzu Corporation.
    (Incorporated herein by reference to Exhibit 10.12 to
    Therma-Waves Registration Statement on Form S-4
    (Registration No. 333-29871).)                                                          
|        | 10 | .11         |  | New Development Agreement, dated
    December 22, 1995, by and between Therma-Wave and Toray
    Industries, Inc. (Incorporated herein by reference to
    Exhibit 10.13 to Therma-Waves Registration Statement
    on Form S-4 (Registration No. 333-29871).)                                                                                                        



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##### Table of Contents



|        |    |             |  |                                                                                                                                                                                                                                                                 
|------- | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .12         |  | Lease Agreement, dated as of May 26, 1995,
    by and between Therma-Wave and Sobrato Interests. (Incorporated
    herein by reference to Exhibit 10.14 to Therma-Waves
    Registration Statement on Form S-4 (Registration
    No. 333-29871).)              
|        | 10 | .13#        |  | Therma-Wave, Inc. 2000 Equity Incentive Plan.
    (Incorporated herein by reference to Exhibit 10.22 to
    Therma-Waves annual report on Form 10-K for the
    period ended March 31, 2000.)                                                                  
|        | 10 | .14#        |  | Amendment No. 1 to Therma-Wave, Inc. 2000
    Equity Incentive Plan. (Incorporated herein by reference to
    Exhibit 99.2 in Therma-Waves Registration Statement
    on Form S-8 (Registration No. 333-83282).)                                               
|        | 10 | .15         |  | Loan Modification Agreement, dated as of
    July 24, 2003, by and between Therma-Wave, Inc. and Silicon
    Valley Bank. (Incorporated herein by reference to
    Exhibit 10.39 to Therma-Waves quarterly report for
    the quarter ended June 29, 2003.)    
|        | 10 | .16         |  | Loan Modification Agreement, dated as of
    May 4, 2004, by and between Therma-Wave, Inc. and Silicon
    Valley Bank.                                                                                                                                         
|        | 10 | .17#        |  | Therma-Wave, Inc. 1997 Stock Purchase and Option
    Plan. (Incorporated herein by reference to Exhibit 10.20 to
    Therma-Waves Registration Statement on Form S-4
    (Registration No. 333-29871).)                                                        
|        | 10 | .18#        |  | Form of Stock Option Agreement under the 2000
    Equity Incentive Plan. (Incorporated herein by reference to
    Exhibit 10.39 to Therma-Waves quarterly report on
    Form 10-Q for the period ended June 30, 2002.)                                         
|        | 10 | .19#        |  | Employment Agreement, dated as of August 10,
    1998, by and between Therma-Wave and L. Ray Christie.
    (Incorporated herein by reference to Exhibit 10.27 to
    Therma-Waves Registration Statement on Form S-1
    (Registration No. 333-76019).)        
|        | 10 | .20#        |  | Amended and Restated Therma-Wave 2000 Employee
    Stock Purchase Plan. (Incorporate herein by reference to
    Exhibit 10.26 to Therma-Waves annual report on
    Form 10-K for the period ended March 31, 2000.)                                             
|        | 10 | .21#        |  | Amendment No. 1 to Therma-Wave, Inc. 2000
    Employee Stock Purchase Plan. (Incorporated herein by reference
    to Exhibit 10.26.1 to Therma-Waves quarterly report
    on Form 10-Q for the period ended July 1, 2001.)                                     
|        | 10 | .22#        |  | Amendment No. 2 to the 2000 Employee Stock
    Purchase Plan. (Incorporated herein by reference to
    Exhibit 10.26.2 to Therma-Waves amended quarterly
    report on Form 10-Q/ A for the period ended
    September 29, 2002.)                              
|        | 10 | .23#        |  | Amendment No. 3 to the 2000 Employee Stock
    Purchase Plan. (Incorporated herein by reference to
    Exhibit 10.29 in Therma-Waves annual report for the
    year ended March 30, 2003.)                                                                     
|        | 10 | .24#        |  | 1997 Employee Stock Purchase and Option Plan.
    (Incorporated herein by reference to Exhibit 10.30 to
    Therma-Waves Registration Statement on Form S-1
    (Registration No. 333-76019).                                                                  
|        | 10 | .25#        |  | Therma-Wave Executive Deferred Compensation Plan,
    effective January 1, 2000. (Incorporated herein by
    reference to Exhibit 10.31 to Therma-Waves annual
    report on Form 10-K for the period ended April 2,
    2000.)                                
|        | 10 | .26         |  | Lease between Minos Management, Inc. as Landlord,
    and Therma-Wave as Tenant, dated May 31, 2000.
    (Incorporated herein by reference to Exhibit 10.32 to
    Therma-Waves annual report on Form 10-K for the
    period ended April 2, 2000.)            
|        | 10 | .27#        |  | Form of Indemnification Agreement with directors
    and executive officers. (Incorporated herein by reference to
    Exhibit 10.33 to Therma-Waves annual report on
    Form 10-K for the period ended April 2, 2000.)                                        
|        | 10 | .28#        |  | 1997 Special Employee Stock Purchase and Option
    Plan. (Incorporated herein by reference to Exhibit 10.31 to
    Therma-Waves Registration Statement on Form S-1
    (Registration No. 333-76019).)                                                         
|        | 10 | .29#        |  | Amendment No. 1 to Employment Agreement,
    dated as of August 21, 2003, between Boris Lipkin and
    Therma-Wave, Inc. (Incorporated herein by reference to
    Exhibit 10.39 to Therma-Waves quarterly report for
    the quarter ended September 28, 2003.)



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##### Table of Contents



|        |    |             |  |                                                                                                                                                                                                                                                                    
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .30#        |  | Amendment No. 1 to Employment Agreement,
    dated as of August 21, 2003, between L. Ray Christie and
    Therma-Wave, Inc. (Incorporated herein by reference to
    Exhibit 10.40 to Therma-Waves quarterly report for
    the quarter ended September 28, 2003.)
|        | 10 | .31         |  | Borrower Agreement, dated as of June 4,
    2004, by and between Therma-Wave, Inc. and the Export-Import
    Bank of the United States.                                                                                                                            
|        | 14 | .1          |  | Code of Ethics applicable to all employees.                                                                                                                                                                                                                        
|        | 21 | .1          |  | Subsidiaries of Therma-Wave. (Incorporated herein
    by reference to Exhibit 21.1 to Therma-Waves annual
    report on Form 10-K for the year ended March 30, 2003.)                                                                                             
|        | 23 | .1          |  | Consent of Independent Registered Public
    Accounting Firm.                                                                                                                                                                                                      
|        | 31 | .1          |  | Certification of the Chief Executive Officer
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                        
|        | 31 | .2          |  | Certification of the Chief Financial Officer
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                        
|        | 32 | .1          |  | Certification of the Chief Executive Officer
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                        
|        | 32 | .2          |  | Certification of the Chief Financial Officer
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                        
|        | 99 | .1          |  | Risk Factors.                                                                                                                                                                                                                                                      



---



|  |                                                                            
|- | ---------------------------------------------------------------------------
|* | Confidential treatment has been granted for
    portions of this agreement.
| 
|# | Denotes management contract or compensatory plan.