<PAGE>
 
               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                   FORM 10-K
 
               ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED JULY 31, 1996          COMMISSION FILE NUMBER: 0-26968

 
                              ETEC SYSTEMS, INC.
            (Exact name of registrant as specified in its charter)
 
                   NEVADA                               94-3094580
       (State or other jurisdiction of      (I.R.S. Employer Identification No.)
        incorporation or organization)
 
               26460 CORPORATE AVENUE, HAYWARD, CALIFORNIA 94545
             (Address and Zip Code of Principal Executive Offices)
 
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510)783-9210
 
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
 
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
 
  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES [X]  NO  [_]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
 
  The aggregate market value of the registrant's Common Stock held by
nonaffiliates on October 21, 1996 (based upon the average of the high and low
sales prices of such stock as of such date) was $685,125,741.
 
  As of October 21, 1996, 19,787,025 shares of the Registrant's Common Stock
were outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  The Registrant's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on December 16, 1996 (the "Proxy Statement") is
incorporated by reference in Part III of this Form 10-K to the extent stated
herein.
 
  This report, including exhibits, consists of 113 pages. The Index of
Exhibits is found on page 57.
<PAGE>
 
                               ETEC SYSTEMS, INC.
 
                        FOR THE YEAR ENDED JULY 31, 1996
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
 <C>      <S>                                                               <C>
                                       PART I
 Item 1.  Business.......................................................     3
 Item 2.  Properties.....................................................    17
 Item 3.  Legal Proceedings..............................................    17
 Item 4.  Submission of Matters to a Vote of Security Holders............    17
 Executive Officers of the Registrant.....................................   18
                                      PART II
 Item 5.  Market for Registrant's Common Stock and Related Stockholder
          Matters........................................................    20
 Item 6.  Selected Consolidated Financial Data...........................    21
 Item 7.  Management's Discussion and Analysis of Financial Condition and
          Results of Operations..........................................    23
 Item 8.  Financial Statements and Supplementary Data....................    33
 Item 9.  Changes in and Disagreements with Accountants on Accounting and
          Financial Disclosure...........................................    54

                                      PART III
 Item 10. Directors and Executive Officers of the Registrant.............    55
 Item 11. Executive Compensation.........................................    55
 Item 12. Security Ownership of Certain Beneficial Owners and Management.    55
 Item 13. Certain Relationships and Related Transactions.................    55

                                      PART IV
 Item 14. Exhibits, Financial Statement Schedules, and Reports on 
          Form 8-K.......................................................    56
</TABLE>
 
  MEBES(R), CORE(R), Etec(R), the Etec logo, Polyscan(TM) and ALTA(R) are
trademarks of the Company. This Annual Report also includes trademarks and
trade names of other companies.
 
                                       2
<PAGE>
 
                                    PART I
 
ITEM 1. BUSINESS.
 
  This item contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed in Certain Factors Affecting Future Results" section below.
 
GENERAL
 
  Etec Systems, Inc. ("Etec" or the "Company") is a world leader in the
production of mask pattern generation equipment for the semiconductor
industry. Etec designs, develops, manufactures and markets equipment that
produces high precision masks, which are used to print circuit patterns onto
semiconductor wafers. Etec sells its MEBES electron beam systems and its CORE
and ALTA laser beam systems at prices currently ranging from approximately
$3.2 million to $7.3 million each and accessories and upgrades at prices
currently ranging from less than $400,000 to $3.0 million each. The Company
also derives significant revenues from service and support of its installed
base of systems. The Company believes that over 250 commercial electron beam
and laser beam mask pattern generation systems are currently installed outside
the former Eastern Bloc, of which over 165 have been produced by Etec.
 
PRODUCTS AND SERVICES
 
  Etec's products consist of electron beam and laser beam maskmaking systems.
The Company's systems are designed to provide a low cost of ownership through
high performance, reliability and ease of maintenance. In addition, the
Company's systems have modular designs to facilitate retrofitting. The Company
is the only maskmaking equipment manufacturer currently offering both electron
beam and laser beam systems. The Company believes that this represents an
important competitive advantage, as the different performance and cost
characteristics of electron beam and laser beam systems permit it to cover a
broad range of technical requirements and cost sensitivities for its
customers.
 
  The different characteristics of electron beam and laser beam systems suit
them to different segments of the mask pattern generation market. Electron
beam systems have a much smaller beam spot size than laser beam systems and
are best suited for leading-edge market segments that require the highest
resolution and accuracy. The Company's MEBES electron beam systems also have
an open control and software architecture, which offer maximum flexibility to
the maskmaker. The primary advantage of laser beam systems is their relative
simplicity and lower cost of ownership compared to electron beam systems.
Another advantage of laser beam systems is the use of optical resists for the
maskmaking process, which are easier to use than electron beam resists.
 
  The Company also sells a variety of hardware and software packages, which
are designed to enhance the performance of previously installed MEBES and CORE
systems. For example, the Company markets retrofit "suites" that upgrade MEBES
III and IV systems to higher performance systems, such as MEBES 4000 or MEBES
4500 systems. In addition, the Company sells accessories to enhance the
performance of the MEBES 4500 system itself, such as a robotic loading module
to automate mask loading and a two-cassette load chamber to permit faster
evacuation of the finished mask from the load chamber. Accessories are
currently priced at less than $400,000, and upgrades currently range in price
from approximately $1.4 million to $3.0 million. From time to time, the
Company also repurchases, refurbishes and resells a limited number of systems.
 
  The Company's warranty obligations for its systems generally cover a 12-
month period beginning upon final customer acceptance. However, most customers
have requested service and support beyond the warranty period, and Etec has
historically derived significant revenues from annual service and maintenance
for its installed base of systems. Approximately 123 of the Company's systems
are currently serviced under one-year contracts with
 
                                       3
<PAGE>
 
Etec. Most customers request a comprehensive package of service and support
that includes a variety of spare parts (excluding electron guns, laser sources
and other more expensive parts) and support from an on-site Etec field
engineer. Service revenues were approximately $32.7 million, $31.5 million and
$28.0 million, in fiscal 1996, fiscal 1995, and fiscal 1994, respectively.
 
ETEC POLYSCAN
 
  In February 1996, in furtherance of the Company's strategy to develop or
acquire pattern generation and lithography-related products that serve
additional markets, Etec Polyscan, acquired substantially all of the assets of
Polyscan, a development-stage company based in Tucson, Arizona. Etec Polyscan,
a wholly-owned subsidiary of the Company formed to operate the acquired
business, designs and develops ultraviolet ("UV") laser direct imaging systems
that the Company intends to manufacture and market for applications that
require large area pattern generation, including printed circuit boards
("PCBs"), multi-chip modules ("MCMs") and flat panel displays ("FPDs").
 
  The Company has never operated in the market segments targeted by Etec
Polyscan, and there can be no assurance that Etec Polyscan will be able to
develop, manufacture and market its products successfully. There also can be
no assurance that any technology synergies will be realized between Etec
Polyscan and the Company's laser beam mask pattern generation business or that
Etec Polyscan's technology can be integrated into the Company's product
development strategy. Etec Polyscan has received orders for systems, but has
not yet shipped a product and has had net operating losses since its
inception. The Company expects that Etec Polyscan will continue to experience
net operating losses.
 
CUSTOMERS
 
  The Company's customers include both captive and commercial (or "merchant")
mask shops. Semiconductor manufacturers employ their captive capabilities
largely to supply their own requirements for masks, while merchant mask shops
sell masks to a variety of semiconductor device manufacturers. Repeat sales to
existing customers represent a significant portion of the Company's product
revenues, and the Company believes that its installed base of over 165 systems
represents a significant competitive advantage.
 
  Historically, the Company has sold a significant proportion of its systems
to a limited number of customers. Sales to the Company's ten largest customers
accounted for approximately 76%, 74% and 76% of total revenues in fiscal 1996,
fiscal 1995, and fiscal 1994, respectively. Sales to the largest customer
during those periods accounted for approximately 17%, 14% and 13% of total
revenues, respectively. Opportunities for new system sales are episodic,
because the number of captive and merchant mask shops worldwide is limited and
each mask shop has historically purchased at most one or two pattern
generation tools per year. As a particular customer completes a new or
expanded facility or production line, sales to that customer may decrease
sharply. The failure to replace such sales with sales to other customers in
succeeding periods would have a material adverse effect on the Company's
business, financial condition and results of operations. The Company expects
that sales to relatively few customers will continue to account for a high
percentage of the Company's revenues in any accounting period in the
foreseeable future. A reduction in orders from any such customer or the
cancellation of any significant order could have a material adverse effect on
the Company's business, financial condition and results of operations. None of
the Company's customers has entered into a long-term agreement requiring it to
purchase the Company's products.
 
INTERNATIONAL SALES AND OPERATIONS
 
  Sales to customers in countries other than the United States accounted for
45%, 44% and 43% of revenues in fiscal 1996, fiscal 1995, fiscal 1994,
respectively, with an additional 21%, 16% and 10% of revenues, respectively,
attributable to sales in the United States for shipment abroad. See Note 13 of
Notes to Consolidated Financial Statements for segment information. The
Company anticipates that international sales will continue to account for a
significant portion of revenues for the foreseeable future. Sales and
operations outside of the United
 
                                       4
<PAGE>
 
States are subject to certain inherent risks, including fluctuations in the
value of the U.S. dollar relative to foreign currencies, tariffs, quotas,
taxes and other market barriers, political and economic instability,
restrictions on the export or import of technology, potentially limited
intellectual property protection, difficulties in staffing and managing
international operations and potentially adverse tax consequences. There can
be no assurance that any of these factors will not have a material adverse
effect on the Company's business, financial condition or results of
operations. In particular, although the Company's international sales are
primarily denominated in U.S. dollars, currency exchange fluctuations in
countries where the Company does business could materially adversely affect
the Company's business, financial condition and results of operations, by
rendering the Company less price-competitive than foreign manufacturers.
 
SALES AND MARKETING
 
  Etec markets and distributes its products directly into its primary markets,
which consist of North America, Japan, South Korea and Europe. The Company
maintains sales offices in California, Japan, France and South Korea.
Customers in Southeast Asia, China and India are currently covered by sales
representatives, with assistance from the sales and marketing staff in
California. The Company's agreements with its sales representatives are
terminable upon 90 days' notice by either party.
 
  Because of the significant investment required to purchase Etec's systems
and their highly technical nature, the sales process is complex, requiring
interaction with several levels of the customer's organization and extensive
technical exchanges, product demonstrations and commercial negotiations. As a
result, the sales cycle can be as long as 12 to 18 months. Purchase decisions
are generally made at a high level within the customer's organization, and the
sales process involves broad participation across the Etec organization, from
the Chief Executive Officer to the engineers who designed the product.
 
  As discussed in the "International Sales and Operations" section above,
sales to customers in countries outside of the United States have accounted
for a significant portion of the Company's revenues. The Company effects sales
in Japan through its wholly-owned subsidiary, Etec Japan. Customer orders for
MEBES equipment received by Etec Japan are placed through Kanematsu
Corporation ("KG Japan") and its United States affiliate ("KG USA"), which in
turn orders the equipment from Etec. KG Japan receives a commission and
provides interim financing to Etec Japan covering the period between KG USA's
payments to Etec and the customer's payments to Etec Japan. The Company's
laser products were sold in Japan and the Far East by a distributor until
April 1995, when the Company began direct sales and marketing of laser beam
systems in that region. As part of that transition, the Company agreed to pay
the distributor a flat fee for each CORE and ALTA system sold in the defined
sales territory for at most the next four years. See Note 12 of Notes to
Consolidated Financial Statements.
 
  As a result of the Company's worldwide distribution and service activities,
the Company from time to time has engaged in the distribution of third
parties' products to gain insight into new markets. For example, the Company
distributes Micrion Corporation's mask repair products in Korea. In December
1994, the Company entered into an exclusive distribution agreement with QC
Optics, Inc. ("QC Optics") to distribute and sell QC Optics' laser-based
inspection products in Japan, Korea, Taiwan and Singapore. QC Optics'
inspection products are used to detect defects in masks, flat panel displays
and magnetic media.
 
BACKLOG
 
  The Company's backlog for products was approximately $147.6 million, $65.2
million, and $30.1 million at July 31, 1996, 1995, and 1994, respectively.
Etec defines backlog to include only those systems, accessories and upgrades
with respect to which a written purchase order or agreement has been received
and a delivery schedule has been specified for product shipment at some time
during the next 12 months. Cancellations of product purchase orders require
that the customer make compensatory payments, depending upon the time of
cancellation. Cancellations prior to 30 days before estimated shipment
generally require payments of up to 50% of the purchase price. Cancellations
within the 30 days prior to the estimated shipment date are generally
 
                                       5
<PAGE>
 
prohibited. However, orders have occasionally been rescheduled by the customer
without compensatory payments. Accordingly, backlog is not necessarily
representative of future sales.
 
PRODUCT DEVELOPMENT
 
  Etec invests heavily in research and development, primarily in electron beam
and laser beam imaging, high-speed data retrieval, processing and delivery
electronics, measurement and positioning systems and software development.
Research and development expenses, net of funding under cooperative
development agreements, were $17.4 million, $10.5 million, and $5.1 million,
in fiscal 1996, fiscal 1995, and fiscal 1994, respectively, representing 12%,
13%, and 7% of revenues, respectively.
 
  Historically, governmental and private sources have funded a significant
portion of Etec's product development efforts. Governmental and quasi-
governmental agencies such as the Department of Defense, ARPA and SEMATECH
have supported Etec as a primary supplier of pattern-generation technologies
to the U.S. semiconductor industry, although such funding declined
significantly from fiscal 1994 to fiscal 1996 due to the completion of major
development projects. The aggregate funding from ARPA, SEMATECH and other
sources amounted to approximately $725,000, $7.3 million, and $16.1 million
for fiscal 1996, fiscal 1995, and fiscal 1994, respectively. The Company
cannot predict whether any such funding will be available to it in future
periods.
 
  SEMATECH provided partial funding for the Company's development of
enhancements to its existing electron beam and laser beam products pursuant to
cooperative development agreements. Funding pursuant to these agreements
amounted to approximately $280,000, $1.3 million, and $5.5 million, in fiscal
1996, fiscal 1995, and fiscal 1994, respectively. SEMATECH and its members
have the right to obtain a nonexclusive royalty-bearing license from the
Company to use the technology developed under the agreements.
 
MANUFACTURING
 
  Although the Company manufactures some of the components and subassemblies
used in its systems, many are purchased from unaffiliated subcontractors,
typically to the Company's specifications. None of the Company's suppliers is
obligated to provide the Company with any specific quantity of components or
subassemblies over any specific period. Most of the components and
subassemblies included in the Company's products are obtained from a single
supplier or a limited group of suppliers. In particular, the Company relies on
sole-source suppliers for its MEBES systems' electron beam sources, high-
voltage power supplies, certain lasers, lenses and other critical components,
each of which is required for the production of the Company's systems. In
addition, because the Company believes that subsystem vendors have increased
their manufacturing expertise, the Company intends to obtain an increasing
percentage of components and subassemblies from third parties, in order to
devote its resources toward systems design, software development, and systems
integration, its primary areas of competence. To date, the Company has
generally been able to obtain adequate, timely delivery of critical
subassemblies and components, although it has experienced occasional delays.
However, some of the Company's suppliers may be unwilling or unable to produce
sufficient volumes of key components to keep pace with the demand for the
Company's systems and upgrades, or to permit the Company to provide customers
with an adequate supply of spare parts. Due to occasional shortfalls in
supply, the Company has from time to time attempted to develop and manufacture
critical parts and subassemblies. In addition, the Company is attempting to
modify product designs to avoid the use of currently obsolete electronic
components. For example, certain components in the Company's MEBES systems
were designed for the MEBES system architecture, which was developed over 20
years ago. There can be no assurance that delays or shortages caused by
suppliers will not occur in the future or that the Company will be successful
in developing critical components internally or in modifying product designs
to avoid the use of obsolete components. In addition, the ALTA data path and
portions of the CORE system contain components that have been, or are being,
discontinued due to obsolescence. Because the manufacture of these components
and subassemblies is very complex and requires long lead times, and because
alternative sources may not be readily available, there can be no assurance
that delays or shortages caused by suppliers will not occur in the future. Any
disruption of the Company's supply of critical components
 
                                       6
<PAGE>
 
and subassemblies could prevent the Company from meeting its manufacturing
schedules, which would damage relationships with customers and could have a
materially adverse effect on the Company's business, financial condition and
results of operations.
 
COMPETITION
 
  The maskmaking equipment industry is highly competitive. The Company
believes that the principal competitive factors in this industry are product
performance, service, technical support, and overall cost of ownership,
including system price, reliability and ease of upgrade. The Company believes
that it presently competes favorably with respect to each of these factors.
Management also believes that the size of Etec's installed base and the
compatibility of its various products provide a significant competitive
advantage due to customers' desire for compatible mask layers and data
formats. However, the Company believes that to remain competitive, it will
require significant financial resources in order to invest in new product
development, to introduce next-generation systems on a timely basis, and to
maintain customer service and support centers worldwide.
 
PATENTS AND OTHER PROPRIETARY RIGHTS
 
  Etec holds 44 United States patents expiring on various dates from 1999
through 2012, with corresponding patents and patent applications claiming
prior right from U.S. patent applications for most such patents in Japan,
South Korea, the European Community and Canada. In the field of electron beam
lithography, Etec owns patents and/or patent applications directed to electron
guns, ion pumps, particle beam systems, deflection assemblies, calibration and
measure processes, and addressing and writing schemes. In the field of laser
beam lithography, Etec owns patents and/or patent applications directed to
scanning optics, laser pattern generation, and rasterization schemes. Etec
also has six pending U.S. patent applications and over 40 pending patent
applications in other countries. There can be no assurance that any of these
applications will be allowed or that any of the allowed applications will be
issued as patents.
 
  Etec has six registered U.S. trademarks. In addition to patent and trademark
protection, the Company relies on the laws of unfair competition, copyright
and trade secrets to protect its proprietary rights. The Company has entered
into confidentiality and invention assignment agreements with its employees
and consultants that are designed to limit access to, and disclosure or use
of, the Company's proprietary information.
 
  Certain important aspects of the Company's systems depend upon licenses
granted by third parties. In particular, the Company has licensed the basic
technological architecture for MEBES, the Company's family of electron beam
systems, as well as certain rights relating to laser beam technology, from
AT&T, Patlex Corporation, and SEMATECH, Inc. The Company's electron beam and
laser beam systems incorporate software and hardware licensed from other third
parties. The Company also relies on trade secrets and proprietary technology
that it seeks to protect through confidentiality agreements with employees,
consultants and other parties.
 
  As is typical in the industry, the Company has from time to time received,
and may in the future receive, communications from third parties alleging
infringements of patents and other intellectual property rights. No assurance
can be given that additional infringement claims by third parties will not be
asserted. In the future, litigation may be necessary to defend the Company
against alleged infringement of others' rights. Any such litigation could
result in substantial cost and diversion of effort by the Company, which by
itself could have a material adverse effect on the Company. Further, adverse
determinations in such litigation could result in the Company's loss of
proprietary rights, subject the Company to significant liabilities, require
the Company to seek licenses from third parties or prevent the Company from
manufacturing or selling its systems, any of which could have a material
adverse effect on the Company's business, financial condition or results of
operations. In addition, there can be no assurance that, in the future,
litigation will not be necessary to enforce the Company's patents or other
intellectual property rights.
 
                                       7
<PAGE>
 
GOVERNMENTAL REGULATIONS AND INDUSTRY STANDARDS
 
  The Company is subject to a variety of governmental regulations relating to
the use, storage, discharge, handling, emission, generation, manufacture and
disposal of toxic or other hazardous substances. The Company believes that it
is currently in compliance in all material respects with such regulations and
that it has obtained or is in the process of obtaining all material
environmental permits necessary to conduct its business. The Company currently
maintains groundwater monitoring wells at its Hayward, California campus,
although it may discontinue monitoring due to the concurrence of the
California Regional Water Quality Board with the Company's proposal to cease
groundwater monitoring at the site.
 
  The Company's products and worldwide operations are subject to numerous
governmental regulations designed to protect the health and safety of
operators of manufacturing equipment. In particular, recent European Union
("EU") regulations relating to electromagnetic fields, electrical power and
human exposure to laser radiation require Certificate Europa ("CE") mark
certification for shipments of laser beam and electron beam products into the
EU. Prior EU regulations in this area have required the Company to modify its
systems for shipment to Europe. The Company's systems currently do not comply
with the additional EU regulations which became effective in January 1996, and
further EU regulations in this area are scheduled to become effective in
January 1997. The Company is currently pursuing product design activities to
obtain CE mark certification for its CORE and ALTA laser beam systems and for
its next generation of MEBES products, but no such activities are planned with
respect to the MEBES 4500. No assurance can be given that the Company will
obtain such certification. If the Company is unable to comply with these EU
regulations, the Company may be barred from selling its products directly or
through its customers to member countries of the EU. In addition, numerous
domestic semiconductor manufacturers and independent mask shops, including
certain of the Company's customers, have subscribed to voluntary health and
safety standards and decline to purchase equipment not meeting such standards.
The Company believes that its products currently comply with all material
governmental health and safety regulations, except for the EU regulations
described above, and with the voluntary industry standards currently in
effect. In part because the scope of future regulations and standards cannot
be predicted, there can be no assurance that the Company will be able to
comply with any future regulation or industry standard. Noncompliance could
result in governmental restrictions on sales or reductions in customer
acceptance of the Company's products. Compliance may also require significant
product modifications, potentially resulting in increased costs and impaired
product performance. In addition, the composition of the Company's workforce
and other aspects of its operations have been subject to extensive
governmental regulation due to the Company's provision of services to federal
agencies such as ARPA.
 
  Certain of the Company's products may not be sold outside of the United
States except pursuant to an export license from the United States Department
of Commerce. While the Company has not experienced significant delays in
obtaining such licenses for major markets, there can be no assurance that
future sales will not be subject to delay due to export license or other
regulatory requirements.
 
EMPLOYEES
 
  As of July 31, 1996, Etec had 686 employees, including 137 in research,
development and engineering-related functions, 214 in manufacturing and
production, 127 in administration, 162 in field service, and 46 in marketing
and sales. Etec's foreign offices employed 122 employees, all foreign
nationals, as of such date. None of Etec's employees is governed by a
collective bargaining agreement, and the Company believes that its relations
with its employees are good.
 
  The Company's financial performance will depend significantly upon the
continued contributions of its officers and key management, technical, sales
and support personnel, many of whom would be difficult to replace. In
addition, the Company believes that certain of its former employees currently
provide services or technical support to the Company's customers or
competitors. There can be no assurance that the Company will be successful in
attracting or retaining qualified personnel.
 
                                       8
<PAGE>
 
                CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
 
CYCLICALITY OF THE MASKMAKING AND SEMICONDUCTOR INDUSTRIES
 
  The Company's operating results depend on capital expenditures by
maskmakers, which in turn depend on the current and anticipated demand for
masks, integrated circuits made from masks and products that use such
integrated circuits. Although the semiconductor industry has experienced
significant growth in recent years, there can be no assurance that such growth
will be sustained. The ratio of semiconductor orders to shipments (the "book-
to-bill" ratio) for U.S.-based semiconductor manufacturers, as reported by the
Semiconductor Industry Association, has declined to less than one in recent
periods. Moreover, the overall semiconductor industry has been and is likely
to continue to be cyclical with periods of oversupply. A downturn in the
demand for semiconductors would likely reduce the demand for masks and could
reduce the demand for the Company's maskmaking equipment. The Company's
ability to reduce expenses in response to any such downturn is limited by its
need for continued investment in research and development and in customer
service and support. Previous downturns in capital investment by the
maskmaking industry have materially adversely affected the Company's business,
financial condition and results of operations in prior periods, and future
downturns may have similar material adverse effects. In addition, due to
changes in semiconductor manufacturing technology, at times the demand for
maskmaking equipment has been depressed while the demand for semiconductor
devices, has remained strong. A downturn in demand for maskmaking equipment
would have a material adverse effect on the Company's business, financial
condition and results of operations.
 
FLUCTUATIONS IN OPERATING RESULTS
 
  The Company derives most of its annual revenues from the sale of a small
number of systems and upgrades at prices currently ranging from approximately
$3.2 million to $7.3 million each for systems, and from approximately $1.4
million to $3.0 million each for upgrades. As a result, any delay in the
recognition of revenue for a single system or upgrade could have a material
adverse effect on the Company's results of operations for a given accounting
period. For example, a system shipment planned for the fourth quarter of
fiscal 1995 was delayed due to the failure to complete factory acceptance
tests prior to the end of the quarter, materially affecting fiscal 1995 fourth
quarter results. In addition, one or more systems originally scheduled to ship
in the first quarter of fiscal 1997 will be delayed due to the failure to
complete factory acceptance tests prior to the end of the first quarter of
fiscal 1997. In addition, some of the Company's sales have been realized near
the end of a quarter. Accordingly, a delay in a shipment scheduled to occur
near the end of a particular quarter could materially adversely affect the
Company's results of operations for that quarter.
 
  The Company's operating results have historically been subject to
significant quarterly and annual fluctuations. The Company believes that its
operating results will continue to fluctuate quarterly and annually due to a
variety of factors, including the cyclicality of the maskmaking and
semiconductor industries, patterns of capital spending by customers, the
timing of significant orders, order cancellations and shipment reschedulings,
market acceptance of the Company's products, fluctuations in the grant and
funding of development contracts, consolidation of mask shops, unanticipated
delays in design, engineering or production or in customer acceptance of
product shipments, changes in pricing by the Company or its competitors, the
timing of product announcements or introductions by the Company or its
competitors, the mix of systems sold, the relative proportions of product
revenues and service revenues, the timing of payments of sales commissions,
the availability of components and subassemblies, changes in product
development costs, expenses associated with acquisitions and exchange rate
fluctuations. In any particular period, average gross margin per system
shipped may vary significantly depending on the types of systems shipped, the
specific configuration of each shipped system, and potential differences in
selling prices among systems ordered at different times. Over the last eight
quarters the Company's gross margin has fluctuated from approximately 39% to
47% of revenues. The Company anticipates that its gross margin will continue
to fluctuate. The Company's net income and cash flow will also be affected by
its ability to apply its net operating loss carryforwards ("NOLs"), which
totaled approximately $23.9 million for federal income tax purposes at July
31, 1996, against taxable income in future periods. The
 
                                       9
<PAGE>
 
Company's utilization of the NOLs cannot exceed approximately $19.0 million
per fiscal year. The Company cannot predict the impact of these and other
factors on its financial performance in any future period.
 
IMPORTANCE OF RECENTLY INTRODUCED PRODUCTS
 
  The Company's future success depends upon the market's acceptance of new
generations of its systems. The Company commenced shipments of its MEBES 4500
electron beam systems in June 1995 and of its ALTA 3000 laser beam systems in
June 1994, both of which are targeted at the 0.25- to 0.35-micron generation
of semiconductor devices currently in pilot production and under development.
The Company has limited experience with the production of the MEBES 4500 and
ALTA 3000 systems, having shipped nine MEBES 4500 systems, two MEBES 4500
upgrades and nine ALTA 3000 systems to date. Any technical or manufacturing
difficulties with these systems (or subsequent generations of the Company's
systems) would have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, there can be no
assurance that the market for the leading-edge applications targeted by the
MEBES 4500 and ALTA 3000 systems will develop as quickly as, or to the degree
that, the Company currently anticipates.
 
RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON PRODUCT DEVELOPMENT
 
  The semiconductor industry in general, and the maskmaking industry in
particular, are characterized by rapid technological change and evolving
industry standards. As a result, the Company must continue to enhance its
existing products and to develop and manufacture new products and upgrades
with improved capabilities. This has required and will continue to require
substantial investments in research and development by the Company to advance
a number of state-of-the-art technologies. Continuous investments in research
and development will also be required to respond to the emergence of new mask
technologies, such as optical proximity correction ("OPC") and phase shift
mask ("PSM") technologies. The failure to develop, manufacture and market new
products, or to enhance existing products, would have a material adverse
effect on the Company's business, financial condition and results of
operations. In addition, the Company's competitors can be expected to continue
to develop and introduce new and enhanced products, any of which could cause a
decline in market acceptance of the Company's products or a reduction in the
Company's margins as a result of intensified price competition.
 
  Changes in mask or semiconductor manufacturing processes could also have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company anticipates continued changes in
semiconductor and pattern generation technologies and processes, which may
include the development of product or process technologies that extend the
useful lives of previously sold maskmaking tools. For example, the Company's
sales were materially adversely affected for several years from the mid-1980s
to the early 1990s due to the introduction of "5X" reduction steppers. There
can be no assurance that the Company will be able to develop, manufacture and
sell products that respond adequately to such changes.
 
  The Company's success in developing and selling new and enhanced products
depends upon a variety of factors, including accurate prediction of future
customer requirements, introduction of new products on schedule, cost-
effective manufacturing and product performance in the field. The Company's
new product decisions and development commitments must anticipate the
equipment needed to satisfy the requirements for lithography processes three
or more years in advance of sales. Any failure to predict accurately customer
requirements and to develop new generations of products to meet those
requirements would have a sustained material adverse effect on the Company's
business, financial condition and results of operations. New product
transitions could adversely affect sales of existing systems, and product
introductions could contribute to quarterly fluctuations in operating results
as orders for new products commence and orders for existing products decline.
There can be no assurance that the Company will be successful in selecting,
developing, manufacturing and marketing new products or enhancements of
existing products.
 
                                      10
<PAGE>
 
DEPENDENCE ON KEY SUPPLIERS; AVAILABILITY OF CRITICAL COMPONENTS
 
  The Company does not maintain any long-term supply agreements with any of
its suppliers, and the majority of the critical components and subassemblies
included in the Company's products are obtained from sole source suppliers or
a limited group of suppliers. The manufacture of certain components and
subassemblies is very complex and requires long lead times. The Company's
systems cannot be produced without certain sole-sourced, critical components.
Alternative suppliers for many of these components may not be readily
available, and no substantial increase in the number of alternative suppliers
is anticipated. In addition, the Company intends to rely to an increasing
degree on outside suppliers because of their specialized expertise in
component fabrication and subsystem assembly. However, some of the Company's
suppliers may be unwilling or unable to produce sufficient volumes of key
components to keep pace with the demand for the Company's systems and
upgrades, or to permit the Company to provide customers with an adequate
supply of spare parts.
 
  The Company's reliance on a limited group of suppliers, and particularly on
sole source suppliers, involves several risks, including the potential
inability to obtain an adequate supply of components and reduced control over
pricing and delivery time. To date, the Company has generally been able to
obtain adequate, timely delivery of critical subassemblies and components,
although it has experienced occasional delays. Due to occasional shortfalls in
supply, the Company has from time to time attempted to develop and manufacture
critical parts and subassemblies. In addition, the Company is attempting to
modify product designs to avoid the use of currently obsolete electronic
components. For example, certain components in the Company's MEBES systems
were designed for the MEBES system architecture, which was developed over 20
years ago. In addition, the ALTA data path and portions of the CORE system
contain components that have been, or are being, discontinued due to
obsolescence. There can be no assurance that delays or shortages caused by
suppliers will not occur in the future or that the Company will be successful
in developing critical components internally or in modifying product designs
to avoid the use of obsolete components. Any inability to obtain adequate,
timely deliveries of subassemblies and components could prevent the Company
from meeting scheduled shipment dates, which would damage relationships with
current and prospective customers and materially adversely affect the
Company's business, financial condition and results of operations. Future
shortages of components from these limited sources could also require the
Company to expend resources on internal parts development and production, or
to alter product designs, which could have a material adverse effect on the
Company's business and results of operations.
 
LIMITED MANUFACTURING CAPACITY
 
  The Company's systems have a large number of components and are highly
complex. The Company has experienced delays from time to time in manufacturing
and delivering its systems and upgrades and may experience similar delays in
the future. Any inability to manufacture and ship systems or upgrades on
schedule could adversely affect the Company's relationships with its customers
and thereby materially adversely affect the Company's business, financial
condition and results of operations. The Company's ability to increase its
manufacturing capacity in response to an increase in demand is limited given
the complexity of the manufacturing process, the lengthy lead times necessary
to obtain critical components and the need for highly skilled personnel.
However, manufacturing capacity is not currently limited by facility
constraints. The failure of the Company to keep pace with customer demand
could lead to extensions of delivery times, which could deter customers from
placing additional orders, and could adversely affect product quality. In an
effort to keep pace with customer demand and to shorten delivery times, the
Company is outsourcing significant subassemblies, is performing vendor
certifications, is partnering to reduce lead times on critical components, and
is attempting to standardize its bills of materials. Additionally, the Company
is attempting to attract additional skilled personnel. There can be no
assurance that these efforts will be successful in increasing the Company's
manufacturing capacity.
 
  The Company conducts all of its manufacturing activities at its leased
facilities in Hayward, California, Beaverton, Oregon and Tucson, Arizona. The
Company's Hayward campus is located in a seismically active area. Although the
Company maintains business interruption insurance, a major catastrophe (such
as an
 
                                      11
<PAGE>
 
earthquake or other natural disaster) at the Hayward or Beaverton sites could
result in a prolonged interruption of the Company's business. All of the
Company's electron beam systems are produced in Hayward, and all of its CORE
and ALTA laser beam systems are produced in Beaverton. Neither facility is
equipped to produce the type of system produced by the other.
 
CONCENTRATION OF CUSTOMERS; LIMITED CONCURRENT SELLING OPPORTUNITIES
 
  Historically, the Company has sold a significant proportion of its systems
to a limited number of customers. Sales to the Company's ten largest customers
accounted for approximately 76%, 74%, and 76% of total revenues in fiscal
1996, fiscal 1995 and fiscal 1994, respectively. Sales to the largest customer
during those periods accounted for approximately 17%, 14% and 13% of total
revenues, respectively. Opportunities for new system sales are episodic,
because the number of captive and merchant mask shops worldwide is limited and
each mask shop has historically purchased at most one or two pattern
generation tools per year. As a particular customer completes a new or
expanded facility or production line, sales to that customer may decrease
sharply. The failure to replace such sales with sales to other customers in
succeeding periods would have a material adverse effect on the Company's
business, financial condition and results of operations. The Company expects
that sales to relatively few customers will continue to account for a high
percentage of the Company's revenues in any accounting period in the
foreseeable future. A reduction in orders from any such customer or the
cancellation of any significant order could have a material adverse effect on
the Company's business, financial condition and results of operations. None of
the Company's customers has entered into a long-term agreement requiring it to
purchase the Company's products. See "Business--Customers."
 
DEPENDENCE ON KEY EMPLOYEES; NEW MANAGEMENT; MANAGEMENT OF GROWTH
 
  The Company's operating results will depend significantly upon the continued
contributions of its officers and key management, engineering, manufacturing,
marketing, customer support and sales personnel, many of whom would be
difficult to replace. The Company does not have an employment agreement with
any of its employees or maintain key person life insurance with respect to any
employee. The loss of any key employee could have a material adverse effect on
the Company's business, financial condition and results of operations.
Employees of the Company are currently required to enter into a
confidentiality agreement as a condition of their employment. However, these
agreements do not expressly prohibit the employees from competing with the
Company after leaving its employ, and certain of its former employees
currently provide services or technical support to the Company's customers or
for its competitors.
 
  The Company's operating results will depend in significant part upon its
ability to attract and retain other qualified management, engineering,
manufacturing, marketing, customer support and sales personnel. Competition
for such personnel is intense, and there can be no assurance that the Company
will be successful in attracting and retaining such personnel. The failure to
attract and retain such personnel could have a material adverse effect on the
Company's business, financial condition and results of operations.
 
  Certain of the Company's senior management, including its Chief Executive
Officer; Chief Financial Officer; Vice President, Operations; Vice President,
Human Resources and Administration; Vice President, Customer Support; Vice
President, Sales and Customer Support; and the General Manager of the
Company's subsidiary, Etec Polyscan, Inc., joined the Company within the past
four years. The Company's ability to compete effectively and to execute its
strategies will depend in part upon its ability to integrate these and future
new managers into its operations. The Company continues to require additional
managerial and technical personnel due to its recent growth, and occasional
delays in filling key positions have placed additional burdens on existing
personnel. There can be no assurance that the Company will be successful in
attracting and retaining qualified managerial and technical personnel
sufficient to meet its requirements.
 
  The recent growth in the Company's sales and expansion of its operations has
placed a considerable strain on its management, financial, manufacturing and
other resources and has required the Company to implement and improve a
variety of operating, financial and other systems, procedures and controls.
There can be no
 
                                      12
<PAGE>
 
assurance that any existing or new systems, procedures or controls will be
adequate to support the Company's operations or that its systems, procedures
and controls will be designed, implemented or improved in a cost-effective and
timely manner. Any failure to implement, improve and expand such systems,
procedures and controls in an efficient manner at a pace consistent with the
Company's business could have a material adverse effect on the Company's
business, financial condition and results of operations.
 
ACQUISITIONS
 
  The Company's business strategy includes expanding its product lines and
markets through internal product development or acquisitions. Any acquisition
may result in potentially dilutive issuances of equity securities, the
incurrence of debt and contingent liabilities, potential reductions in income
due to losses incurred by the acquired business, and amortization expense
related to intangible assets acquired, any of which could materially adversely
affect the Company's financial condition and results of operations. For
example, in the third quarter of fiscal 1996, the Company wrote off $6.3
million of in-process technology relating to the acquisition of substantially
all of the assets of Polyscan described below. Any acquisition will involve
numerous risks, including difficulties in the assimilation of the acquired
company's operations and products, uncertainties associated with operating in
new markets and working with new customers, and the potential loss of the
acquired company's key employees. To date, the Company has had limited
experience in integrating businesses operating in markets other than
semiconductor maskmaking equipment.
 
  In February 1996, Etec Polyscan, Inc. ("Etec Polyscan"), a wholly-owned
subsidiary of the Company, acquired substantially all of the assets and
assumed certain liabilities of Polyscan, a development-stage company based in
Tucson, Arizona that designs and develops laser direct imaging systems for
printed circuit board and multi-chip module applications, for 350,000 shares
of the Company's Common Stock. Etec Polyscan has received orders for systems,
but has not yet shipped a product, and has had net operating losses since its
inception. The Company expects that Etec Polyscan will continue to have net
operating losses for the foreseeable future. The Company has never operated in
the market segments targeted by Etec Polyscan. The Company's failure to
integrate Etec Polyscan's technology into the Company's product development
strategy, or Etec Polyscan's inability to complete its obligations under
development contracts and to manufacture and market its products, may have a
material adverse effect on the Company's business. There can be no assurance
that the Company will be able to integrate Etec Polyscan into its current
business operations or will be able to integrate Etec Polyscan's technology
into the Company's product development strategy or to market and sell Etec
Polyscan's products successfully, or that the Etec Polyscan business will ever
become profitable. There can be no assurance of the effect of any future
acquisition on the Company's business or operating results.
 
COMPETITION
 
  The maskmaking equipment industry is highly competitive. The Company
currently experiences competition worldwide from a number of foreign and
domestic manufacturers, including Hitachi, Ltd. ("Hitachi") and Japan Electron
Optical Laboratory ("JEOL"). Most of the Company's competitors have
substantially greater financial resources than the Company and extensive
engineering, manufacturing, marketing and customer service and support
capabilities. Some competitors have entered into strategic relationships or
alliances with leading semiconductor manufacturers. In particular, the Company
believes that Japanese competitors such as Hitachi and JEOL have longstanding
collaborative relationships with Japanese and other Asian semiconductor
manufacturers. Several industry consortia have been formed in Japan to promote
the development of maskmaking and direct write technology. Because of the
significant investment required to install and integrate maskmaking equipment,
the Company also believes that many customers rely upon a single maskmaking
equipment vendor for multiple generations of equipment, making it difficult to
achieve significant sales to a particular customer once a competitor's system
has been selected.
 
  The Company's competitors can be expected to continue to improve the design
and performance of their current products and processes and to introduce new
products and processes with improved price and performance characteristics.
Product introductions and enhancements by the Company's present or future
 
                                      13
<PAGE>
 
competitors could cause a significant decline in sales or loss of market
acceptance of the Company's systems, intensify price competition or otherwise
make the Company's systems or technology obsolete or noncompetitive. In
addition to competition from companies employing lithography technologies
currently in volume production, the Company believes that it may face
competition from companies employing new technologies, such as the cell
projection technology that is currently under development. In addition, the
Company's MEBES, CORE and ALTA systems all use a raster scanning writing
method. Currently, despite the throughput advantage of vector scanning for
some types of integrated circuit designs, the Company believes that raster
scanning has a competitive advantage over vector scanning due to its greater
accuracy. If changes in integrated circuit manufacturing or in customer
requirements were to make vector scanning systems more attractive, the
Company's raster scanning products could be subjected to more intense
competition from vector scanning systems. There can be no assurance that
competitive pressures will not have a material adverse effect on the Company's
business, financial condition or results of operations.
 
LENGTHY SALES CYCLE
 
  Installing and integrating maskmaking equipment requires a substantial
investment by a customer. In addition, customers often require a significant
number of product presentations and demonstrations, as well as substantial
interaction with the Company's senior management, before reaching a sufficient
level of confidence in the system's performance characteristics and
compatibility with the customer's target applications. Accordingly, the
Company's systems typically have a lengthy sales cycle during which the
Company may expend substantial funds and management time and effort with no
assurance that a sale will result. See "Sales and Marketing."
 
FUTURE CAPITAL NEEDS
 
  The development, manufacture and marketing of pattern generation systems are
highly capital intensive. The Company has also budgeted in excess of $24.6
million for capital expenditures in fiscal 1997. The Company expects that the
proceeds from its public offering and the sale of Common Stock to Intel in
June 1996, together with anticipated cash flow from operations, existing
credit facilities, and existing cash balances, will satisfy its cash
requirements for at least the next twelve months. To the extent that such cash
resources are insufficient to fund the Company's activities, additional funds
will be required. There can be no assurance that additional financing will be
available on reasonable terms or at all. If additional capital is raised
through the sale of additional equity or convertible debt securities, dilution
to the Company's stockholders could occur.
 
REDUCED COOPERATIVE DEVELOPMENT FUNDING
 
  The Company's research and development efforts have historically received
significant funding from governmental and quasi-governmental agencies, such as
the Advanced Research Projects Agency ("ARPA") and SEMATECH, Inc.
("SEMATECH"), a consortium of U.S. semiconductor manufacturers, and from the
private sector. Aggregate funding from all such sources amounted to
approximately $725,000, $7.3 million, and $16.1 million in fiscal 1996, fiscal
1995, and fiscal 1994, respectively. Governmental funding of the Company's
development activities has declined precipitously in recent periods. In the
past year, the Company and SEMATECH ended their most recent cooperative
development agreement. Future funding from governmental, quasi-governmental
and private sources is uncertain, and there can be no assurance that any such
funding will be available to the Company. Accordingly, the Company anticipates
that its net research and development expenditures will continue to increase
over at least the next two years.
 
PATENTS AND OTHER INTELLECTUAL PROPERTY
 
  The Company currently holds 44 United States patents expiring on various
dates from 1999 through 2012, and holds corresponding patents and applications
in several foreign countries for most of such patents. The Company also has
six pending U.S. patent applications and over 40 pending foreign patent
applications. There can be no assurance that any of the Company's patent
applications will be allowed or that any of the allowed
 
                                      14
<PAGE>
 
applications will be issued as patents. Certain important aspects of the
Company's systems depend upon licenses granted by third parties. In
particular, the basic technological architecture for MEBES, the Company's
family of electron beam systems, was licensed to the Company by AT&T. This
license is non-exclusive, and similar licenses could be granted to potential
competitors. Although the Company believes that significant development
efforts would be necessary to generate a commercial production tool from the
basic technology covered by this license, there can be no assurance that
competitors will not be able to utilize this technology to develop products
that could reduce the Company's sales of MEBES systems, accessories and
upgrades. In addition, certain rights relating to laser beam technology have
been licensed from Patlex Corporation and SEMATECH, Inc. The Company's
electron beam and laser beam systems also incorporate software and hardware
licensed from other third parties. If the Company's licenses were invalidated
or terminated, or if their scope became subject to dispute, the Company's
business could be adversely affected. The Company also relies on trade secrets
and proprietary technology that it seeks to protect through confidentiality
agreements with employees, consultants and other parties. There can be no
assurance that these agreements will not be breached, that the Company will
have adequate remedies for any breach, or that the Company's trade secrets or
proprietary technology will not otherwise become known to or independently
developed by others. Overall, while the Company intends to protect its
intellectual property rights vigorously, there can be no assurance that any
patents or other rights held by or licensed to the Company will not be
challenged, invalidated or circumvented, or that protracted and costly
litigation will not be necessary to enforce the Company's patents and other
intellectual property rights.
 
  Semiconductor-related industries have experienced substantial litigation
regarding patent and other intellectual property rights. As is typical in the
industry, the Company has from time to time received, and may in the future
receive, communications from third parties alleging infringements of patents
and other intellectual property rights. No assurance can be given that
additional infringement claims by third parties will not be asserted. In the
future, protracted litigation may be necessary to defend the Company against
alleged infringement of others' rights. Any such litigation, even if
ultimately successful in defense of the Company, could result in substantial
cost and diversion of time and effort by management, which by itself could
have a material adverse effect on the Company's business, financial condition
and results of operations. Further, adverse determinations in such litigation
could result in the Company's loss of proprietary rights, subject the Company
to significant liabilities (including treble damages under certain
circumstances), require the Company to seek licenses from third parties or
prevent the Company from manufacturing or selling its systems, any of which
could have a material adverse effect on the Company's business, financial
condition or results of operations.
 
ENVIRONMENTAL REGULATIONS
 
  The Company is subject to a variety of governmental regulations relating to
the use, storage, discharge, handling, emission, generation, manufacture and
disposal of toxic or other hazardous substances. The Company believes that it
is currently in compliance in all material respects with such regulations and
that it has obtained or is in the process of obtaining all material
environmental permits necessary to conduct its business. Nevertheless, the
failure to comply with current or future regulations could result in
substantial fines being imposed on the Company, suspension of production,
alteration of its manufacturing process or cessation of operations. Such
regulations could require the Company to acquire expensive remediation or
abatement equipment or to incur substantial expenses to comply with
environmental regulations. Any failure by the Company to control the use,
disposal or storage of, or adequately restrict the discharge of, hazardous or
toxic substances could subject the Company to significant liabilities.
 
  In 1990, several monitoring wells were installed on the site of the
Company's headquarters in Hayward, California to monitor levels of Freon 113,
Dichloroethene (1, 1-DCE), Trichloroethene and Chloroform in groundwater under
the site. On June 1, 1995, an environmental consulting firm recommended to the
California Regional Water Quality Board (the "Water Quality Board") that
groundwater monitoring at the site be discontinued, and on July 19, 1995 the
Water Quality Board agreed in writing with this recommendation. However, there
can be no assurance that the Water Quality Board or any other governmental
agency will not require additional monitoring or remediation at the Hayward
site in the future. The Perkin-Elmer Corporation
 
                                      15
<PAGE>
 
("Perkin-Elmer"), the former owner of the property, has agreed to indemnify
the Company, subject to a 50% copayment by the Company of the first $600,000
of indemnifiable costs, in the event that any toxic substances which were
present and identified at the time of the Company's acquisition of the
property in 1990 require remediation. The Company is obligated to indemnify
the current owner of the Hayward property, which is leased by the Company, in
the event that soil or groundwater remediation at the site becomes necessary.
 
HEALTH AND SAFETY REGULATIONS AND STANDARDS
 
  The Company's products and worldwide operations are subject to numerous
governmental regulations designed to protect the health and safety of
operators of manufacturing equipment. In particular, recent European Union
("EU") regulations relating to electromagnetic fields, electrical power and
human exposure to laser radiation require Certificate Europa ("CE") mark
certification for shipments of laser beam and electron beam products into the
EU. Prior EU regulations in this area have required the Company to modify its
systems for shipment to Europe. The Company's systems currently do not comply
with the additional EU regulations which became effective in January 1996, and
further EU regulations in this area are scheduled to become effective in
January 1997. The Company is currently pursuing product design activities to
obtain CE mark certification for its CORE and ALTA laser beam systems and for
its next generation of MEBES products, but no such activities are planned with
respect to the MEBES 4500. No assurance can be given that the Company will
obtain such certification. If the Company is unable to comply with these EU
regulations, the Company may be barred from selling its products directly or
through its customers to member countries of the EU. A disruption in or loss
of sales to the Company's European customers could adversely affect the
Company's customer relationships and results of operations. In addition,
numerous domestic semiconductor manufacturers and independent mask shops,
including certain of the Company's customers, have subscribed to voluntary
health and safety standards and decline to purchase equipment not meeting such
standards. The Company believes that its products currently comply with all
material governmental health and safety regulations, except for the EU
regulations described above, and with the voluntary industry standards
currently in effect. In part because the future scope of these and other
regulations and standards cannot be predicted, there can be no assurance that
the Company will be able to comply with any future regulation or industry
standard. Noncompliance could result in governmental restrictions on sales or
reductions in customer acceptance of the Company's products. Compliance may
also require significant product modifications, potentially resulting in
increased costs and impaired product performance.
 
VOLATILITY OF STOCK PRICE
 
  Since the Company's initial public offering in October 1995, the price of
the Company's Common Stock has fluctuated widely, with sales prices on the
Nasdaq National Market ranging from $7.75 to $39.50 (the high on October 14,
1996). The Company believes that factors such as announcements of developments
related to the Company's business, fluctuations in the Company's operating
results, failure to meet securities analysts' expectations, general conditions
in the maskmaking and semiconductor industries and the worldwide economy,
announcements of technological innovations, new systems or product
enhancements by the Company or its competitors, fluctuations in the level of
cooperative development funding, acquisitions, changes in governmental
regulations, developments in patents or other intellectual property rights and
changes in the Company's relationships with customers and suppliers could
cause the price of the Company's Common Stock to fluctuate, perhaps
substantially. In addition, in recent years the stock market in general, and
the market for small capitalization stocks in particular, has experienced
extreme price fluctuations which have often been unrelated to the operating
performance of affected companies. Such fluctuations could adversely affect
the market price of the Company's Common Stock.
 
FACTORS AFFECTING A CHANGE IN CONTROL
 
  The Company's four largest institutional investors, in the aggregate, own
beneficially approximately 21% of the Company's outstanding shares of Common
Stock. As a result, these stockholders, acting together, may be able to exert
significant influence over the election of directors and other corporate
actions requiring stockholder
 
                                      16
<PAGE>
 
approval. The Company's charter provides for authorized but unissued preferred
stock, the terms of which may be fixed by the Board of Directors. In addition,
certain provisions of Nevada law will prohibit certain significant
stockholders from entering into a business combination with the Company unless
certain conditions are met. These charter and statutory provisions could have
the effect of delaying, deferring or preventing a change of control of the
Company.
 
ITEM 2. PROPERTIES.
 
  The Company maintains its electron beam system design, development and
manufacturing capability at its headquarters located in Hayward, California.
The Company leases the Hayward facility under a lease that expires in fiscal
2012 unless extended at the Company's option for up to four five-year renewal
periods. The Hayward campus consists of two buildings with a total area of
150,000 square feet. In April 1996, the Company commenced construction of a
60,000-square-foot administrative building in Hayward, which is expected to be
completed in early 1997. The manufacturing building, one of the two existing
buildings, has been custom-modified for the production of electron beam
systems and includes an 18,500 square foot cleanroom facility, including 20
test cells, for precision assembly and final system testing. The Company also
leases general office space in Hayward.
 
  CORE and ALTA laser systems are manufactured at a facility in Beaverton,
Oregon with approximately 60,000 square feet under a lease that expires on
June 30, 1999 unless extended at the Company's option for an additional three-
year period. The facility includes approximately 5,000 square feet of
cleanroom space, including six test cells. In early fiscal 1997, the Company
added approximately 2,000 square feet of cleanroom space and four additional
test cells. The Company also leases sales and service offices in France,
Germany, Japan and South Korea. The Company believes its facilities are
adequate to support its current needs.
 
  Etec Polyscan operates an approximately 22,000 square foot facility in
Tucson, Arizona under a lease that expires in 2000. In early fiscal 1997, Etec
Polyscan completed the addition of 4,500 square feet of cleanroom space and
acquired approximately 17,000 square feet of additional space at its Tucson
facility.
 
ITEM 3. LEGAL PROCEEDINGS.
 
  The Company is not currently involved in any material legal proceedings.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
  No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1996.
 
                                      17
<PAGE>
 
EXECUTIVE OFFICERS OF THE REGISTRANT
 
  The following table lists the names, ages and positions held with the
Company of all executive officers of the Company as of July 31, 1996. There
are no family relationships between any director or executive officer and any
other director or executive officer of the Company.
 
  The executive officers of the Company, who are elected by and serve at the
discretion of the Board of Directors are as follows:
 
<TABLE>
<CAPTION>
   NAME                     AGE                           POSITION
   ----                     ---                           --------
   <S>                      <C> <C>
   Stephen E. Cooper.......  50 Chairman of the Board, President and Chief Executive Officer
   Frank E. Abboud.........  36 Vice President, Product Development
   William D. Cole.........  41 Vice President, Sales and Customer Support
   Trisha A. Dohren........  50 Vice President, Human Resources and Administration
   Roy A. Earle............  39 Vice President, Operations
   Melissa A. Ellis........  44 Vice President, Customer Support
   Mark A. Gesley..........  40 Vice President, Technology Development
   Philip J. Koen, Jr. ....  44 Vice President and Chief Financial Officer
   Takeshi (John) Suzuki...  57 President, Etec Japan and Director
   Paul A. Warkentin.......  42 Vice President, Marketing
</TABLE>
 
  Mr. Cooper joined Etec as President and Chief Operating Officer in January
1993 and was named Chief Executive Officer in July 1993. He was initially
appointed to the Board of Directors in March 1993 and became Chairman of the
Board in April 1995. Before joining Etec, Mr. Cooper served as President and
Chief Executive Officer of Bipolar Integrated Technology, a manufacturer of
bipolar emitter coupled logic semiconductors, from 1987 to 1990. From 1980 to
1987, Mr. Cooper held various positions, including President and Chief
Operating Officer, with Silicon Systems, Inc., a manufacturer of
analog/digital semiconductors. From 1973 to 1980, Mr. Cooper held various
engineering and management positions at Intel Corporation, including
Engineering Manager and Wafer Fabrication Manager. Mr. Cooper holds a B.S.E.E.
from the University of California at Santa Barbara. He is also a director of
Vivid Semiconductor.
 
  Mr. Abboud joined Etec in 1985 and has been Vice President, Product
Development since August 1996. From June 1994 to July 1996, Mr. Abboud served
as Vice President, Customer Support. He served as manager of electron beam
raster scan programs from August 1991 to June 1994. During that time he led
several critical product development programs and contracts with SEMATECH for
the development of the MEBES IV and MEBES 4000 products. Mr. Abboud holds a
B.S.E.E. from California State University at Sacramento and his M.S.E.E. from
Santa Clara University.
 
  Mr. Cole joined Etec as Vice President, Sales and Customer Support in August
1996. Before coming to Etec, Mr. Cole served as Vice President, Sales for
Genus, Inc. a manufacturer of ion implementation and chemical vapor deposition
systems, since 1993. Prior to Genus, Mr. Cole was National Sales Manager at
Teradyne, Inc., a world leader in automatic test equipment, telecommunications
test, and backplane connection systems, where he had responsibility for sales
and service for the Western United States. From 1981 to 1985, he was a Sales
Engineer for Recht Associates, manufacturers of electronic components. He
holds a B.S. in Economics/Statistics from the University of California at
Berkeley.
 
  Ms. Dohren joined Etec as Vice President, Human Resources and Administration
in August 1993. Before joining Etec, Ms. Dohren was a human resources
executive with Wells Fargo Bank's Wells Electronic Banking Systems from May
1993 to August 1993. From 1991 to February 1993, she served as Regional Human
Resources Manager with Brooks Brothers. From 1983 to 1991, Ms. Dohren held
various managerial positions including Personnel Manager at Macy's of
California. Ms. Dohren attended San Jose State University.
 
  Mr. Earle, Vice President, Operations, joined Etec in October 1995. Before
joining Etec, Mr. Earle served as Chief Operating Officer and Plant Manager
for Temic Siliconix, a manufacturer of integrated circuits and
 
                                      18
<PAGE>
 
bipolar discretes, from July 1994 to October 1995. He was Senior Director,
Tactical Marketing of Temic Siliconix from 1990 to 1994. Mr. Earle served at
Siliconix, Inc. a semiconductor manufacturer, as Plant Manager from 1989 to
1990 and as Operations Manager from 1988 to 1989. From 1980 to 1988, Mr. Earle
held various operations and engineering positions with GE Ceramics and GE
Semiconductor. He holds a B.Sc. from University College, Dublin, (Ireland),
and an M.Sc. Tech. from the University of Sheffield (United Kingdom).
 
  Ms. Ellis, Vice President, Customer Support, joined Etec in August 1996.
Before joining Etec, Ms. Ellis was with Credence Systems Corp. from 1991 to
1996 where she had worldwide responsibility in the same capacity. Between 1976
and 1991, she held various management positions at Tectronix, Inc., including
Business Unit Manager and Materials Manager. She holds a B.A. degree from
Lewis and Clark College, Portland, Oregon.
 
  Dr. Gesley, Vice President, Technology Development, joined Etec in 1988 as
the electron optics task leader for the MEBES IV product. He holds five
patents related to the MEBES thermal field emission column. Before joining
Etec, Dr. Gesley was with the electron-beam lithography group at the IBM
Thomas L. Watson Research Center in Yorktown Heights, New York. He holds a
B.A. in Physics from Reed College and a Ph.D. in Applied Physics from the
Oregon Graduate Institute of Science and Technology.
 
  Mr. Koen, Vice President, Chief Financial Officer, joined Etec in December
1993 as Chief Financial Officer and Treasurer. He served as Chief Financial
Officer and Vice President, Manufacturing of Levolor Corporation, a consumer
products manufacturer, from April 1989 to December 1993. From 1980 to 1989, he
held several management positions, the last being Director of Business
Development, at Baker Hughes, Inc., a manufacturer of oil field service
equipment. Mr. Koen holds a B.A. in Economics from Claremont McKenna College
and an M.B.A. from the University of Virginia. Mr. Koen is a Certified Public
Accountant (inactive status).
 
  Mr Suzuki has been a director of Etec since May 1994. Mr. Suzuki has been
President and a director of Etec Japan since May 1990. He founded Etec Japan
in 1977. Mr. Suzuki has worked in the electronics industry since 1962 and has
extensive international trade experience.
 
  Dr. Warkentin has been Vice President, Marketing, of Etec since July 1995,
and has served in various other positions, including Vice President, Corporate
Development and Beaverton Site Manager. Dr. Warkentin came to Etec through its
acquisition of ATEQ in November 1991, where his last position was Director of
Development. Dr. Warkentin led a number of product development programs after
joining ATEQ in January 1984. Dr. Warkentin holds a B.A. in Physics and
Chemistry from the University of California, Santa Cruz and a Ph.D. in Physics
from the University of California, San Diego.
 
                                      19
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR THE REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
 
                          PRICE RANGE OF COMMON STOCK
 
  The Company's Common Stock has been traded on the Nasdaq National Market
under the symbol "ETEC" since October 24, 1995. The following table sets forth
the range of quarterly high and low closing sale prices of the Common Stock as
reported on the Nasdaq National Market.
 
<TABLE>
<CAPTION>
   FISCAL 1996                                                     HIGH   LOW
   -----------                                                    ------ ------
   <S>                                                            <C>    <C>
   First Quarter (from October 24, 1995)......................... $11.00 $10.00
   Second Quarter................................................  13.75   8.00
   Third Quarter.................................................  24.75  10.75
   Fourth Quarter................................................  37.00  17.25
</TABLE>
 
  As of October 21, 1996, there were approximately 390 holders of record of
the Company's outstanding Common Stock.
 
                                DIVIDEND POLICY
 
  The Company has never declared or paid dividends on its capital stock and
does not anticipate paying any dividends in the foreseeable future. The
Company currently intends to retain its earnings, if any, for the development
of its business. Currently, the Company and its subsidiaries are prohibited
from paying dividends under the terms of its $30.0 million financing facility.
In addition, the lease of the Company's Hayward, California property restricts
the Company from paying cash dividends under certain conditions.
 
                                      20
<PAGE>
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                        YEAR ENDED JULY 31,
                             ----------------------------------------------
                               1996     1995     1994      1993      1992
                             --------  -------  -------  --------  --------
                              (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                          <C>       <C>      <C>      <C>       <C>      
STATEMENTS OF OPERATIONS
 DATA:
Revenue:
  Products.................  $112,940  $51,395  $40,731  $ 31,650  $ 41,819
  Services.................    32,705   31,521   27,979    26,932    26,769
                             --------  -------  -------  --------  --------
                              145,645   82,916   68,710    58,582    68,588
                             ========  =======  =======  ========  ========
Cost of revenue:
  Cost of products.........    56,632   27,015   25,559    25,450    32,682
  Cost of services.........    23,410   20,604   17,670    16,488    17,655
                             --------  -------  -------  --------  --------
                               80,042   47,619   43,229    41,938    50,337
                             --------  -------  -------  --------  --------
Gross profit...............    65,603   35,297   25,481    16,644    18,251
                             --------  -------  -------  --------  --------
Operating expenses:
  Research, development and
   engineering.............    17,402   10,497    5,102    11,034     9,472
  Selling, general and
   administrative..........    21,269   13,397   10,803    10,049    25,331
  Write-off of in-process
   technology acquired.....     6,269      --       --        --     10,600
                             --------  -------  -------  --------  --------
                               44,940   23,894   15,905    21,083    45,403
                             --------  -------  -------  --------  --------
Income (loss) from
 operations................    20,663   11,403    9,576    (4,439)  (27,152)
Interest expense...........    (1,824)  (4,238)  (5,115)   (5,880)   (5,277)
Other income (expense),
 net.......................     2,669     (352)    (533)      410    (1,116)
                             --------  -------  -------  --------  --------
Income (loss) before income
 tax (benefit) provision
 and extraordinary items...    21,508    6,813    3,928   (9,909)   (33,545)
Income tax (benefit)
 provision.................   (16,283)   2,289    2,316     1,500     1,296
                             --------  -------  -------  --------  --------
Income (loss) before
 extraordinary items.......    37,791    4,524    1,612   (11,409)  (34,841)
Extraordinary (loss) gain
 on early extinguishment of
 debt......................      (930)   5,412      --        --        --
                             --------  -------  -------  --------  --------
Net income (loss)..........    36,861    9,936    1,612   (11,409)  (34,841)
Accretion of mandatorily
 redeemable convertible
 preferred stock...........     1,078    3,092    2,946     2,740     2,541
                             --------  -------  -------  --------  --------
Net income (loss)
 attributable to Common
 Stockholders..............  $ 35,783  $ 6,844  $(1,334) $(14,149) $(37,382)
                             ========  =======  =======  ========  ========
Per share data:
  Income (loss) before
   extraordinary items.....  $   2.07  $  0.31  $  0.12  $  (0.94) $  (2.86)
  Extraordinary items......     (0.05)    0.37      --        --        --
                             --------  -------  -------  --------  -------- 
  Net income (loss)........  $   2.02  $  0.68  $  0.12  $  (0.94) $  (2.86)
                             ========  =======  =======  ========  ========
Weighted average common
 shares....................    18,296   14,594   14,008    12,168    12,167
                             ========  =======  =======  ========  ========
</TABLE>
 
  (See unaudited quarterly data at page 29 of Management's Discussion and
Analysis of Financial Condition and Results of Operations.)
 
  (See factors affecting comparability and selected consolidated balance sheet
data on next page.)
 
                                      21
<PAGE>
 
<TABLE>
<CAPTION>
                                         1996    1995    1994    1993    1992
                                       -------- ------- ------- ------- -------
<S>                                    <C>      <C>     <C>     <C>     <C>
BALANCE SHEET DATA:
Total assets.......................... $208,871 $85,984 $62,782 $66,151 $76,793
Mandatorily redeemable convertible
 preferred stock...................... $    --  $76,397 $54,362 $44,317 $41,577
Long-term debt, including capital
 lease obligations.................... $  6,939 $16,866 $31,251 $46,573 $49,377
</TABLE>
 
  The Company has not declared dividends.
 
FACTORS AFFECTING COMPARABILITY
 
 Fiscal 1996 net income
 
  .  reflects the inclusion of an extraordinary loss of $930,000 recorded as
     a result of the early extinguishment of senior secured notes payable.
     See Note 3 of Notes of Consolidated Financial Statements.
 
  .  reflects a $23.0 million tax benefit realized as a result of reversing a
     portion of the Company's valuation allowance associated with certain
     deferred tax assets. See Note 7 of Notes to Consolidated Financial
     Statements.
 
  .  reflects the write-off of $6.3 million of in-process technology acquired
     in connection with the acquisition of substantially all of the assets
     and the assumption of certain specified liabilities of Polyscan. See
     Note 14 of Notes to Consolidated Financial Statements.
 
 Fiscal 1995 net income
 
  .  reflects the inclusion of an extraordinary gain of $5.4 million recorded
     as a result of the early extinguishment of $19.7 million of subordinated
     notes payable and accrued interest. See Note 3 of Notes to Consolidated
     Financial Statements.
 
 Fiscal 1992 net loss
 
  .  reflects the write-off of $10.6 million of in-process technology
     acquired in connection with its purchase of ATEQ and the write-off of
     $10.2 million of certain inventory and assets.
 
 Weighted average common shares
 
  .  are computed on the basis described in Note 1 of Notes to Consolidated
     Financial Statements.
 
                                      22
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
 
  This item contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that may cause
those differences are discussed in the Certain Factors that May Affect Future
Results section below.
 
OVERVIEW
 
  Etec designs, develops, manufactures, markets and services electron beam and
laser beam mask pattern generation equipment for the semiconductor industry.
Etec was incorporated in 1989 to effect a leveraged buyout (the LBO) in 1990
of the former Electron Beam Technology Division of Perkin-Elmer, which was
itself the continuation of a business commenced in 1970. In November 1991, the
Company purchased ATEQ, a supplier of laser beam maskmaking systems. In
February 1996, the Company acquired substantially all of the assets and
assumed certain specified liabilities of Polyscan, a developer of laser direct
imaging systems for large-area pattern generation applications.
 
  Beginning in fiscal 1994, Etec's new management team focused on reducing
overhead, achieving manufacturing efficiencies and improving the Company's
operating and capital structure, while continuing to develop and market its
electron beam and laser beam systems. Through management's efforts, the
Company improved its margins and restructured its capitalization, thereby
reducing debt and interest expense. Revenues increased in fiscal 1994, 1995,
and 1996, reflecting an upturn in the maskmaking industry and the Company's
introduction of new products.
 
  The Company completed its initial public offering of Common Stock (the IPO)
in October 1995 and another offering in June 1996. Proceeds to the Company
after deducting underwriting discounts and commissions (before deducting
offering expenses) from the combined issuances of 5,374,167 shares totaled
approximately $58.7 million. Concurrent with the offering in June 1996, the
Company completed a private placement of 500,000 shares of Common Stock with
Intel Corporation. The proceeds of this private placement amounted to $10.0
million.
 
  The Company derives most of its annual revenues from the sale of a
relatively small number of systems at prices currently ranging from
approximately $3.2 million to $7.3 million. As a result, any delay in the
recognition of revenue for a single system or upgrade could have a material
adverse effect on the Company's results of operations for a given accounting
period. For example, a system shipment planned for the fourth quarter of
fiscal 1995 was delayed due to the failure to complete factory acceptance
tests prior to the end of the quarter. The revenue from that sale was not
recognized in the fourth quarter of fiscal 1995 and was delayed until
shipment, completion of factory acceptance tests,which occurred during the
first quarter of fiscal 1996. In addition, one or more systems originally
scheduled to ship in the first quarter of fiscal 1997 will also be delayed.
The Company generally recognizes product revenue upon shipment. A provision
for installation costs and estimated future warranty costs is recorded at the
time revenue is recognized. Systems typically carry a one-year warranty. The
Company's service contracts typically have a stated duration of one year,
subject to renewal at the customer's option. Service revenue is deferred and
recognized on a straight-line basis over the period of service.
 
  Sales to customers in countries other than the United States accounted for
45%, 44%, and 43% of total revenues in fiscal 1996, 1995, and 1994,
respectively, with an additional 21%, 16%, and 10% of total revenues,
respectively, attributable to sales in the United States for shipment abroad.
The Company's international sales are primarily denominated in U.S. dollars.
To date, transactions conducted in currencies other than U.S. dollars, and net
monetary assets and liabilities denominated in currencies other than U.S.
dollars, have not presented significant currency exchange exposure except as
discussed in Note 1 to Notes to Consolidated Financial Statements.
Accordingly, the Company has not entered into hedging transactions. The
Company plans to actively monitor its foreign exchange exposure and to take
appropriate action to reduce its foreign exchange risk, if such risk becomes
significant.
 
 
                                      23
<PAGE>
 
  At July 31, 1996, the Company had remaining net operating loss carryforwards
("NOLs") of approximately $23.9 million for federal tax purposes. These
carryforwards, if not utilized to offset future taxable income, expire at
various dates through the year 2009. Additionally, under the Tax Reform Act of
1986, the amount of the benefit from NOLs may be impaired or limited in
certain circumstances, including a cumulative stock ownership change of more
than 50% over a three-year period. The completion of the Company's public
offering in June 1996 resulted in a cumulative change in ownership to the
Company in excess of 50% and, as a consequence, the utilization of NOLs is
limited to approximately $19.0 million per year.
 
  During fiscal 1995, management undertook actions to reduce a substantial
portion of the Company's long-term indebtedness, including the sale and
leaseback of its facility in Hayward, California and the repayment of $6.0
million in respect of senior notes, the exchange of $19.7 million of senior
subordinated debt and accrued interest for preferred stock and convertible
subordinated debt, the acquisition of the minority interest in its Japanese
subsidiary in exchange for Series E Preferred Stock and cash, and the
elimination of ATEQ's minority stockholders through a short-form merger. The
conversion of the senior subordinated debt into preferred stock and
convertible debt resulted in an extraordinary gain of approximately $5.4
million, which was recorded in the fourth quarter of fiscal 1995. All
outstanding series of preferred stock were converted into Common Stock upon
the consummation of the IPO.
 
  The following table sets forth certain consolidated statement of operations
data as a percentage of total revenue and the gross margin data for products
and services for the years ended July 31, 1996, 1995, and 1994:
 
<TABLE>
<CAPTION>
                                                                 YEAR ENDED
                                                                  JULY 31,
                                                               ----------------
                                                               1996  1995  1994
                                                               ----  ----  ----
   <S>                                                         <C>   <C>   <C>
   Revenue:
     Products................................................   78%   62%   59%
     Services................................................   22    38    41
                                                               ---   ---   ---
                                                               100%  100%  100%
                                                               ===   ===   ===
   Gross margin:
     Products................................................   39%   29%   22%
     Services................................................    6    14    15
                                                               ---   ---   ---
                                                                45    43    37
                                                               ---   ---   ---
   Operating expenses:
     Research, development and engineering...................   12    13     7
     Selling, general and administrative.....................   15    16    16
     Write-off of in-process technology acquired.............    4   --    --
                                                               ---   ---   ---
                                                                31    29    23
                                                               ---   ---   ---
   Income from operations....................................   14    14    14
   Interest expense..........................................   (1)   (5)   (7)
   Other income (expense), net...............................    2    (1)   (1)
                                                               ---   ---   ---
   Income before income tax (benefit) provision, and
    extraordinary items......................................   15     8     6
   Income tax (benefit) provision............................  (11)    3     3
                                                               ---   ---   ---
   Income before extraordinary items.........................   26%    5%    3%
                                                               ===   ===   ===
</TABLE>
 
                                      24
<PAGE>
 
YEARS ENDED JULY 31, 1996 AND JULY 31, 1995
 
  Revenue. Revenues are primarily comprised of sales of MEBES, CORE and ALTA
systems, accessories and upgrades, and sales of technical support, maintenance
and other services. Product revenue increased 120% to $112.9 million from
$51.4 million for the years ended July 31, 1996 and 1995, respectively. This
increase reflects the sale of eleven additional systems, higher average
selling prices, changes in product mix toward a higher-priced new product (the
MEBES 4500) introduced in the fourth quarter of fiscal 1995, offset by a
reduction in the sales of upgrades and accessories of approximately $8.3
million.
 
  Service revenue increased 4% to $32.7 million from $31.5 million for the
years ended July 31, 1996 and 1995, respectively, due primarily to price
increases on service contracts and an increase in the number installed baseof
systems serviced.
 
  Gross Profit. The Company's gross profit on product revenue increased 131%
to $56.3 million from $24.4 million for the years ended July 31, 1996 and
1995, respectively. Product gross margins increased to 50% at July 31, 1996
from 47% for the year ended at July 31, 1995. Increased gross profit and the
accompanying increased gross margin percentages were due to an increase in
volume, which includes a shift towards shipments with generally higher selling
prices as well as efficiencies from improvements in manufacturing.
 
  The Company's gross profit on service revenue decreased 15% to $9.3 million
from $10.9 million for the years ended July 31, 1996 and 1995, respectively.
Gross margin on service revenue was 29% and 35% for the years ended July 31,
1996 and 1995, respectively. The decrease in margin reflects increased costs
of training service personnel to support the increasing number of systems
serviced by the Company. The decrease in margin reflects an investment in
service personnel and training to support the growing installed base. The
Company expects that such costs will continue to increase with the result
being further erosion of service margins. continues to make such investments,
which it expects will result in additional erosion of service margins.
 
  Research, Development and Engineering. Research, development and engineering
expenses, net of third-party funding under cooperative development agreements,
increased to $17.4 million, representing 12% of revenue, from $10.5 million,
representing 13% of revenue, for the years ended July 31, 1996 and 1995,
respectively. This increase primarily reflects a reduction in third-party
funding. For the years ended July 31, 1996 and 1995, $725,000 and $6.1
million, respectively, of funds received under the cooperative development
agreements were applied against research, development and engineering
expenses. Excluding these cost reimbursements, gross research, development and
engineering spending was $18.1 million and $16.6 million in each of the years
ended July 31, 1996 and 1995, respectively. The increase in gross spending is
primarily attributable to the advanced procurement of materials for the
Companys current development projects. Due to the Company's commitment to
product development, net research, development and engineering expenses, net
of third party funding, are expected to increase in future periods. Research,
development and engineering expenses, net of third-party funding are expected
to increase to $31.7 million in fiscal 1997.
 
  The Company's success in developing and selling new and enhanced products
depends upon a variety of factors, including accurate prediction of future
customer requirements three or more years in advance of sales, introduction of
new products on schedule, cost-effective manufacturing, and product
performance in the field. There can be no assurance that the Company will be
successful in selecting, developing, manufacturing and marketing new products
or enhancements of existing products.
 
  Selling, General and Administrative. Selling, general and administrative
expenses increased to $21.3 million, representing 15% of revenue, from $13.4
million, representing 16% of revenue, for the years ended July 31, 1996 and
1995, respectively. The increase in selling, general and administrative
expenses was partially due to rent associated with the leaseback of facilities
previously owned, market development fees on certain laser beam systems sold
in Asia, additional costs associated with becoming a public company, increased
profit sharing, and costs associated with an increase in hiring.
 
                                      25
<PAGE>
 
  The Company was party to certain cooperative development agreements that
provided partial funding of general and administrative costs associated with
research and development projects. For the year ended July 31, 1995,
$1.2 million of the funding received under these agreements was offset against
selling, general and administrative expenses. Excluding these cost
reimbursements, gross selling, general and administrative spending was $14.6
million for the year ended July 31, 1995. No such funding was offset against
selling, general and administrative expenses for the year ended July 31, 1996.
 
  Write-Off of In-Process Technology Acquired. In the third quarter of fiscal
1996, the Company acquired substantially all of the assets and assumed certain
specified liabilities of Polyscan, Inc. in exchange for 350,000 shares of the
Company's Common Stock. The excess of the purchase price over the fair value
of the net assets of $6.3 million was allocated to in-process technology
acquired that, because of the uncertainty as to realization, the Company wrote
off in the third quarter of fiscal 1996.
 
  Interest Expense. Interest expense for the years ended July 31, 1996 and
1995 was $1.8 million and $4.2 million, respectively. This decrease in
interest expense reflects the following: (i) the repayment during the second
half of fiscal 1995 of approximately $6.0 million of senior secured debt in
conjunction with the February 1995 sale and leaseback of the Company's Hayward
facility; (ii) the exchange in July 1995 of approximately $19.7 million of
senior subordinated notes and accrued interest for 105,641 shares of
mandatorily redeemable convertible preferred stock (which were converted into
Common Stock on completion of the IPO), plus and approximately $3.6 million of
senior subordinated convertible notes (which were repaid in the first quarter
of fiscal 1996); (iii) the repayment of approximately $9.3 million of senior
secured notes during the first half of fiscal 1996; and (iv) the repayment of
the remaining senior secured notes during the fourth quarter of fiscal 1996
and the refinancing of such debt at a lower interest rate.
 
  Other Income (Expense), Net. Other income was $2.7 million of income for the
year ended July 31, 1996. Included in other income is approximately $1.8
million of interest earned on the investment of the proceeds from the IPO, as
well as $846,000 of transaction gains on the redemption of the minority
interest in Etec Japan, (which was denominated in yen), in the first quarter
of fiscal 1996.
 
  Income Tax (Benefit) Provision. During the year ended July 31, 1996, the
Company recognized a $23.0 million income tax benefit as a result of releasing
a portion of the valuation allowance previously recorded against its deferred
tax assets. Management's evaluation of the recoverability of the Company's
deferred tax assets is based in part upon the current product backlog and the
Company's proven ability to increase manufacturing capacity. Management has
fully reserved deferred tax assets that would (if at all) maybe realized more
than one year in the future. Because of the uncertainty of realization, and
management will continue to evaluate the recoverability of the Company's
deferred tax assets. The Company recorded a benefit for income taxes for the
year ended July 31, 1996 of $16.3 million and a provision for income taxes for
the year ended July 31, 1995 of $2.3 million, primarily reflecting taxes
payable by the Company's foreign subsidiaries and the $23.0 million income tax
benefit in fiscal 1996.
 
  Extraordinary Loss on Early Extinguishment of Debt. During the year ended
July 31, 1996, the Company paid $18.7 million of its 10.65% senior secured
notes before their due dates. As a result of this repayment, which repaid the
senior secured notes in full, the Company recorded an extraordinary loss of
approximately $930,000 related to unamortized debt issuance costs.
 
YEARS ENDED JULY 31, 1995 AND JULY 31, 1994
 
  Revenue. Product revenue increased 26% to $51.4 million from $40.7 million
for the years ended July 31, 1995 and 1994, respectively. This increase
reflected generally higher selling prices, a change in product mix towards
higher-priced MEBES IV systems, and sales of upgrades and accessories, which
grew as a percentage of total revenue.
 
                                      26
<PAGE>
 
  Service revenue increased 13% to $31.5 million from $28.0 million for the
years ended July 31, 1995 and 1994, respectively, due primarily to favorable
exchange rates on foreign service contracts and generally higher service
activity.
 
  Gross Profit. The Company's gross profit on product revenue increased 61% to
$24.4 million from $15.2 million for the years ended July 31, 1995 and 1994,
respectively. The increase in gross profit on product revenue was due to an
increase in product revenue and a higher gross margin on product revenue,
which increased to 47% from 37% for the year ended July 31, 1995 compared to
the year ended July 31, 1994. The increase in productgross margin on product
is primarily attributable to higher margins earned on MEBES IV, MEBES 4000 and
MEBES 4500 systems, generally higher selling prices for the Company's
products, increased manufacturing efficiencies and increased sales of upgrades
and accessories that generally have higher gross margins than new systems.
Additionally, gross margin was favorably impacted for the year ended July 31,
1994 by the sale of two systems that the Company had previously capitalized as
demonstration and test equipment and fully amortized in prior fiscal years.
Excluding the sale of these systems, gross margin for the year ended July 31,
1994 was approximately 32%.
 
  The Company's gross profit on service revenue increased 6% to $10.9 million
from $10.3 million for the years ended July 31, 1995 and 1994, respectively.
Gross margin on service revenue was 35% and 37% for the years ended July 31,
1995 and 1994, respectively. The decrease in margin reflects an increase in
maintenance costs for MEBES III tools.
 
  Research, Development and Engineering. Research, development and engineering
expenses, net of third-party funding, increased to $10.5 million, representing
13% of revenue, from $5.1 million, representing 7% of revenue, for the years
ended July 31, 1995 and 1994, respectively. This increase primarily reflects
an increase in the proportion of such expenses not funded by third parties.
For the years ended July 31, 1995 and 1994, $6.1 million and $13.9 million,
respectively, of funds received under cooperative development agreements were
applied against research, development and engineering expenses. Excluding
these cost reimbursements, gross research, development and engineering
spending was $16.6 million and $19.0 million for the years ended July 31, 1995
and 1994, respectively. The decrease in gross spending of $2.4 million
primarily reflects engineering personnel being reallocated to manufacturing
activities in the year ended July 31, 1995 due primarily to the winding down
of a cooperative development program and manufacturing activities associated
with new product introductions.
 
  Selling, General and Administrative. Selling, general and administrative
expenses increased to $13.4 million, representing 16% of revenue, from $10.8
million, representing 16% of revenue, for the years ended July 31, 1995 and
1994, respectively. The increase in selling, general and administrative
expenses was partially due to rent and professional fees resulting from the
consummation of the sale and leaseback transaction in February 1995. In
addition, bonuses, sales commissions and other sales expenses were greater in
the year ended July 31, 1995, due to increased sales volume and profitability.
 
  For the years ended July 31, 1995 and 1994, respectively, $1.2 million and
$2.2 million of the funding received under cooperative development agreements
was offset against selling, general and administrative expenses. Excluding
these cost reimbursements, gross selling, general and administrative spending
was $14.6 million and $13.0 million for the years ended July 31, 1995 and
1994, respectively.
 
  Interest Expense. Interest expense for the years ended July 31, 1995 and
1994 was $4.2 million and $5.1 million, respectively, and resulted from the
substantial debt incurred to finance the LBO. Interest expense decreased as a
result of the repayment of approximately $6.0 million of senior secured debt
in conjunction with the 1995 sale and leaseback transaction.
 
  Other Income (Expense), Net. Other income (expense), net, was $352,000 and
$533,000 for the years ended July 31, 1995 and 1994, respectively. Included in
other income (expense), net for the years ended July 31, 1995 and 1994 is
$527,000 and $462,000, respectively, of minority interest in earnings of a
subsidiary.
 
 
                                      27
<PAGE>
 
  Income Tax Provision. The Company recorded provisions for income taxes for
each of the years ended July 31, 1995 and 1994 of $2.3 million, respectively.
These provisions primarily reflect taxes payable by the Company's foreign
subsidiaries. Taxes otherwise due in the U.S have been almost completely
offset by net operating loss carryforward benefits.
 
  Extraordinary Gain on Early Extinguishment of Debt. During the year ended
July 31, 1995, the Company recorded an extraordinary gain of approximately
$5.4 million when the holders of the Company's senior subordinated notes
payable and mandatorily redeemable convertible preferred stock, exchanged
approximately $7.1 million and $12.6 million of their senior subordinated
notes and accrued interest for 40,251 and 65,390 shares, respectively, of
Series B mandatorily redeemable convertible preferred stock and approximately
$1.6 million and $2.0 million, respectively, of senior subordinated notes
payable.
 
                                      28
<PAGE>
 
  The following tables present certain unaudited quarterly data for the eight
quarters ended July 31, 1996, and such data expressed as a percentage of total
revenue and the gross margin data for products and services for such quarters.
In the opinion of management, this information has been presented on the same
basis as the audited consolidated financial statements appearing elsewhere in
this Annual Report on Form 10-K, and all necessary adjustments have been
included in the amounts stated below to present fairly the unaudited quarterly
results when read in conjunction with the audited consolidated financial
statements of the Company. Results of operations for any quarter are not
necessarily indicative of the results to be expected for the entire fiscal year
or for any future period.
 
<TABLE>
<CAPTION>
                                                      THREE MONTH ENDED
                          -------------------------------------------------------------------------------
                          JULY 31,  APRIL 30,  JAN. 31,  OCT. 31,  JULY 31,  APRIL 30, JAN. 31,  OCT. 31,
                            1996      1996       1996      1995      1995      1995      1995      1994
                          --------  ---------  --------  --------  --------  --------- --------  --------
                                                      ($ IN THOUSANDS)
<S>                       <C>       <C>        <C>       <C>       <C>       <C>       <C>       <C>
Revenue:
  Products..............  $38,957   $ 33,358   $23,522   $17,103   $13,252    $12,910  $12,630   $12,603
  Services..............    8,653      8,364     8,083     7,605     8,619      8,767    7,194     6,941
                          -------   --------   -------   -------   -------    -------  -------   -------
                           47,610     41,722    31,605    24,708    21,871     21,677   19,824    19,544
                          -------   --------   -------   -------   -------    -------  -------   -------
Cost of revenue:
  Products..............   19,026     16,399    12,826     8,381     6,259      6,987    7,063     6,706
  Services..............    6,616      5,875     5,548     5,371     5,938      5,222    4,968     4,476
                          -------   --------   -------   -------   -------    -------  -------   -------
                           25,642     22,274    18,374    13,752    12,197     12,209   12,031    11,182
                          -------   --------   -------   -------   -------    -------  -------   -------
Gross profit:
  Products..............   19,931     16,959    10,696     8,722     6,993      5,923    5,567     5,897
  Services..............    2,037      2,489     2,535     2,234     2,681      3,545    2,226     2,465
                          -------   --------   -------   -------   -------    -------  -------   -------
                           21,968     19,448    13,231    10,956     9,674      9,468    7,793     8,362
                          -------   --------   -------   -------   -------    -------  -------   -------
Operating expenses:
  Research, development
   and engineering......    5,411      5,152     3,568     3,271     3,545      2,551    2,124     2,277
  Selling, general and
   administrative.......    6,296      5,749     4,771     4,453     4,203      3,543    2,736     2,915
  Write-off of in-
   process technology
   acquired.............      --       6,269       --        --        --         --       --        --
                          -------   --------   -------   -------   -------    -------  -------   -------
                           11,707     17,170     8,339     7,724     7,748      6,094    4,860     5,192
                          -------   --------   -------   -------   -------    -------  -------   -------
Income from operations..   10,261      2,278     4,892     3,232     1,926      3,374    2,933     3,170
Interest expense........     (362)      (338)     (512)     (612)     (869)    (1,028)  (1,146)   (1,195)
Other income (expense),
 net....................      526        543       671       929       138       (188)     (19)     (283)
                          -------   --------   -------   -------   -------    -------  -------   -------
Income before income tax
 (benefit) provision and
 extraordinary items....   10,425      2,483     5,051     3,549     1,195      2,158    1,768     1,692
Income tax (benefit)
 provision..............   (5,220)   (13,213)    1,263       887       689        620      500       480
                          -------   --------   -------   -------   -------    -------  -------   -------
Income before extraordi-
 nary items.............   15,645     15,696     3,788     2,662       506      1,538    1,268     1,212
Extraordinary (loss)
 gain on early
 extinguishment of debt.     (630)       --       (300)      --      5,412        --       --        --
                          -------   --------   -------   -------   -------    -------  -------   -------
Net income..............  $15,015   $ 15,696   $ 3,488   $ 2,662   $ 5,918    $ 1,538  $ 1,268   $ 1,212
                          =======   ========   =======   =======   =======    =======  =======   =======
PERCENTAGE OF REVENUE:
Revenue:
  Products..............       82%        80%       74%       69%       61%        60%      64%       64%
  Services..............       18         20        26        31        39         40       36        36
                          -------   --------   -------   -------   -------    -------  -------   -------
                              100%       100%      100%      100%      100%       100%     100%      100%
                          =======   ========   =======   =======   =======    =======  =======   =======
Gross margin:
  Products..............       42%        41%       34%       35%       32%        27%      28%       30%
  Services..............        4          6         8         9        12         17       11        13
                          -------   --------   -------   -------   -------    -------  -------   -------
                               46         47        42        44        44         44       39        43
                          -------   --------   -------   -------   -------    -------  -------   -------
Operating expenses:
  Research, development
   and engineering......       11         12        11        13        16         12       10        12
  Selling, general and
   administrative.......       13         14        15        18        19         16       14        15
  Write-off of in-
   process technology
   acquired.............      --          15       --        --        --         --       --        --
                          -------   --------   -------   -------   -------    -------  -------   -------
                               24         41        26        31        35         28       24        27
                          -------   --------   -------   -------   -------    -------  -------   -------
Income from operations..       22          6        16        13         9         16       15        16
Interest expense........       (1)        (1)       (2)       (3)       (4)        (5)      (6)       (6)
Other income (expense),
 net....................        1          1         2         4       --          (1)     --         (1)
                          -------   --------   -------   -------   -------    -------  -------   -------
Income before income tax
 (benefit) provision and
 extraordinary items....       22          6        16        14         5         10        9         9
Income tax (benefit)
 provision..............      (11)       (32)        4         4         3          3        3         3
                          -------   --------   -------   -------   -------    -------  -------   -------
Income before extraordi-
 nary items.............       33         38        12        10         2          7        6         6
Extraordinary gain
 (loss) on early
 extinguishment of debt.       (1)       --         (1)      --         25        --       --        --
                          -------   --------   -------   -------   -------    -------  -------   -------
Net income..............       32%        38%       11%       10%       27%         7%       6%        6%
                          =======   ========   =======   =======   =======    =======  =======   =======
</TABLE>
 
                                       29
<PAGE>
 
  Included in the fourth quarter of fiscal 1996 is an extraordinary loss of
$630,000 recorded as a result of the early extinguishment of the remaining
balance of senior secured debt. Included in the second quarter of fiscal 1996
is an extraordinary loss of $300,000 recorded as a result of the early
extinguishment of $5.0 million of senior secured debt. See Note 3 of Notes to
Consolidated Financial Statements.
 
  Included in the fourth quarter of fiscal 1995 is an extraordinary gain of
$5.4 million recorded as a result of the early extinguishment of $19.7 million
of subordinated notes payable and accrued interest.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  Since the beginning of fiscal 1994, the Company has financed its cash needs
primarily with cash from operations, approximately $11.0 million in net
receipts from the sale and leaseback of the Company's Hayward, California
campus in fiscal 1995, $58.7 million from the Company's IPO and an additional
secondaryoffering in fiscal 1996, and $10.0 million from a private placement
with Intel Corporation.
 
  The Company has spent approximately $11.7 million for net capital
expenditures in fiscal 1996 primarily to purchase testing and other equipment,
upgrade its manufacturing facilities and implement an enterprise-wide business
software system.
 
  In April 1996, the Company commenced construction of a 60,000 square foot
administrative building at its Hayward, California campus, and is financing
the construction with available cash. As of July 31, 1996, the Company had
expended $1.4 million related to the new facility. Estimated costs at
completion are $5.0 million. The Company intends to sell the new facility upon
completion in the second quarter of fiscal 1997 to the landlord of its current
facility and enter into a leasing arrangement for a period of 15 years.
 
  In May 1996, the Company obtained a $20.0 million revolving credit facility,
which is described in greater detail in the following discussion on Financing
and Investing Activities.
 
  As of July 31, 1996, the Company had cash and cash equivalents and
marketable securities of $68.6 million. The Company believes that existing
sources of liquidity including cash flow from operations and its $20.0 million
available revolving credit facility, will provide adequate cash to fund its
operations for at least the next twelve months.
 
 Cash Flows from Operations
 
  Net cash provided by operations for the fiscal years ended July 31, 1996,
1995, and 1994 was $3.5 million, $9.1 million, and $3.6 million, respectively.
 
  Cash flows from operations in fiscal 1996 primarily reflected net income of
$36.9 million, decreased by noncash items (which include $23.6 million of
deferred taxes, partially offset by an extraordinary loss on early
extinguishment of debt of $930,000, the write-off of in-process technology
acquired of $6.3 million, and depreciation and amortization of $1.6 million);
increases in accounts receivable of $15.7 million and inventory of $25.4
million; increases in other assets of $579,000, and increases in accounts
payable and accrued and other liabilities of $23.1 million.
 
  Cash flows from operations in fiscal 1995 primarily reflected net income of
$9.9 million, decreased by noncash items (which include an extraordinary gain
of $5.4 million, partially offset by depreciation and amortization of $3.0
million), increases in accounts receivable, inventory, other assets, and
accrued and other liabilities of $14.7 million, and decreases in accounts
payable of $1.2 million.
 
  Cash flows from operations in fiscal 1994 primarily reflected net income of
$1.6 million, increased by noncash items (which include depreciation and
amortization of $3.8 million), decreases in inventory of $7.9 million,
increases in accounts receivable of $4.7 million, and decreases in accounts
payable and accrued and other liabilities of $4.1 million.
 
                                      30
<PAGE>
 
  Fluctuations in accounts receivable, inventory and current liabilities for
all of the above periods were caused primarily by the timing of system orders,
the timing of shipments, customer requested delivery dates and the timing of
payments to vendors. The significant increase in inventory during fiscal 1996
was due primarily to increases in material purchases and work-in-process to
meet scheduled production.
 
  Prior to the shipment of a system, the Company receives payment for a
significant portion of the system sales price. Such payments are generally
received when the Company receives an order and at various agreed upon times
when the system is being manufactured. Therefore, the amount of customer
advances received fluctuates based on the number of systems that are on order
and depending on the status of each system within the manufacturing cycle.
Advances from customers increased significantly to $24.1 million at July 31,
1996 from $12.9 million at July 31, 1995 because the Company's backlog for
products increased to $147.6 million from $65.2 million.
 
 Financing and Investing Activities
 
  During fiscal 1995, the Company sold its headquarters campus located in
Hayward, California for approximately $11.0 million. The Company leased back
the property for an initial term of fifteen years, and has options to renew
the lease for four five-year periods. In August 1996, the Company restructured
the existing sale and leaseback arrangement and refunded $2.6 million of the
original purchase price to its landlord and received a reduction in its annual
rent from $1.4 million to $1.0 million and certain other consideration.
 
  Net cash provided by financing activities for fiscal 1996 and fiscal 1995
was $56.2 million and $162,000, respectively, and net cash used in financing
activities for fiscal 1994 was $2.3 million. During fiscal 1996, the Company
raised approximately $58.7 million before offering expenses in connection with
its IPO and an additional public offering and $10.0 million in a private
placement with Intel Corporation.
 
  During fiscal 1996, the Company repaid $18.7 million of its senior secured
indebtedness, which amount includes the $8.8 million referred to below, and
repaid $3.6 million of senior subordinated notes out of the proceeds of the
IPO. During the fourth quarter, the Company extinguished the remaining $8.8
million of its senior secured indebtedness with $10.0 million of unsecured
replacement financing from another lender (see below). During fiscal 1995 and
fiscal 1994, the Company repaid $6.0 million and $600,000, respectively, of
its senior secured notes. During fiscal 1994, the Company repaid $2.8 million
and $5.2 million, respectively, of a bank loan and other notes payable. During
fiscal 1996, fiscal 1995, and fiscal 1994, the Company received interim
financing on foreign sales of $159,000, $6.2 million and $507,000,
respectively.
 
  On May 24, 1996, the Company entered into a $30.0 million financing facility
with a major financial institution, which includes a $20.0 million two-year
revolving credit facility and a $10.0 million three-year term note.
Indebtedness under the revolving credit facility and term note is unsecured
and bears interest at the London Interbank Offered Rate (5.91% on July 31,
1996) plus 1.25%. The terms of the financing facility require the Company to
comply with certain financial and restrictive covenants, including maintenance
of certain financial ratios and minimum net worth criteria, restrictions on
the incurrence of indebtedness and certain dividend restrictions. On May 31,
1996, the Company drew down the $10.0 million term note to repay in full its
senior secured notes. No amounts have been drawn under the revolving credit
facility.
 
  In June 1995, the Company entered into a loan agreement with Polyscan,
whereby the Company provided financing to Polyscan. The loan bore interest at
prime plus 3% and the balance of $1.8 million was due on January 31, 1996.
During February 1996, Polyscan repaid $600,000 to the Company, and Etec
Polyscan acquired substantially all of the assets and assumed certain
specified liabilities of Polyscan in exchange for 350,000 shares of the
Company's Common Stock. Etec Polyscan also assumed Polyscan's obligation to
repay the outstanding loan in the amount of approximately $1.2 million.
 
                                      31
<PAGE>
 
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
 
  Statements in this report which are prefaced with words such as expects,
anticipates, believes and similar words and other statements of similar sense,
are forward-looking statements. These statements are based on the Company's
current expectations and estimates as to prospective events and circumstances
which may or may not be within the Company's control and as to which there can
be no firm assurances given. These forward-looking statements, like any other
forward-looking statements, involve risks and uncertainties that could cause
actual results to differ materially from those projected or anticipated.
 
  In addition to other risks and uncertainties that may be described elsewhere
in this document, certain risks and uncertainties that could affect the
Company's financial results include the following: potential delays in
shipments; cyclicality of the maskmaking and semiconductor equipment
industries; potential customers capital spending decisions; the development,
market acceptance and successful production of new products and enhancements;
competitors product introductions and enhancements; risks associated with any
future acquisitions, including the Company's ability to successfully integrate
acquired businesses, products, or technologies; and risks associated with
foreign operations, such as foreign exchange risk, import-export controls, and
political risks.
 
  (For a description of the above risks and uncertainties, see the Certain
Factors that May Affect Future Results section under Item 1 of PART I.)
 
                                      32
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
                               ETEC SYSTEMS, INC.
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
ETEC SYSTEMS, INC.
Report of Independent Accountants.........................................  34
Consolidated Balance Sheets at July 31, 1996 and 1995.....................  35
Consolidated Statements of Operations for the years ended July 31, 1996,
 1995 and 1994............................................................  36
Consolidated Statements of Stockholders' Equity (Deficit) for the years
 ended July 31, 1996, 1995 and 1994.......................................  37
Consolidated Statements of Cash Flows for the years ended July 31, 1996,
 1995 and 1994............................................................  38
Notes to Consolidated Financial Statements................................  39
</TABLE>
 
  All other schedules are omitted because they are not required, are not
applicable, or the information is included in the financial statements or notes
thereto.
 
                                       33
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Stockholders of Etec Systems, Inc.
 
  In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of Etec
Systems, Inc. and its subsidiaries at July 31, 1996, and July 31, 1995, and
the results of their operations and their cash flows for each of the three
years in the period ended July 31, 1996 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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 the opinion expressed above.
 
Price Waterhouse LLP
 
San Jose, California
August 27, 1996
 
                                      34
<PAGE>
 
                               ETEC SYSTEMS, INC.
 
                          CONSOLIDATED BALANCE SHEETS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                JULY 31,
                                                            ------------------
                                                              1996      1995
                                                            --------  --------
<S>                                                         <C>       <C>
                                   ASSETS
Current assets:
  Cash and cash equivalents................................ $ 44,472  $ 23,638
  Marketable securities....................................   24,153       --
  Accounts receivable, less allowance for doubtful accounts
   of $1,102 and $1,270 ...................................   37,316    24,572
  Inventory................................................   52,135    24,238
  Other current assets.....................................    3,042     1,972
  Deferred tax assets......................................   24,508       944
                                                            --------  --------
    Total current assets...................................  185,626    75,364
Property, plant and equipment, net.........................   19,381     6,474
Other assets...............................................    3,864     4,146
                                                            --------  --------
                                                            $208,871  $ 85,984
                                                            ========  ========
    LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK, AND
                        STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
  Current maturities of long-term debt..................... $  3,333  $  5,386
  Accounts payable.........................................   14,184     6,575
  Accrued and other liabilities............................   51,084    38,671
  Taxes payable............................................    5,826     1,517
                                                            --------  --------
    Total current liabilities..............................   74,427    52,149
Long-term debt, less current portion.......................    6,667    16,866
Deferred gain on sale of asset.............................    5,571     6,015
Other liabilities..........................................    6,329     1,972
                                                            --------  --------
Total liabilities..........................................   92,994    77,002
                                                            --------  --------
Mandatorily redeemable convertible preferred stock.........      --     76,397
                                                            --------  --------
Commitments and Contingencies (Notes 5, 12, and 15)
Stockholders' equity (deficit):
  Preferred Stock par value $0.01 per share; 10,000,000
   shares authorized, none issued or outstanding...........      --        --
  Common Stock, par value $0.01 per share; 30,000,000 and
   20,000,000 shares authorized, 19,610,964 and 910,402
   shares issued and outstanding...........................      196         9
  Warrants.................................................    1,096       562
  Additional paid-in capital...............................  149,858       345
  Cumulative translation adjustment........................      211     2,936
  Accumulated deficit......................................  (35,484)  (71,267)
                                                            --------  --------
    Total stockholders' equity (deficit)...................  115,877   (67,415)
                                                            --------  --------
                                                            $208,871  $ 85,984
                                                            ========  ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       35
<PAGE>
 
                               ETEC SYSTEMS, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                      YEARS ENDED JULY 31,
                                                    --------------------------
                                                      1996     1995     1994
                                                    --------  -------  -------
<S>                                                 <C>       <C>      <C>
Revenue:
  Products......................................... $112,940  $51,395  $40,731
  Services.........................................   32,705   31,521   27,979
                                                    --------  -------  -------
                                                     145,645   82,916   68,710
                                                    --------  -------  -------
Cost of revenue:
  Cost of products.................................   56,632   27,015   25,559
  Cost of services.................................   23,410   20,604   17,670
                                                    --------  -------  -------
                                                      80,042   47,619   43,229
                                                    --------  -------  -------
Gross profit.......................................   65,603   35,297   25,481
                                                    --------  -------  -------
Operating expenses:
  Research, development and engineering............   17,402   10,497    5,102
  Selling, general and administrative..............   21,269   13,397   10,803
  Write-off of in-process technology acquired......    6,269      --       --
                                                    --------  -------  -------
                                                      44,940   23,894   15,905
                                                    --------  -------  -------
Income from operations.............................   20,663   11,403    9,576
Interest expense...................................   (1,824)  (4,238)  (5,115)
Other income (expense), net........................    2,669     (352)    (533)
                                                    --------  -------  -------
Income before income tax (benefit) provision and
 extraordinary items...............................   21,508    6,813    3,928
Income tax (benefit) provision.....................  (16,283)   2,289    2,316
                                                    --------  -------  -------
Income before extraordinary items..................   37,791    4,524    1,612
Extraordinary (loss) gain on early extinguishment
 of debt...........................................     (930)   5,412      --
                                                    --------  -------  -------
Net income.........................................   36,861    9,936    1,612
Accretion of mandatorily redeemable convertible
 preferred stock...................................    1,078    3,092    2,946
                                                    --------  -------  -------
Net income (loss) attributable to Common
 Stockholders...................................... $ 35,783  $ 6,844  $(1,334)
                                                    ========  =======  =======
Per share data:
  Income before extraordinary items................ $   2.07  $  0.31  $  0.12
  Extraordinary (loss) gain........................    (0.05)    0.37      --
                                                    --------  -------  -------
  Net income....................................... $   2.02  $  0.68  $  0.12
                                                    ========  =======  =======
Weighted average common shares.....................   18,296   14,594   14,008
                                                    ========  =======  =======
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       36
<PAGE>
 
                               ETEC SYSTEMS, INC.
 
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                            COMMON STOCK              ADDITIONAL CUMULATIVE
                          -----------------            PAID-IN   TRANSLATION ACCUMULATED
                            SHARES   AMOUNT WARRANTS   CAPITAL   ADJUSTMENT    DEFICIT    TOTAL
                          ---------- ------ --------  ---------- ----------- ----------- --------
<S>                       <C>        <C>    <C>       <C>        <C>         <C>         <C>
Balance at July 31,
 1993...................     644,017  $  6  $   --     $    212    $   984    $(76,777)  $(75,575)
Issuance of Common
 Stock..................      67,154     1      --            6        --          --           7
Payments on notes
 receivable.............         --    --       --           17        --          --          17
Cumulative translation
 adjustment.............         --    --       --          --         544         --         544
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock
 redemption value.......         --    --       --          --         --       (2,946)    (2,946)
Net income..............         --    --       --          --         --        1,612      1,612
                          ----------  ----  -------    --------    -------    --------   --------
Balance at July 31,
 1994...................     711,171     7      --          235      1,528     (78,111)   (76,341)
Issuance of Common
 Stock..................     199,231     2      --           76        --          --          78
Issuance of warrants....         --    --       562         --         --          --         562
Payments on notes
 receivable.............         --    --       --           34        --          --          34
Cumulative translation
 adjustment.............         --    --       --          --       1,408         --       1,408
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock
 redemption value.......         --    --       --          --         --       (3,092)    (3,092)
Net income..............         --    --       --          --         --        9,936      9,936
                          ----------  ----  -------    --------    -------    --------   --------
Balance at July 31,
 1995...................     910,402     9      562         345      2,936     (71,267)   (67,415)
Stock offerings.........   5,374,167    54      --       56,903        --          --      56,957
Shares and warrants
 issued to equity
 investor...............     500,000     5      600       9,895        --          --      10,500
Shares issued in
 connection with the
 Polyscan acquisition...     350,000     4      --        3,496        --          --       3,500
Issuance of warrants....         --    --     1,031         --         --          --       1,031
Exchange of ATEQ stock
 for Common Stock.......      66,915   --       --          --         --          --         --
Accretion of Mandatorily
 Redeemable Convertible
 Preferred Stock
 redemption value.......         --    --       --          --         --       (1,078)    (1,078)
Conversion of
 Mandatorily Redeemable
 Convertible Preferred
 Stock..................  11,747,057   118      --       77,357        --          --      77,475
Payments on notes
 receivable.............         --    --       --           38        --          --          38
Cumulative translation
 adjustment.............         --    --       --          --      (2,725)        --      (2,725)
Issuance under stock
 plans..................     227,415     2      --          731        --          --         733
Exercise of warrants....     435,008     4   (1,097)      1,093        --          --         --
Net income..............         --    --       --          --         --       36,861     36,861
                          ----------  ----  -------    --------    -------    --------   --------
Balance at July 31,
 1996...................  19,610,964  $196  $ 1,096    $149,858    $   211    $(35,484)  $115,877
                          ==========  ====  =======    ========    =======    ========   ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       37
<PAGE>
 
                               ETEC SYSTEMS, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                      YEARS ENDED JULY 31,
                                                    --------------------------
                                                      1996     1995     1994
                                                    --------  -------  -------
<S>                                                 <C>       <C>      <C>
Cash flows from operating activities:
  Net income......................................  $ 36,861  $ 9,936  $ 1,612
  Adjustments to reconcile net income to net cash
   provided by operating activities:
   Extraordinary loss (gain) on early
    extinguishment of debt........................       930   (5,412)     --
   Write-off of in-process technology acquired....     6,269      --       --
   Depreciation and amortization..................     1,629    2,951    3,790
   Deferred taxes.................................   (23,564)    (442)    (103)
   Other noncash charges..........................       --       527      536
   Changes in assets and liabilities:
     Accounts receivable..........................   (15,743)  (2,745)  (4,676)
     Inventory....................................   (25,393)  (3,217)   7,890
     Other assets.................................      (579)     (18)  (1,347)
     Accounts payable.............................     7,724   (1,178)  (2,703)
     Accrued and other liabilities................    15,348    8,697   (1,425)
                                                    --------  -------  -------
     Net cash provided by operating activities....     3,482    9,099    3,574
                                                    --------  -------  -------
Cash flows from investing activities:
  Purchase of marketable securities, net..........   (24,153)     --       --
  Loan to Polyscan, Inc, net and other............      (637)    (825)     --
  Proceeds from sale of plant.....................       --    10,969      --
  Capital expenditures for property and equipment,
   net............................................   (11,673)  (2,915)  (1,957)
  New building construction costs.................    (1,445)     --       --
                                                    --------  -------  -------
   Net cash (used in) provided by investing
    activities....................................   (37,908)   7,229   (1,957)
                                                    --------  -------  -------
Cash flows from financing activities:
  Repayment of debt...............................   (21,631)  (6,169)  (2,850)
  Issuance of long-term debt......................    10,000      --       --
  Financing from related party....................       159    6,219      507
  Proceeds from issuance of Common Stock..........    67,628      112       24
                                                    --------  -------  -------
   Net cash provided by financing activities......    56,156      162   (2,319)
                                                    --------  -------  -------
  Effect of exchange rate changes on cash.........      (896)     577       39
                                                    --------  -------  -------
  Net change in cash and cash equivalents.........    20,834   17,067     (663)
  Cash and cash equivalents at beginning of the
   period.........................................    23,638    6,571    7,234
                                                    --------  -------  -------
  Cash and cash equivalents at the end of the
   period.........................................  $ 44,472  $23,638  $ 6,571
                                                    ========  =======  =======
Supplemental disclosures of cash flow information:
  Cash paid during the period for interest........  $  2,001  $ 3,342  $ 3,827
                                                    ========  =======  =======
  Cash paid during the period for income taxes....  $  2,972  $ 2,831  $ 2,559
                                                    ========  =======  =======
Supplemental schedule of noncash investing and
 financing activities:
  Conversion of Senior subordinated debt into
   mandatorily redeemable convertible preferred
   stock..........................................  $    --   $10,564  $ 7,099
                                                    ========  =======  =======
  Conversion of mandatorily redeemable convertible
   preferred stock to Common Stock................  $ 77,475  $   --   $   --
                                                    ========  =======  =======
  Acquisition of machinery and equipment from
   nonprofit research and development agency......  $  4,296  $   --   $   --
                                                    ========  =======  =======
  Acquisition of substantially all assets and
   certain liabilities of Polyscan, Inc. in
   exchange for 350,000 shares of Common Stock....  $  3,500  $   --   $   --
                                                    ========  =======  =======
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       38
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1--THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES:
 
  Etec Systems, Inc. (the "Company") designs, develops, manufactures, markets
and services electron beam and laser beam pattern generation equipment for the
semiconductor industry. The Company has operations in the United States,
Japan, Korea, Germany and France. The Company operates in one industry
segment.
 
 Basis of Presentation
 
  The consolidated financial statements include the accounts of the Company
and all of its subsidiaries. Intercompany transactions and balances are
eliminated in consolidation. Accounts denominated in foreign currencies are
translated using the foreign currencies as the functional currencies. Assets
and liabilities of foreign operations are translated to U.S. dollars at
current rates of exchange and revenues and expenses are translated using
weighted average rates. Gains and losses from foreign currency translation are
included as a separate component of stockholders' equity (deficit). Foreign
currency transaction gains and losses are included as a component of other
income (expense), net. For the year ended July 31, 1996, the Company recorded
approximately $846,000 of transaction gains on the settlement accounts
denominated in yen related to the redemption of the minority interest in Etec
Japan (See Note 8-Minority Interest.). For all other periods, such gains and
losses have not been significant.
 
  These financial statements have been prepared on the accrual basis of
accounting in accordance with generally accepted accounting principles. This
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting periods. Actual results could
vary from those estimates.
 
 Revenue Recognition
 
  Product revenue is generally recognized upon shipment. A provision for
installation costs and estimated future warranty costs is recorded at the time
revenue is recognized. Revenue associated with retrofitting certain models is
recognized upon completion of the retrofit. Service revenue is deferred and is
recognized on a straight-line basis over the period of service.
 
 Cash Equivalents and Marketable Securities
 
  The Company considers all highly liquid debt instruments having a maturity
of three months or less on the date of purchase to be cash equivalents.
 
  The Company has classified all investments as available for sale.
Investments classified as available for sale are recorded at fair value and
any temporary difference between an investments cost and fair value is
recorded as a separate component of stockholders' equity. Temporary
differences between cost and fair value for the year ended July 31, 1996 were
not material.
 
  At July 31, 1996, the fair value of the Company's investments approximated
cost. At July 31, 1996, $37.3 million of investments are classified as cash
and cash equivalents on the balance sheet. The investment portfolio at July
31, 1996 is comprised of commercial paper, money market funds, U.S. Government
obligations, and corporate debentures. Maturities of the assets in the
portfolio are one year or less.
 
                                      39
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The Company manages its cash equivalents and short-term investments in a
single portfolio of highly marketable securities, all of which are intended to
be available to meet the Company's current cash requirements.
 
 Inventory
 
  Inventory is stated at the lower of cost or market, with cost being
determined under the first-in, first-out method.
 
 Depreciation and Amortization
 
  Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation is calculated using the straight-line method over
the estimated useful lives of the assets, which range from three to ten years
for machinery and equipment. Assets held under capital leases are amortized
using the straight-line method over the shorter of the lease term or the
estimated useful lives of the assets of three to five years. Leasehold
improvements are amortized using the straight-line method over the shorter of
the lease term or the estimated useful life of the improvement.
 
 Capitalization of Software
 
  The Company capitalizes substantially all costs related to the purchase of
software and its implementation which include purchased software, consulting
fees, and use of certain specified Company resources. As of July 31, 1996,
$3.2 million in costs had been capitalized and are included in machinery and
equipment.
 
 Research, Development and Engineering
 
  Research, development and engineering costs are expensed as incurred. As
more fully described in Note 9, the Company is party to certain research and
development contracts which provide for partial funding of certain research,
development and engineering costs. Amounts funded under these contracts, which
are generally best efforts contracts, are recognized as costs are incurred.
 
 Off-Balance Sheet Risk and Concentrations of Credit Risk
 
  Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash
investments, marketable securities and accounts receivable. The Company places
its temporary cash investments and marketable securities with financial
institutions and other creditworthy issuers and limits the amount of credit
exposure to any one party.
 
  The Company's accounts receivable are derived primarily from sales to
customers located in the U.S., Europe, and the Far East. The Company performs
ongoing credit evaluations of its customers. Additionally, prior to shipment
of systems, the Company receives payment of a portion of the system sales
price. Write-offs during the periods presented have been insignificant.
 
  Sales to the Company's ten largest customers accounted for approximately
76%, 74%, and 76% of revenues in fiscal 1996, fiscal 1995, and fiscal 1994,
respectively.
 
  At July 31, 1996, outstanding receivables from four customers represented
16%, 14%, 11% and 10%, respectively, of the Company's accounts receivable. At
July 31, 1995, outstanding receivables from two customers represented 29% and
28%, respectively, of the Company's accounts receivable.
 
 
                                      40
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 Net Income Per Share
 
  Net income per share is computed using the weighted average number of common
and common equivalent shares outstanding during the period. Common equivalent
shares for the year ended July 31, 1996 consist of stock options and warrants
using the treasury stock method except when antidilutive. Common equivalent
shares for the years ended July 31, 1995 and 1994 consist of common stock
issuable upon the conversion of the Company's Series B, C, D and E mandatorily
redeemable convertible preferred stock using the as if converted method and
the exercise of stock options and warrants using the treasury stock method,
except when antidilutive. Pursuant to the requirements of the Securities and
Exchange Commission, common stock equivalent shares relating to stock options
and warrants using the treasury stock method, and the mandatorily redeemable
convertible preferred stock using the as if converted method, issued
subsequent to July 31, 1994 through the initial public offering ("IPO") date,
are included in the computation of net income per share for the years ended
July 31, 1995 and 1994 as if they were outstanding for the entire period.
 
NOTE 2--BALANCE SHEET COMPONENTS:
 
<TABLE>
<CAPTION>
                                                                  JULY 31,
                                                              -----------------
                                                                1996     1995
                                                              --------  -------
                                                               (IN THOUSANDS)
<S>                                                           <C>       <C>
Inventory:
  Purchased parts............................................ $ 16,861  $ 5,703
  Work-in-process............................................   25,380   10,855
  Spares.....................................................    9,894    7,680
                                                              --------  -------
                                                              $ 52,135  $24,238
                                                              ========  =======
Property, plant and equipment:
  Buildings.................................................. $  2,339  $   693
  Machinery and equipment....................................   27,375   14,938
                                                              --------  -------
                                                                29,714   15,631
  Less accumulated depreciation..............................  (10,333)  (9,157)
                                                              --------  -------
                                                              $ 19,381  $ 6,474
                                                              ========  =======
Accrued and other liabilities:
  Customer advances.......................................... $ 24,061  $12,898
  Accrued employee costs.....................................    5,594    4,362
  Accrued warranty and installation..........................    6,405    2,960
  Payable to related party...................................    1,286    8,936
  Other accrued liabilities..................................   13,738    9,515
                                                              --------  -------
                                                              $ 51,084  $38,671
                                                              ========  =======
</TABLE>
 
  Machinery and equipment at July 31, 1996 and 1995 includes approximately
$612,000 and $244,000, respectively, of assets under leases that have been
capitalized. Accumulated depreciation for such equipment approximated $167,000
and $184,000, respectively.
 
                                      41
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 3--LONG-TERM DEBT:
 
<TABLE>
<CAPTION>
                                                                  JULY 31,
                                                               ----------------
                                                                1996     1995
                                                               -------  -------
                                                               (IN THOUSANDS)
<S>                                                            <C>      <C>
Long-term debt:
  Unsecured term note payable................................. $10,000  $   --
  Senior secured notes payable................................     --    18,706
  Senior subordinated notes payable to Perkin-Elmer...........     --     1,979
  Senior subordinated note payable to IBM.....................     --     1,567
                                                               -------  -------
    Total debt................................................  10,000   22,252
  Less current maturities.....................................  (3,333)  (5,386)
                                                               -------  -------
                                                               $ 6,667  $16,866
                                                               =======  =======
</TABLE>
 
 Unsecured Term Note Payable and Revolving Line of Credit
 
  On May 24, 1996, the Company entered into a $30.0 million financing
commitment with ABN-AMRO Bank, N.V. This facility includes a $20.0 million
two-year revolving line of credit and a $10.0 million three-year term note.
The $10.0 million term note was used to refinance the senior secured notes
payable. As of July 31, 1996, the Company had not used the revolving line of
credit. Indebtedness under the revolving line of credit and term note is
unsecured and bears interest at the London Interbank Offered Rate (5.91% on
July 31, 1996) plus 1.25%. The terms of the financing facility require the
Company to comply with certain financial and restrictive covenants, including
maintenance of certain financial ratios and minimum net worth criteria,
restrictions on the incurrence of indebtedness and repurchase of Company
stock, and certain dividend restrictions. At July 31, 1996, the Company was in
compliance with all covenants.
 
  Minimum annual repayments of the term note are as follows (in thousands):
 
<TABLE>
<CAPTION>
      FISCAL YEAR ENDING JULY 31:
      ---------------------------
      <S>                                                               <C>
        1997........................................................... $ 3,333
        1998...........................................................   3,333
        1999...........................................................   3,334
                                                                        -------
                                                                        $10,000
                                                                        =======
</TABLE>
 
 Senior Secured Notes Payable
 
  During the year ended July 31, 1996, the Company repaid the remaining unpaid
principal balance of $18.7 million under its 10.65% senior secured notes. As a
result of this repayment, the Company recorded an extraordinary loss of
approximately $930,000 related to unamortized debt issuance costs.
 
 Senior Subordinated Notes Payable
 
  In July 1995, IBM and Perkin-Elmer, holders of the Company's senior
subordinated notes payable and mandatorily redeemable convertible preferred
stock, exchanged approximately $7.1 million and $12.6 million of their senior
subordinated notes and accrued interest for 40,251 and 65,390 shares,
respectively, of Series B mandatorily redeemable convertible preferred stock
and approximately $1.6 million and $2.0 million, respectively, of senior
subordinated notes payable. These notes bore interest at 12% and 10.3%,
respectively. As a result of this transaction, the Company recorded an
extraordinary gain, net of tax, of approximately $5.4 million. In computing
the gain, management estimated that the fair value of the senior subordinated
notes at
 
                                      42
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
the date of the exchange was approximately $14.2 million reflecting the
present value of future obligations discounted at approximately 15% to 16%.
The discount rate reflected management's estimate of fair market rates for
high yield, private debt issuances at the time. The fair value of the debt
resulted in an implied value of the Series B mandatorily redeemable
convertible preferred stock at the date of the exchange of approximately $4.88
per common share equivalent. Upon the closing of the IPO on October 24, 1995,
the Series B mandatorily redeemable convertible preferred stock held by IBM
and Perkin-Elmer was converted into 825,660 and 1,341,331 shares of Common
Stock, respectively. The senior subordinated notes payable totaling
approximately $3.6 million were repaid in October 1995.
 
NOTE 4--OTHER LIABILITIES:
 
  Included in other liabilities is a $4.3 million payable to a nonprofit
research and development organization for machinery and equipment acquired.
The liability becomes due on December 1, 1997, or earlier subject to certain
other conditions under the contract.
 
NOTE 5--MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK:
 
  As of July 31, 1995, the Company had issued and outstanding a total of
572,672 shares of mandatorily redeemable convertible preferred stock, par
value $0.01 per share, as follows:
 
<TABLE>
<CAPTION>
                                                                    JULY 31,
                                                                 ---------------
                                                                  1995    1994
                                                                 ------- -------
      <S>                                                        <C>     <C>
      Series B, 365,641 and 260,000 shares designated, issued
       and outstanding at July 31, 1995 and 1994, respectively.  $48,172 $35,465
      Series C, 86,400 shares designated, 81,278 shares issued
       and outstanding.........................................   12,190  11,593
      Series D, 50,000 shares designated, issued and
       outstanding.............................................    7,656   7,304
      Series E, 75,753 shares designated, issued and
       outstanding.............................................    8,379     --
                                                                 ------- -------
                                                                 $76,397 $54,362
                                                                 ======= =======
</TABLE>
 
  Upon completion of the Company's IPO on October 24, 1995, all series of the
Company's mandatorily redeemable convertible preferred stock series were
converted into 11,747,057 shares of Common Stock.
 
NOTE 6--STOCKHOLDERS' EQUITY:
 
 Common Stock
 
  In June 1996, the Company entered into an equity investment agreement
whereby, in exchange for $10.0 million, the Company issued 500,000 shares of
Common Stock plus the warrants described below.
 
 Warrants
 
  The Company issued warrants to the equity investor discussed above to
purchase an additional 75,000 shares at an exercise price equal to $20.00 per
share, which was the price of the 500,000 common shares purchased. Such
warrants only become exercisable if the investor purchases products and
services from the Company in amounts that exceed certain thresholds over the
succeeding four years, or upon the occurrence of certain other conditions. The
estimated fair value of the warrants, included in other assets, is
approximately $600,000 and will be amortized to cost of sales as product
purchases are made by the investor in future periods. The warrants expire in
fiscal 2001.
 
                                      43
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  In February 1995, in conjunction with entering into a sale and leaseback
agreement (Note 12), the Company issued the lessor a warrant to purchase
159,314 shares of the Company's Common Stock at $0.45 per share. Additionally,
the Company issued to the bank providing mortgage financing to the lessor a
warrant to purchase 53,104 shares of Common Stock at $0.45 per share. These
warrants expire on November 15, 2003. The value assigned to these warrants is
being amortized over the lease period, which is 15 years, and is not material.
The warrant agreement was amended in August 1996. (See Note 15-Subsequent
Event.)
 
  In fiscal 1992, in conjunction with the acquisition of the assets and
liabilities of ATEQ Corporation, the Company issued warrants to purchase 67
and 2,159 shares of Series C mandatorily redeemable convertible preferred
stock at an exercise price of $100.00 and $0.01 per share, respectively. Upon
completion of the initial public offering these warrants were exchanged for
warrants to purchase common stock. At July 31, 1996, 52 and 659 of these
warrants are exercisable into 1,064 and 13,515 shares of Common Stock,
respectively. Warrants exercisable into 1,064 shares of Common Stock will
expire in early fiscal 1997. Warrants exercisable into 13,515 shares will
expire in fiscal 2001.
 
  During fiscal 1992 and 1993, the Company issued warrants to Cigna to
purchase 307,341 and 21,873 shares of the Company's Common Stock at $0.70 per
share, respectively, in connection with its senior secured notes. In November,
Cigna received the right to acquire 105,794 additional shares of Common Stock
pursuant to the terms of the Warrant Agreement and the Company recorded debt
issuance costs in the amount of $1.1 million. Subsequently, in February 1996,
435,008 shares of Common Stock were issued upon exercise of such warrants for
an aggregate exercise price and proceeds to the Company of $230,000. In
January 1996, the Company prepaid a portion of its senior secured notes
payable, which resulted in the write-off of unamortized debt issuance costs
and recognition of an extraordinary loss in the amount of $300,000. In June
1996, the Company repaid the remaining balance of its senior secured notes
payable, which resulting in the write-off the remaining unamortized debt
issuance costs and recognition of an extraordinary loss in the amount of
$630,000.
 
  In fiscal 1995, the Company also issued a warrant to purchase 150,000 shares
of the Company's Common Stock at an exercise price of $1.70 per share. This
warrant expires in fiscal 2005. (See Note 11--Related Party Transactions.)
 
NOTE 7--INCOME TAXES:
 
  The components of income before income tax (benefit) provision and
extraordinary items are as follows:
 
<TABLE>
<CAPTION>
                                                           YEAR ENDED JULY 31,
                                                          ---------------------
                                                           1996    1995   1994
                                                          ------- ------ ------
                                                             (IN THOUSANDS)
   <S>                                                    <C>     <C>    <C>
   Domestic.............................................. $15,870 $3,401 $ (353)
   Foreign...............................................   5,638  3,412  4,281
                                                          ------- ------ ------
                                                          $21,508 $6,813 $3,928
                                                          ======= ====== ======
</TABLE>
 
                                      44
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The components of the income tax (benefit) provision are as follows:
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED JULY 31,
                                                       ------------------------
                                                         1996     1995    1994
                                                       --------  ------  ------
                                                           (IN THOUSANDS)
   <S>                                                 <C>       <C>     <C>
   Current:
     U.S.............................................. $  2,179  $  200  $    5
     Foreign..........................................    3,915   2,481   2,359
     State............................................    1,187      50      55
                                                       --------  ------  ------
                                                          7,281   2,731   2,419
   Deferred:
     U.S..............................................  (22,980)    --      --
     Foreign..........................................     (584)   (442)   (103)
                                                       --------  ------  ------
   Income tax (benefit) provision..................... $(16,283) $2,289  $2,316
                                                       ========  ======  ======
</TABLE>
 
  The income tax (benefit) provision differs from the amount computed by
applying the statutory U.S. federal income tax rate as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED JULY 31,
                                                      ------------------------
                                                        1996     1995    1994
                                                      --------  ------  ------
                                                          (IN THOUSANDS)
   <S>                                                <C>       <C>     <C>
   Income tax (benefit) provision at U.S. statutory
    rate............................................. $  7,563  $2,496  $1,493
   State income taxes, net of federal income tax
    benefit..........................................    1,187      33      36
   Purchase accounting non-taxable write-offs........    2,194     --      --
   Foreign earnings taxed at higher rates............    2,103     700     644
   Alternative minimum tax and other.................      810     242     143
   Realized deferred tax assets previously reserved..   (7,160)    --      --
   Change in the valuation allowance.................  (22,980) (1,182)    --
                                                      --------  ------  ------
     Total........................................... $(16,283) $2,289  $2,316
                                                      ========  ======  ======
</TABLE>
 
  The Company recorded a tax benefit of approximately $23.0 million for the
year ended July 31, 1996. The benefit reflects the release in the second half
of fiscal 1996 of approximately $23.0 million of valuation allowances
previously recorded against the Company's deferred tax assets. Management's
evaluation of the recoverability of the Company's deferred tax assets is based
in part upon the current product backlog and its ability to increase
manufacturing capacity. Management has fully reserved deferred tax assets
which may be realized beyond the ensuing twelve-month period because of the
uncertainty regarding their realization.
 
                                      45
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The components of deferred taxes are as follows:
 
<TABLE>
<CAPTION>
                                                                 JULY 31,
                                                              ----------------
                                                               1996     1995
                                                              -------  -------
                                                              (IN THOUSANDS)
<S>                                                           <C>      <C>
Current:
  Nondeductible accruals and reserves........................ $15,624  $11,229
  Uniform capitalization adjustment to inventory.............   1,996    1,536
  Revenue recognized for tax return purposes and deferred for
   financial statements                                           366    2,031
  Net operating loss carryforward............................   6,650      --
  Other......................................................     977      --
  Valuation allowance........................................  (1,105) (13,852)
                                                              -------  -------
  Net current deferred tax asset.............................  24,508      944
                                                              -------  -------
Noncurrent:
  Book depreciation in excess of tax depreciation............   2,294    4,609
  Net operating loss carryforwards...........................   1,735   14,743
  Other......................................................     555    1,110
  Valuation allowance........................................  (4,029) (19,907)
                                                              -------  -------
  Net noncurrent deferred tax asset..........................     555      555
                                                              -------  -------
  Net deferred tax asset..................................... $25,063  $ 1,499
                                                              =======  =======
</TABLE>
 
  At July 31, 1996, the Company had NOL carryforwards (NOLs) for federal
income tax purposes of approximately $23.9 million. These carryforwards, if
not utilized to offset future taxable income and income taxes payable, will
expire at various dates through the year 2009. Additionally, under the Tax
Reform Act of 1986, the amount of the benefit from NOL carryforwards may be
impaired or limited in certain circumstances, including a cumulative stock
ownership change of more than 50% over a three-year period. The completion of
the Company's public offering in June, 1996 resulted in a cumulative change in
ownership of the Company in excess of 50% and as a consequence, the
utilization of NOLs is be subject to a limitation of approximately
$19.0 million per year.
 
NOTE 8--MINORITY INTEREST:
 
  In July 1991, the Company sold 225 newly-issued shares of common stock of
its Japanese subsidiary (Etec Japan) for approximately $4.8 million and a note
for $188,000. The minority holding represented approximately 18% of the
outstanding shares of Etec Japan. Pursuant to the sale agreement, on July 31,
1995, minority stockholders were entitled to elect to have the Company
repurchase their shares at the original purchase price plus interest. which
was defined in the agreement as being the Japanese bank long-term interest
rate plus one percent.
 
  On July 31, 1995, the minority interest investors exchanged their minority
interest in Etec Japan for 75,753 shares of Series E mandatorily redeemable
convertible preferred stock and a final cash payment to one of the holders,
who is a director of the Company, of approximately $400,000, which was paid in
the first quarter of fiscal 1996. This transaction was accounted for under the
purchase method of accounting resulting in the elimination of the minority
liability and the creation of $350,000 of goodwill which is being amortized
over seven years. There were no other significant effects from this
transaction. Upon completion of the IPO, all shares of the Series E
mandatorily redeemable convertible preferred stock were converted to 1,553,898
shares of Common Stock.
 
                                      46
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 9--RESEARCH, DEVELOPMENT AND ENGINEERING CONTRACTS:
 
  The Company has received funding for research, development and engineering
contracts of approximately $725,000, $7.3 million and $16.1 million during the
years ended July 31, 1996, 1995 and 1994, respectively. The Company has
recorded approximately $725,000, $6.1 million and $13.9 million of this
funding as an offset to research, development and engineering expenses during
the years ended July 31, 1996, 1995 and 1994, respectively. The Company has
recorded approximately $1.2 million and $2.2 million, respectively, as an
offset to selling, general and administrative expenses during the years ended
July 31, 1995 and 1994. No such funding was offset against selling, general
and administrative expenses during the year ended July 31, 1996.
 
  In November 1992, the Company entered into a cost reimbursement research and
development contract with the Advanced Research Projects Agency/Naval Air
Systems Command ("ARPA/NAVAIR") under which the Company was entitled to
receive approximately $22.0 million. In connection with this contract, no
funding was received during the year ended July 31, 1996. Funding in the
amount of approximately $5.7 million and $10.3 million was recognized and
billed during the years ended July 31, 1995 and 1994, respectively. Costs
incurred during each of these periods approximated billings and are included
in research, development and engineering and selling, general and
administrative expenses.
 
  During the years ended July 31, 1996, 1995 and 1994, the Company performed
research and development under several cooperative development agreements.
These agreements provide for payments upon the Company's achievement of
specified milestones. Funding for these contracts was $725,000, $1.6 million,
and $5.8 million during the years ended July 31, 1996, 1995 and 1994,
respectively. Costs of approximately $2.9 million, $3.8 million, and $7.5
million for these projects were included in research and development expense
during the years ended July 31, 1996, 1995, and 1994, respectively.
 
  The Company has a cost-reimbursement research and development contract with
the United States Department of Defense, ARPA, pursuant to which the Company
is entitled to receive approximately $3.9 million. Funding is due in three
phases subject to achievement of certain milestones during each phase. As of
July 31, 1996, the Company was in the process of completing phase I and
approximately $1.2 million in funding had been received, which has been
deferred and is included in accrued and other liabilities. As of July 31,
1996, costs incurred related to this contract in the amount of $1.2 million
have been deferred and are included in inventory. In October 1996, $1.1
million in phase II funding was awarded.
 
  In August 1996, the Company was awarded a $1.5 million research and
development contract with MCM-D Consortium. This contract allows for payments
subject to the achievement of certain milestones.
 
NOTE 10--BENEFIT PLANS:
 
 Employee Stock Option Plan
 
  Under the Company's 1990 Employee Stock Option Plan, options to purchase
600,000 shares of Common Stock may be granted. The plan provides that options
may be granted at a price not less than the fair value of a share at the date
of grant. Options generally vest annually over a four-year period and expire
over terms not exceeding ten years.
 
  In fiscal 1994, the Company adopted the 1994 Employee Stock Option Plan.
Under this plan, options to purchase 448,374 shares of Common Stock may be
granted. This Plan provides that options may be granted at a price not less
than the fair value of a share at the date of grant except under certain
inapplicable circumstances. Options generally vest annually over a four-year
period and expire over terms not exceeding ten years.
 
                                      47
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  In fiscal 1995, the Company's Board of Directors approved the 1995 Omnibus
Incentive Plan. Under this plan options to purchase 1,000,000 shares of Common
Stock may be granted. Options vest annually over a period not to exceed five
years and expire over terms not exceeding ten years.
 
  In addition, options to purchase 88,503 shares of Common Stock may be
granted under certain other option agreements. A total of 38,670 options were
outstanding under these agreements at July 31, 1996.
 
 Executive Stock Plan
 
  Under the Company's 1990 Executive Stock Plan, options to purchase 884,959
shares of Common Stock may be granted. The Plan provides that options may be
granted at a price not less than the fair value of a share at the date of
grant. Options generally vest annually over a three-year period and expire
over terms not exceeding ten years.
 
 Directors' Stock Option Plan
 
  In fiscal 1995, the Company adopted the 1995 Directors' Stock Option Plan.
Under this plan, options to purchase 150,000 shares of Common Stock may be
granted. The plan provides that options may be granted at a price equal to the
fair market value at the date of grant. Under this plan, each non-employee
director will receive a one-time grant upon joining the Board of Directors and
annual grants upon the anniversary of the initial grant. The initial grants
vest in two installments, with half of the shares vesting six months after the
grant date and the other half vesting on the first anniversary of the grant
date. Annual grants vest on the first anniversary of the respective grant
date.
 
  A summary of activity for the Employee, Executive and Directors' Stock
Option Plans follows:
 
<TABLE>
<CAPTION>
                                             OPTIONS
                                            AVAILABLE     OPTIONS     EXERCISE
                                            FOR GRANT   OUTSTANDING    PRICE
                                            ----------  ----------- ------------
   <S>                                      <C>         <C>         <C>
   Outstanding, July 31, 1993..............    583,624     794,195     $0.45
     Granted............................... (1,011,527)  1,011,527     $0.45
     Canceled..............................    691,430    (691,430)    $0.45
     Repurchased...........................     89,446         --      $0.45
     Exercised.............................        --     (156,600)    $0.45
                                            ----------   ---------
   Outstanding, July 31, 1994..............    352,973     957,692     $0.45
     Additional options authorized.........  1,150,000         --
     Granted...............................   (565,406)    565,406  $0.45-$ 5.40
     Canceled..............................     71,520     (71,520)    $0.45
     Repurchased...........................    107,415         --      $0.45
     Exercised.............................        --     (306,646)    $0.45
                                            ----------   ---------
   Outstanding, July 31, 1995..............  1,116,502   1,144,932  $0.45-$ 5.40
     Granted...............................   (760,382)    760,382  $7.20-$37.00
     Canceled..............................     19,409     (19,409) $0.45-$13.75
     Exercised.............................        --     (165,695) $0.45-$ 5.40
                                            ----------   ---------
   Outstanding, July 31, 1996..............    375,529   1,720,210  $0.45-$37.00
                                            ==========   =========
</TABLE>
 
  At July 31, 1996, 1995, and 1994, options exercisable totaled 508,376,
412,426, and 404,925, respectively.
 
                                      48
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Employee Stock Purchase Plan
 
  In July 1995, the Company's Board of Directors approved the 1995 Employee
Stock Purchase Plan. Under this plan, employees of the Company can purchase
common stock through payroll deductions. A total of 500,000 shares have been
reserved for issuance under this plan. As of July 31, 1996, 39,189 shares have
been purchased under the Employee Stock Purchase Plan.
 
 401(k) Plan
 
  On June 15, 1990, the Company adopted a 401(k) savings plan. The Plan covers
all eligible employees with more than three months of service. The Company
contributed $191,000, $173,000 and $151,000 to the Plan during the years ended
July 31, 1996, 1995 and 1994, respectively.
 
NOTE 11--RELATED PARTY TRANSACTIONS:
 
  In March 1990, the Company entered into an inventory component purchasing
agreement with Grumman, one of the former holders of its Series B mandatorily
redeemable convertible preferred stock (which were converted into shares of
Common Stock in October 1995, pursuant to which the Company committed to
purchase specified quantities of components from Grumman upon achieving
certain sales levels. In fiscal 1992, Grumman billed the Company $1.4 million
under this agreement. The Company disputed the appropriateness of this
billing, but paid Grumman $1.0 million in fiscal 1993. Grumman continued to
maintain that the Company had not satisfied its obligations under the
agreement. In fiscal 1995, the Company and Grumman entered into an agreement
under which Grumman released the Company from all obligations under the 1990
inventory purchase agreement and the Company issued to Grumman a warrant to
purchase 150,000 shares of the Company's Common Stock at an exercise price of
$1.70 per share. (See Note 6--Stockholders' Equity.)
 
  The Company paid approximately $800,000 and $1.8 million in fiscal 1995 and
1994, respectively, for services provided in conjunction with the research and
development contract with ARPA/NAVAIR to a party which held shares of the
Company's Series B and D mandatorily redeemable convertible preferred stock
until October 1995, at which time all such shares were converted into shares
of Common Stock. No such services were provided to the Company during the year
ended July 31, 1996.
 
  In fiscal 1994, the Company purchased approximately $590,000 of pattern
memory boards, beam sequencers and other related materials from a party which
at that time held shares of the Company's Series B mandatorily redeemable
convertible preferred stock.
 
  In fiscal 1994, a party which at that time held shares of the Company's
Series B and D mandatorily redeemable convertible preferred stock canceled an
order; the Company recognized approximately $500,000 in penalty cancellation
fees which is included in revenue for that period.
 
  In fiscal 1996 and 1995, the Company purchased masks for use by the Company
in the development of new products for approximately $323,000 and $200,000,
respectively, from a party which held shares of the Company's Series B
mandatorily redeemable convertible preferred stock until October 1995, at
which time such shares were converted into Common Stock.
 
  Sales to related parties included in product and service revenue in fiscal
1996, 1995, and 1994 are approximately $21.6 million, $13.0 million, and $15.0
million, respectively.
 
  At July 31, 1996 and 1995, included in accrued liabilities is approximately
$1.3 million and $8.9 million, respectively, due to a party which at that time
held shares of the Company's Series E mandatorily redeemable
 
                                      49
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
convertible preferred stock. The amount is due under a financing arrangement,
whereby the holder provides interim financing of certain Japanese receivables
between the date of billing and the date of collection from the customers of
the Company. Amounts due bear interest at the Japanese prime rate (1.625% at
July 31, 1996) plus 1.25% per annum.
 
NOTE 12--COMMITMENTS AND CONTINGENCIES:
 
  In February 1995, the Company entered into a sale and leaseback agreement,
pursuant to which the Company sold its office/manufacturing facilities (the
"Property") located in Hayward, California for approximately $11.8 million and
leased back the Property for an initial term of fifteen years, with options
for four five-year renewals. Initial annual rental payments to the lessor are
approximately $1.4 million for the first three years. At the end of the third,
sixth, ninth and twelfth years, respectively, the rent will be adjusted by an
amount based on any percentage increase in the Consumer Price Index for the
preceding three years, with a cap of 12%. Under the terms of the lease, the
Company is responsible for paying maintenance, insurance, taxes, and all other
expenses associated with operating and maintaining the Property. The Company
recorded the transaction as a sale and deferred the gain on the sale which was
approximately $7.0 million. This gain is being amortized over the 15-year
operating lease term. The agreement requires the Company to comply with
certain financial covenants and to maintain a fixed charge coverage ratio of
at least 1.5. At July 31, 1996, the Company was in compliance with these
covenants. In August 1996, the sale and leaseback agreement was amended. (See
Note 15--Subsequent Event.)
 
  In addition, the Company leases certain other facilities and equipment under
operating lease agreements. Rent expense under all operating leases for the
years ended July 31, 1996, 1995, and 1994, was $3.5 million, $2.6 million, and
$1.9 million, respectively. Future minimum lease commitments excluding
property taxes, maintenance and insurance under leases having initial or
remaining terms in excess of one year, are as follows (in thousands):
 
<TABLE>
<CAPTION>
      FISCAL YEAR ENDING JULY 31:
      <S>                                                               <C>
        1997........................................................... $ 3,741
        1998...........................................................   3,323
        1999...........................................................   3,438
        2000...........................................................   2,495
        2001...........................................................   2,267
        Thereafter.....................................................  17,492
                                                                        -------
                                                                        $32,756
                                                                        =======
</TABLE>
 
  In April 1996, the Company entered into an agreement with a contractor to
construct a new administrative facility in Hayward, California at a cost not
to exceed approximately $4.3 million. Total estimated costs at completion of
the facility are $5.0 million. As of July 31, 1996, the Company incurred $1.4
million in financing the construction of the new facility, which is included
in other current assets. The Company intends to sell the new facility to its
landlord in fiscal 1997 and enter into a leasing arrangement for a period of
15 years.
 
  In April 1995, the Company signed an agreement with a distributor of the
Company, under which Etec Japan assumed responsibility for sales, direct
customer service and support for the Company's products in the Japanese
market. As part of this agreement, the Company agreed to pay the distributor a
percentage of revenue for each CORE and ALTA system sold in the defined sales
territory for the next four years.
 
 
                                      50
<PAGE>
 
                               ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
NOTE 13--GEOGRAPHIC REPORTING AND CUSTOMER CONCENTRATION:
 
<TABLE>
<CAPTION>
                                                         JAPAN
                                                          AND
                                                UNITED    FAR
                                                STATES   EAST   EUROPE  TOTAL
                                                ------- ------- ------ --------
                                                        (IN THOUSANDS)
<S>                                             <C>     <C>     <C>    <C>
Net revenues to third parties:
  Year ended July 31, 1996
    Domestic................................... $49,913 $   --  $  --  $ 49,913
    Foreign....................................  30,360  59,788  5,584   95,732
                                                ------- ------- ------ --------
                                                $80,273 $59,788 $5,584 $145,645
                                                ======= ======= ====== ========
  Year ended July 31, 1995
    Domestic................................... $33,342 $   --  $  --  $ 33,342
    Foreign....................................  13,353  31,057  5,164   49,574
                                                ------- ------- ------ --------
                                                $46,695 $31,057 $5,164 $ 82,916
                                                ======= ======= ====== ========
  Year ended July 31, 1994
    Domestic................................... $32,651 $   --  $  --  $ 32,651
    Foreign....................................   6,721  24,305  5,033   36,059
                                                ------- ------- ------ --------
                                                $39,372 $24,305 $5,033 $ 68,710
                                                ======= ======= ====== ========
</TABLE>
 
<TABLE>
<CAPTION>
                                                           YEAR ENDED JULY 31,
                                                          ----------------------
                                                           1996    1995    1994
                                                          ------- ------- ------
                                                              (IN THOUSANDS)
<S>                                                       <C>     <C>     <C>
Operating income:
  United States.......................................... $15,340 $ 7,415 $4,377
  Japan and Far East.....................................   5,174   3,975  4,456
  Europe.................................................     149      13    743
                                                          ------- ------- ------
    Total................................................ $20,663 $11,403 $9,576
                                                          ======= ======= ======
</TABLE>
 
<TABLE>
<CAPTION>
                                                                  1996    1995
                                                                -------- -------
                                                                 (IN THOUSANDS)
<S>                                                             <C>      <C>
Identifiable assets:
  United States................................................ $174,015 $51,736
  Japan and Far East...........................................   31,878  30,577
  Europe.......................................................    2,978   3,671
                                                                -------- -------
    Total...................................................... $208,871 $85,984
                                                                ======== =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                                   YEAR ENDED
                                                                    JULY 31,
                                                                 ----------------
                                                                 1996  1995  1994
                                                                 ----  ----  ----
<S>                                                              <C>   <C>   <C>
Customers comprising 10% or more of the Company's total revenue
 for the periods indicated:
  A............................................................    8%   14%    9%
  B............................................................   13%   14%    7%
  C............................................................    6%    4%   12%
  D............................................................    6%    2%   13%
  E............................................................   17%   12%    2%
</TABLE>
 
                                       51
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 14--POLYSCAN ACQUISITION:
 
  On June 27, 1995, the Company entered into a loan agreement with Polyscan,
Inc. ("Polyscan"), whereby the Company advanced $1.8 million to Polyscan. The
loan bore interest at prime plus 3% and the balance was due on January 31,
1996. During February 1996, Polyscan repaid $600,000 to the Company.
 
  On February 5, 1996, Etec Polyscan, Inc. ("Etec Polyscan") acquired
substantially all of the assets and assumed certain specified liabilities of
Polyscan in exchange for 350,000 shares of the Company's Common Stock with an
agreed-upon market value of $3.5 million. Etec Polyscan has retained 175,000
of the Company's common shares issued until February 5, 1998 to provide
payment for any liability of Polyscan or the Polyscan shareholders (which was
not assumed by Etec Polyscan as part of the acquisition) or any adjustment of
the purchase price. One of the liabilities assumed by Etec Polyscan was
Polyscan's obligation to repay the outstanding loan in the amount of
approximately $1.2 million.
 
  The purchase price for book purposes was allocated by the Company
approximately as follows (in thousands):
 
<TABLE>
      <S>                                                              <C>
      Inventory....................................................... $   733
      Other current assets............................................      69
      Other assets....................................................      65
      In-process technology...........................................   6,269
      Accounts payable and accrued expenses (includes note payable to
       the Company)...................................................  (3,636)
                                                                       -------
        Total acquisition costs....................................... $ 3,500
                                                                       =======
</TABLE>
 
  The excess of the purchase price over the fair value of the net assets was
allocated to in-process technology purchase which, because of the uncertainty
as to realization, the Company wrote off in fiscal 1996.
 
  The operating results of this acquisition are included in the Company's
consolidated results of operations from the date of acquisition. The following
unaudited pro forma summary presents the consolidated results of operations as
if the acquisition had occurred at August 1, 1994, after giving effect to
certain adjustments, including interest income on the Polyscan loan and the
increase in common equivalent shares outstanding. Additionally, the 1996 pro
forma information excludes a $6.3 million write-off of in-process technology
acquired. Polyscan's results included in the pro forma presentation for the
years ended July 31, 1996 and 1995, are for the period from July 1, 1995
through January 31, 1996 and the twelve months ended June 30, 1995,
respectively. These pro forma results have been prepared for comparative
purposes only and do not purport to be indicative of what would have occurred
had the acquisition taken place at the beginning of the periods presented or
of the results which may occur in the future.
 
<TABLE>
<CAPTION>
                                                           YEAR ENDED YEAR ENDED
                                                            JULY 31,   JULY 31,
                                                              1996       1995
                                                           ---------- ----------
      <S>                                                  <C>        <C>
      Net income (in thousands)...........................  $42,207     $8,170
      Net income per common share.........................  $  2.28     $ 0.54
</TABLE>
 
NOTE 15--SUBSEQUENT EVENT:
 
  In August 1996, the Company obtained a financing commitment for the sale and
leaseback of its new headquarters consisting of 60,000 square feet of office
space. This building is currently under construction and is scheduled for
completion and occupancy in January 1997. Upon completion, the Company will
sell the building
 
                                      52
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
to its existing landlord and will enter into a 15-year lease that will be
subject to rental adjustments every three years pursuant to an adjustment in
the Consumer Price Index. In addition, the Company has also obtained a
commitment from its landlord to provide financing of up to $4 million for
leasehold improvements to the existing office and manufacturing facilities.
 
  Concurrent with this financing commitment, the Company also agreed to amend
the warrant agreement and to refund a portion of the purchase price of the
Property from the February 1995 sale leaseback transaction (See Note 12--
Commitments and Contingencies). The landlord surrendered its warrant to
acquire 159,314 shares of the Company stock in exchange for a new warrant to
acquire 68,768 shares of the Company stock at $0.45 per share. The bank
surrendered its warrant certificate to acquire 53,104 shares of Company stock
in exchange for 22,461 shares of Common Stock. The Company refunded to the
landlord $2.6 million of the purchase price, resulting in a reduction in the
Company's annual rent from $1.4 million to $1.0 million. The Company has
accounted for the $2.6 million refund payment as a reduction in the deferred
gain recorded as a result of the February 1995 sale and leaseback transaction.
The value of the warrants surrendered and cancelled was not material.
 
                                      53
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
  None.
 
  Effective April 10, 1995, Price Waterhouse LLP was engaged as the Company's
principal independent accountants. Prior to April 10, 1995, KPMG Peat Marwick
LLP ("KPMG") had been the Company's independent accountants. The decision to
change independent accountants was approved by the Company's Board of
Directors. In the period from August 1, 1993 through April 9, 1995 KPMG issued
no audit report which was qualified or modified as to uncertainty, audit scope
or accounting principles, no adverse opinions or disclaimers of opinion on any
of the Company's financial statements, and there were no disagreements with
KPMG on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedures. KPMG has not audited or reported
on any of the Company's financial statements or information included in this
Annual Report on Form 10-K. Prior to April 10, 1995 the Company had not
consulted with Price Waterhouse LLP on items which involved the Company's
accounting principles or the form of audit opinion to be issued on the
Company's financial statements.
 
                                      54
<PAGE>
 
                                   PART III
 
  Certain information required by Part III is incorporated by reference from
the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the solicitation of proxies for the
Company's 1996 Annual Meeting of Stockholders (the "Proxy Statement").
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
  Information relating to directors required by this section is incorporated
by reference from the information in the section entitled, "Election of
Directors--Nominees" in the Proxy Statement. Information with respect to
executive officers of the Company contained in the section entitled "Executive
Officers of the Registrant" in Part I of this Form 10-K.
 
  Item 405 of Regulation S-K calls for disclosure of any known late filing by
an insider to file a report required by Section 16 of the Securities Exchange
Act of 1934. This disclosure is contained in the section entitled, "Compliance
with Section 16(A) of the Exchange Act" in the Proxy Statement and is
incorporated herein by reference.
 
ITEM 11. EXECUTIVE COMPENSATION
 
  The information required by this section is incorporated herein by reference
from the information in the sections entitled "Directors' Compensation" and
"Executive Compensation" in the Proxy Statement.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The information required by this section is incorporated by reference from
the information in the section entitled, "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  The information required by this section is incorporated by reference from
the information in the section entitled, "Certain Relationships and Related
Transactions" in the Proxy Statement.
 
                                      55
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
 
  (a) The following documents were filed as part of this report:
 
    1. Financial Statements--See Index to Consolidated Financial Statements
       at page 33 of this Form 10-K.
 
    2. Financial Statement Schedules--All other schedules are omitted
       because they are not required, are not applicable, or the
       information is included in the financial statements or notes
       thereto.
 
    3. Exhibits--See Index to Exhibits at page 57 of this Form 10-K.
 
  (b) Reports on Form 8-K--No reports on Form 8-K have been filed during the
fourth quarter of fiscal 1996.
 
                                      56
<PAGE>
 
                               ETEC SYSTEMS, INC.
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
                                                                   SEQUENTIALLY
  EXHIBIT                                                            NUMBERED
   NUMBER                  DESCRIPTION OF DOCUMENT                     PAGE
  -------                  -----------------------                 ------------
 <C>        <S>                                                    <C>
  2.1****   Agreement and Plan of Reorganization among the
            Registrant, Etec Polyscan, Inc., Polyscan, Inc. and
            the shareholders of Polyscan, Inc. dated January 30,
            1996................................................
  3.1**     Seventh Amended and Restated Articles of
            Incorporation.......................................
  3.2***    Bylaws of the Registrant, as amended................
 10.1*      1990 Stock Plan of Registrant.......................
 10.2*      1990 Executive Stock Plan of Registrant.............
 10.3*      1994 Employee Stock Option Plan of Registrant.......
 10.4*      1995 Omnibus Incentive Plan of Registrant...........
 10.5*      1995 Employee Stock Purchase Plan of Registrant.....
 10.6*      1995 Directors' Stock Option Plan of Registrant.....
 10.7*      Senior Management Incentive Plan of Registrant......
 10.8*      Lease Agreement dated February 1, 1995 by and
            between Registrant and ESI (CA) QRS 12-6, Inc. .....
 10.9*      Lease Agreement between Beaverton-Redmond Tech
            Properties and ATEQ Corporation dated June 18, 1985,
            as amended May 15, 1987 and September 20, 1989......
 10.10*     Warrant Agreement between Registrant and Cigna dated
            as of November 15, 1991, as amended April 1, 1995...
 10.11*     Series C Shareholders' Rights Agreement by and among
            the Registrant and Certain Former Holders of Capital
            Stock of ATEQ Corporation and Warrants to Purchase
            Capital Stock of ATEQ Corporation dated as of
            November 8, 1991, as amended December 1991 and
            January 14, 1994....................................
 10.12+*    EBES Information Agreement dated October 1, 1975
            between Western Electric Company, Inc. and Etec, as
            amended April 1, 1976, August 3, 1976, July 1, 1980,
            November 22, 1983 and December 20, 1983.............
 10.13*     Consent to Assignment by AT&T to assignment by
            Perkin-Elmer to Etec of the EBES Information
            Agreement dated October 1, 1975 between Western
            Electric Company, Inc. and Etec.....................
 10.14*     Excess Cash Sharing Agreement dated January 2, 1995,
            between Cigna, IBM, Perkin-Elmer and the Registrant.
 10.15*     Senior Subordinated Debt Restructuring Agreement
            dated January 2, 1995 among the Registrant and IBM
            and Perkin-Elmer....................................
 10.16*     Senior Subordinated Debt Exchange Agreement dated as
            of July 31, 1995 among the Registrant and IBM and
            Perkin-Elmer........................................
 10.17*     Letter Agreement between Grumman and Registrant
            dated April 26, 1995................................
</TABLE>
 
 
                                       57
<PAGE>
 
                               ETEC SYSTEMS, INC.
 
                         INDEX TO EXHIBITS--(CONTINUED)
 
<TABLE>
<CAPTION>
                                                                    SEQUENTIALLY
  EXHIBIT                                                             NUMBERED
   NUMBER                  DESCRIPTION OF DOCUMENT                      PAGE
  -------                  -----------------------                  ------------
 <C>        <S>                                                     <C>
 10.18*     Non-statutory Stock Option Agreement by and between
            Catherine P. Goodrich (Lego) and the Company dated as
            of December 6, 1994, as amended July 18, 1995........
 10.19*     Consulting Agreement between the Registrant and
            Charles E. Minihan dated March 8, 1995...............
 10.20*     Agreement on Officer's Retirement between the
            Registrant and John Suzuki dated as of January 25,
            1994.................................................
 10.21*     Form of Indemnity Agreements.........................
 10.22*     Amendment to Senior Subordinated Debt Exchange
            Agreement dated as of August 15, 1995 among the
            Registrant and IBM and Perkin-Elmer..................
 10.23*     Amended and Restated Loan and Security Agreement
            between the Registrant and Polyscan, Inc. dated as of
            August 16, 1995......................................
 10.24*     Registration Rights Agreement dated August 29, 1995
            between the Registrant and Certain Investors.........
 10.25*     First Amendment to Excess Cash Sharing Agreement
            dated August 15, 1995 (including Registrant's 12%
            Senior Subordinated Note and 10.3% Senior
            Subordinated Note)...................................
 10.26***** Amendment Three dated April 3, 1996 to Lease
            Agreement dated June 18, 1985 and as amended May 15,
            1987 and September 20, 1989 between Beaverton-Redmond
            Tech Properties and the Registrant...................
 10.27****  Registration Rights Agreement dated as of February 5,
            1996 among the Registrant, Polyscan, Inc. and the
            stockholders of Polyscan, Inc. ......................
 10.28***** Letter Agreement dated January 25, 1996 between
            Registrant and Cigna amending and modifying certain
            obligations under the Note Purchase Agreement and
            Excess Cash Sharing Agreement with Cigna.............
 10.29***** Credit Agreement among Registrant and the Lenders
            named therein and ABN-AMRO Bank, N.V. as agent for
            Lenders, dated May 24, 1996..........................
 10.30      Amendment and Assumption Agreement dated May 14, 1992
            by and between the Registrant, SEMATECH, INC. and
            ATEQ Corporation.....................................
 10.31      Investor Agreement dated June 28, 1996 by and among
            the Registrant and Intel Corporation.................
 10.32      Agreement dated as of July 23, 1996 by and between
            Registrant and SEMATECH, INC. .......................
 10.33      Letter Agreement dated as of August 7, 1996 between
            Registrant, ESI (CA) QRS 12-6, Inc., and
            Creditanstalt Corporate Finance, Inc. amending Lease
            Agreement dated February 1, 1995.....................
 10.34      Letter Agreement dated as of August 7, 1996 between
            Registrant and Corporate Property Associates 12
            Incorporated and ESI (CA) QRS 12-6, Inc. amending
            Lease Agreement dated February 1, 1995...............
</TABLE>
 
                                       58
<PAGE>
 
                              ETEC SYSTEMS, INC.
 
                        INDEX TO EXHIBITS--(CONTINUED)
 
<TABLE>
<CAPTION>
                                                                    SEQUENTIALLY
  EXHIBIT                                                             NUMBERED
   NUMBER                  DESCRIPTION OF DOCUMENT                      PAGE
  -------                  -----------------------                  ------------
 <C>        <S>                                                     <C>
 11.1       Statement of computation of earnings per share (see
            page 111 of this Form 10-K)..........................
 16.1*      Letter from former independent accountant............
 23.1       Consent of Price Waterhouse LLP (see page 112 of this
            Form 10-K)...........................................
 27.1       Financial Data Schedules.............................
</TABLE>
--------
*     Incorporated herein by reference to Registrant's Registration Statement on
      Form S-1 (File No. 33-95648).
**    Incorporated herein by reference to Exhibit 3.1 to Registrant's Quarterly
      Report on Form 10-Q for the quarter ended October 27, 1995.
***   Incorporated herein by reference to Exhibit 3.1 to Registrant's Quarterly
      Report on Form 10-Q for the quarter ended January 26, 1996.
****  Incorporated herein by reference to Exhibits 2.1 and 2.2, respectively,
      to Registrant's Current Report on Form 8-K dated February 5, 1996.
***** Incorporated herein by reference to Registrant's Registration Statement
      on Form S-1 (File No. 333-04363).
+     Confidential treatment has been previously granted.
 
 
                                      59