** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

**FORM 10-K/A**

**(Amendment No. 1)**

** **

**ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

** **
| **For the fiscal year ended December 31, 2004** | **Commission File Number 000-30637** |
|------------------------------------------------------|--------------------------------------|

** **

**AUGUST TECHNOLOGY CORPORATION**

(Exact name of Registrant as specified in its charter)

 
| **Minnesota**                                              | ** ** | **41-1729485**      |
|------------------------------------------------------------|------------|---------------------|
| (State of incorporation)                                   |       | (I.R.S. Employer    |
|                                                       |       | Identification No.) |
|                                                       |       |                |
| **4900 West 78th Street**                                  |       |                |
| **Bloomington, MN**                                        | ** ** | **55435**           |
| (Address of principal  executive offices)                  |       | (Zip Code)          |
|                                                       |       |                |
| **(952) 820-0080**                                         |
| (Registrant’s telephone  number, including area code) |

 

**Securitiesregistered pursuant to Section 12(b) of the Act:**  None

** **

**Securitiesregistered pursuant to Section 12(g) of the Act:**

** **

**Title of each class:**

**CommonStock, no par value**

** **

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.     Yes ý No o

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of theRegistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this form 10-K or any amendmentto this form 10-K.  o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange ActRule 12b-2).   Yes ý No o

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No ý

 

The aggregatemarket value of voting stock held by nonaffiliates of the Registrant was$208,386,572 as of June 30, 2004.

 

The number ofshares of Common Stock, no par value, outstanding as of February 28, 2005was 17,878,237.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portionsof the definitive Proxy Statement to be delivered to shareholders in connectionwith the 2005 Annual Meeting of Shareholders are incorporated by reference intoPart III.

 

** **

----

** **

**AUGUST TECHNOLOGY CORPORATION**

**EXPLANATORY NOTE**

 

As previously disclosed, August TechnologyCorporation (the “Company”) has restated its consolidated financial statementsfor the year 2004 and for the first two quarters of 2005. The determination torestate these financial statements was made as a result of a correction of the Company’sapplication of revenue recognition principles contained in the FinancialAccounting Standard Board’s Emerging Issues Task Force Issue No. 00-21, “*Revenue Arrangements with Multiple Deliverables*” (“EITF 00-21”).  As a result of subsequently reviewing ourrevenue recognition policies and procedures, we additionally noted that beginningin the fourth quarter of 2002 certain deferred software revenue should havebeen fully recognized upon delivery or customer acceptance rather than ratablyover a twelve-month period.  As a result,the Company has restated its consolidated financial statements for the years2004, 2003 and 2002 and for the first two quarters of 2005 (the “Restatement”).  Our restated consolidated financialstatements will also include disclosure of restated quarterly results for 2004and 2003.  The Audit Committee of theCompany’s Board of Directors (the “Audit Committee”) worked closely with theCompany’s management to review the Restatement and the Company’s policies andpractices for the recognition of revenue. Further information on the adjustments can be found in Note 2, “Restatementof Financial Statements” to the accompanying consolidated financial statements.

 

This Amendment No. 1 onForm 10-K/A (the “Form 10-K/A”) to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004, initially filed with the Securitiesand Exchange Commission (the “SEC”) on March 16, 2005 (the “OriginalFiling”), is being filed to reflect restatements of the Company’s consolidatedbalance sheets as of December 31, 2004 and 2003 and the Company’sconsolidated statements of operations, cash flows and stockholders’ equity forthe years ended December 31, 2004, 2003 and 2002 and the notes relatedthereto. Certain adjustments were recorded to each quarter in 2004 to correctother miscellaneous items identified in prior external audits or quarterlyreviews but were previously passed, none of which were individuallysignificant.  For a more detaileddescription of the Restatement, see Note 2, “Restatement of Financial Statements”to the accompanying audited consolidated financial statements and the section entitled“Restatement” in Management’s Discussion and Analysis of Financial Conditionand Results of Operations contained in this Form 10-K/A.

 

For the convenience of the reader, this Form 10-K/Asets forth the Original Filing in its entirety. However, this Form 10-K/Aonly amends and restates Item 1 of Part I and Items 6, 7, 8 and 9A ofPart II of the Original Filing, in each case, solely as a result of, andto reflect, the Restatement, and no other information in the Original Filing isamended hereby. The foregoing items have not been updated to reflect otherevents occurring after the Original Filing or to modify or update thosedisclosures affected by subsequent events. In addition, pursuant to the rules ofthe SEC, Item 15 of Part IV of the Original Filing has been amendedto contain the consent of the Company’s independent registered publicaccounting firm and currently dated certifications from the Company’s ChiefExecutive Officer and Chief Financial Officer, as required by Sections 302and 906 of the Sarbanes-Oxley Act of 2002. The consent of the Company’sindependent registered public accounting firm and the certifications of theCompany’s Chief Executive Officer and Chief Financial Officer are attached to thisForm 10-K/A as Exhibits 23.1, 31.1, 31.2 and 32.1.

 

Except for the foregoingamended information, this Form 10-K/A continues to speak as of the date ofthe Original Filing, and the Company has not updated the disclosures containedherein to reflect events that occurred at a later date. Other events occurringafter the filing of the Original Filing or other disclosures necessary toreflect subsequent events have been or will be addressed in the Company’samended Quarterly Report on Form 10-Q/A for the quarterly periods ended March 31,2005 and June 30, 2005 and/or the Company’s Quarterly Report on Form 10-Qfor the quarterly period ended September 30, 2005 which are being filedconcurrently with the filing of this Form 10-K/A, and any reports filedwith the SEC subsequent to the date of this filing.

 

The Company has not amendedand does not intend to amend its previously filed Quarterly Reports on Form 10-Qfor the periods affected by the Restatement prior to December 31, 2004.For this reason, the

 

2

----

 

consolidated financial statements and relatedfinancial information for the affected periods contained in such reports shouldno longer be relied upon.

 

3

----

 

**AUGUST TECHNOLOGY CORPORATION**

**FORM 10-K/A**

**TABLE OF CONTENTS**

**FOR THE YEAR ENDED DECEMBER 31,2004**

 
| ** **                            | **Description**                                                                                             | ** ** |
|---------------------------------------|-------------------------------------------------------------------------------------------------------------|------------|
|                                  |                                                                                                        |       |
| **PART I**                       | ** **                                                                                                  |
|                                  |                                                                                                        |       |
| Item 1.                               | Business                                                                                                    |       |
|                                  |                                                                                                        |       |
| Item 2.                               | Properties                                                                                                  |       |
|                                  |                                                                                                        |       |
| Item 3.                               | Legal Proceedings                                                                                           |       |
|                                  |                                                                                                        |       |
| Item 4.                               | Submission of Matters to a Vote of Security Holders                                                         |       |
|                                  |                                                                                                        |       |
| Executive Officers of the  Registrant |                                                                                                        |
|                                  |                                                                                                        |       |
| **PART II**                      | ** **                                                                                                  |
|                                  |                                                                                                        |       |
| Item 5.                               | Market for Registrant’s Equity, Related Shareholder  Matters and Issuer Purchases of Equity Securities |       |
|                                  |                                                                                                        |       |
| Item 6.                               | Selected Financial Data                                                                                     |       |
|                                  |                                                                                                        |       |
| Item 7.                               | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                 |       |
|                                  |                                                                                                        |       |
| Cautionary Statements                 |                                                                                                        |
|                                  |                                                                                                        |       |
| Item 7A.                              | Quantitative and  Qualitative Disclosures about Market Risk                                                 |       |
|                                  |                                                                                                        |       |
| Item 8.                               | Financial Statements and Supplementary  Data                                                                |       |
|                                  |                                                                                                        |       |
| Item 9.                               | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure                       |       |
|                                  |                                                                                                        |       |
| Item 9A.                              | Controls and Procedures                                                                                     |       |
|                                  |                                                                                                        |       |
| Item 9B.                              | Other Information                                                                                           |       |
|                                  |                                                                                                        |       |
| **PART III**                     | ** **                                                                                                  |
|                                  |                                                                                                        |       |
| Item 10.                              | Directors and Executive Officers of  the Registrant                                                         |       |
|                                  |                                                                                                        |       |
| Item 11.                              | Executive Compensation                                                                                      |       |
|                                  |                                                                                                        |       |
| Item 12.                              | Security Ownership of Certain  Beneficial Owners and Management and Related Shareholder Matters             |       |
|                                  |                                                                                                        |       |
| Item 13.                              | Certain Relationships and Related  Transactions                                                             |       |
|                                  |                                                                                                        |       |
| Item 14.                              | Principal Accountant Fees and Services                                                                      |       |
|                                  |                                                                                                        |       |
| **PART IV**                      | ** **                                                                                                  |
|                                  |                                                                                                        |       |
| Item 15                               | Exhibits and Financial Statement  Schedules                                                                 |       |
|                                  |                                                                                                        |       |
| Signatures                            |                                                                                                        |       |
|                                  |                                                                                                        |       |
| Schedule II                      | Valuation and Qualifying Accounts                                                                           |       |
|                                  |                                                                                                        |       |
| Exhibits                              |                                                                                                        |       |

 

4

----

 

**PART I**

 

**Item 1.  Business**

 

**Company Overview**

 

Since our founding in 1992,we have become recognized as a world-class provider of automated defectdetection and product characterization systems for microelectronic devicemanufacturers. Our systems provide these manufacturers with information thatenables process-enhancing decisions, ultimately lowering manufacturing costs,improving time-to-market and enhancing the performance of their products. Wecombine our core competencies in machine vision technology, optics, lightingand precision motion control with our proprietary software and extensivemicroelectronic-specific applications experience to deliver scalable, modularsystems that excel at the automated detection of advanced macro defects, whichwe define to be defects greater in size than 0.5 micron. We sell our systems tomany of the leading microelectronic device manufacturers throughout the worldwithin the markets of semiconductors, advanced packaging applications,optoelectronics, MEMS, data storage and other emerging markets.

 

We have traditionally provided systems to addressthe automated inspection needs of the early stages of the final manufacturingor back-end of the microelectronic device manufacturing process. These needswere met primarily with our NSX Series and 3Di Series ofproducts.  In 2003, we introduced the AXiSeries for frontside advanced macro detection in the front-end of thewafer manufacturing process and within one year, we added the E20 for waferedge inspection and the B20 for wafer backside inspection.  When used in combination the AXi/E20/B20 isthe industry’s first true all-surface advanced macro inspection solutionallowing device manufacturers to inspect the top, edge and bottom of a wafer’ssurface.  We complement this broadinspection capability with an expanding suite of software tools designed toenhance the speed and effectiveness of the process by which devicemanufacturers analyze defects and make decisions regarding their manufacturingprocess to reduce or eliminate such defects. We refer to this process as the “detection-to-decision” process.

 

In addition to internal development, we look toexpand through strategic acquisitions of complementary products andtechnologies. In July of 2004 we completed the acquisition of DMSVision, athird generation defect data management solution developed and commercializedby Inspex, a U.S. company owned by Photonics Management Company, a U.S.subsidiary of Hamamatsu Photonics KK of Japan. DMSVision’s easy-to-use fab-wide defect data management solutionprovides the basis for our next generation “decision” tools including AutomatedDefect Classification (“ADC”), all-surface review and analysis.

 

On January 21, 2005, we entered into anAgreement and Plan of Merger and Reorganization (the “Merger Agreement”) withNanometrics, Incorporated (“Nanometrics”), Major League Merger Corporation (“MergerSub 1”) and Minor League Merger Corporation (“Merger Sub 2”).  Pursuant to the Merger Agreement (a) Nanometricswill effect a reincorporation under Delaware law by merging with and intoMerger Sub 2, a Delaware corporation, with the surviving entity to be renamed August NanometricsInc. (“August Nanometrics”) and (b) Merger Sub 1 will be merged withand into August Technology, with the surviving entity to be a wholly-ownedsubsidiary of August Nanometrics. Each share of our common stock will be converted into the right toreceive 0.6401 of a share of August Nanometrics common stock.  August Nanometrics will make a cashpayment to our shareholders for any fractional shares of August Nanometricscommon stock they would otherwise be entitled to receive instead of issuingfractional shares.

 

On January 27, 2005, we received a letter fromPaul F. McLaughlin, Chairman and Chief Executive Officer of RudolphTechnologies, Inc. (“Rudolph”), stating that Rudolph is prepared to enterinto a merger with us based on a share exchange ratio of 0.6239 share ofRudolph stock for each share of our common stock (equivalent to $10.50 pershare of our common stock based on the closing price of Rudolph stock on January 27,2005).  The letter stated that each ofour shareholders may elect to receive all cash, stock or a combination of cashand stock, subject to proration based on total cash consideration of $40million.

 

5

----

 

Also on January 27, 2005, Rudolph issued apress release with proposed terms slightly different from those described inthe letter.  The press release statedthat Rudolph is prepared to enter into a merger with us whereby each of ourshareholders will receive the value of $2.16 per share in cash and 0.4955 pershare in Rudolph common stock (equivalent to $10.50 per share of our CommonStock, based on the closing price of Rudolph stock on January 27,2005).  The press release stated thateach of our shareholders would have the option to elect to receive all cash,stock or a combination of cash and stock, subject to proration based on totalcash consideration of $40 million.

 

Our Board of Directors has agreed, based on theadvice of its financial advisors and legal counsel, to further examine theRudolph offer provided that Rudolph first executes a confidentiality agreementin the form required by the Merger Agreement with Nanometrics.  As of the date of this filing, we have notreached agreement on the form of confidentiality agreement and no discussionsregarding Rudolph’s offer have taken place.

 

On February 9, 2005, we received a letter fromKenneth Schroeder, President and Chief Executive Officer of KLA-TencorCorporation (“KLA”), regarding KLA’s interest in pursuing a merger withus.  The letter stated that KLA proposedto acquire us in a transaction in which our shareholders would receive $11.50per share.  KLA also stated that it wouldbe willing to consider using stock as consideration.

 

Our Board of Directors has agreed, based on theadvice of its financial advisors and legal counsel, to further examine the KLAoffer provided that KLA first executes a confidentiality agreement in the formrequired by the Merger Agreement with Nanometrics.  As of the date of this filing, we have notreached agreement on the form of confidentiality agreement and no discussionsregarding KLA’s offer have taken place.

 

**OurMarket**

 

Rapid advances insemiconductor and other microelectronic device technology, includingminiaturization, increasing complexity and advanced packaging and interconnectsolutions, allow manufacturers to enhance the quality and capabilities of theirdevices. These advances often increase the complexity of the processes requiredto produce the devices as well as the associated production costs. Because ofthese increased costs and the need to ensure that performance and reliabilityare not sacrificed, the role of inspection and rapid detection of defectsduring multiple stages of the microelectronic production process is becomingincreasingly critical. Defects can occur throughout the manufacturing processas a result of such things as equipment misalignment, contamination, residue,corrosion, or the misapplication of various films. Defects such as scratches,cracks and chip-outs also can be generated by mechanical handling in themanufacturing process.

 

Historically, manufacturers generally have relied onengineers and technicians using microscopes to manually inspect sample batchesof wafers to detect defects during the various stages of the manufacturingprocess.  Studies have shown that fatigueand boredom result in typical efficacy of human inspectors at about 50%compared with in excess of 90% consistency for automated machine visionsystems. As a result, it has been ineffective and cost-prohibitive for manufacturersto capture critical process data by inspecting manually every wafer and dieafter each process step. These manual inspection limitations result in thefollowing:

 

***Yield loss due toa lack of process data.***    The inability to capture adequate data throughoutthe manufacturing process prevents microelectronic device manufacturers fromlocating problems on a timely basis and taking corrective action. Timelycorrective action could minimize the scrapping of valuable wafers and improvethe process and yield for future products.

 

***Productivityconstraints.***    Asmicroelectronic devices have become more complex, the need for more extensiveinspection and defect data has increased significantly. Given theserequirements, manufacturers

 

6

----

 

musteither add more technicians, significantly impacting productivity of themicroelectronic fabrication facility, or assume a greater risk of defectsremaining undetected until later in the process.

 

***Defective productshipments.***    Byinspecting less than 100% of their products, manual inspection requiresmanufacturers to assume a greater risk of shipping defective products to theircustomers.

 

***Slowertime-to-market.***    Asmicroelectronic device and end-product life cycles decrease, the speed at whichmanufacturers must reach optimal production yields has become increasinglycritical. This pressure to minimize time-to-market requires manufacturers toreduce the amount of time spent training technicians, qualifying new productionequipment and managing the logistics of a manual inspection process.

 

***Increased laborand facility requirements.***    The large number of technicians and microscopesneeded to manually inspect microelectronic devices requires valuable floorspace and significant capital commitments. In addition, attracting andretaining qualified technicians has become increasingly difficult.

 

Automated inspection systems and data management andanalysis software enable manufacturers to overcome these limitations by allowingthem to inspect 100% of their products and consistently identify and resolvedefects at various stages of the manufacturing process, helping to drive downproduction costs, increase throughput and decrease time-to-market.

 

**OurSolutions**

 

We deliver automatedadvanced macro defect inspection, metrology, and analysis systems formicroelectronic industries. Our systems provide device manufacturers withvaluable information about their products and processes, at speeds that make itpractical to inspect each device rather than a small sample. We accomplish thisby combining our core competencies in machine vision technology, optics,lighting and precision motion control with our proprietary software andextensive microelectronic-specific applications experience to providecost-effective solutions. We offer our systems at several price performancelevels to satisfy our customers’ diverse requirements. Specifically, weprovide:

 

***Fast, automated, 100% wafer inspection.***    Oursystems are specifically designed to address our customers’ need for fast,automated inspection tools. Our systems are able to inspect up to 110 wafersper hour depending upon the application and wafer size, enabling our customersto inspect 100% of their production without decreasing throughput.  In comparison, depending on the application,our systems can inspect a complex die approximately 100 times faster than ahuman operator.

 

***Data collection to enable higherproductivity and yields.***    Oursystems enable microelectronic device manufacturers to cost-effectively collectand process defect data at multiple key points throughout the productionprocess and provide manufacturers with the information required to improvetheir production processes and yields. Integrated reporting and analysis toolsallow manufacturers to extract critical information about product defects,including location, size and other important defect characteristics.

 

***Scalable, modular inspection platforms.***    Oursystems are designed on common platforms that allow us to configure flexiblesystems to meet our customers’ application and throughput requirements. Thisflexibility provides an easy upgrade path for customers to respond to changesin process technologies, substrate sizes or materials.

 

***Access to expert application developmentresources.***    Our advancedapplication engineers and design experts work collaboratively with ourcustomers to optimize the use of inspection in their manufacturing process.This reduces their process development time and costs. We have fieldapplication engineers in strategic locations throughout the world to work withour customers on-site and provide the knowledge and expertise to deliver atotal inspection solution.

 

***Focus on advanced macro inspection.***    Wefocus on serving various advanced macro inspection applications rather thanattempting to pursue the entire range of possible inspection and metrology

 

7

----

 

applications. This allowsus to most effectively concentrate our resources on delivering leadingsolutions to these 0.5 micron and larger applications. As our businesscontinues to grow we will expand our focus to include other areas of inspectionand metrology that are complimentary to our existing advanced macro inspectionbusiness.

 

**OurStrategy**

 

Our strategy is built aroundachieving our vision to dominate the automated inspection market and generatecomplete product characterization solutions for evolving microelectronicmarkets in order to drive down costs and time-to-market for our customers. Wehave identified five strategic initiatives that are critical to successfullyimplementing our vision:

 

***Marketdiversification.***    Weleverage our core competencies across a variety of microelectronic industriesusing similar manufacturing processes and within multiple applications. Whileour customers include the suppliers of semiconductor devices used in a widerange of electronic products such as cellular phones, personal digitalassistants, cable modems, network switches and personal computers, they alsoinclude suppliers of microelectronic devices within markets such as advancedpackaging applications, MEMS, optoelectronics, data storage and other emergingmarkets. By maintaining our diversification initiatives, we strive to maximizeour market opportunity.

 

The following table represents our net revenues forthe years ended December 31, 2004 and 2003 from each of themicroelectronic markets we serve.

 
| **Microelectronic  Market**     | ** ** | **2004 (Restated)**               | ** **        | **2003 (Restated)** | ** **                        | **Year-over-  year  change** | ** ** |
|---------------------------------|------------|-----------------------------------|-------------------|---------------------|-----------------------------------|------------------------------|------------|
| **Net  Revenues**               | ** ** | **Percent of total net revenues** | **Net  Revenues** | ** **          | **Percent of total net revenues** |
| ** **                      | ** ** | **(in thousands)**                | ** **        | ** **          | ** **                        | **(in thousands)**           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Semiconductor                   |       | $                                 | 46,047            |                | 73                                | %                            | $          | 17,888 |   | 44 | % | 157 | % |
| Advanced packaging applications |       | 8,414                             |              | 14                  | %                                 | 15,822                       |       | 39 | % | -47 | % |
| Optoelectronics                 |       | 5,847                             |              | 9                   | %                                 | 2,581                        |       | 6 | % | 127 | % |
| MEMS                            |       | 1,830                             |              | 3                   | %                                 | 2,775                        |       | 7 | % | -34 | % |
| Data Storage & other   |       | 529                               |              | 1                   | %                                 | 1,734                        |       | 4 | % | -69 | % |
| Total                           |       | $                                 | 62,667            |                |                              |                         | $          | 40,800 |   |   |   | 54 | % |

 

***Technologyleadership.***    Throughour technology leadership we deliver customer-driven product innovationsfocused on price, performance and flexibility. Technology leadership iscritical to increasing our competitive win rate, maintaining strong grossmargins and building market dominance. Our recent product development effortsresulted in several new product enhancements within our NSX Series, AXi Series,and Yield*Pilot*product lines aswell as new capabilities that expanded our front-end fab and all-surfaceapplications.  We shipped the firstAXi/E20/B20 all-surface advanced macro defect inspection system during thefourth quarter of 2004.  These productscontinue to propel us into the front-end of the microelectronic devicemanufacturing process by addressing advanced macro inspection needs.

 

In 2004, 38% of our revenues were derived fromproducts and solutions introduced during the prior two years.  We plan to continue making significantinvestments in research and development to maintain and extend our technologyleadership.

 

***Customerapplication partnerships.***    Our customer application partnership program isdesigned to meet specific customer requirements with solutions that areengineered to their unique specifications. Through this process, we are able toforge stronger and more strategic relationships with existing and new customers.  In 2004, we continued our joint developmentprogram, which was critical in the commercialization of our AXi Series, withone of the top ten semiconductor manufacturers in the world.  This program is continuing to aid in ourpenetration into front-end wafer processing applications.

 

8

----

 

***Global presence.***    We continuallymaintain and enhance our global presence in order to provide the infrastructurenecessary to support our global customer base. In 2004, we enhanced ourpresence in Asia by doubling our Taiwan applications and support operationscenter to better support our customers in Southeast Asia. We believe our directpresence in Southeast Asia and our relationships with large Taiwanese foundrieswill be a catalyst for expansion in mainland China. In March 2004 weopened a direct sales and service office in South Korea.  We also have direct sales and servicepersonnel and independent distributors located strategically in Singapore,Europe and Japan. Our support services include web-based service capability and24-hour global support.

 

***External growth.***    We increase andenhance our growth opportunities through external sources, includingacquisitions, collaborations, licensing and joint ventures. We completed theacquisition of DMSVision in July 2004. We continue to examine potential acquisitions that will provide us withadditional products, technological expertise, or sales and servicecapabilities. The acquisition of DMSVision expands our data analysiscapabilities and brings access to key customers and technology.  We are also active in industrycollaborations, such as the Advanced Packaging and Interconnect Alliance (“APiA”)and the Die Products Consortium (“DPC”). The APiA is focused on enhancingproductivity and process solutions for advanced packaging. The DPC is acollaboration of leading chip manufacturers and equipment suppliers promotingimproved die product quality and manufacturing processes. We believe thatorganizations such as these will enable us to build stronger relationships withindustry leaders and increase our market opportunity by driving the need foradvanced automated inspection products.

 

9

----

 

**Our Products**

 

We strive to be early to market with innovativedefect inspection and review solutions to emerging microelectronic devicemanufacturing needs. In 1997, we introduced the NSX Series, our first automateddefect inspection system for final manufacturing, and since then have maintainedleadership of that market segment. In 2003, we introduced inspection technologyto address the front-end of the microelectronic device manufacturing processwith the introduction of the AXi Series. We also introduced the E20 for edge inspection and the B20 for backsideinspection allowing inspection of the entire surface of a wafer. Also in 2003,we introduced the VersaScope, a semi-automated, microscope-based, defect reviewsystem.  In 2004 we added enhancements toour NSX Series, AXi Series and all-surface capabilities.  The following table summarizes the primaryattributes of our products: 

 
| ** **     | ** ** | ** **     | ** ** | ** **                                                                                                                                                                                                                                             | ** ** | **Applications** |
|----------------|------------|----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|
| ** **     | ** ** | ** **     | ** ** | ** **                                                                                                                                                                                                                                             | ** ** | **Front-End**    | ** ** | ** ** |
| **Product**    | ** ** | **Introduced** | ** ** | **Functionality**                                                                                                                                                                                                                                      | ** ** | **Fab**          | ** ** | **Outgoing  Quality  Control** | ** ** | **Final  Manufacturing** |
| ** **     | ** ** | ** **     | ** ** | ** **                                                                                                                                                                                                                                             | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** |
| AXi Series     |       | 2003           |       | •    Advanced detection of defects>0.5 micron

•    Inspection of patterned andunpatterned wafers

•    In line, high-speed, 100%inspection

•    Full color review |       | X                |   | X |   |   |
| E20            |       | 2003           |       | •    2D defect detection of the wafer’sedge

•    Metrology of edge features                                                                                                                              |       | X                |   | X |   | X |
| B20            |       | 2003           |       | •    2D defect detection of the wafer’sbackside                                                                                                                                                                               |       | X                |   | X |   | X |
| NSX Series     |       | 1997           |       | •    Fully automated defect detection>0.5 micron

•    2D wafer, die & bump inspection

•    In line, high-speed, 100%inspection                                               |       |             |   | X |   | X |
| 3Di Series     |       | 2001           |       | •    2D & 3D wafer bump inspection& metrology system

•    In line, high-speed, 100%inspection                                                                                                    |       |             |   | X |   | X |
| VersaScope (1) |       | 2003           |       | •    Advanced imaging   microscope-based system

•    Harmony review and classificationsystem                                                                                                                  |       | X                |   |   |   |   |
| Yield*Pilot*   |       | 2000           |       | •    Tool-centric defect and metrologyreview and analysis softwareused with the NSX, 3Di, and AXi Series

•    Reduces defect review time

•    Allows offline defect review               |       | X                |   | X |   | X |
| DMSVision (2)  |       | 1994           |       | •    Fabwide software for archival andretrieval of process related data

•    Facilitates root cause analysis,yield enhancement and yield learning                                                             |       | X                |   | X |   |   |
| CV Series      |       | 1993           |       | •    Verification of critical wafercarrier dimensions                                                                                                                                                                              |       | X                |   |   |   |   |

 

----

(1)  Acquiredwith the acquisition of Counterpoint Solutions, Inc. in July 2003.

(2)  Acquiredwith the acquisition of DMSVision in July 2004.

 

10

----

 

***AXiSeries—Automated defect inspection systems.***    In January 2003,we introduced our AXi Series, designed specifically as an advanced macro defectinspection tool to be used throughout the fab process. The ability to inspect100% of wafers for defects between 5 and 10 microns at high throughputs offersdevice manufacturers new insight into their complex manufacturing process.  In 2004, we introduced the AXi-935 for higherthroughput at higher resolutions.  Webelieve other macro defect solutions currently are unable to achieve thiscombination of resolution and throughput. The AXi Series has been deployedon multiple production lines at one of the world’s leading integrated devicemanufacturers and has also been installed at several other chip makers aroundthe world.

 

Our first all-surfaces inspection system, includingan AXi, E20 and B20 shipped in December 2004 for evaluation and testing byone of the world’s leading device manufacturers.  We have several additional all-surfacesystems scheduled for shipment and installation at various customers during thefirst half of 2005.

 

Revenues from all surface inspection systemsrepresented 12%, 11% and 0% of our net revenues during 2004, 2003 and 2002, respectively.

 

***E20 —Automatedwafer edge inspection and metrology systems.***    In July 2003, weintroduced the E20 for wafer edge inspection and metrology, which inspects forchip-outs, cracks, delamination, residual resist, particles and other defectsthat occur along the edge of the wafer. The E20 also automatically performsmetrology of key edge features and is designed for deployment at severallocations throughout the fab. For example, automated edge inspection,implemented during the lithography process, will identify wafer edge variationsand particles early and allow for possible wafer rework that can increaseyields and reduce manufacturing costs. Due to the increase in edge area andwafer stress levels in 300mm wafer processing, the value of wafer edgeinspection is magnified. The E20 also incorporates our latest user-interfaceplatform, making the system easy to set up and run in production.

 

We began to recognize revenue from the E20 in thesecond half of 2004.

 

***B20—Automatedwafer backside inspection and metrology system.    ***In December 2003 we introduced the B20 or wafer backsideinspection, completing the “all-surface” inspection portfolio of products. TheB20 detects backside defects such as cracks and particles which may negativelyimpact further processing of the wafer and cause wafer breakage later in theprocess.  The B20, built on the sameflexible and easy to set up platform as the E20, can be combined with ourfront-side inspection systems (NSX, AXi or 3Di) and edge inspection systems(E20) to provide an “all-surface” wafer inspection solution.

 

We expect to begin to recognize revenue from the B20in the second half of 2005.

 

***NSXSeries—Automated defect inspection systems.***    We became pioneers ofautomated macro defect inspection in 1997 with the introduction of our NSXSeries. These flexible automated wafer and die defect inspection systemsdeliver high-speed, consistent, reliable defect detection to microelectronicdevice manufacturers. As a replacement for the human eye in the inspectionprocess, the NSX Series significantly improves the quality and throughputof the inspection process, leading to lower overall manufacturing costs.

 

The NSX Series is driven by proprietarysoftware and includes integrated yield enhancement tools such as automated datacollection and reporting, extensive communication options and fast setup usingWindows®-based menus. The NSX Series handles all wafer sizes, 50mm up to300mm, with both whole wafer and film frame capabilities. The NSX-115 is thehighest performance model in the series, demonstrating industry-leadinginspection throughput and capabilities, and delivering the bestprice/performance ratio of all NSX models. With five models available in theNSX Series, customers may tailor systems toward their specific application,process or budget by choosing from a range of system capabilities.  The NSX systems are installed in a broadarray of processing steps from front end wafer process applications to finalmanufacturing steps.

 

11

----

 

In 2004 the WAV Series probe mark inspectionand metrology capabilities were incorporated into the NSX Series.  This resulted in a comprehensive wafer anddie inspection solution for use throughout the final manufacturing processes,including following the electrical probing process.

 

Revenues from the NSX Series represented 60%, 49%and 44% of our net revenues in 2004, 2003 and 2002, respectively.

 

***3DiSeries—Automated wafer bump inspection and metrology systems.***    Our 3Di automatedinspection and metrology systems provide two-dimensional (“2D”) andthree-dimensional (“3D”) inspection and metrology capabilities designed for thelatest and most advanced microelectronic device packaging processes, includingflip-chip wafer bumping. In 2002, we enhanced this product family with theintroduction of entry level and higher performance models of the 3Di Series.

 

The 3Di Series incorporates the 2D defectinspection capabilities of the NSX Series and features our proprietaryRapid Confocal Sensor (“RCS”) 3D inspection technology. This patent-pendingtechnology, conceived by merging the proven concepts of confocal microscopywith innovative optical design and proprietary software, has established itshigh speed, high accuracy 3D inspection capabilities in the production lines ofleading microelectronic device manufacturers. The 3Di Series is availablewith up to 300mm wafer handling in addition to film frame handling and may betailored toward specific customer applications with various options andfeatures.

 

Revenues from the 3Di Series represented 6%,15% and 37% of our net revenues during 2004, 2003 and 2002, respectively.

 

***VersaScope—Advancedmicroscope-based imaging system.***    As part of our acquisition of CounterpointSolutions, Inc. (“CSI”) in July 2003, we acquired the VersaScope, aproduct that was in design at CSI. The VersaScope operates with the Harmonysoftware system developed by CSI to automate the control of advancedmicroscope-based inspection equipment and facilitate the processing of defectimages. The VersaScope is designed to offer a unique combination of ease ofuse, flexibility and advanced microscope imaging, enabling technicians to morequickly review, classify and annotate defects. When the VersaScope is coupledwith our broad array of high performance defect detection systems, thecombination provides customers with a unique, efficient and complete inspectionand review solution.

 

***YieldPilot—Defectreview and process analysis software.***    Yield*Pilot*, which provides a means forefficient defect review and classification, continues to play a pivotal role inenabling our customers to make process-enhancing decisions. By filtering,classifying and then presenting only the relevant data, Yield*Pilot*assists process engineers in quicklyand effectively making the decisions that lead to yield enhancements.Currently, over 60% of our systems are delivered with the optional Yield*Pilot*package.

 

***DMSVision—Fab-widedata management software.***    In July 2004 we acquired DMSVision softwaredivision of Inspex, Inc (“DMSVision”), a fab-wide data management systeminstalled at over 25 customer sites worldwide, which enables devicemanufacturers to find the source of killer defects and manufacturing problemsby centralizing all inspection, electrical test and manufacturinginformation.  DMSVision adds anotherdimension to our detection-to-decision process, providing the fab wideinformation to enable process enhancing decisions.  DMSVision is also the platform for our nextgeneration of tool-centric defect and process data management solutions to helpreview and classify topside, edge, and backside defects now being found withour advanced macro inspection systems.

 

***CVSeries—Cassette verification and metrology.***    The CV Series isdesigned to automatically verify critical wafer carrier dimensions. Usingadvanced machine vision technology and proprietary software, our CV Series systemsidentify out-of-tolerance cassettes and up to 300mm Front Opening Unified Pods(“FOUPs”), allowing microelectronic device manufacturers to removedimensionally defective carriers and thereby decrease wafer damage and improveyield.

 

12

----

 

**Researchand Development**

 

Our success depends on our ability to effectivelydevelop and commercialize new technologies and products. Our research anddevelopment activities emphasize application development and new productintroductions in collaboration with our customers. Our engineering teamssupport these efforts with software development, machine vision technology,optics, lighting and precision motion control expertise. Our recent productdevelopment efforts resulted in several new product enhancements within our NSXSeries, AXi Series, and Yield*Pilot*productlines as well as new capabilities that expanded our front-end fab andall-surface applications.  New productintroductions in 2004 include the AXi-935 for front-end advanced macro defectinspection and the NSX-115 for post-fab advanced macro defect inspection.  We also placed significant effort intoleveraging our core automated inspection technologies into other applicationswithin the microelectronic device manufacturing process and anticipateannouncing new products related to this effort in 2005. We spent 22%, 26% and39% of our net revenues on research and development during 2004, 2003 and 2002,respectively.

 

To maintain technology leadership and pursuecustomer driven opportunities for the application of our core technologies, weplan to continue to invest in research and development to bring new products tomarket and add additional capabilities to extend our market leadership and meetour customers’ product characterization needs.

 

**Customers**

 

We have sold our systems to many of the leadingmicroelectronic device manufacturers throughout the world. Customers accounting for more than 10% of net revenues during 2004included Taiwan Semiconductor Manufacturing Co, STMicroelectronics,and Cree, Inc.  Customers accountingfor more than 10% of net revenues during 2003 included Samsung ElectronicsCorporation, Texas Instruments Incorporated, Intel Corporation, and AdvancedSemiconductor Engineering, Inc. Customers accounting for more than 10% of net revenues during 2002included Intel Corporation and Silicon Precision Industries Co., Ltd.  Therewere no other customers, which accounted for greater than 10% of net revenuesduring 2004, 2003, or 2002.

 

Net revenues by geographic region were asfollows:  

 
| ** **       | ** ** | **Years Ended December 31,** | ** ** |
|------------------|------------|-----------------------------------|------------|
| ** **       | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **       | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| United States    |       | 30                                | %          | 24 | % | 48 | % |
| Taiwan           |       | 39                                | %          | 39 | % | 37 | % |
| South Korea      |       | 8                                 | %          | 13 | % | — |   |
| Japan            |       | 4                                 | %          | 6 | % | 4 | % |
| Rest of Asia     |       | 14                                | %          | 6 | % | 4 | % |
| Europe and other |       | 5                                 | %          | 12 | % | 7 | % |
|             |       | 100                               | %          | 100 | % | 100 | % |

 

**Sales, Service andMarketing**

 

We provide direct sales, service and fieldapplication support through strategically placed offices in key regionsthroughout the world. In the United States, these include our offices in NewYork, Texas, Massachusetts, and our corporate headquarters in Minnesota, andinternationally through our offices in Taiwan and South Korea.  In addition, we have key service and supportpersonnel based locally near key semiconductor production facilities around theworld.

 

We market all of ourproducts in Japan through Marubeni Solutions Corporation (“Marubeni”). We havean international distributor agreement with Marubeni that grants them anexclusive territory, provides

 

13

----

 

for price and payment procedures, specifies theapplicable warranty procedures and contains a confidentiality provision.  In conjunction with the March 2004opening of our office in South Korea we terminated the remainder of ourdistributor agreement with Metron Technology B.V.  Previously, we had sales and servicepersonnel in South Korea supporting Metron Technology B.V.  With respect to our European distributors, weterminated our informal agreement with High Tech Trade, Gmbh, effective September 2004, our distributor agreements with Quasys AGeffective April 2004, and FirfaxSystems effective January 2003.

 

**Backlog**

** **

Our backlog was $33.7 million as of December 31,2004, as compared to $18.6 million as of December 31, 2003. Ourbacklog consists of orders for which we have accepted purchase orders and haveeither assigned shipment dates within the next twelve months or under whichsystems have shipped but have not yet met customer specifications. These ordersare subject to cancellation or delay by the customer without penalty. Inaddition, since only a portion of our revenues for any quarter representssystems that were in backlog as of the beginning of that quarter, we do notbelieve that backlog is necessarily an accurate indication of our futurerevenues and performance.

 

**Competition**

 

While we believe that we arecurrently the leader in the commercialization of solutions for the inspectionof advanced macro defects of 0.5 micron and larger, several other firms alsomanufacture similar products. Our primary competitors in final manufacturing,testing and solutions are Camtek Ltd., Hitachi, Ltd., ICOS VisionSystems, Robotic Vision Systems, Inc., and Toray Industries, Inc. Inthe front-end market, we compete with larger competitors, such as KLA-TencorCorporation and Rudolph Technologies, Inc., for certain macroapplications.

 

Significant competitive factors in our marketinclude performance, ease of use, development of new technologies, establishedcustomer base, application support, customer service, product flexibility,price and ability to deliver products on a timely basis. We believe we competefavorably with respect to these factors, but must continue to develop anddesign new and improved products in order to maintain our competitive position.

 

**Manufacturing**

 

We perform system design,assembly and testing at our headquarters in Bloomington, Minnesota. We utilizean outsourcing strategy for the manufacture of many of our components and majorsubassemblies. Our manufacturing activities are considered horizontal in natureand consist primarily of testing and assembling parts, components andsubassemblies acquired from our vendors, and integrating these parts into ourproducts. Our engineering and manufacturing teams work together to continuallyimprove the modularity of our systems and reduce the number of discretecomponents and subassemblies required to serve our various product families. Tomeet specific customer requirements, we often manufacture products that includecustom system engineering and software development. Our manufacturingoperations do not require a major investment in capital equipment.

 

We use numerous domestic and international vendorsto supply parts for the manufacture and support of our products. Although wemake reasonable efforts to ensure that parts are available from multiplequalified suppliers, this is not always possible. Accordingly, some key partsare obtained only from a single supplier or a limited group of suppliers. Weendeavor to minimize the risk of product interruption by selecting andqualifying alternative suppliers for key parts, monitoring the financialcondition of key suppliers and maintaining appropriate inventories of keyparts. We continually strive to reduce our component lead time and build cyclesto maximize the efficiency of our manufacturing operations. We continue to workwith our key suppliers to significantly reduce lead times and to implementsupplier stocking programs. If we do not receive a sufficient quantity of partsin a timely and cost-effective manner to meet production requirements, ourresults of operations may be materially and adversely affected. We do not

 

14

----

 

maintainlong-term supply contracts with any of our suppliers. We do enter into blanketpurchase orders with key suppliers for parts with long lead times. These purchaseorders are generally to lock-in prices and provide the supplier with visibilityof future requirements.

 

**IntellectualProperty**

 

Proprietary informationplays a significant role in the development of our products. We rely upon acombination of contract provisions and copyright, trademark, patent and tradesecret laws to protect our proprietary know-how, ideas, inventions, goodwilland rights in our solutions and products. We also have a policy of seeking U.S.and foreign patents on technology considered of particular strategic orcompetitive importance. As of January 1, 2005, we had 14 issued U.S.patents and 53 pending U.S. patent applications on our key inventions includingthose associated with our key product lines. We have also applied for foreignpatent rights covering our solutions and products in strategic markets. Thetechnological focus of the issued patents and pending applications includesgeneral microelectronic 2D and 3D inspection techniques as well as devices,systems and processes in the following areas: lighting, focusing, sensing,viewing, material handling, imaging, inspecting and data manipulating. We alsolicense non-exclusive software programs from a third party developer andincorporate them into our products.

 

Although we believe that the copyrights, trademarksand patents we own are of value, we do not believe that they will determine oursuccess, which depends principally upon our engineering, manufacturing,marketing and service skills.

 

**Employees**

 

As of February 28, 2005, we employed 254people, including 101 in research and development, 51 in service, technicalsupport and training, 40 in sales and marketing, 40 in manufacturing, and 22 inadministration. We also utilize independent contractors and temporaryemployees. None of our employees is represented by a labor union and weconsider our employee relations to be good.

 

**Available Information**

 

Our website is *http://www.augusttech.com*.We make available free of charge, on or through our website, our annual,quarterly and current reports, and any amendments to those reports, as soon asreasonably practicable after electronically filing such reports with theSecurities and Exchange Commission. Information contained on our website is notpart of this report.

 

15

----

 

**Item 2.  Properties**

 
| **Location**              | ** ** | **Type**                  | ** ** | **Principal Use**                                                                                        | ** ** | **Square Footage** | ** ** | **Ownership** |
|---------------------------|------------|---------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------|
|                      |       |                      |       |                                                                                                     |       |               |       |          |
| Bloomington, MN           |       | Office, plant,  warehouse |       | Headquarters,  Research and Development, Sales and Service, Manufacturing, Marketing and  Administration |       | 95,437             |       | Leased        |
|                      |       |                      |       |                                                                                                     |       |               |       |          |
| Plano, TX                 |       | Office                    |       | Research and  Development, Sales and Service                                                             |       | 10,600             |       | Leased        |
|                      |       |                      |       |                                                                                                     |       |               |       |          |
| Billerica, MA             |       | Office                    |       | Research and  Development and Sales                                                                      |       | 7,456              |       | Leased        |
|                      |       |                      |       |                                                                                                     |       |               |       |          |
| Thornwood, NY             |       | Office                    |       | Research and  Development                                                                                |       | 1,974              |       | Leased        |
|                      |       |                      |       |                                                                                                     |       |               |       |          |
| Hsinchu, Taiwan           |       | Office                    |       | Sales and  Service                                                                                       |       | 5,383              |       | Leased        |
|                      |       |                      |       |                                                                                                     |       |               |       |          |
| Kaohsiung,  Taiwan        |       | Office                    |       | Sales and  Service                                                                                       |       | 1,669              |       | Leased        |
|                      |       |                      |       |                                                                                                     |       |               |       |          |
| Gyeonggi-do,  South Korea |       | Office                    |       | Sales and  Service                                                                                       |       | 3,189              |       | Leased        |

 

We currently occupy 84% of our available space atthe Bloomington office.  We believe thefacilities listed above are adequate to meet our customer requirements, andthat additional or substitute space is available on commercially reasonableterms if needed.  We also believe thatour production facilities have capacity adequate for our current need.

 

**Item 3. Legal Proceedings**

 

From time to time in theordinary course of business, we are subject to claims, asserted or unasserted,or named as a party to lawsuits or investigations. Litigation, in general, andintellectual property and securities litigation in particular, can be expensiveand disruptive to normal business operations. Moreover, the results of legalproceedings cannot be predicted with any certainty and in the case of morecomplex legal proceedings such as intellectual property and securitieslitigation, the results are difficult to predict at all.

 

We have fully settled the commercial litigationbetween us and Rudolph.  On September 23,2003, we and our subsidiary, Semiconductor Technologies & Instruments, Inc.(“STI”), filed a complaint against Rudolph and its subsidiary ISOA, Inc. (“ISOA”).  In the complaint, we and STI sought adeclaratory judgment that we and STI were not using ISOA technology in ourproducts. STI also asserted a claim for breach of contract to recover amountsSTI paid to ISOA in connection with a joint development agreement between STIand ISOA.  Rudolph and ISOA filed ananswer and counterclaim, denying the allegations set forth in the complaint andclaiming that ISOA was entitled to damages for STI’s alleged breach of thejoint development agreement.  ISOA alsosought a declaratory judgment that STI and/or we were wrongfully using ISOA’stechnology without compensating ISOA and that ISOA was entitled to royaltypayments for use of its technology.

 

We acquired STI from ASTI Holdings, Ltd. (“ASTI”) inApril 2003.  In connection with theacquisition, ASTI agreed to indemnify us for claims relating to STI’s disputewith Rudolph and ISOA, up to a maximum value of $670,000.  To secure ASTI’s performance of ASTI’sindemnification obligations, an escrow was created by ASTI and us.

 

On July 22, 2004, we, STI, Rudolph, and ISOAagreed to settle all claims between the parties.  On August 6,2004 we entered into a final settlement agreement with Rudolph.  Under theterms of the

 

16

----

 

confidentialsettlement, ASTI made a one-time payment out of the escrow to Rudolph in theamount of $503,000.  We, STI, Rudolph, and ISOA agreed to release any andall claims against each other relating to the joint development agreement andto dismiss all claims asserted in the litigation with prejudice.

 

August Technology Corporation and each of itsdirectors, Jeff O’Dell, James Bernards, Roger Gower, Michael Wright and LindaHall Whitman, have been named as defendants in two separate lawsuits thatpurport to be class actions claims on behalf of our shareholders.  We received a summons and complaint withrespect to the first of these proceedings on February 4, 2005 and thesecond on February 14, 2005.  Bothlawsuits are brought in Minnesota State Court and claim that the directors havebreached their fiduciary duties to our shareholders in connection with theiractions in agreeing to the proposed merger with Nanometrics Incorporated.  The plaintiffs in both actions seek variousforms of injunctive relief including an order enjoining us and our directorsfrom consummating the merger with Nanometrics. August Technology and its directors believe the lawsuits arewithout merit and plan to vigorously defend against the claims.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

There were no matters submitted to a vote of our shareholders duringthe quarter ended December 31, 2004.

 

**Executive Officers of theRegistrant**

 

The following sets forth the names and ages of ourcurrent executive officers in addition to information regarding theirpositions, their periods of service in such positions and their businessexperience for the past five years. Executive officers generally serve in office for terms of approximatelyone year.

 

| **Name**            | ** ** | **Age**    | ** ** | **Position**                                                               |
|---------------------|------------|------------|------------|----------------------------------------------------------------------------|
| ** **          | ** ** | ** ** | ** ** | ** **                                                                 |
| Jeff L. O’Dell |       | 43         |       | Chief Executive Officer and Director                                       |
|                |       |       |       |                                                                       |
| Stanley D.  Piekos  |       | 57         |       | Chief Financial  Officer, Treasurer and Secretary                          |
|                |       |       |       |                                                                       |
| David L. Klenk      |       | 40         |       | President, Chief  Operating Officer and Assistant Secretary                |
|                |       |       |       |                                                                       |
| Scott A. Gabbard    |       | 38         |       | Chief Accounting Officer, Assistant Secretary and Vice President,  Finance |
|                |       |       |       |                                                                       |
| Cory M. Watkins     |       | 32         |       | Chief Technology  Officer                                                  |
|                |       |       |       |                                                                       |
| D. Mayson Brooks    |       | 46         |       | Vice President, Global Sales and Field Operations                          |
|                |       |       |       |                                                                       |
| Jeffrey T.  Nelson  |       | 49         |       | Vice President,  Manufacturing                                             |

 

*Jeff L. O’Dell*was one of our co-founders and has served asour Chief Executive Officer since 1992 and Chairman of the Board since 1994.From 1992 to July 2001, Mr. O’Dell also served as President. From August 1987to August 1992, Mr. O’Dell was Director of Sales and Marketing forMicroVision Corporation, which develops and manufactures robotic and inspectionsystems. From February 1985 to August 1987, Mr. O’Dell was aField Applications Engineer for Cognex Corporation, which designs, develops andmarkets machine vision systems that are used to automate a wide range ofmanufacturing processes. From March 1984 to February 1985, Mr. O’Dellserved as a Systems Analyst for Control Data Corporation.

 

*Stanley D.Piekos*joined us in April 2003as Chief Financial Officer and Treasurer. From February 1998 until March 2003,Mr. Piekos served as Senior Vice President, Finance and Corporate

 

17

----

 

Development and Chief Financial Officer at AmericanSuperconductor, a developer and manufacturer of products using superconductortechnology for the electric power industry. From May 1994 to February 1998,Mr. Piekos was the Chief Financial Officer for Brooks Automation, asupplier of automation solutions for the semiconductor industry. From June 1985to May 1994, Mr. Piekos worked for Helix Technology Corporation, amanufacturer of products based on cryogenic and vacuum technology, serving asVice President and Chief Financial Officer since 1991. He also held financialand general management positions with W.R. Grace & Co.

 

*David L. Klenk*joined us in April 1993 and has servedas our President since July 2001 and Chief Operating Officer since April 1999.Mr. Klenk served on our Board of Directors from 1994 to March 2000. Mr. Klenkoversees the engineering, manufacturing, sales, customer service and employeeservices groups. Prior to becoming our Chief Operating Officer, Mr. Klenkserved as our Director of Operations.

 

*Scott A. Gabbard*became our Vice President of Finance in July 2002.Mr. Gabbard also currently serves as our Chief Accounting Officer. Priorto becoming Chief Accounting Officer and Vice President of Finance, Mr. Gabbardserved as our Corporate Controller since joining us in February 2000 andas Acting Chief Financial Officer from May 2002 to April 2003. From September 1995through January 2000, Mr. Gabbard was Assistant Controller with U.S.Office Products, an international supplier of office products and businessservices. From August 1993 to September 1995, Mr. Gabbard was anauditor with Price Waterhouse, LLP.

 

*Cory M. Watkins* became our ChiefTechnology Officer in February 2004. Mr. Watkins joined us in October 1997 and served as Directorof Advanced Technology Development from January 2002 until February 2004.  Mr. Watkins has been responsible for thedevelopment of automated wafer inspection including the NSX, 3Di and AXiproduct lines, and is the primary or secondary inventor on numerous patentfilings.  From June 1990 to October 1997,Mr. Watkins was employed by Loram Maintenance of Way, a railroadmaintenance company.  He served invarious capacities with Loram Maintenance of Way, most recently as ChiefEngineer of the Advanced Technology Group, developing rail and wheel inspectiontechnologies.

 

*D. Mayson Brooks*became our Vice President of Global Sales andField Operations in February 2002. Prior to becoming Vice President ofGlobal Sales and Field Operations, Mr. Brooks served as our Vice Presidentof Sales and Marketing since July 1999. Prior to joining us, from June 1987through June 1999, Mr. Brooks worked in various managerial capacitiesfor Air Products and Chemicals, Inc., most recently as Commercial Manager,European electronics division. Mr. Brooks served from June 1981 to May 1987in the United States Navy and was awarded two achievement medals.

 

*Jeffrey T. Nelson* became our Vice President of Manufacturing in November of 2004.  From September 1998 through March 2004,Mr. Nelson was Director of Operations for Medallion, a subsidiary of theElkay Corporation, a producer of various household products.  From April 1996 to September 1998, Mr. Nelsonwas Director of Operations for FSI, a manufacturer of semi conductor capitalequipment.  From March 1978 to April 1996Mr. Nelson held a variety of manufacturing management positions withUnisys Corporation.

 

18

----

 

**PART II**

 

**Item 5.  Market for Registrant’s Equity, RelatedShareholder Matters and Issuer Purchases of Equity Securities**

 

**MarketInformation**

 

Our common stock, no par value (the “Common Stock”), has traded underthe symbol “AUGT” on the NASDAQ National Market since our initial publicoffering on June 14, 2000.  Therewas no market for our Common Stock prior to that date.

 

The following table sets forth the reported high and low closing saleprices for shares of our Common Stock on the NASDAQ National Market during theindicated quarters.  Our closing marketprice on February 28, 2005 was $12.23.

 
| ** **     | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 23.45      |     | $          | 12.47 |   | $ | 5.38 |   | $ | 2.20 |   |
| Second Quarter |       | 17.24    |       | 11.25    |       | 6.23 |   | 3.45 |   |
| Third Quarter  |       | 12.51    |       | 6.87     |       | 14.40 |   | 6.73 |   |
| Fourth Quarter |       | 10.53    |       | 6.14     |       | 20.69 |   | 13.82 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

**Holders**

 

As of February 28, 2005, there were approximately 200 holders ofrecord of our Common Stock.

 

**Dividends**

 

We have not declared or paid cash dividends on our Common Stock to dateand do not anticipate paying cash dividends for the foreseeable future. Wecurrently intend to retain earnings, if any, to support the development of ourbusiness. Payment of future dividends, if any, will be at the discretion of ourboard of directors after taking into account various factors, including ourfinancial condition, operating results and current and anticipated cash needs.

 

19

----

 

**Item 6.  Selected Financial Data**

 

The consolidated statement of operations data setforth below for each of the years ended December 31, 2004, 2003 and 2002and the consolidated balance sheet data as of December 31, 2004 and 2003are derived from the audited consolidated financial statements, includedelsewhere in this Form 10-K/A.  Thefollowing 2004, 2003 and 2002 information has been restated to reflectadjustments to the Original Filing that are further discussed in “ExplanatoryNote” in the forepart of this Form 10-K/A and in Note 2, “Restatement ofFinancial Statements” to our consolidated financial statement included in Part II,Item 8, “Financial Statements and Supplementary Data” of this Form 10-K/A.  The consolidated statement of operations dataset forth below for the years ended December 31, 2001 and 2000 and thebalance sheet data as of December 31, 2002, 2001 and 2000 are derived fromaudited consolidated financial statements, which are not included in this Form 10-K/A.  You should read the data set forth below inconjunction with the audited consolidated financial statements and notes theretoand “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” appearing elsewhere in this Form 10-K/A.

 

20

----

 
| ** **                                                      | ** ** | **Years Ended December 31,**             | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                      | ** ** | **2004 (1)**                                  | ** ** | **2003 (2)** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                      | ** ** | **(Restated)**                                | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **(In thousands, except per share  amounts)** | ** ** |
| **Consolidated Statements of Operations Data:**                 |       |                                          |       |   |   |   |   |   |   |   |   |
| Net revenues                                                    |       | $                                             | 62,667     |   | $ | 40,800 |   | $ | 25,249 |   | $ | 29,784 |   | $ | 31,666 |   |
| Cost of revenues                                                |       | 29,261                                        |       | 18,290 |   | 11,068 |   | 12,039 |   | 12,594 |   |
| Gross profit                                                    |       | 33,406                                        |       | 22,510 |   | 14,181 |   | 17,745 |   | 19,072 |   |
|                                                            |       |                                          |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative expenses                    |       | 22,751                                        |       | 14,359 |   | 13,013 |   | 12,379 |   | 10,426 |   |
| Research and development expenses                               |       | 13,561                                        |       | 10,430 |   | 9,847 |   | 7,940 |   | 6,945 |   |
| Operating income (loss)                                         |       | (2,906                                        | )          | (2,279 | ) | (8,679 | ) | (2,574 | ) | 1,701 |   |
|                                                            |       |                                          |       |   |   |   |   |   |   |   |   |
| Interest income                                                 |       | 847                                           |       | 407 |   | 624 |   | 1,427 |   | 978 |   |
| Other income (expense)                                          |       | 73                                            |       | — |   | — |   | (17 | ) | — |   |
| Income (loss) before provision for (benefit from)  income taxes |       | (1,986                                        | )          | (1,872 | ) | (8,055 | ) | (1,164 | ) | 2,679 |   |
| Provision for (benefit from) income taxes (3)              |       | 292                                           |       | — |   | 687 |   | (813 | ) | 807 |   |
| Net income (loss)                                               |       | $                                             | (2,278     | ) | $ | (1,872 | ) | $ | (8,742 | ) | $ | (351 | ) | $ | 1,872 |   |
|                                                            |       |                                          |       |   |   |   |   |   |   |   |   |
| Net income (loss) per share:                                    |       |                                          |       |   |   |   |   |   |   |   |   |
| Basic                                                           |       | $                                             | (0.13      | ) | $ | (0.13 | ) | $ | (0.67 | ) | $ | (0.03 | ) | $ | 0.17 |   |
| Diluted                                                         |       | $                                             | (0.13      | ) | $ | (0.13 | ) | $ | (0.67 | ) | $ | (0.03 | ) | $ | 0.16 |   |
|                                                            |       |                                          |       |   |   |   |   |   |   |   |   |
| Weighted average common shares:                                 |       |                                          |       |   |   |   |   |   |   |   |   |
| Basic                                                           |       | 17,755                                        |       | 14,381 |   | 13,033 |   | 12,723 |   | 11,049 |   |
| Diluted                                                         |       | 17,755                                        |       | 14,381 |   | 13,033 |   | 12,723 |   | 11,770 |   |
|                                                            |       |                                          |       |   |   |   |   |   |   |   |   |
| ** **                                                      | ** ** | **December 31,**                         | ** ** |
| ** **                                                      | ** ** | **2004**                                      | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                      | ** ** | **(Restated)**                                | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **(In thousands)**                            | ** ** |
| **Consolidated Balance Sheets Data:**                           |       |                                          |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents and marketable debt  securities          |       | $                                             | 50,422     |   | $ | 63,850 |   | $ | 18,777 |   | $ | 25,857 |   | $ | 29,193 |   |
| Working capital                                                 |       | 52,566                                        |       | 63,488 |   | 29,567 |   | 37,171 |   | 36,872 |   |
| Total assets                                                    |       | 98,422                                        |       | 88,947 |   | 39,510 |   | 47,155 |   | 47,897 |   |
| Total debt                                                      |       | —                                        |       | — |   | — |   | — |   | — |   |
| Total shareholders’ equity                                 |       | 79,069                                        |       | 79,146 |   | 35,058 |   | 42,523 |   | 41,685 |   |

 

----

(1)   On July 27, 2004 we acquired substantially all of the assets ofDMSVision.  DMSVision’s results ofoperations have been included with our results of operations since the date ofacquisition.

(2)   On April 15, 2003 we acquired all of the outstanding capital stockof STI.  On July 3, 2003 we acquiredsubstantially all of the assets of CSI. STI and CSI’s results of operations have been included with our resultsof operations since the date of acquisition.

(3)   We recorded a full valuation allowance against our deferred tax assetsin the second quarter of 2002. The recording of the valuation allowance resultedin a provision for income taxes, rather than the recording of a tax benefit onthe pre-tax loss. We have subsequently continued to record a full valuationallowance against our deferred tax assets. The Company has recorded a provisionfor income taxes of $292 in 2004 primarily to provide for foreign andalternative minimum taxes.

 

21

----

 

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

 

Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with the audited consolidated financialstatements and the notes thereto and with the “Cautionary Statements” section includedelsewhere in this Form 10-K/A.  Allapplicable disclosures in the following discussion have been modified toreflect the Restatement, as described below.

 

Inpreparing the consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America, we must makedecisions which impact the reported amounts and the related disclosures. Suchdecisions include the selection of the appropriate accounting principles to beapplied and the assumptions on which to base accounting estimates. In reachingsuch decisions, we apply judgment based on our understanding and analysis ofthe relevant circumstances.  Note 1 tothe consolidated financial statements provides a summary of the significantaccounting policies followed in the preparation of the consolidated financialstatements.

 

**Restatement**

 

We have restated our consolidated financial statements for the years2004, 2003 and 2002 and for the first two quarters of 2005. Our restatedconsolidated financial statements also include disclosure of restated unauditedquarterly results for 2004 and 2003.  Theinitial determination to restate the 2004 and first half 2005 consolidatedfinancial statements was made as a result of a correction of the Company’sapplication of revenue recognition principles, as contained in the FinancialAccounting Standard Board’s Emerging Issues Task Force Issue No. 00-21, “*Revenue Arrangements with Multiple Deliverables*” (“EITF 00-21”).  As a result of subsequently reviewing ourrevenue recognition policies and procedures, we additionally noted thatbeginning in the fourth quarter of 2002 certain deferred software revenueshould have been fully recognized upon delivery or customer acceptance ratherthan ratably over a twelve-month period. This created the need to restate our 2002 and 2003 consolidatedfinancial statements.  Certainadjustments were recorded to each quarter in 2004 and first two quarters of2005 to correct other miscellaneous items identified in prior external auditsor quarterly reviews but were previously passed, none of which wereindividually significant.

 

In 2004 and the first half of 2005, the Company sold AXi 930 systems toa customer for an aggregate amount of approximately $12.2 million ($6.7 millionin 2004 and $5.5 million in the first half of 2005) and recognized the revenuefor these sales.  The cost of revenuesrelated to these sales was $2.7 million in 2004 and $2.7 million in the firsthalf of 2005.  During the same timeperiods, the Company accepted orders from the same customer for enhancementpackages to the AXi 930 system but had not yet delivered the enhancementpackages.  In connection with preparingto finalize its results for the quarter ended September 30, 2005, theCompany determined that recognition of the $12.2 million of revenue from theAXi 930 systems should have been deferred until the delivery of the enhancementpackages, according to EITF 00-21.  Thecustomer cancelled its orders for the enhancement packages on September 27,2005, which allowed the Company to recognize the entire $12.2 million of AXi930 deferred revenue in the quarter ended September 30, 2005.

 

In the fourth quarter of 2002, the Company began deferring Yield Pilotsoftware revenue and recognizing it over a twelve-month period whichrepresented the Company’s obligation to provide warranty and support.  The Company determined based on a subsequentreview of Statement of Position 97-2, “*Software Revenue Recognition*” that YieldPilot software revenues should have been recognized upon delivery or customeracceptance.  The correction of this errorincreased revenue by $0.9 million, $0.5 million and $0.2 million for 2004, 2003and 2002, respectively and had no impact on costs of revenues.

 

The Audit Committee worked closely with the Company’s management toreview the Restatement and the Company’s policies and practices for therecognition of revenue.

 

22

----

 

The Restatement impacted the timing of revenue recognition as the AXi930 enhancement packages have been deferred into the third quarter of 2005 andthe Yield Pilot software revenue is recognized upon delivery or customeracceptance rather than ratably over a twelve-month period.  The primary impact of the Restatement on theconsolidated balance sheet at December 31, 2004 was to increase inventoryat customers under purchase orders related to the deferral of the cost of revenueand to increase customer deposits and deferred revenues related to cashcollected for revenue deferred in the Restatement.  The impact on the December 31, 2003consolidated balance sheet was to decrease deferred revenue related to YieldPilot.  The Restatement had no impact oncash balances or net cash flows from operating, investing, or financingactivities.

 

Further information on the nature and impact of these adjustments isprovided in Note 2 to our consolidated financial statements contained elsewherein this Form 10-K/A.

 

**Overview**

 

We are a world-class provider of automated defectdetection and product characterization systems for microelectronic devicemanufacturers. Our systems provide manufacturers with information that enablesprocess-enhancing decisions, ultimately lowering manufacturing costs anddecreasing time-to-market. We have traditionally provided systems to addressthe automated inspection needs of the early stages of the final manufacturingor back-end of the microelectronic device manufacturing process. These needswere met primarily with our NSX Series and 3Di Series ofproducts.  We have introduced the AXi Series andthe E20 for edge and B20 for backside inspection systems (collectively, the “AllSurface Inspection System”) for advanced macro defect detection primarily inthe front-end of the wafer manufacturing process. When used in conjunction withone another these systems allow a manufacturer to inspect the top, edge andback of a wafer’s surface.  We believe weare the first to offer all surface wafer inspection.  During 2004, we made a significant investmentsupporting front-end system demonstrations at many large semiconductormanufacturers, which allows these customers to evaluate the benefits thesesystems provide.  We expect thesedemonstrations will lead to increased revenues six to nine months aftershipment.

 

We complement this broadinspection capability with an expanding suite of software tools designed toenhance the speed and effectiveness of the process by which devicemanufacturers analyze defects, and make decisions regarding their manufacturingprocess to reduce or eliminate such defects. We refer to this process as the “detection-to-decision” process.

 

In addition to internal development, we look toexpand through strategic mergers and acquisitions of complementary products andtechnologies. In April 2003 we completed the acquisition of SemiconductorTechnologies & Instruments, Inc. (“STI”), enhancing our probemark inspection and metrology capabilities. In July 2003 we acquired theassets of Counterpoint Solutions, Inc. (“CSI”), including the design forthe VersaScope a defect review system for advanced microscope-based imaging andanalysis.  In July 2004 we acquiredcertain assets of the DMSVision software division of Inspex, Inc (“DMSVision”).  We plan to use the DMSVision software tofurther expand and enhance our current defect analysis software offerings.

 

Our business is subject to the highly cyclicalnature of the microelectronic device manufacturing markets we serve. Thesecycles are caused by significant, and often rapid, fluctuations in the supplyand demand of microelectronic devices driven by such factors as changes intechnology and global economic conditions. As a result of these fluctuations,our quarterly orders and revenues have fluctuated dramatically.  After a three year industry downturn we beganto experience an industry recovery during the second half of 2003, whichresulted in a significant increase in revenues and orders during each quarteruntil the third quarter of 2004.  In thethird quarter of 2004 we encountered yet another slowdown resulting in adecrease in the rate of orders being received, and a delay in shipments ofcertain systems under previously received orders.  This resulted in a sequential decrease inquarterly revenues and a lower level of orders in backlog, as compared to theend of the second quarter.  In responseto this slowdown, we implemented certain cost cutting initiatives during thefourth quarter of 2004.  These initiatives included staffingreductions, reductions in management compensation, cuts in discretionaryspending and mandatory time-off for

 

23

----

 

employees (the “Cost Cutting Initiatives”).  We estimate that these actions resulted incost savings of approximately $475,000 during the fourth quarter.  Despite the slowdown in the third quarter of 2004, we experienced a 58.4%and 53.6% overall increase in the level of orders and revenues, respectively,during 2004, and have a record level of backlog at December 31, 2004 of $33.7million, as compared to $18.6 million at December 31, 2003.

 

Management focuses on several key financial metricsin evaluating our financial condition and operating performance.  Although we do not believe backlog is alwaysan accurate indication of future revenues and performance, since only a portionof our revenues for any quarter include systems that were in backlog as of thebeginning of that quarter, we do closely monitor the level of orders bothgeographically and by product line and in relation to the level of revenues,referred to as the book-to-bill ratio. During the fourth quarter of 2004 our book-to-bill ratio was aboveparity.  A book-to-bill ratio greaterthan parity indicates a growing level of backlog.  In addition to monitoring our level of ordersand backlog, we focus on revenues by product family compared to prior-periodand current-year plans, year-over-year revenue growth compared to the overallsemiconductor equipment industry, operating profit or loss performance comparedwith prior-period and current-year plans and the level of operating cash flow.

 

Future quarterly and annual results will continue tobe impacted by fluctuations in supply and demand of microelectronic devices, thetiming of new product announcements and releases by us or our competitors,market acceptance of new or enhanced versions of our products, changes in thepricing of our products and the timing and level of our research anddevelopment expenditures.  We cannotpredict the sustainability or depth of these fluctuations and their impact onour business, and/or the overall industry’s rate of growth. If we are unable toeffectively manage our resources and production capacity during an industrycycle, there could be a material adverse effect on our business, financialcondition and results of operations.

 

**Merger Activities**

 

On January 21, 2005, we entered into a MergerAgreement with Nanometrics, Incorporated (“Nanometrics”), pursuant towhich Nanometrics will reincorporate under Delaware law and August TechnologyCorporation will become a wholly-owned subsidiary of Nanometrics.  In connection with this transaction,Nanometric’s name will be changed to August Nanometrics.  Each share of our common stock will be convertedinto the right to receive 0.6401 of a share of August Nanometrics commonstock.  August Nanometrics will makea cash payment to our shareholders for any fractional shares of August Nanometricscommon stock they would otherwise be entitled to receive instead of issuingfractional shares.

 

On January 27, 2005, we received a letter fromPaul F. McLaughlin, Chairman and Chief Executive Officer of RudolphTechnologies, Inc. (“Rudolph”), stating that Rudolph is prepared to enterinto a merger with us based on a share exchange ratio of 0.6239 share ofRudolph stock for each share of our common stock (equivalent to $10.50 pershare of our common stock based on the closing price of Rudolph stock on January 27,2005).  The letter stated that each ofour shareholders may elect to receive all cash, stock or a combination of cashand stock, subject to proration based on total cash consideration of $40million.

 

Also on January 27, 2005, Rudolph issued apress release with proposed terms slightly different from those described inthe letter.  The press release statedthat Rudolph is prepared to enter into a merger with us whereby each of ourshareholders will receive the value of $2.16 per share in cash and 0.4955 pershare in Rudolph common stock (equivalent to $10.50 per share of our CommonStock, based on the closing price of Rudolph stock on January 27,2005).  The press release stated thateach of our shareholders would have the option to elect to receive all cash,stock or a combination of cash and stock, subject to proration based on totalcash consideration of $40 million.

 

Our Board of Directors has agreed, based on theadvice of its financial advisors and legal counsel, to further examine theRudolph offer provided that Rudolph first executes a confidentiality agreementin the form required by the Merger Agreement with Nanometrics.  As of the date of this filing, we have not

 

24

----

 

reachedagreement on the form of confidentiality agreement and no discussions regardingRudolph’s offer have taken place.

 

On February 9, 2005, we received a letter fromKenneth Schroeder, President and Chief Executive Officer of KLA-TencorCorporation (“KLA”), regarding KLA’s interest in pursuing a merger withus.  The letter stated that KLA proposedto acquire us in a transaction in which our shareholders would receive $11.50per share.  KLA also stated that it wouldbe willing to consider using stock as consideration.

 

Our Board of Directors has agreed, based on theadvice of its financial advisors and legal counsel, to further examine the KLAoffer provided that KLA first executes a confidentiality agreement in the formrequired by the Merger Agreement with Nanometrics.  As of the date of this filing, we have notreached agreement on the form of confidentiality agreement and no discussionsregarding KLA’s offer have taken place.

 

**Resultsof Operations**

 

The following table presents the consolidatedstatements of operations as a percentage of net revenues.

 
| ** **                                      | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                      | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                      | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                                    |       | 100.0                             | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                |       | 46.7                              |       | 44.8 |   | 43.8 |   |
| Gross profit                                    |       | 53.3                              |       | 55.2 |   | 56.2 |   |
|                                            |       |                              |       |   |   |   |   |
| Selling, general and administrative expenses    |       | 36.3                              |       | 35.2 |   | 51.5 |   |
| Research and development expenses               |       | 21.6                              |       | 25.6 |   | 39.0 |   |
| Operating income (loss)                         |       | (4.6                              | )          | (5.6 | ) | (34.3 | ) |
|                                            |       |                              |       |   |   |   |   |
| Interest income                                 |       | 1.3                               |       | 1.0 |   | 2.5 |   |
| Other income                                    |       | 0.1                               |       | — |   | — |   |
| Income (loss) before provision for income taxes |       | (3.2                              | )          | (4.6 | ) | (31.8 | ) |
| Provision for income taxes                      |       | 0.4                               |       | — |   | 2.7 |   |
| Net income (loss)                               |       | (3.6                              | )%         | (4.6 | )% | (34.5 | )% |

 

***Yearended December 31, 2004 compared to the year ended December 31, 2003***

 

*Net Revenues.*  Net revenues increased $21.9 million, or 53.6%,to $62.7 million in 2004, from $40.8 million in 2003.  The increase in net revenues was primarilydue to increased sales of higher throughput NSX Series systems and allsurface inspection systems.  Revenuesfrom these product lines increased primarily as a result of higher sales intothe front end of the wafer fabrication process, and an overall increase indemand due to the industry recovery that began in the second half of 2003 andcontinued through the first half of 2004. Revenues derived from systems sold for front end wafer fab applicationsaccounted for 40% of total revenues in 2004, as compared to 21% in 2003.  Revenues from the NSX Series and allsurface inspection systems were 60% and 12% of total net revenues in 2004,respectively, as compared to 49% and 11%, respectively, in 2003.  Net revenues derived from international salesrepresented 70% and 76% of total net revenues in 2004 and 2003,respectively.  International net revenueswere primarily the result of sales to Taiwan and the rest of Asia, whichcomprised 65% and 64% of total net revenues in 2004 and 2003, respectively.

 

25

----

 

*Gross Margin.*  Gross margin decreased to 53.3% of netrevenues in 2004 as compared to 55.2% of net revenues in 2003.  Grossmargins decreased 1.4 percentage points as a result of the write-off of$870,000 of inventory related to the WAV Series product line, as the WAV’sfunctionality has been integrated into the NSX Series product line.  Inaddition, we have experienced pricing pressure primarily related to ourinspection systems sold into final manufacturing applications as competitorshave continued to enter this market. These decreases were partially offset by increased revenue from ourYield*Pilot* software.  We expect gross margins in the next year tobe between 53% and 57%.

 

*Selling, General andAdministrative.*  Selling,general and administrative expenses increased $8.4 million, or 58.4%, to $22.8million, or 36.3% of net revenues, in 2004, from $14.4 million, or 35.2% of netrevenues, in 2003. The increase in expense dollars was primarily the result ofcosts associated with (i) new hires and contractors in our field serviceand sales groups to support increased revenues, customer demonstrations infront-end wafer processing applications and our direct sales and service officein South Korea, which opened in March 2004; (ii) the ongoingoperations of three acquisitions completed subsequent to the first quarter of2003; (iii) higher variable costs associated with increased revenues; and (iv) compliancewith the Sarbanes Oxley Act.  Theincrease was partially offset by the Cost Cutting Initiatives.  We expect selling, general and administrativeexpense dollars to increase in future quarters, primarily as a result ofvariable expenses associated with an expected higher level of revenues andhigher recruiting, relocation and compensation costs related to the retentionand hiring of employees.  However,selling, general and administrative expenses as a percentage of revenues areexpected to decrease, as revenues are expected to increase at a higher ratethan the increase in selling, general and administrative expenses.

 

*Research and Development.*  Research and development expenses increased $3.1million, or 30.0%, to $13.5 million, or 21.6% of net revenues, in 2004, from$10.4 million, or 25.6% of net revenues, in 2003.  The increase in expense dollars was primarily due to employee compensation and related benefits associated with thehiring of additional staff and an increase in the use of outside contractors tocomplete certain stages of development of the E20 for edge and B20 for backsideinspection systems and VersaScope, and further enhancements to both the NSX Series andAXi Series.  In addition, expensesincreased due to three acquisitions completed subsequent to the first quarterof 2003.  The increase was partiallyoffset by savings from the Cost Cutting Initiatives.  We plan to maintain our commitment to investin the continued expansion of ourbusiness in the front-end of the wafer manufacturing process and expansion ofour suite of software solutions.  Asa result, we currently anticipate that researchand development expense dollars will increase in future quarters.  However, research and development expenses asa percentage of revenues are expected to decrease, as revenues are expected toincrease at a higher rate than the increase in research and developmentexpenses.

 

*Interestincome, net.*  Net interestincome increased $440,000 to $847,000 in 2004 from $407,000 in 2003. Theincrease in interest income was primarily due to an increase in overallinvestment balances, as a result of the proceeds received from a follow-onpublic offering of our Common Stock that was completed on September 23,2003 and the underwriters’ exercise of the over-allotment option on October 21,2003 (the “Offering”).

 

***Income Taxes.***  As a result of historicaloperating losses and uncertainty as to the extent of profitability in futureperiods, we began to record a valuation allowance against our deferred taxassets in the second quarter of 2002 and continue to do so at December 31,2004.  As a result, we did not reflect aprovision for income taxes during 2003, and have recorded a provision forincome taxes of $292,000 for 2004, primarily to reflect foreign income taxowed.  Statement of Financial AccountingStandards (“SFAS”)No. 109 “Accounting forIncome Taxes,” requires the establishment of a valuation allowance to reflectthe likelihood of the realization of deferred tax assets.  We currently expect to have an effectiveincome tax rate of between ten and fifteen percent in 2005, primarily torecognize alternative minimum taxes and foreign income tax owed.  As of December 31, 2004 we had recordeda valuation allowance of $9.3 million.

 

26

----

 

***Yearended December 31, 2003 compared to the year ended December 31, 2002***

 

*Net Revenues.*  Net revenues increased $15.6 million, or 59.8%,to $40.8 million in 2003, from $25.2 million in 2002.  The increase in net revenues was primarilythe result of higher sales of new models within the NSX Series which wereintroduced in the middle of 2002 and revenues from the AXi Series, which wasintroduced in the first quarter of 2003. Although the AXi Series initially shipped in the first quarter of2003, we did not begin to recognize revenue until the second half of 2003.  Revenues in 2003 from the NSX Series andAXi Series were $20.0 million and $4.7 million, of total revenues,respectively, as compared to $11.2 million and none, respectively, in2002.  Overall, revenues from productsintroduced in the last two years increased to $19.0 million, or 47%, in 2003 ascompared to $12.1 million, or 48%, in 2002. Revenues also increased due to sales of products acquired in the STI andCSI acquisitions.  The increase waspartially offset by lower revenues from the 3Di Series.  Net revenues derived from international salesrepresented 76% and 52% of total net revenues in 2003 and 2002,respectively.  International net revenueswere primarily the result of sales to Taiwan and the rest of Asia, whichcomprised 65% and 45% of total net revenues in 2003 and 2002, respectively.

 

*Gross Profit.*  Gross margin decreased to 55.2% of netrevenues in 2003 as compared to 56.2% of net revenues in 2002.  The decrease in gross margin percentage wasprimarily due to (i) a higher level of write-offs of obsolete and excessinventory; (ii) an increase in the number of NSX Series systems that includedsubsystem options manufactured by third parties, which have lower gross marginsthan our core inspection systems; and (iii) lower margins on the AXi Series systemssold under our joint development program with a leading device manufacturer.

 

*Selling, General andAdministrative.*  Selling,general and administrative expenses increased $1.4 million, or 10.3%, to $14.4million, or 35.2% of net revenues, in 2003, from $13.0 million, or 51.5% of netrevenues in 2002. The expense dollars in 2003 increased due to higher variablecosts, such as sales commissions and variable employee compensation costsassociated with the increased level of revenues, recruiting and relocationcosts associated with hiring new employees, costs associated with the ongoingoperations and amortization of purchased technology from the STI and CSIacquisitions, and costs associated with an increase in the number of systemsbeing evaluated by customers.  Theincrease was partially offset by the fact that the prior year included thewrite-off of costs related to potential acquisitions, the modification of ourdistributor agreement with Metron Technology B.V and higher employee severancecosts.

 

*Research and Development.*  Research and development expenses increased$583,000, or 5.9%, to $10.4 million, or 25.6% of net revenues, in 2003, from$9.8 million, or 39.0% of net revenues, in 2002. The expense dollars increasedprimarily due to depreciation and amortization expense related to assets andsoftware capitalized subsequent to the beginning of 2002, employee salaries andrelated benefits associated with the employees of STI and CSI and higher travelcosts related to visiting customer locations. These increases were partially offset by a decrease in the use ofoutside services and contractors in the development of new and existingproducts.  We believe our future operating results will dependsignificantly on our ability to produce products and provide services that havea competitive advantage in our marketplace. To do this, we believe that we mustcontinue to make substantial investments in our research and developmentefforts. Our investments in new technology and existing product enhancementsare intended to enable our customers to achieve a higher return on theircapital investments and higher productivity through cost-effective, leadingedge technology solutions.

 

*Interestincome, net.*  Net interestincome decreased $217,000 to $407,000 in 2003 from $624,000 in 2002. The decreasein interest income was due to lower rates of return earned on investmentbalances in 2003 as compared to 2002 and lower average investment balances in2003.

 

*Income Taxes.*  There was no benefit for income taxes in 2003compared to a provision for income taxes of $687,000, or an effective tax rateof 8.5%, in 2002.  The provision forincome taxes in 2002, rather

 

27

----

 

than a benefit from income taxes related to thepretax loss, is due to the recording of a full valuation allowance againstdeferred tax assets, in the second quarter of 2002.

 

**Liquidityand Capital Resources**

 

At December 31, 2004 our principal sources ofliquidity consisted of cash, cash equivalents and investments in marketabledebt securities of $50.4 million, compared to $63.9 million at December 31,2003, a decrease of $13.5 million.  During 2004, working capital decreased to $52.6million as compared to $63.5 million at December 31, 2003.  The decrease was primarily due to adecrease in cash and equivalents and short-term investments to fund operationsand capital expenditures and increased customer deposits and deferred revenues,partially offset by increased accounts receivable and inventories.  During the next twelve months, and beyond, weintend to utilize our current sources of liquidity to fund operations,specifically to enhance our position in the front-end wafer fabricationprocess.  We have no outstandingdebt at December 31, 2004.  Ourliquidity is affected by many factors, some of which are based on the normalongoing operations of our business, the most significant of which includes thetiming of the collection of receivables, the level of inventories, capitalexpenditures and acquisitions.

 

*Accounts Receivable.*  Ouraccounts receivable increased $4.2 million from December 31, 2003 to December 31,2004.  Our days sales outstanding (“DSO”)during 2004 was 36 days.  This comparesto a DSO of 50 days in 2003.  Thedecrease in DSO is primarily due to the timely collection of our accountsreceivable in 2004.  The increase inaccounts receivable resulted in a use of cash of $4.2 million during 2004, aswe have funded shipments for increased revenues prior to receiving paymentsfrom customers.  Due to the high mix ofinternational revenues during current and prior quarters, which generallyrequire a longer time for collection, we believe our DSO will be between 55 and65 days in future quarters.

 

*Inventories.*  Inventories increased $8.5 million fromDecember 31, 2003 to December 31, 2004.  The increase is primarily due to the need tosupport new product introductions, increased backlog and increaseddemonstration equipment at customers under evaluation, primarily in front-endwafer processing applications.

 

*Inventories at Customers under Purchase Orders.*  Inventoriesat customers under purchase orders increased $4.4 million from December 31,2003 to December 31, 2004, primarily due to shipments of models within ourAXi and NSX Series that have not yet qualified for revenue recognition. Weanticipate that the NSX portion of this inventory will be recognized as revenueduring the first quarter of 2005 and the AXi portion deferred in theRestatement (approximately $2.7 million inventory value) will be recognized asrevenue during the third quarter of 2005. We also expect that this inventory will increase as shipments of newlyintroduced products increase.

 

*Capital Expenditures.*  Our capital expenditures during 2004 were$5.0 million, consisting primarily of the capitalization of finished goods thathave been transferred to engineering for test and characterization, to customerservice for training and to sales for customer application studies. Thisequipment is expected to be utilized for these purposes for its estimated life,generally three years.  Our total capitalexpenditures, including the capitalization of finished goods, are expected tobe between $3.0 million and $4.0 million in 2005, as we continue to expand theuse of internal test and development equipment and enhance our facilities to betterserve our customers.

 

*Acquisitions.*  As aresult of the acquisition of DMSVision in July 2004, we lease 7,456 squarefeet of space in Billerica, Massachusetts.

 

Our liquidity is also affected by factors beyond ourcontrol related to the uncertainties of global economies and the cyclicalnature of the semiconductor and microelectronic industries.  Although liquidity requirements willfluctuate based on the timing and extent of all of these factors and others,management

 

28

----

 

believesthat existing cash and investment balances will be adequate to satisfy ourexisting liquidity requirements for at least the next twelve months.

 

The following tablesummarizes our future cash payments due under contractual obligations as of December 31,2004:

 
| ** ** | ** ** | **Operating  Leases** | ** ** | **Purchase  Obligations** | ** ** | **Open Purchase  Orders** | ** ** | **Total**  | ** ** |
|------------|------------|-----------------------|------------|---------------------------|------------|---------------------------|------------|------------|------------|
| ** ** | ** ** | **(In thousands)**    | ** ** |
| ** ** | ** ** | ** **            | ** ** | ** **                | ** ** | ** **                | ** ** | ** ** | ** ** |
| 2005       |       | $                     | 794        |                      | $          | 4,424                     |       | $          | 3,435      |   | $ | 8,653 |   |
| 2006       |       | 670                   |       | —                    |       | —                    |       | 670        |       |
| 2007       |       | 621                   |       | —                    |       | —                    |       | 621        |       |
| 2008       |       | 621                   |       | —                    |       | —                    |       | 621        |       |
| 2009       |       | 628                   |       | —                    |       | —                    |       | 628        |       |
| Thereafter |       | 1,503                 |       | —                    |       | —                    |       | 1,503      |       |
|       |       |                  |       |                      |       |                      |       |       |       |
| Total      |       | $                     | 4,837      |                      | $          | 4,424                     |       | 3,435      |       | $ | 12,696 |   |
|            |            |                       |            |                           |            |                           |            |            |            |  |  |  |  |

 

The purchase obligations arefor the purchase of goods and services. Although we are primarily liable forpayments on the above operating leases and purchase obligations, based onhistoric operating performance and forecasted future cash flows, managementbelieves the exposure to losses, if any, under these arrangements is notmaterial.

 

The open purchase ordersdisplayed in the table represent amounts we anticipate will become payablewithin the next year for goods and services we have negotiated for delivery.

 

*Cash Flows. *During 2004, net cash used in operating activities was $7.8 million,which resulted primarily from the increases in inventories and accountsreceivable, and a decrease in accounts payable, partially offset by a reductionin customer deposits and deferred revenues, and an increase in depreciation andamortization.  Net cash provided byinvesting activities was $1.2 million, due to $8.8 million of net proceeds frommaturities of marketable debt securities, $2.3 million paid to acquireDMSVision and $5.3 million of additions to property and equipment and otherassets. Net cash provided by financing activities was $2.2 million, primarilyfrom the net proceeds received from the exercises of stock options.

 

During 2003, net cash provided by operatingactivities was $3.8 million, which resulted primarily from the decrease inaccounts receivable and increases in accounts payable and depreciation andamortization, partially offset by the increase in inventories.  Net cash used in investing activities was$39.5 million, due to $37.0 million of net purchases of marketable securities,$1.5 million paid to acquire STI and CSI and $981,000 of additions to propertyand equipment and other assets. Net cash provided by financing activities was$43.8 million, including $42.0 million of net proceeds received from theOffering and underwriters’ exercise of their over-allotment option.

 

During 2002, net cash used in operating activitieswas $6.5 million, which resulted primarily from our net loss and an increase inaccounts receivable, partially offset by non-cash charges, decreased prepaidexpenses and other current assets and inventories.  Net cash provided by investing activities was$5.7 million, due to $7.5 million of net proceeds from the redemption andpurchases of securities, partially offset by $1.8 million of additions toproperty and equipment and other assets. Net cash provided by financingactivities was $1.2 million from the proceeds of issuances of common stock inconjunction with the exercise of stock options by employees and purchases underour employee stock purchase plan.

 

29

----

 

**CriticalAccounting Policies, Significant Judgments and Estimates**

 

The preparation ofconsolidated financial statements and related disclosures in conformity withaccounting principles generally accepted in the United States of Americarequires management to make judgments, assumptions and estimates that affectthe amounts reported. Note 1 of Notes to Consolidated Financial Statementsdescribes the significant accounting policies used in the preparation of theconsolidated financial statements. Certain of these significant accountingpolicies are considered to be critical accounting policies, as defined below.

 

A critical accounting policyis defined as one that is material to the presentation of our consolidatedfinancial statements and/or requires management to make estimates andassumptions that could have a material effect on our financial condition andresults of operations. Specifically, critical accounting estimates have thefollowing attributes: 1) we are required to make assumptions about mattersthat are highly uncertain at the time of the estimate; and 2) differentestimates we could reasonably have used, or changes in the estimate that arereasonably likely to occur, would have a material effect on our financialcondition or results of operations.

 

Estimates and assumptionsabout future events and their effects cannot be determined with certainty. Webase our estimates on historical experience and on various other assumptionsbelieved to be applicable and reasonable under the circumstances. Theseestimates may change as new events occur, as additional information is obtainedand as our operating environment changes. These changes have historically beenminor and have been included in the consolidated financial statements as soonas they became known. In addition, management is periodically faced withuncertainties, the outcomes of which are not within its control and will not beknown for prolonged periods of time. These uncertainties are discussed in the section belowentitled “Cautionary Statements.”

 

Management believes that thefollowing are critical accounting policies:

 

# ***RevenueRecognition. ***We deriverevenues from the sale of systems, spare parts, software and services.

 

*System sales: *We require customers, excluding our distributors, that have newinspection applications to complete pre-shipment authorization testing ofpurchased systems at our facility, prior to shipment.  During this testing, the customer verifiesthat the system meets their specifications and authorizes shipment.  For systems that have completed pre-shipmentauthorization testing, revenue is recognized as follows:

 

•                  Revenuefrom systems that have been demonstrated to meet customer specifications duringpre-shipment authorization testing is recognized when the product has shipped,title and risk of loss have transferred to the customer and collection of theresulting receivable is probable.

 

•                  Revenuefrom systems that have not been demonstrated to meet customer specificationsduring pre-shipment authorization testing is recognized when title and risk ofloss have transferred to the customer, installation has occurred and collectionof the resulting receivable is probable.

 

When a customer with a new inspection applicationdeclines pre-shipment authorization testing of a purchased system, revenue isdeferred until, title and risk of loss have transferred to the customer,installation has occurred and collection of the resulting receivable isprobable.

 

When the customer has already accepted previoussystems with the same specifications, for the same application, we do notrequire pre-shipment authorization testing. Revenue is recognized when the product has shipped, title and risk ofloss have transferred to the customer and collection of the resultingreceivable is probable.

 

30

----

 

System sales are accounted for as multiple-elementarrangements.  In transactions thatinclude multiple products and/or services, we allocate the revenue to eachelement based on their relative fair value (or in the absence of fair value,the residual method) and recognize the associated revenue when all revenuerecognition criteria have been met for each element.

 

*Spare parts revenue:*  Spareparts revenue is recognized when the parts have been shipped, title and risk ofloss have transferred to the customer and collection of the resultingreceivable is probable.

 

*Software revenue:*  Revenuefrom software license fees is recognized upon shipment if collection of theresulting receivable is probable, the fee is fixed or determinable, andvendor-specific objective evidence exists to allocate a portion of the totalfee to any undelivered elements of the arrangement. Such undelivered elementsin these arrangements typically consist of follow-on support. Ifvendor-specific objective evidence does not exist for the undelivered elementsof the arrangement, all revenue is deferred and recognized ratably over thesupport period.

 

*Service revenue:* Service revenue is recognized after the services are performed andcollection of the resulting receivable is probable. Revenue from maintenancecontracts is recognized ratably over the period of the contract.  Service revenues were less than 10% of totalrevenues during the years ended December 31, 2004, 2003 and 2002.

 

TheCompany’s distributors are not granted price protection or a right of return.

 

TheCompany includes amounts billed to customers for shipping and handling asrevenues, and the related expenses in cost of revenues.

 

***Valuation ofAccounts Receivable.***  Wereview accounts receivable to determine which are doubtful of collection. Inmaking the determination of the appropriate allowance for doubtful accounts, weconsider our history of write-offs, relationships with our customers and theoverall credit worthiness of our customers. For the three years ended December 31, 2004, we have had accountsreceivable write-offs totaling $190,000, which included the write-off of onereceivable totaling $164,000.  Changes inthe credit worthiness of customers, general economic conditions and otherfactors may impact the level of future write-offs.  Changes in these factors could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

## ***Valuation of Inventory.***  We review inventory for obsolescence andexcess quantities to determine that items deemed obsolete or excess areappropriately reserved. In making the determination, we consider the quantityof inventory at the balance sheet date assessed against each part’s historicaland future usage rates.  In addition,inventories are evaluated for potential obsolescence due to the effect of knownand anticipated engineering change orders and new products.  For the three years ended December 31,2004, we have written-off inventory totaling $1.1 million, including $870,000related to the discontinuance of the WAV Series.  We have an allowance for obsolete and excessinventory of $1.6 million at December 31, 2004, which represents ourestimate of obsolete and excess inventory. Changes in factors such as technology, customer demand, competitorproduct introductions and other matters could affect the level of obsolete andexcess inventory in the future and have a material adverse effect on ourbusiness, financial condition and results of operations.

##  

***Warranty.***** **We provide warranty coverage on our systems for a period of one year,including parts and labor necessary to repair the systems during the warrantyperiod.  We account for the estimatedwarranty cost as a charge to cost of revenues when revenue is recognized. The estimated warranty cost is based on our historical experience rate ofincurred expenses to corresponding system revenues. We update these estimatedcharges every quarter.

 

31

----

 

***Accounting for Income Taxes.**** *The preparation of our consolidated financial statements requires us toestimate our actual current tax exposure together with our temporarydifferences resulting from differing treatment of tax items for tax andaccounting.  These temporary differencesresult in the recognition of deferred tax assets and liabilities, which areincluded within our consolidated balance sheet. SFAS No. 109 “Accounting for Income Taxes,” requiresthe establishment of a valuation allowance to reflect the likelihood of therealization of deferred tax assets. Significant management judgment is required in determining our provisionfor income taxes, our deferred tax assets and liabilities and any valuationallowance recorded against our net deferred tax assets.  We evaluate the weight of all availableevidence to determine whether it is more likely than not that some portion orall of the deferred income tax assets will not be realized. During the secondquarter of 2002 we recorded a valuation allowance for the full amount of ourdeferred tax assets due to uncertainties surrounding our ability to utilizesome or all of our deferred tax assets, primarily consisting of certain netoperating losses, as well as other temporary differences between book and tax accounting.  If the realization of deferred tax assets inthe future is considered more likely than not, an adjustment to the deferredtax assets would increase net income in the period such determination is made.  In the event that actual results differ fromthese estimates or we adjust these estimates in future periods, we may need toadjust our valuation allowance, which could materially affect our financialposition and results of operations.

 

***Off-Balance Sheet Arrangements.***  Wehave not created, and are not party to, any special-purpose or off-balancesheet entities for the purpose of raising capital, incurring debt or operatingparts of our business that are not consolidated into our financialstatements.  We do not have anyarrangements or relationships with entities that are not consolidated into ourconsolidated financial statements that are reasonably likely to materiallyaffect our liquidity or the availability of our capital resources.

 

**Impact ofAccounting Standards**

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (Revised 2004), “*Share-Based Payment.”* SFAS No. 123R is a revision ofSFAS No. 123, “Accounting for Stock-Based Compensation” and supersedesAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees” and its related implementation guidance. SFAS No. 123Rfocuses primarily on accounting for transactions in which an entity obtainsemployee services through share-based payment transactions. SFAS No. 123Rrequires a public entity to measure the cost of employee services received inexchange for the award of equity instruments based on the fair value of theaward at the date of grant. The cost will be recognized over the period duringwhich an employee is required to provide services in exchange for the award.SFAS No. 123R is effective as of the beginning of the first interim orannual reporting period that begins after June 15, 2005. While we cannotprecisely determine the impact on net earnings as a result of the adoption ofSFAS No. 123R, estimated compensation expense related to prior periods canbe found in Note 1 in the Notes to Consolidated Financial Statements includedin this Form 10-K/A. The ultimate amount of increased compensation expensewill be dependent on whether we adopt SFAS No. 123R using the modifiedprospective or retrospective method, the number of option shares granted duringthe year, their timing and vesting period, and the method used to calculate thefair value of the awards, among other factors we are currently assessing.

 

In November 2003 and March 2004,the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 03-1,“*The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments*.” Theconsensus requires companies to apply new guidance for evaluating whether aninvestment is other-than-temporarily impaired and also requires quantitativeand qualitative disclosure of debt and equity securities, classified asavailable-for-sale or held-to-maturity, that are determined to be onlytemporarily impaired at the balance sheet date. The Company incorporated therequired disclosures for investments accounted for under SFAS No. 115, “Accounting for Certain Investments in Debtand Equity Securities,” as required in fiscal year 2004. In September 2004,the consensus was indefinitely delayed as it relates to the measurement andrecognition of impairment losses for all securities in the scope of paragraphs10-20 of EITF No. 03-1. The disclosures prescribed by EITF No. 03-1and guidance related to impairment

 

32

----

 

measurement prior to the issuance of this consensuscontinue to remain in effect. Adoption is not expected to have a materialimpact on the Company’s consolidated financial statements.

 

In November 2004, the FASB issued SFAS No. 151,“*Inventory Costs - an amendment of ARB No. 43,Chapter 4*.” SFAS No. 151clarifies the accounting for abnormal amounts of idle facility expenses,freight, handling costs, and spoilage. It also requires that allocation offixed production overheads to inventory be based on the normal capacity ofproduction facilities. SFAS No. 151 is effective for inventory costsincurred during fiscal years beginning after June 15, 2005. Adoption ofSFAS No. 151 is not expected to have a material effect on the Company’sfinancial position, results of operations or cash flows.

 

33

----

 

**Cautionary Statements**

** **

Certain statements containedin this Form 10-K/A and other written and oral statements made from timeto time by us do not relate strictly to historical or current facts. As such,they are considered “forward-looking statements” which provide currentexpectations or forecasts of future events. Such statements can be identified by the use of terminology such as “anticipate,”“believe,” “estimate,” “expect,” “intend,” “may,” “could,” “possible,” “plan,” “project,”“should,” “will,” “forecast” and similar words or expressions. Ourforward-looking statements generally relate to our growth strategies, financialresults, product development and sales efforts. One must carefully considerforward-looking statements and understand that such statements involve avariety of risks and uncertainties, known and unknown, and may be affected byinaccurate assumptions, including, among others, those discussed below.Consequently, no forward-looking statement can be guaranteed and actual resultsmay vary materially.  We undertake noobligation to update any forward-looking statement, but investors are advisedto consult any further disclosures by us on this subject in our filings withthe Securities and Exchange Commission, especially on Forms 10-K, 10-Q and 8-K(if any), in which we discuss in more detail various important factors thatcould cause actual results to differ from expected or historic results. We notethese factors as permitted by the Private Securities Litigation Reform Act of1995. It is not possible to foresee or identify all such factors. As such,investors should not consider any list of such factors to be an exhaustivestatement of all risks, uncertainties or potentially inaccurate assumptions.

 

**Although we expect that the merger with Nanometrics will result inbenefits to August Nanometrics, August Nanometrics may not realizethose benefits because of integration and other challenges.**

 

The failure of August Nanometrics to meet thechallenges involved in integrating the global operations of Nanometrics and August Technologysuccessfully or otherwise to realize any of the anticipated benefits of theproposed merger, could seriously harm the results of operations of August Nanometrics.  Realizing the benefits of the proposed mergerwill depend in part on the successful integration of technology, operations andpersonnel.  The integration of thecompanies is a complex, time-consuming and expensive process that, withoutproper planning and implementation, could significantly disrupt the respectivebusinesses of Nanometrics, August Technology and/or August Nanometrics.  The challenges involved in this integrationinclude, but are not limited to, the following:

 

•                  communicating and executing a strategicvision to the market regarding August Nanometrics;

 

**•**                  consolidating operations, including rationalizing corporateinformation technology and administrative infrastructures;

 

**•**                  combining diverse productand service offerings;

 

**•**                  coordinating sales and marketing efforts to effectivelycommunicate the capabilities of August Nanometrics;

 

**•**                  overcoming any perceived adverse changes in business focus,including demonstrating to existing customers of both Nanometrics and August Technologythat the merger will not result in adverse changes in customer servicestandards or business focus and helping customers conduct business easily with August Nanometrics;

 

34

----

 

**•**                  coordinating and harmonizing research and developmentactivities to accelerate introduction of new products and technologies withreduced cost;

 

**•**                  preserving customer, distribution, reseller, manufacturing,supplier, marketing and other important relationships of both Nanometrics and August Technologyand resolving any potential conflicts that may arise;

 

**•**                  minimizing the diversionof management attention from ongoing business concerns;

** **

**•**                  retaining key employees and maintaining employee morale;

** **

**•**                  addressing differences inthe business cultures of Nanometrics and August Technology;

** **

**•**                  addressing the effects of August Technology’semployment contracts and the differences between Nanometrics’ and August Technology’semployee bonus plans on August Nanometrics’ employees;

** **

**•**                  overcoming challenges involved with managing two largegroups of employees in geographically disparate areas;

** **

•                  coordinatingand combining international operations, relationships and facilities, which maybe subject to additional constraints imposed by geographic distance, local lawsand regulations;

 

**•**                  overcoming any potential challenges involved with August Nanometrics’ability to comply with the Sarbanes-Oxley Act of 2002, including its ability tomake the certifications required by Section 404 thereof, in a timelymanner;

** **

**•**                  addressing any disruptions that may be caused bycompetitors of August Nanometrics attempting to acquire it;

** **

**•**                  minimizing any potential interference to August Nanometrics’sales efforts that may be caused by its competitors disseminating falseinformation about August Nanometrics;

** **

**•**                  reducing the effects of potential litigation diverting theattention of management away from day to day integration issues;

** **

**•**                  addressing any challenges involved with August Nanometrics’ability to earn profits with the amortization of fair value of property,plants, equipment and intangible assets; and

** **

**•**                  overcoming the challenges involved with integrating August Technology’sand Nanometrics’ diverse ERP systems worldwide and minimizing any disruptionsthat may be caused by such integration.

** **

August Nanometricsmay not successfully integrate our operations with those of Nanometrics in atimely manner, or at all, and August Nanometrics may not realize theanticipated benefits and synergies of the proposed merger to the extent, or inthe timeframe, anticipated.  Theanticipated benefits of the merger with Nanometrics are based on projectionsand assumptions, including successful integration, not actual experience.  The failure to integrate our business withthe business of Nanometrics or to realize any of the anticipated benefits ofthe proposed merger could seriously hinder August Nanometrics’ plans forproduct development and business as well as business and market expansionfollowing the merger.

 

Inaddition to the integration risks discussed above, August Nanometrics’ability to realize these benefits and synergies could be adversely affected bypractical or legal constraints on its ability to combine operations.  Even if the integration of Nanometrics’ andour operations, products and personnel is

 

35

----

 

successful,it may place a significant burden on management and internal resources.  The diversion of management attention and anydifficulties encountered in the transition and integration process could harm August Nanometrics’business, financial condition and operating results.

 

**Our business may be adversely affected and, under certaincircumstances, we may be required to pay a termination fee under certaincircumstances if the merger with Nanometrics is not completed.**

 

If the merger withNanometrics is not completed, our business and operations may be harmed to theextent that customers, suppliers and others believe that we cannot effectivelycompete in the marketplace without the merger, or there is customer or employeeuncertainty surrounding the future direction of our product and serviceofferings and our strategy on a stand-alone basis.  We may not be able to find an equivalent ormore attractive partner.  Completion ofthe merger with Nanometrics is subject to several closing conditions, includingobtaining requisite regulatory and shareholder approvals, and we andNanometrics may be unable to obtain such approvals on a timely basis or atall.  In addition, we would not derivethe strategic benefits expected to result from the merger if the merger is notcompleted, which could adversely affect our business.  Further, we will be required to paysignificant costs incurred in connection with the merger with Nanometrics,including legal, accounting and a portion of the financial advisory fees,whether or not the merger is completed. Moreover, under specified circumstances, we may be required to pay toNanometrics a termination fee equal to $8.3 million plus any applicable costs,expenses and interest pursuant to the Merger Agreement.

 

**We expect to incur significant costs associated with the merger withNanometrics.**

 

We estimate that we will incur significant directtransaction costs in connection with the merger with Nanometrics, which will berecognized and expensed as incurred.  Inaddition, we will incur legal fees and related costs in connection withdefending August Technology and its directors against two purported classaction lawsuits that have been initiated against us and the members of ourboard of directors.  We believe August Nanometricsmay incur charges to operations, which cannot be reasonably estimated at thistime, in the quarter in which the merger with Nanometrics is completed or thefollowing quarters, to reflect costs associated with integrating the twocompanies.  There can be no assurancethat August Nanometrics will not incur additional material charges insubsequent quarters to reflect additional costs associated with the merger withNanometrics and the integration of the two companies.

 

**We must continue to retain and motivate executives and key employeesand recruit new employees, which may be difficult in light of uncertaintyregarding the proposed merger with Nanometrics and offers from Rudolph and KLA,and failure to do so could seriously harm our business.**

 

In order to be successful, during the period beforethe merger with Nanometrics is completed, we must continue to retain andmotivate executives and other key employees and recruit new employees. Ouremployees may experience uncertainty about their future role with August Nanometricsuntil or after strategies with regard to August Nanometrics are announcedor executed.  These potentialdistractions of the proposed merger with Nanometrics and the unsolicited offersfrom Rudolph and KLA may adversely affect our ability to attract, motivate andretain executives and key employees and keep them focused on the strategies andgoals of August Nanometrics.  Anyfailure by us to retain and motivate executives and key employees during theperiod prior to the completion of this merger could seriously harm ourbusiness, as well as the business of August Nanometrics.

 

**Uncertainty regarding our proposed merger with Nanometrics may causecustomers, distributors, resellers and others to delay or defer decisions whichmay harm our results of operations.**

 

Because our proposed merger with Nanometrics issubject to several closing conditions and because we have received competingoffers from Rudolph and KLA, there may be uncertainty regarding the completionof the proposed merger with Nanometrics. This uncertainty may cause customers, distributors,

 

36

----

 

resellersand others to delay or defer decisions concerning purchases of our products, orelect to switch to other suppliers, which could negatively affect our businessand results of operations.  Prospectivecustomers could also be reluctant to purchase August Nanometrics’ productsdue to uncertainty about the direction of August Nanometrics’ products andwillingness to support and service existing products.  In addition, customers, distributors,resellers and others may also seek to change existing agreements withNanometrics or August Technology as a result of the proposed merger.  These and other actions by customers,distributors, resellers and others could negatively affect our business andresults of operations.

 

**We and our directors have been named as defendants intwo purported class action lawsuits relating to our proposed merger withNanometrics and we are likely to incur significant legal costs in the defenseof these lawsuits and, if we or our directors lose, we may be precluded fromcompleting the merger with Nanometrics and incur additional financialobligations.**

 

We and each of our directors, Jeff O’Dell, JamesBernards, Roger Gower, Michael Wright and Linda Hall Whitman, have been namedas defendants in two separate lawsuits that purport to be class action claimson behalf of our shareholders.  Wereceived a summons and complaint with respect to the first of these proceedingson February 4, 2005 and the second on February 14, 2005.  Both lawsuits are brought in Minnesota DistrictCourt and claim that the directors have breached their fiduciary duties to ourshareholders in connection with their actions in agreeing to the proposedmerger with Nanometrics Incorporated. The plaintiffs in both actions seek various forms of injunctive reliefincluding an order enjoining us and our directors from consummating the mergerwith Nanometrics.  We are likely to incursignificant legal fees and expenses in defending against these claims and toindemnify our directors for their legal fees and expenses in defense of theseclaims.  In addition, there can be noassurance that we or our directors will prevail in these lawsuits, and we orour directors may suffer an adverse result that prevents us from completing ourmerger with Nanometrics or forces us to take other actions or pay damages thatmay adversely affect our business.

 

**The microelectronic industries that we serve arehighly cyclical, causing significant variability in our results of operations.**

 

We primarily serve microelectronic industries andour business depends heavily upon capital expenditures by manufacturers inthese industries. Microelectronic industries are highly cyclical, with periodsof capacity shortage and periods of excess capacity; this is historically dueto sudden changes in demand for microelectronic devices. In periods of excesscapacity, there are often drastic changes in the timing and quantity of capitalequipment purchases and investments in new technology or capacity needs by ourcustomers. The timing, length and volatility of these periods are difficult topredict, resulting in pressure on our revenues, gross margin and net income. Inaddition to affecting our customers, downturns also challenge our suppliers,vendors, other partners, as well as our management, sales, engineering,manufacturing, customer service and other employees, who are vital to oursuccess.

 

During downturns in microelectronic industries,customers typically reduce or delay purchases, and/or delay delivery or cancelorders. As a result, it is imperative that we maintain an organization able toquickly and effectively align with market conditions, including bringing ourcost structures in line with current industry and overall market conditions. Atthe same time, we must also meet the following objectives:

 

•continue to serve our existing customers;

 

•provide new and improved solutions for new and existing customers;

 

•operate effectively with our suppliers; and

 

•motivate and retain key employees.

 

37

----

 

If we are, for any reason, unable to achieve any oneor more of the above objectives in an efficient, effective and timely manner,there could be a material adverse effect on our business, financial conditionand results of operations. Furthermore, any delays or reductions in futurepurchases of capital equipment or delays or cancellations of current orders bymicroelectronic device manufacturers, for any reason, would likely have amaterial adverse effect on our business, financial condition and results ofoperations.

 

**Our future rate of growth is highly dependent on thedevelopment and growth of the market for microelectronic device inspectionequipment.**

 

We primarily target our products to address theneeds of microelectronic device manufacturers for defect inspection andmetrology. If for any reason the market for microelectronic device inspectionequipment fails to grow in the long term, contrary to our current expectations,we may be unable to maintain current revenue levels in the short term andreturn to our historical growth in the long term. Growth in this market isdependent to a large extent upon microelectronic manufacturers replacing manualinspection with automated inspection technology. There is no assurance that manufacturerswill undertake this replacement at the rate we expect.

 

**Our sales and operating results can fluctuatesignificantly from period to period, which may adversely affect the marketprice of our stock.**

 

Our quarterly and annual operating results are affectedby a wide variety of factors that could adversely affect sales or operatingresults, or lead to significant variability in our operating results. Inaddition, because a significant portion of our revenue in any particularquarter has historically come from the sale of a relatively small number ofsystems, the loss of any system sale could have a significant negative impact.A variety of factors could cause this variability, including the following:

 

•order cancellations or delays in orders by customers;

 

•the long sales cycle of our products;

 

•decreases in capital spending by our customers;

 

•new product introductions by our competitors and competitive pricing pressures;

 

•entrance into, or additional resources focused on, our markets by largercompetitors;

 

•component shortages resulting in manufacturing delays; and

 

•delays in the development, introduction and manufacture of our products.

 

We cannot predict the impact of these and otherfactors on our revenues and operating results in any future period. Results ofoperations in any period, therefore, should not be considered indicative of theresults to be expected for any future period. Because of this difficulty inpredicting future performance, our operating results may fall below expectationsof securities analysts or investors in some future quarter or quarters. Ourfailure to meet these expectations would likely adversely affect the marketprice of our common stock.

 

**Global economic and political environments areimportant to economic conditions, and long term continued risk or concernsregarding economic and political circumstances could decrease customer demandfor our products.**

 

Future political or related events similar orcomparable to the September 11, 2001 terrorist attacks, significantmilitary conflicts, or long term reactions of governments and society to suchevents, may significantly affect the willingness or ability of our customers tovisit our facilities or trade shows, review our systems’ capabilities and/orpurchase or take delivery of our products. Such events may also affect ourabilities to visit our customers, perform application studies for ourcustomers, and sell and deliver solutions

 

38

----

 

andto service those solutions. Any decline in the willingness or ability of ourcustomers to travel and visit our facilities, or in our ability to travel andvisit our customers, could have a material adverse effect on our business,financial condition and results of operations. In addition, such events couldhave an adverse effect on the economy generally, and microelectronic industriesin particular, causing our customers to reduce or delay capital equipmentpurchases.

 

**The market acceptance of our products is critical toour growth.**

 

Microelectronic device manufacturing equipment andprocesses are subject to rapid technological changes. We continue to expendsignificant resources developing new systems, new models to existing systemseries and improvements or enhancements on current models. Due to the length ofthe product development cycles in our industries, we must make thesesignificant time and resource expenditures well in advance of any prospect of arevenue stream from such new products. If our customers do not continue to acceptour current products and also accept and integrate our new products into theiroperations, our revenue, cash flow, operating results or stock price would benegatively and materially impacted.

 

**Our growth expectations are dependent on successfullypenetrating the front-end of the microelectronic device manufacturing process.**

 

We continue to enhance our inspection and metrologyproduct offering for the front-end of the microelectronic device manufacturingprocess, a market segment that we have limited experience in serving. We arenot a well-recognized supplier to this market, and will need to establish newcustomer relationships and win the confidence of these customers to competeeffectively in this market. The front-end of the microelectronic device manufacturingmarket is dominated by large, well-established competitors with significantlygreater resources and name recognition than we have. In order to competeeffectively with these larger competitors, we must develop process andapplications expertise to identify the inspection needs of this market andproduce cost-effective, technologically advanced solutions addressing theseneeds. In addition, we must create and execute programs to effectively marketto and service these customers. Failure to successfully penetrate the front-endof the microelectronic device manufacturing market would have a materialadverse affect on our business prospects.

 

**If we are unable to keep pace with rapid technologicalchanges by developing and introducing successful new products and technologiesin a timely manner, our products may become obsolete and our business willsuffer.**

 

The microelectronic capital equipment manufacturingbusiness is a highly competitive business and microelectronic devicemanufacturing equipment and processes are subject to rapid technologicalchanges. We believe that our future success will depend in part upon ourability to continue to enhance our existing product line to meet customer needsand to develop and introduce new products in a timely manner. We cannot assureyou that our product enhancement efforts to improve and advance products, suchas the AXi, NSX and 3Di Series, or our new product development efforts such asthe E20 for edge and B20 for backside inspection systems, will be successful orthat we will be able to respond effectively to technological change. Inaddition, we cannot provide assurance that we will be able to develop newproducts for the most opportunistic new markets and applications.

 

We continue to make significant investments inresearch, development and engineering in new technology and/or businesses withnew or complementary products, services and/or technologies, and we are awareof the numerous risks associated therewith, including but not limited to:

 

• diversion of management’s attention fromday-to-day operational matters and current products and customers;

 

•lack of synergy, or the inability to realize expected synergies;

 

•failure to commercialize the new technology or business;

 

39

----

 

•failure to meet the expected performance of the new technology or business;

 

•lower-than-expected market opportunities or market acceptance of any newproducts; and

 

•unexpected reduction of sales of existing products by new products.

 

If we are unsuccessful at developing new productsand technologies, our revenue, operating results or stock price would benegatively impacted.

 

**Our products are complex and any product or processdevelopment issues could negatively impact our operations or financial results.**

 

Our products are complex and often the applicationsto our customers’ businesses are unique. We believe that our future successwill depend in part upon our ability to meet our customers’ functionality andreliability requirements in a timely manner. We cannot be sure that our productofferings, application assistance, enhancement efforts, or our new productdevelopment efforts will fulfill critical functionality and reliabilityrequirement. In addition, new product offerings that are highly complex interms of software or hardware may require application or service work such asbug fixing prior to acceptance, thereby delaying revenue recognition. If we areunsuccessful in these areas, our market share, revenue, operating results orstock price would be negatively impacted.

 

**Our market is highly competitive and we may losebusiness to larger and better-financed competitors.**

 

The microelectronic defect inspection equipmentindustry is highly competitive in national and international markets. We havemany domestic and foreign competitors. Our current primary competitors in finalmanufacturing, testing and solutions are Camtek Ltd., Hitachi, Ltd.,ICOS Vision Systems, Robotic Vision Systems, Inc., and Toray Industries, Inc.In the front-end market, we compete with larger competitors, such as KLA-TencorCorporation and Rudolph Technologies, Inc., for certain automated macroinspection applications. Most of these competitors, as well as other potentialcompetitors, have substantially greater financial resources and more extensiveengineering, manufacturing, marketing and customer support capabilities than wehave. Unless we are able to continue to invest significant financial resourcesin developing products and enhancing customer support worldwide, we will likelynot be able to compete effectively.

 

As we continue to diversify into the evolving andemerging microelectronic markets, including semiconductors, advanced packaging,optoelectronics, MEMS, flat panel display, printheads, data storage, diskdrives, medical devices and other similar devices, we will face significantlyincreased competition.

 

**Our operating results could be negatively impacted ifwe are unable to obtain the necessary resources to invest in our growth.**

 

We intend to continue to make investments to supportbusiness growth and may require additional funds to respond to future businesschallenges, such as the need to develop new products and enhance existingproducts, enhance our operating infrastructure, acquire complementarybusinesses and technologies and satisfy working capital requirements.Accordingly, we may need to engage in equity or debt financing to secureadditional funds. Equity and debt financing, however, might not be availablewhen needed or, if available, might not be available on terms satisfactory tous. If we are unable to obtain adequate financing or financing on termssatisfactory to us, our ability to continue to support our business growth andto respond to business challenges could be significantly limited.

 

**Our success depends on attracting and retaining keypersonnel.**

 

Our future success will depend in large part uponour ability to recruit and retain highly skilled technical, manufacturing,managerial, financial and marketing personnel. The labor market in which weoperate is highly competitive and as a result, we may not be able to retain andrecruit key personnel. Our

 

40

----

 

failureto hire, retain, or adequately train key personnel could have a negative impacton our future financial and business results.

 

In addition, during the recent microelectronicindustry downturn we have had reductions in our work force, reduced oreliminated salary increases and for certain periods implemented pay cuts at themanagement level, and reduced discretionary spending. Any of the above measuresmay have long term adverse effects on our ability to retain key personnel.

 

**Our business may be harmed if we fail to obtain andprotect our intellectual property rights.**

 

Our ability to obtain intellectual property rightsand licenses and to preserve other intellectual property rights covering ourproducts and our products under development is an important component of ourability to compete in the microelectronic defect inspection industry. Toprotect these rights, we have obtained 14 domestic patents and intend tocontinue to seek patents on our inventions when appropriate. As of December 31,2004, we have 53 pending patent applications in the United States andadditional international applications and expect our portfolio to increase inthe future. The process of seeking intellectual property protection can betime-consuming and expensive. We cannot ensure that:

 

•patents will be issued from currently pending or future applications;

 

• our existing patents or any new patents willbe sufficient in scope or strength to provide meaningful protection or anycommercial advantage to us;

 

•foreign intellectual property laws will protect our intellectual propertyrights; or

 

• others will not independently developsimilar products, duplicate our products or design around our technology.

 

If we do not successfully protect and then enforceour intellectual property rights, our competitive position could suffer, whichcould harm our operating results.

 

We also rely on trade secrets, proprietary know-howand confidentiality provisions in agreements with employees, consultants, keycustomers and vendors to protect our intellectual property. Other parties maynot comply with the terms of their agreements with us and we may not be able toadequately enforce our rights against these people.

 

**Third parties may claim that we are infringing upontheir intellectual property and we could suffer significant litigation costs,licensing expenses or be prevented from selling our products.**

 

Intellectual property rights are uncertain andinvolve complex legal and factual questions. We may be unknowingly infringingupon the intellectual property rights of others and may be liable for thatinfringement, which could result in significant liability for us. If we doinfringe upon the intellectual property rights of others, we could be forced toeither seek a license to those intellectual property rights or to alter ourproducts so that they no longer infringe. A license could be very expensive toobtain or may not be available at all. Similarly, changing our products orprocesses to avoid infringing upon the rights of others may be costly orimpractical.

 

We may become responsible for patent litigationcosts. If we were to become involved in a dispute regarding intellectualproperty, whether ours or that of another company, we may be required toparticipate in legal proceedings. These types of proceedings will be costly andtime-consuming, even if we eventually prevail. If we do not prevail, we mightbe forced to pay significant damages, obtain licenses, modify our products orprocesses, stop making products or stop using processes.

 

**Our dependence on a few significant customers exposesus to operating risks.**

 

Sales to our ten largest customers accounted for 63%,73% and 66% of net revenues in 2004, 2003 and 2002, respectively.  Our customers are able to cancel orders,prior to shipment, with few or no penalties.

 

41

----

 

Ifa significant customer reduces orders or delays shipments for any reason, ourrevenues, operating results and financial condition will be negativelyaffected. In addition, our ability to increase our sales will depend in partupon our ability to obtain orders from new customers for whom there is intensecompetition.

 

**Our dependence on subcontractors and sole or limitedsource suppliers may prevent us from delivering an acceptable product on atimely basis and could result in disruption of our operations.**

 

We rely on subcontractors to manufacture many of thecomponents and subassemblies for our products and we depend on single orlimited source suppliers for some of our components. Our reliance onsubcontractors reduces the level of control we have over the manufacturingprocess and exposes us to significant risks such as inadequate capacity, latedelivery, substandard quality and high costs.

 

If a supplier were to become unable to provide partsin the volumes needed or at an acceptable price, we would have to identify andqualify acceptable replacements from alternative sources of supply, ormanufacture the components internally. Depending on the part, the process ofqualifying subcontractors and suppliers generally takes between 60 and180 days. We generally do not have written supply agreements with oursingle or limited source suppliers and purchase our custom components throughblanket and individual purchase orders. If we were unable to obtain thesecomponents in a timely fashion, we may not be able to meet demands for futureshipments. We believe that we would be able to find alternative solutions ifsupplies were unavailable from any of our sole source suppliers, including thesupplier of our image processing component. This may take time and the disruptionwould adversely affect our results of operations.

 

**We assemble and test all of our products at a singlefacility, and any disruption in the operations of that facility could adverselyimpact our business and operating results.**

 

We assemble and test all of our automated inspectionsystems at one facility located in Bloomington, Minnesota. Any disruption inthe operation of that facility, whether due to technical or labor difficulties,destruction or damage from fire or earthquake, infrastructure failures such aspower or water shortage or any other reason, could interrupt our manufacturingoperations, impair critical systems, disrupt communications with our customersand suppliers and cause us to write off inventory and to lose sales.

 

**Failure to adjust our orders for parts andsubcomponents in an accurate and timely manner in response to changing marketconditions or customer acceptance of our products could adversely affect ourfinancial position and earnings.**

 

Our earnings could be negatively affected and ourinventory levels could materially increase if we are unable to predict ourinventory needs in an accurate and timely manner and adjust our orders forparts and subcomponents should our needs increase or decrease materially due tounexpected increases or decreases in demand for our products. Any materialincrease in our inventories could result in an adverse effect on our financialposition, while any material decrease in our ability to procure neededinventories could result in an inability to supply customer demand for ourproducts thus adversely affecting our revenues.

 

**Our dependence upon international customers andsuppliers may reduce our revenues or impede our ability to supply products.**

 

International sales have accounted for a significantportion of our revenues in recent years.  Sales outside of the United States accountedfor 70%, 76% and 52% of our net revenues in 2004, 2003 and 2002, respectively.In addition, we rely on non-United States suppliers for several components ofthe systems we sell. As a result, a major part of our revenues and the abilityto manufacture our products are subject to the risks associated withinternational commerce. International sales and our relationships withsuppliers and customers may be hurt by many factors, including:

 

• changes in law or policy resulting inburdensome government controls, tariffs, restrictions, embargoes or exportlicense requirements;

 

42

----

 

•political or economic instability in our target international markets;

 

•instability caused by infectious disease or other like outbreaks, or the threator concern thereof;

 

•longer payment cycles common in foreign markets;

 

•difficulties in staffing and managing our international operations;

 

• less favorable foreign intellectual propertylaws making it harder to protect our technology from appropriation bycompetitors;

 

• difficulties in collecting our accountsreceivable because of the geographic distance and unfavorable creditor laws;and

 

• currency fluctuations may increase therelative price of our products in foreign markets and thereby adversely affectsales.

 

We are also subject to risks associated withshipping products outside of the United States including shipping delays,varying business conditions, differing business cultures and culturaldiversities, among other risks. If our international sales or relationshipswith international suppliers and customers are adversely affected by any ofthese factors, our financial condition could be adversely affected.

 

**Our financial performance is highly dependent uponsales to customers in Asia.**

 

Sales to customers in Asia accounted for 65%, 64%and 45% of our net revenues in 2004, 2003 and 2002, respectively. We expect ourdependence upon the Asian market to increase. In recent years, Asia hasexperienced serious economic problems including currency devaluations, debtdefaults, lack of liquidity and recessions. Our revenues depend upon thecapital expenditures of microelectronic manufacturers, many of whom haveoperations and customers in Asia. Serious economic problems in Asia wouldlikely result in a significant decrease in the sale of equipment tomicroelectronic industries. If we are unable to maintain our customerrelationships in Asia, our future financial condition, revenues and operatingresults will be negatively affected.

 

**We will continue to rely upon distributors for aportion of our future sales, and a disruption in our relationships with thesedistributors could have a negative impact on our international sales.**

 

Sales through our independent distributorsrepresented 4%, 9% and 8% of our net revenues in 2004, 2003 and 2002,respectively. One distributor accounts for a significant portion of thesesales. The activities of these distributors are not fully within our control.Although we believe that we maintain good relations with our independentdistributors, the relationships may nevertheless deteriorate in the future. Areduction in the sales or service efforts or financial viability of any of ourindependent distributors, or a termination of our relationships with them,could harm our sales, our financial results and our ability to support ourcustomers.

 

**We have acquired Semiconductor Technologies &Instruments, Inc., or STI, the assets of Counterpoint Solutions Inc., orCSI and certain assets of DMSVision software division of Inspex, Inc., orDMSVision, and we may make other acquisitions; the acquisitions of STI, CSI andDMSVision, and any future acquisitions may not be successful and may adverselyaffect our business.**

 

We are looking for strategic opportunities to growand diversify our product offerings through acquisitions. In this regard, werecently completed the acquisitions of STI, CSI and DMSVision. Your evaluationof our business and prospects may be difficult because of our limited operatinghistory with STI, CSI and DMSVision. There can be no assurance that we will besuccessful in integrating the operations of

 

43

----

 

STI,CSI and DMSVision, identifying other appropriate candidates, or integratingproducts and operations with any such candidates that we may acquire.

 

Any such acquisition could involve the dilutiveissuance of equity securities and the incurrence of debt. In addition, the acquisitionsof STI, CSI and DMSVision and future acquisitions may involve numerousadditional risks, including:

 

•the diversion of the attention of our management team from other businessconcerns;

 

• risks of entering into markets or producingproducts where we have limited or no experience, including difficulties inintegrating purchased technologies and products with our technologies andproducts;

 

•the potential loss of key customers of an acquired company;

 

•the potential loss of key personnel of an acquired company;

 

•exposure to unanticipated liabilities of an acquired company; and

 

•greater financial requirements for purchase price and added working capital.

 

Even when an acquired company has already developedand marketed products, there can be no assurance that the products willcontinue to be successful, that product enhancements will be made in a timelyfashion or that pre-acquisition due diligence will have identified all possibleissues that might arise with respect to the acquired company or its products.

 

**If a microelectronic device manufacturer is loyal toanother microelectronic equipment supplier, we may be unable to sell ourproducts to that potential customer and our sales and market share could sufferas a result.**

 

We believe that once a microelectronic devicemanufacturer has selected one vendor’s capital equipment for a production lineapplication, the manufacturer generally relies upon that capital equipment and,to the extent possible, subsequent generations of the same vendor’s equipment,for the life of the application. Once a vendor’s equipment has been installedin a production line, a microelectronic device manufacturer must often makesubstantial technical modifications and may experience production-line downtimein order to switch to another vendor’s equipment. Accordingly, unless oursystems offer performance or cost advantages that outweigh a customer’s expenseof switching to our systems, it will be difficult for us to achieve significantsales to that customer once it has selected another vendor’s capital equipmentfor an application.

 

**Changes in accounting for stock-based compensationcould adversely affect our results of operations.**

 

We have historicallycompensated our employees, including many key personnel and new hires, throughthe issuance of options to acquire capital stock.  Effective as of the third quarter of fiscalyear ended 2005, we will be required to expense unvested and newly issuedemployee stock options.  This change fromcurrent accounting regulations could have a significant impact on our resultsof operations and could affect the manner in which we conduct business.

 

**If we cannot effectively manage our growth, ourbusiness may suffer.**

 

We intend to continue to grow by increasing oursales efforts and completing strategic acquisitions. To effectively manage ourgrowth, we must, among other things:

 

•engage, train and manage a larger sales force and additional service personnel;

 

•expand the geographic coverage of our sales force;

 

44

----

 

•expand our information systems;

 

•identify and successfully integrate acquired businesses into our operations;and

 

•administer appropriate financial and administrative control procedures.

 

Our anticipated growth will likely place asignificant strain on our management, financial, operational, technical, salesand administrative resources. Any failure to effectively manage our growth maycause our business to suffer and our stock price to decline.

 

**Increased competition could impair sales of ourproducts or cause us to reduce our prices.**

 

We expect our current competitors and othercompanies to continue to improve the design and performance of their productsand to introduce new products with competitive prices and performance characteristics.Competitive pressures may from time to time require us to selectively reduceprices on our systems in an effort to protect our market share. Even if wereduce prices, our potential customers may choose to purchase competingproducts developed by our competitors, many of whom have development,production, marketing and distribution resources significantly greater than ourown. Price reductions or lost sales as a result of these competitive pressureswould reduce our total revenues and adversely impact our financial results.

 

**Our operations could be impaired as a result ofdisasters, business interruptions beyond our control or similar events,including global or regional outbreaks of infectious diseases such as severeacute respiratory syndrome.**

 

Disasters such as earthquakes, flooding, fire, electricity failure, oraccidents that affect our operations, manufacturing facility, or the health ofour employees or customers could adversely affect our operating results andfinancial condition. Continued or future outbreaks of infectious diseases suchas severe acute respiratory syndrome (“SARS”), avian flu, or other similar orcomparable outbreaks or fears or concerns of possible outbreaks maysignificantly affect the willingness or ability of our customers to visit ourfacilities or trade shows, review our systems’ capabilities and/or purchase ortake delivery of our products, as well as our ability to visit our customers,to perform application studies for our customers, to sell and deliver products,and to service those products. Any government mandated or suggestedrestrictions on travel, quarantines, or declines in the willingness or abilityof our customers to travel and visit our facilities or our ability to traveland visit our customers, could have a material adverse effect on our business,financial condition and results of operations.

 

45

----

 

**Item 7A.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

***Market Risk***

 

We are exposed to market risk primarily from changesin interest rates and credit risk.  We donot have material exposure to market risk from fluctuations in foreign currencyexchange rates because all sales are made in U.S. dollars.

 

***Interest Rate Risk***

 

We are exposed to interest rate risk primarily from investments in cashequivalents and short-term and long-term marketable debt securities (the “InvestmentPortfolio”).  The entire InvestmentPortfolio is classified as available-for-sale and, accordingly, is recorded onthe consolidated balance sheet at fair value based on quoted market prices,with unrealized gains and losses reported in Shareholders’ Equity under thecaption “Accumulated other comprehensive income (loss)”.  The entire Investment Portfolio isdenominated in U.S. dollars.  We do notuse derivative financial instruments in the Investment Portfolio.  Due to the short duration of our investmentportfolio, an immediate 10 percent change in interest rates is not expected tohave a material adverse effect on our near-term financial condition or resultsof operations.

 

***Credit Risk***

 

Financial instruments which potentially subject us to credit riskconsist principally of securities in the Investment Portfolio and tradereceivables. We limit credit risk related to the Investment Portfolio byplacing all investments with high credit quality issuers and limit the amountof investment with any one issuer. As of December 31, 2004, 64% of theInvestment Portfolio consisted of government securities and corporatecommercial paper and bonds with maturities of one year or less. We limit creditrisk associated with trade receivables by performing ongoing credit evaluationsand believe that there is no additional risk beyond amounts provided forcollection losses to be inherent in trade receivables.

 

46

----

 

 

**Item 8. Financial Statements and SupplementaryData**

 

**AUGUST TECHNOLOGY CORPORATION**

**Index to Consolidated FinancialStatements**

 
| Report of Independent  Registered Public Accounting Firm                                                         |   |
|------------------------------------------------------------------------------------------------------------------|--------|
| Report of Independent  Registered Public Accounting Firm                                                         |   |
| Consolidated Balance Sheets as of  December 31, 2004 and 2003                                               |   |
| Consolidated Statements of  Operations for the Years Ended December 31, 2004, 2003 and 2002                 |   |
| Consolidated Statements of  Shareholders’ Equity for the Years Ended December 31, 2004, 2003 and  2002 |   |
| Consolidated Statements of  Cash Flows for the Years Ended December 31, 2004, 2003 and 2002                 |   |
| Notes to Consolidated  Financial Statements                                                                      |   |

 

47

----

 

**Report of Independent RegisteredPublic Accounting Firm**

 

The Board of Directors and Shareholders

August Technology Corporation:

 

We have audited the accompanying consolidated balancesheets of August Technology Corporation and subsidiaries as of December 31,2004 and 2003, and the related consolidated statements of operations,shareholders’ equity, and cash flows for each of the years in the three-yearperiod ended December 31, 2004. In connection with our audits of the**consolidatedfinancial statements, we also have audited the financial statement schedule. Theseconsolidated financial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements and financial statement schedule basedon our audits.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of August Technology Corporation and subsidiaries as of December 31,2004 and 2003, and the results of their operations and their cash flows foreach of the years in the three-year period ended December 31, 2004, inconformity with U.S. generally accepted accounting principles. Also in ouropinion, the related financial statement schedule, when considered in relationto the basic consolidatedfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.

 

As discussed in Note 2 to the consolidated financialstatements, the Company has restated its consolidated financial statements as of December 31, 2004 and 2003 and foreach of the years in the three-year period ended December 31, 2004.

 

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of August Technology Corporation and subsidiaries’ internalcontrol over financial reporting as of December 31, 2004, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO), andour report dated March 7, 2005, except as to the second through finalparagraphs of Management’s Report on Internal Control over Financial Reporting(as Restated), which are as of November 8, 2005, expressed an unqualifiedopinion on management’s assessment of, and an adverse opinion on the effectiveoperation of, internal control over financial reporting as of December 31,2004.

 

 
| /s/ KPMG LLP |   |
|--------------|--------|

 

 

Minneapolis, Minnesota

March 7, 2005, exceptas to Note 2 to the consolidated financial statements, which is as of November 8,2005

 

48

----

 

**Report of Independent RegisteredPublic Accounting Firm**

 

TheBoard of Directors and Shareholders

August TechnologyCorporation:

 

Wehave audited management’s assessment, included in the accompanying Management’sReport on Internal Control Over Financial Reporting (as Restated) (Item 9A(c))**that August Technology Corporation didnot maintain effective internal control over financial reporting as of December 31,2004, because of the effect of the material weakness identified in management’srestated assessment, based on criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO)*.*August Technology Corporation’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting.Our responsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

 

A company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includesthose policies and procedures that (1) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permit preparationof financial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.

 

A material weakness is a control deficiency,or combination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. Management has identified andincluded in its restated assessment the following material weakness as of December 31,2004:

 

The Company did not have effective policies and procedures, orpersonnel with sufficient technical knowledge of revenue recognitionprinciples, to ensure thatmulti-element arrangements and related software revenue components wereaccounted for in accordance with generally accepted accounting

 

49

----

 

principles. Specifically, theCompany’s policies and procedures did not provide for sufficient identificationof contract terms, or concurrent transactions, that impact the timing ofrevenue recognition.

 

As a result of the aforementioned materialweakness in internal control over financial reporting as of December 31,2004, the Company recognized amaterial amount of revenue in 2004 and the first half of 2005 that should havebeen deferred until later periods and improperly deferred revenue recognitionstarting in the fourth quarter of 2002 for certain software sales for whichrevenue should have been recognized upon delivery or customer acceptance (seeNote 2 to the Company’s consolidated financial statements for a discussion ofthe Company’s restatement to previously issued financial statements). Thismaterial weakness resulted in the restatement of the Company’s previouslyissued consolidated financial statements as of December 31, 2004 and 2003 and foreach of the years in the three-year period ended December 31, 2004,and the financial information for each of the interim periods in 2004 and 2003.

 

As stated in the second through finalparagraphs of Management’s Report on Internal Control Over Financial Reporting(as Restated) (Item 9A(c)), management’s assessment of the effectiveness of theCompany’s internal control over financial reporting as of December 31,2004 has been restated to reflect the impact of the aforementioned materialweakness in internal control over financial reporting.

 

Inour opinion, management’s restated assessment that the August TechnologyCorporation did not maintain effective internal control over financialreporting as of December 31, 2004, is fairly stated, in all materialrespects, based on criteria established in Internal Control—IntegratedFramework issued by COSO.**Also,in our opinion, because of the effect of the material weakness described aboveon the achievement of the objectives of the control criteria, the August TechnologyCorporation did not maintain effective internal control over financialreporting as of December 31, 2004, based on**criteria established in Internal Control—IntegratedFramework issued by COSO.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the restated consolidated balancesheets of August Technology Corporation and subsidiaries as of December 31,2004 and 2003, and the related restated consolidated statements of operations,shareholders’ equity, and cash flows for each of the years in the three-yearperiod ended December 31, 2004. The aforementioned material weakness wasconsidered in determining the nature, timing and extent of audit test appliedin our audit of the restated 2004 consolidated financial statements, and thisreport does not affect our report dated March 7, 2005*,*exceptas to Note 2 to the consolidated financial statements, which is as of November 8,2005, which expressed an unqualified opinion on those consolidatedfinancial statements.

 

 
| /s/ KPMG LLP |   |
|--------------|--------|

 

 

Minneapolis,Minnesota

March 7,2005, except as to the second through final paragraphs of Management’sReport on Internal Control Over Financial Reporting (as Restated) (Item 9A(c)), which are as of November 8,2005

 

50

----

 

**AUGUST TECHNOLOGY CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                       | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                       | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                                                                                                                       | ** ** | **(Restated)**        | ** ** | **(Restated)** | ** ** |
| **ASSETS**                                                                                                                       |       |                  |       |   |   |
| Current assets:                                                                                                                  |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                       |       | $                     | 5,518      |   | $ | 10,027 |   |
| Short-term  marketable debt securities                                                                                           |       | 28,615                |       | 43,528 |   |
| Accounts  receivable, net                                                                                                        |       | 8,328                 |       | 4,094 |   |
| Inventories                                                                                                                      |       | 20,106                |       | 11,651 |   |
| Inventories at  customers under purchase orders                                                                                  |       | 6,704                 |       | 2,293 |   |
| Prepaid expenses  and other current assets                                                                                       |       | 2,517                 |       | 1,631 |   |
| Total current  assets                                                                                                            |       | 71,788                |       | 73,224 |   |
|                                                                                                                             |       |                  |       |   |   |
| Property and equipment, net                                                                                                      |       | 5,994                 |       | 3,141 |   |
| Long-term marketable debt securities                                                                                             |       | 16,289                |       | 10,295 |   |
| Purchased technology, net                                                                                                        |       | 3,703                 |       | 1,179 |   |
| Goodwill                                                                                                                         |       | 498                   |       | 498 |   |
| Other assets                                                                                                                     |       | 150                   |       | 610 |   |
|                                                                                                                             |       |                  |       |   |   |
| Total assets                                                                                                                     |       | $                     | 98,422     |   | $ | 88,947 |   |
|                                                                                                                             |       |                  |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                   |       |                  |       |   |   |
|                                                                                                                             |       |                  |       |   |   |
| Current liabilities:                                                                                                             |       |                  |       |   |   |
| Accounts payable                                                                                                                 |       | $                     | 3,291      |   | $ | 5,409 |   |
| Accrued  compensation                                                                                                            |       | 1,636                 |       | 1,146 |   |
| Other accrued  liabilities                                                                                                       |       | 2,322                 |       | 1,414 |   |
| Customer deposits  and deferred revenues                                                                                         |       | 11,973                |       | 1,767 |   |
| Total current  liabilities                                                                                                       |       | 19,222                |       | 9,736 |   |
|                                                                                                                             |       |                  |       |   |   |
| Other non-current liabilities                                                                                                    |       | 131                   |       | 65 |   |
| Total  liabilities                                                                                                               |       | 19,353                |       | 9,801 |   |
|                                                                                                                             |       |                  |       |   |   |
| Commitments and contingencies (note 13)                                                                                          |       | —                |       | — |   |
|                                                                                                                             |       |                  |       |   |   |
| Shareholders’ equity:                                                                                                       |       |                  |       |   |   |
| Common stock, no  par value, 42,000,000 shares authorized 17,839,298 and 17,382,538 shares  issued and outstanding, respectively |       | 90,363                |       | 88,086 |   |
| Undesignated  capital stock, no par value, 3,000,000 shares authorized, no shares issued or  outstanding                         |       | —                |       | — |   |
| Deferred  compensation related to stock options                                                                                  |       | —                |       | (49 | ) |
| Accumulated  deficit                                                                                                             |       | (11,188               | )          | (8,910 | ) |
| Accumulated  other comprehensive income (loss)                                                                                   |       | (106                  | )          | 19 |   |
|                                                                                                                             |       |                  |       |   |   |
| Total  shareholders’ equity                                                                                                 |       | 79,069                |       | 79,146 |   |
|                                                                                                                             |       |                  |       |   |   |
| Total  liabilities and shareholders’ equity                                                                                 |       | $                     | 98,422     |   | $ | 88,947 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

51

----

 

**AUGUST TECHNOLOGYCORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

 
| ** **                                   | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|
| ** **                                   | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                   | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                   | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                                 |       | $                                 | 62,667     |   | $ | 40,800 |   | $ | 25,249 |   |
| Cost of revenues                             |       | 29,261                            |       | 18,290 |   | 11,068 |   |
| Gross profit                                 |       | 33,406                            |       | 22,510 |   | 14,181 |   |
|                                         |       |                              |       |   |   |   |   |
| Selling, general and administrative expenses |       | 22,751                            |       | 14,359 |   | 13,013 |   |
| Research and development expenses            |       | 13,561                            |       | 10,430 |   | 9,847 |   |
| Operating loss                               |       | (2,906                            | )          | (2,279 | ) | (8,679 | ) |
|                                         |       |                              |       |   |   |   |   |
| Interest income                              |       | 847                               |       | 407 |   | 624 |   |
| Other income                                 |       | 73                                |       | — |   | — |   |
| Loss before  provision for income taxes      |       | (1,986                            | )          | (1,872 | ) | (8,055 | ) |
| Provision for income taxes                   |       | 292                               |       | — |   | 687 |   |
| Net loss                                     |       | $                                 | (2,278     | ) | $ | (1,872 | ) | $ | (8,742 | ) |
|                                         |       |                              |       |   |   |   |   |
| Net loss per share:                          |       |                              |       |   |   |   |   |
| Basic                                        |       | $                                 | (0.13      | ) | $ | (0.13 | ) | $ | (0.67 | ) |
| Diluted                                      |       | $                                 | (0.13      | ) | $ | (0.13 | ) | $ | (0.67 | ) |
|                                         |       |                              |       |   |   |   |   |
| Weighted average number of shares:           |       |                              |       |   |   |   |   |
| Basic                                        |       | 17,755                            |       | 14,381 |   | 13,033 |   |
| Diluted                                      |       | 17,755                            |       | 14,381 |   | 13,033 |   |

 

52

----

 

**AUGUST TECHNOLOGY CORPORATION**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY**

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

 
| ** **                                                      | ** ** | **Common  Stock**                    | ** ** | **Deferred** | ** ** | **Retained**                                | ** ** | **Accumulated**                      | ** ** | ** **                              | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|--------------|------------|---------------------------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                      | ** ** | **Shares  Issued  And  Outstanding** | ** ** | **Amount**   | ** ** | **Compensation  Related To Stock  Options** | ** ** | **Earnings  (Accumulated  Deficit)** | ** ** | **Other  Comprehensive  Income (Loss)** | ** ** | **Total  Shareholders’  Equity** | ** ** |
| ** **                                                      | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                                  | ** ** | ** **                           | ** ** | ** **                              | ** ** | ** ** | ** ** |
| Balances at  December 31, 2001                             |       | 12,812,164                           |       | $            | 41,020     |                                        | $          | (192                                 | )          | $                                       | 1,704      |   | $ | (9 | ) | $ | 42,523 |   |
| ** **                                                      | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                                  | ** ** | ** **                           | ** ** | ** **                              | ** ** | ** ** | ** ** |
| Net loss  (Restated)                                            |       | —                               |       | —       |       | —                                      |       | (8,742                               | )          | —                                  |       | (8,742 | ) |
| Other  comprehensive income (loss):                             |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Foreign currency  translation adjustments                       |       | —                               |       | —       |       | —                                      |       | —                               |       | (3                                      | )          | (3 | ) |
| Net unrealized  gain on securities                              |       | —                               |       | —       |       | —                                      |       | —                               |       | 55                                      |       | 55 |   |
| Comprehensive  loss (Restated)                                  |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       | (8,690 | ) |
| Issuances of common  stock in conjunction with:                 |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Exercises of  employee stock options                            |       | 303,673                              |       | 942          |       | —                                      |       | —                               |       | —                                  |       | 942 |   |
| Employee stock  purchase plan                                   |       | 36,467                               |       | 220          |       | —                                      |       | —                               |       | —                                  |       | 220 |   |
| Amortization of  deferred compensation related to stock options |       | —                               |       | (24          | )          | 87                                          |       | —                               |       | —                                  |       | 63 |   |
|                                                            |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Balances at  December 31, 2002 (Restated)                  |       | 13,152,304                           |       | 42,158       |       | (105                                        | )          | (7,038                               | )          | 43                                      |       | 35,058 |   |
| ** **                                                      | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                                  | ** ** | ** **                           | ** ** | ** **                              | ** ** | ** ** | ** ** |
| Net loss  (Restated)                                            |       | —                               |       | —       |       | —                                      |       | (1,872                               | )          | —                                  |       | (1,872 | ) |
| Other  comprehensive loss:                                      |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Foreign currency  translation adjustments                       |       | —                               |       | —       |       | —                                      |       | —                               |       | (8                                      | )          | (8 | ) |
| Net unrealized  loss on securities                              |       | —                               |       | —       |       | —                                      |       | —                               |       | (16                                     | )          | (16 | ) |
| Comprehensive  loss (Restated)                                  |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       | (1,896 | ) |
| Issuances of  common stock in conjunction with:                 |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Follow on public  offering, net of expenses                     |       | 3,490,238                            |       | 42,049       |       | —                                      |       | —                               |       | —                                  |       | 42,049 |   |
| Acquisitions                                                    |       | 415,385                              |       | 2,160        |       | —                                      |       | —                               |       | —                                  |       | 2,160 |   |
| Exercises of  employee stock options                            |       | 282,341                              |       | 1,498        |       | —                                      |       | —                               |       | —                                  |       | 1,498 |   |
| Employee stock  purchase plan                                   |       | 42,270                               |       | 219          |       | —                                      |       | —                               |       | —                                  |       | 219 |   |
| Expense related  to issuances of stock options to nonemployees  |       | —                               |       | 7            |       | —                                      |       | —                               |       | —                                  |       | 7 |   |
| Amortization of  deferred compensation related to stock options |       | —                               |       | (5           | )          | 56                                          |       | —                               |       | —                                  |       | 51 |   |
|                                                            |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Balances at  December 31, 2003 (Restated)                  |       | 17,382,538                           |       | 88,086       |       | (49                                         | )          | (8,910                               | )          | 19                                      |       | 79,146 |   |
|                                                            |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Net loss  (Restated)                                            |       | —                               |       | —       |       | —                                      |       | (2,278                               | )          | —                                  |       | (2,278 | ) |
| Other  comprehensive income (loss):                             |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Foreign currency  translation adjustments                       |       | —                               |       | —       |       | —                                      |       | —                               |       | 21                                      |       | 21 |   |
| Net unrealized  loss on securities                              |       | —                               |       | —       |       | —                                      |       | —                               |       | (146                                    | )          | (146 | ) |
| Comprehensive  loss (Restated)                                  |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       | (2,403 | ) |
| Issuances of  common stock in conjunction with:                 |       |                                 |       |         |       |                                        |       |                                 |       |                                    |       |   |   |
| Exercises of  employee stock options                            |       | 414,171                              |       | 1,880        |       | —                                      |       | —                               |       | —                                  |       | 1,880 |   |
| Employee stock  purchase plan                                   |       | 30,714                               |       | 297          |       | —                                      |       | —                               |       | —                                  |       | 297 |   |
| Restricted stock  award                                         |       | 2,500                                |       | 20           |       | —                                      |       | —                               |       | —                                  |       | 20 |   |
| Exercises of  warrants                                          |       | 9,375                                |       | 11           |       | —                                      |       | —                               |       | —                                  |       | 11 |   |
| Tax benefit from  stock options exercised                       |       | —                               |       | 65           |       | —                                      |       | —                               |       | —                                  |       | 65 |   |
| Expense related  to issuances of stock options to nonemployees  |       | —                               |       | 4            |       | —                                      |       | —                               |       | —                                  |       | 4 |   |
| Amortization of  deferred compensation related to stock options |       | —                               |       | —       |       | 49                                          |       | —                               |       | —                                  |       | 49 |   |
| Balances at  December 31, 2004 (Restated)                  |       | 17,839,298                           |       | $            | 90,363     |                                        | $          | —                               |       | $                                       | (11,188    | ) | $ | (106 | ) | $ | 79,069 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

53

----

 

**AUGUST TECHNOLOGY CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                                 | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                 | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                 | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Cash flows from operating activities:                                                      |       |                              |       |   |   |   |   |
| Net loss                                                                                   |       | $                                 | (2,278     | ) | $ | (1,872 | ) | $ | (8,742 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                              |       |   |   |   |   |
| Depreciation and  amortization                                                             |       | 3,007                             |       | 1,951 |   | 1,399 |   |
| Provision for  doubtful accounts                                                           |       | 135                               |       | 195 |   | 148 |   |
| Tax benefit from  stock options exercised                                                  |       | 65                                |       | — |   | — |   |
| Amortization of  deferred compensation related to stock options                            |       | 49                                |       | 51 |   | 63 |   |
| Issuance of  restricted stock                                                              |       | 20                                |       | — |   | — |   |
| Deferred income  taxes                                                                     |       | 19                                |       | — |   | 896 |   |
| Changes in  operating assets and liabilities, net of effect of acquisitions:               |       |                              |       |   |   |   |   |
| Accounts  receivable                                                                       |       | (4,244                            | )          | 3,171 |   | (2,465 | ) |
| Inventories                                                                                |       | (8,427                            | )          | (3,474 | ) | 920 |   |
| Inventories at  customers under purchase orders                                            |       | (4,411                            | )          | (312 | ) | 20 |   |
| Prepaid expenses  and other current assets                                                 |       | (883                              | )          | (188 | ) | 1,427 |   |
| Accounts payable                                                                           |       | (2,116                            | )          | 3,130 |   | 632 |   |
| Accrued  compensation                                                                      |       | 481                               |       | 591 |   | (61 | ) |
| Other accrued  liabilities                                                                 |       | 783                               |       | 849 |   | (113 | ) |
| Customer  deposits and deferred revenues                                                   |       | 9,957                             |       | (245 | ) | (638 | ) |
|                                                                                       |       |                              |       |   |   |   |   |
| Net cash  provided by (used in) operating activities                                       |       | (7,843                            | )          | 3,847 |   | (6,514 | ) |
|                                                                                       |       |                              |       |   |   |   |   |
| Cash flows from  investing activities:                                                     |       |                              |       |   |   |   |   |
| Proceeds from  maturities of marketable debt securities                                    |       | 228,884                           |       | 246,020 |   | 34,738 |   |
| Purchases of  marketable debt securities                                                   |       | (220,110                          | )          | (282,978 | ) | (27,231 | ) |
| Purchases of  property and equipment                                                       |       | (5,021                            | )          | (981 | ) | (1,209 | ) |
| Cash paid in  acquisitions                                                                 |       | (2,343                            | )          | (1,539 | ) | — |   |
| Investments in  other assets                                                               |       | (252                              | )          | — |   | (571 | ) |
|                                                                                       |       |                              |       |   |   |   |   |
| Net cash  provided by (used in) investing activities                                       |       | 1,158                             |       | (39,478 | ) | 5,727 |   |
|                                                                                       |       |                              |       |   |   |   |   |
| Cash flows from  financing activities:                                                     |       |                              |       |   |   |   |   |
| Net proceeds  from follow on offering                                                      |       | —                            |       | 42,049 |   | — |   |
| Net proceeds  from issuances of common stock                                               |       | 2,187                             |       | 1,717 |   | 1,162 |   |
|                                                                                       |       |                              |       |   |   |   |   |
| Net cash  provided by financing activities                                                 |       | 2,187                             |       | 43,766 |   | 1,162 |   |
|                                                                                       |       |                              |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                                     |       | (11                               | )          | (3 | ) | (3 | ) |
|                                                                                       |       |                              |       |   |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                      |       | (4,509                            | )          | 8,132 |   | 372 |   |
|                                                                                       |       |                              |       |   |   |   |   |
| Cash and cash  equivalents at beginning of year                                            |       | 10,027                            |       | 1,895 |   | 1,523 |   |
|                                                                                       |       |                              |       |   |   |   |   |
| Cash and cash  equivalents at end of year                                                  |       | $                                 | 5,518      |   | $ | 10,027 |   | $ | 1,895 |   |
|                                                                                       |       |                              |       |   |   |   |   |
| Supplemental  cash flow information:                                                       |       |                              |       |   |   |   |   |
| Cash refunds  (payments) of income taxes, net                                              |       | $                                 | (99        | ) | $ | 218 |   | $ | 1,747 |   |
| Common stock  issued for acquisitions                                                      |       | $                                 | —     |   | $ | 2,160 |   | $ | — |   |

 

54

----

 

**AUGUST TECHNOLOGY CORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

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

** **

**Note 1– Nature of Business and Summary of Significant Accounting Policies**

 

***Nature of Business.***August TechnologyCorporation (collectively with its subsidiaries, the “Company”) is a worldwideleader in the research, design, development, manufacture, marketing, sales,distribution and service of automated defect detection and review systems usedin the manufacture of microelectronic devices including semiconductor devicesas well as emerging microelectronic device markets. The Company’s systemsautomate the inspection process, allowing manufacturers to inspect 100% oftheir wafers or die, while providing powerful information that manufacturerscan use to increase yield and productivity. The Company has sold these systemsworldwide to major microelectronic device manufacturers.

 

***Principles of Consolidation.***Theconsolidated financial statements include the accounts of August TechnologyCorporation and its wholly owned subsidiaries. All significant intercompanybalances and transactions are eliminated in consolidation.

 

***Use of Estimates.***Managementuses estimates and assumptions in preparing consolidated financial statementsin accordance with generally accepted accounting principles. Those estimatesand assumptions affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported revenues and expenses during thereporting periods. Estimates are used for, but not limited to: allocation ofrevenues in multiple element arrangements, allowance for doubtful accounts,inventory valuation, useful lives of depreciable and intangible assets,warranty provisions and income taxes. Future events and their effects cannot beperceived with certainty. As a result, the estimates used in preparation of theconsolidated financial statements will change as new events occur, asadditional information is obtained and as the Company’s operating environmentchanges. Actual results could differ from those estimates.

 

***Cash and Cash Equivalents. ***Cash and cash equivalents include highly liquidsecurities with original maturities of 90 days or less when purchased.

 

***Investments.***Investments consist ofmarketable debt securities. The investments are stated at fair value based onquoted market prices and may be used for liquidity or other corporate purposes.The Company’s investments are classified as available-for-sale securities. Unrealizedgains and losses are reported in shareholders’ equity under the caption “Accumulatedother comprehensive income (loss)” until maturity or sale of the investment, atwhich time it is included in interest income. Short-term marketable debtsecurities mature in less than one year. Long-term marketable debt securitieshave maturities of more than one year.

 

***Fair Value of Financial Instruments.***The carryingamount of cash and cash equivalents, accounts receivable, marketable debtsecurities and accounts payable approximates fair value as of December 31,2004 and 2003.

 

***Inventories.***Inventories are stated at the lowerof cost (first-in, first-out) or market. Demonstration systems are stated atmanufacturing cost and reserves are recorded to state the demonstration systemsat net realizable value. The Company reviews inventory for obsolescence andexcess quantities to determine that items deemed obsolete or excess areappropriately reserved. In making the determination, the Company considers thequantity of inventory at the balance sheet date assessed against each part’shistorical usage rates and future expected usage rates.

 

55

----

 

***Inventories at Customers UnderPurchase Orders.***Inventories at customers under purchase******ordersrepresents systems that have shipped under the terms of a customer purchaseorder, but have not yet qualified for revenue recognition as the systemshad not met customer specifications as of December 31, 2004 or 2003.

 

***Property and Equipment.***Property and equipmentare recorded at cost and depreciated over the estimated useful lives of therespective assets. The estimated useful lives range from two to seven years. Leaseholdimprovements are amortized using the straight-line method over the lesser ofthe estimated useful lives or lease terms.

 

***Purchased Technology and Goodwill. ***Purchased technology is presented at cost, net of accumulated amortization and is amortized over the estimated useful lives. The estimated useful lives range from two to four years. In accordance with the provisions of Statement of Financial Accounting Standard (“SFAS”) No. 142, “*Goodwill and Intangible Assets*,” goodwill is periodically tested for impairment rather than ratably amortized over a period of time. To test for potential impairment, it was first determined that the Company consisted of a single reporting unit. Secondly, fair value of the reporting unit was determined based upon the quoted market price of the Company’s common stock at December 31, 2004. The fair value of the Company was then compared with the carrying value of net assets. Based on this comparison, it was determined that no impairment existed. Accordingly, the Company did not perform step two of the impairment analysis, in which the exact amount of impairment would have been determined. In step two of the impairment analysis, the Company would have been required to compare the implied fair value of goodwill, determined by allocating the reporting unit’s fair value to all of its assets and liabilities, to its carrying amount.

 

***Capitalized Software Development Costs.***Softwaredevelopment costs incurred subsequent to the establishment of technologicalfeasibility, which is demonstrated by the completion of a working prototype,through general release of the products are capitalized. Capitalized costs areamortized over the lesser of the estimated sales of the product or thestraight-line method over a period of three years. The Company reviews thecarrying value of software development costs regularly and a loss is recognizedwhen the net realizable value falls below the unamortized cost. Net capitalizedsoftware development costs at December 31, 2004 and 2003 were $69 and $65,respectively. Amortization expense for the years ended December 31, 2004,2003, and 2002 was $73, $95, and $88, respectively.

 

***Patent costs.*** Patent costs are presented at cost, net of accumulated amortization and are amortized over their estimated useful lives, generally seven years. Net patent costs at December 31, 2004 and 2003 were $81 and none, respectively. Amortization expense for the years ended December 31, 2004, 2003, and 2002 was $6, none, and none, respectively.

 

***Impairment of Long Lived Assets.***TheCompany reviews long-lived assets for impairment annually or more frequently ifthe occurrence of events or changes in circumstances indicates that thecarrying amount of the assets may not be fully recoverable or the useful livesof these assets are no longer appropriate. Each impairment test is based on acomparison of the carrying amount of an asset to future net undiscounted cashflows. If an impairment is indicated, the asset is written down to itsestimated fair value on a discounted cash flow basis.

 

***Concentrations of Credit Risk.***Financialinstruments that potentially subject the Company to credit risk consistprincipally of investments in cash equivalents and short-term and long-termmarketable debt securities and trade receivables. The Company limits creditrisk by placing all investments with high credit quality issuers and limits theamount of investment with any one issuer. The Company limits credit riskassociated with trade receivables by performing ongoing credit evaluations andmaintains a reserve for potential collection losses based upon collectibilityof all accounts receivable. The Company believes that there is no additionalrisk, beyond amounts provided for collection losses, to be inherent in tradereceivables.

 

56

----

 

***Income Taxes.***Income taxes are accounted forunder the asset and liability method. Deferred income taxes are recognized forthe difference between the financial statement carrying amounts and the taxbasis of existing assets and liabilities. Deferred income taxes are recorded atthe tax rates expected to be in effect when amounts are to be included infuture taxable income. The Company regularly assesses the recoverability ofdeferred tax assets and records a valuation allowance to reduce the deferredtax assets to the amounts believed to be realizable, considering whether it ismore likely than not that some portion or all of the deferred tax assets willbe realized. The ultimate realization of deferred tax assets is dependent uponcarry back to prior periods, tax planning strategies, the scheduled reversal ofdeferred tax liabilities and the generation of future taxable income during theperiods in which those temporary differences become deductible. Based upon theCompany’s level of historical taxable losses in recent years and theuncertainty of future taxable income, the Company concluded during the secondquarter of 2002, and continues to believe, that a full valuation allowanceagainst the deferred tax assets is appropriate. The valuation allowance at December 31,2004 was $9,311.

 

***Comprehensive Income (Loss).***Comprehensiveincome (loss) represents the change in equity during a period from transactionsand other events and circumstances excluding transactions resulting frominvestments by shareholders and distributions to shareholders.

 

***Foreign Currency Translation.***Assetsand liabilities of the Company’s Taiwan, Korean, and United Kingdomsubsidiaries are translated at current period end exchange rates. Income andexpense accounts are translated at the average exchange rate in effect duringthe period. The resulting translation adjustment is excluded from operationsand accumulated as a separate component of shareholders’ equity.

 

***Stock-based Compensation.***The Companymeasures compensation expense for options issued under its stock-based employeecompensation plans using the intrinsic value method. As the exercise price ofoptions granted under these plans is equal to the fair market price of theunderlying common stock on the grant date, no stock-based employee compensationexpense is recognized in the consolidated statements of operations. Compensationexpense related to the issuance of restricted stock awards is measured at thefair market value of the stock at the date of grant, and expensed over thevesting period.

 

During December 2004,the Compensation Committee (the “Committee”) of the Company’s Board ofDirectors reviewed the Company’s stock-based compensation plan in light ofevolving compensation practices and the anticipated issuance by the FinancialAccounting Standards Board (“FASB”) of its revision of FASB Statement No. 123,“*Accounting for Stock-Based Compensation*”**Statement of Financial AccountingStandard (“SFAS”) No. 123 (Revised 2004) which upon adoption requires all share-based payments to employees,including grants of employee stock options, to be recognized in the Company’sconsolidated statement of operations based on their fair values. Afterconsideration of various alternatives, the Committee approved the acceleratedand full vesting of all unvested outstanding employee stock options withexercise prices above $11.00 per share issued prior to December 21, 2004. Theeffect of the vesting acceleration was the vesting of 249 options and therecognition of additional stock-based employee compensation expense of $1,943in the fourth quarter of 2004 in the Company’s pro forma disclosure below. Thispreviously deferred stock-based employee compensation expense, included in thepro forma disclosures, would otherwise in part have been recognized in theCompany’s consolidated statements of operations in future periods after theadoption of SFAS 123R in the third quarter of 2005.

 

The following tableillustrates the effect on net loss and net loss per share if the Company hadapplied the fair value recognition provisions of FASB Statement No. 123, “*Accounting for Stock-Based Compensation”*,to stock-based employee compensation.

 

57

----

 

| ** **                  | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|
| ** **                  | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                  | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net loss, as reported       |       | $                                 | (2,278     | ) | $ | (1,872 | ) | $ | (8,742 | ) |
| Stock compensation expense  |       | (5,043                            | )          | (1,598 | ) | (2,491 | ) |
| Pro forma net loss          |       | $                                 | (7,321     | ) | $ | (3,470 | ) | $ | (11,233 | ) |
|                        |       |                              |       |   |   |   |   |
| Basic net loss per share:   |       |                              |       |   |   |   |   |
| As reported                 |       | $                                 | (0.13      | ) | $ | (0.13 | ) | $ | (0.67 | ) |
| Pro forma                   |       | (0.41                             | )          | (0.24 | ) | (0.86 | ) |
|                        |       |                              |       |   |   |   |   |
| Diluted net loss per share: |       |                              |       |   |   |   |   |
| As reported                 |       | $                                 | (0.13      | ) | $ | (0.13 | ) | $ | (0.67 | ) |
| Pro forma                   |       | (0.41                             | )          | (0.24 | ) | (0.86 | ) |

 

The Company determined the pro forma compensationexpense under the provisions of SFAS No. 123 using the Black-Scholespricing model and the following assumptions:

 
| ** **              | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------|------------|-----------------------------------|------------|
| ** **              | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
|                    |       |                              |       |   |   |   |   |
| Expected life           |       | 4.4 years                         |       | 5.6 years |   | 4.4 years |   |
| Risk free interest rate |       | 3.0                               | %          | 3.0 | % | 3.4 | % |
| Volatility              |       | 73.8                              | %          | 75.1 | % | 74.2 | % |
| Dividend yield          |       | —                            |       | — |   | — |   |

 

Theestimated per share weighted average fair value of all stock options grantedduring the years ended December 31, 2004, 2003 and 2002 was $6.95, $4.75and $3.82, respectively.

 

***Stock-based Payments to Nonemployees.***TheCompany recognizes expense for stock options issued to nonemployees based uponthe fair value of the consideration received or the fair value of the equityinstruments issued in accordance with SFAS No. 123.

 

***Revenue Recognition.***The Company derives revenuesfrom the sale of systems, spare parts, software and services.

 

*System sales:*The Company requirescustomers, excluding the Company’s distributors, that have new inspectionapplications to complete pre-shipment authorization testing of purchasedsystems at the Company’s facility, prior to shipment. During this testing, thecustomer verifies that the system meets their specifications and authorizesshipment. For systems that have completed pre-shipment authorization testing,revenue is recognized as follows:

 

•                  Revenue from systems that have been demonstratedto meet customer specifications during pre-shipment authorization testing isrecognized when the product has shipped, title and risk of loss havetransferred to the customer and collection of the resulting receivable isprobable.

 

58

----

 

•                  Revenue from systems that have notbeen demonstrated to meet customer specifications during pre-shipmentauthorization testing is recognized when title and risk of loss havetransferred to the customer, installation has occurred and collection of theresulting receivable is probable.

 

When acustomer with a new inspection application declines pre-shipment authorizationtesting of a purchased system, revenue is deferred until, title and risk ofloss have transferred to the customer, installation has occurred and collectionof the resulting receivable is probable.

 

Whenthe customer has already accepted previous systems, with the samespecifications, for the same application, the Company does not requirepre-shipment authorization testing. Revenue is recognized when the product hasshipped, title and risk of loss have transferred to the customer and collectionof the resulting receivable is probable.

 

System sales areaccounted for as multiple-element arrangements. In transactions that includemultiple products and/or services, the Company allocates the revenue to eachelement based on their relative fair value (or in the absence of fair value ofdelivered elements, the residual method) and recognizes the associated revenuewhen all revenue recognition criteria have been met for each element.

 

*Spareparts revenue:*Spare parts revenue isrecognized when the parts have been shipped, title and risk of loss havetransferred to the customer and collection of the resulting receivable isprobable.

 

*Software revenue:* Revenue from software license fees isrecognized upon shipment if collection of the resulting receivable is probable,the fee is fixed or determinable, and vendor-specific objective evidence existsto allocate a portion of the total fee to any undelivered elements of thearrangement. Such undelivered elements in these arrangements typically consistof postcontract customer support (“PCS”).  In situations where PCS isincluded during the first year of the license and such support is insignificantand upgrades/enhancements are not provided, the revenue attributable to PCS isrecognized upon shipment or customer acceptance of the software license.  In situations where PCS is included duringthe first year of the license and such support is significant andupgrades/enhancements are frequent, the revenue attributable to PCS isrecognized ratably over the support period based on vendor-specificobjective evidence of fair value**.**Ifvendor-specific objective evidence of fair value does not exist for arrangementswith significant PCS, all revenue is deferred and recognized ratably over thesupport period.

 

*Service revenue:*Service revenue isrecognized after the services are performed and collection of the resultingreceivable is probable. Revenues from maintenance contracts are recognizedratably over the period of the contract. Service revenues were less than 10% ofrevenues during the years ended December 31, 2004, 2003 and 2002.

 

The Company’sdistributors are not granted price protection or a right of return.

 

The Company includesamounts billed to customers for shipping and handling as revenues, and therelated expenses in cost of revenues.

 

***Warranty.***The Companyprovides warranty coverage for its systems for a period of one year, includingparts and labor necessary to repair the systems during the warranty period. Aprovision for the costs related to warranty expense is recorded as a charge tocost of goods sold when revenue is recognized. The estimated warranty cost isbased on our historical experience rate of incurred expenses to correspondingsystem revenues.

 

***Advertising Costs.*** Advertising costs are expensedas incurred.

 

59

----

 

***Research and Development.***Research anddevelopment costs are expensed as incurred.

 

***Net Income (Loss) Per Share.***Basic net income(loss) per share excludes dilution and is computed by dividing net income(loss) available to common shareholders by the weighted average number ofcommon shares outstanding for the period. Diluted net income per share reflectsthe potential dilution that could occur if securities or other contracts toissue common stock were exercised or converted into common stock. When there isa net loss, other potentially dilutive securities are not included in thecalculation of net loss per share since their inclusion would be anti-dilutive.

 

***Reclassifications.***Certain prior year amountshave been reclassified to conform to the 2004 presentation. Thesereclassifications had no impact on previously reported results of operations orshareholders’ equity.

 

***New Accounting Pronouncements***

 

In December 2003, the FASB issued FASB Interpretation (“FIN”) No. 46R,“*Consolidation of Variable InterestEntities,”* which addresses how a business enterprise should evaluatewhether it has a controlling financial interest in an entity through meansother than voting rights and accordingly should consolidate the entity. FIN 46Rreplaces FASB Interpretation No. 46, “*Consolidationof Variable Interest Entities,”* which was issued in January 2003.The Company is required to apply FIN 46R to variable interests in variableinterest entities (“VIE”) created after December 31, 2003. For variableinterests in VIEs created before January 1, 2004, the Interpretation willbe applied beginning on January 1, 2005. For any VIEs that must beconsolidated under FIN 46R that were created before January 1, 2004, theassets, liabilities and noncontrolling interests of the VIE initially would bemeasured at their carrying amounts with any difference between the net amountadded to the balance sheet and any previously recognized interest beingrecognized as the cumulative effect of an accounting change. If determining thecarrying amounts is not practicable, fair value at the date FIN 46R firstapplies may be used to measure the assets, liabilities and noncontrollinginterest of the VIE. The Company believes it has no variable interest entitiesand, therefore, FIN 46R did not have an impact on the Company’s consolidatedfinancial statements.

 

In May 2003, the FASB issued SFAS No. 150, “*Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.”*The Statementestablishes standards for the classification and measurement of certainfinancial instruments with characteristics of both liabilities and equity. TheStatement also includes required disclosures for financial instruments withinits scope. For the Company, the Statement was effective for instruments enteredinto or modified after May 31, 2003, and otherwise will be effective as ofJanuary 1, 2004, except for mandatorily redeemable financial instruments. Forcertain mandatorily redeemable financial instruments, the Statement will beeffective for the Company on January 1, 2005. The effective date has beendeferred indefinitely for certain other types of mandatorily redeemablefinancial instruments. The Company currently does not have any financialinstruments that are within the scope of SFAS No. 150.

 

**Note 2 – Restatement of Financial Statements**

 

We have restated our consolidated financial statements for the years2004, 2003 and 2002 and for the first two quarters of 2005. In addition,certain disclosures in Notes 1, 3, 5, 6, 9, 12, 15 and 16 to the consolidatedfinancial statements contained in this report have been restated to reflect theRestatement adjustments. Our restated consolidated financial statements alsoinclude disclosure of restated unaudited quarterly results for 2004 and 2003. Theinitial determination to restate the 2004 and first half 2005 consolidatedfinancial statements was made as a result of a correction of the Company’sapplication of revenue recognition principles, as contained in the FinancialAccounting Standard Board’s Emerging Issues Task Force Issue No. 00-21, “*Revenue Arrangements with Multiple Deliverables*” (“EITF 00-21”).As a result of subsequently reviewing our revenue recognition policies andprocedures, we additionally noted that beginning in the fourth quarter of 2002certain deferred software revenue should have been fully recognized upondelivery or customer acceptance rather than ratably over a twelve-month period.This created the need to restate our 2003 and 2002 consolidated financialstatements. Certain adjustments were recorded to

 

60

----

 

each quarter in 2004 to correct othermiscellaneous items identified in prior external audits or quarterly reviewsbut were previously passed, none of which were individually significant.

 

In 2004 and the first half of 2005, the Company sold AXi 930 systems toa customer for an aggregate amount of approximately $12.2 million ($6.7 millionin 2004 and $5.5 million in the first half of 2005) and recognized the revenuefor these sales. The cost of revenues related to these sales was $2.7 millionin 2004 and $2.7 million in the first half of 2005. During the same timeperiods, the Company accepted orders from the same customer for enhancementpackages to the AXi 930 system but had not yet delivered the enhancementpackages. In connection with preparing to finalize its results for the quarterended September 30, 2005, the Company determined that recognition of the$12.2 million of revenue from the AXi 930 systems should have been deferreduntil the delivery of the enhancement packages, according to EITF 00-21. Thecustomer cancelled its orders for the enhancement packages on September 27,2005, which allowed the Company to recognize the entire $12.2 million of AXi930 deferred revenue in the quarter ended September 30, 2005.

 

In the fourth quarter of 2002, the Company began deferring Yield Pilotsoftware revenue and recognizing it over a twelve-month period whichrepresented the Company’s obligation to provide warranty and support. TheCompany determined based on a subsequent review of Statement of Position 97-2, “*SoftwareRevenue Recognition*” that Yield Pilot software revenues should havebeen recognized upon delivery or customer acceptance. The correction of thiserror increased revenue by $0.9 million, $0.5 million and $0.2 million for 2004,2003 and 2002, respectively and had no impact on costs of revenues.

 

The Restatement impacted the timing of revenue recognition as the AXi930 enhancement packages have been deferred into the third quarter of 2005 andthe Yield Pilot software revenue is recognized upon delivery or customeracceptance rather than ratably over a twelve-month period. The impact of theRestatement on the consolidated statements of operations for the years ended December 31,2004, 2003 and 2002 is shown in the accompanying tables.

 

The primary impact of the Restatement on the consolidated balance sheetat December 31, 2004 was to increase inventory at customers under purchaseorders related to the deferral of the cost of revenue and to increase customerdeposits and deferred revenues related to cash collected for revenue deferredin the Restatement. The impact on the December 31, 2003 consolidatedbalance sheet was to decrease deferred revenue related to Yield Pilot. TheRestatement had no impact on cash balances or net cash flows from operating,investing, or financing activities. The impact of the Restatement on theconsolidated balance sheets and consolidated statements of cash flows is shownin the accompanying tables.

 

61

----

 

**Thefollowing table presents the effect of the Restatement on the consolidatedbalance sheet:**

 
| ** **                                       | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| ** **                                       | ** ** | **As**                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Previously**             | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                       | ** ** | **Reported**               | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| **ASSETS**                                       |       |                       |       |   |   |   |   |
|                                             |       |                       |       |   |   |   |   |
| Current assets:                                  |       |                       |       |   |   |   |   |
| Cash and cash  equivalents                       |       | $                          | 5,518      |   | $ | — |   | $ | 5,518 |   |
| Short-term  marketable debt securities           |       | 28,615                     |       | — |   | 28,615 |   |
| Accounts  receivable, net                        |       | 8,603                      |       | (275 | ) | 8,328 |   |
| Inventories                                      |       | 20,131                     |       | (25 | ) | 20,106 |   |
| Inventories at  customers under purchase orders  |       | 3,993                      |       | 2,711 |   | 6,704 |   |
| Prepaid expenses  and other current assets       |       | 2,306                      |       | 211 |   | 2,517 |   |
| Total current  assets                            |       | 69,166                     |       | 2,622 |   | 71,788 |   |
|                                             |       |                       |       |   |   |   |   |
| Property and equipment, net                      |       | 5,994                      |       | — |   | 5,994 |   |
| Long-term marketable debt securities             |       | 16,289                     |       | — |   | 16,289 |   |
| Purchased technology, net                        |       | 3,703                      |       | — |   | 3,703 |   |
| Goodwill                                         |       | 498                        |       | — |   | 498 |   |
| Other assets                                     |       | 150                        |       | — |   | 150 |   |
| Total assets                                     |       | $                          | 95,800     |   | $ | 2,622 |   | $ | 98,422 |   |
|                                             |       |                       |       |   |   |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**   |       |                       |       |   |   |   |   |
|                                             |       |                       |       |   |   |   |   |
| Current liabilities:                             |       |                       |       |   |   |   |   |
| Accounts payable                                 |       | $                          | 3,366      |   | $ | (75 | ) | $ | 3,291 |   |
| Accrued  compensation                            |       | 1,691                      |       | (55 | ) | 1,636 |   |
| Other accrued  liabilities                       |       | 2,306                      |       | 16 |   | 2,322 |   |
| Customer  deposits and deferred revenues         |       | 6,841                      |       | 5,132 |   | 11,973 |   |
| Total current  liabilities                       |       | 14,204                     |       | 5,018 |   | 19,222 |   |
|                                             |       |                       |       |   |   |   |   |
| Other non-current liabilities                    |       | 131                        |       | — |   | 131 |   |
| Total  liabilities                               |       | 14,335                     |       | 5,018 |   | 19,353 |   |
|                                             |       |                       |       |   |   |   |   |
| Shareholders’ equity:                       |       |                       |       |   |   |   |   |
| Common stock, no  par value                      |       | 90,347                     |       | 16 |   | 90,363 |   |
| Undesignated  capital stock, no par value        |       | —                     |       | — |   | — |   |
| Accumulated  deficit                             |       | (8,776                     | )          | (2,412 | ) | (11,188 | ) |
| Accumulated  other comprehensive loss            |       | (106                       | )          | — |   | (106 | ) |
| Total  shareholders’ equity                 |       | 81,465                     |       | (2,396 | ) | 79,069 |   |
| Total  liabilities and shareholders’ equity |       | $                          | 95,800     |   | $ | 2,622 |   | $ | 98,422 |   |

 

62

----

 

**The following table presents theeffect of the Restatement on the consolidated balance sheet:**

 
| ** **                                       | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| ** **                                       | ** ** | **As**                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Previously**             | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                       | ** ** | **Reported**               | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| **ASSETS**                                       |       |                       |       |   |   |   |   |
|                                             |       |                       |       |   |   |   |   |
| Current assets:                                  |       |                       |       |   |   |   |   |
| Cash and cash  equivalents                       |       | $                          | 10,027     |   | $ | — |   | $ | 10,027 |   |
| Short-term  marketable debt securities           |       | 43,528                     |       | — |   | 43,528 |   |
| Accounts  receivable, net                        |       | 4,094                      |       | — |   | 4,094 |   |
| Inventories                                      |       | 11,651                     |       | — |   | 11,651 |   |
| Inventories at  customers under purchase orders  |       | 2,293                      |       | — |   | 2,293 |   |
| Prepaid expenses  and other current assets       |       | 1,631                      |       | — |   | 1,631 |   |
| Total current  assets                            |       | 73,224                     |       | — |   | 73,224 |   |
|                                             |       |                       |       |   |   |   |   |
| Property and equipment, net                      |       | 3,141                      |       | — |   | 3,141 |   |
| Long-term marketable debt securities             |       | 10,295                     |       | — |   | 10,295 |   |
| Purchased technology, net                        |       | 1,179                      |       | — |   | 1,179 |   |
| Goodwill                                         |       | 498                        |       | — |   | 498 |   |
| Other assets                                     |       | 610                        |       | — |   | 610 |   |
| Total assets                                     |       | $                          | 88,947     |   | $ | — |   | $ | 88,947 |   |
|                                             |       |                       |       |   |   |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**   |       |                       |       |   |   |   |   |
|                                             |       |                       |       |   |   |   |   |
| Current liabilities:                             |       |                       |       |   |   |   |   |
| Accounts payable                                 |       | $                          | 5,409      |   | $ | — |   | $ | 5,409 |   |
| Accrued  compensation                            |       | 1,146                      |       | — |   | 1,146 |   |
| Other accrued  liabilities                       |       | 1,414                      |       | — |   | 1,414 |   |
| Customer  deposits and deferred revenues         |       | 2,436                      |       | (669 | ) | 1,767 |   |
| Total current  liabilities                       |       | 10,405                     |       | (669 | ) | 9,736 |   |
|                                             |       |                       |       |   |   |   |   |
| Other non-current liabilities                    |       | 65                         |       | — |   | 65 |   |
| Total  liabilities                               |       | 10,470                     |       | (669 | ) | 9,801 |   |
|                                             |       |                       |       |   |   |   |   |
| Shareholders’ equity:                       |       |                       |       |   |   |   |   |
| Common stock, no  par value                      |       | 88,086                     |       | — |   | 88,086 |   |
| Undesignated  capital stock, no par value        |       | —                     |       | — |   | — |   |
| Deferred  compensation related to stock options  |       | (49                        | )          | — |   | (49 | ) |
| Accumulated  deficit                             |       | (9,578                     | )          | 668 |   | (8,910 | ) |
| Accumulated  other comprehensive income          |       | 18                         |       | 1 |   | 19 |   |
| Total  shareholders’ equity                 |       | 78,477                     |       | 669 |   | 79,146 |   |
| Total  liabilities and shareholders’ equity |       | $                          | 88,947     |   | $ | — |   | $ | 88,947 |   |

 

63

----

 

**Thefollowing table presents the effect of the Restatement on the consolidatedstatement of operations:**

 
| ** **                                                                          | ** ** | **Year Ended December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                          | ** ** | **As**                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                          | ** ** | **Previously**                        | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                          | ** ** | **Reported**                          | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                                                                |       |                                  |       |   |   |   |   |
| Net revenues                                                                        |       | $                                     | 68,443     |   | $ | (5,776 | ) | $ | 62,667 |   |
| Cost of revenues                                                                    |       | 31,925                                |       | (2,664 | ) | 29,261 |   |
| Gross profit                                                                        |       | 36,518                                |       | (3,112 | ) | 33,406 |   |
|                                                                                |       |                                  |       |   |   |   |   |
| Selling, general  and administrative expenses                                       |       | 22,798                                |       | (47 | ) | 22,751 |   |
| Research and  development expenses                                                  |       | 13,561                                |       | — |   | 13,561 |   |
| Operating income  (loss)                                                            |       | 159                                   |       | (3,065 | ) | (2,906 | ) |
|                                                                                |       |                                  |       |   |   |   |   |
| Interest income                                                                     |       | 847                                   |       | — |   | 847 |   |
| Other income                                                                        |       | 73                                    |       | — |   | 73 |   |
|                                                                                |       |                                  |       |   |   |   |   |
| Income (loss)  before provision for income taxes                                    |       | 1,079                                 |       | (3,065 | ) | (1,986 | ) |
| Provision for  income taxes                                                         |       | 277                                   |       | 15 |   | 292 |   |
| Net income (loss)                                                                   |       | $                                     | 802        |   | $ | (3,080 | ) | $ | (2,278 | ) |
|                                                                                |       |                                  |       |   |   |   |   |
| Net income  (loss) per share:                                                       |       |                                  |       |   |   |   |   |
| Basic                                                                               |       | $                                     | 0.05       |   | (0.18 | ) | $ | (0.13 | ) |
| Diluted                                                                             |       | $                                     | 0.04       |   | (0.17 | ) | $ | (0.13 | ) |
|                                                                                |       |                                  |       |   |   |   |   |
| Weighted average  shares outstanding used to calculate net income (loss) per share: |       |                                  |       |   |   |   |   |
| Basic                                                                               |       | 17,755                                |       | — |   | 17,755 |   |
| Diluted                                                                             |       | 18,211                                |       | (456 | ) | 17,755 |   |

 

64

----

 

**Thefollowing table presents the effect of the Restatement on the consolidatedstatement of operations:**

 
| ** **                                                                 | ** ** | **Year Ended December 31, 2003** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                 | ** ** | **As**                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **Previously**                        | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                 | ** ** | **Reported**                          | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                                                       |       |                                  |       |   |   |   |   |
| Net revenues                                                               |       | $                                     | 40,323     |   | $ | 477 |   | $ | 40,800 |   |
| Cost of revenues                                                           |       | 18,290                                |       | — |   | 18,290 |   |
| Gross profit                                                               |       | 22,033                                |       | 477 |   | 22,510 |   |
|                                                                       |       |                                  |       |   |   |   |   |
| Selling, general  and administrative expenses                              |       | 14,359                                |       | — |   | 14,359 |   |
| Research and  development expenses                                         |       | 10,430                                |       | — |   | 10,430 |   |
| Operating loss                                                             |       | (2,756                                | )          | 477 |   | (2,279 | ) |
|                                                                       |       |                                  |       |   |   |   |   |
| Interest income                                                            |       | 407                                   |       | — |   | 407 |   |
| Other income                                                               |       | —                                |       | — |   | — |   |
|                                                                       |       |                                  |       |   |   |   |   |
| Loss before  provision for income taxes                                    |       | (2,349                                | )          | 477 |   | (1,872 | ) |
| Provision for  income taxes                                                |       | —                                |       | — |   | — |   |
| Net loss                                                                   |       | $                                     | (2,349     | ) | $ | 477 |   | $ | (1,872 | ) |
|                                                                       |       |                                  |       |   |   |   |   |
| Net loss per  share:                                                       |       |                                  |       |   |   |   |   |
| Basic                                                                      |       | $                                     | (0.16      | ) | $ | 0.03 |   | $ | (0.13 | ) |
| Diluted                                                                    |       | $                                     | (0.16      | ) | $ | 0.03 |   | $ | (0.13 | ) |
|                                                                       |       |                                  |       |   |   |   |   |
| Weighted average  shares outstanding used to calculate net loss per share: |       |                                  |       |   |   |   |   |
| Basic                                                                      |       | 14,381                                |       | — |   | 14,381 |   |
| Diluted                                                                    |       | 14,381                                |       | — |   | 14,381 |   |

 

65

----

 

**Thefollowing table presents the effect of the Restatement on the consolidatedstatement of operations:**

 
| ** **                                                                 | ** ** | **Year Ended December 31, 2002** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                 | ** ** | **As**                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **Previously**                        | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                 | ** ** | **Reported**                          | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                                                       |       |                                  |       |   |   |   |   |
| Net revenues                                                               |       | $                                     | 25,058     |   | $ | 191 |   | $ | 25,249 |   |
| Cost of revenues                                                           |       | 11,068                                |       | — |   | 11,068 |   |
| Gross profit                                                               |       | 13,990                                |       | 191 |   | 14,181 |   |
|                                                                       |       |                                  |       |   |   |   |   |
| Selling, general  and administrative expenses                              |       | 13,013                                |       | — |   | 13,013 |   |
| Research and  development expenses                                         |       | 9,847                                 |       | — |   | 9,847 |   |
| Operating loss                                                             |       | (8,870                                | )          | 191 |   | (8,679 | ) |
|                                                                       |       |                                  |       |   |   |   |   |
| Interest income                                                            |       | 624                                   |       | — |   | 624 |   |
| Other income                                                               |       | —                                |       | — |   | — |   |
|                                                                       |       |                                  |       |   |   |   |   |
| Loss before  provision for income taxes                                    |       | (8,246                                | )          | 191 |   | (8,055 | ) |
| Provision for  income taxes                                                |       | 687                                   |       | — |   | 687 |   |
| Net loss                                                                   |       | $                                     | (8,933     | ) | $ | 191 |   | $ | (8,742 | ) |
|                                                                       |       |                                  |       |   |   |   |   |
| Net loss per  share:                                                       |       |                                  |       |   |   |   |   |
| Basic                                                                      |       | $                                     | (0.69      | ) | $ | 0.02 |   | $ | (0.67 | ) |
| Diluted                                                                    |       | $                                     | (0.69      | ) | $ | 0.02 |   | $ | (0.67 | ) |
|                                                                       |       |                                  |       |   |   |   |   |
| Weighted average  shares outstanding used to calculate net loss per share: |       |                                  |       |   |   |   |   |
| Basic                                                                      |       | 13,033                                |       | — |   | 13,033 |   |
| Diluted                                                                    |       | 13,033                                |       | — |   | 13,033 |   |

 

66

----

 

**The following table presents theeffect of the Restatement on the consolidated statement of cash flows:**

 
| ** **                                                                            | ** ** | **Year Ended December 31, 2004** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                            | ** ** | **As**                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **Previously**                        | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                            | ** ** | **Reported**                          | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                                |       |                                  |       |   |   |   |   |
| Net income  (loss)                                                                    |       | $                                     | 802        |   | $ | (3,080 | ) | $ | (2,278 | ) |
| Adjustments to  reconcile net income (loss) to net cash used in operating activities: |       |                                  |       |   |   |   |   |
| Depreciation and  amortization                                                        |       | 3,007                                 |       | — |   | 3,007 |   |
| Provision for  doubtful accounts                                                      |       | 135                                   |       | — |   | 135 |   |
| Tax benefit from  stock options exercised                                             |       | 50                                    |       | 15 |   | 65 |   |
| Amortization of  deferred compensation related to stock options                       |       | 49                                    |       | — |   | 49 |   |
| Issuance of  restricted stock                                                         |       | 20                                    |       | — |   | 20 |   |
| Deferred income  taxes                                                                |       | 19                                    |       | — |   | 19 |   |
| Changes in  operating assets and liabilities, net of effect of acquisitions:          |       |                                  |       |   |   |   |   |
| Accounts  receivable                                                                  |       | (4,519                                | )          | 275 |   | (4,244 | ) |
| Inventories                                                                           |       | (8,452                                | )          | 25 |   | (8,427 | ) |
| Inventories at  customers under purchase orders                                       |       | (1,700                                | )          | (2,711 | ) | (4,411 | ) |
| Prepaid expenses  and other current assets                                            |       | (672                                  | )          | (211 | ) | (883 | ) |
| Accounts payable                                                                      |       | (2,041                                | )          | (75 | ) | (2,116 | ) |
| Accrued  compensation                                                                 |       | 536                                   |       | (55 | ) | 481 |   |
| Other accrued  liabilities                                                            |       | 767                                   |       | 16 |   | 783 |   |
| Customer  deposits and deferred revenues                                              |       | 4,156                                 |       | 5,801 |   | 9,957 |   |
| Net cash used in  operating activities                                                |       | (7,843                                | )          | — |   | (7,843 | ) |
|                                                                                  |       |                                  |       |   |   |   |   |
| Cash flows from  investing activities:                                                |       |                                  |       |   |   |   |   |
| Proceeds from  maturities of marketable debt securities                               |       | 228,884                               |       | — |   | 228,884 |   |
| Purchases of  marketable debt securities                                              |       | (220,110                              | )          | — |   | (220,110 | ) |
| Purchases of  property and equipment                                                  |       | (5,021                                | )          | — |   | (5,021 | ) |
| Cash paid in  acquisitions                                                            |       | (2,343                                | )          | — |   | (2,343 | ) |
| Investments in  other assets                                                          |       | (252                                  | )          | — |   | (252 | ) |
| Net cash  provided by investing activities                                            |       | 1,158                                 |       | — |   | 1,158 |   |
|                                                                                  |       |                                  |       |   |   |   |   |
| Cash flows from  financing activities:                                                |       |                                  |       |   |   |   |   |
| Net proceeds  from issuances of common stock                                          |       | 2,187                                 |       | — |   | 2,187 |   |
| Net cash  provided by financing activities                                            |       | 2,187                                 |       | — |   | 2,187 |   |
|                                                                                  |       |                                  |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                                |       | (11                                   | )          | — |   | (11 | ) |
| Net decrease in  cash and cash equivalents                                            |       | (4,509                                | )          | — |   | (4,509 | ) |
| Cash and cash  equivalents at beginning of year                                       |       | 10,027                                |       | — |   | 10,027 |   |
| Cash and cash  equivalents at end of year                                             |       | $                                     | 5,518      |   | $ | — |   | $ | 5,518 |   |

 

67

----

 

**The following table presents theeffect of the Restatement on the consolidated statement of cash flows:**

 
| ** **                                                                       | ** ** | **Year Ended December 31, 2003** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                       | ** ** | **As**                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                       | ** ** | **Previously**                        | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                       | ** ** | **Reported**                          | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                           |       |                                  |       |   |   |   |   |
| Net loss                                                                         |       | $                                     | (2,349     | ) | $ | 477 |   | $ | (1,872 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |       |                                  |       |   |   |   |   |
| Depreciation and  amortization                                                   |       | 1,951                                 |       | — |   | 1,951 |   |
| Provision for  doubtful accounts                                                 |       | 195                                   |       | — |   | 195 |   |
| Tax benefit from  stock options exercised                                        |       | —                                |       | — |   | — |   |
| Amortization of  deferred compensation related to stock options                  |       | 51                                    |       | — |   | 51 |   |
| Issuance of  restricted stock                                                    |       | —                                |       | — |   | — |   |
| Deferred income  taxes                                                           |       | —                                |       | — |   | — |   |
| Changes in  operating assets and liabilities, net of effect of acquisitions:     |       |                                  |       |   |   |   |   |
| Accounts  receivable                                                             |       | 3,171                                 |       | — |   | 3,171 |   |
| Inventories                                                                      |       | (3,474                                | )          | — |   | (3,474 | ) |
| Inventories at  customers under purchase orders                                  |       | (312                                  | )          | — |   | (312 | ) |
| Prepaid expenses  and other current assets                                       |       | (188                                  | )          | — |   | (188 | ) |
| Accounts payable                                                                 |       | 3,130                                 |       | — |   | 3,130 |   |
| Accrued  compensation                                                            |       | 591                                   |       | — |   | 591 |   |
| Other accrued  liabilities                                                       |       | 849                                   |       | — |   | 849 |   |
| Customer  deposits and deferred revenues                                         |       | 232                                   |       | (477 | ) | (245 | ) |
| Net cash  provided by operating activities                                       |       | 3,847                                 |       | — |   | 3,847 |   |
|                                                                             |       |                                  |       |   |   |   |   |
| Cash flows from  investing activities:                                           |       |                                  |       |   |   |   |   |
| Proceeds from  maturities of marketable debt securities                          |       | 246,020                               |       | — |   | 246,020 |   |
| Purchases of  marketable debt securities                                         |       | (282,978                              | )          | — |   | (282,978 | ) |
| Purchases of  property and equipment                                             |       | (981                                  | )          | — |   | (981 | ) |
| Cash paid in  acquisitions                                                       |       | (1,539                                | )          | — |   | (1,539 | ) |
| Investments in  other assets                                                     |       | —                                |       | — |   | — |   |
| Net cash used in  investing activities                                           |       | (39,478                               | )          | — |   | (39,478 | ) |
|                                                                             |       |                                  |       |   |   |   |   |
| Cash flows from  financing activities:                                           |       |                                  |       |   |   |   |   |
| Net proceeds  from issuances of common stock                                     |       | 43,766                                |       | — |   | 43,766 |   |
| Net cash  provided by financing activities                                       |       | 43,766                                |       | — |   | 43,766 |   |
|                                                                             |       |                                  |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                           |       | (3                                    | )          | — |   | (3 | ) |
| Net increase in  cash and cash equivalents                                       |       | 8,132                                 |       | — |   | 8,132 |   |
| Cash and cash  equivalents at beginning of year                                  |       | 1,895                                 |       | — |   | 1,895 |   |
| Cash and cash  equivalents at end of year                                        |       | $                                     | 10,027     |   | $ | — |   | $ | 10,027 |   |

 

68

----

 

**The following table presents theeffect of the Restatement on the consolidated statement of cash flows:**

 
| ** **                                                                   | ** ** | **Year Ended December 31, 2002** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **As**                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                   | ** ** | **Previously**                        | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                   | ** ** | **Reported**                          | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Cash flows from  operating activities:                                       |       |                                  |       |   |   |   |   |
| Net loss                                                                     |       | $                                     | (8,933     | ) | $ | 191 |   | $ | (8,742 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                  |       |   |   |   |   |
| Depreciation and  amortization                                               |       | 1,399                                 |       | — |   | 1,399 |   |
| Provision for  doubtful accounts                                             |       | 148                                   |       | — |   | 148 |   |
| Tax benefit from  stock options exercised                                    |       | —                                |       | — |   | — |   |
| Amortization of  deferred compensation related to stock options              |       | 63                                    |       | — |   | 63 |   |
| Issuance of  restricted stock                                                |       | —                                |       | — |   | — |   |
| Deferred income  taxes                                                       |       | 896                                   |       | — |   | 896 |   |
| Changes in  operating assets and liabilities, net of effect of acquisitions: |       |                                  |       |   |   |   |   |
| Accounts  receivable                                                         |       | (2,465                                | )          | — |   | (2,465 | ) |
| Inventories                                                                  |       | 920                                   |       | — |   | 920 |   |
| Inventories at  customers under purchase orders                              |       | 20                                    |       | — |   | 20 |   |
| Prepaid expenses  and other current assets                                   |       | 1,427                                 |       | — |   | 1,427 |   |
| Accounts payable                                                             |       | 632                                   |       | — |   | 632 |   |
| Accrued  compensation                                                        |       | (61                                   | )          | — |   | (61 | ) |
| Other accrued  liabilities                                                   |       | (113                                  | )          | — |   | (113 | ) |
| Customer  deposits and deferred revenues                                     |       | (447                                  | )          | (191 | ) | (638 | ) |
| Net cash used in  operating activities                                       |       | (6,514                                | )          | — |   | (6,514 | ) |
|                                                                         |       |                                  |       |   |   |   |   |
| Cash flows from  investing activities:                                       |       |                                  |       |   |   |   |   |
| Proceeds from  maturities of marketable debt securities                      |       | 34,738                                |       | — |   | 34,738 |   |
| Purchases of  marketable debt securities                                     |       | (27,231                               | )          | — |   | (27,231 | ) |
| Purchases of  property and equipment                                         |       | (1,209                                | )          | — |   | (1,209 | ) |
| Cash paid in  acquisitions                                                   |       | —                                |       | — |   | — |   |
| Investments in  other assets                                                 |       | (571                                  | )          | — |   | (571 | ) |
| Net cash  provided by investing activities                                   |       | 5,727                                 |       | — |   | 5,727 |   |
|                                                                         |       |                                  |       |   |   |   |   |
| Cash flows from  financing activities:                                       |       |                                  |       |   |   |   |   |
| Net proceeds  from issuances of common stock                                 |       | 1,162                                 |       | — |   | 1,162 |   |
| Net cash  provided by financing activities                                   |       | 1,162                                 |       | — |   | 1,162 |   |
|                                                                         |       |                                  |       |   |   |   |   |
| Effect of  exchange rates on cash and cash equivalents                       |       | (3                                    | )          | — |   | (3 | ) |
| Net increase in  cash and cash equivalents                                   |       | 372                                   |       | — |   | 372 |   |
| Cash and cash  equivalents at beginning of year                              |       | 1,523                                 |       | — |   | 1,523 |   |
| Cash and cash  equivalents at end of year                                    |       | $                                     | 1,895      |   | $ | — |   | $ | 1,895 |   |

 

69

----

 

**Note 3 – Business Combinations**

 

The Company completed one purchase acquisition in 2004and two during 2003. The consolidated financial statements include theoperating results of each business from the date of acquisition. Pro formaresults of operations have been presented for all acquisitions that arematerial on either an individual or aggregate basis. For a period of up totwelve months from the acquisition date, the Company may change its originalpurchase price allocation for pre-acquisition uncertainties.

 

***DMSVision software division of Inspex, Inc.***

 

On July 27,2004, the Company purchased certain assets relating to the DMSVision softwaredivision of Inspex, Inc. (“DMSVision”). The purchase was made pursuant to an Asset Purchase Agreement betweenthe Company and Inspex, Inc. dated June 23, 2004.  DMSVision develops and markets product characterization softwaresolutions that allow customers to collect and analyze process information froma broad range of applications.  The totalconsideration paid for DMSVision, including direct acquisition costs,was $2,326 of cash.  In addition, theCompany may owe additional future consideration based on new orders forDMSVision software licenses received in the twelve months after the closingdate.  Based upon the total estimatedcontingent consideration, the payment of the contingency will result in anincrease in the allocation of purchase price to purchased technology.  As a result, amortization expense related tothis asset will increase.  Amounts paidunder this arrangement are not expected to have a material effect on theCompany’s consolidated financial condition or results of operations.  The Company currently estimates the totalcontingent consideration to be paid will be between $150 and $300.

 

The allocation of the purchase price to the net assetsacquired and liabilities assumed based upon their estimated fair market valueswas as follows:

 
| Accounts  receivable |   | $     | 122    |   |
|----------------------|--------|-------|--------|--------|
| Purchased technology |   | 2,474 |   |
| Accrued liabilities  |   | (21   | )      |
| Deferred revenues    |   | (249  | )      |
|                 |   | $     | 2,326  |   |

 

***Semiconductor Technologies & Instruments, Inc.***

 

On April 15, 2003, the Company acquired all ofthe outstanding capital stock of Semiconductor Technologies &Instruments, Inc. (“STI”).  STI manufactures automated defectinspection and metrology tools that are integrated onto probers, providingmicroelectronics manufacturers with an automated solution for inspecting probemarks, ink dots and active die regions.  The total purchase price,including direct acquisition costs, was $2,201 which consisted of $1,445 in cashand 215 shares of the Company’s Common Stock.

 

70

----

 

The allocation of the purchase price to the assetsacquired and liabilities assumed, based upon their estimated fair marketvalues, was as follows:

 
| Accounts receivable                       |   | $     | 347    |   |
|-------------------------------------------|--------|-------|--------|--------|
| Inventories                               |   | 1,527 |   |
| Prepaid expenses and other current assets |   | 72    |   |
| Property and equipment                    |   | 344   |   |
| Purchased technology                      |   | 377   |   |
| Accrued liabilities                       |   | (76   | )      |
| Customer deposits and deferred revenues   |   | (390  | )      |
|                                      |   | $     | 2,201  |   |

 

The following unaudited pro forma consolidatedfinancial information presents the combined results of operations of theCompany, DMSVision, and STI as if the acquisitions occurred at the beginning ofthe periods presented, after giving effect to certain adjustments, includingamortization expense.  The unaudited pro forma consolidated financialinformation does not necessarily reflect the results of operations that wouldhave occurred had the acquisitions been completed as of the dates indicated orof the results that may be obtained in the future.

 
| ** **          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------|------------|-----------------------------------|------------|
| ** **          | ** ** | **2004**                          | ** ** | **2003** | ** ** |
| ** **          | ** ** | **As reported**                   | ** ** | **Pro forma** | ** ** | **As reported** | ** ** | **Pro forma** | ** ** |
| ** **          | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Revenues            |       | $                                 | 62,667     |   | $ | 63,185 |   | $ | 40,800 |   | $ | 42,872 |   |
| Net loss            |       | (2,278                            | )          | (3,279 | ) | (1,872 | ) | (3,978 | ) |
|                |       |                              |       |   |   |   |   |   |   |
| Net loss per share: |       |                              |       |   |   |   |   |   |   |
| Basic               |       | $                                 | (0.13      | ) | $ | (0.18 | ) | $ | (0.13 | ) | $ | (0.28 | ) |
| Diluted             |       | $                                 | (0.13      | ) | $ | (0.18 | ) | $ | (0.13 | ) | $ | (0.28 | ) |

 

***Counterpoint Solutions, Inc.***

 

On July 3, 2003, the Company purchasedsubstantially all of the assets of Counterpoint Solutions, Inc. (“CSI”).  CSI develops wafer inspection, review andfailure analysis solutions.  The totalpurchase price, including direct acquisition costs, was $1,515, which consistedof 200 shares of the Company’s Common Stock and $111 in cash.  The allocation of the purchase price resultedin the Company recording $17 of net assets, $498 of goodwill and $1,000 ofpurchased technology.  During the yearended December 31, 2002, CSI had unaudited revenues of $885 and unauditednet income of $104.

 

71

----

** **

**Note 4– Marketable Debt Securities**

 

The amortized cost and estimated fair value ofavailable-for-sale marketable debt securities were as follows:

 
| ** **      | ** ** | **December 31, 2004** | ** ** |
|-----------------|------------|----------------------------|------------|
| ** **      | ** ** | ** **                 | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **      | ** ** | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **      | ** ** | **Cost**                   | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Corporate bonds |       | $                          | 12,611     |   | $ | 1 |   | $ | (55 | ) | $ | 12,557 |   |
| Municipal bonds |       | 32,400                     |       | 3 |   | (56 | ) | 32,347 |   |
|            |       | $                          | 45,011     |   | $ | 4 |   | $ | (111 | ) | $ | 44,904 |   |

 
| ** **      | ** ** | **December 31, 2003** | ** ** |
|-----------------|------------|----------------------------|------------|
| ** **      | ** ** | ** **                 | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **      | ** ** | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **      | ** ** | **Cost**                   | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Corporate bonds |       | $                          | 12,484     |   | $ | 35 |   | $ | (2 | ) | $ | 12,517 |   |
| Municipal bonds |       | 41,301                     |       | 7 |   | (2 | ) | 41,306 |   |
|            |       | $                          | 53,785     |   | $ | 42 |   | $ | (4 | ) | $ | 53,823 |   |

 

The maturities of available-for-salemarketable debt securities were as follows:

 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                             | ** ** | **Amortized**         | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                             | ** ** | **Cost**              | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** |
| Due within one year                    |       | $                     | 28,662     |   | $ | 28,615 |   | $ | 43,524 |   | $ | 43,528 |   |
| Due after one year through three years |       | 13,349                |       | 13,289 |   | 10,261 |   | 10,295 |   |
| Due after three years                  |       | 3,000                 |       | 3,000 |   | — |   | — |   |
|                                   |       | $                     | 45,011     |   | $ | 44,904 |   | $ | 53,785 |   | $ | 53,823 |   |

 

Net realized gains andlosses were not material for the years ended December 31, 2004, 2003 and2002.

 

72

----

 

**Note 5– Accounts Receivable**

 

Accountsreceivable consisted of the following:

 

| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                      | ** ** | **(Restated)**        | ** ** | ** ** | ** ** |
| Billed receivables              |       | $                     | 7,994      |   | $ | 3,837 |   |
| Unbilled revenue                |       | 1,024                 |       | 812 |   |
|                            |       | 9,018                 |       | 4,649 |   |
| Allowance for doubtful accounts |       | (690                  | )          | (555 | ) |
| Accounts  receivable, net       |       | $                     | 8,328      |   | $ | 4,094 |   |

 

Unbilledrevenue represents revenue that has been earned for equipment shipped but notbilled due to the payment terms of the customer order.

 

**Note 6– Inventories**

 

Inventoriesconsisted of the following:

 

| ** **              | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **              | ** ** | **(Restated)**        | ** ** | ** ** | ** ** |
| Raw materials           |       | $                     | 8,449      |   | $ | 4,645 |   |
| Work in process         |       | 3,558                 |       | 2,305 |   |
| Demonstration equipment |       | 4,152                 |       | 1,603 |   |
| Finished goods          |       | 3,947                 |       | 3,098 |   |
| Inventories             |       | $                     | 20,106     |   | $ | 11,651 |   |
|                         |            |                       |            |  |  |  |  |  |  |

 

**Note 7– Purchased Technology**

 

Purchased technology was as follows:

 

| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Purchased technology                  |       | $                     | 4,651      |   | $ | 1,370 |   |
| Less:   accumulated amortization |       | (948                  | )          | (191 | ) |
| Purchased  technology, net            |       | $                     | 3,703      |   | $ | 1,179 |   |

 

Amortizationexpense for the years ended December 31, 2004, 2003 and 2002 was $757,$191 and none, respectively.  Assuming nochange in the gross carrying value of purchased technology, the estimatedamortization expense for each of the next five years is $1,393, $1,178, $771,$361, and none.

 

73

----

 

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

 

**Note 8– Property and Equipment**

 

Propertyand equipment consisted of the following:

 

| ** **                                             | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Furniture and equipment                                |       | $                     | 7,758      |   | $ | 4,076 |   |
| Computer equipment                                     |       | 2,087                 |       | 1,335 |   |
| Computer software                                      |       | 1,937                 |       | 1,540 |   |
| Leasehold improvements                                 |       | 616                   |       | 426 |   |
|                                                   |       | 12,398                |       | 7,377 |   |
| Less:   accumulated depreciation and amortization |       | (6,404                | )          | (4,236 | ) |
| Property and equipment,  net                           |       | $                     | 5,994      |   | $ | 3,141 |   |

 

Furniture andequipment includes $3,185 and $500 as of December 31, 2004 and 2003,respectively, of finished goods that have been capitalized due to the permanenttransfer of such items to engineering for test and characterization, customerservice for training and sales for customer application studies.  Depreciation expense for the years ended December 31,2004, 2003 and 2002 was $2,171, $1,666 and $1,311, respectively.

 

**Note 9– Income Taxes**

 

Theprovision for income taxes consisted of the following:

 
| ** **                        | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------|------------|-----------------------------------|------------|
| ** **                        | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                        | ** ** | **(Restated)**                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current:                          |       |                              |       |   |   |   |   |
| Federal                           |       | $                                 | 65         |   | $ | — |   | $ | (239 | ) |
| State                             |       | (36                               | )          | — |   | — |   |
| Foreign                           |       | 244                               |       | — |   | 30 |   |
|                              |       | 273                               |       | — |   | (209 | ) |
| Deferred:                         |       |                              |       |   |   |   |   |
| Federal                           |       | 17                                |       | — |   | 679 |   |
| State                             |       | 2                                 |       | — |   | 217 |   |
| Foreign                           |       | —                            |       | — |   | — |   |
|                              |       | 19                                |       | — |   | 896 |   |
| Total provision  for income taxes |       | $                                 | 292        |   | $ | — |   | $ | 687 |   |

 

74

----

 

A reconciliation of the expected federal income taxesat the statutory rate of 34% to the actual provision for income taxes is asfollows:

 
| ** **                                  | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|
| ** **                                  | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                  | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Expected federal income tax                 |       | $                                 | (675       | ) | $ | (636 | ) | $ | (2,739 | ) |
| General business credits                    |       | (61                               | )          | (312 | ) | (283 | ) |
| Tax exempt income                           |       | (15                               | )          | (90 | ) | (58 | ) |
| Nondeductible expenses                      |       | 109                               |       | 59 |   | 100 |   |
| Change in valuation allowance               |       | 917                               |       | 979 |   | 3,454 |   |
| State income tax, net of federal tax effect |       | (22                               | )          | — |   | 144 |   |
| Foreign tax                                 |       | (9                                | )          | — |   | 30 |   |
| Other                                       |       | 48                                |       | — |   | 39 |   |
|                                        |       |                              |       |   |   |   |   |
| Actual provision  for income taxes          |       | $                                 | 292        |   | $ | — |   | $ | 687 |   |

 

75

----

 

Deferred taxes consistedof the following: 

 

| ** **                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                              | ** ** | **(Restated)**        | ** ** | **(Restated)** | ** ** |
| Current deferred tax assets:            |       |                  |       |   |   |
| Deferred  revenue, net of related costs |       | $                     | 1,437      |   | $ | — |   |
| Allowance for  doubtful accounts        |       | 248                   |       | 209 |   |
| Inventory  reserve                      |       | 586                   |       | 198 |   |
| Warranty accrual                        |       | 339                   |       | 90 |   |
| Compensation  accrual                   |       | 143                   |       | 48 |   |
| Accrued lease  obligation               |       | 33                    |       | 12 |   |
|                                    |       |                  |       |   |   |
| Total current  deferred tax assets      |       | 2,786                 |       | 557 |   |
|                                    |       |                  |       |   |   |
| Long-term deferred tax assets:          |       |                  |       |   |   |
| Net operating  loss carryovers          |       | 5,708                 |       | 5,638 |   |
| General business  credits               |       | 1,361                 |       | 1,319 |   |
| Accrued lease  obligation               |       | 40                    |       | 25 |   |
| Amortization of  identified intangibles |       | 138                   |       | — |   |
| Other                                   |       | 38                    |       | — |   |
|                                    |       |                  |       |   |   |
| Total gross  deferred tax assets        |       | 10,071                |       | 7,539 |   |
|                                    |       |                  |       |   |   |
| Current deferred tax liabilities:       |       |                  |       |   |   |
| Prepaid expenses                        |       | (35                   | )          | (51 | ) |
|                                    |       |                  |       |   |   |
| Long-term deferred tax liabilities:     |       |                  |       |   |   |
| Depreciation                            |       | (725                  | )          | (207 | ) |
| Amortization of  goodwill               |       | (19                   | )          | — |   |
|                                    |       |                  |       |   |   |
| Total gross  deferred tax liabilities   |       | (779                  | )          | (258 | ) |
|                                    |       |                  |       |   |   |
| Valuation allowance                     |       | (9,311                | )          | (7,281 | ) |
|                                    |       |                  |       |   |   |
| Net deferred tax  liability             |       | $                     | (19        | ) | $ | — |   |

 

The valuationallowance for deferred tax assets as of December 31, 2004 and 2003 was $9,311 and $7,281, respectively.  The net change in the total valuationallowance for the years ended December 31, 2004 and 2003 was an increaseof $2,030 and $1,992, respectively.

 

At December 31,2004, the Company had federal net operating loss carryforwards of approximately$15,827 that willbegin to expire in 2022 and state net operating loss carryforwards ofapproximately $6,332 that willbegin to expire in 2016.  The netoperating losses are available to offset future federal and state taxableincome, if any.  In addition, the Companyhas general business tax credits for federal and state tax purposes ofapproximately $1,085 and $416, respectively, which are available to offsetfuture federal and state regular income taxes, if any, and will begin to expirein 2015.

 

Subsequentlyrecognized tax benefits relating to the $9,311 valuation allowance for deferred tax assets as of December 31,2004, would be reported in the consolidated statements of operations as anincome tax benefit of $5,726 andin the consolidated statements of shareholders’ equity as a tax benefit fromstock options exercised of $3,585.

 

76

----

 

As of December 31,2004, approximately $89 of earnings attributable to international subsidiarieswas considered to be permanently reinvested. No provision has been made for taxes that might be payable if theseearnings were remitted to the U.S.

 

Inaccordance with SFAS No. 142, the Company does not amortize goodwill forfinancial reporting purposes.  Therefore,the deferred tax liability related to the taxable temporary differences causedby different amortization periods for goodwill will not reverse unless theunderlying assets are sold or an impairment is recorded.  As the Company is currently in a netoperating loss position, they recorded valuation allowances to offset theirrespective income tax benefits, from operations as well as the amount by whichtheir deferred tax assets exceeded their deferred tax liabilities, excludingthe deferred tax liability related to goodwill.

 

On October 22,2004, the American Jobs Creation Act (the “AJCA”) was signed into law.  The AJCA includes a deduction of 85 percentfor certain foreign earnings that are repatriated, as defined in the AJCA, atan effective tax cost of 5.25 percent on any such repatriated foreignearnings.  The Company may elect to applythis provision to qualifying earnings repatriations in fiscal 2005.  The Company has begun an evaluation of theeffects of the repatriation provision. However, the Company does not expect to complete this evaluation untilafter Congress or the Treasury Department provides additional clarifyinglanguage on key elements of the provision. The Company expects to complete their evaluation of the effects of therepatriation provision within a reasonable period of time following thepublication of the additional clarifying language, and the Company does notbelieve this will have a material effect on their financial statements.

 

**Note 10– Short-Term Debt**

 

On April 30,2004, the Company’s revolving credit line agreement expired.  There was no balance outstanding under theagreement at December 31, 2003.

 

**Note 11– Accumulated Other Comprehensive Income (Loss)**

 

The accumulated balances foreach classification of accumulated other comprehensive income (loss) were asfollows:

 
| ** **                                               | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                                     |       |                  |       |   |   |
| Foreign currency translation adjustments                 |       | $                     | 1          |   | $ | (20 | ) |
| Unrealized gains (losses) on marketable debt  securities |       | (107                  | )          | 39 |   |
| Accumulated other  comprehensive income (loss)           |       | $                     | (106       | ) | $ | 19 |   |

 

77

----

 

**Note 12– Shareholders’ Equity**

 

***NetLoss Per Share***

 

The components ofbasic and diluted net loss per share were as follows:

 
| ** **                                     | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                     | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                     | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                                           |       |                              |       |   |   |   |   |
| Net loss                                       |       | $                                 | (2,278     | ) | $ | (1,872 | ) | $ | (8,742 | ) |
|                                           |       |                              |       |   |   |   |   |
| Weighted average  common shares:               |       |                              |       |   |   |   |   |
| Basic                                          |       | 17,755                            |       | 14,381 |   | 13,033 |   |
| Effect of  dilutive stock options and warrants |       | —                            |       | — |   | — |   |
| Diluted                                        |       | 17,755                            |       | 14,381 |   | 13,033 |   |
|                                           |       |                              |       |   |   |   |   |
| Net loss per  share:                           |       |                              |       |   |   |   |   |
| Basic                                          |       | $                                 | (0.13      | ) | $ | (0.13 | ) | $ | (0.67 | ) |
| Diluted                                        |       | $                                 | (0.13      | ) | $ | (0.13 | ) | $ | (0.67 | ) |

 

The total weightedaverage number of stock options and warrants excluded from the calculation ofpotentially dilutive securities either due to the exercise price exceeding theaverage market price or the inclusion of such securities in a calculation ofnet loss per share would have been anti-dilutive for the years ended December 31,2004, 2003 and 2002 were 1,702,1,884 and 1,556, respectively.

 

***Common Stock***

 

On September 23,2003, the Company sold 3,000 shares of its Common Stock at a price of $13.00per share in a follow-on public offering (the “Offering”).  In conjunction with the Offering, on October 21,2003, the underwriters exercised their over-allotment option to acquire anadditional 490 shares of Common Stock at the same price to the public and withthe same underwriting discount as the Offering. The net proceeds from the Offering, including the exercise of theunderwriters over-allotment option, after deducting the underwriting discountand offering expenses, was $42,049.

 

***Deferred Compensation***

 

Inconnection with the grant of stock options to employees in 1999, the Companyrecorded deferred compensation of $428, representing the difference between theestimated deemed value of the Common Stock for accounting purposes and theexercise price of such options at the date of grant. Such amount is presentedas a reduction of shareholders’ equity and was amortized ratably over thevesting period of the options granted, generally five years, and was fullyamortized as of December 31, 2004. The charge to compensation expenserelated to this deferred compensation for the years ended December 31,2004, 2003 and 2002 was $49, $51 and $63, respectively.

 

***Employee Stock Purchase Plan***

 

During 2000, the Board ofDirectors and shareholders adopted the 2000 Employee Stock Purchase Plan (the “2000Purchase Plan”).  The 2000 Purchase Planallows employees, subject to certain restrictions, to purchase the Company’sCommon Stock through payroll deductions. Contributions are limited to 10% of an employee’s compensation.  The purchase price is set at 85% of the lowerof the closing market price of the Company’s Common Stock at the commencementor termination of a participation phase. Participation phases have a duration

 

78

----

 

of six months and begin on January 1 and July 1 of eachyear.  The Board of Directors hasreserved 375 shares of Common Stock for issuance under the 2000 PurchasePlan.  As of December 31, 2004, 156shares of Common Stock had been purchased and 219 shares remain reserved forfuture issuance under the 2000 Purchase Plan.

 

***Stock-based Compensation***

 

TheBoard of Directors and shareholders have adopted the 1997 stock option plan(the “1997 Plan”), which originally provided for 1,125 shares available forissuance primarily to officers, directors and key employees. On April 28,2004, April 30, 2003, April 19, 2001, and April 14, 2000 theshareholders authorized increases in the number of shares available forissuance to 4,250, 3,050, 2,650, and 2,250 shares, respectively.  The 1997 Plan permits the granting ofincentive stock options meeting the requirements of Section 422 of theInternal Revenue Code of 1986, as amended, and also nonqualified stock optionswhich do not meet the requirements of Section 422.  In addition, the April 28, 2004amendment modified thePlan to allow for the granting of restricted stock awards, stock appreciationrights and performance share awards, in addition to stock options, to certaineligible employees, directors and consultants of the Company and itssubsidiaries.  The exercise price ofincentive stock options may not be less than the fair market value of the stockat the date of grant. The exercise price of nonqualified stock optionsmay not be less than 85% of the fair market value of the stock at the date ofgrant. The stock options vest over periods that range from immediate to fiveyears and expire in either seven or ten years from the date of grant.  As ofDecember 31, 2004 all of the stock incentives granted under the 1997 Plan,except for an award of 3 shares of restricted stock, represented grants ofstock options.  The restricted stockaward was issued at the fair market value of the stock at the date of grant,resulting in $20 of deferred compensation expense.  The expense was amortized ratably over thevesting period, and was fully amortized at December 31, 2004.  As of December 31, 2004, there were 981shares available for future grant under the 1997 Plan.

 

Informationwith respect to option activity is as follows:

 

| ** **                            | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** |
|---------------------------------------|------------|-----------------------|------------|--------------------------------------------------|------------|
| Outstanding at December 31, 2001 |       | 1,616                 |       | $                                                | 7.06       |   |
| Granted                               |       | 700                   |       | 6.59                                             |       |
| Exercised                             |       | (304                  | )          | 3.10                                             |       |
| Forfeited                             |       | (217                  | )          | 9.11                                             |       |
|                                  |       |                  |       |                                             |       |
| Outstanding at December 31, 2002 |       | 1,795                 |       | 7.30                                             |       |
| Granted                               |       | 448                   |       | 7.30                                             |       |
| Exercised                             |       | (282                  | )          | 5.30                                             |       |
| Forfeited                             |       | (161                  | )          | 9.35                                             |       |
|                                  |       |                  |       |                                             |       |
| Outstanding at December 31, 2003 |       | 1,800                 |       | 7.43                                             |       |
| Granted                               |       | 721                   |       | 12.23                                            |       |
| Exercised                             |       | (414                  | )          | 4.54                                             |       |
| Forfeited                             |       | (143                  | )          | 10.94                                            |       |
|                                  |       |                  |       |                                             |       |
| Outstanding at December 31, 2004 |       | 1,964                 |       | $                                                | 9.54       |   |

 

79

----

 

The following table summarizes information about stockoptions outstanding at December 31, 2004: 

 
| **Range of Exercise  Prices** | ** ** | **Outstanding  Options** | ** ** | **Weighted  Average  Remaining  Contractual Life  (years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------|------------|--------------------------|------------|-------------------------------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|
| **Exercisable**               |
| ** **                    | ** ** | **Weighted**             |
| **Exercisable**               | ** ** | **Average**              |
| **Options**                   | ** ** | **Exercise Price**       |
|                          |       |                     |       |                                                        |       |                                  |       |       |       |       |       |
| $                             | 1.20 -     |                     | 3.99       |                                                        | 213        |                                  | 3.1        |       | $          | 2.86       |       | 153 |   | $ | 2.46 |   |
| 4.00 -                        |       | 4.36                     |       | 204                                                         |       | 5.2                                   |       | 4.32       |       | 91         |       | 4.31 |   |
| 4.37 -                        |       | 7.10                     |       | 225                                                         |       | 4.8                                   |       | 5.56       |       | 113        |       | 5.25 |   |
| 7.11 -                        |       | 9.19                     |       | 201                                                         |       | 9.0                                   |       | 7.98       |       | 26         |       | 8.02 |   |
| 9.20 -                        |       | 10.05                    |       | 192                                                         |       | 4.4                                   |       | 9.75       |       | 129        |       | 9.76 |   |
| 10.06 -                       |       | 10.38                    |       | 244                                                         |       | 9.8                                   |       | 10.37      |       | 53         |       | 10.37 |   |
| 10.39 -                       |       | 12.00                    |       | 195                                                         |       | 3.8                                   |       | 11.40      |       | 149        |       | 11.62 |   |
| 12.01 -                       |       | 13.75                    |       | 188                                                         |       | 3.5                                   |       | 13.07      |       | 188        |       | 13.07 |   |
| 13.76 -                       |       | 17.42                    |       | 138                                                         |       | 6.2                                   |       | 15.72      |       | 138        |       | 15.72 |   |
| 17.43 -                       |       | 22.65                    |       | 164                                                         |       | 7.6                                   |       | 19.15      |       | 164        |       | 19.15 |   |
|                          |       |                     |       |                                                        |       |                                  |       |       |       |       |       |   |   |
| $                             | 1.20 -     |                     | 22.65      |                                                        | 1,964      |                                  | 5.8        |       | $          | 9.54       |       | 1,204 |   | $ | 10.69 |   |

 

**Note 13– Commitments and Contingencies**

 

***Leases***

 

TheCompany leases its facilities and certain equipment under noncancelableoperating leases. Future minimum lease payments as of December 31, 2004,excluding operating costs, under these leases are as follows:

 
| **For the Years Ending December 31,** | ** ** | **Amount** | ** ** |
|--------------------------------------------|------------|------------|------------|
|                                       |       |       |       |
| 2005                                       |       | $          | 794        |   |
| 2006                                       |       | 670        |       |
| 2007                                       |       | 621        |       |
| 2008                                       |       | 621        |       |
| 2009                                       |       | 628        |       |
| Therafter                                  |       | 1,503      |       |
|                                       |       |       |       |
| Total minimum  lease payments              |       | $          | 4,837      |   |

 

Rentexpense for all operating leases for the years ended December 31, 2004,2003 and 2002 was $811, $757 and $646, respectively.

 

80

----

 

***Purchase commitments***

 

The Company maintains certain open purchasecommitments for the purchase of goods and services.   The minimum purchase commitments for theyear ended December 31, 2005 is estimated to be approximately $4,424.  Although the Company is primarily liable forpayments on the purchase commitments, based on historic operating performanceand forecasted future cash flows, management believes the exposure to losses,if any, under these arrangements is not material.

 

***Guarantees***

 

Pursuant to FIN No. 45,“*Guarantor’s Requirements for Guarantees,including Indirect Indebtedness of Others*,” the Company is required to disclose thechanges in the provision for product warranty. The Company provideswarranty coverage for its systems for a period of one year, including parts andlabor necessary to repair the systems during the warranty period.  The estimated warranty cost is based on ourhistorical experience rate of incurred expenses to corresponding systemrevenues.

 

Informationwith respect to changes in the warranty provision, as required by FIN 45 andincluded in the caption Other Accrued Liabilities on the Consolidated BalanceSheet, is as follows:

 

| ** **                                              | ** ** | **Changes in**         | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|
| ** **                                              | ** ** | **Warranty Liability** | ** ** |
| Accrual at  December 31, 2001                      |       | $                      | 149        |   |
| Warranties issued                                       |       | 101                    |       |
| Costs incurred                                          |       | (139                   | )          |
| Accrual at  December 31, 2002                      |       | 111                    |       |
| Warranties  issued                                      |       | 264                    |       |
| Assumption of  liability in connection with acquisition |       | 53                     |       |
| Costs incurred                                          |       | (189                   | )          |
| Accrual at  December 31, 2003                      |       | 239                    |       |
| Warranties  issued                                      |       | 1,570                  |       |
| Assumption of  liability in connection with acquisition |       | 21                     |       |
| Costs incurred                                          |       | (888                   | )          |
| Accrual at  December 31, 2004                      |       | $                      | 942        |   |

 

***Distributor Termination***

 

In June 2002,the Company paid $428 to Metron Technology B.V. (“Metron”) related to themodification of its distributor agreement with Metron.  The entire amount was recognized withinselling, general and administrative expense in the period incurred.  The modification resulted in focusing Metron’sactivities entirely on South Korea.  TheCompany subsequently terminated the entire agreement with Metron without thepayment of any additional amounts.

 

81

----

*** ***

***Legal Proceedings***

 

Fromtime to time, in the ordinary course of business, the Company is subject toclaims, asserted or unasserted, or named as a party to lawsuits orinvestigations.  Except as describedbelow and in Note 16, the Company is not aware of any asserted or unassertedlegal proceedings or claims that management believes would have a materialadverse effect on the Company’s financial condition or results of operations.

 

The Company fully settled the commercial litigationbetween the Company and Rudolph Technologies, Inc. (“Rudolph”).  On September 23, 2003, the Company andits subsidiary, STI filed a complaint against Rudolph and its subsidiary ISOA, Inc.(“ISOA”).  In the complaint, the Companyand STI sought a declaratory judgment that the Company and STI were not usingISOA technology in their products.  STIalso asserted a claim for breach of contract to recover amounts STI paid toISOA in connection with a joint development agreement between STI andISOA.  Rudolph and ISOA filed an answerand counterclaim, denying the allegations set forth in the complaint andclaiming that ISOA was entitled to damages for STI’s alleged breach of thejoint development agreement.  ISOA alsosought a declaratory judgment that STI and/or the Company were wrongfully usingISOA’s technology without compensating ISOA and that ISOA was entitled toroyalty payments for use of its technology.

 

The Company acquired STI from ASTI Holdings, Ltd. (“ASTI”)in April 2003.  In connection withthe acquisition, ASTI agreed to indemnify the Company for claims relating toSTI’s dispute with Rudolph and ISOA, up to a maximum value of $670.  To secure ASTI’s performance of ASTI’sindemnification obligations, ASTI and the Company created an escrow.

 

On July 22, 2004, theCompany, STI, Rudolph, and ISOA agreed to settle all claims between theparties.  On August 6, 2004 the Company entered into a finalsettlement agreement with Rudolph.  Under the terms of the confidentialsettlement, ASTI made a one-time payment out of the escrow to Rudolph in theamount of $503.  The Company, STI, Rudolph and ISOA agreed to release anyand all claims against each other relating to the joint development agreementand to dismiss all claims asserted in the litigation with prejudice.

 

**Note 14– Employee Retirement Plan**

 

The Company maintains anemployee benefit plan (the “Plan”) pursuant to Section 401(k) of theInternal Revenue Code.  The Plan isavailable to all employees who have reached the age of 18 and providesemployees with tax deferred salary deductions and alternative investmentoptions.  Employees may contribute up to15% of their eligible compensation, subject to certain limitations.  The Company matches 50% of the deferrals upto 6% of the employee’s compensation. The Company made contributions to thePlan for the years ended December 31, 2004, 2003 and 2002 of $295, $251and $259, respectively.

 

82

----

 

**Note 15– Significant Customer, Product Line and Geographic Information**

 

Thepercentage of net revenues derived from major customers and accounts receivablerelated to these customers were as follows:

 

| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|-----------------------------------|------------|
| ** **    | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **    | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net revenues: |       |                              |       |   |   |   |   |
| Customer A    |       | 11                                | %          |   | * |   | * |
| Customer B    |       | 11                                | %          |   | * |   | * |
| Customer C    |       | 10                                | %          |   | * |   | * |
| Customer D    |       |                              | *          | 12 | % |   | * |
| Customer E    |       |                              | *          | 12 | % |   | * |
| Customer F    |       |                              | *          | 11 | % | 15 | % |
| Customer G    |       |                              | *          | 11 | % |   | * |
| Customer H    |       |                              | *          |   | * | 10 | % |
| Total         |       | 32                                | %          | 46 | % | 25 | % |

 
| ** **           | ** ** | **December 31,** | ** ** |
|----------------------|------------|-----------------------|------------|
| ** **           | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **           | ** ** | **(Restated)**        | ** ** | **(Restated)** | ** ** |
| Accounts receivable: |       |                  |       |   |   |
| Customer A           |       | 20                    | %          |   | * |
| Customer B           |       | 24                    | %          |   | * |
| Customer C           |       | 5                     | %          |   | * |
| Customer D           |       |                  | *          | 1 | % |
| Customer E           |       |                  | *          | 7 | % |
| Customer F           |       |                  | *          | 11 | % |
| Customer G           |       |                  | *          | 5 | % |
| Customer H           |       |                  | *          |   | * |
| Total                |       | 49                    | %          | 24 | % |

 

----

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

 

Thepercentage of net revenues by major product line was as follows:

 
| ** **           | ** ** | **Years Ended December 31,** | ** ** |
|----------------------|------------|-----------------------------------|------------|
| ** **           | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **           | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net revenues:        |       |                              |       |   |   |   |   |
| NSX Series           |       | 60                                | %          | 49 | % | 44 | % |
| All Surface  Systems |       | 12                                | %          | 11 | % | 0 | % |
| 3Di Series           |       | 6                                 | %          | 15 | % | 37 | % |
| Other                |       | 22                                | %          | 25 | % | 19 | % |
|                 |       | 100                               | %          | 100 | % | 100 | % |

 

83

----

 

All ofthe Company’s tangible long-lived assets are located in the United States,except for an insignificant amount of property and equipment in Taiwan andSouth Korea.  The Company derivesrevenues from shipments to customers outside of the United States.  The percentage of net revenues by geographicregion was as follows:

 

| ** **       | ** ** | **Years Ended December 31,** | ** ** |
|------------------|------------|-----------------------------------|------------|
| ** **       | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **       | ** ** | **(Restated)**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net revenues:    |       |                              |       |   |   |   |   |
| United States    |       | 30                                | %          | 24 | % | 48 | % |
| Taiwan           |       | 39                                | %          | 39 | % | 37 | % |
| South Korea      |       | 8                                 | %          | 13 | % | — |   |
| Japan            |       | 4                                 | %          | 6 | % | 4 | % |
| Rest of Asia     |       | 14                                | %          | 6 | % | 4 | % |
| Europe and other |       | 5                                 | %          | 12 | % | 7 | % |
|             |       | 100                               | %          | 100 | % | 100 | % |

 

**Note 16– Quarterly Financial Data (unaudited)**

 
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|
| ** **                      | ** ** | **Mar. 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                      | ** ** | **2004**               | ** ** | **2004** | ** ** | **2004** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(Restated) (1)**     | ** ** | **(Restated) (1)** | ** ** | **(Restated) (1)** | ** ** | **(Restated) (1)** | ** ** |
|                            |       |                   |       |   |   |   |   |   |   |
| Net revenues                    |       | $                      | 16,845     |   | $ | 18,024 |   | $ | 11,101 |   | $ | 16,697 |   |
| Gross profit                    |       | 9,787                  |       | 9,865 |   | 4,725 |   | 9,029 |   |
| Operating income (loss)         |       | 1,690                  |       | 1,153 |   | (5,299 | ) | (450 | ) |
| Net income (loss)               |       | 1,850                  |       | 1,283 |   | (5,109 | ) | (302 | ) |
|                            |       |                   |       |   |   |   |   |   |   |
| Net income (loss) per share:    |       |                   |       |   |   |   |   |   |   |
| Basic                           |       | $                      | 0.10       |   | $ | 0.07 |   | $ | (0.29 | ) | $ | (0.02 | ) |
| Diluted                         |       | $                      | 0.10       |   | $ | 0.07 |   | $ | (0.29 | ) | $ | (0.02 | ) |
|                            |       |                   |       |   |   |   |   |   |   |
| Weighted average common shares: |       |                   |       |   |   |   |   |   |   |
| Basic                           |       | 17,622                 |       | 17,778 |   | 17,803 |   | 17,815 |   |
| Diluted                         |       | 18,486                 |       | 18,349 |   | 17,803 |   | 17,815 |   |

 
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|
| ** **                      | ** ** | **Mar. 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                      | ** ** | **2003**               | ** ** | **2003** | ** ** | **2003** | ** ** | **2003** | ** ** |
| ** **                      | ** ** | **(Restated) (1)**     | ** ** | **(Restated) (1)** | ** ** | **(Restated) (1)** | ** ** | **(Restated) (1)** | ** ** |
|                            |       |                   |       |   |   |   |   |   |   |
| Net revenues                    |       | $                      | 6,579      |   | $ | 7,693 |   | $ | 11,774 |   | $ | 14,754 |   |
| Gross profit                    |       | 3,624                  |       | 4,145 |   | 6,674 |   | 8,067 |   |
| Operating income (loss)         |       | (2,351                 | )          | (1,502 | ) | 271 |   | 1,303 |   |
| Net income (loss)               |       | (2,253                 | )          | (1,424 | ) | 342 |   | 1,463 |   |
|                            |       |                   |       |   |   |   |   |   |   |
| Net income (loss) per share:    |       |                   |       |   |   |   |   |   |   |
| Basic                           |       | $                      | (0.17      | ) | $ | (0.11 | ) | $ | 0.02 |   | $ | 0.09 |   |
| Diluted                         |       | $                      | (0.17      | ) | $ | (0.11 | ) | $ | 0.02 |   | $ | 0.08 |   |
|                            |       |                   |       |   |   |   |   |   |   |
| Weighted average common shares: |       |                   |       |   |   |   |   |   |   |
| Basic                           |       | 13,158                 |       | 13,352 |   | 13,844 |   | 17,171 |   |
| Diluted                         |       | 13,158                 |       | 13,352 |   | 14,578 |   | 18,291 |   |

 

84

----

 

----

(1) Asdescribed in Note 2 to our consolidated financial statements, we have restatedour 2004, 2003 and 2002 consolidated statements of operations related torevenue recognition.  The effect of theRestatement on the quarterly results is presented in the following table.

 

85

----

 

**SummaryEffect of the Restatement on Quarterly Financial Data**

** **
| ** **                                      | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **Mar. 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                      | ** ** | **2004**               | ** ** | **2004** | ** ** | **2004** | ** ** | **2004** | ** ** |
| **As Previously Reported**                      |       |                   |       |   |   |   |   |   |   |
| Net revenues                                    |       | $                      | 16,400     |   | $ | 19,855 |   | $ | 15,516 |   | $ | 16,672 |   |
| Cost of revenues                                |       | 7,058                  |       | 9,059 |   | 8,187 |   | 7,621 |   |
| Gross profit                                    |       | 9,342                  |       | 10,796 |   | 7,329 |   | 9,051 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Selling, general and administrative expenses    |       | 5,189                  |       | 5,390 |   | 6,202 |   | 6,017 |   |
| Research and development expenses               |       | 2,908                  |       | 3,322 |   | 3,822 |   | 3,509 |   |
| Operating income  (loss)                        |       | 1,245                  |       | 2,084 |   | (2,695 | ) | (475 | ) |
|                                            |       |                   |       |   |   |   |   |   |   |
| Interest income                                 |       | 201                    |       | 189 |   | 204 |   | 253 |   |
| Other income                                    |       | —                 |       | — |   | 46 |   | 27 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Income (loss) before provision for income taxes |       | 1,446                  |       | 2,273 |   | (2,445 | ) | (195 | ) |
| Provision for income taxes                      |       | —                 |       | 100 |   | — |   | 177 |   |
| Net income (loss)                               |       | $                      | 1,446      |   | $ | 2,173 |   | $ | (2,445 | ) | $ | (372 | ) |
|                                            |       |                   |       |   |   |   |   |   |   |
| Net income (loss) per share:                    |       |                   |       |   |   |   |   |   |   |
| Basic                                           |       | $                      | 0.08       |   | $ | 0.12 |   | $ | (0.14 | ) | $ | (0.02 | ) |
| Diluted                                         |       | $                      | 0.08       |   | $ | 0.12 |   | $ | (0.14 | ) | $ | (0.02 | ) |
|                                            |       |                   |       |   |   |   |   |   |   |
| **Restatement Summary**                         |       |                   |       |   |   |   |   |   |   |
| Net revenues                                    |       | 445                    |       | (1,831 | ) | (4,415 | ) | 25 |   |
| Cost of revenues                                |       | —                 |       | (900 | ) | (1,811 | ) | 47 |   |
| Gross profit                                    |       | 445                    |       | (931 | ) | (2,604 | ) | (22 | ) |
| Selling, general and administrative expenses    |       | —                 |       | — |   | — |   | (47 | ) |
| Provision for income taxes                      |       | 41                     |       | (41 | ) | 60 |   | (45 | ) |
|                                            |       |                   |       |   |   |   |   |   |   |
| **As Restated**                                 |       |                   |       |   |   |   |   |   |   |
| Net revenues                                    |       | $                      | 16,845     |   | $ | 18,024 |   | $ | 11,101 |   | $ | 16,697 |   |
| Cost of revenues                                |       | 7,058                  |       | 8,159 |   | 6,376 |   | 7,668 |   |
| Gross profit                                    |       | 9,787                  |       | 9,865 |   | 4,725 |   | 9,029 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Selling, general and administrative expenses    |       | 5,189                  |       | 5,390 |   | 6,202 |   | 5,970 |   |
| Research and development expenses               |       | 2,908                  |       | 3,322 |   | 3,822 |   | 3,509 |   |
| Operating income  (loss)                        |       | 1,690                  |       | 1,153 |   | (5,299 | ) | (450 | ) |
|                                            |       |                   |       |   |   |   |   |   |   |
| Interest income                                 |       | 201                    |       | 189 |   | 204 |   | 253 |   |
| Other income                                    |       | —                 |       | — |   | 46 |   | 27 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Income (loss) before provision for income taxes |       | 1,891                  |       | 1,342 |   | (5,049 | ) | (170 | ) |
| Provision for income taxes                      |       | 41                     |       | 59 |   | 60 |   | 132 |   |
| Net income (loss)                               |       | $                      | 1,850      |   | $ | 1,283 |   | $ | (5,109 | ) | $ | (302 | ) |
|                                            |       |                   |       |   |   |   |   |   |   |
| Net income (loss) per share:                    |       |                   |       |   |   |   |   |   |   |
| Basic                                           |       | $                      | 0.10       |   | $ | 0.07 |   | $ | (0.29 | ) | $ | (0.02 | ) |
| Diluted                                         |       | $                      | 0.10       |   | $ | 0.07 |   | $ | (0.29 | ) | $ | (0.02 | ) |

 

86

----

 

**Summary Effect of the Restatement onQuarterly Financial Data**

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **Mar. 31,**      | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                      | ** ** | **2003**               | ** ** | **2003** | ** ** | **2003** | ** ** | **2003** | ** ** |
| **As Previously Reported**                      |       |                   |       |   |   |   |   |   |   |
| Net revenues                                    |       | $                      | 6,563      |   | $ | 7,757 |   | $ | 11,685 |   | $ | 14,318 |   |
| Cost of revenues                                |       | 2,955                  |       | 3,548 |   | 5,100 |   | 6,687 |   |
| Gross profit                                    |       | 3,608                  |       | 4,209 |   | 6,585 |   | 7,631 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Selling, general and administrative expenses    |       | 3,207                  |       | 3,213 |   | 3,808 |   | 4,131 |   |
| Research and development expenses               |       | 2,768                  |       | 2,434 |   | 2,595 |   | 2,633 |   |
| Operating income  (loss)                        |       | (2,367                 | )          | (1,438 | ) | 182 |   | 867 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Interest income                                 |       | 98                     |       | 78 |   | 71 |   | 160 |   |
| Other income                                    |       | —                 |       | — |   | — |   | — |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Income (loss) before provision for income taxes |       | (2,269                 | )          | (1,360 | ) | 253 |   | 1,027 |   |
| Provision for income taxes                      |       | —                 |       | — |   | — |   | — |   |
| Net income (loss)                               |       | $                      | (2,269     | ) | $ | (1,360 | ) | $ | 253 |   | $ | 1,027 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Net income (loss) per share:                    |       |                   |       |   |   |   |   |   |   |
| Basic                                           |       | $                      | (0.17      | ) | $ | (0.10 | ) | $ | 0.02 |   | $ | 0.06 |   |
| Diluted                                         |       | $                      | (0.17      | ) | $ | (0.10 | ) | $ | 0.02 |   | $ | 0.06 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| **Restatement Summary**                         |       |                   |       |   |   |   |   |   |   |
| Net revenues                                    |       | 16                     |       | (64 | ) | 89 |   | 436 |   |
| Cost of revenues                                |       | —                 |       | — |   | — |   | — |   |
| Gross profit                                    |       | 16                     |       | (64 | ) | 89 |   | 436 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| **As Restated**                                 |       |                   |       |   |   |   |   |   |   |
| Net revenues                                    |       | $                      | 6,579      |   | $ | 7,693 |   | $ | 11,774 |   | $ | 14,754 |   |
| Cost of revenues                                |       | 2,955                  |       | 3,548 |   | 5,100 |   | 6,687 |   |
| Gross profit                                    |       | 3,624                  |       | 4,145 |   | 6,674 |   | 8,067 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Selling, general and administrative expenses    |       | 3,207                  |       | 3,213 |   | 3,808 |   | 4,131 |   |
| Research and development expenses               |       | 2,768                  |       | 2,434 |   | 2,595 |   | 2,633 |   |
| Operating income  (loss)                        |       | (2,351                 | )          | (1,502 | ) | 271 |   | 1,303 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Interest income                                 |       | 98                     |       | 78 |   | 71 |   | 160 |   |
| Other income                                    |       | —                 |       | — |   | — |   | — |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Income (loss) before provision for income taxes |       | (2,253                 | )          | (1,424 | ) | 342 |   | 1,463 |   |
| Provision for income taxes                      |       | —                 |       | — |   | — |   | — |   |
| Net income (loss)                               |       | $                      | (2,253     | ) | $ | (1,424 | ) | $ | 342 |   | $ | 1,463 |   |
|                                            |       |                   |       |   |   |   |   |   |   |
| Net income (loss) per share:                    |       |                   |       |   |   |   |   |   |   |
| Basic                                           |       | $                      | (0.17      | ) | $ | (0.11 | ) | $ | 0.02 |   | $ | 0.09 |   |
| Diluted                                         |       | $                      | (0.17      | ) | $ | (0.11 | ) | $ | 0.02 |   | $ | 0.08 |   |

 

87

----

 

**Note 17– Subsequent Events**

 

On January 21,2005, the Company entered into an Agreement and Plan of Merger andReorganization (the “Merger Agreement”) with Nanometrics, Incorporated (“Nanometrics”),Major League Merger Corporation (“Merger Sub 1”) and Minor League MergerCorporation (“Merger Sub 2”).  Pursuantto the Merger Agreement (a) Nanometrics will effect a reincorporationunder Delaware law by merging with and into Merger Sub 2, a Delawarecorporation, with the surviving entity to be renamed August NanometricsInc. (“August Nanometrics”) and (b) Merger Sub 1 will be merged withand into the Company, with the surviving entity to be a wholly-owned subsidiaryof August Nanometrics.  Each shareof the Company’s common stock will be converted into the right to receive0.6401 of a share of August Nanometrics common stock.  August Nanometrics will make a cashpayment to the Company’s shareholders for any fractional shares of August Nanometricscommon stock they would otherwise be entitled to receive instead of issuingfractional shares.

 

On January 27,2005, the Company received a letter from Paul F. McLaughlin, Chairman and ChiefExecutive Officer of Rudolph, stating that Rudolph is prepared to enter into amerger with the Company based on a share exchange ratio of 0.6239 share ofRudolph stock for each share of the Company’s common stock (equivalent to$10.50 per share of the Company’s common stock based on the closing price ofRudolph stock on January 27, 2005). The letter stated that each of the Company’s shareholders may elect toreceive all cash, stock or a combination of cash and stock, subject toproration based on total cash consideration of $40 million.

 

Alsoon January 27, 2005, Rudolph issued a press release with proposed termsslightly different from those described in the letter.  The press release stated that Rudolph isprepared to enter into a merger with the Company whereby each shareholder ofthe Company will receive the value of $2.16 per share in cash and 0.4955 pershare in Rudolph common stock (equivalent to $10.50 per share of the Company’sCommon Stock, based on the closing price of Rudolph stock on January 27,2005).  The press release stated thateach of the Company’s shareholders would have the option to elect to receiveall cash, stock or a combination of cash and stock, subject to proration basedon total cash consideration of $40 million.

 

TheCompany’s Board of Directors has agreed, based on the advice of its financialadvisors and legal counsel, to further examine the Rudolph offer provided thatRudolph first executes a confidentiality agreement in the form required by theMerger Agreement with Nanometrics.  As ofthe date of the Original Filing, the Company and Rudolph have not reachedagreement on the form of confidentiality agreement and no discussions regardingRudolph’s offer have taken place.

 

On February 9,2005, the Company received a letter from Kenneth Schroeder, President and ChiefExecutive Officer of KLA-Tencor Corporation (“KLA”), regarding KLA’s interestin pursuing a merger with the Company. The letter stated that KLA proposed to acquire the Company in atransaction in which the Company’s shareholders would receive $11.50 pershare.  KLA also stated that it would bewilling to consider using stock as consideration.

 

TheCompany’s Board of Directors has agreed, based on the advice of its financialadvisors and legal counsel, to further examine the KLA offer provided that KLAfirst executes a confidentiality agreement in the form required by the MergerAgreement with Nanometrics.  As of thedate of the Original Filing, the Company and KLA have not reached agreement onthe form of confidentiality agreement and no discussions regarding KLA’s offerhave taken place.

 

TheCompany and each of its directors, Jeff O’Dell, James Bernards, Roger Gower,Michael Wright and Linda Hall Whitman, have been named as defendants in twoseparate lawsuits that purport to be class actions claims on behalf ofshareholders of the Company.  The Companyreceived a summons and complaint with

 

88

----

 

respect to the first of these proceedings on February 4, 2005 andthe second on February 14, 2005. Both lawsuits are brought in Minnesota State Court and claim that thedirectors have breached their fiduciary duties to the Company’s shareholders inconnection with their actions in agreeing to the proposed merger withNanometrics Incorporated.  The plaintiffsin both actions seek various forms of injunctive relief including an orderenjoining the Company and the directors from consummating the merger withNanometrics.  The Company and itsdirectors believe the lawsuits are without merit and plan to vigorously defendagainst the claims.

 

89

----

** **

**Item 9.  Changes in and Disagreements With Accountantson Accounting and Financial Disclosure**

 

None

 

**Item 9A. Controls and Procedures**

 

**Overview**

 

As previously disclosed in a Current Report on Form 8-Kwhich we filed on September 29, 2005 and as described in our ExplanatoryNote to this Form 10-K/A and Note 2 to our accompanying consolidatedfinancial statements, in connection with preparing to finalize our results forthe quarter ended September 30, 2005, we determined that certain revenuerecognized in 2004 and the first half of 2005 should have been deferred untillater periods.  As a result ofsubsequently reviewing our revenue recognition policies and procedures, we additionallynoted that beginning in the fourth quarter of 2002 certain deferred softwarerevenue should have been fully recognized upon delivery or customer acceptancerather than ratably over a twelve-month period. We also have determined that an internal control deficiency existedrelated to the knowledge and application of revenue recognition methods inaccordance with U.S. generally accepted accounting principles.  Based on the impact of the aforementionedaccounting errors, we determined to restate our financial statements as of December 31,2004 and 2003 and for each of the years in the three-year period ended December 31,2004, as well as interim financial statements for the quarters ended March 31,2005 and June 30, 2005.  Ourrestated consolidated financial statements also include disclosure of restatedquarterly results for 2004 and 2003.

 

Management has determined that the internal controldeficiency that resulted in the aforementioned accounting errors is a materialweakness, as defined by the Public Company Accounting Oversight Board’sAuditing Standard No. 2.  We havedetermined that the material weakness was that we did not maintain adequate controls and procedures to ensurethat multi-element arrangements and related software revenue components wereaccounted for in accordance with generally accepted accounting principles.  The Public Company AccountingOversight Board has defined a material weakness as “a significant deficiency,or combination of significant deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected.” Management has reviewed theinternal control deficiency with our Audit Committee, has discussed it with ourindependent registered public accounting firm, KPMG LLP, and has advised ourAudit Committee that the deficiency is a material weakness in our internalcontrol over financial reporting.

 

**(a)   Conclusion Regarding the Effectiveness ofDisclosure Controls and Procedures**

 

The effectiveness of our orany system of disclosure controls and procedures is subject to certainlimitations, including the exercise of judgment in designing, implementing andevaluating the controls and procedures, the assumptions used in identifying thelikelihood of future events, and the inability to eliminate misconductcompletely. As a result, there can be no assurance that our disclosure controlsand procedures will detect all errors or fraud. By their nature, our, or any,system of disclosure controls and procedures can provide only reasonableassurance regarding management’s control objectives.

 

Under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, we evaluated the design and operation of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, or the “Exchange Act”)as of December 31, 2004. At the time of the initial filing of this report,on the basis of that evaluation, our management, including our Chief ExecutiveOfficer and Chief Financial Officer, concluded that our disclosure controls andprocedures were effective, to give reasonable assurance that the informationrequired to be disclosed by us in reports that we file under the Exchange Actis recorded, processed, summarized and reported within the time periodsspecified in the rules and forms of the SEC and to ensure that informationrequired to be disclosed in the reports filed or submitted under the ExchangeAct is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, in a manner that allows timelydecisions regarding required disclosure.

 

90

----

 

In light of the materialweakness in internal control over financial reporting referenced above, ourChief Executive Officer and Chief Financial Officer now have concluded that ourdisclosure controls and procedures were not effective at a reasonable assurancelevel as of December 31, 2004.

 

In response to this materialweakness, management performed additional analyses and other post-closingprocedures to ensure our restated consolidated financial statements wereprepared in accordance with generally accepted accounting principles.Accordingly, management, including our Chief Executive Officer and ChiefFinancial Officer, believes the restated consolidated financial statementsincluded in this report fairly present, in all material respects, our financialcondition, results of operations and cash flows for the periods presented.

 

**(b)   Changes in Internal Control Over FinancialReporting**

 

There were no changes in ourinternal control over financial reporting that occurred in the fourth quarterof 2004 that materially affected, or were reasonably likely to materiallyaffect, our internal control over financial reporting.

 

During October 2005, weimplemented the remedial measures outlined below to address the identifiedmaterial weakness in connection with the preparation of our restated financialstatements included in this Amendment No. 1 to Form 10-K for the yearended December 31, 2004.  We haverecently dedicated additional resources to the review of our control processesand procedures surrounding revenue recognition. Furthermore, we have been conducting a thorough review and evaluation ofour internal controls over revenue recognition as part of our compliance withthe requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

 

In order to remediate theweakness in our internal control over financial reporting, management hasimplemented the following measures as of the date of filing of this Amendment No. 1to Form 10-K:

 

•                  Enhanced our revenue recognition procedures byupdating our contract evaluation criteria and decision process flowcharts.  These evaluation and process updates were developedas a result of performing a thorough review of applicable accounting literaturerelated to revenue recognition, particularly EITF No. 00-21, “Accountingfor Revenue Arrangements with Multiple Deliverables.”

 

•                  Modified our revenue recognition procedureson software contracts requiring postcontractcustomer support in accordance with the guidelines of SOP 97-2, “SoftwareRevenue Recognition” and subsequent interpretations.

 

•                  Enhanced our revenue recognition proceduresto assure vendor-specific objective evidence is obtained to establish fairvalue for undelivered software elements prior to recognizing revenue.

 

•                  Implemented additional training for accountingpersonnel to enhance their understanding of the applicable revenue recognitionprinciples.

 

•                  Implemented additional training for our salespersonnel to enhance communications of pertinent revenue information to ouraccounting department that would impact accounting for agreements containing multipledeliverables.

 

**(c)    Management’s Report on Internal Control OverFinancial Reporting (as Restated)**

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Exchange Act Rule 13a-15(f).Under the supervision and with the participation of our management, includingour principal executive officer and principal financial officer, we conductedan evaluation of the effectiveness of our internal control over financialreporting based on the framework in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”). At the time of the initialfiling of this report, based on our evaluation under the framework in *Internal Control—Integrated*

 

91

----

 

*Framework,* ourmanagement concluded that our internal control over financial reporting waseffective as of December 31, 2004.

 

On September 23, 2005,the Company determined that it needed to restate its financial statements for2004 and the first half of 2005 to correct errors in accounting forrevenue.  Subsequent review proceduresalso identified the need for the Company to restate its financial statementsfor 2003 and 2002 to correct additional errors in accounting for revenue.  As a result of such financial statementrestatement, management reassessed the Company’s internal control overfinancial reporting using the COSO framework and identified a material weaknessin internal control over financial reporting as of December 31, 2004, asfollows:

 

•                  The Company did not have effective policiesand procedures, or personnel with sufficient technical knowledge of revenuerecognition principles, to ensure thatmulti-element arrangements and related software revenue components wereaccounted for in accordance with generally accepted accounting principles.  Specifically, the Company’s policiesand procedures did not provide for sufficient identification of contract terms,or concurrent transactions, that impact the timing of revenue recognition.

 

Asa result of this material weakness, the Company recognized a material amount of revenue in 2004 and thefirst half of 2005 that should have been deferred until later periods andimproperly deferred revenue recognition starting in the fourth quarter of 2002for certain software sales for which revenue should have been recognized upondelivery or customer acceptance.  Thismaterial weakness resulted in the restatement of the Company’s previouslyissued consolidated financial statements as of December 31, 2004 and 2003and for each of the years in the three-year period ended December 31,2004, and the financial information for each of the quarterly period in 2004and 2003.

 

As a result of theaforementioned material weakness in internal control over financial reporting,management has revised its previously reported assessment of the effectivenessof internal control over financial reporting and has concluded that, as of December 31,2004, the Company’s internal control over financial reporting was noteffective. A material weakness in internal control over financial reporting isa control deficiency (within the meaning of Auditing Standard No. 2 of thePublic Company Accounting Oversight Board, or PCAOB), or combination of controldeficiencies, that results in there being more than a remote likelihood that amaterial misstatement of the annual or interim financial statements will not beprevented or detected.

 

Our restated assessment ofthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2004 has been audited by KPMG LLP, an independentregistered public accounting firm, as stated in their auditors’ report which isincluded in Item 8 of this Form 10-K/A.

 

92

----

** **

**Item 9B. Other Information**

 

On December 30, 2004, the Board of Directorsapproved the Company’s 2005 Annual Incentive Plan (“AIP”).  The AIP is established each year to provide abonus to participants based on the Company’s achievement of annual corporateperformance goals.  Participants in theplan are recommended by management and approved by the Board of Directors andgenerally include the Company’s Chief Executive Officer, President and ChiefOperating Officer, Chief Financial Officer and other executive officers withmanagement authority over the corporate functions responsible for theachievement of the goals.  The bonusearned by each participant will be equal to a fixed percentage of theparticipant’s salary multiplied by the percentage of achievement of the annualcorporate performance goals, as determined by the Board of Directors.  The goals are based upon the following fourmetrics:  (i) revenue growth ascompared to industry growth, weighted 30%; (ii) profitability improvementover 2004; weighted 20%; (iii) orders derived from the front end of themicroelectronic manufacturing process, weighted 35%; and (iv) free cashflow, weighted 15%.  The bonus earned ispaid upon public release of the Company’s annual results.

 

**PART III**

 

**Item 10. Directors and Executive Officers of the Registrant**

 

TheCompany will furnish to the Securities and Exchange Commission a definitiveProxy Statement (the “Proxy Statement”) not later than 120 days after the closeof the year ended December 31, 2004. Other than “Executive Officers of the Registrant”, which is set forth atthe end of Part I of this Form 10-K, the information required by thisitem is incorporated herein by reference to the sections labeled “Election ofDirectors”, “Corporate Governance”, and “Compliance With Section 16(a) ofthe Exchange Act”, which appear in the Proxy Statement.

 

**Item 11. Executive Compensation**

 

Theinformation required by this item is incorporated herein by reference to thesections labeled “Executive Compensation” and “Election of Directors” in theProxy Statement.

 

93

----

 

**Item12.  Security Ownership of CertainBeneficial Owners and Management and Related Shareholder Matters**

 

Theinformation regarding security ownership of certain beneficial owners andmanagement is incorporated herein by reference to the section labeled “PrincipalShareholders and Management Shareholdings” in the Proxy Statement.

 

*Equity Compensation PlanInformation*

 

The following tableprovides information about shares of the Company’s Common Stock that may beissued under the Company’s equity compensation plans, as of December 31,2004:

 
| **Plan  Category**                                          | ** ** | **(a)  Number of securities to be  issued upon exercise of  outstanding options** | ** ** | **(b)  Weighted average exercise  price of outstanding  options** | ** ** | **(c)  Number of securities remaining available for  future issuance under equity compensation  plans (excluding securities reflected in  column (a))** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |       |                                                                              |       |                                                              |       |                                                                                                                                                    |       |
| Equity  compensation plans approved by security holders (1) |       | 1,964,313                                                                         |       | $                                                                 | 9.54       |                                                                                                                                                    | 1,200,093  | (2) |
|                                                        |       |                                                                              |       |                                                              |       |                                                                                                                                                    |       |
| Equity  compensation plans not approved by security holders |       | —                                                                            |       | —                                                            |       | —                                                                                                                                                  |       |
|                                                        |       |                                                                              |       |                                                              |       |                                                                                                                                                    |       |
| Total                                                       |       | 1,964,313                                                                         |       | $                                                                 | 9.54       |                                                                                                                                                    | 1,200,093  |   |

 

----

(1) Includes options under theAugust Technology 1997 Stock Incentive Plan.

(2) Includes218,884 shares available for issuance under the August Technology 2000Employee Stock Purchase Plan.

 

**Item 13. Certain Relationships and Related Transactions**

 

None

 

**Item 14. Principal Accountant Fees and Services**

 

Theinformation required by this item is incorporated herein by reference to the section labeled“Ratification of Independent Registered Public Accounting Firm” in the ProxyStatement.

 

94

----

** **

**PART IV**

** **

**Item 15. Exhibits and Financial Statement Schedules**

 

**(a)****           FinancialStatements.**  The following financialstatements are included in Part II, Item 8 of this Form 10-K/A:

 

Reports of IndependentRegistered Public Accounting Firm

 

Consolidated Balance Sheets as of December 31,2004 and 2003

 

ConsolidatedStatements of Operations for the Years Ended December 31, 2004, 2003 and2002

 

ConsolidatedStatements of Shareholders’ Equity for the Years Ended December 31, 2004,2003 and 2002

 

ConsolidatedStatements of Cash Flows for the Years Ended December 31, 2004, 2003 and2002

 

Notes to Consolidated Financial Statements

 

**(b)****           FinancialStatement Schedules.**  The following schedule isincluded following the signature page of this Form 10-K/A:

 

Schedule II - Valuation and Qualifying Accounts.

 

Allother schedules are omitted since they are not applicable, not required or theinformation is presented in the consolidated financial statements or relatednotes.

 

**(c)****           Exhibits**.

 

Theexhibits included in this report are set forth on the “Exhibit Index to Form 10-K/A”following the signature page of this Form 10-K/A.

 

95

----

 

SIGNATURES

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|                         | AUGUST TECHNOLOGY CORPORATION |
|------------------------------|------------------------------------|
|                         |                               |   |
|                         | By:                                | /s/ JEFF L.  O’DELL |   |
|                         |                               | Jeff L. O’Dell |   |
|                         |                               | *Chief  Executive Officer* |   |
| Date:  November 9, 2005 |                               | *(Principal Executive Officer)* |

 

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated below.

 

Each person whose signature appears below constitutesand appoints Jeff L. O’Dell and Stanley D. Piekos as the undersigned’s true andlawful attorneys-in fact and agents, each acting alone, with full power ofsubstitution and resubstitution, for the undersigned and in the undersigned’sname, place and stead, in any and all amendments to this Form 10-K/A andto file the same, with all exhibits thereto, and other documents in connectiontherewith, with the Securities and Exchange Commission, granted unto saidattorney’s-in-fact and agents, each acting alone, full power and authority todo and perform each and every act and thing requisite and necessary to be donein and about the premises, as fully to all intents and purposes as theundersigned might or could do in person, hereby ratifying and confirming allsaid attorneys-in-fact and agents, each acting alone, or his substitute orsubstitutes, may lawfully do or cause to be done by virtue thereof.

 
| **Signature**            | ** ** | **Title** | ** **                                   | **Date** | ** **            |
|--------------------------|------------|-----------|----------------------------------------------|----------|-----------------------|
|                     |       |      |                                         |     |                  |
| /s/ JEFF L.  O’DELL |       |      | Chairman of the  Board and                   |     | November 9, 2005 |   |
|                     |       |      |   Chief  Executive Officer         |     |                  |   |
|                     |       |      |   (Principal  Executive Officer)   |     |                  |   |
|                     |       |      |                                         |     |                  |   |
| /s/ LYNN J.  DAVIS       |       |      | Director,  President and                     |     | November 9, 2005 |   |
|                     |       |      |   Chief  Operating Officer         |     |                  |   |
|                     |       |      |                                         |     |                  |   |
| /s/ STANLEY D.  PIEKOS   |       |      | Chief Financial  Officer                     |     | November 9, 2005 |   |
|                     |       |      |   (Principal  Financial and        |     |                  |   |
|                     |       |      |     Accounting  Officer) |     |                  |   |
|                     |       |      |                                         |     |                  |   |
| /s/ JAMES A.  BERNARDS   |       |      | Director                                     |     | November 9, 2005 |   |
|                     |       |      |                                         |     |                  |   |
| /s/ ROGER E.  GOWER      |       |      | Director                                     |     | November 9, 2005 |   |
|                     |       |      |                                         |     |                  |   |
| /s/ MICHAEL W.  WRIGHT   |       |      | Director                                     |     | November 9, 2005 |   |
|                     |       |      |                                         |     |                  |   |
| /s/ LINDA HALL  WHITMAN  |       |      | Director                                     |     | November 9, 2005 |   |

 

96

----

 

**Schedule II Valuation andQualifying Accounts**

** **

**VALUATION AND QUALIFYING ACCOUNTS**

**FOR THE THREE YEARS ENDED DECEMBER 31, 2004, 2003 AND2002**

**(In thousands)**

 
| **Description**                  | ** ** | **Date**                           | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Charged to  Other  Accounts** | ** ** | **Deductions (a)** | ** ** | **Balance at  End of  Period** | ** ** |
|----------------------------------|------------|------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|---------------------------------|------------|--------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | ** **                         | ** ** | ** **                           | ** ** | ** **                          | ** ** | ** **                      | ** ** | ** **         | ** ** | ** **                     | ** ** |
| Allowance for  doubtful accounts |       | Year ended  December 31, 2002 |       | $                                    | 402        |                                | $          | 148                             |       | $                  | —     |                           | $          | — |   | $ | 550 |   |
|                             |       | Year ended  December 31, 2003 |       | 550                                  |       | 195                                 |       | —                          |       | (190               | )          | 555                            |       |
|                             |       | Year ended  December 31, 2004 |       | 555                                  |       | 135                                 |       | —                          |       | —             |       | 690                            |       |
|                             |       |                               |       |                                 |       |                                |       |                            |       |               |       |                           |       |
| Inventory  Valuation allowance   |       | Year ended  December 31, 2002 |       | $                                    | 193        |                                | $          | 229                             |       | $                  | —     |                           | $          | (141 | ) | $ | 281 |   |
|                             |       | Year ended  December 31, 2003 |       | 281                                  |       | 494                                 |       | —                          |       | (250               | )          | 525                            |       |
|                             |       | Year ended  December 31, 2004 |       | 525                                  |       | 1,838                               |       | —                          |       | (734               | )          | 1,629                          |       |

 

----

(a) Representswrite-offs of uncollectible accounts receivable and inventory.

 

97

----

# ** **

# **SECURITIES AND EXCHANGE COMMISSION**

Washington, D.C.  20549

 

EXHIBIT INDEXTO FORM 10-K/A

 
| For the fiscal  year ended: |   | Commission File  No.: 000 - 30637 |
|-----------------------------|--------|-----------------------------------|
| December 31,  2004     |   |                              |

 

 

AUGUST TECHNOLOGY CORPORATION

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                            |
|-------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **              | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                 |
| 2.1                     |       | Agreement and  Plan of Merger and Reorganization by and among Nanometrics Incorporated,  Major League Corporation, Minor League Merger Corporation and  August Technology Corporation dated January 21, 2005 (incorporated  by reference to Exhibit 2.1 to the Company’s Current Report on  Form 8-K dated January 21, 2005) |
|                    |       |                                                                                                                                                                                                                                                                                                                                                       |
| 2.2                     |       | Form of  Voting Agreement by and between August Technology Corporation and  certain shareholders of Nanometrics Incorporated (incorporated by reference  to Exhibit 2.2 to the Company’s Current Report on Form 8-K dated  January 21, 2005)                                                                                 |
|                    |       |                                                                                                                                                                                                                                                                                                                                                       |
| 2.3                     |       | Form of  Voting Agreement by and between Nanometrics Incorporated and certain  shareholders of August Technology Corporation (incorporated by reference  to Exhibit 2.3 to the Company’s Current Report on Form 8-K dated  January 21, 2005)                                                                                 |
|                    |       |                                                                                                                                                                                                                                                                                                                                                       |
| 3.1                     |       | Amended and  Restated Articles of Incorporation of the Company (incorporated by reference  to Exhibit 3.1 to the Company’s Registration Statement on Form S-1,  Reg. No. 333-32692)                                                                                                                                                    |
|                    |       |                                                                                                                                                                                                                                                                                                                                                       |
| 3.2                     |       | Amended and  Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2  to the Company’s Registration Statement on Form S-1, Reg.  No. 333-32692)                                                                                                                                                                       |
|                    |       |                                                                                                                                                                                                                                                                                                                                                       |
| 4.1                     |       | Instruments  defining the rights of security holders, including indentures (reference is  made to Exhibits 3.1 and 3.2)                                                                                                                                                                                                                                    |
|                    |       |                                                                                                                                                                                                                                                                                                                                                       |
| 4.2                     |       | Form of  Stock Certificate (incorporated by reference to Exhibit 4.2 to the  Company’s Registration Statement on Form S-1, Reg. No. 333-32692)                                                                                                                                                                                    |
|                    |       |                                                                                                                                                                                                                                                                                                                                                       |
| 10.1                    |       | 1997 Stock  Incentive Plan, as amended and restated through February 4, 2004  (incorporated by reference to the Appendix to the Company’s Proxy Statement  for its 2004 Annual Shareholders Meeting filed on March 11, 2004)**                                                                                                              |

 

98

----

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                |
|-------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **              | ** ** | ** **                                                                                                                                                                                                                                                                                     |
| 10.2*                   |       | Forms of  Incentive Stock Option Agreement and Non-Statutory Stock Option Agreement  currently used under the 1997 Stock Incentive Plan**                                                                                                                                                      |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.3*                   |       | Form of  Restricted Stock Agreement currently used under the 1997 Stock Incentive  Plan**                                                                                                                                                                                                 |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.4                    |       | August Technology  2000 Employee Stock Purchase Plan (incorporated by reference to  Exhibit 10.17 to the Company’s Registration Statement on Form S-1,  Reg. No. 333-32692)**                                                                                         |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.5                    |       | Amendment to  August Technology 2000 Employee Stock Purchase Plan, dated  February 8, 2002 (incorporated by reference to Exhibit 10.2 to the  Company’s Form 10-Q for the quarter ended June 30, 2002)**                                                         |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.6                    |       | 1998 Board of  Directors Compensation Plan, adopted by the Board of Directors, amended and  restated as of July 29, 2003 (incorporated by reference to  Exhibit 10.2 to the Company’s Form 10-Q for the quarter ended  June 30, 2003)**                               |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.7                    |       | International  Distributor Agreement between the Company and Marubeni Solutions Corporation  dated June 14, 1999 (incorporated by reference to Exhibit 10.2 to  the Company’s Registration Statement on Form S-1, Reg.  No. 333-32692)                                |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.8                    |       | Office Warehouse  Lease Agreement between the Company and West 78th Street, Bloomington  Associates, LLC, dated October 18, 1999 (incorporated by reference to  Exhibit 10.9 to the Company’s Registration Statement on Form S-1,  Reg. No. 333-32692)                |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.9                    |       | Amendments to  the Lease Agreement between the Company and West 78th Street,  Bloomington Associates, LLC, dated March 31, 2000 and July 25, 2000  (incorporated by reference to Exhibit 10.22 to the Company’s  Form 10-K for the year ended December 31, 2000) |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.10                   |       | Amendment to the  Lease Agreement between the Company and West 78th Street,  Bloomington Associates, LLC, dated June 18, 2001 (incorporated by  reference to Exhibit 10.32 to the Company’s Form 10-K for the year  ended December 31, 2001)                          |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.11                   |       | Fourth Amendment to Lease Agreement  between the Company and West 78th Street, Bloomington Associates, LLC dated  February 28, 2003 (incorporated by reference to Exhibit 10.38 to  the Company’s Registration Statement on Form S-3, Reg.  No. 333-108106)           |
|                    |       |                                                                                                                                                                                                                                                                                           |
| 10.12                   |       | Fifth Amendment  to Lease Agreement between the Company and 4900 West 78th Street LLC, dated  May 27, 2004 (incorporated by reference to Exhibit 10.1 to the  Company’s Form 10-Q for the quarter ended June 30, 2004)                                                |

 

99

----

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                               |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **              | ** ** | ** **                                                                                                                                                                                                                                    |
| 10.13*                  |       | Sixth Amendment  to Lease Agreement between the Company and 4900 West 78th Street LLC, dated  October 27, 2004                                                                                                                           |
| 10.14                   |       | Lease Agreement  between the Company and 190/STI, L.P. dated March 3, 2003 (incorporated  by reference to Exhibit 10.39 to the Company’s Registration Statement on  Form S-3, Reg. No. 333-108106)                   |
|                    |       |                                                                                                                                                                                                                                          |
| 10.15                   |       | OEM Agreement  between the Company and Santok Software Solutions Inc., dated January 26,  2000 (incorporated by reference to Exhibit 10.15 to the Company’s  Registration Statement on Form S-1, Reg. No. 333-32692) |
|                    |       |                                                                                                                                                                                                                                          |
| 10.16                   |       | Executive  Employment Contract between the Company and D. Mayson Brooks, dated  March 5, 2002 (incorporated by reference to Exhibit 10.28 to the  Company’s Form 10-K for the year ended December 31, 2001)**        |
|                    |       |                                                                                                                                                                                                                                          |
| 10.17                   |       | Executive  Employment Contract between the Company and Jeff L. O’Dell, dated  March 6, 2002 (incorporated by reference to Exhibit 10.22 to the  Company’s Form 10-K for the year ended December 31, 2001)**     |
|                    |       |                                                                                                                                                                                                                                          |
| 10.18                   |       | Executive  Employment Contract between the Company and David Klenk, dated March 6,  2002 (incorporated by reference to Exhibit 10.24 to the Company’s  Form 10-K for the year ended December 31, 2001)**             |
|                    |       |                                                                                                                                                                                                                                          |
| 10.19                   |       | Executive  Employment Contract between the Company and Scott A. Gabbard, dated  July 11, 2002 (incorporated by reference to Exhibit 10.1 to the  Company’s Form 10-Q for the quarter ended September 30, 2002)**     |
|                    |       |                                                                                                                                                                                                                                          |
| 10.20                   |       | Executive  Employment Contract between the Company and Stanley Piekos, dated  April 7, 2003 (incorporated by reference to Exhibit 10.1 to the  Company’s Form 10-Q for the quarter ended March 31, 2003)**           |
|                    |       |                                                                                                                                                                                                                                          |
| 10.21                   |       | Executive Employment Contract between  the Company and Cory Watkins, dated February 5, 2004 (incorporated by  reference to Exhibit 10.36 to the Company’s Form 10-K for the year  ended December 31, 2003)**         |
|                    |       |                                                                                                                                                                                                                                          |
| 10.22*                  |       | Executive Employment Contract between  the Company and Jeffrey Nelson, dated January 17, 2005**                                                                                                                                          |
|                    |       |                                                                                                                                                                                                                                          |
| 10.23                   |       | Code of Ethics,  dated February 7, 2003 (incorporated by reference to Exhibit 10.35  to the Company’s Form 10-K for the year ended December 31, 2002)                                                                |
|                    |       |                                                                                                                                                                                                                                          |
| 10.24*                  |       | August Technology  2005 Annual Incentive Plan**                                                                                                                                                                                          |
|                    |       |                                                                                                                                                                                                                                          |
| 21.1*                   |       | Subsidiaries of  the Company                                                                                                                                                                                                                  |
|                    |       |                                                                                                                                                                                                                                          |
| 23.1***                 |       | Consent of  Independent Registered Public Accounting Firm                                                                                                                                                                                     |
|                    |       |                                                                                                                                                                                                                                          |
| 31.1***                 |       | Certification  pursuant to Exchange Act Rules 13a-14(a) of the Chief Executive  Officer                                                                                                                                             |

 

100

----

 
| **Exhibit Number** | ** ** | **Description**                                                                                                |
|-------------------------|------------|----------------------------------------------------------------------------------------------------------------|
| ** **              | ** ** | ** **                                                                                                     |
| 31.2 ***                |       | Certification  pursuant to Exchange Act Rules 13a-14(a) of the Chief Financial  Officer              |
|                    |       |                                                                                                           |
| 32.1 ***                |       | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to the  Sarbanes-Oxley Act of 2002 |

 

----

 *     Previously filed with the Original Filing

**    Management contract or compensatory plan orarrangement

***  Filed herewith

 

101

----