**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**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 Registrantas 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 telephonenumber, including area code)

**Securities registered pursuant to Section 12(b) ofthe Act:**None

**Securities registered pursuant to Section 12(g) ofthe Act:**

|                             | **Title of each class:** | ** ** |
|-----------------------------|--------------------------|------------|
| Common Stock, no  par value |

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes xNo o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the Registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis form 10-K or any amendment to this form 10-K. o

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2). Yes xNo o

The aggregate market value of voting stock held bynonaffiliates of the Registrant was $208,386,572 as of June 30, 2004.

The number of shares of Common Stock, no par value, outstandingas of February 28, 2005 was 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.

 

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**AUGUST TECHNOLOGY CORPORATIONFORM 10-KTABLE OF CONTENTSFOR THE YEAR ENDED DECEMBER 31, 2004**
|                                       | **Description**                                                                                             | ** ** | ** ** | ** ** | **Page** | ** ** |
|---------------------------------------|-------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|
| **PART I**                       |                                                                                                        |
| Item 1.                               | Business                                                                                                    | 3          |       |
| Item 2.                               | Properties                                                                                                  | 14         |       |
| Item 3.                               | Legal Proceedings                                                                                           | 14         |       |
| Item 4.                               | Submission of Matters to a Vote of  Security Holders                                                        | 15         |       |
| Executive Officers of the  Registrant | 15                                                                                                          |       |
| **PART II**                      |                                                                                                        |
| Item 5.                               | Market for Registrant’s Equity,  Related Shareholder Matters and Issuer Purchases of Equity Securities | 17         |       |
| Item 6.                               | Selected Financial Data                                                                                     | 18         |       |
| Item 7.                               | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                 | 19         |       |
| Cautionary Statements                 | 29                                                                                                          |       |
| Item  7A.                             | Quantitative and Qualitative  Disclosures about Market Risk                                                 | 41         |       |
| Item  8.                              | Financial  Statements and Supplementary Data                                                                | 42         |       |
| Item  9.                              | Changes  in and Disagreements With Accountants on Accounting and  Financial Disclosure                      | 73         |       |
| Item 9A.                              | Controls and  Procedures                                                                                    | 73         |       |
| Item 9B.                              | Other Information                                                                                           | 73         |       |
| **PART III**                     |                                                                                                        |
| Item  10.                             | Directors  and Executive Officers of the Registrant                                                         | 74         |       |
| Item 11.                              | Executive Compensation                                                                                      | 74         |       |
| Item  12.                             | Security  Ownership of Certain Beneficial Owners and Management and Related Shareholder  Matters            | 74         |       |
| Item  13.                             | Certain  Relationships and Related Transactions                                                             | 74         |       |
| Item  14.                             | Principal  Accountant Fees and Services                                                                     | 74         |       |
| **PART IV**                      |                                                                                                        |
| Item  15                              | Exhibits  and Financial Statement Schedules                                                                 | 75         |       |
| Signatures                            | 76                                                                                                          |       |
| Schedule  II                          | Valuation  and Qualifying Accounts                                                                          | 77         |       |
| Exhibits                              | 78                                                                                                          |       |
|                                       |                                                                                                             |            |            |            |          |            |  |

 

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**PART I**

**Item 1**.                        Business

**Company Overview**

Since our founding in 1992, we have become recognizedas a world-class provider of automated defect detection and productcharacterization systems for microelectronic device manufacturers. Our systemsprovide these manufacturers with information that enables process-enhancingdecisions, ultimately lowering manufacturing costs, improving time-to-marketand enhancing the performance of their products. We combine our corecompetencies in machine vision technology, optics, lighting and precisionmotion 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 address theautomated inspection needs of the early stages of the final manufacturing orback-end of the microelectronic device manufacturing process. These needs weremet primarily with our NSX Series and 3Di Series of products. In2003, we introduced the AXi Series for frontside advanced macro detectionin the front-end of the wafer manufacturing process and within one year, weadded the E20 for wafer edge inspection and the B20 for wafer backsideinspection. When used in combination the AXi/E20/B20 is the industry’s firsttrue all-surface advanced macro inspection solution allowing devicemanufacturers to inspect the top, edge and bottom of a wafer’s surface. Wecomplement this broad inspection capability with an expanding suite of softwaretools designed to enhance the speed and effectiveness of the process by whichdevice manufacturers analyze defects and make decisions regarding theirmanufacturing process to reduce or eliminate such defects. We refer to thisprocess as the “detection-to-decision” process.

In addition to internal development, we look to expandthrough strategic acquisitions of complementary products and technologies. In July of2004 we completed the acquisition of DMSVision, a third generation defect datamanagement solution developed and commercialized by Inspex, a U.S. companyowned by Photonics Management Company, a U.S. subsidiary of Hamamatsu PhotonicsKK 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 an Agreementand 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 theMerger Agreement (a) Nanometrics will effect a reincorporation underDelaware law by merging with and into Merger Sub 2, a Delaware corporation,with the surviving entity to be renamed August Nanometrics Inc. (“August Nanometrics”)and (b) Merger Sub 1 will be merged with and into August Technology,with the surviving entity to be a wholly-owned subsidiary of August Nanometrics.Each share of our common stock will be converted into the right to receive0.6401 of a share of August Nanometrics common stock. August Nanometricswill make a 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 

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stock on January 27,2005). The letter stated that each of our shareholders may elect to receive allcash, stock or a combination of cash and stock, subject to proration based ontotal cash consideration of $40 million.

Also on January 27, 2005, Rudolph issued a pressrelease with proposed terms slightly different from those described in theletter. The press release stated that Rudolph is prepared to enter into amerger with us whereby each of our shareholders will receive the value of $2.16per share in cash and 0.4955 per share in Rudolph common stock (equivalent to$10.50 per share of our Common Stock, based on the closing price of Rudolphstock on January 27, 2005). The press release stated that each of ourshareholders would have the option to elect to receive all cash, stock or acombination of cash and stock, subject to proration based on total cashconsideration of $40 million.

Our Board of Directors has agreed, based on the adviceof its financial advisors and legal counsel, to further examine the Rudolphoffer provided that Rudolph first executes a confidentiality agreement in theform required by the Merger Agreement with Nanometrics. As of the date of thisfiling, we have not reached agreement on the form of confidentiality agreementand no discussions regarding 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 with us. Theletter stated that KLA proposed to acquire us in a transaction in which ourshareholders would receive $11.50 per share. KLA also stated that it would bewilling to consider using stock as consideration.

Our Board of Directors hasagreed, based on the advice of its financial advisors and legal counsel, tofurther examine the KLA offer provided that KLA first executes aconfidentiality agreement in the form required by the Merger Agreement withNanometrics. As of the date of this filing, we have not reached agreement onthe form of confidentiality agreement and no discussions regarding KLA’s offerhave taken place.

**Our Market**

Rapid advances in semiconductor and othermicroelectronic device technology, including miniaturization, increasingcomplexity and advanced packaging and interconnect solutions, allowmanufacturers to enhance the quality and capabilities of their devices. Theseadvances often increase the complexity of the processes required to produce thedevices as well as the associated production costs. Because of these increasedcosts and the need to ensure that performance and reliability are notsacrificed, the role of inspection and rapid detection of defects duringmultiple stages of the microelectronic production process is becoming increasinglycritical. Defects can occur throughout the manufacturing process as a result ofsuch things as equipment misalignment, contamination, residue, corrosion, orthe misapplication of various films. Defects such as scratches, cracks andchip-outs also can be generated by mechanical handling in the manufacturingprocess.

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 fatigue and boredom result in typical efficacyof human inspectors at about 50% compared with in excess of 90% consistency forautomated machine vision systems. As a result, it has been ineffective and cost-prohibitivefor manufacturers to capture critical process data by inspecting manually everywafer and die after each process step. These manual inspection limitationsresult in the following:

***Yield loss due to alack of process data.*  **Theinability to capture adequate data throughout the manufacturing processprevents microelectronic device manufacturers from locating problems on atimely 

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basis and takingcorrective action. Timely corrective action could minimize the scrapping ofvaluable wafers and improve the 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 must either add more technicians, significantlyimpacting productivity of the microelectronic fabrication facility, or assume agreater risk of defects remaining 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 labor andfacility requirements.*  **Thelarge number of technicians and microscopes needed to manually inspectmicroelectronic devices requires valuable floor space and significant capitalcommitments. In addition, attracting and retaining qualified technicians hasbecome increasingly difficult.

Automated inspectionsystems and data management and analysis software enable manufacturers toovercome these limitations by allowing them to inspect 100% of their productsand consistently identify and resolve defects at various stages of the manufacturingprocess, helping to drive down production costs, increase throughput anddecrease time-to-market.

**Our Solutions**

We deliver automated advanced macro defect inspection,metrology, and analysis systems for microelectronic industries. Our systemsprovide device manufacturers with valuable information about their products andprocesses, at speeds that make it practical to inspect each device rather thana small sample. We accomplish this by combining our core competencies inmachine vision technology, optics, lighting and precision motion control withour proprietary software and extensive microelectronic-specific applicationsexperience to provide cost-effective solutions. We offer our systems at severalprice performance levels to satisfy our customers’ diverse requirements.Specifically, we provide:

***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. Incomparison, depending on the application, our systems can inspect a complex dieapproximately 100 times faster than a human operator.

***Data collection toenable higher productivity and yields.*  **Our systems enable microelectronic devicemanufacturers to cost-effectively collect and process defect data at multiplekey points throughout the production process and provide manufacturers with theinformation required to improve their production processes and yields.Integrated reporting and analysis tools allow manufacturers to extract criticalinformation about product defects, including location, size and other importantdefect characteristics.

***Scalable, modularinspection 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 expertapplication development resources.*  **Our advanced application engineers and design expertswork collaboratively with our customers to optimize the use of inspection intheir manufacturing 

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process. This reducestheir process development time and costs. We have field application engineersin strategic locations throughout the world to work with our customers on-siteand provide the knowledge and expertise to deliver a total 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 metrologyapplications. This allows us to most effectively concentrate our resources ondelivering leading solutions to these 0.5 micron and larger applications. Asour business continues to grow we will expand our focus to include other areasof inspection and metrology that are complimentary to our existing advancedmacro inspection business.

**Our Strategy**

Our strategy is built around achieving our vision todominate the automated inspection market and generate complete productcharacterization solutions for evolving microelectronic markets in order todrive down costs and time-to-market for our customers. We have identified fivestrategic initiatives that are critical to successfully implementing ourvision:

***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 followingtable represents our net revenues for the years ended December 31, 2004and 2003 from each of the microelectronic markets we serve.
| ** **                       | ** ** | **2004**                | ** ** | **2003**          | ** **   | ** **                                        | ** **   |
|----------------------------------|------------|-------------------------|------------|-------------------|--------------|---------------------------------------------------|--------------|
| **Microelectronic Market**  | ** ** | ** **              | ** ** | **Net  Revenues** | ** **   | **Percent of total  net revenues** | ** **   | **Net Revenues** | ** ** | **Percent of total  net revenues** | ** ** | **Year-over-  year  change** | ** ** |
| ** **                       | ** ** | **(in thousands)** | ** ** | ** **        | *** *** | **(in thousands)**                           | *** *** | *** *** | *** *** | *** *** | *** *** |
| Semiconductor                    |       |                    | $          | 51,779            |         |                                              |         | 76 | % |   |   | $ | 17,595 |   |   |   | 44 | % |   |   | 194 | % |   |
| Advanced  packaging applications |       |                    | 8,430      |              |         |                                              | 12           | % |   |   | 15,772 |   |   |   | 39 | % |   |   | -47 | % |   |
| Optoelectronics                  |       |                    | 5,846      |              |         |                                              | 8            | % |   |   | 2,581 |   |   |   | 6 | % |   |   | 127 | % |   |
| MEMS                             |       |                    | 1,830      |              |         |                                              | 3            | % |   |   | 2,775 |   |   |   | 7 | % |   |   | -34 | % |   |
| Data  Storage & other   |       |                    | 558        |              |         |                                              | 1            | % |   |   | 1,600 |   |   |   | 4 | % |   |   | -65 | % |   |
| Total                            |       |                    | $          | 68,443            |         |                                              |         |   |   |   |   | $ | 40,323 |   |   |   |   |   |   |   | 70 | % |   |
|                                  |            |                         |            |                   |              |                                                   |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***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 first AXi/E20/B20 all-surface advanced macro defectinspection system during the fourth quarter of 2004. These products continue topropel us into the front-end of the microelectronic device manufacturingprocess by addressing advanced macro inspection needs.

In 2004, 43% of our revenues were derived fromproducts and solutions introduced during the prior two years. We plan tocontinue making significant investments in research and development to maintainand extend our technology leadership.

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***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 development program, which was critical in thecommercialization of our AXi Series, with one of the top ten semiconductormanufacturers in the world. This program is continuing to aid in our penetrationinto front-end wafer processing applications.

***Global presence.*  **We continually maintainand 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 directsales and service personnel and independent distributors located strategicallyin Singapore, Europe and Japan. Our support services include web-based servicecapability and 24-hour global support.

***External growth.*  **We increase and enhance our growth opportunitiesthrough external sources, including acquisitions, collaborations, licensing andjoint ventures. We completed the acquisition of DMSVision in July 2004. Wecontinue to examine potential acquisitions that will provide us with additionalproducts, technological expertise, or sales and service capabilities. Theacquisition of DMSVision expands our data analysis capabilities and bringsaccess to key customers and technology. We are also active in industry collaborations,such as the Advanced Packaging and Interconnect Alliance (“APiA”) and the DieProducts Consortium (“DPC”). The APiA is focused on enhancing productivity andprocess solutions for advanced packaging. The DPC is a collaboration of leadingchip manufacturers and equipment suppliers promoting improved die productquality and manufacturing processes. We believe that organizations such asthese will enable us to build stronger relationships with industry leaders andincrease our market opportunity by driving the need for advanced automatedinspection products.

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**Our Products**

Westrive to be early to market with innovative defect inspection and reviewsolutions to emerging microelectronic device manufacturing needs. In 1997, weintroduced the NSX Series, our first automated defect inspection system forfinal manufacturing, and since then have maintained leadership of that marketsegment. In 2003, we introduced inspection technology to address the front-endof the microelectronic device manufacturing process with the introduction ofthe AXi Series. We also introduced the E20 for edge inspection and the B20 forbackside inspection allowing inspection of the entire surface of a wafer. Alsoin 2003, we introduced the VersaScope, a semi-automated, microscope-based,defect review system. In 2004 we added enhancements to our NSX Series, AXi Series andall-surface capabilities. The following table summarizes the primary attributesof our products:
|               | ** ** | ** ** | ** ** | ** **                                                                                                                | ** ** | **Applications**  |
|---------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| ** **    | ** ** | ** ** | ** ** | ** **                                                                                                                | ** ** | **Front-End**     | ** ** | ** ** |
| **Product**   | ** ** | ** ** | ** ** | **Introduced**                                                                                                            | ** ** | **Functionality** | ** ** | **Fab** | ** ** | **Outgoing Quality  Control** | ** ** | **Final  Manufacturing** |
| AXi Series    |       | 2003       |       | ·   Advanced  detection of defects >0.5 micron                                                          |       | X                 |   | X |   |   |
|               |       |       |       | ·   Inspection of  patterned and unpatterned wafers                                                        |       |              |   |   |   |   |
|               |       |       |       | ·   In line,  high-speed, 100% inspection                                                                  |       |              |   |   |   |   |
|               |       |       |       | ·   Full color  review                                                                                     |       |              |   |   |   |   |
| E20           |       | 2003       |       | ·   2D defect detection of the wafer’s edge                                                           |       | X                 |   | X |   | X |
|          |       |       |       | ·   Metrology of  edge features                                                                            |       |              |   |   |   |   |
| B20           |       | 2003       |       | ·   2D defect detection of the wafer’s backside                                                       |       | X                 |   | X |   | X |
| NSX Series    |       | 1997       |       | ·   Fully automated defect detection >0.5  micron                                                       |       |              |   | X |   | X |
|          |       |       |       | ·   2D wafer,  die & bump inspection                                                              |       |              |   |   |   |   |
|          |       |       |       | ·   In line,  high-speed, 100% inspection                                                                  |       |              |   |   |   |   |
| 3Di Series    |       | 2001       |       | ·   2D & 3D wafer bump  inspection & metrology system                                    |       |              |   | X |   | X |
|               |       |       |       | ·   In line,  high-speed, 100% inspection                                                                  |       |              |   |   |   |   |
| VersaScope(1) |       | 2003       |       | ·   Advanced imaging microscope-based system                                                               |       | X                 |   |   |   |   |
|          |       |       |       | ·   Harmony  review and classification system                                                              |       |              |   |   |   |   |
| Yield*Pilot*  |       | 2000       |       | ·   Tool-centric defect and metrology review  and analysis software used with the NSX, 3Di, and AXi Series |       | X                 |   | X |   | X |
|               |       |       |       | ·   Reduces  defect review time                                                                            |       |              |   |   |   |   |
|               |       |       |       | ·   Allows  offline defect review                                                                          |       |              |   |   |   |   |
| DMSVision(2)  |       | 1994       |       | ·   Fabwide software for archival and retrieval  of process related data                                   |       | X                 |   | X |   |   |
|          |       |       |       | ·   Facilitates  root cause analysis, yield enhancement and yield learning                                 |       |              |   |   |   |   |
| CV Series     |       | 1993       |       | ·   Verification of critical wafer carrier  dimensions                                                     |       | X                 |   |   |   |   |
|               |            |            |            |                                                                                                                           |            |                   |  |  |  |  |  |  |

 

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(1)      Acquired with the acquisition of CounterpointSolutions, Inc. in July 2003.

(2)      Acquired with the acquisition of DMSVision inJuly 2004.

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***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. In2004, we introduced the AXi-935 for higher throughput 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, including anAXi, E20 and B20 shipped in December 2004 for evaluation and testing byone of the world’s leading device manufacturers. We have several additionalall-surface systems scheduled for shipment and installation at variouscustomers during the first half of 2005.

Revenues from all surface inspection systemsrepresented 20%, 12% and 0% of our net revenues during 2004, 2003 and 2002,respectively.

***E20******—Automated wafer edge inspection andmetrology systems.***   In July 2003, we introduced theE20 for wafer edge inspection and metrology, which inspects for chip-outs,cracks, delamination, residual resist, particles and other defects that occuralong the edge of the wafer. The E20 also automatically performs metrology ofkey edge features and is designed for deployment at several locationsthroughout the fab. For example, automated edge inspection, implemented duringthe lithography process, will identify wafer edge variations and particlesearly and allow for possible wafer rework that can increase yields and reducemanufacturing costs. Due to the increase in edge area and wafer stress levelsin 300mm wafer processing, the value of wafer edge inspection is magnified. TheE20 also incorporates our latest user-interface platform, making the systemeasy to set up and run in production.

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

***B20—Automated wafer backsideinspection and metrology system.  ***In December 2003we introduced the B20 or wafer backside inspection, completing the “all-surface”inspection portfolio of products. The B20 detects backside defects such ascracks and particles which may negatively impact further processing of thewafer and cause wafer breakage later in the process. 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.  ***Webecame pioneers of automated macro defect inspection in 1997 with theintroduction of our NSX Series. These flexible automated wafer and die defectinspection systems deliver high-speed, consistent, reliable defect detection tomicroelectronic device manufacturers. As a replacement for the human eye in theinspection process, the NSX Series significantly improves the quality andthroughput of the inspection process, leading to lower overall manufacturingcosts.

The NSX Series is driven by proprietary softwareand 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 NSXsystems are installed in a broad array of processing steps from front end waferprocess applications to final manufacturing steps.

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In 2004 the WAV Series probe mark inspection andmetrology capabilities were incorporated into the NSX Series. This resulted ina comprehensive wafer and die inspection solution for use throughout the finalmanufacturing processes, including following the electrical probing process.

Revenues from the NSX Series represented 54%, 50%and 45% of our net revenues in 2004, 2003 and 2002, respectively.

***3DiSeries—Automated wafer bump inspection and metrology systems.  ***Our3Di automated inspection and metrology systems provide two-dimensional (“2D”)and three-dimensional (“3D”) inspection and metrology capabilities designed forthe latest and most advanced microelectronic device packaging processes,including flip-chip wafer bumping. In 2002, we enhanced this product familywith the introduction of entry level and higher performance models of the 3DiSeries.

The 3Di Series incorporates the 2D defectinspection capabilities of the NSX Series and features our proprietary RapidConfocal 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 ouracquisition of Counterpoint Solutions, Inc. (“CSI”) in July 2003, weacquired the VersaScope, a product that was in design at CSI. The VersaScopeoperates with the Harmony software system developed by CSI to automate thecontrol of advanced microscope-based inspection equipment and facilitate theprocessing of defect images. The VersaScope is designed to offer a uniquecombination of ease of use, flexibility and advanced microscope imaging,enabling technicians to more quickly review, classify and annotate defects.When the VersaScope is coupled with our broad array of high performance defectdetection systems, the combination provides customers with a unique, efficientand complete inspection and 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 weacquired DMSVision software division of Inspex, Inc (“DMSVision”), a fab-widedata management system installed at over 25 customer sites worldwide, whichenables device manufacturers to find the source of killer defects andmanufacturing problems by centralizing all inspection, electrical test andmanufacturing information. DMSVision adds another dimension to ourdetection-to-decision process, providing the fab wide information to enableprocess 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.

***CV Series—Cassette verification and metrology.  ***TheCV Series is designed to automatically verify critical wafer carrierdimensions. Using advanced machine vision technology and proprietary software,our CV Series systems identify out-of-tolerance cassettes and up to 300mmFront Opening Unified Pods (“FOUPs”), allowing microelectronic devicemanufacturers to remove dimensionally defective carriers and thereby decreasewafer damage and improve yield.

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**Research andDevelopment**

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 product introductions in 2004 include the AXi-935for front-end advanced macro defect inspection and the NSX-115 for post-fabadvanced 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 20%, 26% and39% of our net revenues on research and development during 2004, 2003 and 2002,respectively.

To maintain technologyleadership and pursue customer driven opportunities for the application of ourcore technologies, we plan to continue to invest in research and development tobring new products to market and add additional capabilities to extend ourmarket leadership and meet our customers’ product characterization needs.

**Customers**

We have sold our systems tomany of the leading microelectronic device manufacturers throughout theworld. Customers accounting for more than 10% of net revenues during 2004included Samsung Electronics Corporation, STMicroelectronics, and TaiwanSemiconductor Manufacturing Co. Customers accounting for more than 10% of netrevenues during 2003 included Samsung Electronics Corporation, TexasInstruments Incorporated, Intel Corporation, and Advanced SemiconductorEngineering, Inc. Customers accounting for more than 10% of net revenuesduring 2002 included Intel Corporation and Silicon Precision Industries Co., Ltd.There were no other customers,which accounted for greater than 10% of net revenues during 2004, 2003, or2002.

Netrevenues by geographic region were as follows:
| ** **       | ** ** | **Years Ended December 31,** | ** ** |
|------------------|------------|---------------------------------------------|------------|
| ** **       | ** ** | **  2004  **            | ** ** | **  2003  ** | ** ** | **  2002  ** | ** ** |
| United States    |       |                                        | 27         | % |   |   | 24 | % |   |   | 48 | % |   |
| Taiwan           |       |                                        | 35         | % |   |   | 38 | % |   |   | 37 | % |   |
| South Korea      |       |                                        | 17         | % |   |   | 14 | % |   |   | — |   |   |
| Japan            |       |                                        | 4          | % |   |   | 7 | % |   |   | 4 | % |   |
| Rest of Asia     |       |                                        | 12         | % |   |   | 5 | % |   |   | 4 | % |   |
| Europe and other |       |                                        | 5          | % |   |   | 12 | % |   |   | 7 | % |   |
|             |       |                                        | 100        | % |   |   | 100 | % |   |   | 100 | % |   |

 

**Sales, Service andMarketing**

We provide direct sales, service and field applicationsupport through strategically placed offices in key regions throughout theworld. In the United States, these include our offices in New York, Texas,Massachusetts, and our corporate headquarters in Minnesota, and internationallythrough our offices in Taiwan and South Korea. In addition, we have key serviceand support personnel based locally near key semiconductor productionfacilities around the world.

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

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providesfor price and payment procedures, specifies the applicable warranty proceduresand 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 andservice personnel in South Korea supporting Metron Technology B.V. With respectto our European distributors, we terminated our informal agreement with HighTech Trade, Gmbh, effective September 2004, our distributor agreementswith Quasys AG effective April 2004, and Firfax Systems effective January 2003.

**Backlog**

Our backlog was $28.4million as of December 31, 2004, as compared to $19.1 million as of December 31,2003. Our backlog consists of orders for which we have accepted purchase ordersand have either assigned shipment dates within the next twelve months or underwhich systems have shipped but have not yet met customer specifications. Theseorders are 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 are currently the leader inthe commercialization of solutions for the inspection of advanced macro defectsof 0.5 micron and larger, several other firms also manufacture similarproducts. Our primary competitors in final manufacturing, testing and solutionsare Camtek Ltd., Hitachi, Ltd., ICOS Vision Systems, Robotic Vision Systems, Inc.,and Toray Industries, Inc. In the front-end market, we compete with largercompetitors, such as KLA-Tencor Corporation and Rudolph Technologies, Inc.,for certain macro applications.

Significant competitivefactors in our market include performance, ease of use, development of newtechnologies, established customer base, application support, customer service,product flexibility, price and ability to deliver products on a timely basis.We believe we compete favorably with respect to these factors, but mustcontinue to develop and design new and improved products in order to maintainour competitive position.

**Manufacturing**

We perform system design, assembly and testing at ourheadquarters in Bloomington, Minnesota. We utilize an outsourcing strategy forthe manufacture of many of our components and major subassemblies. Ourmanufacturing activities are considered horizontal in nature and consistprimarily of testing and assembling parts, components and subassembliesacquired from our vendors, and integrating these parts into our products. Ourengineering and manufacturing teams work together to continually improve themodularity of our systems and reduce the number of discrete components andsubassemblies required to serve our various product families. To meet specificcustomer requirements, we often manufacture products that include custom systemengineering and software development. Our manufacturing operations do notrequire a major investment in capital equipment.

We use numerous domesticand international vendors to supply parts for the manufacture and support ofour products. Although we make reasonable efforts to ensure that parts areavailable from multiple qualified suppliers, this is not always possible.Accordingly, some key parts are obtained only from a single supplier or alimited group of suppliers. We endeavor to minimize the risk of productinterruption by selecting and qualifying alternative suppliers for key parts,monitoring the financial condition of key suppliers and maintaining appropriateinventories of key parts. We continually strive to reduce our component leadtime and build cycles to maximize the efficiency of our manufacturingoperations. We 

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continueto work with 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 notmaintain long-term supply contracts with any of our suppliers. We do enter intoblanket purchase orders with key suppliers for parts with long lead times.These purchase orders are generally to lock-in prices and provide the supplierwith visibility of future requirements.

**IntellectualProperty**

Proprietary information plays a significant role inthe development of our products. We rely upon a combination of contractprovisions and copyright, trademark, patent and trade secret laws to protectour proprietary know-how, ideas, inventions, goodwill and rights in oursolutions and products. We also have a policy of seeking U.S. and foreignpatents on technology considered of particular strategic or competitiveimportance. As of January 1, 2005, we had 14 issued U.S. patents and 53pending U.S. patent applications on our key inventions including thoseassociated with our key product lines. We have also applied for foreign patentrights 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 thatthe copyrights, trademarks and patents we own are of value, we do not believethat they will determine our success, which depends principally upon ourengineering, manufacturing, marketing and service skills.

**Employees**

As of February 28,2005, we employed 254 people, including 101 in research and development, 51 inservice, technical support and training, 40 in sales and marketing, 40 inmanufacturing, and 22 in administration. We also utilize independentcontractors and temporary employees. None of our employees is represented by alabor union and we consider 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 anyamendments to those reports, as soon as reasonably practicable afterelectronically filing such reports with the Securities and Exchange Commission.Information contained on our website is not part of this report.

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**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% ofour available space at the Bloomington office. We believe the facilities listedabove are adequate to meet our customer requirements, and that additional orsubstitute space is available on commercially reasonable terms if needed. Wealso believe that our production facilities have capacity adequate for ourcurrent need.

**Item 3**.                        LegalProceedings

From time to time in the ordinary course of business,we are subject to claims, asserted or unasserted, or named as a party tolawsuits or investigations. Litigation, in general, and intellectual propertyand securities litigation in particular, can be expensive and disruptive tonormal business operations. Moreover, the results of legal proceedings cannotbe predicted with any certainty and in the case of more complex legalproceedings such as intellectual property and securities litigation, the resultsare 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 acomplaint against Rudolph and its subsidiary ISOA, Inc. (“ISOA”). In thecomplaint, we and STI sought a declaratory judgment that we and STI were notusing ISOA technology in our products. STI also asserted a claim for breach ofcontract to recover amounts STI paid to ISOA in connection with a jointdevelopment agreement between STI and ISOA. 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 also sought a declaratory judgment that STIand/or we were wrongfully using ISOA’s technology without compensating ISOA andthat ISOA was entitled to royalty payments for use of its technology.

We acquired STI from ASTI Holdings, Ltd. (“ASTI”) in April 2003.In connection with the acquisition, ASTI agreed to indemnify us for claimsrelating to STI’s dispute with Rudolph and ISOA, up to a maximum value of$670,000. To secure ASTI’s performance of ASTI’s indemnification 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 weentered into a final settlement agreement with Rudolph. Under the terms of theconfidential settlement, ASTI made a one-time payment out of the escrow toRudolph in the amount of 

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$503,000. We, STI,Rudolph, and ISOA agreed to release any and all claims against each otherrelating to the joint development agreement and to dismiss all claims assertedin the litigation with prejudice.

August TechnologyCorporation and each of its directors, Jeff O’Dell, James Bernards, RogerGower, Michael Wright and Linda Hall Whitman, have been named as defendants intwo separate lawsuits that purport to be class actions claims on behalf of ourshareholders. We received a summons and complaint with respect to the first ofthese proceedings on February 4, 2005 and the second on February 14,2005. Both lawsuits are brought in Minnesota State Court and claim that thedirectors have breached their fiduciary duties to our shareholders inconnection with their actions in agreeing to the proposed merger withNanometrics Incorporated. The plaintiffs in both actions seek various forms ofinjunctive relief including an order enjoining us and our directors fromconsummating the merger with Nanometrics. August Technology and itsdirectors believe the lawsuits are without merit and plan to vigorously defendagainst the claims.

**Item 4**.                        Submissionof Matters to a Vote of Security Holders

There were no matterssubmitted to a vote of our shareholders during the quarter ended December 31,2004.

**Executive**Officers of the Registrant

Thefollowing sets forth the names and ages of our current executive officers inaddition to information regarding their positions, their periods of service insuch positions and their business experience for the past five years. Executiveofficers generally serve in office for terms of approximately one 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*wasone of our co-founders and has served as our Chief Executive Officer since 1992and Chairman of the Board since 1994. From 1992 to July 2001, Mr. O’Dellalso served as President. From August 1987 to August 1992, Mr. O’Dellwas Director of Sales and Marketing for MicroVision Corporation, which developsand manufactures robotic and inspection systems. From February 1985 to August 1987,Mr. O’Dell was a Field Applications Engineer for Cognex Corporation, whichdesigns, develops and markets machine vision systems that are used to automatea wide range of manufacturing processes. From March 1984 to February 1985,Mr. O’Dell served as a Systems Analyst for Control Data Corporation.

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

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automation solutions forthe semiconductor industry. From June 1985 to May 1994, Mr. Piekosworked for Helix Technology Corporation, a manufacturer of products based oncryogenic and vacuum technology, serving as Vice President and Chief FinancialOfficer since 1991. He also held financial and general management positionswith W.R. Grace & Co.

*David L. Klenk*joinedus in April 1993 and has served as our President since July 2001 andChief Operating Officer since April 1999. Mr. Klenk served on ourBoard of Directors from 1994 to March 2000. Mr. Klenk oversees theengineering, manufacturing, sales, customer service and employee servicesgroups. Prior to becoming our Chief Operating Officer, Mr. Klenk served asour Director of Operations.

*Scott A. Gabbard*becameour Vice President of Finance in July 2002. Mr. Gabbard alsocurrently serves as our Chief Accounting Officer. Prior to becoming ChiefAccounting Officer and Vice President of Finance, Mr. Gabbard served asour Corporate Controller since joining us in February 2000 and as ActingChief 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 Chief Technology Officer in February 2004. Mr. Watkinsjoined us in October 1997 and served as Director of Advanced TechnologyDevelopment from January 2002 until February 2004. Mr. Watkinshas been responsible for the development of automated wafer inspectionincluding the NSX, 3Di and AXi product lines, and is the primary or secondaryinventor on numerous patent filings. From June 1990 to October 1997, Mr. Watkinswas employed by Loram Maintenance of Way, a railroad maintenance company. Heserved in various capacities with Loram Maintenance of Way, most recently asChief Engineer of the Advanced Technology Group, developing rail and wheelinspection technologies.

*D. Mayson Brooks*becameour Vice President of Global Sales and Field Operations in February 2002.Prior to becoming Vice President of Global Sales and Field Operations, Mr. Brooksserved as our Vice President of Sales and Marketing since July 1999. Priorto joining us, from June 1987 through June 1999, Mr. Brooksworked in various managerial capacities for Air Products and Chemicals, Inc.,most recently as Commercial Manager, European electronics division. Mr. Brooksserved from June 1981 to May 1987 in the United States Navy and wasawarded two achievement medals.

*Jeffrey T. Nelson* became our VicePresident of Manufacturing in November of 2004. From September 1998through March 2004, Mr. Nelson was Director of Operations forMedallion, a subsidiary of the Elkay Corporation, a producer of varioushousehold 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 1996 Mr. Nelson held avariety of manufacturing management positions with Unisys Corporation.

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**PART II**

**Item 5**.                        Marketfor Registrant’s Equity, Related Shareholder Matters and Issuer Purchases ofEquity Securities

**Market Information**

Our common stock, no par value (the “Common Stock”),has traded under the symbol “AUGT” on the NASDAQ National Market since ourinitial public offering on June 14, 2000. There was no market for ourCommon Stock prior to that date.

Thefollowing table sets forth the reported high and low closing sale prices forshares of our Common Stock on the NASDAQ National Market during the indicatedquarters. Our closing market price 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 of record of our Common Stock. 

**Dividends**

We have not declared orpaid cash dividends on our Common Stock to date and do not anticipate payingcash dividends for the foreseeable future. We currently intend to retainearnings, if any, to support the development of our business. Payment of futuredividends, if any, will be at the discretion of our board of directors aftertaking into account various factors, including our financial condition,operating results and current and anticipated cash needs.

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**Item 6.**                        SelectedFinancial Data

Theconsolidated statement of operations data set forth below for each of the yearsended December 31, 2004, 2003 and 2002 and the consolidated balance sheetdata as of December 31, 2004 and 2003 are derived from the auditedconsolidated financial statements, included elsewhere in this Form 10-K.The consolidated statement of operations data set forth below for the yearsended December 31, 2001 and 2000 and the balance sheet data as of December 31,2002, 2001 and 2000 are derived from audited consolidated financial statements,which are not included in this Form 10-K. You should read the data setforth below in conjunction with the audited consolidated financial statementsand notes thereto and “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” appearing elsewhere in this Form 10-K.
| ** **                                                           | ** ** | **Years Ended December 31,**                           | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2004**(1)                                                           | ** ** | **2003**(2) | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                           | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statements of Operations Data:**                      |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Net revenues                                                         |       | $                                                                     | 68,443     |   | $ | 40,323 |   | $ | 25,058 |   | $ | 29,784 |   | $ | 31,666 |   |
| Cost of revenues                                                     |       | 31,925                                                                |       | 18,290 |   | 11,068 |   | 12,039 |   | 12,594 |   |
| Gross profit                                                         |       | 36,518                                                                |       | 22,033 |   | 13,990 |   | 17,745 |   | 19,072 |   |
| Selling, general and  administrative expenses                        |       | 22,798                                                                |       | 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)                                              |       | 159                                                                   |       | (2,756 | ) | (8,870 | ) | (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 |       | 1,079                                                                 |       | (2,349 | ) | (8,246 | ) | (1,164 | ) | 2,679 |   |
| Provision for (benefit from) income taxes(3)                         |       | 277                                                                   |       | — |   | 687 |   | (813 | ) | 807 |   |
| Net income (loss)                                                    |       | $                                                                     | 802        |   | $ | (2,349 | ) | $ | (8,933 | ) | $ | (351 | ) | $ | 1,872 |   |
| Net income (loss) per share:                                         |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Basic                                                                |       | $                                                                     | 0.05       |   | $ | (0.16 | ) | $ | (0.69 | ) | $ | (0.03 | ) | $ | 0.17 |   |
| Diluted                                                              |       | $                                                                     | 0.04       |   | $ | (0.16 | ) | $ | (0.69 | ) | $ | (0.03 | ) | $ | 0.16 |   |
| Weighted average common shares:                                      |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Basic                                                                |       | 17,755                                                                |       | 14,381 |   | 13,033 |   | 12,723 |   | 11,049 |   |
| Diluted                                                              |       | 18,211                                                                |       | 14,381 |   | 13,033 |   | 12,723 |   | 11,770 |   |

 
| ** **                                             | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                             | ** ** | **(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                                        |       | 54,962                  |       | 62,819 |   | 29,376 |   | 37,171 |   | 36,872 |   |
| Total assets                                           |       | 95,800                  |       | 88,947 |   | 39,510 |   | 47,155 |   | 47,897 |   |
| Total debt                                             |       | —                  |       | — |   | — |   | — |   | — |   |
| Total shareholders’ equity                        |       | 81,465                  |       | 78,477 |   | 34,867 |   | 42,523 |   | 41,685 |   |
|                                                        |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)      On July 27, 2004 we acquired substantially all ofthe assets of DMSVision. DMSVision’s results of operations have been includedwith our results of operations since the date of acquisition.

(2)      On April 15, 2003 we acquired all of theoutstanding capital stock of STI. On July 3, 2003 we acquiredsubstantially all of the assets of CSI. STI and CSI’s results of operationshave been included with our results of operations since the date ofacquisition.

(3)      We recorded a full valuation allowance against ourdeferred tax assets in the second quarter of 2002. The recording of thevaluation allowance resulted in a provision for income taxes, rather than the recordingof a tax benefit on the pre-tax loss. We have subsequently continued to recorda full valuation allowance against our deferred tax assets. The Company hasrecorded a provision for income taxes of $277 in 2004 primarily to provide forforeign and alternative minimum taxes.

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**Item 7**.                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial conditionand results of operations should be read in conjunction with the auditedconsolidated financial statements and the notes thereto and with the “CautionaryStatements” section included elsewhere in this Form 10-K.

In preparing theconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America, we must make decisionswhich impact the reported amounts and the related disclosures. Such decisionsinclude the selection of the appropriate accounting principles to be appliedand the assumptions on which to base accounting estimates. In reaching suchdecisions, we apply judgment based on our understanding and analysis of therelevant circumstances. Note 1 to the consolidated financial statementsprovides a summary of the significant accounting policies followed in thepreparation of the consolidated financial statements.

**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 of products. Wehave introduced the AXi Series and the E20 for edge and B20 for backsideinspection systems (collectively, the “All Surface Inspection System”) foradvanced macro defect detection primarily in the front-end of the wafermanufacturing process. When used in conjunction with one another these systemsallow a manufacturer to inspect the top, edge and back of a wafer’s surface. Webelieve we are the first to offer all surface wafer inspection. During 2004, wemade a significant investment supporting front-end system demonstrations atmany large semiconductor manufacturers, which allows these customers toevaluate the benefits these systems provide. We expect these demonstrations willlead to increased revenues six to nine months after shipment.

We complement this broad inspection capability with anexpanding suite of software tools designed to enhance the speed andeffectiveness of the process by which device manufacturers analyze defects, andmake decisions regarding their manufacturing process to reduce or eliminatesuch defects. We refer to this process as the “detection-to-decision” process.

In addition to internal development, we look to expandthrough 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 acquired certain assets of the DMSVisionsoftware division of Inspex, Inc (“DMSVision”). We plan to use the DMSVisionsoftware to further expand and enhance our current defect analysis softwareofferings.

Our business is subject to the highly cyclical natureof the microelectronic device manufacturing markets we serve. These cycles arecaused by significant, and often rapid, fluctuations in the supply and demandof microelectronic devices driven by such factors as changes in technology andglobal economic conditions. As a result of these fluctuations, our quarterlyorders and revenues have fluctuated dramatically. After a three year industrydownturn we began to experience an industry recovery during the second half of2003, which resulted in a significant increase in revenues and orders duringeach quarter until the third quarter of 2004. In the third quarter of 2004 weencountered yet another slowdown resulting in a decrease in the rate of ordersbeing received, and a delay in shipments of certain systems under previouslyreceived orders. This resulted in a sequential decrease in quarterly revenuesand a lower level of 

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orders in backlog, ascompared to the end of the second quarter. In response to this slowdown, weimplemented certain cost cutting initiatives during the fourth quarter of 2004.These initiatives included staffingreductions, reductions in management compensation, cuts in discretionaryspending and mandatory time-off for employees (the “Cost Cutting Initiatives”).We estimate that these actions resulted in cost savings of approximately$475,000 during the fourth quarter. Despite the slowdown in the thirdquarter of 2004, we experienced a 58.4% and 69.7% overall increase in the levelof orders and revenues, respectively, during 2004, and have a record level ofbacklog at December 31, 2004 of $28.4 million, as compared to $19.1 millionat December 31, 2003.

Management focuses on several key financial metrics inevaluating our financial condition and operating performance. Although we donot believe backlog is always an accurate indication of future revenues andperformance, since only a portion of our revenues for any quarter includesystems that were in backlog as of the beginning of that quarter, we do closelymonitor the level of orders both geographically and by product line and inrelation to the level of revenues, referred to as the book-to-bill ratio. Duringthe fourth quarter of 2004 our book-to-bill ratio was above parity. Abook-to-bill ratio greater than parity indicates a growing level of backlog. Inaddition to monitoring our level of orders and backlog, we focus on revenues byproduct family compared to prior-period and current-year plans, year-over-yearrevenue growth compared to the overall semiconductor equipment industry,operating profit or loss performance compared with prior-period andcurrent-year plans and the level of operating cash flow.

Future quarterly andannual results will continue to be impacted by fluctuations in supply anddemand of microelectronic devices, the timing of new product announcements andreleases by us or our competitors, market acceptance of new or enhancedversions of our products, changes in the pricing of our products and the timingand level of our research and development expenditures. We cannot predict thesustainability or depth of these fluctuations and their impact on our business,and/or the overall industry’s rate of growth. If we are unable to effectivelymanage our resources and production capacity during an industry cycle, therecould be a material adverse effect on our business, financial condition andresults 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 connectionwith this transaction, Nanometric’s name will be changed to August Nanometrics.Each share of our common stock will be converted into the right to receive0.6401 of a share of August Nanometrics common stock. August Nanometricswill make a 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 of our shareholders may elect to receive allcash, stock or a combination of cash and stock, subject to proration based ontotal cash consideration of $40 million.

Also on January 27, 2005, Rudolph issued a pressrelease with proposed terms slightly different from those described in theletter. The press release stated that Rudolph is prepared to enter into amerger with us whereby each of our shareholders will receive the value of $2.16per share in cash and 0.4955 per share in Rudolph common stock (equivalent to$10.50 per share of our Common Stock, based on the closing 

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price of Rudolph stock on January 27,2005). The press release stated that each of our shareholders would have theoption to elect to receive all cash, stock or a combination of cash and stock,subject to proration based on total cash consideration of $40 million.

Our Board of Directors has agreed, based on the adviceof its financial advisors and legal counsel, to further examine the Rudolphoffer provided that Rudolph first executes a confidentiality agreement in theform required by the Merger Agreement with Nanometrics. As of the date of thisfiling, we have not reached agreement on the form of confidentiality agreementand no discussions regarding Rudolph’s offer have taken place.

On February 9, 2005, we received a letter fromKenneth Schroeder, President and Chief Executive Officer of KLA-Tencor Corporation(“KLA”), regarding KLA’s interest in pursuing a merger with us. The letterstated that KLA proposed to acquire us in a transaction in which ourshareholders would receive $11.50 per share. KLA also stated that it would bewilling to consider using stock as consideration.

Our Board of Directors hasagreed, based on the advice of its financial advisors and legal counsel, tofurther examine the KLA offer provided that KLA first executes aconfidentiality agreement in the form required by the Merger Agreement withNanometrics. As of the date of this filing, we have not reached agreement onthe form of confidentiality agreement and no discussions regarding KLA’s offerhave taken place.

**Results ofOperations**

Thefollowing table presents the consolidated statements of operations as apercentage of net revenues.
| ** **                                       | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net revenues                                     |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                 |       | 46.6                                        |       | 45.4 |   | 44.2 |   |
| Gross profit                                     |       | 53.4                                        |       | 54.6 |   | 55.8 |   |
| Selling, general and administrative expenses     |       | 33.3                                        |       | 35.6 |   | 52.0 |   |
| Research and  development expenses               |       | 19.8                                        |       | 25.8 |   | 39.3 |   |
| Operating income (loss)                          |       | 0.3                                         |       | (6.8 | ) | (35.5 | ) |
| Interest income                                  |       | 1.2                                         |       | 1.0 |   | 2.5 |   |
| Other income                                     |       | 0.1                                         |       | — |   | — |   |
| Income (loss)  before provision for income taxes |       | 1.6                                         |       | (5.8 | ) | (33.0 | ) |
| Provision for  income taxes                      |       | 0.4                                         |       | — |   | 2.7 |   |
| Net income (loss)                                |       | 1.2                                         | %          | (5.8 | )% | (35.7 | )% |

 

***Year ended December 31, 2004 compared to the yearended December 31, 2003***

*Net Revenues.  *Net revenuesincreased $28.1 million, or 69.7%, to $68.4 million in 2004, from $40.3 millionin 2003. The increase in net revenues was primarily due to increased sales ofhigher throughput NSX Series systems and all surface 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 soldfor front end wafer fab applications accounted for 44% of total revenues in2004, as compared to 21% in 2003. Revenues from the NSX Series and all surfaceinspection systems were 54% and 20% of total net revenues in 2004,respectively, as compared to 50% and 12%, respectively, in 2003. Net revenuesderived from international sales represented 73% and 76% of total net revenuesin 2004 and 2003, respectively. International net revenues 

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were primarily the resultof sales to Taiwan and the rest of Asia, which comprised 68% and 64% of totalnet revenues in 2004 and 2003, respectively.

*Gross Margin.  *Gross margin decreased to 53.4% of netrevenues in 2004 as compared to 54.6% of net revenues in 2003. Grossmargins decreased 1.3 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. In addition, we have experienced pricingpressure primarily related to our inspection systems sold into finalmanufacturing applications as competitors have continued to enter this market. Thesedecreases were partially offset by increased revenue from our Yield*Pilot* software. We expect gross margins in the next year tobe between 53% and 57%.

*Selling, General and Administrative.  *Selling,general and administrative expenses increased $8.4 million, or 58.8%, to $22.8million, or 33.3% of net revenues, in 2004, from $14.4 million, or 35.6% of netrevenues, in 2003. The increase in expense dollars was primarily the result ofcosts associated with (i) new hires and contractors in our field service andsales 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 ongoing operations ofthree acquisitions completed subsequent to the first quarter of 2003; (iii)higher variable costs associated with increased revenues; and (iv) compliancewith the Sarbanes Oxley Act. The increase was partially offset by the CostCutting Initiatives. We expect selling, general and administrative expensedollars to increase in future quarters, primarily as a result of variableexpenses associated with an expected higher level of revenues and higherrecruiting, relocation and compensation costs related to the retention andhiring of employees. However, selling, general and administrative expenses as apercentage of revenues are expected to decrease, as revenues are expected toincrease at a higher rate than the increase in selling, general andadministrative expenses.

*Research and Development.  *Researchand development expenses increased $3.2 million, or 30.0%, to $13.6 million, or19.8% of net revenues, in 2004, from $10.4 million, or 25.8% of net revenues,in 2003. The increase in expense dollars was primarily due to employeecompensation and related benefits associated with the hiring of additionalstaff and an increase in the use of outside contractors to complete certainstages of development of the E20 for edge and B20 for backside inspectionsystems and VersaScope, and further enhancements to both the NSX Series and AXiSeries. In addition, expenses increased due to three acquisitions completedsubsequent to the first quarter of 2003. The increase was partially offset bysavings from the Cost Cutting Initiatives. We plan to maintain our commitmentto invest in the continued expansion of our business in the front-end of thewafer manufacturing process and expansion of our suite of software solutions. Asa result, we currently anticipate that research and development expense dollarswill 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.

*Interest income, net.  *Netinterest income increased $440,000 to $847,000 in 2004 from $407,000 in 2003.The increase 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, 2003and the underwriters’ exercise of the over-allotment option on October 21, 2003(the “Offering”).

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*IncomeTaxes.**  *As a result of historical operating losses anduncertainty as to the extent of profitability in future periods, we began torecord a valuation allowance against our deferred tax assets in the secondquarter of 2002 and continue to do so at December 31, 2004. As a result, we didnot reflect a provision for income taxes during 2003, and have recorded aprovision for income taxes of $277,000 for 2004, primarily to reflect foreignincome tax owed. Statement of Financial Accounting Standards (“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 expectto have an effective income tax rate of between ten and fifteen percent in2005, primarily to recognize alternative minimum taxes and foreign income taxowed. As of December 31, 2004 we had recorded a valuation allowance of $8.5million.

***Year ended December 31, 2003 compared to the yearended December 31, 2002***

*Net Revenues.  *Net revenuesincreased $15.2 million, or 60.9%, to $40.3 million in 2003, from $25.1 millionin 2002. The increase in net revenues was primarily the result of higher salesof new models within the NSX Series which were introduced in the middle of2002 and revenues from the AXi Series, which was introduced in the firstquarter of 2003. Although the AXi Series initially shipped in the firstquarter of 2003, we did not begin to recognize revenue until the second half of2003. Revenues in 2003 from the NSX Series and AXi Series were $20.0million and $4.7 million, of total revenues, respectively, as compared to $11.2million and none, respectively, in 2002. 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 tosales of products acquired in the STI and CSI acquisitions. The increase waspartially offset by lower revenues from the 3Di Series. Net revenues derivedfrom international sales represented 76% and 52% of total net revenues in 2003and 2002, respectively. International net revenues were primarily the result ofsales to Taiwan and the rest of Asia, which comprised 64% and 45% of total netrevenues in 2003 and 2002, respectively.

*Gross Profit.  *Gross margindecreased to 54.6% of net revenues in 2003 as compared to 55.8% of net revenuesin 2002. The decrease in gross margin percentage was primarily due to (i) ahigher level of write-offs of obsolete and excess inventory; (ii) anincrease in the number of NSX Series systems that included subsystemoptions manufactured by third parties, which have lower gross margins than ourcore inspection systems; and (iii) lower margins on the AXi Series systemssold under our joint development program with a leading device manufacturer.

*Selling, General and Administrative.  *Selling,general and administrative expenses increased $1.4 million, or 10.3%, to $14.4million, or 35.6% of net revenues, in 2003, from $13.0 million, or 52.0% 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. The increase was partially offset by the factthat the prior year included the write-off of costs related to potentialacquisitions, the modification of our distributor agreement with MetronTechnology B.V and higher employee severance costs.

*Research and Development.  *Researchand development expenses increased $583,000, or 5.9%, to $10.4 million, or25.8% of net revenues, in 2003, from $9.8 million, or 39.3% of net revenues, in2002. The expense dollars increased primarily due to depreciation andamortization expense related to assets and software capitalized subsequent tothe beginning of 2002, employee salaries and related benefits associated withthe employees of STI and CSI and higher travel costs related to visitingcustomer locations. These increases were partially offset by a decrease in theuse of outside services and contractors in the development of new and existingproducts. We believe our future operating results will depend significantly onour ability to produce products and provide services that have a competitiveadvantage in 

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our marketplace. To dothis, we believe that we must continue to make substantial investments in ourresearch and development efforts. Our investments in new technology andexisting product enhancements are intended to enable our customers to achieve ahigher return on their capital investments and higher productivity through cost-effective,leading edge technology solutions.

*Interest income, net.  *Netinterest income decreased $217,000 to $407,000 in 2003 from $624,000 in 2002.The decrease in interest income was due to lower rates of return earned oninvestment balances in 2003 as compared to 2002 and lower average investmentbalances in 2003.

*Income Taxes.  *Therewas no benefit for income taxes in 2003 compared to a provision for incometaxes of $687,000, or an effective tax rate of 8.3%, in 2002. The provision forincome taxes in 2002, rather 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.

**Liquidity and 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. During2004, working capital decreased to $55.0 million as compared to $62.8 millionat December 31, 2003. The decrease was primarily due to a decreasein cash and equivalents and short-term investments to fund operations andcapital expenditures and increased customer deposits and deferred revenues,partially offset by increased accounts receivable and inventories. During thenext twelve months, and beyond, we intend to utilize our current sources ofliquidity to fund operations, specifically to enhance our position in thefront-end wafer fabrication process. Wehave no outstanding debt at December 31,2004. Our liquidity is affected by many factors, some of which are based on thenormal ongoing operations of our business, the most significant of whichincludes the timing of the collection of receivables, the level of inventories,capital expenditures and acquisitions.

*AccountsReceivable.  *Our accounts receivable increased $4.5million from December 31, 2003 to December 31, 2004. Our days salesoutstanding (“DSO”) during 2004 was 34 days. This compares to a DSO of 50 daysin 2003. The decrease in DSO is primarily due to the timely collection of ouraccounts receivable in 2004. The increase in accounts receivable resulted in ause of cash of $4.5 million during 2004, as we have funded shipments forincreased revenues prior to receiving payments from customers. Due to the highmix of international revenues during current and prior quarters, whichgenerally require a longer time for collection, we believe our DSO will bebetween 55 and 65 days in future quarters.

*Inventories.  *Inventories increased $8.5 millionfrom December 31, 2003 to December 31, 2004. The increase is primarily dueto the need to support new product introductions, increased backlog andincreased demonstration equipment at customers under evaluation, primarily infront-end wafer processing applications.

*Inventories at Customers underPurchase Orders.  *Inventoriesat customers under purchase orders increased $1.7 million from December 31,2003 to December 31, 2004, primarily due to shipments of models within ourNSX Series that have not yet qualified for revenue recognition. Weanticipate that a portion of this inventory will be recognized as revenueduring the first quarter of 2005. We also expect that this inventory willincrease as shipments of newly introduced products increase.

*Capital Expenditures.  *Ourcapital expenditures during 2004 were $5.0 million, consisting primarily of thecapitalization of finished goods that have been transferred to engineering fortest and characterization, to customer service for training and to sales forcustomer application studies. This equipment is expected to be utilized forthese 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 

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2005, as we continue toexpand the use of internal test and development equipment and enhance ourfacilities to better serve our customers.

*Acquisitions.  *Asa result of the acquisition of DMSVision in July 2004, we lease 7,456square feet of space in Billerica, Massachusetts.

Our liquidity is also affected by factors beyond ourcontrol related to the uncertainties of global economies and the cyclical natureof the semiconductor and microelectronic industries. Although liquidityrequirements will fluctuate based on the timing and extent of all of thesefactors and others, management believes that existing cash and investmentbalances will be adequate to satisfy our existing liquidity requirements for atleast the next twelve months.

Thefollowing table summarizes our future cash payments due under contractualobligations 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 are for the purchase of goodsand services. Although we are primarily liable for payments on the aboveoperating leases and purchase obligations, based on historic operatingperformance and forecasted future cash flows, management believes the exposureto losses, if any, under these arrangements is not material.

The open purchase orders displayed in the tablerepresent amounts we anticipate will become payable within the next year forgoods and services we have negotiated for delivery.

*Cash Flows.  *During2004, net cash used in operating activities was $7.8 million, which resultedprimarily from the increases in inventories and accounts receivable, and adecrease in accounts payable, partially offset by a reduction in customerdeposits and deferred revenues, and an increase in depreciation andamortization. Net cash provided by investing activities was $1.2 million, dueto $8.8 million of net proceeds from maturities of marketable debt securities,$2.3 million paid to acquire DMSVision and $5.3 million of additions toproperty and equipment and other assets. Net cash provided by financingactivities was $2.2 million, primarily from the net proceeds received from theexercises of stock options.

During 2003, net cash provided by operating activitieswas $3.8 million, which resulted primarily from the decrease in accountsreceivable and increases in accounts payable and depreciation and amortization,partially offset by the increase in inventories. Net cash used in investingactivities was $39.5 million, due to $37.0 million of net purchases ofmarketable securities, $1.5 million paid to acquire STI and CSI and $981,000 ofadditions to property and equipment and other assets. Net cash provided byfinancing activities was $43.8 million, including $42.0 million of net proceedsreceived from the Offering and underwriters’ exercise of their over-allotmentoption.

During 2002, net cash usedin operating activities was $6.5 million, which resulted primarily from our netloss and an increase in accounts receivable, partially offset by non-cashcharges, decreased prepaid expenses and other current assets and inventories. Netcash provided by investing activities was $5.7 million, due to $7.5 million ofnet proceeds from the redemption and purchases of securities, partially 

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offsetby $1.8 million of additions to property and equipment and other assets. Netcash provided by financing activities was $1.2 million from the proceeds ofissuances of common stock in conjunction with the exercise of stock options byemployees and purchases under our employee stock purchase plan.

**CriticalAccounting Policies, Significant Judgments and Estimates**

The preparation of consolidated financial statementsand related disclosures in conformity with accounting principles generallyaccepted in the United States of America requires management to make judgments,assumptions and estimates that affect the amounts reported. Note 1 ofNotes to Consolidated Financial Statements describes the significant accountingpolicies used in the preparation of the consolidated financial statements.Certain of these significant accounting policies are considered to be criticalaccounting policies, as defined below.

A critical accounting policy is defined as one that ismaterial to the presentation of our consolidated financial statements and/orrequires management to make estimates and assumptions that could have amaterial effect on our financial condition and results of operations.Specifically, critical accounting estimates have the following attributes: 1) weare required to make assumptions about matters that are highly uncertain at thetime of the estimate; and 2) different estimates we could reasonably haveused, or changes in the estimate that are reasonably likely to occur, wouldhave a material effect on our financial condition or results of operations.

Estimates and assumptions about future events andtheir effects cannot be determined with certainty. We base our estimates onhistorical experience and on various other assumptions believed to be applicableand reasonable under the circumstances. These estimates may change as newevents occur, as additional information is obtained and as our operatingenvironment changes. These changes have historically been minor and have beenincluded in the consolidated financial statements as soon as they became known.In addition, management is periodically faced with uncertainties, the outcomesof which are not within its control and will not be known for prolonged periodsof time. These uncertainties are discussed in the section below entitled “CautionaryStatements.”

Management believes that the following are criticalaccounting policies:

***Revenue Recognition.****  *We derive revenues from the sale ofsystems, spare parts, software and services.

*Systemsales:  *We require customers, excluding ourdistributors, that have new inspection applications to complete pre-shipmentauthorization testing of purchased systems at our facility, prior to shipment. Duringthis testing, the customer verifies that the system meets their specificationsand 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 hasshipped, title and risk of loss have transferred to the customer and collectionof the resulting 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 

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product has shipped, titleand risk of loss have transferred to the customer and collection of theresulting receivable is probable.

System sales are accounted for as multiple-elementarrangements. In transactions that include multiple products and/or services,we allocate the revenue to each element based on their relative fair value (orin the absence of fair value, the residual method) and recognize the associatedrevenue when all revenue recognition 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.

*Softwarerevenue:  *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 follow-on support. If vendor-specific objective evidence does not exist forthe undelivered elements of the arrangement, all revenue is deferred andrecognized ratably over the support period.

*Service revenue:  *Servicerevenue is recognized after the services are performed and collection of theresulting receivable is probable. Revenue from maintenance contracts isrecognized ratably over the period of the contract. Service revenues were lessthan 10% of total revenues during the years ended December 31, 2004, 2003and 2002.

The Company’s distributors are not granted priceprotection or a right of return.

The Company includes amounts billed to customers forshipping and handling as revenues, and the related expenses in cost ofrevenues.

***Valuation ofAccounts Receivable.  ***We review accounts receivableto determine which are doubtful of collection. In making the determination ofthe appropriate allowance for doubtful accounts, we consider our history ofwrite-offs, relationships with our customers and the overall credit worthinessof our customers. For the three years ended December 31, 2004, we have hadaccounts receivable write-offs totaling $190,000, which included the write-offof one receivable totaling $164,000. Changes in the credit worthiness ofcustomers, general economic conditions and other factors may impact the levelof future write-offs. Changes in these factors could have a material adverseeffect on our business, financial condition and results of operations.

***Valuation ofInventory.  ***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 potentialobsolescence due to the effect of known and anticipated engineering changeorders and new products. For the three years ended December 31, 2004, wehave written-off inventory totaling $1.1 million, including $870,000 related tothe discontinuance of the WAV Series. We have an allowance for obsolete andexcess inventory of $1.6 million at December 31, 2004, which representsour estimate of obsolete and excess inventory. Changes in factors such astechnology, customer demand, competitor product introductions and other matterscould affect the level of obsolete and excess inventory in the future and havea material adverse effect on our business, financial condition and results ofoperations.

***Warranty.  ***We provide warranty coverage on oursystems for a period of one year, including parts and labor necessary to repairthe systems during the warranty period. We account for the estimated warrantycost as a charge to cost of revenues when revenue is recognized. The estimatedwarranty cost is based on our historical experience rate of incurred expensesto corresponding system revenues. We update these estimated charges everyquarter.

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***Accounting for Income Taxes.****  *The preparation of our consolidatedfinancial statements requires us to estimate our actual current tax exposuretogether with our temporary differences resulting from differing treatment oftax items for tax and accounting. These temporary differences result in therecognition of deferred tax assets and liabilities, which are included withinour consolidated balance sheet. SFAS No. 109 “Accounting for Income Taxes,”requires the establishment of a valuation allowance to reflect the likelihoodof the realization of deferred tax assets. Significant management judgment isrequired in determining our provision for income taxes, our deferred tax assetsand liabilities and any valuation allowance recorded against our net deferredtax assets. We evaluate the weight of all available evidence to determinewhether it is more likely than not that some portion or all of the deferredincome tax assets will not be realized. During the second quarter of 2002 werecorded a valuation allowance for the full amount of our deferred tax assetsdue to uncertainties surrounding our ability to utilize some or all of ourdeferred tax assets, primarily consisting of certain net operating losses, aswell as other temporary differences between book and tax accounting. If therealization of deferred tax assets in the future is considered more likely thannot, an adjustment to the deferred tax assets would increase net income in theperiod 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.****  *We have not created, and are not party to, anyspecial-purpose or off-balance sheet entities for the purpose of raisingcapital, incurring debt or operating parts of our business that are notconsolidated into our financial statements. We do not have any arrangements orrelationships with entities that are not consolidated into our consolidatedfinancial statements that are reasonably likely to materially affect ourliquidity or the availability of our capital resources.

**Impact of Accounting 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. The ultimate amount of increased compensationexpense will be dependent on whether we adopt SFAS No. 123R using themodified prospective or retrospective method, the number of option sharesgranted during the year, their timing and vesting period, and the method usedto calculate the fair value of the awards, among other factors we are currentlyassessing.

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In November 2003 andMarch 2004, the Emerging Issues Task Force (“EITF”) reached a consensus onEITF Issue No. 03-1, “*The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments*.”The consensus requires companies to apply new guidance for evaluating whetheran investment 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 only temporarilyimpaired at the balance sheet date. The Company incorporated the requireddisclosures 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 EITFNo. 03-1 and guidance related to impairment measurement prior to theissuance of this consensus continue to remain in effect. Adoption is notexpected to have a material impact on the Company’s consolidated financialstatements.

In November 2004, theFASB issued SFAS No. 151, “*InventoryCosts—an amendment of ARB No. 43, Chapter 4*.” SFAS No. 151 clarifies theaccounting for abnormal amounts of idle facility expenses, freight, handlingcosts, and spoilage. It also requires that allocation of fixed productionoverheads to inventory be based on the normal capacity of productionfacilities. SFAS No. 151 is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. Adoption of SFAS No. 151is not expected to have a material effect on the Company’s financial position,results of operations or cash flows.

**Cautionary** Statements

Certain statementscontained in this Form 10-K and other written and oral statementsmade from time to time by us do not relate strictly to historical or currentfacts. As such, they are considered “forward-looking statements” whichprovide current expectations or forecasts of future events. Such statements canbe 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. Our forward-looking statementsgenerally relate to our growth strategies, financial results, productdevelopment and sales efforts. One must carefully consider forward-looking statementsand understand that such statements involve a variety of risks anduncertainties, known and unknown, and may be affected by inaccurateassumptions, including, among others, those discussed below. Consequently, noforward-looking statement can be guaranteed and actual results may varymaterially. We undertake no obligation to update any forward-looking statement,but investors are advised to consult any further disclosures by us on thissubject in our filings with the Securities and Exchange Commission, especiallyon Forms 10-K, 10-Q and 8-K (if any), in which we discuss inmore detail various important factors that could cause actual results to differfrom expected or historic results. We note these factors as permitted by thePrivate Securities Litigation Reform Act of 1995. It is not possible to foreseeor identify all such factors. As such, investors should not consider any listof such factors to be an exhaustive statement of all risks, uncertainties orpotentially inaccurate assumptions.

**Although we expect that the merger with Nanometricswill result in benefits to August Nanometrics, August Nanometrics may notrealize those benefits because of integration and other challenges.**

The failure of August Nanometricsto meet the challenges involved in integrating the global operations ofNanometrics and August Technology successfully or otherwise to realize anyof the anticipated benefits of the proposed merger, could seriously harm theresults of operations of August Nanometrics. Realizing the benefits of theproposed merger will depend in part on the successful integration oftechnology, operations and personnel. The integration of the companies is acomplex, time-consuming and expensive process that, without properplanning and implementation, could significantly disrupt the respectivebusinesses of Nanometrics, August Technology and/or August Nanometrics.

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The challenges involved inthis integration include, but are not limited to, the following:

·       communicatingand executing a strategic vision to the market regarding August Nanometrics;

·       consolidatingoperations, including rationalizing corporate information technology and administrativeinfrastructures;

·       combiningdiverse product and service offerings;

·       coordinatingsales and marketing efforts to effectively communicate the capabilities of AugustNanometrics;

·       overcomingany perceived adverse changes in business focus, including demonstrating toexisting customers of both Nanometrics and August Technology that themerger will not result in adverse changes in customer service standards orbusiness focus and helping customers conduct business easily with August Nanometrics;

·       coordinatingand harmonizing research and development activities to accelerate introductionof new products and technologies with reduced cost;

·       preservingcustomer, distribution, reseller, manufacturing, supplier, marketing and otherimportant relationships of both Nanometrics and August Technology andresolving any potential conflicts that may arise;

·       minimizingthe diversion of management attention from ongoing business concerns;

·       retainingkey employees and maintaining employee morale;

·       addressingdifferences in the business cultures of Nanometrics and August Technology;

·  addressing the effects of August Technology’semployment contracts and the differences between Nanometrics’ and AugustTechnology’s employee bonus plans on August Nanometrics’ employees;

·  overcoming challenges involved with managingtwo large groups of employees in geographically disparate areas;

·  coordinating and combining internationaloperations, relationships and facilities, which may be subject to additionalconstraints imposed by geographic distance, local laws and regulations;

·  overcoming any potential challenges involvedwith August Nanometrics’ ability to comply with the Sarbanes-Oxley Act of 2002,including its ability to make the certifications required by Section 404thereof, in a timely manner;

·  addressing any disruptions that may be causedby competitors of August Nanometrics attempting to acquire it;

·  minimizing any potential interference toAugust Nanometrics’ sales efforts that may be caused by its competitors disseminatingfalse information about August Nanometrics;

·  reducing the effects of potential litigationdiverting the attention of management away from day to day integration issues;

·  addressing any challenges involved with AugustNanometrics’ ability to earn profits with the amortization of fair value ofproperty, plants, equipment and intangible assets; and

·  overcoming the challenges involved withintegrating August Technology’s and Nanometrics’ diverse ERP systems worldwideand minimizing any disruptions that may be caused by such integration.

August Nanometrics may notsuccessfully integrate our operations with those of Nanometrics in a timelymanner, or at all, and August Nanometrics may not realize the anticipatedbenefits and synergies of the proposed merger to the extent, or in thetimeframe, anticipated. The anticipated benefits of the merger 

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withNanometrics are based on projections and assumptions, including successfulintegration, 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.

In addition to theintegration risks discussed above, August Nanometrics’ ability to realize thesebenefits and synergies could be adversely affected by practical or legalconstraints on its ability to combine operations. Even if the integration ofNanometrics’ and our operations, products and personnel is successful, it mayplace a significant burden on management and internal resources. The diversionof management attention and any difficulties encountered in the transition andintegration process could harm August Nanometrics’ business, financialcondition and operating results.

**Our business may be adversely affected and, undercertain circumstances, we may be required to pay a termination fee if themerger 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 findan equivalent or more attractive partner. Completion of the merger withNanometrics is subject to several closing conditions, including obtainingrequisite regulatory and shareholder approvals, and we and Nanometrics may beunable to obtain such approvals on a timely basis or at all. In addition, wewould not derive the strategic benefits expected to result from the merger ifthe merger is not completed, which could adversely affect our business. Further,we will be required to pay significant costs incurred in connection with themerger with Nanometrics, including legal, accounting and a portion of thefinancial advisory fees, whether or not the merger is completed. Moreover,under specified circumstances, we may be required to pay to Nanometrics atermination fee equal to $8.3 million plus any applicable costs, expenses andinterest pursuant to the Merger Agreement.

**We expect to incur significant costs associated withthe merger with Nanometrics.**

We estimate that we willincur significant direct transaction costs in connection with the merger withNanometrics, which will be recognized and expensed as incurred. In addition, wewill incur legal fees and related costs in connection with defending August Technologyand its directors against two purported class action lawsuits that have been initiatedagainst us and the members of our board 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 assurance that August Nanometrics will not incuradditional material charges in subsequent quarters to reflect additional costsassociated with the merger with Nanometrics and the integration of the twocompanies.

**We must continue to retain and motivate executives andkey employees and recruit new employees, which may be difficult in light ofuncertainty regarding the proposed merger with Nanometrics and offers fromRudolph and KLA, and failure to do so could seriously harm our business.**

In order to be successful,during the period before the merger with Nanometrics is completed, we mustcontinue to retain and motivate executives and other key employees and recruitnew employees. Our employees may experience uncertainty about their future rolewith August Nanometrics until or after strategies with regard to August Nanometricsare announced or executed. These potential distractions of the proposed mergerwith Nanometrics and the unsolicited offers from Rudolph and KLA may adverselyaffect our ability to attract, motivate and retain executives and key employeesand keep them focused on the strategies and goals 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.

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**Uncertainty regarding our proposed merger withNanometrics may cause customers, distributors, resellers and others to delay ordefer decisions which may harm our results of operations.**

Because our proposedmerger with Nanometrics is subject to several closing conditions and because wehave received competing offers from Rudolph and KLA, there may be uncertaintyregarding the completion of the proposed merger with Nanometrics. Thisuncertainty may cause customers, distributors, resellers and others to delay ordefer decisions concerning purchases of our products, or elect to switch toother suppliers, which could negatively affect our business and results ofoperations. Prospective customers could also be reluctant to purchase August Nanometrics’products due to uncertainty about the direction of August Nanometrics’ productsand willingness to support and service existing products. In addition,customers, distributors, resellers and others may also seek to change existingagreements with Nanometrics or August Technology as a result of theproposed merger. These and other actions by customers, distributors, resellersand others could negatively affect our business and results 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 ourdirectors, Jeff O’Dell, James Bernards, Roger Gower, Michael Wright and Linda HallWhitman, have been named as defendants in two separate lawsuits that purport tobe class action claims on behalf of our shareholders. We received a summons andcomplaint with respect to the first of these proceedings on February 4,2005 and the second on February 14, 2005. Both lawsuits are brought inMinnesota District Court and claim that the directors have breached theirfiduciary duties to our shareholders in connection with their actions inagreeing to the proposed merger with Nanometrics Incorporated. The plaintiffsin both actions seek various forms of injunctive relief including an orderenjoining us and our directors from consummating the merger with Nanometrics. Weare likely to incur significant legal fees and expenses in defending againstthese claims and to indemnify our directors for their legal fees and expensesin defense of these claims. In addition, there can be no assurance that we orour directors will prevail in these lawsuits, and we or our directors maysuffer an adverse result that prevents us from completing our merger withNanometrics or forces us to take other actions or pay damages that mayadversely affect our business.

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

We primarily servemicroelectronic industries and our business depends heavily upon capitalexpenditures by manufacturers in these industries. Microelectronic industriesare highly cyclical, with periods of capacity shortage and periods of excesscapacity; this is historically due to sudden changes in demand formicroelectronic devices. In periods of excess capacity, there are often drasticchanges in the timing and quantity of capital equipment purchases andinvestments in new technology or capacity needs by our customers. The timing,length and volatility of these periods are difficult to predict, resulting inpressure on our revenues, gross margin and net income. In addition to affectingour customers, downturns also challenge our suppliers, vendors, other partners,as well as our management, sales, engineering, manufacturing, customer serviceand other employees, who are vital to our success.

Duringdownturns in microelectronic industries, customers typically reduce or delaypurchases, and/or delay delivery or cancel orders. As a result, it isimperative that we maintain an organization able to quickly and effectivelyalign with market conditions, including bringing our cost structures in linewith current industry and overall market conditions. At the same time, we must alsomeet the following objectives:

·       continueto serve our existing customers;

·       providenew and improved solutions for new and existing customers;

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·       operateeffectively with our suppliers; and

·       motivateand retain key employees.

If we are, for any reason,unable to achieve any one or more of the above objectives in an efficient,effective and timely manner, there could be a material adverse effect on ourbusiness, financial condition and results of operations. Furthermore, anydelays or reductions in future purchases of capital equipment or delays orcancellations of current orders by microelectronic device manufacturers, forany reason, would likely have a material adverse effect on our business,financial condition and results of operations.

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

We primarily target ourproducts to address the needs of microelectronic device manufacturers fordefect inspection and metrology. If for any reason the market formicroelectronic device inspection equipment fails to grow in the long term,contrary to our current expectations, we may be unable to maintain currentrevenue levels in the short term and return to our historical growth in thelong term. Growth in this market is dependent to a large extent uponmicroelectronic manufacturers replacing manual inspection with automatedinspection technology. There is no assurance that manufacturers will undertakethis 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.**

Ourquarterly and annual operating results are affected by a wide variety offactors that could adversely affect sales or operating results, or lead tosignificant variability in our operating results. In addition, because asignificant portion of our revenue in any particular quarter has historicallycome from the sale of a relatively small number of systems, the loss of anysystem sale could have a significant negative impact. A variety of factorscould cause this variability, including the following:

·       ordercancellations or delays in orders by customers;

·       thelong sales cycle of our products;

·       decreasesin capital spending by our customers;

·       newproduct introductions by our competitors and competitive pricing pressures;

·       entranceinto, or additional resources focused on, our markets by larger competitors;

·       componentshortages resulting in manufacturing delays; and

·       delaysin the development, introduction and manufacture of our products.

We cannot predict theimpact of these and other factors on our revenues and operating results in anyfuture period. Results of operations in any period, therefore, should not beconsidered indicative of the results to be expected for any future period.Because of this difficulty in predicting future performance, our operatingresults may fall below expectations of securities analysts or investors in somefuture quarter or quarters. Our failure to meet these expectations would likelyadversely affect the market price 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 orrelated events similar or comparable to the September 11, 2001 terroristattacks, significant military conflicts, or long term reactions of governmentsand society to such events, may significantly affect the willingness or abilityof our customers to visit our facilities or trade shows, review our systems’capabilities and/or purchase or take delivery of our products. Such events mayalso affect our 

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abilitiesto visit our customers, perform application studies for our customers, and selland deliver solutions and to service those solutions. Any decline in thewillingness or ability of our customers to travel and visit our facilities, orin our ability to travel and visit our customers, could have a material adverseeffect on our business, financial condition and results of operations. Inaddition, such events could have an adverse effect on the economy generally,and microelectronic industries in particular, causing our customers to reduceor delay capital equipment purchases.

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

Microelectronic devicemanufacturing equipment and processes are subject to rapid technologicalchanges. We continue to expend significant resources developing new systems,new models to existing system series and improvements or enhancements oncurrent models. Due to the length of the product development cycles in ourindustries, we must make these significant time and resource expenditures wellin advance of any prospect of a revenue stream from such new products. If ourcustomers do not continue to accept our current products and also accept andintegrate our new products into their operations, our revenue, cash flow, operatingresults or stock price would be negatively and materially impacted.

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

We continue to enhance ourinspection and metrology product offering for the front-end of themicroelectronic device manufacturing process, a market segment that we havelimited experience in serving. We are not a well-recognized supplier to thismarket, and will need to establish new customer relationships and win theconfidence of these customers to compete effectively in this market. Thefront-end of the microelectronic device manufacturing market is dominated bylarge, well-established competitors with significantly greater resources andname recognition than we have. In order to compete effectively with theselarger competitors, we must develop process and applications expertise toidentify the inspection needs of this market and produce cost-effective,technologically advanced solutions addressing these needs. In addition, we mustcreate and execute programs to effectively market to and service thesecustomers. Failure to successfully penetrate the front-end of themicroelectronic device manufacturing market would have a material adverseaffect 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 microelectroniccapital equipment manufacturing business is a highly competitive business andmicroelectronic device manufacturing equipment and processes are subject torapid technological changes. We believe that our future success will depend inpart upon our ability to continue to enhance our existing product line to meetcustomer needs and to develop and introduce new products in a timely manner. Wecannot assure you that our product enhancement efforts to improve and advanceproducts, such as the AXi, NSX and 3Di Series, or our new product developmentefforts such as the E20 for edge and B20 for backside inspection systems, willbe successful or that we will be able to respond effectively to technologicalchange. In addition, we cannot provide assurance that we will be able todevelop new products for the most opportunistic new markets and applications.

Wecontinue to make significant investments in research, development andengineering in new technology and/or businesses with new or complementaryproducts, services and/or technologies, and we are aware of the numerous risksassociated therewith, including but not limited to:

·       diversionof management’s attention from day-to-day operational matters and currentproducts and customers;

·       lackof synergy, or the inability to realize expected synergies;

·       failureto commercialize the new technology or business;

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·       failureto meet the expected performance of the new technology or business;

·       lower-than-expectedmarket opportunities or market acceptance of any new products; and

·       unexpectedreduction of sales of existing products by new products.

If we are unsuccessful atdeveloping new products and technologies, our revenue, operating results orstock price would be negatively impacted.

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

Our products are complexand often the applications to our customers’ businesses are unique. We believethat our future success will depend in part upon our ability to meet ourcustomers’ functionality and reliability requirements in a timely manner. Wecannot be sure that our product offerings, application assistance, enhancementefforts, or our new product development efforts will fulfill criticalfunctionality and reliability requirement. In addition, new product offeringsthat are highly complex in terms of software or hardware may requireapplication or service work such as bug fixing prior to acceptance, therebydelaying revenue recognition. If we are unsuccessful in these areas, our marketshare, revenue, operating results or stock price would be negatively impacted.

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

The microelectronic defectinspection equipment industry is highly competitive in national andinternational markets. We have many domestic and foreign competitors. Ourcurrent primary competitors in final manufacturing, testing and solutions areCamtek Ltd., Hitachi, Ltd., ICOS Vision Systems, Robotic VisionSystems, Inc., and Toray Industries, Inc. In the front-end market, wecompete with larger competitors, such as KLA-Tencor Corporation and RudolphTechnologies, Inc., for certain automated macro inspection applications.Most of these competitors, as well as other potential competitors, havesubstantially greater financial resources and more extensive engineering,manufacturing, marketing and customer support capabilities than we have. Unlesswe are able to continue to invest significant financial resources in developingproducts and enhancing customer support worldwide, we will likely not be ableto compete effectively.

As we continue todiversify into the evolving and emerging microelectronic markets, includingsemiconductors, advanced packaging, optoelectronics, MEMS, flat panel display,printheads, data storage, disk drives, medical devices and other similardevices, we will face significantly increased 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 tomake investments to support business growth and may require additional funds torespond to future business challenges, such as the need to develop new productsand enhance existing products, enhance our operating infrastructure, acquirecomplementary businesses and technologies and satisfy working capitalrequirements. Accordingly, we may need to engage in equity or debt financing tosecure additional funds. Equity and debt financing, however, might not beavailable when needed or, if available, might not be available on termssatisfactory to us. If we are unable to obtain adequate financing or financingon terms satisfactory to us, our ability to continue to support our business growthand to respond to business challenges could be significantly limited.

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

Our future success willdepend in large part upon our ability to recruit and retain highly skilledtechnical, manufacturing, managerial, financial and marketing personnel. Thelabor market in which we operate is highly competitive and as a result, we maynot be able to retain and recruit key personnel. Our failure to hire, retain,or adequately train key personnel could have a negative impact on our futurefinancial and business results.

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In addition, during therecent microelectronic industry downturn we have had reductions in our workforce, reduced or eliminated salary increases and for certain periodsimplemented pay cuts at the management level, and reduced discretionaryspending. Any of the above measures may have long term adverse effects on ourability to retain key personnel.

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

Ourability to obtain intellectual property rights and licenses and to preserveother intellectual property rights covering our products and our products underdevelopment is an important component of our ability to compete in themicroelectronic defect inspection industry. To protect these rights, we haveobtained 14 domestic patents and intend to continue to seek patents on ourinventions when appropriate. As of December 31, 2004, we have 53 pendingpatent applications in the United States and additional internationalapplications and expect our portfolio to increase in the future. The process ofseeking intellectual property protection can be time-consuming and expensive.We cannot ensure that:

·       patentswill be issued from currently pending or future applications;

·       ourexisting patents or any new patents will be sufficient in scope or strength toprovide meaningful protection or any commercial advantage to us;

·       foreignintellectual property laws will protect our intellectual property rights; or

·       otherswill not independently develop similar products, duplicate our products ordesign around our technology.

If we do not successfullyprotect and then enforce our intellectual property rights, our competitiveposition could suffer, which could harm our operating results.

We also rely on tradesecrets, proprietary know-how and confidentiality provisions in agreements withemployees, consultants, key customers and vendors to protect our intellectualproperty. Other parties may not comply with the terms of their agreements withus and we may not be able to adequately enforce our rights against thesepeople.

**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 propertyrights are uncertain and involve complex legal and factual questions. We may beunknowingly infringing upon the intellectual property rights of others and maybe liable for that infringement, which could result in significant liabilityfor us. If we do infringe upon the intellectual property rights of others, wecould be forced to either seek a license to those intellectual property rightsor to alter our products so that they no longer infringe. A license could bevery expensive to obtain or may not be available at all. Similarly, changingour products or processes to avoid infringing upon the rights of others may becostly or impractical.

We may become responsiblefor patent litigation costs. If we were to become involved in a disputeregarding intellectual property, whether ours or that of another company, wemay be required to participate in legal proceedings. These types of proceedingswill be costly and time-consuming, even if we eventually prevail. If we do notprevail, we might be forced to pay significant damages, obtain licenses, modifyour products or processes, stop making products or stop using processes.

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

Sales to our ten largest customers accounted for 66%,73% and 66% of net revenues in 2004, 2003 and 2002, respectively. Our customersare able to cancel orders, prior to shipment, with few or no penalties. If asignificant 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 part uponour 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 thedisruption would 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 saleshave accounted for a significant portion of our revenues in recent years. Salesoutside of the United States accounted for 73%, 76% and 52% of our net revenuesin 2004, 2003 and 2002, respectively. In addition, we rely on non-United Statessuppliers for several components of the systems we sell. As a result, a majorpart of our revenues and the ability to manufacture our products are subject tothe 

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risksassociated with international commerce. International sales and ourrelationships with suppliers and customers may be hurt by many factors,including:

·       changesin law or policy resulting in burdensome government controls, tariffs,restrictions, embargoes or export license requirements;

·       politicalor economic instability in our target international markets;

·       instabilitycaused by infectious disease or other like outbreaks, or the threat or concernthereof;

·       longerpayment cycles common in foreign markets;

·       difficultiesin staffing and managing our international operations;

·       lessfavorable foreign intellectual property laws making it harder to protect ourtechnology from appropriation by competitors;

·       difficultiesin collecting our accounts receivable because of the geographic distance andunfavorable creditor laws; and

·       currencyfluctuations may increase the relative price of our products in foreign marketsand thereby adversely affect sales.

We are also subject to risks associated with shippingproducts outside of the United States including shipping delays, varyingbusiness conditions, differing business cultures and cultural diversities,among other risks. If our international sales or relationships withinternational suppliers and customers are adversely affected by any of thesefactors, 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 68%, 64% and45% 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 torely upon distributors for a portion of our future sales, and a disruption inour relationships with these distributors could have a negative impact on ourinternational sales.**

Sales through our independent distributors represented4%, 14% and 8% of our net revenues in 2004, 2003 and 2002, respectively. Onedistributor accounts for a significant portion of these sales. The activitiesof these distributors are not fully within our control. Although we believethat we maintain good relations with our independent distributors, therelationships may nevertheless deteriorate in the future. A reduction in thesales or service efforts or financial viability of any of our independentdistributors, or a termination of our relationships with them, could harm oursales, our financial results and our ability to support our customers.

**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 grow anddiversify our product offerings through acquisitions. In this regard, werecently completed the acquisitions of STI, CSI and DMSVision. Your 

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evaluation of our businessand prospects may be difficult because of our limited operating history withSTI, CSI and DMSVision. There can be no assurance that we will be successful inintegrating the operations of STI, CSI and DMSVision, identifying otherappropriate candidates, or integrating products and operations with any suchcandidates that we may acquire.

Any suchacquisition could involve the dilutive issuance of equity securities and theincurrence of debt. In addition, the acquisitions of STI, CSI and DMSVision andfuture acquisitions may involve numerous additional risks, including:

·       thediversion of the attention of our management team from other business concerns;

·       risksof entering into markets or producing products where we have limited or noexperience, including difficulties in integrating purchased technologies andproducts with our technologies and products;

·       thepotential loss of key customers of an acquired company;

·       thepotential loss of key personnel of an acquired company;

·       exposureto unanticipated liabilities of an acquired company; and

·       greaterfinancial 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.

**Change inaccounting for stock-based compensation could adversely affect our results ofoperations.**

We have historically compensated our employees,including many key personnel and new hires, through the issuance of options toacquire capital stock. Effective as of the third quarter of fiscal year ended2005, we will be required to expense unvested and newly issued employee stockoptions. This change from current accounting regulations could have asignificant impact on our results of operations and could affect the manner inwhich we conduct business.

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

We intend tocontinue to grow by increasing our sales efforts and completing strategicacquisitions. To effectively manage our growth, we must, among other things:

·       engage, train and manage alarger sales force and additional service personnel;

·       expand the geographiccoverage of our sales force;

·       expandour information systems;

·       identifyand successfully integrate acquired businesses into our operations; and

·       administerappropriate financial and administrative control procedures.

Our anticipated growth will likely place a significantstrain on our management, financial, operational, technical, sales andadministrative 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 other companiesto continue to improve the design and performance of their products and tointroduce 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, or accidents that affect our operations, manufacturingfacility, or the health of our employees or customers could adversely affectour operating results and financial condition. Continued or future outbreaks ofinfectious diseases such as severe acute respiratory syndrome (“SARS”), avianflu, or other similar or comparable outbreaks or fears or concerns of possibleoutbreaks may significantly affect the willingness or ability of our customersto visit our facilities or trade shows, review our systems’ capabilities and/orpurchase or take delivery of our products, as well as our ability to visit ourcustomers, to perform application studies for our customers, to sell anddeliver products, and to service those products. Any government mandated orsuggested restrictions on travel, quarantines, or declines in the willingnessor ability of our customers to travel and visit our facilities or our abilityto travel and visit our customers, could have a material adverse effect on ourbusiness, financial condition and results of operations.

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**Item 7A**.                Quantitativeand Qualitative Disclosures about Market Risk

***Market Risk***

We are exposed to marketrisk primarily from changes in interest rates and credit risk. We do not havematerial exposure to market risk from fluctuations in foreign currency exchangerates because all sales are made in U.S. dollars.

***Interest Rate Risk***

We are exposed to interestrate risk primarily from investments in cash equivalents and short-term andlong-term marketable debt securities (the “Investment Portfolio”). The entireInvestment Portfolio is classified as available-for-sale and, accordingly, isrecorded on the consolidated balance sheet at fair value based on quoted marketprices, with unrealized gains and losses reported in Shareholders’ Equity underthe caption “Accumulated other comprehensive income (loss)”. The entireInvestment Portfolio is denominated in U.S. dollars. We do not use derivativefinancial instruments in the Investment Portfolio. Due to the short duration ofour investment portfolio, an immediate 10 percent change in interest rates isnot expected to have a material adverse effect on our near-term financialcondition or results of operations.

***Credit Risk***

Financial instruments which potentially subject us tocredit risk consist principally of securities in the Investment Portfolio andtrade receivables. 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.

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**Item8.**                        FinancialStatements and Supplementary Data

**AUGUST TECHNOLOGYCORPORATION**

**Indexto Consolidated Financial Statements**
| Report of Independent  Registered Public Accounting Firm                                                              |   | 43 |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|----|--------|
| Report  of Independent Registered Public Accounting Firm                                                              |   | 44 |   |
| Consolidated Balance Sheets  as of December 31, 2004 and 2003                                                    |   | 46 |   |
| Consolidated  Statements of Operations for the Years Ended December 31, 2004, 2003 and  2002                     |   | 47 |   |
| Consolidated  Statements of Shareholders’ Equity for the Years Ended December 31,  2004, 2003 and 2002 |   | 48 |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and  2002                     |   | 49 |   |
| Notes  to Consolidated Financial Statements                                                                           |   | 50 |   |

 

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**Report of Independent Registered Public AccountingFirm**

The Board of Directors and ShareholdersAugust 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 statementschedule based on 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.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of August Technology Corporation’sinternal control over financial reporting as of December 31, 2004, basedon criteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO), andour report dated March 7, 2005, expressed an unqualified opinion onmanagement’s assessment of, and the effective operation of, internal controlover financial reporting.

/s/ KPMG LLP

Minneapolis, MinnesotaMarch 7, 2005

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**Report of Independent Registered Public AccountingFirm**

The Board of Directors and ShareholdersAugust Technology Corporation:

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over Financial Reporting**that August Technology Corporationmaintained effective internal control over financial reporting as of December 31,2004, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO)*.*August TechnologyCorporation’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial 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.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management’s assessment that August TechnologyCorporation maintained effective internal control over financial reporting asof December 31, 2004, is fairly stated, in all material respects, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO).**Also, in our opinion, August TechnologyCorporation maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2004, based on**criteria established in InternalControl—Integrated Framework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO).

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We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of August TechnologyCorporation and subsidiaries as of December 31, 2004 and 2003, and therelated consolidated statements of operations, shareholders’ equity, and cashflows for each of the years in the three-year period ended December 31,2004, and our report dated March 7, 2005*,*expressed an unqualified opinion on those consolidated financialstatements.

/s/ KPMG LLP

Minneapolis, MinnesotaMarch 7, 2005

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**AUGUST TECHNOLOGY CORPORATIONCONSOLIDATED BALANCE SHEETS(In thousands, except share amounts)**
| ** **                                                                                                                           | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                           | ** ** | **2004**              |       | **2003** |   |
| **ASSETS**                                                                                                                           |       |                  |       |   |   |
| Current assets:                                                                                                                      |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                            |       | $                     | 5,518      |   | $ | 10,027 |   |
| Short-term marketable debt securities                                                                                                |       | 28,615                |       | 43,528 |   |
| Accounts receivable, net                                                                                                             |       | 8,603                 |       | 4,094 |   |
| Inventories                                                                                                                          |       | 20,131                |       | 11,651 |   |
| Inventories at customers under purchase orders                                                                                       |       | 3,993                 |       | 2,293 |   |
| Prepaid expenses and other current assets                                                                                            |       | 2,306                 |       | 1,631 |   |
| Total current assets                                                                                                                 |       | 69,166                |       | 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                                                                                                                         |       | $                     | 95,800     |   | $ | 88,947 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                        |       |                  |       |   |   |
| Current  liabilities:                                                                                                                |       |                  |       |   |   |
| Accounts payable                                                                                                                     |       | $                     | 3,366      |   | $ | 5,409 |   |
| Accrued compensation                                                                                                                 |       | 1,691                 |       | 1,146 |   |
| Other accrued liabilities                                                                                                            |       | 2,306                 |       | 1,414 |   |
| Customer deposits and deferred revenues                                                                                              |       | 6,841                 |       | 2,436 |   |
| Total current liabilities                                                                                                            |       | 14,204                |       | 10,405 |   |
| Other non-current liabilities                                                                                                        |       | 131                   |       | 65 |   |
| Total liabilities                                                                                                                    |       | 14,335                |       | 10,470 |   |
| Commitments and contingencies (note 12)                                                                                              |       | —                |       | — |   |
| Shareholders’  equity:                                                                                                          |       |                  |       |   |   |
| Common stock, no par value, 42,000,000 shares  authorized 17,839,298 and 17,382,538 shares issued and outstanding, respectively |       | 90,347                |       | 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                                                                                                                  |       | (8,776                | )          | (9,578 | ) |
| Accumulated other comprehensive income (loss)                                                                                        |       | (106                  | )          | 18 |   |
| Total shareholders’ equity                                                                                                      |       | 81,465                |       | 78,477 |   |
| Total liabilities and shareholders’ equity                                                                                      |       | $                     | 95,800     |   | $ | 88,947 |   |

 

See accompanying notes to consolidated financial statements.

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**AUGUST TECHNOLOGY CORPORATIONCONSOLIDATED STATEMENTS OFOPERATIONS(In thousands, except per share amounts)**
| ** **                                       | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net revenues                                     |       | $                                           | 68,443     |   | $ | 40,323 |   | $ | 25,058 |   |
| Cost of revenues                                 |       | 31,925                                      |       | 18,290 |   | 11,068 |   |
| Gross profit                                     |       | 36,518                                      |       | 22,033 |   | 13,990 |   |
| Selling, general and administrative expenses     |       | 22,798                                      |       | 14,359 |   | 13,013 |   |
| Research and  development expenses               |       | 13,561                                      |       | 10,430 |   | 9,847 |   |
| Operating income (loss)                          |       | 159                                         |       | (2,756 | ) | (8,870 | ) |
| Interest income                                  |       | 847                                         |       | 407 |   | 624 |   |
| Other income                                     |       | 73                                          |       | — |   | — |   |
| Income (loss)  before provision for income taxes |       | 1,079                                       |       | (2,349 | ) | (8,246 | ) |
| Provision for  income taxes                      |       | 277                                         |       | — |   | 687 |   |
| Net income (loss)                                |       | $                                           | 802        |   | $ | (2,349 | ) | $ | (8,933 | ) |
| Net income (loss)  per share:                    |       |                                        |       |   |   |   |   |
| Basic                                            |       | $                                           | 0.05       |   | $ | (0.16 | ) | $ | (0.69 | ) |
| Diluted                                          |       | $                                           | 0.04       |   | $ | (0.16 | ) | $ | (0.69 | ) |
| Weighted average  number of shares:              |       |                                        |       |   |   |   |   |
| Basic                                            |       | 17,755                                      |       | 14,381 |   | 13,033 |   |
| Diluted                                          |       | 18,211                                      |       | 14,381 |   | 13,033 |   |

 

See accompanying notes to consolidated financial statements.

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**AUGUST TECHNOLOGY CORPORATIONCONSOLIDATED STATEMENTS OFSHAREHOLDERS’ EQUITY(In thousands, except share amounts)**
| ** **                                                      | ** ** | **Common Stock** | ** ** | **Deferred** | ** ** | **Retained**           | ** ** | **Accumulated**  | ** ** | ** **             | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|--------------|------------|------------------------|------------|------------------|------------|------------------------|------------|
| ** **                                                      | ** ** | **Shares**            | ** ** | ** **   | ** ** | **Compensation**       | ** ** | **Earnings**     | ** ** | **Other**              | ** ** | **Total** | ** ** |
| ** **                                                      | ** ** | **Issued **And   | ** ** | ** **   | ** ** | **Related To**    | ** ** | **(Accumulated** | ** ** | **Comprehensive**      | ** ** | **Shareholders’** | ** ** |
| ** **                                                      | ** ** | **Outstanding**       | ** ** | **Amount**   | ** ** | **Stock Options** | ** ** | **Deficit)**     | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** |
| Balances at December 31, 2001                              |       |                  | 12,812,164 |         |       | $                      | 41,020     |             |       | $                      | (192       | ) |   |   | $ | 1,704 |   |   |   | $ | (9 | ) |   |   | $ | 42,523 |   |   |
| Net loss                                                        |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | (8,933 | ) |   |   | — |   |   |   | (8,933 | ) |   |
| Other  comprehensive income (loss):                             |       |                  |       |         |       |                   |       |             |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation adjustments                        |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | — |   |   |   | (3 | ) |   |   | (3 | ) |   |
| Net unrealized gain on securities                               |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | — |   |   |   | 55 |   |   |   | 55 |   |   |
| Comprehensive loss                                              |       |                  |       |         |       |                   |       |             |       |                   |       |   |   |   |   |   |   |   |   |   | (8,881 | ) |   |
| 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                              |       |                  | 13,152,304 |         |       | 42,158                 |       |             | (105       | )                      |       |   | (7,229 | ) |   |   | 43 |   |   |   | 34,867 |   |   |
| Net loss                                                        |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | (2,349 | ) |   |   | — |   |   |   | (2,349 | ) |   |
| Other  comprehensive loss:                                      |       |                  |       |         |       |                   |       |             |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation adjustments                        |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | — |   |   |   | (8 | ) |   |   | (8 | ) |   |
| Net unrealized loss on securities                               |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | — |   |   |   | (17 | ) |   |   | (17 | ) |   |
| Comprehensive loss                                              |       |                  |       |         |       |                   |       |             |       |                   |       |   |   |   |   |   |   |   |   |   | (2,374 | ) |   |
| 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                              |       |                  | 17,382,538 |         |       | 88,086                 |       |             | (49        | )                      |       |   | (9,578 | ) |   |   | 18 |   |   |   | 78,477 |   |   |
| Net income                                                      |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | 802 |   |   |   | — |   |   |   | 802 |   |   |
| Other  comprehensive income (loss):                             |       |                  |       |         |       |                   |       |             |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation adjustments                        |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | — |   |   |   | 21 |   |   |   | 21 |   |   |
| Net unrealized loss on securities                               |       |                  | —     |         |       | —                 |       |             | —     |                   |       |   | — |   |   |   | (145 | ) |   |   | (145 | ) |   |
| Comprehensive income                                            |       |                  |       |         |       |                   |       |             |       |                   |       |   |   |   |   |   |   |   |   |   | 678 |   |   |
| Issuances  of common stock in conjunction with:                 |       |                  |       |         |       |                   |       |             |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercises of employee stock options                             |       |                  | 414,171    |         |       | 1,879                  |       |             | —     |                   |       |   | — |   |   |   | — |   |   |   | 1,879 |   |   |
| 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                   |       |                  | —     |         |       | 50                     |       |             | —     |                   |       |   | — |   |   |   | — |   |   |   | 50 |   |   |
| 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                             |       |                  | 17,839,298 |         |       | $                      | 90,347     |             |       | $                      | —     |   |   |   | $ | (8,776 | ) |   |   | $ | (106 | ) |   |   | $ | 81,465 |   |   |

 

See accompanying notes to consolidated financial statements.

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**AUGUST TECHNOLOGY CORPORATIONCONSOLIDATED STATEMENTS OFCASH FLOWS(In thousands)**
| ** **                                                                                          | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from  operating activities:                                                              |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                                   |       | $                                           | 802        |   | $ | (2,349 | ) | $ | (8,933 | ) |
| Adjustments to reconcile  net income (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                                                            |       | 50                                          |       | — |   | — |   |
| 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                                                                                 |       | (4,519                                      | )          | 3,171 |   | (2,465 | ) |
| Inventories                                                                                         |       | (8,452                                      | )          | (3,474 | ) | 920 |   |
| Inventories at customers under purchase orders                                                      |       | (1,700                                      | )          | (312 | ) | 20 |   |
| Prepaid expenses and other current assets                                                           |       | (672                                        | )          | (188 | ) | 1,427 |   |
| Accounts payable                                                                                    |       | (2,041                                      | )          | 3,130 |   | 632 |   |
| Accrued compensation                                                                                |       | 536                                         |       | 591 |   | (61 | ) |
| Other accrued liabilities                                                                           |       | 767                                         |       | 849 |   | (113 | ) |
| Customer deposits and deferred revenues                                                             |       | 4,156                                       |       | 232 |   | (447 | ) |
| 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 issuances of common stock                                                         |       | 2,187                                       |       | 43,766 |   | 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 |   | $ | — |   |

 

See accompanying notes to consolidated financial statements.

49

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data)**

**Note 1—Natureof 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.  ***Cashand cash equivalents include highly liquid securities with original maturitiesof 90 days or less when purchased.

***Investments.  ***Investments consistof marketable debt securities. The investments are stated at fair value basedon quoted market prices and may be used for liquidity or other corporatepurposes. The Company’s investments are classified as available-for-salesecurities. Unrealized gains and losses are reported in shareholders’ equityunder the caption “Accumulated other comprehensive income (loss)” untilmaturity or sale of the investment, at which time it is included in interestincome. Short-term marketable debt securities mature in less than one year. Long-termmarketable debt securities have maturities of more than one year.

***Fair Value of FinancialInstruments.  ***The carrying amount of cash and cashequivalents, accounts receivable, marketable debt securities and accountspayable approximates fair value as of December 31, 2004 and 2003.

***Inventories.  ***Inventories are stated at the lower of 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.

50

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note1—Nature of Business and Summary of Significant Accounting Policies(Continued)**

***Inventories at Customers UnderPurchase Orders.  ***Inventories at customers underpurchase******orders represents systemsthat have shipped under the terms of a customer purchase order, but have notyet qualified for revenue recognition as the systems had not met customerspecifications as of December 31, 2004 or 2003.

***Property and Equipment.  ***Propertyand equipment are recorded at cost and depreciated over the estimated usefullives of the respective assets. The estimated useful lives range from two toseven years. Leasehold improvements are amortized using the straight-linemethod over the lesser of the estimated useful lives or lease terms.

***Purchased Technology and Goodwill.  ***Purchasedtechnology is presented at cost, net of accumulated amortization and isamortized over the estimated useful lives. The estimated useful lives rangefrom two to four years. In accordance with the provisions of Statement ofFinancial Accounting Standard (“SFAS”) No. 142, “Goodwill and IntangibleAssets,” goodwill is periodically tested for impairment rather than ratablyamortized over a period of time. To test for potential impairment, it was firstdetermined that the Company consisted of a single reporting unit. Secondly,fair value of the reporting unit was determined based upon the quoted marketprice of the Company’s common stock at December 31, 2004. The fair valueof the Company was then compared with the carrying value of net assets. Basedon this comparison, it was determined that no impairment existed. Accordingly,the Company did not perform step two of the impairment analysis, in which theexact amount of impairment would have been determined. In step two of theimpairment analysis, the Company would have been required to compare theimplied fair value of goodwill, determined by allocating the reporting unit’sfair value to all of its assets and liabilities, to its carrying amount.

***Capitalized Software DevelopmentCosts.  ***Software development costs incurredsubsequent to the establishment of technological feasibility, which isdemonstrated by the completion of a working prototype, through general releaseof the products are capitalized. Capitalized costs are amortized over thelesser of the estimated sales of the product or the straight-line method over aperiod of three years. The Company reviews the carrying value of softwaredevelopment costs regularly and a loss is recognized when the net realizablevalue falls below the unamortized cost. Net capitalized software developmentcosts at December 31, 2004 and 2003 were $69 and $65, respectively. Amortizationexpense for the years ended December 31, 2004, 2003, and 2002 was $73,$95, and $88, respectively.

***Patent costs.  ***Patentcosts are presented at cost, net of accumulated amortization and are amortizedover 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 yearsended 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.

51

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note1—Nature of Business and Summary of Significant Accounting Policies (Continued)**

***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.

***Income Taxes.  ***Incometaxes are accounted for under the asset and liability method. Deferred incometaxes are recognized for the difference between the financial statementcarrying amounts and the tax basis of existing assets and liabilities. Deferredincome taxes are recorded at the tax rates expected to be in effect whenamounts are to be included in future taxable income. The Company regularlyassesses the recoverability of deferred tax assets and records a valuationallowance to reduce the deferred tax assets to the amounts believed to berealizable, considering whether it is more likely than not that some portion orall of the deferred tax assets will be realized. The ultimate realization ofdeferred tax assets is dependent upon carry back to prior periods, tax planningstrategies, the scheduled reversal of deferred tax liabilities and thegeneration of future taxable income during the periods in which those temporarydifferences become deductible. Based upon the Company’s level of historicaltaxable losses in recent years and the uncertainty of future taxable income,the Company concluded during the second quarter of 2002, and continues tobelieve, that a full valuation allowance against the deferred tax assets isappropriate. The valuation allowance at December 31, 2004 was $8,460.

***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, and equityaccounts are translated at historical rates. Income and expense accounts aretranslated at the average exchange rate in effect during the period. Theresulting translation adjustment is excluded from operations and accumulated asa separate component of shareholders’ equity.

***Stock-basedCompensation.  ***The Company measures compensationexpense for options issued under its stock-based employee compensation plansusing the intrinsic value method. As the exercise price of options grantedunder these plans is equal to the fair market price of the underlying common stockon the grant date, no stock-based employee compensation expense is recognizedin the consolidated statements of operations. Compensation expense related tothe issuance of restricted stock awards is measured at the fair market value ofthe stock at the date of grant, and expensed over the vesting 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 allshare-based 

52

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note1—Nature of Business and Summary of Significant Accounting Policies (Continued)**

paymentsto employees, including grants of employee stock options, to be recognized inthe Company’s consolidated statement of operations based on their fair values.After consideration of various alternatives, the Committee approved theaccelerated and full vesting of all unvested outstanding employee stock optionswith exercise prices above $11.00 per share issued prior to December 21,2004. The effect of the vesting acceleration was the vesting of 249 options andthe recognition of additional stock-based employee compensation expense of$1,943 in the fourth quarter of 2004 in the Company’s pro forma disclosurebelow. This previously deferred stock-based employee compensation expense,included in the pro forma disclosures, would otherwise in part have beenrecognized in the Company’s consolidated statements of operations in futureperiods after the adoption of SFAS 123R in the third quarter of 2005.

Thefollowing table illustrates the effect on net income (loss) and net income(loss) per share if the Company had applied the fair value recognitionprovisions of FASB Statement No. 123, “*Accountingfor Stock-Based Compensation”*, to stock-based employee compensation.
| ** **                           | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|
| ** **                           | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income  (loss), as reported      |       | $                                           | 802        |   | $ | (2,349 | ) | $ | (8,933 | ) |
| Stock  compensation expense          |       | (5,043                                      | )          | (1,598 | ) | (2,491 | ) |
| Pro forma net  loss                  |       | $                                           | (4,241     | ) | $ | (3,947 | ) | $ | (11,424 | ) |
| Basic net income (loss) per share:   |       |                                        |       |   |   |   |   |
| As reported                          |       | $                                           | 0.05       |   | $ | (0.16 | ) | $ | (0.69 | ) |
| Pro forma                            |       | (0.24                                       | )          | (0.27 | ) | (0.88 | ) |
| Diluted net income (loss) per share: |       |                                        |       |   |   |   |   |
| As reported                          |       | $                                           | 0.04       |   | $ | (0.16 | ) | $ | (0.69 | ) |
| Pro forma                            |       | (0.24                                       | )          | (0.27 | ) | (0.88 | ) |

 

TheCompany determined the pro forma compensation expense under the provisions ofSFAS No. 123 using the Black-Scholes pricing model and the followingassumptions:
| ** **               | ** ** | **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           |       | —                                      |       | — |   | — |   |

 

The estimated per shareweighted average fair value of all stock options granted during the years endedDecember 31, 2004, 2003 and 2002 was $6.95, $4.75 and $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.

53

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note1—Nature of Business and Summary of Significant Accounting Policies (Continued)**

***Revenue Recognition.  ***TheCompany derives revenues from the sale of systems, spare parts, software andservices.

*Systemsales:  *The Company requires customers, excluding theCompany’s distributors, that have new inspection applications to completepre-shipment authorization testing of purchased systems at the Company’sfacility, prior to shipment. During this testing, the customer verifies thatthe system meets their specifications and authorizes shipment. For systems thathave completed pre-shipment authorization testing, revenue is recognized asfollows:

·        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 newinspection application declines pre-shipment authorization testing of apurchased system, revenue is deferred until, title and risk of loss havetransferred to the customer, installation has occurred and collection of theresulting receivable is probable.

When the customer hasalready accepted previous systems, with the same specifications, for the sameapplication, the Company does not require pre-shipment authorization testing. Revenueis recognized when the product has shipped, title and risk of loss havetransferred to the customer and collection of the resulting receivable isprobable.

System sales are accountedfor as multiple-element arrangements. In transactions that include multipleproducts and/or services, the Company allocates the revenue to each elementbased on their relative fair value (or in the absence of fair value, theresidual method) and recognizes the associated revenue when all revenuerecognition criteria have been met for each element.

*Spareparts revenue:  *Spare parts revenue is recognized whenthe parts have been shipped, title and risk of loss have transferred to thecustomer and collection of the resulting receivable is probable.

*Software revenue:  *Revenue fromsoftware 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 elements inthese arrangements typically consist of follow-on support. If vendor-specificobjective evidence does not exist for the undelivered elements of thearrangement, all revenue is deferred and recognized ratably over the supportperiod.

*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’s distributorsare not granted price protection or a right of return.

54

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note1—Nature of Business and Summary of Significant Accounting Policies (Continued)**

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

***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. A provisionfor the costs related to warranty expense is recorded as a charge to cost ofgoods sold when revenue is recognized. The estimated warranty cost is based onour historical experience rate of incurred expenses to corresponding systemrevenues.

***Advertising Costs.  ***Advertisingcosts are expensed as incurred.

***Research and Development.  ***Researchand development costs are expensed as incurred.

***Net Income (Loss) Per Share.  ***Basicnet income (loss) per share excludes dilution and is computed by dividing netincome (loss) available to common shareholders by the weighted average numberof common shares outstanding for the period. Diluted net income per sharereflects the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into common stock.When there is a net loss, other potentially dilutive securities are notincluded in the calculation of net loss per share since their inclusion wouldbe anti-dilutive.

***Reclassifications.  ***Certainprior year amounts have 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, theFASB issued FASB Interpretation (“FIN”) No. 46R, “*Consolidation of Variable Interest Entities,”*which addresses how a business enterprise should evaluate whether it has acontrolling financial interest in an entity through means other than votingrights and accordingly should consolidate the entity. FIN 46R replaces FASBInterpretation 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 FASBissued SFAS No. 150, “*Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity.”* 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 

55

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note1—Nature of Business and Summary of Significant Accounting Policies (Continued)**

mandatorilyredeemable financial instruments, the Statement will be effective for theCompany on January 1, 2005. The effective date has been deferredindefinitely for certain other types of mandatorily redeemable financialinstruments. The Company currently does not have any financial instruments thatare within the scope of SFAS No. 150.

**Note2**—BusinessCombinations

The Company completed onepurchase acquisition in 2004 and two during 2003. The consolidated financialstatements include the operating results of each business from the date ofacquisition. Pro forma results of operations have been presented for allacquisitions that are material on either an individual or aggregate basis. Fora period of up to twelve months from the acquisition date, the Company maychange its original purchase price allocation for pre-acquisitionuncertainties.

***DMSVision softwaredivision of Inspex, Inc.***

On July 27,2004, the Company purchased certain assets relating to the DMSVisionsoftware division of Inspex, Inc. (“DMSVision”). The purchase was madepursuant to an Asset Purchase Agreement between the Company and Inspex, Inc.dated June 23, 2004. DMSVision develops and markets productcharacterization software solutions that allow customers to collect and analyzeprocess information from a broad range of applications. The total considerationpaid for DMSVision, including direct acquisition costs, was $2,326 of cash. Inaddition, the Company may owe additional future consideration based on neworders for DMSVision software licenses received in the twelve months after theclosing date. Based upon the total estimated contingent consideration, thepayment of the contingency will result in an increase in the allocation ofpurchase price to purchased technology. As a result, amortization expenserelated to this asset will increase. Amounts paid under this arrangement arenot expected to have a material effect on the Company’s consolidated financialcondition or results of operations. The Company currently estimates the totalcontingent consideration to be paid will be between $150 and $300.

Theallocation of the purchase price to the net assets acquired and liabilitiesassumed based upon their estimated fair market values was as follows:
| Accounts  receivable  |   | $     | 122    |   |
|-----------------------|--------|-------|--------|--------|
| Purchased  technology |   | 2,474 |   |
| Accrued  liabilities  |   | (21   | )      |
| Deferred revenues     |   | (249  | )      |
|                  |   | $     | 2,326  |   |

 

***SemiconductorTechnologies & Instruments, Inc.***

On April 15, 2003,the Company acquired all of the outstanding capital stock of SemiconductorTechnologies & Instruments, Inc. (“STI”). STI manufacturesautomated defect inspection and metrology tools that are integrated ontoprobers, providing microelectronics manufacturers with an automated solutionfor inspecting probe marks, ink dots and active die regions. The total purchaseprice, including direct acquisition costs, was $2,201 which consisted of $1,445in cash and 215 shares of the Company’s Common Stock.

56

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note2**—BusinessCombinations (Continued)

The allocation of thepurchase price to the assets acquired and liabilities assumed, based upon theirestimated fair market values, 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  |   |

 

Thefollowing unaudited pro forma consolidated financial information presents thecombined results of operations of the Company, DMSVision, and STI as if theacquisitions occurred at the beginning of the periods presented, after givingeffect to certain adjustments, including amortization expense. The unauditedpro forma consolidated financial information does not necessarily reflect theresults of operations that would have occurred had the acquisitions beencompleted as of the dates indicated or of the results that may be obtained inthe future.
| ** **                   | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------|------------|---------------------------------------------|------------|
| ** **                   | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| ** **                   | ** ** | ** As reported **            | ** ** | **  Pro forma  ** | ** ** | ** As reported ** | ** ** | **  Pro forma  ** | ** ** |
| Revenues                     |       |                                        | $          | 68,443 |   |   |   | $ | 68,961 |   |   |   | $ | 40,323 |   |   |   | $ | 42,395 |   |   |
| Net income (loss)            |       |                                        | 802        |   |   |   | (199 | ) |   |   | (2,349 | ) |   |   | (4,455 | ) |   |
| Net income (loss) per share: |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                        |       |                                        | $          | 0.05 |   |   |   | $ | (0.01 | ) |   |   | $ | (0.16 | ) |   |   | $ | (0.31 | ) |   |
| Diluted                      |       |                                        | $          | 0.04 |   |   |   | $ | (0.01 | ) |   |   | $ | (0.16 | ) |   |   | $ | (0.31 | ) |   |

 

***Counterpoint Solutions, Inc.***

On July 3, 2003, theCompany purchased substantially all of the assets of Counterpoint Solutions, Inc.(“CSI”). CSI develops wafer inspection, review and failure analysis solutions. Thetotal purchase price, including direct acquisition costs, was $1,515, whichconsisted of 200 shares of the Company’s Common Stock and $111 in cash. Theallocation of the purchase price resulted in the Company recording $17 of netassets, $498 of goodwill and $1,000 of purchased technology. During the yearended December 31, 2002, CSI had unaudited revenues of $885 and unauditednet income of $104.

57

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note 3—MarketableDebt Securities**

Theamortized cost and estimated fair value of available-for-sale marketable debtsecurities 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 |   |

 

Thematurities of available-for-sale marketable 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.

**Note 4—AccountsReceivable**

Accountsreceivable consisted of the following:
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Billed  receivables              |       | $                     | 8,150      |   | $ | 3,837 |   |
| Unbilled revenue                 |       | 1,143                 |       | 812 |   |
|                             |       | 9,293                 |       | 4,649 |   |
| Allowance for  doubtful accounts |       | (690                  | )          | (555 | ) |
| Accounts  receivable, net        |       | $                     | 8,603      |   | $ | 4,094 |   |

 

Unbilled revenuerepresents revenue that has been earned for equipment shipped but not billeddue to the payment terms of the customer order.

58

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note 5—Inventories**

Inventoriesconsisted of the following:
| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Raw materials            |       | $                     | 8,474      |   | $ | 4,645 |   |
| Work in process          |       | 3,558                 |       | 2,305 |   |
| Demonstration  equipment |       | 4,152                 |       | 1,603 |   |
| Finished goods           |       | 3,947                 |       | 3,098 |   |
| Inventories              |       | $                     | 20,131     |   | $ | 11,651 |   |

 

**Note 6—PurchasedTechnology**

Purchasedtechnology 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 |   |

 

Amortization expense forthe years ended December 31, 2004, 2003 and 2002 was $757, $191 and none,respectively. Assuming no change in the gross carrying value of purchasedtechnology, the estimated amortization expense for each of the next five yearsis $1,393, $1,178, $771, $361, and none.

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

**Note 7—Propertyand 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 |   |

 

Furnitureand equipment 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. Depreciationexpense for the years ended December 31, 2004, 2003 and 2002 was $2,171,$1,666 and $1,311, respectively.

59

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note 8—Income Taxes**

Theprovision for income taxes consisted of the following:
| ** **                        | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|
| ** **                        | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current:                          |       |                                        |       |   |   |   |   |
| Federal                           |       | $                                           | 50         |   | $ | — |   | $ | (239 | ) |
| State                             |       | (36                                         | )          | — |   | — |   |
| Foreign                           |       | 244                                         |       | — |   | 30 |   |
|                              |       | 258                                         |       | — |   | (209 | ) |
| Deferred:                         |       |                                        |       |   |   |   |   |
| Federal                           |       | 17                                          |       | — |   | 679 |   |
| State                             |       | 2                                           |       | — |   | 217 |   |
| Foreign                           |       | —                                      |       | — |   | — |   |
|                              |       | 19                                          |       | — |   | 896 |   |
| Total provision  for income taxes |       | $                                           | 277        |   | $ | — |   | $ | 687 |   |

 

Areconciliation of the expected federal income taxes at the statutory rate of34% to the actual provision for income taxes is as follows:
| ** **                                   | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                   | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Expected federal  income tax                 |       | $                                           | 367        |   | $ | (799 | ) | $ | (3,037 | ) |
| General business  credits                    |       | (61                                         | )          | (312 | ) | (283 | ) |
| Tax exempt income                            |       | (15                                         | )          | (90 | ) | (58 | ) |
| Nondeductible  expenses                      |       | 109                                         |       | 59 |   | 100 |   |
| Change in  valuation allowance               |       | (140                                        | )          | 1,142 |   | 3,752 |   |
| State income tax,  net of federal tax effect |       | (22                                         | )          | — |   | 144 |   |
| Foreign tax                                  |       | (9                                          | )          | — |   | 30 |   |
| Other                                        |       | 48                                          |       | — |   | 39 |   |
| Actual provision  for income taxes           |       | $                                           | 277        |   | $ | — |   | $ | 687 |   |

 

60

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note 8—Income Taxes(Continued)**

Deferredtaxes consisted of the following: 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Current deferred tax  assets:          |       |                  |       |   |   |
| 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      |       | 1,349                 |       | 557 |   |
|                                   |       |                  |       |   |   |
| Long-term deferred tax  assets:        |       |                  |       |   |   |
| Net operating loss carryovers          |       | 6,294                 |       | 5,886 |   |
| General business credits               |       | 1,361                 |       | 1,319 |   |
| Accrued lease obligation               |       | 40                    |       | 25 |   |
| Amortization of identified intangibles |       | 138                   |       | — |   |
| Other                                  |       | 38                    |       | — |   |
| Total gross deferred tax assets        |       | 9,220                 |       | 7,787 |   |
|                                   |       |                  |       |   |   |
| 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                   |       | (8,460                | )          | (7,529 | ) |
| Net deferred tax  liability            |       | $                     | (19        | ) | $ | — |   |

 

The valuation allowance for deferred tax assets as of December 31,2004 and 2003 was $8,460 and $7,529, respectively. The net change in the totalvaluation allowance for the years ended December 31, 2004 and 2003 was anincrease of $931 and $2,169, respectively.

At December 31, 2004, the Company had federal netoperating loss carryforwards of approximately $17,423 that will begin to expirein 2022 and state net operating loss carryforwards of approximately $6,379 thatwill begin to expire in 2016. The net operating losses are available to offsetfuture federal and state taxable income, if any. In addition, the Company hasgeneral 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.

Subsequently recognizedtax benefits relating to the $8,460 valuation allowance for deferred tax assetsas of December 31, 2004, would be reported in the consolidated statementsof operations as an income tax 

61

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note8—Income Taxes (Continued)**

benefitof $4,860 and in the consolidated statements of shareholders’ equity as a taxbenefit from stock options exercised of $3,600.

As of December 31, 2004, approximately $89 ofearnings attributable to international subsidiaries was considered to bepermanently reinvested. No provision has been made for taxes that might bepayable if these earnings were remitted to the U.S.

In accordance with SFAS No. 142, the Company doesnot amortize goodwill for financial reporting purposes. Therefore, the deferredtax liability related to the taxable temporary differences caused by differentamortization periods for goodwill will not reverse unless the underlying assetsare 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 AJCAincludes a deduction of 85 percent for certain foreign earnings that arerepatriated, as defined in the AJCA, at an effective tax cost of 5.25 percenton any such repatriated foreign earnings. The Company may elect to apply thisprovision to qualifying earnings repatriations in fiscal 2005. The Company hasbegun an evaluation of the effects of the repatriation provision. However, theCompany does not expect to complete this evaluation until after Congress or theTreasury Department provides additional clarifying language on key elements ofthe provision. The Company expects to complete their evaluation of the effectsof the repatriation 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 9—Short-TermDebt**

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

**Note 10—AccumulatedOther Comprehensive Income (Loss)**

Theaccumulated balances for each classification of accumulated other comprehensiveincome (loss) were as follows:
| ** **                                               | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Foreign currency  translation adjustments                |       | $                     | 1          |   | $ | (20 | ) |
| Unrealized gains  (losses) on marketable debt securities |       | (107                  | )          | 38 |   |
| Accumulated other  comprehensive income (loss)           |       | $                     | (106       | ) | $ | 18 |   |

 

62

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note 11—Shareholders’Equity**

***NetIncome (Loss) Per Share***

Thecomponents of basic and diluted net income (loss) per share were as follows:
| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss)                             |       | $                            | 802        |   | $ | (2,349 | ) | $ | (8,933 | ) |
|                                          |       |                         |       |   |   |   |   |
| Weighted average common  shares:              |       |                         |       |   |   |   |   |
| Basic                                         |       | 17,755                       |       | 14,381 |   | 13,033 |   |
| Effect of dilutive stock options and warrants |       | 456                          |       | — |   | — |   |
| Diluted                                       |       | 18,211                       |       | 14,381 |   | 13,033 |   |
|                                          |       |                         |       |   |   |   |   |
| Net income (loss) per  share:                 |       |                         |       |   |   |   |   |
| Basic                                         |       | $                            | 0.05       |   | $ | (0.16 | ) | $ | (0.69 | ) |
| Diluted                                       |       | $                            | 0.04       |   | $ | (0.16 | ) | $ | (0.69 | ) |

 

The total weighted averagenumber 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 486, 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 withthe Offering, on October 21, 2003, the underwriters exercised theirover-allotment option to acquire an additional 490 shares of Common Stock atthe same price to the public and with the same underwriting discount as theOffering. 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***

In connection with thegrant of stock options to employees in 1999, the Company recorded deferredcompensation of $428, representing the difference between the estimated deemedvalue of the Common Stock for accounting purposes and the exercise price ofsuch options at the date of grant. Such amount is presented as a reduction ofshareholders’ equity and was amortized ratably over the vesting period of theoptions granted, generally five years, and was fully amortized as of December 31,2004. The charge to compensation expense related to this deferred compensationfor 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 Plan allows employees, subject to certainrestrictions, 

63

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note11—Shareholders’ Equity (Continued)**

topurchase the Company’s Common Stock through payroll deductions. Contributionsare limited to 10% of an employee’s compensation. The purchase price is set at85% of the lower of the closing market price of the Company’s Common Stock atthe commencement or termination of a participation phase. Participation phaseshave a duration of six months and begin on January 1 and July 1 ofeach year. The Board of Directors has reserved 375 shares of Common Stock forissuance under the 2000 Purchase Plan. As of December 31, 2004, 156 sharesof Common Stock had been purchased and 219 shares remain reserved for futureissuance under the 2000 Purchase Plan.

***Stock-based Compensation***

The Board of Directors and shareholders have adoptedthe 1997 stock option plan (the “1997 Plan”), which originally provided for1,125 shares available for issuance primarily to officers, directors and keyemployees. On April 28, 2004, April 30, 2003, April 19, 2001,and April 14, 2000 the shareholders authorized increases in the number ofshares available for issuance to 4,250, 3,050, 2,650, and 2,250 shares,respectively. The 1997 Plan permits the granting of incentive stock optionsmeeting the requirements of Section 422 of the Internal Revenue Code of1986, as amended, and also nonqualified stock options which do not meet therequirements of Section 422. In addition, the April 28, 2004amendment modified the Plan to allow for the granting of restricted stockawards, stock appreciation rights and performance share awards, in addition tostock options, to certain eligible employees, directors and consultants of theCompany and its subsidiaries. The exercise price of incentive stock options maynot be less than the fair market value of the stock at the date of grant. Theexercise price of nonqualified stock options may not be less than 85% of thefair market value of the stock at the date of grant. The stock options vestover periods that range from immediate to five years and expire in either sevenor ten years from the date of grant. As of December 31, 2004 all of thestock incentives granted under the 1997 Plan, except for an award of 3 sharesof restricted stock, represented grants of stock 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 amortizedratably over the vesting period, and was fully amortized at December 31,2004. As of December 31, 2004, there were 981 shares available for futuregrant under the 1997 Plan.

64

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note11—Shareholders’ Equity (Continued)**

Information with respectto 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 |   |   |

 

The following tablesummarizes information about stock options outstanding at December 31,2004: 

| ** **                                     | ** ** | ** **                | ** ** | **Weighted   Average**                      | ** ** | ** **                                | ** ** | **Exercisable**          |
|------------------------------------------------|------------|---------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|--------------------------|
| **Range of   Exercise  Prices** | ** ** | **Outstanding   Options** | ** ** | **Remaining Contractual Life (years)** | ** ** | **Weighted  Average Exercise Price** | ** ** | **Exercisable  Options** | ** ** | **Weighted  Average  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 |   |

 

65

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note 12—Commitmentsand Contingencies**

***Leases***

The Company leases its facilities and certainequipment under noncancelable operating leases. Future minimum lease paymentsas of December 31, 2004, excluding operating costs, under these leases areas 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      |       |

 

Rent expense for alloperating leases for the years ended December 31, 2004, 2003 and 2002 was$811, $757 and $646, respectively.

***Purchase commitments***

The Company maintainscertain open purchase commitments for the purchase of goods and services.  The minimum purchase commitments for the yearended December 31, 2005 is estimated to be approximately $4,424. Althoughthe Company is primarily liable for payments on the purchase commitments, basedon historic operating performance and forecasted future cash flows, managementbelieves the exposure to losses, if any, under these arrangements is notmaterial.

***Guarantees***

Pursuant to FIN No. 45, “*Guarantor’sRequirements for Guarantees, including Indirect Indebtedness of Others*,”the Company is required to disclose the changes in the provision for productwarranty. The Company provides warranty coverage for its systems for a periodof one year, including parts and labor necessary to repair the systems duringthe warranty period. The estimated warranty cost is based on our historicalexperience rate of incurred expenses to corresponding system revenues.

66

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note12—Commitments and Contingencies (Continued)**

Information with respectto changes in the warranty provision, as required by FIN 45 and included in thecaption Other Accrued Liabilities on the Consolidated Balance Sheet, is asfollows:
| ** **                                              | ** ** | **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, theCompany paid $428 to Metron Technology B.V. (“Metron”) related to themodification of its distributor agreement with Metron. The entire amount wasrecognized within selling, general and administrative expense in the periodincurred. The modification resulted in focusing Metron’s activities entirely onSouth Korea. The Company subsequently terminated the entire agreement withMetron without the payment of any additional amounts.

***Legal Proceedings***

From time to time, in the ordinary course of business,the Company is subject to claims, asserted or unasserted, or named as a partyto lawsuits or investigations. Except as described below and in Note 16, theCompany is not aware of any asserted or unasserted legal proceedings or claimsthat management believes would have a material adverse effect on the Company’sfinancial 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 and its subsidiary, STI filed a complaint against Rudolph andits subsidiary ISOA, Inc. (“ISOA”). In the complaint, the Company and STIsought a declaratory judgment that the Company and STI were not using ISOAtechnology in their products. STI also asserted a claim for breach of contractto recover amounts STI paid to ISOA in connection with a joint developmentagreement between STI and ISOA. Rudolph and ISOA filed an answer andcounterclaim, denying the allegations set forth in the complaint and claimingthat ISOA was entitled to damages for STI’s alleged breach of the jointdevelopment agreement. ISOA also sought a declaratory judgment that STI and/orthe Company were wrongfully using ISOA’s technology without compensating ISOAand that ISOA was entitled to royalty payments for use of its technology.

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note12—Commitments and Contingencies (Continued)**

The Company acquired STI from ASTI Holdings, Ltd. (“ASTI”)in April 2003. In connection with the acquisition, ASTI agreed toindemnify the Company for claims relating to STI’s dispute with Rudolph andISOA, 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 the parties.On August 6, 2004 the Company entered into a final settlement agreementwith Rudolph. Under the terms of the confidential settlement, ASTI made aone-time payment out of the escrow to Rudolph in the amount of $503. TheCompany, STI, Rudolph and ISOA agreed to release any and all claims againsteach other relating to the joint development agreement and to dismiss allclaims asserted in the litigation with prejudice.

**Note 13—EmployeeRetirement Plan**

The Company maintains anemployee benefit plan (the “Plan”) pursuant to Section 401(k) of theInternal Revenue Code. The Plan is available to all employees who have reachedthe age of 18 and provides employees with tax deferred salary deductions andalternative investment options. Employees may contribute up to 15% of theireligible compensation, subject to certain limitations. The Company matches 50%of the deferrals up to 6% of the employee’s compensation. The Company madecontributions to the Plan for the years ended December 31, 2004, 2003 and2002 of $295, $251 and $259, respectively.

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note 14—SignificantCustomer, Product Line and**Geographic Information

The percentage of netrevenues derived from major customers and accounts receivable related to thesecustomers were as follows:
| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net revenues: |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Customer A    |       |                                        | 15         | % |   |   | 12 | % |   |   | * |   |   |
| Customer B    |       |                                        | 10         | % |   |   | * |   |   |   | * |   |   |
| Customer C    |       |                                        | 10         | % |   |   | * |   |   |   | * |   |   |
| Customer D    |       |                                        | *          |   |   |   | 11 | % |   |   | * |   |   |
| Customer E    |       |                                        | *          |   |   |   | 11 | % |   |   | 15 | % |   |
| Customer F    |       |                                        | *          |   |   |   | 12 | % |   |   | * |   |   |
| Customer G    |       |                                        | *          |   |   |   | * |   |   |   | 10 | % |   |
| Total         |       |                                        | 35         | % |   |   | 46 | % |   |   | 25 | % |   |

 
| ** **            | ** ** | **December 31,** | ** ** |
|-----------------------|------------|-----------------------|------------|
| ** **            | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Accounts  receivable: |       |                  |       |   |   |   |   |   |   |
| Customer A            |       |                  | 2          | % |   |   | 1 | % |   |
| Customer B            |       |                  | 19         | % |   |   | * |   |   |
| Customer C            |       |                  | 24         | % |   |   | * |   |   |
| Customer D            |       |                  | *          |   |   |   | 7 | % |   |
| Customer E            |       |                  | *          |   |   |   | 11 | % |   |
| Customer F            |       |                  | *          |   |   |   | 5 | % |   |
| Customer G            |       |                  | *          |   |   |   | * |   |   |
| Total                 |       |                  | 45         | % |   |   | 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** | ** ** |
| Net revenues:       |       |                                        |       |   |   |   |   |
| NSX Series          |       | 54                                          | %          | 50 | % | 45 | % |
| All Surface Systems |       | 20                                          | %          | 12 | % | 0 | % |
| 3Di Series          |       | 6                                           | %          | 15 | % | 37 | % |
| Other               |       | 20                                          | %          | 23 | % | 18 | % |
|                |       | 100                                         | %          | 100 | % | 100 | % |

 

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note14—Significant Customer, Product Line and Geographic Information(Continued)**

All of the Company’stangible long-lived assets are located in the United States, except for aninsignificant amount of property and equipment in Taiwan and South Korea. TheCompany derives revenues from shipments to customers outside of the UnitedStates. The percentage of net revenues by geographic region was as follows:
| ** **       | ** ** | **Years Ended December 31,** | ** ** |
|------------------|------------|---------------------------------------------|------------|
| ** **       | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net revenues:    |       |                                        |       |   |   |   |   |
| United States    |       | 27                                          | %          | 24 | % | 48 | % |
| Taiwan           |       | 35                                          | %          | 38 | % | 37 | % |
| South Korea      |       | 17                                          | %          | 14 | % | — |   |
| Japan            |       | 4                                           | %          | 7 | % | 4 | % |
| Rest of Asia     |       | 12                                          | %          | 5 | % | 4 | % |
| Europe and other |       | 5                                           | %          | 12 | % | 7 | % |
|             |       | 100                                         | %          | 100 | % | 100 | % |

 

**Note 15—QuarterlyFinancial Data (unaudited)**
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **Mar. 31,**                | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                      | ** ** | **2004**                         | ** ** | **2004** | ** ** | **2004** | ** ** | **2004** | ** ** |
| Net revenues                    |       | $                                | 16,400     |   | $ | 19,855 |   | $ | 15,516 |   | $ | 16,672 |   |
| Gross profit                    |       | 9,342                            |       | 10,796 |   | 7,329 |   | 9,051 |   |
| Operating income  (loss)        |       | 1,245                            |       | 2,084 |   | (2,695 | ) | (475 | ) |
| 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 | ) |
| Weighted average common shares: |       |                             |       |   |   |   |   |   |   |
| Basic                           |       | 17,622                           |       | 17,778 |   | 17,803 |   | 17,815 |   |
| Diluted                         |       | 18,486                           |       | 18,349 |   | 17,803 |   | 17,815 |   |

 

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note15—Quarterly Financial Data (unaudited) (Continued)**
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **Mar. 31,**                | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                      | ** ** | **2003**                         | ** ** | **2003** | ** ** | **2003** | ** ** | **2003** | ** ** |
| Net revenues                    |       | $                                | 6,563      |   | $ | 7,757 |   | $ | 11,685 |   | $ | 14,318 |   |
| Gross profit                    |       | 3,608                            |       | 4,209 |   | 6,585 |   | 7,631 |   |
| Operating income  (loss)        |       | (2,367                           | )          | (1,438 | ) | 182 |   | 867 |   |
| 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 |   |
| Weighted average common shares: |       |                             |       |   |   |   |   |   |   |
| Basic                           |       | 13,158                           |       | 13,352 |   | 13,844 |   | 17,171 |   |
| Diluted                         |       | 13,158                           |       | 13,352 |   | 14,578 |   | 18,291 |   |

 

**Note 16—SubsequentEvents (unaudited)**

On January 21, 2005, the Company 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 theMerger Agreement (a) Nanometrics will effect a reincorporation underDelaware law by merging with and into Merger Sub 2, a Delaware corporation,with the surviving entity to be renamed August Nanometrics Inc. (“August Nanometrics”)and (b) Merger Sub 1 will be merged with and into the Company, with thesurviving entity to be a wholly-owned subsidiary of August Nanometrics. Eachshare of the Company’s common stock will be converted into the right to receive0.6401 of a share of August Nanometrics common stock. August Nanometricswill make a cash payment to the Company’s shareholders for any fractionalshares of August Nanometrics common stock they would otherwise be entitledto receive instead of issuing fractional shares.

On January 27, 2005, the Company received aletter from Paul F. McLaughlin, Chairman and Chief Executive Officer ofRudolph, stating that Rudolph is prepared to enter into a merger with theCompany based on a share exchange ratio of 0.6239 share of Rudolph stock foreach share of the Company’s common stock (equivalent to $10.50 per share of theCompany’s common stock based on the closing price of Rudolph 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.

Also on January 27, 2005, Rudolph issued a pressrelease with proposed terms slightly different from those described in theletter. The press release stated that Rudolph is prepared to enter into amerger with the Company whereby each shareholder of the Company will receivethe value of $2.16 per share in cash and 0.4955 per share in Rudolph commonstock (equivalent to $10.50 per share of the Company’s Common Stock, based onthe closing price of Rudolph stock on January 27, 2005). The press releasestated 

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**AUGUST TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In thousands, except per share data)**

**Note16—Subsequent Events (unaudited)**

that each of the Company’sshareholders would have the option to elect to receive all cash, stock or acombination of cash and stock, subject to proration based on total cashconsideration of $40 million.

The Company’s Board of Directors has agreed, based onthe advice 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 dateof this filing, the Company and Rudolph have not reached agreement on the formof confidentiality agreement and no discussions regarding Rudolph’s offer havetaken place.

On February 9, 2005, the Company received aletter from Kenneth Schroeder, President and Chief Executive Officer of KLA-TencorCorporation (“KLA”), regarding KLA’s interest in pursuing a merger with theCompany. The letter stated that KLA proposed to acquire the Company in atransaction in which the Company’s shareholders would receive $11.50 per share.KLA also stated that it would be willing to consider using stock asconsideration.

The Company’s Board of Directors has agreed, based onthe advice of its financial advisors and legal counsel, to further examine theKLA offer provided that KLA first executes a confidentiality agreement in theform required by the Merger Agreement with Nanometrics. As of the date of thisfiling, the Company and KLA have not reached agreement on the form ofconfidentiality agreement and no discussions regarding KLA’s offer have takenplace.

The Company and each of its directors, Jeff O’Dell,James Bernards, Roger Gower, Michael Wright and Linda Hall Whitman, have beennamed as defendants in two separate lawsuits that purport to be class actionsclaims on behalf of shareholders of the Company. The Company received a summonsand complaint with respect to the first of these proceedings on February 4,2005 and the second on February 14, 2005. Both lawsuits are brought inMinnesota State Court and claim that the directors have breached theirfiduciary duties to the Company’s shareholders in connection with their actionsin agreeing to the proposed merger with Nanometrics Incorporated. Theplaintiffs in both actions seek various forms of injunctive relief including anorder enjoining the Company and the directors from consummating the merger withNanometrics. The Company and its directors believe the lawsuits are withoutmerit and plan to vigorously defend against the claims.

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**Item9.**                        Changesin and Disagreements With Accountants on Accounting and Financial Disclosure

None

**Item 9A.**                Controlsand Procedures

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures**

The effectiveness of ouror any 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 anysystem of disclosure controls and procedures can provide only reasonable assuranceregarding 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. On the basis of this review, our management,including our Chief Executive Officer and Chief Financial Officer, concludedthat our disclosure controls and procedures are designed, and are effective, togive reasonable assurance that the information required to be disclosed by usin reports that we file under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the SEC and to ensure that information required to be disclosed in thereports filed or submitted under the Exchange Act is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, in a manner that allows timely decisions regarding requireddisclosure.

Also, there were nochanges in our internal control over financial reporting that occurred in thefourth quarter of 2004 that materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

**Management’sReport on Internal Control Over Financial Reporting**

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. Based on our evaluation under theframework in *Internal Control—IntegratedFramework,* our management concluded that our internal control overfinancial reporting was effective as of December 31, 2004.

Our management’sassessment of the effectiveness of our internal control over financial reportingas of December 31, 2004 has been audited by KPMG LLP, an independentregistered public accounting firm, as stated in their report which is includedherein.

**Item 9B.**               OtherInformation

On December 30, 2004,the Board of Directors approved the Company’s 2005 Annual Incentive Plan (“AIP”).The AIP is established each year to provide a bonus to participants based onthe Company’s achievement of annual corporate performance goals. Participantsin the plan are recommended by management and approved by the Board ofDirectors and generally include the Company’s Chief Executive Officer,President and Chief Operating Officer, Chief Financial Officer and otherexecutive officers with management authority over the corporate functionsresponsible for the achievement of the goals. The bonus earned by eachparticipant will be equal to a fixed percentage of the participant’s salarymultiplied by the percentage of achievement of the annual corporate performancegoals, as determined by the Board of Directors. The goals are based upon thefollowing four metrics:  (i) revenuegrowth as 

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comparedto industry growth, weighted 30%; (ii) profitability improvement over2004; weighted 20%; (iii) orders derived from the front end of themicroelectronic manufacturing process, weighted 35%; and (iv) free cashflow, weighted 15%. The bonus earned is paid upon public release of the Company’sannual results.

**PART III**

**Item10.**                 Directorsand Executive Officers of the Registrant

The Company will furnishto the Securities and Exchange Commission a definitive Proxy Statement (the “ProxyStatement”) not later than 120 days after the close of 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.**                 ExecutiveCompensation

The information requiredby this item is incorporated herein by reference to the sections labeled “ExecutiveCompensation” and “Election of Directors” in the Proxy Statement.

**Item12.**                 SecurityOwnership of Certain Beneficial Owners and Management and Related ShareholderMatters

The information regardingsecurity ownership of certain beneficial owners and management is incorporatedherein by reference to the section labeled “Principal Shareholders andManagement Shareholdings” in the Proxy Statement.

*Equity Compensation Plan Information*

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 |   |   |

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

(2)      Includes 218,884 shares available for issuance underthe August Technology 2000 Employee Stock Purchase Plan.

**Item13.      Certain Relationships and RelatedTransactions**

None

**Item 14.      PrincipalAccountant Fees and Services**

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

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**PART IV**

**Item 15.**                 Exhibits andFinancial Statement Schedules

**(a)****          FinancialStatements.**The following financial statements are included in Part II,Item 8 of this Annual Report on Form 10-K:

Reports of Independent Registered Public AccountingFirm

Consolidated Balance Sheets as of December 31,2004 and 2003

Consolidated Statements of Operations for the YearsEnded December 31, 2004, 2003 and 2002

Consolidated Statements of Shareholders’ Equity forthe Years Ended December 31, 2004, 2003 and 2002

Consolidated Statements of Cash Flows for the YearsEnded December 31, 2004, 2003 and 2002

Notes to ConsolidatedFinancial Statements

**(b)****          FinancialStatement Schedules.**The following schedule is included following thesignature page of this Form 10-K:

Schedule II—Valuation and Qualifying Accounts.

All other schedules areomitted since they are not applicable, not required or the information ispresented in the consolidated financial statements or related notes.

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

The exhibits included in this report are set forth onthe “Exhibit Index to Form 10-K” following the signature page ofthis Form 10-K.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                           | AUGUST TECHNOLOGY CORPORATION |
|---------------------------|-------------------------------|
|                      | By:                           | /s/  JEFF L. O’dELL |
|                      |                          | Jeff L. O’Dell |
| * *                  |                          | *Chief Executive Officer* |
| Date: March 11, 2005 | * *                      | *(Principal Executive Officer)* |

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated below.

Eachperson whose signature appears below constitutes and appoints Jeff L. O’Delland Stanley D. Piekos as the undersigned’s true and lawful attorneys-in factand agents, each acting alone, with full power of substitution andresubstitution, for the undersigned and in the undersigned’s name, place andstead, in any and all amendments to this Annual Report on Form 10-Kand to file the same, with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, granted untosaid attorney’s-in-fact and agents, each acting alone, full power and authorityto do and perform each and every act and thing requisite and necessary to bedone in 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      |       | March 11, 2005 |
|                     |          | Chief Executive Officer         |       |                |
|                     |          | (Principal Executive  Officer)  |       |                |
| /s/ STANLEY  D. PIEKOS   |          | Chief Financial Officer         |       | March 11, 2005 |
|                     |          | (Principal Financial  Officer)  |       |                |
| /s/ SCOTT  A. GABBARD    |          | Chief Accounting Officer  and   |       | March 11, 2005 |
|                     |          | Vice President, Finance         |       |                |
|                     |          | (Principal Accounting  Officer) |       |                |
| /s/ JAMES  A. BERNARDS   |          | Director                        |       | March 11, 2005 |
| /S/ ROGER E. GOWER       |          | Director                        |       | March 11, 2005 |
| /s/ MICHAEL  W. WRIGHT   |          | Director                        |       | March 11, 2005 |
| /s/ LINDA  HALL WHITMAN  |          | Director                        |       | March 11, 2005 |

 

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**Schedule II Valuation and Qualifying Accounts**

**VALUATION AND QUALIFYING ACCOUNTSFOR THE THREE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002(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 |   |   |

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(a)    Represents write-offs of uncollectibleaccounts receivable and inventory.

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**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**EXHIBIT INDEX TO FORM 10-K**

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

 

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AUGUST TECHNOLOGY CORPORATION

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| 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)** |
|                | 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)** |

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|        | 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)                                                |
|   | 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)**                                                      |

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|        | 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                                                                                                                                          |
|   | 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                                                                                                                            |

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*                    Filed herewith

**             Management contractor compensatory plan or arrangement

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