**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, 2003** | ** ** | **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  telephone number, including area code) |

 

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

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

**Title of each class:**

Common Stock, no par value

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes x*  *No 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 x  No o

The aggregate market value of voting stock held bynonaffiliates of the Registrant was $73,008,610 as of June 30, 2003.

The number of shares of Common Stock, no par value,outstanding as of February 23, 2004 was 17,671,930.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portionsof the definitive Proxy Statement to be delivered to shareholders in connectionwith the 2004 Annual Meeting of Shareholders are incorporated by reference intoPart III.

 

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**AUGUST TECHNOLOGYCORPORATIONFORM 10-KTABLE OF CONTENTSFOR THE YEAR ENDED DECEMBER 31, 2003**
| ** **                            | ** ** | **Description**                                                                                 | ** ** | ** ** | ** ** | ** ** | **Page** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|------------|------------|------------|----------|------------|
| **PART I**                       |       |                                                                                            |
| Item 1.                               |       | Business                                                                                        |       | 3          |
| Item 2.                               |       | Properties                                                                                      |       | 13         |
| Item 3.                               |       | Legal Proceedings                                                                               |       | 13         |
| Item 4.                               |       | Submission of Matters to a Vote of  Security Holders                                            |       | 14         |
| Executive  Officers of the Registrant |       | 14                                                                                              |
| **PART II**                      |       |                                                                                            |
| Item 5.                               |       | Market for Registrant’s Common Stock  and Related Shareholder Matters                      |       | 15         |
| Item 6.                               |       | Selected Financial Data                                                                         |       | 16         |
| Item 7.                               |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations     |       | 17         |
| Cautionary Statements                 |       | 26                                                                                              |
| Item  7A.                             |       | Qualitative and Quantitative  Disclosures about Market Risk                                     |       | 35         |
| Item 8.                               |       | Financial Statements and  Supplementary Data                                                    |       | 37         |
| Item 9.                               |       | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure           |       | 62         |
| Item  9A.                             |       | Controls and Procedures                                                                         |       | 62         |
| **PART III**                     |       |                                                                                            |
| Item  10.                             |       | Directors and Executive Officers  of the Registrant                                             |       | 62         |
| Item  11.                             |       | Executive Compensation                                                                          |       | 62         |
| Item  12.                             |       | Security Ownership of Certain  Beneficial Owners and Management and Related Shareholder Matters |       | 62         |
| Item  13.                             |       | Certain Relationships and Related  Transactions                                                 |       | 63         |
| Item  14.                             |       | Principal Accountant Fees and  Services                                                         |       | 63         |
| **PART IV**                      |       |                                                                                            |
| Item  15                              |       | Exhibits, Financial Statement  Schedules and Reports on Form 8-K                           |       | 63         |
| Signatures                            |       | 65                                                                                              |
| Schedule  II                          |       | Valuation and Qualifying  Accounts                                                              |       | 66         |
| Exhibits                              |       | 67                                                                                              |

 

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**PART I**

**Item 1. Business**

**Company Overview**

Since our founding in1992, we have become recognized as a world-class provider of automated defectdetection and product characterization systems for microelectronic devicemanufacturers. Our systems provide these manufacturers with information thatenables process-enhancing decisions, ultimately lowering manufacturing costs,improving time-to-market and enhancing the performance of their products. Wecombine our core competencies in machine vision technology, optics, lightingand precision motion control with our proprietary software and extensivemicroelectronic-specific applications experience to deliver scalable, modularsystems that excel at the automated detection of advanced macro defects, whichwe define to be defects greater in size than 0.5 micron. We sell our systems tomany of the leading microelectronic device manufacturers throughout the worldwithin the markets of semiconductors, advanced packaging applications,optoelectronics, MEMS, data storage and other emerging markets.

We have traditionallyprovided systems to address the automated inspection needs of the early stagesof the final manufacturing or back-end of the microelectronic devicemanufacturing process. These needs were met primarily with our NSX Series and3Di Series of products. We recently introduced the AXi Series and EXiSeries systems for advanced macro detection in the front-end of the wafermanufacturing process. When used in conjunction with the B20 back-sideinspection option these systems allow a manufacturer to inspect the top, edgeand bottom of a wafer’s surface. We believe we will be the first to offer allsurface wafer inspection. We complement this broad inspection capability withan expanding 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 internaldevelopment, we look to expand through strategic acquisitions of complementaryproducts and technologies. In April 2003 we completed the acquisition ofSemiconductor Technologies & Instruments, Inc. (“STI”), addingthe WAV product line for high speed wafer probe mark inspection and metrologyto our product portfolio. In July 2003 we acquired the assets ofCounterpoint Solutions, Inc. (“CSI”), including the design for a recentlyintroduced defect review system for advanced microscope-based defect imagingand analysis. The VersaScope provides us the ability to serve our customersearlier in their device development process and to more quickly analyze defectsand understand their manufacturing process as they move toward high volume production.

**Our Market**

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

Historically,manufacturers generally have relied on engineers and technicians usingmicroscopes to manually inspect sample batches of wafers to detect defectsduring the various stages of the manufacturing process. As a result, it hasbeen impractical and cost-prohibitive for manufacturers to capture critical 

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processdata by inspecting every wafer and die after each process step. These manualinspection limitations result in the following:

***Yield loss due to a lack of process data.******  ***The inabilityto capture adequate data throughout the manufacturing process preventsmicroelectronic device manufacturers from locating problems on a timely basisand taking corrective action. Timely corrective action could minimize thescrapping of valuable wafers and improve the process and yield for futureproducts.

***Productivity constraints.******  ***Asmicroelectronic devices have become more complex, the need for more extensiveinspections 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 product shipments.******  ***By inspectingless than 100% of their products, manual inspection requires manufacturers toassume a greater risk of shipping defective products to their customers.

***Slower time-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 and facility requirements.******  ***The largenumber 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 identify and resolve defects at various stages of the manufacturing process,helping to drive down production costs, increase throughput and decreasetime-to-market.

**Our Solutions**

We deliver automatedadvanced macro defect inspection and metrology systems for microelectronicindustries. Our systems provide device manufacturers with valuable informationabout their products and processes, at a speed that makes it practical toinspect each device rather than a small sample. We accomplish this by combiningour core competencies in machine vision technology, optics, lighting and precisionmotion control with our proprietary software and extensivemicroelectronic-specific applications experience to provide cost-effectivesolutions. We offer our systems at several price performance levels to satisfyour customers’ diverse requirements. Specifically, we provide:

***Fast, automated, 100% wafer inspection.******  ***Our systemsare specifically designed to address our customers’ need for fast, automatedinspection tools. Our systems are able to inspect up to 120 wafers per hourdepending upon the application and wafer size. Depending on the application,our systems can inspect a complex die approximately 100 times faster than ahuman operator. This speed allows our customers to inspect 100% of theirproduction without decreasing throughput.

***Data collection to enable higher productivity andyields.******  ***Our systems enable microelectronicdevice manufacturers to cost-effectively collect and process defect data atmultiple key points in the production process and provide manufacturers withthe information 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, modular inspection platforms.******  ***Our systemsare designed on common platforms that allow us to configure flexible systems tomeet our customers’ application and throughput requirements. This 

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flexibilityprovides an easy upgrade path for customers to respond to changes in processtechnologies, substrate sizes or materials.

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

***Focus on advanced macro inspection.******  ***We focus onserving various advanced macro inspection applications rather than attemptingto pursue the entire range of possible inspection and metrology applications.This allows us to most effectively concentrate our resources on deliveringleading solutions to these 0.5 micron and larger applications. As our businesscontinues to grow we will expand our focus to include other areas of inspectionand metrology that are complimentary to our existing advanced macro inspectionbusiness.

**Our Strategy**

Our strategy is builtaround achieving our vision to dominate the automated inspection market andgenerate complete product characterization solutions for evolvingmicroelectronic markets in order to drive down costs and time-to-market for ourcustomers. We have identified five strategic initiatives that are critical tosuccessfully implementing our vision:

***Market diversification.******  ***We leverageour core competencies across a variety of microelectronic industries usingsimilar manufacturing processes and within multiple applications. While ourcustomers include the suppliers of semiconductor devices used in a wide rangeof electronic products such as cellular phones, personal digital assistants,cable modems, network switches and personal computers, they also include suppliersof microelectronic devices within markets such as advanced packagingapplications,  MEMS, optoelectronics,data storage and other emerging markets. By maintaining our diversificationinitiatives, we strive to maximize our market opportunity while lessening theimpact from the economic cycles of any one industry.

Thefollowing table represents our net revenues for the years ended December 31,2003 and 2002 from each of the microelectronic markets we serve.
| ** **                       | ** ** | **2003**                | ** ** | **2002**            | ** ** | ** **              | ** ** |
|----------------------------------|------------|-------------------------|------------|---------------------|------------|-------------------------|------------|
| ** **                       | ** ** | ** **              | ** ** | **Percent of** | ** ** | ** **              | ** ** | **Percent of** | ** ** | **Year-over-** | ** ** |
| ** **                       | ** ** | **Net**                 | ** ** | **total net**  | ** ** | **Net**                 | ** ** | **total net** | ** ** | **year** | ** ** |
| **Microelectronic Market**  | ** ** | ** **              | ** ** | **Revenues**        | ** ** | **revenues**            | ** ** | **Revenues** | ** ** | **revenues** | ** ** | **change** | ** ** |
| ** **                       | ** ** | **(in thousands)** | ** ** | ** **          | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Semiconductor                    |       |                    | $          | 17,595              |       |                    |       | 44 | % |   |   | $ | 6,011 |   |   |   | 24 | % |   |   | 193 | % |   |
| Advanced  packaging applications |       |                    | 15,772     |                |       |                    | 39         | % |   |   | 12,410 |   |   |   | 50 | % |   |   | 27 | % |   |
| MEMS                             |       |                    | 2,775      |                |       |                    | 7          | % |   |   | 1,781 |   |   |   | 7 | % |   |   | 56 | % |   |
| Optoelectronics                  |       |                    | 2,581      |                |       |                    | 6          | % |   |   | 3,291 |   |   |   | 13 | % |   |   | -22 | % |   |
| Data storage  & other        |       |                    | 1,600      |                |       |                    | 4          | % |   |   | 1,565 |   |   |   | 6 | % |   |   | 2 | % |   |
| Total                            |       |                    | $          | 40,323              |       |                    |       |   |   |   |   | $ | 25,058 |   |   |   |   |   |   |   | 61 | % |   |
|                                  |            |                         |            |                     |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Technology leadership.******  ***Through ourtechnology leadership we deliver customer-driven product innovations focused onprice, performance and flexibility. Technology leadership is critical toincreasing our competitive win rate, maintaining strong gross margins andbuilding market dominance. Our recent product development efforts resulted inseveral new enhancements to our existing NSX Series, 3Di Series and Yield *Pilot*product lines. New introductions in2003 include the AXi Series for advanced macro defect inspection and EXi Series foredge inspection and metrology. These products allow us to more aggressivelyenter the front-end of the microelectronic device manufacturing process byaddressing 

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advanced macroinspection needs. Another new introduction in 2003 was VersaScope, a semi-automateddefect review system for advanced microscope-based imaging and analysisdesigned to allow customers to analyze and eliminate their defects once they’vebeen detected.

In 2003, 47% of ourrevenues were derived from products and solutions introduced during the priortwo years. We plan to continue making significant investments in research anddevelopment to maintain and extend our technology leadership.

***Customer application partnerships.******  ***Our customerapplication partnership program is designed to meet specific customerrequirements with solutions that are engineered to their unique specifications.Through this process, we are able to forge stronger and more strategicrelationships with existing and new customers. In 2003, we completed a jointdevelopment program with one of the top ten semiconductor manufacturers in theworld to facilitate our entry into front end wafer processing applications withthe commercialization of our AXi Series.

***Global presence.******  ***We continuallymaintain and enhance our global presence in order to provide the infrastructurenecessary to support our global customer base. In 2003, we enhanced ourpresence in Asia by adding staff in our Taiwan office to better support ourcustomers in Southeast Asia. We believe our direct presence in Southeast Asiaand our relationships with large Taiwanese foundries will be a catalyst forexpansion in mainland China. In March 2004 we are opening a direct salesand service office in South Korea. We also have direct sales and servicepersonnel and independent distributors located strategically in Singapore,Europe and Japan. Our support services include web-based service capability and24-hour global support.

***External growth.******  ***We increaseand enhance our growth opportunities through external sources, includingacquisitions, collaborations, licensing and joint ventures. We completed theacquisitions of STI and CSI in 2003 and will continue to examine potentialacquisitions that will provide us with additional products, technologicalexpertise, or sales and service capabilities. The acquisition of STI expandsour presence within final manufacturing and brings access to key customers andtechnology. We acquired CSI to improve our data analysis and defectclassification capabilities. 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 and EXi Series of products and the B20 back-sideinspection option permitting inspection of the entire surface of a wafer. Mostrecently, we introduced the VersaScope, a semi-automated, microscope-based,defect review system. The following table summarizes the primary attributes ofour products:
| ** **    | ** **     | ** **                                                                                                                     | **Applications** | ** **                       |
|---------------|----------------|--------------------------------------------------------------------------------------------------------------------------------|------------------|----------------------------------|
| ** **    | ** **     | ** **                                                                                                                     | **Front-End**    | ** **                       | ** ** |
| **Product**   | **Introduced** | **Functionality**                                                                                                              | **Fab**          | **Outgoing   Quality   Control** | **Final   Manufacturing** | **Price Range** |
| VersaScope(1) | 2003           | ·   Advanced  imaging microscope-based system                                                                   | X                |                             |   | $350,000-$750,000 |
|          |           | ·   Harmony  review and classification system                                                                   |             |                             |   |   |
| B20 Option    | 2003           | ·   2D  defect detection on the wafer's back-side                                                               | X                | X                                | X | $140,500-$475,000 |
| EXi Series    | 2003           | ·   2D  defect detection on the wafer's edge                                                                    | X                | X                                | X | $195,500-$530,000 |
|          |           | ·   Metrology  of edge features                                                                                 |             |                             |   |   |
| AXi Series    | 2003           | ·   Advanced  detection of defects >0.5 micron                                                               | X                | X                                |   | $600,000-$1,000,000 |
|          |           | ·   Inspection  of patterned and unpatterned wafers                                                             |             |                             |   |   |
|          |           | ·   In  line, high-speed, 100% inspection                                                                       |             |                             |   |   |
|          |           | ·   Full  color review                                                                                          |             |                             |   |   |
| 3Di Series    | 2001           | ·   2D  & 3D wafer bump inspection & metrology system                                                   |             | X                                | X | $475,000-$1,200,000 |
|          |           | ·   In  line, high-speed, 100% inspection                                                                       |             |                             |   |   |
| Yield*Pilot*  | 2000           | ·   Tool-centric  defect and metrology review and analysis software used with the NSX, 3Di, AXi  and EXi Series | X                | X                                | X | $85,000-$250,000 |
|          |           | ·   Reduces  defect review time                                                                                 |             |                             |   |   |
|          |           | ·   Allows  offline defect review                                                                               |             |                             |   |   |
| NSX Series    | 1997           | ·   Fully  automated defect detection >0.5 micron                                                            |             | X                                | X | $275,000-$1,100,000 |
|          |           | ·   2D  wafer, die & bump inspection                                                                        |             |                             |   |   |
|          |           | ·   In  line, high-speed, 100% inspection                                                                       |             |                             |   |   |
| WAV Series(2) | 1997           | ·   Probe  mark wafer & die defect inspection and metrology                                                 |             | X                                | X | $150,000-$400,000 |
|          |           | ·   Defect  detection >1.0 microns                                                                           |             |                             |   |   |
|          |           | ·   In  line, high-speed, 100% inspection                                                                       |             |                             |   |   |
|          |           | ·   Fully  integrated on prober                                                                                 |             |                             |   |   |
| CV Series     | 1993           | ·   Verification  of critical wafer carrier dimensions                                                          | X                |                             |   | $115,000-$250,000 |

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

(2)      Acquiredwith the acquisition of Semiconductor Technologies and Instruments, Inc. inApril 2003. 

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***VersaScope—******Advanced microscope-based imagingsystem.******  ***As part of ouracquisition of CSI in July 2003, we acquired the VersaScope, a productthat was in design at CSI. The VersaScope operates with the Harmony softwaresystem developed by CSI to automate the control of advanced microscope-basedinspection equipment and facilitate the processing of defect images. TheVersaScope is designed to offer a unique combination of ease of use,flexibility and advanced microscope imaging, enabling technicians to morequickly review, classify and annotate defects. When the VersaScope is coupledwith our broad array of high performance defect detection systems, thecombination is expected to provide customers with a unique, efficient andcomplete inspection and review solution.

We have received aninitial order for two VersaScope systems that we expect to ship in the firstquarter of 2004.

***B20—******Automated wafer back-side inspection and metrologyoption.  ***In December 2003 we introduced the B20 optionfor wafer back-side inspection, completing the “all-surface” inspectionportfolio of products. The B20 detects back-side defects such as cracks andparticles which may negatively impact further processing of the wafer and causewafer breakage later in the process. The B20, built on the same flexible andeasy to set up platform as the EXi, can be combined with our front-sideinspection systems (NSX, AXi or 3Di) or edge inspection systems (EXi) toprovide an “all-surface” wafer inspection solution.

We have received ordersand expect to ship the B20 in the first half of 2004. We expect to begin torecognize revenue from the B20 in the second half of 2004.

***EXi Series—******Automated wafer edge inspection andmetrology systems.  ***In July 2003, we introduced theEXi Series for wafer edge inspection and metrology, which inspects forchip-outs, cracks, delamination, residual resist, particles and other defectsthat occur along the edge of the wafer. The EXi Series also automaticallyperforms metrology of key edge features and is designed for deployment atseveral locations throughout the fab. For example, automated edge inspection,implemented during the lithography process, will identify wafer edge variationsand particles early and allow for possible wafer rework that can increaseyields and reduce manufacturing costs.

Due to the increase inedge area and wafer stress levels in 300mm wafer processing, the value of waferedge inspection is magnified. The EXi Series also incorporates our latestuser-interface platform, making the system easy to set up and run inproduction.

Our first edge inspectionsystem shipped in December 2003 for evaluation and testing by one of theworld’s leading device manufacturers.   Weexpect to begin to recognize revenue from the EXi Series in the first halfof 2004.

***AXi Series—******Automated defect inspection systems.  ***InJanuary 2003, we introduced our AXi Series, designed specifically as anadvanced macro defect inspection tool to be used throughout the fab process.The ability to inspect 100% of wafers for defects between 5 and 10 microns athigh throughputs offers device manufacturers new insight into their complexmanufacturing process. We believe other macro defect solutions currently areunable to achieve this combination of resolution and throughput. The AXi Series hasbeen deployed on multiple production lines at one of the world’s leadingintegrated device manufacturers and has also been ordered by two other chipmanufacturers.

We began to recognizerevenues from the AXi Series during the third quarter of 2003. Revenuesfrom the AXi Series represented 12% of our net revenues during 2003.

***3Di Series—******Automated wafer bump inspection andmetrology systems.  ***Our 3Di automated inspection andmetrology systems provide two-dimensional (“2D”) and three-dimensional (“3D”)inspection and metrology capabilities designed for the latest and most advancedmicroelectronic device packaging processes, including flip-chip wafer bumping.In 2002, we enhanced this product family with the introduction of entry leveland higher performance models of the 3Di Series.

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The 3Di Series incorporatesthe 2D defect inspection capabilities of the NSX Series and features ourproprietary Rapid Confocal Sensor (“RCS”) 3D inspection technology. Thispatent-pending technology, conceived by merging the proven concepts of confocalmicroscopy with innovative optical design and proprietary software, hasestablished its high speed, high accuracy 3D inspection capabilities in theproduction lines of leading microelectronic device manufacturers. The 3Di Series isavailable with up to 300mm wafer handling in addition to film frame handlingand may be tailored toward specific customer applications with various optionsand features.

Revenues from the 3Di Series represented15%, 37% and 7% of our net revenues during 2003, 2002 and 2001, respectively.

***YieldPilot—******Defect review and process analysissoftware.  ***Yield *Pilot*,which provides a means for efficient defect review and classification,continues to play a pivotal role in enabling our customers to makeprocess-enhancing decisions. By filtering, classifying and then presenting onlythe relevant data, Yield *Pilot*assistsprocess engineers in quickly and effectively making the decisions that lead toyield enhancements. Currently, nearly 50% of our systems are delivered with theoptional Yield *Pilot*package—eitherfor evaluation or direct implementation in the customer’s yield enhancementstrategy.

***NSX Series—******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 isdriven by proprietary software and includes integrated yield enhancement toolssuch as automated data collection and reporting, extensive communicationoptions and fast setup using Windows®-based menus. The NSX Series handlesall wafer sizes, 50mm up to 300mm, with both whole wafer and film framecapabilities. The NSX-105 is the highest performance model in the series,demonstrating industry-leading inspection throughput and capabilities, anddelivering the best price/performance ratio of all NSX models. With four models available in theNSX Series, customers may tailor systems toward their specific application,process or budget by choosing from a range of system capabilities.

Revenues from the NSX Series represented50%, 45% and 77% of our net revenues in 2003, 2002 and 2001, respectively.

***WAV Series—******Probe mark inspection systems.  ***TheWAV Series, which was added to our product line with our April 2003acquisition of STI, is a leading solution for high-speed inspection andmetrology of defects caused by the electrical probing process. As devicescontinue to get smaller the electrical probing process is more likely to createdamage. The WAV Series systems check for this potential damage immediatelyfollowing the electrical probing process and warn process engineers ofpotential yield problems.

***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.

**Research andDevelopment**

Our success depends on ourability to effectively develop and commercialize new technologies and products.Our research and development activities emphasize application development andnew product introductions in collaboration with our customers. Our engineeringteams support these efforts with 

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softwaredevelopment, machine vision technology, optics, lighting and precision motioncontrol expertise. Our recent product development efforts resulted in severalnew product enhancements within our NSX Series, 3Di Series and Yield*Pilot*product lines as well as newproducts that expanded our front end fab applications. New productintroductions include the AXi Series for advanced macro inspection, anall-surface advanced macro wafer inspection and metrology tool set forfront-side, back-side and edge wafer inspection, and the VersaScope opticaldefect review system. We also placed significant effort into leveraging ourcore automated inspection technologies into other applications within themicroelectronic device manufacturing process and anticipate announcing newproducts related to this effort in 2004. We spent 26%, 39% and 27%  of our net revenues on research anddevelopment during 2003, 2002 and 2001, 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**

Wehave sold our systems to many of the leading microelectronic devicemanufacturers throughout the world. Customers accounting for more than10% of net revenues during 2003 included Samsung Electronics Corporation, TexasInstruments Incorporated, Intel Corporation and Advanced Semiconductor Engineering, Inc.Customers accounting for more than 10% of net revenues during 2002 includedIntel Corporation and Silicon Precision Industries Co., Ltd. Customersaccounting for more than 10% of net revenues during 2001 included SeagateTechnology LLC and Intel Corporation. There were no other customers, excluding distributors, which accountedfor greater than 10% of net revenues during 2003, 2002 or 2001.

Netrevenues by geographic region were as follows:
| ** **       | ** ** | **Years Ended December 31,** | ** ** |
|------------------|------------|---------------------------------------------|------------|
| ** **       | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| United States    |       | 24                                          | %          | 48 | % | 56 | % |
| Taiwan           |       | 38                                          | %          | 37 | % | 18 | % |
| South Korea      |       | 14                                          | %          | — |   | — |   |
| Japan            |       | 7                                           | %          | 4 | % | 13 | % |
| Europe and other |       | 17                                          | %          | 11 | % | 13 | % |
|             |       | 100                                         | %          | 100 | % | 100 | % |

 

**Sales, Service andMarketing**

We provide direct sales,service and field application support through strategically placed offices inkey regions throughout the world. In the United States, we currently have salesand service personnel in California, Arizona, Florida, New Mexico, NorthCarolina, Oregon, Texas and at our corporate headquarters in Minnesota.Internationally, we service customers directly in Taiwan, China, SoutheastAsia, the United Kingdom, Ireland, Benelux, Scandinavia and France. We alsohave sales and service personnel in Europe and Japan to support ourdistributors in these areas.  In March 2004we are opening an office in South Korea providing direct sales, customerservice and support. With the opening of this office, we are terminating ourdistributor agreement with Metron Technology B.V. Previously, we had sales andservice personnel in South Korea supporting Metron Technology B.V.

With respect to ourEuropean distributors, we terminated our distributor agreement with FirfaxSystems effective January 2003 and notified Quasys AG, which acts as ourdistributor for all products except for the WAV and AXi Series, of our intentto terminate our distributor agreement effective 

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April 2004.We market the WAV Series in Europe through High Tech Trade, GmbH and allof our products in Japan through Marubeni Solutions Corporation. Each of ourdistributors has entered into an international distributor agreement with us.All of our distributor agreements grant our distributors an exclusiveterritory, provide for price and payment procedures, specify the applicablewarranty procedures and contain a confidentiality provision.

**Backlog**

Our backlog was $19.1million as of December 31, 2003, as compared to $9.1 million as of December 31,2002. The $10.0 million increase in backlog resulted from an increase in ordersof $20.0 million that exceeded the $15.2 million growth in net revenuescompared to 2002 with the remainder of the increase primarily a result ofbacklog purchased as part of the two acquisitions completed during the year. Ourbacklog consists of orders for which we have accepted purchase orders and haveeither assigned shipment dates within the next twelve months or under whichsystems have shipped but have not yet met customer specifications. These ordersare subject to cancellation or delay by the customer without penalty. Inaddition, since only a portion of our revenues for any quarter representssystems in backlog, we do not believe that backlog is a meaningful or accurateindication of our future revenues and performance.

**Competition**

While we believe that weare currently the leader in the commercialization of solutions for theinspection of advanced macro defects of 0.5 micron and larger, several otherfirms also manufacture similar products. Our primary competitors in finalmanufacturing are Camtek Ltd., Hitachi, Ltd., Robotic Vision Systems, Inc.and Toray Industries, Inc. As we enter the front-end market, we expect tocompete with larger competitors, such as KLA-Tencor Corporation and RudolphTechnologies, 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 our headquarters in Bloomington, Minnesota. We utilizean outsourcing strategy for the manufacture of many of our components and majorsubassemblies. Our manufacturing activities are considered horizontal in natureand consist primarily of testing and assembling parts, components andsubassemblies acquired from our vendors, and integrating these parts into ourproducts. Our engineering and manufacturing teams work together to continuallyimprove the modularity of our systems and reduce the number of discretecomponents and subassemblies required to serve our various product families. Tomeet specific customer requirements, we often manufacture products that includecustom system engineering and software development. Our manufacturingoperations do not require a major investment in capital equipment.

We use numerous 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 lead timeand build cycles to maximize the efficiency of our manufacturing operations.During 2003, we worked with our key suppliers to significantly reduce leadtimes and to implement a supplier 

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stockingprogram. If we do not receive a sufficient quantity of parts in a timely andcost-effective manner to meet production requirements, our results ofoperations may be materially and adversely affected. We do not maintainlong-term supply contracts with any of our suppliers. We do enter into blanketpurchase orders with key suppliers for parts with long lead times. Thesepurchase orders are generally to lock-in prices and provide the supplier withvisibility of future requirements.

**Intellectual Property**

Proprietary informationplays a significant role in the development of our products. We rely upon acombination of contract provisions and copyright, trademark, patent and tradesecret laws to protect our proprietary know-how, ideas, inventions, goodwilland rights in our solutions and products. We also have a policy of seeking U.S.and foreign patents on technology considered of particular strategic orcompetitive importance. As of January 1, 2004, we had 4 issued U.S.patents and 49 pending U.S. patent applications on our key inventions includingthose associated with our key product lines. We have also applied for foreignpatent rights covering our solutions and products in strategic markets. Thetechnological focus of the issued patents and pending applications includesgeneral microelectronic 2D and 3D inspection techniques as well as devices,systems and processes in the following areas: lighting, focusing, sensing,viewing, material handling, imaging, inspecting and data manipulating. We alsolicense non-exclusive software programs from a third party developer and incorporatethem 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 December 31,2003, we employed 168 people, including 65 in research and development, 33 inservice, technical support and training, 29 in sales and marketing, 23 inmanufacturing and 18 in administration. We also utilize independent contractorsand temporary employees. None of our employees is represented by a labor unionand we consider our employee relations to be good.

**Available Information**

Our web site ishttp://www.augusttech.com. We make available free of charge, on or through ourweb site, our annual, quarterly and current reports, and any amendments tothose reports, as soon as reasonably practicable after electronically filingsuch reports with the Securities and Exchange Commission. Information containedon our web site 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 |       | 78,437                 |       | Leased              |
| Plano, Texas        |       | Office                   |       | Research and  Development, Sales and Service                                                             |       | 10,600                 |       | Leased              |
| Hsinchu, Taiwan     |       | Office                   |       | Sales and Service                                                                                        |       | 5,383                  |       | Leased              |
| Thornwood, New York |       | Office                   |       | Research and Development                                                                                 |       | 1,208                  |       | Leased              |

 

The Company currentlyoccupies 80% of its available space at the Bloomington office. We believe thefacilities listed above will be adequate for the foreseeable future.

**Item3. Legal Proceedings**

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, theresults are difficult to predict at all.

On September 23, 2003, we filed a complaint inthe district court of Dallas County, Texas seeking a declaratory judgment thatwe have no liability to Rudolph Technologies, Inc. or its subsidiary, ISOA, Inc.(doing business as Yield Metrology Group), with respect to claims they haveasserted against us and our subsidiary, STI. In addition, we are seeking ajudgment against Rudolph and ISOA for repayment of royalties previously paid bySTI to ISOA and costs and attorney’s fees incurred in bringing this action. Invarious letters and conversations with STI and us, Rudolph has asserted that STIowes Rudolph development fees and royalty payments pursuant to a December 24,1997 Development Agreement between STI and ISOA, Inc., which Rudolph lateracquired and renamed Yield Metrology Group. Rudolph has also asserted that wemay have used ISOA technology in the development of one of our products and oweadditional royalties to Rudolph as a result. We believe STI has no obligationsto Rudolph under the December 24, 1997 Development Agreement and that wehave used no ISOA technology in any of our products.

In connection with the acquisition of STI, we placed180,000 shares of our common stock issued in the transaction in escrow tosecure ASTI’s performance of its agreement to indemnify us against damages upto a maximum amount of $670,000 in connection with STI’s dispute with Rudolphand to share related outside legal expenses. Of these 180,000 shares, 110,000remain as shares in escrow, while the remaining 70,000 were sold as part of thestock offering in September 2003 with all of the cash proceeds minus feesreturned to the escrow. Shares distributed from the escrow in payment of anyindemnification claim will be valued at the market price of our common stock onthe date of resolution of the claim. The escrow agreement provides that theescrow would have terminated on October 15, 2003 if a legal proceedingregarding these issues had not been initiated prior to that date. Because wehave initiated this legal proceeding, the escrow remains in effect until theresolution of the claims subject to such legal proceeding.

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We may incur significantlegal fees and expenses in pursuing this action for a declaratory judgment. Inaddition, there can be no assurance that we will prevail in such litigation andwe may suffer an adverse result requiring us to pay damages or royaltiesadversely affecting our business. Notwithstanding the foregoing, we believe theindemnification escrow established in connection with the acquisition of STI isreasonably likely to protect us against any losses incurred in connection with Rudolph’sclaims.

**Item4. Submission of Matters to a Vote of Security Holders**

There were no matterssubmitted to a vote of our shareholders during the quarter ended December 31,2003.

**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 |       | 42         |       | Chief Executive Officer  and Director                       |
| Stanley D. Piekos   |       | 56         |       | Chief Financial Officer,  Treasurer and Assistant Secretary |
| David L. Klenk      |       | 39         |       | President,  Chief Operating Officer and Assistant Secretary |
| Scott A. Gabbard    |       | 37         |       | Chief Accounting Officer  and Vice President, Finance       |
| Cory M. Watkins     |       | 31         |       | Chief Technology Officer                                    |
| D. Mayson Brooks    |       | 45         |       | Vice President, Global  Sales and Field Operations          |
| Wayne J. Hubin      |       | 60         |       | 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. From February 1998 untilMarch 2003, Mr. Piekos served as Senior Vice President, Finance andCorporate Development and Chief Financial Officer at American Superconductor, adeveloper and manufacturer of products using superconductor technology for theelectric power industry. From May 1994 to February 1998, Mr. Piekoswas the Chief Financial Officer for Brooks Automation, a supplier of automationsolutions for the semiconductor industry. From June 1985 to May 1994,Mr. Piekos worked for Helix Technology Corporation, a manufacturer ofproducts based on cryogenic and vacuum technology, serving as Vice Presidentand Chief Financial Officer since 1991. He also held financial and generalmanagement positions with 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.

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*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. Mr. Gabbard is a Certified PublicAccountant.

*Cory M. Watkins*recently 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.

*WayneJ. Hubin*has been our Vice President of Manufacturing since November 1999.Before joining us, Mr. Hubin was Manufacturing Operations Manager for BOCEdwards, Inc. from August 1999 to November 1999. From 1984 to August 1999,Mr. Hubin worked in various managerial capacities for FSI International, Inc.,a supplier of micro-lithography, surface conditioning and chemical dispenseequipment used in the fabrication of microelectronics, most recently asManufacturing Operations Manager.

**PART II**

**Item5. Market for Registrant’s Common Stock and Related Shareholder Matters**

**MarketInformation**

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.
| ** ** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------|------------|----------|------------|----------|------------|
| ** ** | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First      |       | $        | 5.38       |     | $          | 2.20 |   | $ | 14.59 |   | $ | 8.05 |   |
| Second     |       | 6.23     |       | 3.45     |       | 16.35 |   | 9.35 |   |
| Third      |       | 14.40    |       | 6.73     |       | 9.23 |   | 3.47 |   |
| Fourth     |       | 20.69    |       | 13.82    |       | 7.40 |   | 3.89 |   |
|            |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

**Holders**

As of February 23,2004, there were approximately 192 holders of record of our Common Stock. Inaddition, based on information obtained from our transfer agent, there are approximately1,802 holders whose stock is held in nominee name and/or street name brokerageaccounts.

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**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. In addition, ourcurrent credit facility limits our ability to pay cash dividends without ourlender’s consent.

**Item6. Selected Financial Data**

Theconsolidated statement of operations data set forth below for each of the yearsended December 31, 2003, 2002 and 2001 and the consolidated balance sheetdata as of December 31, 2003 and 2002 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, 2000 and 1999 and the balance sheet data as of December 31,2001, 2000 and 1999 are derived from audited consolidated financial statements,which are not included in this Form 10-K. You should read the dataset forth below in conjunction with the audited consolidated financialstatements and notes thereto and “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” appearing elsewhere in this Form 10-K.
| ** **                                                      | ** ** | **Years Ended December 31,**                        | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2003**(1)                                                        | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
| ** **                                                      | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated Statement of  Operations Data:**                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net revenues                                                    |       | $                                                                  | 40,323     |   | $ | 25,058 |   | $ | 29,784 |   | $ | 31,666 |   | $ | 12,058 |   |
| Cost of revenues                                                |       | 18,290                                                             |       | 11,068 |   | 12,039 |   | 12,594 |   | 5,110 |   |
| Gross profit                                                    |       | 22,033                                                             |       | 13,990 |   | 17,745 |   | 19,072 |   | 6,948 |   |
| Selling, general and administrative expenses(2)                 |       | 14,359                                                             |       | 13,013 |   | 12,379 |   | 10,426 |   | 4,737 |   |
| Research and development expenses                               |       | 10,430                                                             |       | 9,847 |   | 7,940 |   | 6,945 |   | 2,318 |   |
| Operating income (loss)                                         |       | (2,756                                                             | )          | (8,870 | ) | (2,574 | ) | 1,701 |   | (107 | ) |
| Interest income (expense), net                                  |       | 407                                                                |       | 624 |   | 1,427 |   | 978 |   | (42 | ) |
| Other expense                                                   |       | —                                                             |       | — |   | (17 | ) | — |   | — |   |
| Income (loss) before provision for (benefit from)  income taxes |       | (2,349                                                             | )          | (8,246 | ) | (1,164 | ) | 2,679 |   | (149 | ) |
| Provision for (benefit from) income taxes(3)                    |       | —                                                             |       | 687 |   | (813 | ) | 807 |   | (17 | ) |
| Net income (loss)                                               |       | $                                                                  | (2,349     | ) | $ | (8,933 | ) | $ | (351 | ) | $ | 1,872 |   | $ | (132 | ) |
| Net income (loss)  per share:                                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                                           |       | $                                                                  | (0.16      | ) | $ | (0.69 | ) | $ | (0.03 | ) | $ | 0.17 |   | $ | (0.02 | ) |
| Diluted                                                         |       | $                                                                  | (0.16      | ) | $ | (0.69 | ) | $ | (0.03 | ) | $ | 0.16 |   | $ | (0.02 | ) |
| Weighted average  common shares:                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                                           |       | 14,381                                                             |       | 13,033 |   | 12,723 |   | 11,049 |   | 8,688 |   |
| Diluted                                                         |       | 14,381                                                             |       | 13,033 |   | 12,723 |   | 11,770 |   | 8,688 |   |

 

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| ** **                                             | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|
| ** **                                             | ** ** | **2003**           | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
| ** **                                             | ** ** | **(In thousands)** | ** ** |
| **Consolidated Balance Sheet  Data:**                  |       |               |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents and marketable securities  |       | $                  | 63,850     |   | $ | 18,777 |   | $ | 25,857 |   | $ | 29,193 |   | $ | — |   |
| Working capital                                        |       | 62,818             |       | 29,376 |   | 37,171 |   | 36,872 |   | 2,494 |   |
| Total assets                                           |       | 88,947             |       | 39,510 |   | 47,155 |   | 47,897 |   | 6,676 |   |
| Total debt                                             |       | —             |       | — |   | — |   | — |   | 1,224 |   |
| Total  shareholders’ equity                       |       | 78,477             |       | 34,867 |   | 42,523 |   | 41,685 |   | 3,347 |   |
|                                                        |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)                 OnApril 15, 2003 we acquired all of the outstanding capital stock ofSTI.  On July 3, 2003 we acquiredsubstantially all of the assets of CSI. STI and CSI's results of operations have been included with our resultsof operations since the date of acquisition.

(2)                 Selling,general and administrative expenses for the years ended December 31, 2003,2002, 2001 and 2000 include restructuring related expenses of $254, $1,244,$579, and $326, respectively.

(3)                 Werecorded a full valuation allowance against our deferred tax assets in thesecond quarter of 2002. The recording of the valuation allowance resulted in aprovision for income taxes, rather than the recording of a tax benefit on thepre-tax loss. We have subsequently continued to record a full valuationallowance against our deferred tax assets.

**Item7**. Management’s Discussion and Analysis of FinancialCondition 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**

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 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 worldfor inspecting semiconductors, advanced packaging applications, optoelectronicsdevices, MEMS, data storage devices and micro displays.

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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. Werecently introduced the AXi Series and EXi Series systems foradvanced macro detection in the front-end of the wafer manufacturing process.When used in conjunction with the B20 back-side inspection option these systemsallow a manufacturer to inspect the top, edge and back of a wafer’s surface. Webelieve we will be the first to offer all surface wafer inspection. 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 April 2003we completed the acquisition of STI, adding the WAV Series for high speedwafer probe mark inspection and metrology. In July 2003 we acquired theassets of CSI, including the design for a recently introduced defect reviewsystem for advanced microscope-based imaging and analysis. The VersaScopeprovides us the ability to serve our customers earlier in their devicedevelopment process and to more quickly analyze defects and understand theirmanufacturing process once they initiate high volume production.

Our business is subject to the cyclical nature of themicroelectronic device manufacturing markets we serve. These cycles are causedby significant fluctuations in the supply and demand of microelectronic devicesdriven by such factors as changes in technology and global economic conditions.As a result of these fluctuations, our quarterly orders and sales havefluctuated dramatically. We anticipate that future quarterly and annual resultswill continue to be impacted by fluctuations in supply and demand ofmicroelectronic devices, the timing of new product announcements and releasesby us or our competitors, market acceptance of new or enhanced versions of ourproducts, changes in the pricing of our products and the timing and level ofour research and development expenditures.

During the second quarter of 2001, in response to anindustry downturn, we began to implement components of a series of costmanagement programs. The programs included, at various times, raw material costreductions, reductions in temporary and contract staffs, work force reductions,mandatory time-off, decreases in discretionary spending and reductions inexecutive compensation and overtime. Although we continued to maintain variouscomponents of our cost management programs during 2002 and 2003, these savingswere offset by our decision to invest in developing our worldwide sales andservice organization and in the continued development of new and existingproducts to better serve our customers and maintain our technology leadership. Duringthe second half of 2003 we began to experience signs of an industry recovery. Thishas resulted in a significant increase in the level of orders and sales duringthis period, and resulted in a record level of backlog of $19.1 million at December 31,2003. Although management does not believe backlog is always a meaningful oraccurate indication of future revenues and performance, since only a portion ofour revenues for any quarter represents systems in backlog, 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. Duringboth 2003 and 2002 our book-to-bill ratio was 1.2. A book-to-bill ratio greaterthan 1.0 indicates a growing level of backlog. In response to the currentincrease in activity we have added and continue to recruit additional staff inall functional areas and increased our manufacturing levels to meet theincreased demand. However, we cannot predict the sustainability of a recovery,if any, and/or the industry’s rate of growth in such a recovery. If we areunable to effectively manage our resources and production capacity during anindustry upturn, there could be a material adverse effect on our business,financial condition and results of operations.

In addition to monitoring our level of orders andbacklog, we focus on several key financial metrics in evaluating our financialcondition and operating performance, most importantly revenues by productfamily compared to prior-period revenue performance and current-year plans,revenues generated by 

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products introduced in thelast two years, year-over-year revenue growth compared to the overallsemiconductor equipment industry, operating profit or loss performance comparedwith prior-period and current-year plans and the level of operating cash flow.

We anticipate that futurequarterly and annual results will continue to be impacted by fluctuations insupply and demand of microelectronic devices, the timing of new productannouncements and releases by us or our competitors, market acceptance of newor enhanced versions of our products, changes in the pricing of our productsand the timing and level of our research and development expenditures.

**Results ofOperations**

Thefollowing table presents the consolidated statements of operations as apercentage of net revenues.
| ** **                                             | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net revenues                                           |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                       |       | 45.4                                        |       | 44.2 |   | 40.4 |   |
| Gross profit                                           |       | 54.6                                        |       | 55.8 |   | 59.6 |   |
| Selling, general and administrative expenses           |       | 35.6                                        |       | 52.0 |   | 41.5 |   |
| Research and  development expenses                     |       | 25.8                                        |       | 39.3 |   | 26.7 |   |
| Operating loss                                         |       | (6.8                                        | )          | (35.5 | ) | (8.6 | ) |
| Interest income                                        |       | 1.0                                         |       | 2.5 |   | 4.8 |   |
| Other expense                                          |       | —                                      |       | — |   | (0.1 | ) |
| Loss before  provision for (benefit from) income taxes |       | (5.8                                        | )          | (33.0 | ) | (3.9 | ) |
| Provision for  (benefit from) income taxes             |       | —                                      |       | 2.7 |   | (2.7 | ) |
| Net loss                                               |       | (5.8                                        | )%         | (35.7 | )% | (1.2 | )% |

 

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

*NetRevenues.**  *Netrevenues increased $15.2 million, or 60.9%, to $40.3 million in 2003, from$25.1 million in 2002. The increase in net revenues was primarily the result ofhigher sales of new models within the NSX Series which were introduced inthe middle of 2002 and revenues from the AXi Series, which was introduced inthe first quarter of 2003. Although the AXi Series initially shipped inthe first quarter of 2003, we did not begin to recognize revenue until thesecond half of 2003. Revenues in 2003 from the NSX Series and AXi Series were$20.0 million and $4.7 million, of total revenues, respectively, as compared to$11.2 million 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.

*GrossMargin.**  *Grossmargin decreased to 54.6% of net revenues in 2003 as compared to 55.8% of netrevenues in 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.

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*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. We expect selling, generaland administrative expense dollars to increase in future quarters, primarily asa result of variable expenses associated with the expected higher level ofrevenues and higher recruiting, relocation and compensation costs related tothe hiring of additional employees. However, selling, general andadministrative expenses as a percentage of revenues are expected to decrease,as revenues are expected to increase at a higher rate than the increase inselling, general and administrative expenses.

*Researchand 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 our marketplace. To do this, we believe that we must continue tomake substantial investments in our research and development efforts. Ourinvestments in new technology and existing product enhancements are intended toenable our customers to achieve a higher return on their capital investmentsand higher productivity through cost-effective, leading edge technologysolutions.  As a result, we anticipatethat research and development expense dollars will increase in future quartersdue to ongoing development projects. However, research and development expensesas a percentage of revenues are expected to decrease, as revenues are expectedto increase at a higher rate than the increase in research and developmentexpenses.

*Interest**income, net.**  *Net interest income decreased $217,000 to $407,000 in2003 from $624,000 in 2002. The decrease in interest income was due to lowerrates of return earned on investment balances in 2003 as compared to 2002 andlower average investment balances in 2003. We expect interest income toincrease in 2004 due to an increase in overall investment balances, as a resultof the proceeds received from the follow-on public offering of our Common Stockthat was completed on September 23, 2003 and the underwriters’ exercise ofthe over-allotment option on October 21, 2003 (the “Offering”).

*Income Taxes.**  *There was no benefit for income taxes in 2003compared to a provision for income taxes of $687,000, or an effective tax rateof 8.3%, in 2002. The provision for income taxes in 2002, rather than a benefitfrom income taxes related to the pretax loss, is due to the recording of a fullvaluation allowance against deferred tax assets, in the second quarter of 2002.SFAS No. 109 “Accounting for Income Taxes,” requires the establishment ofa valuation allowance to reflect the likelihood of the realization of deferredtax assets. As a result of our taxable earnings history and uncertainty as tothe extent and timing of profitability in future periods, we have recorded afull valuation allowance of $7.5 million against deferred tax assets at December 31,2003.

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***Year ended December 31, 2002 compared to the yearended December 31, 2001***

*NetRevenues.**  *Netrevenues decreased $4.7 million, or 15.9%, to $25.1 million in 2002 from $29.8million in 2001. The decrease in net revenues was the result of lower NSXrevenues, partially offset by revenues from our 3Di Series, which wasintroduced in the fourth quarter of 2001. The decrease in NSX revenues was dueto the continued downturn in the microelectronic industries. Net revenuesderived from international sales represented 52% and 44% of net revenues in2002 and 2001 respectively. International net revenues were primarily theresult of sales to Asia, which comprised 45% and 34% of net revenues in 2002and 2001, respectively.

*GrossProfit.**  *Grossprofit decreased to $14.0 million, or 55.8% of net revenues, in 2002 from $17.7million, or 59.6% of net revenues, in 2001. The decrease in gross marginpercentage was primarily due to a decrease in the number of systemsmanufactured, which resulted in lower manufacturing utilization and increasedlabor and overhead costs per system manufactured, and was also impacted bysales of models within the 3Di Series that had lower margins than ourother products.

*Selling,General and Administrative.**  *Selling,general and administrative expenses increased $634,000 or 5.1%, to $13.0million, or 52.0% of net revenues, in 2002, from $12.4 million, or 41.5% of netrevenues in 2001. The expense dollars in 2002 primarily increased due to thewrite-off of costs related to potential acquisitions, the modification of ourdistributor agreement with Metron Technology B.V, to focus Metron’s activities entirely on SouthKorea, and employee severance costs. The increase was offset by the fact thatthe prior year included costs related to the modification of our distributoragreement with Metron, as a result of our decision to sell directly tocustomers in Taiwan, and employee severance costs.

*Researchand Development.**  *Researchand development expenses increased $1.9 million, or 24.0%, to $9.8 million, or39.3% of net revenues, in 2002 from $7.9 million, or 26.7% of net revenues, in2001. The increase was primarily due to: (i) our focus on advancing thedevelopment of new and existing products in each of our product lines, whichled to the hiring of additional engineers and the use of additional outsidecontractors; (ii) depreciation and amortization expense related to assetsand software capitalized subsequent to the beginning of 2001; and (iii) travelcosts related to visiting customer locations. These increases were partiallyoffset by various components of the Cost Cutting Program.

*Interest**income, net.**  *Net interest income decreased $803,000 to $624,000 in2002 from $1.4 million in 2001. The decrease is due to lower overall investmentbalances in 2002, due to the use of cash to fund operations and acquireproperty and equipment, and lower rates of return earned on investmentbalances.

*Income Taxes.**  *The provision for income taxes in 2002 was $687,000,or an effective tax rate of 8.3%, compared to a benefit of $813,000, or aneffective tax rate of 69.8%, in 2001. The provision for income taxes in 2002 isdue to the recording of a full valuation allowance against deferred tax assets,in the second quarter of 2002. SFAS No. 109 “Accounting for Income Taxes,”requires the establishment of a valuation allowance to reflect the likelihoodof the realization of deferred tax assets. As a result of our taxable earningshistory and uncertainty as to the extent and timing of profitability in futureperiods, we have recorded a full valuation allowance of $5.4 million againstdeferred tax assets at December 31, 2002. The high effective income taxrate in 2001, compared to the federal statutory rate of 34% plus state andlocal taxes, was primarily due to the impact of federal and state generalbusiness and extraterritorial income credits and tax exempt interest incomethat could not be utilized until future years due to our net loss.

**Liquidity andCapital Resources**

As of December 31, 2003 we had working capital of$62.8 million as compared to $29.4 million at December 31, 2002. Workingcapital increased primarily due to an increase in cash and marketablesecurities due to the sale of 3.0 millionshares of our Common Stock at a price of $13.00 per share in the Offering. Inconjunction with the Offering, on October 21, 2003, the underwritersexercised their option to 

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acquirean additional 490,238 shares of Common Stock to cover over-allotments. The netproceeds received from the Offering, after deducting the underwriting discountsand offering expenses, were $42.0 million. In 2003, we also generated cash fromoperating activities of $3.8 million compared with a net use of cash inoperating activities of $6.5 million during 2002.

At December 31, 2003, our principal sources ofliquidity consisted of cash, cash equivalents and marketable securities of$63.9 million and our revolving credit line, which expires in April 2004. Thecredit line agreement allows for borrowings of up to $5.0 million subject toavailability based on accounts receivable and inventory balances. We have nooutstanding debt at December 31, 2003.

*AccountsReceivable.**  *Accountsreceivable decreased $3.0 million to $4.1 million in 2003, from $7.1 million in2002, representing 50 days sales outstanding (“DSO”) during 2003. This comparesto a DSO of 86 days in 2002. The decrease in accounts receivable DSO wasprimarily due to the timely collection of our accounts receivable in 2003. Dueto the high mix of international revenues during a given quarter, whichgenerally require a longer time for collection, we believe our DSO couldincrease in future quarters.

*Inventories.**  *Inventories increased $5.5 million to $13.9 million in 2003,from $8.4 million in 2002, primarily due to (i) an increase in inventoryat customer sites under purchase orders and as demonstration; (ii) anincrease in raw material, work in process and finished goods inventory tosupport new product introductions and increased backlog; and (iii) inventoryacquired with STI. The increase in inventory at customer sites under purchaseorders is primarily related to shipments of our NSX-105 Series andAXi Series. We anticipate that a portion of the inventory at customer siteswill be recognized as revenue during the first quarter of 2004. We expectinventory at customer sites under purchase orders and demonstration willincrease as shipments of newly introduced products increase.

*CapitalExpenditures.**  *Ourcapital expenditures were $981,000 in 2003 and our total capital expendituresare expected to be between $­2.5 and $3.0 million in 2004. Capital expendituresconsist primarily of the capitalization of finished goods used to support ourengineering, sales and service efforts and enhancing our enterprise resourceplanning system.

*Acquisitions.**  *As a result of the acquisition ofSTI, we entered into a two year lease for 10,600 square feet of space in Plano,Texas at an annual rental cost of $106,000. Asa result of the acquisition of CSI, we entered into a lease for 1,208 squarefeet in Thornwood, New York at a monthly rental cost of $2,200. The lease maybe terminated at any time with a six month notice.

Our liquidity is affected by many factors, some ofwhich are based on the normal ongoing operations of our business, the mostsignificant of which includes the timing of the collection of receivables, thelevel of inventories, capital expenditures and acquisitions. Our liquidity isalso affected by factors beyond our control related to the uncertainties ofglobal economies and the cyclical nature of the semiconductor andmicroelectronic industries. Although liquidity requirements will fluctuatebased on the timing and extent of all of these factors and others, managementbelieves that existing cash and investment balances along with our line ofcredit will be adequate to satisfy our existing liquidity requirements for atleast the next twelve months.

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Thefollowing table summarizes our future cash payments due under contractualobligations as of December 31, 2003:
| ** ** | ** ** | **Operating  Leases**   | ** ** | **Purchase  Obligations** | ** ** | **Total** | ** ** |
|------------|------------|-------------------------|------------|---------------------------|------------|-----------|------------|
| ** ** | ** ** | **(In thousands)** | ** ** |
| 2004       |       |                    | $          | 885                       |       |      |       | $ | 4,843 |   |   | $ | 5,728 |   |
| 2005       |       |                    | 768        |                      |       |      | —     |   |   | 768 |   |
| 2006       |       |                    | 236        |                      |       |      | —     |   |   | 236 |   |
| 2007       |       |                    | 4          |                      |       |      | —     |   |   | 4 |   |
| Total      |       |                    | $          | 1,893                     |       |      |       | $ | 4,843 |   |   | $ | 6,736 |   |

* *

*Cash Flows.**  *During 2003, netcash provided by operating activities was $3.8 million, which resultedprimarily from the decrease in accounts receivable and increases in accountspayable and depreciation and amortization, partially offset by the increase ininventories. Net cash used in investing activities was $39.5 million, due to$37.0 million of net purchases of marketable securities, $1.5 million paid toacquire STI and CSI and $981,000 of additions to property and equipment andother assets. Net cash provided by financing activities was $43.8 million,including $42.0 million of net proceeds received from the Offering andunderwriters’ exercise of their over-allotment option.

During 2002, net cash used in operating activities was$6.5 million, which resulted primarily from our net loss and an increase inaccounts receivable, partially offset by non-cash charges, decreased prepaidexpenses and other current assets and inventories. Net cash provided byinvesting activities was $5.7 million, due to $7.5 million of net proceeds fromthe redemption and purchases of securities, partially offset by $1.8 million ofadditions to property and equipment and other assets. Net cash provided byfinancing activities was $1.2 million from the proceeds of issuances of commonstock in conjunction with the exercise of stock options by employees andpurchases under our employee stock purchase plan.

During 2001, net cash usedin operating activities was $1.4 million, which resulted primarily fromincreased inventories, prepaid and other current assets and decreased accountspayable, partially offset by decreased accounts receivable and an increase incustomer deposits. Net cash used in investing activities was $737,000, due to$2.5 million of additions to property and equipment and other assets, partiallyoffset by $1.8 million of net proceeds from the redemption and purchases ofsecurities held to maturity. Net cash provided by financing activities was$596,000 from the proceeds of issuances of common stock in conjunction with theexercise of stock options by employees and purchases under our employee stock purchaseplan.

**Critical AccountingPolicies, 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) we are required to make assumptions about matters that are highlyuncertain at the time of the estimate; and 2) different estimates we couldreasonably have used, or changes in the estimate that are reasonably likely tooccur, would have a material effect on our financial condition or results ofoperations.

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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 beapplicable and reasonable under the circumstances. These estimates may changeas new events 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 saleof systems, 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 has shipped,title and risk of loss have transferred to the customer and collection of theresulting receivable is probable.

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

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

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

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

*Software**revenue:  *Softwarerevenue is recognized ratably over the support period.

*Servicerevenue:**  *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 insignificantduring the years ended December 31, 2003, 2002 and 2001.

***Valuation ofAccounts Receivable.******  ***We review accounts receivable todetermine which are doubtful of collection. In making the determination of theappropriate 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, 2003, we have hadaccounts receivable write-offs totaling $200,000, which included the write-offof one receivable totaling $164,000. Changes in the credit 

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worthiness of customers,general economic conditions and other factors may impact the level of futurewrite-offs. Changes in these factors could have a material adverse effect on our business,financial condition and results of operations.

***Valuation ofInventory.******  ***We review inventory for obsolescenceand excess 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, 2003, wehave written off inventory totaling $396,000. We have an allowance for obsoleteand excess inventory of $525,000 at December 31, 2003, 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.

***Accounting forIncome Taxes.****  *Thepreparation of our consolidated financial statements requires us to estimateour actual current tax exposure together with our temporary differencesresulting from differing treatment of tax items for tax and accounting. Thesetemporary differences result in the recognition of deferred tax assets andliabilities, which are included within our consolidated balance sheet. Statementof Financial Accounting Standards (“SFAS”) No. 109 “Accounting for IncomeTaxes,” requires the establishment of a valuation allowance to reflect thelikelihood of the realization of deferred tax assets. Significant managementjudgment is required in determining our provision for income taxes, ourdeferred tax assets and liabilities and any valuation allowance recordedagainst our net deferred tax assets. We evaluate the weight of all availableevidence to determine whether it is more likely than not that some portion orall of the deferred income tax assets will not be realized. During the secondquarter of 2002 we recorded a valuation allowance for the full amount of ourdeferred tax assets due to uncertainties surrounding our ability to utilizesome or all of our deferred tax assets, primarily consisting of certain netoperating losses, as well as other temporary differences between book and taxaccounting. If the realization of deferred tax assets in the future isconsidered more likely than not, an adjustment to the deferred tax assets wouldincrease net income in the period such determination is made. In the event thatactual results differ from these estimates or we adjust these estimates infuture periods, we may need to adjust our valuation allowance, which couldmaterially affect our financial position 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 ofAccounting Standards**

In December 2002, the Emerging Issues Task Force(“EITF”) reached a consensus on EITF 00-21, “Revenue Arrangements withMultiple Deliverables”. This Issue addresses certain aspects of the accountingby a vendor for arrangements under which it will perform multiplerevenue-generating activities. In some arrangements, the differentrevenue-generating activities (deliverables) are sufficiently separable andthere exists sufficient evidence of their fair values to separately account forsome or all of the deliverables (that is, there are separate units ofaccounting). In other arrangements, some or all of the deliverables are notindependently functional, or there is not sufficient evidence of their fairvalues to account for them separately. This Issue addresses when and, if so,how an arrangement involving multiple deliverables should be divided intoseparate units of accounting. This Issue does not change otherwise applicablerevenue recognition criteria. The guidance in this Issue is effective forrevenue arrangements 

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entered into in fiscalperiods beginning after June 15, 2003. The adoption of EITF 00-21did not have an effect on our consolidated financial statements.

In January 2003, the Financial AccountingStandards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 46, “Consolidationof Variable Interest Entities”. This Interpretation of Accounting ResearchBulletin (“ARB”) No. 51, “Consolidated Financial Statements”, addressesconsolidation by business enterprises of variable interest entities thatpossess certain characteristics. FIN 46 requires that if a business enterprisehas a controlling financial interest in a variable interest entity, the assets,liabilities and results of the activities of the variable interest entity mustbe included in the consolidated financial statements with those of the businessenterprise. The consolidation requirements of FIN 46 are effective for thefirst reporting period ending after December 15, 2003 for entitiesconsidered to be special-purpose entities. The consolidation requirements forall other entities subject to FIN 46 are effective for our consolidatedfinancial statements of the first reporting period ending after March 15,2004. We do not have any ownership in any variable interest entities as of December 31,2003. We will apply the consolidation requirements of FIN 46 in future periodsshould an interest in a variable interest entity be acquired.

In April 2003, the FASB issued SFAS No. 149,“Amendment of Statement 133 on Derivative Instruments and Hedging”, whichamends and clarifies financial accounting and reporting for derivativeinstruments. SFAS 149 became effective for us in July 2003. The adoptionof SFAS 149 did not have an effect on our consolidated financial statements.

On May 15, 2003, theFASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of Both Liabilities and Equity”. The Statement requiresissuers to classify as liabilities (or assets in some circumstance) threeclasses of freestanding financial instruments that embody obligations for theissuer. Generally, the Statement is effective for financial instruments enteredinto or modified after May 31, 2003 and is otherwise effective at thebeginning of the first interim period beginning after June 15, 2003. The adoptionof SFAS 150 did not have an effect on our consolidated financial statements.

**CautionaryStatements**

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” which providecurrent expectations or forecasts of future events. Such statements can beidentified 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-lookingstatements and 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.

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

We primarily serve microelectronic industries and ourbusiness depends heavily upon capital expenditures by manufacturers in theseindustries. Microelectronic industries are highly cyclical, with periods ofcapacity shortage and periods of excess capacity; this is historically due tosudden changes in demand for microelectronic devices. In periods of excesscapacity, there are often drastic changes in the timing and quantity of capitalequipment purchases and investments in new technology or capacity needs by ourcustomers, including sharp cuts in purchases of capital equipment, includingour products, by customers. The timing, length and volatility of these periodsare difficult to predict, resulting in pressure on our revenues, gross marginand net income. In addition to affecting our customers, downturns alsochallenge our suppliers, vendors, other partners, as well as our management,sales, engineering, manufacturing, customer service and other employees, whoare vital to our success.

During downturns inmicroelectronic industries, customers typically reduce or delay purchases,and/or delay delivery or cancel orders. As a result, it is imperative that wemaintain an organization able to quickly and effectively align with marketconditions, including bringing our cost structures in line with currentindustry and overall market conditions. At the same time, it is imperative thatwe meet the following objectives:

·       continueto serve our existing customers,

·       providenew and improved solutions for new and existing customers,

·       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, may have a material adverse effect on our business, financialcondition 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 aswe expect, we may be unable to maintain current revenue levels in the shortterm and return to our historical growth in the long term. Growth in thismarket is dependent to a large extent upon microelectronic manufacturersreplacing manual inspection with automated inspection technology. There is noassurance that manufacturers will undertake this replacement at the rate weexpect.

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

Our quarterly andannual operating results are affected by a wide variety of factors that couldadversely affect sales or operating results, or lead to significant variabilityin our operating results. In addition, because a significant portion of ourrevenue in any particular quarter has historically come from the sale of arelatively small number of systems, the loss of any sale could have asignificant negative impact. A variety of factors could cause this variability,including the following:

·       ordercancellations or delays in orders by customers;

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·       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, as well as ourabilities to visit our customers, to perform application studies for ourcustomers, to sell and deliver solutions and to service those solutions. Anydecline in the willingness or ability of our customers to travel and visit ourfacilities, or in our ability to travel and visit our customers, could have amaterial adverse effect on our business, financial condition and results ofoperations. In addition, such events could have an adverse effect on theeconomy generally, and microelectronic industries in particular, causing ourcustomers to reduce or delay capital equipment purchases.

**The marketacceptance of our products is critical to our growth.**

Microelectronic devicemanufacturing equipment and processes are subject to rapid technologicalchanges. We continue to spend a significant amount of time and resourcesdeveloping new systems, new models to existing system series and improvementsor enhancements on current models. Due to the length of the product developmentcycles in our industries, we must make these significant time and resourceexpenditures well in advance of any prospect of a revenue stream from such newproducts. If our customers do not continue to accept our current products andalso accept and integrate our new products into their operations, our revenue,cash flow, operating results or stock price could be negatively impacted.

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

We have recentlyintroduced the AXi Series and EXi Series which address inspection andmetrology needs in the front-end of the microelectronic device manufacturingprocess, a market segment that we have limited experience in serving. We arenot a well-recognized supplier to this market, and will need to establish newcustomer relationships and win the confidence of these customers to competeeffectively in this market. The front-end of the microelectronic devicemanufacturing market is dominated by large, well-established competitors withsignificantly greater resources and name recognition than we have. In order tocompete effectively with these larger competitors, we must develop process andapplications 

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expertiseto identify 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 service these customers. Failure tosuccessfully penetrate the front-end of the microelectronic devicemanufacturing market would adversely affect our business.

**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 will beharmed.**

The microelectronic capital equipment manufacturingbusiness is a highly competitive business and microelectronic devicemanufacturing equipment and processes are subject to rapid technologicalchanges. We believe that our future success will depend in part upon ourability to continue to enhance our existing product line to meet customer needsand to develop and introduce new products in a timely manner. We cannot assureyou that our product enhancement efforts to improve and advance products, suchas the NSX Series and the 3Di Series, or our new product developmentefforts such as the AXi Series and EXi Series, will be successful or thatwe will be able to respond effectively to technological change. In addition, wecannot assure that we will choose the most opportunistic new markets andapplications.

We continue to makeand/or review significant investments in research, development and engineeringin new technology and/or businesses with new or complementary products,services and/or technologies, and we are aware of the numerous risks associatedtherewith, including but not limited to:

·       diversionof management’s attention from day to day operational matters;

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

·       failureto commercialize the new technology or business;

·       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 could 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 of our customers are unique. We believe that ourfuture success will depend in part upon our ability to meet our customers’functionality and reliability requirements in a timely manner. We cannot besure that our product offerings, application assistance, enhancement efforts,or our new product development efforts will fulfill every functionality andreliability requirement. In addition, new product offerings that are highlycomplex in terms of software or hardware may require application or servicework such as bug fixing prior to acceptance, thereby delaying revenuerecognition. If we are unsuccessful in these areas, our market share, revenue,operating results or stock price could be negatively impacted.

**Our market ishighly competitive and we may lose business to larger and better-financedcompetitors.**

The microelectronic defect inspection equipmentindustry is highly competitive in all areas of the world. We have many domesticand foreign competitors. Our current primary competitors in final manufacturingare Camtek Ltd., Hitachi, Ltd., Robotic Vision Systems, Inc. andToray Industries, Inc. As we enter the front-end market, we expect tocompete with larger competitors, such as KLA-Tencor 

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Corporation and Rudolph Technologies, Inc.,for certain automated macro inspection applications. Most of these competitors,as well as other potential competitors, have substantially greater financialresources and more extensive engineering, manufacturing, marketing and customersupport capabilities than we have. Unless we are able to invest significantfinancial resources in developing products and enhancing customer supportworldwide, and are able to gain customer acceptance of our products, we may notbe able to 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 similar devices,further competitors may enter our markets, or we may enter the markets of othercompanies.

**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 asearthquakes, flooding, fire, electricity failure, or accidents that affect ouroperations, manufacturing facility, or the health of our employees or customerscould adversely affect our operating results and financial condition. Continuedor future outbreaks of infectious diseases such as severe acute respiratorysyndrome (“SARS”), avian flu, or other similar or comparable outbreaks or fearsor concerns of possible outbreaks may significantly affect the willingness orability of our customers to visit our facilities or trade shows, review oursystems’ capabilities and/or purchase or take delivery of our products, as wellas our ability to visit our customers, to perform application studies for ourcustomers, to sell and deliver products, and to service those products. Anygovernment mandated or suggested restrictions on travel, quarantines, ordeclines in the willingness or ability of our customers to travel and visit ourfacilities or our ability to travel and visit our customers, could have amaterial adverse effect on our business, financial condition and results ofoperations.

**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 business challenges, which include the need to develop new productsor 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 be availablewhen needed or, if available, might not be available on terms satisfactory tous. If we are unable to obtain adequate financing or financing on termssatisfactory to us, our ability to continue to support our business growth andto respond to business challenges could be significantly limited.

**Our success dependson attracting and retaining key personnel.**

Our future success will depend in large part upon ourability to recruit and retain highly skilled technical, manufacturing,managerial, financial and marketing personnel. The labor market in which weoperate is highly competitive and as a result, we may not be able to retain andrecruit key personnel. Our failure to hire, retain, or adequately train keypersonnel could have a negative impact on our performance.

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

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**Our business may beharmed if we fail to obtain and protect our intellectual property rights.**

Our success dependsin part upon our ability to obtain intellectual property rights and licensesand to preserve other intellectual property rights covering our products andour products under development. To protect these rights, we have obtained fourdomestic patents and intend to continue to seek patents on our inventions whenappropriate. As of December 31, 2003, we have 49 pending patentapplications in the United States and additional international applications andexpect our portfolio to grow in the future. The process of seeking intellectualproperty 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 successfully protect and then enforce ourintellectual property rights, our competitive position could suffer, whichcould 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 property rights are uncertain and involvecomplex legal and factual questions. We may be unknowingly infringing upon theintellectual property rights of others and may be liable for that infringement,which could result in significant liability for us. If we do infringe upon theintellectual property rights of others, we could be forced to either seek alicense to those intellectual property rights or to alter our products so thatthey no longer infringe. A license could be very expensive to obtain or may notbe available at all. Similarly, changing our products or processes to avoidinfringing upon the rights of others may be costly 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 have to participate in legal proceedings. These types of proceedings may becostly and time-consuming for us, 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.

**We have initiated litigation against RudolphTechnologies, Inc. and its subsidiary; we may incur significant legalcosts and, if we lose, additional financial obligations.**

On September 23,2003, we filed a complaint in the district court of Dallas County, Texasseeking a declaratory judgment that we have no liability to RudolphTechnologies, Inc. or its subsidiary, ISOA, Inc. (doing business asYield Metrology Group) with respect to claims they have asserted against us andour subsidiary, STI. In addition, we are seeking a judgment against Rudolph andISOA for repayment of royalties previously paid by STI to ISOA and costs andattorney’s fees incurred in bringing this action. In various letters andconversations with STI and us, Rudolph has asserted that STI owes Rudolphdevelopment fees and royalty payments pursuant to a December 24, 1997development agreement between 

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STI andISOA, Inc., which Rudolph later acquired and renamed Yield MetrologyGroup. Rudolph has also asserted that we may have used ISOA technology in thedevelopment of one of our products and owe additional royalties to Rudolph as aresult. We may incur significant legal fees and expenses in pursuing thisaction for a declaratory judgment. In addition, there can be no assurance thatwe will prevail in such litigation and we may suffer an adverse result requiringus to pay damages or royalties adversely affecting our business.

**Our dependence on afew significant customers exposes us to operating risks.**

Sales to our ten largestcustomers accounted for 73%, 66% and 75% of net revenues in 2003, 2002 and2001, respectively. Our customers are able to cancel orders, prior to shipment,with few or no penalties. If a significant customer reduces orders or delaysshipments for any reason, our revenues, operating results and financialcondition will be negatively affected. In addition, our ability to increase oursales will depend in part upon our ability to obtain orders from new customersfor whom there is intense competition.

**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 tobecome unable to provide parts in the volumes needed or at an acceptable price,we would have to identify and qualify acceptable replacements from alternativesources of supply, or manufacture the components internally. Depending on thepart, the process of qualifying subcontractors and suppliers generally takesbetween 60 and 180 days. We generally do not have written supplyagreements with our single or limited source suppliers and purchase our customcomponents through blanket and individual purchase orders. If we were unable toobtain these components in a timely fashion, we may not be able to meet demandsfor future shipments. We believe that we would be able to find alternativesolutions if supplies were unavailable from any of our sole source suppliers,including the supplier of our image processing component. This may take timeand the disruption 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.**

Our processes formanufacturing our automated inspection systems require sophisticated and costlyequipment and a specially designed facility. We assemble and test all of ourautomated inspection systems at one facility located in Bloomington, Minnesota.Any disruption in the operation of that facility, whether due to technical orlabor difficulties, destruction or damage from fire or earthquake,infrastructure failures such as power or water shortage or any other reason,could interrupt our manufacturing operations, impair critical systems, disruptcommunications with our customers and suppliers and cause us to write offinventory 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 beharmed and our inventory levels could materially increase if we are unable topredict our inventory needs in an accurate and timely manner and adjust ourorders for parts and subcomponents should our needs increase or decreasematerially due to unexpected increases or decreases in demand for our products.Any material increase in our inventories could result in an adverse effect on 

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ourfinancial position, while any material decrease in our ability to procureneeded inventories could result in an inability to supply customer demand forour products 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 and growing portion of our revenues in recentyears and we expect that the percentage of sales from international customerswill continue to increase. Sales outside of the United States accounted for76%, 52% and 44% of our net revenues in 2003, 2002 and 2001, respectively. Inaddition, we rely on non-U.S. suppliers for several components of the systemswe sell. As a result, a major part of our revenues and the ability tomanufacture our products are subject to the risks associated with internationalcommerce. International sales and our relationships with suppliers andcustomers 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 torisks associated with shipping products outside of the U.S. including shippingdelays, varying business conditions, differing business cultures and culturaldiversities, among other risks. If our international sales or relationshipswith international suppliers and customers are adversely affected by any ofthese factors, our financial condition could be adversely affected.

**Our financialperformance is highly dependent upon sales to customers in Asia.**

Sales to customers in Asiaaccounted for 64%, 45% and 34% of our net revenues in 2003, 2002 and 2001,respectively. We expect our dependence upon the Asian market to increase. Inrecent years, Asia has experienced serious economic problems including currencydevaluations, debt defaults, lack of liquidity and recessions. Our revenuesdepend upon the capital expenditures of microelectronic manufacturers, many ofwhom have operations and customers in Asia. Serious economic problems in Asiawould likely result in a significant decrease in the sale of equipment tomicroelectronic industries. If we are unable to maintain our customerrelationships in Asia, our future financial condition, revenues and operatingresults will be negatively affected.

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

Sales through our independent distributors represented14%, 8% and 29% of our net revenues in 2003, 2002 and 2001, 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 

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relations with ourindependent distributors, the relationships may nevertheless deteriorate in thefuture. A reduction in the sales or service efforts or financial viability ofany of our independent distributors, or a termination of our relationships withthem, could harm our sales, our financial results and our ability to supportour customers.

**We recently acquired STI and CSI and we may make otheracquisitions; the acquisitions of STI and CSI and any future acquisitions maynot be successful and may adversely affect 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 and CSI. Your evaluation of ourbusiness and prospects may be difficult because of our limited operatinghistory with STI and CSI. There can be no assurance that we will be successfulin integrating the operations of STI and CSI, identifying other appropriatecandidates, or integrating products and operations with any such candidatesthat we may acquire.

Any suchacquisition could involve the dilutive issuance of equity securities and theincurrence of debt. In addition, the acquisitions of STI and CSI and futureacquisitions 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 acquiredcompany has already developed and marketed products, there can be no assurancethat the products will continue to be successful, that product enhancementswill be made in a timely fashion or that pre-acquisition due diligence willhave identified all possible issues that might arise with respect to theacquired 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 amicroelectronic device manufacturer has selected one vendor’s capital equipmentfor a production line application, the manufacturer generally relies upon thatcapital equipment and, to the extent possible, subsequent generations of thesame vendor’s equipment, for the life of the application. Once a vendor’sequipment has been installed in a production line, a microelectronic devicemanufacturer must often make substantial technical modifications and mayexperience production-line downtime in order to switch to another vendor’sequipment. Accordingly, unless our systems offer performance or cost advantagesthat outweigh a customer’s expense of switching to our systems, it will bedifficult for us to achieve significant sales to that customer once it hasselected another vendor’s capital equipment for an application.

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**If we are required to account for stock options as acompensation expense, our net income and earnings per share will besignificantly reduced.**

Some companies have begunto account for stock options as compensation expense thus resulting in areduction of their net income and earnings per share. We currently grant alloptions at fair market value and do not record compensation expense inconnection with the grants. It is possible that future laws, regulations orchanges in accounting standards will require us to record the fair market valueof all stock options as a compensation expense in our consolidated financialstatements. If such a change occurs, our net income and earnings per share maybe significantly reduced.

**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 a larger sales force and additional service personnel;

·       expandthe geographic coverage of our sales force;

·       expandour information systems;

·       identifyand successfully integrate acquired businesses into our operations; and

·       administerappropriate financial and administrative control procedures.

Our anticipated growthwill likely place a significant strain on our management, financial,operational, technical, sales and administrative resources. Any failure toeffectively manage our growth may cause our business to suffer and our stockprice to decline.

**Increasedcompetition could impair sales of our products or cause us to reduce ourprices.**

We expect our currentcompetitors and other companies to continue to improve the design andperformance of their products and to introduce new products with competitiveprices and performance characteristics. Competitive pressures may from time totime require us to selectively reduce prices on our systems in an effort toprotect our market share. Even if we reduce prices, our potential customers maychoose to purchase competing products developed by our competitors, many ofwhom have development, production, marketing and distribution resourcessignificantly greater than our own. Price reductions or lost sales as a resultof these competitive pressures would reduce our total revenues and adverselyimpact our financial results.

**Item7A. Qualitative and Quantitative 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. 

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Due tothe short duration of our investment portfolio, an immediate 10 percent changein interest rates is not expected to have a material adverse effect on ournear-term financial condition 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, 2003, 81% 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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**Item 8**. Financial Statements andSupplementary Data

**AUGUST TECHNOLOGYCORPORATION**

**Indexto Consolidated Financial Statements**
| Independent  Auditors’ Report                                                                               |   | 38 |
|------------------------------------------------------------------------------------------------------------------|--------|----|
| Consolidated  Balance Sheets as of December 31, 2003 and 2002                                               |   | 39 |
| Consolidated Statements of Operations for the  Years Ended December 31, 2003, 2002 and 2001                 |   | 40 |
| Consolidated  Statements of Shareholders’ Equity for the Years Ended December 31,  2003, 2002 and 2001 |   | 41 |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and  2001                |   | 42 |
| Notes to Consolidated Financial  Statements                                                                      |   | 43 |

 

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**INDEPENDENT AUDITORS’REPORT**

TheBoard of Directors and ShareholdersAugust Technology Corporation:

We have audited the accompanying consolidated balancesheets of August Technology Corporation and subsidiaries (the Company) asof December 31, 2003 and 2002, and the related consolidated statements ofoperations, shareholders’ equity, and cash flows for each of the years in thethree-year period ended December 31, 2003. In connection with our auditsof the consolidated financial statements, we also audited the financialstatement schedule as listed in the accompanying index. These consolidatedfinancial statements and financial statement schedule are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on theseconsolidated financial statements and financial statement schedule based on ouraudits.

We conducted our audits in accordance with auditingstandards generally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the consolidated financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the consolidated financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of August TechnologyCorporation and subsidiaries as of December 31, 2003 and 2002, and theresults of their operations and their cash flows for each of the years in thethree-year period ended December 31, 2003, in conformity with accountingprinciples generally accepted in the United States of America. Also in ouropinion, the related financial statement schedule, when considered in relationto the basic consolidated financial statements taken as a whole, presentsfairly, in all material respects, the information set forth therein

/s/ KPMG LLP

Minneapolis, MinnesotaFebruary 6, 2004

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**AUGUST TECHNOLOGY CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)**
| ** **                                                                                                                       | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                       | ** ** | **2003**              | ** ** | **2002** | ** ** |
| **ASSETS**                                                                                                                       |       |                  |       |   |   |
| Current assets:                                                                                                                  |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                        |       | $                     | 10,027     |   | $ | 1,895 |   |
| Short-term marketable securities                                                                                                 |       | 43,528                |       | 15,438 |   |
| Accounts receivable, net                                                                                                         |       | 4,094                 |       | 7,054 |   |
| Inventories                                                                                                                      |       | 11,651                |       | 7,432 |   |
| Inventories at customers under purchase orders                                                                                   |       | 2,293                 |       | 1,012 |   |
| Prepaid expenses and other current assets                                                                                        |       | 1,631                 |       | 1,091 |   |
| Total current assets                                                                                                             |       | 73,224                |       | 33,922 |   |
| Property and equipment, net                                                                                                      |       | 3,141                 |       | 3,439 |   |
| Long-term marketable securities                                                                                                  |       | 10,295                |       | 1,444 |   |
| Purchased technology, net                                                                                                        |       | 1,179                 |       | — |   |
| Goodwill                                                                                                                         |       | 498                   |       | — |   |
| Other assets                                                                                                                     |       | 610                   |       | 705 |   |
| Total assets                                                                                                                     |       | $                     | 88,947     |   | $ | 39,510 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                    |       |                  |       |   |   |
| Current  liabilities:                                                                                                            |       |                  |       |   |   |
| Accounts payable                                                                                                                 |       | $                     | 5,409      |   | $ | 2,273 |   |
| Accrued compensation                                                                                                             |       | 1,146                 |       | 554 |   |
| Other accrued liabilities                                                                                                        |       | 1,414                 |       | 451 |   |
| Customer deposits and deferred revenues                                                                                          |       | 2,436                 |       | 1,268 |   |
| Total current liabilities                                                                                                        |       | 10,405                |       | 4,546 |   |
| Other non-current liabilities                                                                                                    |       | 65                    |       | 97 |   |
| Total liabilities                                                                                                                |       | 10,470                |       | 4,643 |   |
| Commitments and contingencies (note 13)                                                                                          |       | —                |       | — |   |
| Shareholders’  equity:                                                                                                      |       |                  |       |   |   |
| Common stock, no par value, 42,000,000 shares  authorized 17,382,538 and 13,152,304 shares issued and outstanding,  respectively |       | 88,086                |       | 42,158 |   |
| Undesignated capital stock, no par value, 3,000,000  shares authorized, no shares issued or outstanding                          |       | —                |       | — |   |
| Deferred compensation related to stock options                                                                                   |       | (49                   | )          | (105 | ) |
| Accumulated deficit                                                                                                              |       | (9,578                | )          | (7,229 | ) |
| Accumulated other comprehensive income                                                                                           |       | 18                    |       | 43 |   |
| Total shareholders’ equity                                                                                                  |       | 78,477                |       | 34,867 |   |
| Total liabilities  and shareholders’ equity                                                                                 |       | $                     | 88,947     |   | $ | 39,510 |   |

 

See accompanying notes to consolidated financial statements.

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**AUGUST TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS**(In thousands, except per share amounts)
| ** **                                             | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net revenues                                           |       | $                                           | 40,323     |   | $ | 25,058 |   | $ | 29,784 |   |
| Cost of revenues                                       |       | 18,290                                      |       | 11,068 |   | 12,039 |   |
| Gross profit                                           |       | 22,033                                      |       | 13,990 |   | 17,745 |   |
| Selling, general and administrative expenses           |       | 14,359                                      |       | 13,013 |   | 12,379 |   |
| Research and  development expenses                     |       | 10,430                                      |       | 9,847 |   | 7,940 |   |
| Operating loss                                         |       | (2,756                                      | )          | (8,870 | ) | (2,574 | ) |
| Interest income                                        |       | 407                                         |       | 624 |   | 1,427 |   |
| Other expense                                          |       | —                                      |       | — |   | (17 | ) |
| Loss before  provision for (benefit from) income taxes |       | (2,349                                      | )          | (8,246 | ) | (1,164 | ) |
| Provision for  (benefit from) income taxes             |       | —                                      |       | 687 |   | (813 | ) |
| Net loss                                               |       | $                                           | (2,349     | ) | $ | (8,933 | ) | $ | (351 | ) |
| Net loss per  share:                                   |       |                                        |       |   |   |   |   |
| Basic and diluted                                      |       | $                                           | (0.16      | ) | $ | (0.69 | ) | $ | (0.03 | ) |
| Weighted average  number of shares:                    |       |                                        |       |   |   |   |   |
| Basic and diluted                                      |       | 14,381                                      |       | 13,033 |   | 12,723 |   |

 

See accompanying notes to consolidated financial statements.

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**AUGUST TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands, except share amounts)**
| ** **                                                      | ** ** | **Common Stock**                          | ** ** | **Deferred** | ** ** | **Retained**                                          | ** ** | ** **                           | ** ** | ** **                                                    | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------|------------|--------------|------------|-------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **Shares   Issued And  Outstanding** | ** ** | **Amount**   | ** ** | **Compensation  Related To  Stock Options** | ** ** | **Earnings  (Accumulated  Deficit)** | ** ** | **Accumulated Other  Comprehensive  Income (Loss)** | ** ** | **Total  Shareholders'  Equity** | ** ** |
| Balances at  December 31, 2000                                  |       |                                           | 12,633,058 |         |       | $                                                     | 39,935     |                                 |       | $                                                             | (305       | ) |   |   | $ | 2,055 |   |   |   | $ | — |   |   |   | $ | 41,685 |   |   |
| Net loss                                                        |       |                                           | —     |         |       | —                                                |       |                                 | —     |                                                          |       |   | (351 | ) |   |   | — |   |   |   | (351 | ) |   |
| Other comprehensive loss:                                       |       |                                           |       |         |       |                                                  |       |                                 |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency  translation  adjustment                       |       |                                           | —     |         |       | —                                                |       |                                 | —     |                                                          |       |   | — |   |   |   | (9 | ) |   |   | (9 | ) |   |
| Comprehensive loss                                              |       |                                           |       |         |       |                                                  |       |                                 |       |                                                          |       |   |   |   |   |   |   |   |   |   | (360 | ) |   |
| Issuances of common stock  in conjunction with:                 |       |                                           |       |         |       |                                                  |       |                                 |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercises of  employee stock options                            |       |                                           | 150,946    |         |       | 307                                                   |       |                                 | —     |                                                          |       |   | — |   |   |   | — |   |   |   | 307 |   |   |
| Employee stock  purchase plan                                   |       |                                           | 28,160     |         |       | 289                                                   |       |                                 | —     |                                                          |       |   | — |   |   |   | — |   |   |   | 289 |   |   |
| Tax benefit from  stock options  exercised                      |       |                                           | —     |         |       | 501                                                   |       |                                 | —     |                                                          |       |   | — |   |   |   | — |   |   |   | 501 |   |   |
| Issuances of stock  options to nenemployees                     |       |                                           | —     |         |       | 8                                                     |       |                                 | —     |                                                          |       |   | — |   |   |   | — |   |   |   | 8 |   |   |
| Amortization of  deferred compensation related to stock options |       |                                           | —     |         |       | (20                                                   | )          |                                 | 113        |                                                          |       |   | — |   |   |   | — |   |   |   | 93 |   |   |
| 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  adjustment                       |       |                                           | —     |         |       | —                                                |       |                                 | —     |                                                          |       |   | — |   |   |   | (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  adjustment                       |       |                                           | —     |         |       | —                                                |       |                                 | —     |                                                          |       |   | — |   |   |   | (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 |   |   |
| 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 |   |   |

 

See accompanyingnotes to consolidated financial statements.

41

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**AUGUST TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)**
| ** **                                                                                 | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| Cash flows from  operating activities:                                                     |       |                                        |       |   |   |   |   |
| Net loss                                                                                   |       | $                                           | (2,349     | ) | $ | (8,933 | ) | $ | (351 | ) |
| Adjustments to reconcile  net loss to net cash provided by (used in) operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                              |       | 1,951                                       |       | 1,399 |   | 934 |   |
| Provision for doubtful accounts                                                            |       | 195                                         |       | 148 |   | 157 |   |
| Amortization of deferred compensation related to  stock options                            |       | 58                                          |       | 63 |   | 101 |   |
| Deferred income taxes                                                                      |       | —                                      |       | 896 |   | (662 | ) |
| Loss on disposition of assets                                                              |       | —                                      |       | — |   | 17 |   |
| Changes in operating  assets and liabilities, net of effect of acquisitions:               |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                        |       | 3,171                                       |       | (2,465 | ) | 1,986 |   |
| Inventories                                                                                |       | (3,474                                      | )          | 920 |   | (96 | ) |
| Inventories at customers under purchase orders                                             |       | (312                                        | )          | 20 |   | (1,032 | ) |
| Prepaid expenses and other current assets                                                  |       | (195                                        | )          | 1,427 |   | (1,213 | ) |
| Accounts payable                                                                           |       | 3,130                                       |       | 632 |   | (1,127 | ) |
| Accrued compensation                                                                       |       | 591                                         |       | (61 | ) | (641 | ) |
| Other accrued liabilities                                                                  |       | 849                                         |       | (113 | ) | (632 | ) |
| Customer deposits and deferred revenues                                                    |       | 232                                         |       | (447 | ) | 1,123 |   |
| Net cash provided by (used in) operating activities                                        |       | 3,847                                       |       | (6,514 | ) | (1,436 | ) |
| Cash flows from  investing activities:                                                     |       |                                        |       |   |   |   |   |
| Proceeds from maturities of marketable securities                                          |       | 246,020                                     |       | 34,738 |   | 56,471 |   |
| Purchases of marketable securities                                                         |       | (282,978                                    | )          | (27,231 | ) | (54,715 | ) |
| Cash paid in acquisitions                                                                  |       | (1,539                                      | )          | — |   | — |   |
| Purchases of property and equipment                                                        |       | (981                                        | )          | (1,209 | ) | (2,245 | ) |
| Investments in other assets                                                                |       | —                                      |       | (571 | ) | (248 | ) |
| Net cash provided by (used in) investing activities                                        |       | (39,478                                     | )          | 5,727 |   | (737 | ) |
| Cash flows from  financing activities:                                                     |       |                                        |       |   |   |   |   |
| Net proceeds from issuances of common stock                                                |       | 43,766                                      |       | 1,162 |   | 596 |   |
| Net cash provided by financing activities                                                  |       | 43,766                                      |       | 1,162 |   | 596 |   |
| Effect of exchange rates on cash and cash  equivalents                                     |       | (3                                          | )          | (3 | ) | (3 | ) |
| Net increase (decrease) in cash and cash equivalents                                       |       | 8,132                                       |       | 372 |   | (1,580 | ) |
| Cash and cash equivalents at beginning of year                                             |       | 1,895                                       |       | 1,523 |   | 3,103 |   |
| Cash and cash equivalents at end of year                                                   |       | $                                           | 10,027     |   | $ | 1,895 |   | $ | 1,523 |   |
| Supplemental cash  flow information:                                                       |       |                                        |       |   |   |   |   |
| Cash refunds (payments) of income taxes, net                                               |       | $                                           | 218        |   | $ | 1,747 |   | $ | (1,834 | ) |
| Common stock issued for acquisitions                                                       |       | $                                           | 2,160      |   | $ | — |   | $ | — |   |

 

See accompanyingnotes to consolidated financial statements.

42

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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 ofConsolidation.******  ***The consolidated financial statementsinclude the accounts of August Technology Corporation and its wholly ownedsubsidiaries. All significant intercompany balances and transactions areeliminated in consolidation.

***Use of Estimates.******  ***Management uses estimates andassumptions in preparing consolidated financial statements in accordance withgenerally accepted accounting principles. Those estimates and assumptionsaffect the reported amounts of assets and liabilities and the disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported revenues and expenses during the reporting periods.Estimates are used for, but not limited to: allocation of revenues in multipleelement arrangements, allowance for doubtful accounts, inventory valuation,useful lives of depreciable and intangible assets, warranty provisions andincome taxes. Future events and their effects cannot be perceived withcertainty. As a result, the estimates used in preparation of the consolidatedfinancial statements will change as new events occur, as additional informationis obtained and as the Company’s operating environment changes. Actual resultscould differ from those estimates.

***Cash and CashEquivalents.******  ***Cash and cash equivalents includehighly liquid securities with original maturities of 90 days or less whenpurchased.

***Investments.******  ***Investmentsconsist of marketable securities. The investments are stated at fair valuebased on 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 securities mature in less than one year. Long-termmarketable securities have maturities of more than one year.

***Fair Value ofFinancial Instruments.******  ***Thecarrying amount of cash and cash equivalents, accounts receivable, marketablesecurities and accounts payable approximates fair value as of December 31,2003 and 2002.

***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’spast usage rates and future expected usage rates.

43

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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 under purchase ordersrepresents systems that have shipped under the terms of a customer purchaseorder, but have not yet qualified for revenue recognition as the systems hadnot met customer specifications as of December 31, 2003 or 2002.

***Property andEquipment.******  ***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.

***CapitalizedSoftware Development Costs.******  ***Softwaredevelopment costs incurred subsequent to the establishment of technologicalfeasibility, which is demonstrated by the completion of a working model,through general release of the products are capitalized. Capitalized costs areamortized over the lesser of the estimated sales of the product or thestraight-line method over a period of three years. The Company reviews thecarrying value of software development costs regularly and a loss is recognizedwhen the net realizable value falls below the unamortized cost. Net capitalizedsoftware development costs at December 31, 2003 and 2002 were $65 and$160, respectively. Amortization expense for the years ended December 31,2003, 2002 and 2001 was $95, $88 and $37, respectively.

***PurchasedTechnology and Goodwill.******  ***Purchased technology isamortized over the estimated useful lives using the straight-line method andpresented at cost, net of accumulated amortization in the consolidated balancesheet. In accordance with the provisions of Statement of Financial AccountingStandard (“SFAS”) No. 142, “Goodwill and Intangible Assets,” goodwill isperiodically tested for impairment rather than ratably amortized over a periodof time. To test for potential impairment, it was first determined that theCompany consisted of a single reporting unit. Secondly, fair value of thereporting unit was determined based upon the quoted market price of the Company’scommon stock at December 31, 2003. The fair value of the Company was thencompared with the carrying value of net assets. Based on this comparison, itwas determined that no impairment existed. Accordingly, the Company did notperform step two of the impairment analysis, in which the exact amount of an impairmentwould have been determined. In step two of the impairment analysis, the Companywould have been required to compare the implied fair value of goodwill,determined by allocating the reporting unit’s fair value to all of its assetsand liabilities, to its carrying amount.

***Impairment of LongLived Assets.******  ***The Company reviews long-lived assetsfor impairment annually or more frequently if the occurrence of events orchanges in circumstances indicate that the carrying amount of the assets maynot be fully recoverable or the useful lives of these assets are no longerappropriate. Each impairment test is based on a comparison of the carryingamount of an asset to future net undiscounted cash flows. If an impairment isindicated, the asset is written down to its estimated fair value on adiscounted cash flow basis.

***Concentrations ofCredit Risk.******  ***Financial instruments that potentiallysubject the Company to credit risk consist principally of investments in cashequivalents and short-term and long-term marketable securities and tradereceivables. The Company limits credit risk by placing all investments withhigh credit quality issuers and limits the amount of investment with any oneissuer. The Company limits credit risk associated with trade receivables byperforming ongoing credit evaluations and maintains a reserve for potentialcollection losses based upon collectibility of all accounts receivable. TheCompany believes that 

44

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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)**

there is no additionalrisk, beyond amounts provided for collection losses, to be inherent in tradereceivables.

***Income Taxes.******  ***Income taxes are accountedfor under the asset and liability method. Deferred income taxes are recognizedfor the difference between the financial statement carrying amounts and the taxbasis of existing assets and liabilities. Deferred income taxes are recorded atthe tax rates expected to be in effect when amounts are to be included infuture taxable income. The Company regularly assesses the recoverability ofdeferred tax assets and records a valuation allowance to reduce the deferredtax assets to the amounts believed to be realizable, considering whether it ismore likely than not that some portion or all of the deferred tax assets willbe realized. The ultimate realization of deferred tax assets is dependent uponcarry back to prior periods, tax planning strategies, the scheduled reversal ofdeferred tax liabilities and the generation of future taxable income during theperiods in which those temporary differences become deductible. Based upon theCompany’s level of historical taxable losses in recent years and theuncertainty of future taxable income, the Company concluded during the secondquarter of 2002, and continues to believe, that a full valuation allowance againstthe deferred tax assets is appropriate. The valuation allowance at December 31,2003 was $7,529.

***ComprehensiveIncome (Loss).******  ***Comprehensiveincome (loss) represents the change in equity during a period from transactionsand other events and circumstances excluding transactions resulting frominvestment by shareholders and distribution to shareholders.

***Foreign CurrencyTranslation.******  ***Assets and liabilities of the Company’sTaiwan and United Kingdom subsidiaries are translated at current period endexchange rates, and equity accounts are translated at historical rates. Incomeand expense accounts are translated at the average exchange rate in effectduring the period. The resulting translation adjustment is excluded fromoperations and accumulated as a separate component of shareholders’ equity.

***Stock-basedCompensation.******  ***The Company measures compensation expense for itsstock-based employee compensation plans using the intrinsic value method. Asthe exercise price of options granted under these plans is equal to the fairmarket price of the underlying common stock on the grant date, no stock-basedemployee compensation cost is recognized in the consolidated statements ofoperations.

45

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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)**

In December 2002, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accountingfor Stock-Based Compensation Transition and Disclosure.” This Statement amendsSFAS No. 123, “Accounting for Stock-Based Compensation.”  To comply with SFAS 148, the Company ispresenting the following table to illustrate the effect on net loss and netloss per share as if it had applied the fair value recognition provisions ofSFAS 123, as amended, to options granted under the stock-based employeecompensation plans.
| ** **                              | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                              | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net loss, as  reported                  |       | $                                           | (2,349     | ) | $ | (8,933 | ) | $ | (351 | ) |
| Stock  compensation expense, net of tax |       | (1,598                                      | )          | (2,491 | ) | (916 | ) |
| Pro forma net  loss                     |       | $                                           | (3,947     | ) | $ | (11,424 | ) | $ | (1,267 | ) |
| Basic and diluted net  loss per share:  |       |                                        |       |   |   |   |   |
| As reported                             |       | $                                           | (0.16      | ) | $ | (0.69 | ) | $ | (0.03 | ) |
| Pro forma                               |       | (0.27                                       | )          | (0.88 | ) | (0.10 | ) |

 

TheCompany determined the pro forma compensation expense under the provisions ofSFAS No. 123 using the Black-Scholes pricing model and the following assumptions:
| ** **               | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------|------------|---------------------------------------------|------------|
| ** **               | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| Expected life            |       | 5.6 years                                   |       | 4.4 years |   | 5.7 years |   |
| Risk free  interest rate |       | 3.0                                         | %          | 3.4 | % | 4.8 | % |
| Volatility               |       | 75.1                                        | %          | 74.2 | % | 69.9 | % |
| Dividend yield           |       | —                                      |       | — |   | — |   |

 

The estimated per share weighted average fair value ofall stock options granted during the years ended December 31, 2003, 2002and 2001 was $4.75, $3.82 and $7.48, respectively.

***Stock-basedPayments to Nonemployees.******  ***The Companyrecognizes expense for stock options issued to nonemployees based upon the fairvalue of the consideration received or the fair value of the equity instrumentsissued in accordance with SFAS No. 123.

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

*System sales:**  *The Company requires customers,excluding the Company’s distributors, that have new inspection applications tocomplete pre-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.

46

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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)**

·        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, the Companydoes not require pre-shipment authorization testing. Revenue is recognized whenthe product has shipped, title and risk of loss have transferred to thecustomer and collection of the resulting receivable is probable.

System sales are accounted for as multiple-elementarrangements. In transactions that include multiple products and/or services,the Company allocates the revenue to each element based on their relative fairvalue (or in the absence of fair value, the residual method) and recognizes theassociated revenue when all revenue recognition criteria have been met for eachelement.

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

*Software**revenue:  *Softwarerevenue is recognized ratably over the support period.

*Servicerevenue:**  *Service revenue is recognized after theservices are performed and collection of the resulting receivable is probable.Revenues from maintenance contracts is recognized ratably over the period ofthe contract. Service revenues were insignificant during the years ended December 31,2003, 2002 and 2001.

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

***Advertising Costs.******  ***Advertising costs areexpensed as incurred.

***Research andDevelopment.******  ***Researchand development costs are expensed as incurred.

***Net Income (Loss)Per Share.******  ***Basicnet income (loss) per share excludes dilution and is computed by dividingincome (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.******  ***Certain prioryear amounts have been reclassified to conform to the 2003 presentation. Thesereclassifications had no impact on previously reported results of operations orshareholders’ equity.

47

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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)**

***New AccountingPronouncements***

In December 2002, the Emerging Issues Task Force(“EITF”) reached a consensus on EITF 00-21,  “Revenue Arrangements with MultipleDeliverables”. This Issue addresses certain aspects of the accounting by avendor for arrangements under which it will perform multiple revenue-generatingactivities. In some arrangements, the different revenue-generating activities(deliverables) are sufficiently separable and there exists sufficient evidenceof their fair values to separately account for some or all of the deliverables(that is, there are separate units of accounting). In other arrangements, someor all of the deliverables are not independently functional, or there is notsufficient evidence of their fair values to account for them separately. ThisIssue addresses when and, if so, how an arrangement involving multipledeliverables should be divided into separate units of accounting. This Issuedoes not change otherwise applicable revenue recognition criteria. The guidancein this Issue is effective for revenue arrangements entered into in fiscalperiods beginning after June 15, 2003. The adoption of EITF 00-21did not have an effect on the Company’s consolidated financial statements.

In January 2003, the FASB issued FASBInterpretation (“FIN”) No. 46, “Consolidation of Variable InterestEntities”. This Interpretation of Accounting Research Bulletin (“ARB”) No. 51,“Consolidated Financial Statements”, addresses consolidation by businessenterprises of variable interest entities that possess certain characteristics.FIN 46 requires that if a business enterprise has a controlling financialinterest in a variable interest entity, the assets, liabilities, and results ofthe activities of the variable interest entity must be included in theconsolidated financial statements with those of the business enterprise. Theconsolidation requirements of FIN 46 are effective for the first reportingperiod ending after December 15, 2003 for entities considered to bespecial-purpose entities. The consolidation requirements for all other entitiessubject to FIN 46 are effective for consolidated financial statements of thefirst reporting period ending after March 15, 2004. The Company does nothave any ownership in any variable interest entities as of December 31,2003. The Company will apply the consolidation requirements of FIN 46 in futureperiods should an interest in a variable interest entity be acquired.

In April 2003, the FASB issued SFAS No. 149,“Amendment of Statement 133 on Derivative Instruments and Hedging”, whichamends and clarifies financial accounting and reporting for derivativeinstruments. SFAS 149 became effective for the Company in July 2003. Theadoption of SFAS 149 did not have an effect on the Company’s consolidatedfinancial statements.

On May 15, 2003, the Financial AccountingStandards Board issued SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of Both Liabilities and Equity”. The Statementrequires issuers to classify as liabilities (or assets in some circumstance)three classes of freestanding financial instruments that embody obligations forthe issuer. Generally, the Statement is effective for financial instrumentsentered into or modified after May 31, 2003 and is otherwise effective atthe beginning of the first interim period beginning after June 15, 2003. Theadoption of SFAS 150 did not have an effect on the Company’s consolidatedfinancial statements.

48

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

**Note 2**—Business Combinations

The Company completed twopurchase acquisitions during 2003. The consolidated financial statementsinclude the operating results of each business from the date of acquisition.Pro forma results of operations have been presented for all acquisitions thatare material on either an individual or aggregate basis. For a period of up totwelve months from the acquisition date, the Company may change its originalpurchase price allocation for pre-acquisition uncertainties. After twelvemonths, the Company records the fair value of such contingencies that can bereasonably estimated.

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

On April 15, 2003, the Company acquired all ofthe outstanding capital stock of Semiconductor Technologies & Instruments, Inc.,(“STI”). STI manufactures automated defect inspection and metrology tools thatare integrated onto probers, providing microelectronics manufacturers with anautomated solution for inspecting probe marks, ink dots and active die regions.The total purchase price, including direct acquisition costs, was $2,184 whichconsisted of $1,428 in cash and 215 shares of the Company’s Common Stock. Asdiscussed in Note 13, inconnection with the acquisition of STI, the Company had placed 180 shares ofits Common Stock issued in the transaction in escrow as part of the Company’sindemnification protection against damages related to a dispute between STI andRudolph Technologies, Inc. and its subsidiary ISOA, Inc.

Theallocation of the purchase price to the assets acquired and liabilitiesassumed, based upon their estimated fair market values, was as follows:
| Accounts  receivable                       |   | $     | 346    |   |
|--------------------------------------------|--------|-------|--------|--------|
| Inventories                                |   | 1,527 |   |
| Prepaid expenses  and other current assets |   | 71    |   |
| Property and  equipment                    |   | 338   |   |
| Purchased technology                       |   | 370   |   |
| Accrued  liabilities                       |   | (78   | )      |
| Deferred revenue                           |   | (330  | )      |
| Customer deposits                          |   | (60   | )      |
|                                       |   | $     | 2,184  |   |

 

49

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

**Note2—Business Combinations (Continued)**

The following unauditedpro forma consolidated financial information presents the combined results ofoperations of the Company and STI as if the acquisition occurred at thebeginning of the periods presented, after giving effect to certain adjustments,including amortization expense. The unaudited pro forma consolidated financialinformation does not necessarily reflect the results of operations that wouldhave occurred had the acquisition been completed as of the dates indicated orof the results that may be obtained in the future.
| ** **          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------|------------|---------------------------------------------|------------|
| ** **          | ** ** | **2003**                                    | ** ** | **2002** | ** ** |
| ** **          | ** ** | **As reported**                        | ** ** | **Pro forma** | ** ** | **As reported** | ** ** | **Pro forma** | ** ** |
| Revenues            |       |                                        | $          | 40,323 |   |   | $ | 40,593 |   |   | $ | 25,058 |   |   | $ | 28,269 |   |
| Net loss            |       |                                        | (2,349     | ) |   | (3,150 | ) |   | (8,933 | ) |   | (12,643 | ) |
| Net loss per share: |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Basic and diluted   |       |                                        | $          | (0.16 | ) |   | $ | (0.22 | ) |   | $ | (0.69 | ) |   | $ | (0.95 | ) |

 

***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.

**Note 3—MarketableSecurities**

Theamortized cost and estimated fair value of available-for-sale marketablesecurities were as follows:
| ** **      | ** ** | **December 31, 2003** | ** ** |
|-----------------|------------|---------------------------------|------------|
| ** **      | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Corporate bonds |       | $                               | 12,484     |   |   | $ | 35 |   |   |   | $ | (2 | ) |   | $ | 12,517 |   |
| Municipal bonds |       | 41,301                          |       |   | 7 |   |   |   | (2 | ) |   | 41,306 |   |
|            |       | $                               | 53,785     |   |   | $ | 42 |   |   |   | $ | (4 | ) |   | $ | 53,823 |   |

 
| ** **      | ** ** | **December 31, 2002** | ** ** |
|-----------------|------------|---------------------------------|------------|
| ** **      | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Corporate bonds |       | $                               | 8,669      |   |   | $ | 38 |   |   |   | $ | — |   |   | $ | 8,707 |   |
| Municipal bonds |       | 8,158                           |       |   | 17 |   |   |   | — |   |   | 8,175 |   |
|            |       | $                               | 16,827     |   |   | $ | 55 |   |   |   | $ | — |   |   | $ | 16,882 |   |

 

50

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

**Note3—Marketable Securities (Continued)**

The maturities ofavailable-for-sale marketable securities were as follows:
| ** **                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2003**              | ** ** | **2002** | ** ** |
| ** **                              | ** ** | **Amortized  Cost**   | ** ** | **Fair  Value** | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
| Due within one  year                    |       | $                     | 43,524     |   | $ | 43,528 |   | $ | 15,387 |   | $ | 15,438 |   |
| Due after one  year through three years |       | 10,261                |       | 10,295 |   | 1,440 |   | 1,444 |   |
|                                    |       | $                     | 53,785     |   | $ | 53,823 |   | $ | 16,827 |   | $ | 16,882 |   |

 

Net realized gains andlosses were not material for the years ended December 31, 2003 and 2002.

**Note 4—AccountsReceivable**

Accounts receivable consisted of the following:
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2003**              | ** ** | **2002** | ** ** |
| Billed  receivables              |       | $                     | 3,837      |   | $ | 7,209 |   |
| Unbilled revenue                 |       | 812                   |       | 395 |   |
|                             |       | 4,649                 |       | 7,604 |   |
| Allowance for  doubtful accounts |       | (555                  | )          | (550 | ) |
| Accounts  receivable, net        |       | $                     | 4,094      |   | $ | 7,054 |   |

 

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

**Note 5—Inventoriesand Inventories at Customers under Purchase Orders**

Inventoriesconsisted of the following:
| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2003**              | ** ** | **2002** | ** ** |
| Raw materials            |       | $                     | 4,645      |   | $ | 3,053 |   |
| Work in process          |       | 2,305                 |       | 1,415 |   |
| Demonstration  equipment |       | 1,603                 |       | 1,374 |   |
| Finished goods           |       | 3,098                 |       | 1,590 |   |
| Inventories              |       | $                     | 11,651     |   | $ | 7,432 |   |

 

**Note 6—PurchasedTechnology**

As of December 31,2003, purchased technology was $1,370 and related accumulated amortization of$191. Purchased technology is amortized on a straight-line basis over anestimated useful life of four years. Amortization expense for the year ended December 31,2003 was $191. Assuming no change in the gross carrying value of purchasedtechnology, the estimated amortization expense for each of the next five yearsis $342, $342, $343, $152 and none.

51

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

**Note 7—Property andEquipment**

Propertyand equipment consisted of the following:
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2003**              | ** ** | **2002** | ** ** |
| Furniture and  equipment                         |       | $                     | 4,076      |   | $ | 3,487 |   |
| Computer  equipment                              |       | 1,335                 |       | 1,094 |   |
| Computer software                                |       | 1,540                 |       | 1,323 |   |
| Leasehold  improvements                          |       | 426                   |       | 393 |   |
|                                             |       | 7,377                 |       | 6,297 |   |
| Less: accumulated  depreciation and amortization |       | (4,236                | )          | (2,858 | ) |
| Property and  equipment, net                     |       | $                     | 3,141      |   | $ | 3,439 |   |

 

Depreciation expense forthe years ended December 31, 2003, 2002 and 2001 was $1,666, $1,311 and$897, respectively.

**Note 8—Other Assets**

During May 2002, theCompany invested $500 in Excelerate Technologies, Inc. (“Excelerate”) inthe form of a Note Receivable (the “Note”). The Note was amended in February 2003.The Note bears interest at prime and is secured by certain assets. The Notematures and converts into Excelerate preferred stock upon Excelerate raising$1,500 of additional financing via a sale of Excelerate preferred stock. TheNote can be prepaid at anytime by paying the outstanding principal andinterest, along with a prepayment fee of 7.5% on the combined outstandingprincipal and interest. Management determined the note is recoverable basedupon the review of Excelerate’s financial projections and consideration of thevalue of the secured assets.

**Note 9—Income Taxes**

Theprovision for (benefit from) income taxes consisted of the following:
| ** **                                       | ** ** | **Years Ended  December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                       | ** ** | **2003**                                | ** ** | **2002** | ** ** | **2001** | ** ** |
| Current:                                         |       |                                    |       |   |   |   |   |
| Federal                                          |       | $                                       | —     |   | $ | (239 | ) | $ | (152 | ) |
| State                                            |       | —                                  |       | — |   | 1 |   |
| Foreign                                          |       | —                                  |       | 30 |   | — |   |
|                                             |       | —                                  |       | (209 | ) | (151 | ) |
| Deferred:                                        |       |                                    |       |   |   |   |   |
| Federal                                          |       | —                                  |       | 679 |   | (468 | ) |
| State                                            |       | —                                  |       | 217 |   | (194 | ) |
| Foreign                                          |       | —                                  |       | — |   | — |   |
|                                             |       | —                                  |       | 896 |   | (662 | ) |
| Total provision  for (benefit from) income taxes |       | $                                       | —     |   | $ | 687 |   | $ | (813 | ) |

** **

52

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

**Note9—Income Taxes (Continued)**

Areconciliation of the expected federal income taxes at the statutory rate of34% to the actual provision for (benefit from) income taxes is as follows:
| ** **                                        | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                        | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| Expected federal  income tax                      |       | $                                           | (799       | ) | $ | (3,037 | ) | $ | (396 | ) |
| General business  credits                         |       | (312                                        | )          | (283 | ) | (208 | ) |
| Tax exempt income                                 |       | (90                                         | )          | (58 | ) | (81 | ) |
| Nondeductible  expenses                           |       | 59                                          |       | 100 |   | 86 |   |
| Change in  valuation allowance                    |       | 1,142                                       |       | 3,752 |   | — |   |
| Extraterritorial  income exclusion                |       | —                                      |       | — |   | (97 | ) |
| State income tax,  net of federal tax effect      |       | —                                      |       | 144 |   | (127 | ) |
| Foreign tax                                       |       | —                                      |       | 30 |   | — |   |
| Other                                             |       | —                                      |       | 39 |   | — |   |
| Cost (benefit) of  graduated tax rates            |       | —                                      |       | — |   | 10 |   |
| Actual provision  for (benefit from) income taxes |       | $                                           | —     |   | $ | 687 |   | $ | (813 | ) |

 

53

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

**Note9—Income Taxes (Continued)**

Deferred taxes consistedof the following:
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2003**              | ** ** | **2002** | ** ** |
| Current deferred tax  assets:        |       |                  |       |   |   |
| Allowance for doubtful accounts      |       | $                     | 209        |   | $ | 207 |   |
| Inventory reserve                    |       | 198                   |       | 100 |   |
| Warranty accrual                     |       | 90                    |       | 42 |   |
| Compensation accrual                 |       | 48                    |       | 111 |   |
| Accrued lease obligation             |       | 12                    |       | 11 |   |
| Total current deferred tax assets    |       | 557                   |       | 471 |   |
| Long-term  deferred tax assets:      |       |                  |       |   |   |
| Net operating loss carryovers        |       | 5,886                 |       | 4,107 |   |
| General business credits             |       | 1,319                 |       | 1,007 |   |
| Accrued lease obligation             |       | 25                    |       | 30 |   |
| Alternative minimum tax credits      |       | —                |       | — |   |
| Total gross deferred tax assets      |       | 7,787                 |       | 5,615 |   |
| Current deferred  tax liabilities:   |       |                  |       |   |   |
| Prepaid expenses                     |       | (51                   | )          | (51 | ) |
| Long-term  deferred tax liabilities: |       |                  |       |   |   |
| Depreciation                         |       | (207                  | )          | (204 | ) |
| Total gross deferred tax liabilities |       | (258                  | )          | (255 | ) |
| Valuation allowance                  |       | (7,529                | )          | (5,360 | ) |
| Net deferred tax  assets             |       | $                     | —     |   | $ | — |   |

 

The valuation allowance for deferred tax assets as of December 31,2003 and 2002 was $7,529 and $5,360, respectively. The net change in the totalvaluation allowance for the years ended December 31, 2003 and 2002 was anincrease of $2,169 and $5,360, respectively.

At December 31, 2003, the Company had federal netoperating loss carryforwards of approximately $14,721 that will begin to expirein 2022 and state net operating loss carryforwards of approximately $5,372 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 of approximately$1,060 and $206, respectively, which are available to offset future federal andstate regular income taxes, if any, and will begin to expire in 2015.

Subsequently recognized tax benefits relating to the$7,529 valuation allowance for deferred tax assets as of December 31,2003, would be reported in the consolidated statements of operations as anincome tax benefit of $5,590 and in the consolidated statements of shareholders’equity as a tax benefit from stock options exercised of $1,939.

54

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

**Note 10—Short-TermDebt**

On July 26, 2002 the Company entered into arevolving credit line agreement (the “Credit Facility”) with a bank thatexpires in April 2004. The Credit Facility allows for borrowings of up to$5.0 million subject to availability based on accounts receivable and inventorybalances. Interest is payable monthly at the 30-day LIBOR rate plus 2.25%.The Credit Facility contains financial covenants, which include certain levelsof tangible net worth and capital expenditures. As of December 31, 2003,the Company was in compliance with these covenants and there was no balanceoutstanding under the agreement.

On June 30, 2002, theCompany’s previous revolving credit line agreement expired. There was nobalance outstanding under the agreement at December 31, 2001.

**Note 11—AccumulatedOther Comprehensive Income (Loss)**

Theaccumulated balances for each classification of accumulated comprehensiveincome (loss) are as follows:
| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2003**              | ** ** | **2002** | ** ** |
| Currency  translation adjustments           |       | $                     | 38         |   | $ | 55 |   |
| Unrealized losses  on marketable securities |       | (20                   | )          | (12 | ) |
| Accumulated other  comprehensive income     |       | $                     | 18         |   | $ | 43 |   |

 

**Note 12—Shareholders’Equity**

***Net Loss Per Share***

Thecomponents of basic and diluted net loss per share were as follows:
| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net loss                                      |       | $                                           | (2,349     | ) | $ | (8,933 | ) | $ | (351 | ) |
| Weighted average  common shares:              |       |                                        |       |   |   |   |   |
| Basic                                         |       | 14,381                                      |       | 13,033 |   | 12,723 |   |
| Effect of dilutive stock options and warrants |       | —                                      |       | — |   | — |   |
| Diluted                                       |       | 14,381                                      |       | 13,033 |   | 12,723 |   |
| Net loss per share:                           |       |                                        |       |   |   |   |   |
| Basic and diluted                             |       | $                                           | (0.16      | ) | $ | (0.69 | ) | $ | (0.03 | ) |

 

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 31,2003, 2002 and 2001 were 1,884, 1,556 and 1,585, respectively.

55

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

**Note12—Shareholders’ Equity (Continued)**

***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 will be amortized ratably over the vesting period ofthe options granted, generally five years. The charge to compensation expenserelated to this deferred compensation for the years ended December 31,2003, 2002 and 2001 was $51, $63 and $93, 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, to purchase the Company’s Common Stock through payroll deductions.Contributions are limited to 10% of an employee’s compensation. The purchaseprice is set at 85% of the lower of the closing market price of the Company’sCommon Stock at the commencement or termination of a participation phase. Participationphases have a duration of six months and begin on January 1 and July 1of each year. The Board of Directors has reserved 375 shares of Common Stockfor issuance under the 2000 Purchase Plan. As of December 31, 2003, 125shares of Common Stock had been purchased and 250 shares remain reserved forfuture issuance under the 2000 Purchase Plan.

***Stock-based Compensation***

The Board of Directors and shareholders have adoptedthe 1997 incentive stock option plan (the “1997 Option Plan”), which originallyprovided for 1,125 shares available for issuance primarily to officers,directors and key employees. On April 14, 2000, April 19, 2001 and April 30,2003, the shareholders authorized increases in the number of shares availablefor issuance to 2,250, 2,650 and 3,050 shares, respectively. The 1997 OptionPlan permits the granting of incentive stock options meeting the requirementsof Section 422 of the Internal Revenue Code of 1986, as amended, and alsononqualified stock options which do not meet the requirements of Section 422.The exercise price of incentive stock options may not be less than the fairmarket value of the stock at the date of grant. The exercise price ofnonqualified stock options may not be less than 85% of the fair market value ofthe stock at the date of grant. The stock options vest over periods that rangefrom immediate to five years and expire seven years from the date of grant. Asof December 31, 2003, there were 362 shares available for future grantunder the 1997 Option Plan.

56

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

**Note12—Shareholders’ Equity (Continued)**

Information with respectto option activity is as follows:
| ** **                        | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** |
|-----------------------------------|------------|----------------------------|------------|------------------------------------------------------------|------------|
| Outstanding at  December 31, 2000 |       |                       | 1,505      |                                                       |       |   | $ | 5.64 |   |   |
| Granted                           |       |                       | 385        |                                                       |       |   | 11.55 |   |   |
| Exercised                         |       |                       | (151       | )                                                          |       |   | 2.03 |   |   |
| Forfeited                         |       |                       | (123       | )                                                          |       |   | 9.90 |   |   |
| 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 |   |   |

 

Thefollowing table summarizes information about stock options outstanding at December 31,2003: 
|   | ** **                          | ** ** |       | ** **               | ** ** | **Weighted  Average**                         | ** ** | ** **                                 | ** ** | **Exercisable**          | ** ** |
|--------|-------------------------------------|------------|------------|--------------------------|------------|-----------------------------------------------|------------|--------------------------------------------|------------|--------------------------|------------|
|   | **Range of   Exercise Prices** | ** ** |       | **Outstanding  Options** | ** ** | **Remaining  Contractual  Life (years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Exercisable  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|   | $ 0.50 -                       | 1.20       | ** ** |                     |       | 168                                           |       |                                       |       | 1.5                      |       |   |   | $ | 0.93 |   |   |   | 157 |   |   |   | $ | 0.91 |   |   |
|   | 1.21 -                              | 3.96       | ** ** |                     |       | 192                                           |       |                                       |       | 3.6                      |       |   |   | 2.70 |   |   |   | 110 |   |   |   | 2.45 |   |   |
|   | 3.97 -                              | 4.30       | ** ** |                     |       | 209                                           |       |                                       |       | 6.1                      |       |   |   | 4.19 |   |   |   | 79 |   |   |   | 4.30 |   |   |
|   | 4.31 -                              | 4.56       | ** ** |                     |       | 175                                           |       |                                       |       | 6.2                      |       |   |   | 4.42 |   |   |   | 55 |   |   |   | 4.55 |   |   |
|   | 4.57 -                              | 6.15       | ** ** |                     |       | 197                                           |       |                                       |       | 5.2                      |       |   |   | 5.07 |   |   |   | 91 |   |   |   | 5.13 |   |   |
|   | 6.16 -                              | 9.63       | ** ** |                     |       | 185                                           |       |                                       |       | 5.2                      |       |   |   | 8.69 |   |   |   | 95 |   |   |   | 9.45 |   |   |
|   | 9.64 -                              | 10.76      | ** ** |                     |       | 203                                           |       |                                       |       | 5.2                      |       |   |   | 10.25 |   |   |   | 80 |   |   |   | 10.07 |   |   |
|   | 10.77 -                             | 12.00      | ** ** |                     |       | 154                                           |       |                                       |       | 3.9                      |       |   |   | 11.73 |   |   |   | 84 |   |   |   | 11.80 |   |   |
|   | 12.01 -                             | 13.25      | ** ** |                     |       | 139                                           |       |                                       |       | 4.1                      |       |   |   | 12.96 |   |   |   | 80 |   |   |   | 12.92 |   |   |
|   | 13.26 -                             | 18.95      | ** ** |                     |       | 178                                           |       |                                       |       | 5.0                      |       |   |   | 15.41 |   |   |   | 68 |   |   |   | 14.71 |   |   |
|   | $ 0.50 -                       | 18.95      | ** ** |                     |       | 1,800                                         |       |                                       |       | 4.7                      |       |   |   | $ | 7.43 |   |   |   | 899 |   |   |   | $ | 6.90 |   |   |

 

57

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

**Note 13—Commitmentsand Contingencies**

***Leases***

TheCompany leases its facilities and certain equipment under noncancelableoperating leases. Future minimum lease payments as of December 31, 2003,excluding operating costs, under these leases are as follows:
| **For the Years Ending December 31,** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|------------|------------|
| 2004                                                           |       | $          | 885        |       |
| 2005                                                           |       | 768        |       |
| 2006                                                           |       | 236        |       |
| 2007                                                           |       | 4          |       |
| Total minimum  lease payments                                  |       | $          | 1,893      |       |

 

Rent expense for alloperating leases for the years ended December 31, 2003, 2002 and 2001 was$757, $646 and $617, respectively.

***Guarantees***

The Company adopted FIN No. 45,” Guarantor’sRequirements for Guarantees, including Indirect Indebtedness of Others” in thefirst quarter of 2003. FIN 45 requires disclosures concerning the Company’sobligations under certain guarantees.

Pursuant to FIN 45, the Company is required todisclose the changes in the provision for product warranty. The Companyprovides warranty coverage for its systems for a period of one year, includingparts and labor necessary to repair the systems during the warranty period. Theestimated warranty cost is based on our historical experience rate of incurredexpenses to corresponding system revenues.

Informationwith respect to changes in the warranty provision, as required by FIN 45, is asfollows:
| ** **                                              | ** ** | **Changes in  Warranty Liability** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------|------------|
| Accrual at  December 31, 2000                           |       |                                         | $          | 126 |   |   |
| Warranties issued                                       |       |                                         | 173        |   |   |
| Costs incurred                                          |       |                                         | (150       | ) |   |
| 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 |   |   |

 

58

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

**Note13—Commitments and Contingencies (Continued)**

***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, the Company is notaware of any asserted or unasserted legal proceedings or claims that managementbelieves would have a material adverse effect on the Company’s financialcondition or results of operations.

On September 23, 2003, the Company filed acomplaint in the district court of Dallas County, Texas seeking a declaratoryjudgment that the Company has no liability to Rudolph Technologies, Inc.or its subsidiary, ISOA, Inc. (doing business as Yield Metrology Group),with respect to claims they have asserted against the Company and itssubsidiary, STI. In addition, the Company is seeking a judgment against Rudolphand ISOA for repayment of royalties previously paid by STI to ISOA and costsand attorney’s fees incurred in bringing this action. In various letters andconversations with STI and the Company, Rudolph has asserted that STI owesRudolph development fees and royalty payments pursuant to a December 24,1997 Development Agreement between STI and ISOA, Inc., which Rudolph lateracquired and renamed Yield Metrology Group. Rudolph has also asserted that theCompany may have used ISOA technology in the development of one of its productsand owe additional royalties to Rudolph as a result. The Company believes STI hasno obligations to Rudolph under the December 24, 1997 DevelopmentAgreement and that the Company has used no ISOA technology in any of itsproducts.

In connection with the acquisition of STI, the Companyplaced 180 shares of its common stock issued in the transaction in escrow tosecure ASTI’s performance of its agreement to indemnify the Company againstdamages up to a maximum amount of $670 in connection with STI’s dispute withRudolph and to share related outside legal expenses. Of these 180 shares, 110remain as shares in escrow, while the remaining 70 were sold as part of theOffering, with all of the cash proceeds minus fees returned to the escrow. Sharesdistributed from the escrow in payment of any indemnification claim will bevalued at the market price of the Company’s common stock on the date ofresolution of the claim. The escrow agreement provides that the escrow wouldhave terminated on October 15, 2003 if a legal proceeding regarding theseissues had not been initiated prior to that date. Because the Company initiatedthis legal proceeding, the escrow remains in effect until the resolution of theclaims subject to such legal proceeding.

The Company may incursignificant legal fees and expenses in pursuing this action for a declaratoryjudgment. In addition, there can be no assurance that the Company will prevailin such litigation and the Company may suffer an adverse result requiring theCompany to pay damages or royalties adversely affecting its business.Notwithstanding the foregoing, the Company believes the indemnification escrowestablished in connection with the acquisition of STI is reasonably likely toprotect the Company against any losses incurred in connection with Rudolph’sclaims.

**Note 14—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 made 

59

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

**Note14—Employee Retirement Plan (Continued)**

contributionsto the Plan for the years ended December 31, 2003, 2002 and 2001 of $251,$259 and $250, respectively.

**Note 15—SignificantCustomer Information**

Thepercentage of net revenues derived from major customers, which includedistributors, and accounts receivable related to these customers were asfollows:
| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net revenues: |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Customer A    |       |                                        | 12         | % |   |   | * |   |   |   | * |   |   |
| Customer B    |       |                                        | 12         | % |   |   | * |   |   |   | * |   |   |
| Customer C    |       |                                        | 11         | % |   |   | 15 | % |   |   | 12 | % |   |
| Customer D    |       |                                        | 11         | % |   |   | * |   |   |   | * |   |   |
| Customer E    |       |                                        | *          |   |   |   | * |   |   |   | 13 | % |   |
| Customer F    |       |                                        | *          |   |   |   | * |   |   |   | 13 | % |   |
| Customer G    |       |                                        | *          |   |   |   | * |   |   |   | 17 | % |   |
| Customer H    |       |                                        | *          |   |   |   | 10 | % |   |   | * |   |   |
| Total         |       |                                        | 46         | % |   |   | 25 | % |   |   | 55 | % |   |

 
| ** **           | ** ** | **December 31,** | ** ** |
|----------------------|------------|-----------------------|------------|
| ** **           | ** ** | **2003**              | ** ** | **2002** | ** ** |
| Accounts receivable: |       |                  |       |   |   |   |   |   |   |
| Customer A           |       |                  | 1          | % |   |   | * |   |   |
| Customer B           |       |                  | 5          | % |   |   | * |   |   |
| Customer C           |       |                  | 11         | % |   |   | 14 | % |   |
| Customer D           |       |                  | 7          | % |   |   | * |   |   |
| Customer E           |       |                  | *          |   |   |   | * |   |   |
| Customer F           |       |                  | *          |   |   |   | * |   |   |
| Customer G           |       |                  | *          |   |   |   | * |   |   |
| Customer H           |       |                  | *          |   |   |   | 2 | % |   |
| Total                |       |                  | 24         | % |   |   | 16 | % |   |

----

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

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

**Note 16—GeographicInformation**

All ofthe Company’s tangible long-lived assets are located in the United States,except for a small amount of property and equipment in Taiwan. The Companyderives revenues from shipments to customers outside of the United States. Thepercentage of net revenues by country was as follows:
| ** **       | ** ** | **Years Ended  December 31,** | ** ** |
|------------------|------------|-----------------------------------------|------------|
| ** **       | ** ** | **2003**                                | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net revenues:    |       |                                    |       |   |   |   |   |
| United States    |       | 24                                      | %          | 48 | % | 56 | % |
| Taiwan           |       | 38                                      | %          | 37 | % | 18 | % |
| South Korea      |       | 14                                      | %          | — |   | — |   |
| Japan            |       | 7                                       | %          | 4 | % | 13 | % |
| Europe and other |       | 17                                      | %          | 11 | % | 13 | % |
|             |       | 100                                     | %          | 100 | % | 100 | % |

 

**Note 17—QuarterlyFinancial Data (unaudited)**
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **Mar. 31,  2003**          | ** ** | **June 30,  2003** | ** ** | **Sept. 30,  2003** | ** ** | **Dec. 31,  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 |   |

 
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **Mar. 31,  2002**          | ** ** | **June 30,  2002** | ** ** | **Sept. 30,  2002** | ** ** | **Dec. 31,  2002** | ** ** |
| Net revenues                    |       | $                                | 5,510      |   | $ | 6,980 |   | $ | 6,273 |   | $ | 6,295 |   |
| Gross profit                    |       | 3,146                            |       | 4,015 |   | 3,454 |   | 3,375 |   |
| Operating loss                  |       | (1,815                           | )          | (2,114 | ) | (2,673 | ) | (2,268 | ) |
| Net loss                        |       | (803                             | )          | (3,431 | ) | (2,549 | ) | (2,150 | ) |
| Net loss per share:             |       |                             |       |   |   |   |   |   |   |
| Basic and diluted               |       | $                                | (0.06      | ) | $ | (0.26 | ) | $ | (0.19 | ) | $ | (0.16 | ) |
| Weighted average common shares: |       |                             |       |   |   |   |   |   |   |
| Basic and diluted               |       | 12,845                           |       | 13,033 |   | 13,123 |   | 13,130 |   |

 

61

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**Item9. Changes in and Disagreements With Accountants on Accounting and FinancialDisclosure**

None

**Item9A. Controls and Procedures**

As of the end of theperiod covered by this report, we conducted an evaluation, under thesupervision and with the participation of the Chief Executive Officer and ChiefFinancial Officer, of the Company’s disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934 (the “Exchange Act”)). Based on thisevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures are effective to ensurethat information required to be disclosed by the Company in reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms. There was no change in the Company’s internalcontrol over financial reporting during the Company’s most recently completedfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

**PART III**

**Item10. Directors and 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 31,2003. Other than “Executive Officers of the Registrant”, which is set forth atthe end of Part I of this Form 10-K, the information requiredby this item is incorporated herein by reference to the sections labeled “Electionof Directors” and “Compliance With Section 16(a) of the Exchange Act”,which appear in the Proxy Statement.

**Item11. Executive Compensation**

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

**Item 12.  Security Ownership of Certain BeneficialOwners and Management and Related Shareholder Matters**

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.

62

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*Equity CompensationPlan Information*

Thefollowing table provides information about shares of the Company’s Common Stockthat may be issued under the Company’s equity compensation plans, as of December 31,2003:
| **Plan Category**                                      | ** ** | ** ** | ** ** | **(a)  Number of securities to be  issued upon exercise of  outstanding options,  warrants and rights** | ** ** | **(b)  Weighted average  exercise price of  outstanding options,  warrants and rights** | ** ** | **(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)  |       |       | 1,799,630  |                                                                                                                                                      |       |                                                                                                                  | $          | 7.43                                                                                                                                                                                                                    |       |   |   | 612,161  | (2) |   |
| Equity  compensation plans not approved by security holders |       |       | —     |                                                                                                                                                      |       |                                                                                                                  | —     |                                                                                                                                                                                                                    |       |   | — |   |   |
| Total                                                       |       |       | 1,799,630  |                                                                                                                                                      |       |                                                                                                                  | $          | 7.43                                                                                                                                                                                                                    |       |   |   | 612,161 |   |   |

----

(1)      Includesoptions under the August Technology 1997 Stock Option Plan.

(2)                 Includes249,598 shares available for issuance under the August Technology 2000 EmployeeStock Purchase Plan.

**Item13. Certain Relationships and Related Transactions**

None

**Item14. Principal Accountant Fees and Services**

The information requiredby this item is incorporated herein by reference to the section labeled “Ratificationof Independent Auditors” in the Proxy Statement.

**PART IV**

**Item 15.  Exhibits, Financial Statement Schedules andReports on Form 8-K**

**(a)   Documents filed as part of this report.**

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

IndependentAuditors’ Report

ConsolidatedBalance Sheets as of December 31, 2003 and 2002

ConsolidatedStatements of Operations for the Years Ended December 31, 2003, 2002 and2001

ConsolidatedStatements of Shareholders’ Equity for the Years Ended December 31, 2003,2002 and 2001

ConsolidatedStatements of Cash Flows for the Years Ended December 31, 2003, 2002 and2001

Notes to ConsolidatedFinancial Statements

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

ScheduleII—Valuation and Qualifying Accounts.

63

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

**(3)   Exhibits.**

The exhibits included inthis report are set forth on the “Exhibit Index to Form 10-K”following the signature page of this Form 10-K.

**(b)   Reports on Form 8-K.**

A Current Report on Form 8-K dated October 22,2003 was furnished on October 22, 2003 pursuant to Item 12 (Disclosure ofResults of Operations and Financial Condition) to report a press releaseannouncing the Company’s third quarter 2003 financial results.

A Current Report on Form 8-K dated November 30,2003 pursuant to Item 5 (Other Events) was filed on December 3, 2003 toreport the adoption of trading plans under Rule 10b5-1 by certainofficers and directors of the Company.

 

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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 |
| Date: February 27, 2004 |                           | *Chief  Executive Officer(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  Chief Executive Officer  (Principal Executive Officer)     |       | February 27,  2004 |
|                     |
|                     |
| /s/  Stanley D. Piekos   |          | Chief Financial  Officer  (Principal Financial Officer)                                |       | February 27,  2004 |
|                     |
| /s/  Scott A. Gabbard    |          | Chief Accounting  Officer and  Vice President, Finance  (Principal Accounting Officer) |       | February 27,  2004 |
|                     |
|                     |
| /s/  James A. Bernards   |          | Director                                                                               |       | February 27,  2004 |
| /s/  Roger E. Gower      |          | Director                                                                               |       | February 27,  2004 |
| /s/  Michael W. Wright   |          | Director                                                                               |       | February 27,  2004 |
| /s/  Linda Hall Whitman  |          | Director                                                                               |       | February 27,  2004 |

 

65

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**Schedule**II Valuation and Qualifying Accounts

**VALUATIONAND QUALIFYING ACCOUNTSFOR THE THREE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001(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, 2001 |       |     | $          | 255                                            |       |                                          |       | $                                    | 157        |              |       |                                     | $          | — |   |   |   | $ | (10 | ) |   |   | $ | 402 |   |   |
|                             |       | Year ended  December 31, 2002 |       |     | 402        |                                           |       |                                          | 148        |                                 |       |              | —     |                                     |       |   | — |   |   |   | 550 |   |   |
|                             |       | Year ended December 31, 2003  |       |     | 550        |                                           |       |                                          | 195        |                                 |       |              | —     |                                     |       |   | (190 | ) |   |   | 555 |   |   |

 

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(a)    Represents write-offs of uncollectible accountsreceivable.

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**SECURITIESAND EXCHANGE COMMISSIONWashington, D.C. 20549**

**EXHIBIT INDEX TO FORM 10-K**
| For the fiscal year ended: | Commission File No.: 000  - 30637 |
|----------------------------|----------------------------------------|
| December 31, 2003     |                                   |

**AUGUST TECHNOLOGYCORPORATION**
| ** **                                                                    | **Exhibit Number** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **Description** |
|-------------------------------------------------------------------------------|-------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
|              2.1  |                    | Settlement and Purchase  Agreement with ASTI Holdings Limited and Semiconductor  Technologies & Instruments, Inc., dated February 26, 2003  (See agreement for a listing of exhibits and schedules not included herein.  Issuer will furnish copies of omitted exhibits and schedules upon the  Commission’s request) (incorporated by reference to Exhibit 2.1 to the  Company’s Form 10-K for the year ended December 31, 2002) |
|              2.2  |                    | Definitive Agreement  with ASTI Holdings Limited and Semiconductor Technologies &  Instruments, Inc. dated May 23, 2002—see Exhibit 10.16                                                                                                                                                                                                                                                                                                        |
|              2.3  |                    | Amendments dated  March 19, 2003 and April 15, 2003 to the Settlement and Purchase  Agreement with ASTI Holdings Limited and Semiconductor  Technologies & Instruments, Inc. dated February 26, 2003  (incorporated by reference to Exhibit 2.3 to the Company’s Current  Report on Form 8-K/A-3 dated April 15, 2003                                                                                                        |
|              2.4* |                    | Escrow Agreement dated  April 16, 2003 by and among the Company, ASTI Holdings Limited and Wells  Fargo Bank Minnesota, N.A. and Amendment No. 1 dated August 28,  2003.                                                                                                                                                                                                                                                                                       |
|              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 Option Plan,  as amended and restated through July 29, 2003 (incorporated by reference  to Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended  June 30, 2003)**                                                                                                                                                                                                                                                                |
|           10.2                   |                    | 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)                                                                                                                                                                                                               |

67

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|           10.3  |   | International Distributor Agreement between the  Company and Metron Technology B.V. dated September 10, 1999  (incorporated by reference to Exhibit 10.3 to the Company’s Registration  Statement on Form S-1, Reg. No. 333-32692)                                                                                     |
|--------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           10.4  |   | International  Distributor Agreement between the Company and Quasys AG dated  September 23, 1996 (incorporated by reference to Exhibit 10.4 to  the Company’s Registration Statement on Form S-1, Reg.  No. 333-32692)                                                                                                 |
|           10.5  |   | International  Distributor Agreement between the Company and Firfax Systems Ltd. dated  September 3, 1996 (incorporated by reference to Exhibit 10.5 to the  Company’s Registration Statement on Form S-1, Reg. No. 333-32692)                                                                                         |
|           10.6  |   | 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)                                                                 |
|           10.7  |   | Amendments to the Lease  Agreement between the Company and Duke Realty Minnesota, LLC, dated  March 12, 1999 and October 29, 1999 (incorporated by reference to  Exhibit 10.7 to the Company’s Form 10-K for the year ended  December 31, 2002)                                                                   |
|           10.8  |   | Amendment to the  International Distributor Agreement between the Company and Metron Technology  B.V., dated May 19, 2002 (incorporated by reference to Exhibit 17.8  to the Company’s Form 10-K for the year ended December 31, 2002)                                                                                 |
|           10.9  |   | Stock Purchase Warrant  between the Company and III-D Capital, LLC, dated July 24, 1998 (incorporated  by reference to Exhibit 10.13 to the Company’s Registration Statement on  Form S-1, Reg. No. 333-32692)                                                                                                         |
|           10.10 |   | 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)                                                                                                   |
|           10.11 |   | 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)**                                                                                 |
|           10.12 |   | August Technology  2000 Employee Stock Purchase Plan, as amended and restated through  April 30, 2002 (incorporated by reference to Exhibit 10.2 to the  Company’s Form 10-Q for the quarter ended June 30, 2002)**                                                                                               |
|           10.13 |   | Convertible Promissory  Note between the Company and Excelerate Technologies Holdings, LLC, dated  May 6, 2002, as amended by the Amendment to Convertible Promissory Note,  dated October 29, 2002 (incorporated by reference to Exhibit 10.14  to the Company’s Form 10-K for the year ended December 31, 2002) |
|           10.14 |   | 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)**                                                                                                       |
|           10.15 |   | Definitive agreement  with ASTI Holdings Limited and Semiconductor Technologies &  Instruments, Inc., dated May 23, 2002 (incorporated by reference to  Exhibit 10.2 to the Company’s Form 10-Q for the quarter ended  September 30, 2002)                                                               |

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|           10.16 |   | 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) |
|--------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           10.17 |   | August Technology  2001 Annual Incentive Plan (incorporated by reference to Exhibit 10.24  to the Company’s Form 10-K for the year ended December 31, 2000)**                                                                                                         |
|           10.18 |   | Executive Employment  Contract between the Company and Jeff L. O’Dell, dated March 6, 2002  (incorporated by reference to Exhibit 10.22 to the Company’s  Form 10-K for the year ended December 31, 2001)**                                                      |
|           10.19 |   | 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)**                                                              |
|           10.20 |   | 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)**                                                         |
|           10.21 |   | Executive Employment  Contract between the Company and Wayne Hubin, dated March 6, 2002  (incorporated by reference to Exhibit 10.29 to the Company’s  Form 10-K for the year ended December 31, 2001)**                                                              |
|           10.22 |   | August Technology  2002 Annual Incentive Plan (incorporated by reference to Exhibit 10.31  to the Company’s Form 10-K for the year ended December 31, 2001)**                                                                                                         |
|           10.23 |   | 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)                          |
|           10.24 |   | Amendment to the  International Distributor Agreement between the Company and Metron Technology  B.V., dated April 17, 2001 (incorporated by reference to  Exhibit 10.33 to the Company’s Form 10-K for the year ended  December 31, 2001)                            |
|           10.25 |   | Revolving Credit  Agreement between the Company and Excel Bank Minnesota, dated July 26,  2002 (incorporated by reference to Exhibit 10.31 to the Company’s  Form 10-K for the year ended December 31, 2002)                                                          |
|           10.26 |   | Revolving Note between  the Company and Excel Bank Minnesota, dated July 26, 2002 (incorporated  by reference to Exhibit 10.32 to the Company’s Form 10-K for the  year ended December 31, 2002)                                                                      |
|           10.27 |   | Security Agreement  between the Company and Excel Bank Minnesota, dated July 26, 2002  (incorporated by reference to Exhibit 10.33 to the Company’s  Form 10-K for the year ended December 31, 2002)                                                                  |
|           10.28 |   | Termination of the  International Distributor Agreement between the Company and Firfax Systems  Ltd., dated December 18, 2002 (incorporated by reference to  Exhibit 10.34 to the Company’s Form 10-K for the year ended  December 31, 2002)                          |
|           10.29 |   | 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)                                                                                                                 |

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|           10.30  |   | Security Agreement  between the Company and Excelerate Technologies, LLC, dated May 6, 2002  (incorporated by reference to Exhibit 10.36 to the Company’s  Form 10-K for the year ended December 31, 2002)                                                 |
|---------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           10.31  |   | 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)**                                                 |
|           10.32  |   | Amendment to Convertible  Promissory Note between the Company and Excelerate Technologies Holdings, LLC  dated February 13, 2003 (incorporated by reference to Exhibit 10.2  to the Company’s Form 10-Q for the quarter ended March 31, 2003)              |
|           10.33  |   | Financing Agreement  between the Company and Excelerate Technologies, LLC dated May 6, 2002  (incorporated by reference to Exhibit 10.3 to the Company’s  Form 10-Q for the quarter ended March 31, 2003)                                                  |
|           10.34  |   | 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) |
|            10.35 |   | 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)                                                         |
|           10.36* |   | Executive Employment  Contract between the Company and Cory Watkins, dated February 5, 2004**                                                                                                                                                                                  |
|           21.1*  |   | Subsidiaries of the  Company                                                                                                                                                                                                                                                        |
|           23.1*  |   | Independent Auditors’  Consent                                                                                                                                                                                                                                                 |
|           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 contract orcompensatory plan or arrangement

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