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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549****FORM 10-Q****(Mark One)**   þ **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THESECURITIES EXCHANGE ACT OF 1934******For the quarterly period ended June 30, 2007****   o **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THESECURITIES EXCHANGE ACT OF 1934******Forthe transition period from             to******Commission File Number 0-22248****ULTRATECH, INC.**(Exact name of registrant as specified in its charter)   **DELAWARE** **94-3169580**(State or other jurisdiction of (I.R.S. Employer Identification No.)incorporation or organization)     **3050 Zanker Road, San Jose, California** **95134**(Address of principal executive offices) (Zip Code)Registrant’s telephone number, including area code **(408) 321-8835**(Former name, former address and former fiscal year, if changed since last report.)Indicate by check mark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes þ No oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):Large accelerated filer o            Accelerated filer þ           Non-accelerated filer oIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o No þIndicate the number of shares outstanding of each of the issuer’s classes of common stock, as ofthe latest practicable date:   **Class****Outstanding as of July 26, 2007**common stock, $.001 par value 23,310,977  
 

 
**ULTRATECH, INC.****INDEX** **PART I. FINANCIAL INFORMATION****Item 1. Financial Statements**Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2007 and July 1, 2006Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2007 and July 1, 2006Notes to Condensed Consolidated Financial Statements**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations****Item 3. Quantitative and Qualitative Disclosures About Market Risk****Item 4. Controls and Procedures****PART II. OTHER INFORMATION****Item 1. Legal Proceedings****Item 1A. Risk Factors****Item 2. Unregistered Sales of Equity Securities and Use of Proceeds****Item 3. Defaults Upon Senior Securities****Item 4. Submission of Matters to a Vote of Security Holders****Item 5. Other Information****Item 6. Exhibits****SIGNATURES** EXHIBIT 31.1 EXHIBIT 31.2 EXHIBIT 32.1
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**PART I. FINANCIAL INFORMATION****Item 1. Financial Statements****ULTRATECH, INC.****CONDENSED CONSOLIDATED BALANCE SHEETS**           **June 30,**  **December 31,** **(In thousands )** **2007**  **2006***   **(Unaudited)**     ***ASSETS***        Current assets:        Cash and cash equivalents $36,767  $23,883 Short-term investments  59,674   54,207 Accounts receivable, net  19,887   18,054 Inventories  37,265   40,988 Prepaid expenses and other current assets  3,137   2,181        Total current assets  156,730   139,313          Long-term investments  33,997   48,328 Equipment and leasehold improvements, net  19,105   20,326 Demonstration inventories  4,321   4,717 Other assets  2,109   3,366                 Total assets $216,262  $216,050        ***LIABILITIES AND STOCKHOLDERS’ EQUITY***        Current liabilities:        Notes payable $9,705  $6,974 Accounts payable  7,036   10,440 Deferred product and services income  6,244   2,950 Other current liabilities  13,030   13,998        Total current liabilities  36,015   34,362          Other liabilities  6,660   7,580          Stockholders’ equity  173,587   174,108                 Total liabilities and stockholders’ equity $216,262  $216,050         * The Balance Sheet as of December 31, 2006 has been derived from the audited financialstatements at that date.*See accompanying notes to unaudited condensed consolidated financial statements*
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**ULTRATECH, INC.****CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS****(Unaudited)**                   **Three Months Ended**  **Six Months Ended**   **June 30,**  **July 1,**  **June 30,**  **July 1,** **(In thousands, except per share amounts)** **2007**  **2006**  **2007**  **2006** Net sales:                Products $26,296  $22,362  $49,803  $53,771 Services  3,615   3,581   7,476   7,116 Licenses  100   100   100   100              Total net sales  30,011   26,043   57,379   60,987                  Cost of sales:                Cost of products sold  14,413   11,821   28,873   30,937 Cost of services  2,422   2,411   4,530   4,582              Total cost of sales  16,835   14,232   33,403   35,519              Gross profit  13,176   11,811   23,976   25,468 Operating expenses:                Research, development, and engineering  5,836   6,350   11,800   12,503 Selling, general, and administrative  7,561   8,345   16,863   15,642              Operating loss  (221)  (2,884)  (4,687)  (2,677)                 Interest expense  (138)  (32)  (471)  (44)Interest and other income, net  1,446   1,712   3,115   3,229              Income (loss) before income tax  1,087   (1,204)  (2,043)  508 Provision (benefit) for income taxes  67   (28)  182   102                               Net income (loss) $1,020  $(1,176) $(2,225) $406               Net income (loss) per share — basic $0.04  $(0.05) $(0.10) $0.02 Number of shares used in per share computations — basic  23,368   23,927   23,395   23,879                  Net income (loss) per share — diluted $0.04  $(0.05) $(0.10) $0.02 Number of shares used in per share computations — diluted  23,467   23,927   23,395   25,031 *See accompanying notes to unaudited condensed consolidated financial statements*
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**ULTRATECH, INC.****CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS****(Unaudited)**           **Six Months Ended**   **June 30,**  **July 1,** **(In thousands)** **2007**  **2006** *Cash flows from operating activities:*        Net income (loss) $(2,225) $406 Adjustments to reconcile net loss to net cash provided by (used in) operating activities:        Depreciation  3,090   2,977 Amortization  428   627 Accretion of asset retirement obligations  74   108 (Gain) loss on disposal of equipment  4   (5)Stock-based compensation  761   960 Deferred income taxes  —   170 Changes in operating assets and liabilities:        Accounts receivable  (1,833)  111 Inventories  2,220   (9,186)Prepaid expenses and other current assets  118   (1,598)Demonstration inventory  —   (1,853)Other assets  1,257   38 Accounts payable  (3,404)  5,806 Deferred product and services income  3,294   2,724 Other current liabilities  (675)  127 Other liabilities  (1,261)  (558)       Net cash provided by operating activities  1,848   854                 *Cash flows from investing activities:*        Capital expenditures  (384)  (1,507)Proceeds from sale of fixed assets  —   79 Purchase of investments  (16,756)  (23,920)Proceeds from sales and maturities of investments  24,559   20,917        Net cash provided by (used in) investing activities  7,419   (4,431)                *Cash flows from financing activities:*        Proceeds from notes payable  17,570   21,404 Repayment of notes payable  (14,839)  (15,893)Proceeds from issuance of common stock  1,018   2,639 Tax benefit from stock options  2   —        Net cash provided by financing activities  3,751   8,150                 Net effect of exchange rate changes on cash and cash equivalents  (134)  (223)         Net increase in cash and cash equivalents  12,884   4,350          Cash and cash equivalents at beginning of period  23,883   36,344                 Cash and cash equivalents at end of period $36,767  $40,694                 Supplemental disclosures of cash flow information:        Other non-cash activities:        Systems transferred to inventory from equipment and other assets ($1,503) ($754)*See accompanying notes to unaudited condensed consolidated financial statements*
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**Ultratech, Inc.****Notes to Condensed Consolidated Financial Statements****(Unaudited)****June 30, 2007****(1) Description of Business**Ultratech, Inc. (referred to as “Ultratech,” the “Company” and “we”) develops, manufactures andmarkets photolithography and laser thermal processing equipment for manufacturers of integratedcircuits and nanotechnology components located throughout North America, Europe, Japan, Taiwan andthe rest of Asia.We supply step-and-repeat photolithography systems based on one-to-one imaging technology. Withinthe integrated circuits industry, we target the market for advanced packaging applications. Withinthe nanotechnology industry, our target markets include thin film head magnetic recording devices,ink jet print heads, laser diodes and light emitting diodes (LEDs). Our laser thermal processingequipment is targeted at advanced annealing applications within the semiconductor industry.In evaluating our business segments, we gave consideration to the Chief Executive Officer’s reviewof financial information and the organizational structure of our management. Based on this review,we concluded that, at the present time, resources are allocated and other financial decisions aremade based on our consolidated financial information. Accordingly, we have determined that weoperate in one business segment, which is the manufacture and distribution of capital equipment tomanufacturers of integrated circuits and nanotechnology components.**(2) Basis of Presentation**We have prepared the unaudited condensed consolidated financial statements in accordance withgenerally accepted accounting principles for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by U.S. generally accepted accounting principles forcomplete financial statements. In the opinion of management, all adjustments, consisting of onlynormal recurring adjustments considered necessary for fair presentation, have been included.Our fiscal period ends on the Saturday closest to month-end. All references to the quarter refer toour fiscal quarter. Our fiscal quarters covered by this report ended on June 30, 2007 and July 1,2006.Operating results for the three and six months ended June 30, 2007 are not necessarily indicativeof the results that may be expected for the year ending December 31, 2007 or any future period.**USE OF ESTIMATES**— The preparation of the financial statements and related disclosures inconformity with accounting principles generally accepted in the United States requires us to makeestimates and judgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and the related disclosure of contingent assets and liabilities at the date of theconsolidated financial statements. By their nature, these estimates and judgments are subject to aninherent degree of uncertainty. On an ongoing basis, we evaluate our estimates, including thoserelated to inventories, warranty obligations, purchase order commitments, asset retirementobligations, bad debts, estimated useful lives of fixed assets, asset impairment, income taxes,intangible assets, contingencies and litigation. We base our estimates on historical experience andon various other analyses and assumptions that we believe to be reasonable under the circumstances,the results of which form the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.**IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS**— In September 2006, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, *FairValue Measurements*(SFAS No. 157)*,*which replaces the different definitions of fair value in theaccounting literature with a single definition. It defines fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. SFAS No. 157 is effective for fair-value measurements alreadyrequired or permitted by other standards for financial statements issued for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years, with earlier adoptionencouraged. We are currently in the process of determining the impact, if any, of adopting theprovisions of SFAS No. 157 on our results of operations or financial position.
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In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities—Including an amendment of FASB Statement No.*115 (SFAS No. 159), providescompanies with an option to report selected financial assets and liabilities at fair value. Theobjective of SFAS No. 159 is to reduce both the complexity in accounting for financial instrumentsand the volatility in earnings caused by measuring related assets and liabilities differently. SFASNo. 159 also establishes presentation and disclosure requirements designed to facilitatecomparisons between companies that choose different measurement attributes for similar types ofassets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15,2007, with earlier adoption permitted. We are currently in the process of determining the impact ofadopting the provisions of SFAS No. 159 on our results of operations or statement of financialposition.**(3) Stock-Based Compensation**Stock-based compensation expense recognized under SFAS No. 123 (revised 2004), *Share-Based Payment*(SFAS No. 123R), for employees and directors and the effect on our Condensed ConsolidatedStatements of Operations were as follows:                   **Three Months Ended**  **Six Months Ended**   **June 30,**  **July 1,**  **June 30,**  **July 1,** **(In thousands)** **2007**  **2006**  **2007**  **2006** Cost of Sales $50  $37  $83  $69 Research, development, and engineering  78   62   156   108 Selling, general and administrative expenses  274   388   522   783              Total stock-based compensation expense  402   487   761   960 Tax benefit related to stock-based compensation expense  —   —   —   —              Net effect on net loss $402  $487  $761  $960              Effect on net income (loss) per basic and diluted share $0.02  $0.02  $0.03  $0.04              Compensation cost capitalized as part of inventory was immaterial during each of the three- andsix-month periods ended June 30, 2007 and July 1, 2006.Our 1993 Stock Option Plan/Stock Issuance Plan, as amended, and our 1998 Supplemental StockOption/Stock Issuance Plan, as amended, provide for the grant of qualified and non-qualifiedstock-based awards to our eligible employees, consultants and advisors and non-employee directors.We believe that such awards better align the interests of our employees with those of our stockholders. As of June 30, 2007, there were a total of 1.8 million shares reserved for futureawards under these Plans.We used the following weighted-average assumptions to estimate the fair value of our stock optionsgranted during the three- and six-month periods ended June 30, 2007 and July 1, 2006:                   **Three Months Ended** **Six Months Ended**  **June 30,** **July 1,** **June 30,** **July 1,**  **2007** **2006** **2007** **2006**Expected life (in years)  *   4.94   4.94   4.94 Risk-free interest rate  *   4.89%  4.80%  4.89%Volatility factor  *   0.53   0.48   0.53 Dividend yield  *   —   —   —  * Not presented as we did not grant any stock options during the three-month period ended June 30,2007.
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**(4) Net Income (Loss) Per Share**The following sets forth the computation of basic and diluted net income (loss) per share:                   **Three Months Ended**  **Six Months Ended**   **June 30,**  **July 1,**  **June 30,**  **July 1,** **(In thousands, except per share amounts)** **2007**  **2006**  **2007**  **2006** Numerator:                Net income (loss) $1,020  $(1,176) $(2,225) $406 Denominator:                Denominator for basic net income (loss) per share  23,368   23,927   23,395   23,879 Effect of dilutive employee stock options andrestricted stock units  99   —   —   1,152              Denominator for diluted net income per share  23,467   23,927   23,395   25,031                               Net income (loss) per share — basic:                Net income (loss) $0.04  ($0.05) ($0.10) $0.02                               Net income (loss) per share — diluted:                Net income (loss) $0.04  ($0.05) ($0.10) $0.02              For the three- and six-month periods ended June 30, 2007, options to purchase 4.7 million and 5.7million shares of common stock, respectively, were excluded from the computation of diluted netincome (loss) per share, as the effect would have been anti-dilutive, compared to 6.3 million and1.8 million, respectively, in the corresponding periods of 2006. In addition, for the three and sixmonths ended June 30, 2007, restricted stock units for 0.1 million shares of common stock wereexcluded from the computation as well, compared to 0.1 million and zero shares in the correspondingperiods of 2006. Options and restricted stock units are anti-dilutive when we have a net loss orwhen the exercise price and the average unrecognized compensationcost of the stock option or restricted stock unit is greater than the average market price of our commonstock during the period.**(5) Inventories**Inventories consist of the following:           **June 30,**  **December 31,** **(In thousands)** **2007**  **2006** Raw materials $20,065  $18,067 Work-in-process  14,231   9,952 Finished products  2,969   12,969          $37,265  $40,988        **(6) Notes Payable**We have a line of credit agreement with a brokerage firm. Under the terms of this agreement, we mayborrow funds at a cost equal to the current Federal funds open rate plus 100 basis points(approximately 6.25% as of June 30, 2007). Certain of our cash, cash equivalents and investmentssecure borrowings outstanding under this facility, but we are not restricted in the use of thoseassets. Funds are advanced to us under this facility based on pre-determined advance rates on thecash and securities held by us in this brokerage account. This agreement has no set expiration dateand there are no loan covenants, other than the aforementioned collateral requirement. As of June30, 2007, $9.7 million was outstanding under this facility, with a related collateral requirementof approximately $12.9 million of our cash, cash equivalents and investments.
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**(7) Other Current Liabilities**     Other current liabilities consist of the following:           **June 30,**  **December 31,** **(In thousands)** **2007**  **2006** Salaries and benefits $2,966  $3,632 Warranty accrual  2,218   2,264 Advance billings  2,580   2,713 Income taxes payable  171   876 Accrued taxes-other  2,579   2,076 Reserve for losses on purchase order commitments  686   623 Other  1,830   1,814          $13,030  $13,998        **Warranty Accrual**We generally warrant our products for a period of 12 months for new products, or three months forrefurbished products, from the date of customer acceptance for material and labor to repair theproduct; accordingly, an accrual for the estimated cost of the warranty is recorded at the time theproduct is shipped. Extended warranty terms, if granted, result in deferral of revenue equating toour standard pricing for similar service contracts. Recognition of the related warranty cost isdeferred until product revenue is recognized. Factors that affect our warranty liability includethe number of installed units, historical and anticipated rates of warranty claims, and cost perclaim. We periodically assess the adequacy of our recorded warranty liabilities and adjust theamounts as necessary. We believe our warranty accrual, as of June 30, 2007, will be sufficient tosatisfy outstanding obligations as of that date. Changes in our warranty accrual are as follows:                   **Three Months Ended**  **Six Months Ended**   **June 30,**  **July 1,**  **June 30,**  **July 1,** **(In thousands)** **2007**  **2006**  **2007**  **2006** Balance, beginning of the period $2,378  $2,586  $2,264  $2,397 Warranties issued during the period  786   396   1,847   1,313 Settlements made during the period  (673)  (1,152)  (1,692)  (2,270)Changes in liability for pre-existing warranties  (273)  368   (201)  758              Balance, end of the period $2,218  $2,198  $2,218  $2,198              **Deferred Services Revenue**We sell service contracts for which revenue is deferred and recognized ratably over the contractperiod for time based service contracts, or as service hours are delivered for contracts based on apurchased quantity of hours. Changes in our deferred service revenue are as follows:                   **Three Months Ended**  **Six Months Ended**   **June 30,**  **July 1,**  **June 30,**  **July 1,** **(In thousands)** **2007**  **2006**  **2007**  **2006** Balance, beginning of the period $2,295  $3,213  $2,444  $1,970 Service contracts sold during the period  1,275   2,122   2,395   6,079 Service contract revenue recognized during the period  (876)  (2,626)  (2,145)  (5,340)             Balance, end of the period $2,694  $2,709  $2,694  $2,709              
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**(8) Other Liabilities**     Other liabilities consist of the following:           **June 30,**  **December 31,** **(In thousands)** **2007**  **2006** Deferred rent $2,482  $2,737 Deferred compensation  1,146   2,160 Long-term income taxes payable  267   — Asset retirement obligation  2,056   1,982 Postretirement medical obligation  709   701          $6,660  $7,580        **(9) Accumulated Other Comprehensive Loss**     Accumulated other comprehensive loss is comprised of the following items, net of tax:           **June 30,**  **December 31,** **(In thousands)** **2007**  **2006** Unrealized gains (losses) on:        Available-for-sale investments $(835) $(847)Foreign exchange forward contracts  (1)  132 Change in minimum postretirement medical obligation  (181)  (200)       Accumulated other comprehensive loss at end of period $(1,017) $(915)       **(10) Exit Activities**     Changes in our accrued severance and benefits charges are as follows:                               **Balance at**          **Balance at**          **Balance at**   **December 31,**          **March 31,**          **June 30,** **(In thousands)** **2006**  **Expenses**  **Payments**  **2007**  **Expenses**  **Payments**  **2007** Severance and benefits (fourth quarter 2006) $918  $—  $(330) $588  $—  $(173) $415 Severance and benefits (first quarter 2007)  —   727   (480)  247   —   (247)  — Severance and benefits (second quarter 2007)  —   —   —   —   493   (179)  314                       Total $918  $727  $(810) $835  $493  $(599) $729                       In the second quarter of 2007, as a continuing effort to reduce company-wide expenses since thefourth quarter of 2006, we eliminated an additional eight full-time positions, three in the UnitedStates and five internationally. Pursuant to the provisions of FASB Statement No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*, during the second quarter of 2007, werecorded severance and benefits charges totaling $0.5 million related to this plan as selling,general and administrative expenses. As of June 30, 2007, the remaining balance of $0.7 millionrelated to severance and benefit payments incurred during 2006 and 2007 will be fully paid by thesecond quarter of 2008. We recorded severance and benefits charges totaling $1.2 million during thefirst six months of 2007. Out of this $1.2 million, $0.9 million was recorded as selling, generaland administrative expenses, $0.2 million as cost of sales, and the remaining $0.1 million asresearch, development, and engineering expenses.**(11) Stock Repurchase Program**In September 2005, our Board of Directors authorized the repurchase of up to $30.0 million of ourcommon stock in the open market at the then prevailing market prices during the period commencingSeptember 2005 through September 2007. We did not repurchase any shares of our common stock duringthe first six months of 2007. Through June 30, 2007 we had repurchased 1.4 million shares of ourcommon stock at a total purchase price of $20.0 million since September 2005.
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**(12) Employee Benefit Plans*****Employee bonus plans***We currently sponsor an executive incentive bonus plan that distributes employee awards based onthe achievement of predetermined targets. We did not record any expense under this bonus plan forthe three- and six-month periods ended June 30, 2007 compared to $0.2 million and $0.4 million forthe three- and six-month periods ended July 1, 2006, respectively.***Employee savings and retirement plans***We sponsor a 401(k) employee salary deferral plan that allows voluntary contributions by allfull-time employees of from 1% to 20% of their pretax earnings. Our contributions made to this planwere $0.1 million for each of the three-month periods ended June 30, 2007 and July 1, 2006,respectively, and $0.2 million for each of the six-month periods then ended. Our contributions,limited to a maximum of $2,000 per year per employee, generally become 20 percent vested at the endof an employee’s first year of service from the date of hire, and vest 20 percent per year ofservice thereafter until they become fully vested at the end of five years of service. We alsosponsor an executive non-qualified deferred compensation plan (the “Plan”) that allows qualifyingexecutives to defer current cash compensation. As of June 30, 2007, Plan assets, representing thecash surrender value of life insurance policies held by us and liabilities were approximately $1.1million each, respectively, and were included in our Consolidated Balance Sheets under the captions“other assets” and “other liabilities.” In conjunction with this Plan, the related expense for bothquarters ended June 30, 2007 and July 1, 2006 was immaterial.***Postretirement benefits***We have committed to providing lifetime post-retirement medical and dental benefits to the ChiefExecutive Officer and Chief Financial Officer and their spouses, commencing after retirement. Thesemedical and dental benefits are similar to the benefitsprovided to all full-time employees while employed by us, except that we are paying the entire costof the postretirement benefits. During the first quarter of 2007, we amended and restated theemployment agreement with our Chief Financial Officer to provide him and his spouse retirementhealth benefits in the event of a change of control or sale of the Company or in the event that heretires when he is at least 62 years old and has served as an executive officer for 10 consecutiveyears. We recorded net periodic benefit costs of $13,000 and $26,000 for the three- and six-monthperiods ended June 30, 2007, respectively. We recorded net periodic benefit costs of $11,000 and$22,000 for the three- and six-month periods ended July 1, 2006, respectively. These expensesincluded interest cost and amortization of prior service cost.**(13) Income Taxes**In accordance with the adoption of FASB Financial Interpretation Number (FIN) 48, *Accounting forUncertainty in Income Taxes*(FIN 48), we have unrecognized tax benefits of $2.8 million as ofJanuary 1, 2007. We continue to recognize interest and penalties as a component of income taxprovision and have accrued $55,000 for these items as of January 1, 2007. The implementation of FIN48 as of January 1, 2007 resulted in a decrease of $20,000 to the liability for uncertain taxpositions and a decrease to accumulated deficit of $27,000. All other adjustments required uponadoption of FIN 48 were to the deferred tax accounts with an offsetting adjustment to the valuationallowance.If we are able to eventually recognize these uncertain tax positions, $2.5 million of theunrecognized benefit would reduce the effective tax rate. We currently have a full valuationallowance against our U.S. net deferred tax asset which would impact the timing of the effectivetax rate benefit should any of these uncertain tax positions be favorably settled in the future. Weanticipate an increase to the unrecognized tax benefits during fiscal 2007 applicable to researchand development tax credits and foreign tax exposures. While the increase cannot be estimated atthis time, the change is not expected to be material to the fiscal 2007 financial statements.We are subject to federal and state tax examinations for years 1999 forward and 1997 forward,respectively, by virtue of the tax attributes carrying forward from those years. We are alsosubject to audits in the foreign jurisdictions in which we operate for years 2000 and forward.There are no tax examinations currently in progress.
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**(14) Contingencies****Legal Proceedings**On February 29, 2000, we filed lawsuits asserting patent infringement and related claims againstNikon, Canon and ASML in the U.S. District Court for the Eastern District of Virginia. In April2000, we reached a settlement with Nikon, and in September 2001, we reached a settlement withCanon. In the patent litigation against ASML, after transfer to the U.S. District Court for theNorthern District of California, a jury trial was conducted during the second quarter of 2005. Thejury reached a verdict that the patent was infringed, but that the asserted claims of the patentwere invalid. We filed a post-trial motion for a new trial and for judgment as a matter of law inour favor. ASML also filed a motion for judgment as a matter of law seeking to invalidate three ofthe asserted claims for lack of enablement and requested that the Court award costs. On February13, 2006, the Court denied our post-trial motions, including the motion for a new trial, andentered judgment in favor of ASML invalidating three claims of the patent for lack of enablement.The Court also awarded ASML approximately $330,000 in costs. We filed an appeal with the FederalCircuit Court of Appeals, and filed our opening appellate brief on August 31, 2006. Although ASMLoriginally filed a notice of cross-appeal, ASML subsequently withdrew its cross appeal and theCourt entered an order to that effect on December 8, 2006. ASML’s opening appellate brief was filedon December 6, 2006, and our reply brief was filed on January 12, 2007. The case was argued on May11, 2007. On May 14, 2007, the Federal Circuit Court of Appeals affirmed the jury’s verdict and theDistrict Court’s February 13, 2006 Order in favor of ASML.On July 11, 2003, we filed a lawsuit against a Southern California company asserting infringementof certain claims related to U.S. patent No. 5,621,813 in the U.S. District Court in and for theNorthern District of California. On May 17, 2005, the court found the subject patent to be invalid.We appealed this decision. The defendant subsequently brought a motion for reimbursement of itsattorneys’ fees and costs in a total asserted amount of approximately $2 million. We opposed thismotion, and on October 12, 2005, the District Court denied the defendant’s request for attorneys’fees in its entirety. The defendant appealed that decision. On November 3, 2005, the defendantfiled a notice of appeal with respect to the court’s ruling on its motion for attorneys’ fees. InMarch 2006, the Federal Circuit court upheld the district court’s ruling that the subject patent isinvalid. On August 8, 2006, the Federal Circuit court upheld the District Court’s denial ofattorneys’ fees. Neither side appealed the rulings by the Federal Circuit, and they are final.In May 2006, the same company filed a state court lawsuit against us for malicious prosecution andabuse of process claiming that attorney’s fees, costs and other damages were due based on theoutcome of a federal patent litigation suit described above. We do not believe this new action hasmerit, particularly given the denial by the federal court of that company’s request to be awardedattorneys’ fees payable by us in the patent litigation and the subsequent federal appellate court’saffirmation of the order denying any such award. We filed a motion to have the state courtcomplaint dismissed under California’s anti-strategic lawsuit against public participation, oranti-SLAPP, and demurrer statutes. The anti-SLAPP statute is aimed at striking lawsuits that arebrought in order to quash an individual’s constitutional rights to free speech or seeking redressof grievances (i.e. filing suit). The state court granted the anti-SLAPP motion as to the abuse ofprocess claim, but denied it as to the malicious prosecution claim. We have appealed the decisiondenying the anti-SLAPP motion as to the malicious prosecution claim, and briefing thereon shallcommence in October 2007.On March 7, 2007, a stockholder filed a stockholder derivative lawsuit against us and certain ofour current and former directors, officers and employees in the U.S. District Court for theNorthern District of California. The lawsuit asserted claims for violations of federal and statesecurities laws and for breach of fiduciary duty, unjust enrichment and other claims related to thealleged backdating of stock option grants between 1996 and 2003. On May 11, 2007, this lawsuit wasconsolidated with an essentially identical action filed by another stockholder, also in theNorthern District of California. The lawsuits were voluntarily dismissed by the plaintiffs withoutprejudice by a stipulation and order entered by the Court on June 11, 2007.**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**Certain of the statements contained herein, which are not historical facts and which can generallybe identified by words such as “anticipates”, “expects”, “intends”, “will”, “could”, “believes”,“estimates”, “continue”, and similar expressions, are forward-looking statements under Section 27Aof the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended, that involve risks and uncertainties, such as risks related to our dependence on newproduct introductions and market acceptance of new products and enhanced versions of our existingproducts; lengthy sales cycles, including the timing of system installations and acceptances;lengthy and costly development cycles for laser-processing and lithography technologies andapplications; integration, development and associated expenses of the laser processing operation;delays, deferrals and cancellations of orders by customers; cyclicality in the semiconductor andnanotechnology industries; pricing pressures and product discounts; high degree of industrycompetition; intellectual property matters; expiration of licensing arrangements, and the resultingadverse impact on our licensing revenues; changes to financial accounting standards; changes inpricing by us, our competitors or suppliers; customer concentration; international sales; timing ofnew product announcements and releases by us or our competitors; ability to volume produce systemsand meet customer requirements; sole or limited sources of supply; ability and resulting costs toattract or retain
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sufficient personnel to achieve our targets for a particular period; dilutiveeffect of employee stock option grants on net income per share, which is largely dependent upon usachieving and maintaining profitability and the market price of our stock; mix of products sold;rapid technological change and the importance of timely product introductions; outcome oflitigation; manufacturing variances and production levels; timing and degree of success oftechnologies licensed to outside parties; product concentration and lack of product revenuediversification; inventory obsolescence; asset impairment; effects of certain anti-takeoverprovisions; announced and future acquisitions; volatility of stock price; foreign governmentregulations and restrictions; business interruptions due to natural disasters or utility failures;environmental regulations; and any adverse effects of terrorist attacks in the United States orelsewhere, or government responses thereto, or military actions in Iraq, Afghanistan, North Koeraand elsewhere, on the economy in general, or on our business in particular. Due to these andadditional factors, the statements, historical results and percentage relationships set forth beloware not necessarily indicative of the results of operations for any future period. Theseforward-looking statements are based on management’s current beliefs and expectations, some or allof which may prove to be inaccurate, and which may change. We undertake no obligation to revise orupdate any forward-looking statements to reflect any event or circumstance that may arise after thedate of this report.**OVERVIEW**We develop, manufacture and market photolithography and laser thermal processing equipment formanufacturers of integrated circuits and nanotechnology components located throughout NorthAmerica, Europe, Japan, Taiwan and the rest of Asia.We supply step-and-repeat photolithography systems based on one-to-one imaging technology. Withinthe integrated circuits industry, we target the market for advanced packaging applications. Withinthe nanotechnology industry, our target markets include thin film head magnetic recording devices,ink jet print heads, laser diodes and light emitting diodes (LEDs). Our laser thermal processingequipment is targeted at advanced annealing applications within the semiconductor industry.**RESULTS OF OPERATIONS**We derive a substantial portion of our total net sales from sales of a relatively small number ofnewly manufactured systems, which typically range in price from $1.2 million to $5.6 million. As aresult of these high sale prices, the timing and recognition of revenue from a single transactionhas had and most likely will continue to have a significant impact on our net sales and operatingresults for any particular period.Our backlog at the beginning of a period typically does not include all of the sales needed toachieve our sales objectives for that period. In addition, orders in backlog are subject tocancellation, shipment or customer acceptance delays, and deferral or rescheduling by a customerwith limited or no penalties. Consequently, our net sales and operating results for a period have dependedand will continue to depend on our obtaining orders for systems to be shipped and accepted in thesame period in which the order is received. Our business and financial results for a particularperiod could be materially adversely affected if an anticipated order for even one system is notreceived in time to permit shipment and customer acceptance during that period. Furthermore, asubstantial portion of our shipments have historically occurred near the end of the quarter. Delaysin installation and customer acceptance due, for example, to our inability to successfullydemonstrate the agreed-upon specifications or criteria at the customer’s facility, or to thefailure of the customer to permit installation of the system in the agreed upon timeframe, maycause net sales in a particular period to fall significantly below our expectations, which maymaterially and adversely affect our operating results for that period. This risk is especiallyapplicable to the introduction and initial sales of a new product line. Additionally, the failureto receive anticipated orders or delays in shipments due, for example, to rescheduling, delays,deferrals or cancellations by customers, additional customer configuration requirements, or tounexpected manufacturing difficulties or delays in deliveries by suppliers due to their longproduction lead times or otherwise, have caused and may continue to cause net sales in a particularperiod to fall significantly below our expectations, materially adversely affecting our operatingresults for that period. In particular, the long manufacturing and acceptance cycles of ouradvanced packaging family of wafer steppers and laser thermal processing systems and the long leadtime for lenses and other materials, could cause shipments and acceptances of such products to bedelayed from one quarter to the next, which could materially adversely affect our financialcondition and results of operations for a particular quarter.Additionally, the need for continued expenditures for research and development, capital equipment,ongoing training and worldwide customer service and support, among other factors, will make itdifficult for us to reduce our operating expenses in a particular period if we fail to achieve ournet sales goals for the period.
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**Net Sales***Second Quarter*                   **Three Months Ended**         **June 30,**  **July 1,**  **Amount of**  **Percentage** **(In millions)** **2007**  **2006**  **Change**  **Change** Sales of:                Products $26.3  $22.3  $4.0   18%Services  3.6   3.6   0.0   0%Licenses  0.1   0.1   0.0   0%              Total net sales $30.0  $26.0  $4.0   15%              Net sales consist of revenues from products (system sales, spare parts sales and upgrades),services and licensing of technologies. Product sales increased 18% to $26.3 million, compared to$22.3 million in the corresponding quarter of 2006, primarily due to a system unit volume increaseof 12.5% and an increase in average selling prices of 7.7%, resulting from a continuing shift inproduct mix in favor of our new laser processing products and away from our legacy platformproducts.On a product market application basis, system sales to the semiconductor industry, primarily foradvanced packaging and laser processing applications, were $16.2 million for the quarter ended June30, 2007, an increase of 13.6% when compared with system sales of $14.2 million to this market inthe corresponding quarter of 2006. This increase was due to a $3.7 million increase in sales to thelaser processing markets offset by a decrease of $1.7 million to the advanced packaging markets.System sales to the nanotechnology market were $5.6 million for the quarter ended June 30, 2007, anincrease of 50.0% compared with sales of $3.7 million in the corresponding quarter of 2006. Systemsales to the nanotechnology market are highly dependent oncustomer capacity demand in the industries we serve, including thin film heads, automotive MEMS,LED/laser diodes, and ink jet print heads.Revenues from services and licensing activities for the second quarter of 2007 remained at the samelevel as the corresponding quarter of 2006, at $3.6 million and $0.1 million, respectively. Futurerevenues from licensing activities, if any, will be contingent upon existing and future licensingand royalty arrangements. We may not be successful in generating licensing revenues in the futureand do not anticipate the recognition of significant levels of licensing income during theremainder of 2007.At June 30, 2007, we had approximately $6.2 million of deferred product and services incomecompared to $3.0 million at December 31, 2006. Deferred product income is recognized as revenueupon satisfying the contractual obligations for installation and/or customer acceptance. Deferredservices income is recognized as revenue ratably over the contract period or as purchased servicesare rendered.For the quarter ended June 30, 2007, international net sales were $18.1 million, or 60.2% of totalnet sales, compared with $17.1  million, or 65.7% of total net sales for the second quarter of 2006.We expect sales to international customers will continue to represent a significant majority of ourrevenues during the remainder of 2007. Our revenue derived from sales in foreign countries is notgenerally subject to significant exchange rate fluctuations, principally because sales contractsfor our systems are generally denominated in U.S. dollars. In Japan, however, orders are oftendenominated in Japanese yen. This subjects us to the risk of currency fluctuations. We attempt tomitigate this risk by entering into foreign currency forward exchange contracts for the periodbetween when an order is received and when it is recorded as revenue. After recording revenue, weuse various mechanisms, such as foreign currency forward exchange contracts and natural hedges, tooffset substantial portions of the gains or losses associated with our Japanese yen denominatedreceivables due to exchange rate fluctuations. We had approximately $4.0 million of Japanese yendenominated receivables at June 30, 2007. International sales expose us to a number of additionalrisks, including fluctuations in the value of local currencies relative to the U.S. dollar, whichimpact the relative cost of ownership of our products and, thus, the customer’s willingness topurchase our product. (See “Item 1A Risk Factors: International Sales”).
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*Year-To-Date*                   **Six Months Ended**         **June 30,**  **July 1,**  **Amount of**  **Percentage** **(In millions)** **2007**  **2006**  **Change**  **Change** Sales of:                Products $49.8  $53.8  $(4.0)  -7%Services  7.5   7.1   0.4   6%Licenses  0.1   0.1   0.0   0%              Total net sales $57.4  $61.0  $(3.6)  -6%              Product sales decreased 7% to $49.8 million for the six months ended June 30, 2007 as compared tothe same period in 2006. The decrease was primarily attributable to a system unit volume decreaseof 15.8% partially offset by a 7.5% increase in the average selling prices of systems sold. Theincrease in average selling prices was primarily the result of a shift in product mix in favor ofour new laser processing products and away from our legacy product platforms. On a market segmentbasis, the year-over-year decrease in systems sales was primarily attributable to a $14.5 milliondecline in sales to the packaging market, which was offset partially by an $8.3 million and $1.3million increase in sales to the laser thermal processing market and nanotechnology market,respectively.Revenues from services in the first six months of 2007 increased 6% from the comparable period of2006, primarily as a result of increases in service contracts. Revenues from licensing activitiesremained the same in the first six months of 2007 as compared to the same period of 2006. Futurerevenues from licensing activities, if any, will be contingent upon existing and future licensingand royalty arrangements. We may not be successful in generating licensing revenues in the futureand do not anticipate the recognition of significant levels of licensing income during theremainder of 2007.For the first six months of 2007, international net sales were $37.3 million, or 68.0% of total netsales, as compared with $37.3 million, or 61.2% of total net sales, for the comparable period of2006. For the first six months of 2007, as compared to the same period of 2006, sales to Europeincreased  $6.8 million, sales to Japan increased $13.6 million, sales to Taiwan decreased $6.6million and sales to the rest of Asia declined $12.1 million.**Gross Profit**On a comparative basis, gross margins were 43.9% and 45.4% for the second quarter of 2007 and 2006,respectively. This decrease in percentage was primarily due to difference in product mix and highermanufacturing overhead costs resulting from lower plant utilization during the first six months of2007 compared to the corresponding period in 2006. These higher manufacturing overhead costs werepartially offset by our continuing effort to reduce company-wide expenses since the fourth quarterof 2006 and lower warranty and installation costs related to our laser spike annealing systemscompared to the corresponding quarter of 2006 as we became more efficient since the introduction ofour laser spike annealing systems to the market in December 2005. Gross margins remained at 41.8%for each of the six-month periods ended June 30, 2007 and July 1, 2006.Our gross profit as a percentage of sales has been and most likely will continue to besignificantly affected by a variety of factors, including the following: the introduction of newproducts, which typically have higher manufacturing costs until manufacturing efficiencies arerealized and which are typically discounted more than existing products until the products gainmarket acceptance; the mix of products sold; the rate of capacity utilization; write-down ofinventory and open purchase commitments; product discounts, pricing and competition in our targetedmarkets; non-linearity of shipments during the quarter which can result in manufacturinginefficiencies; and the percentage of international sales, which typically have lower gross marginsthan domestic sales principally due to higher field service and support costs.
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**Operating Expenses***Second Quarter*                   **Three Months Ended**         **June 30,**  **July 1,**  **Amount of**  **Percentage** **(In millions)** **2007**  **2006**  **Change**  **Change** Research, development, and engineering $5.8  $6.4  $(0.6)  -9%Selling, general, and administrative  7.6   8.3   (0.7)  -8%              Total operating expenses $13.4  $14.7  $(1.3)  -9%              Research, development and engineering expenses for the second quarter of 2007 were$5.8 million, ascompared to $6.4 million for the same period in 2006. The decrease was primarily due to lowersalaries and benefits expenses of $0.7 million resulting from workforce reductions from ourcontinuing effort to reduce company-wide expense since the fourth quarter of 2006. This reductionwas offset in part by an increase of $0.1 million for the development of the laser spike annealsystem used for 65nm and other next-generation devices.Selling, general, and administrative expenses were $7.6 million for the second quarter of 2007, ascompared with $8.3 million for the same quarter of 2006. As a percentage of net sales, selling,general, and administrative expenses decreased to 25.2% in the quarter ended June 30, 2007,compared to 32.0% in the same quarter of 2006. This decrease was primarily due to our continuingeffort to reduce company-wide expenses of $0.3 million, no accrual for the management incentive plan as compared to an accrual of$0.2 million in the second quarter of 2006, and lower salaries and benefits expenses of $0.7 million resulting from workforcereductions discussed above, which was partially offset by severance and benefit charges of $0.5million recorded during the second quarter of 2007.*Year-To-Date*                   **Six Months Ended**         **June 30,**  **July 1,**  **Amount of**  **Percentage** **(In millions)** **2007**  **2006**  **Change**  **Change** Research, development, and engineering $11.8  $12.5  $(0.7)  -6%Selling, general, and administrative  16.9   15.6   1.3   8%              Total operating expenses $28.7  $28.1  $0.6   2%              Research, development and engineering expenses for the first six months of 2007 were $11.8 millionas compared to $12.5 million for the same period in 2006. The year-to-date decrease was primarilythe result of workforce reductions and our continuing effort to reduce company-wide expenses.Selling, general, and administrative expenses were $16.9 million for the first six months of 2007as compared with $15.6 million for the same period in 2006. As a percentage of net sales, selling,general, and administrative expenses increased to 29.4% in the six months ended June 30, 2007 ascompared to 25.6% for the same period in 2006. This increase, in dollar terms, was primarily due toincrease in customer service expenses of $0.5 million for customer support services provided duringthe first half of 2007 in connection with our laser spike annealing systems, additionalaccounting-related fees of $0.5 million and legal fees of $0.3 million, and increases in severanceand benefit charges of $0.9 million, which were offset partially by the reduction in salaries andbenefits expenses of $0.5 million in connection with  workforce reductions and no accrual for themanagement incentive plan as compared to an accrual of $0.4 million for the first six months of 2006.**Interest and Other Income, Net**Interest and other income, net, which consists primarily of interest income, was $1.4 million and$3.1 million for the three and six months ended 2007 as compared with $1.7 million and $3.2 millionfor the comparable periods of 2006, respectively. This decrease was primarily attributable to lowerinterest income due to lower cash and investment balances during the second quarter and first halfof 2007 compared to the same periods of 2006. As of June 30, 2007, the weighted-average maturity ofour investment portfolio was approximately 1.0 year. As a result, changes in short-term interestrates have had, and will continue to have, a significant impact on our interest income.**Provision (Benefit) for Income Taxes**For the three- and six-month periods ended June 30, 2007, we recorded an income tax provision of$67,000 and $182,000, respectively, as compared to an income tax benefit of $28,000 and an incometax provision of $102,000 for the comparable periods in
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2006. The income tax provision recognizedfor the six months ended June 30, 2007 and July 1, 2006 resulted primarily from foreign incometaxes and the U.S. federal alternative minimum tax.Income tax estimates can be affected by whether and within which jurisdictions future earnings willoccur and how and when cash is repatriated to the United States, as well as other aspects of anoverall income tax strategy. Additionally, taxing jurisdictions could retroactively disagree withour tax treatment of certain items, and some historical transactions have income tax effects goingforward. Accounting rules require these future effects to be evaluated using current laws, rulesand regulations, each of which can change at any time and in an unpredictable manner. We believe wehave adequately provided for any reasonably foreseeable outcome related to these matters, and we donot anticipate any material earnings impact from their ultimate resolution.Each quarter we assess the likelihood that we will be able to recover our deferred tax assets. Weconsider all available evidence, both positive and negative, including historical levels of income,expectations and risks associated with estimates of future taxable income and ongoing prudent andfeasible tax planning strategies in assessing the need for the valuation allowance. As a result ofour analysis of all available evidence, we concluded that it is more likely than not that our netdeferred tax assets will not be realized, with the exception of the Japan, Taiwan and certain Texasdeferred tax assets which we do expect to realize and which have been recorded in the accounts.Therefore, we continue to provide a full valuation allowance against net deferred tax assetsoutside of Japan, Taiwan and Texas. We closely monitor all available evidence, and may release someor all of the valuation allowance in future periods.In accordance with the adoption of FASB Financial Interpretation Number (FIN) 48, *Accounting forUncertainty in Income Taxes*(FIN 48) effective January 1, 2007, we have unrecognized tax benefitsof $2.8 million as of January 1, 2007. We continue to recognize interest and penalties as acomponent of income tax expense and have accrued $55,000 for these items as of January 1, 2007. Theimplementation of FIN 48 resulted in a decrease of $20,000 to the liability for uncertain taxpositions and a decrease to accumulated deficit of $27,000. All other adjustments required uponadoption of FIN 48 were to the deferred tax accounts with an offsetting adjustment to the valuationallowance.If we are able to eventually recognize these uncertain tax positions, $2.5 million of theunrecognized benefit would reduce the effective tax rate. We currently have a full valuationallowance against our U.S. net deferred tax asset which would impact the timingof the effective tax rate benefit should any of these uncertain tax positions be favorably settledin the future. We anticipate an increase to the unrecognized tax benefits during fiscal 2007applicable to research and development tax credits and foreign tax exposures. While the increasecannot be estimated at this time, the change is not expected to be material to the fiscal 2007financial statements.We are subject to federal and state tax examination for years 1999 forward and 1997 forward,respectively, by virtue of the tax attributes carrying forward from those years. We are alsosubject to audits in the foreign jurisdictions in which we operate for years 2000 and forward.There are no tax examinations currently in progress.**Outlook**The anticipated timing of orders, shipments and customer acceptances usually requires that we filla number of production slots in any given quarter in order to meet our sales targets. If we areunsuccessful in our efforts to secure those production orders, or if existing production orders aredelayed or cancelled, our results of operations will be materially adversely impacted. Accordingly,we may not be able to achieve or maintain our current or prior level of sales. We presently expectnet sales for the third quarter of 2007 to be slightly less than the net sales reported in secondquarter of 2007. For the full year of 2007, we believe total net sales will be about the same as the amount reported for 2006.Because our net sales are subject to a number of risks, including risks associated with the marketacceptance of our new laser processing product line, delays in customer acceptance, intensecompetition in the capital equipment industry, uncertainty relating to the timing and marketacceptance of our products, and the condition of the macro-economy and the semiconductor industryand the other risks described in this report and in our Annual Report on Form 10-K for the yearended December 31, 2006, we may not exceed or even maintain our current or prior level of net salesfor any period in the future. Additionally, we believe that the market acceptance and volumeproduction of our advanced packaging systems, laser processing systems and our 1000 Platformsteppers are of critical importance to our future financial results. At June 30, 2007, thesecritical systems represented approximately 82.6% of our backlog. To the extent that these productsdo not achieve or maintain significant sales due to difficulties involving manufacturing orengineering, the inability to reduce the current long manufacturing cycles for these products,competition, excess capacity in the semiconductor or nanotechnology device industries, or for anyother reason, our business, financial condition and results of operations would be materiallyadversely affected.We believe that gross margin for the third quarter of 2007 will be about the same as for thesecond quarter of 2007. However, gross margin for the full year of 2007 is expected to improve compared to 2006.The final gross margin achieved in any quarter will depend heavily
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upon sales volumes and theresulting product mix. Should our sales not reach the level expected, we may incur a higher risk ofinventory obsolescence and excess purchase commitments and lower utilization of our manufacturinginfrastructure, which would materially adversely impact our results of operations. New productsgenerally have lower gross margins until there is widespread market acceptance and until productionand after-sales efficiencies can be achieved. Should significant market demand fail to develop forour laser processing systems and our new advanced packaging offerings, our business, financialcondition and results of operations would be materially adversely affected. In addition, highercosts associated with extended manufacturing and customer acceptance periods on shipments of ourlaser processing products have had, and will continue to have, an adverse impact on our grossmargins. As our company-wide cost cutting initiatives take full effect, we anticipate operatingexpenses for the full year of 2007 will be a few million dollars less than the amount in 2006. For the full year of2007, we believe our operating cash flow will continue to be positive.**LIQUIDITY AND CAPITAL RESOURCES**Net cash provided by operating activities was $1.8 million for the six months ended June 30, 2007,compared with net cash provided by operating activities of $0.9 million for the comparable periodin 2006. Net cash provided by operating activities during the first six months of 2007 wasprimarily attributable to a decrease in deferred product and services income of $3.3 million, adecrease in inventories of $2.2 million and adjustments of non-cash charges of $4.4 million to netloss, principally for depreciation, amortization and stock-based compensation, which was partiallyoffset by a net loss of $2.2 million for the first half of 2007 and increases in accountsreceivable of $1.8 million, accounts payable of $3.4 million and other liabilities of $1.3 million.We believe that because of the relatively long manufacturing cycle of certain of our systems,particularly newer products, our inventories will continue to represent a significant and growingportion of working capital. Currently, we are devoting significant resources to the development,introduction and commercialization of our laser processing system and to the development of ournext generation 1X lithography technologies. Additionally, gross profit margins, inventory andcapital equipment levels may be adversely impacted in the future by costs associated with theproduction of the laser processing system and by future generations of our 1X wafer steppers. Thesecosts include, but are not limited to, additional manufacturing overhead, costs of demonstrationsystems and facilities and the establishment of additional after-sales support organizations.Additionally, there can be no assurance that operatingexpenses will not increase, relative to sales, as a result of adding technical, marketing andadministrative personnel, among other costs, to support our new products. If we are unable toachieve significantly increased net sales or if our sales fall below expectations, our cash flowand operating results will be materially adversely affected until, among other factors, costs andexpenses can be reduced. Our failure to achieve our sales targets for these new products couldresult in additional inventory write-offs and asset impairment charges, either or both of whichcould materially adversely impact our results of operations.During the first six months of 2007, net cash provided by investing activities was $7.4 million,attributable to net proceeds from the sale and maturity of short and long-term investments of $7.8million, offset by capital expenditures of $0.4 million.Net cash provided by financing activities was $3.7 million during the first six months of 2007,attributable to net proceeds under our notes payable of $2.7 million and $1.0 million of proceedsreceived from the issuance of common stock under our employee stock option plans.At June 30, 2007, we had working capital of $120.7 million and long-term investments of $34.0million. Our principal sources of liquidity at June 30, 2007 consisted of $86.7 million in cash,cash equivalents and short-term investments, net of outstanding borrowings under our line ofcredit, and $34.0 million of long-term investments. We have a line of credit agreement with abrokerage firm. Under the terms of this agreement, we may borrow funds at a cost equal to thecurrent Federal funds open rate plus 100 basis points (approximately 6.25% as of June 30, 2007).Certain of our cash, cash equivalents and marketable securities secure borrowings outstanding underthis facility, but we are not restricted in the use of those assets. Funds are advanced to us underthis facility in accordance with pre-determined advance rates based on the cash and securities heldby us in this brokerage account. This agreement has no set expiration date and there are no loancovenants other than a collateral requirement. As of June 30, 2007, $9.7 million was outstandingunder this facility, with a related collateral requirement of approximately $12.9 million of ourcash, cash equivalents and investments.In September 2005, our Board of Directors authorized the repurchase of up to $30.0 million of ourcommon stock in the open market at then prevailing market prices during the period from September2005 through September 2007. We did not repurchase any shares of our common stock during the six monthsended June 30, 2007. Through June 30, 2007, we had repurchased 1.4 million shares of our commonstock at a total purchase price of $20.0 million. Any future repurchase of stock could have asignificant impact on our cash position.
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The development and manufacture of new lithography and laser-based systems and enhancements arehighly capital-intensive. In order to be competitive, we believe we must continue to makesignificant expenditures for capital equipment; sales, service, training and support capabilities;systems, procedures and controls; and expansion of operations and research and development, amongmany other items. We expect that cash generated from operations and our cash, cash equivalents andshort-term investments will be sufficient to meet our cash requirements for at least the nexttwelve months. However, in the near-term, we may continue to utilize existing and future lines ofcredit, and other sources of financing, in order to maintain our present levels of cash, cashequivalents and investments. Beyond the next twelve months, we may require additional equity ordebt financing to address our working capital or capital equipment needs. In addition, we may seekto raise equity or debt capital at any time that we deem market conditions to be favorable.Additional financing, if needed, may not be available on reasonable terms, or at all.We may in the future pursue acquisitions of complementary product lines, technologies orbusinesses. Future acquisitions may result in potentially dilutive issuances of equity securities,the incurrence of debt and contingent liabilities and amortization expenses and impairment chargesrelated to goodwill and other intangible assets, which could materially adversely affect ourfinancial condition and results of operations. In addition, acquisitions involve numerous risks,including difficulties in the assimilation of the operations, technologies, personnel and productsof the acquired companies; the diversion of management’s attention from other business concerns;risks of entering markets in which we have limited or no direct experience; and the potential lossof key employees of the acquired company. In the event we acquire product lines, technologies orbusinesses which do not complement our business, or which otherwise do not enhance our sales oroperating results, we may incur substantial write-offs and higher recurring operating costs, whichcould have a material adverse effect on our business, financial condition and results ofoperations. In the event that any such acquisition does occur, there can be no assurance as to theeffect thereof on our business or operating results.**Foreign Currency**As part of our overall strategy to manage the level of exposure to the risk of foreign currencyexchange rate fluctuations, we attempt to hedge most of our Japanese yen denominated foreigncurrency exposures. We use foreign currency forward contracts to hedge the risk that outstandingJapanese yen denominated receipts from customers, for actual or forecasted sales of equipment afterreceipt ofcustomer orders, may be adversely affected by changes in foreign currency exchange rates. We useforeign currency forward exchange contracts and natural hedges to offset substantial portions ofthe potential gains or losses associated with our Japanese yen denominated assets and liabilitiesdue to exchange rate fluctuations. We enter into foreign currency forward contracts that generallyhave maturities of nine months or less.**Information Available on Company Website**Our website is located at *www.ultratech.com*. We make available, free of charge through our website,our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K (andamendments to those reports), as soon as reasonably practicable after such reports are filedelectronically with the SEC. We have adopted a Code of Ethics for our principal executive officer,principal financial officer, principal accounting officer or controller, or persons performingsimilar functions. We have posted this Code of Ethics on our website. Any future amendments to thisCode will also be posted on our website.**Item 3. Quantitative and Qualitative Disclosures about Market Risk**Reference is made to Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk”in our Annual Report on Form 10-K for the year ended December 31, 2006 and to the subheading“Derivative Instruments and Hedging” in Item 8, “Financial Statements and Supplementary Data”,under the heading “Notes to Consolidated Financial Statements” of our Annual Report on Form 10-Kfor the year ended December 31, 2006.**Interest Rate Risk**Our exposure to market risk due to potential changes in interest rates relates primarily to ourinvestment portfolio, which consisted primarily of fixed interest rate instruments as of June 30,2007. We maintain an investment policy designed to ensure the safety and preservation of ourinvested funds by limiting market risk and the risk of default.Certain of our cash, cash equivalents and short and long-term investments serve as collateral for aline of credit we maintain with a brokerage firm. The line of credit is used for liquiditypurposes, mitigating the need to liquidate investments in order to meet our current operating cashrequirements.
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**Foreign Currency Risk Management**The majority of our revenue, expense and capital purchasing activities are transacted in U.S.dollars. However, we do enter into these transactions in other currencies, primarily Japanese yen.To protect against reductions in value and the volatility of future cash flows caused by changes incurrency exchange rates, we have established cash flow and balance sheet hedging programs.We use foreign currency forward contracts to hedge the risk that outstanding Japanese yendenominated receipts from customers for actual or forecasted sales of equipment may be adverselyaffected by changes in foreign currency exchange rates. Our hedging programs reduce, but do notalways entirely eliminate, the impact of currency movements.**Item 4. Controls and Procedures**We conducted an evaluation of the effectiveness of the design and operation of our disclosurecontrols and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities ExchangeAct of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report(the “Evaluation Date”). Based upon the evaluation, our principal executive officer and principalfinancial officer concluded that, as of the Evaluation Date, our disclosure controls and procedureswere effective and ensure that information required to be disclosed by us in reports that we fileor submit under the Exchange Act is recorded, processed, summarized and reported within the timeperiods specified in Securities and Exchange Commission rules and forms. Disclosure controls andprocedures are controls and other procedures that are designed to ensure that information requiredto be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosurecontrols and procedures include, without limitation, controls and procedures designed to ensurethat information required to be disclosed in our reports filed or submitted under the Exchange Actis accumulated and communicated to management to allow timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures, our managementrecognizes that any controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectives. Management isfurther required to apply judgment in evaluating the cost-benefit relationship of possible controlsand procedures.**Changes in Internal Control Over Financial Reporting**There were no changes in our internal control over financial reporting during the quarter endedJune 30, 2007 that have materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.**PART II. OTHER INFORMATION****Item 1. Legal Proceedings**On February 29, 2000, we filed lawsuits asserting patent infringement and related claims againstNikon, Canon and ASML in the U.S. District Court for the Eastern District of Virginia. In April2000, we reached a settlement with Nikon, and in September 2001, we reached a settlement withCanon. In the patent litigation against ASML, after transfer to the U.S. District Court for theNorthern District of California, a jury trial was conducted during the second quarter of 2005. Thejury reached a verdict that the patent was infringed, but that the asserted claims of the patentwere invalid. We filed a post-trial motion for a new trial and for judgment as a matter of law inour favor. ASML also filed a motion for judgment as a matter of law seeking to invalidate three ofthe asserted claims for lack of enablement and requested that the Court award costs. On February13, 2006, the Court denied our post-trial motions, including the motion for a new trial, andentered judgment in favor of ASML invalidating three claims of the patent for lack of enablement.The Court also awarded ASML approximately $330,000 in costs. We filed an appeal with the FederalCircuit Court of Appeals, and filed our opening appellate brief on August 31, 2006. Although ASMLoriginally filed a notice of cross-appeal, ASML subsequently withdrew its cross appeal and theCourt entered an order to that effect on December 8, 2006. ASML’s opening appellate brief was filedon December 6, 2006, and our reply brief was filed on January 12, 2007. The case was argued on May11, 2007. On May 14, 2007, the Federal Circuit Court of Appeals affirmed the jury’s verdict and theDistrict Court’s February 13, 2006 Order in favor of ASML.On July 11, 2003, we filed a lawsuit against a Southern California company asserting infringementof certain claims related to U.S. patent No. 5,621,813 in the U.S. District Court in and for theNorthern District of California. On May 17, 2005, the court found the subject patent to be invalid.We appealed this decision. The defendant subsequently brought a motion for reimbursement of its
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attorneys’ fees and costs in a total asserted amount of approximately $2 million. We opposed thismotion, and on October 12, 2005, the District Court denied the defendant’s request for attorneys’fees in its entirety. The defendant appealed that decision. On November 3, 2005, the defendantfiled a notice of appeal with respect to the court’s ruling on its motion for attorneys’ fees. InMarch 2006, the Federal Circuit court upheld the district court’s ruling that the subject patent isinvalid. On August 8, 2006, the Federal Circuit court upheld the District Court’s denial ofattorneys’ fees. Neither side appealed the rulings by the Federal Circuit, and they are final.In May 2006, the same company filed a state court lawsuit against us for malicious prosecution andabuse of process claiming that attorney’s fees, costs and other damages were due based on theoutcome of a federal patent litigation suit described above. We do not believe this new action hasmerit, particularly given the denial by the federal court of that company’s request to be awardedattorneys’ fees payable by us in the patent litigation and the subsequent federal appellate court’saffirmation of the order denying any such award. We filed a motion to have the state courtcomplaint dismissed under California’s anti-strategic lawsuit against public participation, oranti-SLAPP, and demurrer statutes. The anti-SLAPP statute is aimed at striking lawsuits that arebrought in order to quash an individual’s constitutional rights to free speech or seeking redressof grievances (i.e. filing suit). The state court granted the anti-SLAPP motion as to the abuse ofprocess claim, but denied it as to the malicious prosecution claim. We have appealed the decisiondenying the anti-SLAPP motion as to the malicious prosecution claim, and briefing thereon shallcommence in October 2007.On March 7, 2007, a stockholder filed a stockholder derivative lawsuit against us and certain ofour current and former directors, officers and employees in the U.S. District Court for theNorthern District of California. The lawsuit asserted claims for violations of federal and statesecurities laws and for breach of fiduciary duty, unjust enrichment and other claims related to thealleged backdating of stock option grants between 1996 and 2003. On May 11, 2007, this lawsuit wasconsolidated with an essentially identical action filed by another stockholder, also in theNorthern District of California. The lawsuits were voluntarily dismissed by the plaintiffs withoutprejudice by a stipulation and order entered by the Court on June 11, 2007.**Item 1A. Risk Factors***In addition to risks described in the foregoing discussions, the following risks apply to ourbusiness and us*:**We currently spend, and expect to continue to spend, significant resources to develop, introduceand commercialize our laser processing systems and AP wafer stepper products, and we may not besuccessful in achieving or increasing sales of these products.**Currently, we are devoting significant resources to the development, introduction andcommercialization of our laser products as well as our lithography wafer steppers. We intend tocontinue to develop these products and technologies during 2007, and will continue to incursignificant operating expenses in the areas of research, development and engineering, manufacturingand general and administrative costs in order to develop, produce and support these new products.Additionally, gross profit margins and inventory levels may be further adversely impacted in thefuture by costs associated with the initial production of our laser processing systems and byfuture generations of our 1X lithography systems. Introduction of new products generally involveshigher installation costs and product performance uncertainties that could delay customeracceptance of our systems, resulting in a delay in recognizing revenue associated with thosesystems and a reduction in gross margins. These costs include, but are not limited to, additionalmanufacturing overhead, additional inventory write-downs, costs of demonstration systems andfacilities, costs associated with the establishment of additional after-sales supportorganizations. Additionally, operating expenses may increase, relative to sales, as a result ofadding additional marketing and administrative personnel, among other costs, to support our newproducts. If we are unable to achieve significantly increased net sales or if our sales fall belowexpectations, our operating results will be materially adversely affected.Our ability to commercialize our laser processing technologies depends on our ability todemonstrate a manufacturing-worthy tool. We do not presently have in-house capability to fabricatedevices. As a result, we must rely on partnering with semiconductor companies to develop the annealprocess. The development of new process technologies is largely dependent upon our ability tointerest potential customers in working on joint process development. Our ability to deliver timelysolutions is also limited by wafer turnaround at the potential customer’s fabrication facility.
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**Our sales cycle is typically lengthy and involves a significant commitment of capital by ourcustomers, which has subjected us, and is likely to continue to subject us, to delays in customeracceptances of our products and other risks, any of which could adversely impact our results ofoperations by, among other things, delaying recognition of revenue with respect to those orders andresulting in increased installation, qualification and similar costs.**Sales of our systems depend, in significant part, upon the decision of a prospective customer toincrease manufacturing capacity or to restructure current manufacturing facilities, either of whichtypically involves a significant commitment of capital. Many of our customers in the past havecancelled the development of new manufacturing facilities and have substantially reduced theircapital equipment budgets. In view of the significant investment involved in a system purchase, wehave experienced and may continue to experience delays following initial qualification of oursystems as a result of delays in a customer’s approval process. Additionally, we are presentlyreceiving orders for systems that have lengthy delivery schedules, which may be due to longerproduction lead times or a result of customers’ capacity scheduling requirements. For these andother reasons, our systems typically have a lengthy sales cycle during which we may expendsubstantial funds and management effort in securing a sale. Lengthy sales cycles subject us to anumber of significant risks, including inventory obsolescence and fluctuations in operatingresults, over which we have little or no control. In order to maintain or exceed our present levelof net sales, we are dependent upon obtaining orders for systems that will ship and be accepted inthe current period. We may not be able to obtain those orders.**The semiconductor industry historically has been highly cyclical and has experienced periods ofoversupply, which has in turn affected the market for semiconductor equipment such as ours andwhich can adversely affect our results of operations during such periods.**Our business depends in significant part upon capital expenditures by manufacturers ofsemiconductors, advanced packaging semiconductors and nanotechnology components which in turndepend upon the current and anticipated market demand for such devices and products utilizing suchdevices. The semiconductor industry historically has been highly cyclical and has experiencedrecurring periods of oversupply. This has, from time to time, resulted in significantly reduceddemand for capital equipment including the systems manufactured and marketed by us. We believe thatmarkets for new generations of semiconductors and semiconductor packaging will also be subject tosimilar fluctuations. Our business and operating results would be materially adversely affected bydownturns or slowdowns in the semiconductor packaging market or by loss of market share.Accordingly, we may not be able to achieve or maintain our current or prior level of sales. Weattempt to mitigate the risk of cyclicality by participating in multiple markets includingsemiconductor, semiconductor packaging, and nanotechnology sectors, as well as diversifying intonew marketssuch as laser-based annealing for implant activation and other applications. Despite such efforts,when one or more of such markets experiences a downturn or a situation of excess capacity, our netsales and operating results are materially adversely affected.**We may not be successful in protecting our intellectual property rights or we could be found tohave infringed the intellectual property rights of others, either of which could weaken ourcompetitive position and adversely affect our results of operations.**Although we attempt to protect our intellectual property rights through patents, copyrights, tradesecrets and other measures, we believe that our success will depend more upon the innovation,technological expertise and marketing abilities of our employees. Nevertheless, we have a policy ofseeking patents when appropriate on inventions resulting from our ongoing research and developmentand manufacturing activities. We own 124 United States and foreign patents, which expire on datesranging from April 2008 to April 2025 and have 83 United States and foreign patent applicationspending. In addition, we have various registered trademarks and copyright registrations coveringmainly software programs used in the operation of our systems. We also rely upon trade secretprotection for our confidential and proprietary information. We may not be able to protect ourtechnology adequately and competitors may be able to develop similar technology independently. Ourpending patent applications may not be issued or U.S. or foreign intellectual property laws may notprotect our intellectual property rights. In addition, litigation may be necessary to enforce ourpatents, copyrights or other intellectual property rights, to protect our trade secrets, todetermine the validity and scope of the proprietary rights of others or to defend against claims ofinfringement. Such litigation has resulted in, and in the future could result in, substantial costsand diversion of resources and could have a material adverse effect on our business, financialcondition and results of operations, regardless of the outcome of the litigation. Patents issued tous may be challenged, invalidated or circumvented and the rights granted thereunder may not providecompetitive advantages to us. Furthermore, others may independently develop similar technology orproducts, or, if patents are issued to us, design around the patents issued to us. Invalidation ofour patents related to those technologies could allow our competitors to more effectively competeagainst us, which could result in less revenue for us.On February 29, 2000, we filed lawsuits asserting patent infringement and related claims againstNikon, Canon and ASML in the U.S. District Court for the Eastern District of Virginia. In April2000, we reached a settlement with Nikon, and in September 2001, we reached a settlement withCanon. In the patent litigation against ASML, after transfer to the U.S. District Court for theNorthern District of California, a jury trial was conducted during the second quarter of 2005. Thejury reached a verdict that the patent was infringed, but that the asserted claims of the patentwere invalid. We filed a post-trial motion for a new trial and for judgment as a matter of law inour favor. ASML also filed a motion for judgment as a matter of law seeking to invalidate three ofthe asserted claims for lack ofenablement and requested that the Court award costs. On February13, 2006, the Court denied our post-trial motions, including the motion for a new trial, andentered judgment in favor of ASML invalidating three claims of the patent for lack of
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enablement.The Court also awarded ASML approximately $330,000 in costs. We filed an appeal with the FederalCircuit Court of Appeals, and filed our opening appellate brief on August 31, 2006. Although ASMLoriginally filed a notice of cross-appeal, ASML subsequently withdrew its cross appeal and theCourt entered an order to that effect on December 8, 2006. ASML’s opening appellate brief was filedon December 6, 2006, and our reply brief was filed on January 12, 2007. The case was argued on May11, 2007. On May 14, 2007, the Federal Circuit Court of Appeals affirmed the jury’s verdict and theDistrict Court’s February 13, 2006 Order in favor of ASML.On July 11, 2003, we filed a lawsuit against a Southern California company asserting infringementof certain claims related to U.S. patent No. 5,621,813 in the U.S. District Court in and for theNorthern District of California. On May 17, 2005, the court found the subject patent to be invalid.We appealed this decision. The defendant subsequently brought a motion for reimbursement of itsattorneys’ fees and costs in a total asserted amount of approximately $2 million. We opposed thismotion, and on October 12, 2005, the District Court denied the defendant’s request for attorneys’fees in its entirety. The defendant appealed that decision. On November 3, 2005, the defendantfiled a notice of appeal with respect to the court’s ruling on its motion for attorneys’ fees. InMarch 2006, the Federal Circuit court upheld the district court’s ruling that the subject patent isinvalid. On August 8, 2006, the Federal Circuit court upheld the District Court’s denial ofattorneys’ fees. Neither side appealed the rulings by the Federal Circuit, and they are final.In May 2006, the same company filed a state court lawsuit against us for malicious prosecution andabuse of process claiming that attorney’s fees, costs and other damages were due based on theoutcome of a federal patent litigation suit described above. We do not believe this new action hasmerit, particularly given the denial by the federal court of that company’s request to be awardedattorneys’ fees payable by us in the patent litigation and the subsequent federal appellate court’saffirmation of the order denying any such award. We filed a motion to have the state courtcomplaint dismissed under California’s anti-anti-SLAPP and demurrer statutes. The anti-SLAPPstatute is aimed at striking lawsuits that are brought in order to quash an individual’sconstitutional rights to free speech or seeking redress of grievances (i.e. filing suit). The statecourt granted the anti-SLAPP motion as to the abuse of process claim, butdenied it as to the malicious prosecution claim. We have appealed the decision denying theanti-SLAPP motion as to the malicious prosecution claim, and briefing thereon shall commence inOctober 2007.We believe that the outcome of these matters will not be material to our business, financialcondition or results of operations.We have from time to time been notified of claims that we may be infringing intellectual propertyrights possessed by third parties. We believe that the outcome of these matters will not bematerial to our business, results of operations or financial condition.Infringement claims by third parties or claims for indemnification resulting from infringementclaims may be asserted in the future and such assertions could materially adversely affect ourbusiness, financial condition and results of operations, regardless of the outcome of anylitigation. With respect to any such future claims, we may seek to obtain a license under the thirdparty’s intellectual property rights. However, a license may not be available on reasonable termsor at all. We could decide, in the alternative, to resort to litigation to challenge such claims.Such challenges could be expensive and time consuming and could materially adversely affect ourbusiness, financial condition and results of operations, regardless of the outcome of anylitigation.**We operate in a highly competitive industry in which customers are required to invest substantialresources in each product, which makes it difficult to achieve significant sales to a particularcustomer once another vendor’s equipment has been purchased by that customer.**The capital equipment industry in which we operate is intensely competitive. A substantialinvestment is required to install and integrate capital equipment into a semiconductor,semiconductor packaging or nanotechnology device production line. We believe that once a devicemanufacturer or packaging subcontractor has selected a particular supplier’s capital equipment, themanufacturer generally relies upon that equipment for the specific production line application and,to the extent possible, subsequent generations of similar products. Accordingly, it is difficult toachieve significant sales to a particular customer once another supplier’s capital equipment hasbeen selected.We experience competition in advanced packaging from various proximity aligner companies such asSuss Microtec AG (Suss Microtec) and projection companies such as Ushio, Inc. (Ushio). In addition,some device manufacturers may consider using reduction steppers for advanced packaging processes.In nanotechnology, we experience competition from proximity aligner companies, such as SussMicrotec, as well as other stepper manufacturers who have developed or are developing toolsspecifically designed for nanotechnology applications. We expect our competitors in the lithographyarena to continue to improve the performance of their current products and to introduce newproducts with improved price and performance characteristics. This could cause a decline in
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salesor loss of market acceptance of our steppers in our served markets, and thereby materiallyadversely affect our business, financial condition and results of operations. Enhancements to, orfuture generations of, competing products may be developed that offer superior cost of ownershipand technical performance features.With respect to our laser annealing technologies, marketed under the LSA100 product name, ourprimary competition comes from companies such as Dainippon Screen Manufacturing Co., Ltd., AppliedMaterials, Inc. and Mattson Technology, Inc. Many of these companies offer products utilizing rapidthermal processing (RTP) which is the current prevailing manufacturing technology. RTP does notprevent semiconductor device manufacturers from scaling the lateral dimensions of their transistorsto obtain improved performance, but diffusion resulting from the time scales associated with RTPlimits the vertical dimension of the junctions. Faster annealing times result in shallower and moreabrupt junctions and faster transistors. We believe that RTP manufacturers recognize the need toreduce thermal cycle times and are working toward this goal. In July 2000, we licensed certainrights to our then existing laser processing technology, with reservations, to a competingmanufacturer of semiconductor equipment. We presently anticipate that this company will offerlaser-annealing tools to the semiconductor industry that will compete with our offerings.Another potential advanced annealing solution utilizes flash lamp annealing technology, or FLA.Several companies have published papers on annealing tools that incorporate flash lamp technologyin order to reduce annealing times and increase anneal temperatures. Developers of FLA technologyclaim to have overcome annealing difficulties at the 65nm node. This technique, which employs xenonflash lamps, has shown improvements over RTP in junction depth and sheet resistance, but we believeFLA suffers from pattern-related non-uniformities and could require additional, costly processes toequalize the reflectivity of different areas within the chip or wafer. Our proprietary laserprocessing solution has been specifically developed to provide junction annealing onnear-instantaneous time-scales, while achieving high activation levels. Laser spike annealing, ourfirst implementation of laser processing, activates dopants in the microsecond-to-millisecond timeframe without melting. Our research indicates that, at temperatures just below the melting point ofsilicon, time durations in the microsecond to millisecond range are required to achieve fullactivation and minimal dopant diffusion.Additionally, competition to our laser processing products may come from other laser annealingtools, including those presently being used by the flat panel display industry to re-crystallizesilicon. Manufacturers of these tools may try to extend the use of their technologies tosemiconductor device applications.We believe that in order to be competitive, we will need to continue to invest significantfinancial resources in new product development, new features and enhancements to existing products,the introduction of new stepper systems in our served markets on a timely basis, and maintainingcustomer service and support centers worldwide. In marketing our products, we may also facecompetition from vendors employing other technologies. In addition, increased competitive pressurehas led to intensified price-based competition in certain of our markets, resulting in lower pricesand margins. Should these competitive trends continue, our business, financial condition andoperating results may be materially adversely affected.**We sell our products primarily to a limited number of customers and to customers in a limitednumber of industries, which subjects us to increased risks related to the business performance ofour customers, and therefore their need for our products, and the business cycles of the marketsinto which we sell.**Historically, we have sold a substantial portion of our systems to a limited number of customers.In the three- and six-month periods ended June 30, 2007, our top five customers accounted for 88.9%and 58.1% of our system sales, respectively, compared to 76.7% and 57.6%, in the comparable periodsof 2006. We expect that sales to a relatively few customers will continue to account for a highpercentage of our net sales in the foreseeable future and believe that our financial results dependin significant part upon the success of these major customers and our ability to meet their futurecapital equipment needs. Although the composition of the group comprising our largest customers mayvary from period to period, the loss of a significant customer or any reduction in orders by asignificant customer, including reductions due to market, economic or competitive conditions in thesemiconductor, semiconductor packaging or nanotechnology industries or in the industries thatmanufacture products utilizing integrated circuits, thin film heads or other nanotechnologycomponents, would likely have a material adverse effect on our business, financial condition andresults of operations. Our ability to maintain or increase our sales in the future depends, inpart, on our ability to obtain orders from new customers as well as the financial condition andsuccess of our existing customers, the semiconductor and nanotechnology industries and the economyin general.In addition to the business risks associated with dependence on a few major customers, thesesignificant customer concentrations have in the past resulted in significant concentrations ofaccounts receivable. These significant and concentrated receivables expose us to additional risks,including the risk of default by one or more customers representing a significant portion of ourtotal receivables. If we
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were required to take additional accounts receivable reserves, ourbusiness, financial condition and results of operations would be materially adversely affected.On a market application basis, sales to the semiconductor industry, primarily for advancedpackaging applications and laser thermal processing, accounted for 74.3% and 79.3% of systemrevenue for the second quarter of 2007 and 2006, respectively, while sales to nanotechnologymanufacturers, including micro systems, thin film head and optical device manufacturers, accountedfor the remaining 25.7% and 20.7% of our systems revenue, respectively. For the first half of 2007,sales to the semiconductor industry and nanotechnology manufacturers accounted for 84.1% and 88.6%,respectively, compared to 15.9% and 11.4% of the corresponding period in 2006. Our future operatingresults and financial condition would be materially adversely impacted by a downturn in any ofthese industries, or by loss of market share in any of these industries. A growing portion of ourbacklog of system orders is comprised of laser spike annealing tools. To date, we have limitedcustomer experience with this technology. Should significant demand not materialize, due totechnical, production, market, or other factors, our business, financial position and results ofoperations would be materially adversely impacted.**We rely on a limited number of outside suppliers and subcontractors to manufacture certaincomponents and subassemblies, and on single or a limited group of outside suppliers for certainmaterials for our products, which could result in a potential inability to obtain an adequatesupply of required components due to the suppliers’ failure or inability to provide such componentsin a timely manner, or at all, and reduced control over pricing and timely delivery of componentsand materials, any of which could adversely affect our results of operations.**Our manufacturing activities consist of assembling and testing components and subassemblies, whichare then integrated into finished systems. We rely on a limited number of outside suppliers andsubcontractors to manufacture certain components and subassemblies. We order one of the mostcritical components of our technology, the glass for our 1X lenses, from external suppliers. Wedesign the1X lenses and provide the lens specifications and the glass to other suppliers, who then grind andpolish the lens elements. We then assemble and test the optical 1X lenses.We procure some of our other critical systems’ components, subassemblies and services from singleoutside suppliers or a limited group of outside suppliers in order to ensure overall quality andtimeliness of delivery. Many of these components and subassemblies have significant production leadtimes. To date, we have been able to obtain adequate services and supplies of components andsubassemblies for our systems in a timely manner. However, disruption or termination of certain ofthese sources could have a significant adverse impact on our ability to manufacture our systems.This, in turn, would have a material adverse effect on our business, financial condition andresults of operations. Our reliance on a sole supplier or a limited group of suppliers and ourreliance on subcontractors involve several risks, including a potential inability to obtain anadequate supply of required components due to the suppliers’ failure or inability to provide suchcomponents in a timely manner, or at all, and reduced control over pricing and timely delivery ofcomponents. Although the timeliness, yield and quality of deliveries to date from oursubcontractors have been acceptable, manufacture of certain of these components and subassembliesis an extremely complex process, and long lead-times are required. Any inability to obtain adequatedeliveries or any other circumstance that would require us to seek alternative sources of supply orto manufacture such components internally could delay our ability to ship our products, which coulddamage relationships with current and prospective customers and have a material adverse effect onour business, financial condition and results of operations.**Our industry is subject to rapid technological change and product innovation, which could result inour technologies and products being replaced by those of our competitors, which would adverselyaffect our business and results of operations.**The semiconductor and nanotechnology manufacturing industries are subject to rapid technologicalchange and new product introductions and enhancements. Our ability to be competitive in these andother markets will depend, in part, upon our ability to develop new and enhanced systems andrelated applications, and to introduce these systems and related applications at competitive pricesand on a timely and cost-effective basis to enable customers to integrate them into theiroperations either prior to or as they begin volume product manufacturing. We will also be requiredto enhance the performance of our existing systems and related applications. Our success indeveloping new and enhanced systems and related applications depends upon a variety of factors,including product selection, timely and efficient completion of product design, timely andefficient implementation of manufacturing and assembly processes, product performance in the fieldand effective sales and marketing. Because new product development commitments must be made well inadvance of sales, new product decisions must anticipate both future demand and the technology thatwill be available to meet that demand. We may not be successful in selecting, developing,manufacturing or marketing new
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products and related applications or enhancing our existing productsand related applications. Any such failure would materially adversely affect our business,financial condition and results of operations.Because of the large number of components in our systems, significant delays can occur between asystem’s introduction and our commencement of volume production of such systems. We haveexperienced delays from time to time in the introduction of, and technical and manufacturingdifficulties with, certain of our systems and enhancements and related software features andoptions, and may experience delays and technical and manufacturing difficulties in futureintroductions or volume production of new systems or enhancements and related software features andoptions.We may encounter additional technical, manufacturing or other difficulties that could further delayfuture introductions or volume production of systems or enhancements. Our inability to complete thedevelopment or meet the technical specifications of any of our systems or enhancements and relatedapplications, or our inability to manufacture and ship these systems or enhancements and relatedtools in volume and in time to meet the requirements for manufacturing the future generation ofsemiconductor or nanotechnology devices would materially adversely affect our business, financialcondition and results of operations. In addition, we may incur substantial unanticipated costs toensure the functionality and reliability of our products early in the products’ life cycles. If newproducts have reliability or quality problems, reduced orders or higher manufacturing costs, delaysin customer acceptance, revenue recognition and collecting accounts receivable and additionalservice and warranty expenses may result. Any of such events may materially adversely affect ourbusiness, financial condition and results of operations.**A substantial portion of our sales are outside of the United States, which subjects us to risksrelated to customer service, installation, foreign economic and political stability, uncertainregulatory and tax rules, and foreign exchange rate fluctuations, all of which make it moredifficult to operate our business.**International sales accounted for approximately 60.2% and 68.0% of total net sales for the three-and six-month periods ended June 30, 2007, respectively, compared to 69.2% and 63.9% in thecomparable periods of 2006. We anticipate that international sales will continue to account for asignificant portion of total net sales. As a result, a significant portion of our net sales willcontinue to be subject to certain risks, including unexpected changes in regulatory requirements;difficulty in satisfying existing regulatory requirements; exchange rate fluctuations; tariffs andother barriers; political and economic instability; difficulties in accounts receivablecollections; natural disasters; difficulties in staffing and managing foreign subsidiary and branchoperations; and potentially adverse tax consequences.Although we generally transact our international sales in U.S. dollars, international sales exposeus to a number of additional risk factors, including fluctuations in the value of local currenciesrelative to the U.S. dollar, which, in turn, impact the relative cost of ownership of our productsand may further impact the purchasing ability of our international customers. However, in Japan, wehave direct sales operations and orders are often denominated in Japanese yen. This may subject usto a higher degree of risk from currency fluctuations. We attempt to mitigate this exposure throughthe use of foreign currency forward exchange contracts. We are also subject to the risks associatedwith the imposition of legislation and regulations relating to the import or export ofsemiconductors and nanotechnology products. We cannot predict whether the United States or anyother country will implement changes to quotas, duties, taxes or other charges or restrictions uponthe importation or exportation of our products. These factors, or the adoption of restrictivepolicies, may have a material adverse effect on our business, financial condition and results ofoperations.**We are dependent on our key personnel, especially Mr. Zafiropoulo, our Chief Executive Officer, andour business and results of operations would be adversely affected if we were to lose our keyemployees.**Our future operating results depend, in significant part, upon the continued contributions of keypersonnel, many of whom would be difficult to replace. We have entered into employment agreementswith only a limited number of our key employees, including our Chief Executive Officer and ChiefFinancial Officer, and our other employees are employed “at will.” Some of these agreements containvesting acceleration and severance payment provisions that could result in significant costs orcharges to us should the employee be terminated without cause, die or have a disability. We do notmaintain any life insurance on any of our key employees. The loss of key personnel could have amaterial adverse effect on our business, financial condition and results of operations. Inaddition, our future operating results depend in significant part upon our ability to attract andretain other qualified management, manufacturing, technical, sales and support personnel for ouroperations. There are only a limited number of persons with the requisite skills to serve in thesepositions and it may become increasingly difficult for us to hire such personnel over time. Attimes, competition for such personnel has been intense, particularly in the San Francisco Bay Area,where we maintain our headquarters and principal operations, and we may not be successful inattracting or retaining such personnel. The failure to attract or retain such persons wouldmaterially adversely affect our business, financial condition and results of operations.
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**Changes in financial accounting standards or policies in the past have affected, and in the futuremay, affect, our reported results of operations.**We prepare our financial statements in conformity with accounting principles generally accepted inthe United States (U.S. GAAP). These principles are subject to interpretation by the FinancialAccounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA),the Securities and Exchange Commission (SEC) and various bodies formed to interpret and createappropriate accounting policies. A change in those policies can have a significant effect on ourreported results and may affect our reporting of transactions which are completed before a changeis announced.Accounting policies affecting many other aspects of our business, including rules relating torevenue recognition, off-balance sheet transactions, employee stock options, restructurings, assetdisposals and asset retirement obligations, intangible assets, derivative and other financialinstruments, and in-process research and development charges, have recently been revised or areunder review. Changes to those rules or the questioning of how we interpret or implement thoserules may have a material adverse effect on our reported financial results or on the way we conductbusiness. In addition, our preparation of financial statements in accordance with U.S. GAAPrequires that we make estimates and assumptions that affect the recorded amounts of assets andliabilities, disclosure of those assets and liabilities at the date of the financial statements andthe recorded amounts of expenses during the reporting period. A change in the facts andcircumstances surrounding those estimates could result in a change to our estimates and couldimpact our future operating results.**Changes in securities laws and listing standards, in particular those that have resulted from thepassage of the Sarbanes-Oxley Act of 2002 and related rules and regulations, have increased ourlegal and financial costs, and we expect to continue to spend significant resources to comply withthese requirements.**The Sarbanes-Oxley Act of 2002 required changes in our corporate governance, public disclosure andcompliance practices. The rules and regulations applicable to us have increased and will continueto increase our legal and financial compliance costs, and have made some activities more difficult,such as by requiring stockholder approval of new option plans. In addition, we have incurred andexpect to continue to incur significant costs in connection with compliance with Section 404 of theSarbanes-Oxley Act regarding internal controls over financial reporting. We incurred significantcosts to achieve initial compliance with Section 404, and we expect ongoing annual costs tomaintain compliance to also be substantial. We also expect these developments to make it moredifficult and more expensive to obtain director and officer liability insurance, and we may berequired to accept reduced coverage or incur substantially higher costs to obtain coverage. Thesedevelopments could make it more difficult for us to attract and retain qualified members of ourboard of directors, particularly to serve on our audit committee, and qualified executive officers.In addition, in connection with our Section 404 certification process, we may identify from time totime deficiencies in our internal controls. Any material weakness or deficiency in our internalcontrols over financial reporting could materially and negatively impact our reported financialresults and the market price of our stock could significantly decline. Additionally, adversepublicity related to the disclosure of a material weakness or deficiency in internal controls overfinancial reporting could have a negative impact on our reputation, business and stock price.**Our equity incentive plans, certain provisions of our Certificate of Incorporation and Bylaws, andDelaware law may discourage third parties from pursuing a change of control transaction with us.**Certain provisions of our Certificate of Incorporation, equity incentive plans, licensingagreements, Bylaws and Delaware law may discourage certain transactions involving a change incontrol of our company. In addition to the foregoing, our classified board of directors, theshareholdings of our officers, directors and persons or entities that may be deemed affiliates andthe ability of the Board of Directors to issue “blank check” preferred stock without furtherstockholder approval could have the effect of delaying, deferring or preventing us fromexperiencing a change in control and may adversely affect the voting and other rights of holders ofour Common Stock.**Our stock price has experienced significant volatility in the past and we expect this to continuein the future as a result of many factors, some of which could be unrelated to our operatingperformance, and such volatility can have a major impact on the number of shares subject tooutstanding stock options that are included in calculating our earnings per share.**We believe that factors such as announcements of developments related to our business, fluctuationsin our operating results, a shortfall in revenue or earnings, changes in analysts’ expectations,general conditions in the semiconductor and nanotechnology industries or the worldwide or regionaleconomies, sales of our securities into the marketplace, an outbreak or escalation of hostilities,
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announcements of technological innovations or new products or enhancements by us or ourcompetitors, developments in patents or other intellectual property rights and developments in ourrelationships with our customers and suppliers could cause the price of our Common Stock tofluctuate, perhaps substantially. The market price of our Common Stock has fluctuated significantlyin the past and we expect it to continue to experience significant fluctuations in the future,including fluctuations that may be unrelated to our performance.As of June 30, 2007, we had options and restricted stock units to purchase approximately 5.5million shares of our Common Stock outstanding. Among other determinants, the market price of ourstock has a major bearing on the number of shares subject to outstanding stock options that areincluded in the weighted-average shares used in determining our net income (loss) per share. Duringperiods of extreme volatility, the impact of higher stock prices can have a materially dilutiveeffect on our net income (loss) per share. Additionally, shares subject to outstanding options areexcluded from the calculation of net income (loss) per share when we have a net loss or when theexercise price of the stock option is greater than the average market price of our Common Stock, asthe impact of the stock options would be anti-dilutive.**Our results of operations and business could be adversely affected by wars and other militaryaction, as well as terrorist attacks and threats and government responses thereto, especially ifany such actions were directed at us or our facilities or customers.**Terrorist attacks in the United States and elsewhere, government responses thereto, and militaryactions in Iraq, Afghanistan and elsewhere, may disrupt our operations or those of our customersand suppliers and may affect the availability of materials needed to manufacture our products orthe means to transport those materials to manufacturing facilities and finished products tocustomers. In addition, any of these events could increase volatility in the United States andworld financial markets which may depress the price of our Common Stock and may limit the capitalresources available to us or our customers or suppliers, which could result in decreasedorders from customers, less favorable financing terms from suppliers, and scarcity or increasedcosts of materials and components of our products. Additionally, terrorist attacks directly upon usmay significantly disrupt our ability to conduct our business. Any of these occurrences could havea significant impact on our operating results, revenues and costs and may result in increasedvolatility of the market price of our Common Stock.**If we acquire companies, products, or technologies, we may face risks associated with thoseacquisitions.**In July 2006 we purchased certain assets of Oraxion, Inc. Oraxion produced inspection equipment forsurface metrology and stress analysis for the semiconductor industry. We may not realize theanticipated benefits of any acquisition or investment. We may in the future pursue additionalacquisitions of complementary product lines, technologies or businesses. Future acquisitions mayresult in potentially dilutive issuances of equity securities, the incurrence of debt and contingentliabilities and amortization expenses and impairment charges related to goodwill and otherintangible assets, which could materially adversely affect our financial condition and results ofoperations. In addition, acquisitions involve numerous risks, including difficulties in theassimilation of the operations, technologies, personnel and products of the acquired companies; thediversion of management’s attention from other business concerns; risks of entering markets inwhich we have limited or no direct experience; and the potential loss of key employees of theacquired company. In the event we acquire product lines, technologies or businesses which do notcomplement our business, or which otherwise do not enhance our sales or operating results, we mayincur substantial write-offs and higher recurring operating costs, which could have a materialadverse effect on our business, financial condition and results of operations. In the event thatany such acquisition does occur, there can be no assurance as to the effect thereof on our businessor operating results.**Our long-term expenses reduction programs may result in an increase in short-term expenses.**In the second quarter of 2007, as a continuing effort to reduce company-wide expenses since thefourth quarter of 2006, we eliminated an additional eight full-time positions, three in the UnitedStates and five internationally. Pursuant to the provisions of FASB Statement No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*, during the second quarter of 2007, werecorded severance and benefits charges totaling $0.5 million related to this plan as selling,general and administrative expenses. As of June 30, 2007, the remaining balance of $0.7 millionrelated to severance and benefit payments incurred during 2006 and 2007 will be fully paid by thesecond quarter of 2008. We recorded severance and benefits charges totaling $1.2 million during thefirst six months of 2007.**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**In September 2005, our Board of Directors authorized the repurchase of up to $30.0 million of ourcommon stock in the open market during the period commencing September 2005 through September 2007.We did not repurchase any shares of our common stock
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during the first six months of 2007. Wepurchased a total of 1.4 million shares of our common stock since September 2005 for a total of$20.0 million.**Item 3. Defaults Upon Senior Securities.**None.**Item 4. Submission of Matters to a Vote of Security Holders.**None.**Item 5. Other Information.**None.**Item 6. Exhibits.**3.1(a)   Amended and Restated Certificate of Incorporation of the Registrant, filedOctober 6, 1993. 3.1.1(a)   Certificate of Amendment of the Amended and Restated Certificate ofIncorporation of the Company, dated May 17, 1995. 3.1.2(a)   Certificate of Amendment of the Amended and Restated Certificate ofIncorporation of the Company, dated June 17, 1998. 3.1.3(a)   Certificate of Amendment of the Amended and Restated Certificate ofIncorporation of the Company, dated June 20, 2003. 3.2(b)   Bylaws of the Registrant, as amended. 31.1 Certification of Chief Executive Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (a) Previously filed with our Quarterly Report on Form 10-Q for the quarter ended June28, 2003 (Commission File No. 0-22248) and incorporated herein by reference. (b) Previously filed with our Current Report on Form 8-K filed on February 2, 2007(Commission File No. 0-22248) and incorporated herein by reference.
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**SIGNATURES**Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly causedthis report to be signed on its behalf by the undersigned thereunto duly authorized.      **ULTRATECH, INC.**