** **

** **

**UNITED STATES**

** SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark One)** | ** ** | ** **                                                                                                            |
|----------------|------------|-----------------------------------------------------------------------------------------------------------------------|
| **ý**     | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF  1934**                    |
|           |       |                                                                                                                  |
| ** **     | ** ** | **For  the quarterly period ended           October  2, 2004** |
| ** **     | ** ** | ** **                                                                                                            |
| **o**          | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF  1934**                   |

 

**For the transition periodfrom            to            **

 

**Commission File Number            0-22248**

 

**ULTRATECH, INC.**

(Exact name of registrant as specified in itscharter)

 

| **DELAWARE**                                                                                                              | ** ** | **94-3169580**                       |
|---------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)                                                            |       | (I.R.S. Employer Identification No.) |
|                                                                                                                      |       |                                 |
| **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.)                                      |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

| Yes         ý |   | No         o |
|-----------------------------------------------------------------|--------|-----------------------------------------------------------|

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).

 

| Yes         ý |   | No         o |
|-----------------------------------------------------------------|--------|-----------------------------------------------------------|

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practical date:

 

| **Class**                     | ** ** | **Outstanding  as of October 29, 2004** |
|-------------------------------|------------|-----------------------------------------|
| common stock, $.001 par value |       | 23,801,768                              |

 

 

 

 

**ULTRATECH, INC.**

 

**INDEX**

 
| **PART 1.**                        | **FINANCIAL INFORMATION**                                                                                                    |   |
|------------------------------------|------------------------------------------------------------------------------------------------------------------------------|--------|
|                               |                                                                                                                         |   |
| **Item  1.**                       | **Condensed  Consolidated Financial Statements**                                                                             |   |
|                               |                                                                                                                         |   |
|                               | Condensed  Consolidated Balance Sheets as of October 2, 2004 and December 31, 2003                                      |   |
|                               |                                                                                                                         |   |
|                               | Condensed Consolidated Statements  of Operations for the three and nine months ended October 2, 2004 and  September 27, 2003 |   |
|                               |                                                                                                                         |   |
|                               | Condensed Consolidated  Statements of Cash Flows for the nine months ended October 2, 2004 and  September 27, 2003           |   |
|                               |                                                                                                                         |   |
|                               | Notes  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 2.**                        | **OTHER INFORMATION**                                                                                                        |   |
|                               |                                                                                                                         |   |
| **Item 1.**                        | **Legal Proceedings**                                                                                                        |   |
|                               |                                                                                                                         |   |
| **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  AND CERTIFICATIONS** |                                                                                                                         |

 

2

----

**PART 1.                FINANCIAL INFORMATION**

**Item 1.    Condensed Consolidated Financial Statements(Unaudited)**

 

**ULTRATECH, INC.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

 
| ** **                                        | ** ** | ** **        | ** **  | ** **          | ** ** |
|---------------------------------------------------|------------|-------------------|-------------|---------------------|------------|
| **(In  thousands)**                               | ** ** | **Oct. 2,  2004** | ** **  | **Dec. 31,  2003*** |       |
| ***ASSETS***                                      |       | **(Unaudited)**   |        |                |       |
|                                              |       |              |        |                |       |
| Current assets:                                   |       |              |        |                |       |
| Cash, cash equivalents and short-term investments |       | **$**             | **161,487** |                | $          |  165,902 |   |
| Accounts receivable, net                          | ** ** | **20,284**        |        | 9,398               |       |
| Inventories                                       | ** ** | **22,782**        |        | 19,037              |       |
| Income taxes receivable                           | ** ** | **—**        |        | 349                 |       |
| Prepaid expenses and other current assets         |       | **1,988**         |        | 2,099               |       |
| Total current assets                              | ** ** | **206,541**       |        | 196,785             |       |
|                                              |       |              |        |                |       |
| Equipment and leasehold improvements, net         |       | **18,913**        |        | 18,481              |       |
|                                              |       |              |        |                |       |
| Demonstration inventories, net                    | ** ** | **5,192**         |        | 3,071               |       |
|                                              |       |              |        |                |       |
| Intangible assets, net                            | ** ** | **190**           |        | 476                 |       |
|                                              |       |              |        |                |       |
| Other assets                                      | ** ** | **2,499**         |        | 1,935               |       |
| Total assets                                      | ** ** | **$**             | **233,335** |                | $          | 220,748 |   |
|                                              |       |              |        |                |       |
| ***LIABILITIES AND STOCKHOLDERS’  EQUITY***  |       |
|                                              |       |              |        |                |       |
| Current liabilities:                              |       |              |        |                |       |
| Notes payable                                     | ** ** | **$**             | **7,900**   |                | $          | 2,564 |   |
| Accounts payable                                  | ** ** | **12,829**        |        | 7,729               |       |
| Deferred product and service income               | ** ** | **4,317**         |        | 1,088               |       |
| Deferred license income                           | ** ** | **1,969**         |        | 4,752               |       |
| Other current liabilities                         | ** ** | **7,822**         |        | 10,151              |       |
| Total current liabilities                         | ** ** | **34,837**        |        | 26,284              |       |
|                                              |       |              |        |                |       |
| Other liabilities                                 | ** ** | **4,844**         |        | 3,725               |       |
|                                              |       |              |        |                |       |
| Total stockholders’ equity                   | ** ** | **193,654**       |        | 190,739             |       |
| Total liabilities and stockholders’ equity   | ** ** | **$**             | **233,335** |                | $          | 220,748 |   |
|                                                   |            |                   |             |                     |            |  |  |  |  |

 

----

* The Balance Sheet as of December 31,2003 has been derived from the audited financial statements at that date.

 

*See accompanying notes tounaudited condensed consolidated financial statements*

 

3

----

| **ULTRATECH, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS** |
|--------------------------------------------------------------------------|
| **(Unaudited)**                                                          |

 
| ** **                                                | ** ** | **Three  Months Ended** | ** ** | **Nine  Months Ended** | ** ** |
|-----------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **(In  thousands, except per share amounts)**             | ** ** | **Oct. 2,  2004**       | ** ** | **Sep. 27,  2003**     | ** ** | **Oct. 2,  2004** | ** ** | **Sep. 27,  2003** |   |
| Net sales:                                                |       |                    |       |                   |       |   |   |   |   |
| Products                                                  | ** ** | **$**                   | **28,295** |                   | $          | 22,732 | ** ** | **$** | **69,775** |   | $ | 62,574 |   |
| Services                                                  | ** ** | **3,171**               |       | 2,885                  | ** ** | **8,943** |   | 7,951 |   |
| Licenses                                                  | ** ** | **927**                 |       | 927                    | ** ** | **2,783** |   | 2,783 |   |
| Total net sales                                           | ** ** | **32,393**              |       | 26,544                 | ** ** | **81,501** |   | 73,308 |   |
| Cost of sales:                                            |       |                    |       |                   |       |   |   |   |   |
| Cost of products sold                                     | ** ** | **13,889**              |       | 11,312                 | ** ** | **35,733** |   | 34,753 |   |
| Cost of services                                          | ** ** | **2,294**               |       | 1,519                  | ** ** | **6,325** |   | 4,884 |   |
| Total cost of sales                                       | ** ** | **16,183**              |       | 12,831                 | ** ** | **42,058** |   | 39,637 |   |
| Gross profit                                              | ** ** | **16,210**              |       | 13,713                 | ** ** | **39,443** |   | 33,671 |   |
| Operating expenses:                                       |       |                    |       |                   |       |   |   |   |   |
| Research, development, and engineering                    |       | **6,478**               |       | 5,544                  |       | **18,936** |   | 15,718 |   |
| Selling, general, and administrative                      |       | **7,433**               |       | 6,362                  |       | **21,680** |   | 16,628 |   |
| Amortization of intangible assets                         | ** ** | **96**                  |       | 96                     | ** ** | **286** |   | 286 |   |
| Restucture of operations                                  | ** ** | **—**              |       | —                 | ** ** | **—** |   | (114 | ) |
| Operating income (loss)                                   | ** ** | **2,203**               |       | 1,711                  | ** ** | **(1,459** | ) | 1,153 |   |
| Interest expense                                          | ** ** | **(36**                 | )          | (112                   | **)**      | **(91** | ) | (235 | ) |
| Interest and other income, net                            | ** ** | **864**                 |       | 1,117                  | ** ** | **2,680** |   | 3,289 |   |
|                                                      |       |                    |       |                   |       |   |   |   |   |
| Income before tax                                         | ** ** | **3,031**               |       | 2,716                  | ** ** | **1,130** |   | 4,207 |   |
| Income tax provision (benefit)                            | ** ** | **186**                 |       | (524                   | **)**      | **24** |   | (79 | ) |
| Net income                                                | ** ** | **$**                   | **2,845**  |                   | $          | 3,240 | ** ** | **$** | **1,106** |   | $ | 4,286 |   |
|                                                      |       |                    |       |                   |       |   |   |   |   |
| Earnings per share - basic:                               |       |                    |       |                   |       |   |   |   |   |
| Net income                                                | ** ** | **$**                   | **0.12**   |                   | $          | 0.14 | ** ** | **$** | **0.05** |   | $ | 0.19 |   |
| Number of shares used in per share computations - basic   |       | **23,764**              |       | 23,010                 |       | **23,704** |   | 22,870 |   |
| Earnings per share - diluted:                             |       |                    |       |                   |       |   |   |   |   |
| Net income                                                | ** ** | **$**                   | **0.12**   |                   | $          | 0.13 | ** ** | **$** | **0.04** |   | $ | 0.18 |   |
| Number of shares used in per share computations - diluted |       | **24,044**              |       | 25,144                 |       | **24,769** |   | 23,883 |   |

 

 

*See accompanying notes tounaudited condensed consolidated financial statements*

 

 

4

----

 

**ULTRATECH, INCCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS****(Unaudited)**

 
| ** **                                                                                   | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(In thousands)**                                                                           | ** ** | **Oct. 2, 2004**      | ** ** | **Sep. 27, 2003** | ** ** |
| *Cash flows from operating activities:*                                                      |       |                  |       |   |   |
| Net income                                                                                   |       | $                     | 1,106      |   | $ | 4,286 |   |
| Adjustments to reconcile net income to net cash provided by (used in)  operating activities: |       |                  |       |   |   |
| Depreciation                                                                                 |       | 4,756                 |       | 4,993 |   |
| Amortization                                                                                 |       | 1,802                 |       | 1,769 |   |
| Non-cash restructuring and asset impairment charges (recoveries)                             |       | —                |       | (62 | ) |
| Loss on disposal of equipment                                                                |       | 9                     |       | 180 |   |
| Deferred compensation                                                                        |       | 162                   |       | 125 |   |
| Deferred income taxes                                                                        |       | 177                   |       | (475 | ) |
| Changes in operating assets and liabilities:                                                 |       |                  |       |   |   |
| Accounts receivable                                                                          |       | (10,886               | )          | (7,046 | ) |
| Inventories                                                                                  |       | (3,745                | )          | 10,201 |   |
| Taxes receivable                                                                             |       | 349                   |       | 474 |   |
| Prepaid expenses and other current assets                                                    |       | (66                   | )          | (419 | ) |
| Demonstration inventory                                                                      |       | (2,810                | )          | (2,890 | ) |
| Other assets                                                                                 |       | (564                  | )          | 230 |   |
| Accounts payable                                                                             |       | 5,100                 |       | 1,307 |   |
| Deferred product and services income                                                         |       | 3,229                 |       | 2,183 |   |
| Deferred license income                                                                      |       | (2,783                | )          | (2,783 | ) |
| Other liabilities                                                                            |       | (1,213                | )          | (3,608 | ) |
| Net cash provided by (used in) operating activities                                          |       | (5,377                | )          | 8,465 |   |
|                                                                                         |       |                  |       |   |   |
| *Cash flows from investing activities:*                                                      |       |                  |       |   |   |
| Capital expenditures                                                                         |       | (5,197                | )          | (4,306 | ) |
| Investments in securities                                                                    |       | (89,472               | )          | (109,290 | ) |
| Proceeds from sales and maturities of investments                                            |       | 108,782               |       | 133,090 |   |
| Net cash provided by investing activities                                                    |       | 14,113                |       | 19,494 |   |
|                                                                                         |       |                  |       |   |   |
| *Cash flows from financing activities:*                                                      |       |                  |       |   |   |
| Proceeds from notes payable                                                                  |       | 25,987                |       | 10,794 |   |
| Repayment of notes payable                                                                   |       | (20,651               | )          | (18,027 | ) |
| Proceeds from issuance of common stock                                                       |       | 2,415                 |       | 6,522 |   |
| Net cash provided by (used in) financing activities                                          |       | 7,751                 |       | (711 | ) |
|                                                                                         |       |                  |       |   |   |
| **Net  effect of exchange rate changes on cash**                                             |       | 321                   |       | (98 | ) |
|                                                                                         |       |                  |       |   |   |
| **Net  increase in cash and cash equivalents**                                               |       | 16,808                |       | 27,150 |   |
|                                                                                         |       |                  |       |   |   |
| **Cash and  cash equivalents at beginning of period**                                        |       | 25,149                |       | 18,178 |   |
|                                                                                         |       |                  |       |   |   |
| **Cash  and cash equivalents at end of period**                                              |       | $                     | 41,957     |   | $ | 45,328 |   |
|                                                                                         |       |                  |       |   |   |
| Supplemental disclosures of cash flow information:                                           |       |                  |       |   |   |
| Other non-cash changes:                                                                      |       |                  |       |   |   |
| Systems transferred from (to) inventory to (from) equipment and other  assets                |       | $                     | 3,129      |   | $ | 1,062 |   |
| Systems transferred from (to) equipment to (from) other assets                               |       | $                     | 1,097      |   | $ | — |   |

 

*See accompanying notes to unaudited condensed consolidatedfinancial statements.*

 

 

5

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**Ultratech, Inc.**

**Notes to Condensed Consolidated Financial Statements**

**(Unaudited)**

**October 2, 2004**

 

**(1) Descriptionof Business**

 

Ultratech, Inc. (referred to as “Ultratech”and “we”) develops, manufactures and markets photolithography and laser thermalprocessing equipment for manufacturers of semiconductor and nanotechnologycomponents located throughout North America, Europe, Japan, Taiwan and the restof Asia.

 

We supply step-and-repeat photolithographysystems based on one-to-one imaging technology. Within the semiconductorindustry, we target the market for advanced packaging applications. Within thenanotechnology industry, our target markets include thin film head magneticrecording devices, optical networking devices, laser diodes and LEDs (lightemitting diodes). Our laser thermal processing equipment is targeted atadvanced annealing applications within the semiconductor industry.

 

In evaluating our business segments,Ultratech gave consideration to the Chief Executive Officer’s review offinancial information and the organizational structure of our management. Basedon this review, we concluded that, at the present time, resources are allocatedand other financial decisions are made based, primarily, on consolidatedfinancial information. Accordingly, we have determined that we operate in onebusiness segment, which is the manufacture and distribution of capitalequipment to manufacturers of integrated circuits and nanotechnologycomponents.

 

**(2) Basis of Presentation**

 

We have prepared the unaudited condensedconsolidated financial statements in accordance with generally acceptedaccounting 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 of the information and footnotes required by U.S.generally accepted accounting principles for complete financial statements. Inthe opinion of management, all adjustments, consisting of only normal recurringadjustments, considered necessary for fair presentation have been included.

 

Operating results for the three and ninemonth periods ended October 2, 2004 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2004, or anyfuture period.

 

USE OF ESTIMATES — The preparation of thefinancial statements and related disclosures, in conformity with U.S. generallyaccepted accounting principles, requires management to make estimates andjudgments that affect the reported amounts in the financial statements andaccompanying notes. On an ongoing basis, management evaluates its estimates,including those related to inventories, warranty obligations, purchase ordercommitments, bad debts, income taxes, intangible assets, useful lives of fixedassets, contingencies and litigation. Management bases its estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates.

 

**(3)Stock Based Compensation**

 

Weaccount for compensation expense related to our stock-based employeecompensation plans under the intrinsic value method. Accordingly, nostock-based employee compensation cost is recorded in the condensedconsolidated statements of operations, as all options granted under these planshad an exercise price equal to the market value of the underlying common stockon the date of grant.

 

 

6

----

 

Thefollowing table illustrates the effect on net income (loss) and net income(loss) per share if we had applied the fair value recognition method to accountfor stock-based employee compensation.

 
| **In thousands, except per share amounts**                                                                                             | ** ** | **Three months ended** | ** **      | **Nine months ended**  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-----------------|------------------------|------------|
| ** **                                                                                                                             | ** ** | **Oct. 2,   2004**     | ** **      | **Sep. 27, 2003** | ** ** | **Oct. 2,  2004** | ** ** | **Sep. 27,  2003** | ** ** |
| Net income as reported                                                                                                                 |       | $                      | 2,845           |                   | $          | 3,240 |   | $ | 1,106 |   | $ | 4,286 |   |
| Total stock-based employee compensation expense, determined under  fair value based method for all

awards, net of related tax effects |       | (3,407                 |  

)  | (2,492                 |       | (23,320 |   | (6,723 |   |
|                                                                                                                                   | )     | )                 | )          |
| Pro forma net income (loss)                                                                                                            |       | $                      | (562            | )                      | $          | 748 |   | $ | (22,214 | ) | $ | (2,437 | ) |
|                                                                                                                                   |       |                   |            |                   |       |   |   |   |   |   |   |   |   |
| Net income (loss) per share - basic, as reported                                                                                       |       | $                      | 0.12            |                   | $          | 0.14 |   | $ | 0.05 |   | $ | 0.19 |   |
| Pro forma net income (loss) per share - basic                                                                                          |       | $                      | (0.02           | )                      | $          | 0.03 |   | $ | (0.96 | ) | $ | (0.11 | ) |
|                                                                                                                                   |       |                   |            |                   |       |   |   |   |   |   |   |   |   |
| Net income (loss) per share - diluted, as reported                                                                                     |       | $                      | 0.12            |                   | $          | 0.13 |   | $ | 0.04 |   | $ | 0.18 |   |
| Pro forma net income (loss) per share - diluted                                                                                        |       | $                      | (0.02           | )                      | $          | 0.03 |   | $ | (0.96 | ) | $ | (0.11 | ) |

 

 

Included in the fairvalue stock-based employee compensation expense above for the three and ninemonth periods ended October 2, 2004, was $1.7 million and $16.2 million,respectively, resulting from the acceleration of vesting of options to purchaseapproximately 0.7 million and 2.3 million shares of common stock, respectively,for all optionees, except for non-employee members of the Board of Directors,whose exercise price, which ranges from $13.36 to $16.15 and $13.36 to $31.38per share, respectively, exceeded the market price of our stock on therespective dates of acceleration, July 19, 2004 and June 25, 2004. We havenever repriced stock options, thus, the exercise prices for the stock optionsaccelerated were unchanged. Only the vesting was changed and now all of theaffected stock options are fully vested. As the exercise price of all the stockoptions affected was greater than their fair market price on the date ofvesting acceleration, there was no impact, under the intrinsic value method, onour consolidated statements of operations.

 

Thetable above used the following weighted-average assumptions to estimate thefair value of stock options at the date of grant using the Black-Scholesoption-pricing model.

 
| ** **                                            | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **Oct. 2,**            | ** ** | **Sep. 27,**          | ** ** | **Oct. 2,** | ** ** | **Sep. 27,** | ** ** |
| ** **                                            | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected life (in years): stock options               |       | 1.1                    |       | 3.6                   |       | 2.1 |   | 3.6 |   |
|                                                  |       |                   |       |                  |       |   |   |   |   |
| Expected life (in years):Employee Stock Purchase Plan |       | —                 |       | 1.25                  |       | 0.5 |   | 1.25 |   |
|                                                  |       |                   |       |                  |       |   |   |   |   |
| Risk-free interest rate                               |       | 2.05                   | %          | 2.64                  | %          | 2.52 | % | 2.55 | % |
|                                                  |       |                   |       |                  |       |   |   |   |   |
| Volatility factor                                     |       | 0.48                   |       | 0.70                  |       | 0.60 |   | 0.71 |   |
|                                                  |       |                   |       |                  |       |   |   |   |   |
| Dividend yield                                        |       | 0.00                   | %          | 0.00                  | %          | 0.00 | % | 0.00 | % |

 

 

Reflected in the table above is thetermination of our Employee Stock Purchase Plan in July 2004.

 

 

 

7

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**(4) Net Income Per Share**

 

The following sets forth the computation ofbasic and diluted net income per share:

 

 
| ** **                                              | ** ** | **Three months ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **Oct. 2,**            | ** ** | **Sep. 27,**          | ** ** | **Oct. 2,** | ** ** | **Sep. 27,** | ** ** |
| **(Unaudited, in thousands, except per share amounts)** | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Numerator:                                              |       |                   |       |                  |       |   |   |   |   |
| Net income                                              |       | $                      | 2,845      |                  | $          | 3,240 |   | $ | 1,106 |   | $ | 4,286 |   |
|                                                    |       |                   |       |                  |       |   |   |   |   |
| Denominator:                                            |       |                   |       |                  |       |   |   |   |   |
| Denominator for basic net income per share              |       | 23,764                 |       | 23,010                |       | 23,704 |   | 22,870 |   |
| Effect of dilutive employee stock options               |       | 280                    |       | 2,134                 |       | 1,065 |   | 1,013 |   |
| Denominator for diluted net income per share            |       | 24,044                 |       | 25,144                |       | 24,769 |   | 23,883 |   |
|                                                    |       |                   |       |                  |       |   |   |   |   |
| Earnings per share - basic:                             |       |                   |       |                  |       |   |   |   |   |
| Net income                                              |       | $                      |  0.12 |                  | $          |  0.14 |   | $ |  0.05 |   | $ |  0.19 |   |
|                                                    |       |                   |       |                  |       |   |   |   |   |
| Earnings per share - diluted:                           |       |                   |       |                  |       |   |   |   |   |
| Net income                                              |       | $                      |  0.12 |                  | $          |  0.13 |   | $ |  0.04 |   | $ |  0.18 |   |
|                                                    |       |                   |       |                  |       |   |   |   |   |
|                                                         |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

For the three and nine month periods endedOctober 2, 2004, options to purchase 3,418,000 and 2,158,000 shares of commonstock at an average exercise price of $22.35 and $25.43, respectively, wereexcluded from the computation of diluted net income per share, as the effectwould have been anti-dilutive. For the three and nine month periods endedSeptember 27, 2003, options to purchase 405,000 and 1,428,000 shares of commonstock at an average exercise price of $29.30 and $23.34, respectively, wereexcluded from the computation of diluted net income per share, as the effectwould have been anti-dilutive. Options are anti-dilutive when we have a netloss or when the exercise price of the stock option is greater than the averagemarket price of our common stock.

 

**(5) Inventories**

 

Inventories consist of the following:

 

 
| ** **         | ** ** | **Oct. 2, 2004** | ** **      | **Dec. 31, 2003** | ** ** |
|--------------------|------------|------------------|-----------------|-------------------|------------|
| **(In thousands)** | ** ** | ** **       | **(Unaudited)** | ** **        | ** ** | ** ** |
| Raw materials      |       | $                | 9,191           |              | $          | 8,647 |   |
| Work-in-process    |       | 11,403           |            | 9,286             |       |
| Finished products  |       | 2,188            |            | 1,104             |       |
|               |       | $                | 22,782          |              | $          | 19,037 |   |
|                    |            |                  |                 |                   |            |  |  |  |

 

**(6)Other Assets**

 

Otherassets consist of the following:

 

 
| ** **                        | ** ** | **Oct. 2,   2004** | ** **      | **Dec. 31, 2003** | ** ** |
|-----------------------------------|------------|--------------------|-----------------|------------------------|------------|
| **(In thousands)**                | ** ** | ** **         | **(Unaudited)** | ** **             | ** ** | ** ** |
| Deferred compensation plan assets |       | $                  | 1,146           |                   | $          | 645 |   |
| Other                             |       | 1,353              |            | 1,290                  |       |
|                              |       | $                  | 2,499           |                   | $          | 1,935 |   |
|                                   |            |                    |                 |                        |            |  |  |  |

 

 

8

 

----

 

**(7)Line of Credit**

 

We have a line of credit agreement with abrokerage firm. Under the terms of this agreement, we may borrow funds at acost equal to the current Federal funds rate plus 100 basis points (2.75% as ofOctober 2, 2004). Certain of our cash, cash equivalents and short-terminvestments secure borrowings outstanding under this facility. Funds areadvanced 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 noset expiration date and there are no loan covenants. As of October 2, 2004,$7.9 million was outstanding under this facility, with a related collateralrequirement of approximately $11.3 million of our cash, cash equivalents and short-terminvestments.

 

**(8)Other Current Liabilities**

 

Othercurrent liabilities consist of the following:

 

 
|                                              |       | **Oct. 2,   2004** | ** **      | **Dec. 31, 2003** |       |
|---------------------------------------------------|------------|--------------------|-----------------|------------------------|------------|
| **(In  thousands)**                               | ** ** |               | **(Unaudited)** | ** **             | ** ** |   |
| Salaries and  benefits                            |       | $                  | 3,160           |                   | $          | 2,841 |   |
| Warranty accrual                                  |       | 1,790              |            | 1,257                  |       |
| Advance billings                                  |       | 592                |            | 1,523                  |       |
| Income taxes  payable (receivable)                |       | (363               | )               | 745                    |       |
| Reserve for  losses on purchase order commitments |       | 984                |            | 841                    |       |
| Other                                             |       | 1,659              |            | 2,944                  |       |
|                                              |       | $                  | 7,822           |                   | $          | 10,151 |   |
|                                                   |            |                    |                 |                        |            |  |  |  |  |

 

**WarrantyAccrual**

 

We generally warrant our products for a periodof 12 months for new products, or 3 months for refurbished products, from thedate of customer acceptance for material and labor to repair the product. Weestimate the costs that may be incurred under our basic limited warranty andrecord a liability in the amount of such costs at the time the product isshipped. Recognition of the related warranty cost is deferred until productrevenue is recognized. Extended warranty terms, if granted, result in deferralof revenue approximating the fair value for similar service contracts. Factorsthat affect our warranty liability include the number of installed units,historical and anticipated rates of warranty claims, and cost per claim. Weperiodically assess the adequacy of our recorded warranty liabilities andadjust the amounts as necessary.

 

Changes in our product liability are asfollows:

 
| ** **                          | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **Oct. 2,**            | ** ** | **Sep. 27,**          | ** ** | **Oct. 2,** | ** ** | **Sep. 27,** | ** ** |
| **(In thousands)**                  | ** ** | ** **             | **2004**   | ** **            | **2003**   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Balance, beginning of the period    |       | $                      | 1,498      |                  | $          | 1,615 |   | $ | 1,257 |   | $ | 1,462 |   |
| Warranties issued during the period |       | 1,088                  |       | 950                   |       | 3,059 |   | 2,794 |   |
| Settlements during the period       |       | (796                   | )          | (902                  | )          | (2,526 | ) | (2,593 | ) |
| Balance, end of the period          |       | $                      | 1,790      |                  | $          | 1,663 |   | $ | 1,790 |   | $ | 1,663 |   |
|                                     |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |

 

 

 

9

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**DeferredService Income**

 

Wesell service contracts for which revenue is deferred and recognized ratablyover the contract period, for time based service contracts, or as services aredelivered, for contracts based on specific items. Changes in our deferredservice contract revenue are as follows:

 
| ** **                                            | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **Oct. 2,**            | ** ** | **Sep. 27,**          | ** ** | **Oct. 2,** | ** ** | **Sep. 27,** | ** ** |
| **(In thousands)**                                    | ** ** | ** **             | **2004**   | ** **            | **2003**   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Balance, beginning of the period                      |       | $                      | 977        |                  | $          | 683 |   | $ | 821 |   | $ | 815 |   |
| Service contracts invoiced during the period          |       | 2,483                  |       | 1,846                 |       | 6,427 |   | 5,222 |   |
| Service contract revenue recognized during the period |       | (2,106                 | )          | (1,862                | )          | (5,894 | ) | (5,370 | ) |
| Balance, end of the period                            |       | $                      | 1,354      |                  | $          | 667 |   | $ | 1,354 |   | $ | 667 |   |
|                                                       |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

**(9)Other Liabilities**

 

Otherliabilities consist of the following:

** **
| ** **                           | ** ** | **Oct. 2,   2004** | ** **      | **Dec. 31, 2003** | ** ** |
|--------------------------------------|------------|--------------------|-----------------|------------------------|------------|
| **(In thousands)**                   |       |               | **(Unaudited)** |                   |       |   |
| Deferred rent                        |       | $                  | 3,167           |                   | $          | 2,784 |   |
| Deferred compensation plan liability |       | 1,303              |            | 751                    |       |
| Other                                |       | 374                |            | 190                    |       |
|                                 |       | $                  | 4,844           |                   | $          | 3,725 |   |
|                                      |            |                    |                 |                        |            |  |  |  |

 

** **

** **

**(10)Comprehensive Income**

 

 

Thecomponents of comprehensive income are as follows:

 
| ** **                                                   | ** ** | **Three months ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                   | ** ** | **Oct. 2,**            | ** ** | **Sep. 27,**          | ** ** | **Oct. 2,** | ** ** | **Sep. 27,** | ** ** |
| **(Unaudited, in thousands)**                                | ** ** | ** **             | **2004**   | ** **            | **2003**   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                                   |       | $                      | 2,845      |                  | $          | 3,240 |   | $ | 1,106 |   | $ | 4,286 |   |
| Accumulated other comprehensive income (loss)                |       |                   |       |                  |       |   |   |   |   |
| Unrealized gain (loss) on available-for-sale investments     |       | (117                   | )          | (263                  | )          | (1,088 | ) | (332 | ) |
| Unrealized gain (loss) on foreign exchange forward contracts |       | 9                      |       | (117                  | )          | 321 |   | (98 | ) |
| Comprehensive income                                         |       | $                      | 2,737      |                  | $          | 2,860 |   | $ | 339 |   | $ | 3,856 |   |
|                                                              |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |

 

 

Accumulatedother comprehensive income presented in the condensed consolidated balancesheets is comprised of changes in unrealized gains or losses onavailable-for-sale securities and the effect of exchange rate changes onforeign exchange forward contracts, net of tax.

 
| ** **                                              | ** ** | **Oct. 2,** | ** ** | **Dec. 31,** | ** ** |
|---------------------------------------------------------|------------|-------------|------------|--------------|------------|
| **(In thousands)**                                      | ** ** | ** **  | **2004**   | ** **   | **2003**   | ** ** |
| Unrealized gains (losses) on:                           |       |        |       |         |       |
| Available-for-sale investments                          |       | $           | 169        |         | $          | 1,257 |   |
| Foreign exchange contracts                              |       | 1           |       | (320         | )          |
| Accumulated other comprehensive income at end of period |       | $           | 170        |         | $          | 937 |   |
|                                                         |            |             |            |              |            |  |  |  |

 

 

 

10

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**Item 2.    Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

Certain of the statements contained herein,which can be identified by words such as “anticipates”, “expects”, “intends”, “will”,“could”, “believes”, “estimates”, “continue”, and similar expressions, may beconsidered forward-looking statements under Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities Exchange Act of1934, as amended, that involve risks and uncertainties, such as delays,deferrals and cancellations of orders by customers; lengthy sales cycles,including the timing of system installations and acceptances; lengthy andcostly development cycles for lithography and laser-processing technologies andapplications; dependence on new product introductions and commercial success ofany new products; integration, development and associated expenses of the laserprocessing operation; intellectual property matters; expiration of licensingarrangements, and the resulting adverse impact on our licensing revenues;cyclicality in the semiconductor and nanotechnology industries; high degree ofindustry competition; pricing pressures and product discounts; changes inpricing by us, our competitors or suppliers; customer concentration; marketacceptance of new products and enhanced versions of our existing products;international sales; changes to financial accounting standards; timing of newproduct announcements and releases by us or our competitors; ability to volumeproduce systems and meet customer requirements; mix of products sold; rapidtechnological change and the importance of timely product introductions;outcome of litigation; sole or limited sources of supply; manufacturingvariances and production levels; timing and degree of success of technologieslicensed to outside parties; product concentration and lack of product revenuediversification; inventory obsolescence; asset impairment; ability andresulting costs to attract or retain sufficient personnel to achieve our targetsfor a particular period; dilutive effect of employee stock option grants on netincome per share, which is largely dependent upon us achieving and maintainingprofitability and the market price of our stock; effects of certainanti-takeover provisions; future acquisitions; volatility of stock price;business interruptions due to natural disasters or utility failures;environmental regulations; and any adverse effects of terrorist attacks in theUnited States or elsewhere, or government responses thereto, or militaryactions in Iraq, Afghanistan and elsewhere, on the economy, in general, or onour business in particular. Due to these and additional factors, thestatements, historical results and percentage relationships set forth below arenot necessarily indicative of the results of operations for any futureperiod.  These forward-looking statementsare based on management’s current beliefs and expectations, some or all ofwhich 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 thatmay arise after the date of this report.

 

**OVERVIEW**

 

Ultratech, Inc. (referred to as “Ultratech”and “we”) develops, manufactures and markets photolithography and laser thermalprocessing equipment for manufacturers of semiconductor and nanotechnologycomponents located throughout North America, Europe, Japan and the rest ofAsia.

 

We supply step-and-repeat photolithographysystems based on one-to-one imaging technology. Within the semiconductorindustry, we target the market for advanced packaging applications.  Within the nanotechnology industry, ourtarget markets include thin film head magnetic recording devices, optical networkingdevices, laser diodes and LEDs (light emitting diodes).  Our laser thermal processing equipment istargeted at advanced annealing applications within the semiconductor industry.

 

**RESULTSOF OPERATIONS**

 

Wederive a substantial portion of our total net sales from sales of a relativelysmall number of newly manufactured systems, which typically range in price from$0.8 million to $3.9 million. As a result of these high sale prices, the timingand recognition of revenue from a single transaction has had and most likelywill continue to have a significant impact on our net sales and operatingresults for any particular period.

 

Ourbacklog at the beginning of a period typically does not include all of thesales needed to achieve our sales objectives for that period. In addition,orders in backlog are subject to cancellation, shipment or customer acceptancedelays, and deferral or rescheduling by a customer with limited or nopenalties. Consequently, our net sales and operating results for a period havebeen and will continue to be dependent upon our obtaining orders for systems tobe shipped and accepted in the same period in which the order is received. Ourbusiness and financial results for a particular period could be materiallyadversely affected if an anticipated order for even one system is not receivedin time to permit shipment and customer acceptance during that period.Furthermore, a substantial portion of our shipments have historically been madenear the end of each quarter. Delays in installation and customer acceptancedue, for example, to our inability to successfully demonstrate the agreed-uponspecifications or criteria at the customer’s facility, or to the failure of thecustomer to permit installation of the system at the agreed upon time, hascaused and may in the future cause net sales in a particular period to fallsignificantly below our expectations, which would materially adversely affectour operating results for that period. This risk is especially applicable 

 

11

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inconnection with the introduction and initial sales of a new product line.Additionally, the failure to receive anticipated orders or delays in shipmentsdue, for example, to rescheduling, delays, deferrals or cancellations bycustomers, additional customer configuration requirements, or to unexpectedmanufacturing difficulties or delays in deliveries by suppliers due to theirlong production lead times, have caused and may in the future cause net salesin a particular period to fall significantly below our expectations, materiallyadversely affecting our operating results for that period. In particular, thelong manufacturing cycles of our Saturn Spectrum family of wafer steppers,laser processing systems and the long lead time for lenses and other materials,could cause shipments of these products to be delayed from one quarter to thenext, which could materially adversely affect our financial condition andresults of operations for a particular quarter.

 

Additionally,the need for continued expenditures for research and development, capitalequipment, ongoing training and worldwide customer service and support, amongother factors, will make it difficult for us to reduce our operating expensesin a particular period if we fail to achieve our net sales goals for theperiod.

 

**Netsales**

 

**ThirdQuarter:**

 
| ** **        | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **    | ** ** |
|-------------------|------------|------------------------|------------|--------------|------------|---------------|------------|
| ** **        | ** ** | **Oct. 2,**            | ** ** | **Sep. 27,** | ** ** | **Amount of** | ** ** | **Percentage** | ** ** |
| **(in millions)** | ** ** | ** **             | **2004**   | ** **   | **2003**   | ** **    | **Change** | ** ** | **Change** | ** ** |
| Sales of:         | ** ** | ** **             | ** ** | ** **   | ** ** | ** **    | ** ** | ** ** | ** ** |
| Systems           |       | $                      | 24.9       |         | $          | 19.3          |       | $ | 5.6 |   | 29 | % |
| Spare parts       |       | 3.4                    |       | 3.4          |       | 0.0           |       | 0 | % |
| Services          |       | 3.2                    |       | 2.9          |       | 0.3           |       | 10 | % |
| Licenses          |       | 0.9                    |       | 0.9          |       | 0.0           |       | 0 | % |
| Total net sales   |       | $                      | 32.4       |         | $          | 26.5          |       | $ | 5.9 |   | 22 | % |
|                   |            |                        |            |              |            |               |            |  |  |  |  |  |  |  |

 

Netsales consist of revenues from system sales, spare parts sales, services andlicensing of technologies. System sales increased 29%, to $24.9 million, in thethird quarter of 2004 as compared to the third quarter of 2003 on steady unitvolumes.  Included in the current quarter’sresults was the sale of one laser processing system.  The increase in systems revenue was due to anincrease in the weighted-average selling prices of systems sold during thethird quarter of 2004 as compared to the same quarter in 2003.  The improved weighted average selling pricewas due to the sale in the third quarter of 2003 of two relatively lower pricedXLS reduction lithography systems, representing $0.9 million of revenue, whichhad been previously written off and a lower percentage of sales of refurbishedsystems in the third quarter of 2004. In the third quarter of 2004 and 2003,refurbished systems accounted for approximately 29% and 42%, respectively, ofunits sold. This percentage can fluctuate from quarter to quarter and, asrefurbished units generally have lower average selling prices than new units,any such fluctuation impacts the weighted average selling price of the systemssold.

 

Ona product market application basis, system sales to the semiconductor industry,primarily for advanced packaging applications, were $18.7 million for thequarter ended October 2, 2004, an increase of 26% when compared with systemsales to this market in the third quarter of 2003. The increase was due to thesale of a laser processing system and a lower percentage of refurbished systemssold in the third quarter of 2004 as compared to 2003 resulting in an increasein our weighted average selling price in 2004. These were offset partially by fewer units sold in total. System salesto the nanotechnology market were $6.2 million for the quarter ended October 2,2004, an increase of 41% as compared with system sales to this market in thethird quarter of 2003, as a result of increased volumes sold to thin film headcustomers.   The weighted average sellingprices of our sales to the nanotechnology market for the two periods were similar.

 

Spareparts sales for the third quarter of 2004 of $3.4 million were unchanged whencompared to the comparable period in 2003. Revenues from services increased10%, to $3.2 million for the third quarter of 2004, primarily as a result of anincrease in new contracts with existing customers in North America and Asia.

 

AtOctober 2, 2004, we had approximately $7.7 million of deferred revenueresulting from products shipped, but not yet installed and accepted, anddeferred services revenue, as compared with $5.3 million at July 3, 2004. The increasewas due to two more systems shipped but not yet recognized as revenue atOctober 2, 2004. Deferred revenue related to our products is recognized uponsatisfying the contractual obligations for installation and/or customeracceptance. During the third quarter of 2004, deferred license income decreasedby $0.9 million, to $2.0 million, as a result of amortization of proceedsreceived in prior periods. Amortization of deferred license income results incurrent period license revenue.  Weexpect license revenue to continue at its current level until it ends in Aprilof 2005.

 

12

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Forthe quarter ended October 2, 2004, international net sales were $18.6 million,or 57% of total net sales, as compared with $16.3 million, or 61% of total netsales for the third quarter of 2003. We expect sales to international customersto represent a significant majority of our revenues during the remainder of2004. Our revenue derived from sales in foreign countries is not generallysubject to significant exchange rate fluctuations, principally because salescontracts for our systems are generally denominated in U.S. dollars. In Japan,however, orders are often denominated in Japanese yen. For the quarter endedOctober 2, 2004, we recorded system sales in Japan of $7.7 million of which 20%were denominated in Japanese yen. This subjects us to the risk of currencyexchange rate fluctuations. We attempt to mitigate this risk by entering intoforeign currency forward exchange contracts for the period between when anorder is received and when it is recorded as revenue. After recording revenue,we use various mechanisms, such as foreign currency forward exchange contractsand natural hedges, to offset substantial portions of the gains or lossesresulting from exchange rate fluctuations associated with our Japanese yendenominated receivables. We had approximately $4.0 million of Japanese yendenominated receivables at October 2, 2004. International sales expose us to anumber of additional risks, beyond fluctuations in the value of localcurrencies relative to the U.S. dollar, which impact the relative cost ofownership of our products and, thus, the customer’s willingness to purchase ourproduct. (See “Additional Risk Factors: International Sales”).

 

**Year-To-Date:**

 
| ** **        | ** ** | **Nine Months Ended** | ** ** | ** **   | ** ** | ** **    | ** ** |
|-------------------|------------|-----------------------|------------|--------------|------------|---------------|------------|
| ** **        | ** ** | **Oct. 2,**           | ** ** | **Sep. 27,** | ** ** | **Amount of** | ** ** | **Percentage** | ** ** |
| **(in millions)** | ** ** | ** **            | **2004**   | ** **   | **2003**   | ** **    | **Change** | ** ** | **Change** | ** ** |
| Sales of:         | ** ** | ** **            | ** ** | ** **   | ** ** | ** **    | ** ** | ** ** | ** ** |
| Systems           |       | $                     | 61.4       |         | $          | 54.1          |       | $ | 7.3 |   | 13 | % |
| Spare parts       |       | 8.4                   |       | 8.5          |       | (0.1          | )          | -1 | % |
| Services          |       | 8.9                   |       | 8.0          |       | 0.9           |       | 11 | % |
| Licenses          |       | 2.8                   |       | 2.8          |       | 0.0           |       | 0 | % |
| Total net sales   |       | $                     | 81.5       |         | $          | 73.3          |       | $ | 8.2 |   | 11 | % |
|                   |            |                       |            |              |            |               |            |  |  |  |  |  |  |

 

Systemsales increased 13%, to $61.4 million, on a unit volume increase of 6%. Theweighted-average selling prices of systems sold during the first three quartersof 2004 increased 7% when compared to the same period in 2003. The improvedweighted average selling price was due to the sale during the comparable periodof 2003 of three relatively lower priced XLS reduction lithography systems,representing $1.4 million of revenue, which had been previously written off anda lower percentage of sales of refurbished systems in 2004. During the firstthree quarters of 2004 and 2003, refurbished systems accounted forapproximately 29% and 33%, respectively, of units sold. On a product marketapplication basis, system sales to the semiconductor industry, primarily foradvanced packaging applications, were $41.7 million for the first threequarters of 2004, an increase of 4% when compared with system sales to thismarket in the comparable period of 2003. This increase was due primarily to anincrease in the weighted average selling price resulting from a lowerpercentage of sales of refurbished systems in 2004. System sales to thenanotechnology market were $19.6 million for the first three quarters of 2004,an increase of 42% as compared with system sales to this market in thecomparable period of 2003, primarily as a result of increased sales to thinfilm head customers.

 

Spareparts sales for the first three quarters of 2004 were essentially unchangedfrom the comparable period in 2003. Revenues from services increased 11%, to$8.9 million for the first three-quarters of 2004, primarily as a result of anincrease in system relocations and general business activity by customers inAsia and new service contracts for existing customers in North America andAsia. Revenues from licensing and licensing support arrangements were unchangedat $2.8 million.

 

Forthe first three quarters of 2004, international net sales were $52.5 million,or 64% of total net sales, as compared with $44.8 million, or 61% of total netsales for the comparable period in 2003.

 

 

13

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**Gross profit (loss)**

 

Ona comparative basis, gross margins were 50.0% and 51.7% for the third quartersof 2004 and 2003, respectively. The decrease in gross margin was due to thefavorable impact in the third quarter of 2003 from the sale of two XLSreduction lithography systems that had been previously written down (1.3percentage points) and operational variances. For the first three quarters of2004 and 2003, gross margins were 48.3% and 45.9%, respectively.  The 2.4 percentage point improvement in grossmargin for the first three quarters of 2004 as compared to the first three quartersof 2003 was due primarily to increased production and service activity offsetpartially by the favorable impact in 2003 from the sale of 3 XLS reductionlithography systems which had been previously written down (0.7 percentagepoints).

 

Exclusiveof licensing revenues, gross margin was 48.6% for the quarter ended October 2,2004 as compared with 49.9% for the same period in 2003. Similarly, for thefirst three quarters of 2004, gross margin, exclusive of licensing revenues,was 46.6% as compared with 43.8% for the same period in 2003.   We believe disclosure of gross marginswithout reference to licensing revenues provides additional appropriatedisclosure to allow comparison of our product and service gross margins overtime because there is little, if any, cost of sales associated with ourlicensing revenues.  We expect licenserevenue to continue at its current level until it ends in April 2005.  Gross margins will be negatively impacted bythe discontinuance of license revenue at that time.

 

Ourgross profit as a percentage of sales has been and most likely will continue tobe significantly affected by a variety of factors, including the mix ofproducts sold; the introduction of new products, which typically have highermanufacturing costs until manufacturing efficiencies are realized and which aretypically discounted more than existing products until the products gain marketacceptance; the rate of capacity utilization; writedowns of inventory and openpurchase commitments; technology support and licensing revenues, which have noassociated cost of sales; product discounts, pricing and competition in ourtargeted markets; non-linearity of shipments during the quarter which canresult in manufacturing inefficiencies; the percentage of international sales,which typically have lower gross margins than domestic sales principally due tohigher field service and support costs; and start-up costs and inefficienciesassociated with the implementation of subcontracting arrangements.

 

**Operating Expenses**

 

Research,development and engineering expenses for the third quarter and the first threequarters of 2004 were $6.5 million and $18.9 million, respectively, an increaseof $0.9 million and $3.2 million, respectively, from the amounts reported forthe comparable periods of 2003. These increases were due to increasedinvestments in the development of our laser processing technologies and ournext generation 1X stepper products. As a percentage of net sales, research,development and engineering expenses decreased to 20.0% in the quarter endedOctober 2, 2004 as compared to 20.9% in the third quarter of 2003 as a resultof increased revenue.  For the firstthree quarters of 2004, research, development and engineering expensesincreased to 23.2% of revenue from 21.4% for the same period in 2003.

 

Selling, general, and administrative expenseswere $7.4 million and $21.7 million for the third quarter and the first threequarters of 2004, respectively, an increase of $1.1 million and $5.1 million,respectively, as compared with the comparable periods in 2003. As a percentageof net sales, selling, general, and administrative expenses decreased to 22.9%in the quarter ended October 2, 2004 as compared to 24.0% in the third quarterof 2003 as a result of increased revenue. For the first three quarters of 2004,selling, general, and administrative expenses increased to 26.6% of revenuefrom 22.7% for the same period in 2003. The increase in expenses in the thirdquarter of 2004 as compared to the third quarter of 2003 was due to increasedmarketing and sales activity primarily driven by our efforts in laserprocessing ($0.6 million), increased legal costs primarily related to our beinga plaintiff in a patent infringement lawsuit ($0.4 million), and other itemswhich in total increased $0.1 million. The increase in year-to-date expenses was due to increased marketing andsales activity primarily driven by our efforts in laser processing ($1.7million), increased legal costs primarily related to our being a plaintiff in apatent infringement lawsuit ($1.2 million), increased costs associated with ourcompliance with the Sarbanes-Oxley Act of 2002 and related SEC and Nasdaq rules($0.6 million), increased commission expense due to increased revenues ($0.4million), and other items which in total increased $1.2 million.

 

 

14

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**Interest and other income, net**

 
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **Oct. 2,**            | ** ** | **Sep. 27,**          | ** ** | **Oct. 2,** | ** ** | **Sep. 27,** | ** ** |
| **(in thousands)**             | ** ** | ** **             | **2004**   | ** **            | **2003**   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest income                |       | $                      | 935        |                  | $          | 1,087 |   | $ | 2,702 |   | $ | 3,377 |   |
| Other income (expense), net    |       | (71                    | )          | 30                    |       | (22 | ) | (88 | ) |
| Interest and other income, net |       | $                      | 864        |                  | $          | 1,117 |   | $ | 2,680 |   | $ | 3,289 |   |
|                                |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |

 

Interestincome was $0.9 million and $2.7 million for the third quarter and first threequarters of 2004, respectively, as compared with $1.1 million and $3.4 millionfor the comparable periods of 2003. The 2003 periods included interest incomereceived related to the settlement of a research and development tax creditclaim with the California Franchise Tax Board of $0.3 million. In addition tothis favorable item in 2003, the decrease noted in the 2004 year-to-date periodas compared to 2003 was due primarily to lower interest rates on ourinvestments. We presently maintain an investment portfolio with aweighted-average maturity of less than one year. Consequently, changes inshort-term interest rates have had a major impact on our interest income.Future changes in interest rates are expected to have a similar impact.

 

**Incometax expense**

 

Forthe three and nine months ended October 2, 2004, we recorded an income taxexpense of $0.2 million and $0.0 million, respectively, as compared to incometax benefits of $0.5 million and $0.1 million for the comparable periods in2003.  The 2004 periods include a $0.1million benefit related to the settlement of tax audit issues in the UnitedKingdom. The recording of an income tax benefit for the three and nine monthsended September 27, 2003 was due a special tax benefit of $0.3 million relatedto the settlement of a research and development tax credit claim with theCalifornia Franchise Tax Board, the recording of a $0.5 million benefit fromthe reversal of reserves associated with deferred tax assets carried on thebalance sheet of our Japanese subsidiary, partially offset by current periodtax expense.  We presently anticipatethat we will recognize income tax expense in 2004 of approximately 10% to 15%of pre-tax income, primarily as a result of foreign income taxes and federalalternative minimum tax. We believe that the tax rate in 2004 will besubstantially less than the statutory rate because of available federal netoperating loss carry-forwards.

 

Income taxes can be affected by estimates of whether,and within which jurisdictions, future earnings will occur and how and whencash is repatriated to the United States, combined with other aspects of anoverall income tax strategy. Additionally, taxing jurisdictions couldretroactively disagree with our tax treatment of certain items, and somehistorical transactions have income tax effects going forward. Accountingrules require these future effects to be evaluated using current laws,rules and regulations, each of which can change at any time and in anunpredictable manner. We believe we have adequately provided for any reasonablyforeseeable outcome related to these matters, and do not anticipate anymaterial earnings impact from their ultimate resolutions.

 

**Outlook**

 

Althoughwe believe that our served markets have generally strengthened during the lasttwelve months, the anticipated timing of orders, shipments and customeracceptances usually requires us to fill a number of production slots in anygiven quarter in order to meet our sales targets. If we are unsuccessful in ourefforts to secure those production orders, or if existing production orders aredelayed or cancelled, our results of operations will be materially adverselyimpacted. Accordingly, we may not be able to achieve or maintain our current orprior level of sales.  We presentlyexpect that net sales for the quarter ending December 31, 2004 will range froma 10% decrease to a 10% increase from the level of net sales reported for thethird quarter of 2004 of $32.4 million.

 

Becauseour net sales are subject to a number of risks, including risks associated withthe introduction of our new laser processing product line including delays incustomer acceptance, intense competition in the capital equipment industry,uncertainty relating to the timing and market acceptance of our products andthe condition of the macro-economy and the semiconductor industry, we may notexceed or maintain our current or prior level of net sales for any period inthe future. Additionally, we believe that the market acceptance and volumeproduction of our Saturn Spectrum 3e, our 300mm offerings, our laser processingsystems, our new generation of 1X steppers and our 1000 series family of wafersteppers, are of critical importance to our future financial results. AtOctober 2, 2004, these critical systems represented 88% of our backlog. To theextent that these products do not achieve or maintain significant sales due todifficulties involving manufacturing or engineering, the inability to reducethe current long manufacturing cycles for these products, competition, excesscapacity in the semiconductor or nanotechnology device industries, customeracceptances, or any other reason, our business, financial 

 

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conditionand results of operations would be materially adversely affected.

 

Webelieve that gross margin for the quarter ending December 31, 2004, will bebetween 48% and 51%, as compared to gross margin of 50% for the third quarterof 2004. Should our sales decline or not increase to the level expected, we mayincur a higher risk of inventory obsolescence and excess purchase commitments,which would materially adversely impact our results of operations.  New products generally have lower grossmargins until there is widespread market acceptance and until production andafter-sales efficiencies can be achieved. Should significant market demand failto develop for our laser processing systems, our business, financial conditionand results of operations may be materially adversely affected. In addition,higher installation costs associated with early sales of our new laserprocessing products could negatively affect our gross margins.

 

Wecontinue to invest significant resources in the development and enhancement ofour laser processing systems and technologies and our 1X products and relatedtechnologies. Further, we expect that selling, general and administrativeexpenses will continue to be impacted by the factors noted above in theexplanation of current period variances. As a result, for the three-month period ending December 31, 2004, wecurrently expect an operating margin of 0% to 10% and net income per sharebetween $0.00 and $0.15.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Netcash used in operating activities was $5.4 million for the first three quartersof 2004, as compared with net cash generated by operating activities of $8.5million for the comparable period in 2003. Net cash used in operatingactivities during the first three quarters of 2004 was attributable to anincrease in accounts receivable of $10.9 million resulting from highershipments in the third quarter of 2004 as compared to the fourth quarter of2003 and an increase in inventories of $3.8 million due to an increase inproduction in anticipation of increased shipments in the fourth quarter of 2004and the launching of new products.  Alsocontributing to the use of cash were an increase in our demonstration inventoryof $2.8 million as we made our new products available for customerdemonstrations, a decrease in deferred license income of $2.8 million as weamortized the unearned income to revenue, and a decrease in other liabilitiesof $1.2 million due primarily to the payment of taxes in foreignjurisdictions.  Partially offsettingthese uses of our cash were an increase in accounts payable of $5.1 millionreflecting our increased business levels, an increase in deferred product andservice income of $3.2 million due to an increase in shipments made but not yetrecognized as revenue as compared to the number of shipments made but not yetrecognized as revenue at December 31, 2003, net income of $1.1 million andnon-cash charges to income for depreciation and amortization of $6.6 million.We expect that accounts receivable, inventory and deferred product and servicesincome levels at December 31, 2004 will be similar to the levels currentlyreported.  Accounts payable is likely toincrease as the result of a leasehold improvement project during the fourthquarter of 2004 as we prepare our manufacturing facility for the production ofour new products.

 

Webelieve that because of the relatively long manufacturing cycle of certain ofour systems, particularly newer products, our inventories will continue torepresent a significant portion of working capital. Currently, we are devotingsignificant resources to the development, introduction and commercialization ofour laser processing systems and to the development of our next generation 1Xlithography technologies. We currently intend to continue to incur significantoperating expenses in the areas of research, development and engineering,manufacturing and selling, general and administrative costs in order to furtherdevelop, produce and support these new products. Additionally, gross profitmargins, inventory and capital equipment levels may be adversely impacted inthe future by costs associated with the initial production of our laserprocessing systems and by future generations of our 1X wafer steppers. Thesecosts include, but are not limited to, additional manufacturing overhead, costsof demonstration systems and facilities and the establishment of additionalafter-sales support organizations. Additionally, our operating expenses mayincrease, relative to sales, as a result of adding additional marketing andadministrative personnel, among other costs, to support our new products. If weare unable to achieve significantly increased net sales or if our sales fallbelow expectations, our cash flow and operating results will be materiallyadversely affected until, among other factors, costs and expenses can bereduced. Failure to achieve our sales targets for these new products couldresult in inventory write-offs and asset impairment charges, either of whichcould materially adversely impact our results of operations.

 

Duringthe first three quarters of 2004, net cash generated by investing activitieswas $14.1 million, attributable to a net decrease in available-for-salesecurities of $19.3 million offset partially by capital expenditures of $5.2million. We are planning to incur capital expenditures during the remainder of2004 of between $4 million and $6 million for equipment and facilityimprovements driven primarily by our new product introductions.

 

Netcash provided by financing activities was $7.8 million during the first threequarters of 2004, attributable to borrowings under our credit facility andproceeds received from the issuance of common stock under our employee stockoption and 

 

 

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stockpurchase plans of $2.4 million .

 

AtOctober 2, 2004, we had working capital of $171.7 million. Our principal sourceof liquidity at October 2, 2004 consisted of $153.6 million in cash, cashequivalents and short-term investments net of our borrowings under our line ofcredit.

 

InSeptember 2002, we entered into a line of credit agreement with abrokerage firm. Under the terms of this agreement, we may borrow funds at acost equal to the current Federal funds rate plus 100 basis points (2.75% as ofOctober 2, 2004). Certain of our cash, cash equivalents and short-terminvestments secure borrowings outstanding under this facility. Funds areadvanced 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 noset expiration date and there are no loan covenants. As of October 2, 2004,$7.9 million was outstanding under this facility, with a related collateralrequirement of approximately $11.3 million of our cash, cash equivalents andshort-term investments.

 

Thedevelopment and manufacture of new lithography systems and enhancements ishighly capital-intensive. In order to be competitive, we believe we mustcontinue to make significant expenditures for capital equipment; sales,service, training and support capabilities; systems, procedures and controls;expansion of operations; and research and development, among many other items.We expect that cash generated from operations and our cash, cash equivalentsand short-term investments will be sufficient to meet our cash requirements forat least the next twelve months. However, in the near-term, we may continue toutilize existing and future lines of credit, and other sources of financing, inorder to maintain our present levels of cash, cash equivalents and short-term investments.Beyond the next twelve months, we may require additional equity or debtfinancing to address our working capital or capital equipment needs. Inaddition, we may seek to raise equity or debt capital at any time that we deemmarket conditions to be favorable. Additional financing, if needed, may not beavailable on reasonable terms, or at all.

 

Wemay in the future pursue acquisitions of complementary product lines,technologies or businesses. Future acquisitions by us may result in potentiallydilutive issuances of equity securities, the incurrence of debt and contingentliabilities and amortization expenses and impairment charges related togoodwill and other intangible assets, which could materially adversely affectour financial condition and results of operations. In addition, acquisitionsinvolve numerous risks, including difficulties in the assimilation of theoperations, technologies, personnel and products of the acquired companies; thediversion of management’s attention from other business concerns; risks ofentering markets in which we have limited or no direct experience; and thepotential loss of key employees of the acquired company. In the event weacquire product lines, technologies or businesses which do not complement ourbusiness, or which otherwise do not enhance our sales or operating results, wemay incur substantial write-offs and higher recurring operating costs, whichcould have a material adverse effect on our business, financial condition andresults of operations. In the event that any such acquisition does occur, therecan be no assurance as to the effect thereof on our business or operatingresults.

 

**Foreigncurrency**

 

Aspart of our overall strategy to manage the level of exposure to the risk offoreign currency exchange rate fluctuations, we attempt to hedge most of ourJapanese yen denominated foreign currency exposures. We use foreign currencyforward exchange contracts to hedge the risk that unremitted Japanese yendenominated receipts from customers for actual or forecasted sales of equipmentafter receipt of customer orders may be adversely affected by changes inforeign currency exchange rates. After recording revenue, we use variousmechanisms, such as foreign currency forward exchange contracts and naturalhedges, to offset substantial portions of the potential gains or lossesassociated with our Japanese yen denominated receivables and liabilities due toexchange rate fluctuations. At October 2, 2004, we had taken action to hedgeapproximately all of these Japanese yen denominated exposures. In addition tonatural hedges resulting from having both assets and liabilities denominated inJapanese yen, we hedge our exposures by entering into foreign currency forwardcontracts that generally have maturities of nine months or less. We often closeforeign currency forward exchange contracts by entering into offsettingcontracts. At October 2, 2004, we had open contracts for the sale of $8.9million of foreign currencies at fixed rates of exchange.  At October 2, 2004, we had no open contractsto purchase foreign currencies.

 

**ADDITIONALRISK FACTORS**

 

*In addition to risks described inthe foregoing discussions, the following risks apply to us and our business:*

 

**LengthySales Cycles **Sales of oursystems depend, in significant part, upon the decision of a prospectivecustomer to increase manufacturing capacity or to restructure currentmanufacturing facilities, either of which typically involves a significantcommitment of capital. Many of our customers in the past have cancelled thedevelopment of new manufacturing facilities and have substantially reducedtheir capital equipment budgets. In view of the significant investment involvedin a 

 

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systempurchase, we have experienced and may continue to experience delays followinginitial qualification of our systems as a result of delays in a customer’sapproval process. Additionally, we are presently receiving orders for systemsthat have lengthy delivery schedules, which may be due to longer productionlead times or a result of customers’ capacity scheduling requirements. Forthese and other reasons, our systems typically have a lengthy sales cycleduring which we may expend substantial funds and management effort in securinga sale. Lengthy sales cycles subject us to a number of significant risks,including inventory obsolescence and fluctuations in operating results, overwhich we have little or no control. In order to maintain or exceed our presentlevel of net sales, we are dependent upon obtaining orders for systems thatwill ship and be accepted in the current period.

 

**Development of New ProductLines; Expansion of Operations **Currently, weare devoting significant resources to the development, introduction andcommercialization of our laser processing systems and next generation 1Xstepper products and to enhancements of our Saturn Spectrum 3e and SaturnSpectrum 300e2 wafer steppers. We intend to continue to developthese products and technologies during the remainder of 2004 and 2005, and toincur significant operating expenses in the areas of research, development andengineering, manufacturing and general and administrative costs in order tofurther develop, produce and support these new products. Additionally, grossprofit margins and inventory levels may be further adversely impacted in thefuture by costs associated with the initial production of our laser processingsystems and by future generations of our 1X lithography systems. Introductionof new products generally involves higher installation costs and productperformance uncertainties that could delay customer acceptance of our systems,resulting in a delay in recognizing revenue associated with those systems and areduction in gross margins. These costs include, but are not limited to,additional manufacturing overhead, additional inventory write-offs, costs ofdemonstration systems and facilities, and costs associated with theestablishment of additional after-sales support organizations. Additionally,operating expenses may increase, relative to sales, as a result of addingadditional marketing and administrative personnel, among other costs, tosupport our new products. If our new products do not result in significantlyincreased net sales or if our sales fall below expectations, our operatingresults will be materially adversely affected.

 

Ourability to commercialize our laser processing technologies depends on ourability to demonstrate a manufacturing-worthy tool. We do not presently havein-house capability to fabricate semiconductor devices. As a result, we mustpartner with semiconductor companies to develop the anneal process. Thedevelopment of new process technologies is largely dependent upon our abilityto interest potential customers in working on joint process development. Ourability to deliver timely solutions is also limited by wafer turnaround at thepotential customer’s fabrication facility.

 

**IntellectualProperty Rights **Although weattempt to protect our intellectual property rights through patents, copyrights,trade secrets and other measures, we believe that our success will depend moreupon the innovation, technological expertise and marketing abilities of ouremployees. Nevertheless, we have a policy of seeking patents when appropriateon inventions resulting from our ongoing research and development andmanufacturing activities. We own 89 U. S. and foreign patents, which expire ondates ranging from June 2006 to November 2022 and have 81 U. S. and foreignpatent applications pending. We also have various registered trademarks andcopyright registrations covering mainly software programs used in the operationof our systems. In addition, we rely upon trade secret protection for ourconfidential and proprietary information. We may not be able to protect ourtechnology adequately and competitors may be able to develop similar technologyindependently. Our pending patent applications may not result in a patent beingissued and U.S. or foreign intellectual property laws may not protect ourintellectual property rights. In addition, litigation may be necessary toenforce our patents, copyrights or other intellectual property rights, toprotect our trade secrets, to determine the validity and scope of theproprietary rights of others or to defend against claims of infringement. Suchlitigation has resulted in, and in the future could result in, substantialcosts and diversion of resources and could have a material adverse effect onour business, financial condition and results of operations, regardless of theoutcome of the litigation. Patents issued to us may be challenged, invalidatedor circumvented and the rights granted thereunder may not provide competitiveadvantages to us. Furthermore, others may independently develop similartechnology or products or design around our patents. Challenges to, orinvalidation of, patents related to our technologies would expose us to therisk of forfeiture of revenues and further risk of damage claims.

 

OnFebruary 29, 2000, we filed lawsuits asserting patent infringement andrelated claims against Nikon, Canon, and ASML in the U.S. District Court forthe Eastern District of Virginia. In April 2000, we reached a settlementwith Nikon, and in September 2001, we reached a settlement with Canon. Thepatent litigation against ASML is ongoing after having been transferred to theNorthern District of California. After the District Court made a preliminarydetermination that ASML did not infringe the patent, we appealed the decisionto the Court of Appeals for the Federal Circuit in Washington, D.C.  The Court of Appeals reversed the preliminarydetermination of the District Court, ruling in our favor, and remanded the caseback to the District Court in Northern California for further proceedings.

 

Weare involved in other lawsuits and legal actions regarding infringement claimsthat we believe not to be material to our business or financial condition.Additionally, we have from time to time been notified of claims that we may beinfringing 

 

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intellectualproperty rights possessed by third parties.

 

Infringementclaims by third parties or claims for indemnification resulting frominfringement claims may be asserted in the future and such assertions, ifproven to be true, may materially adversely affect our business, financialcondition and results of operations, regardless of the outcome of anylitigation. With respect to any such future claims, we may seek to obtain alicense under the third party’s intellectual property rights. However, alicense may not be available to us on reasonable terms or at all. We coulddecide, in the alternative, to resort to litigation to challenge such claims.Such challenges could be expensive and time consuming and could materiallyadversely affect our business, financial condition and results of operations,regardless of the outcome of any litigation.

 

**Cyclicality ofSemiconductor, Semiconductor Packaging and Nanotechnology Industries** Our business depends in significant part uponcapital expenditures by******manufacturersof semiconductors, bumped semiconductors and nanotechnology components,including thin film head magnetic recording devices, which in turn depend uponthe current and anticipated market demand for such devices and productsutilizing such devices. The semiconductor industry historically has been highlycyclical and has experienced recurring periods of oversupply. This has, fromtime to time, resulted in significantly reduced demand for capital equipmentincluding the systems manufactured and marketed by us. We believe that marketsfor new generations of semiconductors and semiconductor packaging will also besubject to similar fluctuations. Our business and operating results would bematerially adversely affected by downturns or slowdowns in the semiconductor,semiconductor packaging or nanotechnology markets or by loss of market share.Accordingly, we may not be able to achieve or maintain our current or priorlevel of sales.

 

Weattempt to mitigate the risk of cyclicality by offering products in multiplemarkets including semiconductor, semiconductor packaging, thin film head andother nanotechnology sectors, as well as diversifying into new markets such asphotolithography for optical networking (a nanotechnology application) andlaser-based annealing for implant activation and other applications. Despitesuch efforts, when one or more of such markets experiences a downturn or asituation of excess capacity, our net sales and operating results arematerially adversely affected.

 

**HighlyCompetitive Industry** The capital equipment industry in which we operateis intensely competitive. A substantial investment is required to install andintegrate capital equipment into a semiconductor, semiconductor packaging ornanotechnology device production line. We believe that once a devicemanufacturer or packaging subcontractor has selected a particular vendor’scapital equipment, the manufacturer generally relies upon that equipment forthe 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 vendor’scapital equipment has been selected.

 

Weexperience competition in advanced packaging from various proximity alignercompanies such as Suss Microtec AG (Suss Microtec) and projection companiessuch as Ushio, Inc. and Tamarack Scientific Co., Inc.. Innanotechnology, we experience competition from proximity aligner companies,such as Suss Microtec, as well as other stepper manufacturers who havedeveloped or are developing tools specifically designed for nanotechnologyapplications. We expect our competitors to continue to improve the performanceof their current products and to introduce new products with improved price andperformance characteristics. This could cause a decline in sales or loss ofmarket share in our served markets, and thereby materially adversely affect ourbusiness, financial condition and results of operations. Enhancements to, orfuture generations of, competing products may be developed that offer superiorcost of ownership and technical performance features.

 

Withrespect to our laser annealing technologies, marketed under the LSA100 productname, our primary competition comes from companies that offer productsutilizing rapid thermal processing (RTP), which currently is theprevailing  manufacturing technology.Another potential advanced annealing solution utilizes flash lamp annealingtechnology (FLA). Several companies have published papers on annealing toolsthat incorporate flash lamp technology in order to reduce annealing times andincrease anneal temperatures. Developers of flash lamp annealing (FLA)technology claim to have overcome annealing difficulties at the 65nm node.Additionally, competition to our laser processing products may come from otherlaser annealing tools, including those presently being used by the flat paneldisplay industry to re-crystallize silicon. Manufacturers of these tools maytry to extend the use of their technologies to semiconductor deviceapplications.  We believe customers willchoose between these technology alternatives based on their assessment of acombination of price and performance benefits for their specific applications.

 

InJuly 2000, we licensed certain rights to our then existing laserprocessing technology, with reservations, to a competing manufacturer ofsemiconductor equipment. We presently anticipate this company will offer laserannealing tools to the semiconductor industry that will compete with ourofferings.

 

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Webelieve that to be competitive, we will require significant financial resourcesin order to continue to invest in new product development, in new features andenhancements to existing products, to introduce new generation stepper systemsin our served markets on a timely basis, and to maintain customer service andsupport centers worldwide. In marketing our products, we may also facecompetition from vendors employing other technologies. In addition, increasedcompetitive pressure has led to intensified price-based competition in certainof our markets, resulting in lower prices and margins. Should these competitivetrends continue, our business, financial condition and operating results may bematerially adversely affected. We may not be able to compete successfully inthe future.

 

**Customerand Market Concentrations **Historically,we have sold a substantial portion of our systems to a limited number ofcustomers. In the third quarter and first three quarters of 2004, fivecustomers represented approximately 76% and 40% of our system revenue,respectively.  At October 2, 2004, thetop five customers for the third quarter and first three quarters of 2004represented 49% and 38%, respectively, of the accounts receivable.  In 2003, Intel Corporation accounted for 26%of our net sales but less than 10% of accounts receivable at December 31, 2003.At October 2, 2004, four customers accounted for 36% of our system backlog.Cancellation, deferrals or rescheduling of orders by any of these customerswould have a material adverse impact on our future results of operations.

 

Weexpect that sales to a relatively few customers will continue to account for ahigh percentage of our net sales in the foreseeable future and believe that ourfinancial results depend in significant part upon the success of these majorcustomers and our ability to meet their future capital equipment needs.Although the composition of the group comprising our largest customers may varyfrom period to period, the loss of a significant customer or any reduction inorders by a significant customer, including reductions due to market, economicor competitive conditions in the semiconductor, semiconductor packaging or nanotechnologyindustries or in the industries that manufacture products utilizing integratedcircuits, thin film heads or other nanotechnology components, would likely havea material adverse effect on our business, financial condition and results ofoperations. Our ability to maintain or increase our sales in the futuredepends, in part, on our ability to obtain orders from new customers as well asthe financial condition and success of our existing customers, thesemiconductor and nanotechnology industries and the economy in general.

 

Inaddition to the business risks associated with dependence on a small number ofmajor customers, these significant customer concentrations have in the pastresulted in significant concentrations of accounts receivable. These significantand concentrated receivables expose us to additional risks, including the riskof default by one or more customers representing a significant portion of ourtotal receivables. If any of our major customers were unable or unwilling topay or if we were required to take additional accounts receivable reserves, ourbusiness, financial condition and results of operations would be materiallyadversely affected.

 

Ona market application basis, sales to the semiconductor industry, primarily foradvanced packaging applications, accounted for approximately 68% and 75% ofsystem revenue for the first three quarters of 2004 and the year endedDecember 31, 2003, respectively. During the first three-quarters of 2004and for the full year 2003, approximately 32% and 25%, respectively, of oursystems revenue was derived from sales to nanotechnology manufacturers,including micro systems, thin film head and optical networking devicemanufacturers. Our future results of operations and financial condition wouldbe materially adversely impacted by a downturn in any of these market segments,or by loss of market share in any of these segments.

 

**International Sales **International net salesaccounted for approximately 64% and 61% of total net sales for the first threequarters of 2004 and the year ended December 31, 2003, respectively. Weanticipate that international sales, which typically have lower gross marginsthan domestic sales, principally due to increased competition and higher fieldservice and support costs, will continue to account for a significant majorityof total net sales. As a result, a significant portion of our net sales willcontinue to be subject to certain risks, including unexpected changes inregulatory requirements; difficulty in satisfying existing regulatoryrequirements; exchange rate fluctuations; tariffs and other barriers; politicaland economic instability; difficulties in accounts receivable collections;natural disasters; some dependence on outside sales representativeorganizations; difficulties in staffing and managing foreign subsidiary andbranch operations; and potentially adverse tax consequences.

 

Althoughwe generally transact our international sales in U.S. dollars, internationalsales expose us to a number of additional risks, including fluctuations in thevalue of local currencies relative to the U.S. dollar, which, in turn, impactthe relative cost of ownership of our products and may further impact thepurchasing ability of our international customers. However, in Japan, we have adirect sales operation and orders are often denominated in Japanese yen. Thismay subject us to a higher degree of risk from currency exchange ratefluctuations. We attempt to mitigate this exposure through the use of foreignexchange forward contracts. We are also subject to the risks associated withthe imposition of legislation and regulations relating to the import or exportof semiconductors and nanotechnology products. We cannot predict whether theUnited 

 

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States,Japan or any other country will implement changes to quotas, duties, taxes orother charges or restrictions upon the importation or exportation of ourproducts. These factors, or the adoption of restrictive policies, may have amaterial adverse effect on our business, financial condition and results ofoperations.

 

**Changes to FinancialAccounting Standards May****Affect the Company’s ReportedResults of Operations **We prepare ourfinancial statements in conformity with U.S. generally accepted accountingprinciples, or U.S. GAAP. These principles are subject to interpretation by theAmerican Institute of Certified Public Accountants, the SEC and various bodiesformed to interpret and create appropriate accounting policies. A change inthose policies can have a significant effect on our reported results and mayaffect our reporting of transactions completed before a change is announced.

 

Accountingpolicies affecting many other aspects of our business, includingrules relating to revenue recognition, off-balance sheet transactions,employee stock options, restructurings, asset disposals, intangible assets,derivative and other financial instruments, and in-process research anddevelopment charges, have recently been revised or are under review. Changes tothose rules or the questioning of how we interpret or implement thoserules may have a material adverse effect on our reported financial results oron the way we conduct business. In addition, our preparation of financialstatements in accordance with U.S. GAAP requires that we make estimates andassumptions that affect the recorded amounts of assets and liabilities,disclosure of those assets and liabilities at the date of the financialstatements and the recorded amounts of expenses during the reporting period. Achange in the facts and circumstances surrounding those estimates could resultin a change to our estimates and could impact our future operating results.

 

**Rapid Technological Change;Importance of Timely Product Introduction **The semiconductor and nanotechnology manufacturingindustries are subject to rapid technological change and new productintroductions and enhancements. Our ability to be competitive in these andother markets will depend, in part, upon our ability to develop new and enhancedsystems and related software tools, and to introduce these systems and relatedsoftware tools at competitive prices and on a timely and cost-effective basisto enable customers to integrate them into their operations either prior to oras they begin volume product manufacturing. We will also be required to enhancethe performance of our existing systems and related software tools. Any successwe may have in developing new and enhanced systems and related software toolsdepends upon a variety of factors, including product selection, timely andefficient completion of product design, timely and efficient implementation ofmanufacturing and assembly processes, product performance in the field andeffective sales and marketing. Because new product development commitments mustbe made well in advance of sales, new product decisions must anticipate bothfuture demand and the technology that will be available to supply that demand.There can be no assurance that we will be successful in selecting, developing,manufacturing or marketing new products and related software tools or enhancingour existing products and related software tools. Any such failure wouldmaterially adversely affect our business, financial condition and results ofoperations.

 

Becauseof the large number of components in our systems, significant delays can occurbetween a system’s introduction and when we commence volume production of suchsystems. We have experienced delays from time to time in the introduction of,and technical and manufacturing difficulties with, certain of our systems andenhancements and related software features and options, and may experiencedelays and technical and manufacturing difficulties in future introductions orvolume production of new systems or enhancements and related software featuresand options.

 

Wemay encounter additional technical, manufacturing or other difficulties thatcould further delay future introductions or volume production of systems orenhancements. Our inability to complete the development or meet the technicalspecifications of any of our systems or enhancements and related softwaretools, or our inability to manufacture and ship these systems or enhancementsand related software tools in volume and in time to meet the requirements for manufacturingthe future generation of semiconductor or nanotechnology devices wouldmaterially adversely affect our business, financial condition and results ofoperations. In addition, we may incur substantial unanticipated costs to ensurethe functionality and reliability of our products early in the products’ lifecycles. If new products have reliability or quality problems, reduced orders orhigher manufacturing costs, delays in customer acceptance, recognition ofrevenue and collecting accounts receivable and additional service and warrantyexpenses may result. Any such event could materially adversely affect ourbusiness, financial condition and results of operations.

 

**Sole orLimited Sources of Supply **Ourmanufacturing activities consist of assembling and testing components andsubassemblies, which are then integrated into finished systems. We rely on alimited number of outside suppliers and subcontractors to manufacture certaincomponents and subassemblies. We order one of the most critical components ofour technology, the glass for our 1X lenses, from external suppliers. We designthe 1X lenses and provide the lens specifications and the glass to othersuppliers, who then manufacture the lens elements. We then assemble the lenselements and test the completed optical 1X lenses.

 

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Weprocure some of our other critical systems’ components, subassemblies andservices from single outside suppliers or a limited group of outside suppliersin order to ensure overall quality and timeliness of delivery. Many of thesecomponents and subassemblies have significant production lead times. To date,we have been able to obtain adequate services and supplies of components andsubassemblies for our systems in a timely manner. However, disruption ortermination of certain of these sources could result in a significant adverseimpact on our ability to manufacture our systems. This, in turn, would have amaterial adverse effect on our business, financial condition and results ofoperations. Our reliance on a sole or a limited group of suppliers and ourreliance on subcontractors involve several risks, including a potentialinability to obtain an adequate supply of required components due to thesuppliers’ failure or inability to provide such components in a timely manner,or at all, and reduced control over pricing and timely delivery of components.Although the timeliness, yield and quality of deliveries to date from oursubcontractors have been acceptable, manufacture of certain of these componentsand subassemblies is an extremely complex process, and long lead-times arerequired. Any inability to obtain adequate deliveries or any other circumstancethat would require us to seek alternative sources of supply or to manufacturesuch components internally could delay our ability to ship our products, whichcould damage relationships with current and prospective customers and have amaterial adverse effect on our business, financial condition and results ofoperations.

 

**Dependence on KeyPersonnel **Our futureoperating results depend, in significant part, upon the continued contributionsof key personnel, many of whom would be difficult to replace. We have enteredinto employment agreements with only a limited number of our employees,including our Chief Executive Officer, President and Chief Operating Officer,and Chief Financial Officer, and our employees are employed “at will.” Theseemployment agreements contain vesting acceleration and severance paymentprovisions that could result in significant costs or charges to us should theemployee be terminated without cause, die or have a disability. We do notmaintain any life insurance on any of our key people. The loss of key personnelcould have a material adverse effect on our business, financial condition andresults of operations. In addition, our future operating results depend insignificant part upon our ability to attract and retain other qualifiedmanagement, manufacturing, technical, sales and support personnel for our operations.There are only a limited number of people with the requisite skills to serve inthese positions and it may become increasingly difficult for us to hire suchpersonnel over time. At times, competition for such personnel has been intense,particularly in the San Francisco Bay Area where we maintain our headquartersand principal operations, and there can be no assurance that we will besuccessful in attracting or retaining such personnel. The failure to attract orretain such persons would materially adversely affect our business, financialcondition and results of operations.

 

**Volatility of Stock Priceand Dilutive Impact of Employee Stock Options **We believe that factors such as announcements ofdevelopments related to our business, fluctuations in our operating results, ashortfall in revenue or earnings, changes in analysts’ expectations, generalconditions in the semiconductor and nanotechnology industries or the worldwideor regional economies, sales of our securities into the marketplace, an outbreakor escalation of hostilities, announcements of technological innovations or newproducts or enhancements by us or our competitors, developments in patents orother intellectual property rights and developments in our relationships withour customers and suppliers could cause the price of our common stock tofluctuate, perhaps substantially. The market price of our common stock hasfluctuated significantly in the past and we expect it to continue to experiencesignificant fluctuations in the future, including fluctuations that may beunrelated to our performance.

 

Asof October 29, 2004, we had options to purchase approximately 6.2 millionshares of common stock outstanding. Among other determinants, the market priceof our stock has a major bearing on the number of shares subject to outstandingstock options that are included in the weighted-average shares used indetermining our net income (loss) per share. During periods of extremevolatility, the impact of higher stock prices can have a materially dilutiveeffect on our net income (loss) per share (diluted).****Additionally,options are excluded from the calculation of net income (loss) per share whenwe have a net loss or when the exercise price of the stock option is greaterthan the average market price of our common stock, as the impact of the stockoptions would be anti-dilutive.

 

**Effects of CertainAnti-Takeover Provisions **Certainprovisions of our Certificate of Incorporation, equity incentive plans,Shareholder Rights Plan, licensing agreements, Bylaws and Delaware law maydiscourage certain transactions involving a change in control 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 deemedaffiliates and the ability of the Board of Directors to issue “blank check”preferred stock without further stockholder approval could have the effect ofdelaying, deferring or preventing a change in control of the Company and mayadversely affect the voting and other rights of holders of Common Stock.

 

**CaliforniaManufacturing Location **We perform allof our manufacturing activities (final assembly, system testing and certainsubassembly) in clean room environments totaling approximately 26,000 squarefeet located in San Jose, California. Performing manufacturing operations inCalifornia exposes us to a higher risk of natural disasters, includingearthquakes. In addition, in the past California has experienced powershortages, which have interrupted our operations.  Such shortages 

 

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couldoccur in the future and could again interrupt our operations resulting inproduct shipment delays, increased costs and other problems, any of which couldhave a material adverse effect on our business, customer relationships andresults or operations. We are not insured against natural disasters and powershortages and the occurrence of such an event could materially adversely impactour results of operations.

 

**EnvironmentalRegulations **We are subjectto a variety of governmental regulations relating to the use, storage,discharge, handling, emission, generation, manufacture and disposal of toxic orother hazardous substances used to manufacture our systems. We believe that weare currently in compliance in all material respects with such regulations andthat we have obtained all necessary environmental permits to conduct ourbusiness. Nevertheless, the failure to comply with current or futureregulations could result in substantial fines being imposed on us, suspensionof production, alteration of the manufacturing process or cessation ofoperations. Such regulations could require us to acquire expensive remediationequipment or to incur substantial expenses to comply with environmentalregulations. Any failure by us to control the use, disposal or storage of, oradequately restrict the discharge of, hazardous or toxic substances couldsubject us to significant liabilities.

 

**Terrorist Attacks andThreats, and Government Responses Thereto, May****NegativelyImpact Our Operations, Revenues, Costs and Stock Price. **Terrorist attacks in theUnited States and elsewhere, government responses thereto, and military actionsin Iraq, Afghanistan and elsewhere, may disrupt our operations or those of ourcustomers and suppliers and may affect the availability of materials needed tomanufacture our products or the means to transport those materials tomanufacturing facilities and finished products to customers. In addition, anyof these events could increase volatility in the United States and worldfinancial markets which may depress the price of our common stock and may limitthe capital resources available to us or our customers or suppliers, whichcould result in decreased orders from customers, less favorable financing termsfrom suppliers, and scarcity or increased costs of materials and components ofour products. Additionally, terrorist attacks directly on Ultratech or ourcustomers or suppliers may significantly disrupt our ability to conduct ourbusiness. Any of these occurrences could have a significant impact on ouroperating results, revenues and costs and may result in increased volatility ofthe market price of our common stock.

 

**Information Available on CompanyWeb-site**

 

Our web-site is located at www.ultratech.com.We make available, free of charge, through our web-site, our annual report onForm 10-K, quarterly reports on Form 10-Q, Form 3, 4 and 5 filings and currentreports on Form 8-K (and amendments to those reports), as soon as reasonablypracticable after such reports are filed with the SEC.

 

**Item 3.****                                  ****Quantitative and QualitativeDisclosures about Market Risk**

 

Referenceis made to Part II, Item 7A, “Quantitative and Qualitative Disclosures AboutMarket Risk” in our Annual Report on Form 10-K for the year endedDecember 31, 2003 and to the subheading “Derivative Instruments andHedging” in Item 8, “Financial Statements and Supplementary Data”, under theheading “Notes to Consolidated Financial Statements” of our Annual Report onForm 10-K for the year ended December 31, 2003.

 

**Interestrate risk**

 

Ourexposure to market risk due to potential changes in interest rates relatesprimarily to our investment portfolio, which consisted primarily of fixedinterest rate instruments as of October 2, 2004. These instruments are held forpurposes other than trading. We maintain an investment policy designed toensure the safety and preservation of our invested funds by limiting marketrisk and the risk of default.

 

**ForeignCurrency Risk Management**

 

Themajority of our revenue, expense and capital purchasing activities aretransacted in U.S. dollars. However, we do enter into these transactions inother currencies, primarily Japanese Yen. To protect against reductions invalue and the volatility of future cash flows caused by changes in currencyexchange rates, we have established transaction and balance sheet hedgingprograms. We use foreign currency forward contracts to hedge the risk thatunremitted Japanese yen denominated receipts from customers for actual orforecasted sales of equipment after receipt of customer orders may be adverselyaffected by changes in foreign currency exchange rates. At October 2, 2004, wehad taken action to hedge approximately all of these Japanese yen denominatedexposures. To hedge this exposure, we enter into foreign currency forwardexchange contracts that generally have maturities of nine months or less. Weoften close foreign currency forward exchange contracts by entering intooffsetting contracts. At October 2, 2004, we had open contracts for the sale of$8.9 million of foreign currencies at fixed rates of exchange. We had no opencontracts to purchase any foreign currencies. Our hedging programs reduce, but do not 

 

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alwaysentirely eliminate, the impact of currency movements.

 

**Item 4.****                                  ****Controls and Procedures**

 

We conducted an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), as of the end of theperiod covered by this report (the “Evaluation Date”).  Based upon the evaluation, our principalexecutive officer and principal financial officer concluded as of theEvaluation Date that our disclosure controls and procedures were effective toensure that information required to be disclosed by us in reports that we fileor submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms.

 

Disclosure controls and procedures arecontrols and other procedures that are designed to ensure that informationrequired to be disclosed in our reports filed or submitted under the ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms. Disclosure controls and proceduresinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Exchange Act is accumulated and communicated to management to allow timelydecisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, our management recognizes that any controlsand procedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives. Management isfurther required to apply judgment in evaluating the cost-benefit relationshipof possible controls and procedures.

 

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**PART 2:****            OTHER INFORMATION**

 

**Item 1****.                LegalProceedings**.

 

OnFebruary 29, 2000, we filed lawsuits asserting patent infringement andrelated claims against Nikon, Canon, and ASML in the U.S. District Court forthe Eastern District of Virginia. In April 2000, we reached a settlementwith Nikon, and in September 2001, we reached a settlement with Canon. Thepatent litigation against ASML is ongoing after having been transferred to theNorthern District of California. After the District Court made a preliminarydetermination that ASML did not infringe the patent, we appealed the decisionto the Court of Appeals for the Federal Circuit in Washington, D.C.  The Court of Appeals reversed the preliminarydetermination of the District Court, ruling in our favor, and remanded the caseback to the District Court in Northern California for further proceedings.

 

Weare involved in other lawsuits and legal actions that we believe are notmaterial to our business or financial condition.

 

**Item 2****.                UnregisteredSales of Equity Securities and Use of Proceeds.**

** **

In August 2004, we issued1,250 shares of our common stock in an unregistered, private placement underSection 4(2) of the Securities and Exchange Act of 1933 to SemiconductorEquipment and Materials International (SEMI), a non-profit global tradeorganization, to support their efforts to educate youth interested in scienceand math about career opportunities in the semiconductor industry.  

 

**Item 3****.                ****Defaults upon Senior Securities.                                                                                        **None.

 

**Item 4****.                Submissionof Matters to a Vote of Security Holders.                                                     **None

 

**Item 5****.                OtherInformation.                                                                                                              **None

 
| **Item 6** | **Exhibits** |
|------------|--------------|
|       | ** **   |
|       | **Exhibits** |
|       |         |   |
| 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 pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant   to Section 906 of the Sarbanes-Oxley Act of 2002. |
|       |         |   |
| 32.2       |         |   | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant   to Section 906 of the Sarbanes-Oxley Act of 2002. |
|            |              |  |  |  |

 

 

 

 

 

 

 

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** **

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                              | **ULTRATECH, INC.** |                                                |
|-----------------------------------|---------------------|-----------------------------------------------------|
| (Registrant)                      |
|                              |                |
| Date:                             | November  5, 2004   |                                                | By: | /s/Bruce  R. Wright |   |
|                              |                | Bruce  R. Wright                                    |
|                              |                | Senior  Vice President, Finance and Chief Financial |
|                              |                | Officer  (Duly Authorized Officer and Principal     |   |
| Financial and Accounting Officer) |
|                                   |                     |                                                     |  |  |  |  |  |

 

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**EXHIBITINDEX**

 
| 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 pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                           |
| 32.2   |   | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

 

 

 

 

 

 

 

 

 

 

 

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