** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D. C.  20549**

** **

**FORM 10-K**

** **

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** **

x  **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**      SECURITIES EXCHANGE ACT OF1934**

** **

**For the Fiscal Year Ended: December 31, 2007**

 

**OR**

** **

o   **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**      SECURITIES EXCHANGE ACT OF1934**

 

**Commission File Number: 000-22780**

 

**FEI COMPANY**

(Exact name of registrant as specified in its charter)

 

| **Oregon**                                                      | ** ** | **93-0621989**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation

or organization) |       | (I.R.S. Employer Identification No.) |
|                                                            |       |                                 |
| **5350 NE Dawson Creek Drive, Hillsboro, Oregon**               | ** ** | **97124-5793**                       |
| (Address of principal executive offices)                        |       | (Zip Code)                           |

 

Registrant’s telephone number, including area code:  **503-726-7500**

 

**Securities registered pursuant toSection 12(b) of the Act:****Common Stockand associated Preferred Stock**

**Purchase Rights (currentlyattached to and trading only with the Common Stock)**

**Name of each exchange on whichregistered: Nasdaq Global Stock Market**

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

 

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# ** **

Indicateby check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.

Yeso     No x

 

Indicateby check mark if the Registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.  o

 

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

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-K,or any amendment to this Form 10-K.  x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company. Seedefinition of “accelerated filer,” “large accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. Large acceleratedfiler x   Accelerated filer o   Non-accelerated filer o (Do not checkif a smaller reporting company) Smaller reporting company o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes o     No x

 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates, computed by reference to thelast sales price ($32.46) as reported by The Nasdaq Global Stock Market, as ofthe last business day of the registrant’s most recently completed second fiscalquarter (June 29, 2007), was $1,173,174,059.

 

The number of shares outstanding of the registrant’sCommon Stock as of February 26, 2008 was 79,276,724 shares.

 

**Documents Incorporated byReference**

 

The Registrant has incorporated by reference into Part IIIof this Annual Report on Form 10-K portions of its Proxy Statement for its2008 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A.

 

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** **

**FEI COMPANY**

**2007 FORM 10-K ANNUAL REPORT**

**TABLE OF CONTENTS**

 
| ** ** | ** ** | ** **                                                                                                          | ** ** | **Page**   | ** ** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
|       |       | **PART I**                                                                                                     | ** ** | ** ** | ** ** |
|       |       |                                                                                                                |       |       |       |
| Item 1.    |       | Business                                                                                                            |       | 2          |       |
|       |       |                                                                                                                |       |       |       |
| Item  1A.  |       | Risk  Factors                                                                                                       |       | 9          |       |
|       |       |                                                                                                                |       |       |       |
| Item 1B.   |       | Unresolved Staff  Comments                                                                                          |       | 21         |       |
|       |       |                                                                                                                |       |       |       |
| Item  2.   |       | Properties                                                                                                          |       | 21         |       |
|       |       |                                                                                                                |       |       |       |
| Item  3.   |       | Legal  Proceedings                                                                                                  |       | 22         |       |
|       |       |                                                                                                                |       |       |       |
| Item 4.    |       | Submission of  Matters to a Vote of Security Holders                                                                |       | 22         |       |
|       |       |                                                                                                                |       |       |       |
|       |       | **PART II**                                                                                                    | ** ** | ** ** | ** ** |
|       |       |                                                                                                                |       |       |       |
| Item 5.    |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       | 22         |       |
|       |       |                                                                                                                |       |       |       |
| Item 6.    |       | Selected Financial  Data                                                                                            |       | 24         |       |
|       |       |                                                                                                                |       |       |       |
| Item 7.    |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       | 26         |       |
|       |       |                                                                                                                |       |       |       |
| Item 7A.   |       | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       | 45         |       |
|       |       |                                                                                                                |       |       |       |
| Item 8.    |       | Financial  Statements and Supplementary Data                                                                        |       | 48         |       |
|       |       |                                                                                                                |       |       |       |
| Item 9.    |       | Changes in and  Disagreements With Accountants on Accounting and Financial Disclosure                               |       | 87         |       |
|       |       |                                                                                                                |       |       |       |
| Item 9A.   |       | Controls and  Procedures                                                                                            |       | 87         |       |
|       |       |                                                                                                                |       |       |       |
| Item 9B.   |       | Other Information                                                                                                   |       | 89         |       |
|       |       |                                                                                                                |       |       |       |
|       |       | **PART III**                                                                                                   | ** ** | ** ** | ** ** |
|       |       |                                                                                                                |       |       |       |
| Item 10.   |       | Directors,  Executive Officers and Corporate Governance                                                             |       | 89         |       |
|       |       |                                                                                                                |       |       |       |
| Item 11.   |       | Executive  Compensation                                                                                             |       | 89         |       |
|       |       |                                                                                                                |       |       |       |
| Item 12.   |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       | 89         |       |
|       |       |                                                                                                                |       |       |       |
| Item 13.   |       | Certain  Relationships and Related Transactions, and Director Independence                                          |       | 89         |       |
|       |       |                                                                                                                |       |       |       |
| Item 14.   |       | Principal  Accountant Fees and Services                                                                             |       | 89         |       |
|       |       |                                                                                                                |       |       |       |
|       |       | **PART IV**                                                                                                    | ** ** | ** ** | ** ** |
|       |       |                                                                                                                |       |       |       |
| Item 15.   |       | Exhibits and  Financial Statement Schedules                                                                         |       | 90         |       |
|       |       |                                                                                                                |       |       |       |
| Signatures |       |                                                                                                                |       | 93         |       |

** **

 

1

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** **

**PART I**

** **

**Item 1.****  Business**

** **

**Overview**

** **

We were founded in 1971and our shares began trading on The Nasdaq Stock Market in 1995. We are a leading supplier of instruments fornanoscale imaging, analysis and prototyping to enable research, development andmanufacturing in a range of industrial, academic and research institutionalapplications. We report our revenue based on a market-focused organization: theNanoElectronics market, the NanoResearch and Industry market, the NanoBiologymarket and the Service and Components market.

 

Ourproducts include focused ion beam systems, or FIBs; scanning electronmicroscopes, or SEMs; transmission electron microscopes, or TEMs; and *DualBeam* systems, which combine a FIB and SEM on a singleplatform.

 

Our *DualBeam* systems include models that have wafer handlingcapability and are purchased by semiconductor and data storage manufacturers (“wafer-level*DualBeam*systems”) and models that havesmall stages and are sold to customers in several markets (“small-stage *DualBeam*systems”).

 

We haveresearch, development and manufacturing operations in Hillsboro, Oregon;Eindhoven, the Netherlands; and Brno, Czech Republic.

 

Oursales and service operations are conducted in the U.S. and approximately 50other countries around the world. We also sell our products through independentagents, distributors and representatives in additional countries.

 

Todate, we have a total worldwide installed base of over 6,800 systems. Thedevelopment of these solutions has been driven by our strong technology basethat includes patented and proprietary technologies and the technical expertiseand knowledge base of research and development personnel worldwide.

 

TheNanoElectronics market consists of customers in the semiconductor, data storageand related industries such as printers and microelectromechanical systems (“MEMs”).For the semiconductor market, our growth is driven by shrinking line widths andprocess nodes of 65 nanometers and smaller, the use of multiple layers of newmaterials such as copper and low-k dielectrics, the increase in wafer size to300 millimeters in diameter and increasing device complexity. Our products areused primarily in laboratories to speed new product development and increaseyields by enabling three-dimensional (“3D”) wafer metrology, defect analysis,root cause failure analysis and circuit edit for modifying device structures.In the data storage market, factors affecting our business include thetransition from longitudinal to perpendicular recording heads, rapidlyincreasing storage densities that require smaller recording heads, thinnergeometries and materials that increase the complexity of device structures. Ourproducts offer 3D metrology for thin film head processing and root causefailure analysis.

 

TheNanoResearch and Industry market includes universities, public and privateresearch laboratories and a wide range of industrial customers, includingautomobiles, aerospace, metals, mining and petrochemicals. Growth in thesemarkets is driven by global corporate and government funding for research anddevelopment in materials science and by development of new products andprocesses based on innovations in materials at the nanoscale. Our solutionsprovide researchers and manufacturers with atomic-level resolution images andpermit development, analysis and production of advanced products. Our productsare also used in root cause failure analysis and quality control applications.

 

TheNanoBiology market includes universities and research institutes engaged inbiotech and life sciences applications, as well as pharmaceutical, biotech,medical device and hospital companies. Our products’ 

 

 

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ultra-highresolution imaging allows cell biologists and drug researchers to createdetailed 3D reconstructions of complex biological structures, enabling them tomap proteins within cells.

 

Ourservice division provides support for products and customers for the entirelife cycle of a tool from installation through the warranty period, and afterwarranty period through contract coverage or on a time and materials basis. Webelieve strong technical support is an important part of the value propositionthat we offer customers when a tool is sold. Our service division providessupport across all markets and all regions.

 

**Core Technologies**

** **

We use several coretechnologies to deliver a range of value-added customer solutions. Our coretechnologies include:

 

·                  focused ion beams, which allowmodification of structures in sub-micron geometries;

 

·                  focused electron beams, which allowimaging, analysis and measurement of structures at sub-micron and even atomiclevels;

 

·                  beam gas chemistries, which increase theeffectiveness of ion and electron beams and allow etching and deposition ofmaterials on structures at sub-micron levels; and

 

·                  system automation and sample managementtools, which provide faster access to data and improved ease of use foroperators of our systems.

 

*Particlebeam technologies—focused ion beams and electron beams.* Theemission and focusing of ions, which are positively or negatively chargedatoms, or electrons from a source material, is fundamental to many of ourproducts. Particle beams are accelerated and focused on a sample forpurposes of high resolution imaging and sample processing. The fundamentalproperties of ion and electron beams permit them to perform various functions.The relatively low mass subatomic electrons interact with the sample andrelease secondary electrons. When collected, these secondary electrons canprovide high quality images at nanometer-scale resolution. Inpreviously thinned samples, collection of high energy electrons transmittedthrough the sample can yield image resolution at the atomic scale. Themuch greater mass ions dislodge surface particles, also resulting indisplacement of secondary ions and electrons. Through the use of FIBs, thesurface can be modified or milled with sub-micron precision by direct action ofthe ion beam or in combination with gases. Secondary electrons and ions mayalso be collected for imaging and compositional analysis. Our ion and electronbeam technologies provide advanced capabilities and applications when coupledwith our other core technologies.

 

*Beamgas chemistry.* Beam gas chemistryplays an important role in enabling our electron and ion beam basedproducts to perform many tasks successfully. Beam gas chemistry involves theinteraction of the primary ion beam with an injected gas near the surface of thesample. This interaction results in either the deposition of material or theenhanced removal of material from the sample. Both of these processes arecritical to optimizing and expanding FIB and SEM applications. Our marketshave growing needs for gas chemistry technologies, and we have aimed ourdevelopment strategy at meeting these requirements.

 

·                  Deposition: Deposition of materialsenables our FIBs to connect or isolate features electrically on, for example,an integrated circuit. A deposited layer of metal also can be used beforeFIB milling to protect surface features for more accurate cross-sectioning orsample preparation.

 

·                  Etching: The fast, clean andselective removal of material is the most important function of our FIBs. OurFIBs have the ability to mill specific types of material faster than othersurrounding material. This process is called selective etching and is usedto enhance image contrast or aid in the modification of various structures.

 

*Systemautomation and sample management.* Drawingon our knowledge of application needs, and using robotics and imagerecognition and reconstruction software, we have developed automationcapabilities that allow us to increase system performance, speed and precision.These capabilities have been especially important to our development effortsfor in-line products and applications in the NanoElectronics market and areexpected to be increasingly important in emerging production and 

 

 

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process controlapplications in NanoResearch and Industry and NanoBiology markets. Twoimportant areas where we have developed significant automation technologies areTEM sample preparation and 3D process control. TEMs are widely used in thesemiconductor and data storage markets to obtain valuable high-resolutionimages of extremely small, even atomic-level, structures. TEM samplepreparation has traditionally been a slow and difficult manual process. Withour *DualBeam* systems andproprietary software, we have automated this process, significantly improvingthe sample consistency and overall throughput. Similarly, by automating 3Dprocess control applications, we allow customers to acquire previouslyunobtainable subsurface process metrics directly from within the productionline, improving process management.

 

**Research and Development**

** **

We have research,development and manufacturing operations in Hillsboro, Oregon; Eindhoven, theNetherlands; and Brno, Czech Republic.

 

Our research anddevelopment staff at December 31, 2007 consisted of 345 employees,including scientists, engineers, designer draftsmen, technicians and softwaredevelopers.

 

In the last year, weintroduced several new and improved products, including the:

 

·                  *Quanta*3D FEG small-stage *DualBeam*;

 

·                  *Phenom*low-cost imaging tool;

 

·                  *Titan**3**  *80-200,with environmental enhancements to our base *Titan* system;

 

·                  V600CEUpgrade circuit edit system;

 

·                  *Nova*NanoSEM 30 scanning electron microscope;

 

·                  *Vitrobot*Mark IV cryo sample preparation tool;

 

·                  *Expida*1255S, enhancement to our wafer-level *DualBeam* line;and

 

·                  *Titan Krios*TEM for high-resolution, automated life sciences applications.

 

We believe our knowledgeof field emission technology and products incorporating focused ion beams remain critical to our performance in thefocused charged particle beam business. Drawing on this technology, we havedeveloped a number of product innovations, including:

 

·                  the scanning transmission electron microscope (“S/TEM”) system platformwith unprecedented stability coupled with aberration correction andmonochromator technology, enabling sub-angstrom resolution;

 

·                  enhanced robotics, processes and tool connectivity enabling in-linesample liftout and S/TEM imaging from semiconductor wafers for defect analysisand process control applications;

 

·                  advanced environmental scanning electron microscope (“ESEM”) detector(the “Helix Detector”) and immersion lens technology, enabling ultra-highresolution SEM imaging at low pressure in the new *Nova*NanoSEM;

 

·                  advanced image processing hardware and software enabling highperformance 3D tomographic, TEM based imaging; and

 

·                  advanced cryogenic fixation technology and subsequent imaging ofaqueous samples at cryo temperatures in a TEM for aqueous biological, andcolloidal polymer, pigment and nanoparticle samples.

 

Fromtime to time, we engage in joint research and development projects with some ofour customers and other parties. In Europe, our electron microscope developmentis conducted in collaboration with universities and research institutions,often supported by European Union research and development programs. Weperiodically have received public funds under Dutch government and EuropeanUnion-funded research and development programs, and expect to continue toleverage these funding opportunities in the future. However, these funds havedecreased over the past several years and we are not able to predict the amountof future funding. We also maintain other informal collaborative relationshipswith universities and other research institutions, and we work with several ofour customers to evaluate new products.

 

 

4

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Themarkets into which we sell our principal products are subject to rapid technologicaldevelopment, product innovation and competitive pressures. Consequently, wehave expended substantial amounts of money on research and development. Wegenerally intend to continue investing in research and development atapproximately the current percentage of our net sales and believe thatcontinued investment will be important to our ability to address the needs ofour customers and to develop additional product offerings. Research anddevelopment efforts continue to be directed toward development of nextgeneration product platforms, new ion and electron columns, beam chemistries,system automation and new applications. We believe these areas hold promise ofyielding significant new products and existing product enhancements. Researchand development efforts are subject to change due to product evolution andchanging market needs. Often, these changes cannot be predicted.

 

**Net research and developmentexpense was $66.0 million in 2007, $57.5 million in 2006 and $56.6 million in2005.**

** **

**Manufacturing**

** **

We have manufacturing operations located in Hillsboro,Oregon; Eindhoven, the Netherlands; and Brno, Czech Republic. Our systemmanufacturing operations consist largely of final assembly and the testing of finished products. Productperformance is documented and validated with factory acceptance and selectivecustomer witness acceptance tests before these products are shipped. We alsofabricate electron and ion source materials and manufacture component productsat our facilities in Oregon and the CzechRepublic.

 

We currently usenumerous vendors to supply parts, components and subassemblies for themanufacture and support of our products. Some key parts, however, may only beobtained from a single supplier or a limited group of suppliers. In particular,we rely on: VDL Enabling Technologies Group, or ETG, Frencken Mechatronics B.V.and AZD Praha STR for our supply of mechanical parts and subassemblies; Gatan, Inc.for critical accessory products; and Neways Electronics, N.V. for some of ourelectronic subassemblies. Some of the subcomponentsthat make up the components andsub-assemblies supplied to us are proprietary in nature and are provided to oursuppliers only from single sources. We monitor those parts subject to single ora limited source supply to minimize factory down time due to unavailability ofsuch parts, which could impact our ability to meet manufacturing schedules.

 

**Sales, Marketing and Service**

** **

Sales, marketing andservice operations are conducted in the U.S. and approximately 50 othercountries around the world. We also sell our products through independentagents, distributors and representatives in various additional countries.

 

Our sales and marketingstaff at December 31, 2007 consisted of 358 employees, including accountmanagers, direct salespersons, sales support management, administration, demolab personnel, marketing support, product managers, product marketingengineers, applications specialists and technical writers. Applicationsspecialists identify and develop new applications for our products, which weexpect to further expand our markets. Our sales force and marketing efforts areorganized through three geographic sales and services divisions: North America,Europe and the Asia-Pacific region.

 

We require salesrepresentatives to have the technical expertise and understanding of thebusinesses of our principal and potential customers to meet the requirementsfor selling our products. Normally, a sales representative will have theknowledge of, and experience with, our products or similar products, markets orcustomers at the time the sales representative is hired. We also provideadditional training to our sales force on an ongoing basis. Our marketingefforts include presentations at trade shows, advertising in trade journals,development of printed collateral materials, customer forums, public relationsefforts in trade media and our website. In addition, our employees publisharticles in scientific journals and make presentations at scientificconferences.

 

 

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In a typical sale, apotential customer is provided with information about our products, includingspecifications and performance data, by one of our sales representatives. Thecustomer then often participates in a product demonstration at our facilities,using samples provided by the customer. The sales cycle for our systemstypically ranges from three to 12 months, but can be longer when ourcustomers are evaluating new applications of our technology.

 

Our products are soldgenerally with a 12 month warranty. Customers may purchase service contractsfor our products of one year or more in duration after expiration of anywarranty. We employ service engineers in each of the three regions in which wehave sales and service divisions. We also contract with independent servicerepresentatives for product service in some foreign countries.

 

**Competition**

** **

Themarkets for our products are highly competitive. Some of our competitors andpotential competitors have greater financial, marketing and productionresources than we do. In addition, some of our competitors may cooperate witheach other. Additionally, markets for our products are subject to constantchange, due in part to evolving customer needs. As we respond to this change,the elements of competition as well as the specific competitors may change.Moreover, one or more of our competitors might achieve a technological advancethat would put us at a competitive disadvantage.

 

Our significantcompetitors, with respect to the manufacture and sale of equipment, include:JEOL Ltd., Hitachi Ltd., Seiko Instruments Inc., Carl Zeiss SMT A.G. and OrsayPhysics S.A. In addition, some of our competitors have formed collaborativerelationships and otherwise may cooperate with each other. We believe the key competitive factors areperformance, range of features, reliability and price. We believe that we arecompetitive with respect to each of these factors. Our ability to remaincompetitive depends in part upon our success in developing new and enhancedsystems and introducing these systems at competitive prices on a timely basis.

 

**Ourservice business faces little significant third-party competition. Because ofthe highly specialized nature of our products and technology, and because ofthe critical mass necessary to support a worldwide field service capability,few competitors have emerged to provide service to our installed base ofsystems. Some of our older, less sophisticated equipment, particularly in theNanoResearch and Industry market, is serviced by independent field serviceengineers who compete directly with us. We believe we will continue to providemost of the field service for our products.**

** **

**Patents and Intellectual Property**

** **

We rely on a combinationof trade secret protection (including use of nondisclosure agreements),trademarks, copyrights and patents to establish and protect our proprietaryrights. These intellectual property rights may not have commercial value or maynot be sufficiently broad to protect the aspect of our technology to which theyrelate or competitors may design around the patents. We own, solely or jointly,approximately 138 patents in the U.S. and approximately 188 patentsoutside of the U.S., many of which correspond to the U.S. patents. Further, we havelicenses for additional patents. Our patents expire over a period of time from2008 to 2027.

 

Several of ourcompetitors hold patents covering a variety of focused ion beam products andapplications and methods of use of focused ion and electron beam products. Someof our customers may use our products for applications that are similar tothose covered by these patents. As the number and sophistication of focused ionand electron beam products in the industry increase through the continuedintroduction of new products by us and others, and the functionality of theseproducts further overlaps, manufacturers and users of ion and electron beamproducts may become increasingly subject to infringement claims.

 

 

6

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We also depend on tradesecrets used in the development and manufacture of our products. We endeavor toprotect these trade secrets but the measures we have taken to protect thesetrade secrets may be inadequate or ineffective.

 

We claim trademarks on anumber of our products and have registered some of these marks. Use of theregistered and unregistered marks, however, may be subject to challenge withthe potential consequence that we would have to cease using marks or pay feesfor their use.

 

Our automation softwareincorporates software from third-party suppliers, which is licensed to endusers along with our proprietary software. We depend on these outside softwaresuppliers to continue to develop automation capacities. The failure of thesesuppliers to continue to offer and develop software consistent with ourautomation efforts could undermine our ability to deliver product applications.

 

**Employees**

** **

At December 31,2007, we had 1,820 full-time equivalent, permanent employees and 46 temporaryemployees worldwide. Some of the 1,219 employees who are employed outside ofthe U.S. are covered by national, industry-wide agreements or national workregulations that govern various aspects of employment conditions andcompensation. None of our U.S. employees are subject to collective bargainingagreements, and we have never experienced a work stoppage, slowdown or strikein any of our worldwide operations. We believe we maintain good employeerelations.

 

***Backlog***

*** ***

At December 31,2007, our total backlog was $310.8 million, which consisted of product andservice and components backlog of unfilled orders of $256.1 million and $54.7million, respectively, compared to $259.1 million and $46.8 million,respectively, at December 31, 2006. Orders received in a particular periodthat cannot be built and shipped to the customer in that period representbacklog. We only recognize backlog for purchase commitments for which the termsof the sale have been agreed upon, including price, configuration, options andpayment terms.****Product backlog consists of allopen orders meeting these criteria. Service and Components backlog consists ofopen orders for service, unearned revenue on service contracts and open ordersfor spare parts. U.S. government backlog is limited to contracted amounts. Inaddition, some of the U.S. government backlog represents uncommitted funds.

 

Of ourtotal backlog at December 31, 2007, approximately 90% is expected to beshippable within 12 months and approximately 10% - 15% requires someincremental development. Customers may cancel or delay delivery on previouslyplaced orders, although our standard terms and conditions include penalties forcancellations made close to the scheduled delivery date. As a result, thetiming of the receipt of orders or the shipment of products could have asignificant impact on our backlog at any date. Historically, cancellations havebeen minor. From time to time, we have experienced difficulty in shipping ourproduct from backlog due to single-sourcing issues and problems insecuring electronic components from a certain vendor. In addition, productshipments have been delayed due to delays in completing certain applicationdevelopment, by our customers pushing out shipments because their facilitiesare not ready to install our systems and by our own manufacturing delays due tothe technical complexity of our products and supply chain issues. For example, a large order from aCanadian university that was announced in 2006, and was planned to ship in thefirst quarter of 2007, is now expected to ship in the first quarter of 2008. For these and other reasons, the amount of backlog atany date is not necessarily indicative of revenue to be recognized in futureperiods.

 

 

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**Geographic Revenue and Assets**

** **

The following tablesummarizes sales by geographic region in 2007 (in thousands):

 
| ** **                  | ** ** | **North  America** | ** ** | **Europe** | ** ** | **Asia-  Pacific** | ** ** | **Total** | ** ** |
|-----------------------------|------------|--------------------|------------|------------|------------|--------------------|------------|-----------|------------|
| Product sales               |       | $                  | 164,757    |       | $          | 179,304            |       | $         | 121,027    |   | $ | 465,088 |   |
| Service and Component sales |       | 65,656             |       | 38,787     |       | 22,979             |       | 127,422   |       |
| Total sales                 |       | $                  | 230,413    |       | $          | 218,091            |       | $         | 144,006    |   | $ | 592,510 |   |

 

Salesto countries which totaled 10% or more of our total net sales in 2007 were asfollows (dollars in thousands):

 
| ** **    | ** ** | **Dollar  Amount** | ** ** | **% of Total  Net Sales** | ** ** |
|---------------|------------|--------------------|------------|---------------------------|------------|
| United States |       | $                  | 228,576    |                      | 38.6       | % |
|               |            |                    |            |                           |            |  |

 

Our long-lived assets were geographicallylocated as follows at December 31, 2007 (in thousands):

 
| United States   |   | $      | 50,862 |   |
|-----------------|--------|--------|--------|--------|
| The Netherlands |   | 20,202 |   |
| Other           |   | 12,702 |   |
| Total           |   | $      | 83,766 |   |

** **

**Seasonality**

** **

**Our history shows that our revenuesand bookings normally peak in the fourth quarter. Bookings are normally thelowest in the second quarter and revenues are normally lowest in the thirdquarter.**

** **

In addition, our saleshave tended to grow more rapidly from the third to the fourth quarter of theyear than in other sequential quarterly periods, primarily because ourNanoResearch and Industry customers budget their spending on an annual basis.Correspondingly, the NanoResearch and Industry market has tended to recorddeclines in revenue from the fourth quarter of one year to the first quarter ofthe next year. These seasonal trends can be offset by numerous other factors,including our introduction of new products, the overall economic cycle and thebusiness cycles in the semiconductor and data storage industries.

 

**Where You Can Find More Information**

** **

Our principal executiveoffices are located at 5350 NE Dawson Creek Drive, Hillsboro, Oregon97124.  Our website is athttp://www.fei.com. We file annual, quarterlyand special reports, proxy statements and other information with the Securitiesand Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 asamended (“Exchange Act”). We make available free of charge on our website ourAnnual Report on Form 10-K, Quarterly Reports on Form 10-Q, CurrentReports on Form 8-K and amendments to these reports as soon as reasonablypracticable after we file such material with, or furnish it to, the SEC. Youcan inspect and copy our reports, proxy statements and other information filedwith the SEC at the offices of the SEC’s Public Reference Room located at100 F Street, NE, Washington D.C. 20549. Please call the SEC at 1-800-SEC-0330for further information on the operation of Public Reference Rooms. The SECalso maintains an Internet website at http://www.sec.gov/ where you can obtainmost of our SEC filings. You can also obtain copies of these materials free ofcharge by contacting our investor relations department at 503-726-7500.

 

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** **

**Item 1A.**** Risk Factors**

** **

A description of therisks and uncertainties associated with our business is set forth below. Youshould carefully consider such risks and uncertainties, together with the otherinformation contained in this report and in our other public filings. If any ofsuch risks and uncertainties actually occurs, our business, financial conditionor operating results could differ materially from the plans, projections andother forward-looking statements included in the section titled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andelsewhere in this report and in our other public filings. In addition, if anyof the following risks and uncertainties, or if any other risks anduncertainties, actually occurs, our business, financial condition or operatingresults could be harmed substantially, which could cause the market price ofour stock to decline, perhaps significantly.

 

**Grossmargins on our products vary between product lines and markets and,accordingly, changes in product mix will affect our results of operations.**

** **

Ifa higher portion of our net sales in any given period have lower gross margins,our overall gross margins and earnings would be negatively affected. Forexample, during the second half of 2007, our net sales contained a smallerportion of sales from our relatively higher margin NanoElectronics segment,which contributed to a decrease in our overall gross margins in the second halfof 2007 compared to the first half of 2007.

 

**Ourbusiness is complex, and changes to the business may not achieve their desiredbenefits.**

** **

Our business is based ona myriad of technologies, encompassed in multiple different product lines,addressing various markets in different regions of the world. A business of ourbreadth and complexity requires significant management time, attention andresources. In addition, significant changes to our business, such as changes inmanufacturing, operations, product lines, market focus or organizationalstructure or focus, can be distracting, time-consuming and expensive. Thesechanges can have short-term adverse effects on our financial results and maynot provide their intended long-term benefits. Failure to achieve thesebenefits would have a material adverse impact on our financial position,results of operations or cash flow.

 

**Weoperate in highly competitive industries, and we cannot be certain that we willbe able to compete successfully in such industries.**

** **

The industries in whichwe operate are intensely competitive. Established companies, both domestic andforeign, compete with us in each of our product lines. Some of our competitorshave greater financial, engineering, manufacturing and marketing resources thanwe do and may price their products very aggressively. Our significantcompetitors include: JEOL Ltd., Hitachi Ltd., Seiko Instruments Inc., CarlZeiss SMT A.G. and Orsay Physics S.A. In addition, some of our competitors haveformed collaborative relationships and otherwise may cooperate with each other.

 

A substantial investmentby customers is required for them to install and integrate capital equipmentinto their laboratories and process applications. As a result, once amanufacturer has selected a particular vendor’s capital equipment, themanufacturer generally relies on that equipment for a specific production lineor process control application and frequently will attempt to consolidate itsother capital equipment requirements with the same vendor. Accordingly, if aparticular customer selects a competitor’s capital equipment, we expect toexperience difficulty selling to that customer for a significant period oftime.

 

Our ability to competesuccessfully depends on a number of factors both within and outside of ourcontrol, including:

 

·                  price;

 

·                  product quality;

 

·                  breadth of product line;

 

·                  system performance;

 

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·                  ease of use;

 

·                  cost of ownership;

 

·                  global technical service and support;

 

·                  success in developing or otherwise introducing new products; and

 

·                  foreign currency movements.

 

We cannot be certain thatwe will be able to compete successfully on these or other factors, which couldnegatively impact our revenues, gross margins and net income in the future.

 

**Becausemany of our shipments occur in the last month of a quarter, we are at risk ofone or more transactions not being delivered according to forecast.**

** **

We have historicallyshipped approximately 75% of our products in the last month of each quarter. Asany one shipment may be significant to meeting our quarterly sales projection,any slippage of shipments into a subsequent quarter may result in our notmeeting our quarterly sales projection, which may adversely impact our resultsof operations for the quarter.

 

**Becausewe have significant operations outside of the U.S., we are subject topolitical, economic and other international conditions that could result inincreased operating expenses and regulation of our products and increaseddifficulty in maintaining operating and financial controls.**

** **

Since a significantportion of our operations occur outside of the U.S., our revenues and expensesare impacted by foreign economic and regulatory conditions. Approximately 61%and 65%, respectively, of our revenues in the years ended December 31,2007 and 2006 came from outside of the U.S. We have manufacturing facilities inBrno, Czech Republic and Eindhoven, the Netherlands and sales offices in manyother countries.

 

Moreover, we operate in50 countries, 29 with a direct presence and an additional 21 via sales agents.Some of our global operations are geographically isolated, are distant fromcorporate headquarters and/or have little infrastructure support. Therefore,maintaining and enforcing operating and financial controls can be difficult.Failure to maintain or enforce controls could have a material adverse effect onour control over service inventories, quality of service, customerrelationships and financial reporting.

 

Our exposure to thebusiness risks presented by foreign economies will increase to the extent wecontinue to expand our global operations. International operations willcontinue to subject us to a number of risks, including:

 

·                  longer sales cycles;

 

·                  multiple, conflicting and changinggovernmental laws and regulations;

 

·                  protectionist laws and business practicesthat favor local companies;

 

·                  price and currency exchange rates andcontrols;

 

·                  taxes and tariffs;

 

·                  export restrictions;

 

·                  difficulties in collecting accountsreceivable;

 

·                  travel and transportation difficultiesresulting from actual or perceived health risks (e.g., SARS and avianinfluenza);

 

·                  changes in theregulatory environment in countries where we do business could lead to delaysin the importation of products into those countries;

 

·                  theimplementation of China RoHS regulations could lead to delays in theimportation of products into China;

 

·                  political and economic instability; and

 

·                  risk of failure of internal controls and failure todetect unauthorized transactions.

 

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** **

**If ourcustomers cancel or reschedule orders or if an anticipated order for even oneof our systems is not received in time to permit shipping during a certainfiscal period, our operating results for that fiscal period may fluctuate andour business and financial results for such period could be materially andadversely affected.**

** **

Our customers are able tocancel or reschedule orders, generally with limited or no penalties, dependingon the product’s stage of completion. The amount of purchase orders at anyparticular date, therefore, is not necessarily indicative of sales to be madein any given period. Our build cycle, or the time it takes us to build aproduct to customer specifications, typically ranges from one to six months.During this period, the customer may cancel the order, although generally wewill be entitled to receive a cancellation fee based on the agreed-uponshipment schedule. In addition, we derive a substantial portion of our netsales in any fiscal period from the sale of a relatively small number ofhigh-priced systems, with a large portion in the last month of the quarter.Further, in some cases, our customers have to make changes to their facilitiesto accommodate the site requirements for our systems and may reschedule theirorders because of the time required to complete these facility changes. This isparticularly true of the high-performance TEMs. As a result, the timing ofrevenue recognition for a single transaction could have a material effect onour revenue and results of operations for a particular fiscal period.

 

Due to these and otherfactors, our net revenues and results of operations have fluctuated in the pastand are likely to fluctuate significantly in the future on a quarterly andannual basis. It is possible that in some future quarter or quarters ourresults of operations will be below the expectations of public market analystsor investors. In such event, the market price of our common stock may declinesignificantly.

 

**Due toour extensive international operations and sales, we are exposed to foreigncurrency exchange rate risks that could adversely affect our revenues, grossmargins and results of operations.**

** **

A significant portion ofour sales and expenses are denominated in currencies other than the U.S.dollar, principally the euro. For the year ended December 31, 2007 and theyear ended December 31, 2006, approximately 30% to 40% of our revenue wasdenominated in euros, while more than half of our expenses were denominated ineuros or other foreign currencies. Particularly as a result of this imbalance,changes in the exchange rate between the U.S. dollar and foreign currencies,especially the euro, can impact our revenues, gross margins, results ofoperations and cash flows. We undertake hedging transactions to limit ourexposure to changes in the dollar/euro exchange rate. The hedges are designedto protect us as the dollar weakens but also provide us with some flexibilityif the dollar strengthens.

 

We enter into variousforward extra contracts, which are a combination of a foreign forward exchangecontract and an option, as well as standard option contracts, to partiallymitigate the impact of changes in the euro against the dollar on our Europeanoperating results. We are evaluating the use of other forms of contracts inaddition to, or as a substitute to, the forward extra contracts as we move into2008. These contracts are considered derivatives. We are required to carry allopen derivative contracts on our balance sheet at fair value. When specificaccounting criteria have been met, derivative contracts can be designated ashedging instruments and changes in fair value related to these derivativecontracts are recorded in other comprehensive income, rather than net income,until the underlying hedged transaction affects net income. When the designatedhedges mature, they are recorded in cost of goods sold. We are required torecord changes in fair value for derivatives not designated as hedges in netincome in the current period. Prior to the second quarter of fiscal 2004, noneof our derivative contracts were designated as hedges and all realized andunrealized gains and losses were recognized in net income in the currentperiod. Our ability to designate derivative contracts as hedges significantlyreduces the volatility in our operating results due to changes in the fairvalue of the derivative contracts.

 

Achieving hedgedesignation is based on evaluating the effectiveness of the derivativecontracts’ ability to mitigate the foreign currency exposure of the linkedtransaction. We are required to monitor the effectiveness of all new and openderivative contracts designated as hedges on a quarterly basis. Based 

 

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on our evaluation in2005, we recorded charges totaling $0.5 million in other income (expense)related to hedge dedesignations and ineffectiveness. We did not record anycharges for hedge dedesignations or ineffectiveness in 2007 or 2006. Failure tomeet the hedge accounting requirements could result in the requirement torecord deferred and current realized and unrealized gains and losses into netincome in the current period. This failure could result in significantfluctuations in operating results. In addition, we will continue to recognizeunrealized gains and losses related to the changes in fair value of derivativecontracts not designated as hedges in the current period net income. Accordingly,the related impact to operating results may be recognized in a different periodthan the foreign currency impact of the linked asset, liability or transaction.

 

We also enter intoforeign forward exchange contracts to partially mitigate the impact of specificcash, receivables or payables positions denominated in foreign currencies.Foreign currency losses recorded in other income (expense), inclusive of theimpact of derivatives which are not designated as hedges, totaled $3.1 millionand $1.9 million, respectively, in 2007 and 2006.

 

**We relyon a limited number of parts, components and equipment manufacturers. Failureof any of these suppliers to provide us with quality products in a timelymanner could negatively affect our revenues and results of operations.**

 

Failure of criticalsuppliers of parts, components and manufacturing equipment to deliversufficient quantities to us in a timely and cost-effective manner couldnegatively affect our business, including our ability to convert backlog intorevenue. We currently use numerous vendors to supply parts, components andsubassemblies for the manufacture and support of our products. Some key parts,however, may only be obtained from a single supplier or a limited group ofsuppliers. In particular, we rely on: VDL Enabling Technologies Group, or ETG,Frencken Mechatronics B.V. and AZD Praha STR for our supply of mechanical partsand subassemblies; Gatan, Inc. for critical accessory products; and NewaysElectronics, N.V. for some of our electronic subassemblies. In addition, someof our suppliers rely on sole suppliers. As a result of this concentration ofkey suppliers, our results of operations may be materially and adverselyaffected if we do not timely and cost-effectively receive a sufficient quantityof quality parts to meet our production requirements or if we are required tofind alternative suppliers for these supplies. We may not be able to expand oursupplier group or to reduce our dependence on single suppliers. If oursuppliers are not able to meet our supply requirements, constraints may affectour ability to deliver products to customers in a timely manner, which couldhave an adverse effect on our results of operations. In addition, world widerestrictions governing the use of certain hazardous substances in electricaland electronic equipment (Restrictions on Hazardous Substances, or “RoHS,”regulations) may impact parts and component availability or our electronicssuppliers’ ability to source parts and components in a timely and cost-effectivemanner. Overall, because we only have a few equipment suppliers, we may be moreexposed to future cost increases for this equipment.

 

**Ouracquisition and investment strategy subjects us to risks associated withevaluating and pursuing these opportunities and integrating these businesses.**

** **

In addition to ourefforts to develop new technologies from internal sources, we also may seek toacquire new technologies or operations from external sources. As part of thiseffort, we may make acquisitions of, or make significant debt and equityinvestments in, businesses with complementary products, services and/ortechnologies. Acquisitions can involve numerous risks, including managementissues and costs in connection with the integration of the operations andpersonnel, technologies and products of the acquired companies, the possiblewrite-downs of impaired assets and the potential loss of key employees of theacquired companies. The inability to effectively manage any of these riskscould seriously harm our business. Additionally, difficulties in integratingany potential acquisitions into our internal control structure could result ina failure of our internal control over financial reporting, which, in turn,could create a material weakness.

 

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During the fourth quarterof 2006, we sold one such investment, Knights Technology. During the thirdquarter of 2006, we sold a cost-method investment for a gain of $5.2 millionand wrote-off the remaining such investments, incurring an aggregate charge of$3.9 million.

 

To the extent we makeinvestments in entities that we control, or have significant influence in, ourfinancial results will reflect our proportionate share of the financial resultsof the entity.

 

**The industriesin which we sell our products are cyclical, which may cause our results ofoperations to fluctuate.**

** **

Our business depends inlarge part on the capital expenditures of customers within our NanoElectronics,NanoResearch and Industry and NanoBiology market segments, which, along withService and Components sales, accounted for the following amounts (inthousands) and percentages of our net sales for the periods indicated:

 
| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| NanoElectronics           |       | $                                | 198,663    |   | 33.5 | % | $ | 154,648 |   | 32.3 | % |
| NanoResearch and Industry |       | 214,551                          |       | 36.2 | % | 165,067 |   | 34.4 | % |
| NanoBiology               |       | 51,874                           |       | 8.8 | % | 40,928 |   | 8.5 | % |
| Service and Components    |       | 127,422                          |       | 21.5 | % | 118,848 |   | 24.8 | % |
|                      |       | $                                | 592,510    |   | 100.0 | % | $ | 479,491 |   | 100.0 | % |

 

The largest sub-parts ofthe NanoElectronics market are the semiconductor and data storage industries.These industries are cyclical and have experienced significant economicdownturns at various times in the last decade. Such downturns have beencharacterized by diminished product demand, accelerated erosion of averageselling prices and production overcapacity. A downturn in one or both of theseindustries, or the businesses of one or more of our customers, could have amaterial adverse effect on our business, prospects, financial condition andresults of operations. In the second half of 2007, we experienced a significantdecline in bookings and revenue in our NanoElectronics segment due to a generaldecline in semiconductor and data storage capital equipment spending. Globaleconomic conditions continue to be volatile and slower growth or reduced demandfor our customers’ products in the future would cause our business to decline.During downturns, our sales and gross profit margins generally decline.

 

The NanoResearch andIndustry market is also affected by overall economic conditions, but is not ascyclical as the NanoElectronics market. However, NanoResearch and Industrycustomer spending is highly dependent on governmental and private fundinglevels and timing, which can vary depending on budgetary or economicconstraints.

 

The NanoBiology market isa smaller and emerging market, and the tools we sell into that market oftenhave average selling prices of over $1.0 million. Consequently, loss of demandamong a relatively small group of potential customers can have a materialimpact on the overall demand for our products. As a result, movement of a smallnumber of sales from one quarter to the next could cause significantvariability in quarter-to-quarter growth rates, even as we believe that thismarket has the potential for long-term growth.

 

As a capital equipmentprovider, our revenues depend in large part on the spending patterns of ourcustomers, who often delay expenditures or cancel orders in reaction tovariations in their businesses or general economic conditions. Because a highproportion of our costs are fixed, we have a limited ability to reduce expensesquickly in response to revenue shortfalls. In a prolonged economic downturn, wemay not be able to reduce our significant fixed costs, such as manufacturingoverhead, capital equipment or research and development costs, which may causeour gross margins to erode and our net loss to increase or earnings to decline.

 

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Ourhistory shows that our revenues and bookings normally peak in the fourthquarter. Bookings are normally the lowest in the second quarter and revenuesare normally lowest in the third quarter.

 

**The lossof one or more of our key customers would result in the loss of significant netrevenues.**

** **

A relatively small numberof customers account for a large percentage of our net revenues, although nocustomer has accounted for more than 10% of total net revenues in the recentpast. Our business will be seriously harmed if we do not generate as muchrevenue as we expect from these key customers, if we experience a loss of anyof our key customers or if we suffer a substantial reduction in orders fromthese customers. Our ability to continue to generate revenues from our key customerswill depend on our ability to introduce new products that are desirable tothese customers.

 

**Becausewe do not have long-term contracts with our customers, our customers may stoppurchasing our products at any time, which makes it difficult to forecast ourresults of operations and to plan expenditures accordingly.**

** **

We do not have long-termcontracts with our customers. Accordingly:

 

·                  customers can stop purchasing our products at any time without penalty;

 

·                  customers may cancel orders that they previously placed;

 

·                  customers may purchase products from our competitors;

 

·                  we are exposed to competitive pricing pressure on each order; and

 

·                  customers are not required to make minimum purchases.

 

If we do not succeed inobtaining new sales orders from existing customers, our results of operationswill be negatively impacted.

 

**Many ofour projects are funded under federal, state and local government contracts andif we are found to have violated the terms of the government contracts orapplicable statutes and regulations, we are subject to the risk of suspensionor debarment from government contracting activities, which could have amaterial adverse effect on our business and results of operations.**

** **

Many of our projects arefunded under federal, state and local government contracts worldwide.****Government contracts are subject tospecific procurement regulations, contract provisions and requirements relatingto the formation, administration, performance and accounting of thesecontracts. Many of these contracts include express or implied certifications ofcompliance with applicable laws and contract provisions. As a result of ourgovernment contracting, claims for civil or criminal fraud may be brought bythe government for violations of these regulations, requirements or statutes.Further, if we fail to comply with any of these regulations, requirements orstatutes, our existing government contracts could be terminated, we could besuspended or debarred from government contracting or subcontracting, includingfederally funded projects at the state level. If one or more of our governmentcontracts are terminated for any reason, or if we are suspended from governmentwork, we could suffer the loss of the contracts, which could have a materialadverse effect on our business and results of operations.

 

**Changes and fluctuations in government spending prioritiescould adversely affect our revenue.**

** **

Because a significantpart of our overall business is generated either directly or indirectly as aresult of worldwide federal and local government regulatory and infrastructurepriorities, shifts in these priorities due to changes in policy imperatives oreconomic conditions, which are often unpredictable, may affect our revenues.

 

Political instability inkey regions around the world coupled with the U.S. government’s commitment tomilitary related expenditures put at risk federal discretionary spending,including spending on nanotechnology research programs and projects that are ofparticular importance to our business. Also, changes in U.S. Congressionalappropriations practices could result in decreased funding for some of ourcustomers. At the state and local levels, the need to compensate for reductionsin federal matching funds, 

 

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as well as financing offederal unfunded mandates, creates strong pressures to cut back on researchexpenditures as well. A potential reduction of federal funding may adverselyaffect our business.

 

**We havelong sales cycles for our systems, which may cause our results of operations tofluctuate and could negatively impact our stock price.**

** **

Our sales cycle can be12 months or longer and is unpredictable. Variations in the length of oursales cycle could cause our net sales and, therefore, our business, financialcondition, results of operations, operating margins and cash flows, tofluctuate widely from period to period. These variations could be based onfactors partially or completely outside of our control.

 

The factors that couldaffect the length of time it takes us to complete a sale depend on manyelements, including:

 

·                  the efforts of our sales force and our independent salesrepresentatives;

 

·                  changes in the composition of our sales force, including the departureof senior sales personnel;

 

·                  the history of previous sales to a customer;

 

·                  the complexity of the customer’s manufacturing processes;

 

·                  the introduction, or announced introduction, of new products by ourcompetitors;

 

·                  the economic environment;

 

·                  the internal technical capabilities and sophistication of the customer;and

 

·                  the capital expenditure budget cycle of the customer.

 

Our sales cycle alsoextends in situations where the sale involves developing new applications for asystem or technology. As a result of these and a number of other factors thatcould influence sales cycles with particular customers, the period betweeninitial contact with a potential customer and the time when we recognizerevenue from that customer, if we ever do, may vary widely.

 

**The lossof key management or our inability to attract and retain managerial,engineering and other technical personnel could have a material adverse effecton our business, financial condition and results of operations.**

** **

Attracting qualifiedpersonnel is difficult, and our recruiting efforts may not be successful.Specifically, our product generation efforts depend on hiring and retainingqualified engineers. The market for qualified engineers is very competitive. Inaddition, experienced management and technical, marketing and support personnelin the technology industry are in high demand, and competition for such talentis intense. The loss of key personnel, or our inability to attract keypersonnel, could have an adverse effect on our business, financial condition orresults of operations.

 

**Ourcustomers experience rapid technological changes, with which we must keep pace,but we may be unable to introduce new products on a timely and cost-effectivebasis to meet such changes.**

** **

Customers in each of ourmarket segments experience rapid technological change and new productintroductions and enhancements. Our ability to remain competitive depends inlarge part on our ability to develop, in a timely and cost-effective manner,new and enhanced systems at competitive prices and to accurately predicttechnology transitions. In addition, new product introductions or enhancementsby competitors could cause a decline in our sales or a loss of marketacceptance of our existing products. Increased competitive pressure also couldlead to intensified price competition, resulting in lower margins, which couldmaterially adversely affect our business, prospects, financial condition andresults of operations.

 

Our success indeveloping, introducing and selling new and enhanced systems depends on avariety of factors, including:

 

·                  selection and development of product offerings;

 

·                  timely and efficient completion ofproduct design and development;

 

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·                  timely and efficient implementation ofmanufacturing processes;

 

·                  effective sales, service and marketingfunctions; and

 

·                  product performance.

 

Because new productdevelopment commitments must be made well in advance of sales, new productdecisions must anticipate both the future demand for products under developmentand the equipment required to produce such products. We cannot be certain thatwe will be successful in selecting, developing, manufacturing and marketing newproducts or in enhancing existing products. On occasion, certain product andapplication development has taken longer than expected. These delays can have anadverse affect on product shipments and results of operations.

 

The process of developingnew high technology capital equipment products and services is complex anduncertain, and failure to accurately anticipate customers’ changing needs andemerging technological trends, to complete engineering and development projectsin a timely manner and to develop or obtain appropriate intellectual propertycould significantly harm our results of operations. We must make long-terminvestments and commit significant resources before knowing whether ourpredictions will result in products that the market will accept. For example,we have invested substantial resources in our new *Phenom*desk topimaging tool and the *Titan*scanningelectron microscope (“S/TEM”), and further development may be requiredto take full advantage of these products. If the completion of furtherdevelopment is delayed, potential revenue growth could be deferred or may nothappen at all.

 

To the extent that amarket does not develop for a new product, we may decide to discontinue ormodify the product. These actions could involve significant costs and/orrequire us to take charges in future periods. If these products are accepted bythe marketplace, sales of our new products may cannibalize sales of ourexisting products. Further, after a product is developed, we must be able tomanufacture sufficient volume quickly and at low cost. To accomplish thisobjective, we must accurately forecast production volumes, mix of products andconfigurations that meet customer requirements. If we are not successful inmaking accurate forecasts, our business and results of operations could besignificantly harmed.

 

**If thirdparties assert that we violate their intellectual property rights, our businessand results of operations may be materially adversely affected.**

** **

Several of ourcompetitors hold patents covering a variety of technologies that may beincluded in some of our products. In addition, some of our customers may useour products for applications that are similar to those covered by thesepatents. From time to time, we and our respective customers have receivedcorrespondence from our competitors claiming that some of our products, as usedby our customers, may be infringing one or more of these patents. To date, noneof these allegations has resulted in litigation. Our competitors or otherentities may, however, assert infringement claims against us or our customersin the future with respect to current or future products or uses, and theseassertions may result in costly litigation or require us to obtain a license touse intellectual property rights of others. Additionally, if claims ofinfringement are asserted against our customers, those customers may seekindemnification from us for damages or expenses they incur.

 

If we become subject toinfringement claims, we will evaluate our position and consider the availablealternatives, which may include seeking licenses to use the technology inquestion or defending our position. These licenses, however, may not beavailable on satisfactory terms or at all. If we are not able to negotiate thenecessary licenses on commercially reasonable terms or successfully defend ourposition, these potential infringement claims could have a material adverseeffect on our business, prospects, financial condition and results ofoperations.

 

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**We may not be able to enforce ourintellectual property rights, especially in foreign countries, which couldmaterially adversely affect our business.**

** **

Our success depends inlarge part on the protection of our proprietary rights. We incur significantcosts to obtain and maintain patents and defend our intellectual property. Wealso rely on the laws of the U.S. and other countries where we develop,manufacture or sell products to protect our proprietary rights. We may not besuccessful in protecting these proprietary rights, these rights may not providethe competitive advantages that we expect or other parties may challenge,invalidate or circumvent these rights.

 

Further, our efforts toprotect our intellectual property may be less effective in some countries whereintellectual property rights are not as well protected as they are in the U.S.Many U.S. companies have encountered substantial problems in protecting theirproprietary rights against infringement in foreign countries. We derivedapproximately 61% and 65%, respectively, of our sales from foreign countries inthe years ended December 31, 2007 and 2006. If we fail to adequatelyprotect our intellectual property rights in these countries, our business maybe materially adversely affected.

 

Infringement of ourproprietary rights could result in weakened capacity to compete for sales andincreased litigation costs, both of which could have a material adverse effecton our business, prospects, financial condition and results of operations.

 

**We aresubstantially leveraged, which could adversely affect our ability to adjust ourbusiness to respond to competitive pressures and to obtain sufficient funds tosatisfy our future manufacturing capacity and research and development needs.**

** **

We have significant indebtedness.As of December 31, 2007, we had total convertible long-term debt ofapproximately $195.9 million due in 2008 and $115.0 million due in 2013.In January 2008, we paid off $45.9 million of the indebtedness due in 2008and have funds available to pay off the additional $150.0 million that is duein June 2008. The degree to which we are leveraged could have importantconsequences, including but not limited to the following:

 

·                  our ability to obtain additionalfinancing in the future for working capital, capital expenditures,acquisitions, general corporate or other purposes may be limited;

 

·                  our shareholders would be diluted if weelect to settle all or a portion of our zero coupon convertible notes inshares, up to a maximum aggregate of 5,528,527 shares of our common stock, uponthe bondholders’ election to convert the notes once certain stock price metricsare met. These shares were included in our diluted share count for theyears ended December 31, 2007 and 2006;

 

·                  our shareholders would be diluted ifholders of all or a portion of our 2.875% subordinated convertible notes electto convert their notes, up to a maximum aggregate of 3,918,395 shares of ourcommon stock. These shares were included in our diluted share count for theyear ended December 31, 2007;

 

·                  a substantial portion of our cash andshort-term investments as of December 31, 2007 will be dedicated to thepayment of the principal of, and interest on, our indebtedness; and

 

·                  we may be more vulnerable to economicdownturns, less able to withstand competitive pressures and less flexible inresponding to changing business and economic conditions.

 

Our ability to payinterest and principal on our debt securities, to satisfy our other debtobligations and to make planned expenditures will be dependent on our futureoperating performance, which could be affected by changes in economicconditions and other factors, some of which are beyond our control. A failureto comply with the covenants and other provisions of our debt instruments couldresult in events of default under such instruments, which could permitacceleration of the debt under such instruments and in some cases accelerationof debt under other instruments that contain cross-default orcross-acceleration provisions. If we are at any time unable to generatesufficient cash flow from operations to service our indebtedness, we may berequired to attempt to renegotiate the terms of the instruments relating to theindebtedness, seek to refinance all or a portion of the indebtedness or obtainadditional 

 

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financing. We cannotassure you that we will be able to successfully renegotiate such terms, thatany such refinancing would be possible or that any additional financing couldbe obtained on terms that are favorable or acceptable to us.

 

At December 31,2007, we held $118.1 million in auction rate securities (“ARS”) which weclassified as current assets. The ARS held by us have long-term statedmaturities for which the interest rates are reset through a Dutch auctiongenerally every 28 days. The auctions have historically provided a liquidmarket for these securities as investors could readily sell their investmentsat auction. Subsequent to December 31, 2007, we began to exit our positionin these securities. As of February 25, 2008, we had successfullyliquidated $8.0 million of these securities, leaving us with $110.1 millioninvested in ARS.

 

With the liquidity issuesexperienced in global credit and capital markets, the ARS held by us have experiencedmultiple failed auctions, beginning on February 19, 2008, as the amount ofsecurities submitted for sale has exceeded the amount of purchase orders. Weexpect additional auction failures during the remainder of February and March2008, which will require us to hold the securities until liquidity is restoredto the credit markets or the securities are redeemed or mature.

 

If uncertainties in thecredit and capital markets continue, these markets deteriorate further or thereare any ratings downgrades on any ARS we hold, we may be required to reclassifythese investments from short-term to long-term investments. In addition, if thefailed auctions or any downgrades are deemed to cause an “other than temporaryimpairment” of our ARS, we may be required to re-value the ARS at some amountbelow par. Any re-valuation of ARS that are other than temporarily impairedwill flow through our operations statement and affect our earnings.

 

**We mayhave exposure to income tax rate fluctuations as well as to additional taxliabilities, which would impact our financial position.**

** **

As a corporation withoperations both in the U.S. and abroad, we are subject to income taxes in boththe U.S. and various foreign jurisdictions. Oureffective tax rate is subject to fluctuation as the income tax rates for eachyear are a function of the following factors, among others:

 

·                  the effects of a mix of profits or losses earned by us and oursubsidiaries in numerous foreign tax jurisdictions with a broad range of incometax rates;

 

·                  our ability to utilize recorded deferred tax assets;

 

·                  changes in uncertain tax positions, interest or penalties resultingfrom tax audits; and

 

·                  changes in tax laws or the interpretation of such laws.

 

Changes in the mix ofthese items and other items may cause our effective tax rate to fluctuatebetween periods, which could have a material adverse effect on our financialresults.

 

We are also subject tonon-income taxes, such as payroll, sales, use, value-added, net worth, propertyand goods and services taxes, in both the U.S. and various foreignjurisdictions.

 

We are regularly underaudit by tax authorities with respect to both income and non-income taxes andmay have exposure to additional tax liabilities as a result of these audits.

 

Significant judgment isrequired in determining our provision for income taxes and other taxliabilities. Although we believe that our tax estimates are reasonable, wecannot assure you that the final determination of tax audits or tax disputeswill not be different from what is reflected in our historical income taxprovisions and accruals.

 

**Many ofour current and planned products are highly complex and may contain defects orerrors that can only be detected after installation, which may harm ourreputation.**

** **

Our products are highlycomplex, and our extensive product development, manufacturing and testingprocesses may not be adequate to detect all defects, errors, failures andquality issues that could impact customer satisfaction or result in claimsagainst us. As a result, we could have to replace certain components and/orprovide remediation in response to the discovery of defects in products afterthey are shipped. The occurrence of any defects, errors, failures or qualityissues could result in cancellation of orders, product returns, diversion ofour resources, legal actions by our customers and other losses to us or to ourcustomers. These occurrences could also result in the loss of, or delay in,market acceptance of 

 

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our products and loss ofsales, which would harm our business and adversely affect our revenues andprofitability.

** **

**Issuesarising from our enterprise resource planning system could affect our operatingresults and ability to manage our business effectively.**

** **

Our ability to design,manufacture, market and service products and systems is dependent oninformation technology systems that encompass all of our major businessfunctions.****In 2005, we abandonedthe implementation of an Oracle-based enterprise resource planning (“ERP”)software system.

 

In lieu of the abandoned project, we have undertakento update and upgrade certain components of our existing system and to addadditional functionality. Updating our existing system presents the potential for additionaldifficulties. Moreover, if the existing system, as updated, is not sufficientto meet our needs, it could adversely affect our ability to do the following ina timely manner: manage and replenish inventory; fulfill and process orders;manufacture and ship products in a timely manner; invoice and collectreceivables; place purchase orders and pay invoices; coordinate sales andmarketing activities; prepare our financial statements and manage ouraccounting systems and controls; and otherwise carry on our business in theordinary course. Any such disruption could adversely affect our business, prospects,financial condition and results of operations. Moreover, difficulties arisingfrom the ERP system could result in a failure of our internal control overfinancial reporting, which, in turn, could result in a material weakness and aqualified report from our independent registered public accounting firm.

 

**We mayhave underestimated past restructuring charges or we may incur futurerestructuring and asset impairment charges, either of which may adverselyimpact our results of operations.**

** **

In 2006, we recordedrestructuring, reorganization, relocation and severance charges of $12.6million, of which $3.3 million was for facilities and severance charges relatedto the closure of certain of our European field offices, the closure of ourTempe, Arizona research and development facility, as well as residual costsrelated to the Peabody, Massachusetts plant closure and the downsizing of therelated semiconductor businesses, and $9.3 million was related to thetermination of our former Chief Executive Officer. Of the $9.3 million charge,$2.2 million was cash compensation and $7.1 million was non-cash stock-basedcompensation. We may incur additional restructuring and related expenses, whichmay have a material adverse effect on our business, financial condition orresults of operations. The charges in connection with these restructurings areonly estimates and may not be accurate. As part of these restructurings, weceased to use certain of our leased facilities and, accordingly, we havenegotiated, and are continuing to negotiate, certain lease terminations and/orsubleases of our facilities. We cannot predict when or if we will be successfulin negotiating lease termination agreements or subleases of our facilities onterms acceptable to us. If we are not successful in negotiating termsacceptable to us, or at all, we may be required to materially increase ourrestructuring and related expenses in future periods. Further, if we haveadditional reductions to our workforce or consolidate additional facilities inthe future we may incur additional restructuring and related expenses, whichcould have a material adverse effect on our business, financial condition orresults of operations.

 

In addition, we test ourgoodwill and other intangible assets for impairment annually or when an eventoccurs indicating the potential for impairment. If we record an impairmentcharge as a result of this analysis, it could have a material impact on ourresults of operations. We could also incur material charges as a result of write-downsof inventories or other tangible assets.

 

**Anyfailure by us to execute planned cost reductions successfully could result intotal costs and expenses that are greater than expected.**

** **

We have undertakenrestructuring plans to bring operational expenses to appropriate levels for ourbusiness. In 2005, we took significant restructuring charges in connection withthe closing of our Peabody, Massachusetts plant and otherwise. We may havefurther workforce reductions or rebalancing actions in the future. Significantrisks associated with these actions and other workforce management 

 

19

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issues that may impairour ability to achieve anticipated cost reductions or that may otherwise harmour business include delays in implementation of anticipated workforcereductions in highly regulated locations outside of the U.S., particularly inEurope and Asia, redundancies among restructuring programs, decreases inemployee morale and the failure to meet operational targets due to the loss ofemployees, particularly sales and service employees and engineers.

 

**Changesin accounting pronouncements or taxation rules or practices may affect howwe conduct our business.**

** **

Changes in accountingpronouncements or taxation rules or practices can have a significanteffect on our reported results. Other new accounting pronouncements or taxationrules and varying interpretations of accounting pronouncements or taxationpractices have occurred and may occur in the future. New rules, changes toexisting rules, if any, or the questioning of current practices may adverselyaffect our reported financial results or change the way we conduct ourbusiness.

 

**Terroristacts, acts of war and natural disasters may seriously harm our business and revenues,costs and expenses and financial condition.**

** **

Terrorist acts, acts ofwar and natural disasters, wherever located around the world, may cause damageor disruption to us or our employees, facilities, partners, suppliers,distributors and customers, any and all of which could significantly impact ourrevenues, expenses and financial condition. This impact could bedisproportionately greater on us than on other companies as a result of oursignificant international presence. The potential for future terrorist attacks,the national and international responses to terrorist attacks and other acts ofwar or hostility have created many economic and political uncertainties thatcould adversely affect our business and results of operations in ways that cannotpresently be predicted. We are largely uninsured for losses and interruptionscaused by terrorist acts, acts of war and natural disasters, including at ourheadquarters located in Oregon, which is in a region subject to earthquakes.

 

**Some ofour systems use hazardous gases and emit x-rays, which, if not properlycontained, could result in property damage, bodily injury and death.**

** **

A hazardous gas or x-rayleak could result in substantial liability and could also significantly damagecustomer relationships and disrupt future sales. Moreover, remediation couldrequire redesign of the tools involved, creating additional expense, increasingtool costs and damaging sales. In addition, the matter could involvesignificant litigation that would divert management time and resources andcause unanticipated legal expense. Further, if such a leak involved violationof health and safety laws, we may suffer substantial fines and penalties inaddition to the other damage suffered.

 

**Unforeseenhealth, safety and environmental costs could impact our future net earnings.**

** **

Some of our operationsuse substances that are regulated by various federal, state and internationallaws governing health, safety and the environment. We could be subject toliability if we do not handle these substances in compliance with safetystandards for storage and transportation and applicable laws. It is our policyto apply strict standards for environmental protection to sites inside andoutside the U.S., even when not subject to local government regulations. Wewill record a liability for any costs related to health, safety orenvironmental remediation when we consider the costs to be probable and theamount of the costs can be reasonably estimated.

 

**We maynot be successful in obtaining the necessary export licenses to conductoperations abroad, and the U.S. Congress may prevent proposed sales to foreigncustomers.**

** **

We are subject to exportcontrol laws that limit which products we sell and where and to whom we sellour products. Moreover, export licenses are required from government agenciesfor some of our products in accordance with various statutory authorities,including the Export Administration Act of 1979, the International EmergencyEconomic Powers Act of 1977, the Trading with the Enemy Act of 1917 and the 

 

20

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Arms Export Control Actof 1976. We may not be successful in obtaining these necessary licenses inorder to conduct business abroad. Failure to comply with applicable exportcontrols or the termination or significant limitation on our ability to exportcertain of our products would have an adverse effect on our business, resultsof operations and financial condition.

 

**Provisionsof our charter documents, our shareholder rights plan and Oregon law could makeit more difficult for a third party to acquire us, even if the offer may beconsidered beneficial by our shareholders.**

** **

Our articles ofincorporation and bylaws contain provisions that could make it harder for athird party to acquire us without the consent of our Board of Directors. OurBoard of Directors has also adopted a shareholder rights plan, or “poison pill,”which would significantly dilute the ownership of a hostile acquirer. Inaddition, the Oregon Control Share Act and the Oregon Business Combination Actlimit the ability of parties who acquire a significant amount of voting stockto exercise control over us. These provisions may have the effect oflengthening the time required for a person to acquire control of us through aproxy contest or the election of a majority of our Board of Directors, maydeter efforts to obtain control of us and may make it more difficult for athird party to acquire us without negotiation. These provisions may apply evenif the offer may be considered beneficial by our shareholders.

 

**Item 1B.**** Unresolved Staff Comments**

** **

None.

 

**Item 2.**** Properties**

** **

Our corporate headquarters is located ina facility we own in Hillsboro, Oregon. This facility totals approximately180,000 square feet and houses a range of activities, including manufacturing,research and development, corporate finance and administration and sales andmarketing.

 

We also maintain a major facility inEindhoven, the Netherlands, consisting of 244,169 square feet of space. Thelease for this space expires in 2018. Present lease payments are approximately$290,000 per month. This facility is used for research and development,manufacturing, sales, marketing and administrative functions.

 

We maintain a manufacturing anddevelopment facility in Brno, Czech Republic, which consists of 92,570 squarefeet of space, and is leased for approximately $140,000 per month. The leaseexpires in 2012.

 

We operate sales and service offices inleased facilities in the People’s Republic of China (“PRC”), Japan, Hong Kong,Singapore, the Netherlands, the United Kingdom and the U.S., as well as othersmaller offices in the other countries where we have direct sales and serviceoperations. In some of these locations, we lease space directly. In otherlocations, we obtain space through service agreements with affiliates ofKoninklijke Philips Electronics N.V. (“Philips”). We closed several Europeansales offices and consolidated these operations into our offices in theNetherlands in the first half of 2006. We expect that our facilitiesarrangements will be adequate to meet our needs for the foreseeable future and,overall, believe we can meet increased demand for facilities that may berequired to meet increased demand for our products. In addition, we believe thatif product demand increases, we can use outsourced manufacturing of spareparts, additional manufacturing shifts and currently underutilized space as ameans of adding capacity without increasing our direct investment in additionalfacilities.

 

21

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** **

**Item 3.**** Legal Proceedings**

** **

As of the date hereof, there is nomaterial litigation pending against us. From time to time, we become party tolitigation and subject to claims arising in the ordinary course of our business.To date, these actions have not had a material adverse effect on our business,financial position, results of operations or cash flows, and although theresults of litigation and claims cannot be predicted with certainty, we believethat the final outcome of such matters will not have a material adverse effecton our business, financial position, results of operations or cash flows.

 

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

** **

No matters were submittedto a vote of our shareholders during the fourth quarter ended December 31,2007.

 

**PART II**

** **

**Item 5.**** Market for Registrant’sCommon Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities**

** **

***StockPrices, Issuances of Common Stock and Dividends***

 

Our common stock is quoted on the NasdaqGlobal Market under the symbol FEIC. The high and low sales prices on theNasdaq Global Market for the past two years were as follows:

 
| **2006**  | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------|------------|----------|------------|---------|------------|
| Quarter 1 |       | $        | 26.00      |    | $          | 19.28 |   |
| Quarter 2 |       | 25.90    |       | 19.78   |       |
| Quarter 3 |       | 23.20    |       | 18.78   |       |
| Quarter 4 |       | 27.37    |       | 20.49   |       |
|           |            |          |            |         |            |  |  |

 
| **2007**  | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------|------------|----------|------------|---------|------------|
| Quarter 1 |       | $        | 36.48      |    | $          | 24.58 |   |
| Quarter 2 |       | 39.25    |       | 32.37   |       |
| Quarter 3 |       | 33.90    |       | 26.50   |       |
| Quarter 4 |       | 34.46    |       | 24.01   |       |
|           |            |          |            |         |            |  |  |

 

The approximate number of beneficialshareholders and shareholders of record at February 26, 2008 was 11,400and 101, respectively.

 

In February 1997,we acquired the electron optics business of Philips pursuant to a combinationagreement between us and a subsidiary of Philips. We issued shares of ourcommon stock to Philips at the time of the combination and agreed to issueadditional shares of our common stock when stock options that were outstandingon the date of the closing of the combination (February 21, 1997) areexercised. The additional shares are issued at a rate of approximately1.22 shares to Philips for each share issued on exercise of these options.During 2007, we did not issue any shares of our common stock to Philips inconnection with this agreement and, as of December 31, 2007, 185,000shares of our common stock remained issuable under this agreement.

 

We did not pay ordeclare any cash dividends in 2007 or 2006. We intend to retain any earningsfor use in our business and, therefore, do not anticipate paying any cashdividends in the foreseeable future.

 

***Equity Compensation Plans***

*** ***

Information regarding securities authorized for issuanceunder equity compensation plans will be included in the section titled “SecuritiesAuthorized for Issuance Under Equity Compensation Plans” in the proxy statementfor our 2008 Annual Meeting of Shareholders and is incorporated by referenceherein.

 

22

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*** ***

***Stock Performance Graph***

*** ***

The following line-graphpresentation compares cumulative five-year shareholder returns on an indexedbasis, assuming a $100 initial investment and reinvestment of dividends, of (a) FEICompany, (b) a broad-based equity market index and (c) anindustry-specific index. The broad-based market index used is the Nasdaq StockMarket Total Return Index - U.S. and the industry-specific index used is theNasdaq Non-Financial Index.

 

 
| ** **           | ** ** | **Base**     | ** ** | **Indexed Returns** | ** ** |
|----------------------|------------|--------------|------------|---------------------|------------|
| ** **           | ** ** | **Period**   | ** ** | **Year Ended**      | ** ** |
| **Company/Index**    | ** ** | **12/31/02** | ** ** | **12/31/03**        | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** | **12/31/07** | ** ** |
| FEI Company          |       | $            | 100.00     |                | $          | 147.16 |   | $ | 137.34 |   | $ | 125.38 |   | $ | 172.47 |   | $ | 162.39 |   |
| Nasdaq Non-Financial |       | 100.00       |       | 153.09              |       | 165.10 |   | 168.84 |   | 185.15 |   | 210.05 |   |
| Nasdaq U.S. Index    |       | 100.00       |       | 149.52              |       | 162.72 |   | 166.18 |   | 182.57 |   | 197.98 |   |
|                      |            |              |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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** **

**Item 6.**  **Selected Financial Data**

** **

The selected consolidatedfinancial data below should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andthe consolidated financial statements and notes thereto included elsewhere inthis Annual Report on Form 10-K.

 
| **In  thousands,  except per share amounts**                  | ** **   | **Year Ended December 31,** | ** **   |
|---------------------------------------------------------------|--------------|----------------------------------|--------------|
| ** **                                                    | ** **   | **2007**                         | ** **   | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ***Statement of Operations Data***                            | *** *** | *** ***                     | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Net sales                                                     |         | $                                | 592,510      |   | $ | 479,491 |   | $ | 420,097 |   | $ | 457,525 |   | $ | 356,892 |   |
| Cost of sales(1)                                              |         | 346,090                          |         | 283,045 |   | 274,903 |   | 276,131 |   | 215,534 |   |
| Gross profit                                                  |         | 246,420                          |         | 196,446 |   | 145,194 |   | 181,394 |   | 141,358 |   |
| Total operating expenses(2)                                   |         | 191,707                          |         | 173,399 |   | 191,752 |   | 150,209 |   | 128,312 |   |
| Operating income (loss)                                       |         | 54,713                           |         | 23,047 |   | (46,558 | ) | 31,185 |   | 13,046 |   |
| Other income (expense), net(3)                                |         | 11,312                           |         | 5,072 |   | (9,831 | ) | (8,264 | ) | (2,831 | ) |
| Income (loss)  from continuing operations before income taxes |         | 66,025                           |         | 28,119 |   | (56,389 | ) | 22,921 |   | 10,215 |   |
| Income tax expense(4)                                         |         | 8,077                            |         | 10,467 |   | 22,071 |   | 7,205 |   | 3,543 |   |
| Income (loss) from continuing operations                      |         | 57,948                           |         | 17,652 |   | (78,460 | ) | 15,716 |   | 6,672 |   |
| Income (loss) from discontinued operations, net of  tax       |         | —                           |         | (947 | ) | 302 |   | 857 |   | 522 |   |
| Gain on disposal  of discontinued operations, net of tax(5)   |         | 390                              |         | 3,335 |   | — |   | — |   | — |   |
| Net income (loss)                                             |         | $                                | 58,338       |   | $ | 20,040 |   | $ | (78,158 | ) | $ | 16,573 |   | $ | 7,194 |   |
|                                                          |         |                             |         |   |   |   |   |   |   |   |   |
| Basic income  (loss) per share from continuing operations     |         | $                                | 1.62         |   | $ | 0.52 |   | $ | (2.34 | ) | $ | 0.47 |   | $ | 0.20 |   |
| Basic income per share from discontinued operations           |         | 0.01                             |         | 0.07 |   | 0.01 |   | 0.03 |   | 0.02 |   |
| Basic net income (loss) per share                             |         | $                                | 1.63         |   | $ | 0.59 |   | $ | (2.33 | ) | $ | 0.50 |   | $ | 0.22 |   |
|                                                          |         |                             |         |   |   |   |   |   |   |   |   |
| Diluted income  (loss) per share from continuing operations   |         | $                                | 1.35         |   | $ | 0.47 |   | $ | (2.34 | ) | $ | 0.41 |   | $ | 0.18 |   |
| Diluted income  per share from discontinued operations        |         | 0.01                             |         | 0.06 |   | 0.01 |   | 0.02 |   | 0.02 |   |
| Diluted net income (loss) per share                           |         | $                                | 1.36         |   | $ | 0.53 |   | $ | (2.33 | ) | $ | 0.43 |   | $ | 0.20 |   |
|                                                          |         |                             |         |   |   |   |   |   |   |   |   |
| Shares used in basic per share calculations                   |         | 35,709                           |         | 33,818 |   | 33,595 |   | 33,253 |   | 32,930 |   |
| Shares used in diluted per share calculations                 |         | 46,254                           |         | 39,752 |   | 33,595 |   | 39,668 |   | 36,844 |   |

 
| ** **                               | ** **   | **December 31,** | ** **   |
|------------------------------------------|--------------|-----------------------|--------------|
| ** **                               | ** **   | **2007**              | ** **   | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ***Balance Sheet Data***                 | *** *** | *** ***          | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Cash and cash equivalents                |         | $                     | 280,593      |   | $ | 110,656 |   | $ | 58,766 |   | $ | 112,162 |   | $ | 97,108 |   |
| Working capital                          |         | 428,071               |         | 477,660 |   | 327,789 |   | 433,895 |   | 420,400 |   |
| Total assets                             |         | 1,008,009             |         | 838,079 |   | 656,031 |   | 841,044 |   | 755,145 |   |
| Current portion of convertible debt      |         | 195,882               |         | — |   | — |   | — |   | — |   |
| Convertible debt, net of current portion |         | 115,000               |         | 310,882 |   | 225,000 |   | 295,000 |   | 295,000 |   |
| Shareholders’ equity                |         | 487,394               |         | 349,908 |   | 292,443 |   | 379,570 |   | 336,293 |   |
|                                          |              |                       |              |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)         Included in 2005cost of sales was $14.2 million of inventory write-downs related to the closureof our Peabody, Massachusetts facility, the relocation and refocus of theproduct lines that were at that facility, a price adjustment on a product salefrom that operation and capitalized software impairment charges related tocertain semiconductor products.

 

(2)         Included in 2006operating expenses were the following:

 

·                  restructuring,reorganization, relocation and severance charges of $12.6 million;

 

·                  merger costs of$0.5 million;

 

·                  asset impairmentcharges of $0.5 million; and

 

·                  a $1.5 milliongain related to the  sale of certainintellectual property rights to a privately-held company.

 

Includedin 2005 operating expenses were the following:

 

·                  $25.4 million of asset impairment chargesprimarily related to semiconductor products and the write-off of all costsrelated to our ERP system as we determined that the future cost required tocomplete the ERP system did not justify the potential return; and

 

·                  $8.5 million of restructuring charges,primarily for severance, lease terminations and relocation expenses for theclosure of our Peabody facility and consolidation of certain of our Europeanfacilities.

 

Includedin 2004 operating expenses was a $0.6 million charge for restructuring,reorganization and relocation.

 

Includedin 2003 operating expenses was a $1.7 million charge for restructuring,reorganization and relocation related to our fourth quarter 2002 and secondquarter 2003 restructuring and reorganization plans, plus $1.2 million for thewrite-off of in-process purchased technology.

 

(3)         Included in otherincome (expense), net in 2007 were a $0.5 million gain related to the disposal of oneof our cost-based investments and a $0.5 million gain on the sale of a minorityinterest in a small technology company.

 

Includedin other income (expense), net in 2006 were the following that affect comparability:

 

·                  interest expenseof $0.5 million in the first half of 2006 related to the repurchase of $29.0million face value of our 5.5% convertible notes;

 

·                  a $5.2 milliongain related to the sale of our entire ownership interest in a privately-heldcompany in the third quarter of 2006; and

 

·                  a $3.9 millioncharge related to the write-off of our equity and debt investment in aprivately-held company in the third quarter of 2006.

 

Includedin 2005 other income (expense), net was $6.4 million for realized losses on investmentsin privately-held companies and the write-down of certain of these investmentsfor which we concluded an “other-than-temporary” impairment existed.

 

Includedin 2003 other income (expense), net was $3.5 million related to currency andhedging gains.

 

(4)         Our 2007 tax provision on income from continuing operation reflectedtaxes on foreign earnings offset by a $4.7 million release of unrecognized taxbenefits, including interest and penalties, as a result of the settlement offoreign tax audits and a tax benefit of $5.3 million related to the release ofvaluation allowance recorded against net operating loss deferred tax assetsutilized to offset income earned in the U.S. . Our 2006 tax provisionconsisted primarily of taxes accrued in foreign jurisdictions and reflects abenefit of $1.5 million related to the release of valuation allowances againsta portion of U.S. deferred tax assets utilized during the period. Our 2005tax expense primarily consisted of $15.1 million in expense related to the establishmentof valuation allowances against the United States deferred tax assets, whichoffset the benefit from U.S. net operating losses generated in 2005.Additionally, we had approximately $10.9 million of foreign tax expense, whichwas offset by a net current tax benefit of $4.1 million primarily related totax audit settlements in the U.S.

 

(5)         Represents thegain on the sale of our Knights Technology assets.

 

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

 

**CautionaryFactors That May Affect Future Results**

** **

This Annual Report on Form 10-K contains forward-lookingstatements that involve risks and uncertainties, as well as assumptions that,if they never materialize or prove incorrect, could cause our results to differmaterially from those expressed or implied by such forward-looking statements.Such forward-looking statements include any expectations of earnings, revenuesor other financial items; any statements of the plans, strategies andobjectives of management for future operations; factors that may affect our2007 operating results; any statements concerning proposed new products,services, developments, changes to our restructuring reserves or anticipatedperformance of products or services; any statements related to future capitalexpenditures; any statements related to the needs or expected growth of ourtarget markets; any statements regarding future economic conditions orperformance; statements of belief; and any statement of assumptions underlyingany of the foregoing. You can identify these statements by the fact that theydo not relate strictly to historical or current facts and use words such as “anticipate,”“estimate,” “expect,” “project,” “intend,” “plan,” “believe” and other wordsand terms of similar meaning. From time to time, we also may provide oral orwritten forward-looking statements in other materials we release to the public.The risks, uncertainties and assumptions referred to above include, but are notlimited to, those discussed here and the risks discussed from time to time inour other public filings. All forward-looking statements included in thisAnnual Report on Form 10-K are based on information available to us as ofthe date of this report, and we assume no obligation to update theseforward-looking statements. You are advised, however, to consult any furtherdisclosures we make on related subjects in our Forms 10-Q and 8-K filed with,or furnished to, the SEC. You also should read Item 1A. “Risk Factors” forfactors that we believe could cause our actual results to differ materiallyfrom expected and historical results. Other factors also could adversely affectus.

** **

**Summary of Productsand Segments**

 

We are a leading supplier of instruments for nanoscale imaging,analysis and prototyping to enable research, development and manufacturing in arange of industrial, academic and research institutional applications. Wereport our revenue based on a market-focused organization: the NanoElectronicsmarket, the NanoResearch and Industry market, the NanoBiology market and theService and Components market.

 

Our products include focused ion beam systems, or FIBs; scanningelectron microscopes, or SEMs; transmission electron microscopes, or TEMs; and *DualBeam* systems, which combine a FIB and SEM on a singleplatform.

 

Our *DualBeam* systems include models that have wafer handlingcapability and are purchased by semiconductor and data storage manufacturers (“wafer-level*DualBeam*systems”) and models that havesmall stages and are sold to customers in several markets (“small-stage *DualBeam*systems”).

 

TheNanoElectronics market consists of customers in the semiconductor, data storageand related industries such as printers and microelectromechanical systems (“MEMs”).For the semiconductor market, our growth is driven by shrinking line widths andprocess nodes of 65 nanometers and smaller, the use of multiple layers of newmaterials such as copper and low-k dielectrics, the increase in wafer size to300 millimeters in diameter and increasing device complexity. Our products areused primarily in laboratories to speed new product development and increaseyields by enabling 3D wafer metrology, defect analysis, root cause failureanalysis and circuit edit for modifying device structures. In the data storagemarket, factors affecting our business include the transition from longitudinalto perpendicular recording heads, rapidly increasing storage densities thatrequire smaller recording heads, thinner geometries and materials that increasethe complexity of device structures. Our products offer 3D metrology for thinfilm head processing and root cause failure analysis.

 

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TheNanoResearch and Industry market includes universities, public and privateresearch laboratories and customers in a wide range of industries, includingautomobiles, aerospace, metals, mining and petrochemicals. Growth in thesemarkets is driven by global corporate and government funding for research anddevelopment in materials science and by development of new products andprocesses based on innovations in materials at the nanoscale. Our solutionsprovide researchers and manufacturers with atomic-level resolution images andpermit development, analysis and production of advanced products. Our productsare also used in root cause failure analysis and quality control applications.

 

TheNanoBiology market includes universities and research institutes engaged inbiotech and life sciences applications, as well as pharmaceutical, biotech,medical device and hospital companies. Our products’ ultra-high resolutionimaging allows cell biologists and drug researchers to create detailed 3Dreconstructions of complex biological structures. Our products are also used inparticle analysis and a range of pathology and quality control applications.

 

**Overview**

** **

Netsales increased to $592.5 million in 2007 compared to $479.5 million in 2006.Revenue growth in each of our product segments contributed to our growth in2007 compared to 2006.

 

At December 31,2007, our total backlog was $310.8 million compared to $305.9 million at December 31,2006. Backlog consisted of product and service and components backlog ofunfilled orders of $256.1 million and $54.7 million, respectively, at December 31,2007 compared to $259.1 million and $46.8 million, respectively, at December 31,2006.

 

**Outlook for 2008**

** **

After achievingrevenue growth of 23.6% in 2007 compared to 2006, we expect slower growth in2008.

 

We expect ourNanoResearch and Industry business to continue to grow as governments,institutions and corporations globally continue to invest in nanotechnologyresearch and product development. If the U.S. experiences a consumer-ledrecession in 2008, as many observers expect, a portion of our NanoResearch andIndustry business could be somewhat affected. However, we believe the globalreach of our products and the multi-year budget cycles of many of our customerswill be sufficient to provide further growth in 2008. We also expect continuedgrowth in our NanoBiology business in 2008, although it will vary from quarterto quarter. This is an emerging, research-oriented market for us, and we expectour revenue to be positively affected by the introduction of the *Titan Krios* TEM in early 2008. We experienced a significantslow-down in bookings in our NanoElectronics business in the second half of2007, mainly due to a cyclical slow-down in the semiconductor capital equipmentindustry. That weakness relative to the first half of 2007 is expected topersist in 2008. While revenue for this segment is likely to decline in 2008,we believe we have the potential to demonstrate better performance than thesemiconductor capital equipment industry as a whole, because of increaseddemand for higher-resolution images as manufacturers move to smaller linewidths and new processes, among other factors. Demand for service of ourproducts is expected to grow modestly as our installed base of products grows.

 

We believe wehold leadership positions, both technologically and in the markets in which wecompete, with our TEM and *DualBeam*products. While some competitors introduced new products in these areas in2007, we expect to maintain our leadership in 2008. In the SEM product line, weexpect to introduce new products in 2008 that will improve our competitiveposition, with the goal of obtaining technological leadership in that productline as well.

 

Our grossmargins improved in 2007 compared with 2006. While our plan is to continue thattrend in 2008, we face a number of challenges. Factors that may contribute toincreased margins include the introduction of new products and plannedoperational improvements in our supply chain, manufacturing operations andservice organization. However, product mix and a weaker U.S. dollar will likelyreduce margins early in 2008. The product mix pressure includes the potentialdecline in the relative size of our 

 

27

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higher-marginNanoElectronics business, as well as the sale of relatively fewer *DualBeam* products within NanoElectronics. The weaker U.S.dollar adversely affects us because our euro-denominated expenses are greaterthan our euro-denominated revenue. Our cash flow hedging program can delay ormitigate the effect of the weaker U.S. dollar, but it cannot counteract themulti-year trend we have seen in recent years. We have programs in place tooffset these negative forces on our margins, including new productintroductions and better operational balance between euro expenses and eurorevenues, but they are likely to offset only part of the impact of the downwardmix and currency fluctuations on margins in 2008.

 

Growth inresearch and development and marketing spending is also negatively affected bythe stronger euro, as well as increases in personnel, because a largepercentage of our research and development operations are located in Europe.Total employment growth is planned to be significantly below the 11% growthrate of 2007, but we do plan to selectively add to critical positions during2008. Overall operating spending is expected to grow in 2008 compared with2007, but at a significantly lower rate of growth than in 2007.

 

Non-operatingincome is expected to decline in 2008 due to lower market interest rates andthe repayment of part of our outstanding debt. Our annual tax rate is alsoexpected to be somewhat higher for 2008, because 2007’s expense for incometaxes was lowered by the settlement of several international tax audits.

 

Our goal for2008 is to increase net income over 2007 levels. However, the combination ofmore modest growth and improvement in gross margins, offset by increasedoperating expenses, lower non-operating income and a higher tax rate, couldresult in net income in 2008 that is below 2007 levels.

 

**Resultsof Operations**

** **

The following table sets forth ourstatement of operations data in thousands of dollars.

 
| ** **                                                    | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                    | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                                     |       | $                                | 592,510    |   | $ | 479,491 |   | $ | 420,097 |   |
| Cost of sales                                                 |       | 346,090                          |       | 283,045 |   | 274,903 |   |
| Gross profit                                                  |       | 246,420                          |       | 196,446 |   | 145,194 |   |
| Research and  development                                     |       | 66,042                           |       | 57,528 |   | 56,577 |   |
| Selling, general  and administrative                          |       | 124,160                          |       | 100,279 |   | 97,460 |   |
| Merger costs                                                  |       | —                           |       | 484 |   | — |   |
| Amortization of  purchased technology                         |       | 1,777                            |       | 2,034 |   | 3,819 |   |
| Asset impairment                                              |       | —                           |       | 465 |   | 25,352 |   |
| Restructuring,  reorganization and relocation costs           |       | (272                             | )          | 12,609 |   | 8,544 |   |
| Operating income  (loss)                                      |       | 54,713                           |       | 23,047 |   | (46,558 | ) |
| Other income  (expense), net                                  |       | 11,312                           |       | 5,072 |   | (9,831 | ) |
| Income (loss)  from continuing operations before income taxes |       | 66,025                           |       | 28,119 |   | (56,389 | ) |
| Income tax  expense                                           |       | 8,077                            |       | 10,467 |   | 22,071 |   |
| Income (loss)  from continuing operations                     |       | 57,948                           |       | 17,652 |   | (78,460 | ) |
| Income (loss)  from discontinued operations, net of tax       |       | —                           |       | (947 | ) | 302 |   |
| Gain on disposal  of discontinued operations, net of tax      |       | 390                              |       | 3,335 |   | — |   |
| Net income  (loss)                                            |       | $                                | 58,338     |   | $ | 20,040 |   | $ | (78,158 | ) |

 

28

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Thefollowing table sets forth our statement of operations data as a percentage ofnet sales.

 
| ** **                                                    | ** ** | **Year Ended December 31,(1)** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                                     |       | 100.0                               | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                                 |       | 58.4                                |       | 59.0 |   | 65.4 |   |
| Gross profit                                                  |       | 41.6                                |       | 41.0 |   | 34.6 |   |
| Research and  development                                     |       | 11.1                                |       | 12.0 |   | 13.5 |   |
| Selling, general  and administrative                          |       | 21.0                                |       | 20.9 |   | 23.2 |   |
| Merger costs                                                  |       | —                              |       | 0.1 |   | — |   |
| Amortization of  purchased technology                         |       | 0.3                                 |       | 0.4 |   | 0.9 |   |
| Asset impairment                                              |       | —                              |       | 0.1 |   | 6.0 |   |
| Restructuring,  reorganization and relocation costs           |       | —                              |       | 2.6 |   | 2.0 |   |
| Operating income  (loss)                                      |       | 9.2                                 |       | 4.8 |   | (11.1 | ) |
| Other income  (expense), net                                  |       | 1.9                                 |       | 1.1 |   | (2.3 | ) |
| Income (loss)  from continuing operations before income taxes |       | 11.1                                |       | 5.9 |   | (13.4 | ) |
| Income tax  expense                                           |       | 1.4                                 |       | 2.2 |   | 5.3 |   |
| Income (loss)  from continuing operations                     |       | 9.8                                 |       | 3.7 |   | (18.6 | ) |
| Income (loss)  from discontinued operations, net of tax       |       | —                              |       | (0.2 | ) | 0.1 |   |
| Gain on disposal  of discontinued operations, net of tax      |       | 0.1                                 |       | 0.7 |   | — |   |
| Net income  (loss)                                            |       | 9.8                                 | %          | 4.2 | % | (18.6 | )% |

 

----

(1) Percentages may not add due to rounding.

 

Net sales increased $113.0 million, or23.6%, to $592.5 million, in 2007 compared to $479.5 million in 2006. Theincrease in net sales reflects increases in all of our market segments, asdiscussed in more detail below.

 

Net sales increased $59.4 million, or14.1%, to $479.5 million, in 2006 compared to $420.1 million in 2005. Theincrease in net sales was driven by improvements in all of our segments,primarily related to increases in our TEM and small-stage *DualBeam*sales.

 

***Net Sales by Segment***

 

Net sales include sales in theNanoElectronics market, the NanoResearch and Industry market, the NanoBiologymarket and the Service and Components market. Net sales by market segment (inthousands) and as a percentage of net sales were as follows:

 
| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| NanoElectronics           |       | $                                | 198,663    |   | 33.5 | % | $ | 154,648 |   | 32.3 | % | $ | 145,951 |   | 34.7 | % |
| NanoResearch and Industry |       | 214,551                          |       | 36.2 | % | 165,067 |   | 34.4 | % | 130,045 |   | 31.0 | % |
| NanoBiology               |       | 51,874                           |       | 8.8 | % | 40,928 |   | 8.5 | % | 35,355 |   | 8.4 | % |
| Service and Components    |       | 127,422                          |       | 21.5 | % | 118,848 |   | 24.8 | % | 108,746 |   | 25.9 | % |
|                      |       | $                                | 592,510    |   | 100.0 | % | $ | 479,491 |   | 100.0 | % | $ | 420,097 |   | 100.0 | % |

 

*NanoElectronics*

 

The $44.0 million, or 28.5%, increase in NanoElectronics sales in 2007compared to 2006 was due to increases in the number of TEM and small-stage *DualBeam* system units sold. We achieved increasedpenetration of TEM sales due to higher resolution image requirements fromcustomers. The increase in small-stage *DualBeam*systems was due to continued adoption of new products. Sales in theNanoElectronics segment moderated in the third and fourth quarters of 2007 ascompared to the first two quarters of 2007 due to a cyclical decline insemiconductor capital spending. We expect this trend to continue in the firstquarter of 2008 and perhaps beyond.

 

The $8.7 million, or 6.0%, increase inNanoElectronics sales in 2006 compared to 2005 was primarily due toimprovements in our wafer-level *DualBeam*, SEMand small-stage *DualBeam* system unit sales, which

 

29

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resulted primarily from general demand inthe semiconductor capital equipment and data storage markets. Theseimprovements were partially offset by volume declines related to products inour semiconductor businesses that were deemphasized during our restructuringactivities in the second half of 2005.

 

*NanoResearch and Industry*

 

The $49.5 million, or 30.0%, increase inNanoResearch and Industry sales in 2007 compared to 2006 was due primarily toincreases in the number of SEM and small-stage *DualBeam*system units sold as nanotechnology research strengthens. In addition, we haveseen strong customer demand in this market for our high-end TEMs, including the*Titan*, other new SEM products andsmall-stage *DualBeam* products introduced in the lasttwo years.

 

The $35.0 million, or 26.9%, increase inNanoResearch and Industry sales in 2006 compared to 2005 was due primarily toan approximately $33.6 million increase related to sales of our TEMs, dueprimarily to a shift in mix to our higher-priced TEMs, including the *Titan*, as well as a slight increase in unit sales. Inaddition, sales of our small-stage *DualBeam*systems increased by $3.0 million in 2006 compared to 2005 as a result ofincreased unit sales.

 

*NanoBiology*

 

The $10.9 million, or 26.7%, increase inNanoBiology sales in 2007 compared to 2006 was due primarily to an increase inthe number of TEM units sold as the adoption of TEM technology increased inlife sciences research applications. NanoBiology is an emerging market for ourequipment, and a significant portion of the tools we sell in this market haverelatively high per unit prices. As a result, quarter-to-quarter growth ratesin this market are likely to fluctuate, although we expect long-term growth.

 

The $5.6 million, or 15.8%, increase inNanoBiology sales in 2006 compared to 2005 was due primarily to a shift in mixto higher-priced TEMs. We also realized an increase in the number of TEMssold in 2006 compared to 2005.

 

*Service and Components*

 

The $8.6 million, or 7.2%, increase inService and Component sales in 2007 compared to 2006 was due primarily to alarger installed base and the fact that the installed base has newer,higher-priced tools, which typically carry higher-priced service contracts.Component sales include sales of individual components as well as refurbishedequipment and decreased $0.6 million, or 7.9%, in 2007 compared to 2006. Thisdecrease was primarily due to weakness in NanoElectronics in the second half of2007 and the timing of orders and shipments.

 

The $10.1 million, or 9.3%, increase inService and Component sales in 2006 compared to 2005 was due primarily to alarger installed base and strong service contract renewals in the second halfof 2006. Component sales contributed $0.8million to the increase in 2006 compared to 2005.

* *

***Net Sales by Geographic Region***

 

A significant portion of our net saleshas been derived from customers outside of the U.S., which we expect tocontinue. The following table shows our net sales by geographic location(dollars in thousands):

 
| ** **          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------|------------|----------------------------------|------------|
| ** **          | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| North America       |       | $                                | 230,413    |   | 38.9 | % | $ | 167,389 |   | 34.9 | % | $ | 125,875 |   | 30.0 | % |
| Europe              |       | 218,091                          |       | 36.8 | % | 187,229 |   | 39.0 | % | 160,891 |   | 38.3 | % |
| Asia-Pacific Region |       | 144,006                          |       | 24.3 | % | 124,873 |   | 26.1 | % | 133,331 |   | 31.7 | % |
|                |       | $                                | 592,510    |   | 100.0 | % | $ | 479,491 |   | 100.0 | % | $ | 420,097 |   | 100.0 | % |

 

30

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*NorthAmerica*

* *

Sales in NorthAmerica increased $63.0 million, or 37.7%, in 2007 compared to 2006. Thisincrease was primarily due to strong bookings in 2006, which resulted inincreased shipments in 2007, improved sales efforts in North America in 2007 followingthe reorganization of our sales management team in North America in 2005, aswell as a generally strong market for our tools.  In addition, 2007 sales were positivelyaffected by the utilization of backlog during the year.

 

Sales in NorthAmerica increased $41.5 million, or 33.0%, in 2006 compared to 2005. Thisincrease was primarily due to increased data storage sales as the conversion toperpendicular recording accelerated, as well as increased TEM sales, includingthe *Titan,*and**increasedsmall-stage *DualBeam* sales. These improvements werepartially driven by improvements in the semiconductor capital equipment anddata storage markets in 2006 compared to 2005. The reorganization of our salesmanagement team in North America in 2005 also contributed to the improved netsales in 2006 compared to 2005.

 

*Europe*

* *

Sales in Europe increased $30.9 million,or 16.5%, in 2007 compared to 2006. Severalnanoresearch centers are being developed in the European region, which hascontributed to an increase in NanoResearch and Industry and NanoBiology sales.We are also focusing on increasing the number of indirect sales agents anddistributors, which has contributed to the increase in sales in both existingand emerging markets. The change in the valuation of the European currencies inrelation to the U.S. dollar during 2007 increased European sales in 2007 byapproximately $17.1 million.

 

Sales in Europe increased $26.3 million,or 16.4%, in 2006 compared to 2005. Thisincrease was primarily due to increased TEM sales, including the *Titan*, partially offset by unusually high volume sales ofour small-stage *DualBeam*systems in the firsthalf of 2005 compared to 2006. In 2005, we reorganized our sales managementteam in Europe, which also contributed to the improved net sales in 2006compared to 2005. European sales were also increased by the strength of theeuro compared with the U.S. dollar.

 

*Asia-PacificRegion*

* *

Sales in the Asia-Pacific regionincreased $19.1 million, or 15.3%, in 2007 compared to 2006. This increase wasprimarily due to higher unit sales,primarily in Japan and China. We are also realizing initial benefits from ourinvestment in additional sales and service resources in 2007 in theAsia-Pacific region.

 

Sales in the Asia-Pacific regiondecreased $8.5 million, or 6.3%, in 2006 compared to 2005. This decreaseresulted from lower volume sales of ourwafer-level *DualBeam* systems and small-stage *DualBeam* systems in 2006 due to unusually high volumes in2005 and a decrease in SEM sales, partially offset by an increase in TEM sales,including the *Titan*.

 

***Costof Sales and Gross Margin***

*** ***

Our gross margin (gross profit as apercentage of net sales) by segment was as follows:

 
| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| NanoElectronics           |       | 51.8                             | %          | 49.2 | % | 35.9 | % |
| NanoResearch and Industry |       | 41.5                             | %          | 42.5 | % | 38.9 | % |
| NanoBiology               |       | 39.8                             | %          | 40.7 | % | 35.2 | % |
| Service and Components    |       | 26.6                             | %          | 28.2 | % | 27.3 | % |
| Overall                   |       | 41.6                             | %          | 41.0 | % | 34.6 | % |

*** ***

Cost of sales includes manufacturingcosts, such as materials, labor (both direct and indirect) and factoryoverhead, as well as all of the costs of our customer service function such aslabor, materials, travel and overhead. We see five primary drivers affectinggross margin: product mix (including the effect of price competition), volume,cost reduction efforts, competitive pricing pressure and currency fluctuations.

 

31

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Cost of sales increased $63.1 million, or22.3%, to $346.1 million in 2007 compared to $283.0 million in 2006. Thisincrease was primarily due to the increase in revenue discussed above, althoughcost of sales as a percentage of revenue decreased slightly, partiallyoffsetting these increases. In addition, the change in the valuation ofEuropean currencies in relation to the U.S. dollar during 2007 increased costof sales by approximately $19.6 million in 2007.

 

The net effect on our gross margin fromthe effect of the change in valuation of currencies on our net sales and costof sales was an approximately $2.6 million decrease, which decreased our grossmargin percentage by approximately 1.7 percentage points. Offsetting thenegative currency effects were approximately $5.0 million of cash flow hedgegains recorded in cost of sales, which improved gross margins by approximatelyone percentage point.

 

Cost of sales increased $8.1 million, or3.0%, to $283.0 million in 2006 compared to $274.9 million in 2005. Thisincrease was primarily due to the increased sales in 2006 compared to 2005 and$0.8 million of stock-based compensation in 2006 compared to none for 2005.These increases were partially offset by $14.2 million of charges incurred towrite-off inventory and capitalized software related to the closure of ourPeabody, Massachusetts facility in 2005, as well as an increase in our overallgross margin as detailed above.

 

Overall gross margins were decreased in2005 by approximately 3.4 percentage points due to the $14.2 million of chargesrelated to the write-down of inventory and capitalized software as discussedabove and the NanoElectronics margins were decreased by approximately 9.7percentage points.

 

*NanoElectronics*

* *

The increase in NanoElectronics grossmargins in 2007 compared to 2006 was due primarily to the sale of more high-endsystems, such as the data storage *Certus DualBeam*product,high-end TEM units and new small-stage *DualBeam*products.

 

The NanoElectronics gross margin improvedsignificantly in 2006 compared to 2005, primarily due to the impact in 2005 ofthe inventory and capitalized software write-offs discussed above.Additionally, gross margins in 2006 increased due to improvements in ourproduct mix for both *DualBeam*systems and TEM products, including the *Titan*.

 

*NanoResearch and Industry*

* *

The decrease in the NanoResearch andIndustry gross margin in 2007 compared to 2006 was primarily due to pricingpressure on our SEM and lower-end TEM systems and costs to ramp production ofour new *Phenom* product, partially offset by ashift in product mix to more high-end TEMs and small-stage *DualBeam*units.

 

The increase in the NanoResearch andIndustry gross margin in 2006 compared to 2005 was primarily due toimprovements in the TEM product mix, partially offset by the shift to thelower-margin small-stage *DualBeam*systems.

 

*NanoBiology*

* *

The decrease in the NanoBiology grossmargin in 2007 compared to 2006 was primarily due to pricing pressures on ourlower-end TEM and SEM systems. These factors were partially offset by the saleof more high-end TEM products, which have higher gross margins than otherproducts within this segment.

 

The increase in the NanoBiology grossmargin in 2006 compared to 2005 was primarily due to improvements in marginsachieved on our TEMs, due in part to sales of the *Titan*.

 

*Service and Components*

* *

The decrease in the Service andComponents gross margin in 2007 compared to 2006 was primarily due to increasedheadcount and travel costs, partially offset by higher revenues from a largerinstalled base.

 

32

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The increase in the Service andComponents gross margin in 2006 compared to 2005 was primarily due toefficiencies gained as net sales increased and a reduction in inventorywrite-downs in 2006 compared to 2005, partially offset by higher repair costsand material usage.

 

***Researchand Development Costs***

*** ***

Research and development (“R&D”)costs include labor, materials, overhead and payments third parties forresearch and development of new products and new software or enhancements toexisting products and software and are presented net of subsidies received forsuch efforts. During 2007, we received subsidies from European governments fortechnology developments specifically in the areas of semiconductor and lifescience equipment.

 

R&D costs were $66.0 million (11.1%of net sales) in 2007, $57.5 million (12.0% of net sales) in 2006 and $56.6million (13.5% of net sales) in 2005.

 

R&D costs are reported net ofsubsidies and were as follows (in thousands):

 
| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Gross spending |       | $                                | 70,058     |   | $ | 61,420 |   | $ | 61,130 |   |
| Less subsidies |       | (4,016                           | )          | (3,892 | ) | (4,553 | ) |
| Net expense    |       | $                                | 66,042     |   | $ | 57,528 |   | $ | 56,577 |   |

 

The $8.5 million increase in R&Dcosts in 2007 compared to 2006 was due to a $1.2 million increase in projectspending in North America and Europe, a $4.2 million increase in labor andrelated costs, including stock-based compensation, due to headcount additions,increased contractors, annual pay raises and increased bonus accruals and a$3.2 million increase related to currency fluctuations.

 

The $1.0 million increase in R&Dcosts in 2006 compared to 2005 was primarily due to a $0.9 million increase instock-based compensation, a $1.6 million increase in employee cash bonuses anda $0.7 million decrease in subsidies received, partially offset by $2.5 millionin savings from restructuring activities, mainly due to the closing of ourPeabody, Massachusetts operations and $0.5 million in project cost savings.Subsidies have decreased as the projects available for subsidies, primarily inthe Netherlands and the U.S., have decreased.

 

***We anticipate that we will continue to invest inR&D at a similar percentage of revenue for the foreseeable future.Accordingly, as revenues increase, we currently anticipate that R&Dexpenditures also will increase. Actual future spending, however, will dependon market conditions.***

*** ***

***Selling,General and Administrative Costs***

*** ***

Selling, general and administrative (“SG&A”)costs include labor, travel, outside services and overhead incurred in oursales, marketing, management and administrative support functions. SG&Acosts also include sales commissions paid to our employees as well as to ouragents.

 

SG&A costs were $124.2 million (21.0%of net sales) in 2007, $100.3 million (20.9% of net sales) in 2006 and $97.5million (23.2% of net sales) in 2005.

 

The $23.9 million increase in SG&Acosts in 2007 compared to 2006 was due primarily to a $12.8 million increase inlabor and related costs, which includes stock-based compensation expense, a$4.8 million increase in agent commissions and other selling costs and a $2.8million increase in legal and accounting expenses. These increases wereprimarily due to increases in headcount, as we are adding to our global salesforce, and higher sales in 2007 compared to 2006. SG&A in 2007 was alsoaffected by a $3.5 million increase related to currency fluctuations.

 

33

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The $2.8 million increase in SG&Acosts in 2006 compared to 2005 was primarily due to $5.6 million of profitsharing and management incentive pay as a result of the achievement ofcorporate profitability targets in 2006 compared to none in 2005. In addition,commissions increased approximately $0.8 million due to the increase in netsales and stock-based compensation increased $4.0 million. These increases werepartially offset by a $1.5 million gain related to the sale of certainintellectual property rights to a privately-held company, approximately$2.1 million of savings related to our 2005 restructuring activities, a $1.6million decrease in legal and audit fees, excluding the merger costs discussedbelow, a $0.9 million decrease in bad debt expense and a $1.2 million decreasein labor and related costs due primarily to lower headcount.

 

***Merger Costs***

*** ***

Merger costs of $0.5 million in 2006related to legal expenses and Board of Directors’ costs incurred for activitiesrelated to a merger proposal. The discussions related to the proposedtransaction were terminated in the first quarter of 2006.

 

***Amortization of PurchasedTechnology***

*** ***

Amortization of purchased technology was$1.8 million in 2007, $2.0 million in 2006 and $3.8 million in 2005.

 

In 2005, we recorded an impairment chargeof $9.3 million against our purchased technology balance, which led to thedecrease in amortization in 2006 compared to 2005. See also Note 5 of Notes toConsolidated Financial Statements.

 

Our purchased technology balance at December 31,2007 was $2.9 million and current amortization of purchased technology isapproximately $0.4 million per quarter, which could increase if we acquireadditional technology.

 

***Asset Impairment***

*** ***

We had no asset impairment charges in2007.

 

Asset impairment charges of $0.5 millionin 2006 were primarily for the write-off of the remaining costs related to theabandonment of our ERP system, which were incurred during the first quarter of2006.

 

In 2005, we took certainactions to align our cost structure with the current prevailing marketconditions, primarily in the semiconductor markets. The actions taken to date,which were necessary as a result of reduced business volumes, have resulted indecreases in our global workforce and also required us to evaluate our goodwilland other long-lived assets for impairment.

 

We recorded assetimpairment charges and write-offs totaling $25.4 million in 2005. These chargesare summarized as follows (in thousands):

 
| ** **                          | ** ** | **Year Ended  December 31,  2005** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|
| Purchased technology                |       | $                                       | 9,328      |   |
| Property, plant and equipment       |       | 7,479                                   |       |
| ERP system abandonment              |       | 7,634                                   |       |
| Patents and other intangible assets |       | 911                                     |       |
|                                |       | $                                       | 25,352     |   |

 

Our goodwill impairment analysis wasfocused on goodwill related to our former microelectronics segment, which wesold to the semiconductor market. Based on our analysis of current andprojected operating results, we concluded that the goodwill allocated to thissegment was not impaired. However, we evaluated the recoverability of thesegment’s long-lived assets and concluded impairments existed. 

 

34

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Accordingly, we recorded impairmentcharges based on the amounts by which the carrying amounts of these assetsexceeded their fair value. Additionally, certain assets were abandoned and,accordingly, written off, including a charge for costs capitalized for theterminated ERP project.

 

***Restructuring, Reorganization,Relocation and Severance***

*** ***

The net $0.3 million expense reversal ofrestructuring, reorganization, relocation and severance costs in 2007 relatedto favorable buyouts of our Peabody lease, offset by changes in estimatesincorporated into our restructuring accrual related to our ability to subleasecertain abandoned facilities under lease.

 

Restructuring,reorganization, relocation and severance in 2006 included a charge of $3.3million for facilities and severance charges related to the closure of certainof our European field offices, closure of a research and development facilityin Tempe, Arizona, as well as residual costs related to the Peabody,Massachusetts plant closure and the downsizing of the related semiconductorbusinesses.

 

EffectiveApril 1, 2006, our Chairman, President and Chief Executive Officer (“CEO”)was terminated. OurCEO was a party to an existing Executive Severance Agreement dated February 1,2002. In accordance with this agreement, in the first quarter of 2006, we recorded a charge of $9.3 million, ofwhich $2.2 million related to the cash severance payments and $7.1 millionrelated to the non-cash expense associated with the fair market value ofmodified stock options.

 

During 2005, we initiatedglobal restructuring activities to realign our cost structure with currentprevailing market conditions. These actions included reductions in workforce,reorganization and relocation of employees as well as closure of our Peabody,Massachusetts facility and certain field offices around the world. Some ofthese actions were initiated in the second quarter of 2005 with the remaindercontinuing through the first half of 2006. These costs were accounted for inaccordance with SFAS No. 146, “*Accounting for Costs Associated with Exit or Disposal Activities.*”Under SFAS No. 146, liabilities for costs associated with exit or disposalactivities are recognized and measured at fair value in the period theliability is incurred.

 

In2005, we also expensed $4.6 million in severance and relocation costs related to workforcereductions and reallocation of personnel geographically. We also incurred $3.9million of restructuring expense for facility closures, largely related to thePeabody, Massachusetts facility (inclusive of $0.2 million in reserve releasesrelated to prior accruals for another facility lease that was terminated).

 

For information regardingthe related accrued liability, see Note 14 of Notes to Consolidated FinancialStatements.

 

***OtherIncome (Expense), Net***

*** ***

Other income (expense)items include interest income, interest expense, foreign currency gains andlosses and other miscellaneous items.

 

Interest incomerepresents interest earned on cash and cash equivalents, investments inmarketable securities and, in 2004, a shareholder note receivable. Interest incomewas $22.4 million in 2007, $13.2 million in 2006 and $7.8 million in 2005.

 

These increase in 2007compared to 2006, as well as the increase in 2006 compared to 2005, resultedfrom increases in our invested balances, primarily due to cash generated byoperations, as well as from the net proceeds from our sale of $115.0 millionprincipal amount of 2.875% convertible debt in May 2006.

 

Interest expense for 2007, 2006 and 2005included interest related to our 5.5% convertible debt issued in August 2001,which we retired in January 2008. Interest expense in 2007 and 2006 alsoincluded interest related to our $115.0 million principal amount of 2.875%convertible debt, which was issued in May 2006. 

 

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The amortization of capitalized noteissuance costs related to our convertible note issuances is also included as acomponent of interest expense in all periods.

 

Interest expense in 2006 and 2005included premiums and commissions paid on the repurchase of a portion of our5.5% convertible subordinated notes as well as the write-off of deferred noteissuance costs totaling $0.5 million and $1.8 million, respectively.

 

Assuming no additional note repurchases,amortization of our remaining convertible note issuance costs, including thoserelated to our 2.875% convertible notes, will total approximately $0.3 millionper quarter through 2008 and $0.1 million per quarter thereafter through thesecond quarter of 2013.

 

Other, netprimarily consists of foreign currency gains and losses on transactions andrealized and unrealized gains and losses on the changes in fair value ofderivative contracts entered into to hedge these transactions.

 

Other, net in 2007included a $0.5 million gainrelated to the disposal of one of our cost-based investments and a $0.5 milliongain for the final escrow payment on the sale of a minority interest in a smalltechnology company.

 

Other, net includedcharge of $3.9 million and $6.4 million in 2006 and 2005, respectively, relatedto impairment charges and realized losses of certain of our cost-methodinvestments. Additionally, in 2006, we recorded a $5.2 million gain related tothe sale of one of our cost-method investments. Our cost-method investments areminority-interest holdings in small, privately-held entities where it is notpractical to estimate fair values. We evaluate our cost-method investments forimpairment whenever events indicate that the carrying amount of the investmentmay not be recoverable within a reasonable period of time. This evaluation isbased on review of interim financial statements and informal discussions withthe senior management of the investee entities.

 

At December 31,2007 and 2006, all cost-method investments have been written down to zero onour balance sheet.

 

***IncomeTax Expense***

*** ***

We recorded a taxprovision of $8.1 million, $10.5 million and $22.1 million, respectively, in2007, 2006 and 2005, which reflected an effective tax rate of 12.2%, 37.2% and39.1%, respectively.

 

Our 2007 tax provision on income from continuingoperation reflected taxes on foreign earnings offset by a $4.7 million releaseof unrecognized tax benefits, including interest and penalties, as a result ofthe settlement of foreign tax audits and a tax benefit of $5.3 million relatedto the release of valuation allowance recorded against net operating lossdeferred tax assets utilized to offset income earned in the U.S.

 

***We adopted the provisions ofInterpretation No. 48 in the first quarter of 2007 and, accordingly,increased the opening balance of retained earnings by $4.1 million to reflectthose tax positions that are more likely than not to be sustained. As of December 31,2007, unrecognized tax benefits were $15.7 million***and related primarily touncertainty surrounding intercompany pricing and permanent establishment. Allunrecognized tax benefits would decrease the effective tax rate if recognized.

*** ***

Our 2006 tax provisionconsisted primarily of taxes accrued in foreign jurisdictions and reflects abenefit of $1.5 million related to the release of valuation allowances againsta portion of U.S. deferred tax assets utilized during the period.

 

Our 2005 tax provision primarilyconsisted of $15.1 million in expense related to the establishment of valuationallowances against the U.S. deferred tax assets, which offset the benefit fromU.S. net operating losses generated in 2005. Additionally, we had approximately$10.9 million of foreign tax expense, which was offset by a net current taxbenefit of $4.1 million primarily related to tax audit 

 

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settlements in the U.S. For 2005, weexperienced an abnormally high effective tax rate as we had profits and relatedtax expense from our international operations, but losses in the U.S. for whichwe did not record a tax benefit.

 

Valuation allowances ondeferred tax assets totaled $39.5 million and $33.5 million as of December 31,2007 and 2006, respectively.

 

Our effective tax rate may differ fromthe U.S. federal statutory tax rate primarily as a result of the effects ofstate and foreign income taxes, research and experimentation tax credits earnedin the U.S. and foreign jurisdictions, adjustments to our unrecognized taxbenefits and our ability or inability to utilize various carry forward tax items.In addition, our effective income tax rate may be affected by changes instatutory tax rates and laws in the U.S. and foreign jurisdictions and otherfactors.

 

***DiscontinuedOperations***

*** ***

In the fourth quarter of2006, we sold the assets and operations related to Knights Technology, whichwas a consolidated subsidiary, and recognized a gain on the disposal of thediscontinued operations of $3.3 million and received cash proceeds of $7.8million. In the first quarter of 2007, we recognized an additional $0.1 milliongain related to post-closing adjustments for working capital items. Inaddition, in the fourth quarter of 2007, we recognized an additional $0.3million gain related to the release of certain acquisition contingencyaccruals, as well as to amounts that had been held in escrow and subsequentlypaid to us once all contingencies surrounding the transaction were resolved.All historical statement of operations data has been restated to reflect thediscontinued operations.

 

Certain financialinformation related to discontinued operations was as follows (in thousands):

 
| **Year Ended December 31,**                            | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenue                                                     |       | $        | —     |     | $          | 5,245    |       | $ | 7,132 |   |
| Pre-tax (loss) income                                       |       | —   |       | (905     | )          | 606      |       |
| Income tax expense                                          |       | —   |       | 42       |       | 304      |       |
| Gain on disposal of discontinued operations, net of  tax    |       | 390      |       | 3,335    |       | —   |       |
| Amount of goodwill and other intangible assets  disposed of |       | —   |       | 3,133    |       | —   |       |
|                                                             |            |          |            |          |            |          |            |  |  |  |

*** ***

***LIQUIDITYAND CAPITAL RESOURCES***

*** ***

Our sources of liquidity and capitalresources as of December 31, 2007 consisted of $453.6 million of cash,cash equivalents, short-term restricted cash and short-term investments, $12.8million in non-current investments, $24.6 million of long-term restricted cash,as well as potential future cash flows from operations. Restricted cash relatesto deposits to secure bank guarantees for customer prepayments that expirethrough 2013.

 

At December 31,2007, we held $118.1 million in auction rate securities (“ARS”) which weclassified as current assets. The ARS held by us have long-term statedmaturities for which the interest rates are reset through a Dutch auctiongenerally every 28 days. The auctions have historically provided a liquidmarket for these securities as investors could readily sell their investmentsat auction. Subsequent to December 31, 2007, we began to exit our positionin these securities. As of February 25, 2008, we had successfullyliquidated $8.0 million of these securities, leaving us with $110.1 millioninvested in ARS.

 

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A chart showing theamounts of each of our ARS, the issuers and whether the underlying collateralfor the notes are guaranteed by the U.S. Department of Education (“USDE”) isset out below. At the time of issuance, each of the ARS was purported to be atleast 100% collateralized. All of the notes come up for auction by March 24,2008.

** **

| **Issuer**        | ** ** | **Principal Amount** | ** **   | **USDE Guarantee** | ** **         | **Maturity Dates** | ** **              |
|-------------------|------------|----------------------|--------------|--------------------|--------------------|--------------------|-------------------------|
| State Agencies    |       | $                    | 60.7 million |               | From 81.13% to 100 | %                  | Range from 2031 to 2047 |   |
|              |       |                 |         |               |               |               |                    |
| Corporate issuers |       | $                    | 49.4 million |               | From 0% to 100     | %                  | Range from 2028 to 2047 |   |

 

With the liquidity issuesexperienced in global credit and capital markets, the ARS held by us haveexperienced multiple failed auctions, beginning on February 19, 2008, asthe amount of securities submitted for sale has exceeded the amount of purchaseorders. We expect additional auction failures during the remainder of February andMarch 2008, which will require us to hold the securities until liquidityis restored to the credit markets or the securities are redeemed or mature.

 

All of the ARS held by uscarry AAA ratings, have not experienced any payment defaults and are backed bystudent loans, some of which are guaranteed under the Federal Family EducationLoan Program of the USDE. Nonetheless, if uncertainties in the credit andcapital markets continue, these markets deteriorate further or there are anyratings downgrades on any ARS we hold, we may be required to reclassify theseinvestments from short-term to long-term investments. In addition, if thefailed auctions or any downgrades are deemed to cause an “other than temporaryimpairment” of our ARS, we may be required to re-value the ARS at some amountbelow par. Any re-valuation of ARS that are other than temporarily impairedwill flow through our operations statement and affect our earnings.

 

We believe that, evenallowing for the reclassification of these securities to long-term and thepossible requirement to hold such securities for an indefinite period of time,our remaining cash and cash equivalents, short-term restricted cash, short-terminvestments and cash expected to be generated from operations will besufficient to meet our expected operational and capital needs for at least thenext twelve months from December 31, 2007, including our upcomingconvertible note repayment obligations.

 

In 2007, cash and cash equivalents andshort-term restricted cash increased $170.4 million to $301.6 million as of December 31,2007 from $130.8 million as of December 31, 2006 primarily as a result of$51.5 million provided by operations, $40.9 million of proceeds from theexercise of employee stock options and employee stock purchases, $105.7 millionof net maturities of marketable securities and a $8.8 million favorable effectof exchange rate changes. These increases were partially offset by $18.5million used for the purchase of property, plant and equipment.

 

Accounts receivableincreased $12.1 million to $157.1 million as of December 31, 2007from $145.0 million as of December 31, 2006, primarily due toincreased sales in the fourth quarter of 2007 compared with the fourth quarterof 2006. The December 31, 2007 balance was also affected by a $9.3 millionincrease related to changes in currency exchange rates. Our days salesoutstanding, calculated on a quarterly basis, was 95 days at December 31,2007 compared to 94 days at December 31, 2006.

 

Inventories increased $41.3 million to$138.8 million as of December 31, 2007 compared to $97.5 millionas of December 31, 2006. The increase primarily was due to purchasing ofraw materials as sales continue to increase, as well as an increase related tocurrency movements of approximately $11.6 million. Our annualized inventoryturnover rate, calculated on a quarterly basis, was 2.6 times for the quarterended December 31, 2007 and 3.5 times for the quarter ended December 31,2006.

 

Other assets,net increased $9.3 million to$16.8 million as of December 31, 2007 compared to $7.5 millionas of December 31, 2006 primarily due to increased long-term leasereceivables, increased taxes receivable and approximately $3.5 million ofintangible asset additions.

 

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Expenditures forproperty, plant and equipment of $18.5 million in 2007 primarily consisted ofexpenditures for machinery and equipment, including instruments used fordemonstration as part of our marketing programs. We expect to continue toinvest in capital equipment, customer evaluation systems and R&D equipmentfor applications development. We estimate our total capital expenditures in2008 to be approximately $29.5 million, primarily for the development andintroduction of new products, demonstration equipment and upgrades andincremental improvements to our enterprise resource planning (“ERP”) system.

 

Accounts payabledecreased $13.9 million to $31.2 million as of December 31, 2007 comparedto $45.1 million as of December 31, 2006. The decrease resulted primarilyfrom lower material purchases as part of inventory reduction programs.Additionally, primarily in our European locations, we have decreased the numberand amount of invoices on hold after negotiations with our suppliers on openissues. We have also noted in price negotiations with suppliers a trend thatsuppliers request shorter payment terms or better adhered to payment terms in exchangefor more favorable pricing.

 

Accrued payrollliabilities increased $5.4 million to $26.1 million as of December 31,2007 compared to $20.7 million as of December 31, 2006. The increaseresulted primarily from profit sharing and variable compensation programs formanagement personnel for 2007 being partially offset by the payment of amountsearned in 2006 in the first quarter of 2007. Additionally, accrued wages andrelated payroll taxes increased from prior year due to headcount and wageincrease.

 

Other liabilitiesincreased $33.1 million to $38.7 million as of December 31, 2007 comparedto $5.6 million as of December 31, 2006. The increase resulted primarilyfrom the reclassification of $9.1 million of unrecognized tax benefits fromincome taxes payable to other long-term liabilities for the impact of theadoption of Interpretation No. 48, as well as current year accruals of$6.3 million related to unrecognized tax benefits. Additionally, long-termliabilities increased $15.6 million related to deferred revenue not expected tobe taken into revenue within the next twelve months.

 

We have a 50.0 millionyen unsecured and uncommitted bank borrowing facility in Japan and variouslimited facilities in select foreign countries.  As part of our contractswith certain customers, we are required to provide letters of credit or bankguarantees which these customers can draw against in the event we do notperform in accordance with our contractual obligations. At December 31,2007, we had $46.0 million of these guarantees and letters of creditoutstanding, of which approximately $45.6 million were secured by restrictedcash deposits. Restricted cash balances securing bank guarantees that expirewithin 12 months of the balance sheet date are recorded as a current asset onour consolidated balance sheets. Restricted cash balances securing bankguarantees that expire beyond 12 months from the balance sheet date arerecorded as long-term restricted cash on our consolidated balance sheet.

 

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**CONTRACTUAL PAYMENT OBLIGATIONS**

** **

A summary of our contractual commitments andobligations as of December 31, 2007 was as follows (in thousands):

 

 
| ** **                             | ** ** | **Payments Due By Period** | ** ** |
|----------------------------------------|------------|----------------------------|------------|
| **Contractual  Obligation**            | ** ** | **Total**                  | ** ** | **2008** | ** ** | **2009 and 2010** | ** ** | **2011 and 2012** | ** ** | **2013 and beyond** | ** ** |
| Convertible Debt                       |       | $                          | 310,882    |   | $ | 195,882 |   | $ | — |   | $ | — |   | $ | 115,000 |   |
| Convertible Debt Interest              |       | 18,121                     |       | 3,517 |   | 6,613 |   | 6,613 |   | 1,378 |   |
| Letters of Credit and Bank  Guarantees |       | 40,200                     |       | 15,578 |   | 4,971 |   | — |   | 19,651 |   |
| Purchase Order Commitments             |       | 63,047                     |       | 63,047 |   | — |   | — |   | — |   |
| Pension Related Obligations            |       | 2,751                      |       | 332 |   | 165 |   | 238 |   | 2,016 |   |
| Deferred Compensation  Liability       |       | 2,769                      |       | — |   | — |   | — |   | 2,769 |   |
| Capital Leases                         |       | 2,697                      |       | 1,429 |   | 1,146 |   | 122 |   | — |   |
| Operating Leases                       |       | 57,016                     |       | 6,912 |   | 11,597 |   | 11,679 |   | 26,828 |   |
| Total                                  |       | $                          | 497,483    |   | $ | 286,697 |   | $ | 24,492 |   | $ | 18,652 |   | $ | 167,642 |   |

 

We also have other liabilities of $15.7 millionrelating to uncertain tax positions. However, as we are unable to reliablyestimate the timing of future payments related to the uncertain tax positions,we have excluded this amount from the table above.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

** **

We do not have anyoff-balance sheet arrangements that have or are reasonably likely to have amaterial current or future effect on our financial condition, changes infinancial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources.

 

***RECENTLY ISSUED ACCOUNTINGPRONOUNCEMENTS***

*** ***

SeeNote 2 of Notes to Consolidated Financial Statements included in Part II,Item 8 of this Form 10-K.

 

***CRITICAL ACCOUNTING POLICIES AND THEUSE OF ESTIMATES***

*** ***

The preparation of financial statementsin conformity with accounting principles generally accepted in the U.S.requires management to make estimates and assumptions. These estimates andassumptions affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amount of revenues and expenses during thereporting period.

 

Significant accounting policies andestimates underlying the accompanying consolidated financial statementsinclude:

 

·                  thetiming of revenue recognition;

 

·                  theallowance for doubtful accounts;

 

·                  valuationsof excess and obsolete inventory;

 

·                  valuationof investments in privately-held companies;

 

·                  thelives and recoverability of equipment and other long-lived assets such asgoodwill and existing technology intangibles;

 

·                  restructuring,reorganization, relocation and severance costs;

 

·                  accountingfor income taxes;

 

·                  warrantyliabilities;

 

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·                  stock-basedcompensation; and

 

·                  accountingfor derivatives.

 

It is reasonably possible that theestimates we make may change in the future.

 

***RevenueRecognition***

*** ***

We recognize revenue when persuasiveevidence of a contractual arrangement exits, delivery has occurred or serviceshave been rendered, the seller’s price to buyer is fixed and determinable, andcollectibility is reasonably assured.

 

For products demonstrated to meet ourpublished specifications, revenue is recognized when the title to the productand the risks and rewards of ownership pass to the customer. The portion ofrevenue related to installation and final acceptance, of which the estimatedfair value is generally 4% of the total revenue of the transaction, is deferreduntil such installation and final customer acceptance are completed. Forproducts produced according to a particular customer’s specifications, revenueis recognized when the product meets the customer’s specifications and when thetitle and the risks and rewards of ownership have passed to the customer. Ineach case, the portion of revenue applicable to installation and customeracceptance is recognized upon meeting specifications at the installation site.For new applications of our products where performance cannot be assured priorto meeting specifications at the installation site, no revenue is recognizeduntil such specifications are met.

 

For sales arrangements containingmultiple elements (products or services), revenue relating to undeliveredelements is deferred at the estimated fair value until delivery of the deferredelements. To be considered a separate element, the product or service inquestion must represent a separate unit under accounting rules and fulfillthe following criteria: the delivered item(s) has value to the customer ona standalone basis; there is objective and reliable evidence of the fair valueof the undelivered item(s); and, if the arrangement includes a general right ofreturn relative to the delivered item(s), delivery or performance of theundelivered item(s) is considered probable and substantially in ourcontrol. If the arrangement does not meet all criteria above, the entire amountof the transaction is deferred until all elements are delivered.

 

We provide maintenanceand support services under renewable, term maintenance agreements. Maintenanceand support fee revenue is recognized ratably over the contractual term, whichis generally 12 months, and commences from contract date.

 

Revenue from time and materials basedservice arrangements is recognized as the service is performed. Spare partsrevenue is generally recognized upon shipment.

 

Deferred revenue represents customerdeposits on equipment orders, orders awaiting customer acceptance and prepaidservice contract revenue. Deferred revenue is recognized in accordance with ourrevenue recognition policies described above.

 

***Allowance forDoubtful Accounts***

*** ***

The allowance for doubtful accounts isestimated based on collection experience and known trends with currentcustomers. The large number of entities comprising our customer base and theirdispersion across many different industries and geographies somewhat mitigatesour credit risk exposure and the magnitude of our allowance for doubtful accounts.Our estimates of the allowance for doubtful accounts are reviewed and updatedon a quarterly basis. Changes to the reserve may occur based upon changes inrevenue levels and associated balances in accounts receivable and estimatedchanges in individual customers’ credit quality. Historically, we have notincurred significant write-offs of accounts receivable, however, an individualloss could be significant due to the relative size of our sales transactions.Our bad debt expense totaled $0.9 million, $0.7 million and $1.7 million,respectively, in 2007, 2006 and 2005. Our 

 

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allowance for doubtful accounts totaled$3.8 million and $4.2 million, respectively, at December 31, 2007 and2006.

 

***Valuation of Excessand Obsolete Inventory***

*** ***

Inventory is stated atthe lower of cost or market, with cost determined by standard cost methods,which approximate the first-in, first-out method. Inventory costs includematerial, labor and manufacturing overhead. Inventory is reviewed forobsolescence and excess quantities on a quarterly basis, based on estimatedfuture use of quantities on hand, which is determined based on past usage,planned changes to products and known trends in markets and technology. Changesin support plans or technology could have a significant impact on obsolescence.Because of the long-lived nature of many of our products, we maintain asubstantial supply of parts for possible use in future repairs and customerfield service. As these service parts become older, we apply a higherpercentage of reserve against the recorded balance, recognizing that the olderthe part, the less likely it is ultimately to be used. Provision for inventoryvaluation adjustments totaled $1.0 million in 2007, were immaterial in 2006 andtotaled $10.1 million in 2005. Provision for service inventory valuationadjustments totaled $4.0 million, $4.2 million and $2.9 million, respectively,in 2007, 2006 and 2005.

 

***Valuation of Investments inPrivately-Held Companies***

*** ***

We made investments in several small,privately held technology companies in which we hold less than 20% of thecapital stock or hold notes receivable. We account for these investments attheir cost unless their value has been determined to be other than temporarilyimpaired, in which case, we write the investment down to its estimated fairvalue. We review these investments periodically for impairment and makeappropriate reductions in carrying value when an “other-than-temporary” declineis evident; however, for non-marketable equity securities, the impairmentanalysis requires significant judgment. We evaluate the financial condition ofthe investee, market conditions and other factors providing an indication ofthe fair value of the investments. During 2005, we recorded impairments andlosses on liquidation related to these investments totaling $6.4 million.During 2006, we wrote off certain of our investments, incurring a charge of$3.9 million, and sold our remaining investments, resulting in a gain of $5.2million, and, accordingly, as of December 31, 2007 and December 31,2006, the carrying value of our investments in privately-held companies waszero on our balance sheet. See also Note 3 of Notes to Consolidated FinancialStatements.

 

***Lives andRecoverability of Equipment and Other Long-Lived Assets***

*** ***

We evaluate the remaininglife and recoverability of equipment and other assets, including intangibleassets, whenever events or changes in circumstances indicate that the carryingamount of the asset may not be recoverable in accordance with SFAS No. 144,“*Accounting for theImpairment or Disposal of Long-Lived Assets*.” If there is anindication of impairment, we prepare an estimate of future, undiscounted cashflows expected to result from the use of the asset and its eventualdisposition. If these cash flows are less than the carrying value of the asset,we adjust the carrying amount of the asset to its estimated fair value.

 

For information onimpairments recognized in 2006 and 2005, see Note 5 of Notes to ConsolidatedFinancial Statements.  No suchadjustments were made in 2007.

 

***Goodwill***

*** ***

Goodwill represents theexcess purchase price over fair value of net assets acquired. Pursuant to SFAS No. 142,“*Goodwill and Other Intangible Assets*,”goodwill and other identifiable intangible assets with indefinite useful livesare no longer amortized, but, instead, a two-step impairment test is performedat least annually, in accordance with the provisions of SFAS No. 142. Wetest goodwill for impairment annually in the fourth quarter. First, the fairvalue of each reporting unit is compared to its carrying value. We have definedour reporting units to be our operating segments as disclosed under SFAS No. 131,

 

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“*Disclosures aboutSegments of an Enterprise and Related Information*.”  If the fair value of the reporting unitexceeds the carrying value, goodwill is not impaired and no further testing isperformed. The second step is performed if the carrying value exceeds the fairvalue. The fair value of the reporting unit’s goodwill must be determined basedon, and compared to, the carrying value of the goodwill. If the carrying valueof a reporting unit’s goodwill exceeds its implied fair value, an impairmentloss equal to the difference will be recorded. No impairments were identifiedin the first step of our goodwill impairment analyses performed during 2007,2006 or 2005.

 

***ExistingTechnology Intangible Assets***

*** ***

Existing technology intangible assetspurchased in business combinations, which represent the estimated value ofproducts utilizing technology existing as of the combination date discounted totheir net present value, are amortized on a straight-line basis over theestimated useful life of the technology. We currently are using amortizationperiods ranging from 5 to 12 years for these assets. Changes in technologycould affect our estimates of the useful lives of such assets. We test ourtechnology intangible assets for impairment whenever events or circumstancesindicate that the carrying amount of assets may not be recoverable inaccordance with SFAS No. 144. We evaluate recoverability by comparing thecarrying amount to future net undiscounted cash flows to be generated by theasset. If such assets are considered to be impaired, the impairment to berecognized is measured as the amount by which the carrying amount of the assetsexceeds the fair value of the assets.**Suchreviews assess the fair value of the assets based upon estimates of future cashflows that the assets are expected to generate. We review the estimated usefullives of the assets on an annual basis. During2005, we recorded impairment charges related to these assets totaling $9.3million, which were included as a component of asset impairment on our consolidatedstatement of operations. For additional information on these impairments, seeNote 5 of Notes to Consolidated Financial Statements. We did not changeestimated useful lives or recognize impairmentcharges related to our technology intangible assets during 2007 or 2006.

 

***Restructuring,Reorganization, Relocation and Severance Costs***

*** ***

Restructuring, reorganization, relocationand severance costs are recognized and recorded at fair value as incurred inaccordance with SFAS No. 146, “*Accounting for Costs Associated with Exit or DisposalActivities.*” Such costs include severance and other costsrelated to employee terminations as well as facility costs related to futureabandonment of various leased office and manufacturing sites. Changes in ourestimates could occur, and have occurred, due to fluctuations in exchangerates, the sublease of unused space, unanticipated voluntary departures beforeseverance was required and unanticipated redeployment of employees to vacantpositions.

 

***Income Taxes***

*** ***

We account for incometaxes using the asset and liability method, which requires the recognition ofdeferred tax assets and liabilities for the expected future tax consequences oftemporary differences between the carrying amounts and tax bases of the assetsand liabilities. In accordance with the provisions of SFAS No. 109, “*Accounting for Income Taxes,*”we record a valuation allowance to reducedeferred tax assets to the amount expected to “more likely than not” berealized in our future tax returns. During 2007 and 2006, we releasedapproximately$5.3 million and $1.5 million, respectively, in valuation allowancerelating to U.S. deferred tax assets utilized during the year to offset U.S.taxable income generated during the respective periods. During 2005, we recordedvaluation allowances against deferred tax assets that existed prior to January 1,2005 and U.S. deferred tax assets originated in 2005. Should we determine thatwe would not be able to realize all or part of our remaining net deferred taxassets in the future, additional increases to the valuation allowance fordeferred tax assets may be required. Conversely, if we determine that certaintax assets that have been reserved for may be realized in the future, we mayreduce our valuation allowance in future periods. Our net deferred tax assetstotaled $2.6 million and $0.5 million, respectively, at December 31, 2007and 2006 and our valuation allowance totaled$39.5 million and $33.5 million, respectively.

 

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In June 2006, theFinancial Accounting Standards Board (“FASB”) issued Interpretation No. 48,“*Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement 109*.” This statement clarifies thecriteria that an individual tax position must satisfy for some or all of thebenefits of that position to be recognized in a company’s financial statements.Interpretation No. 48 prescribes a recognition threshold of more likelythan not, and a measurement attribute for all tax positions taken or expectedto be taken on a tax return, in order for those tax positions to be recognizedin the financial statements. Effective January 1, 2007, we adopted theprovisions of Interpretation No. 48 and recorded a $4.1 million increaseto the opening balance of retained earnings to account for the cumulativeeffect of applying the new standard to previously unrecognized tax benefits.The increase to retained earnings was attributable to the resolution of a U.S.federal tax audit where the result was considered more likely than not underthe recognition and measurement standards of Interpretation No. 48.

 

On January 1, 2007,total unrecognized tax benefits were $17.6 million, of which $9.1 million wouldhave an impact on the effective tax rate. Interest and penalties accrued onunrecognized tax benefits were $1.5 million and were treated as tax expense inthe consolidated statement of operations. Unrecognized tax benefits relatemainly to uncertainty surrounding intercompany pricing, permanent establishmentand the capitalization of certain costs. See Note 13 of Notes to ConsolidatedFinancial Statements for additional information.

 

Significantincome tax exposures include potential challenges to intercompany pricing andpermanent establishment.In the ordinary courseof business, there is inherent uncertainty in quantifying our income taxpositions. We assess our income tax positions and record tax benefits for allyears subject to examination based upon management’s evaluation of the facts,circumstances and information available at the reporting date. For those taxpositions where it is more likely than not that a tax benefit will besustained, we have recorded the largest amount of tax benefit with a greaterthan 50% likelihood of being realized upon ultimate settlement with a taxingauthority that has full knowledge of all relevant information. For those incometax positions where it is not more likely than not that a tax benefit will besustained, no tax benefit has been recognized in the financial statements. Whenapplicable, associated interest and penalties have been recognized as acomponent of income tax expense.

 

***WarrantyLiabilities***

*** ***

Our products generally carry a one-yearwarranty. A reserve is established at the time of sale to cover estimatedwarranty costs and certain commitments for product upgrades. Our estimate ofwarranty cost is primarily based on our history of warranty repairs andmaintenance, as applied to systems currently under warranty. For our newproducts without a history of known warranty costs, we estimate the expectedcosts based on our experience with similar product lines and technology. Whilemost new products are extensions of existing technology, the estimate couldchange if new products require a significantly different level of repair andmaintenance than similar products have required in the past. Our estimatedwarranty costs are reviewed and updated on a quarterly basis. Changes to thereserve occur as volume, product mix and warranty costs fluctuate. Our warrantyreserve totaled $6.6 million and $5.7 million, respectively, at December 31,2007 and 2006. Warranty expense totaled $16.0 million, $11.7 million and $9.3million, respectively, during 2007, 2006 and 2005. The 2005 expense is net of a$1.0 million positive adjustment to warranty expense based on an analysis ofour actual warranty costs incurred compared to our reserve estimate. No suchadjustments were recorded in 2007 or 2006.

 

***Stock-Based Compensation***

*** ***

On January 1, 2006,we adopted SFAS No. 123(R), “*Share-Based Payment*,”which requires the measurement and recognition of compensation expense for allshare-based payment awards granted to our employees and directors, includingemployee stock options, non-vested stock and stock purchases related to ouremployee share purchase plan based on the estimated fair value of the award onthe grant date. Upon the adoption of SFAS No. 123(R), we maintainedour method of valuation for stock option awards using the Black-Scholesvaluation model, which has historically been used for the purpose of 

 

44

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providing pro-formafinancial disclosures in accordance with SFAS No. 123, “*Accounting for Stock-Based Compensation*.”

 

Theuse of the Black-Scholes valuation model to estimate the fair value of stockoption awards requires us to make judgments on assumptions regarding therisk-free interest rate, expected dividend yield, expected term and expectedvolatility over the expected term of the award. The assumptions used incalculating the fair value of share-based payment awards represent management’sbest estimates at the time they are made, but these estimates involve inherentuncertainties and the application of expense could be materially different inthe future.

 

Compensation expense isonly recognized on awards that ultimately vest. Therefore, we have reducedthe compensation expense to be recognized over the vesting period foranticipated future forfeitures. Forfeiture estimates are based onhistorical forfeiture patterns. We update our forfeiture estimatesquarterly and recognize any changes to accumulated compensation expense in theperiod of change. If actual forfeitures differ significantly from ourestimates, our results of operations could be materially impacted.

 

Compensation expense, net of tax,calculated pursuant to SFAS No. 123 totaled $34.4 million in 2005.

 

***Accounting forDerivatives***

*** ***

We use foreign forwardextra contracts (a combination of forward exchange and option contracts) andoption contracts and we are looking at additional instruments in 2008 to hedgecertain anticipated foreign currency exchange transactions. When specificcriteria required by SFAS No. 133, “*Accounting for DerivativeInstruments and Hedging Activities*,” have been met, changes in fairvalues of hedge contracts relating to anticipated transactions are recorded inother comprehensive income rather than net income until the underlying hedgedtransaction affects net income. One of the criteria for this accountingtreatment is that the forward exchange contract amount should not be in excessof specifically identified anticipated transactions. By their nature, ourestimates of anticipated transactions may fluctuate over time and mayultimately vary from actual transactions. When anticipated transactionestimates or actual transaction amounts decrease below hedged levels, or whenthe timing of transactions changes significantly, we reclassify a portion ofthe cumulative changes in fair values of the related hedge contracts from othercomprehensive income to other income (expense) during the quarter in which suchchanges occur.

 

We also use foreignforward exchange contracts to mitigate the foreign currency exchange impact ofour cash, receivables and payables denominated in foreign currencies. Thesederivatives do not meet the criteria for hedge accounting. Changes in fairvalue for derivatives not designated as hedging instruments are recognized innet income in the current period.

 

**Item 7A.**** Quantitative and Qualitative Disclosures About Market Risk**

** **

**Foreign Currency Exchange RateRisk**

** **

A large portion of ourbusiness is conducted outside of the U.S. through a number of foreignsubsidiaries. Each of the foreign subsidiaries keeps its accounting records inits respective local currency. These local-currency-denominated accountingrecords are translated at exchange rates that fluctuate up or down from periodto period and consequently affect our consolidated results of operations andfinancial position. The major foreign currencies in which we experienceperiodic fluctuations are the euro, the Czech koruna, the Japanese yen and theBritish pound sterling. For each of the last three years, more than 62% of oursales occurred outside of the U.S.

 

In addition, because ofour substantial research, development and manufacturing operations in Europe,we incur a greater proportion of our costs in Europe than the revenue we derivefrom sales in that geographic region. Our raw materials, labor and othermanufacturing costs are primarily denominated in 

 

45

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U.S. dollars, euros andCzech korunas. This situation negatively affects our gross margins and resultsof operations when the dollar weakens in relation to the euro or koruna. Astrengthening of the dollar in relation to the euro or koruna would have a netpositive effect on our gross margins and results of operations. Movement ofAsian currencies in relation to the dollar and euro also can affect ourreported sales and results of operations because we derive more revenue than weincur costs from the Asia-Pacific region. In addition, several of ourcompetitors are based in Japan and a weakening of the Japanese yen has theeffect of lowering their prices relative to ours.

 

Assets and liabilities offoreign subsidiaries are translated using the exchange rates in effect at thebalance sheet date. Revenues and expenses are translated using the averageexchange rate during the period. The resulting translation adjustmentsincreased shareholders’ equity and comprehensive income in 2007 by $26.5 million.Holding other variables constant, if the U.S. dollar weakened by 10% againstall currencies that we translate, shareholders’ equity would increase byapproximately $24.6 million as of December 31, 2007. Holding othervariables constant, if the U.S. dollar strengthened by 10% against allcurrencies that we translate, shareholders’ equity would decrease byapproximately $20.2 million as of December 31, 2007.

 

**Risk Mitigation**

** **

We use derivatives tomitigate financial exposure resulting from fluctuations in foreign currencyexchange rates. When specific accounting criteria have been met, changes infair values of derivative contracts relating to anticipated transactions arerecorded in other comprehensive income, rather than net income, until the underlyinghedged transaction affects net income. Changes in fair value for derivativesnot designated as hedging instruments are recognized in net income in thecurrent period. As of December 31, 2007, the aggregate notional amount ofour outstanding derivative contracts was $68.5 million, which contracts havevarying maturities through December 29, 2008. We do not enter intoderivative financial instruments for speculative purposes.

 

Holding other variablesconstant, if the U.S. dollar weakened by 10%, the market value of our foreigncurrency contracts outstanding as of December 31, 2007 would increase byapproximately $2.6 million. The increase in value relating to the forward saleor purchase contracts would, however, be substantially offset by therevaluation of the transactions being hedged. A 10% increase in the U.S. dollarrelative to the hedged currencies would have a similar, but negative, effect onthe value of our foreign currency contracts, substantially offset again by therevaluation of the transactions being hedged.

 

***BalanceSheet Related***

*** ***

We attempt to mitigateour currency exposures for recorded transactions by using forward exchangecontracts to reduce the risk that our future cash flows will be adverselyaffected by changes in exchange rates. We enter into forward sale or purchasecontracts for foreign currencies to hedge specific cash, receivables orpayables positions denominated in foreign currencies. Changes in fair value ofderivatives entered into to mitigate the foreign exchange risks related tothese balance sheet items are recorded in other income (expense) currentlytogether with the transaction gain or loss from the hedged balance sheetposition.

 

Thehedging transactions we undertake are intended to limit our exposure to changesin the dollar/euro exchange rate. Foreign currency losses recorded in otherincome (expense), inclusive of the impact of derivatives, totaled $3.1 million,$1.9 million and $1.5 million, respectively, in 2007, 2006 and 2005.

 

***CashFlow Hedges***

*** ***

We use foreign forwardextra contracts (a combination of forward exchange and option contracts) andalso option contracts to hedge certain anticipated foreign currency exchangetransactions. The foreign exchange hedging structure is set up generally on atwelve-month time horizon. The hedging transactions we undertake primarilylimit our exposure to changes in the U.S. dollar/euro exchange rate. Theforward extra contract hedges are designed to protect us as the U.S. dollarweakens, but also provide us with some flexibility if the dollar strengthens.

 

46

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These derivatives meetthe criteria to be designated as hedges and, accordingly, we record the changein fair value of these hedge contracts relating to anticipated transactions inother comprehensive income rather than net income until the underlying hedgedtransaction affects net income. We recognized realized gains of $5.0 million in2007 in cost of sales related to hedge results, compared to realized gains of$2.0 million in 2006. As of December 31, 2007, $2.2 million of deferredunrealized net gains on outstanding derivatives have been recorded in othercomprehensive income and are expected to be reclassified to net income duringthe next 12 months as a result of the underlying hedged transactions also beingrecorded in net income. We did not record any charges related to hedgededesignations or ineffectiveness in 2007 or 2006. In 2005, we recorded chargestotaling $0.5 million in other income (expense) related to hedge dedesignationsand ineffectiveness. We continually monitor our hedge positions and forecastedtransactions and, in the event changes to our forecast occur, we may havededesignations of our cash flow hedges in the future.

 

**Interest Rate Risk**

 

Our exposure to marketrisk for changes in interest rates primarily relates to our investments. Sincewe had no variable interest rate debt outstanding at December 31, 2007,our interest expense is relatively fixed and not affected by changes ininterest rates. In the event we issue any new debt in the future, increases ininterest rates will increase the interest expense associated with the debt. Thesignificant decline in U.S. interest rates in early 2008, combined with the useof cash to pay off some of our outstanding debt securities, is expected toresult in lower net interest income in 2008 compared with 2007.

 

The primary objective ofour investment activities is to preserve principal while maximizing yieldswithout significantly increasing risk. This objective is accomplished by makingdiversified investments, consisting only of investment grade securities.

 

***Cash,Cash Equivalents and Restricted Cash***

*** ***

As of December 31,2007, we held cash and cash equivalents of $280.6 million and short-termrestricted cash of $21.0 million that consisted of cash and highly liquidshort-term investments having maturity dates of no more than 90 days at thedate of acquisition. Declines of interest rates over time would reduce ourinterest income from our highly liquid short-term investments. A decrease ininterest rates of one percentage point would cause a corresponding decrease inannual interest income of approximately $3.0 million assuming our cash and cashequivalent balances at December 31, 2007 remained constant. Due to thenature of our highly liquid cash equivalents, an increase in interest rateswould not materially change the fair market value of our cash and cashequivalents.

 

***FixedRate Debt Securities***

*** ***

As of December 31,2007, we held short- and long-term fixed rate investments of $43.9 million thatconsisted of corporate notes and bonds and government-backed securities. Theseinvestments are recorded on our balance sheet at fair value based on quotedmarket prices. Unrealized gains/losses resulting from changes in the fair valueare recorded, net of tax, in shareholders’ equity as a component of othercomprehensive income (loss). Interest rate fluctuations impact the fair valueof these investments, however, given our ability to hold these investmentsuntil maturity or until the unrealized losses recover, we do not expect thesefluctuations to have a material impact on our results of operations, financialposition or cash flows. Declines in interest rates over time would reduce ourinterest income from our short-term investments, as our short-term portfolio isre-invested at current market interest rates. A decrease in interest rates ofone percentage point would cause a corresponding decrease in our annualinterest income from these items of approximately $0.4 million assuming ourinvestment balances at December 31, 2007 remained constant.

 

47

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*** ***

***VariableRate-Notes***

*** ***

As of December 31,2007, we held variable-rate auction notes of $118.1 million. These securitiesare primarily backed by government guaranteed student loans and carry thehighest investment ratings.  None ofthese notes are backed by mortgages or collateralized debt obligations.Subsequent to December 31, 2007, certain auctions of these securities havefailed. See also “*Liquidity and Capital Resources*”above. Cost is generally considered to approximate fair value for thesesecurities and their fair value is not significantly impacted by interest ratefluctuations. Declines in interest rates over time would reduce our interestincome from our investments in variable-rate notes, as interest rates are resetperiodically to current market interest rates. A decrease in interest rates ofone percentage point would cause a corresponding decrease in our annualinterest income from these items of approximately $1.2 million assuming ourinvestment balances at December 31, 2007 remained constant.

 

**Fair Value of Convertible Debt**

** **

The fair market value ofour fixed rate convertible debt is subject to interest rate risk. Generally,the fair market value of fixed interest rate debt will increase as interestrates fall and decrease as interest rates rise. The interest rate changesaffect the fair market value of our long-term debt, but do not impact earningsor cash flows. At December 31, 2007, we had $310.9 million of fixed rateconvertible debt outstanding. Based on open market trades, we have determinedthat the fair market value of our long-term fixed interest rate debt wasapproximately $328.8 million at December 31, 2007.

 

**Item 8.**  **Financial Statements and Supplementary Data**

 

Unaudited quarterlyfinancial data**for each of the eight quartersin the two-year period ended December 31, 2007 is as follows:

 
| **In thousands, except per share  data**                      | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|---------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| **2007**                                                      | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** |
| Net sales                                                     |       | $               | 147,959    |            | $          | 148,555         |       | $               | 145,788    |   | $ | 150,208 |   |
| Cost of sales                                                 |       | 84,216          |       | 86,798          |       | 84,556          |       | 90,520          |       |
| Gross profit                                                  |       | 63,743          |       | 61,757          |       | 61,232          |       | 59,688          |       |
| Total operating expenses                                      |       | 44,933          |       | 46,761          |       | 47,773          |       | 52,240          |       |
| Operating income                                              |       | 18,810          |       | 14,996          |       | 13,459          |       | 7,448           |       |
| Other income, net(1)                                          |       | 1,197           |       | 3,130           |       | 3,161           |       | 3,824           |       |
| Income from continuing operations before income  taxes        |       | 20,007          |       | 18,126          |       | 16,620          |       | 11,272          |       |
| Income tax expense (benefit)                                  |       | 5,077           |       | 4,095           |       | 3,236           |       | (4,331          | )          |
| Income from continuing operations                             |       | 14,930          |       | 14,031          |       | 13,384          |       | 15,603          |       |
| Income from discontinued operations, net of tax(2)            |       | 127             |       | —          |       | —          |       | 263             |       |
| Net income                                                    |       | $               | 15,057     |            | $          | 14,031          |       | $               | 13,384     |   | $ | 15,866 |   |
|                                                          |       |            |       |            |       |            |       |            |       |
| Basic income per share from continuing operations             |       | $               | 0.43       |            | $          | 0.39            |       | $               | 0.37       |   | $ | 0.43 |   |
| Basic income per share from discontinued operations           |       | 0.01            |       | —          |       | —          |       | 0.01            |       |
| Basic net income per share                                    |       | $               | 0.44       |            | $          | 0.39            |       | $               | 0.37       |   | $ | 0.44 |   |
|                                                          |       |            |       |            |       |            |       |            |       |
| Diluted income per share from continuing operations           |       | $               | 0.36       |            | $          | 0.33            |       | $               | 0.31       |   | $ | 0.36 |   |
| Diluted income per share from discontinued  operations        |       | —          |       | —          |       | —          |       | 0.01            |       |
| Diluted net income per share                                  |       | $               | 0.36       |            | $          | 0.33            |       | $               | 0.31       |   | $ | 0.37 |   |
|                                                          |       |            |       |            |       |            |       |            |       |
| Shares used in basic per share calculations                   |       | 34,556          |       | 35,742          |       | 36,216          |       | 36,323          |       |
| Shares used in diluted per share calculations                 |       | 45,307          |       | 46,471          |       | 46,419          |       | 46,477          |       |
|                                                          |       |            |       |            |       |            |       |            |       |
| **2006**                                                      | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** |
| Net sales                                                     |       | $               | 112,266    |            | $          | 111,339         |       | $               | 115,602    |   | $ | 140,284 |   |
| Cost of sales                                                 |       | 66,516          |       | 66,483          |       | 68,667          |       | 81,379          |       |
| Gross profit                                                  |       | 45,750          |       | 44,856          |       | 46,935          |       | 58,905          |       |
| Total operating expenses(3)                                   |       | 49,732          |       | 39,536          |       | 39,100          |       | 45,031          |       |
| Operating (loss) income                                       |       | (3,982          | )          | 5,320           |       | 7,835           |       | 13,874          |       |
| Other income, net(4)                                          |       | 203             |       | 994             |       | 2,369           |       | 1,506           |       |
| (Loss) income from continuing operations before  income taxes |       | (3,779          | )          | 6,314           |       | 10,204          |       | 15,380          |       |
| Income tax expense (benefit)(5)                               |       | 1,397           |       | 2,305           |       | 3,284           |       | 3,481           |       |
| (Loss) income from continuing operations                      |       | (5,176          | )          | 4,009           |       | 6,920           |       | 11,899          |       |
| (Loss) income from discontinued operations, net of  tax(2)    |       | (45             | )          | 90              |       | (412            | )          | (580            | )          |
| Gain on disposal of discontinued operations, net of  tax(2)   |       | —          |       | —          |       | —          |       | 3,335           |       |
| Net (loss) income                                             |       | $               | (5,221     | )               | $          | 4,099           |       | $               | 6,508      |   | $ | 14,654 |   |
|                                                          |       |            |       |            |       |            |       |            |       |
| Basic (loss) income per share from continuing  operations     |       | $               | (0.15      | )               | $          | 0.12            |       | $               | 0.20       |   | $ | 0.35 |   |
| Basic (loss) income per share from discontinued  operations   |       | —          |       | —          |       | (0.01           | )          | 0.08            |       |
| Basic net (loss) income per share                             |       | $               | (0.15      | )               | $          | 0.12            |       | $               | 0.19       |   | $ | 0.43 |   |
|                                                          |       |            |       |            |       |            |       |            |       |
| Diluted (loss) income per share from continuing  operations   |       | $               | (0.15      | )               | $          | 0.11            |       | $               | 0.18       |   | $ | 0.30 |   |
| Diluted (loss) income per share from discontinued  operations |       | —          |       | —          |       | (0.01           | )          | 0.06            |       |
| Diluted net (loss) income per share                           |       | $               | (0.15      | )               | $          | 0.11            |       | $               | 0.17       |   | $ | 0.36 |   |
|                                                          |       |            |       |            |       |            |       |            |       |
| Shares used in basic per share calculations                   |       | 33,867          |       | 33,770          |       | 33,752          |       | 33,886          |       |
| Shares used in diluted per share calculations                 |       | 33,867          |       | 39,691          |       | 39,572          |       | 44,079          |       |

 

48

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(1)         Other income, net in the second quarter of2007 included a $0.5 million gain onthe sale of a minority interest in a small technology company and the thirdquarter of 2007 included a $0.5 million gain related to the disposal of one ofour cost-based investments.

(2)        Represents theresults of Knights Technology, which was classified as a discontinued operationin 2006 and sold in the fourth quarter of 2006.

(3)         Included in quarterly operating expenseswere the following that affect comparability:

 

·                  restructuring, reorganization, relocation andseverance charges of $11.6 million, $0.8 million, $0.2 million, respectively,in the first, second and third quarters of 2006;

 

·                  merger costs of $0.5 million in the firstquarter of 2006;

 

·                  asset impairment charges of $0.5 million in thefirst quarter of 2006; and

 

·                  a $1.5 million gain related to the  sale of certain intellectual property rightsto a privately-held company in the third quarter of 2006.

 

(4)         Included inother income, net were the following that affect comparability:

 

·                  interest expense of $0.4 million and $0.1million, respectively, in the first and second quarters of 2006 related to therepurchase of $29.0 million face value of our 5.5% convertible notes;

 

·                  a $5.2 million gain related to the sale of ourentire ownership interest in a privately-held company in the third quarter of2006; and

 

·                  a $3.9 millioncharge related to the write-off of our equity and debt investment in aprivately-held company in the third quarter of 2006.

 

(5)        Income taxexpense (benefit) consisted primarily of taxes accrued in foreign jurisdictionsand a benefit related to the release of valuation allowance against a portionof U.S. deferred tax assets utilized during each quarter of 2006.

 

49

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** **

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

** **

**To the Board of Directors andShareholders of**

**FEI Company**

**Hillsboro, Oregon**

** **

Wehave audited the accompanying consolidated balance sheets of FEI Company andsubsidiaries (the “Company”) as of December 31, 2007 and 2006, and therelated consolidated statements of operations, comprehensive income (loss),stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2007. These financial statements are theresponsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.

 

In ouropinion, such consolidated financial statements present fairly, in all materialrespects, the financial position of FEI Company and subsidiaries as of December 31,2007 and 2006, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2007, inconformity with accounting principles generally accepted in the United Statesof America.

 

Asdiscussed in Note 1 to the consolidated financial statements the Companyadopted Financial Accounting Standards Board Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,”effective January 1, 2007.

 

Asdiscussed in Note 1 to the consolidated financial statements, the Company adoptedStatement of Financial Accounting Standards No. 123R, “Share-BasedPayment,” effective January 1, 2006.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the Company’s internal control overfinancial reporting as of December 31, 2007, based on *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission,and our report dated February 29, 2008 expressed an unqualified opinion onthe Company’s internal control over financial reporting.

 

DELOITTE &TOUCHE LLP

Portland, Oregon

February 29, 2008

 

50

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**FEI Company and Subsidiaries**

**ConsolidatedBalance Sheets**

**(Inthousands)**

 
| ** **                                                                                               | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                               | ** ** | **2007**              | ** ** | **2006** | ** ** |
| **Assets**                                                                                               | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current Assets:                                                                                          |       |                  |       |   |   |
| Cash and cash  equivalents                                                                               |       | $                     | 280,593    |   | $ | 110,656 |   |
| Short-term  investments in marketable securities                                                         |       | 152,041               |       | 234,202 |   |
| Short-term  restricted cash                                                                              |       | 20,984                |       | 20,172 |   |
| Receivables, net  of allowances for doubtful accounts of $3,819 and $4,181                               |       | 157,120               |       | 144,955 |   |
| Inventories                                                                                              |       | 138,762               |       | 97,470 |   |
| Deferred tax  assets                                                                                     |       | 4,788                 |       | 4,386 |   |
| Other current  assets                                                                                    |       | 36,273                |       | 33,474 |   |
| Total Current  Assets                                                                                    |       | 790,561               |       | 645,315 |   |
|                                                                                                     |       |                  |       |   |   |
| Non-current investments in marketable securities                                                         |       | 12,758                |       | 34,900 |   |
| Long-term restricted cash                                                                                |       | 24,621                |       | 6,131 |   |
| Property, plant and equipment, net of accumulated  depreciation of $78,083 and $68,420                   |       | 74,700                |       | 60,394 |   |
| Purchased technology, net of accumulated  amortization of $43,509 and $41,568                            |       | 2,862                 |       | 4,494 |   |
| Goodwill                                                                                                 |       | 40,864                |       | 40,900 |   |
| Deferred tax assets                                                                                      |       | 2,641                 |       | 542 |   |
| Non-current service inventories                                                                          |       | 42,168                |       | 37,920 |   |
| Other assets, net                                                                                        |       | 16,834                |       | 7,483 |   |
| Total Assets                                                                                             |       | $                     | 1,008,009  |   | $ | 838,079 |   |
|                                                                                                     |       |                  |       |   |   |
| **Liabilities and Shareholders’ Equity**                                                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current Liabilities:                                                                                     |       |                  |       |   |   |
| Accounts payable                                                                                         |       | $                     | 31,156     |   | $ | 45,118 |   |
| Accrued payroll  liabilities                                                                             |       | 26,115                |       | 20,736 |   |
| Accrued warranty  reserves                                                                               |       | 6,585                 |       | 5,716 |   |
| Accrued agent  commissions                                                                               |       | 9,119                 |       | 6,175 |   |
| Deferred revenue                                                                                         |       | 60,681                |       | 48,992 |   |
| Income taxes  payable                                                                                    |       | 3,106                 |       | 9,203 |   |
| Accrued  restructuring, reorganization, relocation and severance                                         |       | 580                   |       | 2,439 |   |
| Current portion  of convertible debt                                                                     |       | 195,882               |       | — |   |
| Other current  liabilities                                                                               |       | 29,266                |       | 29,276 |   |
| Total Current  Liabilities                                                                               |       | 362,490               |       | 167,655 |   |
|                                                                                                     |       |                  |       |   |   |
| Convertible debt                                                                                         |       | 115,000               |       | 310,882 |   |
| Deferred tax liabilities                                                                                 |       | 4,479                 |       | 4,062 |   |
| Other liabilities                                                                                        |       | 38,646                |       | 5,572 |   |
|                                                                                                     |       |                  |       |   |   |
| Commitments and contingencies                                                                            |       |                  |       |   |   |
|                                                                                                     |       |                  |       |   |   |
| Shareholders’  Equity:                                                                              |       |                  |       |   |   |
| Preferred stock  - 500 shares authorized; none issued and outstanding                                    |       | —                |       | — |   |
| Common stock -  70,000 shares authorized; 36,405 and 34,052 shares issued and outstanding, no  par value |       | 395,904               |       | 348,479 |   |
| Retained  earnings (accumulated deficit)                                                                 |       | 26,398                |       | (36,041 | ) |
| Accumulated  other comprehensive income                                                                  |       | 65,092                |       | 37,470 |   |
| Total  Shareholders’ Equity                                                                         |       | 487,394               |       | 349,908 |   |
| Total  Liabilities and Shareholders’ Equity                                                         |       | $                     | 1,008,009  |   | $ | 838,079 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

51

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**FEI Company and Subsidiaries**

**ConsolidatedStatements of Operations**

**(Inthousands, except per share amounts)**

 
| ** **                                                     | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                     | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net Sales:                                                     |       |                                     |       |   |   |   |   |
| Products                                                       |       | $                                        | 464,191    |   | $ | 358,137 |   | $ | 308,521 |   |
| Products -  related party                                      |       | 897                                      |       | 2,506 |   | 2,830 |   |
| Service and  components                                        |       | 127,101                                  |       | 116,702 |   | 107,708 |   |
| Service and  components - related party                        |       | 321                                      |       | 2,146 |   | 1,038 |   |
| Total net sales                                                |       | 592,510                                  |       | 479,491 |   | 420,097 |   |
|                                                           |       |                                     |       |   |   |   |   |
| Cost of Sales:                                                 |       |                                     |       |   |   |   |   |
| Products                                                       |       | 252,546                                  |       | 197,742 |   | 195,834 |   |
| Service and  components                                        |       | 93,544                                   |       | 85,303 |   | 79,069 |   |
| Total cost of sales                                            |       | 346,090                                  |       | 283,045 |   | 274,903 |   |
|                                                           |       |                                     |       |   |   |   |   |
| Gross Profit                                                   |       | 246,420                                  |       | 196,446 |   | 145,194 |   |
|                                                           |       |                                     |       |   |   |   |   |
| Operating Expenses:                                            |       |                                     |       |   |   |   |   |
| Research and  development                                      |       | 66,042                                   |       | 57,528 |   | 56,577 |   |
| Selling, general  and administrative                           |       | 124,160                                  |       | 100,279 |   | 97,460 |   |
| Merger costs                                                   |       | —                                   |       | 484 |   | — |   |
| Amortization of  purchased technology                          |       | 1,777                                    |       | 2,034 |   | 3,819 |   |
| Asset impairment                                               |       | —                                   |       | 465 |   | 25,352 |   |
| Restructuring,  reorganization, relocation and severance       |       | (272                                     | )          | 12,609 |   | 8,544 |   |
| Total operating  expenses                                      |       | 191,707                                  |       | 173,399 |   | 191,752 |   |
|                                                           |       |                                     |       |   |   |   |   |
| Operating Income (Loss)                                        |       | 54,713                                   |       | 23,047 |   | (46,558 | ) |
|                                                           |       |                                     |       |   |   |   |   |
| Other Income (Expense):                                        |       |                                     |       |   |   |   |   |
| Interest income                                                |       | 22,372                                   |       | 13,150 |   | 7,819 |   |
| Interest expense                                               |       | (8,735                                   | )          | (7,355 | ) | (9,342 | ) |
| Other, net                                                     |       | (2,325                                   | )          | (723 | ) | (8,308 | ) |
| Total other  income (expense), net                             |       | 11,312                                   |       | 5,072 |   | (9,831 | ) |
|                                                           |       |                                     |       |   |   |   |   |
| Income (loss)  from continuing operations before income taxes  |       | 66,025                                   |       | 28,119 |   | (56,389 | ) |
| Income tax expense                                             |       | 8,077                                    |       | 10,467 |   | 22,071 |   |
| Income (loss) from continuing operations                       |       | 57,948                                   |       | 17,652 |   | (78,460 | ) |
| Income (loss)  from discontinued operations, net of income tax |       | —                                   |       | (947 | ) | 302 |   |
| Gain on disposal  of discontinued operations, net of tax       |       | 390                                      |       | 3,335 |   | — |   |
| Net income (loss)                                              |       | $                                        | 58,338     |   | $ | 20,040 |   | $ | (78,158 | ) |
|                                                           |       |                                     |       |   |   |   |   |
| Basic income (loss) per share from continuing  operations      |       | $                                        | 1.62       |   | $ | 0.52 |   | $ | (2.34 | ) |
| Basic income per share from discontinued operations            |       | 0.01                                     |       | 0.07 |   | 0.01 |   |
| Basic net income (loss) per share                              |       | $                                        | 1.63       |   | $ | 0.59 |   | $ | (2.33 | ) |
|                                                           |       |                                     |       |   |   |   |   |
| Diluted income (loss) per share from continuing  operations    |       | $                                        | 1.35       |   | $ | 0.47 |   | $ | (2.34 | ) |
| Diluted income per share from discontinued  operations         |       | 0.01                                     |       | 0.06 |   | 0.01 |   |
| Diluted net income (loss) per share                            |       | $                                        | 1.36       |   | $ | 0.53 |   | $ | (2.33 | ) |
|                                                           |       |                                     |       |   |   |   |   |
| Shares used in per share calculations:                         |       |                                     |       |   |   |   |   |
| Basic                                                          |       | 35,709                                   |       | 33,818 |   | 33,595 |   |
| Diluted                                                        |       | 46,254                                   |       | 39,752 |   | 33,595 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

52

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**FEI Company and Subsidiaries**

**ConsolidatedStatements of Comprehensive Income (Loss)**

**(Inthousands)**

 

 
| ** **                                                                                                             | ** ** | **For the Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income  (loss)                                                                                                     |       | $                                        | 58,338     |   | $ | 20,040 |   | $ | (78,158 | ) |
| Other  comprehensive income (loss):                                                                                    |       |                                     |       |   |   |   |   |
| Change in  cumulative translation adjustment, zero taxes provided                                                      |       | 26,486                                   |       | 18,313 |   | (22,194 | ) |
| Change in  unrealized loss on available-for-sale securities                                                            |       | 415                                      |       | 793 |   | (928 | ) |
| Change in  minimum pension liability, net of taxes                                                                     |       | 204                                      |       | (603 | ) | — |   |
| Changes due to  cash flow hedging instruments:                                                                         |       |                                     |       |   |   |   |   |
| Net gain (loss)  on hedge instruments                                                                                  |       | 5,494                                    |       | 4,542 |   | (5,219 | ) |
| Reclassification  to net income (loss) of previously deferred gains (losses) related to hedge  derivatives instruments |       | (4,977                                   | )          | (1,974 | ) | 2,879 |   |
| Comprehensive  income (loss)                                                                                           |       | $                                        | 85,960     |   | $ | 41,111 |   | $ | (103,620 | ) |

 

See accompanyingNotes to Consolidated Financial Statements.

 

53

----

** **

**FEI Company and Subsidiaries**

**ConsolidatedStatements of Shareholders’ Equity**

**For TheYears Ended December 31, 2007, 2006 and 2005**

**(Inthousands)**

 

 
| ** **                                                                                                | ** ** | ** **       | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------------|------------|--------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                                | ** ** | ** **       | ** ** | ** **   | ** ** | **Retained**      | ** ** | **Other**              | ** ** | **Total**  | ** ** |
| ** **                                                                                                | ** ** | **Common Stock** | ** ** | **Earnings** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                                                                | ** ** | **Shares**       | ** ** | **Amount**   | ** ** | **(Deficit)**     | ** ** | **Income**             | ** ** | **Equity** | ** ** |
| **Balance  at December 31, 2004**                                                                    |       | 33,413           |       | $            | 315,632    |              | $          | 22,077                 |       | $          | 41,861     |   | $ | 379,570 |   |
|                                                                                                      |       |             |       |         |       |              |       |                   |       |       |       |
| Net loss                                                                                                  |       | —           |       | —       |       | (78,158           | )          | —                 |       | (78,158    | )          |
| Employee  purchases of common stock through employee share purchase plan                                  |       | 207              |       | 3,591        |       | —            |       | —                 |       | 3,591      |       |
| Stock options  exercised                                                                                  |       | 180              |       | 2,287        |       | —            |       | —                 |       | 2,287      |       |
| Stock-based  compensation expense                                                                         |       | —           |       | 58           |       | —            |       | —                 |       | 58         |       |
| Reversal of tax  benefit of non-qualified stock options exercised                                         |       | —           |       | (400         | )          | —            |       | —                 |       | (400       | )          |
| Termination of  convertible note hedge                                                                    |       | —           |       | 10,957       |       | —            |       | —                 |       | 10,957     |       |
| Translation  adjustment                                                                                   |       | —           |       | —       |       | —            |       | (22,194                | )          | (22,194    | )          |
| Unrealized loss  on available for sale securities                                                         |       | —           |       | —       |       | —            |       | (928                   | )          | (928       | )          |
| Net adjustment  for fair value of hedge derivatives                                                       |       | —           |       | —       |       | —            |       | (2,340                 | )          | (2,340     | )          |
| **Balance  at December 31, 2005**                                                                    |       | 33,800           |       | 332,125      |       | (56,081           | )          | 16,399                 |       | 292,443    |       |
|                                                                                                      |       |             |       |         |       |              |       |                   |       |       |       |
| Net income                                                                                                |       | —           |       | —       |       | 20,040            |       | —                 |       | 20,040     |       |
| Employee  purchases of common stock through employee share purchase plan                                  |       | 187              |       | 3,516        |       | —            |       | —                 |       | 3,516      |       |
| Restricted  shares issued and stock options exercised related to employee stock-based  compensation plans |       | 565              |       | 9,631        |       | —            |       | —                 |       | 9,631      |       |
| Shares  repurchased                                                                                       |       | (500             | )          | (11,075      | )          | —            |       | —                 |       | (11,075    | )          |
| Stock-based  compensation expense                                                                         |       | —           |       | 12,860       |       | —            |       | —                 |       | 12,860     |       |
| Tax benefit of  non-qualified stock options exercised                                                     |       | —           |       | 1,422        |       | —            |       | —                 |       | 1,422      |       |
| Translation  adjustment                                                                                   |       | —           |       | —       |       | —            |       | 18,313                 |       | 18,313     |       |
| Unrealized gain  on available for sale securities                                                         |       | —           |       | —       |       | —            |       | 793                    |       | 793        |       |
| Minimum pension  liability, net of taxes                                                                  |       | —           |       | —       |       | —            |       | (603                   | )          | (603       | )          |
| Net adjustment  for fair value of hedge derivatives                                                       |       | —           |       | —       |       | —            |       | 2,568                  |       | 2,568      |       |
| **Balance  at December 31, 2006**                                                                    |       | 34,052           |       | 348,479      |       | (36,041           | )          | 37,470                 |       | 349,908    |       |
|                                                                                                      |       |             |       |         |       |              |       |                   |       |       |       |
| Net income                                                                                                |       | —           |       | —       |       | 58,338            |       | —                 |       | 58,338     |       |
| Employee  purchases of common stock through employee share purchase plan                                  |       | 212              |       | 4,412        |       | —            |       | —                 |       | 4,412      |       |
| Restricted  shares issued and stock options exercised related to employee stock-based  compensation plans |       | 2,141            |       | 36,482       |       | —            |       | —                 |       | 36,482     |       |
| Stock-based  compensation expense                                                                         |       | —           |       | 7,351        |       | —            |       | —                 |       | 7,351      |       |
| Taxes paid as  part of the net share settlement of restricted stock units                                 |       | —           |       | 391          |       | —            |       | —                 |       | 391        |       |
| Restricted stock  unit taxes for net share settlement                                                     |       | —           |       | (1,211       | )          | —            |       | —                 |       | (1,211     | )          |
| Translation  adjustment                                                                                   |       | —           |       | —       |       | —            |       | 26,486                 |       | 26,486     |       |
| Unrealized gain  on available for sale securities                                                         |       | —           |       | —       |       | —            |       | 415                    |       | 415        |       |
| Minimum pension  liability, net of taxes                                                                  |       | —           |       | —       |       | —            |       | 204                    |       | 204        |       |
| Net adjustment  for fair value of hedge derivatives                                                       |       | —           |       | —       |       | —            |       | 517                    |       | 517        |       |
| Implementation  of FIN 48                                                                                 |       | —           |       | —       |       | 4,101             |       | —                 |       | 4,101      |       |
| **Balance  at December 31, 2007**                                                                    |       | 36,405           |       | $            | 395,904    |              | $          | 26,398                 |       | $          | 65,092     |   | $ | 487,394 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

54

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**FEI Company and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(Inthousands)**

 
| ** **                                                                                   | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities:**                                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  (loss)                                                                           |       | $                                        | 58,338     |   | $ | 20,040 |   | $ | (78,158 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities:    |       |                                     |       |   |   |   |   |
| Depreciation                                                                                 |       | 13,690                                   |       | 13,356 |   | 15,023 |   |
| Amortization                                                                                 |       | 3,256                                    |       | 4,436 |   | 9,253 |   |
| Stock-based  compensation                                                                    |       | 7,351                                    |       | 12,820 |   | 58 |   |
| Asset  impairments and write-offs of property, plant and equipment and other assets          |       | —                                   |       | 4,311 |   | 25,352 |   |
| (Gain) loss on  disposal of investments, property, plant and equipment and intangible assets |       | (3                                       | )          | (6,726 | ) | 22 |   |
| Write-off of  deferred bond offering costs                                                   |       | —                                   |       | 404 |   | — |   |
| Premium on bond  redemption                                                                  |       | —                                   |       | — |   | 1,108 |   |
| Write-off of  capitalized software                                                           |       | —                                   |       | — |   | 3,223 |   |
| Write-down of  cost method investments                                                       |       | —                                   |       | — |   | 6,408 |   |
| Gain on sale of  SIMS product line                                                           |       | —                                   |       | — |   | (797 | ) |
| Income taxes  receivable (payable), net                                                      |       | 3,824                                    |       | 1,900 |   | (13,767 | ) |
| Deferred income  taxes                                                                       |       | (1,498                                   | )          | 1,704 |   | 15,810 |   |
| Tax benefit  (reversal) for stock options exercised                                          |       | 391                                      |       | 1,422 |   | (400 | ) |
| Gain on disposal  of discontinued operations                                                 |       | (390                                     | )          | (3,335 | ) | — |   |
| (Increase)  decrease in:                                                                     |       |                                     |       |   |   |   |   |
| Receivables                                                                                  |       | (1,911                                   | )          | (41,833 | ) | 53,872 |   |
| Current account  with Accurel                                                                |       | —                                   |       | — |   | 515 |   |
| Inventories                                                                                  |       | (34,772                                  | )          | (9,831 | ) | (16,906 | ) |
| Other assets                                                                                 |       | (1,471                                   | )          | (1,476 | ) | 11,961 |   |
| Increase  (decrease) in:                                                                     |       |                                     |       |   |   |   |   |
| Accounts payable                                                                             |       | (18,654                                  | )          | 15,915 |   | (7,511 | ) |
| Current account  with Philips                                                                |       | —                                   |       | (2,598 | ) | (1,363 | ) |
| Accrued payroll  liabilities                                                                 |       | 3,371                                    |       | 10,466 |   | (4,620 | ) |
| Accrued warranty  reserves                                                                   |       | 556                                      |       | 313 |   | (1,697 | ) |
| Deferred revenue                                                                             |       | 16,664                                   |       | 2,919 |   | 3,953 |   |
| Accrued  restructuring, reorganization, relocation and severance costs                       |       | (1,927                                   | )          | (2,369 | ) | 4,259 |   |
| Other  liabilities                                                                           |       | 4,731                                    |       | 1,453 |   | (5,183 | ) |
| Net cash provided  by operating activities                                                   |       | 51,546                                   |       | 23,291 |   | 20,415 |   |
|                                                                                         |       |                                     |       |   |   |   |   |
| **Cash  flows from investing activities:**                                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Increase in  restricted cash                                                                 |       | (17,075                                  | )          | (4,965 | ) | (2,160 | ) |
| Acquisition of  property, plant and equipment                                                |       | (18,483                                  | )          | (6,514 | ) | (14,983 | ) |
| Proceeds from  disposal of property, plant and equipment and intangible assets               |       | 5                                        |       | 1,532 |   | 3,023 |   |
| Proceeds from  disposal of discontinued operations                                           |       | —                                   |       | 7,750 |   | — |   |
| Purchase of  investments in marketable securities                                            |       | (247,820                                 | )          | (298,216 | ) | (172,623 | ) |
| Redemption of  investments in marketable securities                                          |       | 353,560                                  |       | 230,707 |   | 177,796 |   |
| Proceeds from  disposal of (investment in) unconsolidated subsidiary                         |       | —                                   |       | 4,829 |   | (2,408 | ) |
| Other                                                                                        |       | (268                                     | )          | (259 | ) | (109 | ) |
| Net cash  provided by (used in) investing activities                                         |       | 69,919                                   |       | (65,136 | ) | (11,464 | ) |
|                                                                                         |       |                                     |       |   |   |   |   |
| **Cash  flows from financing activities:**                                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Redemption of  5.5% convertible notes                                                        |       | —                                   |       | (29,118 | ) | (70,000 | ) |
| Issuance of  2.875% convertible notes, net of offering costs                                 |       | —                                   |       | 111,868 |   | — |   |
| Termination of  convertible note hedge                                                       |       | —                                   |       | — |   | 10,957 |   |
| Repurchase of  common stock                                                                  |       | —                                   |       | (11,075 | ) | — |   |
| Witholding taxes  paid by Company on issuance of vested restricted stock units               |       | (1,213                                   | )          | — |   | — |   |
| Proceeds from  exercise of stock options and employee stock purchases                        |       | 40,894                                   |       | 13,147 |   | 5,878 |   |
| Net cash  provided by (used in) financing activities                                         |       | 39,681                                   |       | 84,822 |   | (53,165 | ) |
|                                                                                         |       |                                     |       |   |   |   |   |
| Effect of  exchange rate changes                                                             |       | 8,791                                    |       | 8,913 |   | (9,182 | ) |
| Increase  (decrease) in cash and cash equivalents                                            |       | 169,937                                  |       | 51,890 |   | (53,396 | ) |
|                                                                                         |       |                                     |       |   |   |   |   |
| **Cash  and cash equivalents:**                                                              | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Beginning of year                                                                            |       | 110,656                                  |       | 58,766 |   | 112,162 |   |
| End of year                                                                                  |       | $                                        | 280,593    |   | $ | 110,656 |   | $ | 58,766 |   |
|                                                                                         |       |                                     |       |   |   |   |   |
| **Supplemental  Cash Flow Information:**                                                     | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash (received  from) paid for income taxes, net                                             |       | $                                        | (5,194     | ) | $ | 5,387 |   | $ | 16,482 |   |
| Cash paid for  interest                                                                      |       | 7,061                                    |       | 5,783 |   | 8,765 |   |
| Notes payable  issued to acquire intangible assets                                           |       | 4,014                                    |       | — |   | — |   |
| Inventories  transferred to fixed assets                                                     |       | 7,313                                    |       | 5,543 |   | 4,782 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

55

----

 

**FEI COMPANY AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

** **

**1.**                                      SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

** **

***Nature of Business***

*** ***

We are a leadingsupplier of instruments for nanoscale imaging, analysis and prototyping toenable research, development and manufacturing in a range of industrial,academic and research institutional applications. We report our revenue basedon a market-focused organization: the NanoElectronics market, the NanoResearchand Industry market, the NanoBiology market and the Service and Componentsmarket.

 

Our products includefocused ion beam systems, or FIBs; scanning electron microscopes, or SEMs;transmission electron microscopes, or TEMs; and *DualBeam*systems, which combine a FIB and SEM on a single platform.

 

Our *DualBeam* systems include models that have wafer handlingcapability and are purchased by semiconductor and data storage manufacturers (“wafer-level*DualBeam*systems”) and models that havesmall stages and are sold to customers in several markets (“small-stage *DualBeam*systems”).

 

We have research,development and manufacturing operations in Hillsboro, Oregon; Eindhoven, theNetherlands; and Brno, Czech Republic.

 

Our sales and serviceoperations are conducted in the U.S. and approximately 50 other countriesaround the world. We also sell our products through independent agents,distributors and representatives in additional countries.

 

***Basis of Presentation***

*** ***

The consolidated financial statementsinclude the accounts of FEI Company and our majority-controlled subsidiaries.All significant intercompany balances and transactions have been eliminated inconsolidation.

 

***Use of Estimates inFinancial Reporting***

*** ***

The preparation of financial statementsin conformity with accounting principles generally accepted in the U.S. requiresmanagement to make estimates and assumptions. These estimates and assumptionsaffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amount of revenues and expenses during the reporting period.Significant accounting policies and estimates underlying the accompanyingconsolidated financial statements include:

 

·                  thetiming of revenue recognition;

 

·                  theallowance for doubtful accounts;

 

·                  valuationsof excess and obsolete inventory;

 

·                  valuationof marketable securities;

 

·                  valuationof investments in privately-held companies;

 

·                  thelives and recoverability of equipment and other long-lived assets such asgoodwill, existing technology intangibles;

 

·                  restructuring,reorganization, relocation and severance costs;

 

·                  accountingfor income taxes;

 

·                  warrantyliabilities;

 

·                  stock-basedcompensation; and

 

·                  accountingfor derivatives.

 

It is reasonably possible that theestimates we make may change in the future.

 

56

----

 

***Concentration of CreditRisk***

*** ***

Instruments that potentially subject usto concentration of credit risk consist principally of cash and cashequivalents, short-term investments and receivables. Our investment policylimits investments with any one issuer to 10% or less of the total investmentportfolio, with the exception of money market funds and securities issued bythe U.S. government or its agencies which may comprise up to 100% of the totalinvestment portfolio. Our exposure to credit risk concentrations within ourreceivables balance is limited due to the large number of entities comprisingour customer base and their dispersion across many different industries andgeographies.

 

***Dependence on KeySuppliers***

*** ***

Failure of criticalsuppliers of parts, components and manufacturing equipment to deliversufficient quantities to us in a timely and cost-effective manner couldnegatively affect our business, including our ability to convert backlog intorevenue. We currently use numerous vendors to supply parts, components andsubassemblies for the manufacture and support of our products. Some key parts,however, may only be obtained from a single supplier or a limited group ofsuppliers. In particular, we rely on: VDL Enabling Technologies Group, or ETG,Frencken Mechatronics B.V. and AZD Praha STR for our supply of mechanical partsand subassemblies; Gatan, Inc. for critical accessory products; and NewaysElectronics, N.V. for some of our electronic subassemblies. In addition, someof our suppliers rely on sole suppliers. As a result of this concentration ofkey suppliers, our results of operations may be materially and adverselyaffected if we do not timely and cost-effectively receive a sufficient quantityof quality parts to meet our production requirements or if we are required tofind alternative suppliers for these supplies. We may not be able to expand oursupplier group or to reduce our dependence on single suppliers. If oursuppliers are not able to meet our supply requirements, constraints may affectour ability to deliver products to customers in a timely manner, which couldhave an adverse effect on our results of operations. In addition, world widerestrictions governing the use of certain hazardous substances in electricaland electronic equipment (Restrictions on Hazardous Substances, or “RoHS,”regulations) may impact parts and component availability or our electronicssuppliers’ ability to source parts and components in a timely andcost-effective manner. Overall, because we only have a few equipment suppliers,we may be more exposed to future cost increases for this equipment.

 

In addition, we rely on alimited number of equipment manufacturers to develop and supply the equipmentwe use to manufacture our products. Thefailure of these manufacturers to develop or deliver quality equipment on atimely basis could have a material adverse effect on our business and resultsof operations. In addition, because we only have a few equipment suppliers, wemay be more exposed to future cost increases for this equipment.

 

***Cash and CashEquivalents***

*** ***

Cash and cash equivalents include cashdeposits in banks, money market funds and other highly liquid marketablesecurities with maturities of three months or less at the date of acquisition.

 

***Restricted Cash***

*** ***

Our restricted cash balances are held indeposit accounts with banks that have issued guarantees and letters of creditto our customers for system sales transactions and customer advance depositsrelating to prepayments for service contracts, mainly in Europe and Asia. Thisrestricted cash can be drawn on by the bank if goods are not delivered orservices are not properly performed. In addition, while the restricted cash isheld in the bank it is earning interest. Given these deposit accounts requiresatisfaction of conditions other than a withdrawal demand for us to receive areturn of principal, are interest bearing and are held for extended periods oftime, we have concluded these balances are similar in nature to our otherinvestments and that inclusion in investing activities on our statement of cashflows is appropriate and consistent with our treatment of other investments.

 

57

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***AccountsReceivable***

*** ***

The roll-forward ofour accounts receivable allowance was as follows (in thousands):

 

 

| **Balance, December 31, 2004** |   | $      | 3,222  |   |
|-------------------------------------|--------|--------|--------|--------|
| Expense                             |   | 1,654  |   |
| Write-offs                          |   | (1,237 | )      |
| Translation adjustments             |   | (334   | )      |
| **Balance, December 31, 2005** |   | 3,305  |   |
| Expense                             |   | 729    |   |
| Write-offs                          |   | (110   | )      |
| Translation adjustments             |   | 257    |   |
| **Balance, December 31, 2006** |   | 4,181  |   |
| Expense                             |   | 939    |   |
| Write-offs                          |   | (1,549 | )      |
| Translation adjustments             |   | 248    |   |
| **Balance, December 31, 2007** |   | $      | 3,819  |   |

 

Write-offs includeamounts written off for specifically identified bad debts.

 

***Marketable Securities***

 

We account for ourinvestments in marketable securities in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 115, “*Accountingfor Certain Investments in Debt and Equity Securities*.” Ourinvestments include marketable debt securities, corporate notes and bonds andgovernment-backed securities with maturities greater than 90 days at the timeof purchase. Our fixed maturity securities are classified as available-for-salesecurities and, accordingly, are carried at fair value, based on quoted marketprices, with the unrealized gains or losses reported, net of tax, inshareholders’ equity as a component of accumulated other comprehensive income(loss).

 

Certain equity securitiesheld in short-term and long-term investments related to the executive deferredcompensation plan are classified as trading securities. Investments designatedas trading securities are carried at fair value on the balance sheet, based onquoted market prices, with the unrealized gains or losses recorded in interestand other income in the period incurred.

 

Realized gains and losseson all investments are recorded on the specific identification method and areincluded in interest and other income. Investments with maturities greater than12 months from the balance sheet date are classified as non-currentinvestments, unless they are expected to be liquidated within the next 12months; in which case, the investment is classified as current.

 

***Inventories***

*** ***

***I***nventoriesare stated at the lower of cost or market, with cost determined by standardcost methods, which approximate the first-in, first-out method. Inventory costsinclude material, labor and manufacturing overhead. Service inventories thatexceed the estimated requirements for the next 12 months based on recent usagelevels are reported as other long-term assets. Management has establishedinventory reserves based on estimates of excess and/or obsolete current andnon-current inventory.

 

***Income Taxes***

*** ***

We account for incometaxes using the asset and liability method, which requires the recognition ofdeferred tax assets and liabilities for the expected future tax consequences oftemporary differences between the carrying amounts and tax bases of the assetsand liabilities. In accordance with the provisions of SFAS No. 109, “*Accountingfor Income Taxes,*”**werecord a valuation allowance to reduce deferred tax assets to the amountexpected to “more likely than not” be realized in our future tax returns.  During 2007 and 2006, we released a portionof the valuation allowance recorded against U.S. deferred tax assets which wereutilized during the periods to offset 2007 and 2006 U.S. taxable income.

 

Should we determine thatwe would not be able to realize all or part of our remaining net deferred taxassets in the future, increases to the valuation allowance for deferred taxassets may be required. 

 

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Conversely, if wedetermine that certain tax assets that have been reserved for may be realizedin the future, we may reduce our valuation allowance in future periods. Our netdeferred tax assets totaled $2.6 million and $0.5 million, respectively, at December 31,2007 and 2006 and our valuation allowance totaled $39.5 million and $33.5million, respectively.

 

In June 2006, theFinancial Accounting Standards Board (“FASB”) issued Interpretation No. 48,“*Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement 109*.” This statement clarifies thecriteria that an individual tax position must satisfy for some or all of thebenefits of that position to be recognized in a company’s financial statements.Interpretation No. 48 prescribes a recognition threshold of more likelythan not, and a measurement attribute for all tax positions taken or expectedto be taken on a tax return, in order for those tax positions to be recognizedin the financial statements. Effective January 1, 2007, we adopted theprovisions of Interpretation No. 48 and recorded a $4.1 million increaseto the opening balance of retained earnings to account for the cumulativeeffect of applying the new standard to previously unrecognized tax benefits.The increase to retained earnings was attributable to the resolution of a U.S.federal tax audit where the result was considered more likely than not underthe recognition and measurement standards of Interpretation No. 48.

 

On January 1, 2007,total unrecognized tax benefits were $17.6 million, of which $9.1 million wouldhave an impact on the effective tax rate. Interest and penalties accrued onunrecognized tax benefits were $1.5 million and were treated as tax expense inthe consolidated statement of operations. Unrecognized tax benefits relatemainly to uncertainty surrounding intercompany pricing, permanent establishmentand the capitalization of certain costs. See Note 13 for additionalinformation.

 

***Property, Plant andEquipment***

*** ***

Land is stated at cost. Buildings andimprovements are stated at cost and depreciated over estimated useful lives ofapproximately 35 years using the straight-line method. Machinery and equipment,including systems used in research and development activities, production andin demonstration laboratories, are stated at cost and depreciated overestimated useful lives of approximately three to seven years using thestraight-line method. Leasehold improvements are amortized over the shorter oftheir economic lives or the lease term. Maintenance and repairs are expensed asincurred. See Note 5 “*Asset Impairment Charges*”for a discussion of property, plant and equipment impairment charges incurredin 2006 and 2005.

 

Demonstration systemsconsist primarily of internally manufactured products and related accessoriesthat we use for marketing purposes in our demonstration laboratories (“NanoPorts”)or for trade shows.  These systems arenot held for sale and accordingly are recorded as a component of property,plant and equipment and depreciated using the straight-line method over theirexpected useful lives of approximately three to seven years with the expensebeing reflected as a component of selling, general and administrative.

 

On occasion we loansystems to customers on a temporary basis while they wait for their tool to bemanufactured or for evaluation. These systems are included in our finishedgoods inventories and the lending/evaluation periods are typically for a timeperiod of less than one year. The sale of disposable products or services isnot typically included in these arrangements. Any expense associated with these systems is recorded as a component ofcost of sales.

 

Additionally, we leasesystems to customers as operating type leases as defined by SFAS No. 13, “*Accounting for Leases*,” where we are the lessor. Underthe operating method, rental revenue is recognized over the leaseperiod. The leased asset is depreciated over the life of thelease. In addition to the depreciation charge, maintenance costs and thecost of any other services rendered under the provision of the lease thatpertain to the current accounting period are charged to expense.

 

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***Purchased Technology***

 

Purchased technology represents theestimated value of products utilizing technology existing as of the purchasedate, discounted to its net present value. Purchased technology is amortized ona straight-line basis over the estimated useful life of the technology,typically 5 to 12 years. See Note 5 “*Asset Impairment Charges*”for a discussion of purchased technology impairment charges incurred in 2005.

 

***Long-Lived AssetImpairment***

 

We evaluate, in accordance with SFAS No. 144,“*Accounting for theImpairment or Disposal of Long-Lived Assets,*” the remaininglife and recoverability of equipment and other assets that are to be held andused, including purchased technology and other intangible assets with definiteuseful lives, whenever events or changes in circumstances indicate that thecarrying amount of the asset may not be recoverable. If there is an indicationof impairment, we prepare an estimate of future, undiscounted cash flowsexpected to result from the use of the asset and its eventual disposition. Ifthese cash flows are less than the carrying value of the asset, we adjust thecarrying amount of the asset to its estimated fair value. Long-lived assets tobe disposed of by sale are valued at the lower of book value or fair value lesscost to sell. See Note 5 “*Asset Impairment Charges*”for a discussion of long-lived asset impairment charges incurred in 2005.

 

***Investments in Privately-HeldCompanies***

 

We made investments in several small,privately held technology companies in which we hold less than 20% of thecapital stock or hold notes receivable. We account for these investments attheir cost unless their value has been determined to be other-than-temporarilyimpaired, in which case we write the investment down to its estimated fairvalue. We review these investments periodically for impairment and makeappropriate reductions in carrying value when an “other-than-temporary” declineis evident. However, for non-marketable equity securities, the impairmentanalysis requires significant judgment. We evaluate the financial condition ofthe investee, market conditions and other factors providing an indication ofthe fair value of the investments. Based on these actions, in 2006 and 2005, weconcluded that certain of these investments had “other-than-temporary”impairments and, accordingly, we recorded impairment charges totaling $3.9million and $2.9 million, respectively, as a component of other income(expense). As of December 31, 2006, all cost-method investments had beenwritten down to zero. During 2007, we recorded gains totaling $1.0 million onthe disposal of two of our cost-method investments. See also Note 3 “*Investments*.”

 

***Goodwill***

 

Goodwill represents theexcess purchase price over fair value of net assets acquired. Pursuant to SFAS No. 142,“*Goodwill and Other Intangible Assets*,”goodwill and other identifiable intangible assets with indefinite useful livesare no longer amortized, but, instead, a two-step impairment test is performedat least annually, in accordance with the provisions of SFAS No. 142. Wetest goodwill for impairment annually in the fourth quarter. First, the fairvalue of each reporting unit is compared to its carrying value. We have definedour reporting units to be our operating segments as disclosed under SFAS No. 131,“*Disclosures about Segments of an Enterprise andRelated Information*.”  If thefair value of the reporting unit exceeds the carrying value, goodwill is notimpaired and no further testing is performed. The second step is performed ifthe carrying value exceeds the fair value. The implied fair value of thereporting unit’s goodwill must be determined and compared to the carrying valueof the goodwill.  If the carrying valueof a reporting unit’s goodwill exceeds its implied fair value, an impairmentloss equal to the difference will be recorded. No impairments were identifiedin step one of our annual analysis during the fourth quarter of 2007, 2006 or2005 as a result of this test.

 

Additionally, in thesecond quarter of 2005, based on our then-current and projected operatingresults, we concluded that there were sufficient indicators to require us toassess whether the portion of our goodwill balance recorded within, what wasthen, our microelectronics reporting unit was impaired. We applied the two-stepimpairment test described above. In determining the fair value used in step oneof the impairment analysis for the microelectronics reporting unit, we employedthe market approach, consisting of the market comparable methodology. Themarket comparable methodology involves comparing the reporting unit to similarpublicly held companies whose equity securities are actively traded on a public

 

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market. Financialmultiples of the comparable public companies are computed and these multipleswere then applied to the reporting unit’s operating results to estimate theirfair value. The estimated fair value of the reporting unit exceeded itscarrying value and, accordingly, no further impairment analysis was required.

 

***Segment Reporting***

 

Based upon definitionscontained within SFAS No. 131, “*Disclosuresabout Segments of an Enterprise and Related Information*,” we havedetermined that we operate in four reportable operating segments:NanoElectronics, NanoResearch and Industry, NanoBiology and Service andComponents. There are no differences between the accounting policies used forour business segments compared to those used on a consolidated basis.

 

***Revenue Recognition***

 

We recognize revenue when persuasiveevidence of a contractual arrangement exits, delivery has occurred or serviceshave been rendered, the seller’s price to buyer is fixed and determinable, andcollectibility is reasonably assured.

 

For products demonstrated to meet ourpublished specifications, revenue is recognized when the title to the productand the risks and rewards of ownership pass to the customer. The portion ofrevenue related to installation and final acceptance, of which the estimatedfair value is generally 4% of the total revenue of the transaction, is deferreduntil such installation and final customer acceptance are completed. Forproducts produced according to a particular customer’s specifications, revenueis recognized when the product meets the customer’s specifications and when thetitle and the risks and rewards of ownership have passed to the customer. Ineach case, the portion of revenue applicable to installation and customeracceptance is recognized upon meeting specifications at the installation site.For new applications of our products where performance cannot be assured priorto meeting specifications at the installation site, no revenue is recognizeduntil such specifications are met.

 

For sales arrangements containingmultiple elements (products or services), revenue relating to undeliveredelements is deferred at the estimated fair value until delivery of the deferredelements. To be considered a separate element, the product or service inquestion must represent a separate unit under accounting rules and fulfillthe following criteria: the delivered item(s) has value to the customer ona standalone basis; there is objective and reliable evidence of the fair valueof the undelivered item(s); and, if the arrangement includes a general right ofreturn relative to the delivered item(s), delivery or performance of theundelivered item(s) is considered probable and substantially in ourcontrol. If the arrangement does not meet all criteria above, the entire amountof the transaction is deferred until all elements are delivered.

 

We provide maintenanceand support services under renewable, term maintenance agreements. Maintenanceand support fee revenue is recognized ratably over the contractual term, whichis generally 12 months, and commences from contract date.

 

Revenue from time and materials basedservice arrangements is recognized as the service is performed. Spare partsrevenue is generally recognized upon shipment.

 

Deferred revenue represents customerdeposits on equipment orders, orders awaiting customer acceptance and prepaidservice contract revenue. Deferred revenue is recognized in accordance with ourrevenue recognition policies described above.

 

***Deferred Revenue***

 

Deferred revenue represents customerdeposits on equipment orders, orders awaiting customer acceptance and prepaidservice contract revenue. Deferred revenue is recognized in accordance with ourrevenue recognition policies described above.

 

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***Product Warranty Costs***

 

Our products generally carry a one-yearwarranty. A reserve is established at the time of sale to cover estimatedwarranty costs as a component of cost of sales on our consolidated statementsof operations. Our estimate of warranty cost is based on our history ofwarranty repairs and maintenance. While most new products are extensions ofexisting technology, the estimate could change if new products require asignificantly different level of repair and maintenance than similar productshave required in the past. Our estimated warranty costs are reviewed andupdated on a quarterly basis. Historically, we have not made significantadjustments to our estimates. However, in the third quarter of 2005, we reducedour warranty reserve by approximately $1.0 million as a result of our continualreview of the actual warranty repair and maintenance activity, which was belowour initial reserve estimates. No significant adjustments were made to ourestimates in 2007 or 2006.

 

A roll-forwardof our warranty liability for the years ended December 31, 2007, 2006 and2005 was as follows (in thousands):

 
| ** ** | **Balance, December 31, 2004**    |   | $       | 9,073  |   |
|------------|----------------------------------------|--------|---------|--------|--------|
|       | Reductions for warranty costs incurred |   | (13,998 | )      |
|       | Warranties issued                      |   | 9,336   |   |
|       | Translation adjustments                |   | 782     |   |
| ** ** | **Balance, December 31, 2005**    |   | 5,193   |   |
|       | Reductions for warranty costs incurred |   | (11,143 | )      |
|       | Warranties issued                      |   | 11,686  |   |
|       | Translation adjustments                |   | (20     | )      |
| ** ** | **Balance, December 31, 2006**    |   | 5,716   |   |
|       | Reductions for warranty costs incurred |   | (15,124 | )      |
|       | Warranties issued                      |   | 15,950  |   |
|       | Translation adjustments                |   | 43      |   |
| ** ** | **Balance, December 31, 2007**    |   | $       | 6,585  |   |

*** ***

***Research and Development***

 

Research and development costs areexpensed as incurred. We periodically receive funds from various organizationsto subsidize our research and development. These funds are reported as anoffset to research and development expense. These subsidies totaled $4.0million, $3.9 million and $4.6 million in 2007, 2006 and 2005, respectively.Subsidies have decreased as the projects available for subsidies, primarily inthe Netherlands and the U.S., have decreased.

 

***Advertising***

 

Advertising costs are expensed asincurred and are included as a component of selling, general and administrativecosts on our consolidated statements of operations. Advertising expense totaled$3.5 million, $2.9 million and $2.6 million in 2007, 2006 and 2005,respectively.

 

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***Computation of Per Share Amounts***

 

Basic earnings per share(“EPS”) and diluted EPS are computed using the methods prescribed by SFAS No. 128,“*Earnings per Share*.”  Following is a reconciliation of basic EPSand diluted EPS (in thousands, except per share amounts):

 
| ** **                                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                        | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                                                                                        | ** ** | **Net Income**                   | ** ** | **Shares** | ** ** | **Per Share Amount(1)** | ** ** | **Net Income** | ** ** | **Shares** | ** ** | **Per Share Amount** | ** ** |
| **Basic  EPS**                                                                                    |       | $                                | 58,338     |   | 35,709 |   | $ | 1.63 |   | $ | 20,040 |   | 33,818 |   | $ | 0.59 |   |
| Dilutive effect  of zero coupon convertible subordinated notes                                    |       | 968                              |       | 5,529 |   | (0.21 | ) | 968 |   | 5,529 |   | (0.06 | ) |
| Dilutive effect  of 2.875% convertible subordinated notes                                         |       | 3,756                            |       | 3,918 |   | (0.05 | ) | — |   | — |   | — |   |
| Dilutive effect  of stock options calculated using the treasury stock method                      |       | —                           |       | 692 |   | (0.02 | ) | — |   | 142 |   | — |   |
| Dilutive effect  of restricted shares                                                             |       | —                           |       | 221 |   | — |   | — |   | 78 |   | — |   |
| Dilutive effect  of shares issuable to Philips                                                    |       | —                           |       | 185 |   | — |   | — |   | 185 |   | — |   |
| **Diluted  EPS**                                                                                  |       | $                                | 63,062     |   | 46,254 |   | $ | 1.36 |   | $ | 21,008 |   | 39,752 |   | $ | 0.53 |   |
|                                                                                              |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| **Potential  common shares excluded from diluted EPS since their effect would be  antidilutive:** |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Stock options,  restricted shares and restricted stock units                                      |       |                             |       | 492 |   |   |   |   |   | — |   |   |   |
| Convertible Debt                                                                                  |       |                             |       | 927 |   |   |   |   |   | 4,845 |   |   |   |

 
| ** **                                                                                       | ** ** | **Year Ended December 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                       | ** ** | **Net Loss**                          | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| **Basic  EPS**                                                                                   |       | $                                     | (78,158    | ) | 33,595 |   | $ | (2.33 | ) |
| Dilutive effect  of zero coupon convertible subordinated notes                                   |       | —                                |       | — |   | — |   |
| Dilutive effect  of stock options calculated using the treasury stock method                     |       | —                                |       | — |   | — |   |
| Dilutive effect  of restricted shares                                                            |       | —                                |       | — |   | — |   |
| Dilutive effect  of shares issuable to Philips                                                   |       | —                                |       | — |   | — |   |
| **Diluted  EPS**                                                                                 |       | $                                     | (78,158    | ) | 33,595 |   | $ | (2.33 | ) |
|                                                                                             |       |                                  |       |   |   |   |   |
| **Potential  common shares excluded from diluted EPS since their effect would be antidilutive:** |       |                                  |       |   |   |   |   |
| Stock options,  restricted shares and restricted stock units                                     |       |                                  |       | 3,543 |   |   |   |
| Convertible Debt                                                                                 |       |                                  |       | 7,043 |   |   |   |

*** ***

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***(1)  Amounts may not add due to rounding.***

*** ***

***Stock-Based Compensation***

 

Effective January 1,2006, we adopted SFAS No. 123R, “*Share-Based Payment*.”We elected to use the modified prospective transition method as provided bySFAS No. 123R and, accordingly, financial statement amounts for the priorperiods presented in this Form 10-K have not been restated to reflect thefair value method of expensing stock-based compensation. Under this method, theprovisions of SFAS No. 123R apply to all awards granted or modified afterthe date of adoption. In addition, the unrecognized expense of awards not yetvested at the date of adoption is recognized in net income in the periods afterthe date of adoption over the remainder the requisite service period. Thecumulative effect of the change 

 

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in accounting principlefrom Accounting Principles Board (“APB”) Opinion No. 25, “*Accounting for Stock Issued to Employees*” to SFAS No. 123Rwas not material.

 

Prior to January 1, 2006, we accounted for stock-basedcompensation using the intrinsic value method as prescribed by APB Opinion No. 25and related interpretations. We provided disclosures of net loss and net lossper share as prescribed by SFAS No. 123, “*Accountingfor Stock-Based Compensation,*” as if it had been applied inmeasuring compensation expense as follows (in thousands, except per shareamounts):

 
| **Year Ended December 31,**                                                                                                                   | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Net loss, as reported                                                                                                                              |       | $        | (78,158    | ) |
| Deduct - total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |       | (34,379  | )          |
| Net loss, pro forma                                                                                                                                |       | $        | (112,537   | ) |
| Basic and diluted net loss per share:                                                                                                              |       |     |       |
| As reported                                                                                                                                        |       | $        | (2.33      | ) |
| Pro forma                                                                                                                                          |       | $        | (3.35      | ) |

 

We did not record any taxbenefit for U.S. losses generated in 2005. Accordingly, the only tax benefitreflected in the pro forma stock-based employee compensation expense in 2005was for non-U.S. based awards.

 

Our stock-basedcompensation expense was included in our statements of operations as follows(in thousands):

 
| **Year Ended December 31,**                                             | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cost of sales                                                                |       | $        | 1,008      |     | $          | 825      |       | $ | — |   |
| Research and development                                                     |       | 950      |       | 852      |       | —   |       |
| Selling, general and administrative                                          |       | 5,393    |       | 4,053    |       | 58       |       |
| Restructuring, reorganization, relocation and CEO  severance related         |       | —   |       | 7,090    |       | —   |       |
|                                                                         |       | 7,351    |       | 12,820   |       | 58       |       |
| Stock-based compensation included as a component of  discontinued operations |       | —   |       | 40       |       | —   |       |
|                                                                         |       | $        | 7,351      |     | $          | 12,860   |       | $ | 58 |   |

 

Compensation expenserelated to restricted shares and restricted stock units is based on the fairvalue of the underlying shares on the date of grant as if the shares werevested. Compensation expense related to options granted pursuant to our stockincentive plans and shares purchased pursuant to our employee share purchaseplan was determined based on the estimated fair values using the Black-Scholesoption pricing model and the following weighted average assumptions:

 
| **Year Ended December 31,**       | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**    | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|-------------|------------|
| Risk-free interest rate                |       | 3.4% - 5.0 | %          | 2.8% - 5.1 | %          | 2.8% - 4.36 | %          |
| Dividend yield                         |       | 0.0        | %          | 0.0        | %          | 0.0         | %          |
| Expected lives:                        |       |       |       |       |       |        |       |
| Option plans                           |       | —     | (1)        | 4.8 years  |       | 5.5 years   |       |
| Employee share  purchase plan          |       | 6 months   |       | 6 months   |       | 6 months    |       |
| Volatility                             |       | 38% - 40   | %          | 38% - 74   | %          | 71% - 74    | %          |
| Discount for post vesting restrictions |       | 0.0        | %          | 0.0        | %          | 0.0         | %          |

 

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(1) No options granted during 2007.

 

The risk-free rate usedis based on the U.S. Treasury yield over the estimated term of the optionsgranted. Expected lives were estimated based on the average between the stockoption awards’ vest date and their contractual life. The expected volatility iscalculated based on the historical volatility of our common stock.

 

We amortize stock-basedcompensation expense related to options granted prior to the adoption of SFAS No. 123Ron a ratable basis and related to options granted after the adoption of SFAS No. 123Rand restricted shares and restricted stock units on a straight-line basis overthe vesting period of the individual 

 

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award with estimatedforfeitures considered. Vesting periods are generally four years. Shares to beissued upon the exercise of stock options will come from newly issued shares.The exercise price of issued options equals the grant date fair value of theunderlying shares and the options generally have a legal life of seven years.Stock-based compensation costs related to inventory or fixed assets were not significantin the years ended December 31, 2007 or 2006.

 

***Foreign CurrencyTranslation***

 

Assets and liabilities denominated in aforeign currency, where the local currency is the functional currency, aretranslated to U.S. dollars at the exchange rate in effect on the respectivebalance sheet date. Gains and losses resulting from the translation of assets,liabilities and equity are included in accumulated other comprehensive incomeon the consolidated balance sheet. Transactions representing revenues, costsand expenses are translated using an average rate of exchange for the period,and the related gains and losses are reported as other income (expense) on ourconsolidated statement of operations.

 

**2.             RECENTLYISSUED ACCOUNTING PRONOUNCEMENTS**

 

***SFAS No. 141Rand SFAS No. 160***

 

In December 2007, the FASB issuedSFAS No. 141R, “*Business Combinations*,”and SFAS No. 160, “*Noncontrolling Interestsin Consolidated Financial Statements.*” SFAS Nos. 141R and 160require most identifiable assets, liabilities, noncontrolling interests andgoodwill acquired in a business combination to be recorded at “full fair value”and require noncontrolling interests (previously referred to as minorityinterests) to be reported as a component of equity, which changes theaccounting for transactions with noncontrolling interest holders. Bothstatements are effective for periods beginning on or after December 15,2008 and earlier adoption is prohibited. SFAS No. 141R will be applied tobusiness combinations occurring after the effective date and SFAS No. 160will be applied prospectively to all noncontrolling interests, including anythat arose before the effective date. Whilewe are still analyzing the effects of applying SFAS Nos. 141R and 160, webelieve that the adoption of SFAS Nos. 141R and 160 will not have a materialeffect on our financial position or results of operations.

 

***EITF07-3***

 

In June 2007, the Emerging IssuesTask Force (“EITF”) issued EITF 07-3, “*Accounting for AdvancePayments for Goods or Services to Be Used in Future Research and DevelopmentActivities,*” which states that non-refundable advance payments forservices that will be consumed or performed in a future period in conductingresearch and development activities on behalf of the company should be recordedas an asset when the advance payment is made and then recognized as an expensewhen the research and development activities are performed. EITF 07-3 isapplicable prospectively to new contractual arrangement entered into in fiscalyears beginning after December 15, 2007. While we are still analyzing the effects of applying EITF 07-3, webelieve that the adoption of EITF 07-3 will not have a material effect on ourfinancial position or results of operations.

 

***SFAS No. 159***

 

In February 2007,******the FASB issued SFAS No. 159,“*The Fair Value Option for Financial Assets andFinancial Liabilities*,” which permits entities to choose to measuremany financial instruments and certain other items at fair value. SFAS No. 159is effective as of the beginning of an entity’s first fiscal year that beginsafter November 15, 2007. While we are still analyzing the effects ofapplying SFAS No. 159, we believe that the adoption of SFAS No. 159will not have a material effect on our financial position or results ofoperations.

 

***SFAS No. 157***

 

In September 2006,the FASB issued SFAS No. 157, “*Fair Value Measurements*,”which establishes a single authoritative definition of fair value, sets out aframework for measuring fair value and requires additional disclosures aboutfair-value measurements. SFAS No. 157 is effective for fiscal yearsbeginning after November 15, 2007. While we are still analyzing theeffects of applying SFAS No. 157, we 

 

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believe thatthe adoption of SFAS No. 157 will not have a material effect on ourfinancial position or results of operations.

 

**3.             INVESTMENTS**

** **

Investments held at December 31,2007 consisted of the following (in thousands):

 
| ** **                    | ** ** | **Cost basis** | ** ** | **Unrealized gains** | ** ** | **Unrealized losses** | ** ** | **Estimated fair value(1)** | ** ** | **Short-term investments** | ** ** | **Long-term investments** | ** ** |
|-------------------------------|------------|----------------|------------|----------------------|------------|-----------------------|------------|-----------------------------|------------|----------------------------|------------|---------------------------|------------|
| **Fixed  Maturities**         | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **                | ** ** |
| Corporate notes  and bonds    |       | $              | 32,965     |                 | $          | 33                    |       | $                           | (17        | )                          | $          | 32,981                    |       | $ | 22,992 |   | $ | 9,989 |   |
| Government-backed  securities |       | 10,925         |       | —               |       | (1                    | )          | 10,924                      |       | 10,924                     |       | —                    |       |
| Auction rate  securities      |       | 118,125        |       | —               |       | —                |       | 118,125                     |       | 118,125                    |       | —                    |       |
| Fixed maturity  securities    |       | 162,015        |       | 33                   |       | (18                   | )          | 162,030                     |       | 152,041                    |       | 9,989                     |       |
|                          |       |           |       |                 |       |                  |       |                        |       |                       |       |                      |       |
| **Equity  Securities**        | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **                | ** ** |
| Other  investments            |       | 2,877          |       | —               |       | (108                  | )          | 2,769                       |       | —                     |       | 2,769                     |       |
| Equity  securities            |       | 2,877          |       | —               |       | (108                  | )          | 2,769                       |       | —                     |       | 2,769                     |       |
|                          |       | $              | 164,892    |                 | $          | 33                    |       | $                           | (126       | )                          | $          | 164,799                   |       | $ | 152,041 |   | $ | 12,758 |   |

 

Investments held at December 31,2006 consisted of the following (in thousands):

 
| ** **                   | ** ** | **Cost basis** | ** ** | **Unrealized gains** | ** ** | **Unrealized losses** | ** ** | **Estimated fair value(1)** | ** ** | **Short-term investments** | ** ** | **Long-term investments** | ** ** |
|------------------------------|------------|----------------|------------|----------------------|------------|-----------------------|------------|-----------------------------|------------|----------------------------|------------|---------------------------|------------|
| **Fixed Maturities**         | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **                | ** ** |
| Corporate notes and bonds    |       | $              | 34,578     |                 | $          | 2                     |       | $                           | (22        | )                          | $          | 34,558                    |       | $ | 34,558 |   | $ | — |   |
| Government-backed securities |       | 98,882         |       | 5                    |       | (491                  | )          | 98,396                      |       | 65,444                     |       | 32,952                    |       |
| Auction rate securities      |       | 133,400        |       | —               |       | —                |       | 133,400                     |       | 133,400                    |       | —                    |       |
| Other                        |       | 800            |       | —               |       | —                |       | 800                         |       | 800                        |       | —                    |       |
| Fixed maturity  securities   |       | 267,660        |       | 7                    |       | (513                  | )          | 267,154                     |       | 234,202                    |       | 32,952                    |       |
|                         |       |           |       |                 |       |                  |       |                        |       |                       |       |                      |       |
| **Equity Securities**        | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **                | ** ** |
| Common stock and equivalents |       | —         |       | —               |       | —                |       | —                      |       | —                     |       | —                    |       |
| Preferred stock              |       | —         |       | —               |       | —                |       | —                      |       | —                     |       | —                    |       |
| Other investments            |       | 1,857          |       | 91                   |       | —                |       | 1,948                       |       | —                     |       | 1,948                     |       |
| Equity  securities           |       | 1,857          |       | 91                   |       | —                |       | 1,948                       |       | —                     |       | 1,948                     |       |
|                         |       | $              | 269,517    |                 | $          | 98                    |       | $                           | (513       | )                          | $          | 269,102                   |       | $ | 234,202 |   | $ | 34,900 |   |

 

----

(1)          Investments forwhich it is not practical to estimate fair value are included at cost andprimarily consist of investments in privately-held companies.

 

Realized gains and losseson sales of marketable securities were insignificant in 2007, 2006 and 2005.

 

We review investments indebt and equity securities for other than temporary impairment whenever thefair value of an investment is less than amortized cost and evidence indicatesthat an investment’s carrying amount is not recoverable within a reasonableperiod of time. In the evaluation of whether an impairment is “other-than-temporary,”we consider our ability and intent to hold the investment until the marketprice recovers, the reasons for the impairment, compliance with our investmentpolicy, the severity and duration of the impairment and expected futureperformance. As of December 31, 2007, $10.9 million of government-backedsecurities and $33.0 million of corporate notes and bonds had unrealized lossesof $17,000 and $1,000, respectively. These unrealized losses are mainly due tointerest rate movements, and no unrealized losses of any significance existedfor a period in excess of 12 months. See also Note 24, “*SubsequentEvents*,” for information regarding the liquidity of our investmentsin auction rate securities.

 

For investments in smallprivately-held companies, which are recorded at cost, it is often not practicalto estimate fair value. In order to assess if impairments exist that are “other-than-temporary,”we reviewed recent interim financial statements and held discussions with theseentities’ management about their 

 

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current financialconditions and future economic outlooks. We also considered our willingness tosupport future funding requirements as well as our intention and/or ability tohold these investments long-term. Based on these actions, in 2006 and 2005, weconcluded that certain of these investments had “other-than-temporary”impairments and, accordingly, we recorded impairment charges totaling $3.9million and $2.9 million, respectively, as a component of other income(expense). Additionally, we recorded a loss of $3.5 million in 2005 as acomponent of other income (expense) related to the liquidation of a portion ofa convertible note investment.

 

During 2006, in additionto the $3.9 million impairment charge mentioned above, we sold one cost-basedinvestment for a gain of $5.2 million. In 2007, we recorded an additional $0.5million gain for the final escrow payment related to the disposal of thisinvestment. We recorded an additional $0.5 million gain in 2007 related tothe sale of another investment, which was previously written down in2006.  All remaining cost method investments were written down to zero asof December 31, 2006.

 

Contractual maturities or expected liquidation dates of long-termmarketable securities at December 31, 2007 were as follows (in thousands):

 
| ** **                   | ** ** | **1 - 2 years** | ** ** | **3 years** | ** ** | **Total** | ** ** |
|------------------------------|------------|-----------------|------------|-------------|------------|-----------|------------|
| Government-backed securities |       | $               | —     |        | $          | —    |       | $ | — |   |
| Corporate notes and bonds    |       | 9,989           |       | —      |       | —    |       |
|                         |       | $               | 9,989      |        | $          | —    |       | $ | 9,989 |   |

** **

**4.             FACTORINGOF ACCOUNTS RECEIVABLE**

** **

In 2007 and 2006, weentered into agreements under which we sold a total of $1.2 million and $2.0million, respectively, of our accounts receivable at a discount to unrelatedthird party financiers without recourse. The transfers qualified for salestreatment under SFAS No. 140, “*Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities*.”Discounts related to the sale of the receivables, which were immaterial, wererecorded on our statements of operations as other expense.

 

**5.             ASSET IMPAIRMENT CHARGES**

** **

We initiatedrestructuring actions in the second quarter of 2005, which continued into 2006,to align our cost structure with the current prevailing market conditions,primarily in the semiconductor markets. The actions taken, which were necessaryas a result of reduced business volumes, resulted in decreases in our globalworkforce and also required us to evaluate our goodwill and long-lived assetsfor impairment in components of our segment previously knows as ourmicroelectronics segment.

 

As a result of theseevaluations, we recorded asset impairment charges and write-downs totaling$39.6 million in 2005 as either components of asset impairment or cost of saleson our consolidated statements of operations. These charges are summarized as follows (in thousands):

 
| **Year Ended December 31,  2005** | ** ** | **Asset Impairment** | ** ** | **Cost of Sales** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------------------|------------|-------------------|------------|-----------|------------|
| Inventory                              |       | $                    | —     |              | $          | 11,016    |       | $ | 11,016 |   |
| Purchased technology                   |       | 9,328                |       | —            |       | 9,328     |       |
| Property, plant and equipment          |       | 7,479                |       | —            |       | 7,479     |       |
| Capitalized software                   |       | —               |       | 3,223             |       | 3,223     |       |
| ERP system abandonment                 |       | 7,634                |       | —            |       | 7,634     |       |
| Patents and other intangibles          |       | 911                  |       | —            |       | 911       |       |
|                                   |       | $                    | 25,352     |              | $          | 14,239    |       | $ | 39,591 |   |

 

In addition, in 2006, werecorded an additional $0.5 million charge as asset impairments on ourconsolidated statements of operations related to the write-off of additionalcosts for our enterprise resource planning (“ERP”) system abandonment.  No impairment charges were recorded in 2007.

 

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***Inventory***

** **

Write-downs of inventoryin 2005 related to portions of our semiconductor businesses and to the closureof our Peabody, Massachusetts facility, which primarily manufactured andsupported products sold to semiconductor markets. In response to the decliningproduct demand which continued throughout 2005, management decided torestructure these businesses, which included lowering demand expectations andaccepting a significant price adjustment of approximately $1.0 million belowcost to complete a sale on a product that we were deemphasizing in the marketplace.

 

***Goodwill***

*** ***

We test goodwill annuallyin the fourth quarter, however, in the second quarter of 2005, based on ourcurrent and projected operating results, we concluded that there were sufficientindicators to require us to assess whether a portion of our recorded goodwillbalance within our microelectronics segment was impaired at this interim date.The impairment review was performed in accordance with SFAS No. 142, *“Goodwill and Other Intangible Assets.”* Based on theseanalyses, we concluded that the goodwill allocated to this segment was notimpaired.

 

***Long-LivedAssets***

** **

As a result of theinitiation of our restructuring actions and due to the weakness in thesemiconductor market, our projected future revenues and cash flows for certainasset groupings were revised downward in the second quarter of 2005. Thesefactors led to indications that the carrying value of certain of our long-livedassets, including purchased intangibles recorded in various acquisitions,property, plant and equipment and patents and other intangibles, may not berecoverable and we performed impairment reviews as of July 3, 2005. Theimpairment reviews were performed in accordance with SFAS No. 144, “*Accounting for the Impairmentor Disposal of Long-Lived Assets.*”  We evaluated the recoverability of thelong-lived assets and concluded that impairments existed. Accordingly, werecorded impairment charges based on the amounts by which the carrying amountsof these assets exceeded their fair value. Fair value was determined based ondiscounted cash flows for the operating entities that had separatelyidentifiable cash flows. In addition, in the fourth quarter of 2005, we decidedto abandon our ERP system project and, accordingly, wrote off all costs relatedto this project. In total, impairment charges for long-lived assets were $25.4million in 2005.

 

**6.             INVENTORIES**

** **

Inventories consisted ofthe following (in thousands):

 
| ** **                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Raw materials and assembled parts                   |       | $                     | 48,732     |   | $ | 28,475 |   |
| Service inventories, estimated current requirements |       | 18,358                |       | 15,237 |   |
| Work-in-process                                     |       | 51,438                |       | 35,459 |   |
| Finished goods                                      |       | 20,234                |       | 18,299 |   |
| Total inventories                                   |       | $                     | 138,762    |   | $ | 97,470 |   |
|                                                |       |                  |       |   |   |
| Non-current service inventories                     |       | $                     | 42,168     |   | $ | 37,920 |   |

 

Non-service inventoryvaluation adjustments totaled $1.0 million in 2007, were insignificant in 2006and totaled $10.1 million in 2005 (inclusive of the write-downs discussed inNote 5). Provision for service inventory valuation adjustments totaled $4.0million, $4.2 million and $2.9 million, respectively, in 2007, 2006 and 2005.

 

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** **

**7.             PROPERTY, PLANT AND EQUIPMENT**

** **

Property, plant and equipment consistedof the following (in thousands):

 
| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Land                                      |       | $                     | 7,780      |   | $ | 7,769 |   |
| Buildings and improvements                |       | 18,000                |       | 17,493 |   |
| Leasehold improvements                    |       | 7,336                 |       | 5,431 |   |
| Machinery and equipment                   |       | 70,539                |       | 56,110 |   |
| Demonstration systems                     |       | 25,232                |       | 22,345 |   |
| Other fixed assets                        |       | 23,896                |       | 19,666 |   |
|                                      |       | 152,783               |       | 128,814 |   |
| Accumulated depreciation                  |       | (78,083               | )          | (68,420 | ) |
| Total property,  plant and equipment, net |       | $                     | 74,700     |   | $ | 60,394 |   |

 

Seealso Note 5 for a discussion of long-lived asset impairments.

 

**8.             GOODWILL, PURCHASED TECHNOLOGY AND OTHER INTANGIBLEASSETS**

** **

The roll-forward of our goodwill was as follows (inthousands):

 
| ** **                 | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| Balance, beginning of year |       | $                                | 40,900     |   | $ | 40,902 |   |
| Adjustments to goodwill    |       | (36                              | )          | (2 | ) |
| Balance, end of year       |       | $                                | 40,864     |   | $ | 40,900 |   |

 

Adjustments to goodwill include translationadjustments resulting from a portion of our goodwill being recorded on thebooks of our foreign subsidiaries.

 

At December 31, 2007 and 2006, our otherintangible assets included purchased technology, patents, trademarks and otherand note issuance costs. The gross amount of our other intangible assets and the relatedaccumulated amortization were as follows (in thousands):

 
| ** **                                                  | ** ** | **Amortization** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **Period**       | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Purchased technology                                        |       | 5 to 12 years    |       | $                     | 46,371     |   | $ | 46,062 |   |
| Accumulated amortization                                    |       |             |       | (43,509               | )          | (41,568 | ) |
|                                                        |       |             |       | $                     | 2,862      |   | $ | 4,494 |   |
|                                                        |       |             |       |                  |       |   |   |
| Patents, trademarks and other                               |       | 2 to 15 years    |       | 7,167                 |       | 3,118 |   |
| Accumulated amortization                                    |       |             |       | (2,534                | )          | (2,034 | ) |
|                                                        |       |             |       | 4,633                 |       | 1,084 |   |
|                                                        |       |             |       |                  |       |   |   |
| Note issuance costs                                         |       | 5 to 7 years     |       | 13,891                |       | 13,887 |   |
| Accumulated amortization                                    |       |             |       | (10,814               | )          | (9,175 | ) |
|                                                        |       |             |       | 3,077                 |       | 4,712 |   |
| Total intangible assets included in other long-term  assets |       |             |       | $                     | 7,710      |   | $ | 5,796 |   |

 

See Note 5 for a discussion of impairmentcharges and write-offs related to purchased software, capitalized software andpatents recognized during 2005.

 

See Note 10 for a discussion of noteissuance cost write-offs totaling $0.3 million and $1.1 million, respectively,related to the convertible note redemptions in 2006 and 2005.

 

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Amortization expense, excludingimpairment charges and note issuance cost write-offs, was as follows (inthousands):

 
| ** **                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------|------------|----------------------------------|------------|
| ** **                    | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Purchased technology          |       | $                                | 1,777      |   | $ | 2,034 |   | $ | 3,819 |   |
| Capitalized software          |       | —                           |       | 131 |   | 2,100 |   |
| Patents, trademarks and other |       | 754                              |       | 502 |   | 519 |   |
| Note issuance costs           |       | 1,640                            |       | 1,490 |   | 1,447 |   |
|                          |       | $                                | 4,171      |   | $ | 4,157 |   | $ | 7,885 |   |

 

Expectedamortization, without consideration for foreign currency effects, is as follows(in thousands):

 
| ** ** | ** ** | **Purchased  Technology** | ** ** | **Patents,  Trademarks  and Other** | ** ** | **Note  Issuance  Costs** | ** ** |
|------------|------------|---------------------------|------------|-------------------------------------|------------|---------------------------|------------|
| 2008       |       | $                         | 1,806      |                                | $          | 846                       |       | $ | 1,082 |   |
| 2009       |       | 659                       |       | 754                                 |       | 452                       |       |
| 2010       |       | 397                       |       | 746                                 |       | 452                       |       |
| 2011       |       | —                    |       | 683                                 |       | 452                       |       |
| 2012       |       | —                    |       | 655                                 |       | 452                       |       |
| Thereafter |       | —                    |       | 949                                 |       | 187                       |       |
|            |            |                           |            |                                     |            |                           |            |  |  |  |

** **

**9.**                                      CREDITFACILITIES

** **

We have a 50.0 millionyen unsecured and uncommitted bank borrowing facility in Japan and variouslimited facilities in select foreign countries.  As part of our contractswith certain customers, we are required to provide letters of credit or bank guaranteeswhich these customers can draw against in the event we do not perform inaccordance with our contractual obligations. At December 31, 2007, we had$46.1 million of these guarantees and letters of credit outstanding, of whichapproximately $45.6 million were secured by restricted cash deposits.Restricted cash balances securing bank guarantees that expire within 12 monthsof the balance sheet date are recorded as a current asset on our consolidatedbalance sheets. Restricted cash balances securing bank guarantees that expirebeyond 12 months from the balance sheet date are recorded as long-termrestricted cash on our consolidated balance sheet.

 

**10.**                               CONVERTIBLENOTES

** **

***2.875%Convertible Subordinated Notes***

*** ***

On May 19, 2006, weissued $115.0 million aggregate principal amount of convertible subordinatednotes. The interest rate on the notes is 2.875%, payable semi-annually. Thenotes are due on June 1, 2013, are subordinated to all previously existingand future senior indebtedness, are effectively subordinated to allindebtedness and other liabilities of our subsidiaries, and rank pari passu inright of payment with our zero coupon convertible subordinated notes and our5.5% convertible subordinated notes. The cost of this transaction, includingunderwriting discounts and commissions and offering expenses, totaled $3.1million and is recorded on our balance sheet in other long-term assets and isbeing amortized over the life of the notes. The amortization of these coststotals $0.1 million per quarter and is reflected as additional interest expensein our statements of operations. The notes are convertible into 3,918,395shares of our common stock, at the note holder’s option, at a price of $29.35per share.

 

***5.5% Convertible Subordinated Notes***

*** ***

On August 3, 2001, we issued $175.0million of convertible subordinated notes, due August 15, 2008, through aprivate placement. The notes are currently redeemable at our option. The notesbear interest at 5.5%, payable semi-annually. The notes are convertible intoshares of our common stock, at the noteholder’s option, at a price of $49.52per share.

 

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We have made the following redemptions ofthese notes:

 
| **Date**           | ** ** | **Amount  Redeemed** | ** **   | **Redemption  Price** | ** **     | **Redemption  Premium** | ** ** | **Related Note  Issuance Costs  Written Off** | ** ** |
|--------------------|------------|----------------------|--------------|-----------------------|----------------|-------------------------|------------|-----------------------------------------------|------------|
| June 2003     |       | $                    | 30.0 million |                  | 102.75         | %                       | $          | 0.8 million                                   |       | $ | 0.7 million |   |
| May 2005      |       | $                    | 70.0 million |                  | 101.0          | %                       | $          | 0.7 million                                   |       | $ | 1.1 million |   |
| February 2006 |       | $                    | 24.9 million |                  | 100.375        | %                       | $          | 0.1 million                                   |       | $ | 0.3 million |   |
| June 2006     |       | $                    | 4.2 million  |                  | 100.4% - 100.5 | %                       | $          | 0.1 million                                   |       | — |   |

 

The redemption premium and write-off ofrelated note issuance costs were included as a component of interest expense inthe period of redemption.

 

These noteswere paid off in full in January 2008. See Note 24, “*Subsequent Events*” for additionalinformation.

 

***Zero CouponConvertible Subordinated Notes***

*** ***

On June 13, 2003, we issued $150.0 millionaggregate principal amount of zero coupon convertible subordinated notes. Theinterest rate on the notes is zero and the notes will not accrete interest. Thenotes are due on June 15, 2023 and are first putable to us at thenoteholder’s option (in whole or in part) for cash on June 15, 2008, at aprice equal to 100.25% of the principal amount, and on June 15, 2013 and2018, at a price equal to 100% of the principal amount. The notes are alsoputable to us at the noteholder’s option upon a change of control at a priceequal to 100% of the principal amount. We can redeem the notes (in whole or inpart) for cash on June 15, 2008, at a price equal to 100.25% of theprincipal amount, or thereafter at a price equal to 100% of the principalamount. The notes are subordinated to all previously existing and future seniorindebtedness and are effectively subordinated to all indebtedness and otherliabilities of our subsidiaries. The cost of this transaction, includingunderwriting discounts and commissions and offering expenses, totaled $4.8million and is recorded on our balance sheet in other long-term assets and isbeing amortized over the life of the notes. The amortization of these coststotals $240,000 per quarter and is reflected as interest expense in ourstatements of operations.

 

The notes are convertible into shares of our commonstock upon the occurrence of certain events at an initial conversion price of$27.132 per share (subject to adjustment), or 5,528,527 shares if the entire$150.0 million is converted. Upon conversion, we have the option to settle thenotes in cash, shares of our common stock, or a combination of cash and shares.

 

**11.**                               CONVERTIBLENOTE HEDGE AND WARRANT TRANSACTIONS

** **

We used a portionof the net proceeds from the offering of our zero coupon convertiblesubordinated notes to enter into convertible note hedge and warranttransactions with respect to our common stock, the exposure for which was heldat the time the notes were issued by Credit Suisse First Boston International,an affiliate of an initial purchaser of the notes. The net cost of the hedgingtransactions of $23.9 million was included as a reduction of common stock inshareholders’ equity in accordance with the guidance in EITF Issue No. 00-19,“*Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock.*”

 

In November 2005, weterminated the hedge and warrant in return for a cash payment of approximately$11.0 million to us from the counterparty to these instruments. The terminationof the hedge and warrant eliminate the potential anti-dilutive effect of thehedge in the event of future conversions of the zero coupon notes. The receiptof the approximately $11.0 million was recorded as an increase to contributedcapital and did not result in any gain or loss in our consolidated statement ofoperations.

 

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**12.**                               LEASEOBLIGATIONS

** **

We have operating leases for certain ofour manufacturing and administrative facilities that extend through 2019. Thelease agreements generally provide for payment of base rental amounts plus ourshare of property taxes and common area costs. The leases generally provide renewal options at current market rates.

 

Rent expense is recognized on astraight-line basis over the term of the lease. Rent expense was $7.1 millionin 2007, $7.1 million in 2006 and $7.8 million in 2005.

 

The approximate future minimum rentalpayments due under these agreements as of December 31, 2007, were asfollows (in thousands):

 
| **Year Ending December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
| 2008                              |       | $          | 6,912      |   |
| 2009                              |       | 5,894      |       |
| 2010                              |       | 5,703      |       |
| 2011                              |       | 5,772      |       |
| 2012                              |       | 5,907      |       |
| Thereafter                        |       | 26,828     |       |
| Total                             |       | $          | 57,016     |   |

** **

**13.**                               INCOMETAXES

** **

Incometax expense (benefit) consisted of the following (in thousands):

 
| ** **                 | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Current:                   |       |                             |       |   |   |   |   |
| Federal                    |       | $                                | —     |   | $ | (1,724 | ) | $ | (4,391 | ) |
| State                      |       | (756                             | )          | 211 |   | 469 |   |
| Foreign                    |       | 11,720                           |       | 10,169 |   | 10,911 |   |
|                       |       | 10,964                           |       | 8,656 |   | 6,989 |   |
| Deferred (benefit) expense |       | (2,887                           | )          | 1,811 |   | 15,082 |   |
| Total income tax expense   |       | $                                | 8,077      |   | $ | 10,467 |   | $ | 22,071 |   |

 

The effective income tax rate applied tonet income (loss) varied from the U.S. federal statutory rate due to thefollowing (in thousands):

 
| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Tax expense (benefit) at statutory rates    |       | $                                | 23,108     |   | $ | 9,841 |   | $ | (19,828 | ) |
| Increase (decrease) resulting from:         |       |                             |       |   |   |   |   |
| State income  taxes, net of federal benefit |       | 343                              |       | 211 |   | 469 |   |
| Foreign taxes                               |       | (7,829                           | )          | 1,265 |   | 3,627 |   |
| Research and  experimentation benefit       |       | (1,268                           | )          | (324 | ) | (300 | ) |
| Tax audit  settlements                      |       | (4,694                           | )          | — |   | 2,780 |   |
| Non-deductible  items                       |       | 1,664                            |       | 915 |   | 260 |   |
| Change in  valuation allowance              |       | (5,305                           | )          | (1,506 | ) | 34,386 |   |
| Other                                       |       | 2,058                            |       | 65 |   | 677 |   |
|                                        |       | $                                | 8,077      |   | $ | 10,467 |   | $ | 22,071 |   |

 

Our 2007 tax provision onincome from continuing operations reflected taxes on foreign earnings offset bya $4.7 million release of unrecognized tax benefits, including interest andpenalties, as a result of the settlement of foreign tax audits and a taxbenefit of $5.3 million related to the release of valuation allowance recordedagainst net operating loss deferred tax assets utilized to offset income earnedin the U.S.

 

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The 2006 income taxprovision on income from continuing operations consisted primarily of taxesaccrued in foreign jurisdictions and reflects a benefit of $1.5 million relatedto the release of valuation allowance against a portion of deferred tax assetsutilized during the period to offset 2006 U.S. taxable income. We continue torecord a valuation allowance against the remaining U.S. deferred tax assets aswe do not believe it is more likely than not that the benefit of the deferredtax assets will be realized in future periods. The 2005 income tax expenseincluded provisions for foreign taxable income, but did not reflect a benefitfor 2005 losses in the U.S. as we recorded full valuation allowances againstthe U.S. deferred tax assets generated from such losses. We also recorded acharge in 2005 for valuation allowances placed on our U.S. deferred tax assetsrecorded as of December 31, 2004.

 

Current taxes payablewere reduced for foreign tax benefits recorded to common stock and related to stockcompensation of $0.4 million and $1.4 million, respectively, in 2007 and 2006.No amounts were recorded in 2005. No tax benefits were recorded in the U.S. forexcess tax benefits relating to stock-based compensation or the convertiblenote hedge in 2007, 2006 or 2005 due to our current valuation allowance againstnet operating losses in the U.S.

 

***DeferredIncome Taxes***

*** ***

Net deferred tax assets and liabilitieswere included in the following consolidated balance sheet accounts:

 
| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Deferred tax  assets — current          |       | $                     | 4,788      |   | $ | 4,386 |   |
| Deferred tax  assets — non-current      |       | 2,641                 |       | 542 |   |
| Other current  liabilities                   |       | (385                  | )          | (351 | ) |
| Deferred tax  liabilities — non-current |       | (4,479                | )          | (4,062 | ) |
| Net deferred tax  assets                     |       | $                     | 2,565      |   | $ | 515 |   |

 

The tax effects of temporary differencesthat gave rise to significant portions of deferred tax assets and deferred taxliabilities were as follows (in thousands):

 
| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Deferred tax assets:           |       |                  |       |   |   |
| Accrued  liabilities           |       | $                     | 945        |   | $ | 1,823 |   |
| Warranty  reserves             |       | 1,331                 |       | 1,060 |   |
| Inventory  reserves            |       | 5,168                 |       | 6,452 |   |
| Allowance for  bad debts       |       | 489                   |       | 734 |   |
| Revenue  recognition           |       | 5,538                 |       | 3,106 |   |
| Loss  carryforwards            |       | 21,771                |       | 13,083 |   |
| Tax credit  carryforwards      |       | 5,384                 |       | 1,747 |   |
| Fixed assets                   |       | 624                   |       | 2,303 |   |
| Intangible assets              |       | 2,507                 |       | 1,155 |   |
| Unrealized  investment         |       | 473                   |       | 1,763 |   |
| Stock  compensation            |       | 334                   |       | 2,512 |   |
| Other assets                   |       | 2,405                 |       | 2,717 |   |
| Gross deferred  tax assets     |       | 46,969                |       | 38,455 |   |
| Valuation  allowance           |       | (39,540               | )          | (33,527 | ) |
| Net deferred tax assets        |       | 7,429                 |       | 4,928 |   |
|                           |       |                  |       |   |   |
| Deferred tax liabilities:      |       |                  |       |   |   |
| Fixed assets                   |       | (229                  | )          | (203 | ) |
| Other  liabilities             |       | (4,635                | )          | (4,210 | ) |
| Total deferred tax liabilities |       | (4,864                | )          | (4,413 | ) |
| Net deferred tax asset         |       | $                     | 2,565      |   | $ | 515 |   |

 

At December 31,2007, we had approximately $57.2 million of U.S. net operating losscarryforwards that can be used to offset future income for U.S. federal incometax purposes, which expire through 2027, and approximately $34.3 million forOregon income tax purposes, which expire through 2022. Approximately 

 

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$27.7 million of theincrease in net operating loss carryforwards was primarily due to excess taxbenefits relating to share-based compensation and other equity related items in2007 offset by utilization of part of the net operating loss carryforwardsagainst 2007 U.S taxable income. Additionally, deferred tax expense of $0.8million, $1.6 million and $1.1 million was recorded in other comprehensiveincome in 2007, 2006 and 2005 respectively.

 

Our valuation allowanceson deferred tax assets totaled $39.5 million and $33.5 million as of December 31,2007 and 2006, respectively. In assessing the realizability of deferred taxassets, SFAS No. 109, “*Accounting forIncome Taxes*,” establishes a more likely than not standard. If it isdetermined that it is “more likely than not” that deferred tax assets will notbe realized, a valuation allowance must be established against the deferred taxassets. The ultimate realization of deferred tax assets is dependent upon thegeneration of future taxable income during the periods in which the associatedtemporary differences become deductible. We consider the scheduled reversal ofdeferred tax liabilities, historical operating performance, projected futuretaxable income and tax planning strategies in making this assessment. Our “morelikely than not” assessment was principally based upon our historical losses inthe U.S., the impact of the restructuring activities discussed in Note 14 andour forecast of future profitability in certain tax jurisdictions, primarilythe U.S.

 

Federal and stateresearch and development tax credit carryforwards as of December 31, 2007were $3.8 million and expire between 2008 and 2027. Federal foreign tax creditsas of December 31, 2007 were $1.3 million and expire in 2010 and 2011. Wealso have $0.8 million of alternative minimum tax carryforwards, which do notexpire.

 

As of December 31,2007, U.S. income taxes have not been provided for approximately $168.9 millionof cumulative undistributed earnings of several non-U.S. subsidiaries, as ourcurrent intention is to reinvest these earnings indefinitely outside the U.S.Foreign tax provisions have been provided for these cumulative undistributedearnings. Upon distribution of those earnings in the form of dividends orotherwise, we would be subject to both U.S. income taxes (subject to anadjustment for foreign tax credits) and withholding taxes payable to thevarious foreign countries. Similarly, we have not provided deferred taxes onthe cumulative translation adjustment related to those non-U.S. subsidiaries.

 

***Unrecognized Tax Benefits Under Interpretation No. 48and Other Tax Contingencies***

*** ***

We adopted the provisionsof FIN 48 on January 1, 2007. As of December 31, 2007, unrecognizedtax benefits related mainly to uncertainty surrounding intercompany pricing andpermanent establishment. A reconciliation of the beginning and ending amount ofunrecognized tax benefits and related deferred tax assets was as follows (inthousands):

 
| ** **                                         | ** ** | **Unrecognized  Tax Benefits** | ** ** | **Deferred  Tax Assets** | ** ** |
|----------------------------------------------------|------------|--------------------------------|------------|--------------------------|------------|
| **Balance at January 1, 2007**                |       | $                              | 17,602     |                     | $          | 8,541 |   |
| Additions for tax positions taken in 2007          |       | 11,261                         |       | —                   |       |
| Additions for tax positions taken in prior periods |       | 380                            |       | —                   |       |
| Decreases for lapses in statutes of limitation     |       | (261                           | )          | —                   |       |
| Decreases for settlements with taxing authorities  |       | (13,235                        | )          | (8,541                   | )          |
| **Balance at December 31, 2007**              |       | $                              | 15,747     |                     | $          | — |   |
|                                               |       |                           |       |                     |       |
| **Net Change**                                     |       | $                              | (1,855     | )                        | $          | (8,541 | ) |

 

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Current and non-currentliability components of unrecognized tax benefits were classified on thebalance sheet as follows (in thousands):

 
| ** **                 | ** ** | **December 31,  2007** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| Other current liabilities  |       | $                           | 332        |   |
| Other liabilities          |       | 15,415                      |       |
| Unrecognized tax  benefits |       | $                           | 15,747     |   |

 

The entire balance ofunrecognized tax benefits, if recognized, would reduce our effective tax rate.

 

We recognize interest andpenalties related to unrecognized tax benefits in income tax expense. Theliability for unrecognized tax benefits included accrued interest and penaltiesof $1.5 million and $1.4 million as of January 1, 2007 and December 31,2007, respectively. Tax expense for the year ended December 31, 2007included a benefit for interest and penalties of $0.1 million, which iscomprised of a benefit of $0.9 million related to the lapse of statutes oflimitation and settlements with taxing authorities and a $0.8 million offsetrelated to interest and penalties on unrecognized tax benefits for prior years.

 

During2007, we requested a bilateral Advance Pricing Agreement (“APA”) between theU.S. and The Netherlands tax authorities under the mutual agreement proceduresof the tax treaty.  For the years ended December 31, 2006 and2007, the requested transfer pricing methodologies would result in a total ofapproximately $35.0 million of additional tax deductions in The Netherlands and$35.0 million of additional taxable income in the U.S. The additionalincome in the U.S. can be offset by net operating loss carryforwards.  Asthe outcome of the requested APA is not considered more likely than not, wehave not recognized the benefit resulting from the use of the net operatingloss carryforwards. Due to the uncertainty surrounding the timing of a possible agreementbetween the taxing authorities, we believe it is reasonably possible thatunrecognized tax benefits could decrease somewhere in the range of zero to $9.7million in the next 12 months.

 

Webelieve it is reasonably possible that the remainder of the unrecognized taxbenefits could decrease by approximately $0.3 million in the next 12 months asthe result of lapses of statutes of limitation.

 

For our major taxjurisdictions, the following years were open for examination by the taxauthorities as of December 31, 2007:

 
| **Jurisdiction** | ** ** | **Open Tax Years** | ** ** |
|------------------|------------|--------------------|------------|
| U.S.             |       | 2004 and forward   |       |
| The Netherlands  |       | 2005 and forward   |       |
| Czech Republic   |       | 2004 and forward   |       |

 

**14.**                               RESTRUCTURING,REORGANIZATION, RELOCATION AND SEVERANCE

** **

Restructuring,reorganization, relocation and severance costs are accounted for in accordancewith SFAS No. 146, “*Accounting for Costs Associated with Exit or Disposal Activities.*”Under SFAS No. 146, liabilities for costs associated with exit or disposalactivities are recognized and measured at fair value in the period theliability is incurred.

 

The $0.3 million net reversal ofrestructuring, reorganization, relocation and severance costs in 2007 relatedto favorable buyouts of our Peabody lease, offset by changes in estimatesincorporated into our restructuring accrual related to our ability to subleasecertain other abandoned facilities under lease.

 

Restructuring,reorganization, relocation and severance in 2006 included charges of $3.3million for facilities and severance charges related to the closure of certainof our European field offices, closure of a research and development facilityin Tempe, Arizona, as well as residual costs related to the Peabody plantclosure and the downsizing of the related semiconductor businesses.

 

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EffectiveApril 1, 2006, our Chairman, President and Chief Executive Officer (“CEO”)was terminated. OurCEO was a party to an existing Executive Severance Agreement dated February 1,2002. Termination of his service was deemed a termination without cause underthe agreement. Pursuant to the terms of this agreement, and following hisexecution and non-revocation of a standard release, our CEO was entitled tocertain severance benefits. These included: (i) a lump sum paymentequaling three years of base salary (approximately $1.59 million); (ii) alump sum payment equal to 100% of his target bonus for 2006 (approximately$583,000); (iii) acceleration of all of his stock options and restrictedstock awards; (iv) permitting him to exercise his options until theearlier of three years after his departure date or the option expiration dateas set forth in the applicable option agreement; (v) a lump sum paymentequaling two times what his reasonably expected health insurance coverage costswould be for 18 months; and (vi) life insurance premium payments not toexceed $5,000.

 

Accordingly, in the firstquarter of 2006, we recorded a chargeof $9.3 million, of which $2.2 million related to the cash severance paymentsand $7.1 million related to the non-cash expense associated with the fairmarket value of the modified stock options, which modified the original awardsto (i) accelerate all unvested stock options; (ii) waive thecancellation clause upon termination of employment; and (iii) extend theirlegal lives as discussed above.

 

In2005, we expensed $4.6 million in severance and relocation costs related to workforcereductions and reallocation of personnel geographically, which was included asa component of restructuring, reorganization, relocation and severance expense.We also incurred $3.9 million of restructuring expense for facility closures,largely related to the Peabody facility (inclusive of $0.2 million in reservereleases related to prior accruals for another facility lease that wasterminated).

 

Thefollowing tables summarize the charges, expenditures and write-offs andadjustments in 2007, 2006 and 2005 related to our restructuring,reorganization, relocation and severance accruals (in thousands):

 
| **Year Ended December 31,  2007**                                 | ** ** | **Beginning  Accrued  Liability** | ** ** | **Charged  (Credited)  to  Expense** | ** ** | **Expenditures** | ** ** | **Write-Offs  and  Adjustments** | ** ** | **Ending  Accrued  Liability** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------------|------------|------------------|------------|----------------------------------|------------|--------------------------------|------------|
| Severance,  outplacement and related benefits for terminated employees |       | $                                 | 178        |                                 | $          | 8                |       | $                                | (187       | )                              | $          | 1 |   | $ | — |   |
| Abandoned  leases, leasehold improvements and facilities               |       | 2,261                             |       | (280                                 | )          | (1,454           | )          | 53                               |       | 580                            |       |
|                                                                   |       | $                                 | 2,439      |                                 | $          | (272             | )          | $                                | (1,641     | )                              | $          | 54 |   | $ | 580 |   |

 
| **Year Ended December 31, 2006**                                  | ** ** | **Beginning  Accrued  Liability** | ** ** | **Charged  to  Expense** | ** ** | **Expenditures** | ** ** | **Write-Offs  and  Adjustments** | ** ** | **Ending  Accrued  Liability** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------|------------|------------------|------------|----------------------------------|------------|--------------------------------|------------|
| Severance,  outplacement and related benefits for terminated employees |       | $                                 | 1,778      |                     | $          | 2,619            |       | $                                | (4,343     | )                              | $          | 124 |   | $ | 178 |   |
| Abandoned  leases, leasehold improvements and facilities               |       | 3,496                             |       | 665                      |       | (1,906           | )          | 6                                |       | 2,261                          |       |
| CEO severance,  excluding stock-based compensation                     |       | —                            |       | 2,235                    |       | (2,235           | )          | —                           |       | —                         |       |
|                                                                   |       | $                                 | 5,274      |                     | $          | 5,519            |       | $                                | (8,484     | )                              | $          | 130 |   | $ | 2,439 |   |

 

Restructuring,reorganization, relocation and severance in 2006 also included the $7.1 millionnon-cash charge for stock-based compensation discussed above.

 
| **Year Ended December 31,  2005**                                 | ** ** | **Beginning  Accrued  Liability** | ** ** | **Charged  to  Expense** | ** ** | **Expenditures** | ** ** | **Write-Offs  and  Adjustments** | ** ** | **Ending  Accrued   Liability** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------|------------|------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Severance,  outplacement and related benefits for terminated employees |       | $                                 | 150        |                     | $          | 4,606            |       | $                                | (2,958     | )                               | $          | (20 | ) | $ | 1,778 |   |
| Abandoned  leases, leasehold improvements and facilities               |       | 870                               |       | 3,938                    |       | (1,254           | )          | (58                              | )          | 3,496                           |       |
|                                                                   |       | $                                 | 1,020      |                     | $          | 8,544            |       | $                                | (4,212     | )                               | $          | (78 | ) | $ | 5,274 |   |

 

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The current estimateaccrued for cash to be paid related to abandoned leases is net of estimatedsublease payments to be received and will be paid over the respective leaseterms.

 

Therestructuring charges are based on estimates that are subject to change.Workforce related charges could change because of shifts in timing,redeployment or changes in amounts of severance and outplacement benefits.Facilities charges could change due to changes in expected sublease income. Ourability to generate sublease income is dependent upon lease market conditionsat the time we negotiate the sublease arrangements. Variances from theseestimates could alter our ability to achieve anticipated expense reductions inthe planned timeframe and modify our expected cash outflows and workingcapital.

 

**15.**                               SHAREHOLDERS’EQUITY

** **

***PreferredStock Rights Plan***

*** ***

On July 21, 2005,the Board of Directors adopted a Preferred Stock Rights Plan. Pursuant tothe Preferred Stock Rights Plan, we distributed Rights as a dividend at therate of one Right for each share of our common stock held by shareholders ofrecord as of the close of business on August 12, 2005. The Rights expireon August 12, 2015, unless redeemed or exchanged.

 

The Rights are notexercisable until the earlier of: (1) 10 days (or such later date as maybe determined by the Board of Directors) following an announcement that aperson or group has acquired beneficial ownership of 20% of our common stock or(2) 10 days (or such later date as may be determined by the Board ofDirectors) following the announcement of a tender offer which would result in aperson or group obtaining beneficial ownership of 20% or more of ouroutstanding common stock, subject to certain exceptions (the earlier of suchdates being called the Distribution Date). The Rights are initially exercisablefor one-thousandth of a share of our Series A Preferred Stock at a priceof $120 per one-thousandth share, subject to adjustment. However, if: (1) afterthe Distribution Date we are acquired in certain types of transactions, or (2) anyperson or group (with limited exceptions) acquires beneficial ownership of 20%of our common stock, then holders of Rights (other than the 20% holder) will beentitled to receive, upon exercise of the Right, common stock (or in case weare completely acquired, common stock of the acquirer) having a market value oftwo times the exercise price of the Right.  Philips Business ElectronicsInternational B.V., or any of its affiliates, shall not be considered for the20% calculation so long as it does not acquire 30% or more of our commonshares.

 

We are entitled to redeemthe Rights, for $0.001 per Right, at the discretion of the Board of Directors,until certain specified times. We may also require the exchange of Rights, at arate of one share of common stock for each Right, under certain circumstances.We also have the ability to amend the Rights, subject to certain limitations.

 

***PEO Combination***

*** ***

On February 21, 1997, we acquiredsubstantially all of the assets and liabilities of the electron optics businessof Koninklijke Philips Electronics N.V. (the “PEO Combination”), in atransaction accounted for as a reverse acquisition.  As part of the PEO Combination, we agreed toissue to Philips additional shares of our common stock whenever stock optionsthat were outstanding on the date of the closing of the PEO Combination areexercised.  Any such additional sharesare issued at a rate of approximately 1.22 shares to Philips for each shareissued on exercise of these options. We receive no additional consideration forthese shares issued to Philips under this agreement. We did not issue anyshares in 2007, 2006 or 2005 to Philips under this agreement. As of December 31,2007, 185,000 shares of our common stock are potentially issuable and reservedfor issuance as a result of this agreement.

 

***Stock Incentive Plans***

*** ***

As of December 31, 2007, a total of5,773,598 shares of our common stock were reserved for issuance pursuant to ourstock incentive plans.

 

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*** ***

***16.          STOCKINCENTIVE PLANS AND STOCK-BASED COMPENSATION***

*** ***

***Stock-BasedCompensation Information***

 

Certain informationregarding our stock-based compensation was as follows (in thousands):

** **
| **Year Ended December 31,**                                                               | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted average grant-date fair value of share  options granted                               |       | $        | —     |     | $          | 6,069    |       | $ | 18,751 |   |
| Weighted average grant-date fair value of restricted  shares and restricted stock units        |       | 8,538    |       | 7,458    |       | 432      |       |
| Total intrinsic value of share options exercised                                               |       | 34,083   |       | 3,711    |       | 1,699    |       |
| Fair value of restricted shares and restricted stock  units vested                             |       | 2,528    |       | 57       |       | —   |       |
| Cash received  from options exercised and shares purchased under all share-based  arrangements |       | 40,894   |       | 13,147   |       | 5,878    |       |
| Tax benefit realized (reversed) for stock options                                              |       | 391      |       | 1,422    |       | (400     | )          |
|                                                                                                |            |          |            |          |            |          |            |  |  |  |

 

***1995Stock Incentive Plan and 1995 Supplemental Stock Incentive Plan***

 

Our1995 Stock Incentive Plan, as amended (the “1995 Plan”) allows for issuance ofa maximum of 9,500,000 shares and our 1995 Supplemental Stock Incentive Plan(the “1995 Supplemental Plan”) allows for issuance of a maximum of 500,000shares.

 

Wemaintain stock incentive plans for selected directors, officers, employees andcertain other parties that allow the Board of Directors to grant options(incentive and nonqualified), stock and cash bonuses, stock appreciationrights, restricted stock units (“RSUs”) and restricted shares. The Board ofDirectors’ ability to grant options under either the 1995 Plan or the 1995Supplemental Plan will terminate, if the plans are not amended, when all sharesreserved for issuance have been issued and all restrictions on such shares havelapsed, or earlier, at the discretion of the Board of Directors. At December 31,2007, there were 2,612,262 shares available for grant under these plans and5,773,598 shares of our common stock were reserved for issuance. Activity underthese plans was as follows (share amounts in thousands):

 
| ** ** | ** **                           | ** ** | **Shares Subject  to Options** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|------------|--------------------------------------|------------|-------------------------------------|------------|--------------------------------------|------------|
| ** ** | **Balances, December 31, 2006** |       | 4,651                               |       | $                                    | 20.73      |   |
|       | Granted                              |       | —                              |       | —                               |       |
|       | Forfeited                            |       | (57                                 | )          | 13.18                                |       |
|       | Expired                              |       | (8                                  | )          | 23.72                                |       |
|       | Exercised                            |       | (2,017                              | )          | 14.61                                |       |
| ** ** | **Balances, December 31, 2007** |       | 2,569                               |       | 25.69                                |       |
|            |                                      |            |                                     |            |                                      |            |  |

 
|       |                                 | ** ** | **Restricted  Shares and Restricted Stock Units** | ** ** | **Weighted  Average Grant Date Per Share Fair Value** | ** ** |
|------------|--------------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** ** | **Balances, December 31, 2006** |       | 343                                               |       | $                                                     | 21.71      |   |
|       | Granted                              |       | 396                                               |       | 21.56                                                 |       |
|       | Forfeited                            |       | (22                                               | )          | 27.61                                                 |       |
|       | Vested                               |       | (124                                              | )          | 16.13                                                 |       |
| ** ** | **Balances, December 31, 2007** |       | 593                                               |       | 22.56                                                 |       |
|            |                                      |            |                                                   |            |                                                       |            |  |

 

Included in the aboveactivity tables are 100,000 options to purchase our common stock and 75,000RSUs granted to our chief executive officer in the third quarter of 2006. Thesegrants were made outside of our plans at an exercise price of $19.38 per sharefor the options and a $19.38 per share fair value at grant date for the RSUs.The stock options and 25,000 of the RSUs vest over four years and 50,000 of theRSUs vested over a one-year period. We reduced the number of shares availablefor grant under the 1995 Plan by a number equal to the option and RSU grantsmade outside the 1995 Plan.

 

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***Summary***

 

Certain informationregarding all options outstanding as of December 31, 2007 was as follows:

 
| ** **                                  | ** ** | **Options  Outstanding** | ** **  | **Options  Exercisable** | ** ** |
|---------------------------------------------|------------|--------------------------|-------------|--------------------------|------------|
| Number                                      |       | 2,568,666                |        | 2,305,763                |       |
| Weighted average exercise price             |       | $                        | 23.25       |                     | $          | 23.69 |   |
| Aggregate intrinsic value                   |       | $                        | 8.7 million |                     | $          | 7.2 million |   |
| Weighted average remaining contractual term |       | 3.9 years                |        | 3.4 years                |       |

 

As of December 31,2007, unrecognized stock-based compensation related to outstanding, butunvested stock options, restricted shares and RSUs was $17.3 million, whichwill be recognized over the weighted average remaining vesting period of twoyears.

 

***Employee Share PurchasePlan***

 

In1998, we implemented an Employee Share Purchase Plan (“ESPP”). A total of2,450,000 shares of our common stock may be issued pursuant to the ESPP, asamended. Under the ESPP, employees may elect to have compensation withheld andplaced in a designated stock subscription account for purchase of our commonstock. Each ESPP offering period consists of one six-month purchase period. Thepurchase price in a purchase period is set at a 15% discount to the lower ofthe market price on either the first day of the applicable offering period orthe purchase date. The ESPP allows a maximum purchase of 1,000 shares by eachemployee during any two consecutive offering periods. A total of 211,509 shareswere purchased pursuant to the ESPP during 2007 at a weighted average purchaseprice of $20.88 per share, which represented a weighted average discount of$9.65 per share compared to the fair market value of our common stock on thedates of purchase. At December 31, 2007, 791,967 shares of our commonstock remained available for purchase and were reserved for issuance under theESPP.

 

***StockOption Acceleration of Vesting***

 

On October 19, 2005,we accelerated the vesting, effective immediately, of certain “out-of-the-money”unvested options, as determined based on the per share price of our commonstock of $19.34 as of the close of market on that date. Options held by ourthen-Chief Executive Officer and members of our Board of Directors wereexcluded from acceleration.

 

In making the decision toaccelerate the vesting of these options, our Board of Directors considered anumber of factors, including the interests of our shareholders in eliminatingthe future amortization of compensation expense represented by unvestedoptions, the accounting impact of vesting acceleration, the potential impact onemployee morale and the potential benefit to the market value of our commonstock.

 

As a result of theacceleration, options representing approximately 1.4 million shares, whichrepresented approximately 26% of the total outstanding options as of that date,became immediately exercisable. No compensation expense was recognized on ourconsolidated statement of operations related to this modification as theoptions modified had exercise prices greater than the fair value of theunderlying stock at the acceleration date. This action, however, did result inan additional charge of approximately $17.9 million in our stock compensationexpense footnote disclosure pursuant to SFAS No. 123 in 2005. See Note 1 “*Summary of**Significant AccountingPolicies — Stock-Based Compensation*.”

 

In addition, the vestingof certain stock options and restricted stock was accelerated in 2006 upon thetermination of our former Chief Executive Officer. See Note 14 above.

 

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**17.          EMPLOYEEBENEFIT PLANS**

** **

***Pension Plans***

 

Employee retirement plans have beenestablished in some foreign countries in accordance with the legal requirementsand customs in the countries involved. The majority of employees in Europe,Asia and Canada are covered by defined benefit, multi-employer or definedcontribution pension plans. The benefits provided by these plans are basedprimarily on years of service and employees’ compensation near retirement.Employees in the U.S. are covered by a profit sharing 401(k) plan, whichis a defined contribution plan.

 

Employees in the Netherlands participatewith other companies in making collectively-bargained payments to theMetal-Electro Industry pension fund. Pension costs relating to thismulti-employer plan were $6.7 million in 2007, $6.3 million in 2006 and $5.7million in 2005.

 

Outside the U.S. and the Netherlands,employees are covered under various defined contribution and defined benefitplans as required by local law.

 

Plan costs for our defined contributionplans outside the U.S. and the Netherlands totaled $0.8 million in 2007, $0.4million in 2006 and $0.2 million in 2005.

 

Plan costs for our defined benefitpension plans were $0.9 million in 2007, $0.3 million in 2006 and $0.6 millionin 2005. Obligations under the defined benefit pension plans are not funded. Aliability for the projected benefit obligations of these plans of $2.5 millionand $2.2 million was included in other non-current liabilities as of December 31,2007 and 2006, respectively. Unrealized gains (losses) recorded in othercomprehensive income related to the additional minimum pension liability forthese plans totaled $0.2 million in 2007 and $(0.6) million in 2006. Due to theimmateriality of these defined benefit pension plan costs, we have not includedall disclosures required by SFAS No. 87, “*EmployersAccounting for Pensions,”* and SFAS No. 132 (Revised 2003), “*Employer’s Disclosures about Pensions and Other PostretirementBenefits.”*

 

***Profit Share andVariable Compensation Programs***

 

In 2006, we modified the Employee ProfitShare Plan that had been in place since 2000. We also have a Management Variable Compensation Planfor management-level employees to reward achievement ofcorporate and individual objectives. The Compensation Committee ofthe Board of Directors generally determines the structure of the overallincentive program at the beginning of each year. In setting the structure andthe amount of the overall target incentive pool,the Compensation Committee considers potential size of the pool inrelation to our earnings and other financial estimates, the achievability of thecorporate targets under the plan, historical payouts under the plan and otherfactors.  The total cost of these plans was $9.2 million in 2007,$9.3 million in 2006 and $0 in 2005.

 

***Profit Sharing 401(k) Plan***

 

We maintain a profit sharing 401(k) planthat covers substantially all U.S. employees. Employees may elect to defer aportion of their compensation, and we may contribute an amount approved by theBoard of Directors. Beginning in 2006, we match 100% of employee contributionsto the 401(k) plan up to 3% of each employee’s eligible compensation.Prior to 2006, we matched 100% of employee contributions up to 11⁄2% with apossible supplemental match, if approved by the Board of Directors, based onour performance, up to a maximum of an additional 3% of eligible compensation.Employees must meet certain requirements to be eligible for the matchingcontribution. We contributed $1.4 million in 2007, $1.1 million in 2006 and$0.6 million in 2005 to this plan. Our 401(k) plan does not allow for theinvestment in shares of our common stock. No supplemental matchingcontributions were made in 2005.

 

***DeferredCompensation Plan***

 

We maintain a deferred compensation plan(the “Plan”) which permits certain employees to defer payment of a portionof their annual compensation. We do not match deferrals or make any additionalcontributions to the Plan. Distributions from the Plan are generally payable asa lump sum payment or in 

 

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multi-year installments as directed bythe participant according to the Plan provisions. Undistributed amounts underthe Plan are subject to the claims of our creditors. As of December 31,2007 and 2006, the invested amounts under the Plan totaled $2.8 millionand $1.9 million, respectively, and were recorded on our balance sheets asnon-current investments in marketable securities and as a long-term liabilityto recognize undistributed amounts due to employees.

 

**18.          RELATED-PARTYACTIVITY**

** **

***Philips***

 

Until December 2006, Philips Business ElectronicsInternational B.V. (“Philips”), a subsidiary of******KoninklijkePhilips Electronics N.V., owned approximately 25% of our common stock. As of December 31,2006, Philips did not own any of our common stock. In addition, during 2006,one of our directors, Mr. Jan C. Lobbezoo served as the Executive VicePresident of Philips International B.V. with responsibility for financialoversight of several minority shareholdings of Koninklijke Philips ElectronicsN.V. For sales to Philips prior to the divesture date, see “*Other Transactions*” below. We continue to purchase certainsubassemblies, as well as research and development services, fromPhilips-related entities.

 

***Other Transactions***

 

We have sold products and services to LSICorporation, Applied Materials, Inc., Nanosys, Inc. and CascadeMicrotech, Inc. A director of Applied Materials, the former Chairman andChief Executive Officer of LSI and the former Executive Chairman of Nanosys areall members of our Board of Directors. In addition, our Chief Financial Officeris currently on the board of directors of Cascade Microtech, Inc.

 

Sales to Philips (while they were arelated party in 2006 and 2005), Applied Materials, LSI (while they were arelated party prior to 2007), Nanosys and Cascade Microtech, Inc. were asfollows (in thousands):

 
| ** **           | ** ** | **Year Ended December 31,** | ** ** |
|----------------------|------------|----------------------------------|------------|
| ** **           | ** ** | **2007**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Product sales:       |       |                             |       |   |   |   |   |
| Applied  Materials   |       | $                                | 897        |   | $ | 1,353 |   | $ | 439 |   |
| LSI Logic            |       | —                           |       | — |   | 4 |   |
| Nanosys              |       | —                           |       | — |   | 289 |   |
| Philips              |       | —                           |       | 842 |   | 2,098 |   |
| Cascade  Microtech   |       | —                           |       | 311 |   | — |   |
| Total product  sales |       | 897                              |       | 2,506 |   | 2,830 |   |
|                 |       |                             |       |   |   |   |   |
| Service sales:       |       |                             |       |   |   |   |   |
| Applied  Materials   |       | 306                              |       | 266 |   | 270 |   |
| LSI Logic            |       | —                           |       | 172 |   | 163 |   |
| Nanosys              |       | —                           |       | 23 |   | 17 |   |
| Philips              |       | —                           |       | 1,685 |   | 588 |   |
| Cascade  Microtech   |       | 15                               |       | — |   | — |   |
| Total service  sales |       | 321                              |       | 2,146 |   | 1,038 |   |
| Total sales          |       | $                                | 1,218      |   | $ | 4,652 |   | $ | 3,868 |   |

 

As of December 31, 2007, Applied Materials owed us $0.1 millionrelated to its purchases.

 

During 2007, we purchased services totaling $157,000 from EasyStreetOnline Services. One of the members of our Board of Directors, Mr. WilliamLattin, also serves on the Board of Directors of EasyStreet Online Services.

 

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**19.          RISKMANAGEMENT AND DERIVATIVES**

** **

We are exposed to globalmarket risks, including the effect of changes in foreign currency exchangerates. We use derivatives to manage financial exposures that occur in thenormal course of business. We do not hold or issue derivatives for trading orspeculative purposes. We formally document all relationships between hedginginstruments and hedged items, as well as our risk-management objective andstrategy for undertaking hedge transactions. This process includes linking allderivatives either to assets and liabilities recorded on the balance sheet orto forecasted transactions. Derivatives entered into by us that are linked toforecasted transactions have been designated as cash flow hedges commencing April 5,2004.

 

All derivatives are recognized on the balance sheet attheir fair value. Unrealized gain positions are recorded as other current assets,and unrealized loss positions are recorded as other current liabilities as allmaturity dates are less than one year. Changes in fair values of outstandingderivatives that are designated as cash flow hedges and are highly effectiveare recorded in other comprehensive income until net income is affected by thevariability of cash flows of the hedged transaction. Changes in the fair valueof derivatives either not designated or effective as hedging instruments arerecognized in earnings in the current period and primarily relate toderivatives linked to specific non-functional currency denominated assets andliabilities on the balance sheet.

 

***CashFlow Hedges***

 

The purpose of ourforeign currency hedging activities is to protect us from the risk that the eventualcash flows resulting from transactions in foreign currencies will be adverselyaffected by changes in exchange rates. It is our policy to utilize derivativesto reduce foreign exchange risks where internal netting strategies cannot beeffectively employed.

 

Derivatives used by us tohedge foreign currency exchange risks are foreign forward extra contracts,which are a combination of foreign exchange contracts and options, and optioncontracts. These instruments protect against the risk that the eventual netcash inflows from foreign currency denominated transactions will be adverselyaffected by changes in exchange rates beyond a range specified at the inceptionof the hedging relationship. We hedge up to 90% of anticipated U.S. dollardenominated sales of our foreign subsidiaries for a rolling 12-month period.

 

As of April 5, 2004,all forward extra contracts entered into by us to hedge forecasted transactionsqualified for, and were designated as, foreign-currency cash flow hedges.Changes in fair values of outstanding cash flow hedge derivatives that arehighly effective are recorded in other comprehensive income until net income isaffected by the variability of the cash flows of the hedged transaction. Inmost cases, amounts recorded in other comprehensive income will be released tonet income in the quarter that the related derivative matures. Results ofhedges are recorded as cost of sales when the underlying hedged transactionaffects net income.

 

Actual amounts ultimatelyreclassified to net income are dependent on the exchange rates in effect whenderivative contracts that are currently outstanding mature. As of December 31,2007, the maximum term over which we are hedging exposures to the variabilityof cash flows for all forecasted and recorded transactions was 12 months. Weformally assess, both at the inception of the hedge and on an ongoing basis,whether the derivatives that are used in hedging transactions have been highlyeffective in offsetting changes in the cash flows of hedged items and whetherthose derivatives may be expected to remain highly effective in future periods.We assess effectiveness of options based on the total cash flows method andrecord total changes in the options’ fair value to other comprehensive incometo the degree the options are effective.

 

We prospectivelydiscontinue hedge accounting when (i) we determine that the derivative isno longer highly effective in offsetting changes in the cash flows of a hedgeditem (including hedged items such as firm commitments or forecastedtransactions); (ii) it is no longer probable that the forecastedtransaction will occur; or (iii) management determines that designatingthe derivative as a hedging instrument is no 

 

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longer appropriate. If wediscontinue hedge accounting, the gains and losses that were accumulated inother comprehensive income (loss) will be recognized immediately in net income.In all situations in which hedge accounting is discontinued and the derivative remainsoutstanding, we will carry the derivative at its fair value on the balancesheet, recognizing future changes in the fair value in current-period netincome (loss).  Any hedge ineffectivenessis recorded in current-period net income.

 

Net realized gains(losses) related to cash flow hedges recorded in cost of sales were $5.0million in 2007, $2.0 million in 2006 and $(2.2) million in 2005. As of December 31,2007 and 2006, $2.2 million and $1.7 million, respectively, of deferred netunrealized gains on outstanding derivatives were recorded as othercomprehensive income. The 2007 deferred unrealized gains are expected to bereclassified to net income during the next 12 months as a result of underlyinghedged transactions also being recorded in net income.

 

In 2005, we recorded acharge of $0.5 million in other income (expense) related to both hedgeineffectiveness and hedge dedesignations. We did not record any gain or loss inother income/expense due to ineffectiveness of derivatives in 2007 or 2006, nordid we record any gain or loss due to discontinued hedge accounting during 2007or 2006.

 

***OtherDerivatives***

 

Changes in the fair valueof foreign forward exchange contracts entered into to mitigate the foreignexchange risks related to non-functionally denominated cash, receivables andpayables are recorded in other income (expense) currently together with thetransaction gain or loss from the hedged balance sheet position. Excludingforward extra contracts and option losses, foreign exchange losses, net of thebalance sheet hedge benefits, were $3.1 million, $1.9 million and $1.0 millionin 2007, 2006 and 2005, respectively.

 

**20.          COMMITMENTSAND CONTINGENT LIABILITIES**

** **

From time to time, we may be a party tolitigation arising in the ordinary course of business. Currently, we are not aparty to any litigation that we believe would have a material adverse effect onour financial position, results of operations or cash flows.

 

We have commitments under non-cancelablepurchase orders, primarily relating to inventory, totaling $63.0 million at December 31,2007. These commitments expire at various times through the fourth quarter of2008.

 

**21.          SEGMENTAND GEOGRAPHIC INFORMATION**

** **

Operating segments are defined ascomponents of an enterprise about which separate financial information isavailable that is evaluated regularly by the chief operating decision maker, ordecision making group, in deciding how to allocate resources and in assessingperformance. Our chief operating decision maker is our Chief Executive Officer.

 

We report our segments based on amarket-focused organization. Our segments are: NanoElectronics, NanoResearchand Industry, NanoBiology and Service and Components.

 

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The following table summarizes variousfinancial amounts for each of our business segments (in thousands):

 
| **Year Ended December 31,  2007** | ** ** | **Nano-  Electronics** | ** ** | **Nano-  Research and Industry** | ** ** | **Nano-  Biology** | ** ** | **Service and Components** | ** ** | **Corporate and  Eliminations** | ** ** | **Total**  | ** ** |
|----------------------------------------|------------|------------------------|------------|----------------------------------|------------|--------------------|------------|----------------------------|------------|---------------------------------|------------|------------|------------|
| Sales to  external customers           |       | $                      | 198,663    |                             | $          | 214,551            |       | $                          | 51,874     |                            | $          | 127,422    |       | $ | — |   | $ | 592,510 |   |
| Gross profit                           |       | 102,940                |       | 88,964                           |       | 20,638             |       | 33,878                     |       | —                          |       | 246,420    |       |
|                                   |       |                   |       |                             |       |               |       |                       |       |                            |       |       |       |
| **Year Ended December 31, 2006**  | ** ** | ** **             | ** ** | ** **                       | ** ** | ** **         | ** ** | ** **                 | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Sales to  external customers           |       | $                      | 154,648    |                             | $          | 165,067            |       | $                          | 40,928     |                            | $          | 118,848    |       | $ | — |   | $ | 479,491 |   |
| Gross profit                           |       | 76,030                 |       | 70,207                           |       | 16,664             |       | 33,545                     |       | —                          |       | 196,446    |       |
|                                   |       |                   |       |                             |       |               |       |                       |       |                            |       |       |       |
| **Year Ended December 31, 2005**  | ** ** | ** **             | ** ** | ** **                       | ** ** | ** **         | ** ** | ** **                 | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Sales to  external customers           |       | $                      | 145,951    |                             | $          | 130,045            |       | $                          | 35,355     |                            | $          | 108,746    |       | $ | — |   | $ | 420,097 |   |
| Gross profit                           |       | 52,438                 |       | 50,626                           |       | 12,453             |       | 29,677                     |       | —                          |       | 145,194    |       |
|                                   |       |                   |       |                             |       |               |       |                       |       |                            |       |       |       |
| **December 31, 2007**             | ** ** | ** **             | ** ** | ** **                       | ** ** | ** **         | ** ** | ** **                 | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Total assets                           |       | $                      | 88,142     |                             | $          | 150,857            |       | $                          | 41,405     |                            | $          | 137,570    |       | $ | 590,035 |   | $ | 1,008,009 |   |
|                                   |       |                   |       |                             |       |               |       |                       |       |                            |       |       |       |
| **December 31, 2006**             | ** ** | ** **             | ** ** | ** **                       | ** ** | ** **         | ** ** | ** **                 | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Total assets                           |       | $                      | 93,987     |                             | $          | 105,329            |       | $                          | 20,198     |                            | $          | 111,677    |       | $ | 506,888 |   | $ | 838,079 |   |

 

Nano-market segmentdisclosures are presented to the gross profit level as this is the primaryperformance measure for which the segment general managers are responsible.Selling, general and administrative, research and development and otheroperating expenses are managed and reported at the corporate level and, givenallocation to the nano-market segments would be arbitrary, have not beenallocated to the market segments. See our Consolidated Statements of Operationsfor reconciliations from gross profit to income before income taxes. Thesereconciling items are not included in the measure of profit and loss for eachreportable segment.

 

Ourlong-lived assets were geographically located as follows (in thousands):

 
| **December 31,** | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
| United States         |       | $        | 50,862     |     | $          | 40,730 |   |
| The Netherlands       |       | 20,202   |       | 17,926   |       |
| Other                 |       | 12,702   |       | 8,772    |       |
| Total                 |       | $        | 83,766     |     | $          | 67,428 |   |

 

The following tablesummarizes sales by geographic region (in thousands):

 
| ** **                  | ** ** | **North America** | ** ** | **Europe** | ** ** | **Asia-Pacific** | ** ** | **Total**  | ** ** |
|-----------------------------|------------|-------------------|------------|------------|------------|------------------|------------|------------|------------|
| **2007**                    | ** ** | ** **        | ** ** | ** ** | ** ** | ** **       | ** ** | ** ** | ** ** |
| Product sales               |       | $                 | 164,757    |       | $          | 179,304          |       | $          | 121,027    |   | $ | 465,088 |   |
| Service and component sales |       | 65,656            |       | 38,787     |       | 22,979           |       | 127,422    |       |
| Total sales                 |       | $                 | 230,413    |       | $          | 218,091          |       | $          | 144,006    |   | $ | 592,510 |   |
|                        |       |              |       |       |       |             |       |       |       |
| **2006**                    | ** ** | ** **        | ** ** | ** ** | ** ** | ** **       | ** ** | ** ** | ** ** |
| Product sales               |       | $                 | 104,879    |       | $          | 150,933          |       | $          | 104,831    |   | $ | 360,643 |   |
| Service and component sales |       | 62,510            |       | 36,296     |       | 20,042           |       | 118,848    |       |
| Total sales                 |       | $                 | 167,389    |       | $          | 187,229          |       | $          | 124,873    |   | $ | 479,491 |   |
|                        |       |              |       |       |       |             |       |       |       |
| **2005**                    | ** ** | ** **        | ** ** | ** ** | ** ** | ** **       | ** ** | ** ** | ** ** |
| Product sales               |       | $                 | 70,477     |       | $          | 126,831          |       | $          | 114,043    |   | $ | 311,351 |   |
| Service and component sales |       | 55,398            |       | 34,060     |       | 19,288           |       | 108,746    |       |
| Total sales                 |       | $                 | 125,875    |       | $          | 160,891          |       | $          | 133,331    |   | $ | 420,097 |   |

 

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Noneof our customers represented 10% or more of our total sales in 2007, 2006 or2005.

 

Sales to countries which totaled 10% or more of our total sales were asfollows (dollars in thousands):

 
| ** **    | ** ** | **Dollar Amount** | ** ** | **% of Total Sales** | ** ** |
|---------------|------------|-------------------|------------|----------------------|------------|
| **2007**      | ** ** | ** **        | ** ** | ** **           | ** ** |
| United States |       | $                 | 228,576    |                 | 38.6       | % |
| ** **    | ** ** | ** **        | ** ** | ** **           | ** ** |
| **2006**      | ** ** | ** **        | ** ** | ** **           | ** ** |
| United States |       | $                 | 165,130    |                 | 34.4       | % |
| Germany       |       | 49,743            |       | 10.4                 | %          |
|          |       |              |       |                 |       |
| **2005**      | ** ** | ** **        | ** ** | ** **           | ** ** |
| United States |       | $                 | 123,958    |                 | 29.5       | % |
| Germany       |       | 54,115            |       | 12.9                 | %          |
| Japan         |       | 47,639            |       | 11.3                 | %          |

** **

**22. DISCONTINUED OPERATIONS**

 

In the fourth quarter of2006, we sold the assets and operations related to Knights Technology that wasincluded as part of our NanoElectronics operating segment. We recognized a gainon the disposal of the discontinued operations of $3.3 million and receivedcash proceeds of $7.8 million. In the first quarter of 2007, we recognized anadditional $0.1 million gain related to post-closing adjustments for workingcapital items. In addition, in the fourth quarter of 2007, we recognized anadditional $0.3 million gain related to the release of certain acquisitioncontingency accruals, as well as to amounts that had been held in escrow andsubsequently paid to us once all contingencies surrounding the transaction wereresolved. All historical balance sheet and statement of operations data hasbeen restated to reflect the discontinued operations.

 

Certain financialinformation related to discontinued operations was as follows (in thousands):

 
| **Year Ended December 31,**                            | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenue                                                     |       | $        | —     |     | $          | 5,245    |       | $ | 7,132 |   |
| Pre-tax (loss) income                                       |       | —   |       | (905     | )          | 606      |       |
| Income tax expense                                          |       | —   |       | 42       |       | 304      |       |
| Gain on disposal of discontinued operations, net of  tax    |       | 390      |       | 3,335    |       | —   |       |
| Amount of goodwill and other intangible assets  disposed of |       | —   |       | 3,133    |       | —   |       |
|                                                             |            |          |            |          |            |          |            |  |  |  |

 

No impairment charge wasrecorded related to the assets of the discontinued operations.

 

**23.  FAIRVALUE OF FINANCIAL ASSETS AND LIABILITIES**

** **

Weestimate the fair value of our monetary assets and liabilities based uponcomparison of such assets and liabilities to the current market values forinstruments of a similar nature and degree of risk.

 

We believe the carrying amounts of cashand cash equivalents, receivables, accounts payable and other currentliabilities are a reasonable approximation of the fair value of those financialinstruments because of the nature of the underlying transactions and theshort-term maturities involved.

 

The fair value and cost of certain financialassets and liabilities was as follows (in thousands):

 
| ** **            | ** ** | **2007**       | ** ** | **2006** | ** ** |
|-----------------------|------------|----------------|------------|----------|------------|
| **December 31,** | ** ** | **Fair Value** | ** ** | **Cost** | ** ** | **Fair Value** | ** ** | **Cost** | ** ** |
| Marketable securities |       | $              | 164,799    |     | $          | 164,892 |   | $ | 269,102 |   | $ | 269,517 |   |
| Convertible notes     |       | $              | 328,810    |     | $          | 310,882 |   | $ | 341,058 |   | $ | 310,882 |   |
| Derivative contracts  |       | $              | 6,089      |     | $          | — |   | $ | 4,724 |   | $ | — |   |

 

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As of December 31, 2007 and 2006,the aggregate notional amount of our outstanding derivative contracts was $68.5million and $56.0 million, respectively. The fair value of these contractsrepresents our forward extra contracts and forward contracts.  The fair value of these contracts wasobtained from financial institutions.

 

**24. SUBSEQUENT EVENTS**

** **

***Redemptionof 5.5% Convertible Subordinated Notes***

 

On January 24, 2008,we redeemed the remaining outstanding balance of our 5.5% convertiblesubordinated notes due August 15, 2008, which totaled $45.9million. Interest paid as part of the note redemption was approximately$1.1 million, of which $0.9 million was accrued as of December 31,2007.  Additionally, we expensed the remaining related bond issuance costsof $0.1 million.

 

***Auction Rate Securities and Liquidity***

 

At December 31,2007, we held $118.1 million in auction rate securities (“ARS”) which we classifiedas current assets. The ARS held by us have long-term stated maturities forwhich the interest rates are reset through a Dutch auction generally every 28days. The auctions have historically provided a liquid market for thesesecurities as investors could readily sell their investments at auction.Subsequent to December 31, 2007, we began to exit our position in thesesecurities. As of February 25, 2008, we had successfully liquidated $8.0million of these securities, leaving us with $110.1 million invested in ARS.

 

A chart showing theamounts of each of our ARS, the issuers and whether the underlying collateralfor the notes are guaranteed by the U.S. Department of Education (“USDE”) isset out below. At the time of issuance each of the ARS was purported to be atleast 100% collateralized. All of the notes come up for auction by March 24,2008.

 

| **Issuer**        | ** ** | **Principal Amount** | ** **   | **USDE Guarantee** | ** **          | **Maturity Dates** | ** **              |
|-------------------|------------|----------------------|--------------|--------------------|---------------------|--------------------|-------------------------|
| State Agencies    |       | $                    | 60.7 million |               | From 81.13% to 100% |               | Range from 2031 to 2047 |   |
|              |       |                 |         |               |                |               |                    |
| Corporate issuers |       | $                    | 49.4 million |               | From 0% to 100%     |               | Range from 2028 to 2047 |   |

 

With the liquidity issuesexperienced in global credit and capital markets, the ARS held by us haveexperienced multiple failed auctions, beginning on February 19, 2008, asthe amount of securities submitted for sale has exceeded the amount of purchaseorders. We expect additional auction failures during the remainder of February andMarch 2008, which will require us to hold the securities until liquidityis restored to the credit markets or the securities are redeemed or mature.

 

All of the ARS held by uscarry AAA ratings, have not experienced any payment defaults and are backed bystudent loans, some of which are guaranteed under the Federal Family EducationLoan Program of the USDE. Nonetheless, if uncertainties in the credit andcapital markets continue, these markets deteriorate further or there are anyratings downgrades on any ARS we hold, we may be required to reclassify theseinvestments from short-term to long-term investments. In addition, if thefailed auctions or any downgrades are deemed to cause an “other than temporaryimpairment” of our ARS, we may be required to re-value the ARS at some amountbelow par. Any re-valuation of ARS that are other than temporarily impairedwill flow through our operations statement and affect our earnings.

 

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** **

**Item 9.****  Changes in and Disagreementswith Accountants on Accounting and Financial Disclosure**

 

None.

 

**Item 9A.****  Controls and Procedures**

** **

***Evaluation of Disclosure Controls and Procedures***

** **

Our management evaluated, with theparticipation and under the supervision of our President and Chief ExecutiveOfficer and Chief Financial Officer, the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this AnnualReport on Form 10-K. Based on this evaluation, our President and ChiefExecutive Officer and our Chief Financial Officer concluded that our disclosurecontrols and procedures are effective to ensure that information we arerequired to disclose in reports that we file or submit under the SecuritiesExchange Act of 1934 is accumulated and communicated to our management,including our President and Chief Executive Officer and our Chief FinancialOfficer, as appropriate to allow timely decisions regarding required disclosureand that such information is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rules andforms.

 

***Changes in Internal Control Over Financial Reporting***

*** ***

There was no change in our internalcontrol over financial reporting that occurred during our last fiscal quarterthat has materially affected or is reasonably likely to materially affect ourinternal control over financial reporting.

 

# ***Management’s Report on Internal Control OverFinancial Reporting***

# *** ***

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting.

 

Our management assessedthe effectiveness of our internal control over financial reporting as of December 31,2007. In making this assessment, we used the criteria set forth in *Internal Control — Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Based on our assessment using those criteria, our management concluded that, asof December 31, 2007, our internal control over financial reporting waseffective.

 

Deloitte &Touche LLP has audited this assessment of our internal control over financialreporting and their report is included below.

 

# ***Inherent Limitations on Effectiveness of Controls***

# *** ***

Our management, includingthe CEO and CFO, does not expect that our disclosure controls or our internalcontrol over financial reporting will prevent or detect all error and allfraud. A control system, no matter how well designed and operated, can provideonly reasonable, not absolute, assurance that the control system’s objectiveswill be met. The design of a control system must reflect the fact that thereare resource constraints, and the benefits of controls must be consideredrelative to their costs. Further, because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatmisstatements due to error or fraud will not occur or that all control issuesand instances of fraud, if any, have been detected. These inherent limitationsinclude the realities that judgments in decision-making can be faulty and thatbreakdowns can occur because of simple error or mistake. Controls can also becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the controls. The design of anysystem of controls is based in part on certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions. Projectionsof any evaluation of controls effectiveness to future periods are subject torisks. Over time, controls may become inadequate because of changes inconditions or deterioration in the degree of compliance with policies orprocedures.

 

 

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** **

**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

** **

Tothe Board of Directors and Shareholders of

FEICompany

Hillsboro,Oregon

 

Wehave audited the internal control over financial reporting of FEI Company andsubsidiaries (the “Company”) as of December 31, 2007, based on criteriaestablished in *Internal Control — Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission. TheCompany’s management is responsible for maintaining effective internal controlover financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting, included in the accompanying *Management’s Reporting on Internal Control over Financial Reporting*.Our responsibility is to express an opinion on the Company’s internal controlover financial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, assessing the risk that a material weaknessexists, testing and evaluating the design and operating effectiveness ofinternal control based on the assessed risk, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

 

Acompany’s internal control over financial reporting is a process designed by,or under the supervision of, the company’s principal executive and principalfinancial officers, or persons performing similar functions, and effected bythe company’s board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Becauseof the inherent limitations of internal control over financial reporting,including the possibility of collusion or improper management override ofcontrols, material misstatements due to error or fraud may not be prevented ordetected on a timely basis. Also, projections of any evaluation of theeffectiveness of the internal control over financial reporting to future periodsare subject to the risk that the controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

Inour opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2007, basedon the criteria established in *Internal Control —Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated financialstatements as of and for the year ended December 31, 2007 of the Companyand our report dated February 29, 2008 expressed an unqualified opinion onthose financial statements, and included an explanatory paragraph regarding theCompany’s adoption of Financial Accounting Standards Board Interpretation No. 48,“Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109,” as of January 1, 2007 and an explanatoryparagraph regarding the Company’s adoption of Statement of Financial AccountingStandards No 123R, “Share-Based Payment,” effective January 1, 2006.

 

DELOITTE &TOUCHE LLP

Portland,Oregon

# **February 29, 2008**

# ** **

 

88

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** **

**Item 9B.****  Other Information**

 

None.

 

**PART III**

 

**Item 10.****  Directors, ExecutiveOfficers and Corporate Governance**

** **

#### **Information required by thisitem will be included under the captions *Election of Directors*,*Meetings and Committees of the Board of Directors*,*Membership of the**AuditCommittee*, *Code of Ethics*,*Executive Officers, Governance*and *Section 16(a) Beneficial Ownership Reporting Compliance*inour Proxy Statement for our 2008 Annual Meeting of Shareholders and isincorporated by reference herein.**

#### ** **

On September 9, 2003, we adopted acode of business conduct and ethics that applies to all directors, officers andemployees. We posted our code of business conduct and ethics on our website atwww.fei.com. We intend to disclose any amendment to the provisions of the codeof business conduct and ethics that apply specifically to directors orexecutive officers by posting such information on our website. We intend todisclose any waiver to the provisions of the code of business conduct andethics that apply specifically to directors or executive officers by filingsuch information on a Current Report on Form 8-K with the SEC, to theextent such filing is required by the Nasdaq Global Market’s listing requirements;otherwise, we will disclose such waiver by posting such information on ourwebsite.

 

**Item 11.****  Executive Compensation**

 

Informationrequired by this item will be included under the captions *DirectorCompensation,**Executive Compensation,Compensation Discussion and Analysis for Named Executive Officers*and*Compensation Committee Interlocks and Insider Participation*inour proxy statement for our 2008 Annual Meeting of Shareholders and isincorporated by reference herein.

 

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

** **

Information required bythis item will be included under the captions *SecurityOwnership of Certain Beneficial Owners and Management* and *Securities Authorized for Issuance Under Equity Compensation Plans*inour proxy statement for our 2008 Annual Meeting of Shareholders and isincorporated by reference herein.

 

**Item 13.****  Certain Relationships andRelated Transactions, and Director Independence**

 

Information required bythis item will be included under the captions *CertainRelationships and Related Transactions*and*Director**Independence* in our Proxy Statement forour 2008 Annual Meeting of Shareholders and is incorporated by referenceherein.

 

**Item 14.****  Principal Accountant Feesand Services**

** **

Information required bythis item will be included under the caption *Ratificationof Appointment of Public Accounting Firm* in our proxy statement forour 2008 Annual Meeting of Shareholders and is incorporated by referenceherein.

 

 

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** **

**PART IV**

 

**Item 15.****  Exhibits and FinancialStatement Schedules**

** **

**FinancialStatements and Schedules**

** **

The ConsolidatedFinancial Statements, together with the report thereon of our independentregistered public accounting firm, are included on the pages indicatedbelow:

 
| ** **                                                                                                         | **Page** |
|--------------------------------------------------------------------------------------------------------------------|----------|
| Report of Independent Registered Public Accounting  Firm                                                           | 50       |
|                                                                                                               |     |
| Consolidated  Balance Sheets as of December 31, 2007 and 2006                                                 | 51       |
|                                                                                                               |     |
| Consolidated  Statements of Operations for the years ended December 31, 2007, 2006 and  2005                  | 52       |
|                                                                                                               |     |
| Consolidated  Statements of Comprehensive Income (Loss) for the years ended  December 31, 2007, 2006 and 2005 | 53       |
|                                                                                                               |     |
| Consolidated  Statements of Shareholders’ Equity for the years ended December 31,  2007, 2006 and 2005   | 54       |
|                                                                                                               |     |
| Consolidated Statements  of Cash Flows for the years ended December 31, 2007, 2006 and 2005                   | 55       |
|                                                                                                               |     |
| Notes  to Consolidated Financial Statements                                                                        | 56       |

 

There are no schedulesrequired to be filed herewith.

 

**Exhibits**

** **

The following exhibitsare filed herewith and this list is intended to constitute the exhibit index. Aplus sign (+) beside the exhibit number indicates the exhibits containing amanagement contract, compensatory plan or arrangement, which are required to beidentified in this report.

** **
| **Exhibit No.** | ** ** | **Description**                                                                                                                          |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(10)              |       | Third Amended  and Restated Articles of Incorporation                                                                                    |
|                 |       |                                                                                                                                     |
| 3.2(13)              |       | Articles of  Amendment to the Third Amended and Restated Articles of Incorporation                                                       |
|                 |       |                                                                                                                                     |
| 3.3(15)              |       | Amended and Restated Bylaws, as amended on  August 17, 2006                                                                         |
|                 |       |                                                                                                                                     |
| 4.1(5)               |       | Indenture  between FEI and BNY Western Trust Company dated August 3, 2001                                                           |
|                 |       |                                                                                                                                     |
| 4.2(5)               |       | Form of  Note for 5.5% Convertible Subordinated Notes due 2008                                                                      |
|                 |       |                                                                                                                                     |
| 4.3(5)               |       | Registration  Rights Agreement between FEI and Credit Suisse First Boston dated  August 3, 2001                                     |
|                 |       |                                                                                                                                     |
| 4.4(9)               |       | Indenture, dated  as of June 13, 2003, between FEI and BNY Western Trust Company, a  California state chartered banking corporation |
|                 |       |                                                                                                                                     |
| 4.5(9)               |       | Form of  Note for Zero Coupon Convertible Subordinated Notes due 2008                                                               |
|                 |       |                                                                                                                                     |
| 4.6(9)               |       | Registration  Rights Agreement, dated as of June 13, 2003, between FEI and the initial  purchasers named therein                    |
|                 |       |                                                                                                                                     |
| 4.7(16)              |       | Indenture, dated as of May 19, 2006, between the Company and The  Bank of New York Trust Company, as trustee                        |
|                 |       |                                                                                                                                     |
| 4.8                  |       | Form of 2.875% Convertible Subordinated Note due 2013  (incorporated by reference to Annex A of Exhibit 4.7)                   |

 

 

90

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                        |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.9(17)              |       | Registration Rights Agreement, dated as of May 19, 2006, among  FEI Company, Merrill Lynch, Pierce, Fenner & Smith Incorporated,  Needham & Company, LLC, Thomas Weisel Partners LLC, D.A.  Davidson & Co. and Merriman Curhan Ford & Co.     |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 4.10(13)             |       | Preferred Stock  Rights Agreement dated July 21, 2005, between FEI and Mellon Investor  Services, LLC                                                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.1+                |       | 1995 Stock  Incentive Plan, as amended effective May 17, 2007                                                                                                                                                                                                                     |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.2+(2)             |       | 1995  Supplemental Stock Incentive Plan                                                                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.3+(1)             |       | Form of  Incentive Stock Option Agreement                                                                                                                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.4+(1)             |       | Form of  Nonstatutory Stock Option Agreement                                                                                                                                                                                                                                      |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.5+                |       | 1995 Employee  Share Purchase Plan, as amended effective May 17, 2007                                                                                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.6(3)              |       | Lease Agreement,  dated October 27, 1997, between Philips Business Electronics International  B.V., as lessor, and Philips Electron Optics B.V., a wholly owned indirect  subsidiary of FEI, as lessee, including a guarantee by FEI of the lessee’s  obligations thereunder |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.7+(17)            |       | Executive Severance Agreement by and between Dr. Don Kania and  FEI Company                                                                                                                                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.8+(17)            |       | Stand-alone Non-statutory Stock Option Agreement (for grant of 100,000  option shares outside of 1995 Stock Incentive Plan as a material inducement  for Dr. Kania to accept employment)                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.9+(17)            |       | Stand-alone Restricted Stock Unit Agreement (for grant of 25,000 units  outside the 1995 Stock Incentive Plan as a material inducement for  Dr. Kania to accept employment)                                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.10+(17)           |       | Stand-alone Restricted Stock Unit Agreement (for grant of 50,000 units  outside of 1995 Stock Incentive Plan as a material inducement for  Dr. Kania to accept employment)                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.11+(17)           |       | Form of Restricted Stock Unit grant (for grant of 75,000 units to  Dr. Kania within the 1995 Stock Incentive Plan)                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.12+(4)            |       | FEI Company  Nonqualified Deferred Compensation Plan                                                                                                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.13(7)             |       | Purchase  Agreement, effective as of November 1, 2002, between FEI and Philips  Enabling Technologies Group Nederland B.V.                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.14(7)             |       | Lease Agreement,  dated December 11, 2002, by and among FEI, Technologicky Park Brno, a.s.  and FEI Czech Republic, s.r.o.                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.15(8)             |       | Master Agreement  for the Acht facility, dated January 14, 2003                                                                                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.16+(11)           |       | Form of  Indemnity Agreement for Directors and Executive Officers of FEI                                                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.17+(21)           |       | Description of  Compensation of Non-Employee Directors                                                                                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.18+(23)           |       | 2008 FEI  Management Variable Compensation Plan Program Summary Description                                                                                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.19+(20)           |       | 2007 Base Salary and Target Management Variable Compensation Payment  Plan for Certain Executive Officers                                                                                                                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.20+(14)           |       | Form of Lock-Up Agreement between FEI and Certain of its  Executive Officers and Other Members of Senior Management                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                   |
| 10.21+(14)           |       | Description of Accelerated Vesting of Certain Stock Options Held by  Employees                                                                                                                                                                                                         |

 

 

91

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                               |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.22+(18)           |       | Employment  Agreement with Robert H. J. Fastenau, dated November 28, 2006                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                          |
| 10.23(19)            |       | Description of  Compensation for Executive Vice President and Chief Financial Officer Raymond  A. Link                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                          |
| 10.24+               |       | Offer Letter of  Employment to Benjamin Loh, dated May 5, 2007                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                          |
| 10.25+(22)           |       | Description of  Compensation for President and Chief Executive Officer, Don R. Kania                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                          |
| 14(11)               |       | Code of Ethics                                                                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                          |
| 21                   |       | Subsidiaries                                                                                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                          |
| 23                   |       | Consent of  Deloitte & Touche, LLP                                                                                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                                          |
| 31.1                 |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) or Rule 15d-14(a) of the Securities  Exchange Act of 1934, as adopted pursuant to Section 302 of The  Sarbanes-Oxley Act of 2002                                |
|                 |       |                                                                                                                                                                                                                                                          |
| 31.2                 |       | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) or Rule 15d-14(a) of the Securities  Exchange Act of 1934, as adopted pursuant to Section 302 of The  Sarbanes-Oxley Act of 2002                                |
|                 |       |                                                                                                                                                                                                                                                          |
| 32.1                 |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(b) or Rule 15d-14(b) of the Securities  Exchange Act of 1934 and 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  Rule 13a-14(b) or Rule 15d-14(b) of the Securities  Exchange Act of 1934 and 18 U.S.C. Section 1350 as adopted pursuant to  Section 906 of The Sarbanes-Oxley Act of 2002 |

----

(1)   Incorporatedby reference to our Registration Statement of Form S-1, as amended,effective May 31, 1995 (Commission Registration No. 33-71146).

(2)   Incorporatedby reference to our Annual Report on Form 10-K for the year ended December 31,1995.

(3)   Incorporatedby reference to our Quarterly Report on Form 10-Q for the quarter ended September 28,1997.

(4)   Incorporatedby reference to our Registration Statement on Form S-3, filed on April 23,2001.

(5)   Incorporatedby reference to our Registration Statement of Form S-3, as amended,effective November 7, 2001.

(6)   Incorporatedby reference to our Annual Report on Form 10-K for the year ended December 31,2001.

(7)   Incorporatedby reference to our Annual Report on Form 10-K for the year ended December 31,2002.

(8)   Incorporatedby reference to our Quarterly Report on Form 10-Q for the quarter ended March 30,2003.

(9)   Incorporatedby reference to our Quarterly Report on Form 10-Q for the quarter ended June 29,2003.

(10) Incorporatedby reference to our Quarterly Report on Form 10-Q for the quarter ended September 28,2003.

(11) Incorporatedby reference to our Annual Report on Form 10-K for the year ended December 31,2003.

(12) Incorporatedby reference to our Annual Report on Form 10-K for the year ended December 31,2004.

(13) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on July 27, 2005.

(14) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on October 24, 2005.

(15) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on August 22, 2006.

(16) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on May 23, 2006.

(17) Incorporatedby reference to our Quarterly Report on Form 10-Q for the quarter ended July 2,2006.

(18) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on December 4, 2006.

(19) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on May 27, 2005.

(20) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on February 27, 2007.

(21) Incorporatedby reference to our Annual Report on Form 10-K filed with the Securitiesand Exchange Commission on March 1, 2007.

(22) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on July 27, 2006.

(23) Incorporatedby reference to our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on February 26, 2008.

 

 

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** **

**SIGNATURES**

 

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

 
| Date:  February 29, 2008 |   | FEI COMPANY              |
|-------------------------------|--------|--------------------------|
|                          |   |                     |
|                          |   | By                       | /s/ DON R. KANIA |
|                          |   | Don R. Kania             |
|                          |   | Director,  President and |
|                          |   | Chief Executive  Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities indicated on February 29, 2008:

 
| **Signature**             | ** ** | **Title**                                             |
|---------------------------|------------|-------------------------------------------------------|
|                      |       |                                                  |
| /s/ DON R. KANIA          |       | Director,  President and                              |
| Don R. Kania              |       | Chief Executive  Officer                              |
|                      |       | (Principal  Executive Officer)                        |
|                      |       |                                                  |
| /s/ RAYMOND A.  LINK      |       | Executive Vice  President and Chief Financial         |
| Raymond A. Link           |       | Officer  (Principal Financial and Accounting Officer) |
|                      |       |                                                  |
| /s/ MICHAEL J.  ATTARDO   |       | Director                                              |
| Michael J.  Attardo       |       |                                                  |
|                      |       |                                                  |
| /s/ LAWRENCE A.  BOCK     |       | Director                                              |
| Lawrence A. Bock          |       |                                                  |
|                      |       |                                                  |
| /s/ WILFRED J.  CORRIGAN  |       | Director                                              |
| Wilfred J.  Corrigan      |       |                                                  |
|                      |       |                                                  |
| /s/ THOMAS F.  KELLY      |       | Director                                              |
| Thomas F. Kelly           |       |                                                  |
|                      |       |                                                  |
| /s/ WILLIAM W.  LATTIN    |       | Director                                              |
| William W.  Lattin        |       |                                                  |
|                      |       |                                                  |
| /s/JAN C.  LOBBEZOO       |       | Director                                              |
| Jan C. Lobbezoo           |       |                                                  |
|                      |       |                                                  |
| /s/ GERHARD H.  PARKER    |       | Director                                              |
| Gerhard H.  Parker        |       |                                                  |
|                      |       |                                                  |
| /s/ JAMES T.  RICHARDSON  |       | Chairman of the  Board                                |
| James T.  Richardson      |       |                                                  |
|                      |       |                                                  |
| /s/ DONALD R.  VANLUVANEE |       | Director                                              |
| Donald R.  VanLuvanee     |       |                                                  |

 

 

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