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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
  FORM 10-Q  (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 26, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from ________to _________ Commission file number 000-26911 THERMA-WAVE, INC. 
  Delaware
    
    94-3000561(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer Identification Number)
 1250 Reliance Way
Fremont, California 94539 
  (510) 668-2200 
  Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES x NO o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES x NO o Indicate the number of shares outstanding of the issuers class of common
stock, as of the latest practical date: Class
Common stock, $0.01 par value
    
    Outstanding as of October 26, 2004
36,002,246




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THERMA-WAVE, INC.
TABLE OF CONTENTS Page No.PART I. FINANCIAL INFORMATIONITEM 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of September 30, 2004 and March 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the Three and Six Months Ended September 30, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the Six Months Ended September 30, 2004 and 2003
    
    
    6Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    7ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    22ITEM 4. Controls and Procedures
    
    
    23PART II. OTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    24ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    24ITEM 3. Defaults Upon Senior Securities
    
    
    24ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    24ITEM 5. Other Information
    
    
    24ITEM 6. Exhibits
    
    
    24SIGNATURESEXHIBIT 22.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




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PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED
BALANCE SHEETS

(In thousands, except share and per share data)
 (Unaudited)
 September 30,
    
    March 31,2004
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    17,205
    
    
    $
    23,899Accounts receivable, net of allowances of $724 and $907 as of
September 30, 2004 and March 31, 2004, respectively
    
    
    18,383
    
    
    
    14,772Inventories
    
    
    22,603
    
    
    
    17,169Other current assets
    
    
    2,489
    
    
    
    2,075Total current assets
    
    
    60,680
    
    
    
    57,915Property and equipment, net
    
    
    3,831
    
    
    
    4,564Other assets, net
    
    
    2,642
    
    
    
    2,710Total assets
    
    $
    67,153
    
    
    $
    65,189LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    10,074
    
    
    $
    7,420Accrued liabilities
    
    
    15,400
    
    
    
    15,730Deferred revenues
    
    
    6,098
    
    
    
    6,887Total current liabilities
    
    
    31,572
    
    
    
    30,037Non-current deferred revenues
    
    
    1,252
    
    
    
    1,815Other long-term liabilities
    
    
    1,090
    
    
    
    1,073Total liabilities
    
    
    33,914
    
    
    
    32,925Commitments and contingencies (Note 5)Stockholders equity:Common stock, $0.01 par value; 75,000,000 shares authorized;35,866,187 shares issued and outstanding at September 30, 2004;35,498,025 shares issued and outstanding at March 31, 2004
    
    
    359
    
    
    
    355Additional paid-in capital
    
    
    335,176
    
    
    
    335,012Notes receivable from stockholders
    
    
    (174
    )
    
    
    (174
    )Accumulated other comprehensive loss
    
    
    (868
    )
    
    
    (735
    )Deferred stock-based compensation
    
    
    (380
    )
    
    
    (1,172
    )Accumulated deficit
    
    
    (300,874
    )
    
    
    (301,022
    )Total stockholders equity
    
    
    33,239
    
    
    
    32,264Total liabilities and stockholders equity
    
    $
    67,153
    
    
    $
    65,189
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 3




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THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except per share data)
 (Unaudited)
 Three months ended September 30,
    
    Six months ended September 30,2004
    
    2003
    
    2004
    
    2003Net revenuesProduct
    
    $
    17,528
    
    
    $
    9,604
    
    
    $
    33,717
    
    
    $
    16,411Services and parts
    
    
    5,074
    
    
    
    4,462
    
    
    
    10,036
    
    
    
    9,558Total net revenues
    
    
    22,602
    
    
    
    14,066
    
    
    
    43,753
    
    
    
    25,969Cost of revenues (1)
    
    
    11,830
    
    
    
    8,499
    
    
    
    22,261
    
    
    
    17,570Gross profit
    
    
    10,772
    
    
    
    5,567
    
    
    
    21,492
    
    
    
    8,399Operating expenses:Research and development (2)
    
    
    4,412
    
    
    
    5,183
    
    
    
    8,791
    
    
    
    10,131Selling, general and administrative (3)
    
    
    5,935
    
    
    
    5,854
    
    
    
    11,691
    
    
    
    11,383Restructuring, severance and other
    
    
    
    
    
    
    108
    
    
    
    373
    
    
    
    1,592Stock-based compensation expense (benefit) (4)
    
    
    (868
    )
    
    
    204
    
    
    
    565
    
    
    
    414Total operating expenses
    
    
    9,479
    
    
    
    11,349
    
    
    
    21,420
    
    
    
    23,520Operating income (loss)
    
    
    1,293
    
    
    
    (5,782
    )
    
    
    72
    
    
    
    (15,121
    )Other income (expense):Interest expense
    
    
    (8
    )
    
    
    (24
    )
    
    
    (8
    )
    
    
    (45
    )Interest income
    
    
    48
    
    
    
    66
    
    
    
    90
    
    
    
    103Other, net
    
    
    (13
    )
    
    
    12
    
    
    
    (3
    )
    
    
    (199
    )Total other income (expense), net
    
    
    27
    
    
    
    54
    
    
    
    79
    
    
    
    (141
    )Income (loss) before provision for income taxes
    
    
    1,320
    
    
    
    (5,728
    )
    
    
    151
    
    
    
    (15,262
    )Provision for income taxes
    
    
    3
    
    
    
    
    
    
    
    3
    
    
    
    Net income (loss)
    
    $
    1,317
    
    
    $
    (5,728
    )
    
    $
    148
    
    
    $
    (15,262
    )Net income (loss) per share:Basic
    
    $
    0.04
    
    
    $
    (0.19
    )
    
    $
    0.00
    
    
    $
    (0.52
    )Diluted
    
    $
    0.03
    
    
    $
    (0.19
    )
    
    $
    0.00
    
    
    $
    (0.52
    )Weighted average common shares outstanding:Basic
    
    
    35,824
    
    
    
    30,036
    
    
    
    35,731
    
    
    
    29,370Diluted
    
    
    37,949
    
    
    
    30,036
    
    
    
    37,882
    
    
    
    29,370
   (1)
    
    Includes stock-based compensation expense (benefit) of $(262) and $15 for the three months ended September 30, 2004 and
2003, respectively, and $56 and $16 for the six months ended September 30, 2004 and 2003, respectively.(2)
    
    Stock-based compensation expense (benefit) is reported separately in operating expenses. The amount attributable to
research and development is $(564) and $126 for the three months ended September 30, 2004 and 2003, respectively, and $322
and $250 for the six months ended September 30, 2004 and 2003, respectively. 4




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(3)
    
    Stock-based compensation expense (benefit) is reported separately in operating expenses. The amount attributable to
selling, general and administrative is $(304) and $78 for the three months ended September 30, 2004 and 2003, respectively,
and $243 and $164 for the six months ended September 30, 2004 and 2003, respectively.(4)
    
    Stock-based compensation expense (benefit) related to operating expenses, including research and development (see footnote
(2)) and selling, general and administrative (see footnote (3)). The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5




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THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS

(In thousands)
 (Unaudited)
 Six months ended September 30,2004
    
    2003Operating activities:Net income (loss)
    
    $
    148
    
    
    $
    (15,262
    )Adjustments to reconcile net income (loss) to net cash used in operating activities:Depreciation and amortization of property and equipment
    
    
    1,322
    
    
    
    2,388Amortization of intangible assets
    
    
    403
    
    
    
    598Amortization of stock-based compensation
    
    
    621
    
    
    
    430Provision (credit) for doubtful accounts receivable
    
    
    (183
    )
    
    
    (1,013
    )Provision for excess, obsolete and reduced-cost inventories
    
    
    1,888
    
    
    
    3,419Loss on disposal of property and equipment
    
    
    15
    
    
    
    191Loss on sale of an investment
    
    
    
    
    
    
    125Changes in operating assets and liabilities:Accounts receivable
    
    
    (3,428
    )
    
    
    4,169Inventories
    
    
    (7,322
    )
    
    
    25Other assets
    
    
    (388
    )
    
    
    1,293Accounts payable
    
    
    2,654
    
    
    
    929Accrued and other liabilities
    
    
    (313
    )
    
    
    (2,175
    )Deferred revenues
    
    
    (1,352
    )
    
    
    345Net cash used in operating activities
    
    
    (5,935
    )
    
    
    (4,538
    )Investing activities:Purchases of property and equipment
    
    
    (604
    )
    
    
    (37
    )Proceeds from sale of an investment
    
    
    
    
    
    
    375Purchase of patents
    
    
    (361
    )
    
    
    (363
    )Net cash used in investing activities
    
    
    (965
    )
    
    
    (25
    )Financing activities:Restricted cash
    
    
    
    
    
    
    1,064Proceeds from issuance of common stock
    
    
    339
    
    
    
    11,988Proceeds from note receivable from stockholders
    
    
    
    
    
    
    22Net cash provided by financing activities
    
    
    339
    
    
    
    13,074Effect of exchange rates on cash
    
    
    (133
    )
    
    
    346Net increase (decrease) in cash and cash equivalents
    
    
    (6,694
    )
    
    
    8,857Cash and cash equivalents at beginning of period
    
    
    23,899
    
    
    
    13,695Cash and cash equivalents at end of period
    
    $
    17,205
    
    
    $
    22,552Supplementary disclosures:Cash paid for interest
    
    $
    
    
    
    $
    22Cash paid for taxes
    
    $
    239
    
    
    $
    9
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 6




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THERMA-WAVE, INC. 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (As of September 30, 2004) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission and include the accounts of Therma-Wave, Inc. (we, our, the
Company) and its wholly-owned subsidiaries. Certain information and footnote
disclosures, normally included in financial statements prepared in accordance
with generally accepted accounting principles, have been condensed or omitted
pursuant to such rules and regulations. In our opinion, the financial
statements reflect all adjustments, consisting only of normal, recurring
adjustments, necessary for a fair statement of the financial position at
September 30, 2004, the operating results for the three and six months ended
September 30, 2004 and 2003, and the cash flows for the six months ended
September 30, 2004 and 2003. These financial statements and notes should be
read in conjunction with our audited financial statements and the notes thereto
included in our Form 10-K for the year ended March 31, 2004. The results of operations for the interim periods are not necessarily
indicative of the results of operations that may be expected for any other
period or for the fiscal year, which ends on April 3, 2005. The second quarters of fiscal years 2005 and 2004 and the fiscal year 2004
ended on September 26, 2004, September 28, 2003 and March 28, 2004,
respectively. For presentation purposes, the accompanying unaudited condensed
consolidated financial statements have been shown as ending on the last day of
the calendar quarter closest to each of these dates. Revenue Recognition Revenues are recognized when our contractual obligations have been
performed, title and risk of ownership have passed to the customer,
collectibility of the sales price has been reasonably assured and customer
acceptance has been obtained, if applicable. Shipments typically are made in
compliance with shipment requirements specified in our customers purchase
order. Freight terms of sales are FOB shipping point unless otherwise
negotiated and agreed in writing between our customer and us. Systems Revenues.Systems (product) sales are accounted for as
multiple-element arrangement sales that require the deferral of a significant
portion of revenues in the amount of the greater of the fair market value of
installation and related post shipment services or a percentage of payment
subject to acceptance. Systems revenues are allocated on a fair value basis to
each component of the multiple-element arrangement. Revenues on each element
are recognized when the contractual obligations have been performed, title and
risk of ownership have passed to the customer, collectibility of the sales
price has been reasonably assured and customer acceptance has been obtained, if
applicable. Estimated contractual warranty obligations are recorded as cost of
revenues when related systems sales are shipped. Systems revenues on newly introduced products are deferred at shipment and
recognized upon customer acceptance. Systems revenues are also deferred when
the customer has the right to return the product for credit. In such cases,
systems revenues are not recognized until all of the following conditions have
been evidenced after the customers purchase order has been fulfilled: the
right of return has expired, and any potential returns would require
authorization by our company under warranty provisions; the price of sales is
fixed or determinable; the payment terms are fixed and enforceable, and
collectibility is reasonably assured. Services Revenues.We derive services revenues from three primary sources:
sale of spare parts, service contracts and service labor. Revenues on the sale
of spare parts are recognized when spare parts have been shipped and title and
risk of ownership have transferred to the customer and collectibility of the
sales price has been reasonably assured. Revenues on service contracts are
deferred and recognized on a straight-line basis over the period of the
contract. Revenues on time and material services performed are recognized when
the services are completed, collectibility of the sales price has been
reasonably assured and customer acceptance has been obtained, if applicable. 7




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Deferred Revenues.Deferred revenues arise from systems (product) sales
and service contracts. Revenues on service contracts are deferred and
recognized on a straight-line basis over the respective contract term. Systems
sales are accounted for as multiple-element arrangements that require the
deferral of a significant portion of revenues in the amount of the greater of
the fair market value of installation and related post shipment services or the
percentage of payment subject to acceptance. Systems revenues are allocated on
a fair value basis to each component of the multiple-element arrangement.
Revenues on each element are recognized when contractual obligations have been
performed, title and risk of ownership have passed to the customer,
collectibility of the sales price has been reasonably assured and customer
acceptance has been obtained if applicable. In accordance with SAB 104, we evaluate our systems sales to determine the
appropriate timing for revenue recognition for each of the multiple elements
involved in each sale. This sometimes results in deferrals of revenues from the
period in which the tool is shipped to future periods. Reclassifications Certain prior year amounts in the unaudited condensed consolidated
statements of cash flows have been changed to conform to current period
classifications. Stock-Based Compensation In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, Accounting for Stock-Based Compensation. The Company has applied
Accounting Principles Board Opinion No. 25 in accounting for its stock option
plans and has adopted the disclosure provisions of SFAS No. 123. In April 2000,
the Financial Accounting Standards Board issued FASB Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation: An
Interpretation of APB No. 25. The Company has adopted the provisions of FIN
44, and such adoption did not materially impact the Companys results of
operations. In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation Transition and Disclosure. The statement amends SFAS
No. 123 to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. The Company has adopted the disclosure provisions of SFAS No.
148. Had compensation costs been determined based upon the fair value at the
grant date for awards under the stock option plans and employee stock purchase
plans, consistent with the methodology prescribed under SFAS No. 123, our pro
forma net loss and pro forma net loss per share under SFAS No. 123 would have
been: Three Months Ended
    
    Six Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss) (in thousands,
except per share data)As reported
    
    $
    1,317
    
    
    $
    (5,728
    )
    
    $
    148
    
    
    $
    (15,262
    )Stock-based employee
compensation expense (benefit)
included in the determination of net loss, as reported
    
    
    (1,130
    )
    
    
    219
    
    
    
    621
    
    
    
    430Stock-based employee
compensation expense as
determined using the fair value
method
    
    
    (950
    )
    
    
    (952
    )
    
    
    (2,351
    )
    
    
    (2,148
    )Pro forma net loss
    
    $
    (763
    )
    
    $
    (6,461
    )
    
    $
    (1,582
    )
    
    $
    (16,980
    )Basic income (loss) per shareAs reported
    
    $
    0.04
    
    
    $
    (0.19
    )
    
    $
    0.00
    
    
    $
    (0.52
    )Pro forma
    
    $
    (0.02
    )
    
    $
    (0.22
    )
    
    $
    (0.04
    )
    
    $
    (0.58
    )Diluted income (loss) per shareAs reported
    
    $
    0.03
    
    
    $
    (0.19
    )
    
    $
    0.00
    
    
    $
    (0.52
    )Pro forma
    
    $
    (0.02
    )
    
    $
    (0.22
    )
    
    $
    (0.04
    )
    
    $
    (0.58
    )
 8




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The weighted average grant-date fair value of our stock options was $2.70
and $1.59 for the three months ended September 30, 2004 and 2003, respectively,
and $2.77 and $1.12 for the six months ended September 30, 2004 and 2003,
respectively. These values were estimated using the Black-Scholes pricing model
with the following assumptions: Three Months Ended
    
    Six Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Risk-free interest rate
    
    
    3.1
    %
    
    
    4.2
    %
    
    
    3.1
    %
    
    
    3.9
    %Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expected volatility
    
    
    96
    %
    
    
    118
    %
    
    
    97
    %
    
    
    118
    %Expected life in years
    
    
    5.0
    
    
    
    2.8
    
    
    
    5.0
    
    
    
    3.4
 The weighted average grant-date fair value of our stock purchase rights
granted under our employee stock purchase plans was $0.82 and $0.26 for the
three months ended September 30, 2004 and 2003, respectively, and $0.27 and
$0.24 for the six months ended September 30, 2004 and 2003, respectively. These
values were estimated using the Black-Scholes pricing model with the following
assumptions: Three Months Ended
    
    Six Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Risk-free interest rate
    
    
    1.4
    %
    
    
    1.1
    %
    
    
    1.3
    %
    
    
    1.0
    %Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expected volatility
    
    
    58
    %
    
    
    93
    %
    
    
    77
    %
    
    
    103
    %Expected life in years
    
    
    1.24
    
    
    
    0.97
    
    
    
    1.15
    
    
    
    0.85
 Stock-based employee compensation expense (benefit) included in net income
as reported includes amounts for two events, specifically, the stock options
assumed during the acquisition of Sensys Corporation, and the stock option
exchange on September 10, 2003. As part of the acquisition of Sensys, we recorded $3.5 million of
stock-based compensation to be amortized over the vesting period of the
options. The related deferred stock compensation amortization expenses were
$44,000, $0.3 million, and $0.2 million for the three months ended September
30, 2004, June 30, 2004 and September 30, 2003, respectively, a portion of
which was included in cost of revenues. For the six months ended September 30,
2004 and 2003, respectively, deferred stock compensation amortization expenses
were $0.3 million and $0.4 million. These charges reflect the vesting schedules
of the stock options and reductions in headcount due to employee turnover and
reduction in force programs that began during fiscal 2003 and continued through
the first three quarters of fiscal 2004. As of September 30, 2004, $0.2 million
of deferred stock compensation related to the Sensys acquisition remains to be
amortized over future periods ending in January 2006. We recorded a benefit from the amortization of deferred compensation
expense related to the variable accounting treatment for stock options of $1.2
million for the three months ended September 30, 2004. For the six months ended
September 30, 2004, we have recorded an expense of $0.3 million from the
amortization of deferred compensation expense related to the variable
accounting treatment for stock options. These expenses and benefits reflect the
options eligible for exchange that were outstanding since September 10, 2003
and the options issued to eligible participants within the six months prior to
or following September 10, 2003. Due to variable accounting, compensation
expense is being recorded for the pro-rata vesting of these options over time
based on increases or decreases in the period-end stock price over and above
the exercise price of the new options. In future quarters, the expense could
increase as more shares become vested and if the stock price increases.
Reductions to expense may also be recorded if the stock price decreases, but
such reductions will be limited to the amount of net expense previously
recorded. 9




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2. Balance Sheet Components September 30,
    
    March 31,2004
    
    2004(In thousands)Inventory:Purchased materials
    
    $
    8,494
    
    
    $
    6,066Systems in process
    
    
    9,911
    
    
    
    8,158Finished systems
    
    
    4,198
    
    
    
    2,945Total inventory
    
    $
    22,603
    
    
    $
    17,169
 September 30,
    
    March 31,2004
    
    2004(In thousands)Property and equipment:Laboratory and test equipment
    
    $
    4,846
    
    
    $
    6,014Office furniture and equipment
    
    
    10,546
    
    
    
    10,100Machinery and equipment
    
    
    694
    
    
    
    819Leasehold improvements
    
    
    8,639
    
    
    
    8,612Total property and equipment, gross
    
    
    24,725
    
    
    
    25,545Accumulated depreciation and
amortization
    
    
    (20,894
    )
    
    
    (20,981
    )Total property and equipment, net
    
    $
    3,831
    
    
    $
    4,564
 During the first six months of fiscal 2005, the company disposed of
equipment having a gross value of $1,424,000 and accumulated depreciation of
$1,409,000. There was a loss of approximately $15,000 on the disposals. September 30,
    
    March 31,2004
    
    2004(In thousands)Accrued liabilities:Accrued compensation and related expenses
    
    $
    2,663
    
    
    $
    2,368Accrued warranty costs
    
    
    1,579
    
    
    
    1,731Commissions payable
    
    
    1,940
    
    
    
    893Income tax payable
    
    
    4,849
    
    
    
    4,870Other accrued liabilities
    
    
    4,369
    
    
    
    5,868Total accrued liabilities
    
    $
    15,400
    
    
    $
    15,730
 3. Comprehensive Income (Loss) Comprehensive income (loss) consists of net income (loss) for the period
and the change in accumulated foreign currency translation adjustments during
the period. For the three months ended September 30, 2004 and 2003,
comprehensive income (loss) amounted to approximately $1.3 million and $(5.5)
million, respectively. For the six months ended September 30, 2004 and 2003,
comprehensive income (loss) amounted to approximately $15,000 and $(14.9)
million, respectively. 4. Net Income (Loss) Per Share Basic net income (loss) per share is based on the weighted-average number
of common shares outstanding excluding contingently issuable or returnable
shares such as unvested common stock or shares that contingently convert into
common stock upon certain events. Diluted net income (loss) per share is based
on the weighted average number of common shares outstanding and the potential
dilution of securities, by including stock options, outstanding warrants, less
the share equivalents in deferred stock-based compensation related to the
Sensys acquisition and the variable accounting treatment of certain stock
options in the weighted average
number of common shares outstanding for a period, to the extent they are
dilutive. 10




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##### Table of Contents



Three months ended
    
    Six months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Reconciliation of basic and diluted shares
(in thousands except per share data) and net
income (loss) per share, basic and diluted:Weighted average shares for
basic net income (loss) per
share
    
    
    35,824
    
    
    
    30,036
    
    
    
    35,731
    
    
    
    29,370Weighted average dilutive
stock options outstanding
under the treasury stock
method
    
    
    2,225
    
    
    
    
    
    
    
    2,252
    
    
    
    Deduction for shares
repurchasable under the
treasury stock method based
on the remaining balance in
deferred stock compensation
related to outstanding stock
options from the Sensys
acquisition and the variable
accounting treatment of
certain stock options
    
    
    (100
    )
    
    
    
    
    
    
    (101
    )
    
    
    Weighted average shares for
diluted net income (loss) per
share
    
    
    37,949
    
    
    
    30,036
    
    
    
    37,882
    
    
    
    29,370Net income (loss)
    
    $
    1,317
    
    
    $
    (5,728
    )
    
    $
    148
    
    
    $
    (15,262
    )Net income per share  basic
    
    $
    0.04
    
    
    $
    (0.19
    )
    
    $
    0.00
    
    
    $
    (0.52
    )Net income per share  diluted
    
    $
    0.03
    
    
    $
    (0.19
    )
    
    $
    0.00
    
    
    $
    (0.52
    )
 The following table summarizes securities outstanding (in thousands) as of
September 30, 2004 and 2003, respectively, which were not included in the
calculation of diluted net income (loss) per share for the three months and six
months ending September 30, 2004 and 2003, respectively. As of September 30,2004
    
    2003Stock options
    
    
    2,661
    
    
    
    5,209Warrants
    
    
    47
    
    
    
    79
 The stock options outstanding that were excluded from the net income
(loss) per share had a weighted average exercise price at September 30, 2004
and 2003 of $6.63 and $9.07, respectively. The warrants outstanding that were
excluded from the net income (loss) per share had a weighted average exercise
price at September 30, 2004 and 2003 of $3.82 and $3.68, respectively. 5. Commitments and Contingencies We lease our facilities under non-cancelable operating leases that require
us to pay maintenance and operating expenses, such as taxes, insurance and
utilities. We are required pursuant to the terms of facility leases to maintain
two standby letters of credit totaling $2.6 million. No amounts have been drawn
against these standby letters of credit. 11




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##### Table of Contents



Rent expense was approximately $0.7 million and $0.6 million for the
fiscal quarters ended September 30, 2004 and 2003,
respectively and approximately $1.3 million and $1.5 million for the six
months ended September 30, 2004 and 2003, respectively. As of September 30,
2004, future minimum lease payments under non-cancelable operating leases
(facilities and equipment leases) and sub-lease income due to us under an
existing sub-lease of an excess facility are as follows (in thousands): 2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    Thereafter
    
    TotalContractual ObligationsOperating lease obligations
    
    $
    1,411
    
    
    $
    1,914
    
    
    $
    686
    
    
    $
    666
    
    
    $
    100
    
    
    $
    
    
    
    $
    4,777Sub-lease income (see Note 7)
    
    $
    10
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    10
 On August 12, 2004, we entered into an agreement involving a mutual
exchange of intellectual property rights, effective July 1, 2004. During the
term of the agreement, Therma-Wave agrees to pay a royalty of $50,000 for each
stand-alone tool shipped by Therma-Wave that uses scatterometry to perform CD
measurements and $12,500 for each integrated tool on behalf of a scatterometry
product sold. These royalties are adjustable annually for increases in the
consumer price index. Amounts due under the agreement have been accrued as
liabilities and charged to cost of sales or pre-paid royalties, as appropriate,
as of September 30, 2004. 6. Financing Arrangements In June 2003, we entered into a loan and security agreement with Silicon
Valley Bank (SVB). The agreement includes a $5.0 million domestic line of
credit, including a sub-limit of $5.0 million for letters of credit, and a
$10.0 million Export-Import Bank of the United States (EXIM) guaranteed,
revolving line of credit. These bank credit facilities allow us to borrow money
under the domestic line bearing a floating interest rate equal to the SVB prime
rate plus 1.50% as of September 30, 2004. The EXIM revolving line allows us to
borrow money at a floating interest rate equal to the SVB prime rate plus 1.75%
as of September 30, 2004. We may request advances in an aggregate outstanding
amount not to exceed the lesser of $15.0 million total under the two lines and
the borrowing base, in each case minus the aggregate face amount of outstanding
letters of credit, including any drawn but un-reimbursed letters of credit. Our
borrowings under the SVB and EXIM guaranteed credit facilities are secured by
substantially all of our assets. The credit facility matures on June 11, 2005.
As of September 30, 2004, we had no borrowings and $3.5 million in outstanding
letters of credit under this agreement, none of which have been drawn against.
As of September 30, 2004, we were in compliance with all the covenants in the
agreement. Indemnification We indemnify some of our suppliers and customers for specified
intellectual property rights pursuant to certain parameters and restrictions.
The scope of these indemnities varies but, in some instances, includes
indemnification for damages and expenses (including reasonable attorney fees)
related to any misuse by us of the intellectual property. No amounts have been
accrued in respect of the indemnification provisions. As of September 30, 2004,
we have not incurred any losses under such indemnification during the periods
covered in this report. Legal Proceedings We are not aware of any material legal proceedings pending against us. We
may be required to initiate additional litigation in order to enforce any
patents issued or licensed to us or to determine the scope and/or validity of a
third partys patent or other proprietary rights. In addition, we may be
subject to additional lawsuits by third parties seeking to enforce their own
intellectual property rights. Any such litigation, regardless of outcome, could
be expensive and time consuming and could subject us to significant liabilities
or require us to cease using or to pay license fees for proprietary third party
technology and, consequently, could have a material adverse effect on our
business, financial condition, results of operations or cash flows. 7. Restructuring, Severance and Other Costs The following table summarizes the changes in restructuring, severance and
other costs during the six months ended September 30, 2004 and 2003,
respectively (in thousands): Liability as of
    
    
    
    
    
    
    
    
    
    Liability as ofMarch 31, 2004
    
    Provision
    
    Utilization
    
    September 30, 2004Consolidation of excess facilities
    
    $
    220
    
    
    $
    373
    
    
    $
    (235
    )
    
    $
    358
 Liability as of
    
    
    
    
    
    
    
    
    
    Liability as ofMarch 31, 2003
    
    Provision
    
    Utilization
    
    September 30, 2003Severance and workforce reduction
    
    $
    558
    
    
    $
    1,418
    
    
    $
    (1,951
    )
    
    $
    25Consolidation of excess facilities
    
    
    662
    
    
    
    82
    
    
    
    (280
    )
    
    
    464Other
    
    
    134
    
    
    
    92
    
    
    
    (171
    )
    
    
    55$
    1,354
    
    
    $
    1,592
    
    
    $
    (2,402
    )
    
    $
    544
 12




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##### Table of Contents



Our restructuring liability as of September 30, 2004 for consolidation of
excess facilities includes the benefit of less than $0.1 million due to an
estimate of future sub-lease income on one excess facility. 8. Warranty Accrual At the time of revenue recognition, we provide an accrual for estimated
costs to be incurred pursuant to our warranty obligation. Our estimate is based
primarily on historical experience. Changes in the warranty accrual during the
six months ended September 30, 2004 and 2003, respectively, are summarized (in
thousands) as follows: Provision for
    
    Settlement ofBeginning
    
    Warranties Issued
    
    Pre-Existing
    
    EndingBalance
    
    During the Period
    
    Warranties
    
    BalanceSix Months Ended September 30, 2004
    
    $
    1,731
    
    
    $
    632
    
    
    $
    (784
    )
    
    $
    1,579Six Months Ended September 30, 2003
    
    $
    983
    
    
    $
    925
    
    
    $
    (598
    )
    
    $
    1,310
 9. Other Assets, Net Capitalized patent acquisition costs are included in non-current other
assets, net. Capitalized patent acquisition costs are amortized over the
estimated useful life of the patent, generally five years. During the quarter
ended September 30, 2004, amortization of patent assets was $0.2 million,
compared to $0.2 million for the quarter ended September 30, 2003. During the
six months ended September 30, 2004, amortization of patent assets was $0.4
million, compared to $0.4 million for the six months ended September 30, 2003.
The six months ended September 30, 2003 included additional amortization of
$0.2 million for a development contract acquired in the Sensys acquisition and
fully expensed as of December 31, 2003. 10. Segment Information We operate in one segment as we manufacture, market and service process
control metrology systems within the semiconductor equipment market. All
products and services are marketed in each geographic region in which we
operate. Net revenues from external customers are attributed to individual
countries based on the location to which the products or services are being
delivered. Revenues from Europe are the sum of net revenues generated in the
United Kingdom, Germany, France, Italy, Israel and Ireland, among others, each
of which does not represent greater than 10% of total net revenues. The
following table summarizes the percentage of our total net revenues by
geography for the three and six months ended September 30, 2004 and 2003,
respectively: Three Months Ended
    
    Six Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues by CountryUnited States
    
    
    26
    %
    
    
    30
    %
    
    
    26
    %
    
    
    39
    %Taiwan
    
    
    25
    %
    
    
    35
    %
    
    
    16
    %
    
    
    22
    %Japan
    
    
    19
    %
    
    
    10
    %
    
    
    15
    %
    
    
    13
    %Europe
    
    
    12
    %
    
    
    18
    %
    
    
    11
    %
    
    
    16
    %Korea
    
    
    11
    %
    
    
    5
    %
    
    
    14
    %
    
    
    4
    %China
    
    
    4
    %
    
    
    1
    %
    
    
    8
    %
    
    
    4
    %Singapore
    
    
    3
    %
    
    
    1
    %
    
    
    10
    %
    
    
    2
    %Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 13




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##### Table of Contents



Revenues in each geographic area are recognized according to our revenue
recognition policy as described in Note 1 to the accompanying Notes to
Unaudited Condensed Consolidated Financial Statements. Transfers and commission
arrangements between geographic areas are at prices sufficient to recover a
reasonable profit. International sales were $16.8 million and $9.9 million in
the second quarters of fiscal 2005 and 2004, respectively. International sales
were $32.6 million and $15.7 million in the first six months of fiscal 2005 and
2004, respectively. Three customers each accounted for 19%, 11% and 11% of our net revenues
for the three months ended September 30, 2004. For the three months ended
September 30, 2003, three customers each accounted for 24%, 14% and 11% of our
net revenues. Two customers each accounted for 11% and 10% of our net revenues
for the six months ended September 30, 2004. For the six months ended September
30, 2003, three customers each accounted for 22%, 14% and 10 % of our net
revenues. The following is a summary of operations in geographic areas (in
thousands). The net revenues reported here reflect the location of operations,
not the location to which the products were delivered. Other foreign areas
include the United Kingdom, Japan, China, Taiwan, Israel and Korea, each of
which is individually not material for separate disclosure. Substantially all
of our long-lived assets are located in the United States. United States
    
    All Other Locations
    
    Eliminations
    
    ConsolidatedThree Months Ended September 30, 2004Sales to unaffiliated customers
    
    $
    20,144
    
    
    $
    2,458
    
    
    $
    
    
    
    $
    22,602Transfers between geographic locations
    
    $
    (557
    )
    
    $
    666
    
    
    $
    (109
    )
    
    $
    Total net revenues
    
    $
    19,587
    
    
    $
    3,124
    
    
    $
    (109
    )
    
    $
    22,602Operating income
    
    $
    760
    
    
    $
    153
    
    
    $
    380
    
    
    $
    1,293Three Months Ended September 30, 2003Sales to unaffiliated customers
    
    $
    12,074
    
    
    $
    1,992
    
    
    $
    
    
    
    $
    14,066Transfers between geographic locations
    
    $
    (248
    )
    
    $
    545
    
    
    $
    (297
    )
    
    $
    Total net revenues
    
    $
    11,826
    
    
    $
    2,537
    
    
    $
    (297
    )
    
    $
    14,066Operating income (loss)
    
    $
    (5,793
    )
    
    $
    79
    
    
    $
    (68
    )
    
    $
    (5,782
    )Six Months Ended September 30, 2004Sales to unaffiliated customers
    
    $
    38,926
    
    
    $
    4,827
    
    
    $
    
    
    
    $
    43,753Transfers between geographic locations
    
    $
    (184
    )
    
    $
    1,076
    
    
    $
    (892
    )
    
    $
    Total net revenues
    
    $
    38,742
    
    
    $
    5,903
    
    
    $
    (892
    )
    
    $
    43,753Operating income (loss)
    
    $
    (304
    )
    
    $
    (14
    )
    
    $
    390
    
    
    $
    72Six Months Ended September 30, 2003Sales to unaffiliated customers
    
    $
    21,774
    
    
    $
    4,195
    
    
    $
    
    
    
    $
    25,969Transfers between geographic locations
    
    $
    40
    
    
    $
    1,048
    
    
    $
    (1,088
    )
    
    $
    Total net revenues
    
    $
    21,814
    
    
    $
    5,243
    
    
    $
    (1,088
    )
    
    $
    25,969Operating income (loss)
    
    $
    (14,982
    )
    
    $
    269
    
    
    $
    (408
    )
    
    $
    (15,121
    )
 14




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations This Quarterly Report on Form 10-Q contains forward-looking statements as
that term is defined in the Private Securities Reform Act of 1995, which are
subject to known and unknown risks and uncertainties that could cause actual
results to differ materially from those expressed or implied by such
statements. The words believe, expect, anticipate, intend and other
similar expressions generally identify forward-looking statements. Potential
investors are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of their dates. Statements relating to our
ability to manage our costs and reduce operating expenses, sustain our
operations and cash position, continue the successful development and
introduction of new products and improvement of current products, and trends in
our financial performance are all based on current expectations. Such
statements are subject to risks, uncertainties and changes in conditions,
particularly those related to industry performance, political unrest, disease,
epidemics, foreign currency exchange rates, activities and potential successes
of competitors and competing products and other risks, some of which are
detailed in documents filed with the Securities and Exchange Commission,
including specifically Exhibit 99.1 to our annual report on Form 10-K for the
year ended March 31, 2004. See also the discussion of forward-looking
statements related to market risk in the first paragraph of Item 3 below. We
undertake no obligation to update the information in this quarterly report on
Form 10-Q. SEC Reports Our quarterly reports on Form 10-Q, annual reports on Form 10-K, current
reports on Form 8-K, and all amendments to these reports filed with the U.S.
Securities and Exchange Commission, are available for review free of charge on
the SECs website and through a link to the SEC website on our website at
www.thermawave.com as soon as reasonably practicable after such material is
electronically filed or furnished to the SEC. Overview Therma-Wave develops, manufactures, markets and services process control
metrology systems used in the manufacture of semiconductors. Process control
metrology is used to monitor process parameters in order to enable
semiconductor manufacturers to improve device performance, maintain high
overall manufacturing yield, reduce the size of the circuit features,
characterize new materials and film stacks as they are introduced at each
technology node and increase equipment productivity. Our current product
families, Therma-Probe®, Opti-Probe®, Opti-Probe RT/CD® and Integra® integrated
metrology products, use proprietary and patented technology to produce precise,
non-contact, non-destructive measurement for the basic building blocks, or
process modules, in the manufacture of integrated circuits. Market Opportunity During the course of implementing several complex process steps in
semiconductor manufacturing, it has grown increasingly necessary to monitor the
failure rate of semiconductor devices as well as the quality of the underlying
process steps, particularly as line widths shrink, metal levels increase and
new materials are introduced into the process. Generally speaking, the
manufacturing process is monitored and diagnosed using two methodologies:  
    
    measuring specific results to determine whether process steps, or a
sequence of process steps, are performing according to specifications,
which is referred to as metrology; and  
    
    determining the locations of yield limiting defects on the wafer,
which is referred to as defect review and analysis. Therma-Waves products primarily address process control related metrology
applications. We are seeing a rapid increase in the use of metrology at all
steps in the process. This reiterates the importance that customers assign to
these measurements. This trend is only expected to accelerate with the rapid
introduction and deployment of new substrates and materials as well as changes
in device structures. The complexity resulting from the combination of new
materials, new structures and device scaling has led to an explosion of process
control challenges. These process control challenges have to be addressed in
order to maintain the trajectory dictated by
Moores law. 15




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##### Table of Contents



Advanced process control, in which a sequence of steps is actively
controlled through feed-forward and feedback techniques, is becoming the norm
especially for the most demanding steps such as gate patterning. Both
stand-alone and integrated metrology are integral to advanced process control.
Novel metrology solutions using optical CD technology are gradually adding
capability to traditional CD-SEM metrology and have enabled this advanced
process control loop. Therma-Waves ion implant and thin film measurement products, including
related service and parts revenues, comprise the majority of our revenues
today. These mature product lines have allowed us to expand into the new
applications that arise at each technology node, resulting in a continually
increasing total available market. Products Therma-Waves metrology solutions for thin film, CD and implant processes
enable many of the advanced process control loops that directly impact device
performance. Our products are used to produce precise, non-contact,
nondestructive measurements on product as well as on test wafers for each basic
process module in the manufacture of integrated circuits. Therma-Waves
metrology platforms, with their unique multi-optical technology, address
measurement requirements for an ever-expanding range of advanced applications.
At the same time, they offer high productivity for the multitude of routine
measurements that must be performed in a process fab. These include ion
implant, dielectric film deposition and etching, conductor film deposition and
etching, chemical mechanical planarization and wafer patterning. Core Products Today: Thin Films  Ion Implant Metrology Therma-Probe and Opti-Probe systems are two well-established, major
product families of in-line process control metrology equipment. Therma-Probe: The Therma-Probe systems employ proprietary thermal wave
technology that uses highly focused but low power laser beams to generate and
detect thermal and plasma wave signals in the silicon wafer. Proprietary
software correlates the signals to the ion implant dose. Recently the
capability of the Therma-Probe has been expanded to include ultra shallow
junction depth and abruptness, both of which must be tightly controlled in
order to achieve the desired device performance. Unlike previous ion implant
metrology systems, the Therma-Probe systems utilize a totally non-contact,
non-damaging technology and thus can be used to monitor product wafers
immediately after the ion implantation process as well as following dopant
activation annealing. These features have been integrated into an easy-to-use
and reliable package with automated wafer handling and statistical data
processing. Opti-Probe: Opti-Probe systems significantly improve upon existing thin-film
metrology systems by successfully integrating up to five distinct film
measurement technologies, three of which are patented by us. By combining the
measured data from these multiple technologies and correlating it using
proprietary software, Opti-Probe systems provide increased measurement
capability leading to higher yields, less mis-processing, less rework, faster
production ramp-up and increased productivity on both test and product wafers.
These are Therma-Waves patented techniques for combining optical measurement
technologies and correlating the results to achieve consistent measurement
results between multiple metrology tools. Addressing New Market: Lithography Metrology Opti-Probe RT/CD and Integra are two additional recently introduced product
families. Opti-Probe CD: Opti-Probe CD is the first optical CD scatterometry system that
combines high-information content spectroscopic ellipsometry with ultra-fast
calculation, using real-time regression, to analyze and display results without
the use of off-line modeling and solution libraries. This allows the use of
complex models that produce high precision results that are robust to
variations in the semiconductor process. Full featured, complex CD profiles can
be calculated in seconds with the desired precision and repeatability over a
wide range of feature sizes and stack structures that are normally encountered
in a production environment and, we believe, with more structural information
than its competitors on sidewall profile and shape. Integra: In 2000, we committed to a program of developing a broad family of
Integrated Metrology, or IM, modules under the product family name Integra. We
have at this time both spectrometer and spectroscopic ellipsometer based IM
units available in the marketplace. Each IM unit is installed directly onto a
semiconductor process tool and can measure each wafer immediately after
processing. In this manner, processing mistakes can be detected at the earliest
possible moment, as opposed to the conventional 16




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##### Table of Contents



procedure in which a 25-wafer lot is typically completed before metrology is
first done, thereby leaving the entire lot at risk of becoming scrap. In
addition, fab cycle times are reduced by replacing some of the stand-alone
metrology measurements with integrated metrology. Critical Accounting Policies and Estimates Our condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.
The methods, estimates and judgments we use in applying our accounting policies
has a significant impact on the results we report in our condensed consolidated
financial statements. On an on-going basis, management evaluates its estimates
and judgments, including those related to revenue recognition, inventory
valuation, allowance for doubtful accounts receivable, valuation of long-lived
assets and intangible assets, income taxes and warranty. Management bases its
estimates and judgments on historical experience and on various other factors
that are believed to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions. An accounting policy is considered to be critical if it requires an
accounting estimate to be made based on assumptions about matters that are
highly uncertain at the time the estimate is made and if different estimates
that reasonably could have been used, or changes in the accounting estimates
that are reasonably likely to occur periodically, could materially impact the
financial statements. For a discussion of critical accounting policies and
estimates, see our annual report on Form 10-K for the year ended March 31,
2004. Results of Operations The following table summarizes our unaudited historical results of
operations as a percentage of net revenues for the periods indicated. The
historical financial data for the three and six months ended September 30, 2004
and 2003 were derived from our unaudited condensed consolidated financial
statements which, in the opinion of management, reflect all adjustments
necessary for the fair statement of the financial condition and results of
operations for such periods. Three months ended September 30,
    
    Six months ended September 30,2004
    
    2003
    
    2004
    
    2003Net revenuesProduct
    
    
    77.6
    %
    
    
    68.3
    %
    
    
    77.1
    %
    
    
    63.2
    %Services and parts
    
    
    22.4
    %
    
    
    31.7
    %
    
    
    22.9
    %
    
    
    36.8
    %Total net revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenues
    
    
    52.3
    %
    
    
    60.4
    %
    
    
    50.9
    %
    
    
    67.7
    %Gross profit
    
    
    47.7
    %
    
    
    39.6
    %
    
    
    49.1
    %
    
    
    32.3
    %Operating expenses:Research and development
    
    
    19.5
    %
    
    
    36.8
    %
    
    
    20.1
    %
    
    
    39.0
    %Selling, general and administrative
    
    
    26.3
    %
    
    
    41.6
    %
    
    
    26.7
    %
    
    
    43.8
    %Restructuring, severance and other
    
    
    0.0
    %
    
    
    0.8
    %
    
    
    0.9
    %
    
    
    6.1
    %Stock-based compensation expense (benefit)
    
    
    (3.8
    )%
    
    
    1.5
    %
    
    
    1.3
    %
    
    
    1.6
    %Total operating expenses
    
    
    42.0
    %
    
    
    80.7
    %
    
    
    49.0
    %
    
    
    90.5
    %Operating income (loss)
    
    
    5.7
    %
    
    
    (41.1
    )%
    
    
    0.1
    %
    
    
    (58.2
    )%Other income (expense):Interest expense
    
    
    0.0
    %
    
    
    (0.2
    )%
    
    
    0.0
    %
    
    
    (0.2
    )%Interest income
    
    
    0.2
    %
    
    
    0.5
    %
    
    
    0.2
    %
    
    
    0.4
    %Other, net
    
    
    (0.1
    )%
    
    
    0.1
    %
    
    
    0.0
    %
    
    
    (0.8
    )%Total other income (expense), net
    
    
    0.1
    %
    
    
    0.4
    %
    
    
    0.2
    %
    
    
    (0.6
    )%Income (loss) before provision for income taxes
    
    
    5.8
    %
    
    
    (40.7
    )%
    
    
    0.3
    %
    
    
    (58.8
    )%Provision for income taxes
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Net income (loss)
    
    
    5.8
    %
    
    
    (40.7
    )%
    
    
    0.3
    %
    
    
    (58.8
    )%
 17




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##### Table of Contents



Net Revenues.Net revenues for the fiscal quarter ended September 30, 2004 were
$22.6 million. Compared to the first quarter of fiscal 2005, net revenues
increased $1.4 million, or 7%, from $21.2 million. Both product (systems) and
services revenues, which include parts, billable labor and materials and
service contracts revenues, increased by 8% and 2% respectively, reflecting
increased demand for our systems and services. During the second fiscal
quarter, we sold a higher percentage of our newer, more advanced systems,
particularly those systems designed for 300 mm manufacturing facilities as
compared to the prior fiscal quarter. For information regarding where our product is sold, see Note 10 to the
accompanying Notes to Unaudited Condensed Consolidated Financial Statements. Net revenues increased $8.5 million, or 61%, from $14.1 million in the
same fiscal quarter of the prior year. This increase came from higher systems
revenues, up $7.9 million or 83%, from the same period last year. Services
revenues increased over the same period last year by $0.6 million or 14%. Net
revenues for the six months ended September 30, 2004 were $43.8 million.
Compared to the same period last year net revenues for the six months ended
September 30, 2004 increased $17.8 million, or 68%, from $26.0 million. Both
product (systems) and service revenue increased, up by 105% and 5%
respectively. Systems revenues are more variable than services revenues in
general, because services revenues are generated from our installed based of
systems, which fluctuates gradually as the warranty periods of newer systems
expire causing those systems to require paid parts and repair services and
older systems are either decommissioned or replaced with newer models. Our primary business is the design, manufacture and sale of our
Therma-Probe, Opti-Probe, Opti-Probe Critical Dimension and Integra integrated
product metrology systems. We also sell replacement and spare parts and service
support for these products, including associated labor, which is often sold in
service contracts for durations of one or more years. International sales accounted for approximately 74% and 70% of our total
net revenues for the three months ended September 30, 2004 and 2003,
respectively. International sales accounted for approximately 74% and 61% of
our total net revenues for the six months ended September 30, 2004 and 2003,
respectively. We anticipate that international sales will continue to account
for a significant portion of our net revenues in the foreseeable future. The
flow of orders and shipments by country are uneven on a quarterly basis,
therefore the percentage of revenues by country may vary greatly from quarter
to quarter. For more information on revenues by country for the first three and
six months of fiscal 2005 and 2004, respectively, see Note 10 to the
accompanying Notes to Unaudited Condensed Consolidated Financial Statements. A substantial portion of our international sales is denominated in U.S.
dollars. As a result, changes in the values of foreign currencies relative to
the value of the U.S. dollar can render our products comparatively more
expensive. Although we have not been negatively impacted in the past by foreign
currency changes in Taiwan, Japan, China, Korea, and Europe, such conditions
could negatively impact our international sales in future periods. Three customers each accounted for 19%, 11% and 11% of our net revenues
for the three months ended September 30, 2004. For the three months ended
September 30, 2003, three customers each accounted for 24%, 14% and 11% of our
net revenues. Two customers each accounted for 11% and 10% of our net revenues
for the six months ended September 30, 2004. For the six months ended September
30, 2003, three customers each accounted for 22%, 14% and 10% of our net
revenues. Gross Profit.Gross profit for the second quarter of fiscal 2005 was $10.8
million, an increase of $0.1 million, from a gross profit of $10.7 million in
the first quarter of fiscal 2005. Compared to the same quarter of fiscal 2004,
gross profit increased $5.2 million, or 93%. As a percentage of net revenues,
gross profit for the second quarter of fiscal 2005 was 47.7%, compared to 50.7%
for the first quarter of fiscal 2005 and 39.6% for the second quarter of fiscal
2004. The increase in gross profit in the second quarter of fiscal 2005 compared
to the second quarter of fiscal 2004 was primarily attributable to increased
higher net revenues of $8.5 million, which also resulted in higher
manufacturing volumes and significantly improved manufacturing efficiencies.
Additionally, cost reduction programs lowered component costs, particularly in
the companys more advanced Opti-Probe and Therma-Probe products. The second
quarter of fiscal 2005 also benefited from a credit to stock-based compensation
expense of $0.3 million compared to a $15,000 charge during the second quarter
of fiscal 2004. Higher sales drove demand for certain inventory that had previously been
written down in value. During the second quarter of fiscal 2005, the company
sold $1.8 million of zero cost and reduced-cost inventories, of which $1.1
million, or 5 margin percentage 18




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##### Table of Contents



points, related to raw materials and sub-assemblies and $0.7 million,
related to cost reductions recognized previously on finished goods held for
sale. Partially offsetting these benefits were provisions of $0.9 million, or
negative 4 margin percentage points, incurred to establish additional reduced
cost basis for other specific inventories in the second quarter of fiscal 2005. During the first quarter of fiscal 2005, the company sold $2.8 million of
zero cost and reduced-cost inventories, of which $2.0 million, or 9 margin
percentage points, related to raw materials and sub-assemblies and $0.8
million, or 4 margin percentage points, related to cost reductions recognized
previously on finished goods held for sale. Partially offsetting these benefits
were provisions of $1.0 million, or negative 5 margin percentage points,
incurred to establish additional reduced-cost basis for other specific
inventories in the first quarter of fiscal 2005. In the second quarter of the fiscal 2004, we sold $3.0 million of zero
cost and reduced-cost inventories, of which $2.1 million, or 15 margin
percentage points, related to raw materials and sub-assemblies and $0.9
million, related to reduced-cost finished goods held for sale. Partially
offsetting these benefits were provisions of $1.7 million, or negative 12
margin percentage points, incurred to write down inventories on hand to their
realizable values. Actual scrap of inventories previously written-off were $0.9 million in
the second quarter of fiscal 2005 compared to $0.9 million in the first quarter
of fiscal 2005 and $0.8 million in the second quarter of fiscal 2004. Looking ahead to the second quarter of fiscal 2005, we expect our product
mix to continue to move toward more advanced and 300 mm product sales. However,
we expect the benefit from sale of previously written off inventories to
decrease by approximately another $1.0 million dollars and become insignificant
in the fourth quarter of fiscal 2005. We expect a decline in the benefit from
the sale of previously written off inventories because most of the previously
written off inventories have been used in prior quarters, and because the
remaining zero cost inventories are used primarily in less advanced 200 mm
products for which demand is decreasing as interest in our more advanced 300 mm
products increases. Our cost reduction programs have continued to progress as
planned. We will begin to gain additional benefit from those programs in the
third quarter of fiscal 2005, but the majority of the benefits will begin in
our fourth quarter of fiscal 2005. As a result, we anticipate that our gross
margins for the third quarter of fiscal 2005 are likely to be in the mid-40
percent range, excluding the impact of charges or benefits due to the variable
accounting treatment for certain stock options (see Note 1 to the accompanying
Notes to Unaudited Condensed Consolidated Financial Statements). Research and Development (R&D), Expenses.R&D expenses for the second quarter
of fiscal 2005 were $4.4 million, flat compared to $4.4 million in the first
quarter of fiscal 2005 and a decrease of 15% from $5.2 million for the same
quarter of last fiscal year. R&D expenses for the first six months of fiscal
2005 were $8.8 million, a decrease of $1.3 million, or 13%, from $10.1 million
for the same period of last fiscal year. The decrease in R&D expenses compared
with last fiscal year primarily reflects lower costs for equipment, project
materials and outside services. We expect our overall R&D expenditures will increase slightly
in the third fiscal quarter of 2005 due to increasing headcount and higher
project costs. We continue to allocate our R&D resources to the programs that
can sustain our technological leadership, which we expect will continue to
strengthen our market position. Selling, General and Administrative (SG&A), Expenses.SG&A expenses for the
second quarter of fiscal 2005 were $5.9 million, an increase of 3% from SG&A
expenses of $5.8 million in the first quarter of fiscal 2005. Compared to the
second quarter of last fiscal year, SG&A expenses were flat at $5.9 million.
SG&A expenses for the first six months of fiscal 2005 were $11.7 million, an
increase of 3% from SG&A expenses of $11.4 million in the first six months of
fiscal 2004. For the third quarter of fiscal 2005 we anticipate SG&A spending
to increase slightly and to increase an additional $0.8 million for compliance
activities related to Section 404 of the Sarbanes-Oxley Act of 2002. Restructuring, Severance and Other.No restructuring, severance and other
expenses were incurred during the second quarter of fiscal 2005. Compared to
the first quarter of fiscal 2005, restructuring, severance and other expenses
decreased by $0.4 million. Compared to the same period last year, restructuring
charges decreased by $0.1 million. For the six months ended September 30, 2004
restructuring charges decreased $1.2 million to $0.4 million from $1.6 million
in the same period of fiscal 2004. Restructuring charges one year ago included
costs related to reduction in force programs. We do not anticipate additional
restructuring charges in the third quarter of fiscal 2005. However, as
sub-lease rates and occupancy estimates change, we may take additional charges
or record credits related to our one excess facility currently available for
sub-lease. Stock-Based Compensation.Stock-based employee compensation expense (benefit)
included in net income as reported includes amounts for two events,
specifically, the stock options assumed during the acquisition of Sensys
Corporation, and the stock option exchange on September 10, 2003. 19




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##### Table of Contents



As part of the acquisition of Sensys, we recorded $3.5 million of
stock-based compensation to be amortized over the vesting period of the
options. The related deferred stock compensation amortization expenses were
$44,000, $0.3 million, and $0.2 million for the three months ended September
30, 2004, June 30, 2004 and September 30, 2003, respectively, a portion of
which was included in cost of revenues. For the six months ended September 30,
2004 and 2003, respectively, deferred stock compensation amortization expenses
were $0.3 million and $0.4 million. These charges reflect the vesting schedules
of the stock options and reductions in headcount due to employee turnover and
reduction in force programs that began during fiscal 2003 and continued through
the first three quarters of fiscal 2004. As of September 30, 2004, $0.2 million
of deferred stock compensation related to the Sensys acquisition remains to be
amortized over future periods ending in January 2006. As a result of the completion of the employee stock option exchange
program, effective September 10, 2003, we recorded a benefit of approximately
$1.2 million of stock-based compensation in the second quarter of fiscal 2005.
The benefit is primarily a result of the decline in the closing stock price
from $4.78 per share at the end of the first quarter of fiscal 2005 compared to
$3.33 per share at the end of the second quarter of fiscal 2005. For the six
months ended September 30, 2004, we recorded a charge of approximately $0.3
million. This charge reflects the options eligible for exchange on September
10, 2003 and reflects options issued to eligible participants within the six
months prior to and following September 10, 2003. Due to variable accounting,
compensation expense is being recorded for the vesting of these options over
time, based on increases or decreases in the period-end stock price over and
above the exercise price of the new options. In future quarters, the expense
could increase as more shares become vested and if the stock price increases.
Reductions to expense may also be recorded if the stock price decreases, but
such reductions will be limited to the amount of net expense previously
recorded. As of the end of the second quarter of fiscal 2005, $0.2 million of
deferred stock compensation related to the variable accounting treatment for
certain stock options remained to be amortized over future periods. The amount
of deferred stock compensation to be amortized is expected to increase as the
vesting of the options increases and to be adjusted either higher or lower
depending on the closing stock price at the end of each period. Other Income (Expense).Other income, net, for the second quarter of fiscal
2005 was $27,000, compared to other income, net, of $52,000 in the first
quarter of fiscal 2005, and other income, net, of $54,000 in the second quarter
of fiscal 2004. Other income, net, for the first six months of fiscal 2005 was
$79,000, compared to other expense, net, of $141,000 in the first six months of
fiscal 2004. Other expense for the six months of fiscal 2004 includes a loss on
the sale of an investment in the amount of $0.1 million and a loss of $0.1
million related to a change in the investment value of contributions to our
deferred executive compensation program. Net Income (Loss).The combination of all the factors discussed above
contributed to a net income of $1.3 million, or $0.04 and $0.03 per basic and
diluted share, respectively, for the second quarter of fiscal 2005, compared
with a net loss of $1.2 million, or negative $0.03 per basic and diluted share,
in the first quarter of fiscal 2005 and a net loss of $5.7 million, or negative
$0.19 per basic and diluted share, in the second quarter of fiscal 2004. Net
income for the first six months of fiscal 2005 was $0.1 million, or $0.00 per
basic and diluted share, compared to a loss of $15.3 million, or negative $0.52
per basic and diluted share, in the first six months of fiscal 2004. We expect
that with our cost reduction programs in place and an expected revenue
increase, we will continue to improve operating results in the upcoming
quarters. However, in the third quarter of fiscal 2004, we anticipate spending
an incremental $0.8 million on compliance activities related to Section 404 of
the Sarbanes-Oxley Act. We expect the third quarter of fiscal 2005 net loss to
be within the range of negative $0.03 per basic and diluted share to positive
$0.01 per diluted share. Liquidity and Capital Resources Our principal liquidity requirements are for working capital. Over the
last three fiscal years, we have funded our operating activities principally
from proceeds from sales of common stock. We have incurred substantial losses
and experienced negative cash flows since fiscal 2000, and we had an
accumulated deficit of $300.9 million at September 30, 2004. Our cash balances
increased during fiscal 2004 primarily as a result of the $11.7 million in net
proceeds from a private placement in September 2003. In the offering, we raised
$12.7 million of gross proceeds and incurred $1.0 million of issuance costs,
$0.9 million of which were payable to Needham & Company who acted as placement
agents. We are using these funds for general corporate purposes. Our cash balance decreased by $6.7 million during the first six months of
fiscal 2005 from $23.9 million to $17.2 million, mostly due to operating
activities, which consumed $5.9 million. Investments in property and equipment
and in our patent portfolio used $1.0 million. Cash raised through the proceeds
from the exercise of stock options contributed cash of $0.3 million. This net
decrease in cash of $6.7 million during the first six months of fiscal 2005
compares to an increase in cash during the first six months of fiscal 2004 of
$8.9 million, most of which reflected the proceeds from a private placement
stock offering. Cash flows used by operating activities were $5.9 million and $4.5 million
for the first six months of fiscal 2005 and 2004, respectively, an increase in
cash used of $1.4 million due to operating activities. The net income in the
first six months of fiscal 2005 20




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##### Table of Contents



was $0.1 million, compared to a net loss of $15.3 million in the first six
months of 2004. Cash was used to fund increases in operating assets,
principally inventory and accounts receivable. Increases in inventory were $7.3
million in the first six months of fiscal 2005 compared to a $25,000 decrease
in inventories in the first six months of fiscal 2004. The increase in
inventory reflects increased purchases to support higher production volumes.
Similarly, accounts receivable increased by $3.4 million in the first six
months of fiscal 2005, reflecting higher shipments and the timing of those
shipments. This increase of $3.4 million, compared to a reduction in accounts
receivable in the first six months of last year of $4.2 million, is due to
higher billings in the first six months of fiscal 2005 compared to the first
six months of fiscal 2004. Days sales outstanding as of September 30, 2004 were
63 days compared to 61 days as of September 30, 2003. Deferred revenues
increased by $1.4 million in the first six months of 2005 compared to a
decrease of $0.3 million in the first six months of fiscal 2004. Accounts
payable increased in the first six months of fiscal 2005 generating operating
cash flows of $2.7 million, compared to $0.9 million in the first six months of
fiscal 2004. Changes in other assets and liabilities decreased cash flows from
operating activities by $0.7 million in the first six months of fiscal 2005
compared to a decrease in cash flows from other assets and liabilities of $0.9
million in the first six months of fiscal 2004. Adjustments to reconcile net
loss to net cash used in operating activities included $4.1 million in non-cash
charges in the first six months of fiscal 2005 compared to $6.1 million in the
first six months of fiscal 2004. These charges included depreciation and
amortization, down $1.1 million; inventory provisions, down $1.5 million;
credits for doubtful accounts, up by $0.8 million; and other changes which net
to a reduction of $0.2 million. Cash flows used by investing activities were $1.0 million in the first six
months of fiscal 2005 compared to cash flows used by investing activities of
$25,000 in the first six months of fiscal 2004. Cash flows used by investing
activities in the first six months of fiscal 2004 included proceeds of $0.4
million from the sale of an investment. In the first six months of fiscal 2005,
purchases of property and equipment were $0.6 million, up from $37,000 in the
first six months of fiscal 2004. Investments in our patent portfolio were
unchanged at $0.4 million in the first six months of fiscal 2005 and 2004,
respectively. Cash flows provided by financing activities were $0.3 million in the first
six months of fiscal of 2005 compared to cash flows provided by financing
activities of $13.1 million in the first six months of fiscal 2004. The cash
flows provided by financing activities last year primarily resulted from net
proceeds from a private placement in September 2003. Off-Balance Sheet Commitments Our off-balance sheet commitments are limited to equipment operating
leases, leases on office and manufacturing space, purchase commitments, minimum
royalty payments under certain software license agreements, and cancellation
fee commitments to vendors related to non-cancelable inventory purchase orders.
Future payments due under these obligations as of September 30, 2004 (in
thousands) are as follows: MinimumOperating
    
    Purchase
    
    Royalty
    
    CancellationLeases
    
    Commitments
    
    Payments
    
    Fees
    
    TotalFiscal Year2005
    
    $
    1,411
    
    
    $
    7,941
    
    
    $
    30
    
    
    $
    518
    
    
    $
    9,9002006
    
    
    1,914
    
    
    
    48
    
    
    
    40
    
    
    
    
    
    
    
    2,0022007
    
    
    686
    
    
    
    
    
    
    
    40
    
    
    
    
    
    
    
    7262008
    
    
    666
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6662009
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1002010 and thereafter
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total future minimum payments
    
    $
    4,777
    
    
    $
    7,989
    
    
    $
    110
    
    
    $
    518
    
    
    $
    13,394
 The total future minimum payments for operating leases in the table above
includes the gross amounts payable under all operating leases and does not
include the benefit of sub-lease income being realized on one excess facility
or the benefit of projected sub-lease income on a second excess facility (see
Notes 5 and 7 to the accompanying Notes to Unaudited Consolidated Financial
Statements). We indemnify some of our suppliers and customers for specified
intellectual property rights pursuant to certain parameters and restrictions.
The scope of these indemnities varies, but in some instances includes
indemnification for damages and expenses (including reasonable attorney fees)
related to any misuse by us of the intellectual property. No amounts have been
accrued in respect of the indemnification provisions at September 30, 2004. 21




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##### Table of Contents



In June 2003, we entered into a loan and security agreement with Silicon
Valley Bank (SVB). The agreement includes a $5.0 million domestic line of
credit, including a sub-limit of $5.0 million for letters of credit, and a
$10.0 million Export-Import Bank of the United States (EXIM) guaranteed,
revolving line of credit. These bank credit facilities allow us to borrow money
under the domestic line bearing a floating interest rate equal to the SVB prime
rate plus 1.50% as of September 30, 2004. The EXIM revolving line allows us to
borrow money at a floating interest rate equal to the SVB prime rate plus 1.75%
as of September 30, 2004. We may request advances in an aggregate outstanding
amount not to exceed the lesser of $15.0 million total under the two lines and
the borrowing base, in each case minus the aggregate face amount of outstanding
letters of credit, including any drawn but un-reimbursed letters of credit. Our
borrowings under the SVB and EXIM guaranteed credit facilities are secured by
substantially all of our assets. The credit facility matures on June 11, 2005.
As of September 30, 2004, we had no borrowings and $3.5 million in outstanding
letters of credit under this agreement, none of which have been drawn against.
As of September 30, 2004, we were in compliance with all the covenants in the
agreement. Inflation The impact of inflation on our business was not material for the fiscal
quarter ended September 30, 2004 or for the comparable period of last year. 
 Item 3. Quantitative and Qualitative Disclosure about Market Risk Market Risk Disclosures The following discussion about market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to market risks
related to changes in interest rates and foreign currency exchange rates. We do
not have any derivative financial instruments. See also the discussion of
forward-looking statements in the first paragraph of Item 2 above. Market Risk Related to Interest Rates and Foreign Currency We are exposed to market risks related to changes in interest rates and
foreign currency exchange rates, however, we believe those risks to be not
material in relation to our operations. We do not have any derivative financial
instruments. Interest Rate Risk Our exposure to market risk for changes in interest rates relates to our
cash investment portfolio. We do not use derivative financial instruments in
our investment portfolio, which consists of only marketable securities with
active secondary or resale markets to ensure portfolio liquidity. We have
minimal cash flow exposure due to rate changes for cash and cash equivalents
because interest income earned on our cash investments is considered
immaterial. Our cash investment portfolio is invested at market interest rates. As of September 30, 2004, our cash and cash equivalents included money
market securities and mutual funds comprised of investment grade commercial
paper. Due to the short-term duration of our investment portfolio, an immediate
10% change in interest rates would not have a material effect on the fair
market value of the portfolio. Therefore, we would not expect our operating
results or cash flows to be affected to any significant degree by the effect of
a sudden change in market interest rates on our securities portfolio. Foreign Currency Exchange Risk We are primarily a U.S. dollar functional currency entity. A substantial
portion of our international sales is denominated in U.S. dollars, and as a
result, we have relatively little exposure to foreign currency exchange risk
with respect to sales. We have determined that the functional currency of our foreign operations
is the local currency in our international operations, which incur most of
their expenses in the local currency. The transactions denominated in
currencies other than our functional currencies create gains and losses that
are reflected in our consolidated statements of operations and amounted to less
than $0.1 million in the three and six months ended September 30, 2004 and
2003, respectively. Due to the low dollar value of transactions made in
currencies other than the functional currencies, we do not expect to experience
significant currency gains and losses in our statements of operations. 22




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##### Table of Contents



We convert the financial statements of our foreign subsidiaries into U.S.
dollars. When there is a change in foreign currency exchange rates, the
conversion of the foreign subsidiaries financial statements into U.S. dollars
leads to a translation gain or loss. The accumulated effects of foreign
translation rate changes related to net assets outside the U.S. are included as
a component of stockholders equity. As of September 30, 2004 we have an
accumulated other comprehensive loss of $0.9 million consisting of foreign
currency translation adjustments, compared to $0.7 million as of March 31,
2004. We do not use forward exchange contracts to hedge exposures denominated in
foreign currencies or any other derivative financial instruments for trading or
speculative purposes. The effect of an immediate 10% change in exchange rates
would not have a material impact on our future operating results or cash flows. Sarbanes-Oxley Act of 2002 Compliance Risk As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the
Securities and Exchange Commission adopted rules requiring public companies to
include a report by management on the companys internal controls over
financial reporting in their Annual Reports on Form 10-K. This report is
required to contain an assessment by management of the effectiveness of
internal controls over financial reporting. In addition, the independent
registered public accounting firm auditing a public companys financial
statements must attest to and report on managements assessment of the
effectiveness of the companys internal controls over financial reporting. We have been working to complete our assessment of the effectiveness of
our internal controls over financial reporting by the time we are required to
file our next Annual Report on Form 10-K, as required by Section 404 of the
Sarbanes-Oxley Act of 2002. Our documentation and testing to date have
identified certain gaps in the documentation and design of internal controls
over financial reporting that we are in the process of remediating. Our
independent registered public accounting firm has likewise been working to
evaluate our assessment and to test the design and operating effectiveness of
our internal controls over financial reporting. Since this is the first year of the new Section 404 requirements, it is
difficult for us or our independent registered public accounting firm to
predict how long it will take to complete the assessment of the effectiveness
of our internal controls over financial reporting, including the final
evaluation of the significance of control deficiencies. This results in a
heightened risk of unexpected delays and obstacles to completing the project on
a timely basis. Accordingly, tight project management to continually gauge the
status of the effort and ensure that it stays on schedule is critical to
success. It is important that we continue diligently to complete our work and
provide our results and assessments to our auditors on a timely basis and in
accordance with the agreed-upon time schedule in order for our independent
registered public accounting firm to complete their assessment on a timely
basis. While we anticipate that we will be able to comply on a timely basis with
these requirements, unforeseen delays may occur which could prevent us from
achieving timely compliance. If we fail to complete our evaluation on a timely
basis and in a satisfactory manner, or if our independent registered public
accounting firm is unable to attest on a timely basis to the adequacy of the
Companys internal control, this may impact the reliability of our internal
controls over financial reporting, and we may be subject to additional scrutiny
by the SEC or our investors regarding our internal controls over financial
reporting. Given the risks inherent in the design and operation of internal
controls over financial reporting, we can provide no assurance as to our, or
our independent registered public accounting firms, conclusions as of March
31, 2005 with respect to the effectiveness of our internal controls over
financial reporting. 
 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures The companys management, including the companys President and Chief
Executive Officer and Senior Vice President, Chief Financial Officer and
Secretary, conducted an evaluation as of September 30, 2004 of the
effectiveness of the companys disclosure controls and procedures (as defined
in Rule 13a-15(e) and Rule 15d-15(e)). Based on that evaluation, the President
and Chief Executive Officer and Senior Vice President, Chief Financial Officer
and Secretary concluded that the disclosure controls and procedures were
effective in ensuring that all material information required to be disclosed in
the reports the company files and submits under the Securities and Exchange Act
of 1934 has been made known to them on a timely basis and that such information
has been properly recorded, processed, summarized and reported, as required. Changes in Internal Controls There have been no significant changes in the companys internal controls
over financial reporting during the most recent fiscal quarter that materially
affected, or are reasonably likely to materially affect, our internal controls
over financial reporting. 23




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PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings We are not aware of any material legal proceedings pending against us. We
may be required to initiate additional litigation in order to enforce any
patents issued to or licensed to us or to determine the scope and/or validity
of a third partys patent or other proprietary rights. In addition, we may be
subject to additional lawsuits by third parties seeking to enforce their own
intellectual property rights. Any such litigation, regardless of outcome, could
be expensive and time consuming and, as discussed above in the prior risk
factor, could subject us to significant liabilities or require us to cease
using proprietary third party technology and, consequently, could have a
material adverse effect on our business, financial condition, results of
operations or cash flows. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders The 2004 Annual Meeting of Stockholders was held on August 23, 2004. The
following proposal was voted: (I) the election of our directors. The vote
tally was as follows: Proposal (I) Directors
    
    Director Class
    
    Total Vote For Each Director:
    
    Total Vote Withheld From Each Director:Peter R. Hanley
    
    (II)
    
    
    27,797,111
    
    
    
    497,347Nam Pyo Suh
    
    (II)
    
    
    27,794,761
    
    
    
    499,697Lawrence Tomlinson
    
    (II)
    
    
    28,013,375
    
    
    
    281,083
 Proposal (I) was approved by our stockholders. 
 Item 5. Other Information None. 
 Item 6. Exhibits Exhibit Number
    
    Description10.1
    
    Agreement between Therma-Wave and KLA-Tencor Corporation effective as of July 1, 2004 (incorporated by
reference to Form 8-K filed August 27, 2004).22.1
    
    Report of Inspector of Election31.1
    
    Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1
    
    Risk Factors (incorporated by reference to the same numbered exhibit in the Companys Annual Report on
Form 10-K for the period ended March 31, 2004 (File No. 000-26911)).
 24




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. THERMA-WAVE, INC. (Registrant) /s/ L. RAY CHRISTIE 
  Senior Vice President,
Chief Financial Officer and Secretary(as Registrant and as Principal Accounting Officer) November 5, 2004 25




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##### Table of Contents



EXHIBIT INDEX Exhibit Number
    
    Description10.1
    
    Agreement between Therma-Wave and KLA-Tencor Corporation effective as of July 1, 2004 (incorporated by
reference to Form 8-K filed August 27, 2004).22.1
    
    Report of Inspector of Election31.1
    
    Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1
    
    Risk Factors (incorporated by reference to the same numbered exhibit in the Companys Annual Report on
Form 10-K for the period ended March 31, 2004 (File No. 000-26911)).