##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
    FORM 10-Q    (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended December 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
þ NO o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). YES þ NO o Indicate the number of shares outstanding of the issuers class of common stock, as of the
latest practical date: Class
    
    Outstanding as of January 31, 2005Common stock, $0.01 par value
    
    36,158,639




---



THERMA-WAVE, INC.
TABLE OF CONTENTS Page No.PART I. FINANCIAL INFORMATIONITEM 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of December 31, 2004 and March 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the Three and Nine Months Ended December 31,
2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2004 and 2003
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    22ITEM 4. Controls and Procedures
    
    
    24PART II. OTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    26ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26ITEM 3. Defaults Upon Senior Securities
    
    
    26ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    26ITEM 5. Other Information
    
    
    26ITEM 6. Exhibits
    
    
    26SIGNATURESEXHIBIT 10.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




---



##### Table of Contents



PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands, except share and per share data)
 (Unaudited)
 December 31,
    
    
    March 31,2004
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    13,711
    
    
    $
    23,899Accounts receivable, net of allowances of $925 and $907 as of
December 31, 2004 and March 31, 2004, respectively
    
    
    22,399
    
    
    
    14,772Inventories
    
    
    25,652
    
    
    
    17,169Other current assets
    
    
    2,413
    
    
    
    2,075Total current assets
    
    
    64,175
    
    
    
    57,915Property and equipment, net
    
    
    3,320
    
    
    
    4,564Other assets, net
    
    
    1,587
    
    
    
    2,710Total assets
    
    $
    69,082
    
    
    $
    65,189LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    8,873
    
    
    $
    7,420Accrued liabilities
    
    
    16,845
    
    
    
    15,730Deferred revenues
    
    
    9,848
    
    
    
    6,887Total current liabilities
    
    
    35,566
    
    
    
    30,037Non-current deferred revenues
    
    
    1,353
    
    
    
    1,815Other long-term liabilities
    
    
    373
    
    
    
    1,073Total liabilities
    
    
    37,292
    
    
    
    32,925Commitments and contingencies (Note 5)Stockholders equity:Common stock, $0.01 par value; 75,000,000 shares authorized;
36,158,026 shares issued and outstanding at December 31, 2004;
35,498,025 shares issued and outstanding at March 31, 2004
    
    
    360
    
    
    
    355Additional paid-in capital
    
    
    335,227
    
    
    
    335,012Notes receivable from stockholders
    
    
    (174
    )
    
    
    (174
    )Accumulated other comprehensive loss
    
    
    (596
    )
    
    
    (735
    )Deferred stock-based compensation
    
    
    (242
    )
    
    
    (1,172
    )Accumulated deficit
    
    
    (302,785
    )
    
    
    (301,022
    )Total stockholders equity
    
    
    31,790
    
    
    
    32,264Total liabilities and stockholders equity
    
    $
    69,082
    
    
    $
    65,189
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 3




---



##### Table of Contents



THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except per share data)
 (Unaudited)
 Three months ended December 31,
    
    
    Nine months ended December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net revenuesProduct
    
    $
    16,044
    
    
    $
    15,579
    
    
    $
    49,761
    
    
    $
    31,990Services and parts
    
    
    5,426
    
    
    
    4,287
    
    
    
    15,462
    
    
    
    13,845Total net revenues
    
    
    21,470
    
    
    
    19,866
    
    
    
    65,223
    
    
    
    45,835Cost of revenues (1)
    
    
    12,368
    
    
    
    9,904
    
    
    
    34,629
    
    
    
    27,474Gross profit
    
    
    9,102
    
    
    
    9,962
    
    
    
    30,594
    
    
    
    18,361Operating expenses:Research and development (2)
    
    
    4,341
    
    
    
    4,497
    
    
    
    13,132
    
    
    
    14,628Selling, general and administrative (3)
    
    
    6,478
    
    
    
    5,316
    
    
    
    18,169
    
    
    
    16,699Restructuring, severance and other
    
    
    
    
    
    
    381
    
    
    
    373
    
    
    
    1,973Stock-based compensation expense (4)
    
    
    37
    
    
    
    795
    
    
    
    602
    
    
    
    1,209Total operating expenses
    
    
    10,856
    
    
    
    10,989
    
    
    
    32,276
    
    
    
    34,509Operating loss
    
    
    (1,754
    )
    
    
    (1,027
    )
    
    
    (1,682
    )
    
    
    (16,148
    )Other income (expense):Interest expense
    
    
    (7
    )
    
    
    (39
    )
    
    
    (15
    )
    
    
    (84
    )Interest income
    
    
    52
    
    
    
    31
    
    
    
    142
    
    
    
    134Other, net
    
    
    7
    
    
    
    4
    
    
    
    4
    
    
    
    (195
    )Total other income (expense), net
    
    
    52
    
    
    
    (4
    )
    
    
    131
    
    
    
    (145
    )Loss before provision for income taxes
    
    
    (1,702
    )
    
    
    (1,031
    )
    
    
    (1,551
    )
    
    
    (16,293
    )Provision for income taxes
    
    
    209
    
    
    
    
    
    
    
    212
    
    
    
    Net loss
    
    $
    (1,911
    )
    
    $
    (1,031
    )
    
    $
    (1,763
    )
    
    $
    (16,293
    )Net loss per share:Basic and Diluted
    
    $
    (0.05
    )
    
    $
    (0.03
    )
    
    $
    (0.05
    )
    
    $
    (0.52
    )Weighted average common shares outstanding:Basic and Diluted
    
    
    36,004
    
    
    
    35,325
    
    
    
    35,822
    
    
    
    31,356
   (1)
    
    Includes stock-based compensation expense (benefit) of $(7) and $215 for the three months
ended December 31, 2004 and 2003, respectively, and $49 and $230 for the nine months ended
December 31, 2004 and 2003, respectively.(2)
    
    Stock-based compensation expense is reported separately in operating expenses. The amount
attributable to research and development is $22 and $489 for the three months ended December
31, 2004 and 2003, respectively, and $344 and $739 for the nine months ended December 31, 2004
and 2003, respectively.(3)
    
    Stock-based compensation expense is reported separately in operating expenses. The amount
attributable to selling, general and administrative is $15 and $306 for the three months ended
December 31, 2004 and 2003, respectively, and $258 and $470 for the nine months ended December
31, 2004 and 2003, respectively.(4)
    
    Stock-based compensation expense 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. 4




---



##### Table of Contents



THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands)
 (Unaudited)
 Nine months ended December 31,2004
    
    
    2003Operating activities:Net loss
    
    $
    (1,763
    )
    
    $
    (16,293
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization of property and equipment
    
    
    2,026
    
    
    
    3,397Amortization of intangible assets
    
    
    612
    
    
    
    2,355Amortization of stock-based compensation
    
    
    651
    
    
    
    1,439Provision (credit) for doubtful accounts receivable
    
    
    18
    
    
    
    (932
    )Provision for excess and obsolete inventories
    
    
    3,423
    
    
    
    4,114Loss on disposal of property and equipment
    
    
    15
    
    
    
    459Loss on sale of an investment
    
    
    
    
    
    
    125Changes in operating assets and liabilities:Accounts receivable
    
    
    (7,645
    )
    
    
    (264
    )Inventories
    
    
    (11,906
    )
    
    
    1,085Other assets
    
    
    568
    
    
    
    1,525Accounts payable
    
    
    1,453
    
    
    
    1,225Accrued liabilities
    
    
    415
    
    
    
    (691
    )Deferred revenues
    
    
    2,499
    
    
    
    (1,970
    )Net cash used in operating activities
    
    
    (9,634
    )
    
    
    (4,426
    )Investing activities:Purchases of property and equipment
    
    
    (797
    )
    
    
    (197
    )Proceeds from sale of an investment
    
    
    
    
    
    
    375Purchase of patents
    
    
    (395
    )
    
    
    (551
    )Net cash used in investing activities
    
    
    (1,192
    )
    
    
    (373
    )Financing activities:Restricted cash
    
    
    
    
    
    
    1,064Proceeds from issuance of common stock
    
    
    499
    
    
    
    11,973Proceeds from notes receivable from stockholders
    
    
    
    
    
    
    23Net cash provided by financing activities
    
    
    499
    
    
    
    13,060Effect of exchange rates on cash
    
    
    139
    
    
    
    556Net increase (decrease) in cash and cash equivalents
    
    
    (10,188
    )
    
    
    8,817Cash and cash equivalents at beginning of period
    
    
    23,899
    
    
    
    13,695Cash and cash equivalents at end of period
    
    $
    13,711
    
    
    $
    22,512Supplementary disclosures:Cash paid for interest
    
    $
    87
    
    
    $
    25Cash paid for income taxes
    
    $
    21
    
    
    $
    9
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5




---



##### Table of Contents



THERMA-WAVE, INC. 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (As of December 31, 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 December 31, 2004, the operating results for the three and nine months ended December
31, 2004 and 2003, and the cash flows for the nine months ended December 31, 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 our current fiscal year
which ends on April 3, 2005. The third quarters of fiscal years 2005 and 2004 and the fiscal year 2004 ended on December
26, 2004, December 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. Liquidity Our principal sources of funds have been and are anticipated to be cash on hand ($13.7 million
as of December 31, 2004), cash flows from operating activities (if any), borrowings under our bank
credit facility and proceeds from the sale of our common stock. We believe that we will have
adequate liquidity and capital resources to meet our current and future financial obligations for
the next twelve months. No assurance can be given, however, that this will be the case. We may
require additional equity or debt financing to meet our working capital requirements or to fund our
research and development activities. There can be no assurance that additional financing will be
available, if required or, if available, will be on terms satisfactory to us. 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 are made in compliance
with shipment requirements specified in our customers purchase order. Freight terms of sales are
ex-works 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 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 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. 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 only
upon customer acceptance assuming all other revenue recognition criteria have been met. 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 the sale is fixed or determinable; the payment terms are fixed and enforceable;
collectibility of the sales price has been reasonably assured and customer acceptance has been
obtained, if applicable. 6




---



##### Table of Contents



Services and Parts Revenues.We derive services and parts 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, 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. 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 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 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 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. 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 financial statements 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 EndedDecember 31,
    
    

Nine
Months EndedDecember 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net loss (in thousands, except per share data)
As reported
    
    $
    (1,911
    )
    
    $
    (1,031
    )
    
    $
    (1,763
    )
    
    $
    (16,293
    )Stock-based employee
compensation expense
included in the determination of
net loss, as reported
    
    
    30
    
    
    
    1,010
    
    
    
    651
    
    
    
    1,439Stock-based employee
compensation expense as
determined using the fair value
method
    
    
    (919
    )
    
    
    (1,630
    )
    
    
    (3,270
    )
    
    
    (3,777
    )Pro forma net loss
    
    $
    (2,800
    )
    
    $
    (1,651
    )
    
    $
    (4,382
    )
    
    $
    (18,631
    )Basic and diluted net loss per shareAs reported
    
    $
    (0.05
    )
    
    $
    (0.03
    )
    
    $
    (0.05
    )
    
    $
    (0.52
    )Pro forma
    
    $
    (0.08
    )
    
    $
    (0.05
    )
    
    $
    (0.12
    )
    
    $
    (0.59
    )
 7




---



##### Table of Contents



The weighted average grant-date fair value of our stock options was $1.83 and $3.83 for the
three months ended December 31, 2004 and 2003, respectively, and $2.46 and $2.02 for the nine
months ended December 31, 2004 and 2003, respectively. These values were estimated using the
Black-Scholes pricing model with the following assumptions: Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Risk-free interest rate
    
    
    3.3
    %
    
    
    3.1
    %
    
    
    3.2
    %
    
    
    3.6
    %Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expected volatility
    
    
    74
    %
    
    
    118
    %
    
    
    89
    %
    
    
    118
    %Expected life in years
    
    
    4.6
    
    
    
    4.2
    
    
    
    4.9
    
    
    
    3.7
 The weighted average grant-date fair value of our stock purchase rights granted under our
employee stock purchase plans was $0.78 and $0.23 for the three months ended December 31, 2004 and
2003, respectively, and $0.44 and $0.24 for the nine months ended December 31, 2004 and 2003,
respectively. These values were estimated using the Black-Scholes pricing model with the following
assumptions: Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Risk-free interest rate
    
    
    1.9
    %
    
    
    0.9
    %
    
    
    1.5
    %
    
    
    1.0
    %Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expected volatility
    
    
    48
    %
    
    
    120
    %
    
    
    67
    %
    
    
    109
    %Expected life in years
    
    
    1.3
    
    
    
    1.1
    
    
    
    1.2
    
    
    
    0.9
 Stock-based employee compensation expense (benefit) included in net loss as reported
for the three months and nine months ended December 31, 2004 and 2003, respectively, 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 $52,000, $44,000, and $0.1 million for the three months ended December
31, 2004, September 30, 2004, and December 31, 2003, respectively. For the nine months ended
December 31, 2004 and 2003, respectively, deferred stock compensation amortization expenses were
$0.4 million and $0.5 million. A portion of the deferred stock amortization expense are included in
cost of revenues. These expenses 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 nine months of fiscal 2004. As of December 31, 2004, $0.1 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 an expense (benefit) from the amortization of deferred compensation
expense related to the variable accounting treatment for stock options of $(22,000) and $0.9
million for the three months ended December 31, 2004 and December 31, 2003, respectively. For the
nine months ended December 31, 2004 and December 31, 2003, respectively, we have recorded an
expense of $0.3 million and $0.9 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 periods, 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 cumulative amortization of deferred
stock compensation of $1.0 million previously recorded. On November 24, 2004 the Company adopted a Director Stock Option Agreement which provides
accelerated vesting of options granted to the Companys Directors upon a change in control of the
Company. The agreement is attached as Exhibit 10.1. 8




---



##### Table of Contents



The Company closed its deferred executive compensation plan on December 16, 2004. As of
December 26, 2004, the date when the third fiscal quarter ended, there was a $0.4 million balance
remaining to be paid to participants. This amount was paid in the subsequent period prior to December 31, 2004. Recently Issued Accounting Pronouncements FAS 123R.In December 2004, the FASB issued FASB Statement No. 123R, Share-Based Payment, an
Amendment of FASB Statement No. 123 (FAS No. 123R). FAS No. 123R requires companies to recognize
in the statement of operations the grant-date fair value of stock options and other equity-based
compensation issued to employees. FAS No. 123R is effective for periods beginning after June 15,
2005, which means for the Companys second quarter of fiscal year 2006. The Companys management is
currently evaluating the impact of FAS No. 123R on the Companys financial position and results of
operations. FAS 151.In November 2004, the FASB has issued FASB Statement No. 151, Inventory Costs, an
Amendment of ARB No. 43, Chapter 4 (FAS No. 151). The amendments made by FAS No. 151 are
intended to improve financial reporting by clarifying that abnormal amounts of idle facility
expense, freight, handling costs, and wasted materials (spoilage) should be recognized as
current-period expenses and by requiring the allocation of fixed production overheads to inventory
based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after
June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years
beginning after November 23, 2004. The provisions of FAS No. 151 will be applied prospectively. The
Company does not expect the adoption of FAS No. 151 to have a material impact on its consolidated
financial position, results of operations or cash flows. FAS 153.In December 2004, the FASB issued SFAS Statement No. 153, Exchanges of Non-monetary
Assets. The Statement is an amendment of APB Opinion No. 29 to eliminate the exception for
non-monetary exchanges of similar productive assets and replaces it with a general exception for
exchanges of non-monetary assets that do not have commercial substance. The effective date is for
exchanges occurring in fiscal periods beginning after June 15, 2005. The Company believes that the
adoption of this standard will have no material impact on its financial statements. 2. Balance Sheet Components December 31, 2004
    
    
    March 31, 2004Inventories (in thousands)Purchased materials
    
    $
    8,804
    
    
    $
    6,066Systems in process
    
    
    11,642
    
    
    
    8,158Finished systems
    
    
    3,614
    
    
    
    1,981Inventories at customer locations
    
    
    1,592
    
    
    
    964Total inventories
    
    $
    25,652
    
    
    $
    17,169
 December 31, 2004
    
    
    March 31, 2004Property and Equipment (in thousands)Laboratory and test equipment
    
    $
    4,879
    
    
    $
    6,014Office furniture and equipment
    
    
    10,718
    
    
    
    10,100Machinery and equipment
    
    
    695
    
    
    
    819Leasehold improvements
    
    
    8,626
    
    
    
    8,612Total property and equipment at cost
    
    
    24,918
    
    
    
    25,545Accumulated depreciation and amortization
    
    
    (21,598
    )
    
    
    (20,981
    )Total property and equipment, net
    
    $
    3,320
    
    
    $
    4,564
 9




---



##### Table of Contents



During the nine months ended December 31, 2004, 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. December 31, 2004
    
    
    March 31, 2004Accrued Liabilities (in thousands)Accrued compensation and related expenses
    
    $
    3,690
    
    
    $
    2,368Accrued warranty costs
    
    
    1,679
    
    
    
    1,731Commissions payable
    
    
    1,840
    
    
    
    893Income tax payable
    
    
    5,061
    
    
    
    4,870Restructuring liabilities
    
    
    271
    
    
    
    220Other accrued liabilities
    
    
    4,304
    
    
    
    5,648Total accrued liabilities
    
    $
    16,845
    
    
    $
    15,730
 3. Comprehensive Loss Comprehensive loss consists of the net loss for the period and the change in accumulated
foreign currency translation adjustments during the period. For the three months ended December 31,
2004 and 2003, comprehensive loss amounted to approximately $1.6 million and $0.8 million,
respectively. For the nine months ended December 31, 2004 and 2003, comprehensive loss amounted to
approximately $1.6 million and $15.7 million, respectively. 4. Net Loss Per Share Basic net 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 loss per share is based on the weighted average number of common shares
outstanding and the potential dilution of securities by including stock options and outstanding
warrants. Outstanding stock options and warrants are considered dilutive only if their exercise
price is less than the closing market price for the Companys stock at the period end.
Additionally, no adjustment is performed for dilutive shares for a period in which the Company has
experienced a net loss. The following table summarizes securities outstanding as of December 31, 2004 and 2003,
respectively, which were not included in the calculation of diluted net loss per share for the
three months and nine months ending December 31, 2004 and 2003, respectively. As of December 31,2004
    
    
    2003Securities Excluded from Diluted Net Loss per Share (in thousands)Stock options
    
    
    6,405
    
    
    
    5,649Warrants
    
    
    47
    
    
    
    79
 The stock options outstanding that were excluded from the diluted net loss per share had a
weighted average exercise price at December 31, 2004 and 2003 of $3.65 and $12.11, respectively.
The warrants outstanding that were excluded from the diluted net loss per share had a weighted
average exercise price at December 31, 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. Rent expense was approximately $0.6 million and $0.7 million for the three months ended
December 31, 2004 and 2003, respectively and approximately $1.9 million and $2.1 million for the
nine months ended December 31, 2004 and 2003, respectively. 10




---



##### Table of Contents



As of December 31, 2004, future minimum lease payments under non-cancelable operating
leases (facilities and equipment leases) are as follows: 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    TotalFuture Minimum Lease
Payments by Fiscal
Year (in thousands)Operating lease obligations
    
    $
    522
    
    
    $
    1,985
    
    
    $
    1,816
    
    
    $
    1,766
    
    
    $
    1,275
    
    
    $
    2,169
    
    
    $
    9,533
 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 paid or accrued as liabilities and charged to cost of
sales or pre-paid royalties, as appropriate, as of December 31, 2004. 6. Financing Arrangements In June 2003, we entered into a loan and security agreement with Silicon Valley Bank, or
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, or
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%, or
6.75%, as of December 31, 2004. The EXIM revolving line allows us to borrow money at a floating
interest rate equal to the SVB prime rate plus 1.75%, or 7.0%, as of December 31, 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 December 31, 2004, we had no
borrowings and $4.6 million in outstanding letters of credit under this agreement, none of which
had been drawn against. During the three months ended December 31, 2004, the Company was in
violation of a covenant to maintain a specified quick ratio. As of December 31, 2004, we were able
to renegotiate a new quick ratio and a new quick ratio formula with the bank and were in compliance
with all the covenants as revised 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 December 31, 2004, we have not incurred any losses under
such indemnification during the periods covered in this report and the Company believes that the
fair value of our indemnification arrangements is not material. Legal Proceedings We are not aware of any material legal proceedings pending against us. We may be required to
initiate 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 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 tables summarize the changes in restructuring, severance and other costs during
the nine months ended December 31, 2004 and 2003, respectively: 11




---



##### Table of Contents



Liability as of
    
    
    
    
    
    
    
    
    
    
    Liability as ofMarch 31, 2004
    
    
    Provision
    
    
    Payments
    
    
    December 31, 2004Restructuring, Severance and Other
Costs (in thousands)Consolidation of excess facilities
    
    $
    220
    
    
    $
    373
    
    
    $
    (322
    )
    
    $
    271
 Liability as of
    
    
    
    
    
    
    
    
    
    
    Liability as ofMarch 31, 2003
    
    
    Provision
    
    
    Payments
    
    
    December 31, 2003Restructuring, Severance and Other
Costs (in thousands)Severance and workforce reduction
    
    $
    558
    
    
    $
    1,773
    
    
    $
    (2,235
    )
    
    $
    96Consolidation of excess facilities
    
    
    662
    
    
    
    82
    
    
    
    (402
    )
    
    
    342Other
    
    
    134
    
    
    
    118
    
    
    
    (211
    )
    
    
    41Total
    
    $
    1,354
    
    
    $
    1,973
    
    
    $
    (2,848
    )
    
    $
    479
 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 nine months ended December 31, 2004 and 2003,
respectively, are summarized as follows: Provision for
    
    
    Settlement ofBeginning
    
    
    Warranties Issued
    
    
    Pre-Existing
    
    
    EndingBalance
    
    
    During the Period
    
    
    Warranties
    
    
    BalanceAccrued Warranty (in thousands)Nine months ended December 31, 2004
    
    $
    1,731
    
    
    $
    1,354
    
    
    $
    (1,406
    )
    
    $
    1,679Nine months ended December 31, 2003
    
    $
    983
    
    
    $
    1,506
    
    
    $
    (1,069
    )
    
    $
    1,420
 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 three months ended December 31, 2004, amortization of patent
assets was $0.2 million, compared to $1.8 million for the three months ended December 31, 2003.
During the nine months ended December 31, 2004, amortization of patent assets was $0.6 million,
compared to $2.4 million for the nine months ended December 31, 2003. The nine months ended
December 31, 2003 included additional amortization of $1.8 million for a development contract
acquired in the Sensys acquisition and was fully expensed as of December 31, 2003. The remaining
net book value of our patent portfolio to be amortized is $1.1 million. 10. Segment Information We operate in one segment as we manufacture, market and service process control metrology
systems used in the manufacture of semiconductor equipment. 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 nine
months ended December 31, 2004 and 2003, respectively: 12




---



##### Table of Contents



Three Months Ended December 31,
    
    
    Nine Months Ended December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Revenues by CountryUnited States
    
    
    29%
    
    
    
    23%
    
    
    
    27%
    
    
    
    32%Taiwan
    
    
    31%
    
    
    
    8%
    
    
    
    21%
    
    
    
    16%Korea
    
    
    20%
    
    
    
    3%
    
    
    
    16%
    
    
    
    4%Japan
    
    
    11%
    
    
    
    44%
    
    
    
    14%
    
    
    
    26%Europe
    
    
    4%
    
    
    
    10%
    
    
    
    8%
    
    
    
    13%China
    
    
    4%
    
    
    
    6%
    
    
    
    7%
    
    
    
    5%Singapore
    
    
    1%
    
    
    
    6%
    
    
    
    7%
    
    
    
    4%Total
    
    
    100%
    
    
    
    100%
    
    
    
    100%
    
    
    
    100%
 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 $15.2 million and $15.3 million in the
three months ending December 31, 2004 and 2003, respectively. International sales were $47.8 million
and $31.0 million in the nine months ended December 31, 2004 and 2003, respectively. Three customers each accounted for 29%, 18% and 16% of our net revenues for the three months
ended December 31, 2004. For the three months ended December 31, 2003, three customers each
accounted for 32%, 12% and 11% of our net revenues. Three customers each accounted for 17%, 13% and
11% of our net revenues for the nine months ended December 31, 2004. For the nine months ended
December 31, 2003, four customers each accounted for 18%, 17%, 11% and 10% of our net revenues. The following is a summary of operations in geographic areas. 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
    
    
    ConsolidatedOperations In Geographic Areas (in
thousands)Three Months Ended December 31, 2004Sales to unaffiliated customers
    
    $
    18,993
    
    
    $
    2,477
    
    
    $
    
    
    
    $
    21,470Transfers between geographic locations
    
    
    236
    
    
    
    602
    
    
    
    (838
    )
    
    
    Total net revenues
    
    
    19,229
    
    
    
    3,079
    
    
    
    (838
    )
    
    
    21,470Operating loss
    
    $
    (1,233
    )
    
    $
    (56
    )
    
    $
    (465
    )
    
    $
    (1,754
    )Three Months Ended December 31, 2003Sales to unaffiliated customers
    
    $
    18,177
    
    
    $
    1,689
    
    
    $
    
    
    
    $
    19,866Transfers between geographic locations
    
    
    116
    
    
    
    387
    
    
    
    (503
    )
    
    
    Total net revenues
    
    
    18,293
    
    
    
    2,076
    
    
    
    (503
    )
    
    
    19,866Operating loss
    
    $
    (332
    )
    
    $
    (477
    )
    
    $
    (218
    )
    
    $
    (1,027
    )
 13




---



##### Table of Contents



United States
    
    
    All Other Locations
    
    
    Eliminations
    
    
    ConsolidatedNine Months Ended December 31, 2004Sales to unaffiliated customers
    
    $
    57,919
    
    
    $
    7,304
    
    
    $
    
    
    
    $
    65,223Transfers between geographic locations
    
    
    52
    
    
    
    1,678
    
    
    
    (1,730
    )
    
    
    Total net revenues
    
    
    57,971
    
    
    
    8,982
    
    
    
    (1,730
    )
    
    
    65,223Operating loss
    
    $
    (1,537
    )
    
    $
    (70
    )
    
    $
    (75
    )
    
    $
    (1,682
    )Nine Months Ended December 31, 2003Sales to unaffiliated customers
    
    $
    39,951
    
    
    $
    5,884
    
    
    $
    
    
    
    $
    45,835Transfers between geographic locations
    
    
    156
    
    
    
    1,435
    
    
    
    (1,591
    )
    
    
    Total net revenues
    
    
    40,107
    
    
    
    7,319
    
    
    
    (1,591
    )
    
    
    45,835Operating loss
    
    $
    (15,314
    )
    
    $
    (208
    )
    
    $
    (626
    )
    
    $
    (16,148
    )
 
 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 14




---



##### Table of Contents



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. 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 critical dimension (CD or OCD) technology are
gradually adding capability to traditional critical dimension-scanning electronic microscope
(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 15




---



##### Table of Contents



Opti-Probe RT/CD (real-time critical dimension) 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 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 unaudited 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 nine
months ended December 31, 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 December 31,
    
    
    Nine Months Ended December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Results of OperationsNet revenuesProduct
    
    
    74.7
    %
    
    
    78.4
    %
    
    
    76.3
    %
    
    
    69.8
    %Services and parts
    
    
    25.3
    %
    
    
    21.6
    %
    
    
    23.7
    %
    
    
    30.2
    %Total net revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenues
    
    
    57.6
    %
    
    
    49.9
    %
    
    
    53.1
    %
    
    
    59.9
    %Gross profit
    
    
    42.4
    %
    
    
    50.1
    %
    
    
    46.9
    %
    
    
    40.1
    %Operating expenses:Research and development
    
    
    20.2
    %
    
    
    22.6
    %
    
    
    20.1
    %
    
    
    31.9
    %Selling, general and administrative
    
    
    30.2
    %
    
    
    26.8
    %
    
    
    27.9
    %
    
    
    36.5
    %
 16




---



##### Table of Contents



Three Months Ended December 31,
    
    
    Nine Months Ended December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Restructuring, severance and other
    
    
    0.0
    %
    
    
    1.9
    %
    
    
    0.6
    %
    
    
    4.3
    %Stock-based compensation expense
    
    
    0.2
    %
    
    
    4.0
    %
    
    
    0.9
    %
    
    
    2.6
    %Total operating expenses
    
    
    50.6
    %
    
    
    55.3
    %
    
    
    49.5
    %
    
    
    75.3
    %Operating loss
    
    
    (8.2
    )%
    
    
    (5.2
    )%
    
    
    (2.6
    )%
    
    
    (35.2
    )%Other income (expense):Interest expense
    
    
    (0.0
    )%
    
    
    (0.2
    )%
    
    
    (0.0
    )%
    
    
    (0.2
    )%Interest income
    
    
    0.3
    %
    
    
    0.2
    %
    
    
    0.2
    %
    
    
    0.3
    %Other, net
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    (0.4
    )%Total other income (expense), net
    
    
    0.3
    %
    
    
    (0.0
    )%
    
    
    0.2
    %
    
    
    (0.3
    )%Loss before provision for income taxes
    
    
    (7.9
    )%
    
    
    (5.2
    )%
    
    
    (2.4
    )%
    
    
    (35.5
    )%Provision for income taxes
    
    
    1.0
    %
    
    
    0.0
    %
    
    
    0.3
    %
    
    
    0.0
    %Net loss
    
    
    (8.9
    )%
    
    
    (5.2
    )%
    
    
    (2.7
    )%
    
    
    (35.5
    )%
 Net Revenues.Net revenues for the three months ended December 31, 2004 were $21.5 million.
Compared to the three months ended September 30, 2004, net revenues decreased $1.1 million, or 5%,
from $22.6 million. The decrease in net revenues sequentially was due to a combination of factors.
First, the industry is believed to be in a down-turn period and we began to feel the effects of
this for the first time, experiencing a slow down in orders, one cancellation and some order
push-outs. We also shipped $3.1 million in product on which we deferred revenue recognition under
the our revenue recognition policy and shipped another $1.4 million for product that we kept in
inventories as evaluation product that we had expected to record as revenue in the period. Our
revenue recognition policy discussed in Note 1 to the accompanying Notes to Unaudited Condensed
Consolidated Financial Statements. Services and parts revenues, which include parts, billable labor and materials and service
contracts revenues, increased by 7% compared to the three months ended September 30, 2004, due to
an increase in net revenues from service contracts initially sold with systems during prior
periods. During the three months ended December 31, 2004, we sold a higher percentage of our newer,
more advanced systems, particularly those systems designed for 300 mm manufacturing facilities as
compared to the three months ended September 31, 2004. However, the prior year period included one
time net revenues from the conclusion of a customer funded research project in the amount of $4.7
million. More than offsetting this in the three months ended December 31, 2004, was an increase
from both higher systems revenues, which were up by $5.2 million, or 48%, and higher services
revenues, up $1.1 million or 27%. For information regarding where our product is sold, see Note 10 to the accompanying Notes to
Unaudited Condensed Consolidated Financial Statements. Net revenues increased in the three months ended December 31, 2004 to $21.5 million, up $1.6
million, or 8%, from $19.9 million in the three months ended December 31, 2003. This increase came
from both higher systems revenues, up $0.5 million, or 3%, and higher services revenues, up $1.1
million or 27%. Net revenues for the nine months ended December 31, 2004 were $65.2 million. Net
revenues for the nine months ended December 31, 2004 increased $19.4 million, or 42%, from $45.8
million in the nine months ended December 31, 2003. Both systems and services revenues increased,
up by 56% and 12%, respectively. Systems revenues are more variable than services revenues in
general, because services revenues are generated from our installed base 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 are often sold in service contracts for durations of one or more years. The growth in our
revenues over the previous quarter and year-to-date came due to improvements in industry market
conditions, from regaining business at two major customers lost in previous years, particularly for
our Therma-Probe product and from growth in our new products Opti-Probe Critical Dimension and
Integra integrated product metrology systems. 17




---



##### Table of Contents



International sales accounted for approximately 71% and 77% of our total net revenues for the
three months ended December 31, 2004 and 2003, respectively. International sales accounted for
approximately 73% and 68% of our total net revenues for the nine months ended December 31, 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, therefore the percentage of revenues by country may vary greatly from period
to period. For more information on revenues by country for the three and nine months ended December
31, 2004 and 2003, 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, Israel and Europe, such conditions could
negatively impact our international sales in future periods. Three customers each accounted for 29%, 18% and 16% of our net revenues for the three months
ended December 31, 2004. For the three months ended December 31, 2003, three customers each
accounted for 32%, 12% and 11% of our net revenues. Three customers each accounted for 17%, 13% and
11% of our net revenues for the nine months ended December 31, 2004. For the nine months ended
December 31, 2003, four customers each accounted for 18%, 17%, 11% and 10% of our net revenues. Gross Profit.Gross profit for the three months ended December 31, 2004 was $9.1 million, an
decrease of $1.7 million, or 16%, from a gross profit of $10.8 million in the three months ended
September 30, 2004. Compared to the three months ended December 31, 2003, gross profit decreased
$0.9 million, or 9%. As a percentage of net revenues, gross profit for the three months ended
December 31, 2004 was 42.4%, compared to 47.7% for the three months ended September 30, 2004 and
50.1% for the three months ended December 31, 2003. There are many factors that influence average gross margin. The two elements that are normally
the most significant in our company are the product revenue mix and price. In our fiscal 2005 third
quarter compared to our fiscal 2005 second quarter, product revenue mix was the most significant
element. First, our net revenues from product or system sales, which generate higher margins,
decreased by over 8% while our typically lower margin net services and parts revenues increased by
nearly 7%. Also, net revenues from systems final acceptances, which have high margins, decreased by
approximately 10%. In addition, our newer more advanced products, particularly 300 mm, continued to
account for a high percentage of our net revenues. This product is less mature than our older
products and therefore currently generates lower average margins. There are cost reduction programs
under way which have already shown progress in reducing these costs and improving margins, and
these programs are expected to improve margins further over the next few quarters. During the three months ended December 31, 2004, we sold $1.8 million of zero-cost and
reduced-cost inventories, of which $1.3 million, or 6 margin percentage points, related to raw
materials and sub-assemblies and $0.5 million, or 2 margin percentage points, related to cost
reductions recognized previously on finished goods held for sale. Partially offsetting these
benefits were provisions of $1.5 million, or negative 7 margin percentage points, incurred to
establish additional reduced cost basis for other specific inventories in the three months ended
December 31, 2004. The net benefit from recoveries of zero-cost and reduced-cost inventories less
new provisions during the three months ended December 31, 2004 was $0.3 million. During the three months ended September 30, 2004, we sold $1.8 million of zero-cost and
reduced-cost inventories, of which $1.1 million, or 5 margin percentage points, related to raw
materials and sub-assemblies and $0.7 million, or 3 margin percentage points, 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 three months ended
September 30, 2004. The net benefit from recoveries of zero-cost and reduced-cost inventories less
new provisions during the three months ended September 30, 2004 was $0.9 million. In the three months ended December 31, 2003, we sold $2.5 million of zero-cost and
reduced-cost inventories, of which $1.9 million, or 9 margin percentage points, related to raw
materials and sub-assemblies and $0.6 million, or 3 margin percentage points, related to
reduced-cost finished goods held for sale. Partially offsetting these benefits were provisions of
$0.6 million, or negative 3 margin percentage points, incurred to establish additional reduced-cost
basis for other specific inventories in the three months ended December 31, 2003. The net benefit
from recoveries of zero-cost and reduced-cost inventories less new provisions during the three
months ended December 31, 2003 was $1.9 million. During the nine months ended December 31, 2004, we sold $6.4 million of zero-cost and
reduced-cost inventories, of which $4.3 18




---



##### Table of Contents



million, or 7 margin points,
related to raw materials and sub-assemblies and $2.0 million, or 3 margin
points, related to reduced-cost finished goods held for sale. Partially offsetting these benefits
were provisions of $3.4 million, or negative 5 margin points, incurred to establish additional
reduced-cost basis for other specific inventories in the nine months ended December 31, 2004. The
net benefit from recoveries of zero-cost and reduced-cost inventories less new provisions during
the nine months ended December 31, 2004 was $3.0 million. During the nine months ended December 31, 2003, we sold $8.1 million of zero-cost and
reduced-cost inventories, of which $6.0 million, or 13 margin points, related to raw materials and
sub-assemblies and $2.1, or 5 margin points, related to reduced-cost finished goods held for sale.
Partially offsetting these benefits were provisions of $4.0 million, or negative 9 margin points,
incurred to establish additional reduced-cost basis for other specific inventories in the nine
months ended December 31, 2003. The net benefit from recoveries of zero-cost and reduced-cost
inventories less new provisions during the nine months ended December 31, 2004 was $4.1 million. The original cost of inventories written-off in prior periods, and scrapped during the three
months ended December 31, 2004, September 30, 2004, and December 31, 2003 was $0.4 million, $0.8
million, and $0.9 million, respectively. For each of the nine months ended December 31, 2004 and
2003, the original cost of inventories written-off in prior periods and scrapped was $2.1 million. Looking ahead to the final three months of fiscal 2005, we expect our product mix to continue
to be mostly advanced and 300 mm product sales. However, we expect the net benefit from sale of
previously written-off inventories to decrease by approximately another $0.1 million dollars and
become insignificant in the fiscal 2006. We expect a decline in the net benefit from the sale of
previously written-off inventories because most of the previously written-off inventories have been
used or disposed of in prior periods, and the remaining zero-cost inventories are used primarily in
less advanced 200 mm products for which demand is decreasing as our customers requirements change
toward our more advanced 300 mm products. For the final three months of fiscal 2005, we anticipate
our operating costs will remain at approximately the same level. However, our industry appears to
be entering a mild downturn, which is expected to result in lower sales volumes, resulting in lower
average gross margins, likely under 40%, for our fiscal fourth quarter. Research and Development (R&D) Expenses.R&D expenses for the three months ended December 31,
2004 were $4.3 million, a decrease of 2% and 4% from R&D expenses of $4.4 million and $4.5 million
in the three months ended September 30, 2004 and December 31, 2003, respectively. R&D expenses for
the first nine months ended December 31, 2004 were $13.1 million, a decrease of $1.5 million, or
10%, from $14.6 million for the nine months ended December 31, 2003. The decrease in R&D expenses
compared with the prior periods primarily reflects lower costs for equipment, project materials and
outside services. We expect our overall R&D expenditures to remain at a similar level in the final
three months of 2005. 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 three months ended
December 31, 2004 were $6.5 million, an increase of 9% from SG&A expenses of $5.9 million in the
three months ended September 30, 2004, primarily due to sharply increased spending on our efforts
to achieve Sarbanes-Oxley Section 404 compliance. Compared to the three months ended December 31,
2003, SG&A expenses increased $1.2 million, or 22%, from $5.3 million. SG&A expenses for the nine
months ended December 31, 2004 were $18.2 million, an increase of 9% from SG&A expenses of $16.7
million for the nine months ended December 31, 2003. For the final three months of fiscal 2005, we
anticipate SG&A spending to remain at approximately the same level. Spending for Sarbanes-Oxley 404
compliance is expected to again be at approximately $0.7 million for the quarter and $1.7 million
for the fiscal year total. Restructuring, Severance and Other.No restructuring, severance and other expenses were
incurred during each of the three-month periods ended December 31, 2004 and September, 30, 2004.
For the three months ended December 31, 2003, restructuring expenses amounted to $0.4 million. For
the nine months ended December 31, 2004 restructuring expenses were $0.4 million, representing a
decrease of $1.6 million from $2.0 million in the nine months ended December 31, 2003.
Restructuring expenses one year ago included costs related to reduction in force programs. We do
not anticipate additional restructuring expenses in the final three months of fiscal 2005. However,
as sub-lease rates and occupancy estimates change, we may record additional expenses or credits
related to our one excess facility currently available for sub-lease. The maximum amount by which
the actual loss could exceed our current estimate is $0.1 million. Stock-Based Employee Compensation.Stock-based employee compensation expense included in net
loss as reported for the three months and nine months ended December 31, 2004 and 2003, respectively, 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




---



##### 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 $52,000, $44,000, and $0.1 million for the three months ended December
31, 2004, September 30, 2004 and December 31, 2003, respectively. For the nine months ended
December 31, 2004 and 2003, respectively, deferred stock compensation amortization expenses were
$0.4 million and $0.5 million. A portion of the deferred stock amortization expense are included in
cost of revenues. These expenses 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 nine months of fiscal 2004. As of December 31, 2004, $0.1 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 $22,000 of stock-based compensation in
the third quarter of fiscal 2005. The benefit is primarily a result of the decline in the closing
stock price from $3.33 per share at the end of the second quarter of fiscal 2005 compared to $3.24
per share at the end of the third quarter of fiscal 2005. For the nine months ended December 31,
2004, we recorded an expense of approximately $0.3 million. This expense 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 periods, 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 December
31, 2004, $0.1 million of deferred stock compensation related to the variable accounting treatment
for certain stock options remained to be amortized over future periods based on the closing stock
price at December 31, 2004. The amount of deferred stock compensation expense (benefit) in the
final three months of fiscal 2005 will reflect three months of vesting and depend primarily on our
closing stock price at the end of fiscal 2005. If the closing stock price is higher than at
December 31, 2004, we expect to record an expense. Conversely, if the closing stock price is lower
than at December 31, 2004, we expect to record a benefit from deferred stock compensation
amortization not to exceed the cumulative amortization of deferred stock compensation of $1.0
million previously recorded. Other Income (Expense).Other income, net, for the three months ended December 31, 2004 was
$52,000, compared to other income, net, of $27,000 in the three months ended September 30, 2004,
and other expense, net, of $4,000 in the three months ended December 31, 2003. Other income, net,
for the first nine months ended December 31, 2004 was $0.1 million, compared to other expense, net,
of $0.1 million in the nine months ended December 31, 2003. Other expense for the nine months ended
December 31, 2003 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. Because the Company closed the deferred executive compensation
program as of December 16, 2004, we are no longer exposed to gains or losses related to changes in
the investment value of deferred executive compensation program balances. Net Loss.The combination of all the factors discussed above contributed to a net loss of $1.9
million, or negative $0.05 per basic and diluted share, for the three months ended December 31,
2004. This compares to a net income of $1.3 million, or $0.04 and $0.03 per basic and diluted
share, respectively, in the three months ended September 30, 2004 and a net loss of $1.0 million,
or negative $0.03 per basic and diluted share, in the three months ended December 31, 2003. Net
loss for the nine months ended December 31, 2004 was $1.8 million, or negative $0.05 per basic and
diluted share, compared to a loss of $16.3 million, or negative $0.52 per basic and diluted share,
in the nine months ended December 31, 2003. For the final three months of fiscal 2005 we anticipate
our costs to remain at approximately the same level. Spending for Sarbanes-Oxley 404 compliance is
expected to again be at approximately $0.7 million for the quarter. However, our industry appears
to be entering a mild downturn which may result in lower sales volumes and could result in lower
net income margins due to lower overhead absorption. We are currently unable to make an accurate
prediction of net loss for the final three months of fiscal 2005 due to the uncertainty related to
our industry. 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 $302.8 million at December 31, 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 agent. We are using these funds for general corporate purposes. 20




---



##### Table of Contents



Our cash balance decreased by $10.2 million during the nine months ended December 31, 2004
from $23.9 million to $13.7 million, mostly due to operating activities, which consumed $9.6
million. Investments in property and equipment and in our patent portfolio used $1.2 million. Cash
raised through the proceeds from the exercise of stock options contributed cash of $0.5 million.
This net decrease in cash of $10.2 million during the nine months ended December 31, 2004 compares
to an increase in cash during the nine months ended December 31, 2003 of $8.8 million, most of which
is a result of the proceeds from a private placement stock offering in September 2003. Cash flows used by operating activities were $9.6 million and $4.4 million for the nine months
ended December 31, 2004 and 2003, respectively, an increase in cash used by operating activities of
$5.2 million. The net loss in the nine months ended December 31, 2004 was $1.8 million, compared to
a net loss of $16.3 million in the nine months ended December 31, 2003. Cash was used to fund
increases in operating assets, principally inventory and accounts receivable. Increases in
inventory were $11.9 million in the nine months ended December 31, 2004 compared to a $1.1 million
decrease in inventories in the nine months ended December 31, 2003. The increase in inventory
reflects increased purchases to support anticipated higher sales volumes. Similarly, accounts receivable increased by $7.6 million in the nine months ended December 31,
2004, reflecting higher shipments and the timing of those shipments. This increase of $7.6 million,
compared to an increase in accounts receivable in the nine months ended December 31, 2003 of $0.3
million, is due to higher billings in the nine months ended December 31, 2004 compared to the nine
months ended December 31, 2003. Days sales outstanding were unchanged at 62 days as of December 31,
2004 and 2003, respectively. Days sales outstanding is calculated based on accounts receivable
divided by billings. In the past we calculated days sales outstanding based on accounts receivable
divided by net revenues. The change in the days sales outstanding calculation is meant to better
represent the days that receivables are outstanding. Days sales outstanding in the prior periods
have been recalculated to conform to the new methodology. Deferred revenues increased by $2.5
million in the nine months ended December 31, 2004 compared to a decrease of $2.0 million in the
nine months ended December 31, 2003. Accounts payable increased in the nine months ended December 31, 2004 generating operating
cash flows of $1.5 million, compared to $1.2 million in the nine months ended December 31, 2003. Changes in other assets and accrued liabilities increased cash flows from operating activities
by $1.0 million in the nine months ended December 31, 2004 compared to a increase in cash flows
from other assets and accrued liabilities of $0.8 million in the nine months ended December 31,
2003. Adjustments to reconcile net loss to net cash used in operating activities included $6.7
million in non-cash expenses in the nine months ended December 31, 2004 compared to $11.0 million
in the nine months ended December 31, 2003. These expenses included depreciation and amortization
on property and equipment and our patent portfolio, down $3.1 million; deferred stock compensation
expense, down $0.8 million; inventory provisions, down $0.7 million; credits for doubtful accounts,
up by $0.9 million; and other changes which net to a reduction of $0.6 million. Cash flows used in investing activities were $1.2 million in the nine months ended December
31, 2004 compared to cash flows used in investing activities of $0.4 million in the nine months
ended December 31, 2003. Cash flows provided by investing activities in the nine months ended
December 31, 2003 included proceeds of $0.4 million from the sale of an investment. In the nine
months ended December 31, 2004, purchases of property and equipment were $0.8 million, up from $0.2
million in the nine months ended December 31, 2003. Investments in our patent portfolio were $0.4
million in the nine months ended December 31, 2004, down from $0.6 million in the nine months ended
December 31, 2003, respectively. Cash flows provided by financing activities were $0.5 million in the nine months ended
December 31, 2004 compared to cash flows provided by financing activities of $13.1 million in the
nine months ended December 31, 2003. The cash flows provided by financing activities last year
primarily resulted from net proceeds from a private placement stock offering in September 2003. Our principal sources of funds have been and are anticipated to be cash on hand ($13.7 million
as of December 31, 2004), cash flows from operating activities (if any), borrowings under our bank
credit facility and proceeds from the sale of our common stock. We believe that we will have
adequate liquidity and capital resources to meet our current and future financial obligations for
the next twelve months. No assurance can be given, however, that this will be the case. We may
require additional equity or debt financing to meet our working capital requirements or to fund our
research and development activities. There can be no assurance that additional financing will be
available, if required or, if available, will be on terms satisfactory to us. Off-Balance Sheet Commitments Our off-balance sheet commitments are limited to equipment operating leases, leases on office
and manufacturing space, purchase 21




---



##### Table of Contents



commitments, minimum royalty payments under certain software license agreements, and minimum
payment guarantees in the form of cancellation fee commitments. Future payments due under these
obligations as of December 31, 2004 are as follows: MinimumOperating
    
    
    Purchase
    
    
    Royalty
    
    
    CancellationLeases
    
    
    Commitments
    
    
    Payments
    
    
    Fees
    
    
    TotalOff Balance Sheet Commitments
by Fiscal Year (in thousands)2005 (3 months)
    
    $
    522
    
    
    $
    10,452
    
    
    $
    30
    
    
    $
    
    
    
    $
    11,0042006 (12 months)
    
    
    1,985
    
    
    
    989
    
    
    
    40
    
    
    
    362
    
    
    
    3,3762007 (12 months)
    
    
    1,816
    
    
    
    
    
    
    
    40
    
    
    
    90
    
    
    
    1,9462008 (12 months)
    
    
    1,766
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,7662009 (12 months)
    
    
    1,275
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,2752010 and thereafter
    
    
    2,169
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,169Total future minimum payments
    
    $
    9,533
    
    
    $
    11,441
    
    
    $
    110
    
    
    $
    452
    
    
    $
    21,536
 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 projected sub-lease
income on one remaining excess facility. 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 December 31, 2004 and the Company believes that the fair value
of our indemnification arrangements is not material. In June 2003, we entered into a loan and security agreement with Silicon Valley Bank, or
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 or
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%, or
6.75%, as of December 31, 2004. The EXIM revolving line allows us to borrow money at a floating
interest rate equal to the SVB prime rate plus 1.75%, or 7.0%, as of December 31, 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 December 31, 2004, we had no
borrowings and $4.6 million in outstanding letters of credit under this agreement, none of which
had been drawn against. During the three months ended December 31, 2004, the Company was in
violation of covenant to maintain a specified quick ratio. As of December 31, 2004, we were able to
renegotiate a new quick ratio and a new quick ratio formula with the bank and were in compliance
with all the covenants in the agreement. Inflation The impact of inflation on our business was not material for the three months ended December
31, 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. 22




---



##### Table of Contents



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 December 31, 2004, our cash and cash equivalents included money market funds. 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. Although we have not been negatively impacted
in the past by foreign currency changes in Taiwan, Japan, China, Korea, Israel and Europe, such
conditions could negatively impact our international sales in future periods. 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 nine months ended December 31, 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. 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 December 31, 2004 we have an accumulated other
comprehensive loss of $0.6 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, design and operating effectiveness of internal
controls over financial reporting that we are in the process of remediating. These gaps include a
material weakness in our controls surrounding revenue recognition  See Item 4 Controls and
Procedures. 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. 23




---



##### Table of Contents



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 currently 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.
We have already experienced unexpected delays in this process as a result of the discovery of the
material weakness relating to revenue recognition described below in Item 4. While we have already
implemented some additional internal controls and are in the process of implementing additional
procedures to remediate this material weakness, we can provide no assurance that we will be able to
remediate this material weakness prior to the filing of our next annual report on Form 10-K. Even
if we are able to eliminate this material weakness, we may fail to
complete our evaluation as
required by Section 404 of the Sarbanes-Oxley Act of 2002 on a timely basis and in a satisfactory
manner, or our independent registered public accounting firm may be unable to attest on a timely
basis to the adequacy of the Companys internal control, which in either case may impact the
reliability of our internal controls over financial reporting, or we may be subject to additional
scrutiny by the SEC or our investors regarding our internal controls over financial reporting,
including the impact of the material weakness referred to above. 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
December 26, 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. In connection with managements review of the Companys results for the quarter ended December
31, 2004, management identified and reported to the Audit Committee of the Companys Board of
Directors and to the Companys independent registered public accounting firm certain significant
control deficiencies. These deficiencies included:  1.
    Insufficient documentation to support revenue recognition decisions including timely
receipt of final acceptances, support for customer change orders and receipt of final
signed contracts and;2.
    Lack of timely communication between business unit and finance personnel related to
sales order status and the impact of changes in key contract terms on revenue recognition. Management has determined that these significant deficiencies constitute a material weakness.
This list of control deficiencies may not be complete and may require additions as the Companys
review of internal controls is still in process. A material weakness is defined by Public Company
Accounting Oversight Board Auditing Standard No. 2 as a significant deficiency (or combination of
significant deficiencies) that results in a more-than-remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented or detected. Prior to the issuance of the our unaudited condensed consolidated financial statements,
management performed a detailed review of all significant revenue transactions during the quarter
to ensure all such transactions were properly recorded in accordance with the Companys established
revenue recognition criteria. 24




---



##### Table of Contents



The Company is addressing the above-noted material weakness by implementing measures to ensure
the timeliness and completeness of all documentation impacting revenue recognition including sales
order agreements, final acceptances and other supporting documentation prepared and/or received by
the Companys business units. The Company will also conduct revenue recognition training of
personnel responsible for authorizing and documenting revenue transactions at the business units
and strengthen expertise in contract administration within the Company. Management will report
its progress in implementing these measures to the Companys Audit Committee on an on-going basis. Changes in Internal Controls There have been no significant changes in the Companys internal controls over financial
reporting other than discussed above during the three months ended December 31, 2004 that materially
affected, or are reasonably likely to materially affect, our internal controls over financial
reporting. 25




---



##### Table of Contents



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 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 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 None. 
 Item 5. Other Information None. 
 Item 6. Exhibits Exhibit Number
    
    Description10.1
    
    Director Stock Option Agreement adopted November 24, 2004.31.1
    
    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)).
 26




---



##### Table of Contents



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) February 4, 2005 27




---



##### Table of Contents



EXHIBIT INDEX Exhibit Number
    
    Description10.1
    
    Director Stock Option Agreement adopted November 24, 2004.31.1
    
    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)).