##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
  FORM 10-Q  (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 27, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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 reports), and (2) has been subject to such
filing requirements for the past 90 days. YES x NO o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES x NO o Indicate the number of shares of the issuers class of common stock, as of
the latest practical date: Class
    
    Outstanding as of June 27, 2004Common stock, $.01 par value
    
    35,802,081




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THERMA-WAVE, INC.
TABLE OF CONTENTS  
 Page No.PART I. FINANCIAL INFORMATIONITEM 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of
June 30, 2004 and March 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the
Three Months Ended June 30, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the
Three Months Ended June 30, 2004 and 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    13ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    20ITEM 4. Controls and Procedures
    
    
    21PART II. OTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    23ITEM 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities
    
    
    23ITEM 3. Defaults Upon Senior Securities
    
    
    23ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    23ITEM 5. Other Information
    
    
    23ITEM 6. Exhibits and Reports on Form 8-K
    
    
    23SIGNATURES
    
    
    24EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  Note: The first quarters of fiscal years 2005 and 2004 and the fiscal year 2004
ended on June 27, 2004, June 29, 2003 and March 28, 2004, respectively. For
presentation purposes, the accompanying condensed consolidated financial
statements have been shown as ending on the last day of the calendar quarter
closest to each of these dates. 2




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##### Table of Contents



PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands)
 (Unaudited)
 June 30,
    
    March 31,2004
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    21,148
    
    
    $
    23,899Accounts receivable, net
    
    
    16,219
    
    
    
    14,772Inventories
    
    
    21,109
    
    
    
    17,169Other current assets
    
    
    1,959
    
    
    
    2,075Total current assets
    
    
    60,435
    
    
    
    57,915Property and equipment, net
    
    
    4,147
    
    
    
    4,564Other assets, net
    
    
    2,704
    
    
    
    2,710Total assets
    
    $
    67,286
    
    
    $
    65,189LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    9,024
    
    
    $
    7,420Accrued liabilities
    
    
    15,630
    
    
    
    15,730Deferred revenues
    
    
    6,631
    
    
    
    6,887Total current liabilities
    
    
    31,285
    
    
    
    30,037Non-current deferred revenues
    
    
    1,887
    
    
    
    1,815Other long-term liabilities
    
    
    1,210
    
    
    
    1,073Total liabilities
    
    
    34,382
    
    
    
    32,925Commitments and contingencies (Note 6)Stockholders equity:Common stock
    
    
    357
    
    
    
    355Additional paid-in capital
    
    
    336,521
    
    
    
    335,012Notes receivable from stockholders
    
    
    (174
    )
    
    
    (174
    )Accumulated other comprehensive loss
    
    
    (812
    )
    
    
    (735
    )Deferred stock-based compensation
    
    
    (794
    )
    
    
    (1,172
    )Accumulated deficit
    
    
    (302,194
    )
    
    
    (301,022
    )Total stockholders equity
    
    
    32,904
    
    
    
    32,264Total liabilities and stockholders equity
    
    $
    67,286
    
    
    $
    65,189
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except per share data)
 (Unaudited)
 Three months ended June 30,2004
    
    2003Net revenuesProduct
    
    $
    16,189
    
    
    $
    6,807Services and parts
    
    
    4,962
    
    
    
    5,096Total net revenues
    
    
    21,151
    
    
    
    11,903Cost of revenues (including stock-based
compensation of $318 and $1)
    
    
    10,431
    
    
    
    9,071Gross profit
    
    
    10,720
    
    
    
    2,832Operating expenses:Research and development (excluding stock-based
compensation of $886 and $124)
    
    
    4,379
    
    
    
    4,948Selling, general and administrative (excluding
stock-based compensation of $547 and $86)
    
    
    5,756
    
    
    
    5,529Restructuring, severance and other
    
    
    373
    
    
    
    1,484Stock-based compensation
    
    
    1,433
    
    
    
    210Total operating expenses
    
    
    11,941
    
    
    
    12,171Operating loss
    
    
    (1,221
    )
    
    
    (9,339
    )Other income (expense):Interest expense
    
    
    
    
    
    
    (21
    )Interest income
    
    
    42
    
    
    
    37Other, net
    
    
    10
    
    
    
    (211
    )Total other income (expense), net
    
    
    52
    
    
    
    (195
    )Net loss
    
    
    (1,169
    )
    
    
    (9,534
    )Net loss per share:Basic and Diluted
    
    $
    (0.03
    )
    
    $
    (0.33
    )Weighted average common shares outstanding:Basic and Diluted
    
    
    35,637
    
    
    
    28,704
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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THERMA-WAVE, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands)
 (Unaudited)
 Three months ended June 30,2004
    
    2003Operating activities:Net loss
    
    $
    (1,169
    )
    
    $
    (9,534
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization of property and equipment
    
    
    663
    
    
    
    1,407Amortization of intangible assets
    
    
    198
    
    
    
    118Amortization of deferred stock-based compensation
    
    
    1,751
    
    
    
    211Credit for doubtful accounts receivable
    
    
    (48
    )
    
    
    (827
    )Inventory provision
    
    
    983
    
    
    
    1,726Loss on disposal of property and equipment
    
    
    
    
    
    
    86Loss on sale of an investment
    
    
    
    
    
    
    125Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,399
    )
    
    
    4,626Inventories
    
    
    (4,923
    )
    
    
    1,195Other assets
    
    
    123
    
    
    
    774Accounts payable
    
    
    1,604
    
    
    
    953Accrued and other liabilities
    
    
    37
    
    
    
    (1,873
    )Deferred revenues
    
    
    (184
    )
    
    
    640Net cash used by operating activities
    
    
    (2,364
    )
    
    
    (373
    )Investing activities:Purchases of property and equipment
    
    
    (246
    )
    
    
    (17
    )Proceeds from sale of an investment
    
    
    
    
    
    
    375Purchase of patents and others
    
    
    (199
    )
    
    
    (209
    )Net cash provided (used) by investing activities
    
    
    (445
    )
    
    
    149Financing activities:Restricted cash
    
    
    
    
    
    
    (2,436
    )Proceeds from issuance of common stock
    
    
    135
    
    
    
    60Proceeds from note receivable from stockholders
    
    
    
    
    
    
    22Net cash provided (used) by financing activities
    
    
    135
    
    
    
    (2,354
    )Effect of exchange rates on cash
    
    
    (77
    )
    
    
    115Net decrease in cash and cash equivalents
    
    
    (2,751
    )
    
    
    (2,463
    )Cash and cash equivalents at beginning of period
    
    
    23,899
    
    
    
    13,695Cash and cash equivalents at end of period
    
    $
    21,148
    
    
    $
    11,232Supplementary disclosures:Cash paid for interest
    
    $
    
    
    
    $
    17Cash paid for taxes
    
    $
    64
    
    
    $
    7
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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THERMA-WAVE, INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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 presentation of the financial position at
June 30, 2004, the operating results for the three months ended June 30, 2004
and 2003, and the cash flows for the three months ended June 30, 2004 and 2003.
These financial statements and notes should be read in conjunction with our
audited financial statements and notes thereto for the year ended March 31,
2004. The results of operations for the interim periods are not necessarily
indicative of the results of operations that may be expected for any other
period or for the fiscal year, which ends on April 3, 2005. The first quarters of fiscal years 2005 and 2004 and the fiscal year 2004
ended on June 27, 2004, June 29, 2003 and March 28, 2004, respectively. For
presentation purposes, the accompanying unaudited condensed consolidated
financial statements have been shown as ending on the last day of the calendar
quarter closest to each of these dates. Revenue Recognition Revenues are recognized when the contractual obligations have been
performed, title and risk of ownership have passed to the customer,
collectibility of the sales price has been reasonably assured and customer
final acceptance has been obtained, if applicable. Shipments typically are made
in compliance with shipment requirements specified in our customers purchase
order. Freight terms of sales are FOB shipping point unless otherwise
negotiated and agreed in written form 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 and a percentage of payment subject to final
acceptance. Systems revenues are allocated on a fair value basis to each
component of the multiple-element arrangement. Revenues on each element are
recognized when the contractual obligations have been performed, title and risk
of ownership have passed to the customer, collectibility of the sales price has
been reasonably assured and customer final acceptance has been obtained, if
applicable. Estimated contractual warranty obligations are recorded when
related systems sales are shipped. Systems revenues on newly introduced products are deferred at shipment and
recognized upon customer final acceptance. Systems revenues are also deferred
when the customer has the right to return the product for credit. In such
cases, systems revenues are not recognized until all of the following
conditions have been evidenced after the customers purchase order has been
fulfilled: the right of return has expired and any potential returns would
require authorization by our company under warranty provisions; the price of
sales is fixed or determinable; the payment terms are fixed and enforceable and
collectibility is reasonably assured. 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. Services Revenues.We derive services revenues from three primary sources:
sale of spare parts, service contracts and service labor. Revenues on the sale
of spare parts are recognized when 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 6




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reasonably assured and customer final acceptance has been obtained, if
applicable. Reclassifications Certain prior year amounts in the unaudited condensed consolidated
statements of cash flows have been changed to conform to current period
classifications. Stock-Based Compensation In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, Accounting for Stock-Based Compensation. The Company has applied
Accounting Principles Board Opinion No. 25 in accounting for its stock option
plans and has adopted the disclosure provisions of SFAS No. 123. In April 2000,
the Financial Accounting Standards Board issued FASB Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation: An
Interpretation of APB No. 25. The Company has adopted the provisions of FIN
44, and such adoption did not materially impact the Companys results of
operations. In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation Transition and Disclosure. The statement amends SFAS
No. 123 to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. The Company has adopted the disclosure provisions of SFAS No.
148. Had compensation costs been determined based upon the fair value at the
grant date for awards under the stock option plans and employee stock purchase
plans, consistent with the methodology prescribed under SFAS No. 123, our pro
forma net loss and pro forma net loss per share under SFAS No. 123 would have
been: Three Months Ended June 30,2004
    
    2003Net loss (in thousands):As reported
    
    $
    (1,169
    )
    
    $
    (9,534
    )Stock-based employee compensation
expense included in the determination
of net loss, as reported
    
    
    1,751
    
    
    
    211Stock-based employee compensation
expense determined using fair value
method
    
    
    (1,401
    )
    
    
    (1,196
    )Pro forma net loss
    
    $
    (819
    )
    
    $
    (10,519
    )Basic and diluted net loss per share:As reported
    
    $
    (0.03
    )
    
    $
    (0.33
    )Pro forma
    
    $
    (0.02
    )
    
    $
    (0.37
    )
 The weighted average grant-date fair value of our stock options was $2.95
and $0.38 for the three months ended June 30, 2004 and 2003, respectively.
These values were estimated using the Black-Scholes pricing model with the
following assumptions: Three Months Ended June 30,2004
    
    2003Risk-free interest rate
    
    
    3.1
    %
    
    
    3.5
    %Expected dividend yield
    
    
    
    
    
    
    Expected volatility
    
    
    100
    %
    
    
    119
    %Expected life in years
    
    
    5.0
    
    
    
    4.5
 7




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The weighted average grant-date fair value of our stock purchase rights
granted under our employee stock purchase plans was $0.17 and $0.18 for the
three months ended June 30, 2004 and 2003, respectively. These values were
estimated using the Black-Scholes pricing model with the following assumptions: Three Months Ended June 30,2004
    
    2003Risk-free interest rate
    
    
    1.2
    %
    
    
    0.4
    %Expected dividend yield
    
    
    
    
    
    
    Expected volatility
    
    
    60
    %
    
    
    147
    %Expected life in years
    
    
    1.25
    
    
    
    0.25
 2. Balance Sheet Components June 30,
    
    March 31,2004
    
    2004(In thousands)Inventories:Purchased materials
    
    $
    8,800
    
    
    $
    6,066Systems in process
    
    
    8,944
    
    
    
    8,158Finished systems
    
    
    3,365
    
    
    
    2,945Total inventories
    
    $
    21,109
    
    
    $
    17,169
 June 30,
    
    March 31,2004
    
    2004(In thousands)Property and equipment:Laboratory and test equipment
    
    $
    6,122
    
    
    $
    6,014Office furniture and equipment
    
    
    10,157
    
    
    
    10,100Machinery and equipment
    
    
    812
    
    
    
    819Leasehold improvements
    
    
    8,626
    
    
    
    8,612Total property and equipment, gross
    
    
    25,717
    
    
    
    25,545Accumulated depreciation and amortization
    
    
    (21,570
    )
    
    
    (20,981
    )Total property and equipment, net
    
    $
    4,147
    
    
    $
    4,564
 During the first quarter of fiscal 2005, the company disposed of fully
depreciated equipment having a gross value of $0.1 million and accumulated
depreciation of $0.1 million. There was no gain or loss on disposal. 8




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June 30,
    
    March 31,2004
    
    2004(In thousands)Accrued liabilities:Accrued compensation and related expenses
    
    $
    3,042
    
    
    $
    2,368Accrued warranty
    
    
    1,626
    
    
    
    1,731Commissions payable
    
    
    1,169
    
    
    
    893Income tax payable
    
    
    4,845
    
    
    
    4,870Other accrued liabilities
    
    
    4,948
    
    
    
    5,868Total accrued liabilities
    
    $
    15,630
    
    
    $
    15,730
 3. Comprehensive Loss Comprehensive loss consists of net loss for the period and the change in
accumulated foreign currency translation adjustments during the period. For the
three months ended June 30, 2004 and 2003, comprehensive loss amounted to
approximately $1.2 million and $9.4 million, respectively. 4. Deferred Revenues Deferred
revenues arise from systems (product) sales and service
contracts. Revenues on service contracts are deferred and recognized on a
straight-line basis over the respective contract term. Systems sales are
accounted for as multiple-element arrangements that require the deferral of a
significant portion of revenues in the amount of the greater of the fair market
value of installation and related post shipment services and the percentage of
payment subject to final acceptance. Systems revenues are allocated on a fair
value basis to each component of the multiple-element arrangement. Revenues on
each element are recognized when contractual obligations have been performed,
title and risk of ownership have passed to the customer, collectibility of the
sales price has been reasonably assured and customer final 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. Systems revenues are also deferred when the customer has the right to
return the product for credit. In such cases, revenues are recognized after the
right of return has expired and any potential returns would require
authorization by our company under warranty provisions and after all other
revenue recognition criteria has been met. 5. 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 in the weighted average number of common
shares outstanding for a period, if dilutive. The following table summarizes securities outstanding (in thousands) as of
each period end which were not included in the calculation of diluted net loss
per share since their inclusion would be anti-dilutive. June 30,2004
    
    2003Common stock held in escrow account
    
    
    
    
    
    
    541Stock options
    
    
    5,510
    
    
    
    5,632Warrants
    
    
    79
    
    
    
    79
 9




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In connection with our acquisition of Sensys Instruments Corporation, or
Sensys, on January 16, 2002, 540,724 shares of Therma-Wave common stock
issuable to the former shareholders of Sensys were held in escrow for a period
of 18 months and during that time could have been used to satisfy certain
working capital adjustments and indemnification claims. Effective July 16,
2003, all the shares held in the escrow account were released to former
shareholders of Sensys. For the three months ended June 30, 2004 and 2003, anti-dilutive stock
options have a weighted average exercise price of $5.29 and $12.11,
respectively. The warrants outstanding at June 30, 2004 that were excluded from
the above calculation had a weighted average exercise price of $3.68. 6. 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 $0.7 million and $0.8 million for the
fiscal quarters ended June 30, 2004 and 2003, respectively. At June 30, 2004,
future minimum lease payments under non-cancelable operating leases (facilities
and equipment leases) and sub-lease income due to us under an existing sub-lease of an excess facility are as follows (in thousands): 2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    Thereafter
    
    TotalContractual ObligationsOperating lease obligations
    
    $
    1,882
    
    
    $
    1,807
    
    
    $
    579
    
    
    $
    558
    
    
    $
    47
    
    
    $
    
    
    
    $
    4,873Sub-lease
income (see Note 8)
    
    $
    20
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    20
 7. Financing Arrangements In June 2003, we entered into a loan and security agreement with Silicon
Valley Bank (SVB). The agreement includes a $5.0 million domestic line of
credit, including a sub-limit of $5.0 million for letters of credit, and a
$10.0 million Export-Import Bank of the United States (EXIM), guaranteed
revolving line of credit. These bank credit facilities allow us to borrow money
under the domestic line bearing a floating interest rate equal to the SVB prime
rate plus 1.50%. The EXIM revolving line allows us to borrow money at a
floating interest rate equal to the SVB prime rate plus 1.75%. We may request
advances in an aggregate outstanding amount not to exceed the lesser of $15.0
million total under the two lines or 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. As
of June 30, 2004, we had $4.6 million in outstanding letters of credit under
this agreement. The credit facilities originally matured on June 13, 2004, but
we have recently extended these credit facilities for one additional year. As
of June 30, 2004, we were in compliance with all the covenants in the
agreement. No amounts have been drawn against these standby letters of credit. 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 at June 30, 2004, nor have
we incurred any losses under such indemnification during the periods covered in
this report. Legal Proceedings We are not aware of any material legal proceedings pending against us. We
may be required to initiate 10




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additional litigation in order to enforce any patents issued to or
licensed to us or to determine the scope and/or validity of a third partys
patent or other proprietary rights. In addition, we may be subject to
additional lawsuits by third parties seeking to enforce their own intellectual
property rights. Any such litigation, regardless of outcome, could be
expensive and time consuming and, as discussed above in the prior risk factor,
could subject us to significant liabilities or require us to cease using 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. 8. Restructuring, Severance and Other Costs The following table summarizes the changes in restructuring, severance and
other costs during the three months ended June 30, 2004 and 2003, respectively
(in thousands): Liability as of
    
    
    
    
    
    
    
    
    
    Liability as ofMarch 31, 2004
    
    Provision
    
    Utilization
    
    June 30, 2004Consolidation of excess facilities
    
    $
    220
    
    
    $
    373
    
    
    $
    (119
    )
    
    $
    474
 Liability as of
    
    
    
    
    
    
    
    
    
    Liability as ofMarch 31, 2003
    
    Provision
    
    Utilization
    
    June 30, 2003Severance and workforce reduction
    
    $
    558
    
    
    $
    1,392
    
    
    $
    (1,583
    )
    
    $
    367Consolidation of excess facilities
    
    
    662
    
    
    
    
    
    
    
    (144
    )
    
    
    518Other
    
    
    134
    
    
    
    92
    
    
    
    (145
    )
    
    
    81$
    1,354
    
    
    $
    1,484
    
    
    $
    (1,872
    )
    
    $
    966
 Our
restructuring liability as of June 30, 2004 for consolidation of excess facilities includes the benefit of an estimate of future
sub-lease income on one excess facility. Should no sub-lease of that facility occur, our undiscounted maximum exposure due to the consolidation of excess
facilities is $0.6 million. In June 2004, we changed our estimate of the potential sub-lease income
related to one of our previously abandoned excess facilities, and also changed
the estimated date by which the facility is likely to be sub-leased. Due to
these changes in estimate, we recognized an additional $0.4 million
restructuring charge in the quarter ended June 30, 2004. If rental rates
decrease in the market, or if it takes longer than expected to sublease these
facilities, the actual loss could exceed this estimate. We anticipate that the
accrued liability at June 30, 2004 of $0.5 million will be paid out by March
2006. 9. 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
three months ended June 30, 2004 and 2003, respectively, are summarized (in
thousands) as follows: Provision for
    
    Settlement ofBeginning
    
    Warranties Issued
    
    Pre-Existing
    
    EndingBalance
    
    During the Period
    
    Warranties
    
    BalanceThree Months Ended June 30, 2004
    
    $
    1,731
    
    
    $
    353
    
    
    $
    (458
    )
    
    $
    1,626Three Months Ended June 30, 2003
    
    $
    983
    
    
    $
    472
    
    
    $
    (316
    )
    
    $
    1,139
 10. Other Assets, Net 11




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##### Table of Contents



Capitalized patent acquisition costs are included in non-current other
assets, net. Capitalized patent acquisition costs are amortized over the
estimated useful life of the patent, generally five years. During the quarter
ended June 30, 2004 amortization of patent assets was $0.2 million, compared to
$0.1 million for the quarter ended June 30, 2003. 11. Employee Stock Option Exchange During the second quarter of fiscal 2004, we commenced and completed an
employee stock option exchange program. The voluntary program allowed
Therma-Wave employees, excluding officers and directors, to return to the
Company existing options issued before July 1, 2002 with an exercise price
greater than $2.00 per share and exchange them for new options that were
granted on September 10, 2003. The number of new options granted in the
employee stock option exchange program was equal to 75% of the number of
options canceled in the exchange. The new option grants have a different
vesting schedule from the original option grants and have an exercise price
equal to $2.38, the fair market value of our common stock on September 10,
2003. Of the 1,366,570 options eligible for exchange, 1,352,108 options, or
99%, were exchanged for 1,014,144 new options with an exercise price of $2.38.
The replacement options vested 50% on June 11, 2004, and will vest the
remaining 50% on April 11, 2005 or according to the performance vesting
schedules of specific option grants. As a result of the modification to the
exercise price of the stock options, the replacement options are accounted for
as variable from the date of modification until the option is either exercised,
forfeited, canceled or expired. The Company has recorded amortization of deferred compensation expense
related to the variable accounting treatment for stock options of $1.5 million
in the quarter ended June 30, 2004. These charges reflect the new options
eligible for exchange that were outstanding since September 10, 2003 and
reflect options issued to eligible participants within the six months prior to
or following September 10, 2003. Due to variable accounting, expense is being
recorded for the pro-rata vesting of these options over time based on increases
in the stock price over and above the exercise price of the new options. In
future quarters, the expense could increase as more shares become vested and if
the stock price increases. Reductions to expense may also be recorded if the
stock price decreases, but such reductions will be limited to the net expense
previously reported. 12. Segment Information We operate in one product segment as we manufacture, market and service
process control metrology systems within the semiconductor equipment market.
All products and services are marketed in each geographic region in which we
operate. Our current product offerings qualify for aggregation under SFAS No.
131 as our products are manufactured and distributed in the same manner, have
similar long-term gross margins and are sold to the same customer base. 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
months ended June 30, 2004 and 2003, respectively. Three Months Ended June 30,Revenues by Country
    
    2004
    
    2003United States
    
    
    25
    %
    
    
    57
    %Singapore
    
    
    18
    
    
    
    4Korea
    
    
    17
    
    
    
    3China
    
    
    12
    
    
    
    7Japan
    
    
    12
    
    
    
    15Europe
    
    
    10
    
    
    
    8Taiwan
    
    
    6
    
    
    
    6TOTAL
    
    
    100
    %
    
    
    100
    %
 Revenues in each geographic area are recognized according to our revenue
recognition policy as described in 12




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Note 1 to the accompanying Notes to Condensed Consolidated Financial
Statements. Transfers and commission arrangements between geographic areas are
at prices sufficient to recover a reasonable profit. Export sales were $15.8
million and $5.2 million in the first quarters of fiscal 2005 and 2004,
respectively. Two
customers each accounted for 17% and 13% of our net revenues for the
three months ended June 30, 2004. For the three months ended
June 30, 2003, one customer accounted for 32% of our net
revenues. The following is a summary of operations in geographic areas (in
thousands). The 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. U.S.
    
    All Other Locations
    
    Eliminations
    
    ConsolidatedThree Months Ended June 30, 2004Sales to unaffiliated customers
    
    $
    18,783
    
    
    $
    2,368
    
    
    $
    
    
    
    $
    21,151Transfers between geographic regions
    
    
    (372
    )
    
    
    (411
    )
    
    
    783
    
    
    
    Total net revenues
    
    $
    18,411
    
    
    $
    1,957
    
    
    $
    783
    
    
    $
    21,151Operating income (loss)
    
    $
    (1,065
    )
    
    $
    (166
    )
    
    $
    10
    
    
    $
    (1,221
    )Three Months Ended June 30, 2003Sales to unaffiliated customers
    
    $
    9,701
    
    
    $
    2,202
    
    
    $
    
    
    
    $
    11,903Transfers between geographic regions
    
    
    (287
    )
    
    
    (504
    )
    
    
    791
    
    
    
    Total net revenues
    
    $
    9,414
    
    
    $
    1,698
    
    
    $
    791
    
    
    $
    11,903Operating income (loss)
    
    $
    (9,190
    )
    
    $
    191
    
    
    $
    (340
    )
    
    $
    (9,339
    )
 
 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. 13




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##### Table of Contents



Overview Therma-Wave develops, manufactures, markets and services process control
metrology systems used in the manufacture of semiconductors. Process control
metrology is used to monitor process parameters in order to enable
semiconductor manufacturers to improve device performance, maintain high
overall manufacturing yield, reduce the size of the circuit features,
characterize new materials and film stacks as they are introduced at each
technology node, and increase equipment productivity. Our current product
families, Therma-Probe®, Opti-Probe®, Opti-Probe RT/CD®, and Integra®
integrated metrology products, use proprietary and patented technology to
produce precise, non-contact, non-destructive measurement for the basic
building blocks, or process modules, in the manufacture of integrated circuits. Market Opportunity During the course of implementing several complex process steps in
semiconductor manufacturing, it has grown increasingly necessary to monitor the
failure rate of semiconductor devices as well as the quality of the underlying
process steps, particularly as line widths shrink, metal levels increase and
new materials are introduced into the process. Generally speaking, the
manufacturing process is monitored and diagnosed using two methodologies:  
    
    measuring specific results to determine whether process steps, or a
sequence of process steps, are performing according to specifications;
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 CD technology are gradually adding
capability to traditional CD-SEM metrology and have enabled this advanced
process control loop. Therma-Waves ion implant and thin film measurement products, including
related service and parts revenues, comprise the majority of our revenues
today. These mature product lines have allowed us to expand into the new
applications that arise at each technology node, resulting in a continually
increasing total available market. Products Therma-Waves metrology solutions for thin film, CD and implant processes
enable many of the advanced process control loops that directly impact device
performance. Our products are used to produce precise, non-contact,
nondestructive measurements on product as well as on test wafers for each basic
process module in the manufacture of integrated circuits. Therma-Waves
metrology platforms, with their unique multi-optical technology capability,
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 14




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##### Table of Contents



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 by using
proprietary software, Opti-Probe systems provide increased measurement
capability leading to higher yields, less misprocessing, less rework, faster
production ramp-up and increased productivity on both test and product wafers.
These are Therma-Waves patented techniques for combining optical measurement
technologies and correlating the results to achieve consistent measurement
results between multiple metrology tools. Addressing New Market: Lithography Metrology Opti-Probe RT/CD and Integra are two additional recently introduced product
families. Opti-Probe CD: Opti-Probe CD is the first optical CD scatterometry system that
combines high-information content spectroscopic ellipsometry with ultra-fast
calculation, using real-time regression, to analyze and display results without
the use of off-line modeling and solution libraries. This allows the use of
complex models that produce high precision results that are robust to
variations in the semiconductor process. Full featured, complex CD profiles can
be calculated in seconds with the desired precision and repeatability over a
wide range of feature sizes and stack structures that are normally encountered
in a production environment and we believe, with more structural information
than its competitors on sidewall profile and shape. Integra: In 2000, we committed to a program of developing a broad family of
Integrated Metrology, or IM, modules under the product family name Integra. We
have at this time both spectrometer and spectroscopic ellipsometer based IM
units available in the marketplace. Each IM unit is installed directly onto a
semiconductor process tool, and can measure each wafer immediately after
processing. In this manner, processing mistakes can be detected at the earliest
possible moment, as opposed to the conventional procedure in which a 25-wafer
lot is typically completed before metrology is first done, thereby leaving the
entire lot at risk of becoming scrap. In addition, fab cycle times are reduced
by replacing some of the stand-alone metrology measurements with integrated
metrology. Critical Accounting Policies and Estimates Our condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.
The methods, estimates and judgments we use in applying our accounting policies
has a significant impact on the results we report in our condensed consolidated
financial statements. On an on-going basis, management evaluates its estimates
and judgments, including those related to revenue recognition, inventory,
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 months ended June 30, 2004 and 2003
were derived from our unaudited condensed consolidated financial statements
which, in the opinion of management, reflect all adjustments necessary for the
fair presentation of the financial condition and results of operations for such
periods. 15




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##### Table of Contents



Three months ended June 30,2004
    
    2003Net revenuesProduct
    
    
    76.5
    %
    
    
    57.2
    %Services and parts
    
    
    23.5
    %
    
    
    42.8
    %Total net revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenues
    
    
    49.3
    %
    
    
    76.2
    %Gross profit
    
    
    50.7
    %
    
    
    23.8
    %Operating expenses:Research and development
    
    
    20.7
    %
    
    
    41.6
    %Selling, general and administrative
    
    
    27.2
    %
    
    
    46.5
    %Restructuring, severance and other
    
    
    1.8
    %
    
    
    12.5
    %Stock-based compensation
    
    
    6.8
    %
    
    
    1.8
    %Total operating expenses
    
    
    56.5
    %
    
    
    102.3
    %Operating loss
    
    
    (5.8
    )%
    
    
    (78.5
    )%Other income (expense):Interest expense
    
    
    0.0
    %
    
    
    (0.2
    )%Interest income
    
    
    0.3
    %
    
    
    0.3
    %Other, net
    
    
    0.0
    %
    
    
    (1.8
    )%Total other income (expense), net
    
    
    0.3
    %
    
    
    (1.6
    )%Net loss
    
    
    (5.5
    )%
    
    
    (80.1
    )%
 Net Revenues.Net revenues for the fiscal quarter ended June 30, 2004 were
$21.2 million. Compared to the fourth quarter of fiscal 2004, net revenues
increased $1.7 million, or 9%, from $19.5 million. Both product (systems) and
services revenues, which include parts, billable labor and materials and
service contracts revenues, increased by 8% and 10% respectively, reflecting
increased demand for our systems and services. Average selling prices were
higher by approximately 7% on a sequential basis for systems compared to the
previous quarter and were flat for services. This was the second consecutive
quarter in which average selling prices increased for systems, and based on
backlog, they are expected to increase again in the next quarter. This is
partly from product mix moving more toward newer advanced products and 300 mm
products, but it may also indicate some strengthening of the market reducing
pricing pressures. Net revenues increased $9.3 million, or 78%, from $11.9
million in the same fiscal quarter of the prior year. This increase came from
higher systems revenues, up $9.4 million or 138% from the same period last
year. Services revenues were slightly lower than in the same period last year
by $0.1 million or 3%. Systems revenues are more variable than services
revenues in general, because services revenues are generated from our installed
based of systems, which fluctuates gradually as new systems are sold and older
systems are either decommissioned or replaced with newer models. Our primary business is the design, manufacture and sale of our
Therma-Probe, Opti-Probe, Opti-Probe Critical Dimension and Integra integrated
product metrology systems. We also sell replacement and spare parts and
service support for these products, including associated labor, which is often
sold in service contracts for durations of one or more years. Gross margins
for our systems sales are typically much higher than gross margins on our
services business. This creates a mix factor that impacts overall average gross
margins, which generally are higher when the percentage of systems sales is
higher. 16




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##### Table of Contents



International sales accounted for approximately 75% and 43% of our total
net revenues for the three months ended June 30, 2004 and 2003, respectively.
We anticipate that international sales will continue to account for a
significant portion of our net revenues in the foreseeable future. The flow of
orders and shipments by country are uneven on a quarterly basis, therefore, the
percentage of revenues by country may vary greatly from quarter to quarter. For
more information on revenues by country for the first three months of fiscal
2004 and 2003, respectively, see Note 12 to the accompanying Notes to Condensed
Consolidated Financial Statements. A substantial portion of our international sales is denominated in U.S.
dollars. As a result, changes in the values of foreign currencies relative to
the value of the U.S. dollar can render our products comparatively more
expensive. Although we have not been negatively impacted in the past by foreign
currency changes in Taiwan, Japan, China, Korea, and Europe, such conditions
could negatively impact our international sales in future periods. Two customers
each accounted for 17% and 13% of our net
revenues for the three months ended June 30, 2004. For the three months ended
June 30, 2003, one customer accounted for 32% of our net revenues. Gross Profit.Gross profit for the first quarter of fiscal 2005 was $10.7
million, an increase of $2.3 million, or 27%, from a gross profit of $8.4
million in the fourth quarter of fiscal 2004. Compared to the same quarter of
fiscal 2004, gross profit increased $7.9 million, or 279%. As a percentage of
net revenues, gross profit for the first quarter of fiscal 2005 was 50.7%,
compared to 43.4% for the fourth quarter of fiscal 2004 and 23.8% for the first
quarter of fiscal 2004. Although margins improved in both systems and services,
the increase in gross profit was primarily attributable to the increase in
systems sales. The increase in unit production improved overhead absorption
about 4% compared to the previous fiscal quarter and more than doubled overhead
absorption compared to the same period last year. Standard costs as a
percentage of systems sales improved about 4% over the prior quarter and about
7% over the same period last year. Period costs charged to cost of sales
declined in the first quarter of 2005 by 37% compared with the previous quarter
and by 64% compared with the first quarter of fiscal 2004. The decline in
period costs reflected a reduction in net warranty charges, and lower
unfavorable manufacturing variances. Period costs in the first quarter of last
year included a one-time $0.6 million provision for a VAT tax exposure in
Korea. Services gross margins improved $0.7 million in the first quarter of
fiscal 2005 compared to the fourth quarter of fiscal 2004, and were comparable
to service gross margins as a percent of revenue in the first quarter of fiscal
2004. Higher systems sales, standard cost reductions as a percentage of
revenues, reduced period expenses, and an improved service margin all
contributed to the gross profit improvement in the fiscal first quarter of
2005. Higher sales drove demand for certain inventory that had previously been
written down in value. During the first quarter of fiscal 2005, the company
sold $2.8 million of zero cost and reduced cost inventories, which had a 13
point benefit to gross profit margin, of which $2.0 million, or 9 margin
points, related to raw materials and sub-assemblies and $0.8 million, or 4
margin points, related to cost reductions recognized previously on finished
goods held for sale. Partially offsetting these benefits were provisions of $1.0
million, or negative 5 margin points, incurred to establish additional reduced
cost basis for other specific inventories in the first quarter of fiscal 2005.
Because the company priced its sales of reduced cost finished goods inventories
lower than prices on other finished goods, the gross margin on sales of reduced
cost finished goods is similar to the gross margin on sales of other higher
value finished goods. In the fourth quarter of fiscal 2004, we sold $2.5
million of zero cost and reduced cost inventories, which had a 13 point benefit
to gross profit margins, of which $2.0 million, or 10 margin points, related to
raw materials and sub-assemblies and $0.5 million, or 3 margin points, related
to cost reductions recognized previously on finished goods held for sale.
Partially offsetting these benefits were charges of $2.2 million, or negative
11 margin points, that were incurred to write down the cost basis of other
specific inventories. In the first quarter of the prior fiscal year, we sold
$2.6 million of zero cost and reduced cost inventories, which had an 18 point
benefit to gross profit margin, of which $2.0 million, or 14 margin points,
related to raw materials and sub-assemblies and $0.6 million, or 4 margin
points, related to cost reductions recognized previously on finished goods held
for sale. We also recognized a $1.7 million inventory provision, or negative 12
margin points, to write down inventories on hand to their realizable values.
Accounting charges to cost of sales for deferred stock compensation related to
the Sensys acquisition and for the variable accounting treatment for certain
stock options were $0.3 million in the first quarter of fiscal 2005, compared
to a credit of $0.1 million in the fourth quarter of fiscal and a charge of
$1,000 in the first quarter of fiscal 2004. Looking ahead to the second quarter of fiscal 2005, we expect mix to
continue to change toward more advanced and 300 mm product sales and pricing
pressures to continue to decrease slowly, allowing margin improvement on our
base product. However, we do not expect to benefit as much as we have in recent
past quarters from sale of zero and reduced cost inventories. As a result, we
anticipate that our gross margins for the second fiscal quarter are likely to
be in the mid 40 percentage range. 17




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##### Table of Contents



Research and Development (R&D), Expenses.R&D expenses for the first quarter of
fiscal 2005 were $4.4 million, an increase of 7% from $4.1 million in the
fourth quarter of fiscal 2004 and a decrease of 11% from $5.0 million from the
same quarter of last fiscal year. The increase of R&D expenses over the fourth
quarter of fiscal 2004 was primarily due to increases in spending on labor and
benefits. The decrease in R&D expenses compared with last fiscal year primarily
reflects a reduction in outside services. We expect our overall R&D
expenditures will increase by $0.2 to $0.3 million in the second fiscal quarter
of 2005 due to increased headcount and higher project costs. We continue to
allocate our R&D resources to the programs that can sustain our technological
leadership, which we expect will continue to strengthen our market position. Selling, General and Administrative (SG&A), Expenses.SG&A expenses for the
first quarter of fiscal 2005 were $5.8 million, a decrease of 8% from SG&A
expenses of $6.3 million in the fourth quarter of fiscal 2004. Compared to the
first quarter of last fiscal year, SG&A expenses increased by 4% from $5.5
million. The decreases in SG&A expenses compared to the fourth quarter of
fiscal 2004 reflected reductions in commissions ($0.2 million) and outside
services ($0.3 million). However, we expect to increase SG&A expenses in
future quarters to support expected revenue growth. In the fiscal second
quarter of 2005 we anticipate an increase in SG&A expenses of $0.2 to $0.3
million primarily due to expenses, including sales commissions, related to
generating and sustaining orders and revenue growth, and due to spending on
Sarbanes-Oxley Act compliance activities. Restructuring, Severance and Other.Restructuring, severance and other expenses
for the first quarter of fiscal 2005 were $0.4 million. This charge was due to
a change in estimate related to expected sub-lease rates and a delay in the
expected sub-lease start date related to one excess facility (see Note 8 to the
accompanying Notes to Condensed Consolidated Financial Statements). Compared to
the fourth quarter of fiscal 2004, restructuring, severance and other expenses
increased by $0.4 million from a credit of $35,000. The credit to restructuring
in the previous quarter reflected the completion of payments due under our
reduction in force programs. Compared to the same period last year,
restructuring charges decreased by $1.1 million. Restructuring charges one
year ago included costs related to reduction in force programs. We do not
anticipate additional restructuring charges in the second quarter of fiscal
2005. However, as sub-lease rates and occupancy estimates change, we may take
additional charges or credits related to our one excess facility currently
available for sub-lease. Stock-Based Compensation.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. In the first quarter of fiscal 2005, we increased this
estimate by $0.2 million due to a reduction in our estimate of turnover among
the employees holding stock options assumed in the Sensys acquisition. The
related deferred stock compensation amortization expenses were $0.3 million,
$0.1 million, and $0.2 million for the quarters ended June 30, 2004, March 31,
2004 and June 30, 2003, respectively, a portion of which was included in cost
of revenues. These charges reflect the vesting schedules of the stock options
and reductions in headcount due to employee turnover and reduction in force
programs during fiscal 2003 and the first three quarters of fiscal 2004. As of
the end of the first quarter of fiscal 2005, $0.2 million of deferred stock
compensation related to the Sensys acquisition remained 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 approximately $1.5 million of
stock-based compensation in the first quarter of fiscal 2005. This charge
reflects the new 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, expense is being
recorded for the vesting of these options over time based on increases in the
stock price over and above the exercise price of the new options. In future
quarters, the expense could increase as more shares become vested and if the
stock price increases. Reductions to expense may also be recorded if the stock
price decreases, but such reductions will be limited to the net expense
previously reported. As of the end of the first quarter of fiscal 2005, $0.6
million of deferred stock compensation related to the variable accounting
treatment for certain stock options remained to be amortized over future
periods. The amount of deferred stock compensation to be amortized is expected
to increase as the vesting of the options increases and also to be adjusted
either higher or lower depending on the closing stock price at the end of each
fiscal period. Other Income (Expense).Other income, net, for the first quarter of fiscal 2005
was $0.1 million, compared to other expense, net, of $1,000 in the fourth
quarter of fiscal 2004, and other expense, net, of $0.2 million in the same
quarter of the prior fiscal year. Other expense for the first quarter of fiscal
2004 includes a loss on the sale of an investment in the amount of $0.1 million
and a loss of $0.1 million related to a change in the investment value of
contributions to our deferred executive compensation program. 18




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Net Loss.The combination of all the factors discussed above contributed to a
net loss of $1.2 million for the first quarter of fiscal 2005, compared with a
net loss of $1.8 million in the fourth quarter of fiscal 2004 and a net loss of
$9.5 million in the same quarter of last fiscal year. We expect that with our
cost reduction programs in place and an expected revenue increase, we will
continue to reduce our net loss in the upcoming quarters. We expect the second
quarter of fiscal 2005 net loss to be within a range of breakeven to negative
$0.03 per basic and diluted share. Liquidity and Capital Resources Our principal liquidity requirements are for working capital. Over the
last three fiscal years, we have funded our operating activities principally
from proceeds from the sale of common stock. We have incurred substantial
losses and experienced negative cash flows since fiscal 2000, and had an
accumulated deficit of $302.2 million at June 30, 2004. Our cash balances
increased during fiscal 2004 primarily as a result of the $11.7 million in net
proceeds from a private placement in September 2003. In the offering, we raised
$12.7 million of gross proceeds and incurred $1.0 million of issuance costs,
$0.9 million of which were payable to Needham & Company who acted as placement
agents. We are using these funds for general corporate purposes. Our
operations were cash positive for the second half of our fiscal year 2004. Our cash balance decreased by $2.8 million in the first quarter of fiscal
2005 from $23.9 million to $21.1 million, mostly due to operating activities
which consumed $2.4 million. Investments in property and equipment and in our
patent portfolio used $0.4 million. Cash raised through the proceeds from the
exercise of stock options contributed $0.1 million. This compares to a decrease
in cash in the first quarter of fiscal 2004 of $2.5 million, most of which
reflected an increase in restrictions on cash due to contractual terms related
to building leases and to directors and officers insurance. These restrictions
were lifted early in the second quarter of fiscal 2004 when security for these
obligations was established through letters of credit under our borrowing
agreement with Silicon Valley Bank (see paragraph at the end of this Liquidity
and Capital Resources section for more information about the credit facilities
with Silicon Valley Bank, or see Note 7 to the accompanying Notes to Condensed
Consolidated Financial Statements). Cash flows used by operating activities were $2.4 million and $0.4 million
for the first three months of fiscal 2005 and 2004, respectively, an increase
in cash used of $2.0 million. While the net loss in the first quarter of fiscal
2005 was $8.4 million lower than in the same period of the prior year, cash was
used to fund increases in operating assets, principally inventory and accounts
receivable. Increases in inventory of $4.9 million in the first quarter of
fiscal 2005 compare to decreases in inventory of $1.2 million in the same
period last year, a $6.1 million increase in cash used by inventory. Similarly,
accounts receivable increased by $1.4 million in the first quarter of fiscal
2005, reflecting higher shipments and the timing of those shipments. This
compared to a reduction in accounts receivable in the first quarter of last
year of $4.6 million, due to the improved collection of receivables. DSO in the
first quarter of this year is 62 days compared to 77 days in the same period
last year. Changes in other assets and liabilities increased cash flows from
operating activities by $1.1 million in the first quarter of fiscal 2005
compared to fiscal 2004. Adjustments to reconcile net loss to net cash used in
operating activities include $0.7 million more in non-cash charges in the
fiscal first quarter of 2005 than in the same period last year. Those charges
were deferred stock compensation charges, up $1.5 million, and inventory
provisions, down $0.7 million. Depreciation costs were $0.7 million lower in the
first quarter of fiscal 2005 than in the comparable period last year. Non-cash
reductions in credits for doubtful accounts receivable in the first quarter of
fiscal 2005 accounted for a $0.8 million decrease in the total adjustments to
net loss compared to the first quarter of fiscal 2004. Cash flows used by investing activities were $0.4 million in the first
quarter of fiscal 2005 compared to cash flows provided by investing activities
of $0.1 million in the first quarter of fiscal 2004. Cash flows provided by
investing activities in the first quarter of the prior year included proceeds
of $0.4 million from the sale of an investment. In the first quarter of fiscal
2005, purchases of property and equipment were $0.2 million, up from $17,000 in
the first quarter of last year. Investments in our patent portfolio were
unchanged at $0.2 million in the first quarters of fiscal 2005 and 2004,
respectively. Cash flows provided by financing activities were $0.1 million in the first
fiscal quarter of 2005 compared to cash used by financing activities of $2.4
million in the first three months of fiscal 2004. The cash used by financing
activities in the first quarter of last year reflects an increase in
restrictions on cash due to contractual terms related to building leases and to
directors and officers insurance. These restrictions were lifted early in the
second quarter of fiscal 2004 when security for these obligations was
established through letters of credit under our borrowing agreement with
Silicon Valley Bank (see paragraph at the end of this Liquidity and Capital
Resources section for more information about the credit facilities with Silicon
Valley Bank, or see Note 7 to the accompanying Notes to Condensed Consolidated
Financial Statements). 19




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Our off-balance sheet commitments are limited to equipment operating
leases, leases on office and manufacturing space, minimum royalty payments
under certain software license agreements, and cancellation fee commitments to
vendors related to non-cancelable inventory purchase orders. Future payments
due under these obligations as of June 30, 2004 (in thousands) are as follows: MinimumOperating
    
    Purchase
    
    Royalty
    
    CancellationFiscal Year:
    
    Leases
    
    Commitments
    
    Payments
    
    Fees
    
    Total2005
    
    $
    1,882
    
    
    $
    8,798
    
    
    $
    40
    
    
    $
    350
    
    
    $
    11,0702006
    
    
    1,807
    
    
    
    373
    
    
    
    40
    
    
    
    
    
    
    
    2,2202007
    
    
    579
    
    
    
    
    
    
    
    40
    
    
    
    
    
    
    
    6192008
    
    
    558
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    5592009
    
    
    47
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    472009 Thereafter
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total future minimum payments
    
    $
    4,873
    
    
    $
    9,172
    
    
    $
    120
    
    
    $
    350
    
    
    $
    14,515
 The total future minimum payments for operating leases in the table above
includes the gross amounts payable under all operating leases and does not include the benefit of sub-lease income being realized on one excess
facility or the benefit of projected sub-lease income on a second
excess facility (see Notes 6 and 8 to the accompanying Notes to Consolidated Financial Statements). We indemnify some of our suppliers and customers for specified
intellectual property rights pursuant to certain parameters and restrictions.
The scope of these indemnities varies, but in some instances includes
indemnification for damages and expenses (including reasonable attorney fees)
related to any misuse by us of the intellectual property. No amounts have been
accrued in respect of the indemnification provisions at June 30, 2004. 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%. The EXIM revolving line allows us to borrow money at a
floating interest rate equal to the SVB prime rate plus 1.75%. We may request
advances in an aggregate outstanding amount not to exceed the lesser of $15.0
million total under the two lines or 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. As
of June 30, 2004, we had $4.6 million in outstanding letters of credit under
this agreement. The credit facilities originally matured on June 13, 2004, but
we have recently extended these credit facilities for one additional year. As
of June 30, 2004, we were in compliance with all the covenants in the
agreement. No amounts have been drawn against these standby letters of credit. Inflation The impact of inflation on our business was not material for the fiscal
quarter ended June 30, 2004 or for the comparable period of last year. 
 Item 3. Quantitative and Qualitative Disclosure about Market Risk Market Risk Disclosures The following discussion about market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to market risks
related to changes in interest rates and foreign currency exchange rates. We do
not have any derivative financial instruments. See also the discussion of
forward-looking statements in the first paragraph of Item 2 above. Market Risk Related to Interest Rates and Foreign Currency 20




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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
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 no cash flow
exposure due to rate changes for cash equivalents and short-term investments,
as all of these investments are at market interest rates. As of June 30, 2004, our cash and cash equivalents included money market
securities and investment grade commercial paper. Due to the short-term
duration of our investment portfolio, an immediate 10% change in interest rates
would not have a material effect on the fair market value of the portfolio.
Therefore, we would not expect our operating results or cash flows to be
affected to any significant degree by the effect of a sudden change in market
interest rates on our securities portfolio. Foreign Currency Exchange Risk We are primarily a U.S. dollar functional currency entity. A substantial
portion of our international sales is denominated in U.S. dollars, and as a
result, we have relatively little exposure to foreign currency exchange risk
with respect to sales. We have determined that the functional currency of our foreign operations
is the local currency in our international operations, which incur most of
their expenses in the local currency. The transactions denominated in
currencies other than our functional currencies create gains and losses that
are reflected in our consolidated statements of operations and amounted to less
than $0.1 million in the fiscal quarters ended June 30, 2004 and 2003
respectively. Due to the low dollar value of transactions made in currencies
other than the functional currencies, we do not expect to experience
significant currency gains and losses in our statements of operations. 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 June 30, 2004 we have an accumulated
other comprehensive loss of $0.8 million consisting of foreign currency
translation adjustments, compared to $1.2 million as of June 30, 2003. 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. 
 Item 4. Controls and Procedures We maintain disclosure controls and procedures, as this term is defined
in Rule 13a-15(e) under the Securities Exchange Act of 1934, or the Exchange
Act, that are designed to ensure that information required to be disclosed by
us in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms, and that this information
is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decision regarding required disclosure. In designing and evaluating our disclosure controls and procedures,
management recognized that disclosure controls and procedures, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the disclosure controls and procedures are
met. Additionally, in designing disclosure controls and procedures, our
management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible disclosure control and procedures. The
design of any disclosure controls and procedures also is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions. During fiscal year 2003, we identified two material weaknesses related to
controls surrounding evaluating and reporting revenue transactions,
particularly in the Asia/Pacific region, and our processes relating to account
analysis and reconciliations, including lack of timely management review. As a
result, in fiscal 2004, we implemented 21




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several changes and additions to our internal controls and procedures including
changing our internal reporting structure to require branch accounting
personnel to report directly to our finance department in the United States,
requiring managers of foreign operations to attest in writing to the validity
of internal controls and revenue recognition for their operations, and
establishing additional review and training procedures. We have not identified
similar material weaknesses or any other material weaknesses during fiscal year
2004 or during the first quarter of fiscal 2005. Based on their evaluation as of the end of the period covered by this
quarterly report on Form 10-Q, our Chief Executive Officer and Chief Financial
Officer have concluded that, subject to the limitations noted above, our
disclosure controls and procedures were effective to ensure that material
information relating to us, including our consolidated subsidiaries, is made
known to them by others within those entities, particularly during the period
in which this quarterly report on Form 10-Q was being prepared. There was no change in our internal control over financial reporting that
occurred during our first fiscal quarter of fiscal 2005 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting, except as noted above. 22




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PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings We are not aware of any material legal proceedings pending against us. We
may be required to initiate additional litigation in order to enforce any
patents issued to or licensed to us or to determine the scope and/or validity
of a third partys patent or other proprietary rights. In addition, we may be
subject to additional lawsuits by third parties seeking to enforce their own
intellectual property rights. Any such litigation, regardless of outcome,
could be expensive and time consuming and, as discussed above in the prior risk
factor, could subject us to significant liabilities or require us to cease
using proprietary third party technology and, consequently, could have a
material adverse effect on our business, financial condition, results of
operations or cash flows. 
  ITEM 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities 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 and Reports on Form 8-K (a) The following exhibits are included herein: Exhibit Number
    
    Description31.1
    
    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)).
 (b) Reports on Form 8-K  (1)
    
    Current Report on Form 8-K on Item 12 filed on July 27, 2004
announcing the filing of the earnings release for the fiscal quarter
ended June 27, 2004. 23




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. THERMA-WAVE, INC. (Registrant) /s/ L. RAY CHRISTIE   Chief Financial Officer(as Registrant and as Principal Accounting Officer) August 2, 2004 24




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EXHIBIT INDEX

Exhibit Number
    
    Description31.1
    
    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)).