UNITED STATES ~~SECURITIES AND EXCHANGE COMMISSION~~

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
For the quarterly period ended June 30, 2005
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 000-30637

AUGUST TECHNOLOGY CORPORATION

(Exact name of Registrant as specified in its charter)

Minnesota		41-1729485
(State of incorporation)		(I.R.S. Employer ~~Identification No.)~~
4900 West 78th Street Bloomington, MN		55435
		Identification No.)
4900 West 78th Street
Bloomington, MN		55435
(Address of principal executive offices)		(Zip Code)
(952) 820-0080
(Registrant’s telephone number, including area code)
N/A
(Former name, former address, and former fiscal year, if changed since last report.)

(952) 820-0080

(Registrant’s telephone number, including area code)

N/A

(Former name, former address, and former fiscal year, if changed since last report.)

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 ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined by Exchange Act Rule 12b-2). Yes ý No o

As of ~~October 29~~July 31, ~~2003,~~ 2005, there were 1718,~~248~~122,~~100~~976 shares of common stock outstanding.

AUGUST TECHNOLOGY CORPORATION

TABLE OF CONTENTS

Description		~~Description~~
PART I	FINANCIAL INFORMATION	~~FINANCIAL INFORMATION~~
Item 1.	~~Item~~Financial 1.Statements (unaudited)	~~Financial Statements~~
			Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002 (unaudited)
	Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004
			Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002 (unaudited)
	Consolidated Statements of Operations for the three and six months ended June 30, 2005 and 2004
			Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002 (unaudited)
	Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004
			Notes to Consolidated Financial Statements (unaudited)
	Notes to Consolidated Financial Statements
Item 2.	~~Item~~Management’s 2.Discussion and Analysis of Financial Condition and Results of Operations	~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~
Item 3.	~~Item~~Quantitative 3.and Qualitative Disclosures About Market Risk	~~Qualitative and Quantitative Disclosures about Market Risk~~
Item 4.	~~Item~~Controls 4.and Procedures	~~Controls and Procedures~~
PART II	OTHER INFORMATION	~~OTHER INFORMATION~~
Item 1.	~~Item~~Legal 1.Proceedings	~~Legal Proceedings~~
	Item 6.	Exhibits and Reports on Form 8-K
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
SIGNATURES
Item 4.	Submission of Matters to a Vote of Security Holders
EXHIBIT INDEX
Item 6.	Exhibits
SIGNATURES
EXHIBIT INDEX

PART I ~~FINANCIAL~~ – FINANCIAL INFORMATION

Item 1. Financial Statements

AUGUST TECHNOLOGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

	September 30, 2003			December 31, 2002
	June 30,			December 31,
	2005			2004
ASSETS
Current assets:
Cash and cash equivalents	$	510,~~097~~313		$	15,~~895~~518
Short-term marketable securities	48,623			15,438
Short-term marketable debt securities	22,583			28,615
Accounts receivable, net	512,~~497~~035			78,~~054~~603
Inventories	921,~~006~~393			720,~~432~~131
Inventories at customers under purchase orders	23,~~727~~646			13,~~012~~993
Prepaid expenses and other current assets	1,~~574~~651			12,~~091~~306
Total current assets	7271,~~524~~621			3369,~~922~~166
Property and equipment, net	35,~~522~~342			35,~~439~~994
Purchased technology, net	1,248			—
Long-term marketable debt securities	9,034			16,289
Long-term marketable securities	1,585			1,444
Purchased technology, net	3,098			3,703
Other assets	1,096			705
Goodwill	498			498
Total assets	$	79,975		$	39,510
Other assets	162			150
Total assets	$	89,755		$	95,800
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	36,~~975~~947		$	23,~~273~~366
Accrued compensation	12,~~299~~952			~~554~~1,691
Accrued liabilities	1,138			451
Other accrued liabilities	2,353			2,306
Customer deposits	3,123			1,268
Customer deposits and deferred revenues	6,769			6,841
Total current liabilities	919,~~535~~021			414,~~546~~204
Other non-current liabilities	73108			97131
Total liabilities	919,~~608~~129			414,~~643~~335
Commitments and contingencies (note 8)	—			—
Shareholders’ equity:
Common stock, no par value, 42,000,000 shares authorized, 16,713,989 and 13,152,304 shares issued and outstanding, respectively	81,046			42,158
Common stock, no par value, 42,000,000 shares authorized, 18,064,032 and 17,839,298 shares issued and outstanding, respectively	91,437			90,347
Undesignated capital stock, no par value, 3,000,000 shares authorized, no shares issued or outstanding	—			—
Deferred compensation related to stock options	(62		)	(105		)
Accumulated deficit	(20,715		)	(8,776		)
Accumulated deficit	(10,605		)	(7,229		)
Accumulated other comprehensive loss	(96		)	(106		)
Accumulated other comprehensive income (loss)	(12		)	43
Total shareholders’ equity	70,626			81,465
Total shareholders’ equity	70,367			34,867
Total liabilities and shareholders’ equity	$	89,755		$	95,800
Total liabilities and shareholders’ equity	$	79,975		$	39,510

See accompanying notes to consolidated financial statements.

AUGUST TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
	2005			2004			2005			2004
Net revenues	$	1119,~~685~~688		$	619,~~273~~855		$	2638,~~005~~105		$	1836,~~763~~255
Cost of revenues	58,~~100~~403			29,~~819~~059			1116,~~603~~762			816,~~148~~117
Gross profit	611,~~585~~285			310,~~454~~796			1421,~~402~~343			1020,~~615~~138
Selling, general and administrative expenses	37,~~808~~237			35,~~780~~390			1013,~~228~~526			10,~~006~~579
Research and development expenses	23,~~595~~324			23,~~347~~322			76,~~797~~990			76,~~211~~230
Operating income (loss)	182			(2,673		)	(3,623		)	(6,602		)
Operating income	724			2,084			827			3,329
Interest income	71			124			247			506
Merger expenses	(11,991		)	—			(13,225		)	—
Income (loss) before provision for income taxes	253			(2,549		)	(3,376		)	(6,096		)
Interest income	335			189			623			390
Provision for income taxes	—			—			—			687
Income (loss) before provision for income taxes	(10,932		)	2,273			(11,775		)	3,719
Net income (loss)	$	253		$	(2,549	)	$	(3,376	)	$	(6,783	)
Provision for income taxes	109			100			164			100
Net income (loss)	$	(11,041	)	$	2,173		$	(11,939	)	$	3,619
Net income (loss) per share:
Basic	$	(0.0261	)	$	(0.1912	)	$	(0.2567	)	$	(0.5220	)
Diluted	$	(0.0261	)	$	(0.1912	)	$	(0.2567	)	$	(0.5220	)
Weighted average number of shares:
Basic	18,005			17,778			17,936			17,700
Diluted	18,005			18,349			17,936			18,421

See accompanying notes to consolidated financial statements.

AUGUST TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
	Six Months Ended June 30,
	2003			2002
	2005			2004
Cash flows from operating activities:
Net loss	$	(3,376	)	$	(6,783	)
Net income (loss)	$	(11,939	)	$	3,619
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization	12,~~368~~115			1,~~042~~019
Provision for doubtful accounts	134			71
Stock-based compensation	30			27
Amortization of deferred compensation related to stock options	45			50
Provision for (recovery of) doubtful accounts	(57		)	79
Deferred income taxes	—			896
Tax benefit from stock options exercised	19			—
Changes in operating assets and liabilities, net of affect of acquisitions:
Deferred income taxes	6			—
Accounts receivable	1,829			(1,762		)
Changes in operating assets and liabilities:
Inventories	(1,713		)	954
Accounts receivable	(3,369		)	(11,185		)
Prepaid expenses and other current assets	(141		)	1,428
Inventories	(1,117		)	(7,048		)
Accounts payable	1,696			309
Inventories at customers under purchase orders	347			(2,779		)
Accrued compensation	745			308
Prepaid expenses and other current assets	664			(402		)
Accrued liabilities	572			(88		)
Accounts payable	3,581			2,220
Customer deposits	919			(31		)
Accrued compensation	1,257			696
Net cash provided by (used in) operating activities	2,078			(3,606		)
Other accrued liabilities	73			9
Customer deposits and deferred revenues	(72		)	3,027
Net cash used in operating activities	(8,462		)	(10,718		)
Cash flows from investing activities:
Purchases of marketable securities	(62,539		)	(22,676		)
Proceeds from maturities of marketable debt securities	45,389			94,356
Maturities of marketable securities	29,161			31,538
Purchases of marketable debt securities	(32,119		)	(91,499		)
Cash paid in acquisitions	(1,485		)	—
Purchases of property and equipment	(843		)	(2,455		)
Purchases of property and equipment	(739		)	(1,177		)
Investment in other assets	(186		)	(77		)
Investment in other assets	—			(559		)
Proceeds from disposition of property and equipment	4			—
Net cash provided by (used in) investing activities	(35,602		)	7,126
Cash paid for acquisitions	(28		)	(17		)
Net cash provided by investing activities	12,217			308
Cash flows from financing activities:
Net proceeds from follow on common stock offering	36,122			—
Net proceeds from issuances of common stock	1,161			1,988
Net proceeds from issuances of common stock to employees	604			1,070
Redemption of common stock	(120		)	—
Net cash provided by financing activities	361,~~726~~041			1,~~070~~988
Effect of exchange rates on cash and cash equivalents	—			(1		)
Effect of exchange rate changes on cash and cash equivalents	(1		)	(13		)
Net increase in cash and cash equivalents	3,202			4,589
Net increase (decrease) in cash and cash equivalents	4,795			(8,435		)
Cash and cash equivalents at beginning of period	15,~~895~~518			110,~~523~~027
Cash and cash equivalents at end of period	$	510,~~097~~313		$	61,~~112~~592
Supplemental cash flow information:
Net cash refunds of income taxes	$	227		$	1,749
Cash payments of income taxes	$	(209	)	$	(78	)
Common stock issued for acquisitions	$	2,160		$	—
Cash payments for merger expenses	$	(12,342	)	$	—

See accompanying notes to consolidated financial statements.

AUGUST TECHNOLOGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

~~SEPTEMBER~~ JUNE 30, ~~2003~~2005

(In thousands, except per share amounts)

(Unaudited)

Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures, normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such rules and regulations. In the opinion of the management of August Technology Corporation (collectively with its subsidiaries, the “Company”), all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included in the consolidated balance sheet at ~~September~~ June 30, ~~2003~~2005, the ~~results~~ consolidated statements of operations for the three and ~~nine~~six months ended ~~September~~ June 30, ~~2003~~ 2005 and ~~2002~~2004, and the consolidated statements of cash flows for the ~~nine~~six months ended ~~September~~ June 30, 2005 ~~2003~~ and ~~2002~~ 2004. The ~~results~~statements of operations of the interim periods are not necessarily indicative of the results of operations that may be expected for any other period or for the year as a whole. These consolidated financial statements and notes hereto should be read in conjunction with the audited ~~consolidated~~ consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2002~~2004, filed with the Securities and Exchange Commission on March 4 16, ~~2003~~2005.

The accompanying consolidated financial statements include the accounts of August Technology Corporation and its wholly owned subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation.

~~Certain~~Management ~~prior~~uses ~~year~~estimates and assumptions in preparing consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. Those estimates and assumptions affect the reported amounts ~~have~~of ~~been~~assets ~~reclassified~~and toliabilities and the disclosure of ~~conform~~contingent toassets and liabilities at the ~~2003~~date ~~presentation~~of the consolidated financial statements and the reported revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Note 2 – Business Combinations

~~Semiconductor~~On ~~Technologies~~January 21, 2005, &the ~~Instruments~~Company entered into an Agreement and Plan of Merger and Reorganization (the “Nanometrics Merger Agreement”) with Nanometrics, Incorporated ~~Inc~~(“Nanometrics”), Major League Merger Corporation and Minor League Merger Corporation. Under the terms of the Nanometrics Merger Agreement each share of the Company’s common stock was to be converted into the right to receive 0.6401 of a share of August Nanometrics common stock. On June 27, 2005, the Company and Nanometrics terminated the Nanometrics Merger Agreement. In accordance with the terms of the Nanometrics Merger Agreement, the Company paid Nanometrics a termination fee of $8,300, and reimbursed $2,600 of merger related expenses.

On April 15, 2003, the Company acquired all of the outstanding capital stock of Semiconductor Technologies & Instruments, Inc., (“STI”). STI manufactures automated defect inspection and metrology tools that are integrated onto probers, providing microelectronics manufacturers with an automated solution for inspecting probe marks, ink dots, and active die regions. The total purchase price, including direct acquisition costs, was $2,156 which consisted of $1,385 in cash and 215 shares of the Company’s Common Stock. The purchase price has been allocated to the net assets acquired and liabilities assumed based upon their estimated fair market values. The results of operations of STI have been included in the Company’s consolidated financial statements since the date of acquisition.6

6On June 27, 2005, the Company entered into an Agreement and Plan of Merger (the “Rudolph Merger Agreement”) with Rudolph Technologies, Inc. (“Rudolph”) and NS Merger Sub, Inc. Under the terms of the Rudolph Merger Agreement each of the Company’s shareholders will have the option to elect to receive either $10.50 per share in cash or 0.7625 of a share of Rudolph common stock, subject to proration and allocation, based on the total cash and shares available in the merger. The agreement requires that the total consideration for the transaction will include a minimum of $37,200 and a maximum of $60,000 of cash subject to shareholder election. The aggregate consideration was approximately $193,000 as of June 27, 2005.

~~The allocation of the purchase price to the assets~~Note 3 ~~acquired~~– ~~and~~Stock-Based ~~liabilities assumed was as follows:~~Compensation

Accounts receivable	$	346
Inventories	1,527
Prepaid expenses and other current assets	72
Property and equipment	329
Accrued liabilities	(76		)
Deferred revenue	(330		)
Customer deposits	(60		)
Purchased technology	348
	$	2,156

The Company applies Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for stock-based compensation. The exercise price of the Company’s stock options equals the market price of the underlying stock on the date of grant for all options granted, and thus, under APB 25, no compensation expense is recognized in the consolidated statements of operations.

The ~~following unaudited pro forma consolidated~~ ~~financial~~estimated ~~information~~per ~~presents~~share ~~the~~weighted ~~combined~~average ~~results~~fair ofvalue ~~operations~~ of ~~the Company~~all ~~and~~stock ~~STI~~options asgranted during if the ~~acquisition~~three ~~occurred~~months atended ~~the beginning of the periods presented~~June 30, ~~after~~2005 ~~giving~~and ~~effect~~2004 towas ~~certain~~$7.15 ~~adjustments,~~and ~~including amortization expense~~$9. ~~The~~53, ~~unaudited~~respectively, ~~pro~~and ~~forma consolidated financial information does~~for ~~not~~the ~~necessarily~~six ~~reflect~~months ~~the~~ended ~~results~~June 30, of2005 ~~operations~~and ~~that~~2004 ~~would~~was ~~have~~$6.78 ~~occurred~~and ~~had~~$9.91, ~~the~~respectively. The ~~acquisition~~fair ~~been~~value ~~completed as~~ of ~~the~~each option ~~dates~~grant ~~indicated~~was orestimated ofusing the ~~results~~Black-Scholes ~~that may~~option bepricing ~~obtained~~model inwith the following ~~future.~~weighted average assumptions:

	Three Months Ended September 30,						Nine Months Ended September 30,
	Three Months Ended June 30,				Six Months Ended June 30,
	2003			2002			2003			2002
	2005		2004		2005		2004
Revenues	$	11,685		$	7,001		$	26,275		$	20,590
Expected life	4.9 years		5.5 years		4.7 years		4.3 years
Net income (loss)	253			(3,689		)	(4,177		)	(10,443		)
Risk free interest rate	3.9	%	3.6	%	3.8	%	2.8	%
Net income (loss) per share:
Volatility	72.5	%	73.7	%	73.3	%	74.1	%
Basic	$	0.02		$	(0.28	)	$	(0.31	)	$	(0.79	)
Dividend yield	—		—		—		—
Diluted	0.02			(0.28		)	(0.31		)	(0.79		)

OnHad ~~September 23, 2003,~~ the ~~Company~~ ~~filed a legal complaint seeking a declaratory judgment that the~~ Company ~~has~~ norecorded ~~liability~~compensation tocost ~~Rudolph~~based ~~Technologies, Inc. or its subsidiary, ISOA, Inc.,~~on ~~with~~the ~~respect~~estimated tofair ~~claims~~value ~~they~~on ~~have asserted that STI owes Rudolph development fees and royalty payments pursuant to a December 24, 1997 Development Agreement (~~the ~~“Development~~date ~~Agreement”). In addition, the Company is seeking repayment~~ of ~~royalties previously paid by STI to ISOA. Rudolph and ISOA filed an answer and counterclaim~~grant, ~~denying the allegations set forth in the Company’s complaint and claiming that ISOA is entitled to damages~~ as adefined ~~result~~by ofStatement ~~STI’s breach~~ of ~~the~~Financial ~~Development~~Accounting ~~Agreement. ISOA~~Standards is(“SFAS”) ~~also seeking a declaratory judgment that STI and/or the Company are wrongfully using ISOA’s technology without compensating ISOA. In connection with the acquisition of STI~~123, ~~the Company placed 180 shares~~“Accounting offor ~~its Common~~ Stock-Based ~~issued~~Compensation,” in the ~~transaction in escrow as part of the~~ Company’s ~~indemnification~~pro ~~protection~~forma ~~against~~net ~~damages up to a maximum amount of~~income ~~$670~~(loss) inwould ~~connection~~have ~~with~~been ~~STI’s~~as ~~dispute with Rudolph. In September 2003, 105 of the escrowed shares were sold and the proceeds of such sale were deposited into the escrow.~~follows:

~~Counterpoint Solutions, Inc.~~7

On July 3, 2003, the Company purchased substantially all of the assets of Counterpoint Solutions, Inc. (“CSI”). CSI develops wafer inspection, review and failure analysis solutions. The total purchase price, including direct acquisition costs, was $1,504, which consisted of 200 shares of the Company’s Common Stock and $100 in cash. Up to an additional $100 of cash will be paid upon the achievement of certain product sales. The allocation of the purchase price resulted in the Company recording net assets of $39, $462 of goodwill and $1,003 of purchased technology.

	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004

Net income (loss), as reported	$	(11,041	)	$	2,173		$	(11,939	)	$	3,619

Add:
Stock-based employee compensation expense included in net income (loss), as reported	29			—			29			—
Deduct:
Stock-based employee compensation expense determined under fair value based method for all awards	(541		)	(521		)	(1,342		)	(1,674		)
Net income (loss), pro forma	$	(11,553	)	$	1,652		$	(13,252	)	$	1,945

Net income (loss) per share:
As reported:
Basic	$	(0.61	)	$	0.12		$	(0.67	)	$	0.20
Diluted	$	(0.61	)	$	0.12		$	(0.67	)	$	0.20

Pro forma:
Basic	$	(0.64	)	$	0.09		$	(0.74	)	$	0.11
Diluted	$	(0.64	)	$	0.09		$	(0.74	)	$	0.11

7On March 30, 2005, the board of directors authorized the Company to enter into an agreement to grant 175,000 nonqualified stock options to the Company’s President and Chief Operating Officer upon acceptance of the position. The grant is not part of the Company’s 1997 Stock Incentive Plan, and was not approved by the Company’s shareholders. The options were granted at fair market value on the date of grant, and vest ratably over five years from the date of grant. In the event of a change in control, the board of directors may provide for the acceleration of vesting of the options.

~~During the year ended December 31, 2002, CSI had revenues of $885 and~~Note 4 ~~net~~– ~~income~~Marketable ofDebt ~~$104. The results of operations of CSI have been included in the Company’s consolidated financial statements since the date of acquisition.~~Securities

~~Note~~The 3amortized –cost and ~~Accounts~~estimated ~~Receivable~~fair value of available-for-sale marketable debt securities were as follows:

Accounts receivable consisted of the following:

	June 30, 2005
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Corporate bonds	$	10,454	$	5	$	(57	)	$	10,402
Municipal bonds	21,287		1		(73		)	21,215
	$	31,741	$	6	$	(130	)	$	31,617

	September 30, 2003			December 31, 2002
	December 31, 2004
Billed receivables	$	5,226		$	7,209
				Gross			Gross
Unbilled revenue	930			395
	Amortized			Unrealized			Unrealized			Fair
	6,156			7,604
	Cost			Gains			Losses			Value
Allowance for doubtful accounts	(659		)	(550		)
Corporate bonds	$	12,611		$	1		$	(55	)	$	12,557
Accounts receivable, net	$	5,497		$	7,054
Municipal bonds	32,400			3			(56		)	32,347
	$	45,011		$	4		$	(111	)	$	44,904

~~Note~~The 4maturities –of ~~Inventories~~available-for-sale ~~and~~marketable ~~Inventories~~debt atsecurities ~~Customers~~were ~~Under~~as ~~Purchase Orders~~follows:

~~Inventories consisted of the following:~~8

	September 30, 2003		December 31, 2002
	June 30, 2005				December 31, 2004
Raw materials	$	4,081	$	3,053
	Amortized		Fair		Amortized		Fair
Work in process	1,905		1,415
	Cost		Value		Cost		Value
Demonstration equipment	1,429		1,374
Due within one year	$	22,652	$	22,583	$	28,662	$	28,615
Finished goods	1,591		1,590
Due after one year through three years	7,789		7,742		13,349		13,289
Inventories	$	9,006	$	7,432
Due after three years	1,300		1,292		3,000		3,000
	$	31,741	$	31,617	$	45,011	$	44,904

~~Inventories~~Net atrealized ~~customers~~gains ~~under purchase orders~~and ~~represent~~losses ~~systems~~were ~~that~~not ~~have~~material ~~shipped~~for ~~under~~ the ~~terms~~six ofmonths aended ~~customer purchase order~~June 30, ~~but~~2005 ~~have~~and ~~not yet qualified for revenue recognition as the systems had not met customer specifications~~2004.

Note 5 – Accounts ~~Purchased Technology~~Receivable

~~The~~Accounts ~~net carrying value of purchased technology~~receivable consisted of the following:

	September 30, 2003			December 31, 2002
	June 30,			December 31,
Purchased technology (note 2)	$	1,351		$	—
	2005			2004
Accumulated amortization	(103		)	—
Billed receivables	$	10,470		$	8,150
Purchased technology, net	$	1,248		$	—
Unbilled revenue	2,255			1,143
	12,725			9,293
Allowance for doubtful accounts	(690		)	(690		)
Accounts receivable, net	$	12,035		$	8,603

~~Purchased~~Note ~~technology~~6 ~~is amortized on a straight-line~~– basis over the estimated remaining useful life. Amortization expense for the three and nine months ended September 30, 2003 was $84 and $103, respectively. Assuming no change in the gross carrying value of purchased technology, the estimated amortization expense for the twelve months ending December 31, 2003 is $187 and for each of the next four years is $338, $338, $338 and $150.Inventories

8Inventories consisted of the following:

Note 6 – Other Assets

	June 30,		December 31,
	2005		2004

Raw materials	$	10,220	$	8,474
Work in process	4,065		3,558
Demonstration equipment	4,312		4,152
Finished goods	2,796		3,947
Inventories	$	21,393	$	20,131

~~On May 6, 2002, the Company invested $500 in Excelerate Technologies, Inc. (“Excelerate”) in the form of a~~ Note Receivable (the “Note”). The Note was amended on February 13, 2003. The Note bears interest at prime and is secured by certain assets. The Note matures and converts into Excelerate preferred stock upon Excelerate raising $1,500 of additional financing via a sale of Excelerate preferred stock. The Note can be prepaid at anytime by paying the outstanding principal and interest, along with a prepayment fee of 7~~.5%~~ on– ~~the~~Purchased ~~combined outstanding principal and interest.~~Technology

~~Note 7~~Purchased –technology ~~Comprehensive~~was as ~~Income (Loss)~~follows:

Comprehensive income (loss) is defined as net income (loss) and other changes in shareholders’ equity from transactions and other events from sources other than shareholders. The components of and changes in other comprehensive income (loss) are as follows:

	June 30,			December 31,
	2005			2004

Purchased technology	$	4,769		$	4,651
Less: accumulated amortization	(1,671		)	(948		)
Purchased technology, net	$	3,098		$	3,703

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
Net income (loss)	$	253		$	(2,549	)	$	(3,376	)	$	(6,783	)
Other comprehensive income (loss):
Foreign currency translation adjustment	(3		)	(4		)	(3		)	(1		)
Net unrealized gain (loss) on securities	(12		)	26			(52		)	66
Comprehensive income (loss)	$	238		$	(2,527	)	$	(3,431	)	$	(6,718	)

Purchased technology increased $118 for the six months ended June 30, 2005 due to contingent consideration paid for the DMSVision acquisition discussed in Note 8 below.

~~Note 8 – Shareholders’ Equity~~9

~~Changes~~Amortization expense for the six months ended June 30, 2005 and 2004 was $724 and $174, respectively. Assuming no additional change in ~~shareholders’~~the ~~equity~~gross ~~during~~carrying value of purchased technology, the ~~nine~~estimated amortization expense for the twelve months ending December 31, 2005 is $1,435 and for each of the next four ~~ended~~years ~~September~~is 30$1,208, ~~2003~~$800, ~~were~~$378 asand ~~follows:~~none.

Shareholders’ equity balance at December 31, 2002	$	34,867
Net loss	(3,376		)
Other comprehensive loss:
Foreign currency translation adjustment	(3		)
Net unrealized loss on securities	(52		)
Comprehensive loss	(3,431		)
Issuances of common stock in conjunction with:
Follow on public offering, net of expenses	36,122
Acquisitions	2,160
Exercises of employee stock options	516
Employee stock purchase plan	88
Amortization of deferred compensation related to stock options	45
Shareholders’ equity balance at September 30, 2003	$	70,367

In December 2004, the Company purchased certain technology from Excelerate Technologies, Inc. (“Excelerate”). The total consideration paid was $800, which included the forgiveness of a $500 convertible note receivable from Excelerate and $300 of cash, of which $150 was paid in January 2005.

OnNote ~~September~~8 ~~23, 2003, the Company sold 3,000 shares~~– ofCommitments ~~its Common Stock at a price of $13.00 per share in a follow on public offering (the “Offering”). The net proceeds from the Offering, after deducting the underwriting discount~~ and ~~offering~~ ~~expenses, was $36,122.~~Contingencies

~~On October 21, 2003, the underwriters exercised their over-allotment option to acquire an additional 490 shares of Common Stock at the same price to the public, and with the same~~Warranties

9The Company provides warranty coverage for its systems for a period of one year, including parts and labor necessary to repair the systems during the warranty period. The estimated warranty cost is based on the Company’s historical experience rate of incurred expenses to corresponding system revenues.

~~underwriting~~The following ~~discount~~table assummarizes the ~~Offering. The~~activity ~~Company~~related ~~received~~to ~~$6,001 from~~ the ~~exercise~~warranty ofliability during the ~~over-allotment option,~~six ~~net~~months ofended ~~the~~June 30, ~~underwriting~~2005 ~~discount.~~and 2004:

Net Income (Loss) Per Share

	Six Months Ended June 30,
	2005			2004

Accrual at beginning of year	$	942		$	239
Warranties issued	395			415
Costs incurred	(188		)	(271		)
Accrual at end of period	$	1,149		$	383

~~The~~Separation ~~components of basic and diluted net income (loss) per share were as follows:~~Agreements

	Three Months Ended September 30,					Nine Months Ended September 30,
	2003		2002			2003			2002
Net income (loss)	$	253	$	(2,549	)	$	(3,376	)	$	(6,783	)
Weighted average common shares:
Basic	13,844		13,123			13,451			13,000
Effect of dilutive stock options and warrants	734		—			—			—
Diluted	14,578		13,123			13,451			13,000
Net income (loss) per share:
Basic	$	0.02	$	(0.19	)	$	(0.25	)	$	(0.52	)
Diluted	0.02		(0.19		)	(0.25		)	(0.52

In the second quarter of 2005, the Company entered into separation agreements with certain executives and other employees that resulted in an expense of $920, of which $29 was paid as of June 30, 2005. The separation agreements require substantially all of the severance benefits to be paid by June 30, 2006.

~~The~~Contingent total weighted average number of stock options and warrants excluded from the calculation of potentially dilutive securities either due to the exercise price exceeding the average market price or the inclusion of such securities in a calculation of net loss per share would have been anti-dilutive for the three months ended September 30, 2003 and 2002 were 517 and 1,465, respectively, and for the nine months ended September 30, 2003 and 2002 were 1,887 and 1,557, respectively.Consideration

~~Stock-~~In connection with the July 27, 2004 acquisition of the DMSVision software division of Inspex, Inc (“DMSVision”), the Company is subject to a contingent consideration arrangement at June 30, 2005. This arrangement is based ~~Compensation~~upon new orders for DMSVision software licenses received in the twelve months after the acquisition. The payment of the contingency results in an increase in the allocation of purchase price to purchased technology. As a result, amortization expense related to this asset increases. Amounts paid under this arrangement are not expected to have a material effect on the Company’s consolidated financial condition or results of operations. The total contingent consideration the Company expects to pay related to the twelve months after the acquisition is $142, of which $24 and $118 was added to purchased technology in 2004 and 2005, respectively. As of June 30, 2005, $90 remained unpaid.

The estimated per share weighted average fair value of all stock options granted during the three months ended September 30, 2003 and 2002 was $6.11 and $3.43, respectively, and for the nine months ended September 30, 2003 and 2002 was $3.82 and $5.04, respectively. The fair value of each option grant was estimated using the Black-Scholes option pricing model with the following weighted average assumptions:10

	Three Months Ended September 30,				Nine Months Ended September 30,
	2003		2002		2003		2002
Expected life	5.9 years		5.8 years		5.6 years		4.5 years
Risk free interest rate	3.2	%	3.9	%	3.0	%	3.9	%
Volatility	75.1	%	74.2	%	75.1	%	74.2	%
Dividend yield	—		—		—		—

Legal Proceedings

10From time to time in the ordinary course of business, the Company is subject to claims, asserted or unasserted, or named as a party to lawsuits or investigations. Litigation, in general, and intellectual property and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings cannot be predicted with any certainty and in the case of more complex legal proceedings such as intellectual property and securities litigation, the results are difficult to predict at all.

~~Had~~The ~~the~~ Company ~~recorded~~and ~~compensation~~each ~~cost~~of ~~based~~its board of directors, Jeff O’Dell, James Bernards, Roger Gower, Michael Wright and Linda Hall Whitman, were named as defendants in two separate lawsuits that purported to be class action claims on behalf of the ~~estimated~~Company’s ~~fair~~shareholders. The Company ~~value~~received ona summons and complaint with respect to the ~~date~~first of ~~grant~~these proceedings on February 4, as2005 ~~defined~~and bythe ~~SFAS~~second on February ~~123~~14, 2005. Both lawsuits were brought in Minnesota State Court and claimed that the directors had breached their fiduciary duties to the Company’s ~~pro~~shareholders ~~forma~~in ~~net~~connection ~~loss~~with ~~would~~their ~~have~~actions in ~~been~~agreeing asto ~~follows:~~the proposed merger with Nanometrics Incorporated. The plaintiffs in both actions sought various forms of injunctive relief including an order enjoining the Company and its board of directors from consummating the merger with Nanometrics.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
Net income (loss), as reported	$	253		$	(2,549	)	$	(3,376	)	$	(6,783	)
Stock-based employee compensation expense determined under fair value based method for all awards	(377		)	(377		)	(1,053		)	(1,658		)
Net loss, pro forma	$	(124	)	$	(2,926	)	$	(4,429	)	$	(8,441	)
Net income (loss) per share:
As reported:
Basic	$	0.02		$	(0.19	)	$	(0.25	)	$	(0.52	)
Diluted	0.02			(0.19		)	(0.25		)	(0.52		)
Pro forma:
Basic	$	(0.01	)	$	(0.22	)	$	(0.33	)	$	(0.65	)
Diluted	(0.01		)	(0.22		)	(0.33		)	(0.65		)

The two proceedings were consolidated and heard as one case. On April 19, 2005, the Court issued a 30 day stay of all proceedings. On April 27, 2005, the plaintiffs scheduled a hearing on a motion to amend the complaint. The hearing was scheduled for June 9, 2005. On May 10, 2005 the Court issued an order dismissing the complaint for asserting derivative claims without complying with the rules governing derivative actions. Thereafter the Court removed the hearing from the calendar.

11On July 18, 2005, a purported shareholder class action lawsuit asserting derivative claims was filed in Minnesota state court against the Company and the individual members of the board named above as well as Lynn J. Davis, who joined the board on March 30, 2005 (the “Board”). The lawsuit claims the directors have breached their fiduciary duties to the Company’s shareholders in connection with their actions in approving the merger agreement with Nanometrics, Inc. and subsequently terminating that merger agreement and entering into a new merger agreement with Rudolph Technologies, Inc. The plaintiff seeks various forms of injunctive relief including an order enjoining the Company and the Board from consummating the proposed merger with Rudolph.

~~Item~~The ~~2. Management’s~~plaintiff in ~~Discussion~~the ~~and~~lawsuit ~~Analysis~~filed on July 18, 2005 is Robert Etem, the owner of 4,200 ~~Financial~~shares ~~Condition~~of ~~and~~the ~~Results~~Company’s ofcommon ~~Operations~~stock. Mr. Etem was also a plaintiff in the lawsuit described above filed on February 14, 2005.

~~Cautionary~~On ~~Factors~~July 14, 2005, the Company filed a ~~That~~patent ~~May~~infringement ~~Affect~~lawsuit ~~Future~~against ~~Results~~Camtek, Ltd. of Migdal Haemek, Israel. The patent infringement lawsuit, filed in U.S. federal court in Minneapolis, alleges that Camtek’s line of inspection equipment sold under the “Falcon” trademark infringes on the Company’s U.S. patent no. 6,826,298.

~~Certain~~Note ~~statements~~9 ~~made~~– inNet ~~this~~Income Quarterly Report on Form 10-Q, as well as oral statements made by us from time to time, which are prefaced with words such as “expects,” “anticipates,” “believes,” “projects,” “intends,” “plans” and similar words and other statements of similar sense, are forward-looking statements. Our forward-looking statements generally relate to our growth strategies, financial results, future financial projections, product development activities and sales efforts. Our actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, including but not limited to market acceptance of our products, our ability to successfully develop new products, our ability to protect our intellectual property, our dependence upon international customers and suppliers, our dependence on a small number of customers that account for a significant portion of revenues, availability of products from our suppliers, cyclicality in the microelectronic manufacturing equipment and other industries, management of growth, integration of acquired businesses, and the other risk factors detailed below and in our filings with the Securities and Exchange Commission, including our prospectus as filed with the SEC on September 24, 2003 pursuant to Rule 424(bLoss)4 ofPer the Rules and Regulations under the Securities Act of 1933 and our Annual Report on Form 10-K for the year ended December 31, 2002, as filed with the SEC on March 4, 2003. We disclaim any obligation to revise forward-looking statements, or to update the reasons actual results could differ materially from those anticipated, to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Because many factors are unforeseeable, the foregoing should not be considered an exhaustive list.Share

~~Introduction~~The components of basic and diluted net income (loss) per share were as follows:

The following discussion of our results of operations and financial condition should be read together with the other financial information and consolidated financial statements and related notes included in this Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of a variety of factors.11

We are a provider of automated defect detection and product characterization systems for microelectronic device manufacturers. Our systems provide manufacturers with information that enables process-enhancing decisions, ultimately lowering manufacturing costs, improving time-to-market and enhancing the performance of their products. We combine our core competencies in machine vision technology, optics, lighting and precision motion control with our proprietary software and extensive microelectronic-specific applications experience to deliver scalable, modular systems that excel at the automated detection of advanced macro defects, which we define to be defects greater in size than 0.5 microns. We sell our systems to many of the leading microelectronic device manufacturers throughout the world for inspecting semiconductors, advanced packaging applications, optoelectronics, MEMS, data storage and micro displays.

	Three Months Ended June 30,					Six Months Ended June 30,
	2005			2004		2005			2004

Net income (loss)	$	(11,041	)	$	2,173	$	(11,939	)	$	3,619

Weighted average common shares:
Basic	18,005			17,778		17,936			17,700
Effect of dilutive stock options and warrants	—			571		—			721
Diluted	18,005			18,349		17,936			18,421

Net income (loss) per share:
Basic	$	(0.61	)	$	0.12	$	(0.67	)	$	0.20
Diluted	$	(0.61	)	$	0.12	$	(0.67	)	$	0.20

WeThe total weighted ~~have~~average ~~traditionally~~number ~~provided~~of ~~systems~~stock tooptions ~~address~~and ~~the~~warrants ~~automated~~excluded ~~inspection~~from ~~needs~~ the calculation of potentially dilutive securities either due to the ~~final~~exercise ~~manufacturing~~price exceeding the average market price or ~~back-end~~the inclusion of such securities in a calculation of net income (loss) per share would have been anti-dilutive for the ~~microelectronic~~three ~~device~~months ~~manufacturing~~ended ~~process~~June 30, ~~including~~2005 ~~test,~~and ~~assembly~~2004 were 2,106 and ~~packaging.~~330, Werespectively, ~~recently~~and ~~have~~for the ~~introduced~~six ~~two~~months ~~new~~ended ~~systems~~June 30, ~~for~~2005 ~~advanced~~and ~~macro~~2004 were 2,053 and 218, respectively.

12Note 10 – Accumulated Other Comprehensive Loss

~~detection earlier in the front-end wafer manufacturing process. In~~The ~~addition~~accumulated tobalances ~~internal~~for ~~development,~~each weclassification ~~look~~of toaccumulated ~~expand~~other ~~through strategic~~comprehensive ~~acquisitions~~loss ofare ~~complementary~~as ~~products and technologies.~~follows:

Our business is subject to the cyclical nature of the microelectronic device manufacturing markets we serve. These cycles are caused by significant fluctuations in the supply and demand of microelectronic devices driven by such factors as changes in technology and global economic conditions. There has been a dramatic reduction in demand for microelectronic device manufacturing equipment since 2000. This decreased demand has caused our quarterly orders and sales to fluctuate dramatically. While we have seen some improvements in market conditions, we are not able to predict when the microelectronic device manufacturers’ capital spending will recover. Future quarterly and annual results will continue to be impacted by fluctuations in supply and demand of microelectronic devices, the timing of new product announcements and releases by us or our competitors, market acceptance of new or enhanced versions of our products, changes in the pricing of our products and the timing and level of our research and development expenditures.

	June 30,			December 31,
	2005			2004

Currency translation adjustments	$	28		$	1
Net unrealized losses on marketable debt securities	(124		)	(107		)
Accumulated other comprehensive loss	$	(96	)	$	(106	)

~~Acquisitions~~12

OnNote ~~April 15, 2003,~~11 we– acquired all of the outstanding capital stock of Semiconductor Technologies & Instruments, Inc. (“STI”). STI manufactures automated defect inspection and metrology tools that are integrated onto probers, providing microelectronics manufacturers with an automated solution for inspecting probe marks, ink dots, and active die regions. The total consideration, including direct acquisition costs, was $2.2 million and consisted of $1.4 million in cash and 215,385 shares of our common stock. The parties initially had placed 215,000 shares issued in the transaction in escrow to secure ASTIShareholders’s performance of certain covenants including ASTI’s agreement to indemnify us against damages in connection with STI’s dispute with a third party. In September 2003, pursuant to an agreement between the parties and the escrow agent, 105,385 of the escrowed shares were sold and the proceeds of such sale were deposited into the escrow.Equity

OnChanges ~~July 3,~~in ~~2003, we~~shareholders’ ~~acquired~~equity ~~substantially~~during ~~all~~ the ~~assets~~six ofmonths ~~Counterpoint~~ended ~~Solutions~~June 30, ~~Inc. (“CSI”). CSI~~2005 ~~develops~~were ~~wafer inspection, review and failure analysis solutions. The transaction was structured~~ as an asset acquisition. The total consideration paid, including direct acquisition costs, was $1.5 million and consisted of $100,000 in cash and 200,000 shares of our common stock. Up to an additional $100,000 of cash will be paid upon the achievement of certain product sales.follows:

Shareholders’ equity balance at December 31, 2004	$	81,465
Net loss	(11,939		)
Accumulated other comprehensive loss:
Foreign currency translation adjustment	27
Net unrealized loss on marketable debt securities	(17		)
Comprehensive loss	(11,929		)
Issuances of common stock in conjunction with:
Exercises of stock options	1,038
Employee stock purchase plan	123
Redemption of common stock	(120		)
Tax benefit from stock options exercised	19
Stock-based compensation	30
Shareholders’ equity balance at June 30, 2005	$	70,626

~~Results~~In May 2005, the Company purchased 11,614 common shares from an executive officer for $120, which represented 90% of ~~Operations~~the market value on the date of purchase. There are currently no plans to repurchase additional shares.

~~The following~~Shareholder ~~table~~Rights ~~sets forth, for the periods indicated, certain operating data as a percentage of net revenues:~~Plan

	Three Months Ended September 30,				Nine Months Ended September 30,
	2003		2002		2003		2002
Net revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of revenues	43.6		44.9		44.6		43.4
Gross profit	56.4		55.1		55.4		56.6
Selling, general and administrative expenses	32.6		60.3		39.4		53.3
Research and development expenses	22.2		37.4		30.0		38.4
Operating income (loss)	1.6		(42.6	)	(14.0	)	(35.1	)
Interest income	0.6		2.0		1.0		2.7
Income (loss) before provision for income taxes	2.2		(40.6	)	(13.0	)	(32.4	)
Provision for income taxes	—		—		—		3.7
Net income (loss)	2.2	%	(40.6	)%	(13.0	)%	(36.1%	)

On June 27, 2005, the Board adopted a Shareholder Rights Plan to protect shareholders from coercive or otherwise unfair takeover tactics and to protect the interests of the Company’s shareholders. Pursuant to the Rights Agreement relating to the Shareholder Rights Plan, the Board has declared a dividend of one preferred share purchase right (a “Right”) for each share of common stock outstanding at the close of business on June 27, 2005. In general terms, the Rights Agreement works by imposing a significant penalty upon any person or group that acquires 10% or more of the Company’s outstanding common stock without the approval of the Board. The Company does not believe the Rights Agreement will interfere with any merger or other business combination approved by the Board.

~~Three~~Each ~~months~~Right will ~~ended~~allow ~~September~~its 30holder to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock for $27.00 once the Rights become exercisable. The Rights will not be exercisable until fifteen days after the public announcement that a person or group has become an “Acquiring Person” by obtaining beneficial ownership of 10% or more of the Company’s outstanding common stock, or, if earlier, fifteen business days after ~~2003~~a ~~compared~~person or group begins a tender or exchange offer which, if completed, would result in that person or group becoming an Acquiring Person. If a person or group becomes an Acquiring Person, all holders of Rights except the Acquiring Person, may, for $27.00 purchase shares of the Company’s common stock with a market value of $54.00, based on the market price of the common stock prior to such acquisition. In addition, if the ~~three~~Company ~~months~~is ~~ended~~later ~~September~~acquired in 30a merger or similar transaction after the Rights have become exercisable and a person or group is, ~~2002~~or becomes, an Acquiring Person, all holders of Rights except the Acquiring Person may, for $27.00, purchase shares of the

Net Revenues. Net revenues increased $5.4 million, or 86.3%, to $11.7 million for the three months ended September 30, 2003, from $6.3 million for the same period in 2002. The increase in net revenues was primarily due to increased sales of our NSX Series, sales related to the AXi Series, which we first recognized revenue on during the current quarter, and sales of the WAV Series, acquired in conjunction with the acquisition of STI. The increase was partially offset by lower revenues from the 3Di Series.13

~~Net~~acquiring ~~revenues~~corporation ~~from~~with ~~international~~a ~~sales~~market ~~represented~~value ~~83% and 70%~~ of ~~total~~$54.00 ~~net~~based ~~revenues for~~on the ~~three~~market ~~months~~price ~~ended~~of ~~September~~the acquiring 30corporation’s stock, ~~2003~~prior ~~and~~to ~~2002,~~such ~~respectively~~merger. The ~~increase~~Board inmay ~~international~~redeem ~~sales was primarily~~ the ~~result~~Rights ~~of increased sales to Asia, which comprised 72% and 68% of net revenues~~ for ~~the three months ended September 30, 2003 and 2002, respectively~~$. ~~The increase in the~~0005 ~~percentage~~per ofRight ~~net~~at ~~revenues~~any ~~from~~time ~~Asia~~before ~~was~~any ~~partially~~person ~~offset~~or bygroup abecomes ~~decrease~~an inAcquiring ~~net revenues from North America, which comprised 17% and 30% of total net revenues for the three months ended September 30, 2003 and 2002, respectively~~Person.

~~During~~Note 12 ~~the~~– ~~three~~Significant ~~months ended September 30~~Customer, ~~2003,~~Product ~~orders~~Line ~~for systems within the NSX~~ and ~~AXi~~Geographic Series increased as compared to the prior quarter. This increase resulted in a book-to-bill ratio above parity during the quarter. As a result of the increase in bookings, we expect revenues to increase during the fourth quarter of 2003 as compared to the third quarter of 2003.Information

~~Gross Profit. Gross profit increased to $6.6 million for the three months ended September 30, 2003, from $3.5 million for the same period in 2002.~~ The ~~gross margin~~ ~~increased to 56.4% for the three months ended September 30, 2003, from 55.1% for the same period in 2002. The increase in gross margin~~ percentage ~~was primarily due to an increase in sales~~ of ~~certain~~net products within the NSX Series and WAV Series, which have higher margins than our other product lines, higher average selling prices within the NSX Series, and higher absorption of fixed manufacturing costs. In addition, prior year revenues ~~included~~derived afrom ~~higher~~major ~~mix~~customers ofwas ~~lower~~as ~~margin models within the 3Di Series.~~follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Net revenues:
Customer A	15	%	10	%		*		*
Customer B	13	%	12	%	18	%	15	%
Customer C		*	17	%		*	10	%
Customer D		*	12	%		*		*
Customer E		*	10	%		*		*
Customer F		*	10	%		*		*
	28	%	71	%	18	%	25	%

~~Selling,~~* Customer ~~General~~represented ~~and~~less ~~Administrative~~than Expenses. Selling, general and administrative expenses consist primarily of employee salaries and related benefits, travel expenses and occupancy related costs. Selling, general and administrative expenses were $3.8 million, or 32.610% of net revenues, ~~for~~during the ~~three months ended September 30, 2003, and $3.8 million, or 60.3% of net revenues, for the same~~ period ~~in 2002~~. Expenses in 2003 included increased variable costs, such as sales commissions and travel, associated with the increased level of revenues, employee compensation costs, expenses associated with the ongoing operations of STI and CSI, and the amortization of purchased technology. These increases were partially offset by the fact that expenses in the third quarter of 2002 included the write-off of acquisition related costs, employee severance costs and expenses related to the modification of our distributor agreement with Metron Technology, B.V.(“Metron”), as a result of our decision to sell directly to customers in Asia, except Japan and South Korea. The quarterly selling, general and administrative expense dollars are expected to increase in the last quarter of 2003, as compared to the third quarter of 2003, primarily as a result of variable expenses associated with the expected higher level of revenues and higher recruiting and relocation costs. However, selling, general and administrative expenses as a percentage of revenues are expected to decrease, as revenues are expected to increase at a higher rate than the increase in selling, general and administrative expenses.

~~Research~~The ~~and~~percentage ~~Development Expenses. Research and development expenses consist primarily~~ of employee salaries and related benefits and consulting fees for individuals engaged in the research, design and development of new products. Research and development expenses increased 10.6% to $2.6 million, or 22.2% of net revenues~~, for~~ the three months ended September 30, 2003, from $2.3 million, or 37.4% of net revenues, for the same period in 2002. The increase in expenses was primarily due to employee salaries and related benefits associated with the employees of STI and CSI, and costs related to completing certain stages of development of the BXi Series and EXi Series, as well as additional features related to the NSX Series. The increase was partially offset by ~~expenses~~major inproduct ~~the~~line ~~prior year including costs related to the development of the NSX-105, which~~ was introduced in the third quarter of 2002, and further development of the 3Di Series, which began shipping in the fourth quarter of 2001. We anticipate that research and development expense dollars will increase in future quarters, as compared to the third quarter of 2003, due to ongoing development projects. However, research and development expenses as a percentage of revenues are expected to decrease, as revenues are expected to increase at a higher rate than the increase in research and development expenses.follows:

Interest Income. Interest income was $71,000 for the three months ended September 30, 2003, compared to $124,000 for the same period in 2002. The decrease in interest income was due to lower rates of return earned on investment balances in 2003 as compared to 2002 and lower overall investment balances in 2003. We expect interest income to increase in the fourth quarter of 2003 due to an increase in overall investment balances, as a result of the proceeds from the follow on public offering of our Common Stock that was completed on September 23, 2003 (the “Offering”).

	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Net revenues:
NSX Series	58	%	56	%	49	%	55	%
All Surface Systems	18	%	16	%	26	%	18	%
3Di Series	2	%	8	%	5	%	9	%
Other	22	%	20	%	20	%	18	%
	100	%	100	%	100	%	100	%

~~Income~~All ~~Taxes. Due to the level~~ of ~~historical~~ ~~operating~~the ~~losses~~Company’s wetangible ~~have~~long-lived ~~incurred,~~assets weare ~~have~~located ~~sufficient~~in ~~net~~the ~~operating~~United ~~losses~~States, toexcept ~~offset~~for ~~the~~an ~~level~~insignificant ofamount ~~income taxes on our pre tax income. As a result~~ of ~~historical~~property ~~operating losses~~ and ~~uncertainty~~equipment ~~as to the extent of profitability~~ in ~~future~~Taiwan ~~periods,~~and ~~we continue~~South ~~to record a full valuation allowance against our deferred tax assets~~Korea. AsThe aCompany ~~result,~~derives werevenues ~~did not reflect a provision~~from ~~for~~shipments ~~income~~to ~~taxes~~customers ~~during~~outside ~~the three months ended September 30, 2003. Statement~~ of ~~Financial~~the ~~Accounting~~United ~~Standards (“SFAS”) No~~States. The ~~109~~percentage ~~“Accounting~~of ~~for Income~~net ~~Taxes,”~~revenues ~~requires~~by the geographic ~~establishment~~region ofin awhich ~~valuation allowance to reflect~~ the ~~likelihood~~customer ofis ~~the~~located ~~realization of deferred tax assets. As of December 31, 2002 the valuation allowance~~ was ~~$5.4~~as ~~million.~~follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Net revenues:
United States	14	%	29	%	16	%	29	%
Taiwan	38	%	44	%	40	%	33	%
South Korea	16	%	12	%	20	%	18	%
Europe	23	%	0	%	18	%	2	%
Japan	2	%	3	%	2	%	4	%
Rest of Asia	7	%	12	%	4	%	14	%
	100	%	100	%	100	%	100	%

~~Nine months ended September 30, 2003 compared to the nine months ended September 30, 2002~~14

~~Net Revenues. Net~~Note ~~revenues increased $7.2 million, or~~13 ~~38.6%,~~– toRecent ~~$26.0~~Accounting million for the nine months ended September 30, 2003, from $18.8 million for the same period in 2002. The increase in net revenues was due primarily to increased sales of our NSX Series, sales related to the AXi Series, and sales of the WAV Series. The increase was partially offset by lower revenues from the 3Di Series.Pronouncements

~~Net~~In June 2005, ~~revenues~~the ~~from~~Financial ~~international~~Accounting ~~sales~~Standards ~~represented~~Board ~~75%~~(“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and ~~58%~~Error Corrections—a replacement of ~~total~~APB ~~net~~No. 20 ~~revenues~~and FAS No. 3.” SFAS 154 provides guidance on the accounting for ~~the~~and ~~nine~~reporting ~~months~~of ~~ended~~accounting ~~September~~changes 30and error corrections. It establishes, ~~2003~~unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. SFAS 154 also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and ~~2002,~~for ~~respectively~~reporting a change when retrospective application is impracticable. The correction ~~increase~~of an error in ~~international~~previously ~~sales~~issued ~~were~~financial statements is not an ~~primarily~~accounting change. However, the reporting ~~result~~ of ~~sales~~an error correction involves adjustments to ~~Asia,~~previously ~~which~~issued financial ~~comprised~~statements ~~64%~~similar ~~and~~to ~~50%~~those ofgenerally ~~net~~applicable to reporting an ~~revenues~~accounting ~~for~~change retrospectively. Therefore, the ~~nine~~reporting ~~months~~of ~~ended~~a ~~September~~correction 30of an error by restating previously issued financial statements is also addressed by SFAS 154. SFAS 154 is required to be adopted in fiscal years beginning after December 15, ~~2003~~2005. Adoption ~~and~~of ~~2002~~SFAS No. 154 is not expected to have a material effect on the Company’s financial position, ~~respectively~~results of operations or cash flows.

~~Gross~~In March 2005, ~~Profit. Gross~~the ~~profit~~FASB ~~increased~~issued toFASB ~~$14~~Interpretation No.4 47, ~~million for~~“Accounting ~~the~~for ~~nine~~Conditional ~~months~~Asset ~~ended~~Retirement ~~September 30~~Obligations,” ~~2003,~~which ~~from~~is ~~$10~~an interpretation of SFAS No.6 143, ~~million~~“Accounting for ~~the same~~Asset ~~period~~Retirement ~~in 2002~~Obligations.” The ~~gross~~interpretation ~~margin~~requires a ~~decreased~~liability ~~to 55.4%~~ for the ~~nine~~fair ~~months~~value ~~ended~~of ~~September~~a ~~30,~~conditional ~~2003,~~asset ~~from~~retirement ~~56.6%~~obligation ~~for~~be ~~the~~recognized ~~same~~if ~~period~~the infair ~~2002. The~~value ~~decrease in~~of ~~gross~~the ~~margin~~liability ~~percentage~~can ~~was~~be ~~primarily~~reasonably ~~due~~estimated. The tointerpretation anis ~~increase,~~effective inno ~~the~~later ~~first and~~than ~~second quarters of 2003, in~~ the ~~number~~end of ~~NSX~~fiscal ~~systems~~years ~~that~~ending ~~included~~after ~~subsystem options manufactured by third parties~~December 15, ~~which have lower gross margins than our core inspection systems~~2005. The ~~decrease in~~interpretation ~~margin~~is ~~was~~not ~~partially~~expected ~~offset~~to byhave ~~higher~~a material ~~average~~impact ~~selling~~on ~~prices within~~ the ~~NSX Series~~Company’s infinancial ~~the~~position, ~~third~~results ~~quarter~~ of ~~2003~~operations or cash flows.

~~Selling~~In December 2004, ~~General~~the FASB issued SFAS No. 123 ~~and~~(Revised ~~Administrative~~2004), ~~Expenses~~“Share-Based Payment.” ~~Selling~~SFAS No. 123R is a revision of SFAS No. 123, “Accounting ~~general~~for ~~and~~Stock-Based Compensation” ~~administrative~~and ~~expenses~~supersedes ~~increased~~Accounting 2Principles Board (“APB”) Opinion No.2% 25, “Accounting for Stock Issued to ~~$10.2~~Employees” ~~million,~~and orits 39related implementation guidance.4% SFAS ~~of net~~No. 123R ~~revenues,~~focuses primarily on accounting for ~~the~~transactions ~~nine~~in ~~months~~which ~~ended~~an ~~September~~entity ~~30,~~obtains employee ~~2003,~~services ~~from~~through ~~$10~~share-based payment transactions.0 SFAS ~~million,~~No. 123R orrequires a public entity ~~53.3%~~to measure the cost of ~~net~~employee ~~revenues,~~services received in exchange for the ~~same~~award of equity instruments based on the fair value of the award at the date of grant. The cost will be recognized over the period during which an employee is required to provide services in ~~2002~~exchange for the award. The ~~increase~~SEC issued guidance in ~~expense~~April 2005 announcing ~~dollars~~that ~~was~~public ~~primarily~~companies ~~due~~will be required to ~~higher~~adopt SFAS No. 123R ~~employee~~by ~~compensation~~their ~~costs,~~first ~~costs~~fiscal ~~associated~~year ~~with~~beginning after June 15, 2005. While the ~~integration~~Company ~~and~~cannot ~~ongoing~~precisely determine ~~operations~~the ofimpact ~~STI~~on ~~and~~net ~~CSI,~~earnings ~~higher~~as ~~variable~~a ~~costs~~result ~~associated~~of ~~with~~ the ~~higher revenues~~adoption of SFAS No. 123R, estimated ~~and~~compensation ~~costs~~expense ~~associated~~related ~~with~~to ~~systems~~prior ~~being~~periods ~~evaluated~~can bybe ~~customers.~~found in Note 3, “Stock-Based Compensation.” The ultimate ~~increase~~amount ~~was~~of ~~partially~~increased ~~offset~~compensation byexpense ~~the~~will ~~fact~~be ~~that~~dependent on whether the Company ~~prior~~adopts ~~year~~SFAS ~~included~~No. 123R using the modified prospective or ~~write-off~~retrospective method, the number of ~~costs~~option ~~related~~shares togranted ~~potential~~during ~~acquisitions~~the year, their timing and vesting period, and the ~~modification~~method ofused ~~our~~to calculate the fair ~~distributor~~value ~~agreement~~of ~~with~~the ~~Metron~~awards, ~~and~~among ~~employee~~other ~~severance~~factors the Company is currently assessing.

~~Research and~~In ~~Development~~November 2004, ~~Expenses. Research~~the ~~and~~FASB ~~development expenses~~issued ~~increased~~SFAS 8No.1% 151, “Inventory toCosts ~~$7.8~~- ~~million,~~an oramendment ~~30.0%~~ of ~~net~~ARB ~~revenues~~No. 43, Chapter ~~for~~4.” SFAS No. 151 clarifies the ~~nine~~accounting ~~months~~for ~~ended~~abnormal ~~September~~amounts 30of idle facility expenses, ~~2003~~freight, ~~from~~handling $7costs, and spoilage.2 It ~~million,~~also orrequires ~~38.4%~~that allocation of ~~net~~fixed ~~revenues, for~~production overheads to inventory be based on the ~~same~~normal capacity ~~period~~of inproduction ~~2002~~facilities. ~~The~~SFAS ~~increase~~No. 151 inis ~~expenses~~effective ~~was~~for ~~primarily~~inventory ~~due to~~ costs ~~related~~incurred toduring ~~completing~~fiscal ~~certain stages~~years ofbeginning ~~the~~after ~~development~~June 15, 2005. Adoption of ~~our~~SFAS ~~new~~No. 151 ~~BXi~~is not ~~Series,~~expected ~~EXi~~to ~~Series~~have ~~and~~a ~~AXi~~material ~~Series,~~effect ~~and employee~~on ~~salaries~~the ~~and~~Company’s ~~related~~financial ~~benefits associated~~position, ~~with~~results ~~the employees~~ of ~~STI~~operations ~~and~~or ~~CSI~~cash flows.

Interest Income. Interest income was $247,000 for the nine months ended September 30, 2003, compared to $506,000 for the same period in 2002. The decrease in interest income was due to lower rates of return earned on investment balances in 2003 as compared to 2002 and lower overall investment balances in 2003.15

~~Income Taxes. Due~~Item ~~to the recording of a full valuation allowance against deferred tax assets, we continued to reflect no benefit from income taxes during the nine months ended September 30, 2003~~2. ~~The~~ ~~recording~~Management’s ofDiscussion ~~the~~and ~~valuation~~Analysis ~~allowance in the second quarter~~ of ~~2002~~Financial ~~resulted~~Condition inand aResults ~~provision for income taxes~~ of ~~$687,000 during the nine months ended September 30, 2002.~~Operations

16Cautionary Factors That May Affect Future Results

~~Liquidity~~Certain statements made in this Quarterly Report on Form 10-Q, as well as oral statements made by us from time to time, which are prefaced with words such as “expects,” “anticipates,” “believes,” “projects,” “intends,” “plans” and ~~Capital~~similar words and ~~Resources~~other statements of similar sense, are forward-looking statements. Our forward-looking statements generally relate to our growth strategies, financial results, future financial projections, product development activities and sales efforts. Our actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, including but not limited to market acceptance of our products, our ability to successfully develop new products, our ability to protect our intellectual property, our dependence upon international customers and suppliers, our dependence on a small number of customers that account for a significant portion of revenues, availability of products from our suppliers, cyclicality in the microelectronic manufacturing equipment and other industries, management of growth, integration of acquired businesses, and the other risk factors detailed below and in our Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the SEC on March 16, 2005. We disclaim any obligation to revise forward-looking statements, or to update the reasons actual results could differ materially from those anticipated, to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Because many factors are unforeseeable, the foregoing should not be considered an exhaustive list.

During the nine months ended September 30, 2003, working capital increased to $63.0 million as compared to $29.4 million at December 31, 2002. The increase was primarily due to an increase in cash and marketable securities due to the sale of 3.0 million shares of our Common Stock at a price of $13.00 per share in a follow on public offering that was completed on September 23, 2003 (the “Offering”). The net proceeds from the Offering, after deducting the underwriting discount and offering expenses, were $36.1 million. On October 21, 2003, the underwriters exercised their option to acquire an additional 490,238 shares of Common Stock to cover over-allotments and we received $6.0 million, net of the underwriting discount.Introduction

~~At September~~The ~~30,~~following ~~2003~~discussion of our ~~principal~~results ~~sources~~ of ~~liquidity~~operations ~~consisted~~and offinancial ~~cash,~~condition ~~cash equivalents~~should ~~and~~be ~~marketable~~read ~~securities~~together with ofthe ~~$55.3~~other ~~million~~financial information and ~~our~~consolidated ~~revolving~~financial ~~credit~~statements and ~~line~~related ~~agreement,~~notes ~~which~~included ~~expires~~ in ~~April~~this ~~2004~~Form 10-Q. ~~The~~This ~~credit~~discussion ~~line~~contains ~~agreement~~forward-looking ~~allows~~statements ~~for~~that ~~borrowings~~involve ~~of up to $5.0 million,~~risks ~~subject to availability based on accounts receivable~~ and ~~inventory balances~~uncertainties. We ~~have no outstanding debt at September 30, 2003.~~ Our ~~liquidity~~actual isresults ~~affected~~could bydiffer ~~many~~materially ~~factors,~~from those ~~some~~anticipated ofin ~~which are based on~~ the ~~normal~~forward-looking ~~ongoing~~statements ~~operations~~as ofa ~~our~~result ~~business, the most significant~~ of ~~which~~a ~~includes~~variety ~~the timing~~ of ~~the collection of receivables,~~ ~~the level of inventories, capital expenditures and acquisitions~~factors.

~~Accounts~~Critical ~~Receivable. Accounts receivable~~Accounting decreased $1.6 million from December 31, 2002 to September 30, 2003, representing 42 days sales outstanding (“DSO”) during the three months ended September 30, 2003. This compares to a DSO of 99 days in the fourth quarter of 2002. The decrease in account receivable DSO was due to an increase in the amount of customer deposits received for systems we recognized revenue on in the third quarter of 2003. Due to the high mix of international revenues during a given quarter, which generally require a longer time for collection, we believe our DSO could increase in future quarters.Policies

~~Inventories. Inventories~~The ~~increased~~preparation ~~$3.3~~of ~~million~~our ~~from~~consolidated ~~December~~financial statements ~~31,~~in ~~2002~~conformity with accounting principles generally accepted in the toUnited ~~September~~States ~~30,~~of ~~2003,~~America ~~primarily~~requires ~~due~~management to ~~(i)~~make ~~inventory~~estimates ~~acquired~~and ~~with~~assumptions that ~~STI;~~affect ~~(ii) an~~the ~~increase~~reported inamounts ~~inventory~~of atassets, ~~customer~~liabilities, ~~sites~~revenues ~~under~~and ~~purchase~~expenses, and ~~orders;~~related disclosure of contingent assets and ~~(iii)~~liabilities. We anbased ~~increase~~these inestimates ~~raw~~and ~~material~~assumptions on historical experience and ~~work~~evaluate inthem ~~process~~on an ~~inventory~~on-going basis to ~~support~~help ~~new~~ensure ~~product introductions~~they ~~and~~remain ~~increased~~reasonable ~~backlog~~under current conditions. Actual ~~The~~results ~~increase~~could indiffer ~~inventory~~from atthose ~~customer~~estimates. We discuss ~~sites~~the ~~under~~development ~~purchase~~and ~~orders~~selection isof ~~primarily~~the ~~related~~critical toaccounting ~~shipments~~estimates with the audit committee of our ~~AXi Series. We~~board ~~anticipate~~of ~~that~~directors on a ~~portion~~quarterly of basis, and the ~~inventory~~audit committee athas ~~customer~~reviewed ~~sites~~our ~~will~~critical beaccounting ~~recognized~~policies as ~~revenue~~described ~~during~~in ~~the~~Item ~~fourth~~7, ~~quarter~~“Management’s Discussion and Analysis of ~~2003. We~~Financial ~~expect~~Condition ~~inventory~~and atResults of ~~customer~~Operations” ~~sites~~in ~~under~~our ~~purchase~~Annual ~~orders~~Report ~~will~~on ~~increase~~Form 10-K asfor ~~shipments~~the ofyear ~~newly~~ended December 31, ~~introduced~~2004. For ~~products~~the ~~increase~~six months ended June 30, 2005, there were no changes to these critical accounting policies.

Capital Expenditures. Our capital expenditures during the quarter were $152,000, and our total capital expenditures are expected to be between $1.0 and $1.5 million in 2003. Capital expenditures consist primarily of the capitalization of finished goods used to support our engineering, sales and service efforts.16

Acquisitions. As a result of the acquisition of STI, we entered into a two year lease for 10,600 square feet of space in Plano, Texas at an annual rental cost of approximately $106,000. As a result of the acquisition of CSI, we will lease 1,200 square feet in Thornwood, New York at a monthly rental cost of approximately $2,200. The lease may be terminated at any time with a six month notice.Overview

We are a world-class provider of automated defect detection and product characterization systems for microelectronic device manufacturers. Our ~~liquidity~~systems isprovide manufacturers ~~also~~with information that enables process-enhancing decisions, ~~affected~~ultimately bylowering ~~factors~~manufacturing ~~beyond~~costs ~~our~~and ~~control~~decreasing ~~related~~time-to-market. We have traditionally provided systems to address the ~~uncertainties~~automated inspection needs of ~~global~~the early stages of the final ~~economies~~manufacturing or back-end of the microelectronic device manufacturing process. These needs were met primarily with our NSX Series and 3Di Series of products. We have introduced the ~~cyclical~~AXi ~~nature~~Series and the E20 for edge and B20 for backside inspection systems (collectively, the “All Surface Inspection System”) for advanced macro defect detection primarily in the front-end of the ~~semiconductor~~wafer manufacturing process. When used in conjunction with one another these systems allow a manufacturer to inspect the top, edge and ~~microelectronic~~back of a wafer’s surface. ~~industries~~We believe we are the first to offer all surface wafer inspection. We continued to support front-end system demonstrations at many large semiconductor manufacturers during the quarter. These demonstrations allow these customers to evaluate the benefits these systems provide. We expect these demonstrations will lead to increased revenues six to nine months after shipment.

17We complement this broad inspection capability with an expanding suite of software tools designed to enhance the speed and effectiveness of the process by which device manufacturers analyze defects, and make decisions regarding their manufacturing process to reduce or eliminate such defects. We refer to this process as the “detection-to-decision” process.

~~Although~~Our ~~liquidity requirements~~business has been, and will ~~fluctuate~~continue ~~based~~to onbe, subject to the ~~timing~~highly ~~and~~cyclical ~~extent~~nature of ~~all~~the ofmicroelectronic ~~these~~device manufacturing markets we serve. These cycles are caused by significant, and often rapid, fluctuations in the supply and demand of microelectronic devices driven by such factors as changes in technology and global ~~others~~economic conditions. As a result of these fluctuations, ~~management~~and ~~believes~~due to the fact that ~~existing~~our ~~cash~~quarterly ~~and~~revenues ~~investment~~are ~~balances~~comprised ~~along~~of systems with selling prices of between $150,000 and $1,000,000, a small change in the number of systems we sell may also cause significant changes in our ~~line~~operating results. Because fluctuations in the timing of ~~credit~~orders ~~will~~from beour ~~adequate~~major customers or in the number of individual systems we sell could cause our revenues to fluctuate ~~satisfy~~significantly in any given quarter or year, we do not believe that period-to-period comparisons of our ~~existing~~financial results are necessarily ~~liquidity~~meaningful, ~~requirements~~and ~~for~~they atshould ~~least~~not be relied upon as an indication of our future performance. Additionally, the ~~next~~rate ~~twelve~~and timing ~~months~~of customer orders may vary significantly from month to month. Accordingly, if sales of our products do not occur when we expect, and we are unable to adjust our estimates on a timely basis, our expenses and inventory levels may increase relative to revenues and total assets.

~~Cash~~We have sold our systems to ~~Flows~~many of the leading microelectronic device manufacturers throughout the world. Historically, a significant portion of our revenues in each quarter and year has been derived from sales to relatively few customers, and we expect this trend to continue. In the six months ended June 30, 2005 and 2004 sales to customers that individually represented at least ten percent of our revenues accounted for 18% and 25% of our net revenues, respectively.

~~Net~~Management ~~cash~~focuses ~~provided by~~on ~~operating~~several ~~activities~~key ~~for~~financial ~~the~~metrics ~~nine~~in ~~months~~evaluating ~~ended~~our ~~September~~financial ~~30,~~condition ~~2003~~and operating ~~was $2~~performance.1 Although we do ~~million,~~not ~~which~~believe ~~resulted~~backlog ~~primarily~~is ~~from~~always ~~decreased~~an ~~accounts~~accurate ~~receivable~~indication ~~and increased~~of ~~customer~~future ~~deposits~~revenues and performance, ~~accounts~~since ~~payable~~only ~~partially~~a ~~offset~~portion byof our ~~net loss~~revenues ~~and~~for ~~increased~~any ~~inventory~~quarter ~~during~~include systems ~~the~~that ~~period. Net~~were ~~cash used~~ in ~~investing~~backlog ~~activities~~as ~~was~~of ~~$35.6~~the ~~million, primarily~~beginning ~~due to $33.4 million~~ of ~~net~~that ~~purchases~~quarter, ofwe ~~marketable~~do ~~securities~~closely ~~resulting~~monitor ~~from~~ the ~~proceeds~~level of ~~the~~orders ~~Offering,~~both ~~$1.4~~geographically ~~million~~and ~~paid~~by toproduct ~~acquire~~line ~~STI~~ and ~~$739,000~~in relation ofto ~~purchases~~the level of ~~property~~revenues, ~~and~~referred ~~equipment~~to as the book-to-bill ratio. ~~Net~~During ~~cash~~the ~~provided~~second byquarter ~~financing~~of ~~activities~~2005, our book-to-bill ratio was ~~$36.7~~above ~~million,~~parity. A ~~including~~book-to-bill ~~$36.1~~ratio ~~million~~above ofparity ~~net~~indicates ~~proceeds~~an ~~received~~increasing ~~from~~level ~~the~~of ~~Offering~~backlog. In addition to monitoring

Net cash used in operating activities for the nine months ended September 30, 2002 was $3.6 million, which resulted primarily from our net loss and increase in accounts receivable, partially offset by non-cash charges and decreased prepaid expenses and other current assets and inventories. Net cash provided by investing activities was $7.1 million, primarily due to $8.8 million of net proceeds from maturities of marketable securities offset by the purchases of $1.7 million of property and equipment and other assets. Net cash provided by financing activities was $1.1 million from the proceeds received from issuances of common stock.17

~~New~~our level of orders and backlog, we focus on ~~Accounting~~revenues ~~Pronouncements~~by product family compared to prior-period and current-year plans, year-over-year revenue growth compared to the overall semiconductor equipment industry, operating profit or loss performance compared with prior-period and current-year plans and the level of operating cash flow.

InMerger December 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF 00-21, “Revenue Arrangements with Multiple Deliverables”. This Issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. In some arrangements, the different revenue-generating activities (deliverables) are sufficiently separable and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (that is, there are separate units of accounting). In other arrangements, some or all of the deliverables are not independently functional, or there is not sufficient evidence of their fair values to account for them separately. This Issue addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. This Issue does not change otherwise applicable revenue recognition criteria. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have an effect on our consolidated financial statements.Activities

InOn ~~April~~January 21, ~~2003~~2005, ~~the~~we ~~FASB issued~~entered ~~SFAS~~into ~~No.~~an Agreement ~~149,~~and ~~“Amendment~~Plan of ~~Statement~~Merger ~~133~~and onReorganization ~~Derivative~~(the ~~Instruments~~“Nanometrics ~~and~~Merger ~~Hedging~~Agreement”,) ~~which~~with ~~amends~~Nanometrics, ~~and~~Incorporated ~~clarifies~~(“Nanometrics”), ~~financial~~Major ~~accounting~~League Merger Corporation and ~~reporting~~Minor ~~for derivative~~League ~~instruments~~Merger Corporation. ~~SFAS~~Under ~~149~~the ~~became~~terms of the Nanometrics Merger ~~effective~~Agreement ~~for~~each usshare inof ~~July~~our ~~2003~~common stock was to be converted into the right to receive 0.6401 of a share of August Nanometrics common stock. ~~The~~On June 27, 2005, we and Nanometrics ~~adoption~~terminated the Nanometrics Merger Agreement. In accordance with the terms of ~~SFAS~~the ~~149~~Nanometrics ~~did~~Merger ~~not~~Agreement, ~~have~~we paid anNanometrics ~~effect~~a ontermination ~~our~~fee ~~consolidated~~of ~~financial~~$8,300, and reimbursed $2,600 of merger ~~statements~~related expenses.

On ~~May 15~~June 27, ~~2003~~2005, ~~the~~we entered into an Agreement ~~Financial~~and ~~Accounting~~Plan ~~Standards~~of ~~Board~~Merger ~~issued~~(the ~~SFAS~~“Rudolph NoMerger Agreement”) with Rudolph Technologies, Inc. (“Rudolph”) ~~150~~and NS Merger Sub, Inc. Under ~~“Accounting~~the ~~for~~terms of the Rudolph Merger Agreement each of our shareholders ~~Certain~~will ~~Financial~~have ~~Instruments~~the ~~with~~option ~~Characteristics~~to elect to receive either $10.50 per share in cash or 0.7625 of ~~Both~~a ~~Liabilities~~share of Rudolph common stock, subject to proration and allocation, ~~Equity”~~based on the total cash and shares available in the merger. The ~~Statement~~agreement requires ~~issuers~~that the total toconsideration ~~classify~~for asthe ~~liabilities~~transaction ~~(or~~will ~~assets~~include ina ~~some~~minimum ~~circumstance)~~of ~~three~~$37,200 ~~classes~~and ofa ~~freestanding~~maximum ~~financial~~of ~~instruments~~$60,000 ~~that~~of ~~embody~~cash ~~obligations~~subject ~~for~~to ~~the~~shareholder ~~issuer~~election. ~~Generally~~The aggregate consideration was approximately $193,000 ~~the~~as ~~Statement~~of June 27, 2005.

18On February 9, 2005, we received a letter from Kenneth Schroeder, President and Chief Executive Officer of KLA-Tencor Corporation (“KLA”), regarding KLA’s interest in pursuing a merger with us. The letter stated that KLA proposed to acquire us in a transaction in which our shareholders would receive $11.50 per share. KLA also stated that it would be willing to consider using stock as consideration. Since the February 9 letter, KLA has made various public statements and additional communications to us (including a press release issued on July 13, 2005) stating that KLA continues to be interested in acquiring August Technology. As of the date of this filing, KLA has been unwilling to execute a confidentiality agreement in a form acceptable to us and we have had no discussions with KLA regarding their proposal.

is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 did not have an effect on our consolidated financial statements.18

~~Item 3. Qualitative~~Results ~~and~~of ~~Quantitative Disclosures about Market Risk~~Operations

Market Risk

	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004

Net revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of revenues	42.7		45.6		44.0		44.5
Gross profit	57.3		54.4		56.0		55.5

Selling, general and administrative expenses	36.8		27.2		35.5		29.2
Research and development expenses	16.9		16.7		18.3		17.1
Operating income	3.6		10.5		2.2		9.2

Merger expenses	(60.9	)	—		(34.7	)	—
Interest income	1.7		0.9		1.6		1.1
Net income (loss) before provision for income taxes	(55.6	)	11.4		(30.9	)	10.3
Provision for income taxes	0.6		0.5		0.4		0.3
Net income (loss)	(56.2	)%	10.9	%	(31.3	)%	10.0	%

WeThree ~~are exposed to market risk primarily from changes in interest rates~~ and ~~credit~~six ~~risk. We~~months doended ~~not~~June 30, ~~have~~2005 ~~material~~compared ~~exposure~~ to ~~market risk~~the ~~from~~three ~~fluctuations in foreign currency exchange rates because all sales are~~and ~~made~~six inmonths ~~U.S.~~ended ~~dollars.~~June 30, 2004

~~Interest~~Net ~~Rate~~Revenues. Net revenues ~~Risk~~decreased $0.2 million, or 0.8%, to $19.7 million for the three months ended June 30, 2005, from the record revenues of $19.9 million for the same period in 2004. Strong growth in revenues from systems sold into final manufacturing assembly and packaging applications were the largest contributors in the three months ended June 30, 2005. Net revenues increased $1.9 million, or 5.1%, to $38.1 million for the six months ended June 30, 2005, from $36.3 million for the same period in 2004. The increase in net revenues during the six months ended June 30, 2005 was primarily due to increased sales of all surface inspection systems into front-end wafer fabrication processes, and revenues from DMSVision, which was acquired in July 2004. This increase during the first half of 2005 was partially offset by lower NSX Series sales into front-end wafer fabrication processes and 3Di Series sales. Revenues derived from systems sold for front-end wafer fab applications accounted for 42.9% and 51.1% of total net revenues in the first half of 2005 and the first half of 2004, respectively. Revenues in the third quarter of 2005 are expected to range from flat to an increase of 10%, as compared to the second quarter of 2005.

WeNet ~~are~~revenues ~~exposed~~from ~~to interest~~international ~~rate~~sales ~~risk~~represented ~~primarily~~86% and ~~from~~71% ~~investments~~of intotal ~~cash~~net ~~equivalents~~revenues ~~and short-term~~for ~~and~~the ~~long-term~~three ~~marketable~~months ~~debt~~ended ~~securities~~June 30, ~~(the~~2005 ~~“Investment~~and ~~Portfolio”)~~2004, respectively. ~~The entire Investment~~International ~~Portfolio,~~revenues ~~classified~~during asthese ~~available-for-sale,~~periods iswere ~~recorded~~primarily on the ~~balance~~result ~~sheet at~~of ~~fair~~sales ~~market~~to ~~value~~Asia, ~~with~~which comprised ~~unrealized~~63% ~~gains~~and or71% ~~losses~~of ~~excluded~~total ~~from~~net ~~earnings~~revenues ~~and included~~for inthe ~~“Accumulated~~three ~~other~~months ~~comprehensive~~ended ~~income~~June 30, 2005 ~~(loss)”~~and ~~until realized~~2004, respectively. ~~The~~Sales ~~entire Investment~~to ~~Portfolio~~Europe isfor ~~denominated~~the inthree ~~U.S.~~months ~~dollars.~~ended June 30, 2005 represented the next Wehighest doconcentration ~~not~~with ~~use~~23% ~~derivative~~of ~~financial~~net ~~instruments~~revenues, inwhich is the ~~Investment~~highest ~~Portfolio~~three-month revenue ever from that continent. ~~Due~~ Net torevenues ~~the~~from ~~short~~international ~~duration~~sales represented 84% and 71% of total ~~our~~net ~~Investment~~revenues ~~Portfolio,~~for anthe ~~immediate~~six ~~100~~months ~~percent~~ended ~~change~~June 30, in2005 ~~interest~~and ~~rates~~2004, isrespectively, ~~not~~and ~~expected~~were toprimarily ~~have~~the aresult ~~material~~of ~~adverse~~sales ~~effect~~to onAsia, ~~our~~which ~~near-term~~comprised ~~financial condition~~66% orand ~~results~~69% of total ~~operations~~net revenues.

~~Credit~~Gross ~~Risk~~Profit. Gross profit as a percent of net revenues increased to 57.3% for the three months ended June 30, 2005, from 54.4% for the same period in 2004. Gross profit as percentage of net revenues increased to 56.0% for the six months ended June 30, 2005, from 55.5% for the same period in 2004. Gross profit percentage increased primarily as a result of revenues from DMSVision software sales and improved margins within the NSX Series, partially offset by higher rework costs related to certain systems and the recording of lower of cost or market adjustments related to certain component parts that became obsolete due to engineering design changes. We expect to continue to experience pricing pressure primarily related to our inspection systems sold

Financial instruments which potentially subject us to credit risk consist principally of securities in the Investment Portfolio and trade receivables. We limit credit risk related to the Investment Portfolio by placing all investments with high quality credit issuers and limit the amount of investments with any one issuer. As of September 30, 2003, 88% of the Investment Portfolio consisted of government securities and corporate commercial paper and bonds with maturities of one year or less. We limit credit risk associated with trade receivables by performing ongoing credit evaluations and believe that there is no additional risk beyond amounts provided for collection losses to be inherent in trade receivables.19

~~Item~~into final manufacturing applications as competitors have continued to enter 4this market. The ~~Controls~~impact ~~and~~of these reductions ~~Procedures~~in gross profit is expected to be offset by higher margin products sold into front end applications. We expect future gross profit as a percentage of net revenues to be between 54% and 57%.

~~Evaluation~~Selling, General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses consist primarily of ~~Disclosure~~employee ~~Controls~~salaries and related benefits, depreciation and ~~Procedures~~amortization, and travel expenses. SG&A expenses were $7.2 million and $13.5 million for the three and six months ended June 30, 2005, compared to $5.4 million and $10.6 million for the same periods in 2004. SG&A expenses as a percentage of net revenues were 36.8% and 35.5% for the three and six months ended June 30, 2005, compared to 27.2% and 29.2% of net revenues for the same periods in 2004. The increase in expense dollars was primarily the result of severance costs, amortization of purchased technology resulting from the DMSVision acquisition and technology purchased from Excelerate, and expenses associated with both increased personnel and support costs associated with an increased number of demo systems. We expect SG&A expense dollars to decrease in the third quarter of 2005, as compared to the second quarter of 2005, due to a reduction in severance expenses, partially offset by increased marketing costs related to tradeshows.

AsResearch ofand ~~the~~Development Expenses. Research ~~end~~and ofdevelopment ~~the~~(“R&D”) expenses ~~period~~consist ~~covered~~primarily byof ~~this~~employee ~~report,~~salaries ~~the~~and ~~Company~~related ~~conducted~~benefits anfor ~~evaluation~~individuals engaged ~~under~~in the ~~supervision~~ ~~and~~research, ~~with~~design ~~the~~and ~~participation~~development of ~~the~~new ~~Company’s~~products. R&D ~~management,~~expenses ~~including the~~were ~~Company’s~~$3.3 ~~Chief~~million ~~Executive~~and ~~Officer~~$7.0 million for the three and ~~Chief~~six ~~Financial~~months ~~Officer~~ended June 30, ~~regarding the~~2005, ~~effectiveness~~compared ofto ~~the~~$3.3 million ~~design~~ and ~~operation~~$6.2 ofmillion for the ~~Company’s~~same ~~disclosure controls~~periods ~~and~~in ~~procedures~~2004. R&D ~~pursuant~~expenses toas ~~Rules~~a ~~13a-15(b)~~percentage of ~~the~~net revenues ~~Securities~~were ~~Exchange Act~~16.9% ofand ~~1934~~18.3% (for the three ~~“Exchange~~and ~~Act”). Based upon~~six ~~that~~months ~~evaluation~~ended June 30, ~~the~~2005, ~~Chief~~compared ~~Executive~~to ~~Officer~~16.7% and ~~Chief~~17.1% ~~Financial~~for the ~~Officer~~same periods in 2004. The increase ~~concluded~~in ~~that~~expense dollars during the ~~Company’s~~six ~~disclosure~~months ~~controls~~ended ~~and~~June 30, ~~procedures~~2005 ~~are~~was ~~effective~~primarily due to ~~ensure~~employee ~~that~~compensation ~~information~~and related ~~that~~benefits isassociated ~~required~~with the hiring of additional staff to complete becertain ~~disclosed~~stages byof development of the ~~Company~~all insurface inspection ~~reports~~systems. In ~~that~~addition, itexpenses ~~files~~increased due ~~under~~to the ~~Exchange~~DMSVision ~~Act~~acquisition iscompleted ~~recorded,~~in ~~processed,~~July 2004. We ~~summarized and~~currently ~~reported~~anticipate ~~within~~that ~~the~~research ~~time~~and ~~periods~~development ~~specified~~expense dollars will increase in the ~~rules~~third quarter of ~~the~~2005 ~~Securities and~~as ~~Exchange~~we ~~Commission~~continue to expand our suite of software solutions.

19Interest Income. Interest income was $0.3 million and $0.6 million for the three and six months ended June 30, 2005, compared to $0.2 million and $0.4 million for the same periods in 2004. The increase in interest income was primarily due to an increase in the rate of return on our investment balances.

~~Changes~~Merger Expenses. Merger expenses were $12.0 million and $13.2 million for the three and six months ended June 30, 2005, compared to none in ~~Internal~~2004. The ~~Controls~~merger expenses included a $10.9 million termination fee paid to Nanometrics for terminating the Nanometrics Merger Agreement, legal and investment banker fees incurred prior to terminating the proposed merger with Nanometrics, and legal and investment banker fees incurred in conjunction with the proposed merger with Rudolph Technologies, Inc.

~~There~~Income ~~were~~Taxes. We currently noanticipate ~~changes~~a pretax profit in 2005 for income tax purposes, as ~~the~~compared ~~Company’s~~to ~~internal~~a ~~controls~~pretax ~~over~~loss ~~financial~~under ~~reporting~~generally ~~that~~accepted ~~occurred~~accounting ~~during~~principles, due to the ~~period~~fact ~~covered~~that bythe ~~this~~merger ~~report~~expenses ~~that~~are ~~have~~primarily ~~materially~~nondeductible ~~affected~~for income tax purposes. In addition, oras ~~are~~a result of ~~reasonably~~historical ~~likely~~operating losses and uncertainty as to ~~materially~~the ~~affect~~extent of profitability in future periods, we began to record a valuation allowance against our deferred tax assets in the ~~Company’s~~second ~~internal~~quarter ~~control~~of ~~over~~2002 and continue to do so at June 30, ~~financial~~2005. Statement ~~reporting~~of Financial Accounting Standards (“SFAS”) No. 109 “Accounting for Income Taxes,” requires the establishment of a valuation allowance to reflect

~~PART~~the IIlikelihood –of ~~OTHER~~the ~~INFORMATION~~realization of deferred tax assets. As of December 31, 2004, the valuation allowance was $8.5 million. The above factors have resulted in the recording of a provision for income taxes for the three and six months ended June 30, 2005 and 2004, primarily to reflect foreign income taxes and federal alternative minimum taxes owed.

~~Item~~Liquidity and Capital ~~1. Legal Proceedings~~Resources

OnAt ~~September 23~~June 30, ~~2003~~ 2005, ~~the Company~~our ~~filed~~principal asources ~~complaint~~of inliquidity ~~the~~consisted ~~district court~~ of ~~Dallas County~~cash, ~~Texas~~cash ~~seeking~~equivalents aand ~~declaratory~~investments ~~judgment~~in ~~that~~marketable ~~the~~debt ~~Company~~securities ~~has~~of no$41.9 ~~liability~~million, compared to ~~Rudolph~~$50.4 ~~Technologies,~~million ~~Inc.~~at ~~or its subsidiary~~December 31, ~~ISOA~~2004, ~~Inc.~~a ~~(doing~~decrease ~~business~~of as$8.5 ~~Yield~~million. The ~~Metrology~~decrease ~~Group),~~was ~~with~~primarily ~~respect~~due to ~~claims~~$12.3 ~~they~~million ~~have~~in ~~asserted~~cash ~~against~~paid ~~the~~for ~~Company~~merger expenses and ~~its~~an ~~subsidiary~~increase in accounts receivable, ~~Semiconductor~~partially ~~Technologies~~offset &by ~~Instruments,~~increases ~~Inc.~~in accounts ~~(“STI”). In~~payable ~~various~~and ~~letters~~accrued ~~and~~compensation. During ~~conversations~~the ~~with~~next ~~STI~~twelve months, and ~~the Company~~beyond, ~~Rudolph~~we ~~has~~intend ~~asserted~~to ~~that~~utilize ~~STI~~our ~~owes Rudolph~~current ~~development~~sources ~~fees~~of liquidity ~~and~~to ~~royalty~~fund ~~payments~~operations, ~~pursuant~~specifically to aenhance ~~December~~our ~~24,~~position ~~1997~~in the ~~Development~~front-end ~~Agreement~~wafer ~~(the~~fabrication ~~“Development~~process. We ~~Agreement”)~~have ~~between~~no ~~STI~~outstanding ~~and~~debt ~~ISOA~~at June 30, ~~Inc~~2005., ~~which~~Our ~~Rudolph~~liquidity ~~later~~is ~~acquired~~affected ~~and~~by ~~renamed~~many ~~Yield Metrology Group. In addition~~factors, ~~the~~some ~~Company~~of iswhich ~~seeking~~are abased on ~~judgment~~the ~~against~~normal ~~Rudolph~~ongoing ~~and~~operations ~~ISOA~~of ~~for~~our ~~repayment~~business, ofthe ~~royalties~~most ~~previously~~significant ~~paid~~of bywhich ~~STI~~includes tothe ~~ISOA~~timing ~~under~~of the ~~Development~~collection ~~Agreement~~of ~~and~~receivables, ~~costs~~the ~~and~~level ~~attorney’s~~of ~~fees~~inventories, ~~incurred~~capital inexpenditures ~~bringing~~and ~~this action~~acquisitions.

OnAccounts ~~September~~Receivable. Accounts receivable 30increased $3.4 million from December 31, ~~2003~~2004 to June 30, ~~Rudolph~~2005. Our ~~and~~days ~~ISOA~~sales ~~filed~~outstanding an(“DSO”) during ~~answer~~the ~~and~~three ~~counterclaim~~months ended June 30, ~~denying~~2005 ~~the~~was ~~allegations~~50 ~~set forth~~days. This compares to a DSO of 45 days in the ~~Company’s~~first quarter ~~complaint~~of ~~and~~2005. The ~~claiming~~increase ~~that~~in ~~ISOA~~the isDSO during ~~entitled~~the tosecond ~~damages as~~quarter ais ~~result~~primarily ofdue ~~STI’s~~to ~~breach~~the timing of ~~the~~revenues ~~Development~~during ~~Agreement~~the quarter. ~~ISOA~~The isincrease ~~also~~in ~~seeking~~accounts receivable resulted in a ~~declaratory~~use ~~judgment that~~of ~~STI~~cash ~~and/or~~during the ~~Company~~six ~~are~~months ~~wrongfully~~ended ~~using~~June 30, 2005, ~~ISOA’s~~as ~~technology~~we ~~without~~have funded shipments for increased revenues prior to receiving ~~compensating~~payments ~~ISOA~~from customers. ~~ISOA~~We isbelieve ~~also seeking~~our aDSO ~~judgment~~will ~~for~~be ~~their~~between ~~attorney’s~~50 ~~fees~~and 65 days in ~~this~~future ~~matter~~quarters.

InInventories. Inventories ~~connection~~increased ~~with~~$1.3 ~~the~~million ~~acquisition of STI, the Company~~from ~~placed 180~~December 31,~~000~~ ~~shares~~2004 ~~of its common stock issued in the transaction in escrow~~ to ~~secure~~June 30, ~~the performance by ASTI Holdings Limited (“ASTI”) of its agreement to~~2005. ~~indemnify~~The ~~the~~increase ~~Company~~is ~~against~~primarily ~~damages~~due up to aan ~~maximum~~increase ~~amount of $670,000~~ in ~~connection~~ ~~with~~raw ~~STI’s~~material dispute with Rudolph. Shares distributed from the escrow in payment of any indemnification claim will be valued at the market price of the Company’s Common Stock on the date of resolution of the claim. In September 2003, pursuant to ansupport ~~agreement~~an ~~between~~anticipated ~~the~~increase ~~Company,~~in ~~ASTI~~revenues ~~and~~during the ~~escrow~~second ~~agent,~~half ~~105,385~~ of ~~the~~2005 ~~escrowed shares were sold~~ and ~~the~~new ~~proceeds of such sale were deposited into the escrow~~product introductions. ~~The~~This ~~escrow~~increase ~~agreement provides that the~~was ~~escrow~~partially ~~would~~offset ~~have~~by ~~terminated on October 15, 2003 if~~ a ~~legal~~decrease ~~proceeding regarding~~in ~~these~~finished ~~issues~~goods ~~had~~due ~~not been initiated prior~~ to ~~that date. Because~~ the ~~Company~~transfer ~~has~~of ~~initiated this legal~~certain ~~proceeding,~~systems ~~the~~to ~~escrow~~property ~~remains~~and inequipment ~~effect~~for ~~until~~internal ~~the~~use ~~resolution~~and ofsales ~~the claims subject~~ to ~~such~~third ~~legal proceeding~~parties.

~~The~~Inventories ~~Company~~at ~~may~~Customers ~~incur~~under ~~significant~~Purchase ~~legal fees and expenses in pursuing this action for a declaratory judgment~~Orders. InInventories ~~addition,~~at ~~there~~customers ~~can~~under bepurchase noorders ~~assurance~~decreased ~~that~~from ~~the~~$4.0 ~~Company~~million ~~will~~at ~~prevail in such~~December 31, ~~litigation~~2004 ~~and~~to ~~the~~$3.6 ~~Company~~million ~~may~~at ~~suffer~~June 30, an2005. We ~~adverse~~anticipate ~~result~~that ~~requiring~~a itportion toof ~~pay damages~~this orinventory ~~royalties~~will ~~adversely~~be ~~affecting~~recognized ~~its~~as revenue ~~business~~during 2005. ~~Notwithstanding~~We ~~the~~anticipate ~~foregoing, the Company~~that ~~believes~~this ~~the~~inventory ~~indemnification~~will ~~escrow~~increase ~~established~~as inshipments ~~connection with the acquisition~~ of ~~STI~~newly isintroduced ~~reasonably likely to protect the Company against any~~products ~~losses incurred in connection with Rudolph’s claims~~increase.

21Capital Expenditures. Our capital expenditures during the first six months of 2005 were $843,000, consisting primarily of the capitalization of finished goods that have been transferred to engineering for test and characterization, and to sales for customer application studies. This equipment is expected to be utilized for these purposes for its estimated life, generally three years. Our total capital expenditures, including the capitalization of finished goods for internal use, are expected to be between $3.0 million and $4.0 million in 2005, as we continue to expand the use of internal test and development equipment and facilities to meet customer demand and better serve our customers.

~~Item~~Our ~~6. Exhibits~~liquidity is also affected by factors beyond our control related to the uncertainties of global economies and ~~Reports~~the cyclical nature of the semiconductor and microelectronic industries. Although liquidity requirements will fluctuate based on ~~Form~~the ~~8-K~~timing and extent of all of these factors

~~(a) Exhibits:~~21

~~The~~and ~~exhibits~~others, ~~listed~~management onbelieves that existing cash and investment balances ~~the~~will ~~Exhibit~~be ~~Index~~adequate ~~are~~to ~~filed~~satisfy ~~herewith~~our existing liquidity requirements for at least the next twelve months.

~~(b) Reports~~Cash ~~on Form 8-K:~~Flows

~~Current~~Net cash ~~Report~~used onin ~~Form~~operating ~~8-K~~activities ~~dated~~for ~~July~~the six months ended June 30, 2005 was $8.5 million, ~~2003~~primarily due to $12.3 million in cash paid for merger expenses and an increase in accounts receivable, partially offset by increases ~~filed~~in ~~July~~accounts 9payable and accrued compensation. Excluding cash payments for merger expenses, ~~2003~~cash generated from operating activities was $3.9 million for the six months ended June 30, 2005. Net cash provided by investing activities was ~~filed~~$12.2 ~~pursuant~~million, primarily due to ~~Item~~$13.3 9million ~~(Regulation~~of FDnet ~~Disclosure)~~proceeds from maturities of marketable debt securities, partially offset by $1.0 million of additions to property and equipment, and other assets. Net cash provided by financing activities was ~~report~~$1.0 ~~the~~million, ~~press~~primarily ~~release~~related ~~announcing~~to ~~the~~proceeds ~~acquisition~~received from exercises of ~~Counterpoint~~stock options. We ~~Solutions~~currently expect to generate ~~Inc~~cash from operating activities during the remainder of 2005.

~~Current~~Net cash ~~Report~~used onin ~~Form~~operating ~~8-K~~activities ~~dated~~for ~~July~~the six months ended June 30, ~~2003~~2004 was $10.7 million, which resulted primarily from increased accounts receivable and inventories partially offset by our net income and increased accounts ~~furnished~~payable ~~July~~and ~~30,~~customer ~~2003,~~deposits. Net cash provided by investing activities was ~~furnished~~$308,000, ~~pursuant~~primarily due to ~~Item~~$2.9 12million ~~(Disclosure~~of net proceeds from sales of marketable securities and partially offset by $2.5 ~~Results~~million for purchases of ~~Operations~~property and ~~Financial~~equipment. Net ~~Condition)~~cash toprovided ~~report~~by ~~the~~financing ~~press~~activities ~~release~~was ~~announcing~~$2.0 million from the ~~Company’s~~proceeds ~~second~~received ~~quarter~~from ~~2003~~issuances ~~financial~~of ~~results~~common stock.

~~Amendment~~New toAccounting Current Report on Form 8-K dated April 15, 2003 and filed August 12, 2003, was filed pursuant to Item 2 (Acquisition or Disposition of Assets) and Item 7 (Financial Statements and Exhibits) to report the acquisition of the stock of Semiconductor Technologies and Instruments, Inc. (“STI”) and to report the audited financial statements of STI and the pro forma condensed combined financial statements of the Company and STI.Pronouncements

~~Amendment~~In toJune 2005, the ~~Current~~Financial ~~Report~~Accounting onStandards ~~Form~~Board ~~8-K~~(“FASB”) ~~dated~~issued ~~April~~Statement 15of Financial Accounting Standards (“SFAS”) No. 154, “Accounting ~~2003~~Changes and ~~filed~~Error ~~August~~Corrections—a 27replacement of APB No. 20 and FAS No. 3.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, ~~2003~~unless impracticable, retrospective ~~was~~application ~~filed~~as ~~pursuant~~the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to ~~Item~~the 7newly ~~(Financial~~adopted accounting principle. SFAS 154 also provides ~~Statements~~guidance for determining whether retrospective application of a change in accounting principle is impracticable and ~~Exhibits)~~for toreporting ~~report~~a change when retrospective application is impracticable. The correction of an ~~exhibit~~error in previously issued financial statements is not an accounting change. However, the reporting of an error correction involves adjustments to previously issued financial statements similar to those generally applicable to reporting an accounting change retrospectively. Therefore, the ~~Company~~reporting ~~and~~of ~~STI~~a correction of an error by restating previously issued financial statements is also addressed by SFAS 154. SFAS 154 is required to be adopted in fiscal years beginning after December 15, 2005. Adoption of SFAS No. 154 is not expected to have a material effect on our financial position, results of operations or cash flows.

22In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations,” which is an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations.” The interpretation requires a liability for the fair value of a conditional asset retirement obligation be recognized if the fair value of the liability can be reasonably estimated. The interpretation is effective no later than the end of fiscal years ending after December 15, 2005. The interpretation is not expected to have a material impact on our financial position, results of operations or cash flows.

~~SIGNATURES~~22

~~Pursuant~~In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment.” SFAS No. 123R is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services through share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for the award of equity ~~requirements~~instruments based on the fair value of the ~~Securities~~award ~~Exchange~~at ~~Act~~the date of ~~1934~~grant. The cost will be recognized over the period during which an employee is required to provide services in exchange for the award. The SEC issued guidance in April 2005 announcing that public companies will be required to adopt SFAS No. 123R by their first fiscal year beginning after June 15, 2005. While we cannot precisely determine the ~~registrant~~impact on ~~has~~net ~~duly~~earnings as a result of the adoption of SFAS No. 123R, estimated ~~caused~~compensation ~~this~~expense ~~report~~related to prior periods can be ~~signed~~found in Note 3, “Stock-Based Compensation.” The ultimate amount of increased compensation expense will be dependent on ~~its~~whether ~~behalf~~we byadopt SFAS No. 123R using the ~~undersigned~~modified ~~thereunto~~prospective ~~duly~~or retrospective method, the number of option ~~authorized~~shares granted during the year, their timing and vesting period, and the method used to calculate the fair value of the awards, among other factors we are currently assessing.

	AUGUST TECHNOLOGY CORPORATION
Date: November 3, 2003	By:	/s/ JEFF L. O’DELL
	Jeff L. O’Dell
	Chief Executive Officer (Principal Executive Officer)
Date: November 3, 2003	By:	/s/ STANLEY D. PIEKOS
	Stanley D. Piekos
	Chief Financial Officer (Principal Financial Officer)
Date: November 3, 2003	By:	/s/ SCOTT A. GABBARD
	Scott A. Gabbard
	Chief Accounting Officer and Vice President, Finance (Principal Accounting Officer)

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs - an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expenses, freight, handling costs, and spoilage. It also requires that allocation of fixed production overheads to inventory be based on the normal capacity of production facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Adoption of SFAS No. 151 is not expected to have a material effect on our financial position, results of operations or cash flows.

~~SECURITIES~~Item ~~AND~~3. ~~EXCHANGE~~Quantitative ~~COMMISSION~~and Qualitative Disclosures About Market Risk

~~Washington, D.C. 20549~~Market Risk

~~EXHIBIT~~We ~~INDEX~~are exposed TOto ~~FORM~~market ~~10-Q~~risk primarily from changes in interest rates and credit risk. We do not have material exposure to market risk from fluctuations in foreign currency exchange rates because all sales are made in U.S. dollars.

~~For~~Interest Rate ~~the quarter ended: Commission File No.: 000-30637 September 30, 2003~~Risk

~~AUGUST~~We are exposed to ~~TECHNOLOGY~~interest ~~CORPORATION~~rate risk primarily from investments in cash equivalents and short-term and long-term marketable debt securities (the “Investment Portfolio”). The entire Investment Portfolio, classified as available-for-sale, is recorded on the balance sheet at fair market value with unrealized gains or losses excluded from earnings and included in “Accumulated other comprehensive income (loss)” until realized. The entire Investment Portfolio is denominated in U.S. dollars. We do not use derivative financial instruments in the Investment Portfolio. Due to the short duration of our Investment Portfolio, an immediate 10 percent change in interest rates is not expected to have a material adverse effect on our near-term financial condition or results of operations.

Exhibit Number		Description
10.1*		Executive Employment Contract between the Company and Pam Lampert, dated September 6, 2003
10.2*		Executive Employment Contract between the Company and Ardelle Johnson, dated September 9, 2003
31.1		Certification pursuant to Exchange Act Rules 13a-14(a) of the Chief Executive Officer
31.2		Certification pursuant to Exchange Act Rules 13a-14(a) of the Chief Financial Officer
32.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to the Sarbanes-Oxley Act of 2002

Credit Risk

* ManagementFinancial ~~contract~~instruments which potentially subject us to credit risk consist principally of securities ~~compensatory~~in ~~plan~~the Investment Portfolio and trade receivables. We limit credit risk related to the Investment Portfolio by placing all investments with high quality credit issuers and limit the amount of investments with any one issuer. As of June 30, 2005, 71.4% of the Investment Portfolio consisted of government securities and corporate bonds with maturities of one year or ~~arrangement~~less. We limit credit risk associated with trade receivables by performing ongoing credit evaluations and believe that there is no additional risk beyond amounts provided for collection losses to be inherent in trade receivables.

24Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, the Company conducted an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rules 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information that is required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules of the Securities and Exchange Commission.

Changes in Internal Controls

There were no changes in the Company’s internal controls over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company and each of its directors, Jeff O’Dell, James Bernards, Roger Gower, Michael Wright and Linda Hall Whitman, were named as defendants in two separate lawsuits that purported to be class action claims on behalf of the Company’s shareholders. The Company received a summons and complaint with respect to the first of these proceedings on February 4, 2005 and the second on February 14, 2005. Both lawsuits were brought in Minnesota State Court and claimed that the directors had breached their fiduciary duties to the Company’s shareholders in connection with their actions in agreeing to the proposed merger with Nanometrics Incorporated. The plaintiffs in both actions sought various forms of injunctive relief including an order enjoining the Company and its board of directors from consummating the merger with Nanometrics.

On July 18, 2005, a purported shareholder class action lawsuit asserting derivative claims was filed in Minnesota state court against the Company and the individual members of the board named above as well as Lynn J. Davis, who joined the board on March 30, 2005 (the “Board”). The lawsuit claims the directors have breached their fiduciary duties to Company’s shareholders in connection with their actions in approving the merger agreement with Nanometrics, Inc. and subsequently terminating that merger agreement and entering into a new merger agreement with Rudolph Technologies, Inc. The plaintiff seeks various forms of injunctive relief including an order enjoining the Company and the Board from consummating the proposed merger with Rudolph.

The plaintiff in the lawsuit filed on July 18, 2005 is Robert Etem, the owner of 4,200 shares of the Company’s common stock. Mr. Etem was also a plaintiff in the lawsuit described above filed on February 14, 2005.

On July 14, 2005, the Company filed a patent infringement lawsuit against Camtek, Ltd. of Migdal Haemek, Israel. The patent infringement lawsuit, filed in U.S. federal court in Minneapolis, alleges that Camtek’s line of inspection equipment sold under the “Falcon” trademark infringes on the Company’s U.S. patent no. 6,826,298.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth the repurchase of stock by the Company in the second quarter:

Period	(a) Total Number of Shares Purchased		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	(d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet be Purchased Under the Plans or Programs

May 19, 2005	11,614	(1)	$	10.332	0	0

(1) Pursuant to a Redemption Agreement between the Company and Michael Plisinski, Vice President of Engineering, the Company repurchased the shares at a price equal to 90% of the closing price of the Company’s stock on the day preceding the repurchase date. There is no agreement to repurchase additional shares.

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

The Company held its Annual Meeting of Shareholders on May 25, 2005 at the Company’s world headquarters at 4900 West 78^th Street, Bloomington, Minnesota. Of the 17,970,496 shares of Common Stock outstanding as of April 13, 2005 (the record date), 16,476,676 (92%) were present or represented by proxy at the meeting.

1. The shareholders approved the Board of Director’s recommendation for setting the number of directorships at six. This proposal received 14,704,125 votes for and 867,318 votes against, with 905,233 votes abstaining.

2. The shareholders elected Lynn J. Davis and Linda Hall Whitman as Class II Directors, pursuant to the following votes:

	Votes For	Votes Withheld

Lynn J. Davis	14,604,115	1,872,561

Linda Hall Whitman	14,283,713	2,192,963

James A. Bernards and Roger E. Gower as Class III directors and Jeff O’Dell and Michael Wright as a Class I directors of the Company were not subject to reelection at this meeting, and thus their terms continued after the meeting.

3. The shareholders ratified the appointment of KPMG LLP as the Company’s independent auditors for the 2005 fiscal year. This proposal received 14,728,283 votes for and 834,143 votes against, with 914,250 votes abstaining.

Item 6. Exhibits

The exhibits listed on the Exhibit Index are filed herewith.

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.

	AUGUST TECHNOLOGY CORPORATION


Date: August 5, 2005	By:			/s/ JEFF L. O’DELL
	Jeff L. O’Dell
	Chief Executive Officer
	(Principal Executive Officer)


Date: August 5, 2005	By:		/s/ STANLEY D. PIEKOS
	Stanley D. Piekos
	Chief Financial Officer
	(Principal Financial Officer)


Date: August 5, 2005	By:	/s/ SCOTT A. GABBARD
	Scott A. Gabbard
	Chief Accounting Officer and
	Vice President, Finance
	(Principal Accounting Officer)

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

EXHIBIT INDEX TO FORM 10-Q

For the quarter ended:		Commission File No.: 000-30637
June 30, 2005

AUGUST TECHNOLOGY CORPORATION

Exhibit Number		Description

10.1		Amendment to Employment Agreement between the Company and David Klenk, dated May 5, 2005

10.2		Separation Agreement and Release between the Company and David Klenk, dated May 5, 2005

31.1		Certification pursuant to Exchange Act Rules 13a-14(a) of the Chief Executive Officer

31.2		Certification pursuant to Exchange Act Rules 13a-14(a) of the Chief Financial Officer

32.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to the Sarbanes-Oxley Act of 2002

Filing Compare · AUGUST TECHNOLOGY CORP