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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[ X ]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2004

OR

[   ]   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 0-25424

655 West Reserve Drive
Kalispell, Montana 59901
(Address of principal executive offices, zip code)

Registrant’s telephone number, including area code: (406) 752-2107

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X   NO __

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES    NO X

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practical date:

Semitool, Inc.
Form 10-Q
Table of Contents

Part I. Financial Information

        Item 1. Condensed Consolidated Financial Statements (Unaudited) 

        Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

        Item 3. Quantitative and Qualitative Disclosures About Market Risk

        Item 4. Controls and Procedures

Part II. Other Information

        Item 1. Legal Proceedings

        Item 6. Exhibits and Reports on Form 8-K

Signatures

Exhibits

PART I — FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

SEMITOOL, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
 (Amounts in Thousands, Except Share Amounts)

SEMITOOL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
  (Amounts in Thousands, Except Per Share Amounts)

SEMITOOL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
  (Amounts in Thousands)

SEMITOOL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
  (Amounts in Thousands)

SEMITOOL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The Company prepared the consolidated financial statements included herein, without audit, pursuant to the rules and regulations of the United States of America Securities and Exchange Commission (SEC). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted as permitted by such rules and regulations. These consolidated statements should be read in conjunction with the consolidated financial statements and the notes thereto for the year ended September 30, 2003 previously filed with the SEC on Form 10-K.

In our opinion these unaudited financial statements contain all of the adjustments (normal and recurring in nature) necessary to present fairly our consolidated financial position as of June 30, 2004, the consolidated results of operations for the three and nine month periods ended June 30, 2004 and 2003, and the consolidated cash flows for the nine month periods ended June 30, 2004 and 2003. The results of operations for the periods presented may not be indicative of those you may expect for the full year.

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. Routinely, we evaluate our estimates, including those related to revenue recognition, bad debts, inventories, investments, intangible assets, income taxes, financing operations, warranty obligations, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Company’s consolidated financial statements include the accounts of Semitool, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation.  Semitool has only one reportable segment. 

New Accounting Pronouncements

In December 2003, the FASB issued Interpretation Number 46R, “Consolidation of Variable Interest Entities” which replaces Interpretation Number 46, “Consolidation of Variable Interest Entities.” This interpretation addresses consolidation by business enterprises of variable interest entities. The Company will be required to adopt this statement on October 1, 2005. The revised interpretation is not expected to have a material effect on our results of operations, financial position or cash flows.

Stock-Based Compensation

The Company accounts for stock-based employee compensation using the intrinsic value method under Accounting Principles Board Opinion No. 25 (APB No. 25), “Accounting for Stock Issued to Employees” and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123) “Accounting for Stock-Based Compensation” as amended by SFAS No 148 (SFAS No. 148) “Accounting for Stock-Based Compensation Transition and Disclosure.” APB No. 25 provides that compensation expense relative to employee stock options is measured based on the intrinsic value of the stock options granted. Compensation expense is recognized in the statement of operations in the case where the stock options are granted at exercise prices below fair market value on the date of grant. If the stock options are granted at market value, no compensation expense is recorded. SFAS No. 123 provides for a fair value based method of accounting for an employee stock option. For stock options, fair value is determined using an option pricing model that takes into account the stock price at the grant date, the exercise price, the expected life of the option, the volatility of the underlying stock and the expected dividends on it, and the risk-free rate over the expected life of the option. SFAS No. 123 requires entities continuing to use an intrinsic value based method of accounting prescribed by APB No. 25 to provide pro forma disclosures of net income and earnings per share as if the fair value method of accounting had been used. SFAS No. 148 requires prominent disclosure of the method used to value options and the effect of the method used on reported results in both annual and interim financial statements.

For options granted at market value, we do not recognize an expense. However, for options granted at exercise prices below fair market value on the date of grant, we recognize compensation expense and amortize deferred stock-based compensation on the accelerated vesting method described in FASB Interpretation Number 28 over the vesting periods of the applicable stock options (normally five years). Had compensation cost for the Option Plan been determined based on the fair value consistent with the provisions of SFAS No. 123, the Company’s net income (loss) and earnings (loss) per share would have been changed to the pro forma amounts shown below (in thousands, except for per share amounts):

Computation of Earnings (Loss) Per Share

The computation of basic and diluted earnings (loss) per share is based on the following (in thousands):

Diluted earnings (loss) per share excludes the effects of antidilutive stock options of 1,511,375 and 1,539,895 for the three months ended June 30, 2004 and 2003, and 58,250 and 1,539,895 for the nine months ended June 30, 2004 and 2003. 

Note 2. Inventories

The Company's inventories are summarized as follows (in thousands):

During the three months ended June 30, 2004, no finished goods inventory was transferred to property, plant and equipment.  For the nine months ended June 30, 2004, $648,000 was transferred to property, plant and equipment for testing and laboratory use. 

Note 3. Warranty Obligations

Our obligations for warranty are accrued concurrently with the revenue recognized on the related equipment. We make provisions for our warranty obligations based upon historical costs incurred for such obligations adjusted, as necessary, for current conditions and factors. Due to the significant uncertainties and judgments involved in estimating our warranty obligations, including changing product designs and specifications, the ultimate amount incurred for warranty costs could change in the near term from our current estimate.

Changes in our accrued warranty liability were as follows (in thousands):

With the exception of product warranties we have not issued any guarantees or any indirect guarantee for the indebtedness of others.

Note 4. Contingencies

Seed Layer Enhancement Litigation:
We are involved in two lawsuits filed in June 2001 against each of Ebara Corporation (“Ebara”) and Novellus Systems, Inc. (“Novellus”) in the United States District Court for the District of Oregon (the “Oregon District Court”).  The two lawsuits claim that Ebara and Novellus infringe a patent we own that relates to the method by which “seed layers” on copper plated wafers are enhanced through certain fabrication steps. The method is embodied in our U.S. Patent No. 6,197,181 (the ‘181 Patent). In both cases we seek an injunction to stop them from practicing this technology as well as damages for past infringement, increased damages for willful infringement, and attorneys’ fees. Both defendants have denied any infringement and also allege that the ‘181 Patent is invalid. In addition, Novellus counterclaimed against us for infringement of four of their patents. The status of each case is set forth below.

Semitool, Inc. v. Ebara Corp. and Ebara Technologies, Inc.:
On July 23, 2004, we entered into a Seed Layer Enhancement Patent License Agreement (the “License Agreement”) and a Settlement Agreement with Ebara. The Settlement Agreement provides for the joint dismissal of the seed layer enhancement litigation with Ebara discussed above. The License Agreement provides for the payment to the Company of (i) a license initiation fee of $3.25 million, (ii) a commercialization fee in the event certain criteria are fulfilled, and (iii) patent license royalties payable to the Company in the event certain criteria are fulfilled. All other terms of the agreements are confidential. Under the Settlement Agreement, the lawsuit will be dismissed upon our receipt of the $3.25 million license initiation fee, which is expected to be received in the fourth quarter of fiscal 2004 and reflected in revenue in that period.

Semitool, Inc. v. Novellus Systems, Inc.:
In response to our suit against Novellus for infringement of our seed layer enhancement patent, they filed counterclaims for infringement of four of their patents: viz., U.S. Patent 6,179,983 “Method and Apparatus for Treating Surface Including Virtual Anode”; U.S. Patent 6,074,544 “Method of Electroplating Semiconductor Wafer Using Variable Currents and Mass Transfer to Obtain Uniform Plated Layer”; U.S. Patent 6,110,346 “Method of Electroplating Semiconductor Wafer Using Variable Currents and Mass Transfer to Obtain Uniform Plated Layer”; and U.S. Patent 6,162,344 “Method of Electroplating Semiconductor Wafer Using Variable Currents and Mass Transfer to Obtain Uniform Plated Layer”.  Novellus’ counterclaim for infringement of their U.S. Patent 6,179,983 has been withdrawn with prejudice and Novellus covenanted not to assert that patent against us. On March 31, 2004, the Oregon District Court ruled that the claims asserted by Novellus in their U.S. Patent 6,110,346 were invalid and, consequently, could not be asserted against us. On July 1, 2004, the Oregon District Court ruled that Semitool did not infringe U.S. Patent 6,074,544 and did not infringe U.S. Patent 6,162,344 in respect of the wet contact rings we currently use in our tools. The portion of the 6,162,344 patent left remaining for trial by the court deals with dry contact rings that have not been used by Semitool in its plating tools since early 2001. The remaining Novellus counterclaim, like our claim, seeks injunctive relief, damages for past infringement, increased damages for willful infringement and attorneys’ fees. We believe there are meritorious defenses to the remaining Novellus’ counterclaim, including both our defenses that we do not infringe their patent and that their patent is invalid. Discovery is closed, and the Oregon District Court has scheduled a trial date for November 2004 for both our claim of infringement and their remaining counterclaim.

Given the inherent uncertainty of litigation, there can be no assurance that the ultimate outcome of the Novellus seed layer enhancement patent lawsuit will be in our favor. It is the opinion of management, based on information available at this time, that the loss of any or all of its claim for patent infringement against Novellus would not have a material adverse effect on its business, financial condition, results of operations or cash flows. We cannot reasonably estimate the potential loss, if any, that might be incurred if we do not prevail in our defenses to Novellus’ counterclaim. If Novellus were to prevail in their remaining counterclaim, it could have a material adverse effect on our business, financial condition, results of operations or cash flows.

The Company is subject to other legal proceedings and claims which have arisen in the ordinary course of our business and have not reached final adjudication. Although there can be no assurance as to the ultimate disposition of these matters, it is the opinion of our management, based upon the information available at this time, that the currently expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

Note 5. Income Taxes

The components of the Company’s income tax provision (benefit) are as follows (in thousands):

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction – Forward – Looking Statements

Statements contained in this Quarterly Report on Form 10-Q which are not purely historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on management’s estimates, projections and assumptions that underlie such statements. Forward-looking statements may contain words such as “may,” “will,” “should,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or the negative of these terms or other comparable terminology. Examples of forward-looking statements include statements regarding:

• key trends in the semiconductor industry that are driving growth;
• the continued recovery of the semiconductor industry;
• expected increased shipments in the fourth quarter;
• the success of our new Raider platform;
• the expected geographic sales mix of our products;
• the continued success of cost management measures;
• litigation costs and outcomes;
• estimates of capital expenditures;
• the impact of various factors on gross margins;
• research and development expenditures;
• the sufficiency of funds and sources of liquidity;
• the ability to finance activities;
• accounting policies and estimates; and
• effects of new accounting standards.

Management cautions that forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from those projected in such forward-looking statements. The risks, uncertainties and other important factors that may cause our results to differ materially from those projected in such forward-looking statements include the cyclicality in the semiconductor industry, rapid technological change, the introduction of competing products and technologies, market non-acceptance of Semitool’s new products and technologies, including our new Raider tool, cancellations or rescheduling of orders, the potential loss of sales or incurrence of liabilities due to manufacturing defects, and litigation. Further, bookings, backlog and shipments are not necessarily an indication of revenue in any future period or future sales of any specific tool. Other risks and uncertainties are detailed under the heading “Factors That Might Affect Our Future Financial Results and Stock Price” and elsewhere in our Annual Report on Form 10-K for our fiscal year ended September 30, 2003. We undertake no obligation to update forward-looking statements to reflect subsequent events, changed circumstances, or the occurrence of unanticipated events.

Documents to Review in Connection with Management’s Discussion and Analysis of Financial Condition and Results Of Operations

This discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes presented in this Form 10-Q and the financial statements and notes in our last filed Annual Report on Form 10-K for a full understanding of our financial position and results of operations for the three and nine month periods ended June 30, 2004.

Overview

We design, manufacture, install and service highly-engineered equipment for use in the fabrication of semiconductor devices. Our products are focused on the wet chemical process steps in integrated circuit, or IC, manufacturing and include systems for wafer surface preparation and electrochemical deposition, or ECD, applications. ECD is a process of plating metal using both chemical and electrical forces. Our surface preparation systems are designed for wet cleaning, stripping and etching processes, including photoresist and polymer removal and metal etching. Our ECD systems are used for copper and gold plating for the IC’s internal wiring, or interconnects; solder and gold bumps for wafer level packaging applications; and other metals for various semiconductor and related applications. Our products address critical applications within the semiconductor manufacturing process, and enable our customers to manufacture more advanced semiconductor devices that feature higher levels of performance. The fabrication of semiconductor devices typically requires several hundred manufacturing steps, with the number of steps continuing to increase for advanced devices. Due to the breadth of our product portfolio and advanced technology capabilities, our solutions address over 100 of these manufacturing steps.

There are several key trends in the semiconductor manufacturing industry driving growth in demand for wafer surface preparation, ECD and other advanced semiconductor equipment:

• smaller device features for lower cost and higher performance;
• new materials to build more advanced semiconductor devices;
• increased use of 300mm wafers to reduce manufacturing costs;
• move to spray processing and single-wafer processing technologies for enhanced surface preparation; and
• wafer level and other advanced packaging enabling smaller portable products.

As the semiconductor manufacturing process increases in complexity and production parameters become more stringent, semiconductor manufacturers have increasingly relied upon providers of semiconductor equipment that features improved process control, smaller footprint and a lower cost of ownership of their manufacturing processes. We provide a broad suite of advanced, highly-engineered, innovative processing systems that include surface preparation and ECD equipment. Our batch and single-wafer processing systems for wet cleaning, stripping and etching feature our proprietary spray technology, as well as our unique process chamber designs. Our ECD equipment leverages our advanced computational techniques and capsule technology for a variety of applications including copper interconnect, seed layer repair and gold and solder bumps for advanced packaging.

Key Performance Indicators

Our management focuses on revenues, gross margin, operating expenses and profitability in managing our business. In addition to these financial measures found in our financial statements, we also use bookings, backlog and shipments as key performance indicators. Bookings are firm orders for which we have received written customer authorization in the fiscal period. Backlog is the balance of undelivered orders at the end of a fiscal period. In order to be included in bookings or backlog, an order must be scheduled to ship within the next twelve months. Backlog and forecasted orders drive our production schedule. Shipments measure how well we have met our production plan and are viewed as a primary measure of factory output.

A summary of key factors which impacted our financial performance during the third quarter includes:

• Litigation legal expenses decreased compared to prior quarters due to the resolution of one case with Applied Materials in the second quarter and lower activity in the remaining cases.  In addition, we recently announced two significant favorable developments in our plaintiff litigation.  On July 1, 2004 we won key rulings in our patent infringement case against Novellus Systems and on July 23, 2004 Ebara Corporation of Japan signed a license agreement for our seed layer enhancement patents.  Under the terms of the agreement, Ebara will pay us a $3.25 million license initiation fee which will be reported in fourth quarter revenue. 
• Our fiscal 2004 third quarter bookings were $45.6 million.
• Shipments in the third quarter of fiscal 2004 were $41.7 million.
• We recorded a net loss of $1.8 million on revenues of $26.6 million in our third quarter.  Of greatest impact was our not receiving final customer acceptances on four Raider tools in the third quarter, which resulted in our not being able to recognize revenue on these shipments.  Because the selling price of each of these tools is in excess of $2 million, not receiving the final acceptances made a critical difference in reported revenue in the third quarter. 
• Our gross margin was 51.2% of net revenue, up from 47.8% in the same period in fiscal 2003.
• Cash, cash equivalents and marketable securities were $20.9 million at June 30, 2004, a decrease of $8.9 million from $29.8 million at March 31, 2004 as we build inventory in anticipation of increased fourth quarter shipments. 

Results of Operations

The following table sets forth our consolidated results of operations for the periods indicated as a percentage of net revenue:

Third Quarter and First Nine Months of Fiscal 2004 Compared with Third Quarter and First Nine Months of Fiscal 2003

Net Revenue

Product and service revenue increased $1.6 million for the three months ended June 30, 2004 as compared to the three months ended June 30, 2003 and decreased $8.6 million for the nine months ended June 30, 2004 as compared to the year-to-date period in fiscal 2003. Improved sales of spare parts offset slightly decreased tool sales in the third quarter of fiscal 2004 to account for the increase in product revenue as compared to the third quarter of fiscal 2003.  In both fiscal 2004 periods, we deferred revenue on multiple Raider systems shipped, whereas in the comparative periods of fiscal 2003, we recognized revenue on multiple tools for which revenue had previously been deferred in accordance with our revenue recognition policy. We introduced the Raider platform in June 2003 and consequently, most of our shipments year-to-date have been the first Raiders to our customers. Revenue is fully deferred on those tools until final customer acceptance is obtained. In contrast, in fiscal 2003, we received multiple new product acceptances for Millennium cleaning and Paragon plating tools from customers for tool orders that had been shipped in earlier periods.

Geographically, our sales have been weighted toward North America in fiscal 2004 as compared with a balanced sales mix between North America, Europe and Asia in fiscal 2003. The current weighting toward North American sales corresponds with our first shipments of the Raider platform.

Gross Profit

In the quarterly comparison, improved absorption of manufacturing costs contributed approximately 3.0 points of the 3.4 percentage point increase in margins.  Inventory reserves decreased quarter over quarter, contributing an additonal two percentage points to the favorable third quater margin increase.  These favorable impacts to the net margin change were offset by an approximate two percentage point margin decrease resulting from fewer installation revenues being reported in the third quarter of fiscal 2004 as compared to the third quarter of fiscal 2003.

The primary increase in gross profit in the year-to-date fiscal 2004 period comparison is the receipt of the $7.5 million license initiation fee which contributed approximately 9.0 percentage points to the 12 percentage point increase in margins year over year.

Third quarter gross margins were minimally impacted by sales of tools containing parts, valued at their written down cost basis, that were included in the $19.1 million inventory write-down in the fourth quarter of fiscal 2003.  Year-to-date gross margins have been favorably impacted by 1.0 percentage points due to the sale of two Millennium tools that contained certain parts valued at their written-down cost basis. In both instances, customers placed orders for equipment from a discontinued product line. Revenues on those sales totaled $4.2 million.

Selling, General and Administrative

Selling, general and administrative (SG&A) expenses include employment costs for sales, marketing, customer support and administrative personnel as well as travel, communications, professional fees and expenses related to sales and service offices at North American and international locations. SG&A expenses decreased $253,000 in the third quarter of fiscal 2004 to 46.6% of net revenue and $4.4 million year-to-date to 40.0% of our net revenue.

Legal expenses decreased more than 77% in the third quarter of fiscal 2004 and 46% year-to-date as compared to the same periods in fiscal 2003 as a result of our efforts to bring our plaintiff litigation to conclusion and to manage our legal costs.  In the quarterly comparison, these decreases were offset by a 12% increase in employment costs as we lifted the pay reductions imposed in fiscal 2003 and restored wages.  Commission expense also increased 70% in the quarterly comparison because of revenue recognized in Asia, where we pay commissions at a higher rate to our independent sales representatives.  

In addition to the decrease in legal expense, the fiscal 2003 to fiscal 2004 year-to-date comparison was also benefited by an 8% decrease in employment costs as a result of reductions in force during fiscal 2003 and a 34% decrease in commission expense as a result of a shifting sales mix to North America from Asia.

Research and Development

Research and Development (R&D) expense consists of salaries, project materials, laboratory costs, consulting fees and other costs associated with our product development efforts. R&D expense increased $275,000 or to 14.1% of net revenue in the third quarter of fiscal 2004 as compared to the third quarter of fiscal 2003.  It decreased $2.5 million to 12.0% of net revenue in the fiscal 2003 to fiscal 2004 year-to-date comparison.

Depreciation expense declined 36% and 43% in the quarterly and year-to-date comparisons, respectively, as assets reached the end of their estimated useful lives.  In the quarterly comparison, this decrease was offset by increases in prototype and general operating expenses.  The fiscal 2003 third quarter was benefited by the reversal of charges when we settled a dispute with an equipment supplier.  Year-to-date, prototype expense has declined because our focus thus far in fiscal 2004 has been meeting new customer requirements for the Raider platform whereas in the prior year we were engaged in the development of this new platform. 

Our research and development expense has fluctuated from quarter to quarter in the past. We expect such fluctuations to continue in the future, both in absolute dollars and as a percentage of net revenue, primarily due to the timing of expenditures and fluctuations in the level of net revenue in a given quarter. We expect to continue to fund research and development expenditures with a multi-year perspective and are committed to technology leadership in our sector of the semiconductor equipment industry.

Other Income (Expense), Net

Income Taxes

Backlog and Deferred Revenue

Approximately 60% of our current backlog is for tools on the Raider platform.  Deferred revenue decreased at June 30, 2004 as compared with June 30, 2003.  In 2003, our deferred revenue pool was decreasing on a quarterly basis because of reduced activity in the industry. At June 30, 2004, deferred revenue was increasing because of increased shipments of Raiders.

We include in backlog those customer orders for which we have written customer authorization and for which shipment is scheduled within the next twelve months. Orders are generally subject to cancellation or rescheduling by customers with limited or no cancellation fees. As the result of systems ordered and shipped in the same quarter, possible changes in customer delivery dates, cancellations and shipment delays, the backlog at any particular date and the bookings for any particular period are not necessarily indicative of actual revenue for any succeeding period. In particular, during periods of downturns in the semiconductor industry we have experienced cancellations and significant shipment delays.

Deferred profit included in our current liabilities is derived from deferred revenue, which relates to equipment shipped to customers that has not been accepted by the customer, less the deferred cost of goods sold, including warranty and installation, and commission expenses. Deferred revenue is not included in orders backlog.

Liquidity and Capital Resources

Selected components of cash flows from operating activities from our consolidated cash flows statements follow:

In the first nine months of fiscal 2004, the primary sources of cash from operating activities were the receipt of the $7.5 million license initiation fee included in income from operations and the receipt of over $16.0 million in income tax refunds. Inventory and accounts payable increased as a result of our plan to reduce manufacturing cycle times and provide faster deliveries to our customers by stocking components that will help shorten our lead times. Trade receivables increased due to the shipment of several Raiders in the latter half of the third quarter. The increase in deferred profit is the result of revenue and expenses deferred on our new Raider products pending final customer acceptance. In fiscal 2003, our deferred profit pool was being relieved as we received customer acceptances on new tools deferred in prior periods.  In fiscal 2004, we are shipping new tools to new customers which, under our revenue recognition policy guided by SAB 104, requires that revenue and the associated expenses be deferred.

In the first nine months of fiscal 2004, investing activities included $5.4 million in purchases of factory equipment and other property and net cash used for the purchase of marketable securities of $4.2 million.

Financing activities consist primarily of cash received from stock option exercises of $1.0 million offset by long-term debt repayments of $181,000 during the first nine months of fiscal 2004.

The following commitments as of June 30, 2004, incurred in the normal course of business, have been included in the consolidated financial statements with the exception of purchase order commitments and operating lease obligations, which are properly excluded under accounting principles generally accepted in the United States of America. They are disclosed in the following table in order to provide a consolidated picture of our financial position and liquidity. We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to the types of financing, liquidity, market or credit risks that could arise if we had engaged in such relationships.

We have agreements with Mr. Raymon F. Thompson, our chairman, to lease aircraft and an aircraft hangar. The current rental rate is approximately $249,000 per month for both the aircraft and the hangar; the lease terms are month-to-month and therefore are not included in the above table.

As of June 30, 2004, our principal sources of liquidity consisted of approximately $11.8 million of cash and cash equivalents, $9.1 million in marketable securities and incoming cash generated from operations. We have also recently negotiated a $15.0 million line of credit, which agreement will be finalized in our fourth quarter.  We believe that we have sufficient cash and cash equivalents, along with funds expected to be generated from operations to meet operating expenses and planned capital expenditures through fiscal 2004 and into the foreseeable future. We estimate capital expenditures will be between $10.0 million and $12.0 million during the next twelve months. We currently have an effective shelf registration statement, which registers the offer and sale of up to an aggregate $75 million of our securities. If additional financial resources are required in the future, we expect either to issue securities from the shelf registration statement, to issue other financial instruments or to obtain a suitable credit facility, whichever management deems advisable. Of course, there can be no assurance that in the future we will be able to issue additional common stock or other financial instruments or that we will be able to obtain a credit facility on acceptable terms.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, inventories, warranty obligations, bad debts, investments, intangible assets, income taxes, financing operations, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies and estimates affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition.  Revenue recognition is significant because revenue is a key component of our results of operations. We recognize revenue under the guidance for Staff Accounting Bulletin No. 104 (SAB 104), “Revenue Recognition.” Under this method, revenue is recognized only when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed or determinable and collectibility is reasonably assured. Our product sales generally contain substantive customer acceptance provisions. Sales of new products to new or existing customers are not recognized until customer acceptance. Likewise, sales of existing products to new customer environments are not recognized until customer acceptance. If multiple elements exist, sales of existing products into existing customer environments are treated as such in accordance with Emerging Issues Task Force Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” The amount of revenue recognized in multiple element arrangements is the lesser of the fair value of the equipment or the contracted amount that was due or payable upon title transfer. The revenue for elements other than equipment is recorded in deferred profit and is recognized when the remaining goods and/or services are delivered or performed. Revenue related to service is recognized upon completion of performance of the service or ratably over the life of the related service contract. Spare parts sales are recognized upon shipment when title and risk of loss pass to the customer. Unearned revenue from service contract agreements is included in Customer Advances in the current liability section of the balance sheet.

In addition, the timing of certain expenses, such as cost of goods sold, including installation and warranty, and commission expenses coincides with the recognition of the related revenues. We follow specific guidelines in measuring revenue; however, certain judgments such as the definition of a new customer environment and new acceptance criteria or if installation is perfunctory may be required in the application of our revenue policy.

Inventories.     Inventories are valued at the lower of cost or market on a first-in, first-out basis. Accordingly, we write down the carrying value of inventories for estimated obsolescence and future marketability. On a quarterly basis, we compare historical and projected sales and usage of raw materials and parts and our assumptions about future use of raw materials, parts and finished goods with our forecast, market demand and industry conditions to determine potential obsolescence or whether the inventory on hand represents excess quantities. As a result of our analysis, we record reserves impacting Cost of Goods Sold, if appropriate. If actual future use, demand or market conditions are less favorable than those projected by us, additional inventory valuation write-downs may be required.  

Warranty Obligations. We provide for the estimated cost of equipment warranties when the related revenue is recognized. We track individual warranties on a tool-by-tool basis and develop estimated rates by equipment class. The rates are used to estimate the warranty accrual for a given specific piece of equipment. These rates are revised periodically to reflect current cost trends due to the current life cycle of that product class. The warranty accrual is reduced by actual costs of providing the warranty or if a balance is remaining at the end of the warranty period, then that amount is also written off. Warranty accrual expense impacts primarily Cost of Goods Sold. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, our warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required.

Allowance for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We record expense as a component of selling, general and administrative within the Statements of Operations.  If the financial condition of our customers were to deteriorate, due to the cyclicality of the industries we serve or for other reasons, resulting in an impairment of their ability to make payments, additional allowances and expense may be required. Likewise, if we are successfully able to collect on an amount presumed to be uncollectible, the allowance for doubtful accounts and the related expense may be reduced.

Impairment of Investments in Marketable Securities. We record an investment impairment charge when we believe an investment has experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future. Any investment impairment would be recorded in the financial statements as Other Expense.

Deferred Tax Assets. We make estimates to determine the amount of our deferred tax assets that we believe is more likely than not to be realized. We consider future taxable income and ongoing prudent tax planning strategies in assessing the need for a valuation allowance; however, should we determine that we will not be able to realize all or part of our net deferred tax asset in the future, a decrease in the deferred tax asset would negatively impact our results of operations, particularly the income tax provision, in the period such determination was made.

New Accounting Pronouncements

In December 2003, the FASB issued Interpretation Number 46R, “Consolidation of Variable Interest Entities” which replaces Interpretation Number 46, “Consolidation of Variable Interest Entities.” This interpretation addresses consolidation by business enterprises of variable interest entities. The Company will be required to adopt this statement on October 1, 2005. The revised interpretation is not expected to have a material effect on our results of operations, financial position or cash flows.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risks

Market risks relating to our operations result primarily from changes in interest rates and changes in foreign currency exchange rates.

As of June 30, 2004, we had approximately $2.4 million in fixed-rate long-term debt. Changes in market interest rates would change the estimated fair value of our long-term debt. We believe that a 10% change in long-term interest rates would not have a material effect on our financial condition, results of operations or cash flows.

All of our international operations are subject to inherent risks in conducting business abroad, including fluctuation in the relative value of currencies. As the Yen is our functional currency in Japan, we use short-term forward exchange contracts to reduce our foreign currency exchange risk related to forecasted sales. At June 30, 2004, we held forward contracts to sell Japanese Yen with a face value of $8.3 million, a market value of $8.4 million and an unrealized loss of $100,000. Additionally, the impact of movements in currency exchange rates on forward contracts are offset to the extent of intercompany receivables denominated in Japanese Yen. We believe the effect of a 10% change in foreign exchange rates on hedged transactions involving Japanese Yen forward exchange contracts and the underlying transactions would not be material to our financial condition, results of operations or cash flows. We do not hold or issue derivative financial instruments for trading or speculative purposes.

Item 4. Controls and Procedures

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Seed Layer Enhancement Litigation:
We are involved in two lawsuits filed in June 2001 against each of Ebara Corporation (“Ebara”) and Novellus Systems, Inc. (“Novellus”) in the United States District Court for the District of Oregon (the “Oregon District Court”). The two lawsuits claim that Ebara and Novellus infringe a patent we own that relates to the method by which “seed layers” on copper plated wafers are enhanced through certain fabrication steps. The method is embodied in our U.S. Patent No. 6,197,181 (the ‘181 Patent). In both cases we seek an injunction to stop them from practicing this technology as well as damages for past infringement, increased damages for willful infringement, and attorneys’ fees. Both defendants have denied any infringement and also allege that the ‘181 Patent is invalid. In addition, Novellus counterclaimed against us for infringement of four of their patents. The status of each case is set forth below.

Semitool, Inc. v. Ebara Corp. and Ebara Technologies, Inc.:
On July 23, 2004, we entered into a Seed Layer Enhancement Patent License Agreement (the “License Agreement”) and a Settlement Agreement with Ebara. The Settlement Agreement provides for the joint dismissal of the seed layer enhancement litigation with Ebara discussed above. The License Agreement provides for the payment to the Company of (i) a license initiation fee of $3.25 million, (ii) a commercialization fee in the event certain criteria are fulfilled, and (iii) patent license royalties payable to the Company in the event certain criteria are fulfilled.  All other terms of the agreements are confidential. Under the Settlement Agreement, the lawsuit will be dismissed upon our receipt of the $3.25 million license initiation fee, which is expected to be received in the fourth quarter of fiscal 2004 and reflected in revenue in that period.

Semitool, Inc. v. Novellus Systems, Inc.:
In response to our suit against Novellus for infringement of our seed layer enhancement patent, they filed counterclaims for infringement of four of their patents: viz., U.S. Patent 6,179,983 “Method and Apparatus for Treating Surface Including Virtual Anode”; U.S. Patent 6,074,544 “Method of Electroplating Semiconductor Wafer Using Variable Currents and Mass Transfer to Obtain Uniform Plated Layer”; U.S. Patent 6,110,346 “Method of Electroplating Semiconductor Wafer Using Variable Currents and Mass Transfer to Obtain Uniform Plated Layer”; and U.S. Patent 6,162,344 “Method of Electroplating Semiconductor Wafer Using Variable Currents and Mass Transfer to Obtain Uniform Plated Layer”. Novellus’ counterclaim for infringement of their U.S. Patent 6,179,983 has been withdrawn with prejudice and Novellus covenanted not to assert that patent against us. On March 31, 2004, the Oregon District Court ruled that the claims asserted by Novellus in their U.S. Patent 6,110,346 were invalid and, consequently, could not be asserted against us. On July 1, 2004, the Oregon District Court ruled that Semitool did not infringe U.S. Patent 6,074,544 and did not infringe U.S. Patent 6,162,344 in respect of the wet contact rings we currently use in our tools. The portion of the 6,162,344 patent left remaining for trial by the court deals with dry contact rings that have not been used by Semitool in its plating tools since early 2001. The remaining Novellus counterclaim, like our claim, seeks injunctive relief, damages for past infringement, increased damages for willful infringement and attorneys’ fees. We believe there are meritorious defenses to the remaining Novellus’ counterclaim, including both our defenses that we do not infringe their patent and that their patent is invalid. Discovery is closed, and the Oregon District Court has scheduled a trial date for November 2004 for both our claim of infringement and their remaining counterclaim.

Given the inherent uncertainty of litigation, there can be no assurance that the ultimate outcome of the Novellus seed layer enhancement patent lawsuit will be in our favor. It is the opinion of management, based on information available at this time, that the loss of any or all of its claim for patent infringement against Novellus would not have a material adverse effect on its business, financial condition, results of operations or cash flows. We cannot reasonably estimate the potential loss, if any, that might be incurred if we do not prevail in our defenses to Novellus’ counterclaim. If Novellus were to prevail in their remaining counterclaim, it could have a material adverse effect on our business, financial condition, results of operations or cash flows.

The Company is subject to other legal proceedings and claims which have arisen in the ordinary course of our business and have not reached final adjudication. Although there can be no assurance as to the ultimate disposition of these matters, it is the opinion of our management, based upon the information available at this time, that the currently expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

    10.1 Employment Agreement between Larry Murphy and Semitool, Inc. dated April 20, 2004*

    31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

    32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

    *Denotes a management contract or compensatory plan or arrangement.

(b) Reports on Form 8-K

    Current Report on Form 8-K dated April 27, 2004, announcing fiscal 2004 second quarter results.

    Current Report on Form 8-K dated April 27, 2004, announcing the appointment of Steve Stahlberg as a director of the Company.

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.