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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

For the Fiscal Year Ended December 31, 2003

For the Transition Period From                  To                 

Commission File Number: 0-21626

Electroglas, Inc.

(Exact Name of Registrant as Specified in its Charter)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value

(Title of Class)

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

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

As of June 30, 2003, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant was approximately $30,700,000, based on the closing sale price as reported on the Nasdaq National Market on such date. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purposes.

As of February 28, 2004, the Registrant had 21,511,748 outstanding shares of Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement in connection with the Annual Meeting of Stockholders, to be held on May 20, 2004, are incorporated by reference into Part III of this Form 10-K.

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ELECTROGLAS, INC.

FORM 10-K

For the Year Ended December 31, 2003

INDEX

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FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K and certain information incorporated herein by reference contain forward looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Annual Report, other than statements that are purely historical, are forward-looking statements. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions also identify forward looking statements. These forward looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward looking statements and include, without limitation, statements regarding:

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The forward-looking statements in this Annual Report on Form 10-K are subject to additional risks and uncertainties further discussed under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation—Factors that May Affect Results and Financial Condition” and are based on information available to us on the date hereof. We assume no obligation to update any forward looking-statement or statements. Actual results, performance or outcomes may differ from current expectations. The reader should also consult the cautionary statements and risk factors listed from time to time in our Reports on Forms 10-Q, 8-K and our 10-K.

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PART I

Item 1.    Business

Overview

We are a supplier of semiconductor manufacturing equipment and software to the global semiconductor industry. We were formed on April 1, 1993, to succeed the wafer prober business conducted by the Electroglas division of General Signal Corporation, our former parent. Immediately prior to the closing of the initial public offering of our Common Stock, or IPO, on July 1, 1993, we assumed the assets and liabilities of the Electroglas division in the asset transfer. Following our IPO, we commenced operations as an independent corporation. We, through our predecessors, have been in the semiconductor equipment business for more than 40 years.

Our primary product line is automated wafer probing equipment and related network software to manage information from that equipment. In conjunction with automated test systems from other suppliers, our

The EG5/300 ARGOS, Electroglas’ highest accuracy 300mm wafer prober, is designed for extremely tight-pitch probing on leading edge devices, which allows chipmakers to address the latest technology challenges

semiconductor manufacturing customers use our wafer probers and network software to test semiconductor wafers for quality and to improve their productivity and control their processes, optimizing manufacturing efficiency. Electroglas’s installed base is one of the largest in the industry, having sold over 15,000 wafer probers.

In January 2001, we acquired Statware Inc., of Corvallis, Oregon, to further expand our network software product offerings in the test management area. Today, the Statware technology is the basis for our web-based applications that allow our customers to monitor and control probers from any location, as well as collect, analyze, and report critical test process information and automatically direct corrective action needed.

We are also involved in the development, manufacture, marketing, and servicing of test handlers as part of our strategy to be a comprehensive semiconductor test solutions provider. Built upon our proven prober technology, the test handlers expand available markets by providing solutions to the final test segment for today’s latest packaging technologies and test processes. This includes Wafer Level Packages (WLP), Known-Good Die (KGD), Microelectromechanical Systems (MEMS), ultra-thin and/or diced wafers. It also includes any package tested strip format, whether panel or leadframe such as Chip Scale Packages (CSP) or Ball Grid Arrays (BGA) as well as traditional Small Outline Integrated Circuits (SOIC).

In 2003, we set our focus on our core competency in wafer probing, delivering advanced wafer probers and extending our wafer probing technologies to drive equipment and process efficiencies throughout the back-end of the semiconductor manufacturing process. As a result we sold our Design for Manufacturing and Fab Solutions software product lines in July 2003, and our Optical Inspection product line in October 2003. The sale of these product lines allows us to spend more time developing and delivering innovative products to help our customers overcome their most critical semiconductor test challenges.

Additional information about Electroglas is available on our web site at www.electroglas.com. Electroglas makes available free of charge on our website our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and amendments to those Reports filed or furnished pursuant to Section

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13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file them with or furnish them to the Securities Exchange Commission, or the SEC. Information contained on our web site is not part of this Annual Report on Form 10-K or our other filings with the SEC.

Industry Background

Semiconductor devices are fabricated by repeating a complex series of process steps on a substrate, or wafer, that is usually made of silicon. Wafers are typically sent through a series of 100 to 400 process steps. A finished wafer consists of many integrated circuits, (each referred to as a “device” or “die” or “chip”), the number of which depends on the area of the circuits and the size of the wafer. These wafers measure from 75mm to 300mm, or 3 to 12 inches, in diameter. Manufacturers have increasingly utilized larger diameter wafers to achieve more cost-effective production. The move to 300mm (12-inch) wafers, a significant trend for equipment manufacturers, began in 2000.

The manufacture of semiconductor devices is very capital intensive. A typical state of the art facility, usually called a “wafer fab”, will cost more than $2 billion. The purchase of semiconductor manufacturing equipment and spare parts, the integration of such equipment into production lines, and the training of employees on a particular supplier’s equipment require significant expenditures by semiconductor manufacturers.

Wafer Probing

A wafer prober successively positions each die on the wafer so that the electrical contact points, or pads, on the die align under and make contact with probe pins, which are located on a probe card mounted on the wafer prober. The probe card, which is generally custom-made by other suppliers for the specific device being tested, is

Wafter probing requires sophisticated machine vision and software capabilities to align each die on a wafer — often to accuracies as tight as 2.5µm — to pins on a probe card connected to a tester that measures electrical performance

connected to a test system, also supplied by other suppliers, which performs the required parametric or functional test. Parametric testing is performed during the wafer fabrication process, referred to as “in-line testing,” and at the completion of the wafer fabrication process, referred to as “end-of-line testing,” to measure electrical parameters that verify the reliability of the wafer fabrication process. Functional testing is performed after the completion of wafer fabrication to identify devices that do not conform to particular electrical specifications or performance criteria. This process is typically called “wafer sort.” Wafers often go through several wafer probing steps during the manufacturing process.

Automatic wafer probers are primarily used during this “wafer sort” process, which occurs after the fabrication steps are completed and before the separation and packaging of each individual device. Wafer probers are also increasingly used during in-line parametric testing. In-line testing requires special equipment features such as cleanroom compatibility and low-noise electrical measurement capability, as tests are carried out during the fabrication process. This testing is done to verify the quality of the manufacturing process while wafers are in an unfinished state where corrective action can occur. A small number of probers are also used for research and development, and quality and process control applications. We estimate, based upon our experience, that wafer sort applications represent as much as 85% of the market for automatic wafer probers. The remaining 15% is divided between in-line and end-of-line testing and laboratory applications.

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There is a growing trend for semiconductor manufacturers to contract with other companies to perform their wafer sort operations. These contract test companies, typically called “test houses”, perform the wafer testing service and often provide assembly and packing services as well.

A semiconductor manufacturer typically purchases wafer probers when outfitting a new wafer fabrication facility or expanding an existing facility. Wafer probers are also purchased to replace equipment in response to major changes in technology such as larger wafer sizes and greater device complexity. A semiconductor fabrication facility typically requires 20 to 80 probers to meet testing requirements on a timely basis. A test house may require hundreds of wafer probe systems to support the testing requirements of the companies that contract with them.

Final Test

Wafers are sent from the wafer sort operation to assembly where they are cut apart with wafer saws, and put into individual protective packages. Once packaged, chips are tested again to make sure they function properly before being shipped to a distribution center. Ultimately, these chips will find their way into electronic systems and then into homes, cars, offices, and so on.

A revolution in semiconductor packaging is currently being driven by the trend to shrink the size and weight of consumer electronics devices, such as mobile phones, personal digital assistants (PDAs), and notebook computers, while increasing performance. This has caused the advent of very small Chip Scale Packages (CSP) and ever more dense Ball Grid Array (BGA) packages, which have made it increasingly difficult to handle devices individually. Manufacturers and test houses are looking for new and more efficient methods to handle these types of packages.

For traditional packages, the desire to reduce the cost of assembly and test has chipmakers looking for ways to increase test efficiency. As demand continues to grow for the highest volume leadframe-based packages, such as SOIC’s, there is increasing need to find new test methods to improve test throughput and lower the cost of test.

One of the primary new technologies for meeting these needs is testing devices while in strip or panel format. The simplest and most commonly known type of strip is the lead-frame used during assembly of conventional packages. With CSP’s and BGA’s, many new types of strips are being introduced. When devices are tested while still held in position on these strips, small high-speed devices can be accurately positioned and numerous devices can be tested and handled simultaneously. CSP and BGA packages are growing much faster than the industry in general. Combined with growing adoption of strip testing for the high volume leadframe-based packages, such as SOIC, the market for strip handlers is also expanding rapidly.

Packaging trends provide new opportunities for Electroglas as final test becomes more like wafer test with large arrays of devices on a substrate, very small package size and contacts, and a need for higher levels of test parallelism to drive down costs

Another strong trend is the increasing number of devices that are being shipped as Known Good Die (KGD), that is, bare die, without any packaging. These devices are typically assembled into multi-chip modules or mounted directly to circuit boards. Also, Micro Electro-Mechanical Structures (MEMS) are emerging as an important market. These devices have been traditionally used in pressure sensors and accelerometers, but have recently expanded into photonics and light handling applications. Finally, there are applications, such as chips for

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smart cards, which require wafers to be thinned below 150 microns. Wafers this thin become difficult to test with conventional handling.

In summary, chip scale and ball grid array packages are increasingly being tested in strip or panel format. Also, bare die and Micro Electro-Mechanical Structures are emerging as important markets along with ultra thin die for smart card applications. These new demands dictate a whole new class of film frame and strip handlers that represent new markets for Electroglas.

Software

Software plays an important role in the Integrated Circuit (IC) manufacturing process. Capital and operating costs of a fabrication facility are very high so semiconductor manufacturers are seeking ways to improve overall equipment efficiency (OEE) and optimize their processes. Manufacturers are seeking ways to produce, correlate, manage, and analyze data in the production processes. In a wafer sort area, network software is increasingly being used to manage wafer information, product specific recipes and equipment information.

Software tools are used to bring together disparate data to help determine which process zones or tools contribute most significantly to yield loss and to automate and optimize the operational efficiency of the semiconductor fabrication facility. The software provides a common location and format for presenting this data and doing cross-correlation between data types for the purpose of overall equipment efficiency analysis and, ultimately, manufacturing process optimization.

Historically, the semiconductor manufacturing companies have maintained an in-house, dedicated software development group to develop much of the software used in this market. This results in highly customized solutions that are inflexible and expensive to maintain. We believe that many organizations are now looking to third-party providers of both standard and customizable solutions to lower their support costs, maximize their engineers’ productivity and increase the overall functionality of their analysis tools.

Our Strategy

We are a major supplier of wafer probers due to a combination of strengths, including a large installed base, advanced technical capabilities, close relationships with the leading manufacturers of integrated circuits, a broad

From the sort floor to final test, Electroglas’ hardware and software enable chipmakers to collect, share, analyze and act on essential semiconductor test data — saving significant time, increasing yields and improving profitability

line of high quality products, and a well-established, highly qualified distribution organization. Building on these capabilities, our strategy is comprised of the following key elements:

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Products

Wafer Probers

Horizon 4000 Series:    The 4090µ (4090micro), introduced in 1997, and the 4090µ Fast Probe, introduced in 2001, are our primary offerings in the Horizon 4000 Series of wafer probers. This product line is positioned to satisfy high-volume semiconductor manufacturing applications for 200mm and smaller wafers. The Horizon 4000 Series provides many advanced automation capabilities, including automatic probe-to-pad-alignment, in-process inspection and optical character recognition, or OCR. The systems can also be configured with a temperature-controlled chuck top, providing the ability to precisely maintain a customer-selected wafer temperature during testing. The 4090µ prober also offers an integrated mini-environment and clean air system to provide a class 1 probing environment. The 4090µ Fast Probe uses special technologies to reduce the system stepping time in applications where the die are very small and there is a very large number of devices on a wafer. The 4090µ

Electroglas’ Horizon 4090µ wafer probing system, designed to address the performance demands of high volume, 200mm production testing at an economical cost

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prober uses the EGCommander system software, which runs under the Windows 2000 operating system. The user interface features color graphics, touch screen programming, probing recipes, control maps, and real-time maps. The Horizon 4000 Series probers feature a distributed multiple processor architecture to maximize productivity and expandability.

The EG4/200:    Introduced in 1999, the EG4/200 is targeted at high-end probing applications for 200mm wafers. The EG4/200 utilizes a unique “probe-centered z-drive” to provide very low deflections, even under extremely high probe forces. This is important when testing multi-site or high pin count devices. The EG4/200 retains many of the features of the Horizon 4000 series probers such as a linear motor and an air-bearing positioning system. The EG4/200 uses the EGCommander system software, which runs under the Windows 2000 operating system.

EG5/300:    Introduced in 1999, the EG5/300 is a new generation of wafer prober from Electroglas. It is targeted at the emerging 300mm wafer probing market. The EG5/300 utilizes a completely new system architecture that allows for faster and more accurate probing over the larger wafer sizes. Closed loop motion control and linear motors ensure precise wafer positioning over a wide range of temperatures and operating conditions. A modular design allows for configuration flexibility to meet the diverse needs of the emerging 300mm market. A new version of the EG5/300 system, named the ARGOS, was introduced in 2001. The ARGOS model provides what we believe is among the highest accuracy capabilities available in the auto prober market. The EG5/300 uses the EGCommander system software, which runs under the Windows 2000 operating system.

EG5/300e and EG4/200e:    The EG5/300e, introduced in December 2000, and the EG4/200e, introduced in July 2001, are targeted at the parametric test (“e-test”) segment of the wafer probe market. The EG5/300e, based on the EG5/300, is targeted at the emerging 300mm market. The EG4/200e, based on the EG4/200 platform addresses the 200mm market. Both systems incorporate patented technology licensed from our partner, Cascade Microtech, Inc. This technology allows extremely precise, low-level electrical measurements to be made at the wafer level. This type of electrical measurement performance is becoming increasingly critical for advanced sub-micron semiconductor processes.

Final Test Products

Pathfinder:    Introduced in 2002, the Pathfinder system is designed to meet the unique test handling requirements of the Known Good Die (KGD) and Wafer Level Package (WLP) markets. The Pathfinder system features a unique material handling system that can handle and position wafers and packages on a film frame after they have been sawn (“diced”). Special alignment techniques are used to compensate for the variability inherent in these sawn wafers and packages. Because it handles wafers while supported by a film frame, Pathfinder is also capable of handling ultra-thin wafers.

Sidewinder:    Introduced in 2003, Sidewinder provides final test handling of packaged semiconductor and discrete components in panel or lead frame format. Termed “strip testing”, Sidewinder’s technology enables the handling of fine geometry packages such as chip scale packages (CSP) that are difficult to test in singulated format, and higher parallel test capability for small outline package (SOP), quad flat no-lead (QFN), and other well established high volume packages. The first strip test handler to be based on advanced 300mm prober technology, Sidewinder combines Electroglas’ proven prober stage with a sophisticated machine vision-based alignment system that offers improved accuracy and system throughput. Sidewinder’s market is comprised of companies who need

Sidewinder leverages Electroglas’ proven prober technology to deliver superior throughput and accuracy for final test handling of packaged semiconductor and discrete components in panel or lead frame format

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technology that enables them to test advanced devices in new packages, as well as companies seeking increased efficiency in testing traditional packages in panel or lead format.

Software Products

From the sort floor to final test, Electroglas’ software enables chipmakers to collect, share, analyze and act on essential data—saving time and helping to improve profitability.

The answers to chipmakers most pressing questions lie in the multitude of data that are generated from their manufacturing processes. Unfortunately, that information is often not easily accessible, making it difficult for engineers and managers to act upon the most recent critical data. Electroglas helps manufacturers overcome this knowledge gap and attain faster answers to questions about their productivity, offering software solutions that provide insight into the manufacturing process.

SORTmanager:    Bridging the gap between raw data and genuine process improvement is the difference between data overload and real productivity gains. Electroglas’ SORTmanager provides that bridge, enabling a

SORTmanager allows users to access and report on data from sort floors anywhere in the world, at any time, using a powerful, secure web environment

secure, web-based environment for the analysis, reporting and control of sort-floor processes. Data about test results, binning, prober performance and throughput can be collected from all SORTmanager-connected wafer probers, and that information can then be delivered via dynamic, interactive web pages that allow users to view the underlying data or perform additional analysis. Powerful web publishing capabilities allow web reports to be created and distributed throughout an enterprise. SORTmanager’s flexible data-access and information viewing capabilities, combined with a comprehensive suite of pre-built applications and a scripting language for fine tuning applications to customer needs, makes SORTmanager a unique and powerful Test Floor Automation tool.

CPM Suite:    CPM Platform and CPM Portal comprise our OEM tool set for managing test floor data from a wide range of semiconductor equipment, databases and other data formats. CPM Platform is a Microsoft^® COM-based foundation for building data analysis and reporting applications for client/server- or web-based semiconductor manufacturing environments. CPM Portal is a customizable, web-based application that provides data access, analysis, and management, as well as automated reporting and alarming conveniently through a Web browser, allowing chipmakers to obtain information whenever and wherever they need it to quickly take action and correct process problems.

Engineering, Research and Development

The market for semiconductor manufacturing equipment is characterized by continuous technological development and a high rate of product innovation. We believe that continued, rapid development of new products and enhancements to existing products is necessary to maintain our competitive position. For example, we devoted a significant portion of our personnel and financial resources to engineering, research and development programs for our wafer prober product line to continue a high level of development for 200mm wafer probers as well as to develop an entirely new platform for 300mm wafer probers. In addition, we have invested in new product areas such as final test and test management software. We use our close relationships with key customers to make product improvements that respond to such customers’ needs.

Engineering, research and development expenses were $21.8 million, $31.6 million and $31.6 million in 2003, 2002 and 2001, respectively, or 48.4%, 55.2% and 37.3% of net sales. Engineering, research and development expenses consist primarily of salaries, project materials, consultant fees, and other costs associated

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with our ongoing efforts in hardware and software product development and enhancement. It is expected that these expenses will decrease in absolute dollars in 2004 from 2003 levels.

Marketing, Sales and Service

We sell our products directly to end-users through both a direct sales force and independent representatives as well as use distributors in certain geographies. We generally sell product on net 30-day terms to most customers. Other, primarily foreign, customers are required to deliver a letter of credit typically payable upon product delivery. We generally warrant our products for a period of up to 12 months from shipment for material and labor repair. Installation and certain training is customarily included in the price of the product. Our field engineers provide customers with call out repair and maintenance services for a fee. Customers may enter into repair and maintenance service contracts covering our products. For a fee, we train customer employees to perform routine service.

We maintain sales and service offices in strategic locations throughout the United States. In Europe, we maintain sales and service offices in France and in Asia, offices in the People’s Republic of China, Singapore and Taiwan. As of December 31, 2003, we employed 82 people worldwide in sales, service, applications, logistics, technical support, and customer service.

Customers

We sell our products to leading semiconductor manufacturers throughout the world. In 2003, ST Microelectronics, National Semiconductor and ASE Test accounted for 16%, 15% and 13% of our net sales. In 2002, ST Microelectronics and Cypress Semiconductor accounted for 13% and 11% of our net sales. In 2001, STMicroelectronics accounted for 12% of net sales.

International sales represented 65%, 48%, and 51% of our net sales in 2003, 2002 and 2001, respectively. These sales represent the combined total of export sales made by United States operations and all sales made by foreign operations.

Manufacturing and Suppliers

Our assembly equipment manufacturing activities consist primarily of integrating components and subassemblies to create finished prober, spares and upgrades configured to customer specifications. We schedule production based upon firm customer commitments and anticipated orders during the planning cycle. In December 2002, we completed our move of equipment manufacturing from San Jose, California to Singapore to reduce production costs. In addition to rapid product innovation, our wafer prober market is subject to significant price competition and cost reduction is required. Certain of the components and subassemblies included in our products are obtained from a single source. However, we believe that alternative sources exist or can be developed.

Quality control is maintained through the assembly and test process, with documented instructions and test procedures and final inspection for all manufactured equipment prior to shipment. We train many of our employees in basic quality skills and regularly participate in quality sharing meetings with other equipment manufacturers and customer quality audits of procedures and personnel. We are ISO 9001/2000 and ISO 14001/1996 Certified.

Backlog

Our backlog was $13.1 million as of December 31, 2003 and $14.0 million as of December 31, 2002. Our backlog consists of product orders for which a customer purchase order has been received and which is scheduled for shipment or is earned within the next twelve months. Orders are subject to cancellation or rescheduling by the

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customer, sometimes with a cancellation charge. Due to possible changes in product delivery schedules and cancellation of product orders and because our sales will often reflect orders shipped in the same quarter received, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. Backlog also includes deferred revenue comprised of products shipped (but not recognizable as revenue per our revenue recognition policy), maintenance revenue that is being amortized over twelve months or less, and services earned or to be performed within the next year.

Competition

The semiconductor equipment industry is highly competitive. The principal competitive factors in the industry are product performance, reliability, price, service and technical support, product improvements, established relationships with customers and product familiarity. We believe that our products compete favorably with respect to each of these factors.

Our major competitors in the prober market segment are Tokyo Electron Limited (“TEL”) and Tokyo Seimitsu (“TSK”), both of which are based in Japan. The main competitors in the test management software market segment are KLA-Tencor and Brooks Automation. For our test handling equipment segment, major competitors include Micro Component Technology (MCT) and Delta Designs, a Cohu Company. Most of our competitors have greater financial, engineering and manufacturing resources than we have, as well as larger service organizations and long-standing customer relationships. We cannot assure you that levels of competition in our particular product market will not intensify or that our technological advantages will be reduced or lost as a result of technological advances by competitors or changes in semiconductor processing technology. For a more detailed discussion of the competition we face, see “Factors that May Affect Results and Financial Condition.”

Patents, Trademarks, Copyrights and Other Intellectual Property

We believe that the success of our business depends more on the technical competence, creativity and marketing abilities of our employees, rather than on patents, trademarks and copyrights. Nevertheless, we have a policy of seeking patents when appropriate on inventions concerning new products and improvements as part of our ongoing research, development and manufacturing activities. We own various patents and have applied for additional patent protection in the United States and abroad for the technology in our products. We also have several registered United States and international trademarks. We maintain unregistered copyrights on our software and typically maintain the source code for our products as a trade secret.

We also rely upon trade secret protection for our confidential and proprietary information. We routinely enter into confidentiality agreements with our employees. There can be no assurance, however, that others will not independently gain information and techniques or otherwise gain access to our trade secrets or that we can meaningfully protect our trade secrets. For a more detailed discussion regarding risks related to our intellectual property, see “Factors that May Affect Results and Financial Condition.”

Employees

As of December 31, 2003, we employed 254 people. Many of our employees are highly skilled, and our success will depend in part upon our ability to attract and retain such employees, who are in great demand. We have never had a work stoppage or strike, and there are no employees represented by a labor union or covered by a collective bargaining agreement. We consider our employee relations to be good.

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Item 2.    Properties

In the first quarter of 2000, we consolidated our executive office, manufacturing, engineering, and research and development operations into an approximately 260,000 square foot facility located in San Jose, California. In March 2003, we purchased the facility. The property and equipment, including closing costs, were recorded at approximately $37.2 million. We are currently occupying 66% of the facility and 34% is available for lease. See Note 12, Commitments and Contingencies.

In January 2002, we entered into a three-year operating lease for a 39,000 square foot manufacturing facility in Singapore with annual lease payments of approximately $0.4 million. The lease agreement allows for a renewal of two years after the expiration of the lease.

Item 3.    Legal Proceedings

We are not currently involved in any legal actions that we believe are material. From time to time, however, we may be subject to various claims and lawsuits by customers, suppliers, competitors, and employees arising in the normal course of business, including suits charging infringement or violations of antitrust laws. Such suits may seek substantial damages and, in certain instances, any damages awarded could be trebled.

Some customers using certain of our products have received letters from Technivison Corporation and the Lemelson Medical Education & Research Foundation, or Lemelson, alleging that the manufacture of semiconductor products infringes certain patents currently held by Lemelson. We believe that our products do not infringe the Lemelson patents and to the best of our knowledge, Lemelson has not asserted that we may be liable for infringing its patents. However, we have received notice from some of the customers receiving letters from Lemelson that, in the event it is determined that the customers’ actions infringe the Lemelson patents, the customers may seek reimbursement from us for some damages or expenses resulting from the infringement. We have in turn notified our suppliers that we may seek reimbursement from them for any resultant costs and fees we incur as a consequence of our customers being held liable for infringement of the Lemelson patents. In addition, some of our suppliers were notified that their equipment may infringe certain Lemelson patents. These suppliers are currently engaged in litigation with Lemelson as regards fourteen of Lemelson’s patents. In January 2004, the trial court held that the patent claims at issue were invalid, unenforceable and not infringed by the suppliers. Lemelson has announced that it will appeal this decision. We cannot predict the outcome of this or similar litigation or the effect of such litigation on our business.

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

No matters were submitted to a vote of our security holders during the fourth quarter ended December 31, 2003.

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PART II

Item 5.    Market for the Registrant’s Common Equity and Related Stockholder Matters

Market Prices for Common Stock

Our common stock is traded on the Nasdaq National Market System under the symbol “EGLS.” The following table sets forth for the periods indicated the actual high and low sales prices per share of common stock as reported on the Nasdaq National Market System:

On February 28, 2004, the closing price of our common stock was $5.30.

We have never declared or paid cash dividends on the shares of common stock and we do not anticipate paying cash dividends in the foreseeable future. We currently intend to retain any future earnings to fund the development and growth of our business. As of February 20, 2004, we had approximately 7,900 shareholders of record.

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Item 6.    Selected Financial Data

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Unaudited Quarterly Consolidated Financial Data

Our fiscal year end is December 31. Our fiscal quarters end on the Saturday nearest the end of the calendar quarters. For convenience, we have indicated that our quarters end on March 31, June 30 and September 30.

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operation

Executive Overview

We are a supplier of semiconductor manufacturing equipment and software to the global semiconductor industry, which includes both chip manufacturers and contract test companies. The demand for our products follows the semiconductor test markets, which have recently started showing signs of growth, yet remain highly cyclical and difficult to forecast. To stay competitive, grow our business over the long term, improve our gross margins, and generate operating cash flows, we must continue to invest in new technologies and product enhancements and at the same, as necessary, rapidly adjust up or down our expense structure during these hard to predict cyclical semiconductor equipment demand cycles.

In view of the recent prolonged downturn in the semiconductor industry and the resulting market pressures, together with recent indications of a possible market recovery, we are focusing our major efforts in the following areas:

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Critical Accounting Policies and Estimates

General:    Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. 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 assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, inventory valuation, warranties, allowance for doubtful accounts, and minority equity investments. 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 affect our more significant judgments or estimates used in the preparation of our consolidated financial statements. Senior management has discussed the development and selection of these critical accounting policies and estimates with the audit committee.

Revenue recognition:    We recognize revenue on the sale of our semiconductor manufacturing equipment when we have received a customer purchase order or contract, when we have delivered the products or services, when we can be assured of the total purchase price without making significant concessions and when we are assured of our ability to collect from our customer. We sell to an industry that is highly cyclical with periods of high demand and significant oversupply. The companies in the semiconductor equipment manufacturing industry continue to consolidate as they are faced with rapidly increasing capital requirements and expensive technological change. In recognizing revenue we make certain assumptions and estimates, namely: for our established products, we recognize revenue upon product shipment or delivery on the basis that we have a legally enforceable claim on payment and for our newer products, we recognize revenue upon signed customer acceptance. New products are defined as products that have a substantially different platform than our established products. We consider a substantially different platform to be a system that performs a different function from our established products or significantly different functionality in our established products (e.g., 12” wafer probing systems compared to existing 8” wafer probers). We consider a new system routinely accepted in the marketplace when three to five successful installations based on our acceptance criteria have been put into customer production.

With respect to collections from our customers, we assume that, based on past history, we will continue to collect our receivables from them without significant delays in payments or product concessions, despite the fact that they have larger financial size relative to us and despite our dependence on them in a heavily concentrated industry. In an arrangement with multiple deliverables (typically a tool sale bundled with any of the following (a) training, (b) installation and (c) maintenance and service), the delivered items are considered a separate unit of accounting if all of the following criteria are met: (i) the delivered items have value to the customer on a stand-alone basis, (ii) objective and reliable evidence of fair value of the undelivered item exists, and (iii) if the arrangement includes a general right of return relative to a delivered item, delivery or performance of the undelivered item is considered probable and substantially in the control of Electroglas. Revenue related to maintenance and service contracts is recognized ratably over the duration of the contracts.

We also derive revenue from software licenses and post-contract customer support (PCS) under Statement of Position (SOP) 97-2 “Software Revenue Recognition”. PCS includes telephone support, bug fixes, and rights to upgrades on a when-and-if-available basis. We recognize the revenue allocable to software licenses and specified upgrades upon delivery of the software product or upgrade to the end user, unless the fee is not fixed or determinable or collectibility is not probable. We consider all arrangements with payment terms longer than

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normal not to be fixed or determinable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. If collectibility is not considered probable, revenue is recognized when the fee is collected. We may enter into licenses to provide software to customers for a period of time, during which the customer, for a single fee, is entitled to receive unspecified products as well as maintenance and support until the end of the contract term. For these contracts, total contract revenue is recognized on a straight-line basis over the contract term. In software arrangements that include rights to multiple software products and/or services, we use the residual method, under which revenues are allocated to the undelivered elements based on vendor-specific objective evidence of fair value of such undelivered elements and the residual amount of revenues are allocated to the delivered elements. For those contracts that consist solely of license and maintenance, we recognize licenses based upon the residual method after all licensed software products have been delivered as prescribed by Statement of Position 98-9 “Modification of SOP No. 97-2 with Respect to Certain Transactions”. We recognize maintenance revenues over the term of the maintenance contract. Vendor-specific objective evidence of the fair value of maintenance for license agreements is determined by reference to the price paid by the Company’s customers when maintenance is sold separately (that is, the renewal rate).

Inventory valuation:    Inventories are stated at lower of cost or market (estimated net realizable value) using the first-in, first-out (FIFO) method. We may record charges to write down inventory due to excess, obsolete and slow moving inventory based on an analysis of the impact of changes in technology on our products (including engineering design changes), the timing of these changes and estimates of future sales volumes. The projections of changes in technology and forecasts of future sales are estimates. We write down inventory to net realizable value based on anticipated product orders, product order history, forecasts and backlog to assess our inventory requirements. If there is weak demand in the semiconductor equipment markets and orders fall below our forecasts, additional write downs of inventories may be required which may negatively impact gross margins in future periods. We periodically review the carrying value of our inventories by evaluating material usage and requirements to determine obsolescence and excess quantities, and reduce the value when appropriate. As a result of these analyses, we wrote down inventories by $7.1 million, $8.1 million and $6.7 million in 2003, 2002 and 2001, respectively.

Warranty:    We generally warrant our products for a period of twelve months and we accrue a current liability for the estimated cost of warranty upon shipment. For our established products, this accrual is based on historical experience; and for our newer products, this accrual is based on estimates from similar products. In addition, from time to time, specific warranty accruals are made for specific technical problems. If we experience unforeseen technical problems with our products in future periods to meet our product warranty requirements, revisions to our estimated cost of warranty may be required, and our gross margins will be negatively impacted.

Allowance for doubtful accounts:    We closely monitor the collection of our accounts receivables and record a reserve for doubtful accounts against aged accounts and specifically identified amounts that we believe are not recoverable. We sell primarily to large, well-established semiconductor manufacturers and semiconductor test companies and we have not experienced significant accounts receivable losses in the past. We have, however, experienced slow downs in receivable collections, especially during semiconductor equipment down cycles, as customers extend their payment schedules to conserve their cash balances. If our customers continue to experience down cycles or their financial conditions were to deteriorate, we may be required to increase our reserve for doubtful accounts.

Long-lived assets:    We evaluate the carrying value of long-lived assets, consisting primarily of property, plant and equipment, whenever certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. In assessing the recoverability of long-lived assets, we compare the carrying value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, the assets will be written down to their estimated fair value. Significant judgments and assumptions are required in the forecast of future operating results used in the preparation of the estimated future cash flows, including long-term forecasts of overall market conditions and our market share. Further, in the course of reviewing our business operations, we may consider divesting certain business operations. Changes in these estimates and business divestures could have a material adverse effect on

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the assessment of the long-lived assets, thereby requiring us to record additional asset write-downs in the future. Charges related to asset impairments are recorded in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

Minority equity investments:    We have two minority equity investments in non-publicly traded companies that are recorded at the original cost reduced by assessed impairment in value, where appropriate. In determining if and when certain minority equity investment’s decline in value below cost is other-than-temporary, we evaluate the market conditions, equity securities offering prices, trends of earnings, price multiples, and other key measures for our investments accounted for at cost. When we believe such a decline to be other-than-temporary, we recognize an impairment loss in the current period’s operating results to the extent of the decline. For securities that do not have a readily determinable market price, we compare the net carrying amount of our cost method investments to similar equity securities with quoted prices when possible after giving effect to differences in risk premiums, estimated future cash flows, and other factors influencing the market value of the securities. When comparisons to quoted securities are not practical, we estimate the fair value based on recent sales and purchases of similar unquoted equity securities, independent appraisals, or internally prepared appraisals to estimate the fair value.

Results of Operations

The components of our statements of operations, expressed as a percentage of net sales, are as follows:

Net Sales

Net sales were $45.0 million in 2003, down 21.3% from $57.1 million in 2002. Net sales were $57.1 million in 2002, down 32.5% from $84.7 million in 2001. These decreases were due primarily to lower revenue on system sales of our core prober business as a result of 17% lower sales prices in 2003 versus 2002 following the downturn in the semiconductor industry as our customers continued to curtail their capital spending in response to persisting excess production capacity conditions as well as a decrease in our market share for prober products.

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Despite the overall decline in prober revenue in 2003, shipments of prober systems increased 4% in 2003 versus 2002. Historically, the semiconductor and semiconductor equipment industries have been cyclical. We continue to have limited visibility with respect to the level of orders for the coming quarters. Net sales in 2003 were also down from 2002 due to the sale of our software (sold in the third quarter of 2003) and inspection (sold in the fourth quarter of 2003) product lines. Sales to related parties are priced in the same manner as other customers.

Net sales are comprised of prober systems, inspection products, software, and aftermarket sales, consisting primarily of after-sales services, spare parts, upgrades and training. Service revenue was less than 10% of annual net sales during the last three fiscal years. Net sales of our products are as follows:

International sales as a percentage of total sales for the years 2003, 2002 and 2001 were 65%, 48% and 51%, respectively. The increase in international sales as a percentage of total sales in 2003 from 2002 was primarily due to an increase in Asian sales relative to a decline in North American sales. The decrease in international sales as a percentage of total sales in 2002 from 2001 was primarily due to a greater decrease in European sales relative to the decrease in North American sales. During 2003, 2002 and 2001, we experienced weakness across all of our major geographic regions. Sales in France included in international sales represented 12%, 10% and 14% of our net sales in 2003, 2002 and 2001, respectively. Sales to the rest of Asia and Europe were primarily denominated in United States dollars, except for France where the invoiced currency was a mix of the United States dollar and the Euro. We expect international sales to represent a significant percentage of net sales and fluctuate as a percentage of total sales as individual manufacturers and semiconductor test companies address their capacity needs at differing stages of the semiconductor production cycle.

Gross Profit (Loss)

Gross profit (loss), as a percentage of sales, was 0.5%, (5.6)% and 25.1% in 2003, 2002 and 2001, respectively. The improvement in gross profit in 2003 compared to 2002 was due to lower manufacturing overhead expenses as a result of our relocation of manufacturing operations from the U.S. to Singapore and other restructuring efforts. This decrease in expenses was offset somewhat by lower revenue per system due to 17% lower average selling prices in 2003 as compared to 2002. The decrease in gross profit in 2002 compared to 2001 was due primarily to reduced unit sales volumes in 2002 and high fixed manufacturing costs as a percentage of total costs in 2002 resulting from redundant U.S. manufacturing operations as we established our new manufacturing operations in Singapore in 2002. In addition, we wrote down inventories by $7.1 million, $8.1 million and $6.7 million in 2003, 2002 and 2001, respectively. We periodically review the carrying value of our inventories by evaluating material usage and manufacturing requirements to determine inventory obsolescence and excess quantities, and we reduce the carrying value of inventory when appropriate. The write down in fiscal 2003 resulted primarily from identified obsolescence of discontinued and sold product lines as we focused our business on our core prober products. The write down in fiscal 2002 increased over 2001 as the outlook for demand in semiconductor equipment in the cyclical downturn continued to be weak. We generally warrant our products for a period of twelve months and accrue the estimated cost of warranty upon shipment. In 2003, due to the sale of the inspection product lines, the accrued liability for estimated cost of warranty was increased by $1.4 million for additional costs to outsource support of customers through the end of their warranty term and for additional warranties associated with discontinuing and selling the product lines. In 2002 due to the establishment of new manufacturing operations in Singapore and the potential for higher defect rates from

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the new plant, the accrued liability for estimated cost of warranty was increased by $0.6 million from the previous year.

We believe that our gross profit will continue to be affected by a number of factors, including changes in demand for semiconductors, competitive pressures on average selling prices, product mix, the level of software sales, our share of the available market, excess manufacturing capacity costs and the proportion of international sales. Continued weak demand and changes in market conditions may cause orders to be below forecasts, which may result in additional excess inventory, which would cause additional write-downs of inventories and would negatively impact gross profit in future periods.

Engineering, Research and Development Expenses

Engineering, research and development, or ER&D expenses were 48.4%, 55.2% and 37.3%, as a percentage of sales, for 2003, 2002 and 2001, respectively. In 2003, ER&D expenses were $21.8 million, down 31% from $31.6 million in 2002. This decrease, as a percentage of sales and in spending year over year, was primarily due to reduced employee headcount and related costs, reductions in outside services and reduced costs due to the sale of software product lines to FEI Company during 2003. ER&D expenses were $31.6 million in 2002 and 2001. While ER&D spending was the same in total for both 2002 and 2001, in 2002 there were increases in outside service and consulting costs related to product development and increased travel, offset by decreased engineering development and reduced headcount related expenses as compared to 2001.

In the current business climate, we intend to control discretionary expenses and continue investing in selective new product development programs. However, we expect engineering, research and development expenses to decrease in 2004 from 2003 levels in absolute dollar value due to the sales of our inspection products and software product lines during 2003. Engineering, research and development expenses consist primarily of salaries, project materials, consultant fees, and other costs associated with our ongoing efforts in hardware and software product development and enhancement, including expenses for tailoring our products to conform to customer requirements.

Selling, General and Administrative Expenses

Selling, general and administrative, or SG&A expenses were 74.6%, 68.6% and 46.0%, as a percentage of sales, in 2003, 2002 and 2001, respectively. In 2003, SG&A expenses were $33.6 million, down 14% from $39.2 million in 2002. This decrease was primarily due to headcount reductions and other cost savings as a result of spending restrictions and cost control measures. These decreases were partially offset by increased commissions to outside sales representatives because of increased sales to Asia. These savings were somewhat offset by the additional rent charge of $8.5 million recorded in the quarter ended March 31, 2003 related to the amortization of the deficiency between the fair value and the guaranteed residual value of our San Jose campus. In 2002, SG&A expenses were $39.2 million, up 0.7% from $38.9 million in 2001. This increase was primarily due to increased promotional and trade show expenses as well as additional rent charges of $2.8 million related to the amortization of our San Jose campus, partially offset by reduced employee costs and sales commissions because of reduced year over year headcount levels.

Restructuring Charges

Singapore relocation and U.S. workforce reduction:    In January 2002, we announced a restructuring plan to reduce our U.S. workforce and exit certain facilities in connection with the relocation of our manufacturing operations to Singapore. As a result of the continued semiconductor equipment downturn, and to better align our cost structure with the market demand for our products, we announced further workforce reductions in October 2002. Overall, 228 employees were designated for termination and 196 employees were terminated. We recorded a restructuring charge of $3.1 million in 2002. During 2003, an additional 127 employees were designated for termination and 158 were terminated. We recorded a restructuring charge of $3.7 million in 2003, primarily for severance packages.

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International office closures:    During September and October of 2002, we announced plans to close our sales office in Japan and other offices in Europe and Asia. During the fourth quarter of 2002, 38 employees were designated for termination and 28 were terminated. In 2002, we recorded a restructuring charge of $1.5 million for severance payments, legal and accounting fees related to the closures, and asset write-downs. In 2003, nine employees designated to be terminated in 2002 were removed from the termination list, primarily due to the sale of certain product lines. Further, we recorded an additional restructuring charge of $0.2 million in 2003, primarily due to additional costs for office closures.

As a result of these restructuring efforts and the sales of product lines in 2003, we expect payroll and benefit payments to decrease by $7.5 million to $8.5 million in 2004 compared to 2003. Restructuring charges of $0.7 million are included in accrued liabilities and are anticipated to be substantially paid in 2004.

Impairment Charges

In 2003 as a result of our assessment of current semiconductor capital equipment market conditions and the related effect on our business, we concluded that there were indicators of impairment of our long-lived assets. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we performed an impairment test, which compared currently utilized property and equipment and non-current assets net book values with the expected undiscounted cash flows from these assets. The estimated undiscounted cash flows of the assets currently in use were sufficient to recover the net book value of these assets. Due to continued declines in corporate real estate values in the San Jose area, management concluded that there were indicators of impairment for the portion of the corporate campus that is currently not being utilized and undertook a review of the value of these assets for possible impairment. Based on management’s evaluation and the results of an independent appraisal, we recorded an impairment charge of $4.1 million for the unused portion of our corporate campus. In addition, we recorded a $2.1 million impairment charge for fixed assets that were no longer in use.

In 2002, we performed a similar impairment test of property and equipment and non-current assets. Based on the quoted market price of the estimated fair value of the assets, we recorded an impairment charge of $2.0 million to write down the carrying value of certain fixed assets and non-current assets held for use in the Prober Division to their estimated fair values. We also recorded $0.4 million related to the write-down of our long-term minority equity investment in NanoNexus.

Although we do not anticipate that we will be required to record additional impairment charges, the semiconductor industry is highly cyclical and the severity of these cycles is difficult to predict. During a down cycle, we must be in a position to adjust our cost and expense structure to prevailing market conditions, which could therefore affect the sufficiency of estimated future cash flows to recover net book value of these assets and require us to record additional impairment charges.

Interest Income

Interest income was $0.5 million, $2.3 million and $7.6 million in 2003, 2002 and 2001, respectively. The year over year decreases were principally due to declining interest rates and lower average yearly cash and short-term investment balances, which declined each year. Also, in March 2003, we used funds to purchase our corporate campus and we used cash in operations in 2002 and 2003.

Interest Expense

Interest expense was $3.4 million, $1.4 million and $0.0 million in 2003, 2002 and 2001, respectively. The year over year increases were principally due to a full year of interest paid on convertible notes in 2003 and one half year paid in 2002. The change in 2003 over 2002 also included a $1.0 million non-cash interest expense charge related to the beneficial conversion feature triggered during the first quarter of 2003 related to our convertible subordinated notes (See Note 11, Convertible Subordinated Notes and Warrants).

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Gain on Revaluation of Warrants

In June 2002, we completed a $35.5 million private placement of 5.25% convertible subordinated notes due 2007 and warrants to purchase 714,573 shares of common stock. In September 2002, upon registration of our notes, warrants, and the shares of common stock into which the notes and warrants are convertible, the warrants, which were initially valued at $2.6 million and classified as a liability, were revalued using the Black-Scholes option pricing model to $0.3 million and reclassified to equity. This revaluation resulted in a gain on revaluation of $2.3 million. Upon registration of the notes, warrants, and shares of common stock into which the notes and warrants are convertible, the re-measured value of the warrants was reclassified to permanent equity and accordingly will not be required to be revalued.

Gains on Sales of Product Lines

On July 15, 2003, we sold certain software product lines (CADNav, Merlin, YieldManager, LCD-YM) and related assets to FEI Company (FEI) for $4.9 million in cash, net of selling expenses ($0.6 million escrowed and restricted for one year) plus the assumption by FEI of $2.5 million of liabilities. In 2003, we recorded a gain on this sale of $6.5 million, after deducting from the consideration the book value of sold assets, transaction and other related costs, and our obligation to FEI under indemnification provisions of the agreement.

On November 6, 2003, we sold the inspection products line and related assets to ATS Systems Oregon, Inc. (ATS) for $1.2 million in cash, net of selling expenses, plus the assumption by ATS of $0.6 million of warranty obligations. In 2003, we recorded a gain on this sale of $1.4 million, after deducting from the consideration the book value of sold assets, transaction and other related costs, and our obligation to ATS under indemnification provisions of the agreement.

Provision (Benefit) for Income Taxes

The income tax provision (benefit) was $(1.2) million, $(4.1) million and $16.4 million in 2003, 2002 and 2001 respectively. The 2003 income tax benefit resulted from a reversal of previously recorded income tax reserves based on changes in estimated exposures in tax jurisdictions. The 2002 income tax benefit primarily resulted from a $1.2 million additional refund due to a change in tax law arising from the enactment of the Job Creation and Worker Assistance Act of 2002 and a $2.7 million reversal of previously recorded income tax reserves for tax years up to and including 1998 relating principally to changes in estimates of these tax reserves. The tax provision of $16.4 million in 2001 resulted from the establishment of a full valuation allowance against total net deferred tax assets. Realization of our deferred tax assets depends on us generating sufficient taxable income in future years in appropriate tax jurisdictions to obtain benefit from the reversal of temporary differences and from net operating loss and credit carryforwards. Due to the uncertainty of the timing and amount of such realization, our management concluded that a full valuation allowance of $98.4 million was required at December 31, 2003.

Synthetic Lease of Corporate Campus

In March 1997, we entered into a $12.0 million, five-year synthetic lease for approximately 21.5 acres of land in San Jose, California. A synthetic lease is a lease that is treated as an operating lease for accounting purposes and a capital lease for tax purposes. Under our synthetic lease, third party lessors funded 100% of the acquisition and construction costs relating to properties leased to us for our corporate campus.

In January 2003, we provided the lessors with a notice to purchase the San Jose, California property by March 2003. In December, we received a fair market appraisal of the property for $37.2 million, $11.3 million less than the guaranteed residual lease value of $48.3 million. Under EITF 96-21, Implementation Issues in Accounting for Leasing Transactions involving Special-Purpose Entities, beginning on the date the deficiency becomes probable, the expected deficiency is accrued by the lessee using the straight-line method over the remaining term of the lease. Because we provided the lessor with a notice to purchase the leased assets by March

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2003, the gross lease payments were calculated over the remaining four months of the lease. Thus, we began amortizing the $11.3 million deficiency at $2.8 million per month effective December 2002, and recorded $8.5 million of additional rent expense in the first quarter of 2003. We completed the purchase of the property in March 2003. The long-term lease receivable and cash collateral were used to fund the purchase price. The land and buildings were recorded at fair value plus closing costs, approximately $37.2 million and the accrued rent of $11.3 million was paid. As a result of the purchase, depreciation expense has increased by approximately $0.9 million per year, and rent expense and interest income has decreased by approximately $0.8 million and $0.7 million, respectively, per year based on current interest rates, effective the second quarter of 2003.

Liquidity and Capital Resources

Our cash, cash equivalents and short-term investments totaled $31.9 million at December 31, 2003, a decrease of $26.3 million from $58.2 million at December 31, 2002.

Cash used in operating activities was $29.9 million for the year 2003, an improvement of $24.1 million over $54.0 million used in operating activities in 2002. Our net loss decreased by $14.6 million in 2003 to $59.0 million compared to $73.6 million in 2002. The $24.1 million improvement in cash used in operating activities in 2003 reflects the cash savings from the reduced net loss as adjusted for an increase in non-cash charges of $6.4 million to $25.6 million in 2003 from $19.2 million in 2002 and an increase in changes in current assets and liabilities of $3.0 million to $3.5 million in 2003 from $0.5 million in 2002. The non-cash charges of $25.6 million in 2003 consisted primarily of $8.7 million depreciation and amortization, $8.5 million in lease impairment charges, $7.1 million of inventory write-downs, $6.3 million of asset impairment charges, and $3.3 million interest expense on our convertible notes, partially offset by a $7.9 million gain on the sale of our software and inspection product lines. The change in net operating assets of $3.5 million in 2003 primarily resulted from a decrease of $3.6 million in inventories, net of $7.1 million in inventory write-downs and $2.5 million inventory disposed through the sale of the inspection product lines, and an increase of $2.8 million in accounts payable, partially offset by an increase of $1.7 million in accounts receivable and a decrease of $1.1 million in accrued liabilities primarily due to the elimination of synthetic lease obligations through the purchase of our San Jose campus in March 2003. We expect cash used in operating activities to decrease further in 2004 compared to 2003 due to anticipated increased gross margins in 2004 on increased sales, anticipated savings from restructuring efforts and anticipated lower spending levels due to the sale of the software and inspection product lines in 2003. This will be somewhat offset by payment of approximately $0.7 million of restructuring charges in 2004.

Cash provided by investing activities was $22.1 million in 2003 largely due to proceeds received from sale of investments. Our utilization of investments decreased by $6.6 million in 2003 to $16.6 million as compared to $23.2 million in 2002. The release of $48.3 million restricted cash from the synthetic lease of our corporate campus was offset by the purchase of the campus for $48.5 million in March 2003. In addition, we received net proceeds from the sale of our inspection products and software product lines of $6.1 million.

Cash used in financing activities in 2003 was $1.6 million primarily due to $1.9 million in interest payments on convertible subordinated notes partially offset by $0.2 million proceeds of sales of common stock to employees. Cash provided by financing activities in 2002 of $31.8 million was primarily the $32.5 million net proceeds raised from the issuance of convertible subordinated notes and $1.4 million proceeds of sales of common stock to employees, partially offset by a $1.2 million payment made on our Japan credit facility and a $0.9 million interest payment on the convertible subordinated notes.

In June 2002, we completed a $35.5 million private placement of 5.25% fixed rate convertible subordinated notes due 2007 and warrants to purchase 714,573 shares of common stock. The net proceeds from this placement were $32.5 million. Interest on the notes is payable semi-annually on the fifteenth of June and December each year. Annual interest payments are $1.9 million. The convertible notes initially enabled the holders to convert principal amounts owed under the notes into an aggregate of 2,598,448 shares of common stock at a conversion

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price of $13.662 per share. The notes contain a beneficial conversion feature, which was triggered on February 21, 2003. As a result, the conversion price was lowered to $10.2465 per share and an additional 866,150 common shares will be issuable upon conversion of the notes. This adjustment to the conversion price resulted in a $1.0 million non-cash charge to interest expense in our first quarter of 2003.

In January 2002, we entered into a three-year operating lease for a 39,000 square foot manufacturing facility in Singapore with annual lease payments of approximately $0.4 million.

Our principal source of liquidity as of December 31, 2003 consisted of $31.9 million of cash, cash equivalents, and short-term investments. During 2003, we took a number of steps to reduce our utilization of cash, cash equivalents, and short-term investments, including the sales of product lines, spending controls and headcount reductions. As a result, our utilization of cash in operating activities declined over the year from $20.3 million in the first quarter to $11.8 million in the second quarter, $9.8 million in the third quarter and cash provided by operating activities of $12.0 million in the fourth quarter. Cash provided from operations in the fourth quarter of 2003 was primarily due to a decrease in inventory and accounts receivable and an increase in accrued liabilities and accounts payable. We currently anticipate that our available cash and cash equivalents at December 31, 2003 should be sufficient to meet our anticipated needs for working capital and capital expenditures to support planned activities through 2004. We are committed to the successful execution of our operating plan and will take further action as necessary to align our operations and reduce expenses. However, we may require additional capital to fund our future operations. External financing vehicles have been and are expected to continue to be available to us. If adequate funds are not available or are not available on terms favorable to us, we may not be able to continue to operate our business pursuant to our current business plan and our ability to run our business would be impaired.

As of December 31, 2003, cash obligations are as follows (in thousands):

Purchase commitments include $2.2 million of purchase orders that are cancelable if business conditions indicate that further curtailment of spending is necessary.

Impact of Recently Issued Accounting Pronouncements

On May 15, 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150), which is effective for all financial instruments created or modified after May 31, 2003 and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. On October 29, 2003, the FASB deferred for an indefinite period the application of the guidance in SFAS 150 to non-controlling interests in limited-life subsidiaries. The FASB decided to defer the application of SFAS 150 to these non-controlling interests until it could consider some of the resulting implementation issues associated with the measurement and recognition guidance for these non-controlling interests. SFAS 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. We adopted SFAS 150 and the effect of adoption had no material impact on our financial position, results of operations or cash flows.

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In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51” (FIN 46). FIN 46 establishes accounting guidance for consolidation of variable interest entities that function to support the activities of the primary beneficiary. FIN 46 applies to any business enterprise, both public and private, that has a controlling interest, contractual relationship or other business relationship with a variable interest entity. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. In December 2003, the FASB issued FIN 46R which superseded FIN 46. FIN46R will be applicable to all non-SPE’s created prior to February 1, 2003 by Public Entities that are not small business issuers at the end of the first interim annual reporting period ending after March 15, 2004. We currently have no contractual relationship or other business relationship with a variable interest entity and therefore we do not expect that the adoption will have an effect on our consolidated financial position or results of operations. However, if we enter into any such arrangement with a variable interest entity in the future, our consolidated financial position or results of operations may be adversely impacted. Because we completed the purchase of our San Jose, California corporate campus in March 2003, FIN 46 does not have an impact on our current financial statements.

Factors that May Affect Results and Financial Condition

Semiconductor industry downturns adversely affect our revenues and operating results.    Our business largely depends on capital expenditures by semiconductor manufacturers and semiconductor test companies, which in turn depend on the current and anticipated market demand for integrated circuits and products that use integrated circuits. The semiconductor industry is highly cyclical and has historically experienced periods of oversupply resulting in significantly reduced demand for capital equipment. The most recent downturn, which began in 2000 has been severe and prolonged. As a result, our ability to accurately forecast future revenues and expense levels is limited. During a down cycle, we must be in a position to adjust our cost and expense structure to prevailing market conditions. Our ability to reduce expenses may be limited by the need to invest in the engineering, research and development and marketing required to penetrate targeted markets and maintain extensive customer service and support. During periods of rapid growth, we must be able to rapidly increase manufacturing capacity and personnel to meet customer demand. We cannot assure you that these objectives can be met, which would likely have a material and adverse effect on our business and operating results.

We have recently experienced substantial declines in revenues and increases in operating losses, and we may experience additional declines in revenues and increases in operating losses in the future.    Our historical financial results have been, and our future financial results are anticipated to be, subject to substantial fluctuations. Our total revenues in 2003 were $45.0 million compared to $57.1 million in 2002. This decline was due primarily to lower revenue on system sales of our core prober business as a result of the current semiconductor industry downturn, excess capacity and the global economic slowdown combined with lower software and inspection products revenues due to the sale of our software and inspection product lines during 2003. We incurred a net loss of $59.0 million in 2003 compared to a net loss of $73.6 million in 2002. Continued current economic slowdown and continued decline in demand for our products and services and other factors could continue to adversely affect our business in the near term and we may continue to experience additional declines in revenue and increases in operating losses. We cannot assure you that we will be able to return to profitability or that, if we do, we will be able to sustain it. We currently anticipate that our future cash from operations, available cash and cash equivalents at December 31, 2003, should be sufficient to meet our anticipated needs for working capital and capital expenditures through the next twelve months. However, we may require additional capital to fund our future operations. If adequate funds are not available or are not available on terms favorable to us, we may not be able to continue to operate our business pursuant to our current business plan and our ability to run our business would be impacted.

Our quarterly results are subject to variability and uncertainty, which could negatively impact our stock price.    We have experienced and expect to continue to experience significant fluctuations in our quarterly results. Our backlog at the beginning of each quarter does not necessarily determine actual sales for any succeeding period. Our sales will often reflect orders shipped in the same quarter that they are received.

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Moreover, customers may cancel or reschedule shipments, and production difficulties could delay shipments. For the years ended December 31, 2003, 2002 and 2001, five of our customers accounted for 54%, 41% and 39%, respectively, of our net sales. If one or more of our major customers delayed, ceased or significantly curtailed its purchases, it could cause our quarterly results to fluctuate and would likely have a material adverse effect on our results of operations. Other factors that may influence our operating results in a particular quarter include the timing of the receipt of orders from major customers, product mix, competitive pricing pressures, the relative proportions of domestic and international sales, our ability to design, manufacture and introduce new products on a cost-effective and timely basis, the delay between expenses to further develop marketing and service capabilities and the realization of benefits from those improved capabilities, and the introduction of new products by our competitors. Accordingly, our results of operations are subject to significant variability and uncertainty from quarter to quarter, which could adversely affect our stock price.

If we do not continue to develop and successfully market new products, our business will be negatively affected.    We believe that our future success will depend in part upon our ability to continue to enhance existing products and to develop and manufacture new products, particularly those related to the implementation of our strategy to become a process management tool provider. As a result, we expect to continue investing in selective new wafer prober product development programs, although we expect engineering, research and development expenses to decrease in 2004 due to the sales of our inspection and software product lines. There can be no assurance that we will be successful in the introduction, marketing and cost effective manufacture of any of our new products; that we will be able to develop and introduce new products in a timely manner; enhance our existing products and processes to satisfy customer needs or achieve market acceptance; or that the new markets for which we are developing new products or expect to sell current products, such as the market for 300mm wafer probers, markets related to the growth of the “Strip” test market for final test will develop sufficiently. To develop new products successfully, we depend on close relationships with our customers and the willingness of those customers to share information with us. The failure to develop products and introduce them successfully and in a timely manner could adversely affect our competitive position and results of operations.

If we do not successfully compete in the markets in which we do business, our business and results of operations will be negatively affected.    Our major competitors in the prober market are Tokyo Electron Limited (“TEL”) and Tokyo Seimitsu (“TSK”), both of which are based in Japan. Some of our competitors have greater financial, engineering and manufacturing resources than we do as well as larger service organizations and long-standing customer relationships. Our competitors can be expected to continue to improve the design and performance of their products and to introduce new products with competitive price/performance characteristics. Competitive pressures may force price reductions that could adversely affect our results of operations. Although we believe we have certain technological and other advantages over our competitors, maintaining and capitalizing on these advantages will require us to continue a high level of investment in engineering, research and development, marketing, and customer service and support. We can not assure you that we will have sufficient resources to continue to make these investments or that we will be able to make the technological advances necessary to maintain such competitive advantages.

Our outstanding convertible notes may be required to be repaid if not converted prior to their maturity; and may, if converted, result in additional dilution to holders of our Common Stock, all of which may adversely affect the value of our Common Stock.    In June 2002, we issued $35.5 million in convertible notes and related warrants. The notes entitle the holders to convert the notes into an aggregate of 3,464,598 shares of our Common Stock at a conversion price of $10.2465 per share, significantly in excess of recent trading prices of our Common Stock. In connection with the issuance of the notes, we also issued warrants for the purchase of 714,573 shares of our Common Stock that are exercisable at a price of $15.4440 per share, also significantly in excess of recent trading prices of our Common Stock. In certain circumstances, we may force the conversion of all or a portion of the notes and may also redeem the notes. However, unless prior to June 2005 the price of our Common Stock exceeds at least $15.3698 per share, we cannot force the automatic conversion of the notes and we will be obligated to pay the notes in full at maturity. We may voluntarily redeem the notes between June 2005 and June 2007 for an aggregate redemption price of as high as approximately $36.2 million plus accrued interest. In

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addition, unless waived or renegotiated, we are obligated to pay the holders of the notes an amount equal to $37.3 million plus accrued interest in the event of a sale, merger or other change in our control.

If we do not successfully protect our intellectual property, our business could be negatively impacted.    Our success depends in significant part on our intellectual property. While we attempt to protect our intellectual property through patents, copyrights and trade secrets, we believe that our success will depend more upon innovation, technological expertise and distribution strength. There can be no assurance that we will successfully protect our technology or that competitors will not be able to develop similar technology independently. No assurance can be given that the claims allowed on any patents we hold will be sufficiently broad to protect our technology. In addition, we cannot assure you that any patents issued to us will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide us with competitive advantages.

Some customers using certain of our products have received letters from Technivison Corporation and the Lemelson Medical Education & Research Foundation, or Lemelson, alleging that the manufacture of semiconductor products infringes certain patents currently held by Lemelson. We believe that our products do not infringe the Lemelson patents and to the best of our knowledge, Lemelson has not asserted that we may be liable for infringing its patents. However, we have received notice from some of the customers receiving letters from Lemelson that, in the event it is determined that the customers’ actions infringe the Lemelson patents, the customers may seek reimbursement from us for some damages or expenses resulting from the infringement. We have in turn notified our suppliers that we may seek reimbursement from them for any resultant costs and fees we incur as a consequence of our customers being held liable for infringement of the Lemelson patents. In addition, some of our suppliers were notified that their equipment may infringe certain Lemelson patents. These suppliers are currently engaged in litigation with Lemelson as regards fourteen of Lemelson’s patents. In January 2004, the trial court held that the patent claims at issue were invalid, unenforceable and not infringed by the suppliers. Lemelson has announced that it will appeal this decision. We cannot predict the outcome of this or similar litigation or the effect of such litigation on our business.

Disruptions or termination of some of our key sources of supplies could damage our customer relations and harm our business.    We use numerous suppliers to supply components and subassemblies for the manufacture and support of our products and systems. While we make reasonable efforts to ensure that such components and subassemblies are available from multiple suppliers, this is not always possible. Although we seek to reduce our dependence on these limited source suppliers, disruption or termination of certain of these sources could occur and such disruptions could have at least a temporary adverse effect on our results of operations and damage customer relationships. Moreover, a prolonged inability to obtain certain components, or a significant increase in the price of one or more of these components, could have a material adverse effect on our business, financial condition and results of operations.

If we do not successfully address the challenges inherent in conducting international sales and operations, our business and results of operations will be negatively impacted.    We have experienced fluctuations in our international sales and operations. International sales accounted for 65%, 48% and 51% of our net sales for 2003, 2002 and 2001, respectively. We expect international sales to continue to represent a significant percentage of net sales. We are subject to certain risks inherent in doing business in international markets, one or more of which could adversely affect our international sales and operations, including:

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Although these and similar regulatory, geopolitical and global economic factors have not yet had a material adverse effect on our operations, there can be no assurance that such factors will not adversely impact our operations in the future or require us to modify our current business practices. In addition, the laws of certain foreign countries where we do business may not protect our intellectual property rights to the same extent as do the laws of the United States. Further, we have found it difficult to penetrate the large Japanese market, which represents a significant percentage of the worldwide wafer prober market. We recently changed our sales strategy in Japan from a direct sales strategy to the use of distributors, and we closed our sales office in Japan. Our past sales in Japan have not been significant and we cannot assure you that the use of distributors will result in an increase in sales in this market.

Our business will be harmed if we cannot hire and retain key employees.    Our future success partly depends on our ability to hire and retain key personnel. We also need to attract additional skilled personnel in all areas to grow our business. While many of our current employees have many years of service with us, there can be no assurance that we will be able to retain our existing personnel or attract additional qualified employees in the future. Our Common Stock is currently trading at a price significantly below the exercise price of most of our outstanding stock options. As a result, these “under water” options are less useful as a motivation and retention tool for our existing employees. On July 16, 2003 we filed a schedule TO with the Securities and Exchange Commission in connection with an exchange offer to exchange certain options of eligible employees for new options with a new exercise price in order to increase the motivational and retention value of our stock option program. During the third quarter of 2003, 126 employees elected to participate in this program.

Our Charter documents and Shareholders Rights Plan, as well as Delaware Law, could make it difficult for a third party to acquire us.    Our Shareholders Rights Plan and certain provisions of our Certificate of Incorporation and Delaware law could discourage potential acquisition proposals and could delay or prevent a change in our control. Such provisions could diminish the opportunities for a stockholder to participate in tender offers, including tender offers at a price above the then current market value of our Common Stock. Such provisions may also inhibit fluctuations in the market price of our Common Stock that could result from takeover attempts. In addition, the Board of Directors, without further stockholder approval, may issue additional series of preferred stock that could have the effect of delaying, deterring or preventing a change in our control. The issuance of additional series of preferred stock could also adversely affect the voting power of the holders of Common Stock, including the loss of voting control to others. We have no current plans to issue any Preferred Stock.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

At December 31, 2003, our cash equivalents and short-term investments consisted primarily of fixed income securities. We maintain an investment policy, which ensures the safety and the preservation of our invested funds by limiting default risk, market risk and reinvestment risk. The portfolio includes only marketable securities with active secondary or resale markets. These securities are subject to interest rate risk and may decline in value when interest rates change. If a 100 basis point change occurred in the value of our portfolio, the impact on our

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financial statements would be approximately $0.3 million. The table below presents notional amounts and related weighted-average interest rates by year of maturity for our investment portfolio.

Foreign Currency Exchange Rate Risk

We believe that our current foreign exchange exposure in all international operations is not material to our consolidated financial statements because we primarily transact in U.S. dollars. Accordingly, we do not use derivative financial instruments to hedge our current foreign exchange exposure. We believe the impact of a 10% change in exchange rates would not be material to our financial condition and results of operations. For further discussion regarding the effect of foreign currency accounting on our business, see Note 1 to our Consolidated Financial Statements—Summary of Significant Accounting Policies, Foreign currency accounting. There have been no significant changes in our market risk from the prior year.

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Item 8.    Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

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ELECTROGLAS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

See the accompanying notes to consolidated financial statements.

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ELECTROGLAS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)