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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended October 2, 2004

OR

for the transition period from                      to                     

COMMISSION FILE NUMBER 001-16611

Mykrolis Corporation

(Exact Name of Registrant as Specified in its Charter)

Delaware

(State or Other Jurisdiction of Incorporation or Organization)

04-3536767

(I.R.S. Employer Identification No.)

129 Concord Road

Billerica, Massachusetts 01821

(Address of principal executive offices)

(978) 436-6500

Registrant’s Telephone Number, Including Area Code

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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x    No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes x    No ¨

The registrant had 41,821,958 shares of common stock outstanding as of October 15, 2004.

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Mykrolis Corporation

INDEX TO FORM 10-Q

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PART I - FINANCIAL INFORMATION

Mykrolis Corporation

Consolidated Statements of Operations

(In thousands except per share data)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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Mykrolis Corporation

Consolidated Balance Sheets

(In thousands except share data)

The accompanying notes are an integral part of the consolidated financial statements.

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Mykrolis Corporation

Consolidated Statements of Shareholders’ Equity

and Comprehensive Income (Loss)

(In thousands)

The accompanying notes are an integral part of the consolidated financial statements.

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Mykrolis Corporation

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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Mykrolis Corporation

Notes to Consolidated Financial Statements

(In thousands except share and per share data)

1. Background and Basis of Presentation

Background

Prior to March 31, 2001, Mykrolis Corporation’s (the “Company”) business was operated as a fully integrated business unit of Millipore Corporation (“Millipore”); the Company became independent through a spin-off by Millipore that was effected in three steps. On March 31, 2001, Millipore transferred to the Company substantially all of the assets and liabilities associated with its microelectronics business (the “Separation”). The Company completed its initial public offering of 7.0 million shares of common stock on August 9, 2001. On February 27, 2002 (the “Distribution Date”), Millipore completed the spin-off of the Company through the distribution to its shareholders of all of the 32.5 million shares of the Company’s common stock owned by Millipore on that date. Effective February 28, 2002 the Company became a fully independent company.

Interim Financial Statements

The accompanying consolidated financial statements have been prepared in accordance with the rules of the Securities and Exchange Commission for interim financial statements and do not include all disclosures required by generally accepted accounting principles in the United States of America. The financial information included herein, other than the consolidated balance sheet at December 31, 2003, has been prepared without audit. The consolidated balance sheet at December 31, 2003 has been derived from, but does not include all the disclosures contained in the audited consolidated financial statements for the year ended December 31, 2003. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Form 10–K Annual Report for the year ended December 31, 2003. The financial information as of October 2, 2004 and for the three and nine months ended October 2, 2004 and September 27, 2003 is unaudited, but includes all adjustments that management considers necessary for a fair presentation of the consolidated results of operations, financial position and cash flows of the Company and of its consolidated subsidiaries. All of these adjustments are of a normal recurring nature. Results for the nine-month period ended October 2, 2004 are not necessarily indicative of results to be expected for the full fiscal year 2004 or for any other future periods.

Fiscal Year

The Company’s fiscal year is the 365-366 day period that commences on January 1 and ends on December 31. Each fiscal quarter ends on the Saturday nearest the calendar month end generally contains 13 weeks and consists of 88 to 94 days. Fiscal year 2004 comprises the 366 day period from January 1 to December 31, 2004 with fiscal quarters ending April 3, July 3, October 2 and December 31. Fiscal year 2003 comprises the 365 day period from January 1 to on December 31, 2003 with fiscal quarters ended March 29, June 28, September 27 and December 31.

Reclassifications

Certain items in the prior year’s consolidated financial statements have been reclassified to conform to the current presentation of the financial statements.

2. Stock Plans

Options for the purchase of the Company’s common stock have been granted to officers, directors and key employees under various nonqualified stock option plans and agreements. The Company accounts for these grants under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is recorded as a charge to operations for options granted under those plans and agreements.

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If the recognition provisions of FASB Statement No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123, had been adopted, the effect on net income (loss) and basic and diluted net income (loss) per share would have been as follows:

The fair value of options granted under the Company’s stock-based plan was estimated at grant date using a Black-Scholes option pricing model with the following weighted-average assumptions:

The Company accounts for stock option grants to non-employees in accordance with EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees, for Acquiring, or in Conjunction with Selling, Goods or Services (“EITF 96-18”). EITF 96-18 requires variable plan accounting with respect to such non-employee stock options, whereby stock-based compensation associated with such options is re-measured at each reporting date from the date of grant until the option is exercised, and incorporates the then-current fair market value of the Company’s common stock, volatility of underlying stock, risk free rates and expected life of the option into the Black-Scholes option pricing model. During the three and nine months ended October 2, 2004, the Company recorded a $6 benefit and $41 charge related to stock-based compensation expense, respectively, which is included in selling, general and administrative expense related to options to purchase 25,000 shares of Mykrolis common stock issued to a non-employee in February 2004. This option grant was not tied to any other agreement with this non-employee.

3. Earnings Per Share

For the three months and nine months ended October 2, 2004 and September 27, 2003, basic and diluted income (loss) per common share was calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the respective period. The weighted average diluted shares outstanding calculation excludes those stock options for which the impact would have been antidilutive. For the three and nine months ended October 2, 2004, there were 4,091,718 antidilutive options. The number of stock options that were antidilutive during the periods ended September 27, 2003 was 7,338,697 due to the Company’s net loss position.

As of October 2, 2004, Mykrolis had outstanding options to purchase an aggregate of 7,457,566 shares of its common stock at a weighted average price of $11.05. Of these options, options to purchase an aggregate of 3,872,250 shares at a weighted average price of $10.36 were fully vested and exercisable.

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4. Acquisition

On August 12, 2004, the Company completed the acquisition of Bentec Scientific LLC, a privately held manufacturer of polyvinyl alcohol (“PVA”) roller brushes used in post-chemical mechanical polishing (“CMP”) clean applications. The purchase price was $10,441 including a deposit of $3,002 paid during the fourth quarter of 2003. The transaction also includes agreements for the seller to manufacture products for the Company at raw material cost until January 2005 and for the Company to pay an aggregate of $400 for research and development services over three years plus up to $2,075 for new product developments when and if delivered. These costs will be expensed as incurred.

The Bentec acquisition was accounted for under the purchase method of accounting and Bentec’s results of operations are included in the Company consolidated financial statements since August 12, 2004, the date of purchase. The aggregate purchase price included transaction costs of $100 and cash of $10,341 of which $2,566 has been withheld until certain conditions are satisfied and to secure the seller’s indemnity obligations.

The following table summarizes the estimated fair values of the assets acquired at the date of acquisition. Valuations of intangible assets were obtained utilizing various resources including valuation consultants.

Of the $3,140 of acquired intangible assets, $840 was assigned to patent core technologies (6-year economic consumption life), $400 was assigned to patent completed technologies (4-year economic consumption life), and $1,900 was assigned to customer relationships (8-year economic consumption life).

The $6,775 of goodwill primarily relates to synergies the Company expects to realize by providing sales and marketing channels for the PVA roller brushes especially in Asia and Japan and is expected to be deductible for tax purposes but will not be benefited until the Company utilizes existing tax-loss carryforwards in the U.S.

5. Other Intangible Assets

Components of the Company’s identifiable other intangible assets are as follows:

The Company recorded amortization expense for its other intangible assets of $477 and $315 for the three months ended October 2, 2004 and September 27, 2003, respectively and $1,359 and $1,118 for the nine months ended October 2, 2004 and September 27, 2003, respectively. Estimated amortization expense for the fiscal years 2004 to 2008 is $1,977, $2,337, $2,292, $1,543 and $822, respectively.

6. Product Warranty Costs

At the time revenue is recognized, the Company provides for estimated cost of product warranties as provided for under contractual arrangements. Warranty obligations are affected by product failure rates and service delivery costs incurred in correcting a product failure. Should such failure rates or costs differ from these estimates, accrued warranty costs would be adjusted in the period that such events or costs become known.

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Changes in the accrued warranty costs during the first nine months of 2004 and 2003 were as follows:

7. Restricted Cash

The Company has provided cash collateral totaling $1,492 on standby letters of credit in connection with the lease for its corporate headquarters, research and development and manufacturing facility in Billerica and other security deposits. At October 2, 2004, this cash collateral was invested in certificates of deposit and money market funds.

8. Other Income (Expense), Net

Other income (expense) is summarized below:

9. Inventories

Inventories are summarized as follows:

10. Employee Retirement Plans

The employees of the Company’s subsidiary in Japan (“Nihon Mykrolis”) are covered by a defined benefit pension plan. The table below set forth the estimated net periodic cost of the Nihon Mykrolis pension plan.

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During the third quarter of 2004 Mykrolis terminated certain unfunded post-retirement medical benefits offered to U.S. retirees. The termination of these benefits resulted in a settlement gain of $805 and a curtailment gain of $1,171 both of which are recorded as a reduction of selling, general and administration expenses for the quarter. This resulted from the reversal of the liabilities associated with these benefits of $1,976.

11. Income Taxes

For the three months ended October 2, 2004, the Company recorded income tax expense of $3,065 on consolidated pre-tax income of $10,362, yielding an effective tax rate of 30% during the quarter. The Company has calculated an annual effective tax rate of 26% which is primarily related to the Company’s foreign operations and results from its overall geographic mix of income, including tax benefits relating to U.S. net operating losses for which no tax benefit had been previously taken. For the three months ended September 27, 2003 the Company recorded income tax expense of $224 with respect to certain foreign operations on a consolidated pre-tax loss of $644, yielding an effective tax rate of negative 35%.

For the nine months ended October 2, 2004, the Company recorded income tax expense of $7,710 on consolidated pre-tax income of $29,715, yielding an annual effective tax rate of 26%. Income tax expense is primarily related to the Company’s foreign operations and results from its overall geographic mix of income, including tax benefits relating to U.S. net operating losses for which no tax benefit had been previously taken. For the nine months ended September 27, 2003 the Company recorded income tax expense of $4,635 with respect to certain foreign operations on a consolidated pre-tax loss of $7,125, yielding an effective tax rate of negative 65%.

During the first quarter of 2004, Millipore notified the Company that certain of the Company’s U.S. tax attributes were utilized in connection with Millipore’s consolidated tax return filings for periods between the Separation and the Distribution Date. Under the terms of the tax sharing agreement with Millipore in connection with the Separation, the Company is entitled to be paid for tax attributes utilized by Millipore. On March 5, 2004, the Company received a payment with respect to these tax attributes of $1,255 from Millipore. As a result, this payment was recorded as an increase in additional paid-in capital included in stockholders’ equity.

12. Business Segment Information

The Company attributes net sales to different geographic areas as presented in the table below.

The Company’s products include consumable products and equipment products that are used in the manufacture of semiconductors and other high precision electronic devices. Consumable products, including service revenue, accounted for 69%, and 71%, of revenues for the three months ended October 2, 2004 and September 27, 2003 respectively, and equipment products accounted for 31% and 29%, respectively, for these same periods. For the nine months ended October 2, 2004 and September 27, 2003, consumable products, including service revenue, accounted for 68%, and 72%, of revenues, respectively, and equipment products accounted for 32% and 28%, respectively, for these same periods. The Company’s products are sold worldwide through a direct sales force and through distributors in selected regions.

13. Significant Customers and Concentration of Risk

During the three months ended October 2, 2004 and September 27, 2003 and the nine months ended October 2, 2004 and September 27, 2003, one customer represented 13.5%, 11.8%, 13.5% and 10.8% of revenues, respectively. Accounts receivable for this customer was $8,516 and $5,713 at October 2, 2004 and December 31, 2003, respectively. There were no other customers that accounted for more than 10% of revenues or accounts receivable during these periods.

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14. Commitments and Contingencies

On March 3, 2003 the Company filed a lawsuit against Pall Corporation in the United States District Court for the District of Massachusetts alleging infringement of two of the Company’s U.S. Patents by a fluid separation device known as the Pall Photo Kleen EZD-2 filter assembly manufactured and sold by the defendant. The Company’s lawsuit also sought a preliminary injunction preventing the defendant from the manufacture, use, sale, offer for sale or importation into the U.S. of the infringing product. After a hearing on Mykrolis’s request for a preliminary injunction, the United States District Court for the District of Massachusetts issued a preliminary injunction against Pall Corporation on April 30, 2004 and ordered Pall to immediately stop making, using, selling, or offering to sell within the U.S., or importing into the U.S., its PhotoKleen EZD-2 Filter Assembly products or “any colorable imitation” of those products. On June 21, 2004, the Company filed a motion with the Court to hold Pall Corporation in contempt of court for failing to comply with the terms of the preliminary injunction; a hearing on this motion was held on July 14, 2004. On August 13, 2004, Pall Corporation filed a motion to dissolve the preliminary injunction; a hearing on this motion was held on October 28, 2004.

The Company is subject to other claims and legal proceedings, which, in the opinion of the Company’s management, are incidental to the Company’s normal business operations. In the opinion of management, although final settlement of these suits and claims may impact the Company’s financial statements in a particular period, they will not, in the aggregate, have a material adverse effect on the Company’s financial position, results of operations or cash flows.

The Company enters into a variety of indemnification commitments in the ordinary course of its business including the following:

The Company has never incurred costs to defend lawsuits or settle claims related to these types of indemnification commitments. As a result, the Company believes the estimated fair value of these commitments is minimal. Accordingly, the Company has no liabilities recorded for these commitments as of October 2, 2004.

During the second quarter of 2004, in conjunction with the employment and relocation of the Vice President of Business Development, the Company entered into a commitment with a third-party employee relocation administrator with respect to the sale of property located in Austin, Texas. As a part of this commitment, the Company agreed to indemnify the third-party relocation administrator against any deterioration in the market value of the property between the officer’s sale of the real property to the third party relocation administrator and resale to a third party at estimated fair market value. In connection with this indemnification commitment, the Company has not recorded a liability as of October 2, 2004.

15. Accrued Restructuring Costs

The Company took several restructuring actions in 2003, 2002 and 2001 to better align its cost structure with prevailing market conditions due to the prolonged industry downturn and to establish separate operations from its former parent. These actions primarily focused on reducing the workforce and consolidating global facilities.

During the nine months ended October 2, 2004, the Company paid $255 for severance costs and $1,314 for leasehold/other costs consisting of lease payments, utility expenses, property taxes and general maintenance costs associated with the vacant Bedford, MA facility. $118 of accretion was recorded in selling, general and administration expenses during the nine months ended October 2, 2004 as a non-cash increase in the restructuring reserve as a result of originally recording the liability at present value. In addition, during the nine months ended October 2, 2004, changes to prior estimates resulted in the reversal of $88 in employee severance costs, primarily due to lower than expected severance benefits paid.

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As of October 2, 2004, the Company’s total accrued restructuring costs were $1,994, of which $116 relates to severance costs for terminated employees that will be paid by the first quarter of 2005, and $1,878 related to facility exit costs, primarily for the leased facility in Bedford, MA, which will be substantially paid by the fourth quarter of 2005.

The activity related to the Company’s restructuring accruals is shown below:

16. Recently Issued Accounting Pronouncements

In December 2003, the FASB issued SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Post-Retirement Benefits,” (“Revised SFAS 132”) that expands financial statement disclosures for defined benefit plans. The change replaces existing SFAS 132 disclosure requirements for pensions and other post-retirement benefits and revises employers’ disclosures about pension plans and other post-retirement benefit plans. It does not change the measurement of recognition of those plans required by SFAS No. 87, “Employers’ Accounting for Pensions” or SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits.” Revised SFAS 132 retains the disclosure requirements contained in the original SFAS 132, but requires additional disclosures about the plan assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit post-retirement plans. Revised SFAS 132 is effective for annual and interim periods with fiscal years ending after December 15, 2003. The Company has adopted these revised disclosure provisions.

In December 2003, the FASB issued FASB Interpretation No. 46-R (“FIN 46-R”) a revised interpretation of FASB Interpretation No 46 (“FIN 46”). FIN 46-R requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN 46-R are effective immediately for all arrangements entered into after January 31, 2003. For all arrangements entered into after January 31, 2003, the Company is required to continue to apply FIN 46-R through the end of the first quarter of fiscal 2004. We do not have any equity interests that would change its current reporting or require additional disclosures outlined in FIN 46-R. For arrangements entered into prior to February 1, 2003, the Company is required to adopt the provisions of FIN 46-R in the first quarter of fiscal 2004. The Company does not have any equity interests entered into prior to February 1, 2003 that would change its current reporting or require additional disclosures outlined in FIN 46-R.

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(In thousands except share and per share data)

You should read the following discussion of the Company’s financial condition and results of operations along with the consolidated financial statements and accompanying notes included herein. This discussion contains forward-looking statements and involves numerous risks and uncertainties, which are described under “Forward Looking Statements Disclaimer” below. The Company’s actual results may differ materially from those contained in any forward-looking statements.

Overview and Financial Condition

We are a worldwide developer, manufacturer and supplier of liquid and gas delivery systems, components and consumables used to precisely measure, deliver, control and purify the process liquids, gases and chemicals that are used in the semiconductor manufacturing process. Prior to March 2001, our business was operated as a fully integrated business unit of Millipore Corporation (“Millipore”). We became an independent company through a spin-off by Millipore, which was completed in February of 2002.

The principal market we serve is the global semiconductor industry, a highly cyclical business which experienced a significant downturn that resulted in deterioration in our net sales and results of operations during the period from 2001 to 2003. This downturn had the greatest impact on our sales of liquid and gas equipment products, as new semiconductor plant construction and upgrades declined. Net sales of our consumable products, which tend to be driven by capacity utilization also declined during this period, although less drastically, and benefited from the recovery of the volume of semiconductor wafers being built in 2003. Commencing during the fourth quarter of 2003 and continuing through the second quarter of 2004, we experienced improved business conditions, which had a positive impact on our sales growth and profitability. During the third quarter of 2004 this recovery began to softened, as key OEM customers announced order delays and reduced booking rates and there was a pause in the growth of wafer starts. The outlook for 2005 is currently unclear; however, should business conditions signal a downturn, we intend to take appropriate actions to manage our profitability to our level of sales.

Net sales during the three months ended October 2, 2004 increased 60.4% over sales for the three month period ended September 27, 2003. Net sales during the nine months ended October 2, 2004 increased 68.5% over the nine month period ended September 27, 2003. Our gross profit as a percentage of net sales was 47.4% for the third quarter of 2004 compared to 45.2% for the three months ended September 27, 2003. For the nine months ended October 2, 2004, gross profit as a percentage of net sales was 48.2% compared to 43.3% for the nine months ended September 27, 2003 which reflected greater leverage of our manufacturing overhead primarily due to increased volume of our gas and liquid delivery products. Selling, general and administrative expenses increased 9.5% for the three months ended October 2, 2004 compared to the three months ended September 27, 2003, due to higher incentive compensation expense in relation to our higher revenue. Research and development expenses increased by 50.3% during the quarter compared to the three months ended September 27, 2003 as we invested in the development of new product platforms to respond to the need for tighter process controls in the semiconductor industry. Selling, general and administrative expenses increased 15.9% for the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003, and research and development expenses increased by 43.6% during the nine months ended October 2, 2004 compared to the nine months ended September 27, 2003. Net cash provided by operating activities during the nine months ended October 2, 2004 and September 27, 2003 was $26,938 and $5,305, respectively.

Critical Accounting Policies and Significant Judgments and Accounting Estimates

The 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 of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and significant judgments and estimates, including those related to net sales, accounts receivable, inventories, long-lived assets and goodwill, deferred tax assets, income tax contingencies, warranty obligations, restructuring charges, pension and other post-retirement benefit obligations, and litigation contingencies. 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 and estimates used in the preparation of the consolidated financial statements. We have reviewed these policies with the Audit and Finance Committee of our Board of Directors.

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Net Sales

Our net sales consist of revenue from sales of products net of trade discounts and allowances. We recognize revenue upon shipment, primarily FOB shipping point, when evidence of an arrangement exists, contractual obligations have been satisfied, title and risk of loss have been transferred to the customer and collection of the resulting receivable is reasonably assured through historical collection results and regular credit evaluations. In most transactions, we have no obligations to our customers after the date products are shipped other than pursuant to warranty obligations. In the event that significant post-shipment obligations or uncertainties exist, revenue recognition is deferred as appropriate until we fulfill such obligations or the uncertainties are resolved.

Accounts Receivable

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments based upon specific identification, by customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventories

We adjust the cost basis of our inventory to reflect its net realizable value, if lower than cost. We provide reserves for estimated excess and obsolete inventory equal to the difference between the cost of inventory and the estimated net realizable value based upon assumptions about future demand and market conditions. We fully reserve for inventories deemed obsolete. We perform quarterly reviews of all inventory items to identify excess and obsolete inventories on-hand by comparing on-hand balances to recent historical usage as well as anticipated or forecasted demand, based upon input from sales, R&D and marketing functions. If estimates of demand diminish further or actual market conditions are less favorable than those projected, additional inventory write-downs may be required.

Long-Lived Assets and Goodwill

We periodically evaluate the recoverability of long-lived assets whenever events and changes in circumstances indicate that the carrying value of an asset or class of assets may not be fully recoverable and exceeds its fair value. For long-lived assets we intend to hold and use, if the carrying amount of the asset exceeds the sum of undiscounted cash flows expected to result from the use of the asset over its useful life, an impairment loss will be recorded. The amount of the impairment loss is measured as the amount by which the carrying amount of the long-lived asset exceeds its fair value. Assets held for sale are valued at fair value less costs to sell the asset.

For goodwill, we assess fair value by measuring discounted cash flows and comparable company analysis for the applicable underlying reporting unit and test for impairment as the difference between the resulting implied fair value of goodwill compared to its recorded carrying value. Goodwill impairment is tested annually or whenever events and changes in circumstances require.

The estimates of useful lives and expected cash flows require us to make significant judgments regarding future periods that are subject to some factors outside our control. Changes in these estimates can result in significant revisions to the carrying value of these assets and may result in material charges to the results of operations.

Deferred Tax Assets

Our valuation allowance against the U.S. deferred tax assets are based on our assessment of historical pre-tax income and projected pre-tax income for early future periods. In addition, there is no valuation allowance against the deferred tax assets in foreign subsidiaries based on our assessment of historical pre-tax income and projected pre-tax income for early future periods. We currently expect there will be sufficient pre-tax income during 2004 to realize deferred tax assets in the foreign subsidiaries. We currently forecast pre-tax income in the U.S. and in addition, we have undertaken tax-planning initiatives designed to generate future U.S. taxable income. As we generate future taxable income in the U.S. against which these tax assets may be applied, some portion or all of the valuation allowance would be reversed and an increase in net income would consequently be reported in future years.

Income Tax Contingencies

Tax contingencies are recorded to address probable exposures involving tax positions we have taken that could be challenged by taxing authorities. These probable exposures result from the varying application of statutes, rules, regulations and interpretations. Our estimate of the value of our tax contingencies contains assumptions based on past experiences and judgments

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about potential actions by taxing jurisdictions. It is reasonably likely that the ultimate resolution of these matters may be greater or less than the amount that we have accrued.

Warranty Obligations

At the time revenue is recognized, we provide for the estimated cost of product warranties as provided for under our contractual arrangements. Our warranty obligation is affected by product failure rates and service delivery costs incurred in correcting a product failure. Should such failure rates or costs differ from these estimates, accrued warranty costs would be adjusted in the period that such events or costs become known.

Restructuring Charges

During 2003, 2002 and 2001, we recorded significant charges to operations in connection with several restructuring programs. The related reserves reflect estimates, including those pertaining to severance costs and facility exit costs. We reassess the reserve requirements to complete each restructuring program at the end of every reporting period and record adjustments to reflect changes in prior estimates. Actual experience may be different from these estimates.

Pension Obligations

We have pension costs and credits, which are developed from actuarial valuations. Inherent in these valuations are key assumptions, including discount rates, compensation increases, healthcare costs and expected return on plan assets, which are usually updated on an annual basis at the beginning of each fiscal year. We are required to consider current market conditions in making these key assumptions. Changes in the related pension costs or credits may occur in the future due to changes in assumptions.

Litigation contingencies

In March of 2003 we filed a lawsuit against Pall Corporation in the United States District Court for the District of Massachusetts alleging infringement of two of the Company’s U.S. Patents by a fluid separation device known as the Pall Photo Kleen EZD-2 filter assembly manufactured and sold by the defendant. Current developments in this litigation are described in Part II, Item 1, of this report to which reference is made.

We are subject to proceedings, lawsuits and other claims, including proceedings under laws and government regulations related to securities, environmental, labor, product and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is based on a careful analysis of each individual issue with the assistance of outside legal counsel. The required reserves may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters.

Operating trends and recent developments

We operate in one reportable business segment that develops, manufactures and sells consumable and capital equipment products to semiconductor fabrication companies and other companies using similar manufacturing processes, as well as to OEM suppliers to those companies. The principal market we serve is the global semiconductor industry, a highly cyclical business. During 2001, 2002 and a portion of 2003, this industry faced a severe downturn, and as a result we experienced significant variations in net sales and results of operations.

Our liquid and gas equipment products were impacted the most by the industry downturn, as new semiconductor fabrication plant construction and upgrades declined. However, after this severe downturn, the fourth quarter of 2003 showed strong revenue growth and improved profitability, led by semiconductor fabrication companies’ increased capacity utilization rates and capacity additions. These improved business conditions also positively impacted our revenue and profitability levels during the first nine months of 2004. During the third quarter of 2004 this recovery began to softened as key OEM customers announced order delays and reduced booking rates and there was a pause in the growth of wafer starts. The outlook for 2005 is currently unclear; however, should business conditions signal a downturn, we intend to take appropriate actions to manage our profitability to our level of sales.

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Our results of operations for the three and nine months ended October 2, 2004 and September 27, 2003 in dollars and as a percentage of net sales were as follows: