Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

For the Fiscal Year Ended December 31, 2004

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 x    No ¨

As of June 30, 2004, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant was approximately $116,011,000, 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 March 8, 2005, the Registrant had 21,954,320 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 26, 2005, are incorporated by reference into Part III of this Form 10-K.

Table of Contents

ELECTROGLAS, INC.

FORM 10-K

For the Year Ended December 31, 2004

INDEX

2

Table of Contents

FORWARD LOOKING STATEMENTS

The discussion in this Annual Report on Form 10-K should be read in conjunction with our accompanying Financial Statements and the related notes thereto. 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, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, as amended. 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:

3

Table of Contents

The forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those stated or implied by the forward looking statements. These risks and uncertainties include:

For a detailed description of these and other risks associated with our business that could cause actual results to differ from those stated or implied in such forward-looking statements, see the disclosure contained under the heading “Factors that May Affect Results and Financial Condition” in this Annual Report on Form 10-K. All forward looking statements included in this document are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward looking statement or statements. The reader should also consult the cautionary statements and risk factors listed in our Reports on Forms 10-K, 10-Q, 8-K and other reports filed from time to time with the Securities and Exchange Commission.

4

Table of Contents

PART I

Item 1.    Business

Overview

We are a supplier of semiconductor manufacturing equipment and software to the global semiconductor industry. We were incorporated in Delaware 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 semiconductor manufacturing customers use our wafer probers and network software to quality test semiconductor wafers and to improve their productivity and control their processes, optimizing manufacturing efficiency. Electroglas’ installed base is one of the largest in the industry, having sold over 15,000 wafer probers.

Introduced in 2004, the 4090µ+ addresses the demands of testing fine pitch devices, semiconductors with copper interconnects and low-k dielectric processes and other advanced applications, while simultaneously reducing test costs by increasing test cell availability and throughput.

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.

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 many package tested strip formats, whether panel or leadframe such as Chip Scale Packages (CSP) or Ball Grid Arrays (BGA) as well as traditional Small Outline Integrated Circuits (SOIC).

Starting 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. This included the sale of Fab Solutions software product lines and our Optical Inspection product line. Our renewed focus allowed us to spend more time developing and delivering innovative products to help our customers overcome their most critical semiconductor test challenges. In 2004, this resulted in the introduction of a new extended performance 200mm wafer prober, the 4090µ+, and the development of a new flagship 300mm prober, the EG6000, introduced in January 2005 that represents a major advancement in prober design and automation and is focused on providing substantially better performance than currently available competitor’s products.

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

5

Table of Contents

Form 10-Q, our Current Reports on Form 8-K and amendments to those Reports filed or furnished pursuant to Section 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. The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and other filings also are available at the SEC’s website at http://www.sec.gov.

Industry Background

Semiconductor devices are fabricated by repeating a complex series of process steps on a substrate, or wafer, which 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”, can 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

Wafer 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 commonly 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. Positioning accuracy is a key requirement of an automatic wafer prober. As manufacturers continue to shrink their device sizes, the manufacturing equipment accuracy must continue to keep pace with reduced feature sizes. Throughput is another key prober feature, because allowing more devices to be tested in a given amount of time reduces the overall cost of test. Similarly, wafer probers are required to be reliable, easy to use, and very robust at handling the test process without failure or interruption, since these cause loss of throughput for the entire test cell.

6

Table of Contents

Recently, new device manufacturing processes, such as the use of copper for the metal layers and the use of very soft, delicate dielectric layers, have required a new level of control over the speed and accuracy with which probes are brought into contact with the pads to prevent damage and yield loss.

Wafer probers are also 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.

There is a growing trend for semiconductor manufacturers to contract with other companies to perform their wafer sort operations. These contract test companies, commonly called “test houses”, perform the wafer testing service and often provide assembly and packaging 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 may require from 20 to over 100 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.

Test Handling

Wafers are sent from the wafer sort operation to assembly where the individual chips are separated with wafer saws, and put into protective packages. Once packaged, chips are tested again to make sure they function properly before being shipped to a customer. Ultimately, these packaged chips will find their way into electronic systems that go into a myriad of familiar consumer and industrial electronic applications.

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 an increasing need to find new test methods to improve test throughput and lower the cost of test.

In addition, 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 (PDA’s), and notebook computers, while increasing performance. This has caused the advent of very small 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.

One of the primary new technologies for meeting these needs is the strip test handler which enables testing devices while in strip or panel format. By performing test while devices are held in position on these strips, strip test handlers allow small high-speed devices to be accurately positioned and numerous devices can be tested and handled simultaneously. Because it handles packaged devices in the matrix format of the strip, a strip test handler has many similarities to a wafer prober, which handles chips in the matrix format of a wafer.

7

Table of Contents

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.

The Electroglas strip test handler, Sidewinder, uses prober technology and unique machine vision and handling methodology to deliver the fastest possible strip-to-strip index time available.

Another trend is the increasing number of devices that are being shipped from device manufacturers as Known Good Die (KGD), that is, bare die, without any packaging. These devices are commonly shipped by the device manufacturers to customers who assemble multi-chip modules or mount them directly to circuit boards. In this application, the bare die is the final “package” for the device manufacturer. Also, semiconductor manufacturers are increasingly using stacked packages to combine two or more chips of differing technologies into a single package. In either of these applications, it is often necessary to test individual chips after devices have been separated on a wafer saw. A film frame handler allows this type of		The Electroglas film-frame handler, Pathfinder, allows testing of devices after dicing using advanced software algorithms that correct for die placement inaccuracies resulting from singulation.
testing to be done while the devices are still mounted on the film (which is held in place by a round metal or plastic frame) used for the wafer sawing process.

8

Table of Contents

Test Floor Management

Process management software plays an important role in Integrated Circuit (IC) manufacturing. 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. Test houses and Integrated Device Manufacturers look to reduce the cost of test and improve quality through software monitoring, analysis, and the automation of their test floors.

In a wafer sort area, network software is increasingly being used to manage wafer information to speed the identification of yield shortfalls and reduce reprobe rates by collecting wafer maps from multiple passes for all systems and storing the files in a common database for viewing, analyzing and archiving. Other uses include prior step verification to insure that wafers will accurately flow through a pre-defined set of steps and will not be tested if they have not completed the previous step in the process and, product file management capabilities that allow the user to save a master template for product file set-up that can be accessed by all test systems on the test floor.

In general, software tools are used to bring together disparate data 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.

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:

9

Table of Contents

Products

Wafer Probers

Horizon 4000 Series:    The 4090µ+ (4090 Micro Plus) was introduced in Q4 2004 and is the new extended performance wafer prober system for 200mm wafers. The 4090µ+ addresses the demands of testing fine pitch devices, semiconductors with copper interconnects and low-k dielectric processes, and other advanced applications. Employing MicroTouch, a feature that decreases the impact force as the probe pins contact the bond pads, the 4090µ+ reduces touchdown damage that can occur when testing fragile copper and low k devices or when pads are located over active circuit geometry. The 4090µ+ increases test cell availability and throughput while simultaneously reducing test cost by making improvements in how probe-to-pad alignment is maintained in varying temperature environments. In addition, the 4090µ+ has simplified and fully automated operations for high volume manufacturing applications, such as those that exist in integrated device manufacturer (IDM) and contract test facilities. Customers who want to use the latest high productivity 200mm probing solution from Electroglas can also cost-effectively upgrade existing Electroglas 4080, 4090 and 4090µ prober systems with 4090µ+ technology. Joining the 4090u+ in the Horizon 4000 Series is the 4090µ Fast Probe, introduced in 2001, which is used in applications where the die are very small and there is a very large number of devices on a wafer. The 4090µ Fast Probe employs special technologies to reduce the system stepping time for high-volume production.

The EG4/200:    Introduced in 1999, the EG4|200 is targeted at high-end probing applications for 200mm wafers. The system 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 EG6000:    Developed in 2004 and introduced in January 2005, the new EG6000 300mm probing system from Electroglas fuses advanced automation with the highest caliber of prober technology. Representing a major advancement in prober design and automation, the system is the only 300mm prober that employs precision direct-drive technology to enable it to achieve the highest positioning accuracy currently available. Simultaneously, the prober can deliver the fastest throughput obtainable as measured from lot-start to lot-end. Designed for advanced applications such as copper and low k dielectrics, the system employs a proprietary stage and control technology to enable highly accurate positioning of the test devices while moving devices into contact with the probes for test. MicroTouch adds the ability to control the impact forces while probing on delicate devices. The EG6000 features the new Advanced Vision System for better accuracy, robustness and speed in aligning devices to the probe card for test. It also features a sophisticated system for automatically measuring and compensating for thermal changes in the system components while testing at hot or cold temperatures.

10

Table of Contents

The EG6000 is based on the same core architecture as the prior 5|300 prober which served the relatively small market for parametric test and process development applications. The EG6000 features a broader range of application capabilities as well as many refinements and improvements in accuracy, throughput, automation, and reliability. This allows the EG6000 to address customer’s needs for high volume production wafer test that forms the large majority of the 300mm prober market.

Parametric Probers:    The EG5|300e, introduced in December 2000, and the EG4|200e, introduced in July 2001, are both targeted at the parametric test (“e-test”) segment of the wafer probe market. The EG5/300e is targeted at the 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.

Test Handlers

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,

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.

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 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. In 2004, Sidewinder was selected by Advanced Packaging, a leading semiconductor publication, as a 2004 Advanced Packaging Award Winner based on its ability to meet a significant industry challenge, creative application of technology; and throughput characteristics.

Test Floor Management 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.

11

Table of Contents

SORTmanager displays single and composite wafer maps and underlying data for custom views of multiple lots that enable users to make the most effective comparison possible for identification and rapid resolution of process issues to correct yield loss.

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 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 management tool.

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 devote 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 continue to invest 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 $16.2 million, $21.8 million and $31.6 million in 2004, 2003 and 2002, respectively, or 25.7%, 48.4% and 55.2% of net sales. 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. It is expected that these expenses will decrease in absolute dollars and as a percentage of net sales in 2005 from 2004 levels.

Marketing, Sales and Service

We sell our products directly to end-users through a direct sales force and independent representatives. 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 are customarily included in the price of the product. Customers may enter into repair and maintenance service contracts covering our products. Our field engineers provide customers (with products not under warranty or service contracts) with call out repair and maintenance services for a fee. 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, we maintain offices in the People’s Republic of China, Singapore and Taiwan.

Customers

We sell our products to leading semiconductor manufacturers and contract test companies throughout the world. In 2004, ST Microelectronics and Atmel each accounted for more than 10% of our net sales. International

12

Table of Contents

sales represented 63%, 65% and 48% of our net sales in 2004, 2003 and 2002, 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 $8.3 million and $13.1 million as of December 31, 2004 and 2003, respectively. 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 customer, sometimes with a cancellation charge. Due to timing of order placement and product lead times, 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 twenty-four 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 and test floor management software segments are Tokyo Electron Limited and Tokyo Seimitsu, both of which are based in Japan. In these markets, these 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

13

Table of Contents

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, 2004, we employed 279 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.

Item 2.    Properties

On December 16, 2004, we entered into an agreement with Integrated Design Technology (IDT) of Santa Clara, California, to sell our 260,000 square foot corporate headquarters facility located in San Jose, California and to lease back a portion of the property for a limited period of time with no rent payment. We are currently occupying 33% of the facility. See Note 14, 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. This lease was renewed at the same rate in December 2004 for two additional years.

In February 2005, we entered into a five-year operating lease for a 78,000 square foot corporate headquarters facility in San Jose, California with annual lease payments ranging from nil to $1.0 million.

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 appealed the decision. Given the pending appeal, and the inherent uncertain in litigation, we cannot assure you that the ultimate outcome will be favorable to us nor can we predict 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, 2004.

14

Table of Contents

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 March 8, 2005, the closing price of our common stock was $4.20.

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 March 8, 2005, we had approximately 6,241 stockholders of record.

15

Table of Contents

Item 6.    Selected Financial Data

16

Table of Contents

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 Operations

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. We are sensitive to a number of key indicators in managing our business. These include: industry and internal book-to-bill ratios, capital equipment utilization rates, capital spending plans of our customers and in the industry—particularly in the 300mm segment, and competitive wins of our products and our competitor’s products. 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. In addition, our 300mm wafer probers have not yet achieved broad market acceptance, which has resulted in a significant loss in market share. The initial product, 5|300, served the small market for 300mm parametric and process development applications, but did not adequately meet customers requirements for high volume production test, which is the large majority of the 300mm prober market. Electroglas has recently introduced a new 300mm prober, the EG6000, to serve this much larger market. 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 time, as necessary, rapidly adjust up or down our expense structure during these hard to predict cyclical semiconductor equipment demand cycles.

17

Table of Contents

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

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, and allowance for doubtful accounts. 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. For more detail about these accounting policies, see Note 1, Significant Accounting Policies.

Revenue recognition:    We recognize revenue on the sale of our 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. In recognizing revenue we make certain assumptions and estimates, namely: (i) 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; (ii) we consider systems delivered separately from options to have value to our customers on a stand alone basis if the options have a unique price assigned and are not significant to the total amount of the order and the options are not fundamental to the functionality of the system; (iii) we consider systems delivered separately from installation and training to have value to our customers on a stand-alone basis because the equipment can readily be sold by the customer, customers are capable of installing our systems without the support of our installers, installation and training are routine and not consequential to the total value of the transaction, and these services are routinely sold on a stand-alone basis; and (iv) for most customers we assume that, based on past history, we will continue to collect our receivables from our customers without payment 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.

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

18

Table of Contents

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. Inventory impairment charges are considered to permanently establish a new cost basis for inventory and are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable, except when the associated inventory balances decline due to disposition or sale of associated product. As a result of these analyses, we wrote down inventories by $0.2 million, $7.1 million and $8.1 million in 2004, 2003 and 2002, 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. Estimates have historically approximated actuals.

Allowance for doubtful accounts:    We closely monitor the collection of our accounts receivables and record a general reserve for doubtful accounts against aged accounts and a specific reserve for 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, from time to time experienced slowdowns 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. If a customer demonstrated a pattern of renegotiating terms or requesting concessions prior to payment, we would defer revenue until the price was considered fixed and determinable. Estimates have historically approximated actuals.

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 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”.

19

Table of Contents

Results of Operations

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

Net Sales

Net sales are comprised of prober systems, software, and aftermarket sales, consisting primarily of 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:

Net sales were up 40.1% in 2004 from 2003. This increase was primarily due to 52% higher prober system sales, largely in our 200mm prober product lines, and 20% higher average selling prices, as customers resumed their capital spending in response to indications of a market recovery. Sales of our test floor management software products increased in 2004 due to the release of our newest platform in late 2003. These increases in prober systems sales and test floor management software in 2004 over 2003 was partially offset by the elimination of sales in other product lines in 2004 due to the sale of our Design for Manufacturing (DFM) and

20

Table of Contents

Fab Solutions software product lines in the third quarter of 2003 and our Optical Inspection product line in the fourth quarter of 2003. Net sales were $45.0 million in 2003 down 21.3% from $57.1 million in 2002. 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. Despite the overall decline in prober revenue in 2003, shipments of prober systems increased 4% in 2003 versus 2002. Net sales in 2003 were also down from 2002, due to the sale of our DFM and Fab Solutions software and inspection product lines. The demand for our products follows the semiconductor test markets, which remain highly cyclical and difficult to forecast. As a result of uncertainties in this market environment, any rescheduling or cancellation of planned capital purchases by our customers will cause our sales to fluctuate on a quarterly basis. Sales to related parties are priced in the same manner as other customers.

Net sales by region were as follows:

International sales as a percentage of total sales for the years 2004, 2003 and 2002 were 63%, 65% and 48%, respectively. 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 demand cycle. During 2003 and 2002, we experienced weakness across all of our major geographic regions. Sales to 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.

Gross Profit (Loss)

Gross profit (loss), as a percentage of sales, was 36.2%, 0.5% and (5.6)% in 2004, 2003 and 2002, respectively. The improvement in gross profit in 2004 compared to 2003 was due to 52% higher unit sales volumes and 20% higher average selling prices. Additionally, manufacturing overhead expenses as a percentage of sales were 7% lower in 2004 than 2003 and 27% lower than 2002 as a result of our relocation of manufacturing operations from the U.S. to Singapore and other restructuring efforts begun in late 2002 and completed in mid-2003. The improvement in gross profit in 2003 compared to 2002 due to 20% lower manufacturing overhead expenses as a percentage of sales was offset somewhat by lower revenue per system due to 17% lower average selling prices in 2003 as compared to 2002. In addition, we wrote down inventories by $0.2 million, $7.1 million and $8.1 million in 2004, 2003 and 2002, 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 2004 resulted primarily from identified obsolescence of certain parts resulting from the planned transition to new products in 2005. 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. 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 2004, the accrued liability for estimated cost of inspection product line warranty support was reduced by $0.9

21

Table of Contents

million. In 2002 due to the establishment of new manufacturing operations in Singapore and the potential for higher defect rates from 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, and excess manufacturing capacity costs. 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 25.7%, 48.4% and 55.2%, respectively as a percentage of sales, for 2004, 2003, and 2002, respectively. In 2004, ER&D expenses were $16.2 million down 25.7% from $21.8 million in 2003. This decrease in spending year over year was primarily due to a 15% reduction in employee headcount and related costs and a 11% reduction associated with the product lines sold in the second half of 2003, partially offset by increased spending on materials and services. As a percentage of sales, ER&D expenses decreased 10% in 2004 as a result of the effect of higher net sales, an additional 5% as a result of the absence of spending for product lines sold in 2003, and an additional 10% as a result of reduced spending. In 2003, ER&D expenses were $21.8 million, down 31.0% 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 in mid-2003.

During these hard to predict cyclical semiconductor equipment demand cycles, we intend to control discretionary expenses and continue investing in our new product programs. 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.

Selling, General and Administrative Expenses

Selling, general and administrative, or SG&A expenses were 27.3%, 74.6% and 68.6%, as a percentage of sales, in 2004, 2003 and 2002, respectively. In 2004, SG&A expenses were $17.2 million down 48.8% from $33.6 million in 2003. This decrease in absolute dollars was primarily due to the non-recurrence of an additional rent charge of $8.5 million recorded in the first quarter of 2003 related to the amortization of the deficiency between the fair value and the guaranteed residual value of our San Jose campus. In addition, savings in SG&A expenses during 2004 included 37% reduced salaries and other cost savings as a result of headcount reductions, spending restrictions and cost control measures. These savings during 2004 were partially offset by a $1.1 million increase in Sarbanes-Oxley compliance costs. As a percentage of sales, SG&A expenses decreased 11% in 2004 as a result of the effect of higher sales and an additional 38% as a result of lower spending. In 2003, SG&A expenses were $33.6 million, down 14.3% 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 and the additional rent charge of $8.5 million recorded in the first quarter of 2003. SG&A expenses consist primarily of employee salaries and benefits, travel, advertising and other promotion expenses, facilities expenses, legal expenses and other infrastructure costs.

As a result of the sale of our San Jose campus in January 2005, we expect general and administrative expenses to decrease by approximately $0.9 million in 2005 compared to 2004 consisting of savings on property taxes, utilities, insurance and depreciation offset by rental expense for our new corporate headquarters.

22

Table of Contents

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. As of December 31, 2002, there were 32 employees designated for termination. 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. During 2004, an additional 14 employees were designated for termination in connection with a restructuring plan adopted for our engineering, research and development operations and 14 were terminated. We recorded a restructuring charge of $1.0 million in 2004 related to office space reductions and severance packages.

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 the 2004 restructuring efforts, we expect engineering, research and development payroll and benefit payments to decrease by $1.5 million to $2.0 million in 2005 compared to 2004. Restructuring charges of $0.8 million are included in accrued liabilities and are anticipated to be substantially paid in 2005.

Impairment Charges

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we performed impairment tests as of December 31, 2004 and 2003, 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. On December 16, 2004, we entered into an agreement to sell our San Jose campus to Integrated Device Technology for approximately $29 million and recorded a $4.1 million impairment charge. In addition, we recorded a $0.1 million impairment charge on fixed assets.

Due to continued declines in corporate real estate values in the San Jose area, management concluded as of December 31, 2003 that there were indicators of impairment for the portion of the corporate campus that was 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 our net sales and the sufficiency of estimated future cash flows to recover net book value of these assets and require us to record additional impairment charges.

23

Table of Contents

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 $6.0 million in cash ($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 $6.4 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.

Interest Income

Interest income was $0.3 million, $0.5 million and $2.3 million in 2004, 2003 and 2002, respectively. The year over year decreases were principally due to lower average yearly cash and short-term investment balances, which declined each year. Cash and short-term investment balances have declined as a result of the purchase of our corporate campus in Q1 2003 and cash in operations in 2004, 2003 and 2002.

Interest Expense

Interest expense was $2.4 million, $3.4 million and $1.4 million in 2004, 2003 and 2002, respectively. Interest expense is primarily comprised of interest expense on our convertible subordinated notes issued in June 2002. The year over year increase from 2002 to 2003 and 2004 was principally due to a full year of interest paid on convertible notes in 2004 and 2003 compared to one half year paid in 2002. In addition, 2003 included a $1.0 million non-cash interest expense charge related to the beneficial conversion feature triggered during the first quarter related to our convertible subordinated notes (See Note 12, Convertible Subordinated Notes and Warrants).

Gain on Revaluation of Warrants

In June 2002, we completed a $35.5 million private placement of 5.25% convertible subordinated notes due in 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.

Gain on Sale of Long Term Investment

In the fourth quarter of 2004, we sold our minority equity investment in Cascade Microtech, Inc. in connection with their initial public offering. We received $6.6 million in net proceeds from the sale, and we recorded a gain of $3.5 million.

Gain on Settlement of Long Term Liability

In the third quarter of 2004, we recognized an $8.3 million gain on the settlement of a long term liability to our former parent company that reduced the amounts payable by us under a tax benefit sharing agreement from $9.5 million to an aggregate of $1.3 million to be paid over the next seven quarters starting in the fourth quarter of 2004. As of December 31, 2004, the accrued liability for this obligation was $0.9 million.

24

Table of Contents

Provision (Benefit) for Income Taxes

The income tax provision (benefit) was $0.1 million, $(1.2) million and $(4.1) million in 2004, 2003 and 2002, respectively. The 2004 income tax provision resulted from taxes assessed on the income of various foreign branches. 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. 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 $105.4 million was required at December 31, 2004.

In October of 2004, the American Jobs Protection Act was signed into law. Certain provisions of this Act allow multinational companies to repatriate cash related foreign earnings at a favorable rate if used to create or maintain jobs in the United States. At December 31, 2004, there are no plans in place to repatriate earnings from foreign subsidiaries as the only cash maintained in these entities is for working capital purposes. Any repatriation of foreign earnings will have an immaterial effect on income taxes.

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 2002, 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 made a determination in December 2002 to purchase the leased assets by March 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 increased by approximately $0.9 million per year, and rent expense and interest income decreased by approximately $0.8 million and $0.7 million, respectively, per year based on current interest rates, effective the second quarter of 2003.

In December 2004, we entered into an agreement to sell our San Jose campus to Integrated Device Technology on January 5, 2005 for $29.0 million, and we continue to occupy certain portions of the buildings through June 30, 2005 under a rent free lease back. We measured the fair value of the land and buildings as of December 31, 2004 based upon the sale price net of closing costs and recorded a $4.1 million impairment charge. The assets included in this agreement were classified as Assets Held for Sale as of December 31, 2004 at their fair market value of $28.3 million.

Liquidity and Capital Resources

Our cash, cash equivalents and short-term investments totaled $31.7 million at December 31, 2004, a decrease of $0.2 million from $31.9 million at December 31, 2003.

25

Table of Contents

Cash used in operating activities in 2004 was $4.7 million, an improvement of $25.2 million over $29.9 million in 2003. Cash used in operating activities in 2003 was $29.9 million, an improvement of $24.1 million over $54.0 million used in operating activities in 2002. Our net operating loss before restructuring and impairment charges and gains on sales of product lines decreased by $44.5 million in 2004 to $10.6 million compared to $55.1 million in 2003. This resulted in a $25.2 million improvement in cash used in operating activities in 2004 compared to 2003 primarily reflecting our reduced net operating loss period over period due to 40.1% increased sales volumes and a 41.1% decrease in operating expenses. Additionally, the improvement in net cash used in operations resulted from a decrease of $2.6 million in accounts receivable due to enhanced collection efforts. These improvements were partially offset by an increase of $1.3 million in inventory from increased material purchases to support higher sales volumes and decreases of $0.5 million in accounts payable and $0.2 million in accrued liabilities. Non-cash charges included in our net operating loss before restructuring and impairment charges and gains on sales of product lines in 2004 consisted primarily of $5.0 million depreciation and amortization and $0.7 million of inventory charges. These non-cash charges in 2004 decreased by $18.6 million from $24.3 million in 2003. We expect cash used in operating activities to decrease further in 2005 compared to 2004 due to anticipated increased gross margins in 2005 on increased sales, anticipated savings from restructuring efforts, anticipated lower spending levels due to the sale of the San Jose campus and ongoing efforts to maintain expense controls, continued efforts to ensure timely collections from our customers, and continued efforts to tightly control inventory purchases.

Cash provided by investing activities was $8.1 million in 2004 largely due to the sale of our long term minority investment in Cascade Microtech, Inc. for $6.6 million in December 2004. Our use of investments decreased by $14.5 million in 2004 to $2.1 million as compared to $16.6 million in 2003 due to our decreased use of cash in operations.

Cash used in financing activities in 2004 was $1.5 million primarily due to $1.9 million in interest payments on convertible subordinated notes partially offset by $0.4 million proceeds of sales of common stock to employees. 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.

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 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. This lease was renewed at the same rate in December 2004 under a two year renewal option. In February 2005, we entered into a five-year operating lease for a 78,000 square foot corporate headquarters building in San Jose, California. Payments are due under this new lease as follows: nil in less than 1 year, $2.1 million in 1-3 years, and $1.0 million in 4-5 years. In 2005, we anticipate spending approximately $1.0 million to $2.0 million on tenant improvements and furniture and fixtures for the new corporate facility.

Our principal source of liquidity as of December 31, 2004 consisted of $31.7 million of cash, cash equivalents, and short-term investments. In addition, we received $28.3 million cash on January 5, 2005 from the sale of our San Jose corporate campus. During 2004, we continued to emphasize reduction of our utilization of cash, cash equivalents, and short-term investments, including improving gross margins on sales, maintaining

26

Table of Contents

spending controls and additional headcount reductions. This reduced utilization of cash in operating activities resulted in the use of $1.8 million in the first quarter, the providing of cash through operating activities of $0.8 million in the second quarter, the use of $1.2 million in the third quarter and the use of $2.5 million in the fourth quarter—a net use of cash in operating activities of $4.7 million for the year ended December 31, 2004. We currently anticipate that our available cash and cash equivalents at December 31, 2004 combined with the proceeds from the sale of our San Jose campus on January 5, 2005 should be sufficient to meet our anticipated needs for working capital and capital expenditures to support planned activities through 2005. The demand for our products follows the semiconductor test markets which remain highly cyclical and difficult to forecast. 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. External financing vehicles have been and are expected to continue to be available to us.

In the third quarter of 2004, we established a revolving line of credit agreement with Comerica Bank under which we may borrow up to $7.5 million based upon eligible accounts receivable balances. This line of credit is secured by certain of our assets and requires that we maintain certain minimum financial covenants. The Company currently maintains cash deposits of $7.5 million that will be considered restricted as compensating balances to the extent we borrow against the revolving line of credit.

As of December 31, 2004, cash obligations are as follows (in thousands):

Purchase commitments include $2.8 million of purchase orders that are cancelable if business conditions indicate that further curtailment of spending is necessary.

We have indemnified IDT for two years with respect to representations and warranties made by us related to the sale of our San Jose campus. The limit of Electroglas’ liability for breach of the representations and warranties was $3.5 million in the sale agreement, and a $0.5 million reserve was recorded in January 2005 for the net present value of the Company’s guarantee obligations under the indemnification provisions.

Impact of Recently Issued Accounting Pronouncements

In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment,” (SFAS 123(R)), which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation,” (SFAS 123). SFAS 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” SFAS 123(R) is effective at the beginning of the first interim or annual period beginning after June 15, 2005. Generally, the approach to accounting for share-based payments in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values (i.e., pro forma disclosure is no longer an alternative to financial statement recognition). We plan to adopt SFAS 123(R) in the third quarter of 2005. While the effect of the adoption is not anticipated to have a material impact on our financial position or cash flows, it is expected to have a material impact on our results of operations. For the third and fourth quarters of 2005, we expect to record stock-based compensation charges of approximately $0.3 million and $0.2 million, respectively, using the Black Scholes

27

Table of Contents

model to value options issued and outstanding as of December 31, 2004. We are currently evaluating the available option pricing models, which will be utilized in implementing SFAS 123(R). The amount of stock-based compensation charges related to 2005 grants cannot be estimated at this time. (See Note 1, Summary of Significant Accounting Policies: Stock based Compensation and Employee Stock Plans.)

In November 2004, the FASB issued Statement No. 151, “Inventory Costs an amendment of ARB 43, Chapter 4 (SFAS 151), which is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for fiscal years beginning after SFAS 151 is issued. SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “… under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges…” SFAS 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, SFAS 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We plan to adopt SFAS 151 in fiscal 2005 and the effect of the adoption is not anticipated to have a material impact on our financial position, results of operations or cash flows.

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, was 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 our investors that these objectives can be met, which would likely have a material and adverse effect on our business and operating results.

Our historical financial results have been, and our future financial results are anticipated to be, subject to substantial fluctuations.    Total revenues for 2004 were $63.0 million compared to $45.0 million in 2003 and $57.1 million in 2002. The increase in 2004 was due primarily to increased unit volume sales combined with higher average selling prices on our prober systems. The decline in 2003 was due primarily to lower revenue on system sales of our core prober business as a result of the recent 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 an operating loss of $15.8 million in 2004 compared to an operating loss of $57.4 million in 2003 and $81.0 million in 2002. In 2004, customers resumed their capital spending in response to recent indications of a possible market recovery, however the demand for our products follows the semiconductor test markets, which remain highly cyclical and difficult to forecast. Recent announcements in the semiconductor test markets indicate a slowing trend affecting our customers’ capital purchases. Another economic slowdown and/or changes in demand for our products and services and other factors could continue to adversely affect our business in the near term, and we may experience additional declines in revenue and increases in operating losses. We cannot assure our investors that we will be able to return to operating 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 and available credit facilities at December 31, 2004 combined with proceeds from the sale of our San Jose campus should be sufficient to meet our anticipated needs for working capital and capital expenditures through the next twelve months. However, we

28

Table of Contents

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 operating 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 results. Our backlog at the beginning of each period does not necessarily determine actual sales for any succeeding period. Our sales have often reflected orders shipped in the same period that they were received. However, customers may cancel or reschedule shipments, and production difficulties could delay shipments. For the years ended December 31, 2004, 2003 and 2002, five of our customers accounted for 63%, 54% and 41%, 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 2005 due to the completion of several product development programs. 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. For example, our 300mm wafer probers have not yet achieved broad market acceptance, which has resulted in a significant loss in market share.

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 and Tokyo Seimitsu, both of which are based in Japan. In this market, these 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.

29

Table of Contents

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 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 control of the Company.

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 our knowledge, Lemelson has not asserted that we may be liable for infringing its 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 appealed this decision. Given the pending appeal, and the inherent uncertain in litigation, we cannot assure you that the ultimate outcome will be favorable to us nor can we predict the effect of such litigation on our business. For a further discussion, see Part II. Other Information—Item 1. Legal Proceedings.

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 63%, 65% and 48% of our net sales for the years ended December 31, 2004, 2003 and 2002, 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:

30

Table of Contents

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. Our past sales in Japan have not been significant.

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. Approximately half of our outstanding common stock options have an exercise price above the current market price of our common stock.

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.

While we believe that we currently have adequate internal controls over financial reporting, we are exposed to risks from recent legislation requiring companies to evaluate those internal controls.    Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control structure and procedures for financial reporting. We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements. This legislation is relatively new and neither companies nor accounting firms have significant experience in complying with its requirements. As a result, we have incurred increased expense and devoted additional management resources to Section 404 compliance. Further, the costs and management time relating to compliance with the requirements of the Sarbanes-Oxley Act of 2002 in the future may also be substantial. In the

31

Table of Contents

event that our chief executive officer, chief financial officer or independent registered public accounting firm determine that our internal controls over financial reporting are not effective as defined under Section 404, investor perceptions of the Company may be adversely affected and could cause a decline in the market price of our stock.

Changes in stock option accounting rules may adversely affect our reported operating results, our stock price, and our ability to attract and retain employees.    In December 2004, the Financial Accounting Standards Board published new rules that will require companies in 2005 to record all stock-based employee compensation as an expense. The new rules apply to stock options grants, as well as a wide range of other share-based compensation arrangements including restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. We will begin to apply the new financial accounting rules in the quarter ending September 30, 2005. In the past, we have depended upon compensating our officers, directors, employees and consultants in part with such stock based compensation awards to attract and retain officers, directors, employees and consultants. Accordingly, if we continue to grant stock options or other stock based compensation awards to our officers, directors, employees, and consultants after the new rules apply to us, our future earnings, if any, will be reduced (or our future losses will be increased) by the expenses recorded for those grants. These compensation expenses may be larger than the compensation expense that we would be required to record were we able to compensate these persons with cash in lieu of securities. Since we are a small company, the expenses we may have to record as a result of future options grants may be significant and may materially negatively affect our reported financial results. The adverse effects that the new accounting rules may have on our future financial statements should we continue to rely on stock-based compensation may reduce our stock price and make it more difficult for us to attract new investors. In addition, reducing our use of stock plans to reward and incent our officers, directors and employees, could result in a competitive disadvantage to us in the employee marketplace and make it difficult to attract and retain key personnel.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

At December 31, 2004, 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 financial statements would be approximately $0.4 million. The table below presents notional amounts and related weighted-average interest rates by year of maturity for our investment and debt portfolios:

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.

32

Table of Contents

Item 8.    Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

33

Table of Contents

ELECTROGLAS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)