ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion contains, in addition to historical information, forward-looking statements. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and in the Company's 1995 annual report on Form 10-K.

In particular, the Company believes that the following factors could impact forward-looking statements made herein or in future written or oral releases and by hindsight, prove such statements to be overly optimistic and unachievable: volatility of the semiconductor and semiconductor equipment industries, customer concentration, dependence on design wins, rapid technological change and dependence on new system introduction, competition, and management of growth.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995

SALES

Sales for the third quarter of 1996 were $21.6 million, a decrease of 16% from third quarter of 1995 sales of $25.6 million. The Company's sales decline in the third quarter of 1996 resulted from the decreased unit sales of the Company's systems and a change in product mix, which also reduced the average selling price for the period. A significant part of this unit sales decrease is attributable to decreased demand by domestic semiconductor equipment customers, primarily the Company's two largest customers.

The Company continues to be cautious about the outlook for future sales to the semiconductor equipment industry. During the most recent quarter, 52% of the Company's revenue came from this industry, down from 57% in the same quarter a year ago.

GROSS MARGIN

The Company's gross margin for the third quarter of 1996 was 30.5% of revenue, down from 50.2% of revenue in the comparable period in 1995, and down from 42.3% in the second quarter of 1996. The decline in gross margin in the third quarter of 1996 was primarily the result of underabsorbed fixed manufacturing costs. Revenues in the current quarter were $3.9 million lower than in the third quarter of 1995 and $8.2 million lower than in the second quarter of 1996, while fixed overhead expenses were increased during 1995 and early 1996 to provide higher capacity. The Company expects underabsorption of manufacturing overhead will continue to adversely impact gross margin until sales

levels improve. Additionally, gross margin was negatively impacted by a shift in product mix toward products on which material costs increased as a percentage of sales and by increased customer service costs, which increased as a percentage of sales, as a result of the lower sales base.

During the third quarter, the Company announced cost containment measures in response to recent declines in orders to the semiconductor capital equipment market. As part of these measures, the Company reduced headcount by 7 percent, reduced leased facilities by 7 percent, initiated a 10% decrease in senior management salaries and reevaluated inventories for excess and obsolete parts. These efforts resulted in additional charges of $350K related to severance pay, charges associated with subleasing facilities and an increased provision for excess inventories.

RESEARCH AND DEVELOPMENT

The Company's research and development costs are associated with researching new technologies, developing new products and improving existing product designs. Research and development expenses for the third quarter of 1996 were $3.3 million, compared to expenses of $2.7 million in the third quarter of 1995, representing an increase of 22%. As a percentage of sales, research and development expenses increased to 15.5% in the third quarter of 1996 from 10.6% in the third quarter of 1995. The increase is primarily associated with costs incurred to support new product development.

The Company believes that continued research and development investment is essential to ongoing development of new products. Since inception, all research and development costs have been internally funded and expensed.

SALES AND MARKETING

Sales and marketing expenses support domestic and international sales and marketing activities which include personnel, trade shows, advertising, and other marketing activities. Sales and marketing expenses for the third quarter of 1996 were $2.2 million, compared to expenses of $1.6 million in the third quarter of 1995, representing an increase of 38%. As a percentage of sales, sales and marketing expenses increased to 10.2% in the third quarter of 1996 from 6.1% in the third quarter of 1995. The dollar increase is attributable to costs associated with expansion of the sales and marketing infrastructure to support the sales volume increase realized in the second quarter of 1996. As a percentage of sales, the major increase is a result of the lower sales base.

The Company is reorganizing its sales and marketing team to better address the specific needs of its customers. As a result, sales and marketing expenses are expected to increase as a percentage of sales in future periods.

GENERAL AND ADMINISTRATIVE

General and administrative expenses support the worldwide financial, administrative, information systems and human resources functions of the Company. General and administrative expenses for the third quarter of 1996 were $0.9 million, compared to expenses of $1.8 million in the third quarter of 1995, representing a decrease of 42%. As a percentage of sales, these expenses decreased to 4.3% in the third quarter of 1996 from 7.0% in the third quarter of 1995. The decrease during the third quarter was primarily attributed to reductions made to previously accrued bonuses and other employee benefits.

The Company is currently implementing information management system software which will replace existing systems to support its growth. The Company expects that significant charges related to training and implementation of the new software will occur during 1996 and 1997. The expenses incurred to date have been recognized in the appropriate functional area.

OTHER INCOME (EXPENSE)

Other income and expense consists primarily of foreign exchange gains and losses, interest expense and other miscellaneous income and expense items. Other income was $0.1 million for the third quarter of 1996, compared to other expenses of $0.6 million in the third quarter of 1995.

The Company has experienced fluctuations in foreign currency exchange rates during the past few months. As a hedge against significant currency fluctuations in the Japanese yen, the Company has entered into various forward foreign exchange contracts to lessen exposures to foreign exchange losses.

PROVISION FOR INCOME TAXES

The income tax provision of $0.1 million for the third quarter of 1996 represented an estimated effective rate of 40.3%. The income tax provision in the comparable period in 1995 was $2.1 million, representing an estimated rate of 34.3%. The Company adjusts its income taxes periodically based upon the anticipated tax status of all foreign and domestic entities.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995

SALES

Sales for the first nine months of 1996 were $78.6 million, an increase of 15% from sales of $68.5 million in the comparable period in 1995. The Company's sales growth during the periods presented has resulted from the increased unit sales of the Company's

systems, primarily in the first half of 1996. A significant part of this growth is attributable to higher sales to domestic customers, primarily the Company's two largest customers.

GROSS MARGIN

The Company's gross margin for the first nine months of 1996 was 37.3% of revenue, down from 49.7% of revenue in the comparable period in 1995. The decline in gross margin in the first nine months of 1996 was primarily affected by higher material costs associated with outsourcing assemblies, changes in product mix, including some shift toward lower margin CE products, and underabsorbed overhead costs. Average selling prices for the two comparative nine month periods remained relatively constant.

RESEARCH AND DEVELOPMENT

Research and development expenses for the first nine months of 1996 were $10.5 million, compared to expenses of $7.1 million in the comparable period in 1995, representing an increase of 48%. As a percentage of sales, research and development expenses increased to 13.3% in the first nine months of 1996 from 10.4% in the first nine months of 1995. The increase is primarily associated with costs incurred to support new product development.

SALES AND MARKETING

Sales and marketing expenses for the first nine months of 1996 were $6.5 million, compared to expenses of $4.3 million in the comparable period in 1995, representing an increase of 51%. As a percentage of sales, these expenses increased to 8.3% in the first nine months of 1996 from 6.3% in the first nine months of 1995. The increase is attributable to costs associated with expansion to support the increase in sales volume, and to provide additional support to customers.

GENERAL AND ADMINISTRATIVE

General and administrative expenses for the first nine months of 1996 were $5.0 million, compared to expenses of $5.4 million in the comparable period in 1995, representing a decrease of 7%. As a percentage of sales, these expenses decreased to 6.3% in the first nine months of 1996 from 7.9% in the first nine months of 1995. The decrease in general and administrative expenses as a percentage of sales was primarily attributed to reductions made to previously accrued bonuses and other employee benefits.

OTHER INCOME (EXPENSE)

Other expenses were $0.1 million for the first nine months of 1996, compared to $0.5 million in the comparable period in 1995.

PROVISION FOR INCOME TAXES

The income tax provision of $2.7 million for the first nine months of 1996 represented an estimated effective rate of 38.1%. The income tax provision in the comparable period in 1995 was $6.2 million, representing an estimated rate of 37.1%. The Company periodically adjusts its income tax provision based upon the anticipated tax status of all foreign and domestic entities.

LIQUIDITY AND CAPITAL RESOURCES

Until the initial public offering of the Company's common stock in November 1995, the Company financed its operations, acquired equipment and met its working capital requirements through borrowings under its revolving line of credit, long-term loans secured by property and equipment and cash flow from operations.

Cash provided by operations totaled $0.5 million for the first nine months in 1996 compared to $2.5 million for the same period in 1995. Cash provided in the first nine months of 1996 was primarily a result of net income offset by decreases in accounts payable. Cash provided in the comparable period in 1995 was primarily a result of net income and increases in accounts payable and income taxes payable offset by increases in accounts receivable and inventories.

Investing activities, consisting primarily of equipment acquisitions and leasehold improvements, used cash of $4.9 million in the first nine months of 1996, versus $2.4 million in the comparable period in 1995. Financing activities in the first nine months of 1996 consisted primarily of note and loan repayments and used cash of $0.4 million. In the comparable period in 1995, financing activities consisted primarily of proceeds from and repayments to the Company's revolving line of credit, proceeds from notes payable, and repayment of notes payable and capital lease obligations and generated cash of $0.6 million.

The Company plans to spend approximately $0.4 million through the remainder of 1996 for the acquisition of equipment and integrated information management system software, leasehold improvements and furnishings.

As of September 30, 1996, the Company had working capital of $34.4 million. The Company's principal sources of liquidity consisted of $8.5 million of cash and cash equivalents and $8.0 million available under an $8.0 million revolving line of credit that bears interest at the prime rate (8.25% at October 15, 1996). The Company has the option to convert up to $3.0 million of its revolving line of credit to a 36-month term loan that would bear interest at prime rate plus 0.50%.

The Company also has a term loan for equipment financing for its US operations. At September 30, 1996, $1.2 million was outstanding under the term loan, which bears

interest at prime plus 0.75% and is due July 31, 1999. During the third quarter, the Company entered into an agreement for a term loan of $0.2 million to provide working capital for its Japan operations. The Company also entered into an agreement in November 1995, that provides the Company with a $1.5 million line of credit to purchase equipment. At September 30, 1996, there were no amounts outstanding under this line of credit.

The Company believes that its cash and cash equivalents, cash flow from operations and available borrowings, will be sufficient to meet the Company's working capital needs through at least the first half of 1997. After that time, the Company may require additional equity or debt financing to address its working capital, capital equipment, or expansion needs. There can be no assurance that additional funding will be available when required or that it will be available on terms acceptable to the Company.