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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 000-26911

(510) 668-2200

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

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

     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 þ          No o

      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.     o

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

      The aggregate market value of the common equity held by non-affiliates of the registrant, based upon the closing price as of the last business day of the registrant’s most recently completed second fiscal quarter (September 28, 2003) as reported by the Nasdaq National Market, was approximately $122 million.

      As of June 1, 2004, the registrant had 35,652,190 shares of common stock outstanding.

      Portions of the Proxy Statement for the 2004 annual stockholders meeting are incorporated by reference into Part III.

THERMA-WAVE, INC.

Form 10-K

TABLE OF CONTENTS

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PART I

      This annual report on Form 10-K contains forward-looking statements, including, without limitation, statements concerning the conditions in the semiconductor and semiconductor capital equipment industries, our operations, economic performance and financial condition, including in particular statements relating to our business and growth strategy and product development efforts. The words “believe,” “expect,” “anticipate,” “intend” and other similar expressions generally identify forward-looking statements. Potential investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties, including, without limitation, those identified under Exhibit 99.1, “Risk Factors,” and elsewhere in this annual report and other risks and uncertainties indicated from time to time in our filings with the SEC. Actual results could differ materially from these forward-looking statements. In addition, important factors to consider in evaluating such forward-looking statements include changes in external market factors, changes in our business or growth strategy, an inability to raise additional funds if necessary, an inability to execute our strategy due to changes in our industry or the economy generally, the emergence of new or growing competitors, an inability to develop or introduce new products as planned, or the acceptance of those products by our customers and various other competitive factors. In light of these risks and uncertainties, there can be no assurance that the matters referred to in the forward-looking statements contained in this annual report will in fact occur.

Overview

      Therma-Wave develops, manufactures, markets and services process control metrology systems used in the manufacture of semiconductors and controls significant market share in the metrology industry. Process control metrology is used to monitor process parameters in order to enable semiconductor manufacturers to maintain high overall manufacturing yield, reduce the size of the circuit features imprinted on the semiconductor to improve the performance of the semiconductor device and increase their equipment productivity. Our current product families, Therma-Probe^®, Opti-Probe^®, Opti-Probe CD™ and RT/CD^®, Integra^® integrated metrology products, use proprietary and patented technology to provide precise, non-contact, non-destructive measurements for the basic building blocks, or process modules, in the manufacture of integrated circuits, or ICs:

	•	Ion Implantation — implanting ions, usually boron, phosphorus or arsenic, into selected areas of the silicon wafer to alter its electrical properties. Ion implantation may be performed typically ten to 24 times in the manufacture of ICs. For example, ion implantation creates the positively- and negatively-doped regions used to create each of the millions of transistors on each integrated circuit. It also is used to adjust the voltage (threshold voltage) at which the transistors will “turn on”. Our Therma-Probe product is used as a standard metrology tool for these ion implantation processes.
	•	Dielectric Film Deposition and Etching — depositing and selectively removing layers of dielectric films on the silicon wafer in order to provide electrical insulation for each layer of the semiconductor IC. Film deposition is typically done by Chemical Vapor Deposition, or CVD, and film removal is typically done by plasma etching. Our Opti-Probe is used as a standard, in-line metrology tool for film thickness in these processes. Our Opti-Probe CD and RT/CD, or Real-Time Critical Dimensions, and Integra integrated metrology products, are newly introduced products which provide rapid, non-destructive wafer-state information for control of the critical dimensions, or CDs, of the etch processes.
	•	Conductor Film Deposition and Etching — depositing and selectively removing layers of metal, polysilicon, and metal barrier films used to interconnect the transistors within a semiconductor device. Film deposition is typically done by Ppysical vapor deposition, or PVD, electrochemical deposition, or ECD, or by CVD. Film removal is typically done by plasma etching or chemical mechanical planarization. Our Opti-Probe is used as a standard metrology tool for the non-opaque conductor films.

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		Our Opti-Probe CD and RT/CD, and Integra integrated metrology products provide rapid, non-destructive wafer-state information for control of the CDs of the etch processes.
	•	Chemical Mechanical Planarization, or CMP — “leveling” the top surface of the wafer after each layer of device features is added. The leveling is done by mechanical polishing in a chemical solution, and is required to maintain flatness of the wafer throughout the sequence of hundreds of process steps. Our Opti-Probe is used as a standard, in-line metrology tool for film thickness in these processes.
	•	Wafer Patterning — using photolithographic techniques to create the fine (sub-micron) structures that define the integrated circuit. The wafer patterning is typically done by “stepper” exposure systems and the photoresist developing and removal is done by coater/developer “track” systems and “asher/strip” systems. Our Opti-Probe is used as a standard, in-line metrology tool for film thickness and reflectivity in these processes. Our Opti-Probe CD and RT/ CD, and Integra integrated metrology products provide rapid, non-destructive wafer-state information for control of the CDs of the wafer patterning process.

      Industry Background

      The demand for semiconductors has increased as the use of semiconductors has expanded beyond personal computers and computer systems to a wide array of additional applications, including telecommunication and data communication systems, automotive systems, consumer electronics, medical products and household appliances. Additionally, the Internet has stimulated the need for more high performance semiconductor devices. As a result, semiconductors have become more complex, requiring:

	•	successive decreases in feature line width, for example, from 150 nanometers, or nm to 130 nm, from 130 nm to 110 nm, and from 110 nm to 90 nm;
	•	as many as 500 process steps; and
	•	an increase in the number of metal or “interconnect” layers.

      Additionally, the life cycle for these semiconductor device processes has been compressed from four years in the early 1990s to approximately two years today. The increase in device complexity and reduction in product life cycles have led to a more costly and complex manufacturing process. At the same time, semiconductor manufacturers have continued to face significant price pressure due to competition in the industry. These factors have led semiconductor manufacturers to intensify efforts to improve fab productivity, including the increased use of process control metrology.

      Process control metrology is used to monitor process parameters in order to enable semiconductor manufacturers to reduce costs and improve device performance. Historically, semiconductor manufacturers have achieved annual reductions in cost per chip function through productivity improvements including reduced feature size, increased wafer size and increased equipment productivity. Although increasing wafer size and yield (percentage of “good” ICs per wafer) will continue to be sources of productivity gains by semiconductor manufacturers, increasingly, we believe, gains will come from reduced feature size and non-yield-derived manufacturing productivity enhancements. This important last category includes increased equipment uptime, reduced manufacturing space requirements, reduced use of wafers for testing purposes and lower tool maintenance costs.

Therma-Wave Metrology Solutions

      Our family of metrology products currently consists of the following product lines:

      The Therma-Probe product family was introduced in 1985 as our initial product line, and the Opti-Probe product family was introduced in 1992. Both product families feature proprietary and patented measurement technologies and offer robotic wafer handling, advanced vision processing, sophisticated but user-friendly

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      Opti-Probe CD and RT/ CD (Real-Time Critical Dimension): The Opti-Probe CD is a spectroscopic ellipsometer-based system that provides nondestructive Critical Dimension metrology for the smallest features of the next generations of ICs. This product employs our new RT/CD analysis software that provides real-time CD and profile results, and solutions based on a previously generated and stored library. During this fiscal year, we continued our expansion from being a hardware system supplier to a more complete CD system supplier (Opti-Probe CD plus RT/CD analysis software).

      Integra integrated metrology products: Integrated Metrology, or IM, is based on compact metrology “modules” which are installed and function inside an IC process system such as an etcher or coater/developer track system to provide metrology on each wafer before it exits the process tool. Originating as a means to further boost IC fab productivity, we believe IM is a growing trend in the semiconductor industry and that our Integra IM product offering is one of the most diverse in the semiconductor metrology industry.

      These products represent a substantial expansion of our fab productivity enhancement offerings to the semiconductor industry, and represent a growth in our addressed market by over 100%.

      For the years ended March 31, 2004, 2003 and 2002, revenues from the Opti-Probe product family accounted for approximately 44%, 41% and 62%, respectively, of our total net revenues. Revenues from the Therma-Probe product family accounted for approximately 8%, 11% and 13%, respectively, of our total net revenues in fiscal 2004, 2003 and 2002.

Therma-Probe Ion Implant Monitoring Products

      A key process step in the fabrication of semiconductor devices is the implantation of ions of boron, phosphorous, arsenic, antimony, and indium into selective areas of the silicon wafer to alter its electrical properties. Control of the accuracy and uniformity of the ion implant dose is critical to device performance and yield. Ion implantation is generally performed several (typically ten to 24) times during the early phases of the fabrication cycle. As a result, there is typically a time lag of several weeks between these implant steps and the first electrical measurements that indicate whether the ion implantation process was properly executed. Failure to identify improper ion implantation can be extremely costly to a semiconductor manufacturer if the wafer production is permitted to continue in error. To test on a more timely basis whether the ion implantation was properly executed, semiconductor manufacturers historically used a four-point probe, which required physical contact between the probe and the silicon wafer surface. Because the physical contact with the wafer surface produces silicon particles (defects), which can kill IC yield, the four-point probe method can only be used on monitor wafers (non-production blank wafers that have no IC devices on them). In contrast to that method, Therma-Probe’s ability to measure nondestructively on actual production IC wafers decreases manufacturing costs by reducing the need for test wafers. In addition, Therma-Probe systems detect implant processing problems that only affect the product wafers and which are not revealed by utilizing test wafer monitoring alone.

      As semiconductor devices decrease in size, demands for the formation of Ultra-Shallow-Junctions, or USJs, for source/drain formation are increasing. One of the main challenges in the scaling of complementary metal oxide semiconductor, or CMOS, devices is the formation, control and monitoring of these USJs. The Therma-Probe system performs nondestructive evaluation of USJs for junction depth and junction abruptness simultaneously. These measurements are enabled by our proprietary USJ software. This Therma-Probe capability allows engineers to monitor and contol the formation of USJs in CMOS device fabrication.

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      The Therma-Probe systems employ proprietary thermal wave technology that uses highly focused but low power laser beams to generate and detect thermal and plasma wave signals in the silicon wafer. Proprietary software correlates the signals to the ion implant dose. Unlike previous ion implant metrology systems, the Therma-Probe systems utilize a non-contact, non-damaging technology and thus can be used to monitor product wafers immediately after the ion implantation process. These features have been integrated into an easy-to-use and reliable package with automated wafer handling and statistical data processing.

      In 2003, we introduced the Therma-Probe XP Series for 200 and 300 mm ion implantation metrology applications. With the introduction of the XP-Series, the dose detectability and long term stability of the original Therma-Probe products have been further improved to provide more robust and repeatable measurement capability for the 90-nm technology node and beyond.

      We believe that our Therma-Probe systems offer the following technological advantages and benefits:

	•	Proprietary Technology. To provide non-contact, non-contaminating ion implant measurements on product wafers, Therma-Probe systems employ proprietary thermal wave technology, which uses highly focused but low power laser beams to generate and detect thermal wave signals in the silicon wafer that can be correlated to the ion implant dose. The thermal wave technology used to measure these signals is an extensively patented technology owned by our company.
	•	Ease of Use and Reliability. The Therma-Probe systems are configured specifically for use by semiconductor device manufacturers and feature automated wafer handling, automated data collection, statistical data processing and data management for 200 and 300 mm wafer applications.
	•	Continuous Improvement. We continue to develop, manufacture and market new and improved Therma-Probe systems to enhance system capability and to lower the cost of ownership to the customer. For example, the most recent generation TP-630XP Series possesses state-of-the-art ion implant measurement technology with enhanced dose detectability, long-term stability, and USJ capabilities for wafer sizes up to 300 millimeters.

      The following table summarizes the Therma-Probe product history:

Opti-Probe Thin-Film Metrology Systems

      The majority of the 200 to 500 process steps required to fabricate semiconductors on a silicon wafer involve the deposition and selective removal of a variety of insulating and conducting thin films. Thin-film metrology systems measure the thickness and material properties of these thin films and, because they are

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      Increasingly, traditional, single-technology film metrology systems have been unable to meet the process control metrology demands of the semiconductor industry. The continual demand for improved precision and repeatability requires the ability to measure thicknesses that range from extremely thin films, which generally measure below 20 angstroms, to films that are hundreds of thousands times thicker. Reflection spectrometers are most suitable for measuring thicker films, whereas ellipsometers are most suitable for measuring very thin films. Furthermore, the industry is now using film stacks composed of several layers of different films and the optical properties of many films are functions of the actual deposition conditions. Generally spectrometers or ellipsometers alone generate insufficient data to simultaneously determine the thicknesses and properties of these film stacks and new films with the precision and accuracy that semiconductor manufacturers require. Reflection spectrometer and most ellipsometer have limited capabilities for such simultaneous measurements of both thickness and optical parameters when used as independent standalone measurement technologies.

      Opti-Probe systems improve upon existing thin-film metrology systems with the integration of up to five distinct film measurement technologies, three of which are patented by our company. By combining the measured data from these multiple technologies, Opti-Probe systems provide increased measurement capability leading to higher yields, less misprocessing, less rework, faster production ramp-up and increased productivity on both test and product wafers.

      Several technological advantages and benefits of Opti-Probe systems including the following:

	•	Proprietary Measurement Technology. Opti-Probe systems combine up to five complementary measurement technologies: Beam Profile Reflectometry, or BPR®, Beam Profile Ellipsometry, or BPE®, Deep Ultra Violet Reflectometery, or DUV, Absolute Ellipsometery, or AE® and Rotating Compensator Spectroscopic Ellipsometery, or RCSE. Each technology addresses specific film measurement applications. The integration of these multiple technologies on a single tool allows for a wide range of capabilities on a single tool. Additionally, due to the amount of data that can be obtained by combining these optical technologies, it is possible to determine the thickness and optical parameters of multiple films simultaneously. We hold patents on the use of many of the combinations of these thin-film measurement technologies.
	•	Proprietary Software. The use of proprietary software algorithms in conjunction with the spectral information collected by the Opti-Probe measurement hardware enables the calculation of the film thickness and optical properties.
	•	Ease of Use and Reliability. Opti-Probe systems are configured specifically for semiconductor device manufacturers and feature automated wafer handling, advanced image processing, automated data collection, statistical data processing and data management.
	•	Continuous Improvement. We continue to develop, manufacture and market new and improved systems. We strive to provide the semiconductor industry with thin-film metrology systems that meet the precision, repeatability and matching requirements for each new technology node.

      In 1992, we introduced the first Opti-Probe system based on our patented BPR measurement technology to meet the film measurement needs for the 250-nm technology node. Over the years the Opti-Probe products

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      The following table summarizes the Opti-Probe product history:

Opti-Probe CD and RT/ CD Products

      In January 2002, we introduced Opti-Probe CD with Real Time CD processing, or RT/ CD, a product designed to measure the lateral Critical Dimensions and cross-sectional shape, or profile, of fine IC features. As semiconductor device manufacturers continue to shrink feature sizes to the 90 nm technology node and smaller, traditional CD metrology techniques such as critical dimension scanning electron microscopy, or CD-SEM, lack the resolution and stability required to provide accurate data about feature critical dimensions and profiles. A significant limitation is that these methods provide only a top-down view of features and provide little or no data about characteristics of the sides or bottom of a structure.

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      Semiconductor manufacturers are often confronted with problems involving variations in profile and sidewall angle. Detailed knowledge of profile shape is of high importance. In shallow trench isolation, or STI, or damascene integration schemes, etched trenches to be filled by downstream process steps may have problematic re-entrant angles, notching, t-topping or other artifacts. These feature artifacts can lead to yield-killing conditions such as voiding and cracking of deposited films in later deposition fill process steps.

      For the critical gate patterning process, tight control of the gate CD correlates to improved device performance and better bin sort yields (and revenues/chip). Furthermore, shape anomalies such as undercut, microtrenching or notching, can have a detrimental effect on device speed and reliability. In these and other applications, precise shape profiling is crucial.

      Our Opti-Probe RT/ CD is the first optical CD scatterometry system that combines high-information content SE, optical measurement with ultra-fast calculation (“real-time regression”) to analyze and display results without the use of off-line modeling and solution libraries. Complex CD profiles can be calculated in seconds with precision and repeatability with structural information not available with standard CD-SEM technologies.

      The Opti-Probe CD system leverages our established Opti-Probe thin-film metrology platform for optical data acquisition. The Opti-Probe’s patented RCSE provides rich spectral data, ensuring detail and accuracy in the results. This non-destructive CD measurement technology is beneficial for the current prevalent microelectronics technology node (130 nm), and is extendable to the 65 nm technology node and beyond for a wide range of process applications.

Integrated Metrology Products

      In 2000, we committed to a program of developing a broad family of IM, modules under the product family name Integra. We have at this time both spectrometer and spectroscopic ellipsometer based IM units available in the marketplace. These are compact metrology units that contain a single measurement technology matched to the specific metrology need of a particular semiconductor process tool (etch, coater/developer, CVD, CMP, stepper, etc.) Each IM unit is installed directly into a semiconductor process tool, and can measure each wafer immediately after processing. In this manner, processing variations can be detected at the earliest possible moment, as opposed to the conventional procedure in which a 25-wafer lot is typically completed before metrology is first done, thereby leaving the entire lot at risk of becoming scrap. With 300 mm wafers, this economic loss becomes increasingly large due to the additional product value of each processed wafer.

      IM is becoming increasingly accepted as a means to reach greater productivity. Advanced semiconductor manufacturing today is under great pressure to deliver greater levels of process performance, production availability and process repeatability in order to minimize risk of product loss, improve manufacturing efficiencies and improve device yields. The transition towards 300 mm wafers, continuing device shrinks and the mixed foundry manufacturing models are key contributors to these trends. To successfully meet these challenges, device manufacturers and process tool equipment manufacturers are actively engaged in developing technologies for advanced process control, or APC. We believe that APC implementation requires the integration of metrology capabilities directly onboard the process tool.

      Device manufacturers can derive a wide range of benefits by implementing integrated metrology and APC strategies in their fabs. By integrating the measurement directly onto the process tool, they can greatly increase the rate of sampling and decrease the delay between the process step and measurement. Increasing the measurement frequency to every single wafer allows for rapid fault detection and correction. This reduces

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      To strengthen our position as a leader in integrated metrology, we acquired Sensys Instruments Corporation in January 2002 and Sensys became a wholly owned subsidiary of our company focusing on integrated metrology applications and developing business with process tool equipment suppliers. Subsequent to the acquisition, all of the integrated metrology development and business operations have been consolidated into a single integrated metrology business focus team concentrating on providing optical CD, thin-film, and overlay integrated metrology solutions to semiconductor process equipment makers.

      All of our integrated metrology products, including the products originally developed by Sensys, are grouped into a family of products with the INTEGRA name. These include:

	•	INTEGRA CCD-i — a second-generation reflectometer unit for high throughput thin-film, CMP and OCD applications based on the CD-i product, and
	•	INTEGRA iX-SE — a spectroscopic ellipsometer unit for high performance thin-film and OCD applications.

      During fiscal 2004, multiple CCD-i units were installed at key development and pilot production fabs in Europe, North America, Taiwan and Japan by a major coater/developer equipment supplier to the semiconductor industry. Additional end-user installations for advanced technology development and production lines are planned during fiscal 2005.

      During fiscal 2004, iX-SE units were installed at key development and pilot production fabs in North America and Taiwan by a major etcher equipment supplier to the semiconductor industry. These units and technology are currently under development and evaluation as metrology systems to enable future Advanced Process Control (APC) in etch module applications.

      As of March 31, 2004, we employed 349 people, including 89 in engineering, research and development, 55 in manufacturing, 131 in customer support, 44 in sales and marketing and 30 in executive and administrative functions. Many of our employees are highly trained and hold advanced post-graduate degrees in science and engineering. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We consider our employee relations to be good. We believe we have been able to attract and retain a highly talented group of managers, designers and engineers that enables us to continually improve our products and customer support. Due to reduction in force programs, we have terminated the employment of approximately 61 persons since March 31, 2003.

      We maintain sales offices and regional sales representatives throughout the world. In the United States, we maintain sales offices in California. We also utilize manufacturers’ sales representatives to cover those regions of the United States with too few customers to support a direct sales effort. In Asia, we maintain sales offices in Japan, China, Korea, Singapore and Taiwan. The Japan and Singapore offices work with manufacturers’ sales representatives to sell our products to customers in Japan, Singapore and Malaysia, while the China, Taiwan and Korea offices sell to customers directly. We also have sales representatives in the United Kingdom working with manufacturers’ sales representatives throughout the rest of Europe.

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      Sales to Taiwan Semiconductor Manufacturing Corporation, Intel Corporation, Tokyo Electon Limited, and Seki Technotron Corp. each accounted for more than 10% of net revenues in fiscal 2004. The following chart indicates the percentage of net revenues from each of these customers for fiscal years 2004, 2003 and 2002, respectively.

      International revenues in fiscal 2004, 2003 and 2002 accounted for approximately 72%, 72% and 62% of net revenues in each of these periods, respectively. We anticipate that international sales will continue to account for a significant portion of our net revenues in the foreseeable future. The following chart indicates the percentage of net revenues that we derived from our sales to Taiwan and Japan, our two largest overseas markets:

      In addition, we provide direct customer support in most parts of the world. In some locations, field service is still provided by the same manufacturers’ sales representative that handles the sales function, but applications support is provided by our employees in that territory. In the United States, we have field service and applications engineers located in Arizona, California, Florida, Idaho, Massachusetts, New Mexico, Oregon, Tennessee, Texas and Washington. Customers contract for dedicated site-specific field service and applications engineers. In Asia, we provide direct customer support in Japan, China, Taiwan, Korea and Singapore. In Europe and the Middle East, our service and applications personnel, located in France, the United Kingdom, Italy, Ireland and Israel provide direct customer support to customers in Europe and the Middle East and to our European manufacturers’ sales representatives. We provide our customers with comprehensive support before, during and after delivery of our products. Prior to shipment, our support personnel typically assist the customer in site preparation and inspection, and provide customers with training at our facilities and at the customer’s location. Our customer training programs include instructions in the maintenance of our systems and in system hardware and software tools for optimizing the performance of our systems. Our field support personnel work with the customers’ employees to install the equipment and demonstrate equipment readiness. In addition, we maintain a group of highly skilled applications scientists to respond to customers’ process needs worldwide when a higher level of technical expertise is required.

      We generally warrant our products for a period of up to 12 months from system acceptance, although this can, at times, be extended according to the terms of a particular contract. Installation and initial training are customarily included in the price of the system. After the expiration of the warranty period, customers may enter into support agreements covering both field service and field applications support. Our field service engineers may also provide customers with repair and maintenance services on a fee basis. Our applications engineers and scientists are also available to work with the customers on recipe development. Additionally, for a fee, we train customers to perform routine maintenance on their purchased tools. We also provide a 24-hour telephone help-line.

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      Our backlog consists of orders not yet shipped, deferred revenues for products that have been shipped and invoiced but have not yet been recognized as revenue in accordance with SAB 104, recurring fees payable under support contracts with our customers and orders for spare parts and billable services, such as non-recurring engineering services. Orders that are scheduled for shipment beyond the twelve-month window are not included in backlog until they fall within the twelve-month window. Orders are subject to rescheduling or cancellation by the customer, usually without penalty. Because of possible changes in product delivery schedules and cancellation of product orders and because our sales will sometimes reflect orders shipped in the same quarter that they are received, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. At March 31, 2004, our backlog was $27.5 million, compared to $19.0 million at March 31, 2003.

      The process control metrology market is characterized by continuous technological development and product innovations. We believe that continued and timely development of new products and enhancements to existing products is necessary to maintain our competitive position. Accordingly, we devote a significant portion of our personnel and financial resources to engineering and research and development programs. As of March 31, 2004, our research, development and engineering staff comprised 89 people. We seek to maintain our close relationships with customers to make improvements in our products that respond to customers’ needs. For example, several of the improvements relating to the Opti-Probe and RT/ CD product families were developed in cooperation with some of our major customers to address their needs for more capable thin-film measurement systems.

      Software development accounts for a significant portion of our research and development efforts. We are currently transitioning all of our software applications from DOS to the Microsoft NT operating system in order to better serve our customers. NT is now the standard operating system used by our Opti-Probe customers for 300 millimeter wafer production.

      Our ongoing engineering and research and development efforts can be classified into three categories: new products; feature enhancements, such as features to improve precision, speed and automation; and customer-driven product enhancements, such as new measurement recipes or algorithms. We have research and development and engineering staffs working both on developing new products and features and on responding to the particular needs of customers. As a result of these efforts, we introduced a new Opti-Probe thin-film measurement family and a new Critical Dimension measurement product in fiscal year 2003.

      Engineering and research and development expenses were $18.7 million, $29.2 million and $29.1 million, in fiscal 2004, 2003 and 2002, respectively, or 29%, 59% and 36% of net revenues for those periods, respectively. We expect engineering and research and development expenditures will continue to represent a substantial percentage of our net revenues for the foreseeable future. The decrease in the percentage of research and development expenses to net revenues for fiscal year 2004 compared to 2003 reflects increased net revenues and decreased spending in 2004. We expect research and development expenditures to increase gradually but to decrease as a percentage of net revenues over time as industry conditions and our net revenues improve.

      Our manufacturing strategy is to produce technologically advanced and high quality metrology systems. We currently perform the majority of our system assembly activities in-house. In order to lower production costs in the future, we intend to perform in-house only those manufacturing activities that add significant value or that require unique technology or specialized knowledge. As a result, we expect to rely increasingly on subcontractors and turnkey suppliers to fabricate components, build assemblies and perform other activities in a cost effective manner.

      Our principal manufacturing activities include assembly and test work, both of which are conducted at our facility in Fremont, California. Assembly activities include inspection, subassembly and final assembly. Test activities include modular testing, system integration and final testing. Components and subassemblies,

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      We schedule production based upon firm customer commitments and anticipated orders. We have structured our production process and facility to be driven by both orders and forecasts and have adopted a modular system architecture to increase assembly efficiency and test flexibility. Cycle times for our products vary significantly. We believe these cycle times will improve as we continue to emphasize manufacturability in our new product designs.

      We conduct the assembly of some optical components and final testing of our systems in clean-room environments. This procedure is intended to reduce the amount of particulates and other contaminants in the final assembled system, and test our products against our customers’ acceptance criteria prior to shipment. Following the final test, the completed system is packaged within triple vacuum-sealed bags to maintain a high level of cleanliness during shipment and installation.

      The market for semiconductor capital equipment is highly competitive. We face substantial competition in each of the markets that we serve. Some of our competitors have greater financial, engineering, manufacturing and marketing resources and broader product offerings than we have. Significant competitive factors in the market for metrology systems include system performance, ease of use, reliability, cost of ownership to the customer, technical support and customer relationships. We believe we compete favorably on the basis of these factors in each of our served markets. We compete with both larger and smaller companies in the markets we serve.

      Our Therma-Probe systems compete primarily with other metrology systems designed to measure ion implant dose in some alternative fashion, such as contact and destructive four-point probe measurement systems, including those manufactured by KLA-Tencor Corporation, Applied Materials, Inc. and Kokusai Electric Ltd. Our Therma-Probe systems are non-contact, nondestructive ion implant metrology systems for product wafers and have a major share of the market. Several years ago, Jenoptik GmbH introduced a competitive product to our Therma-Probe systems, which utilized thermal wave technology. In November 1997, a jury found that Jenoptik’s product infringed on a number of our United States patents. As a result of the settlement of this litigation, Jenoptik has agreed not to sell any of its metrology products in the United States until the patents expire and to pay us a royalty fee for systems sold in Japan. To date, the sale of these products by Jenoptik (or TePla AG, who has purchased these rights from Jenoptik) has not had a material impact on our market position.

      On April 22, 2002, we filed a patent infringement suit against Boxer Cross Inc. We believe the Boxer Cross BX-10 product infringed certain patents held by us related to ion implant monitoring. More recently, Boxer Cross introduced a competitive product to our Therma-Probe systems that utilizes a similar technology. In July 2003, we settled this lawsuit and dismissed our claims.

      Our Opti-Probe film thickness metrology systems primarily compete with systems manufactured by KLA-Tencor Corporation, Rudolph Technologies, Inc., Nanometrics, Inc. and Dai Nippon Screen, Mfg. Co., Ltd. Our Opti-Probe CD and RT/ CD systems participate in a newly developing market of optical CD

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      Suppliers of integrated metrology with whom we compete include most of the companies listed above regarding the Opti-Probe, in addition to Nova Instruments.

      In recent years, there has been merger and acquisition activity among our competitors and potential competitors, as well as by us. Acquisitions by our competitors and potential competitors could allow them to expand their product offerings, which could afford such competitors and potential competitors an advantage in meeting customers’ demands. The greater resources, including financial, marketing and support resources, of competitors potentially engaged in these acquisitions could permit them to accelerate the development and commercialization of new products and the marketing of existing products to their larger installed bases. Accordingly, such business combinations and acquisitions could have a detrimental impact on both our market share and the pricing of our products, which could result in a material adverse effect on our business and results of operations.

Patents and Proprietary Rights

      We believe the success of our business depends as much on the technical competence, creativity and marketing abilities of our employees as on the protection derived from our patents and other proprietary rights. Nevertheless, our success will depend, at least in part, on our ability to obtain and maintain patents and proprietary rights to protect our technology.

      We have a policy of seeking patents where appropriate on inventions concerning new products and improvements as part of our ongoing engineering and research and development activities. We have acquired a number of patents relating to our two key product families, the Therma-Probe and the Opti-Probe systems. As of March 28, 2004, we owned 106 patents. Of these, we owned 88 U.S. patents with expiration dates ranging from 2004 to 2022 and we had filed applications for 100 additional U.S. patents. In addition, we owned 11 foreign patents with expiration dates ranging from 2004 to 2019 and had filed applications for 35 additional foreign patents.

      In May 2004, nine U.S. and six foreign patents expired. All these patents relate to our older Therma-Probe products and technologies that have since been upgraded or replaced with new technologies and more recent patents. The expiration of these patents is not expected to have a material impact on our operations.

      There can be no assurance that any of our pending patent applications will be approved, that we will develop additional proprietary technology that is patentable, that any patents owned by or issued to us will provide us with competitive advantages or that these patents will not be challenged by any third parties. Furthermore, there can be no assurance that third parties will not design around our patents. Any of the foregoing results could have a material adverse effect on our business, financial condition or results of operations.

      In addition to patent protection, we rely upon trade secret protection for our confidential and proprietary information and technology. We routinely enter into confidentiality agreements with our employees. However, there can be no assurance that these agreements will not be breached, that we will have adequate remedies for any breach or that our confidential and proprietary information and technology will not be independently developed by, or become otherwise known, to third parties.

      As of March 28, 2004, we owned 21 registered trademarks in the U.S. and two in Japan and had filed five trademark registration applications in the U.S.

SEC Reports

      Our annual reports on Form 10-K, quarterly reports on Form l0-Q, current reports on Form 8-K, and all amendments to these reports filed with the U.S. Securities and Exchange Commission, are available for review free of charge on the SEC’s website which you can access through our website at

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      Our executive and manufacturing, engineering, marketing, research and development operations are located in a 102,000 square foot building at 1250 Reliance Way in Fremont, California. The facility has approximately 800 square feet of Class 10 clean rooms for customer demonstrations and approximately 20,000 square feet of Class 1000 clean rooms for manufacturing. This facility is occupied under a lease expiring in 2006 at an aggregate annual rental expense of approximately $1.2 million. We have the option of extending this lease for another 15 years after 2006. We own substantially all of the equipment used in our facilities. We also lease a building of approximately 28,000 square feet on Kato Road in Fremont, California, and two buildings of approximately 24,574 square feet in Santa Clara, California. During March 2003, we moved all our employees out of the Kato Road and Santa Clara facilities and into our Reliance Way facility. We are attempting to sublet these buildings to reduce our costs. We have partially sublet one of the buildings in Santa Clara. We believe that our existing facilities, capital equipment and anticipated capital expenditures will be adequate to meet our requirements for at least the next two years and that suitable additional or substitute space will be readily available if needed.

      We also lease sales and customer support offices in Texas, Japan, China, Korea, Taiwan, Singapore, and the United Kingdom.

      On April 22, 2002, we filed a patent infringement suit against Boxer Cross Inc. in the United States District Court, Northern District of California. The suit alleged that Boxer Cross’ BX-10 product infringed certain patents held by Therma-Wave related to ion implant monitoring. On June 7, 2002, Boxer Cross filed its amended answer and counterclaims to our complaint and asserted various affirmative defenses to our claims of patent infringement. The pleading also contained various counterclaims including allegations that Therma-Wave’s Therma-Probe product infringed upon certain patents owned by Boxer Cross and also raised claims of misappropriation of trade secrets, tortious interference with contract, unfair competition and unfair business practices. We replied to Boxer Cross’s counterclaims, denying the material allegations and asserting declaratory judgment counterclaims. On April 29, 2003, Applied Materials announced that it had acquired all of the outstanding stock of Boxer Cross. We settled this lawsuit with Boxer Cross and Applied Materials on July 7, 2003. Pursuant to the settlement, Therma-Wave dismissed its pending patent infringement claims with prejudice. Boxer Cross dismissed its pending patent infringement claims without prejudice and dismissed its pending state law claims with prejudice.

      There are currently no other material legal proceedings pending against us. We may be required to initiate additional litigation in order to enforce any patents issued to or licensed to us or to determine the scope and/or validity of a third party’s patent or other proprietary rights. In addition, we may be subject to additional lawsuits by third parties seeking to enforce their own intellectual property rights. Any such litigation, regardless of outcome, could be expensive and time consuming and, as discussed above in the prior risk factor, could subject us to significant liabilities or require us to cease using proprietary third party technology and, consequently, could have a material adverse effect on our business, financial condition, results of operations or cash flows.

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      No matters were submitted to a vote of security holders during the quarter ended March 31, 2004.

PART II

      Our common stock is traded on The NASDAQ National Market. As of June 1, 2004, there were 183 holders of record of common stock. The following table sets forth, for the periods indicated, the high and low closing prices per share of our common stock as reported on The NASDAQ National Market.

      To date, we have not declared or paid cash dividends to our stockholders. We have no plans to declare or pay cash dividends in the near future. Any future determination to pay dividends will be at the discretion of the board of directors and will depend upon, among other factors, our results of operations, financial conditions, capital requirements and contractual restrictions.

Shares Authorized for Issuance Under Equity Compensation Plans

      The following table summarizes the total shares of our common stock that may be received by holders upon the exercise of currently outstanding options, the weigh