UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended December 26, 2004

OR

For the transition period from ________to _________

Commission file number 000-26911

THERMA-WAVE, INC.

1250 Reliance Way
Fremont, California 94539

(510) 668-2200

     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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES þ NO o

     Indicate the number of shares outstanding of the issuer’s class of common stock, as of the latest practical date:

THERMA-WAVE, INC.
TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

THERMA-WAVE, INC.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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THERMA-WAVE, INC.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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THERMA-WAVE, INC.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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THERMA-WAVE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(As of December 31, 2004)

1. Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of Therma-Wave, Inc. (“we”, “our”, the “Company”) and its wholly-owned subsidiaries. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In our opinion, the financial statements reflect all adjustments, consisting only of normal, recurring adjustments, necessary for a fair statement of the financial position at December 31, 2004, the operating results for the three and nine months ended December 31, 2004 and 2003, and the cash flows for the nine months ended December 31, 2004 and 2003. These financial statements and notes should be read in conjunction with our audited financial statements and the notes thereto included in our Form 10-K for the year ended March 31, 2004.

     The results of operations for the interim periods are not necessarily indicative of the results of operations that may be expected for any other period or for our current fiscal year which ends on April 3, 2005.

     The third quarters of fiscal years 2005 and 2004 and the fiscal year 2004 ended on December 26, 2004, December 28, 2003 and March 28, 2004, respectively. For presentation purposes, the accompanying unaudited condensed consolidated financial statements have been shown as ending on the last day of the calendar quarter closest to each of these dates.

     Liquidity

     Our principal sources of funds have been and are anticipated to be cash on hand ($13.7 million as of December 31, 2004), cash flows from operating activities (if any), borrowings under our bank credit facility and proceeds from the sale of our common stock. We believe that we will have adequate liquidity and capital resources to meet our current and future financial obligations for the next twelve months. No assurance can be given, however, that this will be the case. We may require additional equity or debt financing to meet our working capital requirements or to fund our research and development activities. There can be no assurance that additional financing will be available, if required or, if available, will be on terms satisfactory to us.

     Revenue Recognition

     Revenues are recognized when our contractual obligations have been performed, title and risk of ownership have passed to the customer, collectibility of the sales price has been reasonably assured and customer acceptance has been obtained, if applicable. Shipments are made in compliance with shipment requirements specified in our customer’s purchase order. Freight terms of sales are ex-works shipping point unless otherwise negotiated and agreed in writing between our customer and us.

     Systems Revenues. Systems (product) sales are accounted for as multiple-element arrangement sales that require the deferral of a significant portion of revenues in the amount of the greater of the fair market value of installation and related post shipment services or the percentage of payment subject to acceptance. Systems revenues are allocated on a fair value basis to each component of the multiple-element arrangement. Revenues on each element are recognized when our contractual obligations have been performed, title and risk of ownership have passed to the customer, collectibility of the sales price has been reasonably assured and customer acceptance has been obtained, if applicable. Estimated contractual warranty obligations are recorded as cost of revenues when related systems sales are shipped.

     Systems revenues on newly introduced products are deferred at shipment and recognized only upon customer acceptance assuming all other revenue recognition criteria have been met. Systems revenues are also deferred when the customer has the right to return the product for credit. In such cases, systems revenues are not recognized until all of the following conditions have been evidenced after the customer’s purchase order has been fulfilled: the right of return has expired, and any potential returns would require authorization by our company under warranty provisions; the price of the sale is fixed or determinable; the payment terms are fixed and enforceable; collectibility of the sales price has been reasonably assured and customer acceptance has been obtained, if applicable.

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     Services and Parts Revenues. We derive services and parts revenues from three primary sources: sale of spare parts, service contracts and service labor. Revenues on the sale of spare parts are recognized when spare parts have been shipped, title and risk of ownership have transferred to the customer and collectibility of the sales price has been reasonably assured. Revenues on service contracts are deferred and recognized on a straight-line basis over the period of the contract. Revenues on time and material services performed are recognized when the services are completed, collectibility of the sales price has been reasonably assured and customer acceptance has been obtained, if applicable.

     Deferred Revenues. Deferred revenues arise from systems (product) sales and service contracts. Revenues on service contracts are deferred and recognized on a straight-line basis over the respective contract term. Systems sales are accounted for as multiple-element arrangement sales that require the deferral of a significant portion of revenues in the amount of the greater of the fair market value of installation and related post shipment services or the percentage of payment subject to acceptance. Systems revenues are allocated on a fair value basis to each component of the multiple-element arrangement. Revenues on each element are recognized when our contractual obligations have been performed, title and risk of ownership have passed to the customer, collectibility of the sales price has been reasonably assured and customer acceptance has been obtained, if applicable.

     In accordance with SAB 104, we evaluate our systems sales to determine the appropriate timing for revenue recognition for each of the multiple elements involved in each sale. This sometimes results in deferrals of revenues from the period in which the tool is shipped to future periods.

     Reclassifications

     Certain prior year amounts in the unaudited condensed consolidated financial statements have been changed to conform to current period classifications.

     Stock-Based Compensation

     In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, “Accounting for Stock-Based Compensation.” The Company has applied Accounting Principles Board Opinion No. 25 in accounting for its stock option plans and has adopted the disclosure provisions of SFAS No. 123. In April 2000, the Financial Accounting Standards Board issued FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation: An Interpretation of APB No. 25.” The Company has adopted the provisions of FIN 44, and such adoption did not materially impact the Company’s results of operations. In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure.” The statement amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Company has adopted the disclosure provisions of SFAS No. 148.

     Had compensation costs been determined based upon the fair value at the grant date for awards under the stock option plans and employee stock purchase plans, consistent with the methodology prescribed under SFAS No. 123, our pro forma net loss and pro forma net loss per share under SFAS No. 123 would have been:

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     The weighted average grant-date fair value of our stock options was $1.83 and $3.83 for the three months ended December 31, 2004 and 2003, respectively, and $2.46 and $2.02 for the nine months ended December 31, 2004 and 2003, respectively. These values were estimated using the Black-Scholes pricing model with the following assumptions:

     The weighted average grant-date fair value of our stock purchase rights granted under our employee stock purchase plans was $0.78 and $0.23 for the three months ended December 31, 2004 and 2003, respectively, and $0.44 and $0.24 for the nine months ended December 31, 2004 and 2003, respectively. These values were estimated using the Black-Scholes pricing model with the following assumptions:

     Stock-based employee compensation expense (benefit) included in net loss as reported for the three months and nine months ended December 31, 2004 and 2003, respectively, includes amounts for two events, specifically, the stock options assumed during the acquisition of Sensys Corporation, and the stock option exchange on September 10, 2003.

     As part of the acquisition of Sensys, we recorded $3.5 million of stock-based compensation to be amortized over the vesting period of the options. The related deferred stock compensation amortization expenses were $52,000, $44,000, and $0.1 million for the three months ended December 31, 2004, September 30, 2004, and December 31, 2003, respectively. For the nine months ended December 31, 2004 and 2003, respectively, deferred stock compensation amortization expenses were $0.4 million and $0.5 million. A portion of the deferred stock amortization expense are included in cost of revenues. These expenses reflect the vesting schedules of the stock options and reductions in headcount due to employee turnover and reduction in force programs that began during fiscal 2003 and continued through the first nine months of fiscal 2004. As of December 31, 2004, $0.1 million of deferred stock compensation related to the Sensys acquisition remains to be amortized over future periods ending in January 2006.

     As a result of the completion of the employee stock option exchange program, effective September 10, 2003, we recorded an expense (benefit) from the amortization of deferred compensation expense related to the variable accounting treatment for stock options of $(22,000) and $0.9 million for the three months ended December 31, 2004 and December 31, 2003, respectively. For the nine months ended December 31, 2004 and December 31, 2003, respectively, we have recorded an expense of $0.3 million and $0.9 million from the amortization of deferred compensation expense related to the variable accounting treatment for stock options. These expenses and benefits reflect the options eligible for exchange that were outstanding since September 10, 2003 and the options issued to eligible participants within the six months prior to or following September 10, 2003. Due to variable accounting, compensation expense is being recorded for the pro-rata vesting of these options over time based on increases or decreases in the period-end stock price over and above the exercise price of the new options. In future periods, the expense could increase as more shares become vested and if the stock price increases. Reductions to expense may also be recorded if the stock price decreases, but such reductions will be limited to the cumulative amortization of deferred stock compensation of $1.0 million previously recorded.

     On November 24, 2004 the Company adopted a Director Stock Option Agreement which provides accelerated vesting of options granted to the Company’s Directors upon a change in control of the Company. The agreement is attached as Exhibit 10.1.

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     The Company closed its deferred executive compensation plan on December 16, 2004. As of December 26, 2004, the date when the third fiscal quarter ended, there was a $0.4 million balance remaining to be paid to participants. This amount was paid in the subsequent period prior to December 31, 2004.

     Recently Issued Accounting Pronouncements

     FAS 123R. In December 2004, the FASB issued FASB Statement No. 123R, “Share-Based Payment, an Amendment of FASB Statement No. 123” (“FAS No. 123R”). FAS No. 123R requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation issued to employees. FAS No. 123R is effective for periods beginning after June 15, 2005, which means for the Company’s second quarter of fiscal year 2006. The Company’s management is currently evaluating the impact of FAS No. 123R on the Company’s financial position and results of operations.

     FAS 151. In November 2004, the FASB has issued FASB Statement No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“FAS No. 151”). The amendments made by FAS No. 151 are intended to improve financial reporting by clarifying that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period expenses and by requiring the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities.

     The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. The provisions of FAS No. 151 will be applied prospectively. The Company does not expect the adoption of FAS No. 151 to have a material impact on its consolidated financial position, results of operations or cash flows.

     FAS 153. In December 2004, the FASB issued SFAS Statement No. 153, “Exchanges of Non-monetary Assets.” The Statement is an amendment of APB Opinion No. 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. The effective date is for exchanges occurring in fiscal periods beginning after June 15, 2005. The Company believes that the adoption of this standard will have no material impact on its financial statements.

2. Balance Sheet Components

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     During the nine months ended December 31, 2004, the Company disposed of equipment having a gross value of $1,424,000 and accumulated depreciation of $1,409,000. There was a loss of approximately $15,000 on the disposals.

3. Comprehensive Loss

     Comprehensive loss consists of the net loss for the period and the change in accumulated foreign currency translation adjustments during the period. For the three months ended December 31, 2004 and 2003, comprehensive loss amounted to approximately $1.6 million and $0.8 million, respectively. For the nine months ended December 31, 2004 and 2003, comprehensive loss amounted to approximately $1.6 million and $15.7 million, respectively.

4. Net Loss Per Share

     Basic net loss per share is based on the weighted-average number of common shares outstanding excluding contingently issuable or returnable shares such as unvested common stock or shares that contingently convert into common stock upon certain events.

     Diluted net loss per share is based on the weighted average number of common shares outstanding and the potential dilution of securities by including stock options and outstanding warrants. Outstanding stock options and warrants are considered dilutive only if their exercise price is less than the closing market price for the Company’s stock at the period end. Additionally, no adjustment is performed for dilutive shares for a period in which the Company has experienced a net loss.

     The following table summarizes securities outstanding as of December 31, 2004 and 2003, respectively, which were not included in the calculation of diluted net loss per share for the three months and nine months ending December 31, 2004 and 2003, respectively.

     The stock options outstanding that were excluded from the diluted net loss per share had a weighted average exercise price at December 31, 2004 and 2003 of $3.65 and $12.11, respectively. The warrants outstanding that were excluded from the diluted net loss per share had a weighted average exercise price at December 31, 2004 and 2003 of $3.82 and $3.68, respectively.

5. Commitments and Contingencies

     We lease our facilities under non-cancelable operating leases that require us to pay maintenance and operating expenses, such as taxes, insurance and utilities. We are required pursuant to the terms of facility leases to maintain two standby letters of credit totaling $2.6 million. No amounts have been drawn against these standby letters of credit.

     Rent expense was approximately $0.6 million and $0.7 million for the three months ended December 31, 2004 and 2003, respectively and approximately $1.9 million and $2.1 million for the nine months ended December 31, 2004 and 2003, respectively.

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As of December 31, 2004, future minimum lease payments under non-cancelable operating leases (facilities and equipment leases) are as follows:

     On August 12, 2004, we entered into an agreement involving a mutual exchange of intellectual property rights, effective July 1, 2004. During the term of the agreement, Therma-Wave agrees to pay a royalty of $50,000 for each stand-alone tool shipped by Therma-Wave that uses scatterometry to perform CD measurements and $12,500 for each integrated tool on behalf of a scatterometry product sold. These royalties are adjustable annually for increases in the consumer price index. Amounts due under the agreement have been paid or accrued as liabilities and charged to cost of sales