Prepared by MERRILL CORPORATION

QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

ULTRATECH STEPPER, INC.
(Exact name of registrant as specified in its charter)

DELAWARE		94-3169580
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification number)
3050 Zanker Road, San Jose, California		95134
(Address of principal executive offices)		(Zip Code)

(Former name, former address and former fiscal year, if changed since last report.)

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 re-quired to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /

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

Class		Outstanding as of November 7, 2001
common stock, $.001 par value		22,438,218

		Page No.
PART 1.	FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000	3
	Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2001 and 2000	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
PART 2.	OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 2.	Changes in Securities and Use of Proceeds	29
Item 3.	Defaults upon Senior Securities	29
Item 4.	Submission of Matters to a Vote of Security Holders	29
Item 5.	Other Information	29
Item 6.	Exhibits and Reports on Form 8-K	29
SIGNATURES	30

Ultratech Stepper, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2001

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included.

COMPANY AND INDUSTRY INFORMATION—The Company operates in one business segment, which is the manufacture and distribution of photolithography equipment to manufacturers of integrated circuits, thin film heads and micromachined components.

USE OF ESTIMATES—The preparation of the accompanying unaudited condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

REVENUE RECOGNITION—Sales of the Company's products are recorded after the contractual obligation for installation has been satisfied and customer acceptance provisions have lapsed, provided collections of the related accounts receivable are probable. The Company also sells service contracts for which revenue is recognized ratably over the contract period.

Effective January 1, 2000, the Company changed its method of accounting for product sales to recognize such revenues when the contractual obligation for installation has been satisfied, or when installation is substantially complete, and customer acceptance provisions have lapsed, provided collections of the related receivable are probable.

The cumulative effect of this change in accounting principle includes system revenue, cost of sales and certain expenses, including warranty and commission expenses, that will be recognized when both installation and customer acceptance provisions are satisfied, subsequent to January 1, 2000.

FISCAL PERIODS: The Company's third fiscal quarter in 2001 and 2000 ended on September 29, 2001 and September 30, 2000, respectively. For convenience of presentation, the Company's financial statements have been shown as having ended on September 30, 2001 and September 30, 2000.

Operating results for the three and nine month periods ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001, or any future period.

(In thousands)	Sept. 30, 2001		Dec. 31, 2000
	(Unaudited)
Raw materials	$	8,126	$	14,309
Work-in-process		17,795		11,088
Finished products		2,824		4,865

	$	28,745	$	30,262

(In thousands)	Sept. 30, 2001		Dec. 31, 2000
	(Unaudited)
Salaries and benefits	$	3,117	$	4,551
Warranty reserves		2,350		3,776
Advance billings		6,584		7,470
Income taxes payable		4,741		5,190
Accrued restructuring cost		6,311		—
Reserve for losses on purchase order commitments		3,954		3,203
Other		3,429		2,913

	$	30,486	$	27,103

The following sets forth the computation of basic and diluted net income (loss) per share:

For the three and nine-month periods ended September 30, 2001, options to purchase 3,444,000 shares of Common Stock at an average exercise price of $17.72 were excluded from the computation of diluted net income (loss) per share as the effect would have been anti-dilutive. This compares to the exclusion of 1,547,000 options and 3,922,000 options at an average exercise price of $20.31 and $15.23, respectively, for the three and nine-month periods ended September 30, 2000. Options are anti-dilutive when the Company has a net loss or when the exercise price of the stock option is greater than the average market price of the Company's Common Stock.

Accumulated other comprehensive income (loss) presented in the accompanying condensed consolidated balance sheets consists entirely of accumulated unrealized holding gain on available-for-sale securities and the effect of exchange rate changes on foreign exchange forward contracts, as a result of adopting FAS 133 (also see footnote 6—accounting for derivative instruments and hedging activities). The unrealized holding gain on available-for-sale securities is not currently adjusted for income taxes as a result of the Company's operating loss carry forward.

The components of accumulated derivative loss as a result of adopting FAS 133 are as follows:

Effective January 1, 2001, the Company adopted the Financial Accounting Standards Board (FASB) Statement No. 133 (FAS 133), "Accounting for Derivative Instruments and Hedging Activities", FAS 137, "Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB Statement No. 133" and FAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities—an Amendment of FAS 133." These FASB statements require that all derivative financial instruments, such as foreign exchange contracts, be recognized in the financial statements and be measured at fair value regardless of the purpose or intent for holding them. Changes

in the fair value of derivative financial instruments are either recognized periodically in income or stockholders' equity (as a component of comprehensive income), depending on whether the derivative is being used to hedge changes in fair value or cash flows. The adoption of these statements did not have a material effect on the Company's financial statements.

The carrying value of the Company's financial instruments approximates fair value. The fair value of financial instruments is generally determined by reference to market values resulting from trading on a national securities exchange or in an over-the-counter market.

Foreign exchange contracts are used primarily by the Company to hedge the risk that unremitted Japanese yen denominated receipts from customers for actual or forecasted sales of equipment after receipt of customer purchase orders and the unremitted Japanese yen denominated payments to suppliers for actual or forecasted deliveries of raw material from Japan after issuance of Company purchase orders may be adversely affected by changes in foreign currency exchange rates. As part of its overall strategy to manage the level of exposure to the risk of foreign currency exchange rate fluctuations, the Company attempts to hedge most of these Japanese yen denominated foreign currency exposures anticipated over the ensuing twelve-month period. At September 30, 2001, the Company had taken action to hedge approximately 100% of these Japanese yen denominated exposures. To hedge this exposure, the Company used foreign exchange contracts that generally have maturities of nine months or less, which generally will be rolled over to provide continuing coverage throughout the year. The Company often closes foreign exchange sale contracts by purchasing an offsetting purchase contract.

The Company records these foreign exchange contracts at fair value in its consolidated balance sheet and the related gains or losses on these contracts are deferred in stockholders' equity (as a component of comprehensive income). These deferred gains and losses are recognized in income in the period in which the sales or purchases being hedged are received and recognized in income. However, to the extent that any of these contracts are not considered to be perfectly effective in offsetting the change in the value of the sales or purchases being hedged, any changes in fair value relating to the ineffective portion of these contracts are immediately recognized in income. Gains and losses on foreign exchange contracts are generally included as a component of interest and other income, net, in the Company's consolidated statement of operations.

At September 30, 2001, the Company had contracts for the sale of $2.0 million and the purchase of $1.9 million of foreign currencies at fixed rates. The Company had not deferred any gains or losses on foreign exchange contracts at September 30, 2001.

In September 2001, the Company reached a decision to consolidate its manufacturing operations and eliminate approximately 20% of its workforce. As a result of this decision, the Company recognized a restructuring charge of $12.0 million in the quarter ended September 30, 2001. The non-cash components of this charge include a $4.1 million impairment charge for intangible assets related to the Company's XLS reduction product platform acquired in 1998 and a $1.2 million impairment charge for fixed assets to be disposed of in conjunction with the consolidation of manufacturing facilities. The cash components of this charge include $4.3 million for estimated

expenditures related to the closure of facilities, $1.9 million for employee severance costs and $0.5 million for other restructuring costs. As of September 30, 2001, the amount of restructuring costs accrued but unpaid was $6.3 million.

During the quarter ended June 30, 2000, the Company shut down the operations of its UltraBeam unit. As a direct result of this decision, the Company recognized a charge in the quarter ended June 30, 2000 of $8.0 million, or $0.38 per share (diluted). During the quarter ended September 30, 2000, the Company recognized an additional charge of $1.7 million, or $0.08 per share (diluted) primarily attributed to revised estimates of amounts to be realized upon the disposition of operating assets. For the nine-month period ended September 30, 2001, the Company recognized a total charge of $9.7 million related to the shutdown of UltraBeam. At September 30, 2001, there were no outstanding payables or accruals associated with this charge.

As a direct result of dramatically worsening conditions in the semiconductor industry, heightened by the events of September 11^th, which further weakened the U.S. and world economies, the Company reached a decision to discontinue its XLS reduction stepper production and focus its efforts on developing next-generation platforms for its reduction technologies, principally 157nm. As a result of this decision, the Company recognized a special charge of $11.0 million, which consisted of inventory write-downs of $8.5 million and purchase order commitment reserves of $2.5 million.

During the quarter ended September 30, 2000, the Company exercised an option it held to purchase 6.34 acres of undeveloped land it leased in San Jose, California and sold this property to a third party. This transaction resulted in a net gain of $16.0 million before related income taxes, or $0.74 per share (diluted).

On July 20, 2001 the Financial Accounting Standards Board (FASB) issued Statement No. 141 (FAS 141) "Business Combinations" and Statement No. 142 (FAS 142) "Goodwill and Other Intangible Assets".

FAS 141 requires that all business combinations be accounted for under a single method—the "purchase" method for all business combinations initiated after June 30, 2001. The Company adopted FAS 141 in the second quarter of 2001 and the adoption of this statement had no material effect on the Company's financial statements.

FAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. Intangible assets that are acquired individually or with a group of other assets (excluding those acquired in a business combination) should be accounted for in financial statements upon their acquisition. Goodwill and intangible assets that have indefinite useful lives will not be amortized, but will be tested at least annually for impairment. Intangible assets that have finite useful lives will continue to be amortized over their useful lives. The Company expects to adopt the Statement effective January 1, 2002. The Company has not yet determined the impact this statement will have on its future results of operations.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Certain of the statements contained in this report may be considered forward-looking statements under Section 21E of the Securities Exchange Act of 1934, as amended, that involve a number of risks and uncertainties. In addition to the factors discussed herein, factors that could cause actual results to differ materially include the following: cyclicality in the Company's served markets, including the current severe downturn in the semiconductor industry; delays, deferrals and cancellations of orders by customers; product concentration and lack of product revenue diversification; high degree of industry competition; expiration of technology support and licensing arrangements; lengthy development cycles for advanced lithography technologies and applications; lengthy sales cycles, including the timing of system acceptances; inventory obsolescence; manufacturing inefficiencies and the ability to volume produce systems; mix of products sold; integration and development of Verdant operations; failure to develop and commercialize the Company's reduction stepper products; timing and degree of success of technologies licensed to outside parties; the ability and resulting costs to attract or retain sufficient personnel to achieve the Company's targets for a particular period; sole or limited sources of supply; international sales; customer concentration; rapid technological change and the importance of timely product introductions; future acquisitions; changes to financial accounting standards; intellectual property matters; environmental regulations; effects of the California energy crisis; effects of certain anti-takeover provisions; volatility of stock price; any adverse effects of the recent terrorist attacks in the United Sates, or the related U.S. retaliation, on the economy, in general or on our business in particular; and the other risk factors listed in this filing and other Company filings with the SEC. The Company undertakes no obligation to update any of its disclosures to reflect such future events.

Due to these and additional factors, certain statements, historical results and percentage relationships discussed below will not necessarily be indicative of the results of operations for any future period.

Ultratech develops, manufactures and markets photolithography equipment (steppers) designed to reduce the cost of manufacturing integrated circuits (ICs), including advanced packaging processes, thin film heads (TFHs) for disk drives and micro-machined components. The Company supplies step-and-repeat systems based on one-to-one and reduction optical technologies to customers located throughout North America, Europe, Japan and the rest of Asia. These products range from low-cost systems for high-volume manufacturing to advanced systems for cost-effective production of leading-edge devices and for research and development applications.

Effective January 1, 2000, the Company changed its method of accounting for system sales to recognize such revenues when the contractual obligations for installation and customer acceptance have been satisfied, provided collections of the related receivable are probable.

In April 2000, the Company reached a decision to shut down its UltraBeam operations.

In April 2000, the Company settled litigation it had initiated against Nikon Inc. ("Nikon") and in September 2001, the Company settled related litigation it had initiated against Canon, Inc. ("Canon"). The Company is presently proceeding in a related action against ASM Lithography, Ltd. ("ASML"). There can be no assurance that the Company will prevail in this action.

In July 2000, the Company entered into an agreement with Applied Materials, Inc. ("Applied Materials") under which Applied Materials has licensed the laser thermal processing technology of the Company's Verdant Technologies Division. Additionally, Ultratech develops, manufactures and markets its own laser thermal processing systems used in the development and future production of advanced semiconductor devices.

The Applied Materials and Nikon agreements and the land sale resulted in special income tax charges during the quarter ended September 30, 2000 of $2.4 million, or $0.11 per share (diluted). Excluding special items and the taxes associated with them, net income for the quarter ended September 30, 2000 was $3.2 million, or $0.15 per share (diluted).

In September 2001, the Company reached a decision to discontinue its XLS product line and to close its Wilmington, Massachusetts facility. The Company also announced a workforce reduction of approximately 20%, inclusive of those employees impacted by the plant closure. These decisions resulted in special charges for the quarter ended September 30, 2001 of $11.0 million, or $0.49 per share (diluted), for inventory write-downs and purchase order commitment reserves related to the discontinuance of the XLS product line and $12.0 million, or $0.54 per share (diluted), related to plant closure, asset impairment, employee severance and other costs of restructuring the Company's operations. Excluding these special items, the net loss for the quarter ended September 30, 2001 was $3.0 million, or $0.14 per share (diluted).

The following discussion should be read in conjunction with the Company's 2000 Annual Report on Form 10-K, which is available from the Company upon request.

The Company's operating results have fluctuated significantly in the past and most likely will continue to fluctuate significantly in the future. Factors that have caused operating results to fluctuate significantly in the past and most likely will continue to cause fluctuations in the future include those mentioned above as well as: inventory and open purchase commitment reserve positions; patterns of capital spending by customers; concentration of credit risk; lengthy development cycles for new products; market acceptance of new products and enhanced versions of the Company's existing products; delayed shipments to customers due to customer configuration changes and other factors; lengthy manufacturing cycles for the Company's products; the timing of new product announcements and releases by the Company or its competitors; manufacturing inefficiencies associated with the startup of new product introductions; product discounts; changes in pricing by the Company, its competitors or suppliers; shutdown of operations; acquisition activities requiring issuance of additional equity or debt securities, the expenditure of cash and the devotion of substantial management resources; sale of assets; outcome of litigation; political and economic instability throughout the world, in particular the Asia/Pacific region; changes in sales or distribution agreements; natural disasters; regulatory changes; business interruptions related to the Company's occupation of its facilities, including related to the recent energy crisis in California, where the Company's headquarters and principal operations are located; and any adverse effects of the recent terrorist attacks in the United States, or related U.S. retaliation, on the economy, in general or on our business in particular.

The Company's gross profit as a percentage of sales has been and most likely will continue to be significantly affected by a variety of factors, including the mix of products sold; product discounts and competition in the Company's targeted markets; technology support and licensing revenues, which have little, if any, associated cost of sales; inventory and open purchase commitment reserve provisions; the rate of capacity utilization; non-linearity of shipments during the quarter; the introduction of new products, which typically have higher manufacturing costs until manufacturing efficiencies are realized and are typically discounted more than existing products until the products gain market acceptance; the percentage of international sales, which typically have lower gross margins than domestic sales

principally due to higher field service and support costs; and the implementation of subcontracting arrangements.

The Company derives a substantial portion of its total net sales from sales of a relatively small number of newly manufactured systems, which typically range in price from $900,000 to $3.4 million for the Company's 1X steppers, and from $1.5 million to more than $7.0 million for the Company's reduction steppers. As a result of these high sale prices, the timing of recognition of revenue from a single transaction has had and most likely will continue to have a significant impact on the Company's net sales and operating results for any particular period.

The Company's backlog at the beginning of a period typically does not include all of the sales needed to achieve the Company's sales objectives for that period. In addition, orders in backlog are subject to cancellation, shipment or customer acceptance delays, and deferral or rescheduling by a customer with limited or no penalties. Consequently, the Company's net sales and operating results for a period have been and will continue to be dependent upon the Company obtaining orders for systems to be shipped and accepted in the same period in which the order is received. The Company's business and financial results for a particular period could be materially adversely affected if an anticipated order for even one system is not received in time to permit shipment and customer acceptance during that period. Furthermore, a substantial portion of the Company's shipments has historically been realized near the end of each quarter. Delays in installation and customer acceptance due, for example, to the inability of the Company to successfully demonstrate the agreed-upon specifications or criteria at the customer's facility, or to the failure of the customer to permit installation of the system in the agreed upon time, may cause net sales in a particular period to fall significantly below the Company's expectations, which may materially adversely affect the Company's operating results for such period. Additionally, the failure to receive anticipated orders or delays in shipments due, for example, to reschedulings, delays, deferrals or cancellations by customers, additional customer configuration requirements, or to unexpected manufacturing difficulties or delays in deliveries by suppliers due to their long production lead times or otherwise, have caused and may continue to cause net sales in a particular period to fall significantly below the Company's expectations, which has and could continue to materially adversely affect the Company's operating results for such period. In particular, the long manufacturing cycles of the Company's Saturn Wafer Stepper®, and the Company's reduction stepper product offerings, and the long lead time for lenses and other materials, could cause shipments of such products to be delayed from one quarter to the next, which could materially adversely affect the Company's financial condition and results of operations for a particular quarter.

The Company's business has in prior years been subject to seasonality, although the Company believes such seasonality has been masked in recent years by cyclical trends within the semiconductor and thin film head industries. In addition, the need for continued expenditures for research and development, capital equipment, ongoing training and worldwide customer service and support, among other factors, will make it difficult for the Company to reduce its operating expenses in a particular period if the Company fails to achieve its net sales goals for the period.

Net sales consist of revenues from system sales, spare parts sales, service and licensing of technologies. For the quarter ended September 30, 2001, net sales were $24.3 million, a decrease of 42% as compared with net sales of $42.2 million for the comparable period in 2000. System sales decreased 53%, to $14.7 million, on a unit volume decline of 55%. The decline in unit volume was primarily attributable to weaker demand from semiconductor packaging customers in Japan and the rest of Asia, partially offset by higher system sales to Europe. However, as a result of worsening global economic conditions, the Company experienced sales declines across all product market segments and product platforms. Revenues from services declined 37%, to $3.0 million, primarily as a result of decreased utilization of plant capacity within the semiconductor industry. Revenues from licensing and

licensing support arrangements increased to $3.2 million, from $2.5 million in the comparable period in 2000, as a result of agreements entered into in late 2000 and 2001. For the quarter ended September 30, 2001, a single licensing agreement generated $2.3 million in license revenue. This arrangement expires in February 2002. Spare part sales decreased 4%, to $3.4 million.

For the nine-month period ended September 30, 2001, net sales were $109.2 million, an increase of 3% as compared with net sales of $105.6 million for the comparable period in 2000. System sales decreased less than 1%, to $78.0 million, as a unit volume decline of 22% was partially offset by higher weighted-average selling prices and a product mix shift toward higher-priced systems. In particular, the Company experienced significantly lower unit sales of its 1000 product family of wafer steppers to the thin film head industry. Geographically, the year-over-year decrease in system sales resulted primarily from decreased sales to Asia, excluding Japan. All other major geographic regions for the Company experienced modest year-over-year increases in system sales. In addition to the weakness noted in the Company's thin film head business, the dramatic downturn in the semiconductor industry has also resulted in fewer system sales to this important product market segment. The impact of these declining markets was partially offset by sharply higher demand for the Company's systems in the micromachining and optical networking product market segments. Revenues from services decreased 12%, to $11.3 million. Revenues from spare part sales decreased 10%, to $10.4 million. Revenues from licensing and licensing support arrangements increased to $9.4 million, from $3.0 million in the comparable period in 2000, as a result of agreements entered into in 2000 and 2001. For the nine-month period ended September 30, 2001, a single licensing agreement generated $6.9 million in license revenue. This arrangement expires February 2002.

At September 30, 2001, the Company had approximately $4.4 million of deferred revenue resulting from products shipped but not yet installed and accepted, as compared with $7.1 million at June 30, 2001 and $15.7 million at December 31, 2000. The net result of shipments and acceptances during the quarter ended September 30, 2001 was a net decrease in deferred product and service income of approximately $567,000. During the quarter ended September 30, 2001, deferred license income increased by $772,000 as a result of new licensing arrangements, partially offset by the license revenue recognized during the quarter. Deferred income related to the Company's products is recognized upon installation and customer acceptance of the systems. Deferred income related to service revenue is recognized over the life of the related service contract. Deferred income relative to the Company's licensing activities is recognized over the estimated useful life of the licensed technologies, or the period of any technology transfer support arrangements.

On a product market application basis, system sales to the semiconductor industry were $50.0 million for the nine-month period ended September 30, 2001, a decrease of 26% as compared with system sales of $67.5 million in the comparable period in 2000. System sales to the micro-systems market, which includes sales to thin film head manufacturers, were $28.0 million, an increase of 161% as compared with sales of $10.7 million in the comparable period in 2000. This increase was primarily attributable to the sale of the Company's systems to micro-machining and optical networking device customers, partially offset by fewer sales of the Company's systems to thin film head customers.

For the nine-month period ended September 30, 2001, international net sales were $57.7 million, or 53% of total net sales, as compared with $57.0 million, or 54% of total net sales for the comparable period in 2000. The increase in international sales, in terms of absolute dollars, was primarily attributable to increased sales of the Company's Saturn Spectrum 3 Wafer Stepper to semiconductor packaging companies in the Japan and Asia, excluding Japan, territories. The Company anticipates that a substantial portion of its overall sales will continue to come from semiconductor packaging manufacturers in the Japan and Asia, excluding Japan, territories. The Company's operations in foreign countries are not generally subject to significant exchange rate fluctuations, principally because sales contracts for the Company's systems are generally denominated in U.S. dollars. In Japan, however, orders are typically denominated in Japanese yen. This subjects the Company to the risk of currency

fluctuations. The Company attempts to mitigate this exposure through the use of foreign exchange contracts; however, this effort can be costly and there can be no assurance of the success of any such efforts. International sales expose the Company to a number of additional risks, including fluctuations in the value of local currencies relative to the U.S. dollar, which, in turn, impact the relative cost of ownership of the Company's products. (See "Additional Risk Factors: International Sales; Japanese Market").

Both the semiconductor and thin film head industries are presently experiencing severe downturns due, in part, to the macro-economic conditions facing the U.S. and world economies. Although the Company's total backlog increased substantially during 2000, the Company's backlog has decreased substantially during the nine-month period ended September 30, 2001. This decline was a result of slowing order rates and customer cancellations. Additionally, the Company has recently experienced a high level of customer reschedulings. The Company presently believes that weakness in orders may continue for at least the next couple of quarters, materially adversely impacting the Company's sales, gross margins and results of operations. Further, the anticipated timing of shipments and customer acceptances will require the Company to fill a number of production slots in the current quarter in order to meet its near-term sales targets. If the Company is unsuccessful in its efforts to secure those production orders, or if existing production orders are delayed or cancelled, its results of operations will be materially adversely impacted in the near-term. Accordingly, the Company can give no assurance that it will be able to achieve or maintain its current or prior level of sales.

As a result of current order trends, the severe downturn in the electronics industries and generally weak macro-economic conditions, the Company presently expects that net sales for the quarter ending December 31, 2001 will be substantially lower than net sales in the comparable period in 2000 and sequentially lower than net sales recognized in the quarter ended September 30, 2001. Further, the Company anticipates that it will experience operating and net losses for the three-month period ending December 31, 2001. Because the Company's net sales are subject to a number of risks, including intense competition in the capital equipment industry and the timing and market acceptance of the Company's products, there can be no assurance that the Company will exceed or maintain its current or prior level of net sales for any period in the future.

The Company's gross profit (loss) as a percentage of net sales, or gross margin, was (10.5%) for the quarter ended September 30, 2001, as compared with 40.3% for the comparable period in 2000. Exclusive of special charges, gross margin for the quarter ended September 30, 2001 was 34.7%. For the nine-month period ended September 30, 2001, gross margin was 33.2%, as compared with 36.6% for the comparable period in 2000. Exclusive of special charges, gross margin for the nine-month period ended September 30, 2001 was 43.3%. On a comparative basis, gross margin was favorably impacted in the three and nine-month periods ended September 30, 2001 by higher weighted-average selling prices, increased licensing and licensing support revenues and cost-containment measures. Gross margin for the quarter and nine-month period ended September 30, 2001 was adversely impacted by a special charge of $11.0 million relating to the discontinuance of the Company's XLS product platform and dramatically higher manufacturing and after-sales inefficiencies, resulting from lower production and shipment volumes.

As a direct result of dramatically worsening conditions in the semiconductor industry, heightened by the events of September 11^th, which further weakened the U.S. and world economies, the Company decided to discontinue its XLS reduction stepper production and focus its efforts on developing next-generation platforms for its reduction technologies, principally 157nm. As a result of this decision, the Company recognized inventory write-downs of $8.5 million and additional purchase order commitment reserves of $2.5 million.

The Company believes that gross margin for the quarter ending December 31, 2001 will be lower than levels achieved during the comparable period a year ago, resulting primarily from higher inefficiencies caused by decreased production and shipment levels, partially offset by cost containment measures. Further weakness in the Company's business may result in a higher risk of inventory obsolescence, which would materially adversely impact results of operations. In particular, the Company has made significant investments in long-lead items relating to the introduction of its 157nm reduction stepper technologies. These assets face certain technology risks in addition to the risks inherent with slowing business conditions. Additionally, increased price-based competition may contribute to further erosion of gross margin.

New products generally have lower gross margins until there is widespread market acceptance and until production and after-sales efficiencies can be achieved. Should the Saturn Spectrum 3, Verdant laser thermal processing system or the Company's advanced reduction stepper offerings, fail to develop or generate significant market demand, the Company's business, financial condition and results of operations would be materially adversely affected.

The Company's research, development and engineering expenses were $5.9 million for the quarter ended September 30, 2001, as compared with $6.7 million for the comparable period in 2000. For the nine-month period ended September 30, 2001, the Company's research, development and engineering expenses were $19.7 million, as compared with $19.8 million for the comparable period in 2000. The current quarter decrease in spending was primarily attributable to cost containment measures implemented in 2001. The year-to-date decline in spending was primarily attributable to the shutdown of the Company's UltraBeam operations, which occurred early in the second quarter of 2000, and cost containment measures implemented in 2001, partially offset by increased spending on the Company's laser thermal processing and 1X and advanced reduction stepper technologies.

The Company continues to invest significant resources in the development and enhancement of its Verdant laser thermal processing systems and technologies, together with continuing expenditures for its 1X and advanced reduction optical products and technologies. The Company presently expects that the absolute dollar amount of research, development and engineering expenses for the quarter ending December 31, 2001 will be lower than levels incurred in the comparable period in 2000, primarily as a result of continuing cost containment efforts.

Amortization of goodwill was $0.4 million for the quarter ended September 30, 2001, as compared with $0.5 million for the comparable period in 2000. The Company anticipates that amortization will decline to $0.1 million for the quarter ending December 31, 2001, as a direct result of impairment charges recognized on certain intangible assets acquired in the acquisition of the Company's reduction stepper business in 1998 (see "Restructure of operations"). For the nine-month period ended September 30, 2001, the Company's amortization of goodwill was $1.4 million, as compared with $1.6 million for the comparable period in 2000.

Selling, general and administrative expenses were $6.8 million for the quarter ended September 30, 2001, as compared with $8.6 million for the comparable period in 2000. As a percentage of net sales, selling, general and administrative expenses increased to 27.9% in the quarter ended September 30, 2001, as compared with 20.3% of net sales for the comparable period in 2000. The current quarter decline, in absolute dollars, was primarily attributable to cost containment measures implemented in 2001, lower sales and support expenses typically associated with a decline in sales and lower required employee profit sharing provisions. For the nine-month period ended September 30, 2001, selling, general and administrative expenses were $23.5 million, as compared with $22.3 million for the comparable period in 2000. On a year-to-date basis, selling, general and administrative expenses increased to 21.5%, as compared with 21.1% for the comparable period in 2000. The Company presently anticipates that selling, general and administrative expenses for the three-month period ending December 31, 2001 will decrease, relative to the comparable period in 2000, due primarily to lower anticipated net sales and continued efforts at cost containment.

During the quarter ended June 30, 2000, the Company shutdown the operations of its UltraBeam unit. As a direct result of this decision, the Company recognized a charge in the quarter ended June 30, 2000 of $8.0 million, or $0.38 per share (diluted). During the quarter ended September 30, 2000, the Company recognized an additional charge of $1.7 million, or $0.08 per share (diluted) primarily attributed to revised estimates of amounts to be realized upon the sale of operating assets. For the nine-month period ended September 30, 2001, the Company recognized a total charge of $9.7 million related to the shutdown of UltraBeam. At September 30, 2001, there were no outstanding payables or accruals associated with this charge.

Interest and other income, net, which consists primarily of interest income, was $1.9 million for the quarter ended September 30, 2001, as compared with $2.0 million for the comparable period in 2000. For the nine-month period ended September 30, 2001, interest and other income, net, was $6.1 million, as compared with $5.5 million for the comparable period in 2000. The year-to-date increase was

attributable to higher invested balances, partially offset by lower rates of return as a result of recent declines in short-term interest rates. As a result of these lower short-term interest rates, the Company presently anticipates that interest and other income, net, will be lower for the quarter ending December 31, 2001, as compared with the comparable period in 2000.

The Company recognized income taxes of $0.1 million and $0.9 million for the three-month and nine-month periods ended September 30, 2001, relating primarily to foreign income tax requirements. There was no income tax benefit recognized on the Company's pre-tax losses in 2001 and 2000, due to uncertainty related to the utilization of its net operating loss carry-forward. The difference between the rate recognized in the current quarter and the statutory rate is primarily attributable to certain deferred tax asset reserves recognized in prior years.

Net cash used in operating activities was $0.7 million for the nine-month period ended September 30, 2001, as compared with $5.7 million provided by operating activities during the comparable period in 2000. Cash used in operating activities was primarily attributable to the net loss of $15.4 million, partially offset by non-cash charges to income of $14.1 million and changes in operating assets and liabilities of $0.6 million. The increase in cash attributable to net changes in operating assets and liabilities was primarily attributable to a reduction in accounts receivable of $10.4 million and an increase in other current liabilities of $3.4 million, partially offset by a reduction in deferred license income of $5.4 million, a reduction in accounts payable of $4.6 million and a reduction in deferred product and services income of $3.5 million.

The Company sells certain of its accounts receivable in order to mitigate its credit risk and to enhance cash flow. Sales of accounts receivable typically precede final customer acceptance of the system. Although credit risk effectively passes to the third party financial institution, among other terms and conditions, the agreements include provisions that require the Company to repurchase receivables if disputes arise with the customer regarding suitability of the product. At September 30, 2001, $2.6 million of sold accounts receivable were outstanding to third-party financial institutions. The Company may continue to sell certain of its accounts receivable in the future. There can be no assurance that this form of financing will be available on reasonable terms, or at all.

The Company believes that because of the relatively long manufacturing cycle of certain of its systems, particularly newer products, the Company's inventories will continue to represent a significant portion of working capital. In particular, the Company recently increased its purchases of inventory, long-term demonstration inventory, long-term prepaid inventory and capital equipment for its Saturn Spectrum 3e wafer stepper, Verdant laser thermal processing system and its 157nm advanced reduction stepper. Higher inventory and capital asset levels may increase the risk of inventory obsolescence and asset impairment, which may adversely impact the Company's results of operations.

The semiconductor industry is presently experiencing a severe downturn due, in part, to macro-economic conditions facing the U.S. and world economies. As a result, the Company has recently experienced significantly lower order rates for its systems and this trend may continue in the near-term. Prolonged weakness in the Company's business would place the Company's inventories at a greater risk of obsolescence. Lower demand for the Company's systems may lead to additional inventory write-offs and purchase commitment reserves, which would materially adversely impact the Company's results of operations. Additionally, worsening business conditions increase the likelihood of further restructuring of operations and impairments to the Company's assets, either of which would materially adversely impact results of operations.

During the nine-month period ended September 30, 2001, net cash used in investing activities was $4.6 million, primarily attributable to capital expenditures of $4.3 million and a net investment in available-for-sale securities of $0.3 million.

Cash provided by financing activities was $14.7 million during the nine-month period ended September 30, 2001, primarily attributable to proceeds of $15.9 million from the issuance of Common Stock pursuant to the Company's employee stock option and stock purchase plans, partially offset by the repayment of $1.2 million of notes payable.

At September 30, 2001, the Company had working capital of $162.6 million. The Company's principal source of liquidity at September 30, 2001 consisted of $176.7 million in cash, cash equivalents and short-term investments.

The development and manufacture of new lithography systems and enhancements are highly capital-intensive. In order to be competitive, the Company must continue to make significant expenditures for capital equipment; sales, service, training and support capabilities; systems, procedures and controls; and expansion of operations and research and development, among many other items. The Company expects that anticipated cash flows from operations and its cash, cash equivalents and short-term investments will be sufficient to meet the Company's cash requirements for the next twelve months. Beyond the next twelve months, the Company may require additional equity or debt financing to address its working capital or capital equipment needs.

Additionally, the Company may in the future pursue additional acquisitions of complementary product lines, technologies or businesses. Future acquisitions by the Company may result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities and amortization expenses and impairment charges related to goodwill and other intangible assets, which could materially adversely affect any Company profitability. In addition, acquisitions involve numerous risks, including difficulties in the assimilation of the operations, technologies, personnel and products of the acquired companies; the diversion of management's attention from other business concerns; risks of entering markets in which the Company has limited or no direct experience; and the potential loss of key employees of the acquired company. In the event the Company acquires product lines, technologies or businesses which do not complement the Company's business, or which otherwise do not enhance the Company's sales or operating results, the Company may incur substantial write-offs and higher recurring operating costs, which could have a material adverse effect on the Company's business, financial condition and results of operations. In the event that any such acquisition does occur, there can be no assurance as to the effect thereof on the Company's business or operating results.

To the extent that the Company's financial resources are insufficient to fund the Company's activities, additional funds will be required. There can be no assurance that additional financing will be available on reasonable terms, or at all.

The Company uses foreign exchange contracts to hedge the risk that unremitted Japanese yen denominated receipts from customers for actual or forecasted sales of equipment after receipt of customer purchase orders and the unremitted Japanese yen denominated payments to suppliers for actual or forecasted deliveries of raw material from Japan after issuance of Company purchase orders may be adversely affected by changes in foreign currency exchange rates. As part of its overall strategy to manage the level of exposure to the risk of foreign currency exchange rate fluctuations, the Company attempts to hedge most of these Japanese yen denominated foreign currency exposures anticipated over the ensuing twelve-month period. At September 30, 2001, the Company had taken action to hedge approximately 100% of these Japanese yen denominated exposures. To hedge this exposure, the Company used foreign exchange contracts that generally have maturities of nine months or less, which generally will be rolled over to provide continuing coverage throughout the year. The

Company often closes foreign exchange sale contracts by purchasing an offsetting purchase contract. At September 30, 2001, the Company had contracts for the sale of $2.0 million and the purchase of $1.9 million of foreign currencies at fixed rates.

The introduction of a European single currency, the Euro, was initially implemented as of January 1, 1999, and the transition period will continue through January 1, 2002. As of September 30, 2001, the adoption of the Euro has not had a material effect on the Company's foreign exchange and hedging activities or the Company's use of derivative instruments. While the Company will continue to evaluate the impact of the Euro introduction over time, based on currently available information, management does not believe that the introduction of the Euro currency will have a material adverse impact on the Company's financial condition or overall trends in results of operations.

Cyclicality of Semiconductor, Semiconductor Packaging and Thin Film Head Industries The Company's business depends in significant part upon capital expenditures by manufacturers of semiconductors and micro-systems, including thin film head magnetic recording devices, which in turn depend upon the current and anticipated market demand for such devices and products utilizing such devices. The semiconductor industry historical has been highly cyclical and has experienced recurring periods of oversupply. This has, from time to time, resulted in significantly reduced demand for capital equipment including the systems manufactured and marketed by the Company. The semiconductor industry is presently experiencing a downturn. The Company also believes that markets for new generations of semiconductors and semiconductor packaging will also be subject to similar fluctuations. Accordingly, the Company can give no assurance that it will be able to achieve or maintain its current or prior level of sales.

The Company attempts to mitigate the risk of cyclicality by participating in multiple markets including semiconductor, semiconductor packaging, thin film head and micromachining, as well as diversifying into new markets such as photolithography for optical networking. Despite such efforts, when one or more of such markets experiences a downturn or a situation of excess capacity, such as is presently occurring in the semiconductor and thin film head markets, the Company's net sales and operating results are materially adversely affected.

During 2000 and 1999, approximately 18% and 30%, respectively, of the Company's net sales were derived from sales to microsystems manufacturers, including thin film head and optical networking device manufacturers. For the nine-month period ended September 30, 2001, approximately 32% of the Company's net sales were derived from sales to micro-systems manufacturers. The Company believes the TFH market is currently in a state of over-capacity and expects this situation to last for at least the next several quarters. This has and will continue to result in lower sales and delays or deferrals of customer orders from these industries, which will continue to materially adversely affect the Company's business, financial condition and results of operations in the near term. Additionally, the Company is experiencing increased competition in this market from Nikon, Canon and ASML. The Company's business and operating results would be materially adversely affected by continued downturns or slowdowns in the TFH market or by loss of market share.

Highly Competitive Industry The capital equipment industry in which the Company operates is intensely competitive. A substantial investment is required to install and integrate capital equipment into a semiconductor, semiconductor packaging or thin film head production line. The Company believes that once a device manufacturer or packaging subcontractor has selected a particular vendor's capital equipment, the manufacturer generally relies upon that equipment for the specific production line application and, to the extent possible, subsequent generations of similar products. Accordingly, it

is difficult to achieve significant sales to a particular customer once another vendor's capital equipment has been selected. The Company experiences intense competition worldwide from a number of leading foreign and domestic stepper manufacturers, such as Nikon, Canon and ASML, all of which have substantially greater financial, marketing and other resources than the Company. Nikon supplies a 1X stepper for use in the manufacture of liquid crystal displays and Canon, Nikon and ASML offer reduction steppers for thin film head fabrication. With respect to the semiconductor packaging market, the Company experiences intense competition from various proximity aligner companies such as Suss Microtec AG (Karl Suss).

Current thin film head front-end production involves manufacturing steps that require critical feature sizes. Although the Company's advanced reduction stepper product offerings address critical feature sizes, additional development of these product lines is necessary to fully address the unique requirements of thin film head manufacturing. ASML and Nikon have each introduced an i-line step-and-scan system as a lower cost alternative to the deep ultra-violet (DUV) step-and-scan system for use on the less critical layers. These systems compete with wide-field steppers, such as the Company's Saturn and Titan steppers, for advanced mix-and-match applications. In addition, the Company believes that the high cost of developing new lithography tools has increasingly caused its competitors to collaborate with customers and other parties in various areas such as research and development, manufacturing and marketing, or to acquire other competitors, thereby resulting in a combined competitive threat with significantly enhanced financial, technical and other resources. The Company expects its competitors to continue to improve the performance of their current products. These competitors have stated that they will introduce new products with improved price and performance characteristics that will compete directly with the Company's products. This could cause a decline in sales or loss of market acceptance of the Company's steppers, and thereby materially adversely affect the Company's business, financial condition and results of operations. There can be no assurance that enhancements to, or future generations of, competing products will not be developed that offer superior cost of ownership and technical performance features. The Company believes that to be competitive, it will require significant financial resources in order to continue to invest in new product development, features and enhancements, to introduce next generation stepper systems on a timely basis, and to maintain customer service and support centers worldwide. In marketing its products, the Company may also face competition from vendors employing other technologies. In addition, increased competitive pressure has led to intensified price-based competition in certain of the Company's markets, resulting in lower prices and margins. Should these competitive trends continue, the Company's business, financial condition and operating results would continue to be materially adversely affected. There can be no assurance that the Company will be able to compete successfully in the future.

Foreign integrated circuit manufacturers have a significant share of the worldwide market for certain types of ICs for which the Company's systems are used. The Japanese stepper manufacturers are well established in the Japanese stepper market, and it is extremely difficult for non-Japanese lithography equipment companies to penetrate the Japanese stepper market. Although the Company has experienced recent success in its introduction of its Saturn Spectrum 3 into the Japanese marketplace, to date the Company has not established itself as a major competitor in the Japanese equipment market and there can be no assurance that the Company will be able to achieve significant sales to Japanese manufacturers in the future. (See "International Sales; Japanese Market").

Development of New Product Lines; Expansion of Operations Currently, the Company is devoting significant resources to the development, introduction and commercialization of its Verdant laser thermal processing system and its advanced XLS 157nm reduction stepper, and to the volume production of its Saturn Spectrum 3e wafer stepper. During the remainder of 2001, the Company will continue to develop these products and will continue to incur significant operating expenses in the areas of research, development and engineering, manufacturing and general and administrative costs in

order to further develop, produce and support these new products. Additionally, gross profit margins and inventory levels may be further adversely impacted in the future by costs associated with the initial production of these new product lines. These costs include, but are not limited to, additional manufacturing overhead, additional inventory write-offs, costs of demonstration systems and facilities, costs associated with managing multiple sites and the establishment of additional after-sales support organizations. Additionally, there can be no assurance that operating expenses will not increase, relative to sales, as a result of adding additional marketing and administrative personnel, among other costs, to support the Company's new products. If the Company is unable to achieve significantly increased net sales or its sales fall below expectations, the Company's operating results will be materially adversely affected until, among other factors, costs and expenses can be reduced.

Lengthy Sales Cycle Sales of the Company's systems depend, in significant part, upon the decision of a prospective customer to increase manufacturing capacity or to restructure current manufacturing facilities, either of which typically involves a significant commitment of capital. Many of the Company's customers have cancelled the development of new manufacturing facilities and have substantially reduced their capital equipment budgets. In view of the significant investment involved in a system purchase, the Company has experienced and may continue to experience delays following initial qualification of the Company's systems as a result of delays in a customer's approval process. Additionally, the Company is presently receiving orders for systems that have lengthy delivery schedules, which may be due to longer production lead times or a result of customers' capacity scheduling requirements. In order to maintain or exceed the Company's present level of net sales, the Company is dependent upon obtaining orders for systems that will ship and be accepted in the current period. There can be no assurance that the Company will be able to obtain those orders. For these and other reasons, the Company's systems typically have a lengthy sales cycle during which the Company may expend substantial funds and management effort in securing a sale. Lengthy sales cycles subject the Company to a number of significant risks, including inventory obsolescence and fluctuations in operating results, over which the Company has little or no control.

Customer Concentration Historically, the Company has sold a substantial portion of its systems to a limited number of customers. In 2000, one customer accounted for approximately 10% of total net sales. In 1999, no single customer accounted for 10% or more of the Company's net sales. For the nine-month period ended September 30, 2001, no single customer accounted for 10% or more of total net sales. However, one customer accounted for $2.3 million and $6.9 million of licensing revenue for the three and nine-month periods ended September 30, 2001, respectively, from an agreement that expires February 2002. The Company expects that sales to a relatively few customers will continue to account for a high percentage of its net sales in the foreseeable future and believes that the Company's financial results depend in significant part upon the success of these major customers and the Company's ability to meet their future capital equipment needs. Although the composition of the group comprising the Company's largest customers may vary from period to period, the loss of a significant customer or any reduction in orders by any significant customer, including reductions due to market, economic or competitive conditions in the semiconductor, semiconductor packaging or micro-systems industries or in the industries that manufacture products utilizing integrated circuits, thin film heads or micro-machined components, may have a material adverse effect on the Company's business, financial condition and results of operations. The Company's ability to maintain or increase its sales in the future will depend, in part, upon its ability to obtain orders from new customers as well as the financial condition and success of its existing customers, the semiconductor and thin film head industries and the economy in general, of which there can be no assurance. (See "Additional Risk Factors: Cyclicality of Semiconductor, Semiconductor Packaging and Thin Film Head Industries").

In addition to the business risks associated with dependence on major customers, these significant customer concentrations have in the past resulted in significant concentrations of accounts receivable. These significant and concentrated receivables expose the Company to additional risks, including the risk of default by one or more customers representing a significant portion of the Company's total receivables. If the Company were required to take additional accounts receivable reserves its business, financial condition and results of operations would be materially adversely affected.

Rapid Technological Change; Importance of Timely Product Introduction The semiconductor, semiconductor packaging and micro-systems manufacturing industries are subject to rapid technological change and new product introductions and enhancements. The Company's ability to be competitive in these and other markets will depend, in part, upon its ability to develop new and enhanced systems and related software tools, and to introduce these systems and related software tools at competitive prices and on a timely and cost-effective basis to enable customers to integrate them into their operations either prior to or as they begin volume product manufacturing. The Company will also be required to enhance the performance of its existing systems and related software tools. Any success of the Company in developing new and enhanced systems and related software tools depends upon a variety of factors, including product selection, timely and efficient completion of product design, timely and efficient implementation of manufacturing and assembly processes, product performance in the field and effective sales and marketing. Because new product development commitments must be made well in advance of sales, new product decisions must anticipate both future demand and the technology that will be available to supply that demand. There can be no assurance that the Company will be successful in selecting, developing, manufacturing or marketing new products and related software tools or enhancing its existing products and related software tools. Any such failure would materially adversely affect the Company's business, financial condition and results of operations.

Because of the large number of components in the Company's systems, significant delays can occur between a system's introduction and the commencement by the Company of volume production of such systems. The Company has experienced delays from time to time in the introduction of, and technical and manufacturing difficulties with, certain of its systems and enhancements and related software tools and may experience delays and technical and manufacturing difficulties in future introductions or volume production of new systems or enhancements and related software tools.

There can be no assurance that the Company will not encounter additional technical, manufacturing or other difficulties that could further delay future introductions or volume production of systems or enhancements. The Company's inability to complete the development or meet the technical specifications of any of its systems or enhancements and related software tools, or its inability to manufacture and ship these systems or enhancements and related software tools in volume and in time to meet the requirements for manufacturing the future generation of semiconductor or thin film head devices would materially adversely affect the Company's business, financial condition and results of operations. In addition, the Company may incur substantial unanticipated costs to ensure the functionality and reliability of its products early in the products' life cycles. If new products have reliability or quality problems, reduced orders or higher manufacturing costs, delays in collecting accounts receivable and additional service and warranty expenses may result. Any of such events may materially adversely affect the Company's business, financial condition and results of operations.

Although the Company attempts to protect its intellectual property rights through patents, copyrights, trade secrets and other measures, it believes that any success will depend more upon the innovation, technological expertise and marketing abilities of its employees. Nevertheless, the Company has a policy of seeking patents when appropriate on inventions resulting from its ongoing research and development and manufacturing activities. The Company owns various United States and foreign patents, which expire on dates ranging from May 2002 to December 2018, and has various United

States and foreign patent applications pending. The Company also has various registered trademarks and copyright registrations covering mainly software programs used in the operation of its stepper systems. The Company also relies upon trade secret protection for its confidential and proprietary information. There can be no assurance that the Company will be able to protect its technology adequately or that competitors will not be able to develop similar technology independently. There can be no assurance that any of the Company's pending patent applications will be issued or that foreign intellectual property laws will protect the Company's intellectual property rights. In addition, litigation may be necessary to enforce the Company's patents, copyrights or other intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations, regardless of the outcome of the litigation. There can be no assurance that any patent issued to the Company will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages to the Company. Furthermore, there can be no assurance that others will not independently develop similar products, duplicate the Company's products or, if patents are issued to the Company, design around the patents issued to the Company. Additionally, the Company presently has several agreements in force to license certain of its technologies. Challenges to, or invalidation of, patents related to those technologies would expose the Company to the risk of forfeiture of revenues and further risk of damage claims.

On February 29, 2000, in the U.S. District Court of Virginia, the Company filed patent infringement lawsuits against Nikon, Canon and ASM Lithography. In April 2000, the Company reached a settlement with Nikon and in September 2001, the Company reached a settlement with Canon. The litigation against ASM Lithography is ongoing. The Company has recently been sued in the District Court in Massachusetts for alleged infringement of certain patents owned by Silicon Valley Group, Inc. ("SVG"), a company recently acquired by ASM Lithography. This case is very new and the Company is evaluating the claim.

Although there are no pending lawsuits against the Company regarding infringement claims with respect to any existing patent or any other intellectual property right (with the exception of the SVG claim), the Company has from time to time been notified of claims that it may be infringing intellectual property rights possessed by third parties. Certain of the Company's customers have received notices of infringement from Technivision Corporation and the Lemelson Medical, Education and Research Foundation, Limited Partnership alleging that the manufacture of certain semiconductor products and/or the equipment used to manufacture those semiconductor products infringes certain issued patents. The Company has been notified by certain of these customers that the Company may be obligated to defend or settle claims that the Company's products infringe any of such patents and, in the event it is subsequently determined that the customer infringes any of such patents, they intend to seek reimbursement from the Company for damages and other expenses resulting from this matter.

Although there are no pending lawsuits against the Company regarding infringement claims with respect to any existing patents or any other intellectual property rights (with the exception of the SVG claim), there can be no assurance that infringement claims by third parties or claims for indemnification resulting from infringement claims in the future will not be asserted, or that such assertions, if proven to be true, will not materially adversely affect the Company's business, financial condition and results of operations, regardless of the outcome of any litigation. With respect to any such future claims, the Company may seek to obtain a license under the third party's intellectual property rights. There can be no assurance, however, that a license will be available on reasonable terms or at all. The Company could decide, in the alternative, to resort to litigation to challenge such claims. Such challenges could be extremely expensive and time consuming and could materially adversely affect the Company's business, financial condition and results of operations, regardless of the outcome of any litigation.

Sole or Limited Sources of Supply The Company is relying increasingly on outside vendors and subcontractors to manufacture certain components and subassemblies. This strategy has enabled the Company to increase its manufacturing capacity. The Company orders one of the most critical components of its technology, the glass for its 1X lenses, from suppliers on purchase orders. Additionally, the Company orders reduction lenses from suppliers on purchase orders. These lenses are designed to the Company's specifications and tested by the supplier.

In addition to glass, the Company procures many of its other critical systems' components, subassemblies and services from a single outside supplier or a limited group of outside suppliers in order to ensure overall quality and timeliness of delivery. Many of these components and subassemblies have significant production lead times. To date, the Company has been able to obtain adequate services and supplies of components and subassemblies for its systems in a timely manner. However, disruption or termination of certain of these sources could result in a significant adverse impact on the Company's ability to manufacture its systems. This, in turn, would have a material adverse effect on the Company's business, financial condition and results of operations. The Company's reliance on sole or a limited group of suppliers and the Company's increasing reliance on subcontractors involve several risks, including a potential inability to obtain an adequate supply of required components due to the suppliers' failure or inability to provide such components in a timely manner, or at all, and reduced control over pricing and timely delivery of components. Although the timeliness, yield and quality of deliveries to date from the Company's subcontractors have been acceptable, manufacture of certain of these components and subassemblies is an extremely complex process, and long lead-times are required. Any inability to obtain adequate deliveries or any other circumstance that would require the Company to seek alternative sources of supply or to manufacture such components internally could delay the Company's ability to ship its products, which could damage relationships with current and prospective customers and have a material adverse effect on the Company's business, financial condition and results of operations.

International Sales; Japanese Market International net sales accounted for approximately 54% and 53% of total net sales for the years 2000 and 1999, respectively. For the nine-month period ended September 30, 2001, international net sales accounted for approximately 53% of total net sales, as compared with 54% for the comparable period in 2000. The Company anticipates that international sales, which typically have lower gross margins than domestic sales, principally due to increased competition and higher field service and support costs, will continue to account for a significant portion of total net sales and may increase as a percentage of total net sales in the near-term. As a result, a significant and growing portion of the Company's net sales will continue to be subject to certain risks, including dependence on outside sales representative organizations; transitions to direct sales organizations from outside sales representative organizations, such as the Company is currently undertaking in Taiwan; unexpected changes in regulatory requirements; difficulty in satisfying existing regulatory requirements; exchange rate fluctuations; tariffs and other barriers; political and economic instability; difficulties in accounts receivable collections; natural disasters; difficulties in staffing and managing foreign subsidiary and branch operations; and potentially adverse tax consequences. Although the Company generally transacts its international sales in U.S. dollars, international sales expose the Company to a number of additional risk factors, including fluctuations in the value of local currencies relative to the U.S. dollar, which, in turn, impact the relative cost of ownership of the Company's products and may further impact the purchasing ability of its international customers. In Japan, however, the Company has commenced direct sales operations and orders are often denominated in Japanese yen. This may subject the Company to a higher degree of risk from currency fluctuations. The Company attempts to mitigate this exposure through the use of foreign exchange contracts. The Company is also subject to the risks associated with the imposition of legislation and regulations relating to the import or export of semiconductors and thin film head products. The Company cannot predict whether changes to quotas, duties, taxes or other charges or restrictions will be implemented by the United States, Japan or any other country upon the importation or exportation of the Company's

products in the future. There can be no assurance that any of these factors or the adoption of restrictive policies will not have a material adverse effect on the Company's business, financial condition and results of operations.

Dependence on Key Personnel The Company's future operating results depend, in significant part, upon the continued contributions of key personnel, many of whom would be difficult to replace. None of such persons has an employment or non-competition agreement with the Company. The Company does not maintain any life insurance on any of its key persons. The loss of key personnel could have a material adverse effect on the business, financial condition and results of operations of the Company. In addition, the Company's future operating results depend in significant part upon its ability to attract and retain other qualified management, manufacturing, and technical, sales and support personnel for its operations. There are only a limited number of persons with the requisite skills to serve in these positions and it may become increasingly difficult for the Company to hire such personnel over time. Competition for such personnel is intense, particularly in the San Francisco Bay Area where the Company maintains its headquarters and principal operations, and there can be no assurance that the Company will be successful in attracting or retaining such personnel. The failure to attract or retain such persons would materially adversely affect the Company's business, financial condition and results of operations.

California Energy Crisis The Company's headquarters and principal operations are located in the San Francisco Bay Area of California. California has recently found itself in a utility crisis caused, in part, by a lack of affordable power sources and the financial instability of several of its primary providers. The San Francisco Bay Area has undergone several periods of "rolling blackouts", a technique used by the Company's power provider to conserve its resources. The Company's operations have been temporarily halted on several occasions as a result of these conservation measures, although these interruptions have not occurred in the last six months. Additionally, the Company has recently been notified of, and is presently experiencing, significantly higher utility rates. Additional suspensions of the Company's operations or increases in utility rates could result in materially higher costs and lost revenues, either of which would materially adversely impact the Company's business, financial condition and results of operations.

Changes to Financial Accounting Standards May Affect the Company's Reported Results of Operations The Company prepares its financial statements to conform with generally accepted accounting principles, or GAAP. These principles are subject to interpretation by the American Institute of Certified Public Accountants, the SEC and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on the Company's reported results and may even affect its reporting of transactions completed before a change is announced.

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 (SAB 101), entitled "Revenue Recognition in Financial Statements." Effective January 1, 2000, the Company changed its method of accounting for product sales to recognize such revenues when the contractual obligation for installation has been satisfied, or when installation is substantially complete, and customer acceptance provisions have lapsed, provided collection of the related receivable are probable. The cumulative effect of the change in accounting principle includes system revenue, cost of sales and certain expenses, including warranty and commission expenses, which were recognized when both installation and customer acceptance provisions were satisfied, subsequent to January 1, 2000.

Accounting policies affecting many other aspects of our business, including rules relating to intangible assets, derivatives, financial instruments, purchase and pooling-of-interests accounting for business combinations, revenue recognition, in-process research and development charges, employee stock purchase plans and stock option grants, have recently been revised or are under review. Changes to those rules or the questioning of current practices may have a material adverse effect on the

Company's reported financial results or on the way it conducts business. In addition, the Company's preparation of financial statements in accordance with GAAP requires that it make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of those assets and liabilities at the date of the financial statements and the recorded amounts of expenses during the reporting period. A change in the facts and circumstances surrounding those estimates could result in a change to the Company's estimates and could impact its future operating results.

Effects of Certain Anti-Takeover Provisions Certain provisions of the Company's Certificate of Incorporation, equity incentive plans, Shareholder Rights Plan, licensing agreements, Bylaws and Delaware law may discourage certain transactions involving a change in control of the Company. In addition to the foregoing, the Company's classified board of directors, the shareholdings of the Company's officers, directors and persons or entities that may be deemed affiliates and the ability of the Board of Directors to issue "blank check" preferred stock without further stockholder approval could have the effect of delaying, deferring or preventing a change in control of the Company and may adversely affect the voting and other rights of holders of Common Stock.

Volatility of Stock Price The Company believes that factors such as announcements of developments related to the Company's business, fluctuations in the Company's operating results, a shortfall in revenue or earnings, changes in analysts' expectations, sales of securities of the Company into the marketplace, general conditions in the semiconductor and magnetic recording head industries or the worldwide or regional economies, an outbreak of hostilities, announcements of technological innovations or new products or enhancements by the Company or its competitors, developments in patents or other intellectual property rights and developments in the Company's relationships with its customers and suppliers could cause the price of the Company's Common Stock to fluctuate, perhaps substantially. In addition, in recent years the stock market in general, and the market for shares of small capitalization stocks and semiconductor capital equipment stocks in particular, including the Company's, have experienced extreme price fluctuations, which have often been unrelated to the operating performance of affected companies. There can be no assurance that the market price of the Company's Common Stock will not continue to experience significant fluctuations in the future, including fluctuations that may be unrelated to the Company's performance.

Among other determinants, the market price of the Company's stock has a major bearing on the number of stock options outstanding that are included in the weighted-average shares used in determining the Company's net income (loss) per share. During periods of extreme volatility, the impact of higher stock prices can have a materially dilutive effect on the Company's net income (loss) per share (diluted).

Terrorist Attacks and Threats, and Government Responses Thereto, May Negatively Impact All Aspects of Our Operations, Revenues, Costs and Stock Price. The recent terrorist attacks in the United States, and the United States retaliation therefor, and any similar future events may disrupt our operations or those of our customers and suppliers and may affect the availability of materials needed to manufacture our products or the means to transport those materials to manufacturing facilities and finished products to customers. In addition, any of these events could increase volatility in the United States and world financial markets which may limit the capital resources available to the Company or its customers or suppliers, which could result in decreased orders from customers, less favorable financing terms from suppliers, and scarcity or increased costs of materials and components of our products. Any of these occurrences could have a significant impact on our operating results, revenues and costs and may result in increased volatility of the market price of our Common Stock.

Reference is made to Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk" in the Company's Annual Report on Form 10-K for the year ended December 31, 2000 and to the subheading "Derivative Instruments and Hedging" in Item 8, "Financial Statements and Supplementary Data", under the heading "Notes to Consolidated Financial Statement" of the Company's Annual Report on Form 10-K for the year ended December 31, 2000.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

(In thousands)		Sept. 30, 2001			Dec. 31, 2000*
		(Unaudited)
*ASSETS*
Current assets:
	Cash, cash equivalents and short-term investments	$	176,709		$	163,681
	Accounts receivable, net		13,497			23,942
	Inventories		28,745			30,262
	Prepaid expenses and other current assets		1,974			3,129

Total current assets			220,925			221,014
Equipment and leasehold improvements, net			25,797			28,833
Demonstration inventories, net			1,334			6,542
Intangible assets, net			5,636			6,880
Other assets			2,586			800

Total assets		$	256,278		$	264,069

*LIABILITIES AND STOCKHOLDERS' EQUITY*
Current liabilities:
	Notes payable	$	—		$	1,152
	Accounts payable		7,678			12,228
	Deferred product and service income		3,245			6,728
	Deferred license income		16,935			22,369
	Other current liabilities		30,486			27,103

Total current liabilities			58,344			69,580
Other liabilities			188			232
Stockholders' equity:
	Common stock		23			22
	Additional paid-in capital		195,415			179,530
	Accumulated other comprehensive gain (loss), net		2,730			(299	)
	Treasury stock		(6,867	)		(6,867	)
	Retained earnings		6,445			21,871

Total stockholders' equity			197,746			194,257

Total liabilities and stockholders' equity		$	256,278		$	264,069

		Three Months Ended						Nine Months Ended
(In thousands, except per share amounts)		Sept. 30, 2001			Sept. 30, 2000			Sept. 30, 2001			Sept. 30, 2000
Net sales:
	Products	$	18,147		$	35,011		$	88,442		$	89,796
	Services		2,975			4,703			11,298			12,839
	Licenses		3,227			2,502			9,433			3,009

Total net sales			24,349			42,216			109,173			105,644
Cost of sales:
	Cost of products sold		13,621			21,834			53,399			57,412
	Cost of services		2,291			3,362			8,521			9,516
	Cost of discontinued products		10,993			—			10,993			—

Total cost of sales			26,905			25,196			72,913			66,928

Gross profit (loss)			(2,556	)		17,020			36,260			38,716
Operating expenses:
	Research, development, and engineering		5,925			6,664			19,746			19,822
	Amortization of goodwill		420			495			1,412			1,564
	Selling, general, and administrative		6,792			8,560			23,494			22,274
	Restructure of operations		11,988			—			11,988			—
	Shutdown of operations		—			1,686			—			9,670

Operating loss			(27,681	)		(385	)		(20,380	)		(14,614	)
Gain on sale of land			—			15,983			—			15,983
Interest expense			(86	)		(69	)		(200	)		(211	)
Interest and other income, net			1,852			1,975			6,072			5,501

Income (loss) before tax and cumulative effect of a change in accounting principle			(25,915	)		17,504			(14,508	)		6,659
Income taxes			110			2,433			918			2,433

Income (loss) before cumulative effect of a change in accounting principle			(26,025	)		15,071			(15,426	)		4,226
Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"			—			—			—			(18,883	)

Net income (loss)		$	(26,025	)	$	15,071		$	(15,426	)	$	(14,657	)

Earnings per share—basic:
Income (loss) before cumulative effect of a change in accounting principle		$	(1.17	)	$	0.71		$	(0.70	)	$	0.20
Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"			—			—			—		$	(0.89	)
Net income (loss)		$	(1.17	)	$	0.71		$	(0.70	)	$	(0.69	)
Number of shares used in per share computations—basic			22,296			21,093			22,043			21,238
Earnings per share—diluted:
Income (loss) before cumulative effect of a change in accounting principle		$	(1.17	)	$	0.70		$	(0.70	)	$	0.20
Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"			—			—			—		$	(0.89	)
Net income (loss)		$	(1.17	)	$	0.70		$	(0.70	)	$	(0.69	)
Number of shares used in per share computations—diluted			22,296			21,669			22,043			21,238

	Nine Months Ended
(In thousands)	Sept. 30, 2001			Sept. 30, 2000
*Cash flows from operating activities:*
Net loss	$	(15,426	)	$	(14,657	)
Gain from sale of land		—			(15,983	)
Change in accounting principle—SAB 101 "Revenue Recognition in Financial Statements"		—			18,883
Charges to income not affecting cash		14,110			10,202
Net effect of changes in operating assets and liabilities		594			7,213

Net cash provided by (used in) operating activities		(722	)		5,658
*Cash flows from investing activities:*
Capital expenditures		(4,283	)		(14,765	)
Net reduction (increase) in available-for-sale securities		(276	)		4,151
Net reduction in restricted long-term investments		—			5,549
Proceeds from sale of land		—			16,165

Net cash provided by (used in) investing activities		(4,559	)		11,100
*Cash flows from financing activities:*
Net proceeds (repayment) from issuance of notes payable		(1,152	)		439
Buy-back of common stock		—			(6,866	)
Net proceeds from issuance of common stock pursuant to employee stock plans		15,853			1,743

Net cash provided by (used in) financing activities		14,701			(4,684	)
Net effect of exchange rate changes on cash		16			—
Net increase in cash and cash equivalents		9,436			12,074
Cash and cash equivalents at beginning of period		55,346			46,978

Cash and cash equivalents at end of period	$	64,782		$	59,052

		Three Months Ended					Nine Months Ended
(Unaudited, in thousands, except per share amounts)		Sept. 30, 2001			Sept. 30, 2000		Sept. 30, 2001			Sept. 30, 2000
Numerator:
	Income (loss) before cumulative effect of a change in accounting principle	$	(26,025	)	$	15,071	$	(15,426	)	$	4,226
	Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"		—			—		—			(18,883	)

	Net income (loss)	$	(26,025	)	$	15,071	$	(15,426	)	$	(14,657	)

Denominator:
	Denominator for basic net income (loss) per share		22,296			21,093		22,043			21,238
	Effect of dilutive employee stock options		—			576		—			—

	Denominator for diluted net income (loss) per share		22,296			21,669		22,043			21,238

Earnings per share — basic:
	Income (loss) before cummulative effect of a change in accounting principle	$	(1.17	)	$	0.71	$	(0.70	)	$	0.20

	Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"		—			—		—		$	(0.89	)

	Net income (loss)	$	(1.17	)	$	0.71	$	(0.70	)	$	(0.69	)

Earnings per share—diluted:
	Income (loss) before cummulative effect of a change in accounting principle	$	(1.17	)	$	0.70	$	(0.70	)	$	0.20

	Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"		—			—		—		$	(0.89	)

	Net income (loss)	$	(1.17	)	$	0.70	$	(0.70	)	$	(0.69	)

		Three Months Ended					Nine Months Ended
(Unaudited, in thousands)		Sept. 30, 2001			Sept. 30, 2000		Sept. 30, 2001			Sept. 30, 2000
Net income (loss)		$	(26,025	)	$	15,071	$	(15,426	)	$	(14,657	)
Accumulated other comprehensive income (loss)
	Unrealized holding gain on available-for-sale securities		1,403			926		3,013			998
	Unrealized holding gain on foreign exchange forward contracts		576			—		16			—
	Tax effect		—			—		—			—

Comprehensive income (loss)		$	(24,046	)	$	15,997	$	(12,397	)	$	(13,659	)

Item 1.	Legal Proceedings.	None.
Item 2.	Changes in Securities and Use of Proceeds.	None.
Item 3.	Defaults upon Senior Securities.	None.
Item 4.	Submission of Matters to a Vote of Security Holders.	None
Item 5.	Other Information.	None
Item 6.	Exhibits and Reports on Form 8-K
	(a) Exhibits	None
	(b) Reports on Form 8-K
	Current Reports on Form 8-K, dated August 23, 2001 and September 28, 2001 were filed during the quarter ended September 30, 2001, reporting updates to the Company's quarterly teleconference guidance.

				ULTRATECH STEPPER, INC. (Registrant)
Date:		November 9, 2001		By:		/s/Bruce R. Wright Bruce R. Wright Senior Vice President, Finance and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)