We are a supplier of semiconductor manufacturing equipment and software to the global semiconductor industry. We were incorporated in Delaware in April 1993, to succeed the wafer prober business conducted by the Electroglas division of General Signal Corporation, our former parent. Immediately prior to the closing of the initial public offering of our Common Stock, or IPO, in July 1993, we assumed the assets and liabilities of the Electroglas division in an asset transfer. Following our IPO, we commenced operations as an independent corporation. We, through our predecessors, have been in the semiconductor equipment business for more than 40 years.

          Our primary product line is automated wafer probing equipment and related network software to manage information from that equipment. In conjunction with automated test systems from other suppliers, our semiconductor manufacturing customers use our wafer probers and network software to quality test semiconductor wafers. Electroglas’ installed base is one of the largest in the industry, with over 15,000 wafer probers sold.

          In January 2001, we acquired Statware Inc., of Corvallis, Oregon, to further expand our network software product offerings in the test management area. Today, the Statware technology is the basis for our web-based applications that allow our customers to monitor and control probers from any location, as well as collect, analyze, and report critical test process information and automatically direct corrective action.

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

          We are also involved in the market of selling test handlers as part of our strategy to be a comprehensive semiconductor test solutions provider. Built upon our proven prober technology, the test handlers expand available markets by providing solutions to the final test segment for today’s latest packaging technologies and test processes. This includes Wafer Level Packages (WLP), Known-Good Die (KGD), Microelectromechanical Systems (MEMS), ultra-thin and/or diced wafers. It also includes many package tested strip formats, whether panel or leadframe such as Chip Scale Packages (CSP) or Ball Grid Arrays (BGA) as well as traditional Small Outline Integrated Circuits (SOIC).

          Starting in 2003, we directed our focus on our core competency of wafer probing and extending our wafer probing technologies throughout the back-end of the semiconductor manufacturing process. In 2003 we sold our Design for Manufacturing (“DFM”) and Fab Solutions software product lines and our Optical Inspection product line. Our renewed focus allowed us to spend more time developing and delivering innovative products to help our customers overcome their most critical semiconductor test challenges. In 2004, we introduced a new extended performance 200mm wafer prober, the 4090µ+, and in January 2005 a new 300mm prober, the EG6000, that represents a major advancement in prober design and automation and is focused on providing better performance than currently available competitor’s products.

          Additional information about Electroglas is available on our web site (www.electroglas.com) . Electroglas makes available free of charge on our website Reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file them with or furnish them to the Securities Exchange Commission. The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our filings also are available at the SEC’s website at http://www.sec.gov .

Industry Background

          Semiconductor devices are fabricated by repeating a complex series of process steps on a substrate, or wafer, which is usually made of silicon. Wafers are typically sent through a series of 100 to 400 process steps. A finished wafer consists of many integrated circuits, each referred to as a “device” or “die” or “chip”, the number of which depends on the area of the circuits and the size of the wafer. These wafers measure from 75mm to 300mm, or 3 to 12 inches, in diameter. Manufacturers have increasingly utilized larger diameter wafers to achieve more cost-effective production.

The move to 300mm (12-inch) wafers, a significant trend for equipment manufacturers, began in 2000. The manufacture of semiconductor devices is very capital intensive. A typical state of the art facility, usually called a “wafer fab”, can cost more than $2.0 billion. The purchase of semiconductor manufacturing equipment and spare parts, the integration of such equipment into production lines, and the training of employees on a particular supplier’s equipment requires significant expenditures by semiconductor manufacturers.

Wafer Probing

          A wafer prober successively positions each die on the wafer so that the electrical contact points, or pads, on the die align under and make contact with probe pins, which are located on a probe card mounted on the wafer prober. The probe card, which is generally custom-made by other suppliers for the specific device being tested, is connected to a test system, also supplied by other suppliers, which performs the required parametric or functional test. Parametric testing is typically performed during the wafer fabrication process, referred to as “in-line testing,” to measure electrical parameters of the device being fabricated. Functional testing is performed after the completion of wafer fabrication to identify devices that do not conform to particular electrical specifications or performance criteria. This process is commonly called “wafer sort.” Wafers often go through several wafer probing steps during the manufacturing process.

Wafer probing requires sophisticated machine vision and software capabilities to align each die on a wafer — often to accuracies as tight as 2.5µm — to pins on a probe card connected to a tester that measures electrical performance.

          Automatic wafer probers are primarily used during this “wafer sort” process, which occurs after the fabrication steps are completed and before the separation and packaging of each individual device. Positioning accuracy is a key requirement of an automatic wafer prober.  As manufacturers continue to shrink their device sizes, the manufacturing equipment accuracy must continue to keep pace with reduced feature sizes.  Throughput is another key prober feature, because allowing more devices to be tested in a given amount of time reduces the overall cost of test.  Similarly, wafer probers are required to be reliable, easy to use, portable, and very robust at handling the test process without failure or interruption, since these cause loss of throughput for the entire test cell. Recently, new device manufacturing processes, such as the use of copper for the metal layers and the use of very soft, delicate dielectric layers, have required a new level of control over the speed and accuracy with which probes are brought into contact with the pads to prevent damage and yield loss.

          Wafer probers are also used during in-line parametric testing. In-line testing requires special equipment features such as cleanroom compatibility and low-noise electrical measurement capability, as tests are carried out during the fabrication process. This testing is done to verify the quality of the manufacturing process while wafers are in an unfinished state where corrective action can occur. A small number of probers are also used for research and development, and quality and process control applications. We estimate based upon our experience that wafer sort applications represent as much as 85%-90% of the market for automatic wafer probers. The remainder is divided between in-line and laboratory applications.

          There is a growing trend for semiconductor manufacturers to contract with other companies to perform their wafer sort operations. These contract test companies, commonly called “test houses”, perform the wafer testing service and often provide assembly and packaging services as well.

          A semiconductor manufacturer typically purchases wafer probers when outfitting a new wafer fabrication facility or expanding an existing facility. Wafer probers are also purchased to replace equipment in response to major changes in technology such as larger wafer sizes and greater device complexity. A semiconductor fabrication facility may require from 20 to over 100 probers to meet testing requirements on a timely basis. A test house may require hundreds of wafer probe systems to support the testing requirements of the companies that contract with them.

Test Handling

          Wafers are sent from the wafer sort operation to assembly where the wafers are sawed into individual chips and put into protective packages. Once packaged, chips are tested again to make sure they function properly before being shipped to a customer. Ultimately, these packaged chips find their way into electronic systems that go into a myriad of familiar consumer and industrial electronic applications. For traditional packages, the desire to reduce the cost of assembly and test has chipmakers looking for ways to increase test efficiency.  As demand continues for the highest volume leadframe-based packages, such as SOIC’s, there is an increasing need to find new test methods to improve test throughput and lower the cost of test.  In addition, semiconductor packaging is currently being driven by the trend to shrink the size and weight of consumer electronics devices, such as mobile phones, personal digital assistants (PDAs), and notebook computers, while increasing performance. This has caused the advent of very small packages which are difficult to handle individually. Manufacturers and test houses are looking for new and more efficient methods to handle these types of packages.

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

Packaging trends provide new opportunities for Electroglas as final test becomes more like wafer test with large arrays of devices on a substrate, very small package size and contacts, and a need for higher levels of test parallelism.

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

Test Floor Management

Process management software plays an important role in Integrated Circuit (IC) manufacturing. Capital and operating costs of a fabrication facility are very high so semiconductor manufacturers seek ways to improve overall equipment efficiency (OEE) and optimize their processes. Test houses and Integrated Device Manufacturers look to reduce the cost of test and improve quality through software monitoring, analysis, and the automation of their test floors.  In wafer sort, network software is increasingly being used to manage wafer information to speed the identification of yield shortfalls and to reduce reprobe rates by collecting wafer maps from multiple passes for all systems and storing the files in a common database for viewing, analyzing and archiving. Other uses include prior step verification to insure that wafers accurately flow through a pre-defined set of steps and are not tested if they have not completed the previous step in the process and, product file management capabilities that allow the user to save a master template for product file set-up that can be accessed by all test systems on the test floor.

Our Strategy

          We are a major supplier of wafer probers due to a combination of strengths, including a large installed base, advanced technical capabilities, close relationships with the leading manufacturers of integrated circuits, a broad line of high quality products, and a well-established, highly qualified distribution organization. Building on these capabilities, our strategy is comprised of the following key elements:

 

• Focus on supplying high-speed tools for high-volume semiconductor testing that meet our customers’ requirements for accuracy, reliability, and production-worthiness. We have refocused our efforts on our core technology, semiconductor test, including wafer probing and prober-based test handlers. We have invested in research and development to add features and functionality to our 200mm wafer prober products, as well as to improve and expand our advanced 300mm wafer probing platform as the semiconductor industry transitions from 200mm wafers to 300mm wafers. In addition, we have developed advanced test floor management software and applications to allow our wafer prober customers to more effectively manage their test floor operations. We expect to continue to invest in research and development of our wafer prober products and software to anticipate and address technological advances in semiconductor processing.

 

 

 

• Maintain customer relationships based on trust and dependability and good service. We have long-standing relationships with our customers and we seek to strengthen our existing customer relationships by providing high levels of service and support. Our development of products and product enhancements is market-driven. Marketing, engineering, sales and management personnel collaborate with customer counterparts to determine customers’ needs and specifications, partnering with them to develop solid solutions for wafer probing, prober-based test handling, and test floor management to drive greater efficiencies in their wafer and device testing processes.

 

 

 

 

• Emphasize quality products.   We believe in providing high-quality products that are dependable tools for our customer’s manufacturing processes. We have received quality awards from our customers and the SEMATECH Partnering for Total Quality award. We have a company-wide quality program, and we received International Organization for Standardization (ISO) 9002 Certification in 1997 and ISO 9001 Certification in 2000. Our Singapore manufacturing facility was ISO Certified in 2002 to the new ISO 9001/2000 Standard and ISO 14001/1996 Environmental Standard.

Products

Wafer Probers

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

          The EG6000:  Developed in 2004 and introduced in January 2005, the new EG6000 300mm probing system from Electroglas is the only 300mm prober that employs precision direct-drive technology to enable it to achieve the highest positioning accuracy currently available. Designed for advanced applications such as copper and low k dielectrics, the system employs a proprietary stage and control technology enabling highly accurate positioning of the test devices while moving devices into contact with the probes for test. MicroTouch adds the ability to control the impact forces while probing on delicate devices. In addition, patent pending active vibration cancellation technology reduces internally and externally generated vibrations while maintaining the integrity of the connection between devices under test and the probe pins, which can improve test yield.  It also allows the prober t higher throughput in typical test applications with raised test floors that are subject to vibration. The EG6000 features the new Advanced Vision System for better accuracy, robustness and speed in aligning devices to the probe card for test.

It also features a sophisticated system for automatically measuring and compensating for thermal changes in the system components while testing at hot or cold temperatures. The EG6000 is based on the same core architecture as the prior 5|300 prober which served the relatively small market for parametric test and process development applications.  The EG6000 features a broader range of application capabilities as well as many refinements and improvements in accuracy, throughput, automation, portability, and reliability. This allows the EG6000 to address customer’s needs for high volume production wafer test which is the majority of the 300mm prober market.

          Parametric Probers:  The EG6000e , introduced in December 2005 is targeted at the parametric test (“e-test”) segment of the wafer probe market. This system incorporates patented technology licensed from, Cascade Microtech, Inc. This technology allows extremely precise, low-level electrical measurements to be made at the wafer level. This type of electrical measurement performance is becoming increasingly critical for advanced sub-micron semiconductor processes.

Test Handlers

          Pathfinder:   Introduced in 2002, the Pathfinder system is designed to meet the unique test handling requirements of the Known Good Die (KGD) and Wafer Level Package (WLP) markets. The Pathfinder system features a unique material handling system that can handle and position wafers and packages on a film frame after they have been sawn (“diced”). Special alignment techniques are used to compensate for the variability inherent in these sawn wafers and packages.  Because it handles wafers while supported by a film frame, Pathfinder is also capable of handling ultra-thin wafers.

          Sidewinder: Introduced in 2003, Sidewinder provides final test handling of packaged semiconductor and discrete components in panel or lead frame format. Termed “strip testing”, Sidewinder’s technology enables the handling of fine geometry packages such as chip scale packages (CSP) that are difficult to test in singulated format, and higher parallel test capability for small outline package (SOP), quad flat no-lead (QFN), and other well established high volume packages. The only strip test handler to be based on advanced 300mm prober technology, Sidewinder, combines Electroglas’ proven prober stage with a sophisticated machine vision-based alignment system that offers improved accuracy and system throughput. Sidewinder’s market is comprised of companies who need technology that enables them to test advanced devices in new packages, as well as companies seeking increased efficiency in testing traditional packages in panel or lead format.

Sidewinder leverages Electroglas' proven prober technology to deliver superior throughput and accuracy for final test handling of packaged semiconductor and discrete components in panel or lead frame format.

Test Floor Management Software Products

          From the sort floor to final test, Electroglas’ software enables chipmakers to collect, share, analyze and act on essential data - saving time and helping to improve profitability.  The answers to chipmakers most pressing questions lie in the multitude of data that are generated from their manufacturing processes. Unfortunately, this information is often not easily accessible, making it difficult for engineers and managers to act upon the most recent critical data. Electroglas helps manufacturers overcome this knowledge gap and attain faster answers to questions about their productivity, offering software solutions that provide insight into the manufacturing process.

          SORTmanager: Bridging the gap between raw data and genuine process improvement is the difference between data overload and real productivity gains. Electroglas’ SORTmanager provides that bridge, enabling a secure, web-based environment for the analysis, reporting and control of sort-floor processes. Data about test results, binning, prober performance and throughput can be collected from all SORTmanager -connected wafer probers, and this information can then be delivered via dynamic and interactive web pages that allow users to view the underlying data or perform additional analysis.  Powerful web publishing capabilities allow web reports to be created and distributed throughout an enterprise.  SORTmanager ’s flexible data-access and information viewing capabilities, combined with a comprehensive suite of pre-built applications and a scripting language for fine tuning applications to customer needs, makes SORTmanager a unique and powerful test floor management tool.

Engineering, Research and Development

          The market for semiconductor manufacturing equipment is characterized by continuous technological development and a high rate of product innovation. We believe that continued, rapid development of new products and enhancements to existing products is necessary to maintain our competitive position. For example, we devote a significant portion of our personnel and financial resources to engineering, research and development programs to continue development for our 200mm wafer probers products as well as to continue development of our EG6000 300mm platform. In addition, we continue to invest in new product areas such as final test and test management software. We use our close relationships with our key customers to make product improvements that respond to our customers’ needs.

          Engineering, research and development expenses were $11.5 million, $5.5 million, $16.2 million, and $21.8 million for the fiscal year ended May 31, 2006, the five month period ending May 31, 2005, and the fiscal years ended December 31, 2004, and 2003, respectively, or 26%, 49%, 26%, and 48% of net sales.

Marketing, Sales and Service

          We sell our products directly to end-users through a direct sales force and independent representatives. We generally sell products to customers on net 30 to 60 day terms from shipment or acceptance. Other, primarily Asian customers, are required to deliver a letter of credit typically payable upon product delivery. We generally warrant our products for a period of 13 months from the date of shipment for material and labor repair. Installation and certain training are customarily included in the price of the product. Customers may enter into repair and maintenance service contracts covering our products. Our field engineers provide customers (with products not under warranty or service contracts) with call out repair and maintenance services. We also train our customers’ employees to perform routine service for a fee.

          We maintain sales and service personnel throughout the United States in strategic locations to meet our customers’ needs. In Europe, we maintain sales and service offices in France, and in Asia, the People’s Republic of China, Singapore and Taiwan.

Customers

          We sell our products to leading semiconductor manufacturers and contract test companies throughout the world. In 2006, ST Microelectronics accounted for more than 10% of our net sales. International sales represented 58%, 73%, 63%, and 65% of our net sales for the fiscal year ended May 31, 2006, the five month period ended May 31, 2005, and the fiscal years ended December 31, 2004, and 2003, respectively. These sales represent the combined total of export sales made by United States operations and all sales made by foreign operations.

Manufacturing and Suppliers

          Our assembly equipment manufacturing activities consist primarily of integrating components and subassemblies to create finished probers and spares and upgrades configured to customer specifications. We schedule production based on firm customer commitments and anticipated orders during the planning cycle. In December 2002, we completed our move of equipment manufacturing from San Jose, California to Singapore to reduce production costs. In addition to rapid product innovation, our wafer prober market is subject to significant price competition and cost reduction is required. Certain of our components and subassemblies included in our products are obtained from a single source. We believe that alternative sources exist or can be developed, if required. Quality control is maintained throughout the assembly and test process, with documented instructions and test procedures and final inspection for all manufactured equipment prior to shipment. We train many of our employees in basic quality skills and regularly participate in quality sharing meetings with other equipment manufacturers and customer quality audits of procedures and personnel. We are ISO 9001/2000 and ISO 14001/1996 Certified.

Backlog

          Our backlog was $9.1 million and $8.4 million as of May 31, 2006 and 2005, respectively. Our backlog consists of product orders for which a customer purchase order has been received and which is scheduled for shipment or is to be earned within the next twelve months. Orders are subject to cancellation or rescheduling by the customer, sometimes with a cancellation charge. Due to timing of order placement and product lead times, changes in product delivery schedules and cancellations, and because sales will often reflect orders shipped in the same quarter received, our backlog at any particular date is not necessarily indicative of sales for the succeeding period. Backlog also includes deferred revenue comprised of products shipped (but not recognizable as revenue per our revenue recognition policy), maintenance revenue that is being amortized over twenty-four months or less, and services earned or to be performed within the next year.

Competition

          The semiconductor equipment industry is highly competitive. The principal competitive factors in the industry are product performance, reliability, price, service and technical support, product improvements, established relationships with customers, and product familiarity. We believe that our products compete favorably with respect to these factors. Our major competitors in the prober market are Tokyo Electron Limited (“TEL”) and Tokyo Seimitsu (“TSK”), both of which are based in Japan. In this market, these competitors have greater financial, engineering and manufacturing resources than we have, as well as larger service organizations and long-standing customer relationships. We cannot assure you that levels of competition will not intensify or that our technological advantages will be reduced or lost as a result of technological advances by competitors or changes in semiconductor processing technology. For a more detailed discussion of the competition we face, see “Factors that May Affect Results and Financial Condition.”

Patents, Trademarks, Copyrights and Other Intellectual Property

          We believe that the success of our business depends more on the technical competence, creativity and marketing abilities of our employees, rather than on patents, trademarks and copyrights. Nevertheless, we have a policy of seeking patents when appropriate on inventions concerning new products and improvements as part of our ongoing research, development and manufacturing activities. We own over 30 patents and have applied for additional patent protection in the United States and abroad for the technology in our products. We also have several registered United States and international trademarks. We maintain unregistered copyrights on our software and typically maintain the source code for our products as a trade secret. We also rely on trade secret protection for our confidential and proprietary information. We routinely enter into confidentiality agreements with our employees. There can be no assurance, however, that others will not independently gain information and techniques or otherwise gain access to our trade secrets or that we can meaningfully protect our trade secrets. For a more detailed discussion regarding risks related to our intellectual property, see “Factors that May Affect Results and Financial Condition.”

Employees

          As of May 31, 2006, we employed 278 people. Many of our employees are highly skilled, and our success will depend in part upon our ability to attract and retain such employees, who are in great demand. We have never had a work stoppage or strike, and there are no employees represented by a labor union or covered by a collective bargaining agreement. We consider our employee relations to be good.

Item 1A.  Factors that May Affect Results and Financial Condition

          Semiconductor industry downturns adversely affect our revenues and operating results . Our business largely depends on capital expenditures by semiconductor manufacturers and semiconductor test companies, which in turn depend on the current and anticipated market demand for integrated circuits and products that use integrated circuits. The semiconductor industry is highly cyclical and has historically experienced periods of oversupply resulting in significantly reduced demand for capital equipment. During a down cycle, we must be in a position to adjust our cost and expense structure to prevailing market conditions. Our ability to reduce expenses may be limited by our need to invest in the engineering, research and development and marketing required to penetrate targeted markets and maintain extensive customer service and support. During periods of rapid growth, we must be able to rapidly increase manufacturing capacity and personnel to meet customer demand. We cannot assure our investors that these objectives can be met, which would likely have a material and adverse effect on our business and operating results.

          Our historical financial results have been, and our future financial results are anticipated to be, subject to substantial fluctuations.  Total revenues were $44.3 million, $11.2 million, $63.0 million and $45.0 million, respectively, for the year ended May 31, 2006, the five months ended May 31, 2005 and the years ended December 31, 2004 and 2003. We incurred operating losses of $15.7 million, $11.5 million, $15.8 million and $57.4 million in the year ended May 31, 2006, the five months ended May 31, 2005, and the years ended December 31, 2004 and 2003, respectively. The demand for our products follows the semiconductor test markets, which remain highly cyclical and difficult to forecast. Another economic slowdown and/or changes in demand for our products and services and other factors could continue to adversely affect our business in the near term, and we may experience additional declines in revenue and increases in operating losses. We cannot assure our investors that we will be able to return to operating profitability or that, if we do, we will be able to sustain it. We currently anticipate that our future cash from operations, available cash and cash equivalents and available credit facilities at May 31, 2006 should be sufficient to meet our anticipated needs for working capital and capital expenditures through the next twelve months. However, we may require additional capital to fund our future operations. If adequate funds are not available or are not available on terms favorable to us, we may not be able to continue to operate our business pursuant to our current business plan and our ability to run our business would be impacted.

          Our operating results are subject to variability and uncertainty, which could negatively impact our stock price.   We have experienced and expect to continue to experience significant fluctuations in our results.  Our backlog at the beginning of each period does not necessarily determine actual sales for any succeeding period.  Our sales have often reflected orders shipped in the same period that they were received.  Customers may cancel or reschedule shipments, and production difficulties could delay shipments.  For the years ended May 31, 2006, December 31, 2004 and 2003, five of our customers accounted for 51%, 63%, and 54%, respectively, of our net sales.  If one or more of our major customers delayed, ceased or significantly curtailed its purchases, it could cause our quarterly results to fluctuate and would likely have a material adverse effect on our of operations.  Other factors that may influence our operating results in a particular quarter include the timing of the receipt of orders from major customers, product mix, competitive pricing pressures, the relative proportions of domestic and international sales, our ability to design, manufacture and introduce new products on a cost-effective and timely basis, the delay between expenses to further develop marketing and service capabilities and the realization of benefits from those improved capabilities, and the introduction of new products by our competitors.  Accordingly, our results of operations are subject to significant variability and uncertainty from quarter to quarter, which could adversely affect our stock price.

          If we do not continue to develop and successfully market new products, our business will be negatively affected.  We believe that our future success will depend in part upon our ability to continue to enhance existing products and to develop and manufacture new products. As a result, we expect to continue investing in selective new wafer prober and strip handler product development programs. There can be no assurance that we will be successful in the introduction, marketing and cost effective manufacture of any of our new products; that we will be able to develop and introduce new products in a timely manner; enhance our existing products and processes to satisfy customer needs or achieve market acceptance; or that the new markets for which we are developing new products or expect to sell current products, such as the market for 300mm wafer probers and the markets related to the growth of the “Strip” test market for final test, will develop sufficiently. To develop new products successfully, we depend on close relationships with our customers and the willingness of those customers to share information with us. The failure to develop products and introduce them successfully and in a timely manner could adversely affect our competitive position and results of operations. For example, our 300mm wafer probers have not yet achieved broad market acceptance due to the lateness of the introduction of a production prober, which has resulted in a significant loss in market share.  Additionally, the customer evaluation process for our new 300mm prober products and our strip test handler products can be lengthy and can consume significant Company resources.  Our future sales will be impacted by our ability to successfully complete these new product evaluations.

          If we do not successfully compete in the markets in which we do business, our business and results of operations will be negatively affected .  Our major competitors in the prober market are Tokyo Electron Limited (“TEL”) and Tokyo Seimitsu (“TSK”), both of which are based in Japan. In the prober market, these competitors have greater financial, engineering and manufacturing resources than we do as well as larger service organizations and long-standing customer relationships. Our competitors can be expected to continue to improve the design and performance of their products and to introduce new products with competitive price/performance characteristics. Competitive pressures may force price reductions that could adversely affect our operating results. Although we believe we have certain technological and other advantages over our competitors, maintaining and cap on these advantages will require us to continue a high level of investment in engineering, research and development, marketing, and customer service. We can not assure you that we will have sufficient resources to continue to make these investments or that we will be able to make the technological advances necessary to maintain such competitive advantages.

           Our outstanding convertible notes (“Notes”) may be required to be repaid if not converted prior to their maturity; and may, if converted, result in additional dilution to holders of our Common Stock, all of which may adversely affect the value of our Common Stock . We currently have $8.5 million in Notes outstanding which entitle the holders to convert the Notes into an aggregate of 830,000 shares of our Common Stock at a conversion price of $10.2465 per share, significantly in excess of recent trading prices of our Common Stock. In connection with the issuance of the original $35.5 million Notes in June 2002, we also issued warrants for the purchase of 715,000 shares of our Common Stock that are exercisable at a price of $15.4440 per share. In certain circumstances, we may force the conversion of all or a portion of theNotes and may also redeem the Notes. We may voluntarily redeem the outstandin g balance of the Notes before June 2007 for an aggregate redemption price of as high as approximately $8.7 million plus accrued interest. In addition, unless waived or renegotiated, we are obligated to pay the holders of the Notes an amount equal to $8.9 million plus accrued interest in the event of a sale, merger or other change in control of the Company. Paying off the Notes at maturity, or redeeming some or all of the Notes prior to maturity, could materially impact our resources and make it difficult to meet our anticipated needs for working capital and capital expenditures to support our planned activities and operations.  As a result, we may in the future need to raise additional capital.  There can be no assurance that we would be able to raise additional capital on favorable terms, or at all.

          If we do not successfully protect our intellectual property, our business could be negatively impacted .  Our success depends in significant part on our intellectual property. While we attempt to protect our intellectual property through patents, copyrights and trade secrets, we believe that our success will depend more upon innovation, technological expertise and distribution strength. There can be no assurance that we will successfully protect our technology or that competitors will not be able to develop similar technology. No assurance can be given that the claims allowed on any patents we hold will be sufficiently broad to protect our technology. In addition, we cannot assure you that any patents issued to us will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide us with competitive advantages.

          Disruptions or termination of some of our key sources of supplies could damage our customer relations and harm our business .  We use numerous suppliers to supply components and subassemblies for the manufacture and support of our products and systems. While we make reasonable efforts to ensure that such components and subassemblies are available from multiple suppliers, this is not always possible.  Although we seek to reduce our dependence on these limited source suppliers, disruption or termination of certain of these sources could occur and such disruptions could have at least a temporary adverse effect on our results of operations and damage customer relationships. Moreover, a prolonged inability to obtain certain components, or a significant increase in the price of one or more of these components, could have a material adverse effect on our business, financial condition and results of operations.

          If we do not successfully address the challenges inherent in conducting international sales and operations, our business and results of operations will be negatively impacted .  We have experienced fluctuations in our international sales and operations.  International sales accounted for 58%, 73%, 63%, and 65% of our net sales for the year ended May 31, 2006, five months ended May 31, 2005, and years ended December 31, 2004 and 2003, respectively.  We expect international sales to continue to represent a significant percentage of net sales.  We are subject to certain risks inherent in doing business in international markets, one or more of which could adversely affect our international sales and operations, including:

 

• the imposition of government controls on our business and/or business partners;

 

• fluctuations in the United States dollar, which could increase our foreign sales prices in local currencies;

 

• export license requirements;

 

• restrictions on the export of technology;

 

• changes in tariffs;

 

• legal and cultural differences in the conduct of business;

• difficulties in staffing and managing international operations;

 

• strikes;

 

• longer payment cycles;

 

• difficulties in collecting accounts receivable in foreign countries;

 

• withholding taxes that limit the repatriation of earnings;

 

• trade barriers and restrictions;

 

• immigration regulations that limit our ability to deploy employees;

• political instability;

 

• war and acts of terrorism;

 

• natural disasters; and

 

• variations in effective income tax rates among countries where we conduct business.

          Although these and similar regulatory, geopolitical and global economic factors have not yet had a material adverse effect on our operations, there can be no assurance that such factors will not adversely impact our operations in the future or require us to modify our current business practices. In addition, the laws of certain foreign countries where we do business may not protect our intellectual property rights to the same extent as do the laws of the United States. Further, we have found it difficult to penetrate the large Japanese market, which represents a significant percentage of the worldwide wafer prober market.  Our past sales in Japan have not been significant.

          In addition, an increasing portion of our products and the products we purchase from our suppliers are sourced or manufactured in foreign locations, including China, and a large portion of the devices our products test are fabricated and tested by foundries and subcontractors in Taiwan, Singapore, China and other parts of Asia. As a result, we are subject to a number of economic and other risks, particularly during times of political or financial instability in these regions. Disruption of manufacturing or supply sources in these international locations could materially adversely impact our ability to fill customer orders and potentially result in lost business.

          Our business will be harmed if we cannot hire and retain key employees .  Our future success partly depends on our ability to hire and retain key personnel. We also need to attract additional skilled personnel in all areas to grow our business. While many of our current employees have many years of service with us, there can be no assurance that we will be able to retain our existing personnel or attract additional qualified employees in the future. Our Common Stock is currently trading at a price below the exercise price of most of our outstanding stock options.

          Our Charter documents and Shareholders Rights Plan, as well as Delaware Law, could make it difficult for a third party to acquire us .  Our Shareholders Rights Plan and certain provisions of our Certificate of Incorporation and Delaware law could discourage potential acquisition proposals and could delay or prevent a change in our control. Such provisions could diminish the opportunities for a stockholder to participate in tender offers, including tender offers at a price above the then current market value of our Common Stock. Such provisions may also inhibit fluctuations in the market price of our Common Stock that could result from takeover attempts. In addition, the Board of Directors, without further stockholder approval, may issue additional series of preferred stock that could have the effect of delaying, deterring or preventing a change in our control. The issuance of additional series of preferred stock could also adversely affect the voting power of the holders of Common Stock, including the loss of voting control to others.  We have no current plans to issue any Preferred Stock.

          We may continue to encounter difficulties in maintaining the effectiveness of our internal control over financial reporting and we expect to incur additional expenses and diversion of management’s time as a result of performing future system and process evaluation, testing and remediation required to comply with future management assessment and auditor attestation requirements, as well as, remediate the currently reported  material weakness.  Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent auditors to attest to, the effectiveness of our internal control structure and procedures for financial reporting each year. We expect to continue to incur expenses and to devote management resources to maintaining Section 404 compliance. In the event that our chief executive officer, chief financial officer or independent registered public accounting firm determine that our internal controls over financial reporting are not effective, as has occurred for this fiscal year, as defined under Section 404, investor perceptions of Electroglas may be adversely affected and could cause a decline in the market price of our stock.

          Stock based compensation expense will adversely affect our reported operating results which may adversely affect our stock price and our ability to attract and retain employees . Beginning June 1, 2006, we will record expense for all stock-based compensation, including stock option grants and employee stock purchases. In the past, we have depended upon compensating our officers, directors, employees and consultants in part with such stock based compensation awards to attract and retain officers, directors, employees and consultants. If we continue to grant stock options or other stock based compensation awards to our officers, directors, employees, and consultants after June 1, 2006, our future earnings, if any, will be reduced (or our future losses will be increased) by the expenses recorded for those grants. These compensation expenses may be larger than the compensation expense that w be required to record were we able to compensate these persons with cash in lieu of securities. Since we are a small company, the expenses we may have to record as a result of future options grants may be significant and may materially negatively affect our reported financial results. The adverse effects that the new accounting rules may have on our future financial statements should we continue to rely on stock-based compensation may reduce our stock price and make it more difficult for us to attract new investors. In addition, reducing our use of stock plans to reward and incent our officers, directors and employees, could result in a competitive disadvantage to us in the employee marketplace and make it difficult for us to attract and retain key personnel.

Item 1B.  Unresolved Staff Comments

None.