10-Q 1 mainbody.txt GENUS, INC. 10Q 09-30-2003 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2003 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ___ to ___ Commission file number 0-17139 Genus, Inc. (Exact name of registrant as specified in its charter) CALIFORNIA 94-279080 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1139 KARLSTAD DRIVE, SUNNYVALE, CALIFORNIA 94089 (Address of principal executive offices) (Zip code) (408) 747-7120 (Registrant's telephone number, including area code) NOT APPLICABLE (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 Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act). Yes No X --- As of November 3, 2003, the issuer had 32,416,257 shares of common stock outstanding. ================================================================================

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 3

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 4

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5 Notes to Condensed Consolidated Financial Statements (Unaudited) Basis Of Presentation The accompanying condensed consolidated financial statements have been prepared in accordance with SEC requirements for interim financial statements. These financial statements should be read in conjunction with the condensed consolidated financial statements and notes thereto included in the Company's 2002 Annual Report on Form 10-K. The information furnished reflects all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for the fair statement of financial position, results of operations and cash flows for the interim periods. The results of operations for the interim periods presented are not necessarily indicative of results to be expected for the full year. Liquidity The Company has an accumulated deficit of $111.6 million and a net loss of $3.8 million during the nine months ended September 30, 2003. The Company is in the process of executing its business strategy and has plans to eventually achieve profitable operations on an ongoing basis. Management believes that existing cash, cash generated by operations, and available financing will be sufficient to meet projected working capital, capital expenditure and other cash requirements for the next twelve months. Management cannot provide assurances that its cash and its future cash flows from operations alone will be sufficient to meet operating requirements and allow the Company to service debt and repay any underlying indebtedness at maturity. If the Company does not achieve anticipated cash flows, we may not be able to meet planned product release schedules and forecast sales objectives. In such event the Company will require additional financing to fund on-going and planned operations and may need to implement expense reduction measures. In the event the Company needs additional financing, there is no assurance that funds would be available to the Company or, if available, under terms that would be acceptable to the Company. Net Loss Per Share Basic net loss per share is computed by dividing net loss to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net loss per share is computed by dividing net loss to common shareholders by the sum of the weighted average number of common shares outstanding and potential common shares (when dilutive). A reconciliation of the numerator and denominator of basic and diluted net loss per share is as follows (in thousands, except per share data):

Stock options, warrants and convertible debt to purchase approximately 8,710,000 shares of common stock were outstanding as of September 30, 2003 but were not included in the computation of diluted net earnings per share because their effect would be anti-dilutive. 6 Notes to Condensed Consolidated Financial Statements (Unaudited) Stock options and warrants to purchase approximately 12,675,000 shares of common stock were outstanding as of September 30, 2002, but were not included in the computation of diluted net loss per share because their effect would be anti-dilutive. Stock Compensation. The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees" and Financial Accounting Standards Board Interpretation No. 44 "Accounting for Certain Transactions Involving Stock Compensation." Generally, the Company's policy is to grant options with an exercise price equal to the quoted market price of the Company's stock on the date of the grant. Accordingly, no compensation cost has been recognized in the Company's statements of operations. Pro forma information regarding net loss and net loss per share as if the Company recorded compensation expense based on the fair value of stock-based awards have been presented in accordance with Statement of Financial Accounting Standards No.148, "Accounting for Stock-Based Compensation - Transition and Disclosure" and is as follows for the three and nine months ended September 30, 2003 and 2002 (in thousands, except per share data):

The above pro forma effects on net loss may not be representative of the effects on future results as options granted typically vest over several years and additional option grants are expected to be made in future years. The fair value of options was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for the three and nine months ended September 30, 2003, and 2002: 7 Notes to Condensed Consolidated Financial Statements (Unaudited)

The weighted average fair value of options granted in the three months ended September 30, 2003 and 2002 was $2.38 and $1.13, respectively. The weighted average fair value of options granted in the nine months ended September 30, 2003 and 2002 was $1.86 and $1.95, respectively. The fair value of the employees' stock purchase rights under the 1989 Employee Stock Purchase Plan was estimated using the Black-Scholes option-pricing model with the following assumptions for the nine months ended September 30, 2003 and 2002:

The weighted average fair value of those purchase rights granted in the nine months ended September 30, 2003 and 2002 was $0.80 and $0.86, respectively. Revenue Recognition. The Company derives revenue from the sale and installation of semiconductor manufacturing systems and from engineering services and the sale of spare parts to support such systems. 8 Notes to Condensed Consolidated Financial Statements (Unaudited) Equipment selling arrangements generally involve contractual customer acceptance provisions and installation of the product occurs after shipment and transfer of title. Effective January 1, 2000, at which time the Company had not established verifiable objective evidence of the fair value of installation services, the Company commenced deferring recognition of revenue from such equipment sales until installation was complete and the product was accepted by the customer to comply with the provisions of Securities and Exchange Commission Staff Accounting Bulletin No. 101. In the third quarter of 2002, the Company established verifiable objective evidence of fair value of installation services, one of the requirements for Genus to recognize revenue for multiple-element arrangements prior to completion of installation services. Accordingly, under SAB 101, if Genus has met defined customer acceptance experience levels with both the customer and the specific type of equipment, then the Company recognizes equipment revenue upon shipment and transfer of title. A portion of revenue associated with undelivered elements such as installation and on-site support related tasks is recognized when the installation is completed and the customer accepts the product and for on-site support as the support service is provided. For products that have not been demonstrated to meet product specifications for the customer prior to shipment, revenue is recognized when installation is complete and the customer accepts the product. Revenues can fluctuate significantly as a result of the timing of customer acceptances. At September 30, 2003 and December 31, 2002, the Company had deferred revenue of $2.6 million and $2.7 million, respectively. Revenues from sale of spare parts are generally recognized upon shipment. Revenues from engineering services are recognized as the services are completed over the duration of the contract. Borrowings On December 20, 2001 and as amended on March 26, 2002 and March 20, 2003, the Company maintains line of credit facilities for a maximum of $15.0 million, based on eligible receivables and inventory. The interest rate is prime plus 1.75% per annum and the facility expires on June 29, 2004. The loan is collateralized by a first priority perfected security interest in the Company's assets and has a covenant requiring the Company to maintain a minimum tangible net worth (calculated as the excess of total assets over total liabilities adjusted to exclude intangible assets and balances receivable from officers or affiliates and to exclude the convertible notes) of $15.0 million. As of September 30, 2003, there was $2.0 million outstanding under this credit facility, the maximum amount available to the Company. On January 4, 2002, the Company received gross proceeds of $1.2 million under a secured loan, which is payable over 36 months, accrues interest of 8.75% per annum and is secured by two systems in the Company's demonstration lab. There was $313,000 outstanding at September 30, 2003. CONVERTIBLE NOTES AND WARRANTS On August 15, 2002, the Company raised $7.0 million, net of issuance costs, by issuing $7.8 million unsecured 7% convertible notes and warrants to purchase 2,761,000 shares of common stock. - The convertible notes are convertible into common stock at a price of $1.42 per share and $525,000 of the notes were subsequently converted into 370,000 shares of common stock. In addition, a $300,000 convertible note was issued and was subsequently converted into common stock at a price of $1.25 per share. All convertible notes accrue interest at 7% per annum, payable semi-annually each February 15 and August 15, in cash or, at the election of the Company, in registered stock. The remaining convertible notes are redeemable three years after issuance or may be converted into 4,912,000 shares of common stock prior to the redemption date at the election of the investors. 9 Notes to Condensed Consolidated Financial Statements (Unaudited) - The warrants were exercisable for 2,641,000 shares of common stock at an exercise price of $1.42 per share and for 120,000 shares of common stock at an exercise price of $1.25 per share. Warrants for 600,000 shares of common stock were previously exercised. In August 2003, all the remaining warrants under this arrangement were exercised and the Company issued 2,161,000 shares of common stock in exchange for cash proceeds of $3 million. The Company classified the warrants as equity and allocated a portion of the proceeds from the convertible notes to the warrants, using the relative fair value method in accordance with APB No. 14. " Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants". The allocation of proceeds to the warrants reduced the carrying value of the convertible notes. As a result, the fair value of the common stock issuable upon conversion of the notes exceeded the carrying value of the convertible notes, resulting in a beneficial conversion feature. The value of the beneficial conversion feature is accreted over the stated term of the convertible notes in accordance with EITF No. 98-5 " Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" and EITF No. 00-27, "Application Issue No. 98-5 to Certain Convertible Instruments". The net cash proceeds from the issuance of the convertible notes and warrants were recorded as follows (in thousands):

The $2.2 million difference between the $5.6 million original carrying value of the notes and the $7.8 million face value of the notes, representing the value of the warrant and the beneficial conversion feature, has been recorded as equity and is accreted as interest expense over the three year term of the convertible notes, using the effective interest rate method. The Company incurred issuance costs of approximately $868,000, representing cash of $814,000 and warrant with a fair value of $54,000. The warrants to purchase 79,000 shares of common stock at $1.42 per share was subsequently net exercised for 38,631 shares of common stock. Issuance costs are included with other assets and are amortized as interest expense over the stated term of the convertible notes. The carrying value of the convertible note and deferred issuance costs at September 30, 2003 is calculated as follows (in thousands): 10 Notes to Condensed Consolidated Financial Statements (Unaudited)

The Company recorded interest costs related to the convertible notes and warrants of $350,000 and $1.1 million during the three and nine months ended September 30, 2003. Interest cost includes coupon interest of $122,000 and $371,000 during the three and nine months ended September 30, 2003. In the event of a change of control of the Company, the note holders may elect to receive repayment of the notes at a premium of 10% over the face value of the notes. Inventories Inventories comprise the following (in thousands):

Inventory at customers' locations represent the cost of systems shipped to customers for which we have not recognized revenue and for which we are awaiting customer acceptance. Accrued Expenses Accrued expenses comprise the following (in thousands):

11 Notes to Condensed Consolidated Financial Statements (Unaudited) The Company generally provides one-year labor and two-year material warranty on its products. Warranty expenses are accrued at the time that revenue is recognized from the sale of products. At present, based upon historical experience, the Company accrues material warranty equal to 2% and 5% of shipment value for its 200mm and 300mm products, respectively, and labor warranty equal to $20,000 per system for both its 200mm and 300mm products. At the end of every quarter, the Company reviews its actual spending on warranty and reassesses if its accrual is adequate to cover warranty expenses on the systems in the field which are still under warranty. Differences between the required accrual and recorded accrual are charged or credited to warranty expense for the period. Changes in the warranty accrual during the three and nine months ended September 30, 2003 were as follows (in thousands):

12 Notes to Condensed Consolidated Financial Statements (Unaudited) Common Stock and Warrants On January 25, 2002, the Company sold 3,871,330 shares of common stock, and warrants to purchase 580,696 shares of common stock, for aggregate proceeds of approximately $7.9 million. The warrants issued to the purchasers in the private placement are exercisable for $3.23 per share and the warrants have a five-year term. As of September 30, 2003, all these warrants were exercisable and outstanding. In August 2002, the Company completed a $7.8 million financing in a private placement of subordinated notes convertible into common stock and warrants convertible into or exercisable for common stock. Refer to the Convertible Notes and Warrants footnote for further information. Related Party Transactions Mario M. Rosati, a Director of the Company is also a member of the law firm of Wilson Sonsini Goodrich & Rosati, the general counsel of the Company. During the nine months ended September 30, 2003 and 2002, the Company paid $412,000 and $1,455,000 respectively, to Wilson Sonsini Goodrich & Rosati. At September 30, 2003, the Company owed approximately $44,000 to Wilson Sonsini Goodrich & Rosati. Comprehensive Loss The following are the components of comprehensive loss (in thousands):

The components of accumulated other comprehensive loss is as follows (in thousands):

13 Notes to Condensed Consolidated Financial Statements (Unaudited) Legal Proceedings On June 6, 2001, ASM America, Inc. ("ASMA") filed a patent infringement action against Genus, Inc. ASMA's Complaint alleges that Genus is directly and indirectly infringing U.S. Patent No. 5,916,365 (the "365 Patent"), entitled "Sequential Chemical Vapor Deposition," and U.S. Patent No. 6,015,590 (the "590 Patent") entitled "Method For Growing Thin Films," which ASMA claims to own or exclusively license. The Complaint seeks monetary and injunctive relief. Genus served its Answer to ASMA's complaint on August 1, 2001. Also on August 1, 2001, Genus counterclaimed against ASMA and ASM International, N.V. ("ASMI") for (1) infringement of U.S. Patent No. 5,294,568 (the "568 Patent") entitled "Method of Selective Etching Native Oxide"; (2) declaratory judgment that the '365 and '590 Patents are invalid, unenforceable, and not infringed by Genus; and (3) antitrust violations. An initial Case Management Conference was held on October 16, 2001. On January 9, 2002, the Court issued an order granting ASMA leave to amend its complaint to add Dr. Sherman as a party and to add a claim that Genus is directly and indirectly infringing U.S. Patent No 4,798,165 (the "165 Patent") entitled "Apparatus for Chemical Vapor Deposition Using an Axially Symmetric Gas Flow", which ASMA claims to own. The Court also severed and stayed discovery and trail of Genus' antitrust claims until after the trial of the patent claims. On February 4, 2002, Genus served its Amended Answer to ASMA's amended complaint and counterclaimed against ASMA for declaratory judgment that the '165 Patent is invalid, unenforceable, and not infringed by Genus. On August 15, 2002, the Court issued a claim construction order regarding the '590, '365, and 598' Patents. A claim construction hearing regarding the '165 Patent was held on September 26, 2002, and the Court issued a claim construction ruling regarding this patent on November 13, 2002. On September 23, 2002 Genus filed motions for summary judgment on noninfringement regarding the '590 and '365 Patents. On November 20, 2002, the Court granted the Genus motion for summary judgment on noninfringement of the '365 Patent. On January 10, 2003, the Court granted Genus' motion for summary judgment on the '590 Patent. On April 11, 2003, Genus settled its lawsuit with ASMI (the "Settlement"). Under the terms of the Settlement, Genus gained a royalty-free license to each of the patents ASMI asserted in the litigation, including both ALD patents as well as Patent '165. By specific agreement of the parties, these licenses are applicable to Genus' successors and affiliates. Genus has likewise obtained a covenant from ASMI that it will not sue Genus for patent infringement or antitrust violations for the next five years. In return, Genus has granted ASMI and its successors and affiliates a royalty-free license to the patent Genus asserted in the litigation, Patent '568, and has agreed to dismiss its antitrust claims against ASMI. Genus has also agreed not to sue ASMI for patent infringement or antitrust violations for the next five years. No payments have been made by either Genus or ASMI in exchange for these licenses and the covenant not to sue. However, under the terms of the Settlement, ASMI has the right to pursue an appeal of the District Court's judgments of non-infringement regarding the ALD patents. The agreement specifies that if the Federal Circuit vacates either of the existing judgments related to the ALD patents based on a change in the District Court's claim construction, Genus will pay ASMI $1 million for the royalty-free licenses to the ALD patents it has been granted under the agreement. 14 Notes to Condensed Consolidated Financial Statements (Unaudited) Recent Accounting Pronouncements In November 2002, the Emerging Issues Task Force reached a consensus on Issue 00-21(EITF 00-21), Multiple-Deliverable Revenue Arrangements. EITF 00-21 addresses how to account for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. The consensus mandates how to identify whether goods or services or both which are to be delivered separately in a bundled sales arrangement should be accounted for separately because they are "separate units of accounting." The guidance can affect the timing of revenue recognition for such arrangements, even though it does not change rules governing the timing or patterns of revenue recognition of individual items accounted for separately. The final consensus will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. Additionally, companies will be permitted to apply the consensus guidance to all existing arrangements as the cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, Accounting Changes. The Company adopted EITF 00-21 during the third quarter of 2003 and the adoption did not result in any material impact on our financial position, cash flows or results of operations. In May 2003, the EITF reached a consensus on Issue 03-05 (EITF 03-05), Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software. EITF 03-05 provides guidance on whether non-software deliverables included in arrangements that contain more-than-incidental software are included within the scope of SOP 97-2. This issue does not address the allocation of the overall arrangement fee to the software and the non-software elements of the arrangement. This issue does not address the determination of whether the software is more than incidental but assumes that an arrangement includes software that is more than incidental to the products or services as a whole. The provisions of EITF 03-05 applies to new revenue arrangements entered into after the beginning of an entity's reporting period beginning after August 13, 2003. The Company believes the adoption of this standard will have no material effect on our consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting of derivative instruments and hedging activities under SFAS No. 133. The amendments pertain to decisions made: (i) as part of the Derivatives Implementation Group process that require amendment to SFAS 133, (ii) in connection with other FASB projects dealing with financial instruments, and (iii) in connection with the implementation issues raised related to the application of the definition of a derivative. SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for designated hedging relationships after June 30, 2003. SFAS 149 will be applied prospectively. The Company adopted SFAS 149 during the third quarter of 2003 and the adoption did not result in any material impact on our financial position, cash flows or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and further requires that an issuer classify as a liability (or an asset in some circumstances) financial instruments that fall within its scope because that financial instrument embodies an obligation of the issuer. Many of such instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments as they relate to minority interest in consolidated finite-lived entities. The Statement is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance of the date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The Company adopted SFAS 150 during the third quarter of 2003 and the adoption did not result in any material impact on our financial position, cash flows or results of operations. 15 Notes to Condensed Consolidated Financial Statements (Unaudited) In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities - an interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied to the first reporting period ending after December 15, 2003. The Company believes that the adoption of this standard will have no material effect on our consolidated financial statements. Subsequent Events On November 7, 2003, the Company completed a private placement of approximately 6.4 million shares of its common stock at a per share price of $5.25. The offering resulted in gross proceeds to the company of approximately $33.6 million, before costs related to the private placement. The purchase price for the shares represented approximately a 5 percent discount to the average closing price for 10 days prior to the close on November 7, 2003. No warrants were issued in this transaction. The company stated that it expects to use the net proceeds of the offering for working capital and general corporate purposes. Halpern Capital, Inc. acted as the lead placement agent to Genus for this private placement. 16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Certain information contained in this Quarterly Report on Form 10-Q is forward- looking in nature. All statements included in this Quarterly Report on Form 10- Q or made by management of Genus, Inc., other than statements of historical fact, are forward-looking statements. Examples of forward-looking statements include statements regarding the Company's future financial results, operating results, business strategies, projected costs, products, competitive positions and plans and objectives of management for future operations. These forward-looking statements are based on management's estimates and projections as of the date hereof and include the assumptions that underlie such statements. In some cases, forward-looking statements can be identified by terminology such as "may," "will," "should", "would," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue," or the negative of these terms or other comparable terminology. Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in the section below entitled "Risk Factors." Other risks and uncertainties are disclosed in the Company's prior SEC filings, including its Annual Report on Form 10-K for the fiscal year ended December 31, 2002. These and many other factors could affect the Company's future financial and operating results, and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by the Company or on its behalf. CRITICAL ACCOUNTING POLICIES The financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and require management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related footnotes. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which the Company believes are the most critical to aid in fully understanding and evaluating our reported financial results include the following: Revenue recognition The Company derives revenue from the sale and installation of semiconductor manufacturing systems and from engineering services and the sale of spare parts to support such systems. Equipment selling arrangements generally involve contractual customer acceptance provisions and installation of the product occurs after shipment and transfer of title. Effective January 1, 2000, the Company did not have verifiable objective evidence of the fair value of installation services. The Company generally defers recognition of revenue from equipment sales until installation is complete and the product is accepted by the customer. In the third quarter of 2002, the Company established verifiable objective evidence of fair value of installation services, one of the requirements for Genus to recognize revenue for multiple-element arrangements prior to completion of installation services. Accordingly, if a product delivered to a customer has met defined customer acceptance experience levels with both the customer and the specific type of equipment, then the Company recognizes equipment revenue upon shipment and transfer of title. A portion of revenue associated with undelivered elements such as installation and on-site support related tasks is recognized for installation when the installation is completed and the customer accepts the product and for on-site support as the support service is provided. For products that have not been demonstrated to meet product specifications for the customer prior to shipment, revenue is recognized when installation is complete and the customer accepts the product. Revenues can fluctuate significantly as a result of the timing of customer acceptances and the applicability of multiple element accounting to products shipped in any particular period. At September 30, 2003 and 2002, the Company had deferred revenue of $2.6 million and $2.9 million, respectively. Revenues from sale of spare parts are generally recognized upon shipment. Revenues from engineering services are recognized as the services are completed over the duration of the contract. Accrual for warranty expenses The Company generally provides one-year labor and two-year material warranty on its products. Warranty expenses are accrued at the time that revenue is recognized from the sale of products. At present, based upon historical experience, the Company accrues material warranty equal to 2% and 5% of shipment value for its 200mm and 300mm products, respectively, and labor warranty equal to $20,000 per system for both its 200mm and 300mm products. At the end of every quarter, the Company reviews its actual 17 spending on warranty and reassesses if its accrual is adequate to cover warranty expenses on the systems in the field which are still under warranty. Differences between the required accrual and recorded accrual are charged or credited to warranty expenses for the period. At September 30, 2003 and 2002, the Company had accrued $1,586,000 and $878,000, respectively, for material and labor warranty obligations. Actual results could differ from estimates. In the unlikely event that a problem is identified that would result in the need to replace components on a large scale, we would experience significantly higher expenses and our results of operations and financial condition could be materially and adversely effected. Valuation of Inventories Inventories are recorded at the lower of standard cost, which approximates actual cost on a first-in-first-out basis, or market value. We write down inventories to net realizable value based on forecasted demand and market conditions. Raw material and purchased parts include spare parts inventory for systems and was $4.5 million at September 30, 2003 and December 31, 2002. The forecasted demand for spare parts takes into account the Company's obligations to support systems for periods that are as long as five years. Actual demand and market conditions may be different from those projected by the Company. This could have a material effect on operating results and financial position. Net inventory write-downs during the nine months ended September 30, 2003 and 2002, were $431,000 and $901,000, respectively. Valuation of research and demonstration equipment Equipment includes research and demonstration equipment, which is located in our Applications Laboratory and is used to demonstrate to our customers the capabilities of our equipment to process wafers and deposit films. The gross value of demonstration equipment is based on the cost of materials and actual factory labor and overhead expenses incurred in manufacturing the equipment. Costs related to refurbishing or maintaining existing demonstration equipment, which do not add to the capabilities or useful life of the equipment, are not capitalized and are expensed as incurred. Demonstration equipment is stated at cost and depreciated over a period of five years. If the Company sells the equipment, it may experience gross margins that are different from the gross margins achieved on equipment manufactured specifically for customers. RESULTS OF OPERATIONS ----------------------- NET SALES. Net sales for the three and nine months ended September 30, 2003 were $ 9.1 million and $41.5 million, when compared to net sales of $12.2 million and $28.5 million for the corresponding periods in 2002. Revenues during the third quarter of 2003 included two 300mm systems, one ALD and one CVD system. Revenue during the third quarter of 2002 included one 200mm CVD systems, two 200mm ALD system and one 200mm ALD upgrade system revenue. During the nine months ended September 30, 2003, twelve systems were recognized as revenue compared to eight systems and an upgrade recognized as revenue in the first nine months of 2002. Based on the slow recovery of the semiconductor capital equipment market and the uncertainty on the timing of the orders, Genus has maintained its booking guidance to the $45 million to $60 million range and full year revenue guidance in the $50 million to $60 million range. 18 COST OF GOODS SOLD. Cost of goods sold for the three and nine months ended September 30, 2003 were $7.0 million and $29.4 million, compared to $7.8 million and $20.5 million for the same periods in 2002. Gross profit as a percentage of revenues was 23% for the third quarter of 2003 compared to 36% in the third quarter of 2002. Gross profit as a percentage of revenues was 29% for the nine months ended September 30, 2003 compared to 28% for the corresponding period in 2002. The decrease in gross margin as a percentage of revenues during the third quarter of 2003 as compared to third quarter of 2002 is primarily due to lower revenues resulting in lower production volumes and decreased manufacturing efficiencies. The adverse mix effect during the third quarter of 2003 as compared to third quarter of 2002 was a result of our recognizing a higher portion of 300mm systems during the third quarter of 2003, which currently has a lower margin than other systems. The increase in gross margin during the nine months ended September 30, 2003 compared to the nine months ended September 30, 2002 was primarily due to higher revenues, resulting in higher production volumes and increased manufacturing efficiencies. RESEARCH AND DEVELOPMENT. Research and development (R&D) expenses for the quarter ended September 30, 2003 were $1.7 million, compared with $2.1 million or 18% of net sales for the both periods in 2003 and 2002. For the nine months ended September 30, 2003, research and development expenses were $5.8 million or 14% of sales, compared to $6.1 million or 21% of net sales for the nine months ended September 30, 2002. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative (SG&A) expenses were $2.8 million and $8.8 million for the three and nine months ended September 30, 2003 compared to $3.5 million and $10.2 million in the corresponding periods in 2002. As a percent of net sales, selling, general and administrative expenses were 31% and 21% for the three and nine months ended September 30, 2003 compared to 29% and 36% for the corresponding periods in 2002. The dollar decreases in selling, general and administrative expenses in the nine month period ended September 30, 2003 compared with corresponding period in 2002 was primarily due to lower legal costs, partially offset by increased in facilities expenses and severance costs. INTEREST EXPENSE. Interest expense for the three and nine months ended September 30, 2003 was $411,000 and $1,318,000, respectively, compared to interest expense of $160,000 and $278,000 for the corresponding periods in 2002. The increase in interest expense during the three and nine months ended September 30, 2003, compared with the corresponding period in 2002 was primarily due to an increase in interest expense and accretion and amortization of discount and issuance costs related to the convertible notes that were issued during the third quarter of 2002. OTHER INCOME (EXPENSE), NET. Other income (expense), net for the three and nine months ended September 30, 2003 were $35,000 and $84,000 respectively compared to other income (expense), net of ($46,000) and ($215,000) for the corresponding periods in 2002. PROVISION FOR INCOME TAXES. We did not record any provision for income taxes in the U.S. and Japan for the three and nine months ended September 30, 2003 and 2002, as we recorded losses in these entities. We provide for a full valuation allowance against the tax benefit associated with these losses. We recorded $56,000 in income tax expense for our South Korean subsidiary for the three and nine months ended September 30, 2003, as compared to $71,000 and $159,000 recorded for the corresponding periods in 2002. 19 LIQUIDITY AND CAPITAL RESOURCES At September 30, 2003, our cash and cash equivalents were $10.5 million, a $1.0 million decrease over cash and cash equivalents of $11.5 million held as of December 31, 2002 .The reduction in cash and cash equivalents at September 30, 2003 as compared with the cash and cash equivalents balance at December 31, 2002 primarily resulted from losses generated in the nine month period ended September 30, 2003. Cash generated by operating activities totaled $2.4 million for the nine months ended September 30, 2003, and consisted primarily of net loss of $3.8 million, decreases in accounts payable of $3.3 million, partially offset by decrease in accounts receivable of $4.2 million, decrease in inventories of $1.8 million, increase in accrued expenses and customer advances of $712,000, decrease in other assets of $757,000, and depreciation of $2.4 million. Financing activities used cash of $1.2 of million for the nine months ended September 30, 2003, and primarily consisted payments of debt of $5.8 million, net, partially offset from proceeds from issuance of common stock of $4.8 million. We made capital expenditures of $2.4 million for the nine months ended September 30, 2003. These expenditures were primarily related to purchase of property, plant and equipment. Our primary source of funds at September 30, 2003 consisted of $10.5 million in cash and cash equivalents, $3.3 million of accounts receivable, and our credit line of up to $15 million with Silicon Valley Bank, of which $2.0 million, the maximum available amount, was outstanding at September 30, 2003. A summary of our contractual obligations as of September 30, 2003 is as follows (in thousands):

The Company has an accumulated deficit of $111.6 million and a net loss of $3.8 million during the nine months ended September 30, 2003. The Company is in the process of executing its business strategy and has plans to eventually achieve profitable operations on an ongoing basis. Management believes that existing cash, cash generated by operations, and available financing will be sufficient to meet projected working capital, capital expenditure and other cash requirements for the next twelve months. Management cannot provide assurances that its cash and its future cash flows from operations alone will be sufficient to meet operating requirements and allow the Company to service debt and repay any underlying indebtedness at maturity. If the Company does not achieve anticipated cash flows, we may not be able to meet planned product release schedules and forecast sales objectives. In such event the Company will require additional financing to fund on-going and planned operations and may need to implement expense reduction measures. In the event the Company needs additional financing, there is no assurance that funds would be available to the Company or, if available, under terms that would be acceptable to the Company. 20 RECENT ACCOUNTING PRONOUNCEMENTS In November 2002, the Emerging Issues Task Force reached a consensus on Issue 00-21(EITF 00-21), Multiple-Deliverable Revenue Arrangements. EITF 00-21 addresses how to account for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. The consensus mandates how to identify whether goods or services or both which are to be delivered separately in a bundled sales arrangement should be accounted for separately because they are "separate units of accounting." The guidance can affect the timing of revenue recognition for such arrangements, even though it does not change rules governing the timing or patterns of revenue recognition of individual items accounted for separately. The final consensus will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. Additionally, companies will be permitted to apply the consensus guidance to all existing arrangements as the cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, Accounting Changes. The Company adopted EITF 00-21 during the third quarter of 2003 and the adoption did not result in any material impact on our financial position, cash flows or results of operations. In May 2003, the EITF reached a consensus on Issue 03-05 (EITF 03-05), Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in Arrangement Containing More-Than-Incidental Software. EITF 03-05 provides guidance on whether non-software deliverables included in arrangements that contain more-than-incidental software are included within the scope of SOP 97-2. This issue does not address the allocation of the overall arrangement fee to the software and the non-software elements of the arrangement. This issue does not address the determination of whether the software is more than incidental but assumes that an arrangement includes software that is more than incidental to the products or services as a whole. The provisions of EITF 03-05 applies to new revenue arrangements entered into after the beginning of an entity's reporting period beginning after August 13, 2003. The Company believes the adoption of this standard will have no material effect on our consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting of derivative instruments and hedging activities under SFAS No. 133. The amendments pertain to decisions made: (i) as part of the Derivatives Implementation Group process that require amendment to SFAS 133, (ii) in connection with other FASB projects dealing with financial instruments, and (iii) in connection with the implementation issues raised related to the application of the definition of a derivative. SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for designated hedging relationships after June 30, 2003. SFAS 149 will be applied prospectively. The Company adopted SFAS 149 during the third quarter of 2003 and the adoption did not result in any material impact on our financial position, cash flows or results of operations. 21 In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and further requires that an issuer classify as a liability (or an asset in some circumstances) financial instruments that fall within its scope because that financial instrument embodies an obligation of the issuer. Many of such instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments as they relate to minority interest in consolidated finite-lived entities. The Statement is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance of the date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The Company adopted SFAS 150 during the third quarter of 2003 and the adoption did not result in any material impact on our financial position, cash flows or results of operations. In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities - an interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied to the first reporting period ending after December 15, 2003. The Company believes that the adoption of this standard will have no material effect on our consolidated financial statements. RISK FACTORS Sections of Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. Actual results could differ materially from those projected in the forward-looking statements as a result of the factors set forth above in Management's Discussion and Analysis and the Risk Factors set forth below. WE HAVE EXPERIENCED LOSSES OVER THE LAST FEW YEARS AND WE MAY NOT BE ABLE TO ACHIEVE OR SUSTAIN PROFITABILITY 22 We have experienced losses of $11.6 million, $6.7 million and $9.7 million for 2002, 2001 and 2000, respectively. While we believe our cash position, anticipated cash from operations, and our available credit facilities are sufficient for the next twelve months, we cannot provide assurances that future cash flows from operations will be sufficient to meet operating requirements and allow us to service debt and repay any underlying indebtedness at maturity. If we do not achieve the cash flows that we anticipate, we may not be able to meet our planned product release schedules and our forecast sales objectives. In such event we will require additional financing to fund on-going and planned operations and may need to implement further expense reduction measures, including, but not limited to, the sale of assets, the consolidation of operations, workforce reductions, and/or the delay, cancellation or reduction of certain product development, marketing, licensing, or other operational programs. Some of these measures would require third-party consents or approvals, including that of our bank, and we cannot provide assurances that these consents or approvals will be obtained. There can be no assurance that we will be able to make additional financing arrangements on satisfactory terms, if at all, and our operations and liquidity would be materially adversely affected. We cannot assure our shareholders and investors that we will achieve profitability in fiscal 2003 and beyond, nor can we provide assurances that we will achieve the sales necessary to avoid further expense reductions in the future. . SUBSTANTIALLY ALL OF OUR NET SALES COME FROM A SMALL NUMBER OF LARGE CUSTOMERS In nine month period ended September 30, 2003, Samsung Electronics Company, Ltd., Seagate Technologies, Inc. and IBM, accounted for 74%, 9%, and 9%, of revenues, respectively. In the nine month period ended September 30, 2002, Samsung Electronics Company, Ltd., and Seagate accounted for 51%, and 23% of our revenues, respectively. The semiconductor manufacturing industry generally consists of a limited number of larger companies. Consequently, we expect that a significant portion of our future product sales will continue to be concentrated within a limited number of customers None of our customers has entered into a long-term agreement with us requiring them to purchase our products. If any of our customers were to encounter financial difficulties or become unable to continue to do business with us at or near current levels, our business, results of operations and financial condition could be materially harmed. Customers may delay or cancel orders or may stop doing business with us for a number of reasons including: - customer departures from historical buying patterns; - general market conditions; - economic conditions; or - competitive conditions in the semiconductor industry or in the industries that manufacture products utilizing integrated circuits. WE DEPEND UPON A LIMITED NUMBER OF SUPPLIERS FOR MANY COMPONENTS AND SUBASSEMBLIES, AND SUPPLY SHORTAGES OR THE LOSS OF THESE SUPPLIERS COULD RESULT IN INCREASED COST OR DELAYS IN THE MANUFACTURE AND SALE OF OUR PRODUCTS. 23 We rely on third parties to manufacture the components used in our products. Some of our suppliers are sole or limited source. In addition, some of these suppliers are relatively small-undercapitalized companies that may have difficulties in raising sufficient funding to continue operations. There are risks associated with the use of independent suppliers, including unavailability of or delays in obtaining adequate supplies of components and potentially reduced control of quality, production costs and timing of delivery. We may experience difficulty identifying alternative sources of supply for certain components used in our products. In addition, the use of alternate components may require design alterations, which may delay installation and increase product costs. These components may not be available in the quantities required, on reasonable terms, or at all. Financial or other difficulties faced by our suppliers or significant changes in demand for these components or materials could limit their availability. Any failures by these third parties to adequately perform may impair our ability to offer our existing products, delay the submission of products for regulatory approval, and impair our ability to deliver products on a timely basis or otherwise impair our competitive position. Establishing our own capabilities to manufacture these components would be expensive and could significantly decrease our profit margins. Our business, results of operations and financial condition would be adversely affected if we were unable to continue to obtain components in the quantity and quality desired and at the prices we have budgeted. WE ARE SUBJECT TO RISKS BEYOND OUR CONTROL OR INFLUENCE AND ARE HIGHLY DEPENDENT ON OUR INTERNATIONAL SALES, PARTICULARLY SALES IN ASIAN COUNTRIES Export sales accounted for approximately 78% of our total net sales for the nine months ended September 30, 2003. Net sales to our South Korean-based customers accounted for approximately 73% of total net sales for the nine months ended September 30, 2003. Export sales accounted for approximately 72%, 93% and 98% of our total net sales in 2002, 2001 and 2000, respectively. Net sales to our South Korean-based customers accounted for approximately 56%, 73% and 92% of total net sales in 2002, 2001 and 2000, respectively. We anticipate that international sales, including sales to South Korea, will continue to account for a significant portion of our net sales. As a result, a significant portion of our net sales will be subject to additional risks, including: - unexpected changes in foreign law or regulatory requirements; - exchange rate volatility; - tariffs and other barriers; - political and economic instability; - military confrontation; - Severe Acute Respiratory Syndrome (SARS); - difficulties in accounts receivable collection; - extended payment terms; - difficulties in managing distributors or representatives; - difficulties in staffing our subsidiaries; - difficulties in managing foreign operations; and - potentially adverse tax consequences. Our foreign sales are primarily denominated in U.S. dollars and we do not engage in hedging transactions. As a result, our foreign sales are subject to the risks associated with unexpected changes in exchange rates, which could increase the cost of our products to our customers and could lead these customers to delay or defer their purchasing decisions. 24 Wherever currency devaluations occur abroad, our goods become more expensive for our customers in that country. In addition, difficult economic conditions may limit capital spending by our customers. These circumstances may also affect the ability of our customers to meet their payment obligations, resulting in the cancellations or deferrals of existing orders and the limitation of additional orders. OUR SALES REFLECT THE CYCLICALITY OF THE SEMICONDUCTOR INDUSTRY, WHICH COULD CAUSE OUR OPERATING RESULTS TO FLUCTUATE SIGNIFICANTLY AND COULD CAUSE US TO FAIL TO ACHIEVE ANTICIPATED SALES Our business depends upon the capital expenditures of semiconductor manufacturers, which in turn depend on the current and anticipated market demand for integrated circuits and products utilizing integrated circuits. Although we are marketing our atomic layer deposition technology to non-semiconductor markets such as magnetic thin film heads, flat panel displays, micro-electromechanical systems and inkjet printers, we are still dependent on sales to semiconductor manufacturers. The semiconductor industry is cyclical which impacts the semiconductor industry's demand for semiconductor manufacturing capital equipment. Semiconductor industry downturns have significantly decreased our revenues, operating margins and results of operations in the past. During the industry downturn in 1998, several of our customers delayed or cancelled investments in new manufacturing facilities and equipment due to declining DRAM prices, the Asian economic downturn, and general softening of the semiconductor market. This caused our sales in 1998 to be significantly lower than in the prior three years. After the dramatic industry boom for semiconductor equipment that peaked early in the year 2000, another cyclical downturn is presently occurring. The sharp and severe industry downturn in 2001 was the largest in the industry's history. Almost all previous downturns have been solely due to pricing declines. However, the 2001 downturn in the industry marked a corresponding decline in unit production, as well as price reduction. We expect that our revenues will continue to be further impacted by the continued downturn in the semiconductor industry and global economy, which may prevent us from increasing our revenues and achieving profitability. OUR FUTURE GROWTH IS DEPENDENT ON ACCEPTANCE OF NEW PRODUCTS AND MARKET ACCEPTANCE OF OUR SYSTEMS RELATING TO THOSE PRODUCTS We believe that our future growth will depend in large part upon the acceptance of our new thin films and processes, especially our atomic layer deposition technology. As a result, we expect to continue to invest in research and development in these new thin films and the systems that use these films. There can be no assurance that the market will accept our new products or that we will be able to develop and introduce new products or enhancements to our existing products and processes in a timely manner to satisfy customer needs or achieve market acceptance. The failure to do so, or even a delay in our introduction of new products or enhancements, could harm our business, financial condition and results of operations. We must manage product transitions successfully, as introductions of new products could harm sales of existing products. We derive our revenue primarily from the sale of equipment used to chemically deposit tungsten silicide in the manufacture of memory chips. We estimate that the life cycle for these tungsten silicide deposition systems is three-to-ten years. There is a risk that future technologies, processes or product developments may render our product offerings obsolete and we may not be able to develop and introduce new products or enhancements to our existing products in a timely manner or at all. 25 WE MAY NOT BE ABLE TO CONTINUE TO SUCCESSFULLY COMPETE IN THE HIGHLY COMPETITIVE SEMICONDUCTOR INDUSTRY AGAINST COMPETITORS WITH GREATER RESOURCES The semiconductor manufacturing capital equipment industry is highly competitive. We face substantial competition throughout the world. We believe that to remain competitive, we will require significant financial resources to develop new products, offer a broader range of products, establish and maintain customer service centers and invest in research and development. Many of our existing and potential competitors have substantially greater financial resources, more extensive engineering, manufacturing, marketing, and customer service capabilities and greater name recognition. We expect our competitors to continue to improve the design and performance of their current products and processes and to introduce new products and processes with improved price and performance characteristics. If our competitors enter into strategic relationships with leading semiconductor manufacturers covering thin film products similar to those sold by us, it would materially adversely affect our ability to sell our products to such manufacturers. In addition, to expand our sales we must often replace the systems of our competitors or sell new systems to customers of our competitors. Our competitors may develop new or enhanced competitive products that will offer price or performance features that are superior to our systems. Our competitors may also be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their product lines. We may not be able to maintain or expand our sales if our resources do not allow us to respond effectively to such competitive forces. WE MAY NOT ACHIEVE ANTICIPATED REVENUE GROWTH IF WE ARE NOT SELECTED AS VENDOR OF CHOICE FOR NEW OR EXPANDED FABRICATION FACILITIES AND IF OUR SYSTEMS AND PRODUCTS DO NOT ACHIEVE BROADER MARKET ACCEPTANCE Because semiconductor manufacturers must make a substantial investment to install and integrate capital equipment into a semiconductor fabrication facility, these manufacturers will tend to choose semiconductor equipment manufacturers based on established relationships, product compatibility and proven system performance. Once a semiconductor manufacturer selects a particular vendor's capital equipment, the manufacturer generally relies for a significant period of time upon equipment from this vendor of choice for the specific production line application. To do otherwise creates risk for the manufacturer because the manufacture of a semiconductor requires many process steps and a fabrication facility will contain many different types of machines that must work cohesively to produce products that meet the customers' specifications. If any piece of equipment fails to perform as expected, the customer could incur significant costs related to defective products, production line downtime, or low production yields. A semiconductor manufacturer frequently will attempt to consolidate its other capital equipment requirements with the same vendor. Accordingly, we may face narrow windows of opportunity to be selected as the "vendor of choice" by potential new customers. It may be difficult for us to sell to a particular customer for a significant period of time once that customer selects a competitor's product, and we may not be successful in obtaining broader acceptance of our systems and technology. If we are not able to achieve broader market acceptance of our systems and technology, we may be unable to grow our business and our operating results and financial condition will be harmed. 26 OUR LENGTHY SALES CYCLE INCREASES OUR COSTS AND REDUCES THE PREDICTABILITY OF OUR REVENUE Sales of our systems depend upon the decision of a prospective customer to increase manufacturing capacity. That decision typically involves a significant capital commitment by our customers. Accordingly, the purchase of our systems typically involves time-consuming internal procedures associated with the evaluation, testing, implementation and introduction of new technologies into our customers' manufacturing facilities. For many potential customers, an evaluation as to whether new semiconductor manufacturing equipment is needed typically occurs infrequently. Following an evaluation by the customer as to whether our systems meet its qualification criteria, we have experienced in the past and expect to experience in the future delays in finalizing system sales while the customer evaluates and receives approval for the purchase of our systems and constructs a new facility or expands an existing facility. Due to these factors, our systems typically have a lengthy sales cycle during which we may expend substantial funds and management effort. The time between our first contact with a customer and the customer placing its first order typically lasts from nine to twelve months and is often longer. This lengthy sales cycle makes it difficult to accurately forecast future sales and may cause our quarterly and annual revenue and operating results to fluctuate significantly from period to period. If anticipated sales from a particular customer are not realized in a particular period due to this lengthy sales cycle, our operating results may be adversely affected for that period. IF WE ARE FOUND TO INFRINGE THE PATENTS OR INTELLECTUAL PROPERTY OF OTHER PARTIES, OUR ABILITY TO GROW OUR BUSINESS MAY BE SEVERELY LIMITED. From time to time, we may receive notices from third parties alleging infringement of patents or intellectual property rights. It is our policy to respect all parties' legitimate intellectual property rights, and we will defend against such claims or negotiate licenses on commercially reasonable terms where appropriate. However, no assurance can be given that we will be able to negotiate any such necessary licenses on commercially reasonable terms, or at all, or that any litigation resulting from such claims would not have a material adverse effect on our business and financial results. Litigation is time consuming, expensive and its outcome is uncertain. We may not prevail in any litigation in which we are involved. Should we be found to infringe any of the patents asserted or any other intellectual property rights of others, in addition to potential monetary damages and any injunctive relief granted, we may need either to obtain a license to commercialize our products or redesign our products so they do not infringe any third party's intellectual property. If we are unable to obtain a license or adopt a non-infringing product design, we may not be able to proceed with development, manufacture and sale of our products, which would have an immediate and materially adverse impact on our business and our operating results. WE ARE DEPENDENT UPON KEY PERSONNEL WHO ARE EMPLOYED AT WILL, WHO WOULD BE DIFFICULT TO REPLACE AND WHOSE LOSS WOULD IMPEDE OUR DEVELOPMENT AND SALES We are highly dependent on key personnel to manage our business, and their knowledge of business, management skills and technical expertise would be difficult to replace. Our success depends upon the efforts and abilities of Dr. William W.R. Elder, our chairman and chief executive officer, Dr. Thomas E. Seidel, our chief technology officer, and other key managerial and technical employees. The loss of Dr. Elder or Dr. Seidel or other key employees could limit or delay our ability to develop new products and adapt existing products to our customers' evolving requirements and would also result in lost sales and diversion of management resources. None of our executive officers are bound by a written employment agreement, and the relationships with our employees are at will. 27 Because of competition for additional qualified personnel, we may not be able to recruit or retain necessary personnel, which could impede development or sales of our products. Our growth depends on our ability to attract and retain qualified, experienced employees. There is substantial competition for experienced engineering, technical, financial, sales and marketing personnel in our industry. In particular, we must attract and retain highly skilled design and process engineers. Competition for such personnel is intense, particularly in the San Francisco bay area where we are based. If we are unable to retain our existing key personnel, or attract and retain additional qualified personnel, we may from time to time experience inadequate levels of staffing to develop, market, or manufacture our products or to perform services for our customers. As a result, our growth could be limited due to our lack of capacity to develop and market our products to customers, or our failure to meet delivery commitments or our service levels could lead to customer dissatisfaction. OUR FAILURE TO COMPLY WITH ENVIRONMENTAL REGULATIONS COULD RESULT IN SUBSTANTIAL LIABILITY TO US We are subject to a variety of federal, state and local laws, rules and regulations relating to the protection of health and the environment. These include laws, rules and regulations governing the use, storage, discharge, release, treatment and disposal of hazardous chemicals during and after manufacturing, research and development and sales demonstrations. If we fail to comply with present or future regulations, we could be subject to substantial liability for clean up efforts, property damage, personal injury and fines or suspension or cessation of our operations. We use the following regulated gases at our manufacturing facility in Sunnyvale: tungsten hexafluoride, dichlorosilane silicide, silane and nitrogen. We also use regulated liquids such as hydrofluoric acid and sulfuric acid. The city of Sunnyvale, California, where our facilities are located, imposes high environmental standards to businesses operating within the city. Genus has received an operating license from Sunnyvale. Presently, our compliance record indicates that our methods and practices successfully meet standards. Moving forward, if we fail to continuously maintain high standards to prevent the leakage of any toxins from our facilities into the environment, restrictions on our ability to expand or continue to operate our present locations could be imposed upon us or we could be required to acquire costly remediation equipment or incur other significant expenses. WE DEPEND UPON NINE INDEPENDENT SALES REPRESENTATIVES FOR THE SALE OF OUR PRODUCTS AND ANY DISRUPTION IN THESE RELATIONSHIPS WOULD ADVERSELY AFFECT US We currently sell and support our thin film products through direct sales and customer support organizations in the United States, Europe, South Korea and Japan and through nine independent sales representatives and distributors in the United States, Europe, South Korea, Taiwan, China and Malaysia. We do not have any long-term contracts with our sales representatives and distributors. Any disruption or termination of our existing distributor relationships could negatively impact sales and revenue. WE ESTABLISHED A DIRECT SALES ORGANIZATION IN JAPAN AND WE MAY NOT SUCCEED IN EFFECTIVELY PENETRATING THE JAPANESE MARKETPLACE In 2000, we invested significant resources in Japan by establishing a direct sales organization, Genus-Japan, Inc. To date, we have had limited success in penetrating in Japanese semiconductor industry. Although we continue to invest significant resources in our Japan office, we may not be able to attract new customers in the Japanese semiconductor industry, and as a result, we may fail to yield a profit or return on our investment in our office in Japan. 28 THE PRICE OF OUR COMMON STOCK HAS FLUCTUATED IN THE PAST AND MAY CONTINUE TO FLUCTUATE SIGNIFICANTLY IN THE FUTURE, WHICH MAY LEAD TO LOSSES BY INVESTORS OR TO SECURITIES LITIGATION Our common stock has experienced substantial price volatility, particularly as a result of quarter-to-quarter variations in our, our competitors or our customers' actual or anticipated financial results, our competitors or our customers' announcements of technological innovations, revenue recognition policies, changes in earnings estimates by securities analysts and other events or factors. Also, the stock market has experienced extreme price fluctuations which have affected the market price of many technology companies, in particular, and which have often been unrelated to the operating performance of these companies. These broad market fluctuations, as well as general economic and political conditions in the United States and the countries in which we do business, may adversely affect the market price of our common stock. BUSINESS INTERRUPTIONS COULD ADVERSELY AFFECT OUR BUSINESS Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. A disaster could severely damage our ability to deliver our products to our customers. Our products depend on our ability to maintain and protect our operating equipment and computer systems, which are primarily located in or near our principal headquarters in Sunnyvale, California. Sunnyvale exists near a known earthquake fault zone. Although our facilities are designed to be fault tolerant, the systems are susceptible to damage from fire, floods, earthquakes, power loss, telecommunications failures, and similar events. Although we maintain general business insurance against interruptions such as fires and floods, there can be no assurance that the amount of coverage will be adequate in any particular case. WE ARE OBLIGATED TO ISSUE SHARES OF OUR STOCK UNDER OUTSTANDING OPTIONS AND WARRANTS AND SUCH ISSUANCE WILL DILUTE YOUR PERCENTAGE OWNERSHIP IN GENUS As of September 30, 2003, we have approximately 3,798,000 shares of common stock underlying warrants, and outstanding employee stock options. Of the stock options, 1,816,000 shares are exercisable as of September 30, 2003. All of the shares underlying the warrants are currently exercisable. Some warrants have terms providing for an adjustment of the number of shares underlying the warrants in the event that we issue new shares at a price lower than the exercise price of the warrants, where we make a distribution of common stock to our shareholders or effect a reclassification. If all of the shares underlying the exercisable options and warrants were exercised and sold in the public market, the value of your current holdings in Genus may decline because there may not be sufficient demand to purchase the increased number of shares that would be available for sale. WE HAVE IMPLEMENTED ANTI-TAKEOVER MEASURES THAT MAY RESULT IN DILUTING YOUR PERCENTAGE OWNERSHIP OF GENUS STOCK On September 7, 2000, the Company's Board of Directors declared a dividend pursuant to a newly adopted Share Purchase Rights Plan, which replaced a similar earlier plan that had expired on July 3, 2000. The intended purpose of the Rights Plan is to protect shareholders' rights and to maximize share value in the event of an unfriendly takeover attempt. As of the record date of October 13, 2000, each 29 share of common stock of Genus, Inc. outstanding was granted one right under the new plan. Each right is exercisable only under certain circumstances and upon the occurrence of certain events and permits the holder to purchase from the Company one one-thousandth (0.001) of a share of Series C Participating Preferred Stock at an initial exercise price of forty dollars ($40.00) per one one-thousandth share. The 50,000 shares of Series C preferred stock authorized in connection with the Rights Plan will be used for the exercise of any preferred shares purchase rights in the event that any person or group (the Acquiring Person) acquires beneficial ownership of 15% or more of the outstanding common stock. In such event, the shareholders (other than the Acquiring Person) would receive common stock of the Company having a market value of twice the exercise price. Subject to certain restrictions, the Company may redeem the rights issued under the Rights Plan for $0.001 per right and may amend the Rights Plan without the consent of rights holders. The rights will expire on October 13, 2010, unless redeemed by the Company. In the event that circumstances trigger the transferability and exercisability of rights granted in our Rights Plan, your current holdings in Genus may decline as a result of dilution to your percentage ownership in Genus or as a result of a reduction in the per share value of our stock resulting from the increase in the number of outstanding shares available and your failure to exercise your rights under the Rights Plan. In the event of a change of control of the Company, the convertible note holders may elect to receive repayment of the notes at a premium of 10% over the face value of the notes. FORWARD-LOOKING STATEMENTS We make forward-looking statements in this 10-Q report that may not prove to be accurate. This 10-Q report contains or incorporates forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 regarding, among other items, our business strategy, growth strategy and anticipated trends in our business. We may make additional written or oral forward-looking statements from time to time in filings with the Securities and Exchange Commission or otherwise. When we use the words "believe," "expect," "anticipate," "project" and similar expressions, this should alert you that this is a forward-looking statement. We base these forward-looking statements on our expectations. They are subject to a number of risks and uncertainties that cannot be predicted, quantified or controlled. Future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. Statements in this 10-Q report, including those set forth above in "Risk Factors,", and in documents incorporated into this 10-Q report, describe factors, among others, that could contribute to or cause these differences. In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this 10-Q report will in fact transpire or prove to be accurate. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this section. Statements in this report, including those set forth above in "Risk Factors," and in documents incorporated into this report, describe factors, among others, that could contribute to or cause these differences. In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this report will in fact transpire or prove to be accurate. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this section. 30 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as our business practices evolve and could seriously harm our financial results. All of our international sales, except spare parts and service sales made by our subsidiary in South Korea and Japan, are currently denominated in U.S. dollars. The spare parts and service sales of $7.2 million for nine months ended September 30, 2003 generated by the South Korean subsidiary are WON denominated and Japanese subsidiary are YEN denominated. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and, therefore, reduce the demand for our products. Reduced demand for our products could materially adversely affect our business, results of operations and financial condition. We have both fixed rate and floating rate interest obligations. Fixed rate obligations may result in interest expenses in excess of market rates if interest rates fall, while floating rate obligations may result in additional interest costs if interest rates rise. An increase of one percentage point in interest rates would not materially impact the results of our operations. At any time, fluctuations in interest rates could affect interest earnings on our cash, cash equivalents or increase any interest expense owed on the line of credit facility. We believe that the effect, if any, of reasonably possible near term changes in interest rates on our financial position, results of operations and cash flows would not be material. Currently, we do not hedge these interest rates exposures. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. There was no change in our internal control over the financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. During the fiscal 2002 financial reporting process, management, in consultation with the Company's independent accountants, identified deficiencies involving internal controls over inventories, warranties and the Company's Korean operations which constituted a "Reportable Condition" under standards established by the American Institute of Certified Public Accountants. Management believes that these matters have not had any material impact on our financial statements. Management established a project plan and implemented processes and controls to address these deficiencies. 31 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The information required by this Part II, Item 1 is incorporated herein by reference to that certain disclosure under the caption "Legal Proceedings" in Part I, Item 1 of this Form 10-Q ITEM 5. OTHER INFORMATION On November 7, 2003, the Company completed a private placement of approximately 6.4 million shares of its common stock at a per share price of $5.25. The offering resulted in gross proceeds to the company of approximately $33.6 million, before costs related to the private placement. The purchase price for the shares represented approximately a 5 percent discount to the average closing price for 10 days prior to the close on November 7, 2003. No warrants were issued in this transaction. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No. Description ---- ----------- 2.1 Asset Purchase Agreement, dated April 15, 1998, by and between Varian Associates, Inc. and Registrant and exhibits thereto (15) 3.1 Amended and Restated Articles of Incorporation of Registrant as filed September 6, 1997 (11) 3.2 By-laws of Registrant, as amended (13) 4.1 Common Shares Rights Agreement, dated as of April 27, 1990, between Registrant and Bank of America, N.T. and S.A., as Rights Agent (4) 4.2 Convertible Preferred Stock Purchase Agreement, dated February 2, 1998, among the Registrant and the Investors (14) 4.3 Registration Rights Agreement, dated February 2, 1998, among the Registrant and the Investors (14) 4.4 Certificate of Determination of Rights, Preferences and Privileges of Series A Convertible Preferred Stock (14) 4.5 Certificate of Determination of Rights, Preferences and Privileges of Series B Convertible Preferred Stock (17) 4.6 Redemption and Exchange Agreement, dated July 16, 1998, among the Registrant and the Investors (17) 4.7 Registration Rights Agreement, dated January 17, 2002, as amended, amongst the Registrant and the Investors (20) 4.8 Securities Purchase Agreement dated July 31, 2002 among the Company and the Purchasers signatory thereto. (21) 4.9 Resale Registration Rights Agreement dated August 14, 2002 among the Company and the Purchasers signatory thereto. (21) 4.10 7% Convertible Subordinated Note Due 2005 dated August 14, 2002. (21) 10.1 Lease, dated December 6, 1985, for Registrant's facilities at 4 Mulliken Way, Newburyport, Massachusetts, and amendment and extension of lease, dated March 17, 1987 (1) 10.2 Assignment of Lease, dated April 1986, for Registrant's facilities at Unit 11A, Melbourn Science Park, Melbourn, Hertz, England (1) 10.3 Registrant's 1989 Employee Stock Purchase Plan, as amended (5) 10.4 Registrant's 1991 Incentive Stock Option Plan, as amended (10) 10.5 Registrant's 2000 Stock Plan (19) 10.6 Distributor/Representative Agreement, dated August 1, 1984, between Registrant and Aju Exim (formerly Spirox Holding Co./You One Co. Ltd.) (1) 10.7 Exclusive Sales and Service Representative Agreement, dated October 1, 1989, between Registrant and AVBA Engineering Ltd. (3) 32 10.8 Exclusive Sales and Service Representative Agreement, dated as of April 1, 1990, between Registrant and Indosale PVT Ltd. (3) 10.9 License Agreement, dated November 23, 1987, between Registrant and Eaton Corporation (1) 10.10 Exclusive Sales and Service Representative Agreement, dated May 1, 1989, between Registrant and Spirox Taiwan, Ltd. (2) 10.11 Lease, dated April 7, 1992, between Registrant and The John A. and Susan R. Sobrato 1979 Revocable Trust for property at 1139 Karlstad Drive, Sunnyvale, California (6) 10.12 Asset Purchase Agreement, dated May 28, 1992, by and between the Registrant and Advantage Production Technology, Inc. (7) 10.13 License and Distribution Agreement, dated September 8, 1992, between the Registrant and Sumitomo Mutual Industries Ltd. (8) 10.14 Lease Agreement, dated October 1995, for Registrant's facilities at Lot 62, Four Stanley Tucker Drive, Newburyport, Massachusetts (9) 10.15 International Distributor Agreement, dated July 18, 1997, between Registrant and Macrotron Systems GmbH (12) 10.16 Credit Agreement, dated August 18, 1997, between Registrant and Sumitomo Bank of California (12) 10.18 Settlement Agreement and Mutual Release, dated April 20, 1998, between Registrant and James T. Healy (16) 10.19 Form of Change of Control Severance Agreement (16) 10.20 Settlement Agreement and Mutual Release, dated January 1998, between the Registrant and John Aldeborgh (18) 10.21 Settlement Agreement and Mutual Release, dated May 1998, between the Registrant and Mary Bobel (18) 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a). 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ------------------------------- (1) Incorporated by reference to the exhibit filed with Registrant's Registration Statement on Form S-1 (No. 33-23861) filed August 18, 1988, and amended on September 21, 1988, October 5, 1988, November 3, 1988, November 10, 1988, and December 15, 1988, which Registration Statement became effective November 10, 1988. (2) Incorporated by reference to the exhibit filed with the Registrant's Registration Statement on Form S-1 (No. 33-28755) filed on May 17, 1989, and amended May 24, 1989, which Registration Statement became effective May 24, 1989. (3) Incorporated by reference to the exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. (4) Incorporated by reference to the exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1990. (5) Incorporated by reference to the exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990. (6) Incorporated by reference to the exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992. (7) Incorporated by reference to the exhibit filed with the Registrant's Report on Form 8-K dated September 12, 1992. (8) Incorporated by reference to the exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 21, 1992. (9) Incorporated by reference to the exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995. 33 (10) Incorporated by reference to the exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. (11) Incorporated by reference to the exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. (12) Incorporated by reference to the exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. (13) Incorporated by reference to the exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. (14) Incorporated by reference to the exhibit filed with the Registrant's Current Report on Form 8-K dated February 12, 1998. (15) Incorporated by reference to the exhibit filed with the Registrant's Current Report on Form 8-K dated April 15, 1998. (16) Incorporated by reference to the exhibit filed with the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 1997. (17) Incorporated by reference to the exhibit filed with the Registrant's Current Report on Form 8-K dated July 29, 1998. (18) Incorporated by reference to the exhibit filed with the Registrant's Quarterly Report on Form 10-Q/A for the quarter ended September 30, 1998. (19) Incorporated by reference to the exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000. (20) Incorporated by reference to the exhibit filed with the Registrant's Current Report on Form 8-K dated January 25, 2002. (21) Incorporated by reference to the exhibit filed with the Registrant's Current Report on Form 8-K dated August 20, 2002. (b) Report of Form 8-K The Company furnished, but did not file, one current report on Form 8-K during the three months ended September 30, 2003. The report dated July 31, 2003, contained the Company's press release announcing it's earnings for the three months ended June 30, 2003. 34 GENUS, INC. SIGNATURES 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. Date: November 13, 2003 GENUS, INC. /s/ William W.R. Elder -------------------------- William W.R. Elder, President, Chief Executive Officer and Chairman /s/ Shum Mukherjee -------------------------- Shum Mukherjee Chief Financial Officer (Principal Financial and Principal Accounting Officer) 35

GENUS INC 10-Q