Item 5.     Operating and Financial Review and Prospects

5.A    Operating Results

(a)    General

Orbotech is an Israeli corporation with two reportable operating segments: Production Support Solutions for the Electronics Industry and Automatic Check Reading. The Company is principally engaged in the design, development, manufacture, marketing and/or service of yield-enhancing, production support solutions for specialized applications in the supply chain of the electronics industry. The Company’s products for the electronics industry are primarily AOI and process control systems and imaging and CAM solutions, principally for application in the production of PCBs and FPDs. Through Orbograph, the Company also develops and markets automatic check reading solutions to banks and other financial institutions and has developed a proprietary technology for web-based, location-independent data entry for check processing and forms processing.

The Company derives revenues from two sources: (i) sales of the Company’s products; and (ii) services provided with respect to the Company’s products. In 2004, 2003 and 2002, revenues derived from sales of products constituted approximately 78%, 71% and 71%, respectively, of the Company’s total revenues, with the

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remaining revenues being derived from service for product support. During those periods, approximately 97%, 95% and 96%, respectively, of revenues from both product sales and service were derived from product lines related to its production support solutions for the electronics industry, and the balance from product lines related to automatic check reading. The Company expects that revenues from its products for inspection of electronic components and related services will continue to account for a predominant portion of total sales and service revenues in the near future. Most of the Company’s inspection-related revenues are derived from repeat sales to existing customers, and the Company expects that repeat sales will continue to account for a significant portion of such revenues in the future. See Note 13a to the Consolidated Financial Statements listed in Item 18 for a description of each segment and information as to segment revenues, operating income or loss, assets and related data.

The currency of the primary economic environment in which the operations of the Company are conducted is the U.S. Dollar. Virtually all of the Company’s sales are made outside Israel in non-Israeli currencies, mainly the U.S. Dollar, and most of its purchases of materials and components are made, and most marketing and service costs are incurred, outside Israel in non-Israeli currencies, primarily the U.S. Dollar. Thus, the functional currency of the Company is the U.S. Dollar.

(b)    Adoption of U.S. GAAP

For each of the years up to and including the year ended December 31, 2001, the Company prepared its primary financial statements in accordance with Israeli GAAP, with a reconciliation to U.S. GAAP presented in a note to the financial statements. However, the Company elected, as from 2002, to change the basis of accounting used in its primary financial statements from Israeli GAAP to U.S. GAAP. The Company believes that since its shares are traded only in the United States and the majority of such shares are beneficially owned by United States persons, investors and other users of its financial statements would benefit if the primary financial statements were prepared in accordance with U.S., rather than Israeli, GAAP. Nevertheless, having been advised by the SEC that its staff does not object to the Company’s so doing, the Company continues to account for Frontline using the proportionate method of consolidation, including summarized footnote disclosures of the amounts proportionately consolidated, rather than the equity method as is called for under U.S. GAAP pursuant to Accounting Principles Board Opinion No. 18.

Unless otherwise stated, all financial data presented in this Annual Report on Form 20-F have been adjusted to give effect to the adoption by the Company of U.S. GAAP.

(c)    Critical Accounting Policies

To improve understanding of the Company’s financial statements, it is important to obtain some degree of familiarity with the Company’s principal or significant accounting policies. These policies are described in Note 1 to the Consolidated Financial Statements listed in Item 18. The Company reviews its financial reporting, disclosure practices and accounting policies annually to ensure that the financial statements, which are developed, in part, on the basis of these accounting policies, provide complete, accurate and transparent information concerning the financial condition of the Company. As part of this process, the Company has reviewed the selection and application of its critical accounting policies and financial disclosures as at December 31, 2004, and it believes that the Consolidated Financial Statements listed in Item 18 present fairly, in all material respects, the consolidated financial position of the Company as at that date.

In preparing the Company’s financial statements in accordance with U.S. GAAP, the Company’s management must often make estimates and assumptions, which may affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures as at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex, and consequently actual results may differ from those estimates. For any given individual estimate or assumption made by the Company, there may be alternative estimates or assumptions which are also reasonable. However, the Company believes that, given

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the facts and circumstances before it at the time of making the relevant judgments, estimates or assumptions, it is unlikely that applying any such other reasonable judgment would cause a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity for the periods presented in the Consolidated Financial Statements listed in Item 18.

The Company is also subject to risks and uncertainties that may cause actual results to differ from estimates and assumptions, such as changes in the economic environment, competition, foreign exchange, taxation and governmental programs. Certain of these risks, uncertainties and assumptions are discussed under the heading Cautionary Statement Regarding Forward-Looking Information and in Item 3.D—Risk Factors.

The Company considers its most significant accounting policies to be those discussed below.

(i)    Revenue Recognition

The Company recognizes revenue from sale of products to end users upon delivery, provided that appropriate signed documentation of the arrangement, such as a signed contract, purchase order or letter of agreement, has been received, the fee is fixed or determinable and collectibility is reasonably assured. The Company does not, in the normal course of business, provide a right of return to its customers.

Installation and training are not considered essential to the product capabilities since they do not require specialized skills and can be performed by other vendors.

The Company grants its customers a warranty, usually for a period of six to twelve months, on systems sold. Upon revenue recognition, the Company defers a portion of the sale price that relates to the expected warranty (based on past experience) and recognizes it as service revenue ratably over the warranty period. Service revenue in respect of the Company’s systems is recognized ratably over the contractual period or as services are performed. Annual service fees are generally based on the list price of the Company’s products. It has been the Company’s experience that many of its customers elect to receive maintenance services from the Company on a continuing contractual basis after the conclusion of the warranty period.

In circumstances where the product has been delivered but revenue deferred, the Company records the proceeds it has received as deferred income. The deferred income balance equals the amount of deferred product revenue that has been received less applicable product costs.

The Company recognizes revenue from sale of software to end users upon delivery, provided that appropriate signed documentation of the arrangement, such as a signed contract, purchase order or letter of agreement, has been received, the fee is fixed or determinable, and collectibility is probable. When software is made available to customers electronically, it is deemed to have been delivered when the Company has provided the customer with the access codes necessary to enable immediate possession of the software. If collectibility is in question, revenue is recognized when the fee is collected.

Maintenance revenues are comprised of revenue from support arrangements that include technical support and the right to unspecified upgrades on an if-and-when-available basis. Revenues from these services are deferred and recognized on a straight-line basis, over the life of the related agreement, which is typically one year.

(ii)    Inventory Valuation

Inventories are valued at the lower of cost or market value. Cost is determined as follows: components—on the moving average basis; labor and overhead—on the basis of actual manufacturing costs. If actual market conditions prove less favorable than those projected by management, additional inventory write-downs may be required. Inventories are written down for estimated obsolescence based upon assumptions about future demand and market conditions. Likewise, favorable future demand and market conditions could positively impact future operating results if inventory that has been written down is sold.

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(iii)    Allowance for Doubtful Accounts

The Company performs ongoing credit evaluations of its customers for the purpose of determining the appropriate allowance for doubtful accounts. In respect of sales to customers in emerging economies, the Company generally requires letters of credit from banks. The allowance for doubtful accounts is determined for specific debts the collection of which is doubtful.

(iv)    Liability for Employee Rights Upon Retirement

The Company does not have any obligations to its employees upon retirement which are not fully provided for in the Consolidated Financial Statements listed in Item 18. In accordance with labor laws and agreements in force with respect to its Israeli and Japanese employees, the Company has liability for severance pay upon retirement, and the Company fully records such obligations at each balance sheet date on an undiscounted basis, based on salary components which, in management’s opinion, create entitlement to severance pay. The severance pay liability of the Company and its Israeli subsidiaries to their Israeli employees, based upon the number of years of service and the latest monthly salary, is in large part covered by regular deposits with recognized pension funds, deposits with severance pay funds and purchases of insurance policies. See Note 6 to the Consolidated Financial Statements listed in Item 18.

The Company has not undertaken to provide any post-retirement health benefits to its employees.

(v)    Taxes on Income

Taxes on income are calculated based on the Company’s assumptions as to its entitlement to various benefits under the Approved Enterprise Law. The Company’s entitlement to such benefits is conditional upon its compliance with the terms and conditions prescribed in this law. In the event of its failure to do so these benefits may be canceled and the Company may be required to refund the amount of the benefits already received, in whole or in part, with the addition of Israeli CPI linkage differentials and interest. The Approved Enterprise Law was recently amended and these amendments are being evaluated by the Company. Based upon currently available information, the Company believes that these amendments should not impact the status or benefits applicable to the Company’s current Approved Enterprises. The termination or curtailment of the Approved Enterprise Law or the loss or reduction of such benefits could increase the Company’s tax rates, thereby reducing its net profits or increasing its net losses, and could have a material adverse effect on the Company’s business, financial condition and results of operations.

Deferred income taxes are determined utilizing the asset and liability method based on the estimated future tax effects of differences between the financial accounting and tax bases of assets and liabilities under the applicable tax laws. Deferred income tax provisions and benefits are based on the changes in the deferred tax asset or tax liability from period to period. Valuation allowance is included in respect of deferred tax assets when it is considered more likely than not that such assets will not be realized. In the event that the tax assets are not realized, income tax expense would increase or, conversely, if the valuation allowance is overestimated, the Company would benefit from a future tax credit.

The Company may incur additional tax liability in the event of intercompany dividend distributions by its subsidiaries. Such additional tax liability in respect of non-Israeli subsidiaries has not been provided for in the Company’s financial statements, as the Company does not expect these subsidiaries to distribute dividends in the foreseeable future.

Taxes that would apply in the event of disposal of investments in subsidiaries have not been taken into account in computing deferred income taxes, as it is the Company’s intention to hold, and not to realize, these investments.

The Company may incur additional tax liability in the event of distribution of tax-exempt income. The Company intends permanently to reinvest the amounts of tax-exempt income of its Approved Enterprises and does not intend to cause dividends to be distributed from such income. Therefore, no deferred taxes have been provided in respect of such tax-exempt income.

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(vi)    Amortization of Intangible Assets

On October 27, 1992, the Company acquired all the ordinary shares of Orbot and subsequently merged with Orbot on January 1, 1993. The Merger was accounted for using the purchase method. In connection with the acquisition, goodwill in the amount of approximately $16.3 million was recorded and, through December 31, 2001, was amortized over a period of ten years. At December 31, 2001, $1.3 million remained unamortized. As a result of subsequent acquisitions, the Company recorded goodwill and other intangible assets of approximately $29.8 million in aggregate which, until the end of 2001, were being amortized over a period of five years from the respective dates of acquisition. At December 31, 2001, $18.7 million remained unamortized.

As from January 1, 2002, pursuant to Statement of Financial Accounting Standards (“ FAS ”) No.142 of the Financial Accounting Standards Board of the United States (the “ FASB ”), “Goodwill and Other Intangible Assets”, goodwill is no longer amortized but rather is tested for impairment annually. During 2002, the Company identified its various reporting units, which consist of its operating segments, and performed the necessary allocations of its intangible assets between goodwill and other intangible assets, mainly intellectual property. The Company has utilized expected future discounted cash flows to determine the fair value of the reporting units and whether any impairment of goodwill existed as of the date of adoption of FAS 142. As a result of the application of the transitional impairment test, the Company does not have to record a cumulative effect of accounting change for the estimated impairment of goodwill. The Company designated September 30 of each year as the date on which it will perform its annual goodwill impairment test. On September 30, 2004, an impairment test was conducted on the unamortized goodwill pursuant to which it was determined that, as of the date of the impairment test, no impairment existed. Changes in the fair value of the reporting units following material changes in the assumptions as to the future cash flows and/or discount rates could result in an unexpected impairment charge to goodwill.

The Company’s acquired intangible assets other than goodwill, comprised primarily of intellectual property, are being amortized on a straight-line basis over a period of five years, based on past experience. The amortization expense for 2004 totaled approximately $2.3 million and is anticipated to total approximately $2.1 million for 2005. If an event or a change in circumstances indicates that the carrying amount of such intangible assets may not be recoverable through undiscounted future cash flows, the carrying amount of these assets will be reviewed for impairment and, if necessary, written down to their estimated fair values.

See Notes 1i, 1j and 5 to the Consolidated Financial Statements listed in Item 18.

(d)    Recently Issued Accounting Pronouncements

In December 2004, the FASB issued the revised FAS No. 123, “Share-Based Payment” (“ FAS 123(R )”), which addresses the accounting for share-based payment transactions in which the Company obtains employee services in exchange for: (a) equity instruments of the Company; or (b) liabilities that are based on the fair value of the Company’s equity instruments or that may be settled by the issuance of such equity instruments. This Statement eliminates the ability to account for employee share-based payment transactions using Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (as the Company has done), and requires instead that such transactions be accounted for using the grant-date fair value based method over the period during which the recipient is required to provide service in exchange for the award. This Statement was to have been effective as of the beginning of the first interim or annual reporting period that commences after June 15, 2005 (July 1, 2005 for the Company); however, on April 14, 2005, the SEC delayed effectiveness for companies with fiscal years ending December 31 (such as the Company) to January 1, 2006. This Statement applies to all awards granted or modified after the Statement’s effective date. Accordingly, the cost of all such awards by the Company commencing January 1, 2006 will be recorded as compensation expense in the consolidated statements of operations instead of being presented only on a pro forma basis in the financial statement footnotes. In addition, compensation cost for the unvested portion of previously granted awards that remain outstanding on the Statement’s effective date will be recognized in the consolidated statements of operations on or after the effective date, as the related services are rendered, based on the awards’ grant-date fair value as previously calculated for the pro-forma disclosure under FAS 123.

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The Company expects that upon the adoption of FAS 123(R), it will apply the modified prospective application transition method, as permitted by the Statement. Under such transition method, upon the adoption of FAS 123(R), the Company’s financial statements for periods prior to the effective date of the Statement will not be restated and the compensation expense for periods through December 31, 2005 will continue to be presented on a pro forma basis in the footnotes to the financial statements.

The Company expects that the adoption of FAS 123(R) will have a material effect on its results of operations (although not its financial condition). The impact on net income as a result of the adoption of FAS 123(R), from a historical perspective, is set forth in Note 1r to the Consolidated Financial Statements listed in Item 18; however the Company believes that this historical impact is not indicative of the impact subsequent to the effectiveness of FAS 123(R).

The unrecorded maximum compensation expense for the options outstanding at January 1, 2005 that will remain unvested at December 31, 2005 is estimated at approximately $4.0 million at that date. The remaining compensation expense at December 31, 2005 relating to these options would be recorded in the consolidated financial statements for the following periods:

These amounts do not reflect the cost of any additional awards which may be granted subsequent to December 31, 2004 and prior to January 1, 2006, or any forfeitures, subsequent to December 31, 2004, of any awards granted prior to January 1, 2006. They also do not reflect the compensation cost of any awards granted commencing January 1, 2006, which will be reflected in full in the consolidated financial statements over the vesting period in accordance with FAS 123(R).

The Company is currently evaluating the impact that FAS 123(R) will have on its results of operations with respect to future equity grants. This will depend on a variety of factors including the level and type of future awards and their terms, and valuation considerations such as expected option life, volatility of the market price of the Ordinary Shares and applicable interest rates. The Company is not currently able to estimate the additional compensation expense from future grants but will examine carefully this expense and its relation to net income when making future grants.

In November 2004, the FASB issued FAS No. 151, “Inventory Costs—an amendment of ARB 43, Chapter 4” (“ FAS 151 ”). This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material, requiring that these items be recognized as current-period charges. In addition, this Statement requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This Statement will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005 (January 1, 2006 for the Company); however earlier application of FAS 151 is permitted. The provisions of this Statement shall be applied prospectively. The Company does not expect this Statement to have a material effect on its financial statements or its results of operations.

In July 2004, the FASB issued EITF Issue No. 02-14, “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock”. EITF Issue No. 02-14 addresses whether the equity method of accounting applies when an investor does not have an investment in voting common stock of an investee but exercises significant influence through other means. EITF Issue No. 02-14 states that an investor should only apply the equity method of accounting when it has investments in either common stock or in-substance common stock of the investee, provided that the investor has the ability to exercise significant

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influence over the operating and financial policies of the investee. The provisions in EITF Issue No. 02-14 are effective for reporting periods beginning after September 15, 2004 (October 1, 2004 for the Company). The adoption of EITF 02-14 by the Company did not have any effect on the Company’s financial statements or its results of operations.

In March 2004, the FASB issued EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, which provides new guidance for assessing impairment losses on debt and equity investments. Additionally, EITF Issue No. 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB postponed the implementation of the accounting provisions of EITF Issue No. 03-1; however, the disclosure requirements remain effective and have been adopted by the Company in the Consolidated Financial Statements listed in Item 18. The Company will evaluate the effect, if any, of EITF Issue No. 03-1 when final guidance is released.

(e)    Geographical Analysis; Worldwide Economic Situation; Cost of Revenues

(i)    Geographical Analysis and Worldwide Economic Situation

The following table sets forth the Company’s sales and service revenues by geographic area for the periods indicated:

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Approximately 76% of the Company’s revenues from equipment sales and service revenue during 2004 (compared to 75% during 2003 and 76% during 2002) were derived from the Far East, including approximately 30% from revenues in Taiwan, 22% from revenues in China, 11% from revenues in Japan and 9% from revenues in Korea. Of the approximately 75% of Company revenues from equipment sales and service which were derived from the Far East in 2003, approximately 29% were from Taiwan, 20% from Japan, 16% from China and 4% from Korea. In addition, virtually all of the Company’s revenues from its automatic check reading products during 2004 and 2003 were derived from sales in North America. The Company monitors developments, including banking and currency difficulties, in the financial markets and economies of all countries and regions in which it markets its products and their possible impact upon the Company.

The improved business climate in North America and Europe during 2004 resulted in increased levels of manufacturing activity for more technologically sophisticated PCB products, particularly in the latter part of the year, and as a result the Company recorded higher revenues from both of these regions. Revenues from Japan decreased significantly during the year, reflecting a trend among Japanese bare PCB and FPD manufacturers towards shifting their manufacturing operations to other Asian countries, particularly China. Revenues from other Pacific Rim countries also increased as the strong business environment led to greater capacity utilization in both the PCB and FPD industries in this region.

During 2003, and especially in the later part of the year, the Company recognized higher revenues from equipment sales in North America and Europe, driven principally by increased high-end PCB manufacturing activity in those regions. The increased sales activity in Taiwan and Japan, and the reduced activity in Korea, during the year reflected in part the specific timing of certain substantial FPD equipment orders and deliveries. The overall growth in service revenue derived from the Far East was a function of increased manufacturing activity in that region and the resulting greater number of service contracts with customers. The continued shift of PCB manufacturing activities from North America to the Far East, and particularly China, reflected manufacturers’ ongoing efforts to take advantage of the lower manufacturing costs prevailing in China.

During 2004, the global electronics industry continued to recover from the effects of the depressed economic activity that had been prevalent throughout the period from late 2000 until the middle of 2003. However, the duration, extent and stability of this recovery is uncertain, and the Company’s current ability to foresee future changes in the total volume of orders for its products and services remains limited. The worldwide economic slowdown of 2000 to 2003, and the current recovery, impacted substantially upon the Company’s financial results. The inherent uncertainties associated with the global economic environment and the financial markets and economies of those countries in which the Company markets its products, together with the related possible changes in demand for its products, means that past operating results may not necessarily be indicative of the future. Accordingly, while the Company is cautiously optimistic about the current state of the worldwide electronics industry and the general economic environment, it is not presently able to anticipate how such matters will affect its results during 2005, and no assurances as to future developments in respect of such matters can be given. See Item 5.D—Trend Information.

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(ii)    Cost of Revenues

(f)    Effective Corporate Tax Rate

The Company’s income tax obligations consist of those of the Company in Israel and those of each of its subsidiaries in their respective taxing jurisdictions. Through December 31, 2002, the Company elected not to exercise the option available to it under Israeli tax laws to calculate its taxable income in Dollars. As a result, the Company’s income tax obligations in Israel were based upon its earnings determined in Israeli currency on a real basis (having regard to the changes in the Israeli CPI) and not in Dollars, the functional currency of the Company’s financial statements. The effective tax rate in the Company’s financial statements for the years prior to 2003 was, therefore, influenced mainly by the following: (a) the split of taxable income between the various tax jurisdictions; (b) the availability of tax loss carryforwards and the extent to which valuation allowance has been recorded against deferred tax assets; (c) the difference between the change in the exchange rate of the Dollar to New Israeli Sheqels (“ NIS ”) and the change in the Israeli CPI; and (d) the portion of the Company’s income which is entitled to tax benefits due to those of its production facilities which are Approved Enterprises.

Beginning January 1, 2003, the Company elected to exercise the option under Israeli tax laws to calculate its taxable income in Dollars so as to reduce any potential exposure based on the differential between the change in the exchange rate of the Dollar to the NIS and the change in the Israeli CPI. The Company is bound by this election for a period of at least three years. Accordingly, during this period, the Company’s effective tax rate will be influenced mainly by the factors described above other than the difference in changes in the exchange rate as compared to changes in the Israeli CPI.

The combination of the above factors produced effective tax rates of 12.9%, 3.2% and (6.6)% for the years 2004, 2003 and 2002, respectively.

See Item 4.B—Business Overview—Additional Considerations Relating to the Company’s Operations in Israel; Note 9 to the Consolidated Financial Statements listed in Item 18; and Taxes on Income.

(g)    Impact of Inflation and Currency Fluctuations

The Dollar cost of the Company’s operations in Israel is influenced by the differential between the rate of inflation in Israel and any change in the value of the NIS in relation to the Dollar. The Company’s Dollar costs will increase if this “gap” widens and Israeli currency is revalued or, if devalued, its devaluation rate fails to keep

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pace with the rate of inflation in Israel, and, conversely, the Company may benefit if Israeli currency devalues against the Dollar at a rate that exceeds the rate of inflation in Israel. In the years ended December 31, 2004, 2003, 2002, 2001 and 2000, the annual inflation rate in Israel as adjusted for the change in the rate of exchange of the Israeli currency in relation to the Dollar was 2.8%, 5.7%, (0.8)%, (7.8)% and 2.7%, respectively. The closing representative exchange rate of the Dollar at the end of each such period, as reported by the Bank of Israel, was NIS 4.308, NIS 4.379, NIS 4.737, NIS 4.416 and NIS 4.041, respectively. As a result, the Company experienced increases in the Dollar costs of operations in Israel in 2004, 2003 and 2000, and decreases in 2002 and 2001. The changes in the Dollar cost of the Company’s operations in Israel relate primarily to the cost of salaries in Israel, which are paid in, and constitute a substantial portion of, the Company’s expenses in NIS. These NIS related expenses constituted approximately 20%, 22% and 25% of the total expenses of the Company for 2004, 2003 and 2002, respectively. There can be no assurance that the Company will not be materially adversely affected if Israeli currency is revalued in relation to the Dollar or, if devalued, inflation in Israel exceeds the devaluation of the NIS against the Dollar or if the timing of such devaluation lags behind increases in inflation in Israel.

In addition, the Company receives most of its European revenues in Euros and its Japanese revenues in Japanese Yen, and expenses in Euros and Japanese Yen are generally less than its respective revenues in these currencies. The management of balances in Euros and Japanese Yen is conducted mainly through hedging agreements in an effort to reduce the effects of fluctuations in the exchange rate. See Item 11—Quantitative and Qualitative Disclosures about Market Risk. The Company’s cash reserves are held almost entirely in Dollars.

The representative exchange rate for converting NIS into Dollars, as published by the Bank of Israel on April 18, 2005, was NIS 4.381 = $1.00.

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(h)    Results of Operations

The following table sets forth certain financial data as a percentage of revenues for the periods indicated.

(i)    Year Ended December 31, 2004 Compared To Year Ended December 31, 2003

The Company’s financial results for 2004 reflected the strong improvement during the year in the global economic environment and the worldwide electronics industry, as a result of which the Company recorded significantly increased revenues and profitability compared to 2003.

Revenues in 2004 totaled $315.2 million compared with $228.4 million in 2003. This increase of approximately 38% was principally attributable to the worldwide recovery in economic conditions and growth in business confidence, which gave rise to increased capital expenditures by PCB and FPD manufacturers. Revenues from service activities increased to $69.6 million from the $65.4 million recorded in 2003, reflecting higher income from service contracts arising primarily as a result of customers’ increased capacity utilization.

Revenues from the sale and service of PCB-related equipment increased to $208.2 million from the $155.0 million recorded in 2003. Of these revenues, $174.2 million, representing approximately 55% of the Company’s total revenues, was attributable to sales and service of AOI systems for bare PCBs and $34.0 million, representing approximately 11% of the Company’s total revenues, was attributable to sales and service of AOI

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systems for assembled PCBs. In 2003, $133.4 million of revenues, representing approximately 58% of the Company’s total revenues, was attributable to sales and service of systems for bare PCBs and $21.6 million of revenues, representing approximately 9% of the Company’s total revenues, was attributable to sales and service of AOI systems for assembled PCBs.

During 2004, the Company sold a significantly increased number of direct imaging systems (36 compared to 18 in 2003). The Company believes that this reflects both the growing acceptance of direct imaging technology among bare PCB manufacturers as well as the considerable improvement in the Company’s direct imaging product offerings. Initial revenues were recorded in the fourth quarter of 2004 from the introduction of the Paragon direct imaging system and the Discovery PCB-AOI system, both of which have been well received by customers.

The Company’s higher revenues during the year from sales of AOI systems for assembled PCBs reflect the steadily increasing awareness and acceptance of AOI as an integral part of the manufacturing process, and also benefited from the withdrawal, during the latter part of 2003, of a major competitor from the PCB assembly business. Although the overall level of penetration of AOI within the assembled PCB manufacturing industry remains relatively low, the Company maintains the view that this area is still maturing and that there exists a clear and growing need on the part of assembly houses for AOI and in-line process control solutions of the type developed and offered by the Company.

Revenues from the sale and service of FPD-related equipment increased to $97.8 million from the $63.1 million recorded in 2003. This increase primarily resulted from initial investments made by FPD manufacturers in sixth generation FPD fabrication plants for the production of wall-mounted TFT-LCD televisions sets for home use, and their continued investment in fifth generation FPD fabrication plants for the production of notebook and desktop monitor applications. During 2004, two new FPD manufacturing plants were constructed in mainland China (the first of their kind in that country), and the Company succeeded in supplying its fifth generation FPD-AOI systems to both of these facilities, as well as to a major new electronic products manufacturer in Taiwan. In the fourth quarter of 2004, the Company recorded initial revenues from its sixth generation, in-line FPD-AOI systems delivered to two customers in Taiwan during the third quarter of 2004. During the second half of 2004 the Company delivered its new, seventh generation in-line FPD-AOI system to a major Korean FPD manufacturing customer, which was accepted in February 2005, and the Company recorded the revenues from these sales in the first quarter of 2005.

Revenues from the Company’s automatic check reading products decreased to $9.3 million in 2004, from $10.3 million in 2003. The Company believes that this was due, in part, to a degree of hesitation experienced by many banks and financial institutions as a result of the uncertainties associated with the implementation of the Check 21 Law, which was enacted in 2003 and entered into force in October 2004.

The increase in cost of products sold in 2004 of $40.5 million, or 51.3% (excluding the write-down of inventories in 2003), arose principally from an increase of $38.4 million, or 59.4%, in the cost of materials and components, resulting mainly from the significantly increased volume of products sold. Labor costs increased $1.7 million, or 20.7%, reflecting an increase in the number of employees in Israel engaged in manufacturing, and increased salaries. Overhead and other expenses rose $0.4 million, or 7.1%.

The increase in cost of services rendered in 2004 of $5.1 million, or 9.8%, was comprised of increases of: $1.3 million, or 10.3%, in materials consumed; $2.0 million, or 8.1%, in labor costs; and $1.8 million, or 12.3%, in overhead and other expenses. These increases were principally due to the higher levels of FPD business activity in the Far East and the consequent expansion of the Company’s FPD-related customer support infrastructure in that region, particularly in Korea and China.

Gross profit for 2004 was $138.6 million, or 44.0% of revenues, compared to $90.0 million, or 39.4% of revenues, in 2003. Gross profit for 2003 reflected a $7.4 million charge for the write-down of inventory. Gross profit for 2004 from sales of equipment was $125.9 million, or 51.3% of product sales, compared to $76.4 million, or 46.9%, during 2003 (including the write-down of inventory). Gross profit for 2004 from services

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rendered was $12.7 million, or 18.2% of service revenues, compared to $13.6 million, or 20.8%, during 2003. This decrease was attributable to the larger proportion in 2004 than in 2003 of service contracts in the Far East, where contract prices are typically lower than in other regions, as well as the higher installation and support costs associated with the Company’s new FPD in-line products. The overall increase in gross margin for 2004 was a function of the larger proportion of product revenues as a percentage of total revenues during the year.

The increase in gross research and development expenditures, to $49.7 million in 2004 from $42.1 million in 2003, reflected the Company’s continuing efforts to expand into new technologies, develop products designed to address new applications and provide enhancements to existing products. During 2004, the Company received $1.7 million in Israeli Government participation in its research and development expenditures, compared to $2.6 million in 2003.

Selling, general and administrative expenses increased to $53.0 million in 2004 from the $48.0 million recorded in 2003. This was partially due to the higher levels of investment by the Company in its sales and marketing infrastructure in the Far East in light of the continued migration of high-volume PCB manufacturing, and the initial migration of FPD manufacturing, to that region, particularly China, as well as the increased commission payments to the Company’s sales staff resulting from the overall growth in sales volume.

The amortization of other intangible assets during 2004 totaled $2.3 million compared to $2.4 million in 2003.

Net financial income totaled $1.3 million in 2004, compared with $2.4 million in 2003. The decrease in interest income, from $2.7 million to $1.9 million, resulted from further reductions in prevailing interest rates, particularly towards the end of 2004. The Company also recorded an exchange rate gain of $1.6 million during 2003 and incurred $1.1 million in interest expenses during that year on indebtedness to the Government of Israel which was paid in January 2004. The Company had small translation gains and no interest expense in 2004.

During 2004, the Company wrote down, from $3.1 million to $0.2 million, its investment, made through the Fund, in a private Israeli company engaged in the research and development of products for the photonics industry, to adjust the value of the investment as reflected in the last financing round of that company, in which the Company did not participate.

Taxes on income in 2004 reflected a charge of $4.3 million, compared to a charge of $0.1 million in 2003. The Company’s effective tax rates for 2004 and 2003 were 12.9% and 3.2%, respectively. Generally, the Company’s effective tax rate varies largely as a function of benefits received from the State of Israel, particularly those relating to Approved Enterprises. See Effective Corporate Tax Rate.

The share in profits of an associated company of $0.2 million in 2004, compared with losses of $0.5 million in 2003, reflects the Company’s share in the profits of Coreflow, in which the Company holds a 38% equity interest (calculated on a fully diluted basis). The minority share in profits of a consolidated subsidiary of $0.1 million in 2004 reflects the 9% minority interest in Orbograph. This is compared to a share in profits of $0.5 million in 2003. Until 2002 the Company accounted for 100% of Orbograph’s profits and losses since as long as Orbograph had accumulated losses Orbotech funded Orbograph’s negative shareholders’ equity. Should Orbograph incur losses in the future, the minority shareholders will, for so long as their interest in shareholders’ equity remains positive, participate in such losses.

Net income for the year ended December 31, 2004 was $29.5 million, or $0.90 per share (diluted), compared with a net loss of $3.0 million, or $0.09 per share (diluted), for the year ended December 31, 2003.

(j)    Year Ended December 31, 2003 Compared To Year Ended December 31, 2002

The Company’s financial results for 2003 reflected a year that commenced with a limited degree of stabilization in the electronics industry and witnessed an improving business environment as the year progressed. During the latter part of 2003, the Company’s PCB customers began to report stronger demand for their products which, combined with their depressed investment levels for new equipment in previous years and their growing capacity utilization rates, resulted in increased demand for the Company’s products.

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During the fourth quarter of 2003, the Company recorded special charges of $10.9 million, net of taxes, consisting principally of a restructuring charge of $3.8 million resulting from headcount reductions and operational rationalizations, a write-off of $7.4 million ($6.3 million net of taxes) of inventory due to the accelerated acceptance, during that quarter, of new PCB products and new generations of FPD products resulting in obsolescence of certain components used in superseded products, and a charge of $0.7 million related to the Company’s write-down of the Fund’s venture capital investment in one private Israeli company in which the Company has an equity interest. The cumulative effect of the staff reduction measures taken from August 2001 to December 2003 was an overall decrease in the Company’s workforce from approximately 1,900 in August 2001 to approximately 1,400 at the end of December 2003. The operational rationalizations occurred primarily in North America and Europe, where business conditions in the electronics industry had been adversely affected by the continuing migration to the Far East of PCB manufacturing. The previous reductions in management salaries, implemented during 2001 and 2002, were reversed with effect from the beginning of 2003.

Revenues in 2003 totaled $228.4 million compared with $216.4 million in 2002. This increase of approximately 6% was principally attributable to the gradually improving business environment, leading to an increase in demand for the Company’s products. Revenues from service activities increased to $65.4 million from the $62.1 million recorded in 2002, reflecting higher income from service contracts arising primarily as a result of customers’ increased capacity utilization.

Revenues from the sale and service of PCB-related equipment increased to $155.0 million from the $149.3 million recorded in 2002. Of these revenues, $133.4 million, representing approximately 58% of the Company’s total revenues, was attributable to sales and service of AOI systems for bare PCBs and $21.6 million, representing approximately 9% of the Company’s total revenues, was attributable to sales and service of AOI systems for assembled PCBs. In 2002, $129.4 million of revenues, representing approximately 60% of the Company’s total revenues, was attributable to sales and service of systems for bare PCBs and $19.9 million of revenues, representing approximately 9% of the Company’s total revenues, was attributable to sales and service of AOI systems for assembled PCBs.

During the second quarter of 2003, the Company introduced a new direct imaging system, the DP-100SL, featuring a solid state laser, which provided improved cost performance to the customer, primarily through reduced site preparation and service requirements. This system was well received by PCB manufacturers, as evidenced by increased sales of direct imaging systems during the latter part of 2003, and has contributed, the Company believes, to an overall wider acceptance of direct imaging technology among the Company’s PCB customers.

The modest increase in revenues from sales of AOI systems for assembled PCBs reflected the still limited recognition throughout the electronics assembly industry of the potential benefits of AOI, combined with what would appear to have been continued hesitancy on the part of assembly houses in making additional capital investments. Although the overall level of penetration of AOI within the assembled PCB manufacturing industry remained low, the Company believes this area is still maturing and will, in the future, be characterized by more widespread acceptance of AOI as the industry standard in electronics assembly manufacturing.

Revenues from the sale and service of FPD-related equipment increased to $63.1 million from the $58.2 million recorded in 2002. This increase was primarily due to the continuing investments by FPD manufacturers in fifth generation FPD fabrication plants for the production of notebook and desktop monitor applications and their initial investments in sixth generation FPD fabrication plants for the production of wall-mounted TFT-LCD televisions sets for home use. During the latter part of 2003, the FPD industry began to experience higher demand for FPDs for use in the manufacture of TFT-LCD televisions, and consequently the Company received significantly increased orders for its FPD inspection equipment with delivery dates during 2004 and 2005.

Revenues from the Company’s automatic check reading products totaled $10.3 million in 2003, compared with $8.8 million in 2002, representing an increase of approximately 17%. The Company believes that this

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reflected a steadily growing awareness on the part of banks and other financial institutions of the potential benefits to them of automatic check reading solutions of the type provided by the Company’s data conversion software.

Gross profit for 2003 was $90.0 million, or 39.4% of revenues, compared to $86.1 million, or 39.8% of revenues, in 2002. Gross profit for 2003 reflected a $7.4 million charge for the write-down of inventory. Gross profit for 2003 from sales of equipment was $76.4 million, or 46.9% of product sales (including the inventory write-down), compared to $75.9 million, or 49.2%, during 2002. Gross profit for 2003 from services rendered was $49.2 million, or 20.8% of service revenues, compared to $10.2 million, or 16.4%, during 2002. The increase in gross profit from equipment sales in 2003 (before the inventory write-down) was indicative of a shift in product mix towards more technologically advanced solutions. The increase in gross profit from services rendered reflected the streamlining of the Company’s customer support operations as a result of the previous restructuring of the Company’s North American and European operations.

The reduction in gross research and development expenditures, from $44.4 million in 2002 to $42.1 million in 2003, reflected the selective curtailment of research and development activities during the transitional period of economic uncertainty, especially in the earlier part of 2003. Nevertheless, the Company continued to focus its research and development efforts towards the introduction of new products and technologies designed to maintain its position of technological leadership in the industries that it serves. During 2003, the Company received $2.6 million in Israeli Government participation in its research and development expenditures, compared to $2.2 million in 2002.

Selling, general and administrative expenses decreased to $48.0 million in 2003 from the $50.2 million recorded in 2002. This decrease included the effects of the restructuring measures adopted during the fourth quarter of 2002. The Company continued to expand its sales and marketing activities in the Far East in view of the ongoing migration to that region, and in particular to China, of high-volume PCB manufacturing operations and the increased FPD activity in that region.

The amortization of other intangible assets during 2003 totaled $2.4 million compared to $2.5 million in 2002.

During the fourth quarter of 2003, the Company initiated a restructuring program designed to further reduce its cost structure (the “ 2003 Program ”). The 2003 Program incorporated adjustments (including staff dismissals) to the infrastructures of certain of the Company’s European subsidiaries, motivated primarily by the shift in sales activity from Europe to other geographical locations, as well as the restructuring of various operational activities both in Israel and in certain other of the Company’s subsidiaries. The 2003 Program resulted in total restructuring charges to the Company of $3.8 million, which were recorded in the fourth quarter of 2003. All liabilities relating to the 2003 Program were paid during the last quarter of 2003 or during 2004.

The implementation of the 2003 Program in Europe, which represented $2.0 million of the total charges of $3.8 million, consisted of the dismissal of nine persons who had been employed by certain of the Company’s European subsidiaries, and the closure of two of the Company’s satellite offices, located in the United Kingdom and Italy. This element of the 2003 Program was concluded by June 2004, and resulted in an estimated annual cost reduction to the Company of approximately $950,000, which was in line with original estimates.

The implementation of the 2003 Program in Israel and the Company’s other subsidiaries, which represented $1.6 million of the total charges of $3.8 million, consisted of the dismissal of 25 employees in Israel and 10 employees of the Company’s other subsidiaries, and the closure of one satellite office in Israel. This element of the 2003 Program was concluded during the first quarter of 2004, and resulted in an estimated annual cost reduction to the Company of approximately $2.8 million, which was in line with original estimates.

In addition, the 2003 Program included a $0.2 million charge related to a write-off of the intellectual property of a subsidiary of Frontline in the United Kingdom, the operations of which were terminated in the fourth quarter of 2003.

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Net financial income totaled $2.4 million in 2003, compared with $2.9 million in 2002. The decrease in interest income, from $3.8 million to $2.7 million, resulted from reductions in applicable interest rates. The Company also recorded an exchange rate gain of $1.6 million during the year, compared with an exchange rate gain of $0.6 million in 2002. The Company incurred $1.1 million in interest expenses in 2003, compared with $0.6 million in 2002, with respect to its liability to the Government of Israel arising from the OCS Agreement.

During 2003, the Company wrote down, from $1.1 million to $0.4 million, its investment, made through the Fund, in a private Israeli company engaged in the research and development of products for bio-medical applications using machine vision technology, to adjust the value of the investment as reflected in the last financing round of that company, in which the Company did not participate.

Taxes on income in 2003 reflected a charge of $0.1 million, compared to a credit of $1.1 million in 2002. The Company’s effective tax rates for 2003 and 2002 were 3.2% and (6.6)%, respectively. Generally, the Company’s effective tax rate varies largely as a function of benefits received from the State of Israel, particularly those relating to Approved Enterprises. See Effective Corporate Tax Rate.

The share in losses of an associated company of $0.5 million in 2003, compared with $0.2 million in 2002, reflected the Company’s share in the losses of Coreflow. The minority share in profits of a consolidated subsidiary of $0.5 million in 2003 reflected the 8% minority interest in Orbograph.

Net loss for the year ended December 31, 2003 was $3.0 million, or $0.09 per share (diluted), compared with a net loss of $15.8 million, or $0.49 per share (diluted), for the year ended December 31, 2002.

5.B    Liquidity and Capital Resources

The Company’s financial position remained strong during 2004, with cash, cash equivalents, bank deposits and marketable securities increasing to $181.8 million at the end of 2004 from the $158.7 million recorded a year earlier. This increase resulted primarily from strong positive cash flow from operating activities of $33.8 million, which was partially offset by cash used in investing and financing activities, including $4.9 million for capital expenditures and the final $6.2 million payment with respect to the liability to the Government of Israel arising from the OCS Agreement.

Inventories grew from $53.0 million as at December 31, 2003 to $71.5 million as at December 31, 2004, due primarily to the increased level of operations during 2004. Inventories as a percentage of revenues decreased to 22.7% as at December 31, 2004, compared with 23.2% as at December 31, 2003. Net trade accounts receivable rose by $22.0 million at year end because of the increase in products sold; however, the period trade receivables were outstanding (calculated by dividing trade receivables at year end into latest quarter revenues), decreased to 118 days on December 31, 2004 from 134 days on December 31, 2003 because of improved collections. The Company did not record any significant bad debts during 2004. The growth in trade accounts payable of $16.1 million and other accruals of $13.1 million was primarily a function of the increased overall level of business conducted by the Company during 2004, particularly in the second half of the year.

Capital expenditures during 2004 totaled $4.9 million compared with $3.9 million in 2003, as the Company expended greater amounts in equipping its manufacturing facilities and in upgrading its management information systems, as a reflection of the increased levels of business activity during 2004.

The Company had unutilized credit lines totaling $50.2 million at December 31, 2004.

The Company is not aware of any material commitments for capital expenditures in the future and believes that its currently available cash and cash equivalents and funds generated from operations will be sufficient to meet its working capital requirements for the next twelve months.

The Company uses financial instruments and derivatives in order to limit its exposure to risks arising from changes in exchange rates. The use of such instruments does not expose the Company to additional exchange rate

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risks since the derivatives are held against an asset (for example, excess assets in Euros). See Item 11—Quantitative and Qualitative Disclosures About Market Risk. The Company’s policy in utilizing these financial instruments is to protect the Dollar value of its cash and cash equivalent assets rather than to serve as a source of income. For information as to monetary balances in non-Dollar currencies, see Note 11 to the Consolidated Financial Statements listed in Item 18.

5.C    Research and Development, Patents and Licenses, etc.

(a)    Research and Development Policy

The Company places considerable emphasis on research and development projects designed to upgrade its existing product lines and to develop new industrial and service applications of its technologies. As of December 31, 2004, 365 employees were engaged primarily in research and development for the Company.

The following table shows the total research and development expenditures of the Company and participation in such expenditures by the Government of Israel for the periods indicated:

Since 2002 the Company has participated in a royalty free, OCS funded program for the development of generic technologies, for which the Company became eligible as a result of the OCS Agreement. During the years ended December 31, 2004, 2003 and 2002, the Company’s expenses to the Israeli Government with respect to royalty obligations under an Israeli Government program in which the Company previously participated (all of which related to Orbograph) were approximately $0.3 million, $0.4 million and $0.3 million, respectively. See Note 7a(1) to the Consolidated Financial Statements listed in Item 18.

Israeli Government consent is required to manufacture products developed with such participations outside of Israel and to transfer to third parties know-how developed through projects in which the Government participates. Such restrictions do not apply to the export from Israel of the Company’s products developed with such know-how.

(b)    Intellectual Property

To safeguard its proprietary product design and technology, the Company relies, in part, on patent, trade secret, trademark and copyright law, as well as technical safeguards. Proprietary software is generally protected under copyright law. Additionally, the Company relies upon trade secrets and regularly enters into non-disclosure agreements with its employees, subcontractors and potential business associates. As of March 31, 2005, the Company held 107 patents covering 54 different inventions and had 189 pending patent applications.

Notwithstanding the above, there can be no assurance that any patent owned or licensed by the Company will not be invalidated, designed around, challenged or licensed to others, that any of the Company’s pending or future patent applications will be issued with the scope of the claims sought by the Company, if at all, or that non-disclosure agreements will not be breached. In addition, patent coverage may not be extended to all countries, and effective copyright and trade secret protection may be unavailable or limited in certain countries. There can also be no assurance that the steps taken by the Company will prevent misappropriation of its technology. It is also possible that technology developed by the Company may be infringing on patents or other rights held by others. The Company has received in the past, and may in the future receive, communications asserting that the technology used in some of its products requires third-party licenses. Any infringement claims,

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whether or not meritorious, could result in costly litigation or arbitration and divert the attention of technical and management personnel. Any adverse outcome in any litigation alleging infringement could result in the loss of proprietary rights, require the Company to develop non-infringing technology or enter into royalty or licensing agreements (which it may not be successful in achieving) or prevent the Company from manufacturing or selling its products.

The Company has agreed to indemnify certain of its customers against intellectual property claims arising from the purchase and use of the Company’s products. Some customers of the Company that use certain of its products have received notices of infringement alleging that methods carried out on equipment supplied by the Company and used in the inspection of PCBs in the course of manufacture infringe patents issued to others relating, among other things, to “machine vision i.e., computer image analysis”. Certain of the Company’s customers have notified the Company that they may seek indemnification from the Company for damages and expenses which may result from use of the Company’s products; however the Company believes that the risk of its having to make payment in this regard is remote. To date, no demands have been made, nor have any claims been filed, against the Company, with respect to these indemnities.

Although the Company continues actively to pursue the protection of its intellectual property in the belief that its patents have significant value, it also believes that rapid technological improvement and factors such as the knowledge and experience of the Company’s management personnel and employees and their continued ability to define, develop, enhance and market new products and services afford additional protection which may, in some instances, exceed patent protection.

5.D    Trend Information

The global electronics industry strengthened during 2004 and in the early part of 2005, after recovering from the severe economic downturn experienced from 2000 to the middle of 2003. In recent periods the Company’s PCB customers (particularly in the Far East) have been reporting high utilization levels and solid demand for their products leading, in turn, to increased demand for the Company’s PCB products. In addition, the Company continues to benefit from the trend in the electronics industry towards technological enhancements and more sophisticated electronic devices. PCB manufacturers are seeking more advanced inspection and production solutions, and as a result the Company is continuing to experience strong demand for its PCB-AOI and direct imaging systems. For most of 2004 this demand was met primarily by PCB-AOI models introduced in 2003, particularly the Spiron-8800 VIP AOI systems and the DP-100SL solid state laser direct imaging systems. In the latter part of 2004 and the early part of 2005, the products offered by the Company consisted primarily of the Paragon direct imaging system and the Discovery PCB-AOI system, both of which were introduced in the fourth quarter of 2004 and have been well received by customers.

Although the Company’s assembled PCB business recorded a strong year in 2004 compared with the previous year, the Company believes this business has considerable potential which has yet to be realized. However, due to the strongly competitive environment and the still limited recognition throughout the electronics assembly industry of the potential benefits of AOI, the Company does not expect the overall level of its assembled PCB business to increase significantly in the near to middle term.

During 2004 and in the early part of 2005 the FPD industry has continued to experience significant investment growth in new fabrication plants. The Company’s FPD customers are reportedly preparing for additional capital expenditures during the remainder of 2005, in response to higher demand for LCDs for use in consumer products, particularly large wall-mounted television sets for home use. The Company anticipates that the quantity of new FPD fabrication lines, combined with the growing importance of the inspection functions and other applications for the Company’s FPD inspection systems within existing and future FPD fabrication lines, should continue to result in growth for its FPD business. However, the relatively rapid transition to sixth, seventh and eighth generation glass sizes, though offering significant opportunities to the Company, also generates substantial challenges, primarily as a result of the need to increase product functionality in response to escalating customer requirements in a competitive environment. Furthermore, the increased customer support costs

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associated with the mix between off-line and in-line inspection solutions offered by the Company, combined with price pressure from major customers, has led to a decrease in gross margins from the Company’s FPD-AOI products. The Company expects this trend will be particularly evident in the first quarter of 2005 but should moderate during subsequent quarters. During the first quarter of 2005, the Company recognized initial revenues from its new, seventh generation in-line FPD-AOI systems delivered commencing in the second half of 2004 to a major Korean FPD manufacturing customer. Although the Company expects to make additional sales of seventh generation, in-line FPD-AOI systems during the remainder of 2005, it is probable that the recognition in the first quarter of the revenues from this particular order will mean that FPD-related revenues for the first quarter of 2005 will be substantially higher than those anticipated for the second quarter.

As a result of the improvement in the Company’s business and the factors described above, the Company remains cautiously optimistic as to the demand for its products. In addition, it is confident that its continuing emphasis on research and development has laid a sound foundation for future growth. Nevertheless, the Company is not able to predict the duration, extent or stability of the current improved business and economic environment, and its ability to foresee future trends in the flow of orders for certain of its systems remains generally limited, as is its ability to forecast the extent to which these factors may affect its revenues, profitability and capital resources during 2005.

5.E    Off-Balance Sheet Arrangements

The Company does not use off-balance sheet arrangements or transactions with unconsolidated, limited-purpose entities to provide liquidity, financing or credit support or to engage in leasing, hedging or research and development activities or which would expose the Company to liability that is not reflected on the face of its financial statements. The Company is not a party to any “off-balance sheet arrangements” which are required to be disclosed under this Item 5.E of Form 20-F.

5.F    Tabular Disclosure of Contractual Obligations

The following table summarizes the Company’s contractual obligations as at December 31, 2004:

Operating lease obligations represent commitments under various commercial facility leases. Purchase obligations represent outstanding purchase commitments for inventory components ordered in the normal course of business. The Company does not have outstanding any short-term or long-term indebtedness and is not a party to any capital leases.

5.G    Safe Harbor

The safe harbor provided in Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act shall apply to forward-looking information provided pursuant to Items 5.E and F.

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