You should read the following discussion in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under Item 1A, Part I, "Risk Factors," and elsewhere in this Form 10-K. We do not guarantee future results, levels of activity, performance or achievements. We do not intend to update any of the forward-looking statements after the date of this document to conform them to actual results or to changes in our expectations.

Overview

Revenues increased to $113.0 million in 2012 compared to $104.6 million 2011 as
a result of increased sales in our Probes segment. Income from continuing
operations was $6.1 million in 2012 compared to a loss from continuing
operations in 2011 of $3.8 million. The loss from continuing operations in 2011
included the following charges (in thousands):



                 Restructuring charges                    $ 3,418
                 Factory moving and other project costs     1,174

                                                          $ 4,592

Outlook for 2013

We begin 2013 coming off a record year for Cascade Microtech. Our revenue growth during 2012 of 8% compared to 2011 was driven by demand for our Probes products. Looking forward to 2013, we expect continued growth as it appears that industry demand forecasted for our products will improve over the levels achieved in 2012.

Restructuring Charges

During 2011, we took actions to reduce our overall cost structure. We recorded restructuring charges in connection with employee severance benefits. We also recorded restructuring charges in connection with excess leased facilities, net of estimated sublease income that we believe could be reasonably obtained. If the real estate markets worsen and we are not able to sublease the properties as expected, additional charges will be recognized in the period such determination is made. Likewise, if the real estate market strengthens and we are able to sublease the properties earlier or at more favorable rates than projected, a benefit will be recognized.

We had no new restructuring charges in 2012.

Discontinued Operations

On September 22, 2011, we sold substantially all of the assets and liabilities related to our Sockets operations to R&D Sockets, Inc. for $525,000 in cash and a note receivable from the buyer for $25,000, which was paid in December 2012. In connection with the transaction, the buyer assumed our obligations under the lease agreement covering administrative offices and a manufacturing facility related to our Sockets business. See Note 16 of Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K for additional information.

Results of Operations

The following table sets forth our consolidated statement of operations data for the periods indicated as a percentage of revenue.(1)

                                                          For the Year Ended December 31,
                                                       2012              2011            2010
Statement of Operations Data
Revenue                                                  100.0 %          100.0 %         100.0 %
Cost of sales                                             55.8             60.4            61.7

Gross profit                                              44.2             39.6            38.3
Operating expenses:
Research and development                                   9.8             11.3            12.8
Selling, general and administrative                       27.8             32.3            34.3

Total operating expenses                                  37.5             43.6            47.0

Income (loss) from operations                              6.7             (4.0 )          (8.8 )
Other income (expense), net                               (0.7 )            0.5              -

Income (loss) from continuing operations before
income taxes                                               6.0             (3.5 )          (8.7 )
Income tax expense                                         0.6              0.2              -

Income (loss) from continuing operations                   5.4             (3.6 )          (8.8 )
Loss from discontinued operations, net of tax               -              (1.9 )          (2.4 )

Net income (loss)                                          5.4 %           (5.5 )%        (11.2 )%

(1) Percentages may not add due to rounding.

Certain financial information by segment was as follows (dollars in thousands):

                                                                Corporate
                                  Systems        Probes        Unallocated         Total
  Year Ended December 31, 2012
  Revenue                         $ 74,368      $ 38,595      $          -       $ 112,963
  Gross profit                    $ 29,391      $ 20,560      $          -       $  49,951
  Gross margin                        39.5 %        53.3 %               -            44.2 %
  Income (loss) from operations   $ 10,370      $ 10,158      $     (12,971 )    $   7,557

  Year Ended December 31, 2011
  Revenue                         $ 75,837      $ 28,773      $          -       $ 104,610
  Gross profit                    $ 27,985      $ 13,431      $          -       $  41,416
  Gross margin                        36.9 %        46.7 %               -            39.6 %
  Income (loss) from operations   $ 11,002      $    484      $     (15,676 )    $  (4,190 )

  Year Ended December 31, 2010
  Revenue                         $ 65,422      $ 27,175      $          -       $  92,597
  Gross profit                    $ 23,336      $ 12,110      $          -       $  35,446
  Gross margin                        35.7 %        44.6 %               -            38.3 %
  Income (loss) from operations   $  5,096      $   (546 )    $     (12,658 )    $  (8,108 )

Revenue

Revenue information was as follows (dollars in thousands):



                        Year Ended December 31,         Dollar
            Revenue       2012             2011         Change        % Change
            Systems   $     74,368       $  75,837     $ (1,469 )          (1.9 )%
            Probes          38,595          28,773        9,822            34.1 %

            Total     $    112,963       $ 104,610     $  8,353             8.0 %

                         Year Ended December 31,         Dollar
             Revenue       2011              2010        Change       % Change
             Systems   $      75,837       $ 65,422     $ 10,415           15.9 %
             Probes           28,773         27,175        1,598            5.9 %

             Total     $     104,610       $ 92,597     $ 12,013           13.0 %

Systems

Certain financial information which contributed to the Systems revenue results
was as follows:



                                                     2012 compared              2011 compared
                                                        to 2011                    to 2010
Percentage increase (decrease) in station
unit sales                                                      2.2 %                     (8.9 )%
Percentage increase (decrease) in average
sales price ("ASP")                                            (4.8 )%                    27.5 %

The decrease in Systems revenue in 2012 compared to 2011 was primarily due to a decrease in ASP as we sold fewer higher-end 300mm and special application systems. The decrease was partially offset by an increase in unit sales of lower priced 150mm and 200mm stations.

The increase in Systems revenue in 2011 compared to 2010 was the result of an increase in ASP, offset partially by a decrease in unit sales of more compact 150mm manual stations. ASP in 2011 compared to ASP in 2010 was positively affected by changes in sales mix, as a larger number of higher-end 300 mm and special application stations were sold relative to total unit sales.

Sales of 300mm, cryogenic and high-power systems collectively represented 23%, 27% and 21% of total Systems unit sales in 2012, 2011 and 2010, respectively.

Probes

The increase in Probes revenue in 2012 compared to 2011 was primarily the result of increased unit sales of our engineering probes and production probe cards due to an increase in market share and customer demand.

The increase in Probes revenue in 2011 compared to 2010 was primarily the result of higher unit sales of our production probe cards and engineering probes.

Cost of Sales and Gross Margin

Cost of sales includes purchased materials, fabrication, assembly, test,
installation labor, overhead, customer-specific engineering costs, warranty
costs, royalties and provision for inventory valuation reserves.

Cost of sales information was as follows (dollars in thousands):



                           Year Ended December 31,         Dollar
         Cost of Sales       2012             2011         Change        % Change
         Systems         $     44,977       $  47,852     $ (2,875 )          (6.0 )%
         Probes                18,035          15,342        2,693            17.6 %

         Total           $     63,012       $  63,194     $   (182 )          (0.3 )%

                             Year Ended December 31,        Dollar
           Cost of Sales       2011             2010        Change       % Change
           Systems         $     47,852       $  42,086     $ 5,766           13.7 %
           Probes                15,342          15,065         277            1.8 %

           Total           $     63,194       $  57,151     $ 6,043           10.6 %

Cost of sales was affected by changes in sales as discussed above combined with the factors that caused fluctuations in our gross margin (gross profit as a percentage of revenue), as discussed below.

Gross margins were as follows:

                                        Year Ended December 31,
                    Gross Margins     2012         2011        2010
                    Systems             39.5 %      36.9 %      35.7 %
                    Probes              53.3 %      46.7 %      44.6 %
                    Overall             44.2 %      39.6 %      38.3 %

Systems

The increase in Systems gross margins in 2012 compared to 2011 was primarily due to decreased factory costs following our factory consolidation and restructuring activities during the second and third quarters of 2011.

The increase in Systems gross margins in 2011 compared to 2010 was primarily due to a $0.7 million decrease in inventory valuation charges. Inventory valuation charges totaled $1.1 million in 2010, primarily related to restructuring charges following our acquisition of SUSS Test in January 2010, compared to $0.4 million in 2011. In addition, 2010 included $1.0 million of purchase price allocation adjustments to value finished goods and work-in-process inventory acquired in connection with the SUSS Test acquisition at their estimated selling price less cost to sell. Accordingly, when such inventory was sold, it resulted in near zero gross margins. Factory consolidation costs of approximately $0.9 million were included in gross margin for 2011. Other changes were attributable to sales mix, as a larger number of high-end systems were sold in 2011.

Probes

The increase in Probes gross margins in 2012 compared to 2011 was primarily due to higher sales volumes, which resulted in lower unallocated fixed overhead costs recorded as period expenses in cost of sales.

The increase in Probes gross margins in 2011 compared to 2010 was primarily due to decreased factory costs and higher sales volumes, which resulted in lower unallocated fixed overhead costs recorded as period expenses in cost of sales.

Overall

The overall increase in gross margins in 2012 compared to 2011 was attributable to the increase in gross margin of both operating segments.

Overall changes in gross margins from 2010 to 2011 are primarily attributable to changes in Systems gross margin as that segment represented greater than two-thirds of total revenue and cost of sales in 2011 and 2010.

Research and Development

Research and development costs are expensed as incurred and include compensation and related expenses for personnel, materials, consultants and overhead.

Information regarding our research and development expense was as follows (dollars in thousands):

Year Ended December 31, Dollar 2012 2011 Change % Change Research and development $ 11,017 $ 11,807 $ (790 ) (6.7 )%

Year Ended December 31, Dollar 2011 2010 Change % Change Research and development $ 11,807 $ 11,815 $ (8 ) (0.1 )%

The decrease in research and development expense in 2012 compared to 2011 was primarily due to decreases in employee compensation. The decrease in employee compensation was driven by decreases in headcount and stock-based compensation expense.

Research and development expense was flat in 2011 compared to 2010 as a result of a $0.5 million increase in salary, benefits and incentive compensation being offset by a $0.3 million increase in government grant reimbursements and a $0.2 million decrease in project related expenses.

Selling, General and Administrative

Selling, general and administrative, or SG&A, expense includes compensation and related expenses for personnel, travel, outside services, manufacturers' representative commissions, internally developed patent and trademark amortization and overhead incurred in our sales, marketing, customer support, management, legal and other professional and administrative support functions, as well as costs to operate as a public company.

Information regarding our SG&A expense was as follows (dollars in thousands):

Year Ended December 31, Dollar 2012 2011 Change % Change Selling, general and administrative $ 31,377 $ 33,799 $ (2,422 ) (7.2 )%

Year Ended December 31, Dollar 2011 2010 Change % Change Selling, general and administrative $ 33,799 $ 31,739 $ 2,060 6.5 %

SG&A in 2011 included $3.3 million of restructuring charges compared to none in 2012. Partially offsetting the decline in restructuring charges were an increase in external sales commissions of $0.4 million, an increase in employee incentive compensation costs of $0.3 million and increase in charges to the allowance for doubtful accounts of $0.2 million.

The increase in 2011 compared to 2010 was primarily due to a $2.1 million increase in restructuring charges and a $1.4 million increase in salary, benefits and incentive compensation, partially offset by a $0.7 million decrease in internal and external commissions due to changes in commissions programs and sales mix, and a $0.7 million decrease in professional fees primarily due to the expense recognized in 2010 from the acquisition of SUSS Test in January 2010.

Restructuring charges included in SG&A during 2011 related to the abandonment of excess leased facilities in connection with the consolidation of our manufacturing operations and our corporate headquarters. Restructuring charges included in SG&A in 2010 included charges related to our acquisition of SUSS Test and the reorganization of our sockets business in Minnesota, and primarily included termination and severance related charges.

Other Income (Expense)

Other income (expense) typically includes interest income, interest expense, gains and losses on foreign currency forward contracts and foreign currency gains and losses. Other income (expense) may also include other miscellaneous non-operating gains and losses.

Other income (expense), net was comprised of the following (in thousands):

                                                            Year Ended December 31,
                                                          2012          2011       2010
 Interest income, net                                   $     52       $   92      $  70
 Foreign currency gains (losses)                            (950 )        595        (26 )
 Gains (losses) on foreign currency forward contracts        166         (144 )      (73 )
 Other                                                       (17 )         29         39

                                                        $   (749 )     $  572      $  10

Interest income represents interest earned on cash and cash equivalents and investments in marketable securities.

Foreign currency gains and losses primarily result from a combination of changes in foreign currency exchange rates and the net value of monetary assets and liabilities denominated in yen, euro and other foreign currencies.

Income Taxes

Information regarding our income tax expense was as follows (dollars in
thousands):



                                                               Year Ended December 31,
                                                            2012          2011        2010
Income tax provision related to continuing operations     $    709        $ 180       $  36
Income tax provision as a percentage of income (loss)
from continuing operations                                    10.4 %        5.0 %       0.4 %

Generally, the provision for income taxes is the result of the mix of profits and losses earned by us and our subsidiaries in tax jurisdictions with a broad range of income tax rates and changes in tax reserves.

Our 2012 income tax provision primarily represents the estimated current tax expense on income in foreign tax jurisdictions, offset by a deferred tax benefit related to reserves and allowances in foreign jurisdictions.

Our 2011 income tax provision primarily represents the estimated current tax expense on income in foreign tax jurisdictions, offset by a decrease in unrecognized tax benefits related to a prior year tax position.

Our 2010 income tax provision included tax expense due to taxable income in foreign tax jurisdictions, offset by a net benefit in Germany that primarily related to the release of the valuation allowance against deferred tax assets due to the acquisition of SUSS Test in January 2010.

Liquidity and Capital Resources

Net cash provided by operating activities in 2012 was $10.6 million and primarily consisted of our net income of $6.1 million, net non-cash expenses of $6.0 million and net changes in our operating assets and liabilities as described below.

Accounts receivable, net decreased by $2.8 million to $21.1 million at December 31, 2012, compared to $23.9 million at December 31, 2011. The decrease in accounts receivable was primarily due to improved collections of customer receivables.

Inventories increased by $0.7 million to $24.3 million at December 31, 2012, compared to $23.6 million at December 31, 2011. The increase in inventory was primarily due to increased purchases of raw materials and build-up of finished goods in preparation for orders expected to ship during the first half of 2013. This increase was partially offset by inventory charges of $1.4 million in 2012 for excess and obsolete inventory. If our actual results are significantly different than our current expectations for 2013, we may incur additional charges to write down inventory in future periods.

Prepaid expenses and other assets decreased by $1.6 million to $2.5 million at December 31, 2012, compared to $4.1 million at December 31, 2011 primarily due to collection of value added tax ("VAT") receivables.

Deferred revenue decreased by $1.8 million to $3.9 million at December 31, 2012, compared to $5.7 million at December 31, 2011, primarily due to a decrease in customer deposits.

Accrued liabilities decreased by $1.1 million to $6.6 million at December 31, 2012, compared to $7.7 million at December 31, 2011, primarily due to decreases in accrued income taxes, sales taxes and VAT.

Other long-term liabilities decreased by $1.3 million to $2.9 million at December 31, 2012, compared to $4.2 million at December 31, 2011, primarily due to the decrease in accrued lease abandonment costs.

Fixed asset purchases of $1.8 million in 2012 primarily related to production-related equipment. We anticipate fixed asset additions for 2013 to be approximately $3.6 million, primarily for production-related equipment, facility improvements, research and development tools, business information systems and information technology equipment.

In February 2012, our board of directors authorized a stock repurchase program under which up to $1.0 million of our common stock could be repurchased from time to time in the open market or in privately negotiated transactions during the period through June 30, 2012. Pursuant to this plan, a total of 214,087 shares were repurchased at an average price of $4.67 per share, for a total purchase price of $1.0 million.

In November 2012, our board of directors authorized a stock repurchase program under which up to $2.0 million of our common stock could be repurchased from time to time in the open market or in privately negotiated transactions. Through December 31, 2012, a total of 59,006 shares were repurchased at an average price of $5.60 per share, for a total purchase price of $0.3 million. As of December 31, 2012, $1.7 million remained available for repurchases. This plan does not have an expiration date.

Changes in our assets and liabilities as presented on our Consolidated Statements of Cash Flows do not equal the changes in such assets and liabilities as calculated for our Consolidated Balance Sheets due to the effects of fluctuating foreign exchange rates.

We anticipate meeting our cash requirements for the next 12 months and for the foreseeable future from existing cash and cash equivalents and short-term marketable securities, which totaled $23.2 million at December 31, 2012. Cash, cash equivalents and marketable securities at December 31, 2012 includes earnings of $4.5 million at foreign subsidiaries that is permanently reinvested.

We continue to evaluate opportunities for acquisition and expansion and any such transactions, if consummated, may use a portion of our cash and marketable securities or may result in the issuance by us of debt or equity securities. Issuances of debt securities would increase our leverage and interest exposure; issuances of equity securities could dilute the ownership interest of equity shareholders.

Seasonality

Typically, our first quarter revenues are lower than our revenues from the preceding fourth quarter. In addition, as is typical in our industry, we recognize a large percentage of our quarterly revenue in the last month of the quarter. However, our seasonality can be affected by general economic trends and it should not be expected that historical revenue patterns will continue.

Contractual Commitments

The following is a summary of our contractual commitments and obligations as of
December 31, 2012 (in thousands):



                                                               Payments Due By Period
                                                                     2014 and      2016 and       2018 and
Contractual Obligation                     Total         2013          2015          2017          beyond
Operating leases                          $  9,132     $  3,340     $    5,106     $     686     $
Purchase order commitments (1)               4,424        4,422              2            -              -
Forward contracts                            2,836        2,836             -             -              -

                                          $ 16,392     $ 10,598     $    5,108     $     686     $       -

(1) Purchase order commitments primarily represent open orders for inventory.

Critical Accounting Policies and the Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that have become increasingly difficult to make in the current economic environment. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses during the reporting period. It is possible that the estimates we make may change in the future.

Revenue Recognition

Revenue from product sales to customers and distributors that do not have special acceptance criteria is recognized when a written purchase order has been obtained, the price is fixed and determinable, the product is shipped, title has transferred and collectability is reasonably assured. Generally, we ship our products with origin terms. For any shipments with destination terms, we defer revenue until delivery to the customer. Revenue from customers who have special acceptance criteria is not recognized until all acceptance criteria are satisfied. Revenue for installation services, consisting of assembly and testing, is recognized when the services are performed. Deferred revenue related to service contracts is recognized over the life of the contract, typically one to two years.

Our transactions may involve the sale of systems and services under multiple element arrangements. Revenue under multiple element arrangements is allocated based on the fair value of each element. A typical multiple element arrangement may include some or all of the following components: products, accessories, installation services, training and extended warranty contracts. The total sales price is allocated based on the relative fair value of each component.

Allowance for Doubtful Accounts

The allowance for doubtful accounts is estimated based on past collection . . .