Application of Critical Accounting Policies and Estimates

In accordance with Securities and Exchange Commission guidance, those material accounting policies that we believe are the most critical to an investor's understanding of our financial results and condition and require complex management judgment are discussed below.

Our critical accounting policies and estimates are as follows:

• revenue recognition;

• valuation of long-lived assets;

• estimation of valuation allowances and accrued liabilities, specifically product warranty, inventory provisions and allowance for doubtful accounts;

• stock-based compensation; and

• income taxes.

Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectibility is reasonably assured. If our equipment sales involve sales to our existing customers who have previously accepted the same type(s) of equipment with the same type(s) of specifications, we account for the product sales as a multiple element arrangement. Revenue from multiple element arrangements is allocated among the separate accounting units based on the residual method. Under the residual method, the revenue is allocated to undelivered elements based on fair value of such undelivered elements and the residual amounts of revenue allocated to delivered elements. We recognize the equipment revenue upon shipment and transfer of title. The other

multiple elements also include installation, service contracts and training. Equipment installation revenue is valued based on estimated service person hours to complete installation and quoted service labor rates and is recognized when the installation has been completed and the equipment has been accepted by the customer. Service contract revenue is valued based on estimated service person hours to complete the service and published or quoted service labor rates and is recognized over the contract period. Training revenue is valued based on quoted training class prices and is recognized when the customers complete the training classes or when a customer-specific training period has expired. The quoted service labor rates and training class prices are rates actually charged and billed to our customers.

All other product sales with customer-specific acceptance provisions are recognized upon customer acceptance. Future revenues may be negatively impacted if we are unable to meet customer-specific acceptance criteria. Revenue related to spare part sales is recognized upon shipment or delivery based on the title transfer terms. Revenues related to maintenance and service contracts are recognized ratably over the duration of such contracts.

The timing and amount of revenue recognized depends on whether revenue is recognized upon shipment versus acceptance. For revenue recognized upon acceptance, it is dependent upon when customer-specific criteria are met.

Valuation of Long-Lived Assets

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, in accordance with Financial Accounting Standards Board ("FASB") SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." An asset or asset group is considered impaired if its carrying amount exceeds the undiscounted future net cash flow the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. If estimated fair value is less than the book value, the asset is written down to the estimated fair value and an impairment loss is recognized.

If we determine that the carrying amount of long-lived assets, including intangible assets, may not be recoverable, we measure any impairment based on the fair value of the long-lived assets. Net intangible assets and long-lived assets amounted to $18.3 million as of August 30, 2008.

In fiscal 2008, we had positive cash flows from operations. If our long-term future plans do not continue to yield positive cash flows in excess of the carrying amount of our long-lived assets, we would anticipate possible future impairments of those assets.

Considerable management judgment is necessary in estimating future cash flows and other factors affecting the valuation of long-lived assets, including intangible assets, including the operating and macroeconomic factors that may affect them. We use historical financial information, internal plans and projections and industry information in making such estimates.

We did not recognize any impairment charges for our long-lived assets, including intangible assets, during fiscal 2008, 2007 or 2006. We currently believe the fair value of these long-lived assets, including intangible assets, exceeds the carrying amount.

Product Warranty

We record a liability for warranty claims at the time of sale. The amount of the liability is based on the trend in the historical ratio of claims to sales, releases of new products and other factors. The warranty periods for new equipment manufactured by us range from six months to two years. Special warranty provisions are also accrued for major rework campaigns. Although management believes the likelihood to be relatively low, claims experience could be materially different from actual results because of the introduction of new, more complex products; competition or other external forces; manufacturing changes that could impact product quality; or as of yet unrecognized defects in products sold.

Warranty provisions, claims and changes in estimates for the fiscal years ended August 30, 2008, August 25, 2007, and August 26, 2006 were as follows (in thousands):

                                  August 30,       August 25,       August 26,
                                     2008             2007             2006

           Beginning balance     $      3,811     $      3,964     $      4,117
           Warranty provisions          1,153            1,514            2,112
           Warranty claims             (2,207 )         (1,667 )         (2,265 )

           Ending balance        $      2,757     $      3,811     $      3,964

Inventory Provisions

We record provisions for inventory shrinkage and for potentially excess, obsolete and slow moving inventory. The amounts of these provisions are based upon historical loss trends, inventory levels, physical inventory and cycle count adjustments, expected product lives, forecasted sales demand and recoverability. Results could be materially different if demand for our products decreased because of economic or competitive conditions, length of the industry downturn, or if products become obsolete because of technical advancements in the industry or by us.

Since we recorded the POLARIS system product inventory provisions as a result of the wind-down of our Microlithography business in the second quarter of fiscal 2003, we have had sales of POLARIS system product inventory that had previously been written down to zero and reductions in inventory buyback requirements of $10.7 million and have disposed of $6.8 million of POLARIS system product inventory. The original cost of POLARIS system product inventory available for sale or to be disposed of as of August 30, 2008 that has been written down to zero was approximately $8.9 million.

Allowance for Doubtful Accounts

Management must make estimates of the uncollectibility of our accounts receivable. The most significant risk is the risk of sudden unexpected deterioration in the financial condition of a significant customer who is not considered in the allowance. Management specifically analyzes accounts receivable and analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Results could be materially impacted if the financial condition of a significant customer deteriorated and related accounts receivable are deemed uncollectible. Accounts receivable are charged off after management determines that they are uncollectible.

A rollforward of the allowance for doubtful accounts for the fiscal years ended August 30, 2008, August 25, 2007 and August 26, 2006 is as follows (in thousands):

                                        Balance at                                                          Balance at
                                       Beginning of                                           Write-          End of
                                           Year           Recoveries        Adjustments        Offs            Year

Fiscal year ended August 30, 2008      $         196      $       (68 )    $           -      $     -      $        128
Fiscal year ended August 25, 2007      $         520      $       (55 )    $         (43 )    $  (226 )    $        196
Fiscal year ended August 26, 2006      $         922      $      (336 )    $         (29 )    $   (37 )    $        520

We collected $68,000 of receivables in fiscal 2008, $55,000 in fiscal 2007 and $336,000 in fiscal 2006 that had previously been written off resulting in credits to selling, general and administrative expenses.

Stock-Based Compensation

We implemented the fair value recognition provisions of SFAS No. 123R effective August 28, 2005 using the modified prospective method. Under this method, we recognize compensation expense for all stock-based awards granted on or after August 28, 2005 and for previously granted awards not yet vested as of August 28,

2005. We recorded stock compensation expense of $565,000 in fiscal 2008, $593,000 in fiscal 2007 and $1.1 million in fiscal 2006.

We utilize a Black-Scholes option-pricing model to estimate fair value of each award on the date of grant. The Black-Scholes model requires the input of certain assumptions that involve management judgment. Key assumptions that affect the calculation of fair value include the expected life of stock-based awards and our stock price volatility. Additionally, we expense for only those shares expected to vest. The assumptions used in calculating the fair value of stock-based awards and the forfeiture rate of such awards reflect management's best estimates. However, circumstances may change and additional data may become available over time, which could result in changes to these assumptions that materially impact the fair value determination of future awards or their estimated rate of forfeiture. If factors change and we use different assumptions in the application of SFAS 123R in future periods, the compensation expense recorded under SFAS 123R may differ significantly from the expense recorded in the current period. See Note 12 of Notes to Consolidated Financial Statements for additional information on stock-based compensation.

Income Taxes

Our effective income tax rate is based on income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. We have established valuation allowances against a portion of the U.S. and non-U.S. net operating losses to reflect the uncertainty of our ability to fully utilize these benefits given the limited carryforward periods permitted by the various jurisdictions. The evaluation of the realizability of our net operating losses requires the use of considerable management judgment to estimate the future taxable income for the various jurisdictions, for which the ultimate amounts and timing of such estimates may differ. The valuation allowance can also be impacted by changes in the tax regulations.

Significant judgment is required in determining our unrecognized tax benefits. We have established accruals using management's best judgment and adjust these accruals as warranted by changing facts and circumstances. A change in our tax liabilities in any given period could have a significant impact on our results of operations and cash flows for that period.

We adopted the provisions of FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109," during the first quarter of fiscal 2008. During fiscal 2008, we effectively settled tax audits in foreign tax jurisdictions which resulted in a $0.6 million decrease in the accrual for unrecognized tax benefits. The benefit was partially offset by state income tax expense and foreign tax expense.

Industry Update

Leading industry analysts in the semiconductor and equipment industry have very disparate opinions and forecasts regarding the state of our industry. Recently, Gartner, Inc., a leading equipment industry research group, forecasted 2009 equipment spending to decrease 9.0% from the 2008 level; whereas, another leading analyst is forecasting declines of 20% to 30% from 2008 levels. The forecasts provided by analysts are impacted by macroeconomic developments, including the current difficulties in global credit markets, a decline in many individuals' investment portfolios, political uncertainty and an overall increase in unemployment rates. These conditions have adversely impacted consumer confidence and spending on technology. Many semiconductor manufacturers are reducing their production and factory utilization levels are declining. Some device manufacturers are eliminating less productive fabrications and considering consolidation and joint venture opportunities. Increasingly, device manufacturers are adopting fabrication light (semiconductor manufacturers that produce devices in their own facilities and also outsource a portion of the manufacturing to third parties) or other outsourcing philosophies. Despite the overall decrease in equipment spending, leading device manufacturers' spending for technology advancement appears to be continuing. It appears that the decline in demand for our spare parts and services has reached a bottom, and our customers are focused on controlling inventory levels while evaluating products that can provide increased productivity when market conditions

improve.* Given the tight credit environment, customers are evaluating products and technology more carefully prior to making any long term investment.

Overview

Industry conditions were weaker than anticipated in our fourth quarter of fiscal 2008 as oversupply in the memory segment and macro-economic conditions took a toll on our customers. As a result of order delays from several customers during the quarter, orders were $13.6 million and revenues decreased to $14.1 million.

The protracted industry downturn led to our implementation of cost reductions in September 2008, including a reduction in our headcount by approximately 63 positions, representing 14% of our global workforce as of the end of the third quarter of fiscal 2008. In conjunction with the staff reductions, we consolidated our European and U.S. sales and service organizations to better support our customers in these regions. In addition, we refocused our Allen, Texas and Chaska, Minnesota resources toward the products that we believe provide the most significant opportunity for near-term revenue and future marketshare gains. We anticipate that the cost reduction plan will result in $5.0 to $6.0 million of annual cost savings.*

While deteriorating economic and industry conditions impacted our overall order level and financial performance in fiscal 2008, progress was made on many of the strategies we rolled out at the beginning of the fiscal year. Due to effective cash management strategies, we generated $1.0 million of cash from operations. On the commercial side, we shipped several ZETA® systems with our new high temperature ViPRtm technology to customers in Korea, Japan and Europe. On the development front, we shipped our first multi-chamber ORION® single wafer wet system to a leading manufacturer for use in 32nm development.

Results of Operations

Sales Revenue and Shipments

Fiscal 2008 sales revenue decreased to $78.3 million as compared to $116.2 million in fiscal 2007. The decrease in sales revenue in fiscal 2008 related to the decline in shipments from $116.9 million in fiscal 2007 to $77.9 million in fiscal 2008 associated with industry conditions. Fiscal 2007 sales revenue increased to $116.2 million as compared to $113.2 million in fiscal 2006. The increase in sales in fiscal 2007 related to an increase in international sales of $9.3 million, partially offset by a $6.3 million decrease in domestic sales.

Shipments were $77.9 million in fiscal 2008 as compared to $116.9 million in fiscal 2007 and $109.7 million in fiscal 2006.

Based upon our revenue recognition policy, certain shipments to customers are not recognized until customer acceptance. Therefore, depending on timing of shipments and customer acceptances, there are time periods where shipments may exceed sales revenue or due to timing of acceptances, sales revenue may exceed shipments.

International sales were $59.3 million for fiscal 2008, representing 76% of total sales during fiscal 2008, $79.6 million for fiscal 2007, representing 69% of total sales during fiscal 2007, and $70.4 million for fiscal 2006, representing 62% of total sales during fiscal 2006. The decrease in fiscal 2008 international sales dollar amount as compared to fiscal 2007 was related to decreases in Europe, and Southeast Asia and Japan of $21.6 million, partially offset by an increase of $1.6 million in Korea. The increase in fiscal 2007 international sales as compared to fiscal 2006 was related to increases in Asia and Europe. Due to its broader customer base, SC products have a higher percentage of international sales than POLARIS system products. See Note 14 of the Notes to Consolidated Financial Statements for additional information regarding our international sales.

We ended fiscal 2008 with a backlog of approximately $5.6 million as compared to $15.2 million at the end of fiscal 2007. Backlog consists of orders with delivery dates within the next 12 months for which a customer purchase order has been received. Because of the timing and relative size of orders and the possibility of cancellations or customer delays, backlog is not necessarily indicative of sales for future periods.

We expect first quarter fiscal 2009 orders to be between $13 million and $15 million.* This assumes the receipt of several follow-on orders that are anticipated late in the quarter.* We expect first quarter fiscal 2009

revenue to be in the range of $13 million to $15 million.* Achieving the revenue range is subject to us receiving purchase orders and obtaining timely acceptance from customers.

Gross Margin

Our gross profit margin fluctuates due to a number of factors, including the mix of products sold; the geographic mix of products sold, with international sales generally having lower gross profit than domestic sales; initial product placement discounts; utilization of manufacturing capacity; sales of POLARIS system product inventory previously written down to zero; and the competitive pricing environment.

Gross margin as a percentage of sales was 42.1% for fiscal 2008 as compared to 40.5% for fiscal 2007 and 46.7% for fiscal 2006. The increase in gross margin from fiscal 2007 to fiscal 2008 related primarily to a change in product mix in which the sale of spare parts and service represented 34% of our total sales in fiscal 2008 as compared to 26% in fiscal 2007, as spare parts and service generally have higher margins. This positive impact was partially offset by a decrease in utilization of manufacturing capacity in fiscal 2008 as compared to fiscal 2007 related to the decline in shipments from $116.9 million in fiscal 2007 to $77.9 million in fiscal 2008. Severance costs included in cost of sales were $142,000 in fiscal 2008 as compared to $300,0000 in fiscal 2007. We had sales of POLARIS system inventory previously written down to zero of $0.9 million in fiscal 2008 and 2007.

The decrease in gross margins from fiscal 2006 to fiscal 2007 related to an increase in the percentage of international sales from 62% of total sales in fiscal 2006 to 69% of total sales in fiscal 2007 and a $1.0 million increase in inventory reserves associated with a decline in bookings. The decrease also related to a decrease in sales of POLARIS system product inventory previously written down to zero from $2.1 million in fiscal 2006 to $0.9 million in fiscal 2007 and $0.3 million of severance costs in fiscal 2007.

We will continue to try to sell the POLARIS system product inventory that had previously been written down to zero to our customers as spares, refurbished systems and upgrades to existing systems. If unsuccessful, some of the items will be disposed. Any material sales of the impaired inventory will be disclosed. The original cost of POLARIS system product inventory available for sale or to be disposed of as of August 30, 2008 that has been written down to zero was approximately $8.9 million.

We expect the gross profit margins for the first quarter of fiscal 2009 to be between 40% to 42% of revenues.* Our factory utilization rate is not expected to change significantly.*

Selling, General and Administrative Expenses

Selling, general and administrative expenses in fiscal 2008 were $29.0 million, or 37.1% of total sales, as compared to $34.5 million, or 29.7% of total sales, in fiscal 2007 and $36.2 million, or 32.0% of total sales, in fiscal 2006. The decrease in selling, general and administrative expense in fiscal 2008 as compared to fiscal 2007 related to the decrease in sales and the cost reduction initiatives associated with reductions in headcount taken in the second half of fiscal 2007, partially offset by realignment expenses of $1.3 million in fiscal 2008 compared to severance costs of $0.9 million in fiscal 2007. The decrease in selling, general and administrative expenses in fiscal 2007 as compared to fiscal 2006 related primarily to savings associated with cost reduction efforts associated with headcount reductions taken in the second half of fiscal 2007, partially offset by $0.9 million of severance costs.

Selling, general and administrative expenses for the first quarter of fiscal 2009 are expected to be in the range of $6.3 million to $6.5 million, reflecting two months of savings related to the September cost reduction actions.*

Research and Development Expenses

Research and development expenses for fiscal 2008 were $19.0 million, or 24.2% of total sales, as compared to $24.1 million, or 20.7% of total sales, in fiscal 2007 and $24.3 million, or 21.5% of total sales, in fiscal 2006. The decrease in fiscal 2008 as compared to fiscal 2007 related primarily to cost reduction efforts associated with headcount reductions taken in the second half of fiscal 2007, partially offset by

$0.5 million of severance costs in fiscal 2008. The decrease in fiscal 2007 as compared to fiscal 2006 related primarily to cost reduction efforts associated with headcount reductions, partially offset by $0.6 million of severance costs.

A significant portion of our fiscal 2008 research and development resources were focused on broadening the applications capabilities of our products and supporting initial product placements with customers. In addition, we continued the development of our ORION® single wafer wet system.

We expect research and development expenses to range from $4.3 million to $4.5 million for the first quarter of fiscal 2009, as we continue to invest in our ZETA® ViPRtm and ORION® single wafer programs while sustaining minimum resources to support our other products.*

Impairment and Loss on Sale of Investment

We recorded $4.1 million of impairment and loss on the sale of investment in fiscal 2007 related to transactions with Apprecia. See further discussion related to the transactions and the impairment at Note 3 of the Notes to Consolidated Financial Statements.

We recorded a $0.5 million impairment of an investment in fiscal 2006. We had an investment in a Malaysian foundry that was accounted for under the cost method. The investment was $0.5 million as of August 27, 2005. On March 22, 2006, the majority shareholder of this Malaysian foundry announced that the foundry would merge with another foundry and form a new entity. Subsequent to the merger announcement, we were contacted by the majority shareholder and given the option of selling our shares at a nominal value to the majority shareholder or providing additional debt to the foundry as part of a pre-merger restructuring. Based on this information, we deemed the investment as being fully impaired as of February 25, 2006 and recorded a loss of $0.5 million in the second quarter of fiscal 2006. We sold our shares in the foundry at a nominal value to the majority shareholder during the third quarter of fiscal 2006.

Income Tax Expense

We recorded an income tax benefit of $624,000 in fiscal 2008 related to uncertain tax positions that were effectively settled with tax authorities during fiscal 2008, partially offset by state income tax expense and foreign tax expense. We recorded income tax expense of $122,000 in fiscal 2007 and $50,000 in fiscal 2006, primarily as a result of foreign and state taxes. As of August 30, 2008 and August 25, 2007, we had $600,000 and $1.3 million, respectively, of liabilities recorded related to unrecognized tax benefits. Accrued interest and penalties on these unrecognized tax benefits were $0.1 million and $0.2 million as of August 30, 2008 and August 25, 2007, respectively. We recognize potential interest and penalties related to income tax positions, if any, as a component of provision for income taxes on the consolidated statements of operations. Included in the liability balance as of August 30, 2008 are approximately $0.6 million of unrecognized tax benefits that, if recognized, will affect our effective tax rate.

Our deferred tax assets on the balance sheet as of August 30, 2008 have been fully reserved for with a valuation allowance. We do not expect to reduce our valuation allowance until we are consistently profitable on a quarterly basis.*

We have net operating loss carryforwards for federal income tax purposes of approximately $163.5 million at August 30, 2008, which will begin to expire in fiscal 2011 through fiscal 2029 if not utilized. Of this amount, approximately $15.0 million is subject to Internal Revenue Code Section 382 limitations on utilization, which limits the amount that we can offset taxable income to approximately $1.4 million per year.

Equity in Earnings (Loss) of Affiliate

Equity in earnings (loss) of affiliates was approximately $27,000 for fiscal 2007 and ($274,000) for fiscal 2006. The losses in fiscal 2006 related primarily to a decrease in Apprecia sales, as well as a change in product mix.

After May 15, 2007, we discontinued recording equity in earnings (loss) of . . .