The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 6. "Selected Financial Data," our consolidated financial statements and related notes included elsewhere in this document. In addition to historical information, the discussion below contains certain forward-looking statements that involve risks and uncertainties. These forward-looking statements include, but are not limited to, those matters discussed under the heading "Forward- looking Statements," above. Our actual results could differ materially from those anticipated by these forward-looking statements due to various factors, including, but not limited to, those set forth under Item 1A. "Risk Factors" in this Annual Report on Form 10-K and elsewhere in this document.

Overview

We are a supplier of semiconductor wafer processing equipment used in the fabrication of integrated circuits (ICs). Our manufacturing equipment is used for transistor level, or front-end-of-line manufacturing, and also in specialized applications for processing the interconnect layer, or back-end-of-line processing. Our manufacturing equipment utilizes innovative technology to deliver advanced processing capabilities and high productivity for the fabrication of current and next-generation ICs.

Our business depends upon capital expenditures by manufacturers of semiconductor devices. The level of capital expenditures by these manufacturers depends upon the current and anticipated market demand for such devices. Because the demand for semiconductor devices is highly cyclical, the demand for wafer processing equipment is also highly cyclical.

During 2008, there was a significant weakness in the semiconductor equipment market, which was exacerbated by the global economic slowdown, and weakness in the credit markets, followed by a global recession. Consequently, revenues decreased by 50 percent to $133.6 million from $267.3 million in 2007. Gross Profit decreased year over year by $75.7 million or 61.4 percent, primarily due to lower revenue, factory under-absorption at these low revenue levels and higher provisions for inventory write-downs. Despite this trend, we invested in our future by increasing our research, development and engineering activity expenses in 2008 to expand our product offerings in dielectric etch, RTP and dry strip products. Selling, general and administrative expenses were also higher by $4.2 million or 6.5 percent as a result of significantly higher receivable reserves and additional provisions for evaluation tools at customer sites. Other significant items in 2008 included restructuring charges of $6.0 million, goodwill impairment of $18.1 million and impairment of intangibles and other long-lived assets of $9.4 million. Net loss before tax was $89.9 million, or 67.3 percent of net sales in 2008, compared to net income before taxes of $32.5 million, or 12.1 percent of net sales in 2007.

We had $103.4 million of cash, cash equivalents and short-term investments and no long-term debt at December 31, 2008. With our current cash position, we believe we have sufficient resources to meet our requirements for the next year. In 2007, the Company's Board of Directors authorized the repurchase of up to $50 million of shares of common stock through open-market purchases or private transactions. In 2008 and 2007, 0.3 million and 3.5 million shares, respectively were repurchased under this program for a total of $35.0 million.

Beginning in the second half of 2007 and throughout 2008, we experienced weakness in the overall semiconductor market combined with the global financial crisis, and we expect that weakness to continue into 2009 and perhaps into 2010. Oversupply conditions in the semiconductor market have significantly reduced the utilization at our customer's fabrication plants and delayed capital investments to subsequent quarters. We are uncertain as to when revenues will increase to breakeven levels. There continue to be several uncertainties that will impact gross profit margin during 2009. At these low revenue levels, we will continue to have significant under-absorption of our factories and may have

During 2009, we will respond to these challenges with significant cost reduction measures, while continuing to invest in our core and new products to position us for success in the semiconductor equipment market. We continue to focus on our objectives to outsource manufacturing in Fremont and Germany to reduce manufacturing overhead costs. Our global headcount has been reduced by approximately 35 percent as a result of various restructuring activities during 2008. We have optimized our worldwide facilities, reduced variable headcount expenses through shutdowns, unpaid time-off, and are taking several measures to reduce travel, outside service and facility related costs. We will continue to review our operations and take further cost reduction measures as necessary, in order to minimize the cash used in operations, and retain sufficient cash reserves for the next twelve months. However, though we have implemented these cost cutting and operational flexibility measures, we are largely dependent upon increases in sales in order to improve our profitability.

Going forward, the success of our business will be dependent on numerous factors, including, but not limited to, the market demand for semiconductors and semiconductor wafer processing equipment; and our ability to (a) significantly grow the Company, either organically or through acquisitions, in order to enhance our competitiveness and profitability; (b) develop and bring to market new products that address our customers' needs; (c) grow customer loyalty through collaboration with and support of our customers; (d) maintain a cost structure that will enable us to operate effectively and profitably throughout changing industry cycles and (e) generate the gross profits necessary to enable us to make the necessary investments in our business.

Results of Operations

Years Ended December 31, 2008 and 2007

The following table sets forth our consolidated results of operations for the
years ended December 31, 2008 and 2007, and the year-over-year increase
(decrease) in our results, expressed both in dollar amounts (in thousands) and
as a percentage of net sales, except where indicated:

                                   Year Ended December 31,               Increase (Decrease)
                        ---------------------------------------------   ----------------------
                                2008                    2007
                        ---------------------   ---------------------

Net sales               $ 133,551    100.0  %   $ 267,286    100.0  %   $ (133,735)   (50.0) %
Cost of sales              86,005     64.4        144,075     53.9         (58,070)   (40.3)
                        ----------   ------     ----------   ------     -----------   ------
Gross profit               47,546     35.6        123,211     46.1         (75,665)   (61.4)
                        ----------   ------     ----------   ------     -----------   ------
Operating expenses:
   Research,
development and
engineering                36,833     27.6         34,116     12.7           2,717      8.0
   Selling, general
and administrative         68,530     51.3         64,343     24.1           4,187      6.5
   Amortization of
intangibles                   512      0.4            511      0.2               1      0.2
   Restructuring
charges                     5,989      4.5             -        -            5,989      n/a
   Impairment of
goodwill                   18,076     13.5             -                    18,076      n/a
   Impairment of            9,431      7.1             -        -            9,431      n/a
intangibles and         ----------   ------     ----------   ------     -----------   ------
long-lived assets
      Total operating     139,371    104.4         98,970     37.0          40,401     40.8
expenses                ----------   ------     ----------   ------     -----------   ------
Income (loss) from
operations                (91,825)   (68.8)        24,241      9.1        (116,066)     n/a
Interest income             3,292      2.5          7,037      2.6          (3,745)   (53.2)
Interest expense             (144)    (0.1)           (31)      -             (113)     n/a
Other income               (1,175)    (0.9)         1,207      0.4          (2,382)     n/a
(expense), net          ----------   ------     ----------   ------     -----------   ------
Income (loss) before
income taxes              (89,852)   (67.3)        32,454     12.1        (122,306)     n/a
Provision for income        2,311      1.7          4,901      1.8          (2,590)   (52.8)
taxes                   ----------   ------     ----------   ------     -----------   ------
Net income (loss)       $ (92,163)   (69.0) %    $ 27,553     10.3  %   $ (119,716)     n/a  %
                        ----------   ------     ----------   ------     -----------   ------

Deferred revenue at December 31, 2008 decreased to $4.2 million from $7.2 million at December 31, 2007, primarily due to a $3.4 million net decrease in deferred revenue for system shipments and a $0.4 million net increase in deferred revenue for service contracts.

Gross Profit and Gross Profit Margin. Gross profit was $47.5 million for the year ended December 31, 2008, a decrease of $75.7 million or 61.4 percent compared to $123.2 million for the year ended December 31, 2007. The decrease was due primarily to a 50 percent decline in net sales in 2008 when compared to 2007, manufacturing under absorption of $7.4 million in 2008 compared to $1.9 million in 2007, and $8.4 million in inventory reserves and manufacturing direct costs in 2008 compared to $1.8 million in 2007. The weakness in the overall semiconductor equipment market resulted in lower revenue levels and the corresponding under absorption of fixed manufacturing overhead costs in our factories. We have taken additional inventory reserves for excess inventory due to lower forecasted revenue volumes. We have reduced manufacturing headcount by approximately 55 percent as a result of our restructuring activities announced in the third and fourth quarters. This has resulted in a reduction in manufacturing overhead costs, but the significant revenue decline has still resulted in under-absorption of costs.

Gross profit margin for the year ended December 31, 2008 decreased to 35.6 percent from 46.1 percent for the year ended December 31, 2007, a decline of 10.5 percent. The decrease in gross profit margin was primarily due to under absorption of fixed manufacturing costs due to lower production levels and additional inventory reserves.

Due to intense competition, we continue to face pricing pressures that can affect our gross profit margin. Our gross profit margin has varied over the years and will continue to be affected by many factors, including competitive pressures, product mix, economies of scale, material and other costs, overhead absorption levels and the timing of revenue recognition in accordance with accounting rules.

Research, Development and Engineering ("RD&E"). RD&E expenses were $36.8 million for the year ended December 31, 2008, an increase of $2.7 million or 8 percent compared to $34.1 million for the year ended December 31, 2007. The increase was primarily due to $1.9 million in higher depreciation on lab tools, lower research and development credits from a research partner of $0.8 million, $0.3 million higher outside service expenses, and $0.2 million of other costs, partially offset by lower material expenses of $0.5 million as our millisecond anneal product transitioned into later stages of product development.

Selling, General and Administrative ("SG&A"). SG&A expenses were $68.5 million for the year ended December 31, 2008, an increase of $4.2 million or 6.5 percent compared to $64.3 million for the year ended December 31, 2007. The increase in SG&A expenses was primarily due to $4.4 million higher receivables provisions, additional amortization of $2.2 million for evaluation tools at customer sites, a $1.6 million one-time material credit related to reserve releases in 2007 against a government funded project, $1.3 million higher installation expenses related to the evaluation tools at customer sites and $1.5 million higher expenses arising from market development and selling efforts. These increases were partially offset by $3.5 million in reduced payroll expenses arising from restructuring activities, $2.0 million savings from contract re-negotiations and reduced third-party services, and $1.3 million in lower sales commissions and insurance costs.

Restructuring Expenses. During 2008, we implemented several restructuring programs in response to the weakness in the overall semiconductor industry. As part of the fourth quarter restructuring activity, we implemented a reorganization of our structure to reduce costs of operations and streamline the organization going forward. We reduced about 110 positions or 20 percent of the global work force through reductions in force and outsourcing. We incurred restructuring charges including benefits of $2.5 million in severance expenses and have paid out $0.6 million against this reserve. We expect to incur another $1.1 million for severance expenses and complete all activities related to this plan by the second quarter of 2009.

As part of the third quarter restructuring activity, we implemented a cost alignment plan to reduce headcount and optimize facilities worldwide. We reduced 63 positions or 11 percent of the global work force. Manufacturing positions represented approximately fifty percent of the positions impacted. We optimized our facilities worldwide and as a result, intend to reduce our leased space in Germany. We incurred restructuring charges of $2.5 million for severance costs and $0.4 million for lease termination expenses and have paid out $0.9 million against this reserve. We have made an adjustment to the reserve of $0.1 million. We expect to incur another $1 million for possible lease termination expenses and complete all activities related to this plan by the second quarter of 2009.

As part of the second quarter restructuring activity announced in June, we eliminated approximately 25 positions, or about 5 percent of the global workforce primarily in the office support organizations. We incurred restructuring charges of $0.7 million for severance expenses and have paid $0.6 million against this reserve. We have made adjustments to the reserve of $0.1 million. All activities against this plan have been completed.

In summary, as a result of our restructuring activities in 2008, we have reduced our headcount by approximately 35 percent or 200 employees, and optimized facilities worldwide. The estimated annual savings from all the restructuring activities are expected to be approximately $19 million. A percentage of the savings will be re-invested in our new product development activities and the remainder will help us reduce our cash loss from operations. During 2008, restructuring charges were $6.0 million primarily representing severance expenses and $2.0 million was paid against this restructuring reserve. We expect to incur future charges of $1.0 million for lease termination expenses and $1.1 million in additional severance expenses against these restructuring programs and expect to complete all activities against these plans by the second quarter of 2009. There were no restructuring charges for the year ended December 31, 2007.

Impairment of Goodwill. In 2008, we recorded an impairment charge of $18.1 million to write off the book value of goodwill, as required by SFAS No. 142, Goodwill and Other Intangible Assets. The write off represented the entire net book value of goodwill. There was no impairment charge related to goodwill for the year ended December 31, 2007. See Note 5 to the accompanying financial statements for further detail on goodwill impairment.

Impairment of Intangibles and Long-Lived Assets. In 2008, we recorded impairment charges to write off the net book value of all of our intangible assets of $6.6 million and certain lab assets of $2.8 million, as required by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The write off of the intangible assets represented the entire net book value of certain technology acquired from Vortek in October of 2004. There were no impairment charges related to intangibles and long-lived assets for the year ended December 31, 2007. See Note 5 to the accompanying financial statements for further detail on impairment of intangibles and Note 4 for further detail on impairment of long-lived assets.

Interest and Other Income (Expense), Net. Interest income of $3.3 million decreased in 2008 by $3.7 million compared with 2007 due to lower cash investment balances in 2008 and lower average interest rate yields of 2.6 percent compared to 4.7 percent in 2007. The $2.4 million increase in other expense, net in 2008 compared with 2007 was

Provision for Income Taxes. The provision for income taxes in 2008 consisted entirely of a $2.3 million provision for foreign taxes. The provision for income taxes in 2007 consisted primarily of a $0.2 million provision for Federal and state income taxes and a $4.7 million provision for foreign taxes. Currently, we have provided a full valuation allowance for all jurisdictions except Germany as we have determined that, due to uncertainties and other considerations related to our current operations and our expectations of future operations, it is more likely than not that our deferred tax assets generated from net operating loss carryforwards will not be realized. Our provision for income taxes could be favorably impacted during 2009 if our results of operations and forecasts for future profitability improve sufficiently to indicate that the related deferred tax assets will be realized. Such a change in management's expectations could result in a future material change to our valuation allowance assessment and the resulting future income tax provision.

Years Ended December 31, 2007 and 2006

The following table sets forth our consolidated results of operations for the
years ended December 31, 2007 and 2006, and the year-over-year increase
(decrease) in our results, expressed in both amounts (in thousands) and as a
percentage of net sales, except where indicated:

                                   Year Ended December 31,               Increase (Decrease)
                        ---------------------------------------------   ----------------------
                                2007                    2006
                        ---------------------   ---------------------

Net sales               $ 267,286    100.0  %   $ 281,781    100.0  %   $ (14,495)     (5.1) %
Cost of sales             144,075     53.9        172,720     61.3        (28,645)    (16.6)
                        ----------   ------     ----------   ------     ----------   -------
Gross profit              123,211     46.1        109,061     38.7         14,150      13.0
                        ----------   ------     ----------   ------     ----------   -------
Operating expenses:
   Research,
development and
engineering                34,116     12.7         28,314     10.0          5,802      20.5
   Selling, general
and administrative         64,343     24.1         62,523     22.2          1,820       2.9
   Amortization of
intangibles                   511      0.2            688      0.2           (177)    (25.7)
   Gain on
disposition of Wet
business                       -        -            (572)    (0.2)           572    (100.0)
   Impairment of               -        -           2,618      0.9         (2,618)   (100.0)
intangibles             ----------   ------     ----------   ------     ----------   -------
      Total operating      98,970     37.0         93,571     33.2          5,399       5.8
expenses                ----------   ------     ----------   ------     ----------   -------
Income from
operations                 24,241      9.1         15,490      5.5          8,751      56.5
Interest income             7,037      2.6          5,448      1.9          1,589      29.2
Interest expense              (31)    (0.0)          (197)    (0.1)           166     (84.3)
Other income                1,207      0.4            467      0.2            740     158.5
(expense), net          ----------   ------     ----------   ------     ----------   -------
Income before income
taxes                      32,454     12.1         21,208      7.5         11,246      53.0
Provision (benefit)         4,901      1.8          4,094      1.4            807      19.7
for income taxes        ----------   ------     ----------   ------     ----------   -------
Net income               $ 27,553     10.3  %    $ 17,114      6.1  %    $ 10,439      61.0  %
                        ----------   ------     ----------   ------     ----------   -------

Sales. The decrease in net sales in 2007 compared with 2006 was primarily due to an $18.1 million decrease in system sales, or 7.7 percent, and a $0.6 million decrease in service and spare parts sales, or 1.5 percent. Our net sales for 2007 also included $11.5 million of royalty revenue from Dainippon Screen Manufacturing Co., Ltd. (DNS), compared with $7.5 million for 2006. The sales decline in 2007 reflected the overall decline in capital spending by semiconductor manufacturers. In 2007, we received business from leading semiconductor manufacturers in all regions we serve - China, Europe, Japan, Korea, Singapore, Taiwan and the United States.

International sales, predominantly to customers based in Europe and Asia, including China, Japan, Korea, Singapore and Taiwan, accounted for 92 percent of net sales in 2007, compared to 89 percent for 2006. We anticipate that international sales will continue to account for a significant portion of our net sales.

Gross profit margin increased by 7.4 percentage points in 2007 compared to 2006, 4.2 percentage points of which was due to net recognition of previously deferred systems revenue in accordance with our revenue recognition policy, 1.0 percentage point of which was due to higher gross profit margin related to systems sales, 1.7 percentage points of which was due to DNS royalties and 0.5 percentage point of which was due to higher gross profit margin from service and spare parts sales.

Research, Development and Engineering. The increase in RD&E expenses in 2007 compared with 2006 was primarily due to increased activity in 2007 to expand our portfolio of products capable of addressing stringent sub-45 nm requirements.

Selling, General and Administrative. The increase in SG&A expenses in 2007 compared with 2006 was primarily the result of a $5.1 million increase in employee compensation and a $1.2 million increase in stock-based compensation as determined in accordance with SFAS No. 123(R), Share-Based Payment, which were partially offset by a $1.6 million decrease related to the release of amounts previously accrued upon completing all remaining obligations under a foreign government-funded capital development project, a $1.6 million decrease of accounts receivable that were collected during the period and were previously reserved, and a $1.1 million decrease in outside services. As a percentage of net sales, our SG&A expenses increased in 2007 compared to 2006 because of the increased SG&A spending in 2007 and a decrease in net sales in 2007.

Amortization of Intangibles. Amortization expenses in 2007 and 2006 were due to our acquisition of Vortek in October 2004.

Gain on Disposition of Wet Business. In 2006, we concluded all activities related to the disposition of the Wet business, and released an over-accrual of $0.6 million upon completion of our obligations under the sale of the Wet business.

Interest and Other Income (Expense), Net. Interest income increased in 2007 compared with 2006 due to higher cash investment balances in 2007. Interest expense for 2007 and 2006 was minimal. The $0.7 million increase in other income, net in 2007 compared with 2006 was primarily due to a $0.6 million increase due to foreign currency translation and a $0.1 million increase in net gains on forward foreign exchange contracts settled in 2007.

Provision for Income Taxes. The provision for income taxes in 2007 primarily consisted of a $0.2 million provision for Federal and state income taxes and a $4.7 million provision for foreign taxes. The provision for income taxes in 2006 primarily consisted of a $2.3 million provision for Federal and state income taxes, a $1.3 million provision for taxes in Germany and a provision of $0.5 million for other foreign taxes.

Stock-based Compensation

During the years ended December 31, 2008, 2007 and 2006, we recorded $3.5 million, $3.2 million and $2.0 million, respectively, of stock-based compensation related to stock options. As of December 31, 2008, there was $5.1 million of unrecorded deferred stock-based compensation, after estimated forfeitures, related to stock options, which will be recognized over an estimated weighted-average amortization period of 2.6 years. During the years ended December 31, 2008, 2007 and 2006, we recorded $0.1 million, $0.1 million and $0.1 million, respectively, of stock-based compensation related to our . . .