Overview:

Aetrium designs, manufactures and markets a variety of electromechanical equipment used in the handling and testing of integrated circuits, or ICs, which constitute the highest revenue component of the semiconductor industry. Our primary focus is on high volume ICs, the latest IC package designs, and the latest IC manufacturing processes. Our test handler products are purchased primarily by semiconductor manufacturers and their assembly and test subcontractors and are used in the test, assembly and packaging, or TAP, segment of semiconductor manufacturing. Our reliability test products are used to validate IC designs and monitor semiconductor wafer fabrication processes. Our products automate critical functions to improve manufacturing yield, raise quality levels, increase product reliability and reduce manufacturing costs.

As an equipment supplier to the semiconductor industry, Aetrium's results are driven primarily by worldwide demand for ICs, which in turn depends on end-user demand for electronic products. The demand for our products can fluctuate significantly from period to period due to the direct or indirect impact of numerous factors, including but not limited to changes in the supply and demand for ICs, changes in IC manufacturing capacity, advancements in industry technologies, changes in U.S. and worldwide economic conditions and competitive factors.

Semiconductor industry conditions were generally favorable in 2006 but weakened in the second half of the year. Industry conditions continued to be relatively weak in 2007 although they improved for some segments where the demand for certain IC device types increased. Aetrium experienced increasing order activity in the first three quarters of 2007 for some of our test handler models, particularly those that are used in analog device-type applications. This led to sequential increases in quarterly net sales in 2007 to $5.1 million, $5.9 million, $7.7 million and $9.3 million, respectively. Although our net sales increased sequentially to $9.3 million in the fourth quarter of 2007, new orders decreased significantly from third quarter levels, consistent with generally weakening demand for equipment in the TAP segment of the semiconductor equipment industry. Our total sales in 2007 were $28.0 million compared with $28.2 million in 2006.

Amid general economic concerns, semiconductor and semiconductor equipment industry conditions continued to be weak in the first half of 2008. In the first quarter of 2008 our net sales decreased to $5.6 million compared with $9.3 million in the fourth quarter of 2007. In the second quarter of 2008, our orders increased over first quarter levels but a significant portion of the orders were received late in the quarter for shipment in subsequent periods and our net sales decreased further to $3.2 million. Our net sales increased to $5.5 million in the third quarter but worldwide economic and semiconductor industry business conditions deteriorated during the quarter as the well publicized global financial crisis deepened. Aetrium's business outlook weakened as well. Our order activity slowed significantly in the latter part of the third quarter and total orders decreased from second quarter levels. Business conditions continued to deteriorate during the fourth quarter as weak economic conditions evolved into a full-blown global financial collapse. As the end of the year approached, many IC manufacturers, including Aetrium's primary customers, made significant adjustments to their operations and reduced their capital expenditure plans in anticipation of significantly declining demand for ICs. Consequently, our net sales decreased to $2.9 million in the fourth quarter. Fiscal year 2008 sales totaled $17.2 million compared with $28.0 million in 2007, a decrease of 38%. In fourth quarter 2008, as it became clear that general economic and semiconductor industry business conditions may be weak for an extended period of time, we immediately took steps to reduce our expenses accordingly. We eliminated contract workers, terminated twelve employees, or 15% of our regular workforce, and reduced other operating expenses as well. In January

2009 we implemented wage reductions of 10% for all employees and up to 25% for our executive officers.

Our order activity has continued to be very weak in early 2009 and we expect general economic and Aetrium business conditions to be challenging at least through the first half of the year. Any prolonged continuation or worsening of the industry slowdown will likely adversely impact our longer term operating results as well.

Off-Balance Sheet Arrangements:

We did not have any off-balance sheet arrangements as of December 31, 2008 or 2007.

Critical Accounting Policies and Estimates:

Management's discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the critical accounting policies that require the most significant judgments and estimates used in the preparation of our consolidated financial statements are those related to share-based compensation, revenue recognition, accounts receivable, inventories, warranty obligations and income taxes.

Share-Based Compensation

We account for share-based compensation in accordance with the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" (SFAS 123R), which requires the measurement and recognition of all share-based compensation using the fair value method.

We determine the fair value of share-based awards on the grant date by using the Black-Scholes option valuation model. We also use the Black-Scholes model to determine the fair value of modifications to awards by determining and comparing the fair value of the modified award with the fair value of the award immediately before the modification. Option valuation models, including Black-Scholes, require the input of subjective assumptions, and changes in the assumptions used can materially affect the calculation of the fair value of an award. These assumptions include expected stock price volatility, risk-free interest rate, expected dividend yield, and the expected life of the award. We estimate future stock price volatility based primarily on historical daily stock price observations of our common stock. Risk-free interest rate is estimated based on U.S. Treasury bill rates consistent with the expected term of an award. We assume an expected dividend yield of zero based on our intention to retain any future earnings for use in our operations. Expected life of an award is estimated primarily based on vesting provisions, the contractual term of the award, and historical experience of previous awards with similar terms or, if appropriate in the circumstances, we use the simplified method for estimating the expected life of an award, as permitted by Staff Accounting Bulletin No.
107. SFAS 123R also requires that estimated forfeitures be considered in the calculation of future compensation expense at the date of grant. We use historical data, as adjusted if deemed appropriate, to estimate future option forfeiture rates for purposes of recognizing share-based compensation expense.

Revenue Recognition

Our policy is to recognize revenue on product sales upon shipment if contractual obligations have been substantially met, collection of the proceeds is assessed as being reasonably assured, and title and risk of loss have passed to the customer, which is generally the case for sales of spare parts, accessories, change kits and some equipment and equipment upgrades. In instances where title does not pass upon shipment, revenue is recognized upon delivery or customer acceptance based upon the terms of the sales agreement. In instances where equipment or equipment upgrade sales contracts include significant post-shipment obligations to be performed by Aetrium, revenue for the entire transaction is deferred until such obligations have been completed or, if applicable, the transaction is accounted for as a multiple-element arrangement. For arrangements containing multiple elements, the amounts allocated to delivered and undelivered elements are based on their fair value and revenue is recognized upon delivery of each element. In instances where contractual terms can only be satisfied after shipment, such as meeting customer-specified acceptance requirements at the customer's site, revenue is not recognized until there is objective evidence that the applicable contract terms have been met. Due to the high selling prices of certain types of equipment, the timing of revenue recognition of a relatively small number of transactions may have a significant impact on our reported operating results.

Accounts Receivable

We maintain an allowance for doubtful accounts that reflects our estimate of losses that may result from the uncollectibility of accounts receivable. Our allowance for doubtful accounts is based primarily on an analysis of individual accounts for which we have information indicating the customer may not be able to pay amounts owed to us. In these cases, based on the available facts and circumstances, we estimate the amount that will be collected from such customers. We also evaluate the collectibility of our accounts receivable in the aggregate based on factors such as the aging of receivable amounts, customer concentrations, historical experience, and current economic trends and conditions. We adjust our allowance for doubtful accounts when additional information is received that impacts the amount reserved. If circumstances change, our estimates of the recoverability of accounts receivable could be reduced or increased by a material amount. Such a change in estimated recoverability would be accounted for in the period in which the facts that give rise to the change become known.

Inventories

We adjust our inventories for estimated excess and obsolete inventory equal to the difference between the cost of inventory and its estimated realizable value based upon assumptions about future product demand and market conditions. If actual product demand or market conditions are less favorable than those projected by management, additional inventory adjustments may be required.

Warranty Obligations and Equipment Improvement Costs

We accrue estimated warranty costs in the period that the related revenue is recognized. Our warranty cost estimates and warranty reserve requirements are determined based upon product performance, historical warranty experience and costs incurred in addressing product performance issues. Should product performance or cost factors differ from our estimates, adjustments to our warranty accrual may be required. On occasion, we may provide no-charge equipment improvements for customers at our discretion. Such costs are accrued when identified, quantified and approved by management.

Income Taxes

We record the benefit we will derive in future accounting periods from tax losses and credits and deductible temporary differences as "deferred tax assets" which are included in the caption "Deferred income taxes" on our consolidated balance sheet. In accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," we record a valuation allowance to reduce the carrying value of our deferred tax assets if, based on all available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. At December 31, 2006, we provided a valuation allowance of approximately $25.6 million to fully reserve our deferred tax assets. At December 31, 2007, we reduced the valuation allowance to approximately $21.7 million based on our assessment of the realizability of our deferred tax assets at that date. At December 31, 2008, we assessed the realizability of our deferred tax assets and the amount of our valuation allowance. Based on our evaluation of future profit potential and other relevant factors, we determined that there was not sufficient positive or negative evidence to warrant an increase or decrease in the amount of the valuation allowance and that a valuation allowance of $21.7 million was appropriate at December 31, 2008. We will continue to assess the assumptions used to determine the amount of our valuation allowance and we may adjust the valuation allowance in future periods based on changes in assumptions of estimated future income and other factors. If the valuation allowance is reduced, we would record an income tax benefit in the period the valuation allowance is reduced. If the valuation allowance is increased, we would record additional income tax expense.

Results of Operations:

Selected statement of operations data as a percentage of our net sales for 2008 and 2007 were as follows:

                                                       2008         2007
              Net sales                               100.0 %      100.0 %
              Cost of goods sold                       52.0         49.7
              Gross profit                             48.0         50.3
              Operating expenses:
              Selling, general and administrative      37.9         23.3
              Research and development                 17.5         12.7
              Total operating expenses                 55.4         36.0
              Income (loss) from operations            (7.4 )%      14.3 %

Net Sales:

Our net sales by product line as a percentage of total sales for 2008 and 2007
were as follows:

                                                       2008      2007
                Test handler products                    59 %      69 %
                Reliability test equipment products      15        17
                Change kits and spare parts              26        14
                Total                                   100 %     100 %

Net sales were $17.2 million in 2008 compared with $28.0 million in 2007, a 38% decrease. Net sales of test handlers were $10.2 million compared with $19.2 million in 2007, a decrease of 47%. Net sales of reliability test equipment were $2.5 million in 2008 compared with $4.8 million in 2007, also a decrease of 47%. The decreases in test handler and reliability test equipment sales in 2008 were attributed to a general weakness in the semiconductor equipment industry that developed late in 2007, continued into fiscal year 2008 and worsened in the second half of the year as global economic conditions

deteriorated. Sales of change kits and spare parts were $4.5 million in 2008 compared with $4.0 million in 2007, an increase of 12%. Sales of change kits and spare parts sometimes increase in periods of reduced equipment sales as some customers strive to improve the utilization of existing equipment rather than purchase new equipment, which we believe occurred to some extent in 2008.

Gross Profit:

Aetrium's gross profit as a percentage of net sales can fluctuate based on a number of factors, including but not limited to the mix of products sold, distribution channel mix, price discounting, product maturity, inventory writedowns, and utilization of manufacturing capacity associated with varying production levels. Gross profit was 48.0% of net sales in 2008 compared with 50.3% in 2007. Our gross margin decreased in 2008 primarily due to inefficiencies associated with lower production and net sales levels and to a less favorable distribution mix. Discounted sales to distributors represented 54% of total net sales in 2008 compared with 45% in 2007.

Selling, General and Administrative Expenses:

Selling, general and administrative, or SG&A, expenses consist primarily of employee compensation and related costs, independent representative commissions, travel, warranty and no-charge equipment improvement costs. SG&A expenses were $6.5 million in each of fiscal years 2008 and 2007. Wages, share-based compensation and related costs increased $0.6 million in 2008 primarily due to wage increases and additional personnel hired for field service and sales support activities. Travel and equipment demonstration expenses increased $0.3 million to support increased field service activities and sales efforts to expand our customer base. These expense increases in 2008 were offset by $0.4 million in reduced commission expense and $0.5 million in reduced sales and profit-related incentives due to lower sales and profits in 2008.

Research and Development Expenses:

Research and development expenses were $3.0 million in 2008 compared with $3.5 million in 2007, a decrease of 15%. The decrease in 2008 was primarily attributable to reductions in contract services and travel costs. Research and development expenses represented 17.5% of total net sales in 2008 compared with 12.7% of total net sales in 2007. New product development is an essential part of our strategy to gain market share. Over time, we expect to invest approximately 12% to 15% of our revenues in research and development although we may exceed this range in periods of reduced revenues as was the case in 2008.

Interest Income, Net:

Interest income, net, amounted to $0.3 million and $0.4 million in 2008 and 2007, respectively. These amounts consisted primarily of interest income from the investment of excess funds. The decrease in interest income in 2008 reflects generally declining interest rates offset in part by an increase in average invested cash balances.

Income Tax Benefit:

We recorded an income tax benefit of $0.3 million in 2008, which reflected a 33.7% effective tax rate. In 2007, we recorded an income tax net benefit of $2.2 million, which included income tax expense of $1.8 million (37.5% effective tax rate) and an income tax benefit of approximately $4.0 million resulting from a reduction in our deferred tax asset valuation allowance as explained below.

From fiscal year 2000 through 2006, Aetrium had provided a valuation allowance to fully reserve our deferred tax assets. The valuation allowance amounted to $25.6 million at December 31, 2006. At December 31, 2007, we reduced the valuation allowance by $4.0 million based on our assessment of the realizability of our deferred tax assets at that date. See Note 13 to our consolidated financial statements.

If the current global economic crisis and semiconductor industry downturn worsen and/or continue for an extended period of time, the potential realization of our deferred tax assets would likely be adversely impacted, in which case we could be required to increase our valuation allowance and record a corresponding charge to income tax expense.

Financial Condition, Liquidity and Capital Resources:

Cash and cash equivalents decreased by approximately $0.5 million in the year ended December 31, 2008. We used $0.4 million in cash to fund operating activities during this period. The major components of cash flows from operating activities were our net loss of $0.6 million, a $0.3 million increase in deferred taxes, a $1.5 million increase in inventories, a $0.2 million decrease in accounts payable, a $0.4 million decrease in accrued compensation and a $0.3 million decrease in other accrued liabilities, offset in part by $0.7 million in non-cash depreciation and share-based compensation expense, a $2.0 million decrease in accounts receivable and a $0.1 million decrease in other assets. Inventories increased due to selective increases of certain inventories in the first half of 2008 to meet anticipated customer delivery requirements, an increase in the number of demonstration equipment units used for new customer evaluations, and lower-than-anticipated net sales in the second half of the year. Accounts payable decreased primarily due to reduced inventory purchases in the fourth quarter of 2008 compared with the fourth quarter of 2007. Accrued compensation decreased primarily due to the elimination of profit-related incentives in the second half of 2008. The decrease in accrued liabilities included a $0.1 million decrease in accrued warranty and no-charge equipment improvement costs due primarily to lower sales and a $0.1 million decrease in deferred revenue. Accounts receivable decreased primarily due to a significant decrease in net sales in the fourth quarter of 2008 compared with the fourth quarter of 2007. Net cash provided by investing activities in 2008 was not significant. Net cash used in financing activities in 2008 amounted to $0.1 million and was primarily related to the repurchase of shares of common stock in connection with stock option exercises.

Cash and cash equivalents increased by approximately $3.7 million in the year ended December 31, 2007. We generated $3.0 million in cash from operating activities during this period. The major components of cash flows from operating activities were net income of $6.7 million, $0.5 million in non-cash depreciation, amortization and share-based compensation expense, a $0.2 million non-cash inventory obsolescence charge, a $0.3 million increase in accounts payable and a $0.3 million increase in accrued compensation, partially offset by a $2.3 million increase in deferred income taxes, a $1.4 million increase in accounts receivable, a $0.5 million increase in inventories, a $0.1 million increase in other current assets, and a $0.5 million decrease in other accrued liabilities. Inventories and accounts payable increased as we increased purchases to support anticipated sales levels, demo equipment needs, and customer delivery requirements. Deferred income taxes increased due to a reduction in our deferred tax asset valuation allowance. Accrued compensation increased primarily due to higher incentives based on the profits achieved in the fourth quarter of 2007 compared with the fourth quarter of 2006. Accounts receivable increased primarily due to the higher net sales level in the fourth quarter of 2007 compared with the fourth quarter of 2006. The decrease in other accrued liabilities included primarily the payment of $0.6 million in severance and related costs associated with the 2006 sale of our Dallas, Texas operations. Net cash provided by investing activities in 2007 was not significant. Net cash provided by financing activities amounted to $0.6 million in 2007, consisting primarily of proceeds from employee stock option exercises.

Historically we have supported our capital expenditure and working capital needs with cash generated from operations and our existing cash and cash equivalents. We believe our cash and cash equivalents of $11.6 million at December 31, 2008 will be sufficient to meet capital expenditure and working capital needs at least through 2009. In addition, we have a revolving credit line agreement with a bank that provides for borrowings up to $2.0 million. The credit agreement expires in October 2009. We believe we will be able to extend the agreement at that time or obtain similar financing, if needed. However, there can be no assurance that such financing will be available with terms favorable to us or at all. As discussed above, worldwide economic conditions are very weak and it is not known how long the current downturn in the semiconductor industry may last. A worsening or prolonged continuation of the current slowdown in our industry would likely adversely impact the demand for and prices of our products and adversely affect future cash flows. Also, we may acquire other companies, product lines or technologies that are complementary to our business, and our working capital needs may change as a result of such acquisitions.

Recent Accounting Pronouncements:

In March 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 161, "Disclosures about Derivative Instruments and Hedging Activities" (SFAS 161). This statement is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity's financial position, financial performance, and cash flows. SFAS 161 became effective for Aetrium at the beginning of fiscal year 2009 and had no impact on our consolidated financial position, results of operations or cash flows.

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements" (SFAS 160). This statement amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 became effective for Aetrium at the beginning of fiscal year 2009 and had no impact on our consolidated financial position, results of operations or cash flows.

In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141(Revised 2007), "Business Combinations" (SFAS 141R). SFAS 141R establishes principles and requirements for how the acquirer in a business combination recognizes and measures in its financial statements the fair value of identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree at the acquisition date. SFAS 141R determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R became effective for Aetrium at the beginning of fiscal year 2009 and had no impact on our consolidated financial position, results of operations or cash flows.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" (SFAS 159). This pronouncement permits entities to choose to measure many financial instruments and certain other items at fair value that were not previously required to be measured at fair value. SFAS 159 became effective for Aetrium at the beginning of fiscal year 2008, and its implementation had no impact on our consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, "Fair Value" (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 became

effective for Aetrium at the beginning of fiscal year 2008, and its implementation had no impact on our consolidated financial position, results of operations or cash flows.