The information in this report, except for the historical information, contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and is subject to the safe harbor created by that statute. Typically, we identify forward-looking statements by use of an asterisk "*." In some cases, you can identify forward-looking statements by terminology such as "expects," "anticipates," "intends," "may," "should," "plans," "believes," "seeks," "estimates," "could," "would," or the negative of such terms or other comparable terminology. These forward-looking statements include but are not limited to expected orders; expected revenues; expected financial results; expected cash usage and other expected financial performance measures for the third quarter of fiscal 2009. These statements are subject to various risks and uncertainties, both known and unknown. Factors that could cause actual results to differ include, but are not limited to changes in industry conditions; order delays or cancellations; general economic conditions; changes in customer capacity requirements and demand for microelectronics; the extent of demand for our products and our ability to meet demand; global trade policies; worldwide economic and political stability; our successful execution of internal performance plans; the cyclical nature of our business; volatility of the market for certain products; performance issues with key suppliers and subcontractors; the level of new orders; the financial condition of our customers and their ability to pay; the timing and success of current and future product and process development programs; the success of our direct distribution organization; legal proceedings; the potential impairment of long-lived assets; and the potential adverse financial impacts resulting from declines in the fair value and liquidity of investments we presently hold; as well as other factors listed from time to time in our SEC reports including, but not limited to, the Risk Factors set forth in our Form 10-K for the fiscal year ended August 30, 2008. Readers also are cautioned not to place undue reliance on these forward-looking statements as actual results could differ materially. We undertake no duty to update any of the forward-looking statements after the date of this report.
This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this report.
Industry
Gartner, Inc. ("Gartner"), a leading equipment industry research group, in March 2009 revised downward its semiconductor demand forecast for calendar 2009. Gartner now predicts that demand for semiconductors will decrease approximately 24.1 percent in calendar 2009, from the $256 billion calendar 2008 level. Demand for semiconductors decreased 4.1 percent in calendar 2008. The calendar 2009 decline is expected to occur across all device types as consumer and corporate demand for microelectronics is expected to remain weak.
Many device producers have announced operation shutdowns with some announcing the possibility of additional shutdown periods in calendar 2009 if conditions do not improve. Some device manufacturers have announced the closing of less productive fabrication facilities. Increasingly, device manufacturers are adopting some form of "fabrication light" manufacturing philosophy by outsourcing a portion of the manufacturing to third parties in an attempt to reduce capital investments and transition their business from a fixed cost to a variable cost model.
As recently forecasted by Gartner, total wafer fabrication equipment spending in calendar 2009 is expected to decrease 46 percent from calendar 2008. This decrease follows a 31 percent decline in calendar 2008 from calendar 2007. In general, analysts have a mixed view on forecasted total equipment spending for 2009; however, all are forecasting another significant year-over-year decline as factory utilization rates remain subdued.
We do not expect device manufacturers to be increasing capacity in the near future.* We expect that any device manufacturer investments will likely be in the area of expanding future technology nodes or productivity improvement.* Manufacturers appear to be remaining cautious toward placing new orders and several are asking

equipment manufacturers to provide evaluation systems or extended payment terms as they deal with the current credit crunch. Overview
The decline in the value of personal investments, credit availability and increasing unemployment are continuing to adversely impact consumer confidence and technology spending. As a result, most semiconductor manufacturers are experiencing low factory utilization levels and have reduced or delayed making any material capital investments. Even though several device producers have recently reported improved utilization levels, we anticipate that low utilization levels will persist until at least early calendar 2010. According to SEMI, the global industry association for companies that supply manufacturing technology and materials to the world chip makers, total monthly worldwide industry orders for our primary market, surface conditioning equipment, declined nearly 90 percent from January 2007 through February 2009.
In March, we reduced our headcount, further reduced management salaries, established two shutdown weeks, and implemented other cost reduction initiatives. Since the beginning of fiscal 2009, we have reduced headcount and other costs that are expected to lower the Company's annual operating cost by $11.0 to $12.0 million, which will reduce our cash flow breakeven revenue level and position us for improved financial performance when the industry recovers.* Application of Critical Accounting Policies and Estimates In accordance with SEC 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 include installation, service contracts and training. Equipment installation revenue is

valued based on estimated service person hours to complete installation and published or 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 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 the FASB's 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, may not be recoverable, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model or another valuation technique. Net intangible assets and long-lived assets amounted to $16.5 million as of February 28, 2009.
In fiscal 2008, we had positive cash flows from operations. In the first six months of fiscal 2009, we did not generate positive cash flows from operations. If we do not return to positive cash flows from operations and generate cash flows in excess of the carrying amount of our long-lived assets, future impairments of those assets may occur.*
Considerable management judgment is necessary in estimating future cash flows and other factors affecting the valuation of long-lived assets, including intangible assets, and 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. These estimates are subject to some uncertainty due to the current economic conditions.
We did not recognize any impairment charges for our long-lived assets, during the second quarters or the first six months of fiscal 2009 or 2008. We currently believe the fair value of those long-lived assets exceeds the carrying amount. Product Warranty Estimation
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 typically range from one to two years. Special warranty reserves 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 yet unrecognized defects in products sold.

During the second quarter of fiscal 2008, we reversed approximately $250,000 of unused prior period warranty accruals associated with improved claims experience.
Inventory Provisions Estimation
We record provisions for inventory shrinkage and for potentially excess, obsolete and slow moving inventory. These provisions are based upon historical loss trends, inventory levels, 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 reserves primarily 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 approximately $10.9 million, have disposed of approximately $6.8 million of POLARIS system product inventory and have recorded additional reserves of $1.9 million. The original cost of POLARIS system product inventory available for sale or to be disposed of as of February 28, 2009 that has been written down to zero was approximately $8.1 million. Allowance for Doubtful Accounts Estimation Management must estimate the uncollectibility of our accounts receivable. The most significant risk is a sudden unexpected deterioration in financial condition of a significant customer who is not considered in the allowance. Management specifically analyzes accounts receivable, 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 written off after management determines that they are uncollectible. As of the end of the second quarter of fiscal 2009, our accounts receivable included $2.0 million attributable to a past due receivable with a customer in Asia. The customer has delayed their payment due to their cash flow issues and lower than expected capacity utilization. We still believe that this receivable is collectible and will continue to monitor the situation closely.* Stock-Based Compensation
We utilize the 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 only the fair value of those awards 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 their estimated rate of forfeiture.
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 unrecognized tax benefits. We have established accruals for unrecognized tax benefits using management's best judgment and adjust these accruals as warranted by changing facts and circumstances. A change in our accruals in any given period could have a significant impact on our results of operations for that period.
We adopted the provisions of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN48") during the first quarter of fiscal 2008, which had no impact on our financial position or results of operation. There was no change in the accrual for unrecognized tax benefits for the second quarter of fiscal 2009. The accrual for unrecognized tax benefits decreased by $0.1 million for the first six months of fiscal 2009, and $0.1 million for the second quarter and for the first six months of fiscal 2008.

SECOND QUARTER AND FIRST HALF OF FISCAL 2009 COMPARED WITH SECOND QUARTER AND
FIRST HALF OF FISCAL 2008
The Company
     The following table sets forth on a consolidated basis, for the fiscal
periods indicated, certain income and expense items as a percent of total sales.

                                           Percent of Sales              Percent of Sales
                                             Quarter Ended               Six Months Ended
                                       February 28,     March 1,     February 28,     March 1,
                                           2009           2008           2009           2008
Sales                                       100.0 %      100.0 %          100.0 %      100.0 %
Cost of sales                                86.0         52.3             72.1         57.1

Gross margin                                 14.0         47.7             27.9         42.9
Selling, general and administrative          70.3         32.2             56.1         31.1
Research and development                     53.6         22.4             43.2         20.7

Operating loss                             (109.9 )       (6.9 )          (71.4 )       (8.9 )
Other income (loss), net                      1.2          1.8              0.9          1.6

Loss before income taxes                   (108.7 )       (5.1 )          (70.5 )       (7.3 )
Income tax expense (benefit)                  0.4         (0.4 )            0.1         (0.1 )

Net loss                                   (109.1 )%      (4.7 )%         (70.6 )%      (7.2 )%

Revenue and Shipments
Sales revenue decreased to $8.6 million for the second quarter of fiscal 2009 as compared to $21.4 million for the second quarter of fiscal 2008. The decrease related primarily to a decrease in shipments from $23.7 million in the second quarter of fiscal 2008 to $12.7 million in the second quarter of fiscal 2009. Sales revenue decreased to $20.9 million for the first half of fiscal 2009 as compared to $43.9 million for the first half of fiscal 2008. The decrease related primarily to a decrease in shipments from $44.4 million in the first half of fiscal 2008 to $22.3 million in the first half of fiscal 2009. The decreases in shipments in the fiscal 2009 periods as compared to the fiscal 2008 periods related to industry and overall global economic conditions. The fiscal 2009 periods were also impacted by the revenue deferral of a machine demonstration completed in the second quarter of fiscal 2009. Although the demonstration tool had been accepted and paid for by the customer in the second quarter of fiscal 2009, the same customer ordered an expansion module shortly after the demonstration tool was ordered. The accounting guidance requires that the tool and the expansion be viewed as one arrangement and recorded as a single unit of accounting. Therefore, the revenue and costs related to this demonstration tool was included in deferred profit as of the end of the second quarter of fiscal 2009.
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 acceptance, sales revenue may exceed shipments.

International revenue was $6.3 million, representing 73% of total revenue, during the second quarter of fiscal 2009 and $15.9 million, representing 74% of total revenue, during the second quarter of fiscal 2008. International revenue was $15.6 million, representing 75% of total revenue, during the first half of fiscal 2009 and $34.9 million, representing 80% of total revenue, during the first half of fiscal 2008.
We currently expect third quarter of fiscal 2009 revenues to be between $13 and $15 million.* In order to achieve this revenue level, we will need to receive several anticipated system orders from customers that can be shipped and recognized as revenue in the third quarter of fiscal 2009 and the acceptance of the demonstration tool and expansion module previously discussed.* 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; the sales of inventory previously written down to zero; and the competitive pricing environment.
Gross margin as a percentage of sales for the second quarter of fiscal 2009 was 14.0% as compared to 47.7% for the second quarter of fiscal 2008. The gross margin in the second quarter of fiscal 2008 was favorably impacted approximately 1.0% by reversals of unused prior period warranty accruals associated with improved warranty claims experience. Gross margin as a percentage of sales for the first half of fiscal 2009 was 27.9% as compared to 42.9% for the first half of fiscal 2008. The decreases in margin in the fiscal 2009 periods were due to an increase in manufacturing variances associated with the lower manufacturing utilization as a result of lower production and shipment levels as well as $0.7 million of severance and $0.5 million increase in the inventory obsolescence reserves recorded in the second quarter of fiscal 2009. For additional information related to these severance charges, see Note 8 of the Notes to Consolidated Financial Statements.
The change in margins was also impacted by the usage of POLARIS® system product inventory that had previously been written down to zero. During the second quarters of fiscal 2009 and 2008, we had sales of POLARIS® system product inventory with an original cost of $158,000 and $331,000, respectively, that had previously been written down to zero. During the first halves of fiscal 2009 and 2008, we had sales of POLARIS® system product inventory with an original cost of $257,000 and $670,000, respectively, that had previously been written down to zero.
We will continue to try to sell the impaired inventory to our customers as spares, refurbished systems and upgrades to existing systems. If unsuccessful, some of the items will be disposed. Any significant sales of the impaired inventory will be disclosed. Gross margins will be favorably impacted if inventory carried at a reduced cost is sold.
Gross margins for the third quarter of fiscal 2009 are expected to be in the range of 32% to 34% of revenues as we do not anticipate any significant improvement in factory utilization and due to lower margins on the initial product placement of the ORION® systems.* We do not anticipate any additional severance expense or significant increases in the inventory obsolescence reserves to impact gross margins for the third quarter of fiscal 2009.*

Selling, General and Administrative Expenses Selling, general and administrative expenses decreased to $6.1 million in the second quarter of fiscal 2009 as compared to $6.9 million for the second quarter of fiscal 2008. Selling, general and administrative expenses decreased to $11.7 million for the first half of fiscal 2009 as compared to $13.6 million for the same period in fiscal 2008. The decreases in the year-over-year selling, general and administrative expenses related primarily to cost reduction initiatives associated with reductions in headcount and salary reductions taken in the first half of fiscal 2009 and improved service technician utilization rates. The decreases were net of $1.2 million of severance expense recorded in the second quarter of fiscal 2009. For additional information related to these severance charges, see Note 8 of the Notes to Condensed Consolidated Financial Statements.
We expect selling, general and administrative expenses in the third quarter of fiscal 2009 to be in the range of $4.5 million to $4.7 million as we continue to focus on managing these costs.*
Research and Development Expenses
Research and development expenses were $4.6 million for the second quarter of fiscal 2009 as compared to $4.8 million for the same period in fiscal 2008. Research and development expenses were $9.0 million for the first six months of fiscal 2009 as compared to $9.1 million for the first half of fiscal 2008. The decreases related primarily to cost reduction initiatives associated with reductions in headcount and salary reductions taken in the first half of fiscal 2009. The decreases were net of $1.0 million of severance expense recorded in the second quarter of fiscal 2009. For additional information related to these severance charges, see Note 8 of the Notes to Condensed Consolidated Financial Statements. During the second quarter of fiscal 2009 we continued investing in the ORION® single wafer wet system while sustaining support for all other products.
We expect research and development expenses for the third quarter of fiscal 2009 to be in the range of $3.3 to $3.5 million.* This includes the engineering resources required to support customer demonstration tool placements and our ORION® system introduction initiative.
Income Taxes
We recorded tax expense of $39,000 in the second quarter of fiscal 2009 and $28,000 in the first half of fiscal 2009. The tax expense in the fiscal 2009 periods related primarily to foreign taxes. We recorded a tax benefit of $77,000 in the second quarter of fiscal 2008 and $65,000 in the first half of fiscal 2008. The income tax benefit in fiscal 2008 periods related to a tax position that was effectively settled with taxing authorities during the second quarter of fiscal 2008, which was partially offset by state income tax expense.
Our deferred tax assets on our balance sheet as of February 28, 2009 have been fully reserved with a valuation allowance. We do not expect to significantly 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 $177 million, 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. This limitation is approximately $1.4 million per year. Net Loss
Net loss was $9.4 million in the second quarter of fiscal 2009 as compared to a net loss of $1.0 million in the second quarter of fiscal 2008. Net loss was $14.7 million for the first half of fiscal 2009 as compared to a net loss of $3.1 million for the first half of fiscal 2008.

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