Certain statements in this Quarterly Report on Form 10-Q are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). In addition, we may, from time to time, make oral forward looking statements. Forward looking statements may be identified by the words "anticipate," "believe," "expect," "intend," "will" and similar expressions, as they relate to us or our management. These statements include, without limitation, the statement that we believe that our existing cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash requirements for working capital and capital expenditures for the next twelve months.

The forward looking statements contained herein reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Actual results may differ materially from those projected in such forward looking statements due to a number of factors, risks and uncertainties, including the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2008. We disclaim any obligation to update any forward looking statements as a result of developments occurring after the date of this Quarterly Report, other than as required by law.

Critical Accounting Policies

The preparation of consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported. Certain of these significant accounting policies are considered to be critical accounting policies, as defined below.

A critical accounting policy is defined as one that is both material to the presentation of our consolidated financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on our financial condition or results of operations. Specifically, these policies have the following attributes: (1) we are required to make judgments and assumptions about matters that are highly uncertain at the time of the estimate; and (2) different estimates we could reasonably have used, or changes in the estimate that are reasonably likely to occur, could have a material effect on our financial position and results of operations.

Estimates and assumptions about future events and their effects cannot be determined with certainty. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. These changes have been included in the consolidated financial statements as soon as they became known. In addition, management is periodically faced with uncertainties, the outcomes of which are not within its control and will not be known for prolonged periods of time. Certain of these uncertainties are discussed in our Annual Report on Form 10-K for the year ended December 31, 2008 in the sections entitled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Based on a critical assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, management believes that our consolidated financial statements are fairly stated in accordance with accounting principles generally accepted in the United States of America, and provide a fair presentation of our financial position and results of operations.

For more information, please see our critical accounting policies as previously disclosed in our 2008 Annual Report on Form 10-K.

See Note 16 to the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q regarding the impact of recent accounting pronouncements on the Company's financial position and results of operations.

Results of Operations for the Three and Nine Month Periods Ended September 30, 2009 and 2008

We are a worldwide leader in the design, development, manufacture and support of high-performance process control metrology, defect inspection, and data analysis systems used by semiconductor device manufacturers. We provide yield management solutions used in both wafer processing and final manufacturing through a family of standalone systems and integrated modules for both transparent and opaque thin film measurements and macro-defect inspection. All of these systems feature production-worthy automation and are backed by worldwide customer support.

Rudolph's business is affected by the annual spending patterns of our customers on semiconductor capital equipment. The amount that our customers devote to capital equipment spending depends on a number of factors, including general worldwide economic conditions as well as other economic drivers such as personal computer, cell phone and personal electronic device sales. Current forecasts by industry analysts for the semiconductor device manufacturing industry project a year-over-year decrease in capital spending of approximately 50% for 2009. We monitor capital equipment spending through announced capital spending plans by our customers and monthly-published industry data such as the book-to-bill ratio. The book-to-bill ratio is a three month running statistic that compares bookings or orders placed with capital equipment suppliers to billings or shipments. A book-to-bill above one shows that semiconductor device equipment manufacturers are ordering equipment at a pace that exceeds the equipment suppliers' shipments for the period. The three month rolling average North American semiconductor equipment book-to-bill ratio was 1.2 for the month of September 2009, increasing from the December 2008 book-to-bill ratio of 0.9.

Historically, a significant portion of our revenues in each quarter and year has been derived from sales to relatively few customers, and we expect this trend to continue. For the nine month period ended September 30, 2009 and for the years ended December 31, 2008, 2007 and 2006, sales to customers that individually represented at least five percent of our revenues accounted for 50.4%, 36.3%, 37.1%, and 40.9% of our revenues, respectively.

We do not have purchase contracts with any of our customers that obligate them to continue to purchase our products, and they could cease purchasing products from us at any time. A delay in purchase or cancellation by any of our large customers could cause quarterly revenues to vary significantly. In addition, during a given quarter, a significant portion of our revenues may be derived from the sale of a relatively small number of systems. Our transparent film measurement systems range in average selling price from approximately $250,000 to $1.0 million per system, our opaque film measurement systems range in average selling price from approximately $900,000 to $2.0 million per system and our macro-defect inspection and probe card and test analysis systems range in average selling price from approximately $250,000 to $1.4 million per system. Accordingly, a small change in the number of systems we sell may also cause significant changes in our operating results. Because fluctuations in the timing of orders from our major customers or in the number of our individual systems we sell could cause our revenues to fluctuate significantly in any given quarter or year, we do not believe that period-to-period comparisons of our financial results are necessarily meaningful, and they should not be relied upon exclusively as an indication of our future performance.

A significant portion of our revenues has been derived from customers outside of the United States. In the nine month period ended September 30, 2009, approximately 73.2% of our revenues were derived from customers outside of the United States, of which 63.6% were derived from customers in Asia and 9.6% were derived from customers in Europe. In the twelve month period ended December 31, 2008, approximately 76.5% of our revenues were derived from customers outside of the United States, of which 57.0% were derived from customers in Asia and 19.5% were derived from customers in Europe. In the twelve month period ended December 31 2007, approximately 77.1% of our revenues were derived from customers outside of the United States, of which 58.5% were derived from customers in Asia and 18.6% were derived from customers in Europe. We expect that revenues generated from customers outside of the United States will continue to account for a significant percentage of our revenues.

The sales cycle for our systems typically ranges from nine to 15 months, and can be longer when our customers are evaluating new technology. Due to the length of these cycles, we invest significantly in research and development and sales and marketing in advance of generating revenues related to these investments. Additionally, the rate and timing of customer orders may vary significantly from month to month. Accordingly, if sales of our products do not occur when we expect, our expenses and inventory levels may increase relative to revenues and total assets.

Revenues. Our revenues are primarily derived from the sale of our systems, services, spare parts and software licensing. Our revenues were $23.3 million and $49.7 million for the three and nine month periods ended September 30, 2009, compared to $39.0 million and $114.6 million for the three and nine month periods ended September 30, 2008, representing decreases of 40.2% and 56.6% in the respective year-over-year periods.

The following table lists the different sources of our revenue (dollar amounts in thousands):

                              Three Months Ended                     Nine Months Ended
                                September 30,                          September 30,
                           2009               2008                2009              2008
  Systems:
    Metrology        $    2,986    13%  $    3,886    10%   $   7,777    15%  $   19,944    17%
    Inspection           11,640    50%      23,569    60%      20,350    41%      64,659    56%
  Parts                   3,726    15%       6,568    17%       9,197    19%      15,493    14%
  Services                3,174    14%       3,824    10%       9,375    19%      10,529     9%
  Software licensing      1,804     8%       1,139     3%       3,033     6%       3,987     4%
     Total revenue   $   23,330   100%  $   38,986   100%    $ 49,732   100%   $ 114,612   100%

The year-over-year decrease in systems revenue for the nine month periods ended September 30, 2009 and 2008 is due to continued weakness in the global economy, including the overall semiconductor industry, and reflects a decrease in inspection systems revenues of $44.3 million and a decrease in metrology systems revenue of $12.2 million. Systems revenue generated by our latest product releases and major enhancements in each of our product families amounted to 43% and 34% of total revenues for the three and nine month periods ended September 30, 2009, compared to 42% of total revenues for both the three and nine month periods ended September 30, 2008. The year-over-year decrease in total parts and services revenue for the nine month periods ended September 30, 2009 and 2008 is primarily due to decreased spending by our customers due to the prolonged semiconductor industry downturn. Parts and services revenues are generated from part sales, maintenance service contracts, system upgrades, as well as time and material billable service calls. The year-over-year increase in software licensing revenues for the three month periods ended September 30, 2009 and 2008 is primarily due to the Adventa acquisition.

Deferred revenues of $5.9 million are recorded in other current liabilities at September 30, 2009 and primarily consist of $2.6 million for deferred maintenance agreements and $3.3 million for systems awaiting acceptance and outstanding deliverables.

Gross Profit. Our gross profit has been and will continue to be affected by a variety of factors, including manufacturing efficiencies, product sales mix, production volume, inventory step-up from purchase accounting, excess and obsolete inventory write-offs, pricing by competitors or suppliers, new product introductions, customization and reconfiguration of systems, international and domestic sales mix, and parts and service margins. Our gross profit was $9.5 million and $17.2 million for the three and nine month periods ended September 30, 2009, compared to $16.8 million and $49.6 million for the three and nine month periods ended September 30, 2008. Our gross profit represented 40.6% and 34.5% of our revenues for the three and nine month periods ended September 30, 2009 and 43.1% and 43.3% of our revenues for the same periods in the prior year. The decrease in gross profit as a percentage of revenue for the three and nine month periods ended September 30, 2009, compared to the three and nine month periods ended September 30, 2008 is primarily due to product mix, volume, and idle manufacturing facility costs.

Research and Development. Our research and development expense was $6.4 million and $19.2 million for the three and nine month periods ended September 30, 2009, compared to $8.3 million and $24.6 million for the same periods in the prior year. Research and development expense represented 27.5% and 38.6% of our revenues for the three and nine month periods ended September 30, 2009, compared to 21.4% of revenues for both the three and nine month periods in the prior year. The year-over-year dollar decrease for each of the three and nine month periods ended September 30, 2009 and 2008 in research and development expenses primarily reflects reduced compensation cost and lower project costs as part of our continued cost reduction efforts, offset by an increase in litigation expenses and expenses related to the activities of the Adventa acquisition.

Selling, General and Administrative. Our selling, general and administrative expense was $8.3 million and $22.4 million for the three and nine month periods ended September 30, 2009, compared to $7.9 million and $27.5 million for the same periods in the prior year. Selling, general and administrative expense represented 35.5% and 45.1% of our revenues for the three and nine month periods ended September 30, 2009 compared to 20.3% and 24.0% of our revenues for the same periods in the prior year. The year-over-year dollar decrease for the nine month periods ended September 30, 2009 and 2008 in selling, general and administrative expense was primarily due to the elimination of administrative costs associated with prior business combinations, and lower compensation costs in the 2009 period, offset by a reserve established for an account receivable related to a customer that is in financial difficulty and expenses related to the Adventa acquisition.

In reaction to the slowdown in the semiconductor industry, which began in early 2008, the Company has reduced ongoing operating expense by approximately 18%. The Company currently anticipates that operating expenses in the fourth quarter of 2009 will be approximately $14.3 to $15.3 million.

Interest income and other, net. Interest income and other, net was $29 thousand and $0.2 million for the three and nine month periods ended September 30, 2009, compared to $0.3 million and $0.8 million for the same periods in the prior year. The year-over-year decrease in interest income and other, net was primarily attributable to lower average cash balances and lower interest rates in the 2009 periods.

Income Taxes. For the three and nine month periods ended September 30, 2009, we recorded income tax benefits of $0.7 million and $1.7 million, as compared to $0.4 million and $2.7 million for the comparable periods in 2008. The income tax benefits recognized for the three and nine months ended September 30, 2009 resulted primarily from projected tax refunds due from the carryback of current losses.

Each quarter we assess the likelihood that we will be able to recover our deferred tax assets. We consider available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. As a result of our analysis, we concluded that it is more likely than not that substantially all of our net deferred tax assets will not be realized. Therefore, we continue to provide a valuation allowance against these net deferred tax assets. A portion of our net deferred tax assets relate to R&D credits which are reserved for in our FASB ASC 740 provision. We closely monitor available evidence, and may reverse some or all of the valuation allowance in future periods, if appropriate.

Liquidity and Capital Resources

At September 30, 2009, we had $61.1 million of cash, cash equivalents and marketable securities and $126.5 million in working capital. At December 31, 2008, we had $78.3 million of cash, cash equivalents and marketable securities and $147.7 million in working capital.

Typically during periods of revenue growth, changes in accounts receivable and inventories represent a use of cash as we incur costs and expend cash in advance of receiving cash from our customers. Similarly, during periods of declining revenue, changes in accounts receivable and inventories represent a source of cash as inventory purchases decline and revenue from prior periods is collected.

Operating activities used $12.1 million in cash and cash equivalents for the nine month period ended September 30, 2009. The net cash and cash equivalents used in operating activities during the nine month period ended September 30, 2009 was primarily a result of net loss, adjusted to exclude the effect of non-cash operating charges, of $12.7 million, an increase in accounts receivable of $6.5 million, and a decrease of other current liabilities of $0.4 million, partially offset by a decrease in inventory of $6.5 million and an increase in accounts payable and accrued liabilities of $1.4 million. Operating activities provided $11.3 million in cash and cash equivalents for the nine month period ended September 30, 2008. The net cash and cash equivalents provided by operating activities during the nine month period ended September 30, 2008 was primarily a result of net loss, adjusted to exclude the effect of non-cash charges of $8.7 million, and decreases in accounts receivable of $13.5 million, partially offset by increases in prepaid expenses and other assets of $6.4 million, inventories of $3.3 million and a decrease in accounts payable and accrued liabilities of $1.6 million.

Net cash and cash equivalents used in investing activities during the nine month period ended September 30, 2009 of $4.6 million was due to purchases of marketable securities of $10.0 million, the acquisition costs for a business combination of $5.0 million and capital expenditures of $0.3 million, partially offset by proceeds from sales of marketable securities of $10.9 million. Net cash and cash equivalents provided by investing activities during the nine month period ended September 30, 2008 of $1.3 million was due to proceeds from sales of marketable securities of $20.5 million, partially offset by acquisition costs for business combinations of $8.5 million, purchases of marketable securities of $8.2 million, and capital expenditures of $2.5 million.

Net cash and cash equivalents provided by financing activities of $0.1 million for both the nine month periods ended September 30, 2009 and 2008 was due to proceeds received for sales of shares through share-based compensation plans.

From time to time we evaluate whether to acquire new or complementary businesses, products and/or technologies. We may fund all or a portion of the purchase price of these acquisitions in cash, stock, or a combination of cash and stock. On January 22, 2008, we announced that we had acquired all intellectual property and selected assets from privately-held RVSI Inspection, LLC, headquartered in Hauppauge, New York, and on August 3, 2009, we announced that we had acquired Adventa Control Technologies, Inc., headquartered in Plano, Texas. We accounted for these acquisitions as business combinations.

In July 2008, our Board of Directors approved a stock repurchase program of up to 3 millio n shares of Company common stock. As of the time of filing this Quarterly Report on Form 10-Q, we have not purchased any shares under this program.

Our future capital requirements will depend on many factors, including the timing and amount of our revenues and our investment decisions, which will affect our ability to generate additional cash. We believe that our existing cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash requirements for working capital and capital expenditures for the next twelve months. Thereafter, if cash generated from operations and financing activities is insufficient to satisfy our working capital requirements, we may seek additional funding through bank borrowings, sales of securities or other means. There can be no assurance that we will be able to raise any such capital on terms acceptable to us or at all.