UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended November 29, 2008

or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 0-17276

FSI INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

MINNESOTA		41-1223238
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
3455 Lyman Boulevard, Chaska, Minnesota		55318
(Address of principal executive offices)		(Zip Code)

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

þ YES     o NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o YES     þ NO

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

Common Stock, no par value — 31,160,000 shares outstanding as of January 7, 2009

 

 

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

		PAGE NO.
PART I. FINANCIAL STATEMENTS
Item 1. Condensed Consolidated Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of November 29, 2008 and August 30, 2008			3
Condensed Consolidated Statements of Operations for the quarters ended November 29, 2008 and November 24, 2007			5
Condensed Consolidated Statements of Cash Flows for the quarters ended November 29, 2008 and November 24, 2007			6
Notes to the Condensed Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 3. Quantitative and Qualitative Disclosures About Market Risk			22
Item 4. Controls and Procedures			23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			23
Item 1.A. Risk Factors			24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			24
Item 3. Defaults upon Senior Securities			24
Item 4. Submission of Matters to a Vote of Security Holders			24
Item 5. Other Information			24
Item 6. Exhibits			24
SIGNATURE			25
EX-31.1
EX-31.2
EX-32.1

PART I. ITEM 1. FINANCIAL STATEMENTS

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
NOVEMBER 29, 2008 AND AUGUST 30, 2008

(unaudited)
(in thousands)

ASSETS

		November 29,				August 30,
		2008				2008
Current assets:
Cash and cash equivalents		$	11,046			$	14,788
Restricted cash			662				275
Marketable securities			75				850
Trade accounts receivable, net of allowance for doubtful accounts of $107 and $128, respectively			6,109				9,614
Inventories			28,356				27,169
Other receivables			4,824				4,813
Prepaid expenses and other current assets			3,318				3,339
Total current assets			54,390				60,848
Property, plant and equipment, at cost			76,260				79,076
Less accumulated depreciation and amortization			(58,926	)			(60,810	)
Property, plant and equipment, net			17,334				18,266
Restricted cash			—				500
Long-term marketable securities			6,247				6,447
Investment			460				460
Intangible assets, net of accumulated amortization of $14,355 and $14,294, respectively			—				61
Other assets			1,071				1,071
Total assets		$	79,502			$	87,653

(continued)

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
NOVEMBER 29, 2008 AND AUGUST 30, 2008
(continued)
(unaudited)
(in thousands)

LIABILITIES AND STOCKHOLDERS’ EQUITY

		November 29,				August 30,
		2008				2008
Current liabilities:
Trade accounts payable		$	4,610			$	4,305
Accrued expenses			8,886				10,392
Current portion of capital lease obligations			618				841
Customer deposits			10				7
Deferred profit			2,358				3,867
Total current liabilities			16,482				19,412
Long-term accrued expenses			489				583
Stockholders’ equity:
Preferred stock, no par value; 9,700 shares authorized; none issued and outstanding			—				—
Series A Junior Participating Preferred Stock, no par value; 300 shares authorized; none issued and outstanding			—				—
Common stock, no par value; 50,000 shares authorized; 30,839 shares issued and outstanding			226,352				226,352
Accumulated deficit			(165,284	)			(159,967	)
Accumulated other comprehensive loss			(910	)			(997	)
Other stockholders’ equity			2,373				2,270
Total stockholders’ equity			62,531				67,658
Total liabilities and stockholders’ equity		$	79,502			$	87,653

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS ENDED NOVEMBER 29, 2008 AND NOVEMBER 24, 2007

(unaudited)
(in thousands, except per share amounts)

		November 29,				November 24,
		2008				2007
Sales		$	12,244			$	22,439
Cost of goods sold			7,617				13,836
Gross margin			4,627				8,603
Selling, general and administrative expenses			5,657				6,735
Research and development expenses			4,393				4,286
Operating loss			(5,423	)			(2,418	)
Interest expense			(17	)			(36	)
Interest income			132				300
Other (loss) income, net			(20	)			35
Loss before income taxes			(5,328	)			(2,119	)
Income taxes			(11	)			13
Net loss		$	(5,317	)		$	(2,132	)
Net loss per common share:
Basic		$	(0.17	)		$	($0.07	)
Diluted		$	(0.17	)		$	(0.07	)
Weighted average common shares — basic			30,839				30,545
Weighted average common shares — diluted			30,839				30,545

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE QUARTERS ENDED NOVEMBER 29, 2008 AND NOVEMBER 24, 2007

(unaudited)
(in thousands)

		November 29,				November 24,
		2008				2007
OPERATING ACTIVITIES:
Net loss		$	(5,317	)		$	(2,132	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock compensation expense			109				137
Depreciation			937				942
Amortization			61				109
Changes in operating assets and liabilities:
Restricted cash			113				(1	)
Accounts receivable			3,505				(3,151	)
Inventories			(1,187	)			4,252
Prepaid expenses and other current assets			10				12
Trade accounts payable			305				277
Accrued expenses			(1,605	)			(757	)
Customer deposits			3				(1,046	)
Deferred profit			(1,510	)			168
Net cash used in operating activities			(4,576	)			(1,190	)
INVESTING ACTIVITIES:
Capital expenditures			(5	)			(23	)
Purchase of marketable securities			—				(27,925	)
Sale of marketable securities			975				28,625
Net cash provided by investing activities			970				677
FINANCING ACTIVITIES:
Principal payments on capital lease			(223	)			(136	)
Net cash used in financing activities			(223	)			(136	)
Effect of exchange rates on cash			87				(176	)
Decrease in cash and cash equivalents			(3,742	)			(825	)
Cash and cash equivalents at beginning of period			14,788				15,040
Cash and cash equivalents at end of period		$	11,046			$	14,215

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

(1) Description of Business and Summary of Significant Accounting Policies

     Description of Business

     FSI International, Inc. (the “Company”) is a global supplier of surface conditioning equipment (process equipment that is used to etch and clean organic and inorganic materials from the surfaces of a silicon wafer), and technology and support services for microelectronics manufacturing. The Company’s broad portfolio of batch and single-wafer cleaning products includes process technologies for immersion (a method used to clean silicon wafers by immersing the wafers in multiple tanks filled with process chemicals), spray (sprays chemical mixtures, water and nitrogen in a variety of sequences on to the microelectronic substrate), vapor (utilizes gas phase chemistries to selectively remove sacrificial surface films) and CryoKinetic (a momentum transfer process used to remove non-chemically bonded particles from the surface of a microelectronic device). The Company’s support services programs provide product and process enhancements to extend the life of installed FSI equipment.

     The Company’s customers include microelectronics manufacturers located throughout North America, Europe, Japan and the Asia-Pacific region.

     Condensed Consolidated Financial Statements

     The accompanying condensed consolidated financial statements have been prepared by the Company without audit and reflect all adjustments (consisting only of normal and recurring adjustments, except as disclosed in the notes) which are, in the opinion of management, necessary to present a fair statement of the results for the interim periods presented. The condensed consolidated financial statements have been prepared in accordance with the regulations of the Securities and Exchange Commission (“SEC”) but omit certain information and footnote disclosures necessary to present the financial statements in accordance with accounting principles generally accepted in the United States of America. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 30, 2008, previously filed with the SEC.

     Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that could affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

     New Accounting Pronouncements

     In September, 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and requires additional disclosures about fair value measurements. This statement applies only to fair value measurements that are already required or permitted by other accounting standards, except for measurements of share-based payments and measurements that are similar to, but not intended to be, fair value. This statement is expected to increase the consistency of fair value measurements, but imposes no requirements for additional fair-value measures in financial statements. The provisions under SFAS No. 157 were adopted by the Company in the first quarter of fiscal 2009. See Note 9 of the Notes to Condensed Consolidated Financial Statements for the disclosure of the impact from the adoption of this pronouncement.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     In February 2007, the FASB issued SFAS No.159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 amends SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 was adopted by the Company in the first quarter of fiscal 2009. The Company does not measure any of its financial instruments at fair value as permitted under SFAS 159.

     In December 2007, the FASB issued SFAS 141 (revised 2007) (“SFAS 141R”), “Business Combinations,” and SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements,” to improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements, respectively. The provisions of SFAS 141R and SFAS 160 are effective for the Company beginning in the first quarter of fiscal 2010. The Company is still evaluating the impact the adoption of these pronouncements will have on its consolidated financial statements.

(2) Inventories

          Inventories are summarized as follows (in thousands):

		November 29,				August 30,
		2008				2008
Finished products		$	1,999			$	1,999
Work-in-process			11,578				9,319
Subassemblies			4,986				4,992
Raw materials and purchased parts			9,793				10,859
		$	28,356			$	27,169

(3) Accrued Expenses

     Accrued expenses are summarized as follows (in thousands):

		November 29,				August 30,
		2008				2008
Salaries and benefits		$	2,130			$	1,934
Vacation			1,526				1,582
Realignment			1,325				1,991
Product warranty			2,442				2,757
Other			1,463				2,128
		$	8,886			$	10,392

     See Note 8 of the Notes to Condensed Consolidated Financial Statements for discussion related to the realignment accrual.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(4) Supplementary Cash Flow Information

     The following summarizes supplementary cash flow items (in thousands):

		Quarters Ended
		November 29,				November 24,
		2008				2007
Income taxes received		$	(17	)		$	(5	)
Interest paid			—				36

(5) Comprehensive Loss

     Other comprehensive loss pertains to revenues, expenses, gains and losses that are not included in the net loss but rather are recorded directly in stockholders’ equity. For the quarters ended November 29, 2008 and November 24, 2007, other comprehensive loss consisted of the foreign currency translation adjustment. The components of comprehensive loss are summarized as follows (in thousands):

		Quarters Ended
		November 29,				November 24,
		2008				2007
Net loss		$	(5,317	)		$	(2,132	)
Items of other comprehensive income (loss):
Foreign currency translation			87				(177	)
Comprehensive loss		$	(5,230	)		$	(2,309	)

(6) Stock-Based Compensation

     Stock-based compensation expense for new stock options granted or vested under the Company’s stock incentive plans and employee stock purchase plan was reflected in the condensed consolidated statements of operations for the first quarter of each of fiscal 2009 and 2008 as follows (in thousands):

		Quarters Ended
		November 29,				November 24,
		2008				2007
Cost of goods sold		$	10			$	2
Selling, general and administrative			79				112
Research and development			20				23
		$	109			$	137

     The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing method. The Company uses historical data to estimate the expected price volatility, the expected option life and the expected forfeiture rate. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The Company has not made any dividend payments nor does it expect to pay dividends in the foreseeable future. There were no options granted during the first quarter of fiscal 2008 and 5,000 options were granted in the first quarter of fiscal 2009.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     The following assumptions were used to estimate the fair value of options granted during the first quarter of fiscal 2009 using the Black-Scholes option-pricing model:

		Quarter Ended
		November 29,
		2008
Stock options:
Volatility			71.0	%
Risk-free interest rates			2.2	%
Expected option life			5.4
Stock dividend yield			—

A summary of our option activity for the first quarter of fiscal 2009 is as follows (in thousands, except price per share and contractual term):

										Weighted-
						Weighted-				average
						average				Remaining				Aggregate
		Number of				Exercise Price				Contractual				Intrinsic
		Shares				Per Share				Term				Value
Outstanding as of August 30, 2008			3,679			$	6.58
Options granted			5				1.17
Options forfeited			(10	)			3.06
Options expired			(14	)			6.78
Options exercised			—				—
Outstanding as of November 29, 2008			3,660			$	6.58				4.3				—
Exercisable as of November 29, 2008			3,285			$	7.07				3.8				—

     The intrinsic value for options outstanding or exercisable as of November 29, 2008 was zero, as the closing price of the Company’s stock at the end of the first quarter of fiscal 2009 was less than the exercise price of the options outstanding or exercisable.

     A summary of the status of our unvested option shares as of November 29, 2008 is as follows (in thousands except fair value amounts):

						Weighted-average
		Number of				Grant-Date Fair
		Shares				Value
Unvested at August 30, 2008			428			$	1.51
Options granted			5				0.72
Options forfeited			(10	)			1.92
Options vested			(48	)			1.94
Unvested at November 29, 2008			375			$	1.43

     As of November 29, 2008, there was $450,000 of total unrecognized compensation cost related to unvested share-based compensation granted under our plans. That cost is expected to be recognized over a weighted-average period of 0.9 years. The total fair value of option shares vested during the first quarters of fiscal 2009 and fiscal 2008 was $109,000 and $137,000, respectively.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(7) Product Warranty

     Warranty provisions and claims for the quarters ended November 29, 2008 and November 24, 2007 were as follows (in thousands):

		November 29, 2008				November 24, 2007
Beginning balance — warranty accrual		$	2,757			$	3,811
Warranty provisions			101				465
Warranty claims			(416	)			(443	)
Ending balance — warranty accrual		$	2,442			$	3,833

(8) Cost Reductions and Realignment

     In fiscal 2008, the Company committed to a plan to reduce its headcount by approximately 60 positions, or about 14% of the Company’s global workforce from the end of the third quarter of fiscal 2008. The plan was implemented in September 2008. In conjunction with the staff reductions, the Company’s European and United States sales and service organizations were consolidated to better support the customer base in these regions. Also, the Company refocused its remaining Allen, Texas and Chaska, Minnesota-based engineering resources toward products which the Company believes will provide the most significant opportunity for near-term revenue and future market share gains. A total of 63 positions were eliminated in September 2008 of which 19 were manufacturing positions, 19 were sales, service and marketing positions, five were administration positions and 20 were engineering positions. Severance and outplacement costs recorded in fiscal 2008 were allocated as follows: $1,314,000 to selling, general and administrative expense, $536,000 to research and development expense and $142,000 to cost of goods sold.

     The fiscal 2008 severance and outplacement costs are summarized as follows (in thousands):

						Amount Paid
		Amount				Through				Accrual at
		Charged				November 29,				November 29,
		Fiscal 2008				2008				2008
Selling, general and administrative expenses		$	1,314			$	269			$	1,045
Research and development expenses			536				283				253
Cost of goods sold			142				115				27
Total severance and outplacement costs		$	1,992			$	667			$	1,325

(9) Marketable Securities and Impairment of Investment

     As of November 29, 2008, the Company had investments in taxable auction rate securities (“ARS”) reported at a fair value of $6.3 million after reflecting a $0.4 million other than temporary impairment against $6.7 million par value. The other than temporary impairment has been recorded in other expense in fiscal 2008. The Company valued the majority of ARS using a mark-to-model approach that relies on discounted cash flows, market data and inputs derived from similar instruments. This model takes into account, among other variables, the base interest rate, credit spreads, downgrade risks and default/recovery risk, the estimated time required to work out the disruption in the traditional auction process and its effect on liquidity, and the effects of insurance and other credit enhancements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     The ARS held by the Company are marketable securities with long-term stated maturities for which the interest rates are reset through a Dutch auction every 28 days. The auctions have historically provided a liquid market for these securities as investors historically could readily sell their investments at auction. Due to the liquidity issues experienced in global credit and capital markets, the ARS held by the Company have experienced multiple failed auctions, beginning on February 19, 2008, as the amount of securities submitted for sale has exceeded the amount of purchase orders. During fiscal 2008, $0.8 million of the ARS held by the Company were partially redeemed. An additional $1.0 million were redeemed in the first quarter of fiscal 2009 and an additional $0.3 million were redeemed in December 2008.

     All of the ARS held by the Company continue to carry investment grade ratings and have not experienced any payment defaults. Of the ARS held by the Company, $6.6 million in par value are backed by student loans and are collateralized, insured and guaranteed by the United States Federal Department of Education and are classified as long-term. In the first quarter of fiscal 2009, an issuer of certain of these ARS offered to repurchase such ARS in a conditional tender offer received by the Company in October 2008 from the issuer. The tender offer expired December 4, 2008 without meeting the minimum participation requirements. ARS that did not successfully auction, reset to the maximum interest rate as prescribed in the underlying indenture and all of the Company’s holdings continue to be current with their interest payments. If uncertainties in the credit and capital markets continue, these markets deteriorate further or any ARS the Company holds are downgraded by the rating agencies, the Company may be required to recognize additional impairment charges.

     SFAS No. 157 defines and establishes a framework for measuring fair value and expands disclosure about fair value measurements. Furthermore, SFAS No. 157 specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect the Company’s own assumptions of market participant valuation (unobservable inputs). The Company valued its ARS based on level 3 inputs in which values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These level 3 inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset.

(10) Contingencies

     In late calendar 2006, the Company determined that certain of its replacement valves, pumps and heaters could fall within the scope of United States export licensing regulations to products that could be used in connection with chemical weapons processes. The Company determined that these regulations require it to obtain licenses to ship some of its replacement spare parts, spare parts kits and assemblies to customers in certain controlled countries as defined in the export licensing regulations. During the second quarter of fiscal 2007, the Company was granted licenses to ship replacement spare parts, spare parts kits and assemblies to all customers in the controlled countries where the Company conducts business.

     The applicable export licensing regulations frequently change. Moreover, the types and categories of products that are subject to export licensing are often described in the regulations in general terms and could be subject to differing interpretations.

     In the second quarter of fiscal 2007, the Company made a voluntary disclosure to the United States Department of Commerce to clarify its licensing practices and to review its practices with respect to prior sales of certain replacement valves, pumps and heaters to customers in several controlled countries as defined in the licensing regulations.

     The United States Department of Commerce could assess penalties for any past violation of export control regulations. The potential penalties are dependent upon the number of shipments in violation of the export control regulations. The penalties can range from zero to $50,000 per violation. Management believes that the resolution of this matter will not have a material adverse impact to the Company’s consolidated financial condition. The licenses that were granted during the second quarter of fiscal 2007 do not necessarily mitigate the Company’s risk with respect to past violations.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(11) Share Repurchase Plan

     In October 2008, the Company authorized the repurchase of up to $3 million of the Company’s common stock to be effected from time to time in transactions in the public markets or in private purchases. The timing and extent of any repurchases will depend upon market conditions, the trading price of the Company’s shares and other factors, subject to the restrictions relating to volume, price and timing of share repurchases under applicable law. The repurchase program may be modified, suspended or terminated at any time by the Company without notice. The Company did not repurchase any of its common stock during the first quarter of fiscal 2009.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     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 for the second 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 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 December 2008 revised downward its semiconductor demand forecast for calendar 2008 and 2009. Gartner now predicts that demand for semiconductors will decrease approximately 4.4 percent in calendar 2008 from the $274 billion calendar 2007 level. Gartner attributes the decline primarily to lower memory device demand. Quarterly memory system orders have now declined 82 percent from the calendar 2007 first quarter run rate to the calendar 2008 third quarter run rate. Gartner is forecasting a 16.3 percent decrease in demand for semiconductors in calendar 2009 from calendar 2008, as Gartner expects consumer and corporate demand for microelectronics 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 2008 is expected to decrease approximately 31 percent, when compared to the $36 billion calendar 2007 level. In general, analysts have a mixed view on how significant the calendar 2009 forecasted total equipment spending will decline; however, most are forecasting another significant year-over-year decline as semiconductor manufacturers’ factory utilization rates continue to decline. Gartner is currently forecasting that total wafer fabrication equipment spending will decrease 33 percent in calendar 2009 as compared to calendar 2008.

     We do not expect to see much of an investment in capital spending by device manufacturers in calendar 2009. Indeed, many device manufacturers remain cautious toward placing new orders; in addition, we expect to continue to receive requests from device manufacturers to provide evaluation systems or extended payment terms as they deal with the current credit crunch.

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 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 trade 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, including intangible 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 $17.3 million as of November 29, 2008.

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

     Considerable management judgment is necessary in estimating future cash flows and other factors affecting the valuation of long-lived assets, including intangible assets, 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.

     We did not recognize any impairment charges for our long-lived assets, including intangible assets, during the first quarters 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 six months 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.

Inventory Provisions Estimation

     We record reserves for inventory shrinkage and for potentially excess, obsolete and slow moving inventory. These reserves 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 $10.8 million, have disposed of approximately $6.8 million of POLARIS system product inventory and have recorded additional reserves of $1.8 million. The original cost of POLARIS system product inventory available for sale or to be disposed of as of November 29, 2008 that has been written down to zero was approximately $8.7 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. We collected receivables of $21,000 in the first quarter of fiscal 2009 and $67,000 in the first quarter of fiscal 2008 that had previously been written down to zero, resulting in credits to selling, general and administrative expenses.

   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 those shares expected to vest. The assumptions used in calculating the fair value of stock-based awards and the forfeiture rate of such awards reflect management’s best estimates. However, circumstances may change and additional data may become available over time, which could result in changes to these assumptions that materially impact the fair value determination of future awards or their estimated rate of forfeiture.

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 for all 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. The accrual for unrecognized benefits decreased by $11,000 for the first quarter of fiscal 2009 and zero for the first quarter of fiscal 2008.

FIRST QUARTER OF FISCAL 2009 COMPARED WITH FIRST QUARTER OF FISCAL 2008

The Company

     The following table sets forth for the fiscal quarter indicated, certain income and expense items as a percent of our total sales.

		Percent of Sales
		November 29,				November 24,
First quarter ended:		2008				2007
Sales			100.0	%			100.0	%
Cost of goods sold			62.2				61.7
Gross profit			37.8				38.3
Selling, general and administrative			46.2				30.0
Research and development			35.9				19.1
Operating loss			(44.3	)			(10.8	)
Other income, net			0.8				1.3
Loss before income taxes			(43.5	)			(9.5	)
Income taxes			(0.1	)			—
Net loss			(43.4	%)			(9.5	%)

Sales Revenues and Shipments

     Sales revenues decreased to $12.2 million for the first quarter of fiscal 2009 as compared to $22.4 million for the first quarter of fiscal 2008. The decrease related primarily to industry and overall global economic conditions. The decreases occurred in all regions with the most significant decrease occurring in European sales where sales decreased 78% in the first quarter of fiscal 2009 from the first quarter of fiscal 2008. International sales were $9.3 million, representing 76% of total sales during the first quarter of fiscal 2009 and $19.1 million, representing 85% of total sales, during the first quarter of fiscal 2008.

     Shipments were $9.6 million in the first quarter of fiscal 2009 as compared to $20.7 million in the first quarter of fiscal 2008.

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

     We currently expect second quarter of fiscal 2009 revenues to be between $11 and $14 million.* In order to achieve this revenue level, we will need to receive several system orders that can be shipped and recognized as revenue in the second quarter.*

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 was 37.8% for the first quarter of fiscal 2009 compared to 38.3% for the first quarter of fiscal 2008. The decrease in gross margin was primarily related to a decrease in capacity utilization of manufacturing related to the decline in shipments. This was partially offset by a change in product mix in which the sale of spare parts and service represented 42% of our total sales in the first quarter of fiscal 2009 as compared to 29% of our total sales in the first quarter of fiscal 2008, as spare parts and service generally have higher margins.

     Gross profit margins are expected to be 40% to 42% of revenues for the second quarter of fiscal 2009.* We anticipate improved capacity utilization as a result of expected higher shipments in the second quarter of fiscal 2009 as compared to the first quarter of fiscal 2009.*

Selling, General and Administrative Expenses

     Selling, general and administrative expenses were $5.7 million in the first quarter of fiscal 2009 and $6.7 million in the first quarter of fiscal 2008. The decrease related primarily to cost reduction initiatives associated with reductions in headcount taken in the first quarter of fiscal 2009. For additional information regarding these initiatives, see Note 8 of the Notes to Condensed Consolidated Financial Statements.

     We expect selling, general and administrative expenses in the second quarter of fiscal 2009 to be in the range of $5.6 to $5.8 million as we continue to focus on managing costs.*

Research and Development Expenses

     Research and development expenses were $4.4 million for the first quarter of fiscal 2009 and $4.3 million for the first quarter of fiscal 2008. The increase related primarily to new product and process development expenses. The majority of our research and development investment is focused on expanding the application capabilities of our products, supporting customer evaluations and continuous improvement programs for our products and services.

     We expect research and development expenses to range from $4.1 to $4.3 million for the second quarter of fiscal 2009.* This reflects the engineering resources required to support customer demonstrations, evaluation tool placements and our ORION^® System introduction initiative.

Income Taxes

     We recorded an income tax benefit of $11,000 in the first quarter of fiscal 2009 and income tax expense of $13,000 in the first quarter of fiscal 2008.

     Our net deferred tax assets on the balance sheet as of November 29, 2008 have been fully reserved for 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 $169.2 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

     The net loss was $5.3 million in the first quarter of fiscal 2009 as compared to a net loss of $2.1 million in the first quarter of fiscal 2008.

     Assuming that we can achieve the projected revenues, gross margin and operating expense levels, we expect to report a net loss between $4.0 and $5.5 million in the second quarter of fiscal 2009.*

Liquidity and Capital Resources

     Our cash, restricted cash, cash equivalents and marketable securities were approximately $18.0 million as of November 29, 2008, a decrease of $4.8 million from the end of fiscal 2008. The decrease was due primarily to $4.6 million of net cash used for operations.

     As of November 29, 2008, we had investments in auction rate securities (“ARS”) reported at a fair value of $6.3 million after reflecting a $0.4 million other than temporary impairment against $6.7 million par value. The other than temporary impairment was recorded in other expense for fiscal 2008. We value the majority of our ARS using a mark-to-model approach that relies on discounted cash flows, market data and inputs derived from similar instruments. This model takes into account, among other variables, the base interest rate, credit spreads, downgrade risks and default/recovery risk, the estimated time required to work out the disruption in the traditional auction process and its effect on liquidity, and the effects of insurance and other credit enhancements.

     The ARS we hold are marketable securities with long-term stated maturities for which the interest rates are reset through a Dutch auction every 28 days. The auctions have historically provided a liquid market for these securities as investors historically could readily sell their investments at auction. Due to the liquidity issues experienced in global credit and capital markets, the ARS held by us have experienced multiple failed auctions, beginning on February 19, 2008, as the amount of securities submitted for sale has exceeded the amount of purchase orders. During fiscal 2008, $0.8 million of ARS were partially redeemed. An additional $1.0 million were redeemed in the first quarter of fiscal 2009 and an additional $0.3 million were redeemed in December 2008.

     All of the ARS held by us continue to carry investment grade ratings and have not experienced any payment defaults. Of the ARS held by us, $6.6 million par value are backed by student loans and are collateralized, insured and guaranteed by the United States Federal Department of Education and are classified as long-term. In the first quarter of fiscal 2009, an issuer of certain of these ARS offered to repurchase such ARS in a conditional tender offer received by us in October 2008 from the issuer. The tender offer expired December 4, 2008 without meeting the minimum participation requirements. ARS that did not successfully auction reset to the maximum interest rate as prescribed in the underlying indenture and all of our holdings continue to be current with their interest payments. If uncertainties in the credit and capital markets continue, these markets deteriorate further or any ARS we hold are downgraded by the rating agencies, we may be required to recognize additional impairment charges.

     In addition, these ARS may not provide the liquidity to us as we need it, and it could take until the final maturity of the underlying notes (from 5 to 35 years) to realize our investments’ recorded value. Currently, there is a very limited market for any of these securities and future liquidations at this time, if possible, would likely be at a significant discount.

     Accounts receivable decreased $3.5 million from the end of fiscal 2008. The decrease in accounts receivable related primarily to the decrease in shipments to $9.6 million in the first quarter of fiscal 2009 as compared to $13.1 million in the fourth quarter of fiscal 2008. Accounts receivable will fluctuate quarter to quarter depending on individual customers’ timing of shipping dates and payment terms.

     Inventory was approximately $28.4 million at November 29, 2008 and $27.2 million at the end of fiscal 2008. The increase in inventory related primarily to an increase in work-in-process inventory associated with anticipated demonstration tool and new product placement orders. Inventory provisions were $15.9 million at the end of fiscal 2008 and remained the same at the end of the first quarter of fiscal 2009.

     Trade accounts payable increased to $4.6 million as of November 29, 2008 as compared to $4.3 million at the end of fiscal 2008. The increase in trade accounts payable related primarily to the timing of inventory receipts and payments to vendors.

     As of November 29, 2008, our current ratio of current assets to current liabilities was 3.3 to 1.0, and working capital was $37.9 million.

     The following table provides aggregate information about our contractual payment obligations and the periods in which payments are due (in thousands):

		Payments due by period
						Less than 1												More than 5
Contractual Obligations:		Total				Year				1-3 years				3-5 years				years
Operating lease obligations		$	1,338			$	815			$	505			$	18			$	—
Capital lease obligations			640				640								—				—
Purchase obligations			3,161				3,161				—				—				—
Royalty obligations			143				143				—				—				—
Other long-term commitments (1)			1,625				125				500				500				500
Total		$	6,907			$	4,884			$	1,005			$	518			$	500

     The contractual obligations table does not include $0.5 million of accruals for unrecognized tax benefits, as the timing of payments or reversals is uncertain.

     Capital expenditures were $5,000 in the first quarter of fiscal 2009, as compared to $23,000 in the first quarter of fiscal 2008. We expect capital expenditures to be less than $300,000 in the second quarter of fiscal 2009.* Depreciation and amortization for the second quarter of fiscal 2009 is expected to be between $0.9 and $1.0 million.*

     In October 2008, we authorized the use of up to $3 million of our cash to repurchase outstanding shares of our common stock to be effected from time to time in transactions in the public markets or in private purchases. The timing and extent of any repurchases will depend upon market conditions, the trading price of our shares and other factors, subject to the restrictions relating to volume, price and timing of share repurchases under applicable law. The repurchase program may be modified, suspended or terminated at any time by us without notice. We did not repurchase any of our common stock during the first quarter of fiscal 2009.

     We anticipate using $5.0 to $6.5 million of net cash for operations in the second quarter of fiscal 2009.* This is dependent upon the timing of shipments, timely accounts receivable collections and successful inventory, accounts payable and capital investment management. We believe that with existing cash, restricted cash, cash equivalents and marketable securities, there will be sufficient funds to meet our projected working capital and cash requirements through at least fiscal 2009.* We believe that success in our industry requires substantial capital to maintain the flexibility to take advantage of opportunities as they arise. One of our strategic objectives is, as market and business conditions warrant, to consider divestitures, investments or acquisitions of businesses, products or technologies. We may fund such activities with additional equity or debt financing. The sale of additional equity or debt securities, whether to maintain flexibility or to meet strategic objectives, could result in additional dilution to our shareholders. We currently do not have a line of credit arrangement.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

New Accounting Pronouncements

     In September 2006, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and requires additional disclosures about fair-value measurements. This Statement applies only to fair-value measurements that are already required or permitted by other accounting standards, except for measurements of share-based payments and measurements that are similar to, but not intended to be, fair value. This statement is expected to increase the consistency of fair value measurements, but imposes no requirements for additional fair-value measures in financial statements. The provisions under SFAS No. 157 were effective for us beginning in the first quarter of fiscal 2009. See Note 9 of the Notes to Condensed Consolidated Financial Statements for a discussion of the impact on us due to the adoption of this pronouncement.

     In February 2007, the FASB issued SFAS No.159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 amends SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 was effective for us beginning in the first quarter of fiscal 2009. We do not measure any of our financial instruments at fair value as permitted under SFAS 159.

     In December 2007, the FASB issued SFAS 141 (revised 2007) (“SFAS 141R”), “Business Combinations,” and SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements,” to improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements, respectively. The provisions of SFAS 141R and SFAS 160 are effective for us beginning in the first quarter of fiscal 2010. We are still evaluating the impact the adoption of these pronouncements will have on our consolidated financial statements.

ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Our cash flows and earnings are subject to fluctuations in foreign exchange rates due to investments in foreign-based subsidiaries. As of November 29, 2008, our investments included 100% interests in our sales and service offices located in Europe and Asia and a 20% interest in Apprecia Technology, Inc. (formerly known as m•FSI LTD), which operates as a distributor for us in Japan. We denominate the majority of our sales outside of the U.S. in U.S. dollars.

     We have direct sales, service and applications support and logistics responsibilities for our products in Europe and the Asia Pacific region and incur labor, service and other expenses in foreign currencies. As a result, we may be exposed to fluctuations in foreign exchange rate risks. As of November 29, 2008, we had not entered into any hedging activities and our foreign currency transaction gains and losses for the first quarter of fiscal 2009 were insignificant. We are currently evaluating various hedging activities and other options to minimize these risks.

     We do not have significant exposure to changing interest rates as we currently have no long-term debt. As of November 29, 2008, amortized cost approximated market value for all outstanding marketable securities. We do not undertake any specific actions to cover our exposure to interest rate risk and we are not party to any interest rate risk management transactions. The impact on loss before income taxes of a 1% change in short-term interest rates would be approximately $180,000 based on cash, restricted cash, cash equivalents and marketable securities balances as of November 29, 2008.

     As of November 29, 2008, our investment portfolio included ARS reported at a fair value of $6.3 million after reflecting a $0.4 million other than temporary impairment against $6.7 million par value. ARS are usually found in the form of municipal bonds, preferred stock, a pool of student loans or collateralized debt obligations. The interest rates of our ARS are reset every 28 days through an auction process and at the end of each reset period, investors can sell or continue to hold the securities at par.

     Of the ARS held by us, $6.6 million par value are backed by student loans and are collateralized, insured and guaranteed by the United States Federal Department of Education. All ARS held by us are rated by the major independent rating agencies and carry investment grade ratings and have not experienced any payment defaults.

     All of our ARS have experienced failed auctions due to sell orders exceeding buy orders. These failures are not believed to be a credit issue, but rather reflect a lack of liquidity in the market for these securities. Under the contractual terms, the issuer is obligated to pay penalty interest rates should an auction fail. In the event we need to access funds associated with failed auctions, they are not expected to be accessible until a successful auction occurs, the issuer redeems the issue, a buyer is found outside of the auction process or the underlying securities have matured and are paid upon maturity in accordance with their terms.

     We determined and recorded an other than temporary impairment of approximately $0.4 million in fiscal 2008. If the issuers of the ARS are unable to successfully close future auctions or do not redeem the ARS, or the United States government fails to support its guaranty of the obligations, we may be required to record additional impairment charges.

ITEM 4. CONTROLS AND PROCEDURES

     As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on this evaluation, the principal executive officer and the principal financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

     In late calendar 2006, we determined that certain of our replacement valves, pumps and heaters could fall within the scope of United States export licensing regulations to products that could be used in connection with chemical weapons processes. We determined that these regulations require us to obtain licenses to ship some of our replacement spare parts, spare parts kits and assemblies to customers in certain controlled countries as defined in the export licensing regulations. During the second quarter of fiscal 2007, we were granted licenses to ship replacement spare parts, spare parts kits and assemblies to all customers in the controlled countries where we currently conduct business.

     The applicable export licensing regulations frequently change. Moreover, the types and categories of products that are subject to export licensing are often described in the regulations in general terms and could be subject to differing interpretations.

     In the second quarter of fiscal 2007, we made a voluntary disclosure to the United States Department of Commerce to clarify our licensing practices and to review our practices with respect to prior sales of certain replacement valves, pumps and heaters to customers in several controlled countries as defined in the licensing regulations.

     The United States Department of Commerce could assess penalties for any past violation of export control regulations. The potential penalties are dependent upon the number of shipments in violation of the export control regulations. The penalties can range from zero to $50,000 per violation. We believe

that the resolution of this matter will not have a material adverse impact on our consolidated financial condition. The licenses that were granted during the second quarter of fiscal 2007 do not necessarily mitigate our risk with respect to past violations.

ITEM 1.A. Risk Factors

     There have not been any material changes from the risk factors previously disclosed in our Form 10-K for the fiscal year ended August 30, 2008.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

               None

ITEM 3. Defaults upon Senior Securities

               None

ITEM 4. Submission of Matters to a Vote of Security Holders

               None

ITEM 5. Other Information

               None

ITEM 6. Exhibits

(a) Exhibits
2.1		Agreement and Plan of Reorganization, dated as of January 21, 1999 among FSI International, Inc., BMI International, Inc. and YieldUP International Corporation (3)
2.2		Agreement and Plan of Reorganization by and Among FSI International, Inc., Spectre Acquisition Corp., and Semiconductor Systems, Inc. (1)
2.3		Asset Purchase Agreement dated as of June 9, 1999 between FSI International, Inc. and The BOC Group, Inc. (4)
3.1		Restated Articles of Incorporation of the Company. (2)
3.2		Restated and amended By-Laws. (6)
3.5		Articles of Amendment of Restated Articles of Incorporation (5)
31.1		Certification by Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(filed herewith)
31.2		Certification by Principal Financial and Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(filed herewith)
32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(filed herewith)

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		FSI INTERNATIONAL, INC.
		[Registrant]
DATE: January 8, 2009
		By:		/s/ Patricia M. Hollister
		Patricia M. Hollister,
		Chief Financial Officer
		on behalf of the
		Registrant and as
		Principal Financial and Accounting Officer

INDEX TO EXHIBITS

Exhibit		Description		Method of Filing
2.1		Agreement and Plan of Reorganization, dated as of January 21, 1999 among FSI International, Inc., BMI International, Inc. and YieldUP International Corporation (3)		Incorporated by reference.
2.2		Agreement and Plan of Reorganization by and Among FSI International, Inc., Spectre Acquisition Corp., and Semiconductor Systems, Inc. (1)		Incorporated by reference.
2.3		Asset Purchase Agreement dated as of June 9, 1999 between FSI International, Inc. and The BOC Group, Inc. (4)		Incorporated by reference.
3.1		Restated Articles of Incorporation of the Company. (2)		Incorporated by reference.
3.2		Restated and amended By-Laws. (6)		Incorporated by reference.
3.5		Articles of Amendment of Restated Articles of Incorporation (5)		Incorporated by reference.
31.1		Certification by Principal Executive Officer Pursuant to section 302 of the Sarbanes-Oxley Act of 2002.		Filed herewith.
31.2		Certification by Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.		Filed herewith.
32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.		Filed herewith.