UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2010

\| \|	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: 000-23576

STRASBAUGH

(Exact name of registrant as specified in its charter)

California

(State or other jurisdiction

of incorporation or organization)

825 Buckley Road, San Luis Obispo, California

(Address of principal executive offices)

77-0057484

(I.R.S. Employer

Identification No.)

93401

(Zip Code)

(805) 541-6424

(Registrant’s telephone number, including area code)

Not applicable.

(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. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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.

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of July 31, 2010, there were 14,705,587 shares of the issuer’s common stock issued and outstanding.

CAUTIONARY STATEMENT

All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements or characterizations of historical fact, are “forward-looking statements.” Examples of forward-looking statements include, but are not limited to, statements concerning projected net sales, costs and expenses and gross margins; our accounting estimates, assumptions and judgments; the demand for our products; the competitive nature of and anticipated growth in our industry; and our prospective needs for additional capital. These forward-looking statements are based on our current expectations, estimates, approximations and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by such words as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similar expressions and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are set forth in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2009, which could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. These forward-looking statements speak only as of the date of this report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, except as otherwise required by law.

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TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

		Page
Item 1.	Financial Statements		1

	Condensed Consolidated Balance Sheets as of June 30, 2010 (unaudited) and December 31, 2009 (audited)		1

	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and 2009 (unaudited)		2

	Condensed Consolidated Statement of Redeemable Convertible Preferred Stock and Shareholders’ Deficit for the Six Months Ended June 30, 2010 (unaudited)		3

	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009 (unaudited)		4

	Notes to Condensed Consolidated Financial Statements for the Three and Six Months Ended June 30, 2010 (unaudited)		5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		24

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		34

Item 4.	Controls and Procedures		34

Item 4T.	Controls and Procedures		34

PART II
OTHER INFORMATION
Item 1.	Legal Proceedings		35

Item 1A.	Risk Factors		35

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		35

Item 3.	Defaults Upon Senior Securities		35

Item 4.	(Removed and Reserved)		35

Item 5.	Other Information		35

Item 6.	Exhibits		36

Signatures			36

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ITEM 1. FINANCIAL STATEMENTS

STRASBAUGH AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

AS OF JUNE 30, 2010 (UNAUDITED) AND DECEMBER 31, 2009 (AUDITED)

(In thousands, except share data)

ASSETS

	June 30,		December 31,
	2010		2009
CURRENT ASSETS	(unaudited)
Cash and cash equivalents	$	1,095	$	1,240
Accounts receivable, net of allowance for doubtful accounts of $13 at June 30, 2010 and December 31, 2009		4,302		3,298
Inventories		2,031		5,256
Prepaid expenses		196		287
		7,624		10,081
PROPERTY, PLANT, AND EQUIPMENT		2,066		2,046
OTHER ASSETS
Capitalized intellectual property, net of accumulated amortization of $86 at June 30, 2010 and $82 at December 31, 2009		361		402
Other assets		24		28
		385		430
TOTAL ASSETS	$	10,075	$	12,557

LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ DEFICIT
CURRENT LIABILITIES
Accounts payable	$	848		$	1,323
Accrued expenses		2,972			2,379
Customer deposits		168			3,997
Deferred revenue		36			48
		4,024			7,747
OTHER LIABILITIES
Preferred stock related embedded derivative and warrants		170			4
		4,194			7,751
COMMITMENTS AND CONTINGENCIES (Notes 6, 7, 8 and 9)
REDEEMABLE CONVERTIBLE PREFERRED STOCK
Redeemable convertible preferred stock (“Series A”), no par value, $15,593 aggregate preference in liquidation at June 30, 2010, 5,909,089 shares authorized, 5,909,089 shares issued and outstanding		12,531			11,203
SHAREHOLDERS’ DEFICIT
Preferred stock, no par value, 9,090,911 shares authorized, zero shares issued and outstanding		—			—
Common stock, no par value, 100,000,000 shares authorized, 14,705,587 and 14,705,587 issued and outstanding at June 30, 2010 and December 31, 2009, respectively		56			56
Additional paid-in capital		22,640			23,776
Accumulated deficit		(29,346	)		(30,229	)
		(6,650	)		(6,397	)
TOTAL LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ DEFICIT	$	10,075		$	12,557

The accompanying notes are an integral part of these statements.

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STRASBAUGH AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 AND 2009 (Unaudited)

(In thousands, except per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
	(unaudited)						(unaudited)
REVENUES
Tools	$	3,755		$	589		$	9,600		$	1,086
Parts and Service		2,252			1,206			3,690			2,216
NET REVENUES		6,007			1,795			13,290			3,302
COST OF SALES
Tools		2,631			458			6,198			772
Parts and Service		793			608			1,774			1,314
TOTAL COST OF SALES		3,424			1,066			7,972			2,086
GROSS PROFIT		2,583			729			5,318			1,216
OPERATING EXPENSES
Selling, general and administrative expenses		1,381			820			3,088			1,780
Research and development		770			1,026			1,403			1,986
		2,151			1,846			4,491			3,766
INCOME (LOSS) FROM OPERATIONS		432			(1,117	)		827			(2,550	)
OTHER INCOME (EXPENSE)
Rental income		117			144			213			292
Interest income		1			2			1			6
Interest expense		(5	)		(6	)		(10	)		(11	)
(Loss) gain on change in value of embedded derivative and warrants (Note 2)		(119	)		(49	)		(166	)		1,559
Other income (expense), net		26			(19	)		20			(31	)
		20			72			58			1,815
INCOME (LOSS) BEFORE INCOME TAXES		452			(1,045	)		885			(735	)
INCOME TAX BENEFIT (EXPENSE)		—			14			(2	)		13
NET INCOME (LOSS)	$	452		$	(1,031	)	$	883		$	(722	)
NET INCOME (LOSS) PER COMMON SHARE
Basic (Note 1)	$	(0.02	)	$	(0.11	)	$	(0.03	)	$	(0.13	)
Diluted (Note 1)	$	(0.02	)	$	(0.11	)	$	(0.03	)	$	(0.13	)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic		14,706			14,202			14,706			14,202
Diluted		14,706			14,202			14,706			14,202

The accompanying notes are an integral part of these statements.

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STRASBAUGH AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENT OF REDEEMABLE CONVERTIBLE PREFERRED STOCK

AND SHAREHOLDERS’ DEFICIT FOR THE SIX MONTHS ENDED JUNE 30, 2010 (Unaudited)

(In thousands, except share data)

																			Total
																			Shareholders’
																			Deficit and
	Redeemable																		Redeemable
	Convertible												Additional						Convertible
	Preferred Stock				Preferred Stock				Common Stock				Paid-in			Accumulated			Preferred
	Shares		Amount		Shares		Amount		Shares		Amount		Capital			Deficit			Stock
Balance, December 31, 2009		5,909,089	$	11,203		—	$	—		14,705,587	$	56	$	23,776		$	(30,229	)	$	4,806

Net income																	883			883
Stock-based compensation expenses		—		—		—		—		—		—		192			—			192
Accretion of redeemable convertible preferred stock		—		715		—		—		—		—		(715	)		—			—
Preferred stock dividend accumulated		—		613		—		—		—		—		(613	)		—			—
Balance, June 30, 2010		5,909,089	$	12,531		—	$	—		14,705,587	$	56	$	22,640		$	(29,346	)	$	5,881

The accompanying notes are an integral part of these statements.

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STRASBAUGH AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009 (Unaudited)

(In thousands)

	Six Months Ended June 30,
	2010			2009
	(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	883		$	(722	)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Depreciation and amortization		172			187
Change in inventory reserve		(2	)		51
Non-cash interest expense		10			11
Stock-based compensation		192			181
Loss (gain) on embedded derivative (Note 2)		148			(1,374	)
Loss (gain) on warrants (Note 2)		18			(185	)
Intellectual property impairment loss		51			—
Losses on sales of investment securities		—			6
Changes in assets and liabilities:
Accounts receivable		(1,004	)		644
Inventories		3,227			135
Prepaid expenses, deposits and other assets		95			55
Accounts payable		(475	)		(598	)
Accrued expenses		583			(19	)
Deferred revenue		(12	)		(20	)
Customer deposits		(3,829	)		2,094
Net Cash Provided By Operating Activities		57			446
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from the sale of investment securities		—			294
Purchase of property and equipment		(186	)		(114	)
Capitalized cost for intellectual property		(16	)		(33	)
Net Cash (Used In) Provided By Investing Activities		(202	)		147
NET CHANGE IN CASH AND CASH EQUIVALENTS		(145	)		593
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		1,240			49
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	1,095		$	642

The accompanying notes are an integral part of these statements.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies

Organization and Description of Business

The condensed consolidated financial statements include the accounts of Strasbaugh, a California corporation formerly known as CTK Windup Corporation (“Strasbaugh”), and its wholly-owned subsidiary, R. H. Strasbaugh, a California corporation (“R. H. Strasbaugh,” and together with Strasbaugh, the “Company”). All material inter-company accounts and transactions have been eliminated in the consolidation.

The Company designs, manufactures, markets and sells precision surfacing systems and solutions for the global semiconductor and semiconductor equipment, silicon wafer and silicon wafer equipment, data storage, micro-electromechanical system (“MEMS”), light emitting diode (“LED”) and precision optics markets. Products are sold to customers throughout the United States, Europe, and Asia and Pacific Rim countries.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC” or the “Commission”) and therefore do not include all information and footnotes necessary for a complete presentation of the financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America, or US GAAP.

The unaudited condensed consolidated financial statements do, however, reflect all adjustments, consisting of only normal recurring adjustments, which are, in the opinion of management, necessary to state fairly the financial position as of June 30, 2010 and the results of operations and cash flows for the related interim periods ended June 30, 2010 and 2009. However, these results are not necessarily indicative of results for any other interim period or for the year. It is suggested that the accompanying condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

Estimates and Assumptions

The preparation of financial statements in accordance with US GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of increases and decreases in revenues and expenses during the reporting periods. Actual results could differ from those estimates and those differences could be material. Significant estimates include the fair value of the Company’s common stock and the fair value of options, preferred stock related embedded derivatives and warrants to purchase common stock, provision for doubtful accounts receivable, inventory obsolescence, and depreciation and amortization. Certain prior year amounts in the accompanying condensed consolidated financial statements have been reclassified to conform to the current year’s presentation.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Supplemental Disclosure of Cash Flow Information

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2010		2009		2010		2009
Cash paid for income taxes	$	—	$	1,000	$	2,000	$	1,000
Fair value accretion on redeemable convertible preferred stock	$	364,000	$	312,000	$	715,000	$	613,000
Preferred stock dividend	$	310,000	$	286,000	$	613,000	$	566,000

Concentrations of Credit Risk

Financial instruments that subject the Company to credit risk consist primarily of cash, cash equivalents and trade accounts receivable. With regard to cash and cash equivalents, the Company maintains its excess cash balances in checking and money market accounts at high-credit quality financial institution(s). The Company has not experienced any significant losses in any of the short-term investment instruments we have used for excess cash balances. The Company does not require collateral on its trade receivables. Historically, the Company has not suffered significant losses with respect to trade accounts receivable. However, recent developments in the global economy and credit markets have caused unusual fluctuations in the values of various investment instruments. Additionally, these developments have, in some cases, limited the availability of credit funds that borrowers such as the Company normally utilize in day-to-day operations which could impact the timing or ultimate recovery of trade accounts. No assurances can be given that these recent developments will not negatively impact the Company’s operations as a result of concentrations of these investments.

The Company sells its products on credit terms, performs ongoing credit evaluations of its customers, and maintains an allowance for potential credit losses. During the three and six month periods ended June 30, 2010, the Company’s top 10 customers accounted for 82% and 84% of net revenues, respectively, and 65% and 59% for the three and six month periods ended June 30, 2009, respectively. Sales to major customers (over 10%) as a percentage of net revenues were 71% and 63%, for the three and six months ended June 30, 2010, respectively, and 31% and 23%, for the three and six month periods ended June 30, 2009, respectively.

A decision by a significant customer to substantially decrease or delay purchases from the Company, or the Company’s inability to collect receivables from these customers, could have a material adverse effect on the Company’s financial condition and results of operations. As of June 30, 2010, the amount due from the major customers (over 10%) discussed above represented 68% of the Company’s total accounts receivable.

Product Warranties

The Company provides limited warranty for the replacement or repair of defective products at no cost to its customers within a specified time period after the sale. The Company makes no other guarantees or warranties, expressed or implied, of any nature whatsoever as to the goods including without limitation, warranties to merchantability, fit for a particular purpose of non-infringement of patent or the like unless agreed upon in writing. The Company estimates the costs that may be incurred under its limited warranty and maintains reserves based on actual historical warranty claims coupled with an analysis of unfulfilled claims at the balance sheet date. Warranty claims costs are not material given the nature of the Company’s products and services which normally result in repairs and returns in the same accounting period.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Fair Value of Financial Assets and Liabilities

The carrying value of financial instruments approximates their fair values. The carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate fair value because of the short-term maturity of these instruments.

The Company’s assets (liabilities) measured at fair value on a recurring basis were determined using the following inputs:

	Fair Value Measurements at June 30, 2010
				Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total			(Level 1)		(Level 2)		(Level 3)
Preferred stock related embedded derivative	$	(152,000	)	$	—	$	—	$	(152,000	)
Warrants		(18,000	)		—		—		(18,000	)
Total	$	(170,000	)	$	—	$	—	$	(170,000	)

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Fair Value of Financial Assets and Liabilities (continued)

	Fair Value Measurements at December 31, 2009
				Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total			(Level 1)		(Level 2)		(Level 3)
Preferred stock related embedded derivative	$	(4,000	)	$	—	$	—	$	(4,000	)
Warrants		—			—		—		—
Total	$	(4,000	)	$	—	$	—	$	(4,000	)

Beginning January 1, 2009, the Company carried its Series A Preferred Stock related embedded derivative (the “Series A Conversion Feature”) and warrants issued to certain investors (“Investor Warrants,” described in Note 8) on its balance sheet as liabilities (see Note 2) carried at fair value determined by using the Black Scholes valuation model. As of June 30, 2010, the assumptions used in the valuation of the Series A Conversion Feature included the Series A Preferred Stock conversion price of $2.20 and in the valuation of the Investor Warrants the conversion price of $2.42, as well as the Company’s stock price of $0.75, discount rate of 0.4%, and volatility of 51%.

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Preferred Stock Related Embedded Derivative and Warrant Liabilities
	Six Months Ended
	June 30,
	2010		2009
Balance beginning of period	$	4,000	$	1,692,000
Total unrealized losses (gains)
Included in earnings		166,000		(1,559,000	)
Included in other comprehensive income		—		—
Settlements		—		—
Transfers in and/or out of Level 3		—		—
Balance end of period	$	170,000	$	133,000
The amount of total losses (gains) during period included in earnings attributable to the change in unrealized losses (gains) relating to liabilities still held at end of period	$	166,000	$	(1,559,000	)

The Company has no assets measured at fair value on a recurring basis and there are no assets or liabilities measured at fair value on a nonrecurring basis.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Segment Information

The Company’s results of operations for the three and six months ended June 30, 2010 and 2009, represent a single segment referred to as global semiconductor and semiconductor equipment, silicon wafer and silicon wafer equipment, MEMS, LED, data storage and precision optics industries. Export sales represent approximately 18% and 32% of sales for the three and six months ended June 30, 2010, respectively, and approximately 29% and 23% of sales for the three and six months ended June 30, 2009, respectively.

The geographic breakdown of the Company’s sales was as follows:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2010			2009			2010			2009
United States		82	%		71	%		68	%		77	%
Europe		4	%		22	%		5	%		8	%
Asia and Pacific Rim countries		14	%		7	%		27	%		15	%

The geographic breakdown of the Company’s accounts receivable was as follows:

	June 30,			December 31,
	2010			2009
United States		76	%		61	%
Europe		6	%		7	%
Asia and Pacific Rim countries		18	%		32	%

Cash and Cash Equivalents

For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.

Accounts Receivable

Accounts receivable are due from companies operating primarily in the global semiconductor, silicon wafer, electronics, precision optics, and aerospace industries located throughout the United States, Europe, Asia and the Pacific Rim countries. Credit is extended to both domestic and international customers based on an evaluation of the customer’s financial condition and generally collateral is usually not required. For international customers, additional evaluation steps are performed, where required, and more stringent terms, such as letters of credit, are used as necessary.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Accounts Receivable (continued)

The Company estimates an allowance for uncollectible accounts receivable. The allowance for probable uncollectible receivables is based on a combination of historical data, cash payment trends, specific customer issues, write-off trends, general economic conditions and other factors. These factors are continuously monitored by management to arrive at the estimate for the amount of accounts receivable that may be ultimately uncollectible. In circumstances where the Company is aware of a specific customer’s inability to meet its financial obligations, the Company records a specific allowance for doubtful accounts against amounts due, to reduce the net recognized receivable to the amount it reasonably believes will be collected. Management believes that the allowance for doubtful accounts at June 30, 2010 and December 31, 2009 are reasonably stated.

Revenue Recognition

The Company derives revenues principally from the sale of tools, parts and services. The Company recognizes revenue pursuant to SEC staff guidance covering revenue recognition. Revenue is recognized when there is persuasive evidence an arrangement exists, delivery has occurred or services have been rendered, the Company’s price to the customer is fixed or determinable, and collection of the related receivable is reasonably assured. Selling arrangements may include contractual customer acceptance provisions and installation of the product occurs after shipment and transfer of title. The Company recognizes revenue upon shipment of products or performance of services and defers recognition of revenue for any amounts subject to acceptance until such acceptance occurs. Provisions for the estimated future cost of warranty are recorded at the time the products are shipped.

Generally, the Company obtains a non-refundable down-payment from the customer. These fees are deferred and recognized as the tool is shipped. All sales contract fees are payable no later than 60 days after delivery and payment is not contingent upon installation. In addition, the Company’s tool sales have no right of return, or cancellation rights. Tools are typically modified to some degree to fit the needs of the customer and, therefore, once a purchase order has been accepted by the Company and the manufacturing process has begun, there is no right to cancel, return or refuse the order.

The Company has evaluated its arrangements with customers and revenue recognition policies under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-25, “Revenue Recognition-Multiple-Element Arrangements,” and determined that its components of revenue are separate units of accounting. Each unit has value to the customer on a standalone basis, there is objective and reliable evidence of the fair value of each unit, and there is no right to cancel, return or refuse an order. The Company’s revenue recognition policies for its specific units of accounting are as follows:

·	Tools – The Company recognizes revenue once a customer has visited the plant and signed off on the tool or it has met the required specifications and the tool is completed and shipped.

·	Parts – The Company recognizes revenue when the parts are shipped.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Revenue Recognition (continued)

Service – Revenue from maintenance contracts is deferred and recognized over the life of the contract, which is generally one to three years. Maintenance contracts are separate components of revenue and not bundled with our tools. If a customer does not have a maintenance contract, then the customer is billed for time and material and the Company recognizes revenue after the service has been completed.

Upgrades – The Company offers a suite of products known as “enhancements” which are generally comprised of one-time parts and/or software upgrades to existing Company and non-Company tools. These enhancements are not required for the tools to function, are not part of the original contract and do not include any obligation to provide any future upgrades. The Company recognizes revenue once these upgrades and enhancements are complete. Revenue is recognized on equipment upgrades when the Company completes the installation of the upgrade parts and/or software on the customer’s equipment and the equipment is accepted by the customer. The upgrade contracts cover a one-time upgrade of a customer’s equipment with new or modified parts and/or software. After installation of the upgrade, the Company has no further obligation on the contracts, other than standard warranty provisions.

The Company includes software in its tools. Software is considered an incidental element of the tooling contracts and only minor modifications which are incidental to the production effort may be necessary to meet customer requirements. The software is used solely in connection with operating the tools and is not sold, licensed or marketed separately. The tools and software are fully functional when the tool is completed, and after shipment, the software is not updated for new versions that may be subsequently developed and, the Company has no additional obligations relative to the software. However, software modifications may be included in tool upgrade contracts. The Company’s software is incidental to the tool contracts as a whole. The software and physical tool modifications occur and are completed concurrently. The completed tool is tested by either the customer or the Company to ensure it has met all required specifications and then accepted by the customer prior to shipment, at which point revenue is recognized. The revenue recognition requirements of FASB ASC 985-605, “Software-Revenue Recognition,” are met when there is persuasive evidence an arrangement exists, the fee is fixed or determinable, collectability is probable and delivery and acceptance of the equipment has occurred, including upgrade contracts for parts and/or software, to the customer.

Installation of a tool occurs after the tool is completed, tested, formally accepted by the customer and shipped. The Company does not charge the customer for installation nor recognize revenue for installation as it is an inconsequential or perfunctory obligation and it is not considered a separate element of the sales contract or unit of accounting. If the Company does not perform the installation service there is no effect on the price or payment terms, there are no refunds, and the tool may not be rejected by the customer. In addition, installation is not essential to the functionality of the equipment because the equipment is a standard product, installation does not significantly alter the equipment’s capabilities, and other companies are available to perform the installation. Also, the fair value of the installation service has historically been insignificant relative to the Company’s tools.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Derivative Income

In accordance with FASB ASC 815-40-15 “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions” (Note 2), the Company is required to account for the Series A Conversion Feature and Investor Warrants as derivative liabilities. The Company is required to mark to market each reporting quarter the value of the Series A Conversion Feature and Investor Warrants. The Company revalues these derivative liabilities at the end of each reporting period. The periodic change in value of the derivative liabilities is recorded as either non-cash derivative income (if the value of the Series A Conversion Feature and Investor Warrants decrease) or as non-cash derivative expense (if the value of the Series A Conversion Feature and Investor Warrants increase). Although the values of the embedded derivative and warrants are affected by interest rates, the remaining contractual conversion period and the Company’s stock volatility, the primary cause of the change in the values will be the value of the Company’s Common Stock. If the stock price goes up, the value of these derivatives will generally increase and if the stock price goes down the value of these derivatives will generally decrease.

Shipping Costs

During the three and six month periods ended June 30, 2010, freight and handling amounts billed to customers by the Company and included in revenues totaled approximately $0 and $1,000, respectively, and $3,000 and $8,000 for the three and six month periods ended June 30, 2009, respectively. Freight and handling fees incurred by the Company of approximately $10,000 and $81,000 are included in cost of sales for the three and six month periods ended June 30, 2010, respectively, and $17,000 and $29,000 for the three and six month periods ended June 30, 2009, respectively.

Foreign Currency Transactions

The accounts of the Company are maintained in U.S. dollars. Transactions denominated in foreign currencies are recorded at the rate of exchange in effect on the dates of the transactions. Balances payable in foreign currencies are translated at the current rate of exchange when settled.

Earnings Per Share

Basic net income (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of outstanding common shares for the period. The net income available is computed by subtracting the preferred shareholders’ dividend and accreted interest from net income. Diluted net income (loss) per share is computed by using the treasury stock method and dividing net income available to common stockholders plus the effect of assumed conversions (if applicable) by the weighted average number of outstanding common shares after giving effect to all potential dilutive common stock, including options, warrants, common stock subject to repurchase and convertible preferred stock, if any.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Earnings Per Share (continued)

Reconciliations of the numerator and denominator used in the calculation of basic and diluted net loss per common share are as follows:

	For The Three Months Ended						For The Six Months Ended
	June 30,						June 30,
	2010			2009			2010			2009
Numerator:
Net income (loss)	$	452,000		$	(1,031,000	)	$	883,000		$	(722,000	)
Preferred stock accretion		(364,000	)		(312,000	)		(715,000	)		(613,000	)
Preferred stock dividend		(310,000	)		(286,000	)		(613,000	)		(566,000	)
Net loss available to common shareholders – basic		(222,000	)		(1,629,000	)		(445,000	)		(1,901,000	)
Adjustment to net loss for assumed conversions		—			—			—			—
Net loss available to common shareholders – diluted	$	(222,000	)	$	(1,629,000	)	$	(445,000	)	$	(1,901,000	)

	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
	2010		2009		2010		2009
Denominator:
Shares outstanding, beginning		14,705,587		14,201,587		14,705,587		14,201,587
Weighted-average shares issued		—		—		—		—
Weighted-average shares outstanding—basic		14,705,587		14,201,587		14,705,587		14,201,587
Effect of dilutive securities		—		—		—		—
Weighted-average shares outstanding—diluted		14,705,587		14,201,587		14,705,587		14,201,587

Shares of common stock issuable pursuant to the Series A Preferred Stock totaling 5,909,089 and 1,271,797 shares issuable pursuant to outstanding warrants for the three and six months ended June 30, 2010 and 2009, and shares issuable upon exercise of outstanding stock options totaling 432,046 and 1,327,416 as of June 30, 2010 and 2009, respectively, are excluded from the computation of diluted loss per common share because the Company had a net loss available to common shareholders for the periods and to include the representative share increments would be anti-dilutive. Accordingly, for the three and six months ended June 30, 2010 and 2009, basic and diluted net loss per common share is computed based solely on the weighted average number of shares of common stock outstanding during the period.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Income Taxes and Deferred Income Taxes

Income taxes are provided for the effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the basis of certain assets and liabilities for financial and income tax reporting. Deferred taxes are classified as current or noncurrent depending on the classification of the assets and liabilities to which they relate. Deferred taxes arising from temporary differences that are not related to an asset or liability are classified as current or noncurrent, depending on the periods in which the temporary differences are expected to reverse. A valuation allowance is established when necessary to reduce deferred tax assets if it is more likely than not that all, or some portion of, such deferred tax assets will not be realized.

Series A Preferred Stock and Warrants

The Company evaluates its Series A Preferred Stock and Warrants (as defined in Note 8) on an ongoing basis considering the provisions of FASB ASC Topic 480, “Distinguishing Liabilities from Equity” which establishes standards for issuers of financial instruments with characteristics of both liabilities and equity related to the classification and measurement of those instruments The Series A Preferred Stock Conversion Feature and Warrants are evaluated considering the provisions of FASB ASC Topic 815, “Derivatives and Hedging,” which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities, considering FASB ASC 815-40, “Derivatives and Hedging-Contracts in Entity’s Own Equity.”

Impacts of New Accounting Pronouncements

In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements, (amendments to FASB ASC Topic 605, Revenue Recognition)” and ASU 2009-14, “Certain Arrangements That Include Software Elements, (amendments to FASB ASC Topic 985, Software).” ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company does not expect adoption of ASU 2009-13 or ASU 2009-14 to have a material impact on the Company’s consolidated results of operations or financial condition.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 1 – Summary of Significant Accounting Policies (continued)

Impacts of New Accounting Pronouncements (continued)

In June 2009, the FASB issued guidance included in ASC 810-10-30, “Consolidation-Overall-Initial Measurement.” This guidance is a revision to pre-existing guidance pertaining to the consolidation and disclosures of variable interest entities. Specifically, it changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. This guidance will require a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements. This guidance was effective for the Company on January 1, 2010 and the adoption of this guidance did not have a material impact on the Company’s consolidated results of operations or financial condition.

In June 2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument (Or an Embedded Feature) is Indexed to an Entity’s Own Stock,” which was primarily codified into FASB ASC 815-40, “Derivatives and Hedging-Contracts in Entity’s Own Equity.” The guidance provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. This guidance was effective for financial statements issued for fiscal years beginning after December 15, 2008. Early application was not permitted. Implementation of this guidance has had a significant impact on the Company’s financial condition and results of operations (See Note 2).

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 2 – Implementation of FASB ASC 815-40-15 “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions”

In June 2008, the FASB ratified guidance included in ASC 815-40-15 “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions,” which provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. ASC 815-40-15 contains provisions describing conditions when an instrument or embedded feature would be considered indexed to an entity’s own stock for purposes of evaluating the instrument or embedded feature under FASB ASC Topic 815 “Derivatives and Hedging,” which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts.

As a result of the settlement provisions in the Series A Conversion Feature and the application of ASC 815-40-15, effective January 1, 2009, the Series A Conversion Feature was required to be bifurcated from its host and accounted for as a derivative instrument. Also, as a result of the settlement provision in the Investor Warrants and the application of ASC 815-40-15, effective January 1, 2009, the Investor Warrants were required to be accounted for as derivative instruments. Accordingly, effective January 1, 2009, the Series A Conversion Feature and Investor Warrants are recognized as liabilities in the Company’s consolidated balance sheet.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 2 – Implementation of FASB ASC 815-40-15 “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions” (continued)

The cumulative effect of this change in accounting principle was recognized as an adjustment to the opening balance of the Company’s equity on January 1, 2009. The Series A Preferred Stock host remains classified in temporary equity and stated at its fair value and the fair value of the Series A Conversion Feature is bifurcated from the host instrument and recognized as a liability on the Company’s consolidated balance sheet. In addition, the Investor Warrants are recognized at fair value as a liability on the Company’s consolidated balance sheet. The fair value of the conversion feature, the warrants and other issuance costs of the Series A Preferred Stock financing transaction, are recognized as a discount to the Series A Preferred Stock host. The discount is accreted to the Series A Preferred Stock host from paid in capital, over the period from the issuance date through the earliest redemption date of the Series A Preferred Stock.

The following table illustrates the changes to the Company’s consolidated balance sheet resulting from the implementation of ASC 815-40-15 effective January 1, 2009:

	Balance December 31, 2008			Cumulative Effect Adjustment			Balance January 1, 2009

Preferred stock related embedded derivative	$	—		$	1,493,000		$	1,493,000
Warrants	$	—		$	199,000		$	199,000
Series A preferred stock	$	11,964,000		$	(3,191,000	)	$	8,733,000
Additional paid-in capital	$	26,803,000		$	(1,138,000	)	$	25,665,000
Accumulated deficit	$	(32,186,000	)	$	2,637,000		$	(29,549,000	)

The fair values of the Series A Conversion Feature, included in the “Preferred stock related embedded derivative” liability and the Investor Warrants included in the “Warrants” liability, on the Company’s consolidated balance sheet at January 1, 2009, were estimated using the Black-Scholes model to be $1,493,000 and $199,000, respectively.

At June 30, 2009, the Company determined that, using the Black Scholes model, the fair value of the preferred stock related embedded derivative and the investor warrants had declined. Accordingly, the Company recorded a “Gain on change in value of embedded derivative and warrants” and recorded a corresponding reduction in the “Preferred stock related embedded derivative” and “Warrant” liabilities of $1,374,000, and $185,000, respectively, for the period from January 1, 2009 to June 30, 2009. The effect of the income from these derivatives on the loss from continuing operations and net loss for the six months ended June 30, 2009 was to reduce the net loss of $2,281,000 to a net loss of $722,000, and to reduce the net loss per common share from $0.24 to a net loss per common share of $0.13. For the three months ended June 30, 2009, the Company recorded a loss on the change in fair value of the embedded derivative and warrants and recorded a corresponding increase in the "Preferred stock related embedded derivative" and "Warrant" liability of $44,000 and $5,000, respectively. The effect of the expense from these derivatives on the loss from continuing operations and net loss for the three months ended June 30, 2009 was to increase the net loss of $982,000 to a net loss of $1,031,000, however, the expense had no effect on the net loss per common share.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 3 – Management’s Plans

At June 30, 2010, the Company had an accumulated deficit of approximately $29,346,000 and has reported net losses for each of its fiscal years ending December 31, 2009, 2008 and 2007. The Company has invested substantial resources in product development, which has negatively impacted its cost structure and contributed to a significant portion of its prior period losses. Additionally, the decline in the semiconductor industry during 2007, 2008 and 2009 has added to those losses as revenues declined.

Management’s plans with respect to these matters include efforts to increase revenues through the sale of existing products and new technology and continuing to reduce or control certain operating expenses. As a result of these efforts and due to some improvements in the semiconductor industry, the Company has achieved revenues of $13,290,000 and net income of $883,000 for the six months ended June 30, 2010. Management believes that the Company’s current backlog and working capital is sufficient to maintain operations in the near term and that product development can be reduced or curtailed in the future to further manage cash expenditures. There are no current plans to seek additional outside capital at this time. There are no assurances that the Company will achieve profitable operations in the future or that additional capital will be raised or obtained by the Company if cash generated from operations is insufficient to pay current liabilities.

NOTE 4 – Inventories

Inventories consist of the following:

	June 30, 2010			December 31, 2009
	(unaudited)
Parts and raw materials	$	5,198,000		$	5,593,000
Work-in-process		527,000			1,655,000
Finished goods		—			1,704,000
		5,725,000			8,952,000
Inventory reserves		(3,694,000	)		(3,696,000	)
	$	2,031,000		$	5,256,000

NOTE 5 – Property, Plant and Equipment

Property, plant and equipment consist of the following:

	June 30, 2010			December 31, 2009
	(unaudited)
Buildings and improvements	$	2,283,000		$	2,283,000
Shop and lab equipment		6,313,000			6,184,000
Transportation equipment		188,000			170,000
Furniture and fixtures		1,152,000			1,113,000
Computer equipment		2,326,000			2,326,000
		12,262,000			12,076,000
Less: accumulated depreciation and amortization		(10,196,000	)		(10,030,000	)
	$	2,066,000		$	2,046,000

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 5 – Property, Plant and Equipment (continued)

Depreciation expense totaled approximately $84,000 and $84,000 for the three month periods ended June 30, 2010 and 2009, respectively, and $166,000 and $167,000 for the six month periods ended June 30, 2010 and 2009, respectively.

NOTE 6 – Stock Compensation Plans

Share based compensation expense is measured at grant date, based on the fair value of the award, and is recognized over the employees requisite service period. The share based compensation expense for the three month periods ended June 30, 2010 and 2009 was $16,000 and $90,000, respectively, and $192,000 and $181,000 for the six month periods ended June 30, 2010 and 2009, respectively.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2010		2009		2010		2009
Selling, general and administrative	$	10,000	$	68,000	$	140,000	$	137,000
Research and development	$	3,000	$	13,000	$	29,000	$	25,000
Cost of goods sold	$	3,000	$	9,000	$	23,000	$	19,000

On July 22, 2009, the Company issued an offer to holders of outstanding stock options issued under the Company’s 2007 Share Incentive Plan (“Eligible Options”), to exchange their Eligible Options for shares of common stock of the Company on a 2 for 1 basis (the “Option Exchange Program”). The offer expired on September 25, 2009. As result of this offer, the Company accepted 1,008,000 stock options for exchange and cancellation, and issued 504,000 restricted shares of common stock on October 12, 2009. All 504,000 restricted shares fully vested on March 31, 2010, and as of that date, the value of the restricted share award was fully amortized. For the six months ended June 30, 2010, an incremental cost of $53,000 was recognized in connection with the vesting of the restricted share award.

As of June 30, 2010, there was $53,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. The cost is expected to be recognized over a weighted-average remaining recognition period of 0.4 years.

NOTE 7 – Commitments and Contingencies

Litigation

The Company is subject to various lawsuits and claims with respect to such matters as product liabilities, employment matters and other actions arising out of the normal course of business. While the effect on future financial results is not subject to reasonable estimation because considerable uncertainty exists, in the opinion of Company counsel, the ultimate liabilities resulting from such lawsuits and claims will not materially affect the financial condition or results of operations.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 7 – Commitments and Contingencies (continued)

Lease Commitments

Effective January 4, 2010, the Company entered into a new lease agreement for its manufacturing and sales facility with the chairman, president, CEO and significant shareholder of the Company. The term of the lease agreement is one year commencing January 4, 2010 and ending January 4, 2011. Under the terms of the lease, the Company pays monthly lease payments and is liable for all property taxes, insurance, repairs, and maintenance. The monthly rent is currently $84,000. Rent expense under the Company’s shareholder lease totaled approximately $250,000 and $500,000 for the three and six month periods ended June 30, 2010 and 2009, respectively.

Sublease Agreement

The Company entered into two sublease agreements with unaffiliated third parties during 2008. The first sublease agreement provided for monthly rent of approximately $24,000 and was to expire on February 28, 2010, this sublease was renewed and extended effective February 1, 2010 for an initial period of two years, and providing for monthly rent of approximately $21,000. The second subtenant closed their business and vacated the premises in June 2010. Rental income totaled approximately $117,000 and $144,000 for the three month periods ended June 30, 2010 and 2009, respectively, and $213,000 and $292,000 for the six month periods ended June 30, 2010 and 2009, respectively.

Employment Agreement Termination

On June 25, 2010, the Company terminated the employment of its President and Chief Executive Officer (“Chief Executive”). Under certain terms of the Company’s employment agreement with the Chief Executive, as a result of the termination of employment by the Company without cause, the Chief Executive is entitled to six months of his current base salary and a prorated incentive bonus for the fiscal year ending December 31, 2010, if any. As a result of these and other provisions in the Chief Executive’s employment agreement the Company has accrued and expensed approximately $171,000 during the quarter ending June 30, 2010. In addition, on June 25, 2010 the Company’s Board of Directors appointed Alan Strasbaugh, the Company’s Chairman of the Board, as the acting President and Chief Executive Officer of the Company. Mr. Strasbaugh is also a significant shareholder and landlord of the Company (see “Lease Commitments” above).

NOTE 8 – Redeemable Convertible Series A Preferred Stock

Series A Preferred Stock Financing

On May 24, 2007, immediately after the closing of the Share Exchange Transaction, the Company entered into an agreement with 21 accredited investors for the sale by it in a private offering of 5,909,089 shares of its Series A Preferred Stock at a purchase price of $2.20 per share, for gross proceeds of $13,000,000.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 8 – Redeemable Convertible Series A Preferred Stock (continued)

Series A Preferred Stock Financing (continued)

The Series A Preferred Stock ranks senior in liquidation and dividend preferences to the Company’s common stock. Holders of the Series A Preferred Stock are entitled to semi-annual cumulative dividends payable in arrears in cash in an amount equal to 8% of the purchase price per share of the Series A Preferred Stock. Each share of Series A Preferred Stock is convertible by the holder at any time after its initial issuance at an initial conversion price of $2.20 per share such that one share of common stock would be issued for each share of Series A Preferred Stock. Subject to certain exceptions, the conversion ratio is subject to customary antidilution adjustments and adjustments if the Company subsequently issues certain equity securities at a price equivalent of less than $2.20 per share. The conversion ratio is not subject to an antidilution adjustment as a result of stock option grants under the Company’s 2007 Share Incentive Plan with exercise prices lower than the conversion price of the Series A Preferred Stock. In addition, the Company has no present intention to issue equity securities at a price equivalent of less than $2.20 per share. The shares of Series A Preferred Stock are also subject to forced conversion, at a conversion price as last adjusted, anytime after May 24, 2008, if the closing price of the Company’s common stock exceeds 200% of the conversion price then in effect for 20 consecutive trading days. As of June 30, 2010, the shares of Series A Preferred Stock have not been subject to forced conversion. The holders of Series A Preferred Stock vote together as a single class with the holders of the Company’s other classes and series of voting stock on all actions to be taken by its shareholders. Each share of Series A Preferred Stock entitles the holder to the number of votes equal to the number of shares of our common stock into which each share of Series A Preferred Stock is convertible. In addition, the holders of Series A Preferred Stock are afforded numerous customary protective provisions with respect to certain actions that may only be approved by holders of a majority of the shares of Series A Preferred Stock. The Company is also required at all times to reserve and keep available out of its authorized but unissued shares of common stock, such number of shares of common stock sufficient to effect the conversion of all outstanding shares of Series A Preferred Stock. On or after May 24, 2012 the holders of then outstanding shares of our Series A Preferred Stock will be entitled to redemption rights. The redemption price is equal to the per-share purchase price of the Series A Preferred Stock, which is subject to adjustment as discussed above and in the Company’s articles of incorporation, plus any accrued but unpaid dividends. The Series A Preferred Stock contain provisions prohibiting certain conversions of the Series A Preferred Stock.

Warrants

In connection with the Series A Preferred Stock financing transaction, the Company issued to the investors five-year warrants (“Investor Warrants”) to purchase an aggregate of 886,363 shares of common stock and issued to its placement agent, B. Riley and Co. Inc. and its assignees, five-year warrants (“Placement Warrants”) to purchase an aggregate of 385,434 shares of common stock. As of June 30, 2010, the Investor Warrants and the Placement Warrants (the “Warrants”) remain outstanding and have an exercise price of $2.42 per share. The Investor Warrants became exercisable beginning 180 days after May 24, 2007 and the Placement Warrants became immediately exercisable upon issuance on May 24, 2007.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 9 – Equity

Registration Rights Agreement

The Company is obligated under a registration rights agreement related to the Series A Preferred Stock financing arrangement to file a registration statement with the Commission, registering for resale shares of common stock underlying the Series A Preferred Stock and shares of common stock underlying the Investor Warrants, issued in connection with the Series A Preferred Stock financing. The registration obligations required, among other things, that a registration statement be declared effective by the Commission on or before October 6, 2007. As the Company was unable to meet this obligation in accordance with the requirements contained in the registration rights agreement the Company entered into with the investors, the Company is required to pay to each investor liquidated damages equal to 1% per month of the amount paid by the investor for the common shares still owned by the investor on the date of the default and 1% of the amount paid by the investor for the common shares still owned by the investor on each monthly anniversary of the date of the default that occurs prior to the cure of the default. The maximum aggregate liquidated damages payable to any investor will be equal to 10% of the aggregate amount paid by the investor for the shares of the Company’s Series A Preferred Stock. Accordingly, the maximum aggregate liquidation damages that the Company would be required to pay under this provision is $1,300,000. However, the Company is not obligated to pay any liquidated damages with respect to any shares of common stock not included on the registration statement as a result of limitations imposed by the SEC relating to Rule 415 under the Securities Act.

The Company’s registration statement was declared effective by the SEC on November 6, 2008. Based on the number of shares registered and the length of the default period, the penalties and interest under the agreement were estimated and accrued at June 30, 2010 and December 31, 2009, in the amounts of $254,000 and $244,000, respectively.

NOTE 10 – Income Taxes

The Company estimates its income tax expense for interim periods using an estimated annual effective tax rate. The provision for the six months ended June 30, 2010 is a result of minimum tax payments and the benefits recognized in 2009 resulted from refunds of prior year tax payments. The Company has a valuation allowance covering its deferred tax assets, including its net operating loss carryforwards, because management believes that it is more likely than not that all, or some portion of, such deferred tax assets will not be realized.

The Company has federal and state net operating loss carryforwards of approximately $26,538,000 and $9,169,000, respectively, at June 30, 2010, which will begin to expire in 2019 for federal purposes. Annual utilization of the federal net operating loss carryforwards may be limited for federal tax purposes as a result of an Internal Revenue Code Section 382 change in ownership rules. The state net operating loss carryforwards expire at various dates through 2029. Included in the balance at June 30, 2010, are $0 of tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to taxing authorities to an earlier period. Also included in the balance at June 30, 2010, are $0 of unrecognized tax benefits that, if recognized, would impact the effective tax rate. The Company made no adjustment to its amount of unrecognized tax benefits during the six month period ended June 30, 2010.

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STRASBAUGH AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 (UNAUDITED)

NOTE 10 – Income Taxes (continued)

The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. The Company had no amount accrued for the payment of interest and penalties at June 30, 2010.

NOTE 11 – Subsequent Event

None.

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

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements for the three and six months ended June 30, 2010 and the related notes and the other financial information included elsewhere in this report. This report and our financial statements and notes to financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing our business strategies. Our actual results could differ materially from those expressed in these forward-looking statements as a result of any number of factors, including those set forth under the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2009 and elsewhere in this report. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation:

·	the projected growth or contraction in the industries within which we operate;

·	our business strategy for expanding, maintaining or contracting our presence in these markets;

·	anticipated trends in our financial condition and results of operations; and

·	our ability to distinguish ourselves from our current and future competitors.

We do not undertake to update, revise or correct any forward-looking statements.

Any of the factors described above or in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2009 could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.

Overview

We develop, manufacture, market and sell an extensive line of precision surfacing products including polishing, grinding and precision optics tools and systems, to customers in the semiconductor and semiconductor equipment, silicon wafer and silicon wafer equipment, data storage, micro-electromechanical system, light emitting diode and precision optics markets worldwide. Many of our products are used by our customers in the fabrication of semiconductors and silicon wafers.

Our net revenues increased by $4,212,000, or 235%, to $6,007,000 for the three months ended June 30, 2010 as compared to $1,795,000 for the three months ended June 30, 2009 and increased by $9,988,000, or 302%, to $13,290,000 for the six months ended June 30, 2010 as compared to $3,302,000 for the six months ended June 30, 2009. We reported net income of $452,000 for the three months ended June 30, 2010 as compared to a net loss of $1,031,000 for the three months ended June 30, 2009 and net income of $883,000 for the six months ended June 30, 2010 as compared to a net loss of $722,000 for the six months ended June 30, 2009. Excluding the non-cash losses totaling $166,000 and the non-cash gains totaling $1,559,000, for the six months ended June 30, 2010 and 2009, respectively, on our preferred stock related embedded derivative and warrants, our net income increased by $3,330,000 during the six months ended June 30, 2010 compared to the same period in 2009. Our financial performance during the three and six months ended June 30, 2010 improved significantly over the same periods in 2009 as the semiconductor industry began showing signs of recovery in late 2009 from the slowdown that began in 2007, and as we began receiving and fulfilling orders for our new product offerings. As a result of the industry slowdown, we experienced a substantial decline in tool system sales as customers delayed major purchasing decisions during 2009. We believe that the semiconductor industry is poised for additional growth throughout the remainder of 2010. Our priority over the next several months is to continue to find ways to strengthen our balance sheet and conserve cash for working capital purposes.

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Implementation of Financial Accounting Standards Board Accounting Standards Codification 815-40-15 “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions”

In June 2008, the Financial Accounting Standards Board, (“FASB” ratified guidance included in Accounting Standards Codification (“ASC”) 815-40-15 “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions,” which provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. ASC 815-40-15 contains provisions describing conditions when an instrument or embedded feature would be considered indexed to an entity’s own stock for purposes of evaluating the instrument or embedded feature under FASB ASC Topic 815 “Derivatives and Hedging,” which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts.

As a result of the settlement provisions in our Series A Preferred Stock related embedded derivative (the “Series A Conversion Feature”) and the application of ASC 815-40-15, effective January 1, 2009, the Series A Conversion Feature was required to be bifurcated from its host and accounted for as a derivative instrument. Also, as a result of the settlement provision in warrants issued to certain investors (“Investor Warrants” described in Note 8 of our condensed consolidated financial statements) and the application of ASC 815-40-15, effective January 1, 2009, the Investor Warrants were required to be accounted for as derivative instruments. Accordingly, effective January 1, 2009, our Series A Conversion Feature and Investor Warrants are recognized as liabilities in our consolidated balance sheet.

The cumulative effect of this change in accounting principle was recognized as an adjustment to the opening balance of our equity on January 1, 2009. The Series A Preferred Stock host remains classified in temporary equity and stated at its fair value and the fair value of the Series A Conversion Feature is bifurcated from the host instrument and recognized as a liability on our consolidated balance sheet. In addition, the Investor Warrants are recognized at fair value as a liability on our consolidated balance sheet. The fair value of the conversion feature, the warrants and other issuance costs of the Series A Preferred Stock financing transaction, are recognized as a discount to the Series A Preferred Stock host. The discount is accreted to the Series A Preferred Stock host from our paid in capital, over the period from the issuance date through the earliest redemption date of the Series A Preferred Stock.

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The following table illustrates the changes to our consolidated balance sheet resulting from the implementation of ASC 815-40-15 effective January 1, 2009:

	Balance December 31, 2008			Cumulative Effect Adjustment			Balance January 1, 2009

Preferred stock related embedded derivative	$	—		$	1,493,000		$	1,493,000
Warrants	$	—		$	199,000		$	199,000
Series A preferred stock	$	11,964,000		$	(3,191,000	)	$	8,733,000
Additional paid-in capital	$	26,803,000		$	(1,138,000	)	$	25,665,000
Accumulated deficit	$	(32,186,000	)	$	2,637,000		$	(29,549,000	)

The fair values of the Series A Conversion Feature, included in the “Preferred stock related embedded derivative” liability and the Investor Warrants included in the “Warrants” liability, on our consolidated balance sheet at January 1, 2009, were estimated using the Black-Scholes model to be $1,493,000 and $199,000, respectively.

At June 30, 2009, we determined that, using the Black Scholes model, the fair value of the preferred stock related embedded derivative and the investor warrants had declined. Accordingly, we recorded a “Gain on change in value of embedded derivative and warrants” and recorded a corresponding reduction in the “Preferred stock related embedded derivative” and “Warrant” liabilities of $1,374,000, and $185,000, respectively, for the period from January 1, 2009 to June 30, 2009. The effect of the income from these derivatives on the loss from continuing operations and net loss for the six months ended June 30, 2009 was to reduce the net loss of $2,281,000 to a net loss of $722,000, and to reduce the net loss per common share from $0.24 to a net loss per common share of $0.13. For the three months ended June 30, 2009, we recorded a loss on the change in fair value of the embedded derivative and warrants and recorded a corresponding increase in the "Preferred stock related embedded derivative" and "Warrant" liability of $44,000 and $5,000, respectively. The effect of the expense from these derivatives on the loss from continuing operations and net loss for the three months ended June 30, 2009 was to increase the net loss of $982,000 to a net loss of $1,031,000, however, the expense had no effect on the net loss per common share.

Critical Accounting Policies

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe that the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our financial statements:

Revenue Recognition. We derive revenues principally from the sale of tools, parts and services. We recognize revenue pursuant to guidance issued by the staff of the Securities and Exchange Commission, or SEC, covering revenue recognition. Revenue is recognized when there is persuasive evidence an arrangement exists, delivery has occurred or services have been rendered, our price to the customer is fixed or determinable, and collection of the related receivable is reasonably assured. Selling arrangements may include contractual customer acceptance provisions and installation of the product occurs after shipment and transfer of title. We recognize revenue upon shipment of products or performance of services and defer recognition of revenue for any amounts subject to acceptance until such acceptance occurs. Provisions for the estimated future cost of warranty are recorded at the time the products are shipped.

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Generally, we obtain a non-refundable down-payment from the customer. These fees are deferred and recognized as the tool is shipped. All sales contract fees are payable no later than 60 days after delivery and payment is not contingent upon installation. In addition, our tool sales have no right of return, or cancellation rights. Tools are typically modified to some degree to fit the needs of the customer and, therefore, once a purchase order has been accepted by us and the manufacturing process has begun, there is no right to cancel, return or refuse the order.

We have evaluated our arrangements with customers and revenue recognition policies under FASB ASC 605-25, “Revenue Recognition-Multiple-Element Arrangements,” and determined that our components of revenue are separate units of accounting. Each unit has value to the customer on a standalone basis, there is objective and reliable evidence of the fair value of each unit, and there is no right to cancel, return or refuse an order. Our revenue recognition policies for our specific units of accounting are as follows:

·	Tools – We recognize revenue once a customer has visited the plant and signed off on the tool or it has met the required specifications and the tool is completed and shipped.

·	Parts – We recognize revenue when the parts are shipped.

Service – Revenue from maintenance contracts is deferred and recognized over the life of the contract, which is generally one to three years. Maintenance contracts are separate components of revenue and not bundled with our tools. If a customer does not have a maintenance contract, then the customer is billed for time and material and we recognize revenue after the service has been completed.

Upgrades – We offer a suite of products known as “enhancements” which are generally comprised of one-time parts and/or software upgrades to existing Strasbaugh and non-Strasbaugh tools. These enhancements are not required for the tools to function, are not part of the original contract and do not include any obligation to provide any future upgrades. We recognize revenue once these upgrades and enhancements are complete. Revenue is recognized on equipment upgrades when we complete the installation of the upgrade parts and/or software on the customer’s equipment and the equipment is accepted by the customer. The upgrade contracts cover a one-time upgrade of a customer’s equipment with new or modified parts and/or software. After installation of the upgrade, we have no further obligation on the contracts, other than standard warranty provisions.

We include software in our tools. Software is considered an incidental element of the tooling contracts and only minor modifications which are incidental to the production effort may be necessary to meet customer requirements. The software is used solely in connection with operating the tools and is not sold, licensed or marketed separately. The tools and software are fully functional when the tool is completed, and after shipment, the software is not updated for new versions that may be subsequently developed and, we have no additional obligations relative to the software. However, software modifications may be included in tool upgrade contracts. Our software is incidental to the tool contracts as a whole. The software and physical tool modifications occur and are completed concurrently. The completed tool is tested by either the customer or us to ensure it has met all required specifications and then accepted by the customer prior to shipment, at which point revenue is recognized. The revenue recognition requirements of FASB ASC 985-605, “Software-Revenue Recognition,” are met when there is persuasive evidence an arrangement exists, the fee is fixed or determinable, collectibility is probable and delivery and acceptance of the equipment has occurred, including upgrade contracts for parts and/or software, to the customer.

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Installation of a tool occurs after the tool is completed, tested, formally accepted by the customer and shipped. We do not charge the customer for installation nor recognize revenue for installation as it is an inconsequential or perfunctory obligation and it is not considered a separate element of the sales contract or unit of accounting. If we do not perform the installation service there is no effect on the price or payment terms, there are no refunds, and the tool may not be rejected by the customer. In addition, installation is not essential to the functionality of the equipment because the equipment is a standard product, installation does not significantly alter the equipment’s capabilities, and other companies are available to perform the installation. Also, the fair value of the installation service has historically been insignificant relative to our tools.

Derivative Income. In accordance with FASB ASC 815-40-15 “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions,” we are required to account for the Series A Conversion Feature and Investor Warrants as derivative liabilities. We are required to mark to market each reporting quarter the value of the Series A Conversion Feature and Investor Warrants. We revalue these derivative liabilities at the end of each reporting period. The periodic change in value of the derivative liabilities is recorded as either non-cash derivative income (if the value of the embedded derivative and investor warrants decrease) or as non-cash derivative expense (if the value of the embedded derivative and investor warrants increase). Although the values of the embedded derivative and warrants are affected by interest rates, the remaining contractual conversion period and our stock volatility, the primary cause of the change in the values will be the value of our common stock. If the stock price goes up, the value of these derivatives will generally increase and if the stock price goes down the value of these derivatives will generally decrease.

Warranty Costs. Warranty reserves are provided by management based on historical experience and expected future claims. Management believes that the current reserves are adequate to meet any foreseeable contingencies with respect to warranty claims.

Allowance for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts is based on specific identification of customer accounts and our best estimate of the likelihood of potential loss, taking into account such factors as the financial condition and payment history of major customers. We evaluate the collectability of our receivables at least quarterly. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Management believes that our current allowances for doubtful accounts are adequate to meet any foreseeable contingencies.

Inventory. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value-based upon assumptions about future demand, future pricing and market conditions. If actual future demand, future pricing or market conditions are less favorable than those projected by management, additional inventory write-downs may be required and the differences could be material. Once established, write-downs are considered permanent adjustments to the cost basis of the obsolete or unmarketable inventories.

Valuation of Intangibles. From time to time, we acquire intangible assets that are beneficial to our product development processes. We use our best judgment based on the current facts and circumstances relating to our business when determining whether any significant impairment factors exist.

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Deferred Taxes. We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. We have considered estimated future taxable income and ongoing tax planning strategies in assessing the amount needed for the valuation allowance. Based on these estimates, all of our deferred tax assets have been reserved. If actual results differ favorably from those estimates used, we may be able to realize all or part of our net deferred tax assets.

Litigation. We account for litigation losses in accordance with FASB ASC 450-20, “Contingencies-Loss Contingencies.” Under ASC 450-20, loss contingency provisions are recorded for probable losses at management’s best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount is recorded. These estimates are often initially developed substantially earlier than the ultimate loss is known, and the estimates are refined each accounting period, as additional information is known. Accordingly, we are often initially unable to develop a best estimate of loss; therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased or a best estimate can be made, resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Due to the nature of current litigation matters, the factors that could lead to changes in loss reserves might change quickly and the range of actual losses could be significant, which could adversely affect our results of operations and cash flows from operating activities.

Series A Preferred Stock and Warrants. We evaluate our Series A Preferred Stock and Warrants (as defined in Note 8 of our condensed consolidated financial statements) on an ongoing basis considering the provisions of FASB ASC Topic 480, “Distinguishing Liabilities from Equity” which establishes standards for issuers of financial instruments with characteristics of both liabilities and equity related to the classification and measurement of those instruments The Series A Preferred Stock Conversion Feature and Warrants are evaluated considering the provisions of FASB ASC Topic 815, “Derivatives and Hedging,” which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities, considering FASB ASC 815-40, “Derivatives and Hedging-Contracts in Entity’s Own Equity.”

Results of Operations

The tables presented below, which compare our results of operations from one period to another, present the results for each period, the change in those results from one period to another in both dollars and percentage change, and the results for each period as a percentage of net revenues. The columns present the following:

·	The first two data columns in each table show the absolute results for each period presented.

The columns entitled “Dollar Variance” and “Percentage Variance” show the change in results, both in dollars and percentages. These two columns show favorable changes as a positive and unfavorable changes as negative. For example, when our net revenues increase from one period to the next, that change is shown as a positive number in both columns. Conversely, when expenses increase from one period to the next, that change is shown as a negative in both columns.

·	The last two columns in each table show the results for each period as a percentage of net revenues.

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Three Months Ended June 30, 2010 Compared to the Three Months Ended June 30, 2009

												Results as a Percentage
						Dollar			Percentage			of Net Revenues for the
	Three Months Ended					Variance			Variance			Three Months Ended
	June 30,					Favorable			Favorable			June 30,
	2010		2009			(Unfavorable)			(Unfavorable)			2010			2009
	(In thousands)
Net revenues	$	6,007	$	1,795		$	4,212			235	%		100	%		100	%
Cost of sales		3,424		1,066			(2,358	)		(221	)%		57	%		59	%
Gross profit		2,583		729			1,854			254	%		43	%		41	%
Selling, general and administrative expenses		1,381		820			(561	)		(68	)%		23	%		46	%
Research and development expenses		770		1,026			256			25	%		12	%		57	%
Income (loss) from operations		432		(1,117	)		1,549			139	%		8	%		(62	)%
Total other income		20		72			(52	)		(72	)%		0	%		4	%
Income (loss) before income taxes		452		(1,045	)		1,497			143	%		8	%		(58	)%
Income tax benefit		—		14			(14	)		(100	)%		—			1	%
Net income (loss)	$	452	$	(1,031	)	$	1,483			144	%		8	%		(57	)%

Net Revenues. Net revenues increased by $4,212,000, to $6,007,000 in the second quarter of 2010 compared to the same period in 2009. Sales of tool systems increased by $3,166,000, to $3,755,000, in the second quarter of 2010 compared to $589,000 for the same period in 2009. Revenue from parts and services increased by $1,046,000, to $2,252,000 in the second quarter of 2010, compared to $1,206,000 for the same period in 2009. The low levels of revenue in the second quarter of 2009 are reflective of the slowdown in the semiconductor industry during which customers delayed major purchasing decisions.

Gross Profit. The $1,854,000 increase in gross profit as well as the rise in gross margin to 43% in the second quarter of 2010 as compared to 41% for the same period in 2009 are substantially attributable to increased sales volume as well as price increases on parts and machines. The low levels of gross profit in the second quarter of 2009 are reflective of the slowdown in the semiconductor industry during which customers delayed major purchasing decisions.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $561,000 primarily as a result of the higher level of sales commissions and operating activities in the second quarter of 2010 as compared to the same period in 2009. Salaries and wages increased in 2010 compared to 2009 primarily due to several weekly periods of plant shut-downs in 2009. Sales commissions increased approximately $112,000 in the second quarter of 2010 compared to the same period in 2009 as a result of higher sales volume in 2010. Severance costs related to the termination of an executive’s employment agreement in June 2010 totaled approximately $171,000 and contributed to the increase in the selling, general and administrative expense during the quarter.

Research and Development Expenses. The $256,000 decrease in research and development expense reflects the lower level of development effort during the second quarter of 2010 compared to the same period in 2009 as several significant projects were completed in 2009. We continue to conduct substantial on-going engineering improvements on existing product lines, as well as efforts to develop new technology. We expect that research and development spending will increase during the remainder of 2010 as we complete the work on new technologies and position ourselves to launch new products in the future.

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Other Income (Expense). The $52,000 decrease in other income was primarily due to non-cash losses from the change in value of our embedded derivative and warrants totaling $119,000 in the second quarter of 2010 as compared to losses of $49,000 in the same period in 2009.

Six Months Ended June 30, 2010 Compared to the Six Months Ended June 30, 2009

													Results as a Percentage
													of Net Revenues for the
	Six Months Ended						Dollar			Percentage			Six Months Ended
	June 30,						Variance			Variance			June 30,
	2010			2009			Favorable (Unfavorable)			Favorable (Unfavorable)			2010			2009
				(In thousands)
Net revenues	$	13,290		$	3,302		$	9,988			302	%		100	%		100	%
Cost of sales		7,972			2,086			(5,886	)		(282	)%		60	%		63	%
Gross profit		5,318			1,216			4,102			337	%		40	%		37	%
Selling, general and administrative expenses		3,088			1,780			(1,308	)		(73	)%		23	%		54	%
Research and development expenses		1,403			1,986			583			29	%		11	%		60	%
Income (loss) from operations		827			(2,550	)		3,377			132	%		6	%		(77	)%
Total other income		58			1,815			(1,757	)		(97	)%		1	%		55	%
Income (loss) before income taxes		885			(735	)		1,620			220	%		7	%		(22	)%
Income tax (expense) benefit		(2	)		13			(15	)		(115	)%		—			—
Net income (loss)	$	883		$	(722	)	$	1,605			222	%		7	%		(22	)%

Net Revenues. Net revenues increased by $9,988,000 to $13,290,000 in the first half of 2010 compared to the same period in 2009. Sales of tool systems increased by $8,514,000 to $9,600,000, in the first half of 2010 compared to $1,086,000 for the same period in 2009. Revenue from parts sales and services increased by $1,474,000 to $3,690,000, in the first half of 2010, compared to $2,216,000 for the same period in 2009. The low levels of revenues for the six months ended June 30, 2009 are reflective of the slowdown in the semiconductor industry during which customers delayed major purchasing decisions.

Gross Profit. The $4,102,000 increase in gross profit as well as the rise in gross margin to 40% in the first half of 2010 as compared to 37% for the same period in 2009 are substantially attributable to increased sales volume in 2010. The low levels of gross profit for the six months ended June 30, 2009 are reflective of the slowdown in the semiconductor industry during which customers delayed major purchasing decisions.

Selling, General and Administrative Expenses. The $1,308,000 increase in selling, general and administrative expenses is primarily a result of the higher level of sales commissions and operating activities in the first half of 2010 compared to the same period in 2009. Salaries and wages for the first half of 2010 increased over the same period in 2009 primarily due to several weekly periods of plant shut-downs in 2009 and a higher headcount in 2010. Sales commissions increased approximately $439,000 in the first half of 2010 as a result of the substantial increase in revenues compared to the same period in 2009. In addition, severance costs related to the termination of an executive’s employment agreement in June 2010 totaled approximately $171,000, and travel, consulting services, and royalty expenses increased in the first half of 2010 as compared to the same period in 2009.

Research and Development Expenses. The $583,000 decrease in research and development expense during the first half of 2010 compared to the same period in 2009 as several significant projects were completed in 2009. We continue to conduct substantial on-going engineering improvements on existing product lines, as well as efforts to develop new technology. We expect that research and development spending will increase during the second half of 2010 as we complete the work on new technologies and position ourselves to launch new products.

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Other Income (Expense). The $1,757,000 decrease in other income was primarily due to non-cash gains totaling $1,559,000 resulting from the decrease in the fair value of our preferred stock related embedded derivative and warrant liabilities during the first half of 2009 compared to the $166,000 of non-cash losses on the change in value of these derivatives during the first half of 2010.

Liquidity and Capital Resources

As of June 30, 2010, we had working capital of $3,600,000, as compared to $2,334,000 at December 31, 2009. This increase resulted primarily from our profitable operations during the first six months of 2010. Cash decreased $145,000 during the first half of 2010 primarily as a result of investments in property and equipment, which decrease was, somewhat offset by a small amount of cash generated from operating activities. At June 30, 2010 and December 31, 2009 we had an accumulated deficit of $29,346,000 and $30,229,000, respectively, and cash and cash equivalents of $1,095,000 and $1,240,000, respectively.

Our available capital resources at June 30, 2010 consisted primarily of approximately $1,095,000 in cash and cash equivalents and $4,302,000 in accounts receivable. We expect that our future available capital resources will consist primarily of cash on hand, cash generated from our business, and future debt and/or equity financings, if any.

Cash provided by operating activities for the six months ended June 30, 2010 was $57,000, as compared to $446,000 for the six months ended June 30, 2009, and included net income of $883,000 and a net loss of $722,000 for the six months ended June 30, 2010 and 2009, respectively. Included in the results for the first half of 2010 were non-cash charges for stock-based compensation of $192,000, depreciation and amortization of $172,000, intellectual property impairment of $51,000, as well as non-cash losses of $166,000 from derivative liabilities. Included in the results for the first half of 2009 was a non-cash gain of $1,559,000 from the derivative liabilities. Material changes in assets and liabilities at June 30, 2010 occurring since December 31, 2009 that affected these results include:

·	an increase in accounts receivable of $1,004,000;

·	a decrease in customer deposits of $3,829,000; and

·	A decrease in inventory before reserves of $3,227,000.

Cash used in investing activities totaled $202,000 for the six months ended June 30, 2010 as compared to $147,000 of cash provided by investing activities for the six months ended June 30, 2009. These results for the six months ended June 30, 2010 include $186,000 of equipment purchases and $16,000 representing the capitalized cost of intellectual property. The results for the six months ended June 30, 2009 included proceeds of $294,000 from the sales of investment securities.

There were no cash flows from financing activities in the first six months of 2010 or 2009.

We believe that current and future available capital resources, revenues generated from operations, and other existing sources of liquidity, will be adequate to meet our anticipated working capital and capital expenditure requirements for at least the next twelve months. If, however, our capital requirements or cash flow vary materially from our current projections or if unforeseen circumstances occur, we may require additional financing. Our failure to raise capital, if needed, could restrict our growth, limit our development of new products or hinder our ability to compete.

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Backlog

As of August 6, 2010, we had a backlog of approximately $7.2 million. Our backlog includes firm non-cancelable customer commitments for 15 tools and approximately $721,000 in parts and upgrades. Management believes that all products currently in our backlog will be shipped by January 31, 2011.

Effects of Inflation

The impact of inflation and changing prices has not been significant on the financial condition or results of operations of either our company or our operating subsidiary.

Impacts of New Accounting Pronouncements

In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements, (amendments to FASB ASC Topic 605, Revenue Recognition)” and ASU 2009-14, “Certain Arrangements That Include Software Elements, (amendments to FASB ASC Topic 985, Software).” ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect adoption of ASU 2009-13 or ASU 2009-14 to have a material impact on our consolidated results of operations or financial condition.

In June 2009, the FASB issued guidance included in ASC 810-10-30, “Consolidation-Overall-Initial Measurement.” This guidance is a revision to pre-existing guidance pertaining to the consolidation and disclosures of variable interest entities. Specifically, it changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. This guidance will require a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements. This guidance was effective for us on January 1, 2010 and the adoption of this guidance did not have a material impact on our consolidated results of operations or financial condition.

In June 2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument (Or an Embedded Feature) is Indexed to an Entity’s Own Stock,” which was primarily codified into FASB ASC 815-40, “Derivatives and Hedging-Contracts in Entity’s Own Equity.” The guidance provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. This guidance was effective for financial statements issued for fiscal years beginning after December 15, 2008. Early application was not permitted. Implementation of this guidance has had a significant impact on our financial condition and results of operations. (See discussion of the implementation of ASC 815-40-15 “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions above.)

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer (“the Certifying Officers”) as of June 30, 2010. Based on that evaluation, the Certifying Officers concluded that the Company’s disclosure controls and procedures are effective as of June 30, 2010. There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 4T. CONTROLS AND PROCEDURES

Not applicable.

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are subject to various legal proceedings, claims and litigation with respect to such matters as product liabilities, employment matters and other actions arising out of the normal course of business. While the amounts claimed may be substantial, the ultimate liability cannot presently be determined because of considerable uncertainties that exist. Therefore, it is possible that the outcome of those legal proceedings, claims and litigation could adversely affect our quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes such matters will not adversely affect our financial position, results of operations or cash flows.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition and results of operations. The risks described in our Annual Report on Form 10-K for the year ended December 31, 2009 are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. (REMOVED AND RESERVED)

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS

Exhibit

Number Description

31.1	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (*)

31.2	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes–Oxley Act of 2002 (*)

32.1	Certification of President 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.

SIGNATURES

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.

STRASBAUGH

Dated: August 15, 2010

By:

/s/ RICHARD NANCE

Richard Nance, Chief Financial Officer

(principal financial and accounting officer)

EXHIBITS FILED WITH THIS REPORT

Exhibit

Number Description

31.1	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes–Oxley Act of 2002

31.2	Certification Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes–Oxley Act of 2002

32.1	Certification of President 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

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Strasbaugh 10-Q