UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2009

¨	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 000-50553

LOGO

ENTORIAN TECHNOLOGIES INC.

(Exact name of registrant as specified in its charter)

Delaware

56-2354935

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

4030 West Braker Lane, Austin, TX 78759

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code:

(512) 334-0111

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 ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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 ¨ NO ¨

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


Large accelerated filer ¨		Accelerated filer ¨		Non-accelerated filer ¨		Smaller reporting company x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of June 30, 2009, was 46,807,486.

ENTORIAN TECHNOLOGIES INC.

FORM 10-Q QUARTERLY REPORT

QUARTERLY PERIOD ENDED JUNE 30, 2009

TABLE OF CONTENTS


		Page
	PART I – FINANCIAL INFORMATION

Item 1.	Consolidated Balance Sheets – June 30, 2009 (unaudited) and December 31, 2008	3
	Consolidated Statements of Operations (unaudited) for the three months ended June 30, 2009 and 2008	4
	Consolidated Statements of Operations (unaudited) for the six months ended June 30, 2009 and 2008	5
	Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2009 and 2008	6
	Notes to the Consolidated Financial Statements (unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4T.	Controls and Procedures	33

	PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46
Item 3.	Defaults Upon Senior Securities	46
Item 4.	Submission of Matters to a Vote of Security Holders	46
Item 5.	Other Information	46
Item 6.	Exhibits	47

CAUTIONARY STATEMENT

EXCEPT FOR THE HISTORICAL FINANCIAL INFORMATION CONTAINED HEREIN, THE MATTERS DISCUSSED IN THIS REPORT ON FORM 10-Q (AS WELL AS DOCUMENTS INCORPORATED HEREIN BY REFERENCE) MAY BE CONSIDERED “FORWARD-LOOKING” STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTS INCLUDE DECLARATIONS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF ENTORIAN TECHNOLOGIES INC. AND ITS MANAGEMENT, AND MAY BE EVIDENCED BY WORDS SUCH AS WE “EXPECT,” “ANTICIPATE,” “TARGET,” “PROJECT,” “BELIEVE,” “GOALS,” “ESTIMATE,” “POTENTIAL,” “PREDICT,” “MAY,” “MIGHT,” “COULD,” “INTEND,” VARIATIONS OF THESE TYPES OF WORDS AND SIMILAR EXPRESSIONS. YOU ARE CAUTIONED THAT ANY FORWARD-LOOKING STATEMENTS ARE NOT GUARANTIES OF FUTURE PERFORMANCE AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE INDICATED BY THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO THESE DIFFERENCES INCLUDE THOSE DISCUSSED UNDER “RISK FACTORS” AND ELSEWHERE IN THIS REPORT. ENTORIAN TECHNOLOGIES INC. DISCLAIMS ANY INTENTION OR OBLIGATION TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.

ALL PERCENTAGE AMOUNTS AND RATIOS WERE CALCULATED USING THE UNDERLYING DATA IN THOUSANDS.

PART I

ITEM 1.

FINANCIAL STATEMENTS

ENTORIAN TECHNOLOGIES INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)


	June 30, 2009			December 31, 2008
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	9,109		$	15,651
Investments		8,859			1,639
Accounts receivable, net of allowance of $79 in 2009 and $597 in 2008		11,511			5,256
Inventories		4,789			5,018
Prepaid expenses		406			510
Income tax recoverable		1,645			1,571
Deferred tax asset		274			271
Other current assets		1,804			1,592

Total current assets		38,397			31,508
Property, plant and equipment, net		3,554			4,439
Long-term investments		—			7,337
Other intangible assets, net		9,345			10,611
Other assets		79			81

Total assets	$	51,375		$	53,976

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	12,091		$	4,995
Accrued compensation		499			1,951
Accrued liabilities		1,579			1,490
Deferred revenue		522			45

Total current liabilities		14,691			8,481
Other accrued liabilities		143			180
Deferred tax liabilities		170			170
Convertible notes payable		3,633			3,847
Related party convertible notes payable		6,428			6,805
Redeemable preferred stock; $0.001 par value; 5,000,000 shares authorized		—			—
Stockholders’ equity:
Common stock; $0.001 par value; 100,000,000 shares authorized at June 30, 2009 and December 31, 2008; 53,394,109 shares and 53,362,815 shares issued at June 30, 2009 and December 31, 2008, respectively		53			53
Additional paid-in capital		149,998			149,375
Treasury stock, at cost; 6,586,623 shares and 6,466,904 shares at June 30, 2009 and December 31, 2008, respectively		(25,883	)		(25,850	)
Accumulated other comprehensive income		11			26
Accumulated deficit		(97,869	)		(89,111	)

Total stockholders’ equity		26,310			34,493

Total liabilities and stockholders’ equity	$	51,375		$	53,976

The accompanying notes are an integral part of these consolidated condensed financial statements.

ENTORIAN TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data; unaudited)


	Three Months Ended June 30,
	2009			2008
Revenue:
Product	$	6,928		$	7,677
License		822			1,236

Total revenue		7,750			8,913
Cost of revenue:
Product (1)		6,026			8,382
Amortization of acquisition intangibles		626			603
Impairment of acquisition intangibles		—			160

Total cost of revenue		6,652			9,145

Gross profit (loss)		1,098			(232	)
Operating expenses:
Selling, general and administrative (1)		2,829			2,727
Research and development (1)		2,107			1,093
Restructuring		120			214
Amortization of acquisition intangibles		35			167
Goodwill impairment		(159	)		—

Total operating expenses		4,932			4,201

Loss from operations		(3,834	)		(4,433	)
Other income (expense):
Interest income		42			352
Interest expense		(194	)		(3	)
Other, net		269			29

Total other income, net		117			378

Loss before income taxes		(3,717	)		(4,055	)
Provision (benefit) for income taxes		22			(52	)

Net loss	$	(3,739	)	$	(4,003	)

Loss per share:
Basic	$	(0.08	)	$	(0.09	)

Diluted	$	(0.08	)	$	(0.09	)

Shares used in computing loss per share:
Basic		46,842			46,763
Diluted		46,842			46,763

(1) Includes stock-based compensation expense as follows:

Cost of revenue	$	3		$	84
Selling, general and administrative expense	$	272		$	494
Research and development expense	$	57		$	111

The accompanying notes are an integral part of these consolidated condensed financial statements.

ENTORIAN TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data; unaudited)


	Six Months Ended June 30,
	2009			2008
Revenue:
Product	$	19,871		$	14,889
License		918			2,636

Total revenue		20,789			17,525
Cost of revenue:
Product (1)		15,590			17,295
Amortization of acquisition intangibles		1,252			1,191
Impairment of acquisition intangibles		—			160

Total cost of revenue		16,842			18,646

Gross profit (loss)		3,947			(1,121	)
Operating expenses:
Selling, general and administrative (1)		6,027			6,956
Research and development (1)		4,293			2,397
Restructuring		2,437			214
Amortization of acquisition intangibles		70			353
Goodwill impairment		(159	)		—

Total operating expenses		12,668			9,920

Loss from operations		(8,721	)		(11,041	)
Other income (expense):
Interest income		120			858
Interest expense		(317	)		(6	)
Other, net		196			57

Total other income (expense), net		(1	)		909

Loss before income taxes		(8,722	)		(10,132	)
Provision (benefit) for income taxes		36			(267	)

Net loss	$	(8,758	)	$	(9,865	)

Loss per share:
Basic	$	(0.19	)	$	(0.21	)

Diluted	$	(0.19	)	$	(0.21	)

Shares used in computing loss per share:
Basic		46,868			46,750
Diluted		46,868			46,750

(1) Includes stock-based compensation expense as follows:

Cost of revenue	$	11		$	167
Selling, general and administrative expense	$	468		$	968
Research and development expense	$	145		$	231

The accompanying notes are an integral part of these consolidated condensed financial statements.

ENTORIAN TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands; unaudited)


	Six Months Ended June 30,
	2009			2008
Cash flows from operating activities:
Net loss	$	(8,758	)	$	(9,865	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation, amortization and impairment of intangibles		2,559			3,654
Stock-based compensation expense		624			1,366
Other non-cash charges		158			183
Deferred income taxes		(4	)		(6	)
Net change in operating assets and liabilities		(620	)		(3,200	)

Net cash used in operating activities		(6,041	)		(7,868	)

Cash flows from investing activities:
Purchases of investments		—			(4,418	)
Sales and maturities of investments		200			20,381
Additions to property, plant and equipment		(1,077	)		(834	)
Proceeds from sale of equipment		570			5
Patent application costs		(149	)		(198	)

Net cash provided by (used in) investing activities		(456	)		14,936

Cash flows from financing activities:
Net proceeds from the issuance of common stock		—			84
Share repurchases		(34	)		(150	)
Payments on capitalized lease obligations		(11	)		(10	)

Net cash used in financing activities		(45	)		(76	)

Net increase (decrease) in cash and cash equivalents		(6,542	)		6,992
Cash and cash equivalents at beginning of period		15,651			34,013

Cash and cash equivalents at end of period	$	9,109		$	41,005

The accompanying notes are an integral part of these consolidated condensed financial statements.

ENTORIAN TECHNOLOGIES INC.

NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

1.	Basis of Presentation

The accompanying unaudited consolidated financial statements of Entorian Technologies Inc. (we, us, our), have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the SEC). These financial statements do not include all of the information and footnotes required by United States generally accepted accounting principles for annual financial statements. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The preparation of financial statements in conformity with United States generally accepted accounting principles requires us to make estimates and assumptions that affect reported assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities. Actual results could differ significantly from those estimates. In addition, operating results for the three and six months ended June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009, or for any other period.

Following our acquisition of Augmentix Corporation (Augmentix) on July 14, 2008, we divided our operations into two reportable segments, Memory Solutions and Rugged Technology Solutions. Subsequently, as a result of exiting the manufacturing activities of our memory business, which we completed during the first quarter of 2009, we now operate under only Rugged Technology Solutions. See Note 9, “Augmentix Corporation Acquisition,” for additional information regarding our Augmentix acquisition.

These financial statements and notes should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2008, which we filed with the SEC on March 12, 2009.

Concentration of Risk

Until our acquisition of Augmentix, we derived nearly all of our revenue from sales or licenses of our Stakpak and memory module solutions. In the first quarter of 2009, we terminated our memory solutions manufacturing business and now are focusing on our Rugged Technology Solutions business, which derives nearly all of its revenue from sales to Dell. For the three and six months ended June 30, 2009, Dell accounted for approximately 78% and 65%, respectively, of our total revenue. We expect these sales to continue to account for a substantial portion of our total revenue in the foreseeable future.

In addition, we have an arrangement with a manufacturer in which this third party purchases and takes title of certain inventory relating to certain of our products upon shipment from the original manufacturers of such inventory. This third party recovers the cost of inventory upon the sale of finished goods to us. This program offers us several advantages; however, this arrangement also results in concentrated credit and inventory risk for us. Approximately $6.3 million of our accounts receivable balance at the end of the quarter was with this third party. This was partially offset by a balance of $5.3 million in accounts payable due to this third party for the production of finished goods and inventory delivered by the manufacturer relating to certain of our products at June 30, 2009. As our sales increase, these amounts will increase, which will also increase the risk to us. We are exploring ways to minimize our risk with respect to this relationship. If we are not able to do so, we may restructure this relationship to reduce the risks we face.

Recently Issued Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 168, “The FASB Accounting Standards Codification and Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162” (SFAS 168). This pronouncement establishes the FASB Standards Accounting Codification (Codification) as the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied to non-governmental entities and rules and interpretive releases of the SEC as authoritative GAAP for SEC registrants. The Codification will supersede all the existing non-SEC accounting and reporting standards upon its effective date. SFAS 168 is effective for interim or annual periods ending after September 15, 2009. We do not expect the adoption of SFAS 168 to have a material impact on our financial position, results of operations, cash flows or disclosures.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (SFAS 165), to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 also identifies the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that should be made about events or transactions that occur after the balance sheet date. This pronouncement was effective for interim or annual financial periods ending after June 15, 2009, and shall be applied prospectively. The adoption of SFAS 165 did not have a material impact on our financial position, results of operations, cash flows or disclosures. See Note 18, “Subsequent Events,” for additional information.

In April 2009, the FASB issued FASB Staff Position (FSP) No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (FAS 107-1 and APB 28-1), to require disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies and to require those disclosures in all interim financial statements. This pronouncement was effective for interim periods ending after June 15, 2009. The adoption of FSP FAS 107-1 and APB 28-1 did not have a material impact on our financial position, results of operations, cash flows or disclosures.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (FSP FAS 115-2 and FAS 124-2), to provide guidance in determining whether impairments in debt securities are other than temporary, and to modify the presentation and disclosures for such instruments. This pronouncement was effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP FAS 115-2 and FAS 124-2 did not have a material impact on our financial position, results of operations, cash flows or disclosures.

In April 2009, the FASB issued FSP No. FAS 157-4, “Determining the Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That are Not Orderly” (FSP FAS 157-4), to provide additional guidance in determining whether a market for a financial asset is not active and a transaction is not distressed for fair value measurement purposes. This pronouncement was effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP FAS 157-4 did not have a material impact on our financial position, results of operations, cash flows or disclosures.

2.	Fair Value Measurements

On January 1, 2009, we adopted FASB Statement No. 157, “Fair Value Measurements” (SFAS 157), for our non-financial assets and liabilities. This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The following table details the fair value measurements within the fair value hierarchy of our financial and non-financial assets (in thousands):


	Fair Value at June 30, 2009		Fair Value Measurements at June 30, 2009 Using:
Description	Fair Value at June 30, 2009		Quoted Prices in Active Markets Using Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities	$	1,608	$	1,608	$	—	$	—
Trading securities		6,733		—		—		6,733
Put option on trading securities		518		—		—		518
Assets held for sale		172		—		172		—

	$	9,031	$	1,608	$	172	$	7,251


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance at December 31, 2008	$	7,337
Transfers in to (out of) Level 3		—
Net gain included in other income (expense)		114
Purchases, issuances and settlements		(200	)

Balance at June 30, 2009	$	7,251

We have included our investments related to auction rate securities (ARS) of approximately $6.7 million, or 92% of par value, and our put option of $0.5 million, respectively, in the Level 3 category. See Note 4, “Investments,” for additional information regarding our auction rate securities.

As a result of our decision to close our operations in Reynosa, Mexico, we decided to sell approximately $0.8 million in fixed assets from our Memory Solutions business, which we recorded as assets held for sale at December 31, 2008. During the three months ended March 31, 2009, we recorded an impairment charge of approximately $0.4 million related to our assets held for sale based on quoted market prices for similar assets. Also, during the second quarter of 2009, we sold various assets recorded as assets held for sale with a net book value of approximately $0.2 million for a net gain of approximately $0.3 million.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115” (SFAS 159). This standard allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value. The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. During November 2008, we accepted a settlement offer from one of our investment providers to sell, at par value, our ARS at any time during a two-year period beginning June 30, 2010 and ending July 2, 2012. In connection with this settlement, we elected to account for the put option related to our ARS under SFAS 159. During the six months ended June 30, 2009, we recorded a net loss of $0.1 million in Other income (expense) related to the change in fair value of our put option.

3.	Accounts Receivable, net

The following are the components of accounts receivables (in thousands):


	June 30,			December 31,
	2009			2008
Gross accounts receivable	$	11,590		$	5,853
Allowance for doubtful accounts		(79	)		(597	)

	$	11,511		$	5,256

The increase in our accounts receivable balance at June 30, 2009, compared to December 31, 2008, was primarily due to receivables of $7.4 million related to the sale of previously consigned inventory to our manufacturing partners. At June 30, 2009, these receivables were offset by a balance of $7.6 million in accounts payable to these manufacturing partners for the production of finished goods and inventory delivered by the

manufacturer relating to certain of our products. The balance in our allowance for doubtful accounts at December 31, 2008 was primarily due to the bankruptcy of a large memory business customer. We wrote off the associated receivable and allowance for doubtful accounts during the second quarter of 2009.

4.	Investments

As of June 30, 2009, we held approximately $6.7 million in ARS at 92% of par value and $0.5 million in a put option, which are classified as short-term investments in the Level 3 category.

Our ARS are investments in student loans. The final maturity dates of the ARS that we own are between 2034 and 2041 and the securities are rated Aaa and AA. Approximately 68% of the student loans underlying our ARS are guaranteed by the federal government under the Federal Family Education Loans Program (FFELP). The FFELP guarantees between 95% and 98% of the par value of these loans. The remaining 32% of our ARS are private loans, of which 85% are insured.

Our ARS have historically traded at par and are callable at par at the option of the issuer. Beginning in February 2008, auctions for these securities began to fail, and the interest rates for these ARS reset to the maximum rate according to the applicable investment offering document. As of June 30, 2009, there was insufficient observable ARS market information available to determine the fair value of these investments. Therefore, our ARS were valued based on a pricing model that included certain assumptions, such as our ARS maximum interest rate, probability of passing auction, default probability and discount rate. Based on this assessment of fair value, as of June 30, 2009, we determined there was an increase in the fair value of our ARS of approximately $0.1 million during the six months ended June 30, 2009.

As of June 30, 2009, the maximum auction rates for our ARS ranged from 0.5% to 1.1%. Through June 30, 2009, we have continued to receive interest payments on our ARS in accordance with their terms and believe we will continue to receive interest payments as long as we hold these securities. During the six months ended June 30, 2009, approximately $0.2 million of our ARS was called at par by the issuer.

During November 2008, we accepted an offer provided to us by the investment firm through which we hold our ARS to sell them to this firm, at par value, at any time over a two-year period, beginning June 30, 2010 and ending July 2, 2012. The agreement also provides access to loans of 75% of the market value of our ARS until June 30, 2010. As a result of accepting this offer, during 2008 we transferred our ARS from available-for-sale to trading as allowed under SFAS 115 and reclassified approximately $0.9 million from other comprehensive loss to other expense. In addition, upon acceptance of this settlement, we recorded the estimated fair value of the put option of approximately $0.7 million, which was classified as long-term investments in the Level 3 category, and elected to apply the fair value provisions of SFAS 159 to this put option. We will recognize future changes in the fair value of the ARS and the put option in the statement of operations. The fair value adjustments to the ARS and the put option will largely offset and should result in a minimal net impact to the statement of operations in future periods. As of June 30, 2009, we reclassified our ARS and related put option to short-term investments based on our intent to sell them to the investment firm on June 30, 2010.

Trading Securities

Our trading securities as of June 30, 2009 and December 31, 2008 were as follows (in thousands):


	June 30, 2009					December 31, 2008
	Estimated Fair Value		Net Realized Loss			Estimated Fair Value		Net Realized Loss
Auction rate securities	$	6,733	$	(592	)	$	6,662	$	(863	)

Total trading securities	$	6,733	$	(592	)	$	6,662	$	(863	)

Net losses on our ARS that we classified as trading securities held at the reporting date were $0.6 million and $0.9 million as of June 30, 2009 and December 31, 2008, respectively.

Available-for-Sale Securities

Our available-for-sale securities are carried at fair value with unrealized gains and losses, if any, included as a component of accumulated other comprehensive income (loss). Realized gains and losses are recognized based on the specific identification method.

The amortized cost, net unrealized gains and losses and estimated fair value of our available-for-sale securities as of June 30, 2009 and December 31, 2008 were as follows (in thousands):


	Amortized Cost		Net Unrealized Gains		Net Unrealized Losses		Estimated Fair Value
June 30, 2009
Municipal bonds	$	1,596	$	12	$	—	$	1,608

	$	1,596	$	12	$	—	$	1,608

December 31, 2008
Municipal bonds	$	1,613	$	26	$	—	$	1,639

	$	1,613	$	26	$	—	$	1,639

Net unrealized gains at June 30, 2009 and December 31, 2008 were the result of fluctuations in the current market value of our available-for-sale securities in the marketplace.

Maturities of investment securities classified as available-for-sale at June 30, 2009 and December 31, 2008 by contractual maturity are shown below (in thousands). Expected maturities will vary from contractual maturities because borrowers may have the right to recall or prepay obligations with or without call or prepayment penalties.


	June 30, 2009				December 31, 2008
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Within 1 year	$	—	$	—	$	—	$	—
Between 1 and 5 years		—		—		—		—
Between 5 and 10 years		1,596		1,608		1,613		1,639
After 10 years		—		—		—		—

	$	1,596	$	1,608	$	1,613	$	1,639

During the three and six months ended June 30, 2009, we did not sell any of our investment securities held as available-for-sale. We sold approximately $8.6 million and $20.4 million in investment securities held as available-for-sale during the three and six months ended June 30, 2008, respectively.

5.	Inventories

Inventories consisted of the following (in thousands) at the respective dates:


	June 30, 2009		December 31, 2008
Raw materials	$	2,394	$	4,849
Work in process		—		—
Finished goods		2,395		169

	$	4,789	$	5,018

The decrease in our inventory balance at June 30, 2009, compared to December 31, 2008, was primarily driven by the decision to exit manufacturing activities of our Memory Solutions business during the first quarter of 2009, the transition to a new product platform and the sale of previously consigned inventory to our manufacturing partners. At June 30, 2009 and December 31, 2008, our reserve for excess, slow-moving and obsolete inventory was approximately $0.1 million and $3.0 million, respectively. The decrease in our reserve for excess, slow-moving and obsolete inventory at June 30, 2009, compared to December 31, 2008, was primarily due to the final disposal of our memory inventory.

6.	Property, Plant and Equipment

As a result of our decision to implement a new enterprise resource planning (ERP) system during the second quarter of 2009, we reviewed the remaining useful life related to our office equipment and software associated with our legacy system. Based on that review, we determined the remaining useful life for our office equipment and software related to our legacy system did not extend beyond March 31, 2009 and recorded additional depreciation of approximately $0.3 million, or $0.01 per share, during the six months ended June 30, 2009.

In addition, as a result of our decision to close our operations in Reynosa, Mexico, we decided to sell approximately $0.8 million in fixed assets from our Memory Solutions business, which we recorded as assets held for sale at December 31, 2008. During the three months ended March 31, 2009, we recorded an impairment charge of approximately $0.4 million related to our assets held for sale based on quoted market prices for similar assets, which we recorded in Restructuring expense. Also, during the first quarter of 2009, we recorded a provision of approximately $0.5 million related to certain fixed assets no longer used in manufacturing, which we recorded in Restructuring expense. During the second quarter of 2009, we sold various assets recorded with a net book value of approximately $0.2 million for a net gain of approximately $0.3 million. These assets were recorded as assets held for sale.

7.	Income Taxes

We accrue a provision for federal, state and foreign income taxes at the applicable statutory rates adjusted for non-deductible expenses, tax-exempt income and the application of a valuation allowance for certain deferred tax assets, for which we believe there is uncertainty regarding their realization. The provision for income taxes may include amounts intended to satisfy unfavorable adjustments by tax authorities in any current or future examination of our income tax returns.

We recorded a provision for income taxes of $36,000 during the six months ended June 30, 2009 and an income tax benefit of $0.3 million during the six months ended June 30, 2008. The provision for the six months ended June 30, 2009 reflected our estimated annual effective tax rate of 0%. The provision for the six months ended June 30, 2008 reflected an estimated annual effective tax rate of 3%.

For the six months ended June 30, 2009 and 2008, our effective tax rate differed from the federal statutory rate of 35%, primarily due to recording an increase in the valuation allowance against our net U.S. deferred tax assets as there is substantial doubt we will realize the majority of the benefit of our net deferred tax asset.

We file income tax returns in the U.S. federal jurisdiction and in various state and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003. The tax years 2003 through 2008 remain open to examination by all the major taxing jurisdictions to which we are subject, though we are not currently under examination by any major taxing jurisdictions.

We had no liability for unrecognized tax benefits at December 31, 2008 or June 30, 2009.

8.	Restructuring

During the fourth quarter of 2008, we recorded restructuring expense of $2.7 million due to a workforce reduction of approximately 180 positions as a result of our plan to close manufacturing activities for our Memory Solutions business. During the first quarter of 2009, we completed closing our manufacturing activities, resulting in an additional accrual of approximately $1.9 million. This additional charge that we recorded during the six months ended June 30, 2009 included approximately $1.5 million related to employee severance expenses and $0.4 million related to exiting one of our facilities located in Austin, Texas. In addition, during the six months ended June 30, 2009, we recorded a restructuring charge of $0.5 million related to certain fixed assets no longer used in manufacturing. The following table details the changes in the related restructuring accrual (in thousands) during the first six months of 2009:


	Severance			Facility			Total
Restructuring accrual at December 31, 2008	$	833		$	—		$	833
Restructuring expenses accrued		1,473			394			1,867
Payments of restructuring expenses		(1,963	)		(47	)		(2,010	)

Restructuring accrual at June 30, 2009	$	343		$	347		$	690

9.	Augmentix Corporation Acquisition

On July 14, 2008, we acquired all of the outstanding ownership interests in Augmentix, a provider of rugged computing solutions. We paid approximately $23.5 million in cash and approximately $10.7 million in convertible notes, subject to a post-closing adjustment based on Augmentix’s working capital and transaction costs. Effective June 3, 2009, we finalized the post-closing working capital adjustment. The result was an adjustment to the working capital in our favor of approximately $0.6 million and a corresponding reduction to Goodwill impairment expense of approximately $0.2 million. The convertible notes were reduced from approximately $10.7 million to approximately $10.1 million.

Our acquisition of Augmentix was a transaction between commonly controlled entities, as our majority owner, Austin Ventures, also owned approximately 55% of the outstanding equity securities of Augmentix (on an as-converted to common stock basis). As a result of the acquisition, Austin Ventures received approximately $15.1 million in cash and convertible notes.

We included Augmentix’s results of operations in our consolidated results subsequent to the acquisition date, which was July 14, 2008.

10.

Convertible Notes Payable

In connection with our acquisition of Augmentix, we issued approximately $10.7 million in convertible notes with an annual interest rate of 6% to certain stockholders of Augmentix. Effective June 3, 2009, we finalized the post-closing working capital adjustment as set forth in the merger agreement. The result was an adjustment to the working capital in our favor of approximately $0.6 million. The convertible notes were reduced from approximately $10.7 million to approximately $10.1 million. Interest payments are due each January 31 and July 30, with the principal due on December 31, 2010. The former Augmentix stockholders have the right to convert the principal and any unpaid interest into our common stock at a conversion price of $2.50 at any time prior to the earlier of (i) December 31, 2010, (ii) a change of control of Entorian or (iii) the redemption of all of the outstanding principal amount of the notes. At any time subsequent to the issuance of the convertible notes, we have the right to redeem the notes for the redemption amount, which is equal to the outstanding principal balance plus accrued interest, with at least 30 days prior written notice. As of June 30, 2009, the fair value of our convertible notes was approximately $9.3 million, and these notes were convertible into approximately 4.1 million shares of common stock.

On July 21, 2008, we received a letter from The NASDAQ Stock Market notifying us that for the 30 consecutive business days preceding the date of the letter, the bid price of our common stock had closed below the $1.00 per share requirement for continued inclusion on The NASDAQ Global Market pursuant to NASDAQ Marketplace Rule 4450(a)(5). In accordance with NASDAQ Marketplace Rule 4450(e)(2), we had 180 calendar days from the date of the NASDAQ letter, or until January 20, 2009, to regain compliance. To regain compliance, the closing bid price of our common stock must meet or exceed $1.00 per share for a minimum of ten consecutive business days. NASDAQ suspended compliance with the minimum bid price rule, and as a result, we now have until November 4, 2009, to comply with this requirement. If we are not able to comply, we may request stockholder approval to effect a reverse stock split or we may delist from NASDAQ. If we do not regain compliance, NASDAQ will delist our common stock.

In addition, NASDAQ requires that the market value of publicly held shares be at least $5.0 million. As of August 12, 2009, the market value of our publicly held shares was approximately $3.7 million. If necessary, we could issue additional shares to increase the value of our publicly held shares. Should NASDAQ notify us that we are deficient in meeting this requirement, we would have 90 days to comply.

Given these factors, our Board of Directors may decide to delist from NASDAQ. If our stock is delisted for a period of 20 consecutive trading days, this event would constitute an event of default under our outstanding convertible notes, which could result in the noteholders requiring payment in full of the principal balance and interest of the notes. In addition, given the ongoing costs associated with public reporting, we may take actions to deregister our shares under the Exchange Act.

11.

Letter of Credit

During the first quarter of 2009, a financial institution issued a letter of credit to one of our suppliers, which guarantees up to $0.5 million of our outstanding account balance with this supplier. As a result of this agreement, we are required to maintain a compensating balance of $0.5 million on deposit with the financial institution for a term of 12 months ending on February 26, 2010. As of June 30, 2009, we had this required amount on deposit.

12.

Commitments and Contingencies

During October 2008, we entered into a minimum purchase agreement with one of our vendors. The minimum purchase terms stipulate the purchase of $0.2 million of product by March 31, 2009, an additional $0.3 million by September 30, 2009, and an additional $0.5 million by March 31, 2010. As of March 31, 2009, we met our minimum purchase requirement for this time period and expect to continue to fulfill the minimum purchase requirement within the agreed-upon time frame.

We have indemnification agreements with our directors and executive officers. The agreements do not set monetary limits on our indemnity obligations. We have a director and officer insurance policy that enables us to recover a portion of any future amounts paid in respect of our indemnity obligations to our directors and officers.

In connection with closing our manufacturing facility in Mexico, we terminated most of our remaining employees in the fourth quarter of 2008 and the first quarter of 2009, all of whom signed a release of claims in exchange for severance. Approximately 100 of these former employees filed a legal action against us with the Labor Board in Reynosa, claiming that we did not pay them their full severance amounts as required by Mexican law. We agreed to pay the additional severance, and entered into a settlement agreement on April 23, 2009 in which we agreed to pay approximately $0.2 million.

Currently we are not involved in any material legal proceedings. However, from time to time, we may be subject to legal proceedings, claims in the ordinary course of business, claims in foreign jurisdictions where we operate, and non-contractual customer claims we may agree to in the interest of maintaining business relationships.

Samsung License Agreement

We have a license arrangement with Samsung Electronics Co., Ltd. (Samsung), pursuant to which we have licensed certain technologies to Samsung, and Samsung provides to us quarterly reports of its license usage and pays corresponding royalty amounts in accordance with the terms of the agreement. We have primarily relied on these reports from Samsung and subsequent cash payment to record revenue from this license agreement.

During the second quarter of 2008, Samsung sent us a letter asserting that it made errors in the royalty reports that it previously delivered to us during the period beginning in the fourth quarter of 2005 and ending in the first quarter of 2008. Samsung stated that it believes that these errors resulted in an overpayment to us of an aggregate of approximately $2.9 million, and Samsung has requested that we refund this amount. Samsung paid to us a total of $14.2 million during this time period.

Because of information provided to us by Samsung regarding excessive yield loss and independent information we have obtained, we do not believe it would be appropriate to make any changes to our financial reports or book allowances related to this refund request, and we believe that our revenue recognition has been appropriate.

13.

Common Stock

As of June 30, 2009 and December 31, 2008, we had 53,394,109 and 53,362,815 shares of common stock issued, respectively.

During the first six months of 2009, we purchased 119,719 shares of our common stock under our stock repurchase program at a total cost of approximately $34,000. As of June 30, 2009, we may purchase up to an additional $6.7 million of our stock under this program.

14.

Stock-Based Compensation

In July 2003, we adopted the 2003 Stock Option Plan, which currently has 16,830,000 authorized shares. Options generally vest over a four-year period and are exercisable for a period of ten years from the date of grant.

We account for all forms of our share-based payments to employees, including stock options, under SFAS 123(R), utilizing the Black-Scholes method of valuation.

Information with respect to stock option activity for the six months ended June 30, 2009 is as follows:


	Outstanding Options
	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2008	10,106,816		$	1.72
Granted	54,000		$	0.21
Exercised	(10,750	)	$	0.01
Cancelled or forfeited	(1,548,013	)	$	3.25

Outstanding at June 30, 2009	8,602,053		$	1.44	7.3	$	381

Options exercisable at June 30, 2009	3,066,077		$	2.90	3.7	$	31

As of June 30, 2009, there was approximately $2.1 million of unrecognized compensation cost related to outstanding stock options, which we expect to recognize over a weighted average period of 3.1 years. For the six months ended June 30, 2009 and 2008, the total intrinsic value of exercised stock options was approximately $2,000 and $0.1 million, respectively.

For grants issued during the six months ended June 30, 2009 and 2008, the weighted average assumptions used in determining fair value under the Black-Scholes model are outlined in the following table:


	Six Months Ended June 30, 2009		Six Months Ended June 30, 2008
Expected volatility	96.5	%	64.3	%
Dividend yield	0.0	%	0.0	%
Expected term (in years)	6.8		7.0
Risk-free interest rate	2.3	%	3.8	%

The computation of expected volatility is based on historical volatility of our common stock. The expected term of options is estimated based on the average of the vesting period and contractual term of the options. The risk-free rate is based on U.S. Treasury yields for securities in effect at the time of grant, with terms approximating the expected term until exercise of the option. The weighted-average fair value of stock options granted during the six months ended June 30, 2009 and 2008 was $0.16 and $0.82, respectively. During the three and six months ended June 30, 2009, we recorded share-based compensation expense for options of approximately $0.3 million and $0.5 million, respectively. During the three and six months ended June 30, 2008, we recorded share-based compensation expense for options of approximately $0.5 million and $0.9 million, respectively.

Restricted Stock Units

During the second quarter of 2006, we adopted our Equity-Based Compensation Plan, which provides for granting restricted stock awards, stock appreciation rights, restricted stock units (RSUs), bonus stock and dividend equivalents to eligible employees. As of June 30, 2009, we had 800,000 authorized shares under this plan. RSUs vest over a four-year period.

Information with respect to RSU activity for the six months ended June 30, 2009 is as follows:


	Number of RSUs		Weighted Average Grant Date Fair Value
Outstanding at December 31, 2008	147,803		$	5.59
Granted	—		$	—
Vested	(29,875	)	$	5.76
Forfeited	(52,772	)	$	5.61

Outstanding at June 30, 2009	65,156		$	5.49

Share-based compensation related to RSUs is recorded based on our stock price as of the grant date. For the three and six months ended June 30, 2009, RSU compensation expense was $0.1 million and $0.2 million, respectively. For the three and six months ended June 30, 2008, RSU compensation expense was $0.2 million and $0.4 million, respectively.

15.

Accumulated Other Comprehensive Income

The components of our accumulated other comprehensive income were as follows (in thousands) at the respective dates:

The components of our comprehensive loss, net of tax, were as follows (in thousands):


	Three Months Ended June 30,
	2009			2008
Net loss	$	(3,739	)	$	(4,003	)
Change in unrealized loss on investment securities, net of tax		(11	)		(351	)

Comprehensive loss, net of tax	$	(3,750	)	$	(4,354	)


	Six Months Ended June 30,
	2009			2008
Net loss	$	(8,758	)	$	(9,865	)
Change in unrealized loss on investment securities, net of tax		(15	)		(742	)

Comprehensive loss, net of tax	$	(8,773	)	$	(10,607	)

16.

Loss Per Share

Basic loss per share is computed by dividing net loss by the weighted-average number of vested common shares outstanding for the period. Diluted loss per share is computed under the treasury method giving effect to all potential dilutive common stock, including options, RSUs, warrants and common stock subject to repurchase. The treasury method assumes that estimated proceeds received from exercising potential dilutive common stock instruments will be used to repurchase shares of treasury stock on the open market.

A reconciliation of the numerator and denominator used in the calculation of basic and diluted loss per share follows (in thousands, except per share data):


	Three Months Ended June 30,
	2009			2008
Numerator:
Net loss	$	(3,739	)	$	(4,003	)

Denominator:
Weighted average common shares outstanding		46,842			46,763
Less: Weighted average common shares subject to repurchase		—			—

Total weighted average common shares used in computing basic loss per share		46,842			46,763
Effect of dilutive securities:
Common shares subject to repurchase, stock options, RSUs and warrants		—			—

Total weighted average common shares used in computing diluted loss per share		46,842			46,763

Loss per share:
Basic	$	(0.08	)	$	(0.09	)

Diluted	$	(0.08	)	$	(0.09	)


	Six Months Ended June 30,
	2009			2008
Numerator:
Net loss	$	(8,758	)	$	(9,865	)

Denominator:
Weighted average common shares outstanding		46,868			46,750
Less: Weighted average common shares subject to repurchase		—			—

Total weighted average common shares used in computing basic loss per share		46,868			46,750
Effect of dilutive securities:
Common shares subject to repurchase, stock options, RSUs and warrants		—			—

Total weighted average common shares used in computing diluted loss per share		46,868			46,750

Loss per share:
Basic	$	(0.19	)	$	(0.21	)

Diluted	$	(0.19	)	$	(0.21	)

17.

Segment Information

We determine our operating segments in accordance with Statement of Financial Accounting Standard No. 131, “Disclosures about Segments of an Enterprise and Related Information” (SFAS 131). Following our acquisition of Augmentix, we divided our operations into two reportable segments, Memory Solutions and Rugged Technology Solutions. Subsequently, as a result of exiting the manufacturing activities of our memory business, which we completed during the first quarter of 2009, we now operate under only Rugged Technology Solutions. Our chief operating decision maker currently reviews our operating results using consolidated financial information to assess financial performance and to allocate resources. Our Memory Solutions segment produced advanced module and system-level technologies for demanding high-reliability and high-performance markets. Our Rugged Technology Solutions segment produces rugged computing technologies.

18.

Subsequent Events

We have evaluated subsequent events through August 14, 2009, the filing date of this Quarterly Report on Form 10-Q. During July 2009, a portion of one of our auction-rate securities was called at par by the issuer for $0.2 million.

We entered into a lease agreement with Invensys Electronica Reynosa, S. de R.L. de C.V. to lease our manufacturing facility in Reynosa, Mexico, effective July 31, 2009. The lease has a term of five years, with two renewal periods of five years each. Invensys may terminate the lease after the third year.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The terms “Entorian,” “we,” “us” and “our” refer to Entorian Technologies Inc. and all of its subsidiaries that are consolidated in conformity with United States generally accepted accounting principles.

Cautionary Statement

The following discussion should be read along with the unaudited consolidated condensed financial statements and notes included in Item 1 of this Quarterly Report on Form 10-Q, as well as the audited consolidated financial statements and notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2008, which we filed with the SEC on March 12, 2009. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts and projections, and the beliefs and assumptions of our management including, without limitation, our expectations and beliefs regarding the following: fulfilling our minimum purchase requirement within the agreed-upon time frame with respect to a minimum purchase agreement we entered into with one of our suppliers; our future success will depend in large part upon our relationships with key Dell personnel; our sales to Dell will continue to account for a substantial portion of our total revenue in the foreseeable future; the lack of significant credit losses from our customers; our current assets, including cash, cash equivalents and investments, and expected cash flows from operating activities, will be sufficient to fund our operations in 2009, our anticipated additions to property, plant and equipment, interest payments and any share repurchases under our stock repurchase program for at least the next 12 months; the current liquidity issues related to our auction rate securities will not impact our ability to fund our ongoing business operations; we will continue to receive interest payments as long as we hold the auction rate securities; our facilities are suitable and adequate to meet our current operating needs; a ten percent change in interest rates will not have a significant impact on our interest income; the strength of our intellectual property rights is, and will continue to be, important to the success of our business; our revenue recognition with respect to Samsung’s claim has been appropriate; our future success will depend upon our ability to attract and retain personnel; and our adoption of SFAS 168 will not have a material impact on our financial position, results of operations, cash flows or disclosures. Words such as “we expect,” “anticipate,” “target,” “project,” “believe,” “goals,” “estimate,” “potential,” “predict,” “may,” “might,” “could,” “intend,” variations of these types of words and similar expressions are intended to identify these forward-looking statements. Readers are cautioned that these forward-looking statements are predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements.

Among the important factors that could cause actual results to differ materially from those indicated by our forward-looking statements are those discussed in “Risk Factors” in Item 1A of this Quarterly Report on Form 10-Q and elsewhere in this report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason. Readers should carefully review the risk factors described in Item 1A, as well as in the documents filed by us with the SEC, specifically our Annual Report on Form 10-K for the year ended December 31, 2008, which we filed with the SEC on March 12, 2009, as well as our Quarterly Reports on Form 10-Q and in our other SEC filings, as they may be amended from time to time.

Overview

Until July 2008, we focused exclusively on providing advanced module and system-level products for high-reliability and high-performance markets by offering stacking services, as well as memory module services, as explained in more detail below. Historically, we reported our revenue under one segment.

On July 14, 2008, we acquired Augmentix Corporation. Augmentix primarily re-engineers and “ruggedizes” certain Dell products to provide solutions with the latest technologies, high performance levels, enhanced functionality and reliability, and the potential for a low total cost of ownership for mission-critical, rugged computing solutions. As a result of this acquisition, we reported under two segments, Memory Solutions and Rugged Technology Solutions.

On December 17, 2008, we announced our plan to close manufacturing activities of our Memory Solutions business in the first quarter of 2009. We are licensing our stacking patent portfolio and have transferred our memory and stacking customers and certain manufacturing assets to third parties. Following our acquisition of Augmentix, we decided to shift our focus away from commodity component markets towards vertical computing segments. As a result of exiting the manufacturing activities of our memory business, which we completed during the first quarter of 2009, we now operate under only Rugged Technology Solutions.

We have an IP portfolio of more than 200 patents and patent applications pending, many of which relate to our now-closed memory business. We are collecting royalties under one license agreement with respect to our memory patents and are exploring other strategic alternatives with respect to these patents.

Rugged Technology Solutions

Through Augmentix, we develop innovative, highly differentiated and leveraged solutions for a large OEM customer, enabling us to address targeted vertical markets representing incremental growth opportunities. Our rugged notebook solutions, which we sell to a large OEM as part of an engineering and manufacturing relationship, redefine the value customers should expect from military standard (MIL-STD 810F) rugged devices.

We also re-engineer and ruggedize Dell PowerEdge servers to provide leveraged solutions that are setting new standards for rugged servers with the latest technologies, extreme performance levels and enhanced functionality and reliability.

NASDAQ Update

In accordance with NASDAQ Marketplace Rule 4450(e)(2), we had 180 calendar days from the date of the NASDAQ letter, or until January 20, 2009, to regain compliance. To regain compliance, the closing bid price of our common stock must meet or exceed $1.00 per share for a minimum of ten consecutive business days. NASDAQ suspended compliance with the minimum bid price rule, and as a result, we now have until November 4, 2009, to comply with this requirement. If we are not able to comply, we may request stockholder approval to effect a reverse stock split or we may delist from NASDAQ. If we do not regain compliance, NASDAQ will delist our common stock.

Given these factors, our Board of Directors may decide to delist from NASDAQ. In addition, given the ongoing costs associated with public reporting, we may take actions to deregister our shares under the Exchange Act.

If our common stock is delisted by NASDAQ, the trading market for our common stock would be adversely affected, as price quotations would not be readily obtainable, which would likely have a material adverse effect on the market price of our common stock and on the ability of stockholders to buy or sell our shares. In addition, if our stock is delisted for a period of 20 consecutive trading days, this event would constitute an event of default under our outstanding convertible notes of approximately $10.1 million, which could result in the noteholders requiring payment in full of the principal balance and interest of the notes. If we deregister our shares from the Exchange Act, there will be no public market for our shares.

Samsung Update

We have a license arrangement with Samsung, pursuant to which we have licensed certain technologies to Samsung, and Samsung provides to us quarterly reports of its license usage and pays corresponding royalty amounts in accordance with the terms of the agreement. We have primarily relied on these reports from Samsung and subsequent cash payment to record revenue from this license agreement.

Results of Operations - a comparison of the three months ended June 30, 2009 and 2008

The following table presents our results of operations for the periods indicated expressed as a percentage of total revenue:


	Three Months Ended June 30,
	2009		2008
Revenue:
Product	89.4	%	86.1	%
License	10.6		13.9

Total revenue	100.0		100.0
Cost of revenue:
Product	77.7		94.0
Amortization and impairment of acquisition intangibles	8.1		8.6

Total cost of revenue	85.8		102.6

Gross profit (loss)	14.2		(2.6	)
Operating expenses:
Selling, general and administrative	36.5		30.6
Research and development	27.2		12.2
Restructuring	1.5		2.4
Amortization of acquisition intangibles	0.5		1.9
Goodwill impairment	(2.1	)	—

Total operating expenses	63.6		47.1

Loss from operations	(49.4	)	(49.7	)
Other income, net	1.5		4.2

Loss before income taxes	(47.9	)	(45.5	)
Provision (benefit) for income taxes	0.3		(0.6	)

Net loss	(48.2	)%	(44.9	)%

Total Revenue


	Three Months Ended June 30,
	2009		2008		Change
	(in thousands, except %)
Product revenue	$	6,928	$	7,677	(9.8	)%
License revenue		822		1,236	(33.5	)%

Total revenue	$	7,750	$	8,913	(13.0	)%

Our product revenue for the second quarter of 2009 was $6.9 million, a decrease of 9.8% from $7.7 million for the second quarter of 2008. License revenue for the second quarter of 2009 was $0.8 million, a decrease of 33.5% from $1.2 million for the second quarter of 2008.

The decrease in our product revenue during the second quarter of 2009, compared to the second quarter of 2008, was driven by our decision to exit memory manufacturing during the first quarter of 2009. The decrease in revenue from memory products was largely offset by revenue generated from rugged technology products as a result of the Augmentix acquisition in July 2008.

The decline in license revenue during the three months ended June 30, 2009, compared to the three months ended June 30, 2008, was due to decreased demand for stacked memory.

The following table summarizes sales to customers that represented 10% or more of consolidated total revenue for the periods indicated:


	Three Months Ended June 30,
	2009		2008
Dell	78	%	*
SMART	11	%	25	%
Google	*		17	%
Micron	*		15	%

*	Amount does not equal or exceed 10% for the indicated period.

Gross profit (loss)


	Three Months Ended June 30,
	2009			2008			Change
	(in thousands, except %)
Gross profit (loss)	$	1,098		$	(232	)	NA	%
Percent of total revenue		14.2	%		(2.6	)%

Gross profit for the three months ended June 30, 2009 was $1.1 million, or 14.2% of our total revenue, compared to a gross loss of $0.2 million, or 2.6% of our total revenue, for the three months ended June 30, 2008.

The increase in our gross profit for the three months ended June 30, 2009, compared to June 30, 2008, was primarily due to the strategic decision to shift our focus away from commodity component markets toward vertical computing segments. As a result of this decision, gross profit was enhanced by the elimination of overhead expenses associated with our memory manufacturing activities.

Selling, general and administrative expense


	Three Months Ended June 30,
	2009			2008			Change
	(in thousands, except %)
Selling, general and administrative	$	2,829		$	2,727		3.7	%
Percent of total revenue		36.5	%		30.6	%

Selling, general and administrative expense for the three months ended June 30, 2009 was $2.8 million, or 36.5% of total revenue. This amount reflected an increase of approximately $0.1 million, or 3.7%, compared to $2.7 million, or 30.6% of total revenue, in the three months ended June 30, 2008. For the second quarter of 2009 and 2008, selling, general and administrative expense included stock-based compensation expense of $0.3 million and $0.5 million, respectively.

The increase in selling, general and administrative expense during the second quarter of 2009, compared to the second quarter of 2008, was primarily due to the reversal of the $0.8 million liability associated with the Southland earn-out consideration during the second quarter of 2008. The resulting increase was partially offset by reduced selling and stock-based compensation expenses.

Research and development expense


	Three Months Ended June 30,
	2009			2008			Change
	(in thousands, except %)
Research and development	$	2,107		$	1,093		92.8	%
Percent of total revenue		27.2	%		12.2	%

Research and development expense for the three months ended June 30, 2009 was $2.1 million, or 27.2% of total revenue, which reflected an increase of $1.0 million, or 92.8%, compared with $1.1 million, or 12.2% of total revenue, for the three months ended June 30, 2008. For the second quarter of 2009 and 2008, research and development expense included stock-based compensation expense of approximately $0.1 million.

The increase in research and development expense during the second quarter of 2009, relative to the second quarter of 2008, was primarily due to increased development costs associated with the acquisition of Augmentix, partially offset by decreased costs related to our memory business.

Amortization and impairment of acquisition intangibles


	Three Months Ended June 30,
	2009		2008		Change
	(in thousands, except %)
Amortization and impairment of acquisition intangibles	$	661	$	930	(28.9	)%

Amortization and impairment of acquisition intangibles was $0.7 million for the three months ended June 30, 2009, which reflected a decrease of $0.3 million, or 28.9%, compared with $0.9 million for the three months ended June 30, 2008.

The acquisition intangibles were originally valued using a discounted cash flow methodology. As a result, each year the total annual amortization expense of these intangibles is scheduled to decline. For interim periods within each year, amortization expense is recorded on a straight-line basis. As of June 30, 2008, as a result of the anticipated reduction in the future cash flow from our license agreement with Samsung, we tested our customer relationship intangible asset for impairment. As a result of our review, we recorded an impairment charge of approximately $0.2 million.

Goodwill impairment


	Three Months Ended June 30,
	2009			2008		Change
	(in thousands, except %)
Goodwill impairment	$	(159	)	$	—	(100	)%

In connection with our acquisition of Augmentix, we recorded goodwill of $4.0 million, and during the fourth quarter of 2008, we conducted our annual goodwill impairment test. As a result of that test, we recorded a non-cash charge of $4.0 million for the impairment of the goodwill created by the Augmentix acquisition. Effective June 3, 2009, we finalized the post-closing working capital adjustment as set forth in the merger agreement, and that adjustment resulted in a $0.2 million recovery of certain expenditures that were included in the original goodwill. As a result of this recovery and the prior impairment of the goodwill, we recorded a reduction in goodwill impairment expense in the second quarter of 2009.

Other income, net


	Three Months Ended June 30,
	2009		2008		Change
	(in thousands, except %)
Other income, net	$	117	$	378	(69.0	)%

Other income, net for the three months ended June 30, 2009, was $0.1 million, compared to $0.4 million for the three months ended June 30, 2008.

The change in other income, net from the three months ended June 30, 2009, compared to the same period of 2008, was primarily due to a lower balance in our cash, cash equivalents and investments as a result of our Augmentix acquisition. In addition, during the second quarter of 2009, we recorded approximately $0.2 million in interest expense related to our convertible notes payable that we issued in connection with our acquisition of Augmentix and other financing charges.

Provision (benefit) for income taxes

We recorded a provision for income taxes of $22,000 during the second quarter of 2009 and an income tax benefit of $52,000 during the second quarter of 2008. Our effective tax rate was approximately (1)% and 1% for the second quarter of 2009 and 2008, respectively. For the second quarter of 2009 and 2008, our effective tax rate differed from the federal statutory rate of 35% primarily due to recording an increase in the valuation allowance against our net deferred tax assets. Management has determined that there is substantial doubt we will realize the majority of the benefit of our net deferred tax asset.

Results of Operations - a comparison of the six months ended June 30, 2009 and 2008

The following table presents our results of operations for the periods indicated expressed as a percentage of total revenue:


	Six Months Ended June 30,
	2009		2008
Revenue:
Product	95.6	%	85.0	%
License	4.4		15.0

Total revenue	100.0		100.0
Cost of revenue:
Product	75.0		98.7
Amortization and impairment of acquisition intangibles	6.0		7.7

Total cost of revenue	81.0		106.4

Gross profit (loss)	19.0		(6.4	)
Operating expenses:
Selling, general and administrative	29.0		39.7
Research and development	20.7		13.7
Restructuring	11.7		1.2
Amortization of acquisition intangibles	0.3		2.0
Goodwill impairment	(0.8	)	—

Total operating expenses	60.9		56.6

Loss from operations	(41.9	)	(63.0	)
Other income, net	0.0		5.2

Loss before income taxes	(41.9	)	(57.8	)
Provision (benefit) for income taxes	0.2		(1.5	)

Net loss	(42.1	)%	(56.3	)%

Total Revenue


	Six Months Ended June 30,
	2009		2008		Change
	(in thousands, except %)
Product revenue	$	19,871	$	14,889	33.5	%
License revenue		918		2,636	(65.2	)%

Total revenue	$	20,789	$	17,525	18.6	%

Our product revenue for the six months ended June 30, 2009 was $19.9 million, an increase of 33.5% from $14.9 million for the six months ended June 30, 2008. License revenue for the six months ended June 30, 2009 was $0.9 million, a decrease of 65.2% from $2.6 million for the six months ended June 30, 2008.

The increase in our product revenue during the six months ended June 30, 2009, compared to the six months ended June 30, 2008, was primarily due to the revenue generated from our rugged technology products, of which we had none in the first six months of 2008. This increase was partially offset by the decision to exit our memory manufacturing activities during the six months ended June 30, 2009.

The decline in license revenue during the six months ended June 30, 2009, compared to the six months ended June 30, 2008, was due to decreased demand for stacked memory.

The following table summarizes sales to customers that represented 10% or more of consolidated total revenue for the periods indicated:


	Six Months Ended June 30,
	2009		2008
Dell	65	%	*
SMART	*		21	%
Micron	*		17	%
Google	*		12	%

*	Amount does not equal or exceed 10% for the indicated period.

Gross profit (loss)


	Six Months Ended June 30,
	2009			2008			Change
	(in thousands, except %)
Gross profit (loss)	$	3,947		$	(1,121	)	NA	%
Percent of total revenue		19.0	%		(6.4	)%

Gross profit for the six months ended June 30, 2009 was $3.9 million, or 19.0% of our total revenue, compared to a gross loss of $1.1 million, or 6.4% of our total revenue, for the six months ended June 30, 2008.

The increase in our gross profit for the six months ended June 30, 2009, compared to June 30, 2008, was primarily due to the strategic decision to shift our focus away from commodity component markets towards vertical computing segments. As a result of this decision, gross profit was enhanced by the elimination of overhead expenses associated with our memory manufacturing activities.

Selling, general and administrative expense


	Six Months Ended June 30,
	2009			2008		Change
	(in thousands, except %)
Selling, general and administrative	$	6,027		$	6,956	(13.4	)%
Percent of total revenue		29.0	%		39.7

Selling, general and administrative expense for the six months ended June 30, 2009 was $6.0 million, or 29.0% of total revenue. This amount reflected a decrease of approximately $0.9 million, or 13.4%, compared to $7.0 million, or 39.7% of total revenue, in the six months ended June 30, 2008. For the first six months of 2009 and 2008, selling, general and administrative expense included stock-based compensation expense of $0.5 million and $1.0 million, respectively.

The decline in selling, general and administrative expense during the first half of 2009, compared to the first half of 2008, was largely due to a legal settlement and acquisition-related expenses incurred in the first six months of 2008. In addition, lower selling and stock-based compensation expenses for the six months ended June 30, 2009 were partially offset by the reversal of the $1.1 million liability associated with the Southland earn-out consideration during the six months ended June 30, 2008.

Research and development expense


	Six Months Ended June 30,
	2009			2008			Change
	(in thousands, except %)
Research and development	$	4,293		$	2,397		79.1	%
Percent of total revenue		20.7	%		13.7	%

Research and development expense for the six months ended June 30, 2009 was $4.3 million, or 20.7% of total revenue, which reflected an increase of $1.9 million, or 79.1%, compared with $2.4 million, or 13.7% of total revenue, for the six months ended June 30, 2008. For the first six months of 2009 and 2008, research and development expense included stock-based compensation expense of approximately $0.1 million and $0.2 million, respectively.

The increase in research and development expense during the six months ended June 30, 2009, compared to the six months ended June 30, 2008, was primarily due to the addition of development costs associated with our rugged technology products as a result of our acquisition of Augmentix in July 2008.

Restructuring expense

During the six months ended June 30, 2009, we recorded restructuring expense of $2.4 million as a result of the completion of our plan to close manufacturing activities of our Memory Solutions business, which we initiated during the fourth quarter of 2008. The additional charge of approximately $2.4 million included approximately $1.5 million related to employee severance expenses, $0.5 million provision related to certain fixed assets no longer used in manufacturing and $0.4 million related to exiting one of our facilities located in Austin, Texas.

Amortization and impairment of acquisition intangibles


	Six Months Ended June 30,
	2009		2008		Change
	(in thousands, except %)
Amortization and impairment of acquisition intangibles	$	1,322	$	1,704	(22.4	)%

Amortization and impairment of acquisition intangibles was $1.3 million for the six months ended June 30, 2009, a decrease of $0.4 million, or 22.4%, compared to $1.7 million for the six months ended June 30, 2008.

The acquisition intangibles were originally valued using a discounted cash flow methodology. As a result, each year the total annual amortization expense of these intangibles is scheduled to decline. As of June 30, 2008, as a result of the anticipated reduction in the future cash flow from our license agreement with Samsung, we tested our customer relationship intangible asset for impairment. As a result of our review, we recorded an impairment charge of approximately $0.2 million.

Goodwill impairment


	Six Months Ended June 30,
	2009			2008		Change
	(in thousands, except %)
Goodwill impairment	$	(159	)	$	—	(100	)%

agreement, and that adjustment resulted in a $0.2 million recovery of certain expenditures that were included in the original goodwill. As a result of this recovery and the prior impairment of the goodwill, we recorded a reduction in goodwill impairment expense in the second quarter of 2009.

Other income (expense), net


	Six Months Ended June 30,
	2009			2008		Change
	(in thousands, except %)
Other income (expense), net	$	(1	)	$	909	NA	%

Other expense, net for the six months ended June 30, 2009, was $1,000, compared to other income, net of $0.9 million for the six months ended June 30, 2008.

The change in other income (expense), net from the six months ended June 30, 2009, compared to the same period of 2008, was primarily due to a lower balance in our cash, cash equivalents and investments as a result of our Augmentix acquisition. In addition, during the first six months of 2009, we recorded approximately $0.3 million in interest expense related to our convertible notes payable that we issued in connection with our acquisition of Augmentix and other financing charges.

Provision (benefit) for income taxes

We recorded a provision for income taxes of $36,000 for the six months ended June 30, 2009 and an income tax benefit of $0.3 million during the six months ended June 30, 2008. Our effective tax rate was approximately 0% and 3% for the six months ended June 30, 2009 and 2008, respectively. For the six months ended June 30, 2009 and 2008, our effective tax rate differed from the federal statutory rate of 35% primarily due to recording an increase in the valuation allowance against our net deferred tax assets. Management has determined that there is substantial doubt we will realize the majority of the benefit of our net deferred tax asset.

Liquidity and Capital Resources

As of June 30, 2009, we had working capital of $23.7 million, including $18.0 million of cash, cash equivalents and investments, compared to working capital of $23.0 million, including $17.3 million of cash, cash equivalents and investments, as of December 31, 2008. In addition to our working capital, we held approximately $0 and $7.3 million in long-term investments at June 30, 2009 and December 31, 2008, respectively.

As of December 31, 2008, our long-term investments consisted of tax-exempt ARS, which have a long-term maturity with the interest rate being reset to the maximum rate according to the applicable investment offering document. During the first quarter of 2008, auctions for certain of these securities began to fail. As of June 30, 2009, we held approximately $6.7 million of ARS. The underlying collateral of our ARS consists primarily of student loans, of which 68% are guaranteed by the federal government as part of the FFELP. The FFELP guarantees between 95% and 98% of the par value of these loans. The remaining 32% of our ARS are private loans, of which 85% are insured. During the first quarter of 2009, approximately $0.2 million of our ARS was called at par by the issuer. As of June 30, 2009, there was insufficient observable ARS market information available to determine the fair value of these investments. Therefore, our ARS were valued based on a pricing model that included certain assumptions, such as our ARS maximum interest rate, probability of passing auction, default probability and discount rate. During November 2008, we accepted an offer provided to us by the investment firm through which we hold our ARS to sell our auction rate securities to this firm, at par value, at any time over a two-year period, beginning June 30, 2010 and ending July 2, 2012. The agreement also provides access to loans of 75% of the market value of our ARS until June 30, 2010. In connection with this settlement, we recorded a gain of approximately $0.7 million in other expense related to the change in fair value of our put option. As of June 30, 2009, we reclassified our ARS and put option to short-term investments based on our intent to sell them to the investment firm on June 30, 2010. See Note 4, “Investments,” for additional information.

In order to produce our rugged notebook and server solutions, we leverage select components and materials from Dell. This includes elements such as main logic boards, memory, base LCDs, and power supplies, among other components and materials. We also leverage the Dell logistics and supply chain so that we have continuity of supply. Additional elements, such as chassis, thermal systems, optical enhancements, and other rugged elements, are procured from contracted vendors.

Net cash used in operating activities was $6.0 million for the six months ended June 30, 2009, compared to $7.9 million for the six months ended June 30, 2008. The decrease in net cash used in operating activities was primarily due to a net decrease of $2.6 million in cash used for operating assets and liabilities and a $1.1 million decrease in net loss, partially offset by a $1.1 million decrease in depreciation, amortization and impairment of intangibles, and a $0.7 million decrease in stock-based compensation expense.

Net cash used in investing activities was $0.5 million for the six months ended June 30, 2009, compared to net cash provided by investing activities of $14.9 million for the six months ended June 30, 2008. The change in net cash provided by investing activities was due primarily to the $15.8 million decrease in proceeds from the sale and maturities of investments, net of purchases, in the first six months of 2009, compared to the first six months of 2008, partially offset by an increase of $0.3 million in proceeds from the sale of equipment, net of purchases.

Net cash used in financing activities during the six months ended June 30, 2009 was $45,000, primarily related to the purchase of our common stock as part of our stock repurchase program for $34,000. Net cash used in financing activities during the six months ended June 30, 2008 was $76,000, primarily related to the purchase of our common stock as part of our stock repurchase program for $0.2 million, partially offset by the issuance of common stock under our employee stock plans.

During the first quarter of 2009, a financial institution issued a letter of credit to one of our suppliers, which guarantees up to $0.5 million of our outstanding account balance to this supplier. As a result of this agreement, we are required to maintain a compensating balance of $0.5 million on deposit with the financial institution for a term of 12 months ending on February 26, 2010. As of June 30, 2009, we had this required amount on deposit.

We incurred negative cash flows from operations in 2008 and the first six months of 2009. In order to improve profitability and enhance cash flow, we decided to shift our focus away from commodity component markets towards vertical computing segments. As a result, on December 17, 2008, we announced our plan to terminate manufacturing of our Memory Solutions business in the first quarter of 2009. We will continue to receive royalties with respect to our stacking patent portfolio and have transferred our memory and stacking customers and certain manufacturing assets to third parties. Based on these changes in our business operations, we believe that our current assets, including cash and cash equivalents, investments and expected cash flow from operations, will be sufficient to fund our operations, our anticipated additions to property, plant and equipment, interest payments and any share repurchases under our stock repurchase program for at least the next 12 months. However, it is possible that we may need or elect to raise additional funds to fund our activities beyond the next year or to acquire other businesses, products or technologies. We could raise these funds by borrowing money or selling more stock to the public or to selected investors. In addition, while we may not need additional funds, we may elect to sell additional equity securities or obtain credit facilities for other reasons. We cannot assure that we will be able to obtain additional funds on commercially favorable terms, or at all. If we raise additional funds by issuing more equity or convertible debt securities, the ownership percentages of existing stockholders would be reduced. In addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to those of the holders of our common stock.

Manufacturing Relationship

In addition, we have an arrangement with a manufacturer in which this third party purchases and takes title of certain inventory relating to certain of our products upon shipment from the original manufacturers of such inventory. This third party recovers the cost of inventory upon the sale of finished goods to us. This program offers us several advantages; however, this arrangement also results in concentrated credit and inventory risk for us. A large percentage of our accounts receivable balance at the end of the quarter was with this third party. This was partially offset by a balance in accounts payable due to this third party for finished goods. In addition, by transferring inventory to this third party, the financial failure of this third party could freeze this inventory, preventing us from accessing it and using it for our products. As our sales increase, these amounts will increase, which will also increase the risk to us. As of June 30, 2009, our accounts receivable reflected amounts owed to us of $6.3 million related to this transfer of inventory. Additionally, our liability to our vendors for the production of finished goods and inventory delivered by the manufacturer relating to certain of our products was approximately $5.3 million. We are exploring ways to minimize our risk with respect to this relationship. If we are not able to do so, we may restructure this relationship to reduce the risks we face.

Convertible Notes

Also, if our stock is delisted for a period of 20 consecutive trading days, this event would constitute an event of default under our outstanding convertible notes of approximately $10.1 million, which could result in the noteholders requiring payment in full of the principal balance and interest of the notes.

Critical Accounting Estimates

The preparation of financial statements in conformity with United States generally accepted accounting principles requires that management make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. We believe that the following discussion addresses our most critical accounting estimates, which are those that are most important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective and complex judgments.

Revenue Recognition and Presentation. We purchase inventory for resale to our manufacturing partners. We evaluate these transactions and determine if the costs and revenue should be presented on a gross or net basis. In making this determination, we primarily consider if: (1) we did not add value to the inventory through our manufacturing processes, (2) we did not take risk of ownership of the inventory and (3) our net revenue from the transaction is predefined. In situations where these conditions were met, we net the expense of the components against the revenue from the transaction.

Royalty revenue from our license agreements is recognized in the quarter in which our licensees report royalties to us.

Deferred Revenue. Our agreement with our largest OEM related to sales of a specific product line allows for price reductions, issued as rebates, as certain volume levels of shipments are reached. The per-unit price of lower-quantity tiers is variable above a certain minimum price, since the price can be retroactively adjusted downward if certain volume levels are satisfied. Pursuant to Emerging Issues Task Force 01-9, “Accounting for Consideration Given by a Vendor to a Customer” (EITF 01-9) Issue 6, we consider these pricing changes as a right of return and defer the amount of rebate that could occur until the end of the period when the actual volume levels are reasonably estimable. We estimate the amount of sales based on experience as well as forecasts provided by our OEM. Revenue above the fixed minimum price is deferred until the actual volume levels are achieved. The estimate is revised each reporting period and is ultimately adjusted to actual at the end of the year.

Impairment of Assets. We evaluate the recoverability of losses on long-lived assets, such as property, plant and equipment and intangible assets, when events or changes in circumstances indicate that the undiscounted cash flows estimated to be generated by such assets are less than the carrying value of these assets, and accordingly, all or a portion of this carrying value may not be recoverable. Impairment losses are then measured by comparing the fair value of the assets to the carrying amounts. Determining the appropriate fair value model and calculating the fair value of intangible assets require the input of highly subjective assumptions, including the expected future cash flows from, and the expected life of, the intangible asset, the appropriate discount rate, future customer turnover and operating margins. The assumptions used in calculating the fair value of intangible assets represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, we could reach a different conclusion regarding whether an intangible asset is impaired and, if so, the amount of the impairment loss.

Inventory and Inventory Reserves. We value our inventory at standard cost and review our inventory for quantities in excess of production requirements and for obsolescence. We maintain a reserve for excess, slow moving and obsolete inventory, as well as for inventory with a carrying value in excess of its market value. We review inventory on hand quarterly and record a provision for lower of cost or market, and for excess, slow moving and obsolete inventory, if necessary. The review is based on several factors, including a current assessment of future product demand, historical experience and market conditions. If actual conditions are less favorable than those that we projected, additional inventory reserves may be required.

Warranty. We repair or replace products that have been authorized for repair or replacement by our customers. We utilize a third-party service provider to perform a full range of service and support options, ranging from telephone, online, on-site, return-to-depot, and customer replaceable units (parts) available in the continental U.S. and in select international cities. The costs of such repairs or replacements are expensed as actual costs are incurred. We warrant products for periods ranging from 12 to 37 months following the sale of our products. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, our warranty obligations are affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs increase, our warranty costs to support the products in the field could increase.

Income Taxes. We determine deferred tax assets and liabilities based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the years in which the differences are expected to affect taxable income. Inherent in the measurement of these deferred balances are certain judgments and interpretations of existing tax law and other published guidance. We establish valuation allowances when necessary to reduce deferred tax assets to the amounts expected to be realized. Our effective tax rate considers our judgment of expected tax liabilities in the various taxing jurisdictions, within which we are subject to tax as well as the future recovery of deferred tax assets. The recorded amounts of income tax are subject to adjustment upon audit, changes in interpretation and changes in judgment utilized in determining estimates.

Stock-Based Compensation. Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R) using the modified prospective transition method. Under the fair value recognition provisions of SFAS 123(R), we recognize stock-based compensation net of an estimated forfeiture rate on a straight-line basis over the requisite service period of the award and only recognize compensation cost for those shares expected to vest.

Determining the appropriate fair value model and calculating the fair value of share-based payment awards require the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from the amount we have recorded in the current period.

Recently Issued Accounting Pronouncements

In June 2009, the FASB issued SFAS 168, to establish the FASB Codification as the source of authoritative GAAP recognized by the FASB to be applied to non-governmental entities and rules and interpretive releases of the SEC as authoritative GAAP for SEC registrants. The Codification will supersede all the existing non-SEC accounting and reporting standards upon its effective date. SFAS 168 is effective for interim or annual periods ending after September, 15, 2009. We do not expect the adoption of SFAS 168 to have a material impact on our financial position, results of operations, cash flows or disclosures.

In May 2009, the FASB issued SFAS 165, to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 also identifies the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that should be made about events or transactions that occur after the balance sheet date. This pronouncement was effective for interim or annual financial periods ending after June 15, 2009, and shall be applied prospectively. The adoption of SFAS 165 did not have a material impact on our financial position, results of operations, cash flows or disclosures.

In April 2009, the FASB issued FAS 107-1 and APB 28-1, to require disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies and to require those disclosures in all interim financial statements. This pronouncement was effective for interim periods ending after June 15, 2009. The adoption of FSP FAS 107-1 and APB 28-1 did not have a material impact on our financial position, results of operations, cash flows or disclosures.

In April 2009, the FASB issued FAS 115-2 and FAS 124-2, to provide guidance in determining whether impairments in debt securities are other than temporary, and to modify the presentation and disclosures for such instruments. This pronouncement was effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP FAS 115-2 and FAS 124-2 did not have a material impact on our financial position, results of operations, cash flows or disclosures.

In April 2009, the FASB issued FAS 157-4, to provide additional guidance in determining whether a market for a financial asset is not active and a transaction is not distressed for fair value measurement purposes. This pronouncement was effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP FAS 157-4 did not have a material impact on our financial position, results of operations, cash flows or disclosures.

Subsequent Events

Available Information

We maintain a web site at www.entorian.com, which makes available free of charge our filings with the SEC. Our Quarterly Reports on Form 10-Q, Annual Report on Form 10-K, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 are available through the Investor Relations page of our web site as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. We also maintain a web site at www.augmentix.com. Our web sites and the information contained therein or connected thereto are not intended to be incorporated into this Quarterly Report on Form 10-Q.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Risk. Most of our transactions are denominated in U.S. dollars. The functional currency of our subsidiary in Mexico is the U.S. dollar. As a result, we have little exposure to currency exchange risks and foreign exchange losses have been minimal to date. We do not currently enter into forward exchange contracts to hedge exposure denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. In the future, if we believe that our currency exposure has increased, we may consider entering into hedging transactions to help mitigate that risk.

Interest Rate Risk. The primary objective of our investment activities is to preserve principal while maximizing the related income without significantly increasing risk. Even so, some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and certificates of deposit. The risk associated with fluctuating interest rates is limited to our investment portfolio and we do not believe that a 10% change in interest rates will have a significant impact on our interest income. At June 30, 2009, all of our cash was held in deposit or money market accounts, or invested in investment grade securities. From time to time, we may have amounts on deposit with financial institutions that are in excess of the federally insured limit of $250,000; however, the majority of our deposits are held in accounts insured by the Federal Deposit Insurance Corporation (FDIC) Transaction Account Guarantee Program, which provides an unlimited guarantee through December 31, 2009. We have not experienced any losses on deposits of cash and cash equivalents.

Our exposure to market rate risk for changes in interest rates relates to our convertible notes. The fair market value of our convertible notes is subject to interest rate risk because of their fixed interest rate and market risk due to the convertible feature of our convertible notes. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall, and decrease as interest rates rise. The fair market value of our convertible notes will also increase as the market price of our stock increases and decrease as the market price falls. The interest and market value changes affect the fair market value of our convertible notes but do not impact their carrying value.

Our short-term investments include approximately $6.7 million in ARS. During the first quarter of 2008, auctions for certain of these securities began to fail. The funds associated with failed auctions are not expected to be accessible until June 30, 2010, or until a successful auction occurs, the issuer redeems the securities, a buyer is found outside of the auction process or the underlying securities mature. Additionally, if we determine that an other-than-temporary decline in the fair value of any of our ARS has occurred, we may be required to adjust the carrying value of the investments through an impairment charge. See Note 4, “Investments,” for additional information.

ITEM 4T.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this quarterly report, and concluded that our disclosure controls and procedures were effective for this purpose.

Changes in Internal Control Over Financial Reporting. During the quarter ended June 30, 2009, we implemented a new ERP system. In conjunction with the ERP implementation, we modified the design, operation and documentation of our internal control over financial reporting. Specifically, we modified controls in the business processes impacted by the new system, such as user access security, system reporting and authorization and reconciliation procedures. There were no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that materially affected, or were reasonably likely to materially affect, such internal control over financial reporting.

PART II

ITEM 1.

LEGAL PROCEEDINGS

Currently, we are not involved in any material legal proceedings. However, from time to time, we may be subject to legal proceedings, claims in the ordinary course of business, claims in foreign jurisdictions where we operate, and non-contractual customer claims or requested concessions we may agree to in the interest of maintaining business relationships.

ITEM 1A.

RISK FACTORS

Our business faces significant risks. The risk factors set forth below may not be the only ones that we face. Additional risks that we are not aware of yet or that currently are not material may adversely affect our business operations.

We may not be able to increase our revenue and our operating results are likely to fluctuate, which may cause the trading price of our common stock to decline.

We may not be able to increase revenue or generate gross profits or net income. Our revenue and operating results are likely to fluctuate, causing our stock price to fluctuate. If our revenue or operating results fall below the expectations of market analysts or investors, the market price of our common stock could decline substantially.

Factors that may contribute to fluctuations in our revenue and operating results include the risk factors discussed elsewhere in this Quarterly Report on Form 10-Q and the following additional factors:

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the timing and volume of sales of our products;

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market demand for, and changes in the average sales prices of, our products and technologies;

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a shortage of critical parts, which may negatively impact our ability to fulfill customer orders;

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fluctuating demand for, and life cycles of, our products;

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changes in our relationship with Dell, our largest customer with which we have an exclusive sales and marketing agreement regarding certain ruggedized computer notebook products;

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inconsistency in forecasts provided to us by Dell, resulting in increased inventory exposure as we build to the current Dell forecast;

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decreases in military spending and the budgets of federal, state and local agencies, impacting sales of our ruggedized products;

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the failure of our ruggedized products to meet the military specification MIL-STD-810F, which is the required specification for products to be considered rugged;

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operational risks from our reliance on suppliers, subcontractors and third-party manufacturers for the production of ruggedized products;

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changes in the level of our operating expenses;

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our ability to develop new products that are successfully qualified and utilized by customers;

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our ability to have manufactured and shipped products within a particular reporting period;

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deferrals or cancellations of customer orders in anticipation of the development and commercialization of new technologies or for other reasons;

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our ability to enter into new licensing arrangements, and the terms and conditions for payment to us of license fees under those arrangements;

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changes in our royalties caused by changes in demand for products incorporating semiconductors that use our licensed technologies;

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changes in our products and technologies;

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seasonal purchasing patterns for our products, with lower revenue generally occurring in the first and second quarters;

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the timing of the introduction by others of competing, replacement or substitute products and technologies;

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our ability to enforce our intellectual property rights or to defend claims that we infringe the intellectual property rights of others, as well as our ability to protect our intellectual property, and the significant costs to us of related litigation; and

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general economic conditions that may affect demand for our products.

We are dependent upon an exclusive contract with Dell for revenue generated from the sale of our ruggedized notebook products, which represents a significant portion of our revenue, and in the event of any adverse change to our relationship with Dell, our business, financial condition and results of operations could be adversely affected.

Presently, Dell is our only customer for our rugged notebooks. Revenue from Dell is expected to represent a substantial percentage of our total revenue in 2009. If Dell reduces or discontinues its business with us, our business, financial condition and results of operations could be adversely affected.

In addition, we heavily rely on the Dell sales force to sell our ruggedized notebook products and the Dell service organization to provide support to us. If we experience issues regarding insufficient training or lack of sales efforts by the Dell sales force, the decline of sales of our ruggedized notebook products could have a material and adverse effect on our operating results.

A substantial percentage of our total revenue depends on the sale of ruggedized notebook products, and as a result, any significant reduction of sales of these products could materially and adversely affect our operating results.

Because our revenue is derived substantially from sales of our ruggedized notebook products, we are highly dependent upon the continued market acceptance of these products. Continued market acceptance of our ruggedized notebook products is critical to our future success. Any significant reduction of sales of these products could materially and adversely affect our business.

We are dependent on a limited number of suppliers for our ruggedized products, and the loss of these suppliers and our inability to procure new suppliers at comparative costs could have a material and adverse effect on our business, financial condition and results of operations.

We purchase notebooks and components from a limited number of suppliers. Dell is the sole supplier of many of the components that are used in our ruggedized laptop computers. While we believe that alternative sources are available, contractual obligations to Dell preclude our ability to secure new suppliers. The loss of our supplier could cause a disruption in the availability of these products. In addition, we have a limited number of suppliers for other components, and a disruption in the supply of these components may also cause a disruption in the availability of these components and a delay in manufacturing, which could have a material adverse effect on our business.

We depend on third parties to manufacture our ruggedized products, subjecting us to certain operational risks.

We currently depend on third-party manufacturers to manufacture our ruggedized products and ruggedized products under development, and this reliance subjects us to significant operational risks, any of which could impair our ability to deliver products to our customers should they occur. Our reliance involves a number of risks, including:

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reduced management and control of component purchases;

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reduced control over delivery schedule and quality assurance;

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reduced control over manufacturing yields;

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lack of adequate capacity during periods of excess demand;

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limited warranties on products supplied to us;

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potential increases in prices;

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interruption of supplies as a result of fire, natural calamity, strike or other significant events; and

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misappropriation of our intellectual property.

We rely on sales forecasts provided by Dell, subjecting us to certain inventory risks.

We rely on sales forecasts provided by Dell on a monthly basis. We build our rugged notebooks to these forecasts as they are provided to us, which may result in increased inventory exposure in the event Dell reduces its forecast after we have procured materials. Any such reduced forecast by Dell could have a material and adverse effect on our operating results.

Our relationship with a third party manufacturer presents certain risks to us that could negatively affect our business, results of operations and financial condition.

We have an arrangement with a manufacturer in which this third party purchases and takes title of certain inventory relating to certain of our products upon shipment from the original manufacturers of such inventory. This third party recovers the cost of inventory upon the sale of finished goods to us. This program offers us several advantages; however, this arrangement also results in concentrated credit and inventory risk for us. A large percentage of our accounts receivable balance at the end of the quarter was with this third party. This was partially offset by a balance in accounts payable due to this third party for finished goods. In addition, by transferring inventory to this third party, the financial failure of this third party could freeze this inventory, preventing us from accessing it and using it for our products. As our sales increase, these amounts will increase, which will also increase the risk to us. We are exploring ways to minimize our risk with respect to this relationship. If we are not able to do so, we may restructure this relationship to reduce the risks we face. In the meantime, the financial failure of this third party could negatively affect our business, results of operations and financial condition.

Budget constraints of the U.S. military, federal, state and local governments could negatively impact sales of our ruggedized products, which could materially and adversely affect our operating results.

We market to the U.S. military forces as potential customers of our ruggedized products, as well as other state and local governments. Any decrease in spending by these agencies or a change in the current political situation or overall market conditions may negatively impact sales of our ruggedized products, which could materially and adversely affect our operating results.

In the event of a failure of our ruggedized products to meet the military specification MIL-STD-810F, our business, financial condition and results of operations could be adversely affected.

Our products are ruggedized to meet (and in some cases, exceed) the military specifications MIL-STD-810F. Created by the U.S. government, the MIL-STD-810F specifications cover a broad range of tests that measure the durability of equipment used under harsh conditions. A failure to meet this standard would result in our products not qualifying as “rugged” products, which could have a material and adverse effect on our operating results. In addition, this standard could change, third-party components could fail to meet the required specifications, or a third-party manufacturer could fail to produce our products according to the required specifications, each of which could also have a material and adverse effect on our operating results.

Some of our suppliers and subcontractors do not have long operating histories or significant financial strength.

Some of the suppliers and subcontractors with which we engage to provide services to us are small companies without a long operating history or significant financial strength. We have selected these third parties because of their flexibility in dealing with our schedules, their prices and expertise, among other factors, but they may not have the reliability or financial position of larger, more well-established suppliers and subcontractors. As a result, we face increased risks in dealing with these third parties in terms of their financial position, ability to continue operations and meet their commitments and quality control, among other issues, which could materially and adversely affect our operating results.

We depend on key Dell personnel, and in the event of changes to these Dell personnel, our business could be harmed.

We believe our future success will depend in large part upon our relationships with key Dell personnel. If any of these key personnel leave their current positions with Dell, this could jeopardize our future relationship with Dell, as well as delay the development and introduction of, and negatively impact our ability to sell, our ruggedized notebook products.

We rely on Dell to purchase products from our inventory hub so that we can receive payment for our products. If Dell does not take possession of these products, we will not be paid, which could materially and adversely affect our business, financial condition and results of operations.

We stock certain of our products in a hub based on a forecast from Dell, from which Dell purchases products and pays us after taking possession. This arrangement allows us to receive payment for these products on a regular basis, so that we can pay our suppliers on a timely basis without significant exposure to our working

capital. If we stock our hub but Dell does not purchase our products, this could result in an increase in our inventory levels, as well as an increase in our working capital exposure, since we will be required to pay our suppliers prior to receiving payment from Dell. This change could materially and adversely affect our business, financial condition and results of operations. In the future, our supply chain with Dell may change, which could impact our inventory levels, our working capital exposure, as well as our cash position.

Because we do not have long-term agreements with our customers and generally do not have a significant backlog of unfilled orders, our revenue and operating results in any quarter are difficult to forecast.

With the exception of our exclusive sales and marketing contract between Augmentix and Dell, we do not have long-term purchase agreements with customers. Because our expense levels are based in part on our expectations as to future revenue and to a large extent are fixed in the short term, we likely will be unable to adjust spending on a timely basis to compensate for any unexpected shortfall in revenue. Accordingly, any significant shortfall of revenue in relation to our expectations could hurt our operating results and depress our stock price.

The NASDAQ Stock Market notified us that the bid price of our common stock had closed below the per-share requirement for continued inclusion on NASDAQ, which could result in delisting our securities, and which could limit investors’ ability to trade in our securities and trigger repayment obligations we have regarding our outstanding notes.

We must successfully complete our recent ERP implementation, as well as maintain our information technology systems.

During the second quarter of 2009, we implemented a new ERP system. This implementation subjects us to inherent costs and risks associated with replacing and changing our legacy system, including our ability to fulfill customer orders, potential disruption of our internal control structure, substantial capital expenditures, additional administration expenses, demands on management time and other risks of delays or difficulties in transitioning to

the new system. Our ERP implementation may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. In addition, the implementation of a new technology system may cause disruptions in our business operations. Our ability to mitigate existing and future disruptions could negatively affect our business, results of operations and financial condition.

We face several issues in connection with shutting down our manufacturing facility in Reynosa, Mexico.

We are closing down our manufacturing facility in Reynosa, Mexico, and have listed the facility for sale or lease. There are many legal and regulatory issues we face, and regulations with which we must comply, as a result of our decision to close this facility. In addition, we may not be able to sell or lease our facility in a timely manner. If we encounter regulatory or other issues, or if we are unable to sell or lease our facility in a timely manner, our financial condition and results of operations could be adversely affected.

If we fail to protect our proprietary rights, our customers or our competitors might gain access to our technologies, which could adversely affect our ability to sell our products, to license our memory solutions, to compete successfully in our markets, as well as result in refunds we are required to pay to Dell and other customers and harm our operating results.

We believe that the strength of our intellectual property rights is, and will continue to be, important to our business. If any of our key patents or other intellectual property rights are invalidated or deemed unenforceable, if a court limits the scope of the claims in any of our key patents or other intellectual property rights, if we fail to protect our intellectual property or unknowingly develop products based on the intellectual property of third parties, our business could be adversely affected. We indemnify Dell and other customers for patent infringement, so in the event an infringement claim is made with respect to the notebooks we sell to Dell or other products sold to customers, if we cannot defend against the claim made, we may have to refund to Dell and other customers the purchase price of the products sold, as well as defend against the infringement claim. In addition, if we do not protect our proprietary rights, the likelihood that companies will continue to license our memory solutions could be significantly reduced. If we fail to obtain patents or if the patents issued to us do not cover all of the claims we asserted in our patent applications, others could use portions of our intellectual property without the payment of license fees and royalties. The results of the factors set forth above could significantly harm our business, financial condition and results of operations.

We rely on a combination of license, development and nondisclosure agreements and other contractual provisions and patent, trademark and trade secret laws, and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality agreements with our employees, consultants and third parties, and control access to and distribution of our documentation and other proprietary information. It is possible that these efforts to protect our intellectual property rights may not:

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prevent challenges to, or the invalidation or circumvention of, our existing patents;

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result in patents that lead to commercially viable products or provide competitive advantages for our products;

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prevent our competitors from independently developing similar products, duplicating our products or designing around the patents owned by us;

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prevent third-party patents from having an adverse effect on our ability to do business;

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provide adequate protection for our intellectual property rights;

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prevent disputes with third parties regarding ownership of our intellectual property rights;

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prevent disclosure of our trade secrets and know-how to third parties or into the public domain; or

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result in valid patents, including international patents, from any of our pending applications.

A court invalidation or limitation of our key patents could harm our business, financial condition and results of operations.

Our patent portfolio contains some patents that are particularly significant to our ongoing license revenue. If any of these key patents are invalidated, or if a court limits the scope of the claims in any of these key patents, the likelihood that companies will take new licenses and that current licensees will continue to agree to pay under their existing licenses could be reduced. The resulting loss in license fees and royalties could harm our business, financial condition and results of operations.

Our debt obligations expose us to risks that could adversely affect our business, operating results and financial condition.

In July 2008, we issued an aggregate principal amount of approximately $10.7 million in convertible notes (the “Notes”) due in 2010, which amount currently is approximately $10.1 million due to an adjustment to these notes. The level of our indebtedness, among other things, could:

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require us to dedicate a portion of our expected cash flow or our existing cash to service our indebtedness, which would reduce the amount of our cash available for other purposes, including working capital, capital expenditures and research and development expenditures;

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make it difficult for us to incur additional debt or obtain any necessary financing in the future for working capital, capital expenditures, debt service, acquisitions or general corporate purposes;

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limit our flexibility in planning for or reacting to changes in our business;

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limit our ability to sell ourselves or engage in other strategic transactions;

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make us more vulnerable in the event of a downturn in our business; or

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place us at a possible competitive disadvantage relative to less leveraged competitors and competitors that have greater access to capital resources.

If we experience a decline in revenue due to any of the factors described in this section entitled “Risk Factors,” or otherwise, we could have difficulty paying amounts due on our indebtedness. Although the Notes mature in 2010, the holders of the Notes may require us to repurchase their Notes prior to maturity under certain circumstances, including specified fundamental changes such as the sale of a majority of the voting power of the Company. If we are unable to generate sufficient cash flow or are otherwise unable to make required payments, or if we fail to comply with the various requirements of the Notes, we would be in default, which would permit the holders of our indebtedness to accelerate the maturity of the indebtedness and could cause defaults under any other indebtedness that we may have outstanding at such time. Specifically, if our stock is delisted for a period of 20 consecutive trading days, this event would constitute an event of default, which could result in the noteholders requiring payment in full of the principal balance and interest of the notes.

Any default under our indebtedness could have a material adverse effect on our business, operating results and financial condition.

Conversion of the Notes would dilute the ownership interests of existing stockholders.

Certain former Augmentix stockholders have the right to convert the principal and any unpaid interest into our common stock at a conversion price of $2.50 at any time prior to the earlier of (i) December 31, 2010, (ii) a change of control of the Company or (iii) the redemption of all of the outstanding principal amount of the Notes. The conversion of some or all of the Notes will dilute the ownership interest of our existing stockholders. Any sales in the public market of the common stock issuable upon conversion could adversely affect prevailing market prices of our common stock.

If our product failure rates increase, Dell could terminate our relationship and we could be subject to increased warranty costs, both of which could have a material adverse effect on our results of operations and financial condition.

We repair or replace products that have been authorized for repair or replacement by our customers. We utilize a third-party service provider to perform a full range of service and support options, ranging from telephone, email, online, on-site, return-to-depot and customer replaceable units (parts). We warrant products for periods ranging from 12 to 37 months following the sale of our products. While we engage in extensive product

quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, our warranty obligations are affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs increase, our warranty costs to support the products in the field could increase, which could have a material and adverse effect on our results of operations and financial condition. In addition, Dell could terminate its contract with us, which would also have a material and adverse effect on our results of operations and financial condition.

We are subject to risks relating to product concentration and lack of revenue diversification.

Until our acquisition of Augmentix, we derived nearly all of our revenue from sales or licenses of our Stakpak and memory module solutions. We terminated our memory solutions manufacturing business and now are focusing on our Rugged Technology Solutions business, which derives nearly all of its revenue from sales to Dell. We expect these sales to continue to account for a substantial portion of our total revenue in the near term. Continued market acceptance of our products is critical to our future success. As a result, our business, financial condition and results of operations could be adversely affected by:

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any decline in demand for our products;

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failure of our products and technologies to achieve continued market acceptance;

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the introduction of products and technologies that can serve as a substitute for, replacement of or represent an improvement over, our products and technologies;

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technological innovations that we are unable to address with our products and technologies; and

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any inability by us to release new products or enhanced versions of our existing products and technologies on a timely basis or the failure of our products to achieve market acceptance.

It is difficult for us to verify royalty amounts owed to us under our license agreements, and licensees may report errors in their reports after they have paid us, which may cause us to lose revenue.

The standard terms of our license agreements require our licensees to document the manufacture and sale of products that incorporate our technologies and report this data to us on a periodic basis. Although our standard license terms give us the right to audit books and records of our licensees to verify this information, audits can be expensive, time consuming and potentially detrimental to our ongoing business relationship with our licensees. As a result, to date, we have primarily relied on the accuracy of the reports themselves without independently verifying the information in them. Our failure to audit our licensees’ books and records may result in us receiving less royalty revenue than we are entitled to under the terms of our license agreements. In addition, a licensee may report errors in reporting after the licensee has paid us royalties, which is the action Samsung has taken with royalties it has paid us from the fourth quarter of 2005 and ending in the first quarter of 2008. If we are required to refund royalties paid in earlier quarters, a refund could adversely affect our business, financial condition, results of operations and cash position.

If our products include defective parts, we may be subject to product liability or other claims.

If we sell products that are defective or contain defective components, we could be subject to product liability claims and product recalls, safety alerts or advisory notices. While we have product liability insurance coverage, we cannot assume that it will be adequate to satisfy claims made against us in the future or that we will be able to obtain insurance in the future at satisfactory rates or in adequate amounts. Product liability claims or product recalls in the future, regardless of their ultimate outcome, could have a material adverse effect on our business, financial condition, results of operations and reputation, and on our ability to attract and retain customers.

The viability of our ODM business model could be threatened if we are unable to control costs.

Dell expects us to deliver products and new designs within certain cost parameters, and our ability to pass unexpected costs on to Dell is limited. We also experience pressure to reduce our margins. Accordingly, if we are unable to design or procure ruggedized notebook products efficiently, our business model could be unprofitable.

If the supply of materials used to manufacture our products is interrupted, our financial condition and results of operations could be adversely affected.

In order to have our ruggedized products manufactured, we require components, such as, but not limited to, main logic boards, memory, base LCDs, power supplies, chassis, thermal systems, optical enhancements, and other rugged elements. We typically procure these materials from limited sources. Shortages in some of these materials may occur from time to time, and have occurred in the past. In addition to shortages, we could experience quality problems with these materials. If our supply of materials is interrupted for any reason, or our manufacturing turnaround times are extended, our financial condition and results of operations could be adversely affected.

We are vulnerable to increases in shipping costs, which could have an adverse impact on our gross profit margin.

Presently, our supply chain configuration requires us to bear the expense of transporting our rugged notebook products over 10,000 miles before our manufacturing process is complete and the products are made available to our primary customer. Historically, we have almost exclusively relied on air transportation to ship our products due to the need to deliver products in a timely manner.

If the cost of air transportation increases in the future, or we are unable to decrease our reliance on air transportation and decrease the distances we must transport products, we could face a decline in our gross profit margins.

We are a small company with limited resources compared to some of our current and potential competitors, and we may not be able to compete effectively and maintain or increase our market share.

Some of our current and potential competitors have longer operating histories, significantly greater resources and name recognition, and a larger base of customers than we have. Some of these companies are better positioned to influence industry acceptance of a particular industry standard or competing technology than we are. These companies may also be able to devote greater resources to the development, promotion and sale of products, and may be able to deliver competitive products or technologies at a lower price. They also may be able to adopt more aggressive pricing policies than we can adopt.

We expect our competitors to continue to improve the performance of their current products, reduce their prices and introduce new services and technologies that may offer greater performance and improved pricing, any of which could cause a decline in revenue or loss of market acceptance of our products. In addition, our competitors may develop enhancements to, or future generations of, competitive products that may render our products or technologies obsolete or uncompetitive. These and other competitive pressures may prevent us from competing successfully against current or future competitors, and may materially harm our business. Competition could decrease our prices, reduce our revenue, lower our gross profits or decrease our market share.

If we acquire other businesses or technologies in the future, these acquisitions could disrupt our business and harm our business, financial condition and results of operations.

As part of our growth and product diversification strategy, we will evaluate opportunities to acquire other businesses, intellectual property or technologies that would complement our current offerings, expand the breadth of our markets or enhance our technical capabilities. For example, on August 31, 2007, we acquired Southland Micro Systems, a provider of memory products and services for leading OEMs, and on July 14, 2008, we acquired Augmentix, a provider of mission-critical mobile and server computing solutions for use in demanding environments. Acquisitions entail a number of risks that could materially and adversely affect our business and operating results, including:

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difficulties in integrating the operations, systems, technologies or products of the acquired companies;

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the risk of diverting management’s time and attention from the normal daily operations of the business;

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insufficient revenue to offset increased expenses associated with acquisitions;

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difficulties in retaining business relationships with suppliers and customers of the acquired companies;

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risks of entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;

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the potential loss of key employees of the acquired company; and

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the potential need to amortize intangible assets.

Future acquisitions also could cause us to incur additional debt or contingent liabilities or cause us to issue equity securities. These actions could negatively impact the ownership percentages of our existing stockholders, our financial condition and results of operations.

Our limited experience in acquiring other businesses, product lines and technologies may make it difficult for us to overcome problems we may encounter in connection with any acquisitions we undertake.

We evaluate and explore strategic opportunities as they arise, including business combinations, strategic relationships, capital investments and the purchase, licensing or sale of assets. Our experience in acquiring other businesses, product lines and technologies is limited. The attention of our small management team may be diverted from our core business if we undertake future acquisitions. Future acquisitions may also require us to incur debt or issue equity securities that may result in dilution of existing stockholders. Potential future acquisitions also involve numerous risks, including, among others:

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problems and delays in successfully assimilating and integrating the purchased operations, personnel, technologies, products and information systems;

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unanticipated costs and expenditures associated with the acquisition, including any need to infuse significant capital into the acquired operations;

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adverse effects on existing business relationships with suppliers, customers and strategic partners;

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risks associated with entering markets and foreign countries in which we have no or limited prior experience;

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contractual, intellectual property or employment issues;

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potential loss of key employees of purchased organizations; and

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potential litigation arising from the acquired company’s operations before the acquisition.

We may make acquisitions that are dilutive to existing shareholders, result in unanticipated accounting charges or otherwise adversely affect our results of operations.

We may grow our business through business combinations or other acquisitions of businesses, products or technologies that allow us to complement our existing product offerings, expand our market coverage, increase our engineering workforce or enhance our technological capabilities. If we make any future acquisitions, we could issue stock that would dilute our earnings and stockholders’ percentage ownership, reduce our cash reserves, incur substantial debt, or assume contingent liabilities.

Furthermore, acquisitions may require material infrequent charges and could result in adverse tax consequences, deferred compensation charges, substantial depreciation, in-process research and development charges, the amortization of amounts related to deferred compensation and identifiable purchased intangible assets or impairment of goodwill, any of which could negatively impact our results of operations.

Our marketing and sales efforts may be unsuccessful.

We have limited sales and marketing resources. As our business evolves, we may have to employ more rigorous sales and marketing efforts, hire more sales and marketing personnel and engage in lengthy negotiations to reach agreement with potential customers. As a result, our operating expenses may increase, and we may incur losses in periods that precede the generation of revenue. If the sales and marketing efforts of our technologies are unsuccessful, then we may not be able to sell or license our technologies.

If we experience credit losses or other collections issues, our business, financial condition and results of operations could suffer.

We have not historically recorded a bad debt allowance or established reserves for our accounts receivable because we did not have significant credit losses or other collections issues during the periods for which financial information is presented. However, we now have a bad debt allowance due to the bankruptcy of a large memory business customer. Although we do not believe that we will incur any additional material credit losses in the foreseeable future, if we were to do so, our financial condition and results of operations could be harmed.

If we are unable to develop new and enhanced products that achieve market acceptance in a timely manner, our financial condition, results of operations and competitive position could be harmed.

Our future success will be based in large part on our ability to reduce our dependence on Dell by increasing revenue associated with our other products and by developing other new technologies and enhancements that can achieve market acceptance in a timely and cost-effective manner. Successful development and introduction of new technologies on a timely basis require that we:

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identify and adjust to changing requirements of customers;

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identify and adapt to emerging technological trends in our target markets;

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maintain effective marketing strategies;

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timely design and introduce cost-effective, innovative and performance-enhancing features that differentiate our products from those of our competitors; and

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successfully develop our relationships with existing and potential customers.

Funds associated with our auction rate securities may not be accessible in the short term, and we may be required to adjust the carrying value of these securities through an impairment charge.

As discussed in Note 4 to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, our investment securities consist of ARS, which are not currently liquid or readily available to convert to cash. We do not believe that the current liquidity issues related to our ARS will impact our ability to fund our ongoing business operations. However, we will not be able to access these funds until a future auction for these ARS is successful or until we sell the securities in a secondary market, which currently is not active. During October 2008, we accepted an offer provided to us by the investment firm through which we hold our ARS to sell our ARS to them at par value at any time over a two-year period, beginning June 30, 2010 and ending July 2, 2012. As of June 30, 2009, we reclassified our ARS and related put option to short-term investments based on our intent to sell them to the investment firm on June 30, 2010.

The failure of any bank in which we deposit our funds could impair our operations.

The current banking crisis may place our deposits with our banks at risk and the FDIC deposit insurance will not be sufficient to cover any potential loss arising from a bank failure. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash, cash equivalents and investments could impair our operations.

Austin Ventures controls us, and will continue to control us, as long as it beneficially owns a majority of our common stock.

Austin Ventures beneficially owns approximately 78% of our outstanding common stock. Because Austin Ventures and its affiliates own more than 50% of our common stock, we are considered a “controlled company” under NASD Marketplace Rule 4350(c)(5), and we are exempt from NASD rules that would otherwise require that our board of directors consist of a majority of independent directors. As a “controlled company,” we also are

exempt from NASD rules that require the compensation of officers and the nomination of company directors be determined by a committee of independent directors or a majority of independent directors. Our board of directors currently consists of eight directors, of which three qualify as independent directors under NASD rules. As long as Austin Ventures beneficially owns a majority of our outstanding common stock, Austin Ventures will continue to be able to elect all members of our board of directors. Purchasers of our common stock will not be able to affect the outcome of any stockholder vote until Austin Ventures beneficially owns less than a majority of our outstanding common stock. As a result, Austin Ventures will control all matters affecting us, including:

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the composition of our board of directors and, through it, any determination with respect to our business direction and policies, including the appointment and removal of officers;

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any determinations with respect to mergers or other business combinations;

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our acquisition or disposition of assets; and

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our corporate finance activities.

In addition, to the extent that Austin Ventures continues to beneficially own a significant portion of our outstanding common stock, although less than a majority, it will continue to have a significant influence over all matters submitted to our stockholders and to exercise significant control over our business policies and affairs. Under our certificate of incorporation, as amended, if Austin Ventures ceases to own at least 30% of our outstanding common stock, the approval of the holders of at least two-thirds of our common stock will be required for stockholders to amend our certificate of incorporation or bylaws, to increase or decrease the authorized number of shares of our capital stock or to remove a director. Furthermore, concentration of voting power could have the effect of delaying, deterring or preventing a change of control or other business combination that might otherwise be beneficial to our stockholders. This significant concentration of share ownership may also adversely affect the trading price for our common stock because investors may perceive disadvantages in owning stock in a company that is controlled by a small number of stockholders. Austin Ventures is not prohibited from selling a controlling interest in us to any third party, or from selling its shares at any time, which could adversely affect our stock price.

Austin Ventures and its designees on our board of directors may have interests that conflict with our interests.

Austin Ventures and its designees on our board of directors may have interests that conflict with, or are different from, our own. Conflicts of interest between Austin Ventures and us may arise, and such conflicts of interest may not be resolved in a manner favorable to us, including potential competitive business activities, corporate opportunities, indemnity arrangements, registration rights, sales or distributions by Austin Ventures of our common stock and the exercise by Austin Ventures of its ability to control our management and affairs. Our certificate of incorporation does not contain any provisions designed to facilitate resolution of actual or potential conflicts of interest, or to ensure that potential business opportunities that may become available to both Austin Ventures and us will be reserved for or made available to us. Pertinent provisions of law will govern any such matters if they arise. In addition, Austin Ventures and its director designees could delay or prevent an acquisition or merger even if the transaction would benefit other stockholders.

We depend on a few key personnel to manage our business effectively, and if we lose the services of any of those personnel or are unable to hire additional personnel, our business could be harmed.

Our future success will depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing personnel. We believe that our future success will be dependent on retaining the services of our key personnel, developing their successors, modifying our internal processes to reduce our reliance on specific individuals, and on properly managing the transition of key roles should departures or additions to the management team occur. The loss of any of our key employees, or the inability to attract or retain qualified personnel, including engineers and sales and marketing personnel, could delay the development and introduction of, and negatively impact our ability to sell, our services and technologies.

We may be involved in costly legal proceedings to enforce or protect our intellectual property rights or to defend against claims that we infringe the intellectual property rights of others.

Litigation is inherently uncertain, and an adverse outcome could subject us to significant liability for damages or invalidate our proprietary rights. Legal proceedings we initiate to protect our intellectual property rights could also result in counterclaims or countersuits against us. Any litigation, regardless of its outcome, could be time consuming and expensive to resolve and could divert our management’s time and attention. Any intellectual property litigation also could force us to take specific actions, including:

•

cease selling products that are claimed to be infringing a third party’s intellectual property;

•

obtain licenses to make, use, sell, offer for sale or import the relevant technologies from the intellectual property’s owner, which licenses may not be available on reasonable terms, or at all;

•

redesign those products that are claimed to be infringing a third party’s intellectual property; or

•

pursue legal remedies with third parties to enforce our indemnification rights, which may not adequately protect our interests.

We have found it necessary to litigate against others, including our customers, to enforce our intellectual property and contractual and commercial rights, as well as to challenge the validity and scope of the proprietary rights of others and to defend against claims of infringement or invalidity.

Our stock price is volatile.

Our common stock has been publicly traded since February 2004. The market price of our common stock has been subject to significant fluctuations since the date of our initial public offering. The stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices of securities, particularly securities of technology companies. We have limited liquidity in terms of the number of outstanding shares of our common stock that are publicly traded, which may adversely affect the value of our stock. In addition, we have an ongoing stock repurchase program, which could further decrease our liquidity. As a result, the market price of our common stock may materially decline, regardless of our operating performance. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation of this type is often expensive and diverts management’s attention and resources.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table provides information with respect to our purchase of our common stock during the quarter ended June 30, 2009:


Period	Total Number of Shares Purchased (1)	Average Price Paid per Share (2)		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs
April	33,845	$	0.26	33,845	Approx. $6.8 million
May	13,441	$	0.26	13,441	Approx. $6.7 million
June	32,560	$	0.34	32,560	Approx. $6.7 million

Total	79,846	$	0.29	79,846

(1)	On February 2, 2006, our Board of Directors renewed our existing $15.0 million stock repurchase program for up to $10.0 million to purchase shares of our common stock. On November 14, 2006, our Board of Directors authorized an additional $10.0 million to purchase shares of our common stock.

(2)	Excludes commissions paid.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

We held our 2009 Annual Meeting of Stockholders on April 23, 2009. Following are the results of voting on the election of directors submitted to stockholders at this meeting:


Joseph C. Aragona	For: 43,640,643	Withheld: 1,580,671

Stephan B. Godevais	For: 43,849,142	Withheld: 1,372,172

Martin J. Garvin	For: 44,987,964	Withheld: 233,350

Kevin P. Hegarty	For: 45,081,327	Withheld: 139,987

Clark W. Jernigan	For: 43,758,520	Withheld: 1,462,794

Joseph A. Marengi	For: 43,851,883	Withheld: 1,369,431

Kirshna Srinivasan	For: 43,758,520	Withheld: 1,462,794

A. Travis White	For: 45,069,827	Withheld: 151,487

ITEM 5.

OTHER INFORMATION

Not applicable.

ITEM 6.

EXHIBITS

Incorporated by Reference

Exhibit
Number

Exhibit Description

Form

File Number

Exhibit

Filing
Date

Filed
Herewith

3.1

Amended and Restated Certificate of Incorporation

10-Q

000-50553

3.1.1

11/7/05

3.2

Certificate of Ownership and Merger

8-K

000-50533

3.1

2/27/08

3.3

Amended and Restated Bylaws

10-Q

000-50553

3.3

5/15/08

4.2

Specimen certificate for shares of common stock of Staktek Holdings, Inc.

S-1/A

333-110806

4.2

1/20/04

10.1

Lease Agreement with Invensys Electronica Reynosa, S. de R.L. de C.V., dated July 31, 2009

31.1

Certificate of the Chief Executive Officer pursuant to 18 U.S.C. §1350 (Section 302 of the Sarbanes-Oxley Act of 2002)

31.2

Certificate of the Chief Financial Officer pursuant to 18 U.S.C. §1350 (Section 302 of the Sarbanes-Oxley Act of 2002)

32.1

Certificate of the Chief Executive Officer pursuant to 18 U.S.C. §1350 (Section 906 of the Sarbanes-Oxley Act of 2002)

32.2

Certificate of the Chief Financial Officer pursuant to 18 U.S.C. §1350 (Section 906 of the Sarbanes-Oxley Act of 2002)

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.

ENTORIAN TECHNOLOGIES INC.

/s/ Stephan B. Godevais

Stephan B. Godevais

President and Chief Executive Officer

Date: August 14, 2009

/s/ W. Kirk Patterson

W. Kirk Patterson

Senior Vice President and Chief Financial Officer

Date: August 14, 2009

June 30,
2009

December 31,
2008

Unrealized gain on investment securities, net of tax

Accumulated other comprehensive income

ENTORIAN TECHNOLOGIES INC 10-Q