Form 10-Q

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 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):

Indicate by check mark 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, 2008, was 46,870,883.

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.

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


(1) Includes stock-based compensation expense as follows:
Cost of revenue	$	84	$	110
Selling, general and administrative expense	$	494	$	1,273
Research and development expense	$	111	$	238

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

The accompanying unaudited consolidated condensed financial statements of Entorian Technologies Inc., formerly Staktek Holdings, Inc. (we, us, our), have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (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, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008, or for any other period.

These financial statements and notes should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2007, which we filed with the SEC on March 14, 2008.

In February 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) FAS 157-2, which delayed the effective date of Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157) to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). We do not expect the adoption of SFAS 157 for our non-financial assets and liabilities to have a material impact on our financial position and results of operations.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (SFAS 141R). This standard establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree. SFAS 141R also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The impact of adopting SFAS 141R will depend on the future business combinations that we may pursue after its effective date.

On January 1, 2008, we adopted SFAS 157 for our financial assets. 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 assets (in thousands):

We have included our investments related to auction rate securities (ARS) of approximately $9.5 million in the Level 3 category. Our auction rate securities have historically traded at par and are callable at par at the option of the issuer. As of June 30, 2008, there was insufficient observable ARS market information available to determine the fair value of these investments. Therefore, our auction rate securities were valued based on a pricing model that included certain assumptions, such as our ARS tax-exempt status, an interest rate of 175% of the S&P index, a discount rate of approximately 4.7%, credit quality, a maturity date of four to five years, insurance wraps and the portfolio composition. Based on this assessment of fair value, as of June 30, 2008, we determined there was a decline in the fair value of our ARS investments of approximately $0.7 million, which we deemed temporary and recorded in other comprehensive loss due to our intent to hold these securities until we can realize the par value. See Note 3, “Investments,” for additional information regarding our auction rate securities.

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. SFAS 159 was effective during the first quarter of 2008; however, we did not elect to adopt the fair value option for eligible financial instruments under SFAS 159.

As of June 30, 2008, we held approximately $9.5 million of auction rate securities (ARS). Of this total, we classified approximately $7.0 million as non-current investments, in the Level 3 category, and approximately $2.5 million as short-term investments, as explained in more detail below.

Our auction rate securities have historically traded at par and are callable at par at the option of the issuer. As of June 30, 2008, there was insufficient observable ARS market information available to determine the fair value of these investments. Therefore, our auction rate securities were valued based on a pricing model that included certain assumptions, such as our ARS tax-exempt status, an interest rate of 175% of the S&P index, a discount rate of approximately 4.7%, credit quality, a maturity date of four to five years, insurance wraps and the portfolio composition. Based on this assessment of fair value, as of June 30, 2008, we determined there was a decline in the fair value of our ARS investments of approximately $0.7 million, which we deemed temporary and recorded in other comprehensive loss due to our intent and ability to hold these securities until we can realize the par value.

The final maturity dates of the ARS that we own are between 2029 and 2041 and the securities are rated Aaa and AA. Approximately 71% of our ARS is 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 29% of our ARS are private loans, of which 85% are insured.

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, 2008, the maximum auction rates for our ARS ranged from 2.9% to 7.0%. Through June 30, 2008, 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. We cannot predict how long they will remain illiquid and whether we will be able to liquidate them prior to their maturities at prices approximating their face amounts. Certain issuers have notified us that they expect to redeem their auction-rate securities within the next 12 months, which is the reason we have classified $2.5 million of our auction rate securities as short-term investments as of

June 30, 2008. In addition, during August 2008, the investment firm through which we hold our ARS has notified us that it will be redeeming auction rate securities at par value over a two-year period, beginning in the fourth quarter of 2008, and for clients with immediate liquidity needs, it will be providing loans for up to 100% of the par value of the auction rate securities.

At June 30, 2008 and December 31, 2007, our reserve for excess, slow-moving and obsolete inventory was approximately $1.5 million and $0.8 million, respectively.

Goodwill represents the excess purchase price over the fair value of net assets acquired in our acquisition of Southland Micro Systems, Inc. (Southland) on August 31, 2007. We allocate goodwill to reporting units for goodwill impairment testing.

We assess whether goodwill is impaired on an annual basis. Upon determining the existence of goodwill impairment, we measure that impairment based on the amount by which the book value of goodwill exceeds its fair value. Additional impairment assessments may be performed on an interim basis if we encounter events or changes in circumstances that would indicate that, more likely than not, the book value of goodwill has been impaired.

We evaluate the recoverability of losses on intangible assets when events or changes in circumstances indicate that their carrying value may not be recoverable. When these factors and circumstances exist, we compare the projected undiscounted future cash flows of these assets to their respective carrying values. Impairment, if any, is measured as the excess of the carrying amount over the fair value, based on undiscounted cash flows. As of June 30, 2008, as a result of the anticipated reduction in the future cash flow from our license agreement with Samsung Electronics Co., Ltd. (Samsung), we impaired the remaining residual value of the customer relationship intangible asset and recorded a charge of approximately $0.2 million, which is included in Amortization and impairment of acquisition intangibles in cost of revenue. The value was initially recorded based upon the projected discounted net cash flows attributable to this relationship.

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. Foreign income tax includes withholding tax on certain royalty income received from foreign customers. 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 benefit for income taxes of $0.3 million during the six months ended June 30, 2008 and we recorded a provision for income taxes of $0.9 million during the six months ended June 30, 2007.

For the six months ended June 30, 2008, our effective tax rate differed from the federal statutory rate of 35%, primarily due to the application of a valuation allowance against our net U.S. deferred tax assets as we believe there is uncertainty regarding their realization. For the six months ended June 30 2007, our effective tax rate differed from the federal statutory rate of 35%, primarily due to the tax implications of our stock-based compensation, tax-exempt interest income and the application of a valuation allowance against our net U.S. deferred tax assets.

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 2007 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, 2007 or June 30, 2008. In the event we have unrecognized tax benefits, we will recognize the related accrued interest and penalties as income tax expense.

During the three months ended June 30, 2008, we recorded a restructuring charge of approximately $0.2 million due to a workforce reduction of approximately 60 positions as a result of transferring our manufacturing operations in Irvine, California to Reynosa, Mexico. We expect to incur an additional charge of approximately $0.1 million during the third quarter of 2008. We expect to complete the transition by the end of the third quarter and will maintain an office in Irvine for sales and other administrative positions. The following table details the changes in the related restructuring accrual (in thousands) during the six months ended June 30, 2008:

At June 30, 2008, approximately 72% of our employees in Mexico, or approximately 47% of our total employees, were represented by a labor organization that has entered into a labor contract with us.

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.

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.

Recently, 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 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. Samsung subsequently informed us that it recently discovered it has been shipping two different types of packaging for the same chip for which it assigned the same part number, and Samsung asserts that one of the two types is not subject to our license agreement.

At this time, we do not feel the information provided by Samsung is sufficient to support its refund request and believe our revenue recognition is correct. Additionally, we do not have sufficient information to determine any other rights that we may have with respect to this matter.

As part of our purchase of Southland on August 31, 2007, we offered compensation of up to $7 million to the sellers if certain financial goals are achieved over the two years subsequent to closing the acquisition. We must estimate, on a quarterly basis, if these goals will be met, but final determination of achieving the goals will only

be known on the first and second anniversary dates of the effective date. As a result, from quarter to quarter, changes in our estimates could result in reversing or recognizing significant amounts of compensation expense. In addition, the sellers may elect to receive payment in either cash or stock. We must, based on our current stock price compared to the earn-out exercise price, predict which form of payment the sellers will elect to receive. During the second quarter of 2008, we reversed the liability associated with the earn-out of approximately $0.8 million. This reduction reflects an updated estimate of the results of Southland for the first earn-out period.

On March 8, 2007, we filed an action in the U.S. District Court for the District of Massachusetts, Boston Division, against Kentron Technologies, Inc. and Chris Karabatsos, an individual, seeking damages and injunctive relief relating to the defendants’ false and disparaging statements regarding us and our ArctiCore™ technologies that we proposed to the JEDEC Solid State Technology Association (JEDEC), an industry standards-setting organization, for possible adoption as a standard. In particular, we alleged that the defendants’ actions constituted unfair competition under the Lanham Act, intentional interference with prospective business relations, defamation, business disparagement and caused actionable injury to our business reputation. On July 11, 2007, the defendants filed their answer and a counterclaim, in which they made claims of unfair methods of competition and unfair, deceptive acts by us, in violation of the laws of the Commonwealth of Massachusetts. On July 12, 2007, the defendants filed a motion to dismiss our Lanham Act claims, and we also filed a motion to dismiss their counterclaims. The judge denied these motions. We also filed a motion to compel discovery, which the judge granted on October 24, 2007. On April 22, 2008, we entered into a settlement and purchase agreement with Kentron Technologies, Inc. and Mr. Chris Karabatsos for approximately $0.6 million, which we recorded during the first quarter of 2008, resolving our pending litigation regarding our ArctiCore technologies. The settlement included the sale by Kentron and Karabatsos of certain of their intellectual property to us so that we may pursue standardization of our ArctiCore technologies with JEDEC.

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.

As of June 30, 2008 and December 31, 2007, we had 53,175,261 and 52,876,038 shares of common stock issued, respectively.

During the first six months of 2008, we purchased 131,728 shares of our common stock under our stock repurchase program at a total cost of approximately $0.1 million. As of June 30, 2008, we may purchase up to an additional $6.9 million of our stock under this program.

In July 2003, we adopted the 2003 Stock Option Plan, which we have amended and which currently has 15,030,000 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 Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payment” (SFAS 123(R)), utilizing the Black-Scholes method of valuation.

Information with respect to stock option activity for the six months ended June 30, 2008 is as follows:

As of June 30, 2008, there was approximately $4.0 million of unrecognized compensation cost related to outstanding stock options. For the six months ended June 30, 2008, the total intrinsic value of exercised stock options was approximately $0.1 million.

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

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, 2008 was $0.82. 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.

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, 2008, 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, 2008 is as follows:

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, 2008, RSU compensation expense was $0.2 million and $0.4 million, respectively.

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

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

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):

In connection with our Southland acquisition, on September 1, 2007, we entered into a lease agreement with an entity owned by two of our current Entorian employees (former Southland principals) to lease our Irvine facility for a term of three years. We incurred approximately $0.1 million and $0.3 million in total operating expense related to this lease during the three and six months ended June 30, 2008, respectively.

As a result of the relocation of our manufacturing operations from Irvine, California to Reynosa, Mexico and our plan to sublease the Irvine facility, we determined the useful life of the leasehold improvements related to our Irvine facility did not extend beyond June 30, 2008. As a result of our review, we accelerated the depreciation associated with our Irvine leasehold improvements, resulting in an additional depreciation charge of approximately $0.6 million, or $0.01 per share, during the three months ended June 30, 2008.

On July 10, 2008, we announced that our Board of Directors elected Martin J. Garvin to serve as an independent director and member of our Audit Committee, to hold office for a term expiring at the annual meeting of stockholders to be held in April 2009. Mr. Garvin served as Senior Vice President and Chief Procurement Officer of Dell, Inc., from 2001 through 2008, and was responsible for the strategic leadership and management of the Dell Global Supply Chain. The appointment of Mr. Garvin, who is an “independent” director, as defined by NASDAQ, to serve on the Audit Committee brings us into compliance with NASDAQ Marketplace Rule 4350, which requires that public companies listed on the NASDAQ National Market System have three independent directors serving on this committee.

Effective July 11, 2008, we terminated our unsecured revolving loan agreement with Guaranty Bank, originally dated March 10, 2005.

On July 11, 2008, we, August Merger Sub Corporation, one of our wholly owned subsidiaries (Merger Sub), Augmentix Corporation (Augmentix) and Centennial Ventures VII, L.P., as the stockholder representative (the Stockholder Representative), entered into an Agreement and Plan of Merger (the Merger Agreement), under which Merger Sub would be merged with and into Augmentix (the Merger), with Augmentix continuing after the Merger as the surviving corporation and our wholly owned subsidiary. On July 14, 2008 (the Effective Time), we completed this acquisition.

Under the Merger Agreement, we acquired all of the outstanding ownership interests in Augmentix. We paid $23.5 million in cash and issued approximately $10.7 million in convertible notes, for total consideration of approximately $34.2 million, including certain post-closing adjustments based on Augmentix’s working capital.

As a condition to the acquisition, we entered into an escrow agreement with the Stockholder Representative and Wells Fargo Bank, N.A., as escrow agent, whereby an escrow fund in the amount of approximately $4.3 million in cash and notes was deposited into an escrow account from the proceeds of the acquisition as security for certain conditions and indemnification obligations of Augmentix’s stockholders under the Merger Agreement. This amount held in escrow is subject to release over a period of two years, less any amounts for unresolved and settled claims.

Immediately prior to the Effective Time, all of the unexercised outstanding options to acquire the common stock of Augmentix under its stock option plan, whether vested or unvested, were either exercised or terminated and cancelled, and we did not assume these Augmentix stock options. We issued approximately 1.5 million new options to purchase Entorian common stock to Augmentix employees as of the Effective Time, and agreed to pay approximately $0.5 million in retention bonuses to certain Augmentix employees over the 18-month period following the Effective Time.

The Merger Agreement contains representations, warranties and indemnities customary for transactions of this type. The foregoing summary of certain terms of the Merger Agreement does not purport to be complete, and is subject to and qualified in its entirety by reference to the Merger Agreement, a copy of which is filed as Exhibit 2.1 to Form 8-K on July 16, 2008.

Prior to entering into the Merger Agreement, Austin Ventures owned approximately 78% of our outstanding common stock and approximately 55% of Augmentix’s outstanding common stock. On a diluted basis, the ownership shares were 77% and 46%, respectively. As a result of the convertible notes that we issued to Augmentix stockholders in the acquisition, Austin Ventures holds approximately $7 million of our convertible notes. In addition, two representatives of Austin Ventures, Joseph Marengi and Krishna Srinivasan, served on Augmentix’s Board of Directors prior to our acquisition. Mr. Marengi has served on our Board of Directors since 2007, and Mr. Srinivasan joined our Board of Directors following the acquisition, as set forth below.

On July 15, 2008, our Board of Directors increased the size of the Board from seven directors to eight directors, and we announced the election of Krishna Srinivasan to serve as a director, to hold office for a term expiring at the annual meeting of stockholders to be held in April 2009. Mr. Srinivasan was not appointed to serve on any committee of the Board of Directors. He served as a director of Augmentix Corporation since its inception and is currently a partner with Austin Ventures.

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 have 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 may, in its discretion, require us to maintain a bid price of at least $1.00 per share for a period in excess of ten consecutive business days, but generally no more than 20 consecutive business days, before determining that we have demonstrated an ability to maintain long-term compliance. In order to gain compliance with the minimum bid price rule, we may implement a reverse stock split. If we do not regain compliance, NASDAQ will notify us of its determination to delist our common stock, which decision may be appealed to a NASDAQ Listings Qualification Panel.

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.

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, 2007, which we filed with the SEC on March 14, 2008. 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 regarding the following: the sales of our products to a limited number of customers and with a limited number of key technologies; deriving a material portion of our future revenue from license royalties; the lack of significant credit losses from our customers; manufacturing delays as we develop or refine new manufacturing technologies and methods; our belief that our current assets, including cash, cash equivalents and investments, and expected cash flows from operating activities, will be sufficient to fund our operations, our anticipated additions to property, plant and equipment and any share repurchases under our stock repurchase program for at least the next 12 months; our belief that our package-stacking technologies and manufacturing processes are directly applicable to the Flash memory market; our belief that our facilities are suitable and adequate to meet our current operating needs; our belief that a ten percent change in interest rates will not have a significant impact on our interest income; our belief that our strong patent portfolio and intellectual property position will allow us to expand our business; our belief that the strength of our intellectual property rights is, and will continue to be, critical to the success of our business and will allow us to compete favorably against our competition; our intent to vigorously protect our intellectual property; our intent to grow our business through business combinations or other acquisitions; our intent to expand our research and development activities; our belief that our future success will depend upon our ability to attract and retain personnel; our belief regarding increasing our investment in research and development; our expectation regarding increasing the opportunity to deploy our IP to top-tier server original equipment manufacturers (OEMs) and data center end customers through our Southland acquisition; our expectation that we will manufacture all of our memory modules in Mexico; our expectation that adopting SFAS 157 for our nonfinancial assets and liabilities will not have a material impact on our financial position and results of operations; our expectation that we will complete the transition of our manufacturing operation from Irvine, California to Reynosa, Mexico in the third quarter of 2008; our expectation that we will incur an additional charge of approximately $80,000 during the third quarter of 2008 regarding the transition or our manufacturing operation; our belief that we will continue to receive interest payments on our auction rate securities as long as we hold these securities; our expectation of announcing a new research and development project during the end of 2008; our belief that that our ability to deliver memory stacking and module technologies in high volume and with short turnaround times distinguishes us from other similar service providers; our intent to exploit our intellectual properties and capabilities to establish market leadership in new technologies; and our intent to devote additional personnel and other resources to research and development in future periods to address market opportunities for advanced technologies. 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, 2007, which we filed with the SEC on March 14, 2008, 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.

We are a provider of advanced module and system-level products for high-reliability and high-performance markets. Our development and implementation of thin, small outline package (TSOP) and ball grid array (BGA) package-stacked technologies have resulted in core competencies in thermal management, high-density package stacking, electrical interconnect and standard assembly process. This technical expertise has provided a natural progression toward high-density technology innovations for enterprise and emerging consumer electronics markets.

Our Stakpak^® memory solutions increase operational performance by doubling, tripling or quadrupling the amount of capacity in the same physical footprint as required by standard packaging technology.

Our module technologies enable high-density, small-profile and thermally-enhanced memory modules that are not possible using conventional designs. Electrical, mechanical and thermal characteristics are combined to meet evolving system design complexities for increasing memory capacity and throughput rates of emerging applications.

Our customers can outsource their manufacturing needs to us, license our technologies for their in-house stacking of memory units, buy memory units from one of our licensees, such as Samsung, SMART Modular Technologies, Inc. (SMART), and Toshiba Corporation (Toshiba), or optimize their needs through a combination of these approaches.

As of June 30, 2008, our patent portfolio consisted of more than 200 patents and patent applications pending.

Through an acquisition and internal development efforts, we are working to diversify our products and markets. On August 31, 2007, we acquired Southland Micro Systems, Inc. (Southland), a provider of memory products and services to OEMs since 1987. Southland is located in Irvine, California, with additional sales offices in San Jose, California and Boise, Idaho. Through this acquisition, one of our goals is to increase the opportunity to deploy IP to top-tier server OEMs and data center end customers. On July 14, 2008, we acquired Augmentix Corporation, a provider of mission-critical mobile and server computing solutions for use in demanding environments. In addition, we have internal development efforts that we anticipate announcing during the end of 2008.

We believe that our ability to deliver memory stacking and module technologies in high volume and with short turnaround times distinguishes us from other similar service providers. Our sophisticated manufacturing processes combine proprietary assembly equipment with standard, back-end automation in a state-of-the-art manufacturing facility in Reynosa, Mexico. Since we began manufacturing our products, we have been increasing the degree of automation, overall efficiency and production yields of our manufacturing processes. We have been ISO certified to the ISO9001:2000 standard since 2001, as assessed by Bureau Veritas Quality International (N.A.) Inc.

The market to provide memory solutions is intensely competitive. Within that market, we believe that we compete primarily with other providers of high-capacity technologies and services to OEMs and manufacturers of high-density memory chips. The primary factors upon which we compete are product quality and reliability, manufacturing capacity, cycle times, price and prompt and effective customer service.

Most of our customers, including Hewlett-Packard (HP), Micron Technology, Inc. (Micron), Samsung and SMART, also are competitors of ours, and may have the ability to manufacture competitive products at lower costs. Our current or potential competitors may also sell bundled arrangements offering a more complete or cost-effective product despite the technical merits or advantages of our services or technologies. We also face competition from current and prospective customers that continually evaluate our capabilities against the merits of manufacturing products internally. Competition may also arise due to the development of cooperative relationships among our current and potential competitors or third parties to increase the ability of their products to address the needs of our prospective customers. In addition, we expect to face competition from existing competitors and new and emerging companies that may enter our existing or future markets with similar or alternative products, which may be less costly or provide additional features. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

We are also taking steps to improve our gross margin. With the acquisition of Southland, we have two manufacturing facilities. Earlier in the year, we began transitioning equipment from our Irvine, California facility to our facility in Reynosa, Mexico. This transition is still underway and we expect we will complete it by the end of 2008. We expect that this consolidation to one manufacturing facility will generate an improvement in our gross margin.

Results of Operations - a comparison of the three months ended June 30, 2008 and 2007

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

Our product revenue for the second quarter of 2008 was $7.7 million, an increase of 2.9% from $7.4 million for the second quarter of 2007. License revenue for the second quarter of 2008 was $1.2 million, an increase of 59.5% from $0.8 million for the second quarter of 2007.

The increase in our product revenue during the second quarter of 2008, as compared to the second quarter of 2007, was primarily due to the revenue generated from our Southland memory module products, of which we had none in the second quarter of 2007. This increase was partially offset by the decline in demand for our memory stacking products during the second quarter of 2008, as compared to the second quarter of 2007, due to a decrease in both leaded-package and ball grid array (BGA) stacks. This decline was driven by the continuing shift from DDR-1 to DDR-2 technologies. DDR-2 devices are enclosed in BGA packages and the demand for stacks of this technology has not grown to offset the decline in leaded packages. The demand for BGA stacks has been hindered by the availability of other competitive solutions, including dual-die and planar technologies.

The increase in our license revenue for the second quarter of 2008, as compared to the second quarter of 2007, was mainly the result of increased royalties from SMART.

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

Gross loss for the three months ended June 30, 2008 was $0.2 million, or 2.6% of our total revenue, as compared to gross profit of $1.4 million, or 17.1% of our total revenue, for the three months ended June 30, 2007.

The reduction in our gross profit for the three months ended June 30, 2008, as compared to June 30, 2007, was primarily due to a shift towards the sale of memory modules, which carry a lower gross margin than our historical stacking products. In addition, the gross margin on our stacking products declined due to fixed costs being spread over lower volumes. To improve the gross margin, we are consolidating our manufacturing to one location. In the first half of 2008, we began transitioning manufacturing from our Irvine facility to our facility in Reynosa, Mexico. We expect this transition to be complete at the end of the third quarter of 2008.

Selling, general and administrative expense for the three months ended June 30, 2008 was $2.7 million, or 30.6% of total revenue. This amount reflected a decrease of approximately $0.7 million, or 19.5%, as compared to $3.4 million, or 41.1% of total revenue, in the three months ended June 30, 2007. For the second quarter of 2008 and 2007, selling, general and administrative expense included stock-based compensation expense of $0.5 million and $1.3 million, respectively.

The decrease in selling, general and administrative expense during the second quarter of 2008, compared to the second quarter of 2007, was primarily due to lower stock-based compensation expense of approximately $0.8 million and the $0.8 million reversal of the liability associated with the Southland earn-out consideration. These decreases were partially offset by increased personnel-related costs of approximately $0.6 million resulting from the Southland acquisition.

Research and development expense for the three months ended June 30, 2008 was $1.1 million, or 12.2% of total revenue, which reflected a decrease of $0.4 million, or 26.8%, as compared with $1.5 million, or 18.1% of total revenue, for the three months ended June 30, 2007. For the second quarter of 2008 and 2007, research and development expense included stock-based compensation expense of approximately $0.1 million and $0.2 million, respectively.

The decrease in research and development expense during the second quarter of 2008, relative to the second quarter of 2007, was primarily due to decreased personnel-related costs as we transitioned away from the consumer electronics market. We plan on devoting additional personnel and other resources to research and development in future periods to address market opportunities for advanced technologies.

Amortization and impairment of acquisition intangibles was $0.9 million for the three months ended June 30, 2008, which reflected a decrease of $0.3 million, or 25.1%, as compared with $1.2 million for the three months ended June 30, 2007.

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.

Other income, net for the three months ended June 30, 2008, was $0.4 million, as compared to $0.8 million for the three months ended June 30, 2007.

The decrease in other income, net from the second quarter of 2007 to the second quarter of 2008, was due primarily to a lower balance in our cash, cash equivalents and investments as a result of our Southland acquisition and a reduction in our rate of return.

We recorded an income tax benefit of $52,000 and a provision of $1.3 million for the three months ended June 30, 2008 and 2007, respectively. The $52,000 benefit for the three months ended June 30, 2008 reflects our estimated annual effective tax rate of 3% and the cumulative effect of our change in estimated effective tax rate from 4% in the first quarter, 2008 to 3% in the second quarter, 2008. The $1.3 million provision for the three months ended June 30, 2007 included a provision of $0.4 million, or $0.01 per share, as a result of a change in our forecast, which changed our estimated annual effective tax rate from 7% to (6)%. The three months ended June 30, 2007 included a discrete charge of $0.7 million to establish a valuation allowance against our net U.S. deferred tax assets.

For the second quarter of 2008, our effective tax rate differed from the federal statutory rate of 35%, primarily due to the application of a valuation allowance against our net U.S. deferred tax assets as we believe there is uncertainty regarding their realization. For the second quarter of 2007, our effective tax rate differed from the federal statutory rate of 35%, primarily due to the tax implications of our stock-based compensation, tax-exempt interest income and the application of a valuation allowance against our net U.S. deferred tax assets.

Results of Operations - a comparison of the six months ended June 30, 2008 and 2007

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

Our product revenue for the six months ended June 30, 2008 was $14.9 million, an increase of 1.7% from $14.6 million for the six months ended June 30, 2007. License revenue for the six months ended June 30, 2008 was $2.6 million, an increase of 16.1% from $2.3 million for the six months ended June 30, 2007.

The increase in our product revenue during the six months ended June 30, 2008, as compared to the six months ended June 30, 2007, was primarily due to the revenue generated from our Southland memory module products, of which we had none in the second quarter of 2007. This increase was partially offset by the decline in demand for our memory stacking products during the six months ended June 30, 2008, compared to the six months ended June 30, 2007, due to a decrease in both leaded-package and BGA stacks. This decline was driven by the continuing shift from DDR-1 to DDR-2 technologies. DDR-2 devices are enclosed in BGA packages and the demand for stacks of this technology has not grown to offset the decline in leaded packages. The demand for BGA stacks has been hindered by the availability of other competitive solutions, including dual-die and planar technologies.

The increase in our license revenue for the six months ended June 30, 2008, compared to the six months ended June 30, 2007, was mainly the result of increased royalties from SMART and Toshiba, partially offset by decreased royalties from Samsung.

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

Gross loss for the six months ended June 30, 2008 was $1.1 million, or 6.4% of our total revenue, as compared to a gross profit of $2.5 million, or 15.0% of our total revenue, for the six months ended June 30, 2007.

The reduction in our gross profit for the six months ended June 30, 2008, compared to June 30, 2007, was primarily due to a shift towards the sale of memory modules, which carry a lower gross margin than our historical

stacking products. In addition, the gross margin on our stacking products declined due to fixed costs being spread over lower volumes. Finally, the six months ended June 30, 2008 include an inventory charge of approximately $0.6 million. To improve the gross margin, we are consolidating our manufacturing to one location. In the first half of 2008, we began transitioning manufacturing from our Irvine facility to our facility in Reynosa, Mexico. We expect this transition to be complete at the end of the third quarter of 2008.

Selling, general and administrative expense for the six months ended June 30, 2008 was $7.0 million, or 39.7% of total revenue. This amount reflected an increase of approximately $0.3 million, or 3.4%, as compared to $6.7 million, or 39.8% of total revenue, in the six months ended June 30, 2007. For the first six months of 2008 and 2007, selling, general and administrative expense included stock-based compensation expense of $1.0 million and $2.5 million, respectively.

The increase in selling, general and administrative expense during the first six months of 2008, compared to the first six months of 2007, was primarily due to increased personnel-related costs resulting from the acquisition of Southland, a charge associated with the Kentron settlement and charges associated with acquisition. These increases were partially offset by a reduction in our stock-based compensation expense of approximately $1.5 million during the first six months of 2008, as compared to 2007, and the reversal of the liability associated with the Southland earn-out consideration of approximately $1.1 million.

Research and development expense for the six months ended June 30, 2008 was $2.4 million, or 13.7% of total revenue, which reflected a decrease of $0.9 million, or 26.7%, as compared with $3.3 million, or 19.3% of total revenue, for the six months ended June 30, 2007. For the first six months of 2008 and 2007, research and development expense included stock-based compensation expense of approximately $0.2 million and $0.5 million, respectively.

The decrease in research and development expense during the six months ended June 30, 2008, compared to the six months ended June 30, 2007, was primarily due to decreased personnel-related costs as we transitioned away from the consumer electronics market. We plan on devoting additional personnel and other resources to research and development in future periods to address market opportunities for advanced technologies.

Amortization and impairment of acquisition intangibles was $1.7 million for the six months ended June 30, 2008, a decrease of $1.4 million, or 44.7%, compared to $3.1 million for the six months ended June 30, 2007.

As of March 31, 2007, as a result of our customers’ increased use of competitive technologies and the associated uncertainty around our future revenue, we tested our trademark intangible asset for impairment. As a result of our review, we recorded an impairment charge of approximately $0.7 million, which is included in “Amortization and impairment of acquisition intangibles” in cost of revenue. As of March 31, 2007, we also determined that the trademark intangible asset has an estimated remaining useful life of four years. During the second quarter of 2007, we began amortizing the remaining balance of $1.1 million over its estimated useful life in proportion to the estimated contribution to discounted cash flows during the four-year period.

Other income, net for the six months ended June 30, 2008, was $0.9 million, as compared to $1.6 million for the six months ended June 30, 2007.

The decrease in other income, net from the first six months ended June 30, 2007 to the first six months ended June 30, 2008, was due primarily to a lower balance in our cash, cash equivalents and investments as a result of our Southland acquisition and a reduction in our rate of return.

We recorded an income tax benefit of $0.3 million and a provision of $0.9 million for the six months ended June 30, 2008 and 2007, respectively. The six months ended June 30, 2007 included a discrete charge of $0.7 million to establish a valuation allowance against our net U.S. deferred tax assets. Our effective tax rate was approximately 3% and (15)% for the first six months of 2008 and 2007, respectively.

As of June 30, 2008, we had working capital of $52.9 million, including $45.2 million of cash, cash equivalents and investments, compared to working capital of $66.3 million, including $61.9 million of cash, cash equivalents and investments, as of December 31, 2007. In addition to our working capital, we held approximately $7.0 million in long-term investments at June 30, 2008 and none at December 31, 2007.

Our long-term investments and a portion of our short-term investments consist of tax-exempt auction rate securities, 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, 2008, we held approximately $9.5 million of auction rate securities. The underlying collateral of our ARS consists primarily of student loans, of which 71% are supported by the federal government as part of the Federal Family Education Loan Program (FFELP). The FFELP guarantees between 95% and 98% of the par value of these loans. The remaining 29% of our ARS are private loans, of which 85% are insured. Certain issuers have notified us that they expect to redeem their auction-rate securities within the next 12 months. As a result, we have classified $2.5 million of our auction rate securities as short-term investments as of June 30, 2008. See Note 3, “Investments,” for additional information.

Net cash used in operating activities was $7.9 million for the six months ended June 30, 2008, compared to net cash provided by operating activities of $1.6 million for the six months ended June 30, 2007. The increase in net cash used in operating activities was primarily due to a $2.8 million increase in net loss, a $1.8 million decrease in stock-based compensation expense, a $1.6 million decrease in depreciation, amortization and impairment of intangibles, and a net increase of $3.2 million in cash used for operating assets and liabilities.

Net cash provided by investing activities was $14.9 million for the six months ended June 30, 2008, compared to $4.1 million for the six months ended June 30, 2007. The change in net cash provided by investing activities was due primarily to the $11.4 million increase in proceeds from the sale and maturities of investments, net of purchases, in the first six months of 2008, as compared to the first six months of 2007. In addition, the change in net cash provided by investing activities was due to an increase in equipment purchased of $0.5 million during the first six months of 2008 as compared to the first six months of 2007.

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. Net cash used in financing activities during the six months ended June 30, 2007 was $2.7 million, due to the repurchase of common shares for $2.8 million.

On June 30, 2008, we amended our unsecured revolving credit agreement with Guaranty Bank (the Lender), under which we may borrow up to $14 million at any given time through September 22, 2008 (the Credit Agreement). The Credit Agreement is guaranteed by Entorian Technologies L.P. Other than nominal closing costs associated with implementing the agreement, there are no ongoing fees associated with this Credit Agreement unless we borrow. The interest rate on borrowings outstanding is based on the London interbank offered rate (LIBOR) plus between 1.25% and 1.60% or the commercial-based rate minus between 0.50% and 1.00%, depending upon the amount of cash or liquid investments that we have on deposit with the Lender. Effective July 11, 2008, as part of our acquisition of Augmentix, we terminated our unsecured revolving loan agreement with Guaranty Bank.

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 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 cash 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 provide assurance 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.

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 engage in transactions where we sell consigned inventory to third parties and where we provide licensees with inventory. 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 the following: (1) we are not adding value to the inventory through our manufacturing processes, (2) we do not take risk of ownership of the inventory and (3) our net revenue from the transaction is predefined. In situations where these conditions are met, we net the expense of the components against the revenue from the transaction.

We recognize initial nonrefundable license fees when (1) we enter into a legally binding arrangement with a customer for the license, (2) we deliver the products, (3) customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties and (4) collection is reasonably assured. We may provide training and/or other assistance to our licensees under the terms of the license agreement. The amount of training or assistance provided is limited and incidental to the licensed technology. In instances where training or other assistance is provided under the terms of a license agreement, the estimated fair value of such services is deferred until these services are provided. The associated revenue is included in product revenue. In instances where we provide training or other assistance that is considered inconsequential to the license agreement, the estimated fair value of the services is recognized in connection with the initial license fee and is included in license revenue.

Royalty revenue from our license agreements is recognized in the quarter in which our licensees report royalties to us. Certain licensees do not provide us with forward estimates or current-quarter information concerning their shipments. Because we are not able to reasonably estimate the amount of royalties earned during the period in which these licensees actually ship products using our technologies, we do not recognize royalty revenue until the royalties are reported to us and the collection of these royalties is reasonably assured.

Impairment of Assets. We evaluate the recoverability of losses on long-lived assets, such as property 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, as well as the appropriate discount rate. 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.

Goodwill is our only intangible asset that is not amortized. We evaluate goodwill annually for impairment as of October 1 and periodically when indicators of impairment exist. The goodwill impairment test requires judgment regarding the determination of fair value of our reporting units, and the determination of fair value of our assets and liabilities. A reporting unit is defined as a component of an entity for which the operating results are regularly reviewed by management and discrete financial information is available. We periodically assess our goodwill for indications of impairment on a reporting unit level.

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, 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.

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 realizability 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 Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payment” (SFAS 123(R)) using the modified prospective transition method and, therefore, we did not restate prior periods’ results. Under this method, we recognize compensation expense for all share-based payments granted after January 1, 2006, as well as those granted prior to but not yet vested as of January 1, 2006, in accordance with SFAS 123(R). 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. Prior to SFAS 123(R) adoption, we accounted for share-based payments under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25).

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.

Southland Earn-Out Consideration. As part of the purchase of Southland, we are required to pay up to $7 million to the sellers if certain financial goals are achieved over the two years subsequent to closing the acquisition. We must estimate, on a quarterly basis, if these goals will be met, but final determination of achieving the goals will only be known on the first and second anniversary dates of the closing date. As a result, from quarter to quarter, changes in our estimates could result in reversing or recognizing significant amounts of compensation expense. In addition, the sellers may elect to receive payment in either cash or stock. We must, based on our current stock price compared to the earn-out exercise price, predict which form of payment the sellers will elect to receive. If our stock price is not an accurate indicator of the sellers’ eventual election, our total liabilities could be misstated.

In February 2008, the FASB issued FSP FAS 157-2, which delayed the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). We do not expect the adoption of SFAS 157 for our non-financial assets and liabilities to have a material impact on our financial position and results of operations.

In December 2007, the FASB issued SFAS 141R. This standard establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree. SFAS 141R also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The impact of adopting SFAS 141R will depend on the future business combinations that we may pursue after its effective date.

On July 10, 2008, we announced that our Board of Directors elected Martin J. Garvin to serve as an independent director and member of our Audit Committee, to hold office for a term expiring at the annual meeting of stockholders to be held in April 2009. Mr. Garvin served as Senior Vice President and Chief Procurement Officer of Dell, Inc., from 2001 through 2008, and was responsible for the strategic leadership and management of the Dell Global Supply Chain. The appointment of Mr. Garvin, who is an “independent director” as defined by NASDAQ, to serve on the Audit Committee brings us into compliance with NASDAQ Marketplace Rule 4350, which requires that public companies listed on the NASDAQ National Market System have three independent directors serving on this committee.

Effective July 11, 2008, we terminated our unsecured revolving loan agreement with Guaranty Bank, originally dated March 10, 2005.

As a condition to the acquisition, we entered into an escrow agreement with the Stockholder Representative and Wells Fargo Bank, N.A., as escrow agent, whereby an escrow fund in the amount of approximately $4.3 million in cash and Notes was deposited into an escrow account from the proceeds of the Acquisition as security for certain conditions and indemnification obligations of Augmentix’s stockholders under the Merger Agreement. This amount held in escrow is subject to be released over a period of two years, less any amounts for unresolved and settled claims.

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. Our web site and the information contained therein or connected thereto are not intended to be incorporated into this Quarterly Report on Form 10-Q.

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 very 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. As of June 30, 2008, all of our cash was held in deposit or money market accounts, or invested in investment grade securities. At June 30, 2008, we had amounts on deposit with financial institutions that were in excess of the federally insured limit of $100,000. We have not experienced any losses on deposits of cash and cash equivalents.

Our long-term investments and a portion of our short-term investments consist of auction rate securities of approximately $9.5 million. 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 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 auction-rate securities has occurred, we may be required to adjust the carrying value of the investments through an impairment charge. See Note 3, “Investments,” for additional information.

The SEC defines the term “disclosure controls and procedures” to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Our chief executive officer and chief financial officer have concluded, based upon the evaluation of the effectiveness of our disclosure controls and procedures by our management as of the end of the period covered by this quarterly report based on the “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission, and excluding the controls performed at our Southland subsidiary, that our disclosure controls and procedures were effective for this purpose. This assessment excludes the controls performed at our Southland subsidiary because we acquired it in the second half of 2007. While we are addressing Southland’s controls and procedures, we are permitted to exclude an acquisition from our assessment of internal controls over financial reporting if, among other circumstances and factors, there is not adequate time between the closing date of the acquisition and the assessment date to assess its internal controls. There was no change in our internal controls during the quarter ended June 30, 2008 that materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

It should be noted that in designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met due to numerous factors, ranging from errors to conscious acts of an individual, or individuals acting together. In addition, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of inherent limitations in a cost-effective control system, misstatements due to error and/or fraud may occur and not be detected.

On March 8, 2007, we filed an action in the U.S. District Court for the District of Massachusetts, Boston Division, against Kentron Technologies, Inc. and Chris Karabatsos, an individual, seeking damages and injunctive relief relating to the defendants’ false and disparaging statements regarding us and our ArctiCore technologies that we proposed to the JEDEC Solid State Technology Association (“JEDEC”), an industry standards-setting organization, for possible adoption as a standard. In particular, we have alleged that the defendants’ actions constituted unfair competition under the Lanham Act, intentional interference with prospective business relations, defamation, business disparagement and have caused actionable injury to our business reputation. On July 11, 2007, the defendants filed their answer and a counterclaim, in which they made claims of unfair methods of competition and unfair, deceptive acts by us, in violation of the laws of the Commonwealth of Massachusetts. On July 12, 2007, the defendants filed a motion to dismiss our Lanham Act claims, and we also filed a motion to dismiss their counterclaims. The judge denied these motions. We also filed a motion to compel discovery, which the judge granted on October 24, 2007. On April 22, 2008, we entered into a settlement and purchase agreement with Kentron Technologies, Inc. and Mr. Chris Karabatsos, resolving our pending litigation regarding our ArctiCore technologies. The settlement included the sale by Kentron and Karabatsos of certain of their intellectual property to us so that we may pursue standardization of our ArctiCore technologies with JEDEC.

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.

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:

Fluctuations in the demand for our solutions occur as the price of next-generation monolithic memory chips declines and as OEMs respond to demand for their products, which will contribute to volatility in our revenue and operating results and may adversely impact our stock price. The rate at which OEMs adopt our memory products using a particular generation of high-density memory chips, if they adopt our memory products at all, may affect our revenue and operating results. In the past, it has taken several quarters for new, higher-density memory chips to achieve market acceptance. Once accepted by the market, demand for our memory products using these chips can accelerate rapidly and then level off such that rapid growth in sales of these products is not indicative of continued future growth. Likewise, demand for legacy memory chips can quickly decline when a new, higher-density memory chip is introduced and receives market acceptance. Sales of our products and product lines toward the end of a product’s market life may fluctuate significantly, and the precise timing of these fluctuations is difficult, if not impossible, to predict.

In other cases, revenue may decline as customers anticipate making new product purchases. The need for continued significant expenditures for capital equipment purchases, research and development and ongoing customer service and support, among other factors, makes it difficult for us to reduce our operating expenses in any particular period if our expectations for revenue for that period are not met. Due to the various factors mentioned above, the results of any prior quarterly or annual periods should not be relied upon as an indication of our future operating performance.

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 and are substantially dependent upon customer orders received and fulfilled in that quarter.

We do not have long-term purchase agreements with customers. Our customers generally place purchase orders for deliveries no more than three months in advance and sometimes no more than a day in advance. These purchase orders generally have no cancellation or rescheduling penalty provisions. Therefore, cancellations, reductions or delays of orders from any significant customer could have a material adverse effect on our business, financial condition and results of operations.

Our business model is one in which there typically is not a backlog of unfilled orders. Rather, a majority of our revenue and earnings in any quarter depends upon customer orders for our products that we receive and fulfill in that quarter. 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.

We depend on a limited number of customers for a substantial portion of our revenue, and the loss of, or a significant reduction in orders from, any key customer could significantly reduce our revenue.

The loss of any of our key customers, or a significant reduction in sales to any one of them, would significantly reduce our revenue and adversely affect our business. Our five largest customers accounted for 64% of our total revenue during the six months ended June 30, 2008, 75% of our total revenue in 2007 and 89% of our total revenue in 2006. In particular, SMART, Micron and Google, Inc. (Google) accounted for 21%, 17% and 12%, respectively, of our total revenue in the first six months ended June 30, 2008. Most of the markets for our current products and technologies are dominated by a small number of potential customers. Therefore, our operating results in the foreseeable future will continue to depend on our ability to effect sales to these customers, as well as the ability of these customers to sell products that incorporate memory utilizing our technologies. In the future, these customers may decide not to specify products that incorporate our technologies for use in their systems, purchase fewer memory products than they did in the past or alter their purchasing patterns. In addition, we may be more likely to make concessions to these customers regarding potential returns, repairs, or other issues than we would make if they were not significant customers.

Some of our customers have sought or are seeking to design alternative solutions, either internally or through third parties, to address their need for greater memory capacity. The success of these efforts could have an adverse effect on the prices we are able to charge our customers and the volume of units that incorporate our solutions, which would negatively affect our revenue and operating results.

Consolidation in some of our customers’ industries may result in increased customer concentration and the potential loss of customers. From time to time, the composition of our major customer base has changed from quarter to quarter as the market demand for our customers’ products has changed, and we expect this variability to continue in the future. We expect that sales of our products to a limited number of customers will continue to represent a majority of our revenue in the foreseeable future. The loss of, or a significant reduction in purchases by, any of our major customers could harm our business, financial condition and results of operations.

A natural disaster, epidemic, labor strike, war or political unrest where our customers’ facilities are located could reduce our sales to such customers.

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.

If our common stock is delisted by NASDAQ, the trading market for our common stock would likely be adversely affected, as price quotations may not be as readily obtainable, which would likely have a material adverse effect on the market price of our common stock.

The price of DRAM is volatile, and excess inventory of DRAM, other components and finished products could adversely affect our gross margin.

Given our acquisition of Southland, we purchase more DRAM for the products we manufacture than we historically have purchased prior to this acquisition. The price of DRAM is subject to rapid fluctuation and variability. The prices of our products are adjusted periodically based largely on the market price of DRAM. Once our prices with a customer are negotiated, we are generally unable to revise pricing with that customer until our next regularly scheduled price adjustment. Consequently, we are exposed to the risks associated with the volatility of the price of DRAM during that period. If the market price for DRAM increases, we generally cannot pass this price increase on to our customer for products purchased under an existing purchase order. As a result, our cost of sales could increase and our gross margin could decrease. Alternatively, if there is a decline in the price of DRAM, we will need to reduce our selling prices for subsequent purchase orders, which may result in a decline in our expected net sales.

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 or license our memory solutions or to compete successfully in our markets and harm our operating results.

Our solutions rely on our proprietary rights, and we believe that the strength of our intellectual property rights is, and will continue to be, critical to the success of our business. If any of our key patents or other intellectual property rights are invalidated or deemed unenforceable, or if a court limits the scope of the claims in any of our key patents or other intellectual property rights, the likelihood that companies will continue to purchase or 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 resulting loss in revenue 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:

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

Our patent portfolio contains some patents that are particularly significant to our ongoing revenue and business. If any of these key patents is 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 significantly reduced. The resulting loss in license fees and royalties could significantly harm our business, financial condition and results of operations.

Our revenue may suffer if we cannot continue to license or enforce our intellectual property rights or if third parties assert that we violate their intellectual property rights.

We rely upon patent, copyright, trademark and trade secret laws in the United States and similar laws in other countries, and agreements with our employees, customers, suppliers and other parties, to establish and maintain our intellectual property rights in our technology. However, any of our direct or indirect intellectual property rights could be challenged, invalidated or circumvented. Further, the laws of certain countries do not protect our proprietary rights to the same extent as do the laws of the United States. Therefore, in certain jurisdictions we may be unable to protect our technology adequately against unauthorized third-party use, which could adversely affect our business. Third parties also may claim that we or our customers are infringing upon their intellectual property rights. Even if we believe that the claims are without merit, the claims can be time consuming and costly to defend and divert management’s attention and resources away from our business. Claims of intellectual property infringement also might require us to enter into costly settlement or license agreements or pay costly damage awards. Some of our license agreements provide limited indemnities and we may agree to indemnify others in the future. Our indemnification obligations could result in substantial expenses. In addition to the time and expense required for us to indemnify our licensees, a licensee’s development, marketing and sales of licensed semiconductors could be severely disrupted or shut down as a result of litigation, which in turn could severely hamper our business, financial condition and results of operations. If we cannot or do not license the infringed technology at all or on reasonable terms or substitute similar technology from another source, our business could suffer.

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

To date, we have derived nearly all of our revenue from sales or licenses of our Stakpak and memory module solutions, and we expect these solutions to continue to account for a large portion of our total revenue in the near term. Continued market acceptance of these solutions is critical to our future success. As a result, our business, financial condition and results of operations could be adversely affected by:

The average selling prices of our products and technologies could decrease rapidly, which may negatively impact our revenue and gross margins.

We may experience substantial period-to-period fluctuations in our future revenue and operating results due to a decline in the average selling prices for our products and technologies. From time to time, we reduce the average unit price of our products and technologies in anticipation of future competitive pricing pressures, declining memory chip prices, introductions of new products and technologies by us or our memory suppliers and other factors. The high-density memory market is extremely cost sensitive due to potentially high-order volumes combined with memory buyers’ expectations for aggressive price reductions over time. As a consequence, the average selling prices of monolithic memory chips historically have declined as new product generations are commercialized. We expect that these factors will continue to create downward pressure on our average selling prices, which may, in turn, negatively impact our revenue and gross margins, particularly if we are unable to offset reductions in average selling prices by increasing our unit volumes or reducing our manufacturing costs. To maintain our gross margins, we will need to develop and introduce new products and technologies on a timely basis and continually reduce our costs. Our failure to do so could cause our revenue and gross margins to decline.

We are a relatively 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. In addition, some of our current and potential competitors have established relationships with the decision makers at our current or potential customers. These competitors may be able to leverage their existing relationships to discourage their customers from purchasing products from us or persuade them to replace our products with their products.

In addition, some of our significant customers are competitors of ours, and may have the ability to manufacture competitive products at lower costs. Our current or potential competitors may also offer bundled arrangements offering a more complete or cost-effective product, despite the technical merits or advantages of our products or technologies. We also face competition from current and prospective customers that continually evaluate our capabilities against the merits of manufacturing products internally. Competition may also arise due to the development of cooperative relationships among our current and potential competitors or third parties to increase the ability of their products to address the needs of our prospective customers. In addition, we expect to face competition from existing competitors and new and emerging companies that may enter our existing or future markets with similar or alternative products, which may be less costly or provide additional features. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

We have many competitors who have developed competing technologies. For example, planar solutions allow additional memory devices to be directly attached on the printed circuit board without the need for stacking. Some of the major OEMs and memory suppliers currently are using planar solutions and we expect them to continue to utilize planar solutions in the near future in legacy DDR technologies, as well as in next-generation DDR-2 and DDR-3 technologies with the migration to smaller footprint packages.

In addition, memory packages have been developed that place multiple memory chips into a single package that allows these memory chips to fit in the same area as a single Stakpak. Other competitors utilize competing

technologies that stack standard memory chips. We also could face competition from many new technologies, such as 3D memory cells, stacked wafers, stacked die and module innovations or module stacking. These and other new technologies could change the demand for or performance requirements of memory products, and could provide the market with cost-effective memory solutions that outperform our Stakpak solutions.

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 our products and technologies are used in defective products or include defective parts, we may be subject to product liability or other claims.

If we manufacture memory products that are defective, used in defective or malfunctioning products 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 licensees and customers.

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, 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:

Future acquisitions also could cause us to incur 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 continually 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:

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.

We expect a portion of our future revenue to be derived from license royalties, which is inherently risky.

Because we expect a portion of our future revenue to be derived from license royalties, our future success depends on:

Although we have engaged in discussions with potential licensees for our Stakpak technologies, we historically have not devoted significant resources to licensing our technologies and currently have only four license arrangements. We face risks inherent in a royalty-based business model, many of which are outside of our control, such as the following:

It is difficult to predict when we will enter into additional license agreements, if at all. The time it takes to establish a new licensing arrangement can be lengthy. We may also incur delays or deferrals in the execution of license agreements as we develop new technologies. The timing of our receipt of royalty payments and the timing of how we recognize license revenue under license agreements may fluctuate and significantly impact our quarterly or annual operating results. Because we may recognize a significant portion of license fee revenue in the quarter that the license is signed, the timing of signing license agreements may significantly impact our quarterly or annual operating results. Under our typical license agreements, we also receive ongoing royalty payments, and these may fluctuate significantly from period to period based on sales of products incorporating our licensed technologies.

It is difficult for us to verify royalty amounts owed to us under our license agreements, and this 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.

Because our licensing cycle is lengthy and costly, it is difficult to predict future revenue, which may cause us to miss market estimates and may result in our stock price declining.

Pursuing and entering into new license agreements generally requires significant marketing and sales efforts. The length of time it takes to establish a new licensing relationship can range from six to 12 months or longer. Because our licensing cycle is a lengthy process, the accurate prediction of future revenue from new licenses is difficult.

In addition, engineering services are dependent upon the varying level of assistance desired by licensees and, therefore, revenue from these services is also difficult to predict as it is recognized in the period in which we render service. There can be no assurance that we can accurately estimate the amount of resources required to complete projects, or that we will have, or be able to expend, sufficient resources required to complete a project. Furthermore, there can be no assurance that the product development schedule for these projects will not be changed or delayed. All of these factors make it difficult to predict future licensing revenue that may result in us missing analysts’ estimates and may cause our stock price to decline.

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.

Our reliance on our memory manufacturer customers for the memory chips used in products that incorporate our technologies subjects us to the risk of a shortage of these chips, adversely impacting our ability to fulfill orders from other customers, risks of natural disasters and other factors that could cause disruptions in the supply of memory chips.

Our ability to fulfill customer orders is dependent on a sufficient supply of memory chips to which we apply our manufacturing services. Historically, our customers have shipped on consignment their memory chips to be stacked, which we stack and then return to them. We have no memory supply contracts under which we are currently operating. In acquiring memory chips, supply options are very limited because of the small number of memory manufacturers. Our dependence on our customers’ provision of memory chips to us on a just-in-time basis, rather than through guaranteed supply contracts, subjects our business to risks associated with unforeseen disruptions in the industry availability of memory chips. In the past, there have been shortages of DRAM chips available in the market. These shortages negatively impacted our ability to fulfill customer orders, which resulted in a decrease in shipments in these quarters. Any future shortage could result in a similar decrease in shipments, which would adversely impact our financial condition and results of operations.

In addition, natural disasters or other factors could cause delays or reductions in product shipments that could negatively affect our revenue, financial condition and results of operations. Moreover, since the majority of memory chips are manufactured in the Pacific Rim region, we believe that the risk of exposure of memory suppliers to earthquakes, typhoons, political unrest, terrorist activity, infectious diseases or other similar events is of particular concern. Any unexpected interruption in the manufacture of other key electronic components used in association with products that incorporate our technologies could disrupt production of devices that use our services and technologies, thereby adversely affecting either our ability to deliver products to our customers or the customers’ demand for our services and technologies.

We have an indefinite-lived intangible asset and other intangible assets that may become impaired, which could significantly affect our results of operations in the period recognized.

In accordance with generally accepted accounting principles, we evaluate the recoverability of our indefinite-lived intangible asset (goodwill) on an annual basis and periodically evaluate the recoverability of all of our intangible assets when indicators of impairment exist. The following factors may result in an impairment of goodwill or other intangible assets: significant negative industry or economic trends; disruptions to our business; declines in revenue or market capitalization; or other factors may result in an impairment of goodwill or other intangible assets. Future impairment charges could significantly affect our results of operations in the periods recognized.

If we are unable to manufacture our products efficiently or we experience credit losses or other collections issues, our business, financial condition and results of operations could suffer.

We are continuously modifying our manufacturing processes in an effort to maintain satisfactory manufacturing yields and product performance, lower our costs and reduce the time it takes to design products based on our technologies. In addition, new manufacturing processes are required as we ramp high-volume production of new technologies. We face increased risks with these new processes and we incur significant start-up costs associated with implementing new manufacturing technologies, methods and processes and purchasing new equipment, which could impact our gross margins. We expect to experience manufacturing delays and inefficiencies as we develop or refine new manufacturing technologies and methods, implement them in volume production and qualify them with customers, which could cause our operating results to decline. As we manufacture more complex products, the risk of encountering delays or difficulties increases.

In addition, if demand for our products increases significantly, we will need to expand our operations to manufacture sufficient quantities of products without increasing our production times or our unit costs. As a result of such expansion, we could be required to purchase new equipment, upgrade existing equipment, develop and implement new manufacturing processes and hire additional personnel. Further, new or expanded manufacturing facilities could be subject to qualification by our customers. We cannot be certain that we will be able to add required manufacturing capacity or that we will be able to maintain control over product quality, delivery schedules, manufacturing yields and costs as we increase our output. Any difficulties in expanding our manufacturing operations could cause product delivery delays and lost sales.

If demand for our products decreases, we could have excess manufacturing capacity. The fixed costs associated with excess manufacturing capacity could cause our operating results to decline. If we are unable to achieve further manufacturing efficiencies and cost reductions, particularly if we are experiencing pricing pressures in the marketplace, our 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 have not had significant credit losses or other collections issues during the periods for which financial information is presented. As a result of our acquisition of Southland in 2007, we now have an immaterial bad debt allowance. Although we do not believe that we will incur any 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 solutions 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 our current Performance Stakpak solution by increasing revenue associated with our other solutions 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:

Our research and development efforts are focused primarily on furthering the technologies related to our non-leaded solutions and other new product initiatives. If the development of these technologies is delayed or abandoned, or if these new technologies fail to achieve market acceptance, our growth prospects, financial condition, results of operations and competitive position could be adversely affected. Furthermore, if markets for these new technologies develop later than we anticipate, or do not develop at all, demand for our solutions that are currently in development would suffer, resulting in lower sales of these products than we currently anticipate.

Products that incorporate our technologies generally have long sales and implementation periods, and our customers require that our technologies undergo a lengthy and expensive qualification process without any assurance of revenue.

Products that incorporate our technologies are complex and are typically intended for use in applications that may be critical to the systems being developed by our customers. Prospective customers generally must make a significant commitment of resources to test and evaluate our technologies and to integrate memory modules and other system parts into larger systems. As a result, our sales process is often subject to delays associated with lengthy approval processes that typically accompany the design, testing and adoption of new, technologically complex products. This may delay the time in which we recognize revenue and result in our investing significant resources well in advance of orders for our products.

Prior to incorporating memory products utilizing our technologies, our customers require our processes and technologies to undergo an extensive qualification process, which involves testing products utilizing our technologies, as well as rigorous reliability testing. This qualification process may continue for six months or

longer. However, qualification by a customer does not ensure any sales to that customer. Even after successful qualification and sales to a customer of products incorporating our technologies, changes in our technologies may require a new qualification process, which may result in additional delays. After our products are qualified, it can take an additional six months or more before the customer commences production of components or devices that incorporate our products. Despite these uncertainties, we devote substantial resources, including design, engineering, sales, marketing and management efforts, toward qualifying our products with customers in anticipation of sales. If we are unsuccessful or delayed in qualifying any of our products with a customer, such failure or delay would preclude or delay sales of such products to the customer, which may impede our growth and cause our business to suffer.

If the supply of materials used to manufacture our products is interrupted, or our manufacturing turnaround times are extended, our financial condition and results of operations could be adversely affected.

In order to manufacture our solutions, we require raw materials and components such as, but not limited to, DRAM, flex circuits, printed circuit boards, aluminum cores, resistors, capacitors, advanced memory buffers, epoxy adhesive, solder, nitrogen, ink marking supplies and tape and reel supplies. We typically procure these materials from limited sources to take advantage of volume pricing discounts. Shortages in these materials may occur from time to time, and have occurred in the past with respect to the supply of flex circuit relating to our ArctiCore product line. In addition to shortages, we could experience quality problems with these materials, which could result in returning them to our suppliers. These shortages and returns could extend the turnaround times of our manufacturing services. 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.

Our manufacturing operation is located in Reynosa, Mexico; our failure to continue to manage this operation, as well as issues associated with the location of this facility, could materially and adversely affect our business.

We currently manufacture virtually all of our Stakpak units in Mexico, and we expect to manufacture all of our memory modules in Mexico when we complete moving our manufacturing equipment from Irvine, California to Mexico by the end of the third quarter of 2008. The relocation of our operations, and any future growth of our operations, may place a significant strain on our management personnel, systems and resources. We may need to implement a variety of new and upgraded operational and financial systems, procedures and controls, including the improvement of our accounting and other internal management systems. We also expect that we will need to continue to expand, train, manage and motivate our workforce. All of these endeavors will require substantial management time and attention, and we anticipate that we will require additional management personnel and internal processes to manage these efforts. If we are unable to effectively manage our expanding operations, our business could be materially and adversely affected.

In addition, this facility in Mexico is exposed to certain risks as a result of its location, including:

Any of these risks could interfere with the operation of this facility or restrict or delay our ability to move components, finished products or manufacturing equipment across the United States–Mexico border and result in reduced production, increased costs, or both. In the event that this facility’s production is reduced or we encounter disruptions or delays in moving products across the border, we could fail to ship products on schedule and could face a reduction in future orders from dissatisfied customers. If our costs to operate this facility increase, our gross margins would decrease. Reduced shipments and margins would have an adverse effect on our business, financial condition and results of operations.

We operate our manufacturing facility in Mexico as a Maquiladora and any loss of this status or change in the laws affecting Maquiladoras, or disputes with the labor union in Mexico, could materially harm our business, financial condition and results of operations.

We currently manufacture virtually all of our Stakpak products at our manufacturing facility in Mexico, and we expect to manufacture all of our memory modules in Mexico when we complete moving our manufacturing equipment from Irvine, California to Mexico. This facility is authorized to operate as a Maquiladora by the Ministry of Economy of Mexico. Mexico has enacted this legislation to promote the use of such manufacturing operations by foreign companies, and continuation of these operations depends upon, among other factors, compliance with applicable laws and regulations of the United States and Mexico. Maquiladora status allows us to import items into Mexico duty-free, provided that such items, after processing, are re-exported from Mexico within 18 months. Maquiladora status is subject to various restrictions and requirements, including:

Because assembly operations in Mexico continue to be less expensive than comparable operations in the United States, in recent years many companies have established Maquiladora operations in the Reynosa area to take advantage of lower labor costs. Increasing demand for labor, particularly skilled labor and professionals, from new and existing Maquiladora operations could in the future result in increased labor costs. The loss of our Maquiladora status, changes in the Maquiladora program, the inability to recruit, hire and retain qualified employees, a significant increase in labor costs, unfavorable exchange rates or interruptions in the trade relations between the United States and Mexico could have a material adverse effect on our business, financial condition and results of operation.

While we are not party to any collective bargaining agreements with any of our employees in the United States, as of June 30, 2008, 191, or 72%, of our employees in Mexico were represented by a labor organization that has entered into a labor contract with us. As a result, our Reynosa operations are subject to union activities, including organized strikes or other work stoppages, and cost factors arising from our negotiations of employment terms with the representatives of this union. To date, we have not experienced any organized strikes or other work stoppages at our facility in Reynosa.

The consumer electronics market is a highly competitive and volatile market and if we are not successful in this or other new markets, our business, financial condition and results of operations could be adversely affected.

We believe our package-stacking technologies and manufacturing processes are directly applicable to Flash memory market, but we are a recent entrant to this market, and many of the memory suppliers and memory module makers are increasingly focusing on the consumer Flash memory market. Further, the consumer market is highly competitive and is characterized by aggressive pricing practices, downward pressure on gross margins, frequent introduction of new products, short product life cycles, evolving industry standards, continual improvement in product price/performance characteristics, rapid adoption of technological and product advancements by competitors, price sensitivity on the part of consumers, dynamic customer demand patterns, seasonal revenue trends and a large number of competitors. In addition, the consumer market can be much more volatile than other segments of the memory market. To be successful, we will need to continually introduce new products and technologies, enhance existing products in order to remain competitive, and effectively stimulate customer demand for new products and upgraded versions of our existing products. The success of new product introductions is dependent on a number of factors, including market acceptance; our ability to manage the risks associated with product transitions and production ramp issues; the availability of products in appropriate quantities to meet anticipated demand; and the risk that new products may have quality or other defects in the early stages of introduction. The gross margins in the consumer business are also lower than the other markets on which we are focused, which may adversely affect our financial performance and could lead to a decreased valuation of the Company. As a result, we cannot determine in advance the ultimate effect that new products will have on our sales, licensing or results of operations, and, as a result, if we are not successful in this or other new markets, our business, financial condition and results of operations could be adversely affected.

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 3 to the Consolidated Condensed Financial Statements included in this Quarterly Report, our investment securities consist of auction rate securities, which are not currently liquid or readily available to convert to cash. We do not believe that the current liquidity issues related to our auction rate securities 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. In addition, if this liquidity issue persists, it is possible that we will be required to further adjust the fair value of our auction rate securities. If we determine that the decline in the fair value of our auction rate securities is other than temporary, we would recognize an impairment charge in our statement of operations, which could be material and which could adversely affect our financial results. Finally, if our circumstances changed and we were obligated to sell the securities in a secondary market or borrow against them, it would likely be on terms unfavorable to us.

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:

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.

Our operations could be disrupted by power outages, political unrest, natural disasters or other disasters.

We operate a manufacturing facility in Reynosa, Mexico. This area is subject to earthquakes, fires, flooding and other natural disasters. This facility is also subject to an epidemic, political unrest, war, labor strikes or work stoppages. Interruptions in supply or utilities at these locations would likely result in the disruption of our manufacturing services, cause significant delays in shipments of our products and materially and adversely affect our operating results.

In addition, our disaster recovery plans may not be adequate or effective. We do not carry earthquake insurance. Other insurance that we carry is limited in the risks covered and the amount of coverage. Our insurance would not be adequate to cover all of our resulting costs, business interruption and lost profits if a natural disaster were to occur. A natural disaster rendering one of our manufacturing facilities totally or partially unusable, whether or not covered by insurance, would materially and adversely affect our business and financial condition.

We intend to expand our research and development activities and other operations, and this expansion may strain our resources and increase our operating expenses.

We intend to increase our research and development activities and other operations, both in the United States and in Mexico, as we grow our business and expand our technology offerings. We may do so through both internal growth and acquisitions. We expect that this expansion could strain our systems and operational and financial controls.

Products that incorporate our technologies must conform to industry standards in order to be widely accepted by OEMs for use in their products.

Our services and technologies are used to create products that comprise only a part of a larger system. Typically, the components of these systems comply with industry standards in order to operate efficiently together. We depend on companies that provide other components of systems and devices to support prevailing industry standards. Many of these companies are significantly larger and more influential in affecting industry standards than we are. Some industry standards may not be widely adopted or implemented consistently, and competing standards may emerge that may be preferred by our customers or end users. If larger companies do not support the same industry standards that we do, or if competing standards emerge, market acceptance of our products could be adversely affected, which would harm our business.

Industry standards are continually evolving, and our ability to compete in the future will depend on our ability to identify and ensure compliance with these evolving industry standards. The emergence of new industry standards could render our products incompatible with products developed by other suppliers. As a result, we could be required to invest significant time and effort and to incur significant expense to implement new services and technologies to ensure compliance with relevant standards. If our products or those of our customers are not in compliance with prevailing industry standards for a significant period of time, we may not be able to sell our services and technologies and our financial condition and results of operations would suffer. In addition, if we do not correctly anticipate new technologies and standards, or if the products that we develop based on these new technologies and standards fail to achieve market acceptance, our competitors may be better able to address market demand than we would and our business, financial condition and results of operations would be adversely affected.

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.

We believe 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:

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 failure to comply with environmental laws and regulations could subject us to significant fines and liabilities, and new laws and regulations or changes in regulatory interpretation or enforcement could make compliance more difficult and costly.

We are subject to various and frequently changing federal, state and local, and foreign governmental laws and regulations relating to the protection of the environment, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites and the maintenance of a safe workplace. We could incur substantial costs, including clean-up costs, civil or criminal fines or sanctions and third-party claims for property damage or personal injury, as a result of violations of or liabilities under environmental laws and regulations or non-compliance with the environmental permits required for our facilities. These laws, regulations and permits also could require the installation of costly pollution control equipment or operational changes to limit pollutant emissions or decrease the likelihood of accidental releases of hazardous substances.

In addition, new laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination at our sites or the imposition of new clean-up requirements could require us to curtail our operations, restrict our future expansion, subject us to liability and cause us to incur future costs that would have a negative effect on our financial condition and results of operations.

Economic, political and other risks associated with international sales and operations could adversely affect our revenue.

Since we sell our services and technologies worldwide, our business is subject to risks associated with doing business internationally. Our revenue originating outside the United States as a percentage of our total revenue was 30% during the six months ended June 30, 2008, 18% in 2007 and 22% in 2006. International turmoil, exacerbated by the war in Iraq, the escalating tensions in North Korea and violence in the Middle East, have contributed to an uncertain political and economic climate, both in the United States and globally, which may affect our ability to generate revenue on a predictable basis. In addition, terrorist attacks and the threat of future terrorist attacks both domestically and internationally have negatively impacted the worldwide economy. As we ship memory units both in the United States and internationally, the threat of future terrorist attacks may adversely affect our business. These conditions make it difficult for us and for our customers to accurately forecast and plan future business activities and could have a material adverse effect on our business, financial condition and results of operations.

A portion of our revenue is derived from customers based in Asia. The economies of Asia have been highly volatile and recessionary in the past, resulting in significant fluctuations in local currencies and other instabilities. Some countries in Asia have recently been affected by infectious diseases. These instabilities continue and may occur again in the future. Our exposure to the business risks presented by the economies of Asia will increase to the extent that we continue to expand our customer base and activities in that region. An outbreak of an infectious disease could result in reduced demand for products incorporating our technologies, extend the qualification periods for our technologies or otherwise adversely affect our business.

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.

The following table provides information with respect to our purchase of our common stock during the quarter ended June 30, 2008:

We held our 2008 Annual Meeting of Stockholders on April 17, 2008. Following are the results of voting on the election of directors submitted to stockholders at this meeting:

Following are the results of voting to increase the authorized shares in our Amended and Restated 2003 Stock Option Plan by 3.5 million shares:

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/ Wayne R. Lieberman

Wayne R. Lieberman

Chief Executive Officer

Date: August 13, 2008

/s/ W. Kirk Patterson

W. Kirk Patterson

Senior Vice President and Chief Financial Officer

Date: August 13, 2008


Large accelerated filer ¨		Accelerated filer ¨

Non-accelerated filer ¨		Smaller reporting company x


	PART I – FINANCIAL INFORMATION	Page

Item 1.	Consolidated Condensed Balance Sheets – June 30, 2008 (unaudited) and December 31, 2007	3
	Consolidated Condensed Statements of Operations (unaudited) for the three months ended June 30, 2008 and 2007	4
	Consolidated Condensed Statements of Operations (unaudited) for the six months ended June 30, 2008 and 2007	5
	Consolidated Condensed Statements of Cash Flows (unaudited) for the six months ended June 30, 2008 and 2007	6
	Notes to the Consolidated Condensed Financial Statements (unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	31

	PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Submission of Matters to a Vote of Security Holders	49
Item 5.	Other Information	49
Item 6.	Exhibits	50


	June 30, 2008			December 31, 2007
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	41,005		$	34,013
Investments		4,145			27,912
Accounts receivable		5,095			5,681
Inventories		3,928			2,921
Prepaid expenses		933			633
Income tax recoverable		1,924			1,969
Deferred tax asset		148			143
Other current assets		1,347			916

Total current assets		58,525			74,188
Property, plant and equipment, net		8,072			9,212
Long-term investments		7,038			—
Goodwill		4,953			4,953
Other intangible assets, net		9,178			10,826
Other assets		46			234

Total assets	$	87,812		$	99,413


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,536		$	3,348
Accrued compensation		1,989			1,428
Accrued liabilities		2,112			3,056
Current maturities of capitalized lease obligations		21			21

Total current liabilities		5,658			7,853
Capitalized lease obligations, less current maturities		44			54
Other accrued liabilities		181			199
Deferred tax liabilities		37			38
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, 2008 and December 31, 2007; 53,175,261 shares and 52,876,038 shares issued at June 30, 2008 and December 31, 2007, respectively		53			52
Additional paid-in capital		164,677			163,298
Treasury stock, at cost; 6,304,378 shares and 6,172,650 shares at June 30, 2008 and December 31, 2007, respectively		(25,751	)		(25,601	)
Accumulated other comprehensive income (loss)		(698	)		44
Accumulated deficit		(56,389	)		(46,524	)

Total stockholders’ equity		81,892			91,269

Total liabilities and stockholders’ equity	$	87,812		$	99,413


	Three Months Ended June 30,
	2008			2007
Revenue:
Product	$	7,677		$	7,464
License		1,236			775

Total revenue		8,913			8,239
Cost of revenue:
Product (1)		8,382			5,729
Amortization and impairment of acquisition intangibles		763			1,103

Total cost of revenue		9,145			6,832

Gross profit (loss)		(232	)		1,407

Operating expenses:
Selling, general and administrative (1)		2,727			3,389
Research and development (1)		1,093			1,493
Restructuring		214			—
Amortization of acquisition intangibles		167			138

Total operating expenses		4,201			5,020

Loss from operations		(4,433	)		(3,613	)

Other income (expense):
Interest income		352			839
Interest expense		(3	)		(6	)
Other, net		29			(21	)

Total other income, net		378			812

Loss before income taxes		(4,055	)		(2,801	)
Provision (benefit) for income taxes		(52	)		1,307

Net loss	$	(4,003	)	$	(4,108	)

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

Diluted	$	(0.09	)	$	(0.09	)

Shares used in computing loss per share:
Basic		46,763			47,380
Diluted		46,763			47,380


	Six Months Ended June 30,
	2008			2007
Revenue:
Product	$	14,889		$	14,646
License		2,636			2,271

Total revenue		17,525			16,917
Cost of revenue:
Product (1)		17,295			11,577
Amortization and impairment of acquisition intangibles		1,351			2,803

Total cost of revenue		18,646			14,380

Gross profit (loss)		(1,121	)		2,537

Operating expenses:
Selling, general and administrative (1)		6,956			6,728
Research and development (1)		2,397			3,269
Restructuring		214			—
Amortization of acquisition intangibles		353			276

Total operating expenses		9,920			10,273

Loss from operations		(11,041	)		(7,736	)

Other income (expense):
Interest income		858			1,675
Interest expense		(6	)		(8	)
Other, net		57			(53	)

Total other income, net		909			1,614

Loss before income taxes		(10,132	)		(6,122	)
Provision (benefit) for income taxes		(267	)		922

Net loss	$	(9,865	)	$	(7,044	)


Loss per share:
Basic	$	(0.21	)	$	(0.15	)

Diluted	$	(0.21	)	$	(0.15	)

Shares used in computing loss per share:
Basic		46,750			47,414
Diluted		46,750			47,414
(1) Includes stock-based compensation expense as follows:
Cost of revenue	$	167		$	211
Selling, general and administrative expense	$	968		$	2,513
Research and development expense	$	231		$	484


	Six Months Ended June 30,
	2008			2007
Cash flows from operating activities:
Net loss	$	(9,865	)	$	(7,044	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation, amortization and impairment of intangibles		3,654			4,727
Stock-based compensation expense		1,366			3,208
Other non-cash charges		183			219
Deferred income taxes		(6	)		561
Net change in operating assets and liabilities		(3,200	)		(49	)

Net cash provided by (used in) operating activities		(7,868	)		1,622


Cash flows from investing activities:
Purchases of investments		(4,418	)		(16,582	)
Sales and maturities of investments		20,381			21,175
Additions to property, plant and equipment		(834	)		(314	)
Proceeds from sale of equipment		5			60
Patent application costs		(198	)		(245	)

Net cash provided by investing activities		14,936			4,094


Cash flows from financing activities:
Net proceeds from the issuance of common stock		84			89
Excess tax benefit related to the exercise of employee stock options		—			46
Share repurchases		(150	)		(2,794	)
Payments on capitalized lease obligations		(10	)		(9	)

Net cash used in financing activities		(76	)		(2,668	)

Net increase in cash and cash equivalents		6,992			3,048

Cash and cash equivalents at beginning of period		34,013			40,797

Cash and cash equivalents at end of period	$	41,005		$	43,845


			Fair Value Measurements at June 30, 2008 Using:
Description	Fair Value at June 30, 2008		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	$	11,183	$	1,645	$	—	$	9,538


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance at December 31, 2007	$	—
Transfers in (out) of Level 3		10,250
Total losses included in other comprehensive loss		(712	)
Purchases, issuances and settlements		—

Balance at June 30, 2008	$	9,538


	June 30, 2008		December 31, 2007
Raw materials	$	3,000	$	2,565
Work in process		27		15
Finished goods		901		341

	$	3,928	$	2,921


Restructuring accrual at December 31, 2007	$	—
Restructuring expenses accrued		214
Payments of restructuring expenses		—

Restructuring accrual at June 30, 2008	$	214


	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, 2007	5,333,260		$	3.31
Granted	1,435,000		$	1.25
Exercised	(202,192	)	$	0.41
Cancelled or forfeited	(277,410	)	$	3.60

Outstanding at June 30, 2008	6,288,658		$	2.92	7.7	$	222

Options exercisable at June 30, 2008	3,246,562		$	3.52	6.5	$	223


	Three Months Ended June 30, 2008	Six Months Ended June 30, 2008
Expected volatility	64.3%	64.3% – 65.2%
Dividend yield	0.0%	0.0%
Expected term (in years)	7.0	7.0
Risk-free interest rate	3.9%	2.6% – 3.9%


	Number of RSUs		Weighted Average Grant Date Fair Value
Outstanding at December 31, 2007	505,995		$	5.55
Granted	—			—
Vested	(142,250	)	$	5.42
Forfeited	(34,525	)	$	5.42

Outstanding at June 30, 2008	329,220		$	5.61


	June 30, 2008			December 31, 2007
Unrealized gain (loss) on investment securities, net of tax	$	(698	)	$	44

Accumulated other comprehensive income (loss)	$	(698	)	$	44


	Three Months Ended June 30,
	2008		2007
Revenue:
Product	86.1	%	90.6	%
License	13.9		9.4

Total revenue	100.0		100.0
Cost of revenue:
Product	94.0		69.5
Amortization and impairment of acquisition intangibles	8.6		13.4

Total cost of revenue	102.6		82.9

Gross profit (loss)	(2.6	)	17.1

Operating expenses:
Selling, general and administrative	30.6		41.1
Research and development	12.2		18.1
Restructuring	2.4		—
Amortization of acquisition intangibles	1.9		1.7

Total operating expenses	47.1		60.9

Loss from operations	(49.7	)	(43.8	)
Other income, net	4.2		9.8

Loss before income taxes	(45.5	)	(34.0	)
Provision (benefit) for income taxes	(0.6	)	15.9

Net loss	(44.9	)%	(49.9	)%


	Three Months Ended June 30,				Change
	2008		2007		Change
	(in thousands, except %)
Product revenue	$	7,677	$	7,464	2.9	%
License revenue		1,236		775	59.5	%

Total revenue	$	8,913	$	8,239	8.2	%


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	11,718	$	1.25	11,718	Approx. $6.9 million
May	19,250	$	1.14	19,250	Approx. $6.9 million
June	53,922	$	0.87	53,922	Approx. $6.9 million

Total	84,890	$	0.98	84,890