FSI INTERNATIONAL INC - FORM 10-Q

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EX-31.2 - CERTIFICATION BY PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER - FSI INTERNATIONAL INC	dex312.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - FSI INTERNATIONAL INC	dex321.htm
EX-31.1 - CERTIFICATION BY PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 302 - FSI INTERNATIONAL INC	dex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended May 28, 2011

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

For the transition period from to

Commission File Number: 0-17276

FSI INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)


MINNESOTA		41-1223238
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

3455 Lyman Boulevard, Chaska, Minnesota		55318
(Address of principal executive offices)		(Zip Code)

952-448-5440

(Registrant’s telephone number, including area code)

N/A

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x YES ¨ NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ YES ¨ NO

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

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

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

Common Stock, No Par Value – 38,742,000 shares outstanding as of June 27, 2011

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q


		PAGE NO.
PART I.	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements (unaudited):
	Condensed Consolidated Balance Sheets as of May 28, 2011 and August 28, 2010		3

	Condensed Consolidated Statements of Operations for the quarters ended May 28, 2011 and May 29, 2010		5

	Condensed Consolidated Statements of Operations for the nine months ended May 28, 2011 and May 29, 2010		6

	Condensed Consolidated Statements of Cash Flows for the nine months ended May 28, 2011 and May 29, 2010		7

	Notes to Condensed Consolidated Financial Statements		8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		17

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		24

Item 4.	Controls and Procedures		24

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		24

Item 1.A.	Risk Factors		24

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		25

Item 3.	Defaults upon Senior Securities		25

Item 5.	Other Information		25

Item 6.	Exhibits		25

	SIGNATURE		26

PART I. ITEM 1. FINANCIAL INFORMATION

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

MAY 28, 2011 AND AUGUST 28, 2010

ASSETS

(unaudited)

(in thousands)


	May 28, 2011			August 28, 2010
Current assets:
Cash and cash equivalents	$	27,240		$	34,365
Restricted cash		322			322
Trade accounts receivable, net of allowance for doubtful accounts of $112		17,749			18,935
Inventories, net		45,667			26,145
Other receivables		2,595			2,489
Prepaid expenses and other current assets		1,925			1,184


Total current assets		95,498			83,440


Property, plant and equipment, at cost		73,121			71,502
Less accumulated depreciation		(59,503	)		(58,298	)

		13,618			13,204

Long-term marketable securities		1,907			3,612
Investment		460			460
Other assets		1,669			1,582


Total assets	$	113,152		$	102,298

(continued)

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

MAY 28, 2011 AND AUGUST 28, 2010

(continued)

LIABILITIES AND STOCKHOLDERS’ EQUITY

(unaudited)

(in thousands)


	May 28, 2011			August 28, 2010

Current liabilities:
Trade accounts payable	$	10,243		$	8,396
Accrued expenses		6,864			8,020
Customer deposits		342			—
Deferred profit		4,073			2,669


Total current liabilities		21,522			19,085

Long-term accrued expenses		446			410

Stockholders’ equity:
Preferred stock, no par value; 9,700 shares authorized; none issued and outstanding		—			—
Series A Junior Participating Preferred Stock, no par value; 300 shares authorized; none issued and outstanding		—			—
Common stock, no par value; 50,000 shares authorized; issued and outstanding, 38,742 and 38,554 shares, at May 28, 2011 and August 28, 2010, respectively		245,232			244,796
Accumulated deficit		(158,820	)		(165,349	)
Accumulated other comprehensive loss		(82	)		(870	)
Other stockholders’ equity		4,854			4,226


Total stockholders’ equity		91,184			82,803


Total liabilities and stockholders’ equity	$	113,152		$	102,298

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE QUARTERS ENDED MAY 28, 2011 AND MAY 29, 2010

(unaudited)

(in thousands, except per share data)


	May 28, 2011		May 29, 2010

Sales	$	25,598	$	28,653
Cost of sales		13,731		14,930

Gross margin		11,867		13,723

Selling, general and administrative expenses		4,675		4,716
Research and development expenses		3,155		3,398

Operating income		4,037		5,609

Interest income		25		22
Other income, net		55		323

Income before income taxes		4,117		5,954

Income tax expense		6		90


Net income	$	4,111	$	5,864


Net income per common share:
Basic	$	0.11	$	0.18
Diluted	$	0.10	$	0.18

Weighted average common shares – basic		38,714		32,160
Weighted average common shares – diluted		39,248		32,606

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE NINE MONTHS ENDED MAY 28, 2011 AND MAY 29, 2010

(unaudited)

(in thousands, except per share data)


	May 28, 2011			May 29, 2010

Sales	$	67,231		$	62,195
Cost of sales		37,144			33,863

Gross margin		30,087			28,332

Selling, general and administrative expenses		14,303			12,777
Research and development expenses		9,327			9,417

Operating income		6,457			6,138

Interest income		79			73
Gain on sale of securities		—			6
Other (expense) income, net		(8	)		302

Income before income taxes		6,528			6,519

Income tax (benefit) expense		(1	)		100


Net income	$	6,529		$	6,419


Net income per common share:
Basic	$	0.17		$	0.20
Diluted	$	0.17		$	0.20

Weighted average common shares – basic		38,631			31,905
Weighted average common shares – diluted		39,079			32,211

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED MAY 28, 2011 AND MAY 29, 2010

(unaudited)

(in thousands)


	May 28, 2011			May 29, 2010
OPERATING ACTIVITIES:
Net income	$	6,529		$	6,419
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Stock compensation expense		677			1,271
Gain on sale of securities		—			(6	)
Depreciation		1,582			1,961
Loss (gain) on disposition of fixed assets		16			(88	)
Changes in operating assets and liabilities:
Restricted cash		—			121
Trade accounts receivable		1,186			(10,318	)
Inventories		(19,522	)		(3,463	)
Prepaid expenses and other assets		(934	)		(246	)
Trade accounts payable		1,847			4,645
Accrued expenses		(1,169	)		(54	)
Customer deposits		342			210
Deferred profit		1,404			111

Net cash (used in) provided by operating activities		(8,042	)		563


INVESTING ACTIVITIES:
Capital expenditures		(2,012	)		(541	)
Proceeds from sales of property, plant and equipment		—			88
Decrease in restricted cash		—			375
Sales of marketable securities		1,705			100

Net cash (used in) provided by investing activities		(307	)		22


FINANCING ACTIVITIES:
Net proceeds from issuance of common stock		436			383

Net cash provided by financing activities		436			383


Effect of exchange rate changes on cash and cash equivalents		788			(376	)


(Decrease) increase in cash and cash equivalents		(7,125	)		592

Cash and cash equivalents at beginning of period		34,365			6,760


Cash and cash equivalents at end of period	$	27,240		$	7,352

See accompanying notes to condensed consolidated financial statements.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(1)

Description of Business and Summary of Significant Accounting Policies

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

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

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared by the Company without audit and reflect all adjustments (consisting only of normal and recurring adjustments, except as disclosed in the notes) which are, in the opinion of management, necessary to present a fair statement of the results for the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 28, 2010, previously filed with the Securities Exchange Commission (“SEC”). The Company’s fiscal year ends on the last Saturday in August and is comprised of 52 or 53 weeks.

The Company determined that certain expenses were understated as a result of intercompany transactions being recorded improperly. The error was discovered prior to filing the first quarter fiscal 2011 Form 10-Q and was thought to be limited in nature. During the second quarter of fiscal 2011, additional analysis was performed. The Company corrected the error to properly present its condensed consolidated financial statements as of and for the three and six months ended February 26, 2011 in accordance with generally accepted accounting principles. The Company adjusted beginning accumulated deficit by an immaterial amount of $778,000 to reflect the correction of the cumulative understatement of expenses for periods through August 30, 2008. The Company corrected the remaining understatement of $341,000 related to the fiscal year 2010 within the three months ended November 27, 2010 and $222,000 related to the fiscal year 2009 within the three months ended February 26, 2011.

As a result of recording the correcting adjustment for the cumulative understatement of expenses for periods through August 30, 2008, the condensed consolidated balance sheet as presented for August 28, 2010 was adjusted. The Company increased accumulated deficit by $778,000 to $165.3 million from $164.6 million. The Company decreased accumulated other comprehensive loss from $1.6 million to $0.9 million.

As a result of recording the correcting adjustment for the cumulative understatement of expenses for periods subsequent to August 30, 2008, the condensed consolidated statement of operations presented for the nine months ended May 28, 2011 was adjusted. Net income for the nine months ended May 28, 2011 was reduced by $563,000. The correction reduced diluted earnings per share by $0.01 to $0.17 for the nine months ended May 28, 2011.

The Company has concluded that the impact of this error is not material to any one period within its previously issued financial statements. The Company determined that reflecting the cumulative correction within the financial statements as an immaterial revision to beginning accumulated deficit and as an adjustment to the condensed

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

consolidated statements of operations for the nine months ended May 28, 2011 is also not material. The Company will reflect the revision to its beginning accumulated deficit for previously issued financial statements in its prospective filings with the SEC.

Use of Estimates

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

(2)

Inventories, Net

Inventories are valued at the lower of cost or market, determined by the first-in, first-out method, or net realizable value. The Company records provisions for inventory shrinkage and for potentially excess, obsolete and slow moving inventory. The amounts of these provisions are based upon historical loss trends, inventory levels, physical inventory and cycle count adjustments, expected product lives, forecasted sales demand and recoverability. Inventories, net are summarized as follows (in thousands):


	May 28, 2011		August 28, 2010

Finished products, including evaluation systems	$	6,402	$	4,238
Work-in-process		21,088		9,453
Raw materials		18,177		12,454

	$	45,667	$	26,145

(3)

Accrued Expenses

Accrued expenses are summarized as follows (in thousands):


	May 28, 2011		August 28, 2010

Salaries and benefits	$	1,753	$	1,028
Discretionary compensation and bonus		687		2,964
Vacation		1,162		1,055
Product warranty		1,229		1,127
Other		2,033		1,846

	$	6,864	$	8,020

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(4)

Comprehensive Income

Other comprehensive income pertains to revenues, expenses, gains and losses that are not included in the net income but rather are recorded directly in stockholders’ equity. The components of comprehensive income are summarized as follows (in thousands):


	Quarters Ended					Nine Months Ended
	May 28, 2011		May 29, 2010			May 28, 2011		May 29, 2010

Net income	$	4,111	$	5,864		$	6,529	$	6,419
Foreign currency translation		61		(121	)		788		(376	)

Comprehensive income	$	4,172	$	5,743		$	7,317	$	6,043

(5)

Stock-Based Compensation

Stock-based compensation expense for stock options granted or vested under the Company’s stock incentive plans and employees stock purchase plan (“ESPP”) was reflected in the condensed consolidated statements of operations for the third quarter and first nine months of each of fiscal 2011 and 2010 as follows (in thousands):


	Quarters Ended				Nine Months Ended
	May 28, 2011		May 29, 2010		May 28, 2011		May 29, 2010

Cost of sales	$	34	$	16	$	85	$	117
Selling, general and administrative		173		82		427		587
Research and development		67		46		165		567

	$	274	$	144	$	677	$	1,271

The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model. The Company uses historical data to estimate the expected price volatility, the expected option life and the expected forfeiture rate. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The Company has not made any dividend payments nor does it expect to pay dividends in the foreseeable future. The following assumptions were used to estimate the fair value of options granted during the first nine months of fiscal 2011 and fiscal 2010 using the Black-Scholes option-pricing model:


	Nine Months Ended
	May 28, 2011			May 29, 2010
Stock options:
Volatility		80.4	%		79.9	%
Risk-free interest rate		2.0	%		2.4	%
Expected option life		5.5			5.4
Stock dividend yield		—			—

ESPP:
Volatility		80.4	%		79.9	%
Risk-free interest rate		0.2	%		0.2	%
Expected option life		0.5			0.5
Stock dividend yield		—			—

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

There were no stock options granted under the Company’s option plan or under the ESPP in the third quarter of fiscal 2011 or fiscal 2010.

A summary of option activity for the first nine months of fiscal 2011 is as follows (in thousands, except price per share and contractual term):


	Number of Shares			Weighted- average Exercise Price Per Share		Weighted- average Remaining Contractual Term		Aggregate Intrinsic Value

Outstanding as of August 28, 2010		3,146		$	5.02
Options granted		404			4.62
Options forfeited		—			—
Options expired		(301	)		8.36
Options exercised		(128	)		1.92


Outstanding as of May 28, 2011		3,121		$	4.77		5.3	$	3,194


Exercisable as of May 28, 2011		2,309		$	5.22		4.0	$	2,111

The intrinsic value of options exercised during the third quarter of fiscal 2011 was $77,000 and during the first nine months of fiscal 2011 was $328,000.

A summary of the status of the Company’s unvested options as of May 28, 2011 is as follows (in thousands, except fair value amounts):


	Number of Shares			Weighted-average Grant-Date Fair Value

Unvested at August 28, 2010		730		$	1.55
Options granted		404			3.11
Options forfeited		—			—
Options vested		(322	)		1.55


Unvested at May 28, 2011		812		$	2.35

As of May 28, 2011, there was $1,674,000 of total unrecognized compensation cost related to unvested share-based compensation granted under our plans. That cost is expected to be recognized over a weighted-average period of 1.2 years. The total fair value of option shares vested was $274,000 during the third quarter of fiscal 2011, $677,000 during the first nine months of fiscal 2011, $144,000 during the third quarter of fiscal 2010, and $1,271,000 during the first nine months of fiscal 2010.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(6)

Product Warranty

Warranty provisions and claims for the quarters and nine months ended May 28, 2011 and May 29, 2010 were as follows (in thousands):


	Quarters Ended						Nine Months Ended
	May 28, 2011			May 29, 2010			May 28, 2011			May 29, 2010

Beginning balance – warranty accrual	$	1,208		$	1,152		$	1,127		$	1,702
Warranty provisions		268			153			787			499
Warranty claims		(247	)		(261	)		(905	)		(547	)
Change in estimates		—			—			220			(610	)

Ending balance – warranty accrual	$	1,229		$	1,044		$	1,229		$	1,044

(7)

Marketable Securities and Fair Value Measurements

During the first nine months of fiscal 2011, the Company sold $1.8 million par value of auction rate securities (“ARS”) for the book value of $1.7 million.

The Company accounts for its marketable securities as available-for-sale and reports them at fair market value. As of May 28, 2011, the Company had investments in ARS reported at a fair value of $1.9 million after reflecting a $0.1 million other-than-temporary impairment against $2.0 million par value. The other-than-temporary impairment was recorded in fiscal 2008. The Company valued the majority of its ARS using a mark-to-model approach that relies on discounted cash flows, market data and inputs derived from similar instruments. This model takes into account, among other variables, the base interest rate, credit spreads, downgrade risks and default/recovery risk, the estimated time required to work out the disruption in the traditional auction process and its effect on liquidity, and the effects of insurance and other credit enhancements.

The ARS held by the Company are marketable securities with long-term stated maturities for which the interest rates are reset every 28 days through an auction process and at the end of each reset period, investors can sell or continue to hold the securities at par. Due to the liquidity issues experienced in global credit and capital markets, the ARS held by the Company have experienced multiple failed auctions, beginning on February 19, 2008, as the amount of securities submitted for sale has exceeded the amount of purchase orders. During the second quarter of fiscal 2008, the Company reclassified $8.5 million of ARS from current marketable securities to long-term marketable securities on the consolidated balance sheet due to difficulties encountered at auction and the conditions in the general debt markets creating uncertainty as to when successful auctions may be reestablished.

The remaining $2.0 million par value ARS held by the Company as of May 28, 2011 are backed by student loans and are collateralized, insured and guaranteed by the United States Federal Department of Education and are classified as long-term. All of the ARS held by the Company continue to carry investment grade ratings and have not experienced any payment defaults. ARS that did not successfully auction, reset to the maximum interest rate as prescribed in the underlying indenture and all of the Company’s holdings continue to be current with their interest payments. If uncertainties in the credit and capital markets continue, these markets deteriorate further or any ARS the Company holds are downgraded by the rating agencies, the Company may be required to recognize additional impairment charges.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The Company categorizes its assets and liabilities into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. The three levels are defined as follows:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company valued its cash and cash equivalents and restricted cash based on level 1 inputs.

The Company valued its ARS based on level 3 inputs in which values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These level 3 inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the ARS.

The fair value measurements as of May 28, 2011 of cash and cash equivalents, restricted cash and marketable securities are summarized below (in thousands):


	Fair Value		Level 1		Level 2		Level 3
Cash and cash equivalents	$	27,240	$	27,240		—		—
Restricted cash		322		322		—		—
Marketable securities		1,907		—		—	$	1,907

The fair value measurements as of August 28, 2010 of cash and cash equivalents, restricted cash and marketable securities are summarized below (in thousands):


	Fair Value		Level 1		Level 2		Level 3
Cash and cash equivalents	$	34,365	$	34,365		—		—
Restricted cash		322		322		—		—
Marketable securities		3,612		—		—	$	3,612

(8)

Income Taxes

As of May 28, 2011 and August 28, 2010, the Company had $446,000 and $410,000, respectively, of liabilities recorded related to unrecognized tax benefits. Included in the liability balance as of May 28, 2011 and as of August 28, 2010 are approximately $409,000 and $360,000, respectively, of unrecognized tax benefits that, if recognized, will affect the Company’s effective tax rate. Accrued interest and penalties on these unrecognized tax benefits as of May 28, 2011 and August 28, 2010 were $37,000 and $50,000, respectively. The Company recognizes potential interest and penalties related to income tax positions, if any, as a component of provision for income taxes on the consolidated statements of operations. The Company does not anticipate that the total amount of unrecognized tax benefits will significantly change during the next twelve months.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of numerous state and foreign jurisdictions. The Company is subject to U.S. federal tax, state tax and foreign tax examinations by tax authorities for fiscal years after 2003. Income tax examinations that the Company may be subject to for the various state and foreign taxing authorities vary by jurisdiction.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The Company recorded an income tax expense of $6,000 in the third quarter fiscal 2011 and an income tax benefit of $1,000 for the first nine months of fiscal 2011 related primarily to foreign taxes and a refundable Minnesota research and development credit. The Company recorded an income tax expense of $90,000 in the third quarter fiscal 2010 and an income tax expense of $100,000 for the first nine months fiscal 2010 related primarily to foreign taxes.

(9)

Contingencies

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

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

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

In October 2009, the Company entered into a settlement agreement with the Office of Export Enforcement for $450,000. The Company paid $5,000 per month for ten months beginning in November 2009. The remaining $400,000 owed under the settlement was suspended for 12 months. The 12 month suspension period expired October 29, 2010. The Company believes it has maintained compliance with all export laws during the suspension period and does not anticipate any additional payments.

(10)

Share Repurchase Plan

In October 2008, the Company authorized the repurchase of up to $3 million of the Company’s common stock to be effected from time to time in transactions in the public markets or in private purchases. The timing and extent of any repurchases will depend upon market conditions, the trading price of the Company’s shares and other factors, subject to the restrictions relating to volume, price and timing of share repurchases under applicable law. The repurchase program may be modified, suspended or terminated at any time by the Company without notice. The Company did not repurchase any of its common stock during fiscal 2010 or the first nine months of fiscal 2011.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(11)

Stock Offering

The Company filed a shelf registration statement with the SEC on March 30, 2010 to register an indeterminate number of shares of common stock, preferred stock, warrants and units, the aggregate initial offering price of which is not to exceed $50 million. On June 14, 2010, the Company closed on a public offering of 6.2 million shares of its common stock at a public offering price of $3.05 per share. Net proceeds from the sale of the shares, after underwriter discounts and commissions and other offering expenses, were approximately $17.6 million. Following the June 2010 stock offering, the Company has registered under its shelf registration statement an indeterminate number of shares of common stock, preferred stock, warrants and units with an aggregate initial offering price not to exceed $31 million.

(12)

Other Sales Information

Geographic Information

International sales were approximately 62% of total sales in the third quarter of fiscal 2011, approximately 63% of total sales in the third quarter of fiscal 2010, 57% of total sales in the first nine months of fiscal 2011 and 56% of total sales in the first nine months of fiscal 2010. The basis for determining sales by geographic region is the location that the product is shipped to. Included in these percentages and the table below are sales to related parties. Sales by geographic area are summarized as follows (in thousands):


	Quarters Ended				Nine Months Ended
	May 28, 2011		May 29, 2010		May 28, 2011		May 29, 2010
Asia	$	10,016	$	14,852	$	20,051	$	27,400
Europe		5,781		3,118		18,123		7,626
Other		33		1		55		4

Total International		15,830		17,971		38,229		35,030
Domestic		9,768		10,682		29,002		27,165

	$	25,598	$	28,653	$	67,231	$	62,195

South Korea accounted for 19% of total sales in the third quarter of fiscal 2011, 41% of total sales in the third quarter of fiscal 2010, 14% of total sales in the first nine months of fiscal 2011 and 33% of total sales in the first nine months of fiscal 2010.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Customer Information

The following summarizes significant customers comprising 10% or more of the Company’s trade accounts receivable as of May 28, 2011 and August 28, 2010 and 10% or more of sales for the third quarters and first nine months of fiscal 2011 and 2010, which includes sales through related parties to end-users:


	% of Trade Accounts Receivable as of						% of Sales for the Fiscal Quarter Ended						% of Sales for the First Nine Months Ended
	May 28, 2011			August 28, 2010			May 28, 2011			May 29, 2010			May 28, 2011			May 29, 2010
Customer A		14	%		*			35	%		44	%		37	%		43	%
Customer B		*			17	%		*			*			12	%		*
Customer C		*			14	%		*			16	%		*			*
Customer D		13	%		10	%		*			*			*			*
Customer E		12	%		*			*			*			*			*
Customer F		30	%		19	%		*			*			*			*
Customer G		*			11	%		*			*			*			*

*	Trade accounts receivable from or sales to respective customer were less than 10% as of the end of or during the fiscal period.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

ITEM 2.

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

The information in this report, except for the historical information, contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and is subject to the safe harbor created by that statute. Typically, we identify forward-looking statements by use of an asterisk “*.” In some cases, you can identify forward-looking statements by terminology such as “expects,” “anticipates,” “intends,” “may,” “should,” “plans,” “believes,” “seeks,” “estimates,” “could,” “would,” or the negative of such terms or other comparable terminology. These statements are subject to various risks and uncertainties, both known and unknown. Factors that could cause actual results to differ include, but are not limited to, changes in industry conditions; order delays or cancellations; general economic conditions; changes in customer capacity requirements and demand for microelectronics; the extent of demand for our products and our ability to meet demand; global trade policies; worldwide economic and political stability; our successful execution of internal performance plans; the cyclical nature of our business; volatility of the market for certain products; performance issues with key suppliers and subcontractors; the level of new orders; the timing and success of current and future product and process development programs; the success of our direct distribution organization; legal proceedings; the potential impairment of long-lived assets; and the potential adverse financial impacts resulting from declines in the fair value and liquidity of investments we presently hold; the impact of natural disasters on parts and consumables supply and demand for products; as well as other factors listed from time to time in our SEC reports including, but not limited to, the Risk Factors set forth in our Form 10-K for the fiscal year ended August 28, 2010 and Item 1A herein. Readers also are cautioned not to place undue reliance on these forward-looking statements as actual results could differ materially. We undertake no duty to update any of the forward-looking statements after the date of this report.

The Gartner Reports described in this document (the “Gartner Report”) represent data, research opinions or viewpoints published, as part of a syndicated subscription service, by Gartner, Inc. (“Gartner”), and are not representations of fact. Each Gartner Report speaks as of its original publication date (and not as of the date of this document) and the opinions expressed in the Gartner Reports are subject to change without notice.

This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this report.

Industry

In June, Gartner decreased its calendar year 2011 revenue forecasts for the semiconductor and equipment industries from those made in March of 2011. As of June 2011, Gartner forecasted that semiconductor revenue would grow 5.1% to $315 billion in calendar 2011 as opposed to the 6.2% growth to $319 billion forecasted in March 2011. The calendar 2011 year-over-year increase is expected to be led by NAND flash growth of 28%. However, Gartner is forecasting a 12% decline in DRAM revenues for the same period, reflective of a significant decline in chip average selling prices offset by strong bit unit growth .

Industry analysts expect demand for smart cell phones, media tablets and automotive electronics to be key contributors to the calendar 2011 semiconductor revenue growth. Recently, announcements of declining device demand have led to a more cautious forecast for several of the foundry producers.

In June 2011, Gartner forecasted that wafer fabrication equipment spending is expected to grow approximately 11.7% in calendar 2011 as opposed to 12.4% growth forecasted in March 2011. This forecast is being made despite the well published expansion delays at certain device producers.

Over the past 90 days, both semiconductor and equipment producers have become more cautious with respect to the outlook for the remainder of calendar 2011. Sourcing issues from Japan, excess supply chain inventory and macroeconomic factors have all contributed to the near-term industry uncertainty.

Application of Critical Accounting Policies and Estimates

In accordance with SEC guidance, those material accounting policies that we believe are the most critical to an investor’s understanding of our financial results and condition and require complex management judgment are discussed below.

Our critical accounting policies and estimates are as follows:

•

revenue recognition;

•

valuation of long-lived assets;

•

estimation of valuation allowances and accrued liabilities, specifically product warranty, inventory provisions and allowance for doubtful accounts;

•

stock-based compensation; and

•

income taxes.

Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectibility is reasonably assured. If our equipment sales involve sales to our existing customers who have previously accepted the same type(s) of equipment with the same type(s) of specifications, we account for the product sales as a multiple element arrangement. Revenue from multiple element arrangements is allocated among the separate accounting units based on the relative selling price of each deliverable. We recognize the equipment revenue upon shipment and transfer of title. The equipment revenue is determined based on the estimated selling price which is determined by management’s judgment. The other multiple elements include installation, service contracts and training. Equipment installation revenue is determined based on estimated service person hours to complete installation and quoted service labor rates and is recognized when the installation has been completed and the equipment has been accepted by the customer. Service contract revenue is determined based on estimated service person hours to complete the service and quoted service labor rates and is recognized over the contract period. Training revenue is determined based on quoted training class prices and is recognized when the customers complete the training classes or when a customer-specific training period has expired. The quoted service labor rates and training class prices are rates actually charged and billed to our customers.

All other product sales with customer-specific acceptance provisions are recognized upon customer acceptance. Future revenues may be negatively impacted if we are unable to meet customer-specific acceptance criteria. Revenue related to spare part sales is recognized upon shipment or delivery based on the trade terms. Revenues related to maintenance and service contracts are recognized ratably over the duration of such contracts.

The timing and amount of revenue recognized depends on whether revenue is recognized upon shipment versus acceptance. For revenue recognized upon acceptance, it is dependent upon when customer-specific criteria are met.

We collect various sales and value-added taxes on certain product and service sales. These product and service sales are accounted for on a net basis.

Impairment of Long-Lived Assets

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the undiscounted future net cash flow the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. If estimated fair value is less than the book value, the asset is written down to the estimated fair value and an impairment loss is recognized.

Product Warranty Estimation

We record a liability for warranty claims at the time of sale. The amount of the liability is based on the trend in the historical ratio of claims to sales, releases of new products and other factors. The warranty periods for new equipment manufactured by us typically range from six months to two years. Special warranty reserves are also accrued for major rework campaigns. Although management believes the likelihood to be relatively low, claims experience could be materially different from actual results because of the introduction of new, more complex products; competition or other external forces; manufacturing changes that could impact product quality; or as yet unrecognized defects in products sold.

Inventory Provisions Estimation

We record provisions for inventory shrinkage and for potentially excess, obsolete and slow moving inventory. The amounts of these provisions are based upon historical loss trends, inventory levels, physical inventory and cycle count adjustments, expected product lives, forecasted sales demand and recoverability. Results could be materially different if demand for our products decreased because of economic or competitive conditions, length of the industry downturn, or if products become obsolete because of technical advancements in the industry or by us. In the first nine months of fiscal 2011 we recorded approximately $1.7 million and in the first nine months of fiscal 2010 we recorded approximately $1.5 million of additional inventory provisions associated primarily with engineering design changes.

Allowance for Doubtful Accounts Estimation

Management must estimate the uncollectibility of our accounts receivable. The most significant risk is a sudden unexpected deterioration in financial condition of a significant customer who is not considered in the allowance. Management specifically analyzes accounts receivable and analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Results could be materially impacted if the financial condition of a significant customer deteriorated and related accounts receivable are deemed uncollectible. Accounts receivable are determined to be past due based on payment terms and are written off after management determines that they are uncollectible.

Stock-Based Compensation

We utilize the Black-Scholes option-pricing model to estimate fair value of each award on the date of grant. The Black-Scholes model requires the input of certain assumptions that involve management judgment. Key assumptions that affect the calculation of fair value include the expected life of stock-based awards and our stock price volatility. Additionally, we expense only those shares expected to vest. The assumptions used in calculating the fair value of stock-based awards and the forfeiture rate of such awards reflect management’s best estimates. However, circumstances may change and additional data may become available over time, which could result in changes to these assumptions that materially impact the fair value determination of future awards or their estimated rate of forfeiture.

Income Taxes

Our effective income tax rate is based on income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. We have established valuation allowances for all operating losses to reflect the uncertainty of our ability to fully utilize these benefits given the limited carryforward periods permitted by the various jurisdictions. The evaluation of the realizability of our net operating losses requires the use of considerable management judgment to estimate the future taxable income for the various jurisdictions, for which the ultimate amounts and timing of such estimates may differ. The valuation allowance can also be impacted by changes in the tax regulations.

Significant judgment is required in determining unrecognized tax benefits. We have established accruals for unrecognized tax benefits using management’s best judgment and adjust these accruals as warranted by changing facts and circumstances. A change in our accruals in any given period could have a significant impact on our results of operations for that period. The accrual for unrecognized benefits increased by $37,000 for the first nine months of fiscal 2011 and increased by $55,000 for the nine months of fiscal 2010.

THIRD QUARTER AND FIRST NINE MONTHS OF FISCAL 2011 COMPARED TO THIRD QUARTER AND FIRST NINE MONTHS OF FISCAL 2010

The Company

The following table sets forth on a consolidated basis, for the fiscal period indicated, certain income and expense items as a percent of total sales.


	Percent of Sales Quarter Ended						Percent of Sales Nine Months Ended
	May 28, 2011			May 29, 2010			May 28, 2011			May 29, 2010

Sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales		53.6			52.1			55.2			54.4

Gross margin		46.4			47.9			44.8			45.6
Selling, general and administrative		18.3			16.4			21.3			20.6
Research and development		12.3			11.9			13.9			15.1

Operating income		15.8			19.6			9.6			9.9
Other income, net		0.3			1.2			0.1			0.6

Income before income taxes		16.1			20.8			9.7			10.5
Income tax expense		—			0.3			—			0.2

Net income		16.1	%		20.5	%		9.7	%		10.3	%

Sales Revenue and Shipments

Sales revenue decreased to $25.6 million for the third quarter of fiscal 2011 as compared to $28.7 million for the third quarter of fiscal 2010. The decrease in sales revenue related to a decrease in shipments from $28.9 million in the third quarter of fiscal 2010 to $22.9 million in the third quarter of fiscal 2011. This decrease reflects weaker industry conditions during the quarter than anticipated as macro-economic conditions and the repercussions of the Japan earthquake and tsunami impacted several of our customers. Sales revenue increased to $67.2 million for the first nine months of fiscal 2011 as compared to $62.2 million for the first nine months of fiscal 2010. The increase in sales revenue related to an increase in shipments from $62.1 million in the first nine months of fiscal 2010 to $72.0 million in the first nine months of fiscal 2011 associated with improved industry and overall global economic conditions during the first nine months of fiscal 2011.

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

International sales revenues were $15.8 million, representing 62% of total sales, during the third quarter of fiscal 2011 and $18.0 million, representing 63% of total sales, during the third quarter of fiscal 2010. International sales were $38.2 million, representing 57% of total sales, during the first nine months of fiscal 2011 and $35.0 million, representing 56% of total sales, during the first nine months of fiscal 2010.

Gross Margin

Our gross profit margin fluctuates due to a number of factors, including the mix of products sold; initial product placement discounts; utilization of manufacturing capacity; and the competitive pricing environment.

Gross margin as a percentage of sales for the third quarter of fiscal 2011 was 46.4% as compared to 47.9% for the third quarter of fiscal 2010. Gross margin as a percentage of sales for the first nine months of fiscal 2011 was 44.8% as compared to 45.6% for the first nine months of fiscal 2010. The decrease in gross margins for fiscal 2011 periods was due primarily to changes in product mix between the periods. The Company expects gross margins to continue to be impacted by product mix and initial product placements discounts.*

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $4.7 million for the third quarters of fiscal 2011 and 2010. The consistent expense for the third quarter of fiscal 2011 as compared to fiscal 2010 is due to the net impact of higher fiscal 2011 expense associated with an increase in service personnel offset by a decrease associated with a change in discretionary compensation expense from $0.6 million in the third quarter of fiscal 2010 to $31,000 in the third quarter of fiscal 2011. Selling, general and administrative expenses were $14.3 million for the first nine months of fiscal 2011 as compared to $12.8 million for the same period in fiscal 2010. The increase in the first nine months of fiscal 2011 as compared to the fiscal 2010 period in selling, general and administrative expenses related primarily to an increase in service personnel. The increase in the first nine months of fiscal 2011 as compared to the fiscal 2010 period was partially offset by discretionary compensation expense of $0.3 million for the first nine moths of fiscal 2011 compared to $0.6 million in the first nine months of fiscal 2010.

Research and Development Expenses

Research and development expenses were $3.2 million for the third quarter of fiscal 2011 as compared to $3.4 million for the third quarter of fiscal 2010. The decrease in the third quarter of fiscal 2011 as compared to the fiscal 2010 period related primarily to a discretionary incentive compensation expense of $12,000 in the third quarter of fiscal 2011, compared to $0.4 million in the third quarter of fiscal 2010. Research and development expenses were $9.3 million for the first nine months of fiscal 2011 as compared to $9.4 million for the same period in fiscal 2010. The decrease in the first nine months of fiscal 2011 as compared to the fiscal 2010 period related primarily to the discretionary compensation expense of $0.1 million for the first nine months of fiscal 2011 compared to $0.4 million in the first nine months of fiscal 2010 and higher non-cash stock compensation expense of $567,000 in the first nine months of fiscal 2010 as compared to $165,000 in the first nine months of fiscal 2011. The higher non-cash stock compensation expense in the fiscal 2010 period was due to vesting under our employees stock purchase plan and the increase in our stock price. The decreases were partially offset by an increase in engineering personnel in fiscal 2011. The majority of our research and development resources are focused on broadening the applications capabilities of, and supporting demonstrations and evaluations for our products as well as product cost reduction efforts.

Income Taxes

We recorded an income tax expense of $6,000 in the third quarter fiscal 2011 and an income tax benefit of $1,000 for the first nine months fiscal 2011 related primarily to foreign taxes and a refundable Minnesota research and development credit. We recorded an income tax expense of $90,000 in the third quarter fiscal 2010 and an income tax expense of $100,000 for the first nine months fiscal 2010 related primarily to foreign taxes.

Our deferred tax assets on the balance sheet as of May 28, 2011 have been fully reserved with a valuation allowance. We will continue to evaluate the need to make adjustments to our valuation allowance based on anticipated future operating performance.*

We have net operating loss carryforwards for federal income tax purposes of approximately $165.1 million, which will begin to expire in fiscal year 2019 through fiscal 2030 if not utilized. Of this amount, approximately $15.0 million is subject to Internal Revenue Code Section 382 limitations on utilization. This limitation is approximately $1.4 million per year.

Net Income

Net income was $4.1 million in the third quarter of fiscal 2011, as compared to a net income of $5.9 million in the third quarter of fiscal 2010. Net income was $6.5 million for the first nine months of fiscal 2011, as compared to a net income of $6.4 million for the first nine months of fiscal 2010.

Liquidity and Capital Resources

Cash and cash equivalents, restricted cash and long-term marketable securities were approximately $29.5 million as of May 28, 2011, a decrease of $8.8 million from the end of fiscal 2010. The decrease related primarily to $8.0 million of cash used in operations due to an increase in inventory associated with increased orders and the placement of tools at customer sites for evaluation.

As of May 28, 2011, we had investments in ARS reported at a fair value of $1.9 million after reflecting a $0.1 million other than temporary impairment against $2.0 million par value. The other than temporary impairment was recorded in fiscal 2008. The ARS we hold are marketable securities with long-term stated maturities for which the interest rates are reset every 28 days through an auction process. During the first nine months of fiscal 2011, we sold $1.8 million par value of ARS for the book value of $1.7 million. These ARS may not provide the liquidity to us as we need it, and it could take until the final maturity of the underlying notes (from 32 to 33 years) to realize our investments’ recorded value. Currently, there is a very limited market for any of these securities and any liquidation at this time, if possible, would likely be at a significant discount.

Accounts receivable decreased by $1.2 million from $18.9 million at the end of fiscal 2010 to $17.7 million as of May 28, 2011. The decrease in accounts receivable related primarily to a decrease in shipments from $29.1 million in the fourth quarter of fiscal 2010 to $22.9 million in the third quarter of fiscal 2011. Accounts receivable will fluctuate from quarter to quarter, depending on individual customers’ timing of shipment dates and payment terms. In certain situations, extended payment terms may be granted to customers.

Inventory increased to $45.7 million at May 28, 2011 as compared to $26.1 million at the end of fiscal 2010. The increase in inventory was due to an increase in all inventory categories primarily associated with the anticipation of ORION^® evaluation acceptance and follow-on orders. Inventory provisions were $8.0 million at May 28, 2011 as compared to provisions of $9.4 million at the end of fiscal 2010. The decrease related primarily to scrapping of $3.1 million of obsolete inventory, partially offset by $1.7 million of additional reserves.

Trade accounts payable increased to $10.2 million as of May 28, 2011 as compared to $8.4 million at the end of fiscal 2010. The increase in trade accounts payable related primarily to the timing of inventory receipts and vendor payments.

As of May 28, 2011, our current ratio of current assets to current liabilities was 4.4 to 1.0 and working capital was $74.0 million.

The following table provides aggregate information about our contractual payment obligations as of May 28, 2011 and the periods in which payments are due (in thousands):


	Payments due by period
	Total		Less than 1 Year		1-3 years		3-5 years		More than 5 years
Contractual Obligations:

Operating lease obligations	$	469	$	302	$	151	$	16	$	—
Purchase obligations⁽¹⁾		16,157		16,157		—		—		—
Royalty obligations		842		842		—		—		—
Other long-term commitments ⁽²⁾		1,250		125		500		500		125


Total	$	18,718	$	17,426	$	651	$	516	$	125

⁽¹⁾	Purchase obligations include purchase orders entered into in the ordinary course of business.

⁽²⁾	Other long-term commitments represent payments related to minimum royalty payments or discounts granted under a license agreement.

The contractual obligations table does not include $0.4 million of accruals for unrecognized tax benefits, as the timing of payments or reversals is uncertain.

Capital expenditures were approximately $2,012,000 in the first nine months of fiscal 2011 and $541,000 in the first nine months of fiscal 2010.

We filed a shelf registration statement with the SEC on March 30, 2010 to register an indeterminate number of shares of common stock, preferred stock, warrants and units, the aggregate initial offering price of which is not to exceed $50 million. On June 14, 2010, we closed on a public offering of 6.2 million shares of our common stock at a public offering price of $3.05 per share. Net proceeds from the sale of the shares, after underwriter discounts and commissions and other offering expenses, were approximately $17.6 million. Following the June 2010 stock offering, we have registered under the shelf registration statement an indeterminate number of shares of common stock, preferred stock, warrants and units with an aggregate initial offering price not to exceed $31 million.

We believe that with existing cash, cash receipts, cash equivalents, marketable securities and internally generated funds, there will be sufficient funds to meet our currently projected working capital requirements, and to meet other cash requirements through at least fiscal 2012.* We believe that success in our industry requires substantial capital to maintain the flexibility to take advantage of opportunities as they arise. One of our strategic objectives is, as market and business conditions warrant, to consider divestitures, investments or acquisitions of businesses, products or technologies. We may fund such activities with additional equity or debt financing.* The sale of additional equity or debt securities, whether to maintain flexibility or to meet strategic objectives, could result in additional dilution to our shareholders.*

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our cash flows and earnings are subject to fluctuations in foreign exchange rates due to investments in our foreign-based affiliates. As of May 28, 2011, our investments included a 100% interest in our sales and service offices located in Europe and Asia and a 20% interest in Apprecia Technology, Inc., which operates as our distributor in Japan. We denominate the majority of our sales outside of the U.S. in U.S. dollars.

We have direct sales, service and applications support and logistics responsibilities for our products in Europe and the Asia Pacific region and incur labor, service and other expenses in foreign currencies. As a result, we may be exposed to fluctuations in foreign exchange rate risks. As of May 28, 2011, we had not entered into any hedging activities and our foreign currency transaction gains and losses for the third quarter and first nine months of fiscal 2011 were insignificant. We are currently evaluating various hedging activities and other options to minimize these risks.

We do not have significant exposure to changing interest rates as we currently have no long-term debt. We do not undertake any specific actions to cover our exposure to interest rate risk and we are not party to any interest rate risk management transactions. The annual impact on loss before income taxes of a 1% change in short-term interest rates would be approximately $295,000 based on our cash and cash equivalents, restricted cash and long-term marketable securities balances as of May 28, 2011.

As of May 28, 2011, our investment portfolio included ARS reported at a fair value of $1.9 million after reflecting a $0.1 million other than temporary impairment against $2.0 million par value. The interest rates of our ARS are reset every 28 days through an auction process and at the end of each reset period.

ITEM 4.

CONTROLS AND PROCEDURES

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

PART II. OTHER INFORMATION

ITEM 1.

Legal Proceedings

We are not subject to any material pending legal proceedings.

ITEM 1.A.

Risk Factors

There have not been any material changes from the risk factors previously disclosed in our Form 10-K for the fiscal year ended August 28, 2010, except as set forth below.

We cannot predict the impact that recent events in Japan may have on our business and operations in the future.

On March 11, 2011, Japan experienced an 8.9 magnitude earthquake, triggering a tsunami that lead to widespread damage and business interruption. The repercussions of the Japan earthquake and tsunami impacted several of our customers resulting in product order delays and requests for delays of system shipments from several customers in the third quarter of fiscal 2011. We cannot predict what, if any, additional impact the interruptions in Japan may have on our operations in the future.

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

ITEM 3.

Defaults upon Senior Securities

None

ITEM 5.

Other Information

None

ITEM 6.

Exhibits

(a) Exhibits


3.1		Restated Articles of Incorporation of the Company. (1)

3.2		Restated By-Laws. (1)

3.3		Articles of Amendment of Restated Articles of Incorporation. (1)

10.1		Incentive Compensation Plan. (2)

31.1		Certification by Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (filed herewith)

31.2		Certification by Principal Financial and Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (filed herewith)

32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (filed herewith)

(1)	Filed as an Exhibit to the Company’s Registration Statement on Form S-3 filed with the SEC on March 30, 2010, SEC File No. 333-165785, and incorporated by reference.

(2)	Filed as an Exhibit to the Company’s Report on Form 10-Q for the quarter ended February 26, 2011, SEC File No. 0-17276 and incorporated by reference.

FSI INTERNATIONAL, INC. AND SUBSIDIARIES

SIGNATURE

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


		FSI INTERNATIONAL, INC.
		[Registrant]

By:		/s/ Patricia M. Hollister
		Patricia M. Hollister
		Chief Financial Officer on behalf of the Registrant and as Principal Financial and Accounting Officer

DATE: June 30, 2011

INDEX TO EXHIBITS


Exhibit	Description	Method of Filing

3.1	Restated Articles of Incorporation of the Company. (1)	Incorporated by reference.

3.2	Restated By-Laws. (1)	Incorporated by reference.

3.3	Articles of Amendment of Restated Articles of Incorporation. (1)	Incorporated by reference.

10.1	Incentive Compensation Plan. (2)	Incorporated by reference.

31.1	Certification by Principal Executive Officer Pursuant to section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

31.2	Certification by Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(1)	Filed as an Exhibit to the Company’s Registration Statement on Form S-3 filed with the SEC on March 30, 2010, SEC File No. 333-165785, and incorporated by reference.

(2)	Filed as an Exhibit to the Company’s Report on Form 10-Q for the quarter ended February 26, 2011, SEC File No. 0-17276 and incorporated by reference.

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