Overview:

     Aetrium designs, manufactures and markets a variety of electromechanical equipment used by the semiconductor industry to handle and test semiconductor and passive electronic devices, such as integrated circuits, or ICs, and discrete electronic components.

     The semiconductor capital equipment industry is often described as a cyclical growth industry characterized by a long-term growth trend occasionally interrupted by periods of contraction and significant declines in revenue. General industry conditions and the demand for Aetrium’s products can fluctuate significantly from period to period as a result of numerous factors, including but not limited to changes in U.S. and worldwide economic conditions, supply and demand for ICs and discrete electronic components, changes in semiconductor manufacturing capacity, advancements in industry technologies and competitive factors. For these and other reasons, our operating results for 2000, 2001 and 2002 may not be indicative of future operating results.

     Aetrium’s business was impacted by changes in industry and economic conditions throughout the period 2000 to 2002. After a period of contraction in 1998 and early 1999, semiconductor equipment industry conditions generally improved in the second half of 1999 and continued to improve in early 2000. We experienced increased demand for our products in 2000 as semiconductor manufacturers added substantially to their production capacity in response to increased global demand for ICs and discrete electronic components, and our 2000 revenues increased 24% compared with 1999. Towards the end of 2000, the demand for semiconductor equipment decreased sharply as the U.S. and global economies slowed and the demand for ICs and discrete electronic components softened.

     In 2001, excess inventories, excess production capacity and continuing weakness in the U.S. and global economies combined to produce a record-setting downturn in the semiconductor industry. For only the second time in 25 years, fewer ICs and discrete electronic components were shipped than the year before, as unit sales of ICs and discrete electronic components fell by 21%. As a result, semiconductor manufacturers severely curtailed capital spending, and revenues for the test, assembly and packaging, or TAP, segment of the semiconductor equipment industry dropped approximately 63% in 2001 from 2000 levels. Our revenues decreased each quarter in 2001 and our revenues for the year were down 57% compared with 2000.

     Generally weak industry conditions continued into the first quarter of 2002. In the second quarter, many semiconductor manufacturers began to experience stronger demand for integrated circuits and improvements in capacity utilization. However, the anticipated recovery stalled in the second half of the year amid weakening economic conditions, concerns about war and lower consumer demand for products containing ICs and discrete electronic components. As a result, revenues for the TAP segment of the semiconductor industry dropped an additional approximately 23% from 2001 totals, for an aggregate decrease of 71% from 2000 levels, and many industry forecasters are predicting that any meaningful industry recovery will be delayed until the second half of 2003. In 2002, Aetrium’s revenues continued to decline in the first quarter compared to the fourth quarter of 2001 and quarterly revenues remained relatively flat through the remainder of the year. Our 2002 revenues of $12.7 million were down 37% compared with 2001 and down 72% compared with 2000.

17

Table of Contents

Critical Accounting Policies and Estimates:

     Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the critical accounting policies that require the most significant judgments and estimates used in the preparation of our consolidated financial statements are those related to revenue recognition, bad debts, inventories, intangible assets, goodwill, warranty obligations, and income tax accounting.

     Our policy is to recognize revenue on product sales upon shipment if contractual obligations have been substantially met, collection of the proceeds is assessed as being reasonably assured, and title and risk of loss have passed to the customer, which is generally the case for sales of spare parts, accessories, change kits and some equipment and equipment upgrade sales. Some equipment or equipment upgrade sales contracts, however, may include post-shipment obligations and/or contractual terms that can only be satisfied after shipment, such as installation and meeting customer-specified acceptance requirements at the customer’s site. In these cases, revenue is not recognized until such obligations have been completed and there is objective evidence that the applicable contract terms have been met. Due to the high selling price of certain types of equipment, the timing of revenue recognition of a relatively small number of transactions may have a significant impact on our quarterly results.

     We maintain an allowance for doubtful accounts that reflects our estimate of losses that may result from the uncollectibility of accounts receivable. Our allowance for doubtful accounts is based primarily on an analysis of individual accounts for which we have information indicating the customer may not be able to pay amounts owed to us. In these cases, based on the available facts and circumstances, we estimate the amount that will be collected from such customers. We also evaluate the collectibility of our accounts receivable in the aggregate based on factors such as the aging of receivable amounts, customer concentrations, historical experience, and current economic trends and conditions. We adjust our allowance for doubtful accounts when additional information is received that impacts the amount reserved. If circumstances change, our estimates of the recoverability of accounts receivable could be reduced or increased by a material amount. Such a change in estimated recoverability would be accounted for in the period in which the facts that give rise to the change become known. As of December 31, 2002, our allowance for doubtful accounts was $0.3 million.

     We establish valuation reserves on our inventories for estimated excess and obsolete inventory equal to the difference between the cost of inventory and its estimated market value based upon assumptions about future product demand and market conditions. If actual product demand or market conditions are less favorable than those projected by management, additional inventory reserves may be required. As of December 31, 2002, our inventory excess and obsolescence reserve was $4.0 million.

     Effective January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS 142 provides that goodwill is no longer amortized, but rather is reviewed for impairment at the beginning of the fiscal year in which the standard is adopted and at least annually thereafter. SFAS 142 requires a two-step process in the review of goodwill for impairment. In step one we compare the fair value of our single reporting unit ( i.e. , Aetrium) with the net carrying value of our assets, including goodwill. If our fair value is less than our net asset carrying value, we perform the second step of the

18

Table of Contents

impairment test. In step two, we compare the aggregate fair values of our non-goodwill assets and liabilities with the fair value of Aetrium in order to determine the implied fair value of goodwill. At January 1, 2002, we determined that the carrying value of our goodwill exceeded its implied fair value by $6.5 million and recorded a goodwill impairment charge in that amount. At December 31, 2002, we determined that the carrying value of our goodwill exceeded its implied fair value by $0.7 million and recorded a goodwill impairment charge in that amount. As of December 31, 2002, after recording the goodwill impairment charge at that date, we had no remaining goodwill balance.

     We review our identifiable intangible assets and other long-lived assets whenever an event or change in circumstances indicates that the carrying value of an asset may be impaired. If such an event or change in circumstances occurs and potential impairment is indicated because the carrying values exceed the estimated future undiscounted cash flows, we would measure the impairment loss as the amount by which the carrying value of the asset exceeds its fair value. During 2002, as a result of our identified impairment of the carrying value of goodwill, we reviewed our identifiable intangible and other long-lived assets for potential impairment and concluded that the carrying value of these assets was not impaired. As of December 31, 2002, the carrying value of our identifiable intangible assets was $2.6 million.

     We accrue estimated warranty costs in the period that the related revenue is recognized. Our warranty cost estimates and warranty reserve requirements are determined based upon product performance, historical warranty experience, and costs incurred in addressing product performance issues. Should product performance or cost factors differ from our estimates, adjustments to our warranty accrual may be required. As of December 31, 2002, our warranty reserve was $0.4 million.

     Our deferred tax assets are reduced by a valuation allowance when we believe it is more likely than not that some portion or all of the deferred tax assets will not be realized. In the fourth quarter of 2000, in accordance with SFAS No. 109, “Accounting for Income Taxes,” due to then recent operating losses, reduced sales order activity in late 2000, and softening industry conditions in early 2001, we recorded a valuation allowance against our deferred tax assets. If we generate taxable income consistently in future periods, our assessment of our ability to realize these deferred tax assets may change and we may reduce this valuation allowance, which would be reported as an income tax benefit. As of December 31, 2002, our valuation allowance was $25.1 million.

19

Table of Contents

Results of Operations:

     Selected statement of operations items as a percentage of our net sales for 2002, 2001 and 2000 were as follows:

     In December 1999, the Securities and Exchange Commission, or SEC, issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” or SAB101. SAB101 summarizes the SEC’s views in applying generally accepted accounting principles to selected revenue recognition issues, including equipment sales contracts that contain provisions related to installation and customer acceptance.

     Prior to 2000, we generally recognized revenue upon shipment if contractual obligations were substantially complete, post-delivery obligations were inconsequential, and customer acceptance and payment were reasonably assured. In the fourth quarter of 2000, in accordance with SAB101 guidance, we changed our accounting policy such that certain equipment revenue, depending on contract terms and other factors, is recognized subsequent to shipment, generally after installation and customer-specified acceptance processes have been completed. As required, the accounting change was made retroactive to January 1, 2000. The cumulative effect of the accounting change was an after-tax charge of $0.8 million ($.09 per share), which includes revenue of approximately $3.0 million less cost of sales and certain related

20

Table of Contents

expenses such as commissions. Substantially all of the $3.0 million in deferred revenue was recognized in 2000 upon satisfying the new revenue recognition criteria.

     Our net sales decreased to $12.7 million in 2002 compared with $20.0 million in 2001, a decrease of 37%. Quarterly revenues were relatively flat during 2002, ranging from $3.1 to $3.2 million. Equipment sales decreased across all product lines in 2002 as a result of the prolonged downturn in the semiconductor equipment industry that began in late 2000 and continued through 2001 and 2002. Sales of test handlers, representing 51% of total sales in 2002, decreased 39% relative to 2001. Sales of our reliability test equipment decreased 36% in 2002 compared to 2001. Sales of our semiconductor automation products decreased because of a sharp decline in sales of burn-in board loaders as well as a reduction in sales to OEM customers, whose businesses have also been adversely impacted by the industry downturn. Sales of spare parts and change kits increased in 2002 from 2001 levels, reflecting improving capacity utilization for some customers and certain product applications.

     Net sales decreased 57% to $20.0 million in 2001 compared with $46.1 million in 2000. The severe semiconductor industry downturn experienced in 2001 resulted in significant decreases in our revenues for the first three quarters and sequentially flat revenues in the fourth quarter. The decline in revenues occurred across all of our product lines. Sales of our test handlers, representing 53% of total sales in 2001, decreased 55% compared to 2000 as customers experienced significant excess manufacturing capacity for many product applications. Sales of our reliability test equipment decreased also, but increased from 13% in 2000 to 18% in 2001 as a percentage of our revenues as semiconductor manufacturers continued to invest in new equipment to support the increasing use of copper materials in their manufacturing processes. Our semiconductor automation product sales declined as a percentage of our revenues in 2001 both because of the impact of the industry downturn on our OEM customers and because of a decline in sales of burn-in board loaders. Sales of spare parts and change kits in 2001 were unchanged as a percentage of our revenues, and declined in all areas from 2000 levels.

Gross Profit:

     Gross profit, as a percentage of net sales, was 53.3% in 2002 compared with 34.9% in 2001 and 49.2% in 2000. Results for 2001 and 2000 included unusual inventory write-down charges due to lower product demand resulting from the significant industry downturn and certain specific events as described below:

	•		In fourth quarter 2001, we recorded an unusual inventory write-down of $2.7 million. By year-end 2001, the consensus forecast of industry analysts was that the severe semiconductor industry downturn that started in late 2000 had reached an end, but that significant recovery of the semiconductor equipment industry would not occur before the second half of 2002, and that the recovery for our industry would be slow. Previous industry analyst forecasts had suggested that the semiconductor industry downturn would not be as severe or as long. We determined that under the conditions then most recently forecasted, by the time significant capacity requirements emerged for mature IC packages, some of our older products focused on those applications would be superceded by our newer products and those of our competitors. Accordingly, we wrote down the value of our inventories for these older products to their estimated net realizable values based upon a revised expectation of limited future sales of these products.
	•		In 2000, we recorded unusual inventory write-downs totaling $0.9 million. The write-downs were primarily related to inventories for dynamic random access memory, or DRAM, test handler applications, a volatile market segment that we decided not to pursue further. In the second quarter, we recorded an inventory write-down of $0.4 million related to our decision to

21

Table of Contents

			discontinue marketing and manufacturing our oldest DRAM test handler, the model M3200. As a result of this decision, all inventories related to the production of the M3200 were written down to scrap value and were substantially disposed of by December 31, 2000. In the fourth quarter, we recorded an inventory write-down of $0.5 million. This charge was primarily related to our decision to discontinue marketing our DTX thermal test handler product to the DRAM market segment and rather to focus our marketing of the DTX on high power logic semiconductor applications, which required significant product design changes. As a result of this decision, DTX-related inventories were evaluated and written down to estimated net realizable value.
	•		The unusual inventory write-downs in 2001 and 2000 were determined through a detailed analysis of inventories with consideration given to anticipated usage through future equipment and spares sales, and the potential use of common parts in other products.

     In addition to the unusual inventory charges discussed above, we regularly record inventory charges due to the evolving nature of our products. Our products are continually improved and modified to better meet evolving market requirements. These ongoing product improvements and modifications result in parts inventory obsolescence as parts are replaced due to the product changes. To address this recurring obsolescence, we recorded inventory charges of $0.1 million in 2002, $1.0 million in 2001, and $0.8 million in 2000, in addition to the unusual inventory charges discussed above.

     Excluding the unusual charges described above, gross profit of 53.3% of net sales in 2002 would have compared with 48.3% and 51.2% in 2001 and 2000, respectively. Gross margins improved in 2002 despite lower revenue levels primarily due to lower costs resulting from restructuring activities, including the restructuring of North St. Paul, Minnesota operations in December 2001, which resulted in lower costs for all of 2002.

     The gross profit margin decrease in 2001 compared with 2000 was due primarily to significantly lower sales volume, offset in part by reduced overhead expenses resulting from restructuring activities during the year. We significantly reduced our manufacturing overhead expenses in 2001 through workforce reductions and reorganization of our operations at our North St. Paul, Minnesota operations and the consolidation of those operations into a single facility.

Selling, General and Administrative Expenses:

     Selling, general and administrative, or SG&A, expenses were $7.1 million in 2002 compared with $11.2 million in 2001 and $17.5 million in 2000. The decrease in 2002 resulted primarily from a full year of cost savings realized from the restructuring activities in 2001 described below. Commissions expense decreased in 2002 due to lower sales volume and savings realized from the termination of our U.S. independent sales representatives early in the year. In addition, we recorded no goodwill amortization expense in 2002 compared with $0.7 million in 2001 due to the implementation of SFAS No. 142 as explained in Note 5 to our consolidated financial statements. SG&A expenses decreased in 2001 compared with 2000 due to lower commissions expense on significantly lower revenues and due to restructuring activities implemented during the year, including workforce reductions, the closing of our Poway, California facility, the consolidation of our North St. Paul, Minnesota operations into a single facility, and the reorganization of our North St. Paul, Minnesota operations.

Research and Development Expenses:

     Research and development expenses were $2.3 million in 2002 compared with $4.7 million in 2001 and $8.5 million in 2000. The decrease in 2002 research and development expenses reflects

22

Table of Contents

reductions in wages, materials and contract services, including a full year of cost savings realized from the restructuring activities in 2001. The decrease in research and development expenses in 2001 compared with 2000 was primarily attributable to a reduction in engineering personnel, including workforce reductions related to the closing of our Poway, California facility in early 2001, as well as workforce reductions we made during the course of 2001 at our North St. Paul, Minnesota and Dallas, Texas facilities.

Goodwill Impairment Charges:

     Effective January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS 142 provides that goodwill is no longer amortized, but rather is reviewed for impairment at the beginning of the fiscal year in which the standard is adopted and at least annually thereafter. In accordance with SFAS 142, we evaluated our existing goodwill and intangible assets as of January 1, 2002 and determined that certain intangibles did not meet the criteria for recognition apart from goodwill as set forth in SFAS 141, “Business Combinations.” Therefore, the aggregate carrying value of these intangibles as of January 1, 2002 in the amount of $52,000 was reclassified to goodwill. We also reassessed the useful lives of our acquired identifiable intangible assets at January 1, 2002 and determined that no adjustments to the remaining amortization periods were necessary.

     The adoption of SFAS 142 required that we complete a transitional goodwill impairment test as of January 1, 2002 using a two-step process. We completed step one of the impairment test by comparing the fair value of our single reporting unit ( i.e., Aetrium) with the net carrying value of our assets, including goodwill. The fair value of Aetrium was determined based on quoted market prices of our common stock, as adjusted for a control premium. Since the carrying value of our net assets exceeded their fair value, we concluded that there was a potential impairment. Because there was an indication of a potential impairment, we completed step two of the impairment test in order to measure the amount of any impairment loss. In performing the second step of the impairment test, we compared the aggregate fair values of our non-goodwill assets and liabilities with the fair value of Aetrium in order to determine the implied fair value of goodwill. Step two of the impairment test indicated that the carrying value of our goodwill exceeded its implied fair value by $6.5 million. In accordance with SFAS 142, this impairment charge (net of income taxes of $0) was recorded in our consolidated statement of operations as a change in accounting principle effective January 1, 2002.

     Aetrium completed its annual goodwill impairment test at December 31, 2002, again using the prescribed two-step process. We completed step one of the impairment test by comparing the fair value of Aetrium with the net carrying value of our assets, including goodwill. The fair value of Aetrium was determined based on quoted market prices of our common stock, as adjusted for a control premium consistent with that applied in performing our impairment test at January 1, 2002. Since the carrying value of our net assets exceeded their fair value, indicating potential impairment, we completed the second step of the test in order to measure the amount of any impairment loss. In performing the second step of the impairment test, we compared the aggregate fair values of our non-goodwill assets and liabilities with the fair value of Aetrium in order to determine the implied fair value of goodwill. Step two of the impairment test indicated that the carrying value of our goodwill exceeded its implied fair value by $0.7 million. This impairment charge is included in operating expenses in our consolidated statement of operations for the year ended December 31, 2002. We believe that the following were the most significant factors that led to the decrease in the public trading market value of our common stock and the resulting goodwill impairment: the continued weakness of the world economies; the possibility and uncertainty of war with Iraq; the continued depressed average selling prices and excess capacity in the semiconductor industry; the resulting continuation of a record downturn in the semiconductor equipment industry; the impact of these factors on our financial position and the results of our operations;

23

Table of Contents

and the decline in the public trading market value of semiconductor equipment companies in general in 2002.

     The change in the carrying amount of goodwill for the year ended December 31, 2002 was as follows (in thousands):

Unusual Charges:

Fiscal 2001

     During 2001, as Aetrium continued to be impacted by the downturn in the semiconductor equipment industry that began in late 2000, we continued various restructuring activities to improve operating efficiencies and reduce costs. In 2001, we completed the transfer of our operations in Poway, California to North St. Paul, Minnesota, we restructured our operations in Minnesota, we reduced our facility costs through the consolidation of operations, and we significantly reduced our workforce. Unusual charges recorded in 2001 related to these activities were as follows (in thousands):

     During 2001, in response to declining revenue levels throughout the year, we implemented workforce reductions in March, April, June, and December. These workforce reductions included the elimination of 98 positions in manufacturing, sales, administration, and engineering. We recorded charges of $928,000 for severance and related costs associated with these terminations. The charges were recorded in the periods when the restructuring plans were approved by management, severance benefits were determined, and the affected employees were notified. The workforce reductions resulted in quarterly cost savings of approximately $1.3 million.

     In May 2001, we consolidated our North St. Paul, Minnesota operations from two buildings into one and vacated a building that is under lease through February 2006. We recorded facility exit charges

24

Table of Contents

of $606,000 for estimated future non-cancelable lease payments and other facility costs we expected to incur related to the vacated building. Also, in connection with the vacated facility, we recorded a charge of $215,000 for abandoned leaseholds and losses on the sale of certain equipment.

     Aetrium conducted operations in a leased facility in Grand Prairie, Texas until that business was transferred to our Dallas, Texas facility in early 2000. We recorded a facility exit charge in 2000 related to the vacated Grand Prairie facility, for which the lease term ended in June 2003. In late 2001, due to our inability to locate a subtenant and due to softening economic conditions, we recorded an additional facility exit charge of $193,000 to cover the non-cancelable lease payments and other costs we estimated we would incur until a subtenant could be found.

     In 2001, we incurred moving and other transition costs amounting to $261,000 that were related to restructuring our operations. Of this amount, approximately $203,000 was incurred in the first quarter primarily related to the relocation and other final costs associated with the transfer of operations from Poway, California to Minnesota and $58,000 was related to moving expenses incurred in the second quarter when we combined our operations in Minnesota from two buildings into one.

Fiscal 2000

     During 2000, we initiated a number of activities to reduce costs and improve operating efficiencies. These actions included consolidating our two operations in Texas, closing our Lawrence, Massachusetts facility, and restructuring our operations in Poway, California. Unusual charges recorded in 2000 related to these activities were as follows (in thousands):

      Consolidation of Texas Operations.

     During the first quarter of 2000, we consolidated our two operations in Texas. Strategically significant manufacturing and development activities being conducted at our Grand Prairie facility were transferred to our facility in Dallas. The transfer was completed in mid-March 2000 and the Grand Prairie facility was closed in late March 2000.

     Charges related to this restructuring included the following: approximately $565,000 for severance and related costs; $385,000 for facility exit costs, including estimated non-cancelable lease payments and other facility costs we expected to incur during the estimated time needed to find a sub-tenant; $121,000 related to the write-down of abandoned leaseholds and equipment; and $186,000 related to the write-down of impaired intangibles, primarily capitalized trained workforces. The elimination of 56 positions in Texas and reduced facility and other costs resulted in quarterly cost savings of approximately $0.9 million, which reductions were partially offset by increased costs at the Dallas facility.

25

Table of Contents

      Closure of Lawrence, Massachusetts Facility .

     In the first quarter of 2000, we decided to close our Lawrence, Massachusetts facility. Development activities associated with our proprietary conductive thermal technology were transferred to our North St. Paul, Minnesota facility. We sold or licensed certain assets associated with the Lawrence operation, including the environmental test equipment product line. Consideration received for these assets was the transferee’s assumption of certain future obligations related to the transferred product line and royalties on future sales. As indicated below, the transferee of the product line subsequently bought out the royalty contract later in the year. We ceased operations at our Lawrence facility in late March 2000 and the facility was vacated in May 2000.

     Charges related to closing this facility included approximately $844,000 for severance and related costs and $101,000 for facility exit costs, including rent, taxes and other facility expenses we incurred during the six weeks from the time operations ceased until we moved out of the facility. In addition, we recorded charges in the first quarter of $229,000 related to impaired intangibles associated with the transferred product line and $672,000 for losses on the sale of the business assets and abandoned leaseholds. The charge related to the loss on the sale of the business assets was subsequently reduced by $629,000 in the second half of 2000 for cash proceeds we received pursuant to the royalty contract, resulting in a net charge of $43,000. The elimination of 38 positions in Lawrence and reduced facility costs resulted in quarterly cost savings of approximately $0.6 million, which reductions were partially offset by increased costs at our Minnesota facility.

      Poway, California Restructuring.

     In the second quarter of 2000, we announced that we would transfer manufacturing and certain administrative functions at our Poway, California facility to our North St. Paul, Minnesota operation. Certain marketing and engineering activities were to remain in Poway. The restructuring plan included a workforce reduction, vacating a leased 45,000 square-foot building, and transferring the remaining marketing and engineering personnel to a 10,000 square-foot facility nearby. This action resulted in the elimination of 20 positions in manufacturing, engineering, accounting and administration. The lease for the 45,000 square-foot facility was subsequently assigned to a third party.

     In October 2000, we announced our intention to transfer the remaining marketing and engineering operations in Poway to North St. Paul and to close the Poway facility. Prior to December 31, 2000, management approved the restructuring plan that included the elimination of an additional 20 positions in engineering and administration and closing the facility by March 31, 2001. The affected employees were identified and notified of the terminations and related severance benefits prior to December 31, 2000. Some employees were terminated prior to December 31, 2000 with the remaining termination dates scheduled for March 31, 2001 or sooner. We subleased the 10,000 square-foot facility to a third party, effective April 1, 2001.

     Charges related to the Poway restructuring during 2000 included approximately $748,000 for severance and related costs, $472,000 for facility exit costs, and $331,000 related to the write-down of abandoned leaseholds and equipment. The severance costs were related to the elimination of a total of 40 positions. The facility exit costs were related to exiting both facilities and included noncancellable lease payments and other operating costs incurred after vacating as well as costs incurred to sublease the facilities.

     The elimination of 40 positions and reduced facility and other costs associated with the Poway restructuring represented quarterly cost savings of approximately $1.0 million. These cost reductions were partially realized in the second half of 2000 after the second quarter restructuring with the balance of

26

Table of Contents

the estimated savings being realized after the facility closed on March 31, 2001. These cost decreases were partially offset by increases at the North St. Paul, Minnesota facility related to the transfer of operations.

     The following table summarizes severance and facility exit restructuring charges and the associated accrual activity for the three years ended December 31, 2002 (in thousands):

     In May 2002, we negotiated an early buyout and termination of the lease for the vacant facility in Grand Prairie, Texas. The remaining $375,000 accrual for facility exit costs at December 31, 2002 is primarily related to the vacated building in North St. Paul, Minnesota and we estimate the accrual will be utilized at the rate of approximately $25,000 per quarter.

Other Income, Net:

     Other income, net, which consists primarily of interest income from the investment of excess funds, amounted to $91,000 in 2002, compared with $248,000 in 2001 and $429,000 in 2000. The decreases are attributable to lower average cash balances during each year and generally declining interest rates.

Income Taxes:

     In the fourth quarter of 2000, due to then recent operating losses and weakening industry conditions in late 2000 and early 2001, we recorded a valuation allowance against our deferred tax assets and we determined that we would not record any income tax expense or benefit in the future until we are consistently profitable on a quarterly basis. Therefore, no income tax benefit related to current operations was recorded in 2002 and 2001. However, we did record income tax benefits of $0.4 million in the third quarter of 2002 and $0.2 million in the third quarter of 2001 related to refunds of income taxes paid and expensed prior to 2001. Refunds received in 2002 resulted from tax legislation enacted in 2002.

Financial Condition, Liquidity and Capital Resources:

     Cash and cash equivalents decreased by $1.4 million in 2002 to $5.8 million. We used $1.3 million of cash in operating activities in 2002. The major components of cash flows used in operating

27

Table of Contents

activities were a net loss of $9.3 million and decreases in other accrued liabilities of $1.9 million, partially offset by $7.2 million in non-cash goodwill impairment charges, $1.3 million in non-cash depreciation and amortization expense and a decrease in inventories of $1.5 million. The decrease in other accrued liabilities reflects payments of accrued severance and other restructuring costs during the year and a decrease in customer deposits and deferred revenue due primarily to lower sales volumes. Inventories decreased throughout 2002 as a result of deliberate inventory reduction initiatives implemented beginning in 2001.

     Cash and cash equivalents decreased by $2.0 million in 2001 to $7.2 million. We used $1.9 million of cash in operating activities in 2001. The major components of cash flows used in operating activities were a net loss of $10.7 million and decreases in accounts payable of $3.2 million, accrued compensation of $1.0 million, and other accrued liabilities of $1.9 million, partially offset by $2.2 million in non-cash depreciation and amortization expense, write-downs of the carrying value of inventories of $3.7 million, restructuring charges of $1.7 million and a decrease in accounts receivable of $6.5 million. The decreases in accounts payable and accounts receivable are primarily attributable to lower production and revenue levels in late 2001 compared to the prior year due to the severe downturn in the semiconductor industry. The decrease in accrued compensation is due to workforce reductions and wage reductions we implemented in 2001 in response to the semiconductor industry downturn.

     Cash and cash equivalents decreased by $4.1 million in 2000 to $9.1 million. We used $3.7 million of cash in operating activities in 2000. The major components of cash flows used in operating activities were a net loss of $22.5 million, increases in accounts receivable of $1.9 million and inventories of $3.3 million and a decrease in other accrued liabilities of $2.6 million, partially offset by $2.6 million in non-cash depreciation and amortization expense, a $15.4 million non-cash decrease in deferred taxes, $2.9 million in write-downs of inventories and other assets and $3.1 million in restructuring charges. Despite higher sales volume, receivables decreased in 2000 due to the fourth quarter adoption of SAB101, which has the effect of shortening the length of time receivables are outstanding because we do not record the receivable upon shipment in cases where customer acceptance provisions cause us to defer revenue recognition. Inventories and accounts payable increased in 2000 due to increased production and sales activity in late 2000 compared to 1999. Also, a portion of the increase in inventories is attributable to the inclusion of equipment at customer sites for which revenue is deferred until installation and/or acceptance is completed. The decrease in deferred taxes resulted from the establishment of a valuation allowance in 2000.

     Our use of cash in investing activities in 2002, 2001 and 2000 related principally to expenditures for property and equipment, which amounted to $41,000, $71,000, and $599,000, respectively. In November 2001, we purchased 426,410 shares of our common stock for $544,000 from a shareholder group. In December 2001, we sold the same number of shares of our stock to the same group for the same purchase price.

     We believe our cash and short-term investments of $5.8 million at December 31, 2002 will be sufficient to meet capital expenditure and working capital needs for at least the next twelve months. Historically, we have supported our capital expenditure and working capital needs with cash generated from operations, and in the long term we expect to continue to do the same. However, a prolonged continuation of the current industry downturn or future semiconductor industry downturns could negatively impact the demand for and price of our products and adversely affect future cash flows. Also, we may acquire other companies, product lines or technologies that are complementary to our business, and our working capital needs may change as a result of such acquisitions.

28

Table of Contents

     As of December 31, 2002, we had no outstanding long-term debt. We have a line of credit with a bank that provides for borrowings of up to the lesser of $5.0 million, or 80% of eligible accounts receivable and 50% of eligible inventory. The line of credit is collateralized by receivables and inventories. There were no line of credit advances outstanding as of December 31, 2002 and 2001. At December 31, 2002, we had $1.8 million available to borrow under the line of credit. Borrowings on this line of credit are on a demand basis.

     Future minimum annual lease payments under operating leases as of December 31, 2002 are as follows (in thousands):

     The above minimum lease payments have not been reduced by minimum sublease rentals of $0.3 million due in the future under noncancellable subleases.

     The above minimum lease payments do not include the facility lease that has been assigned to a third party and on which we remain contingently liable. The lease expires in January 2010 and minimum remaining payments amount to $3.8 million as of December 31, 2002.

     In January 2003, we signed an agreement to extend the lease for our facility in Dallas, Texas for three years. The lease provides for an initial annual base rent of approximately $132,000 with increases of approximately 5% annually through April 2006. The above minimum lease payments do not reflect this lease extension.

     On March 5, 2003, we received a letter from The Nasdaq Stock Market, Inc. regarding our noncompliance with the qualification standards for continued listing of our common stock on The Nasdaq National Market as a result of the closing bid price of our common stock being less than $1.00 for thirty consecutive business days. As is more fully described under the caption “Business Risks and Uncertainties: Failure to meet The Nasdaq National Market Listing Requirements” in this Item 7, we may have until May 30, 2004 to regain compliance with the minimum closing bid price requirement before being delisted from The Nasdaq National and SmallCap Markets. We have no present plans to raise capital through the equity markets. However, if our common stock is delisted from The Nasdaq National and SmallCap Markets, the liquidity of our common stock could be impaired, and prices for the shares of our common stock could be lower than might otherwise prevail.

Recent Accounting Pronouncements

     In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations.” SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies the criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. We made no acquisitions after June 30, 2001 and, therefore, SFAS No. 141 had no impact on our 2002 or 2001 results.

     We adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” on January 1, 2002. SFAS 144 supercedes SFAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of;” however, it retains the fundamental provisions of SFAS 121 related to the recognition and measurement of the impairment of long-lived assets to be held and used and

29

Table of Contents

the measurement of long-lived assets to be disposed of by sale. The adoption of SFAS 144 had no impact on our financial position or results from operations.

     In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that costs associated with exit or disposal activities be recognized when they are incurred rather than at the time of commitment to an exit or disposal plan. SFAS 146 also changes the methods of measuring certain exit costs. SFAS 146 is effective for all exit and disposal activities initiated after December 31, 2002. We will apply this standard to exit or disposal activities initiated after December 31, 2002.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition Disclosure — an amendment of SFAS No. 123.” This Statement amends SFAS 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. SFAS 148 is effective for fiscal years ending after December 15, 2002, and disclosure requirements are effective for interim periods beginning after December 15, 2002. We intend to continue to account for stock-based compensation using the intrinsic value method prescribed by APB Opinion No. 25 and related interpretations. We have included disclosures required by SFAS 148 in our Consolidated Financial Statements included in this Annual Report on Form 10-K and will begin making the additional disclosures required by SFAS 148 for interim period reporting in the first quarter of 2003. Accordingly, the adoption of SFAS 148 will not impact our financial position or results of operations.

     In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This interpretation elaborates on the disclosures required in financial statements concerning obligations under certain guarantees. It also clarifies the requirements related to the recognition of liabilities by a guarantor at the inception of certain guarantees. The disclosure requirements of this interpretation were effective for Aetrium on December 31, 2002 and, accordingly, are reflected in our financial statement disclosures related to accounting for warranty costs. The recognition provisions of the interpretation are effective for Aetrium in 2003 and are applicable only to guarantees issued or modified after December 31, 2002. We do not expect the adoption of this interpretation to have a material impact on our financial position or results of operations.

Business Risks and Uncertainties:

     Several important risks and uncertainties exist which could have an impact on our future operating results. These factors could cause our actual results to differ materially from our anticipated results or results that are reflected in any forward-looking statements in this Annual Report on Form 10-K. These factors, and their impact on the success of our operations and our ability to achieve our goals, include the following:

      Market Fluctuations in the Semiconductor Industry

     Our business and results of operations depend upon capital expenditures by manufacturers of ICs and discrete electronic components. As a result, our operating results are materially dependent upon economic and business conditions in the semiconductor industry. This industry has been subject to significant market fluctuations and has experienced periodic downturns, which often have had a disproportionate effect on capital equipment suppliers, such as Aetrium. In periods of excess capacity, the semiconductor industry sharply reduces purchases of capital equipment, such as our products. A

30

Table of Contents

downturn or slowdown in the semiconductor industry could substantially reduce our revenues and operating results and could harm our financial condition. In 2001 and 2002, the semiconductor industry experienced a severe downturn of unprecedented magnitude. The severe downturn experienced in the semiconductor industry over the past several quarters has reduced our revenues, and we expect that our revenues will remain at reduced levels until semiconductor industry capital expenditures increase.

      Fixed Cost Constraints on Reduction of Expenses

     Many of our expenses, particularly those relating to properties, capital equipment and certain manufacturing overhead items, are fixed in the short term. Accordingly, reduced demand for our products and services causes our fixed production costs to be allocated across reduced production volumes, which negatively affects our gross margins and profitability. Our ability to reduce expenses is further constrained because we must continue to invest in research and development to maintain our competitive position and to maintain service and support for our existing customer base. The cost reduction efforts we took in 2001 resulted in an improvement in our gross margins in 2002. However, at current revenue levels we expect that our gross margins will continue to be negatively affected by reduced production volumes. Our current visibility on our future operating results is severely limited given the continuing impact of the semiconductor industry downturn in 2001 and 2002, and we cannot accurately predict if or when the production volumes will increase or if or when our operating results will improve.

      Impact of Cost Reduction and Reorganization Actions

     During the course of 2001 and 2002, as the downturn in the semiconductor industry continued to deepen, we implemented cost reduction and reorganization actions to address our declining revenues, such as workforce reductions, consolidation of operations, pay freezes and reductions, and reductions in other expenditures. In the event our revenue levels decline further, we may elect to implement additional cost reduction actions to conserve our cash. Our reduced personnel and expenditure levels and the loss of the capabilities of personnel we have terminated could inhibit us in the timely completion of product development efforts, the effective service of and responsiveness to customer requirements, and the timely ramp up of production in response to eventual improving market conditions.

      Successful Development and Introduction of New Products and Product Improvements

     We operate in an industry that is highly competitive with respect to timely product innovations. The market for our products is characterized by rapid technological change and evolving industry standards. The development of more complex ICs has driven the need for new equipment and processes to produce such devices at an acceptable cost. We believe that our future success will depend in part upon our ability to anticipate changes in technologies, IC and discrete electronic component package types, market trends and industry standards. If we cannot successfully develop and introduce new and enhanced cost-effective products on a timely basis that are accepted in the marketplace, our business and operating results would likely suffer.

      Reliance on Significant Customers

     We rely on a limited number of customers for a substantial percentage of our net sales. A reduction, delay or cancellation of orders from one or more of these significant customers, or the loss of one or more of these customers, would likely negatively impact our operating results.

31

Table of Contents

      Reduction in the Sales Efforts by our Current Distributors

     We market and sell our test handlers and reliability test products outside of the United States primarily through international distributors that are not under our direct control. We have limited internal sales personnel. A reduction in the sales efforts by our current distributors, or the termination of one or more of these relationships with Aetrium, could negatively affect our operating results.

      Reduction in our International Sales

     We expect that international sales will continue to account for a significant portion of our net sales. As a result, our operations are subject to a number of risks inherent in international business activities, which could negatively impact our operating results

      Failure to Retain our IC Processing Equipment OEMs

     We market our Automation Modules product line to a limited number of IC processing equipment OEMs. Our ability to retain our OEM customers and attract new OEM customers depends upon a number of factors, including the changing needs and financial condition of these customers. Our failure to retain OEM customers could result in the loss of Automation Modules product line sales, as well as the loss of outstanding receivables due from such OEM customers. Our revenues from our Automation Modules product line were severely impacted by the record industry downturn in 2001 and 2002 as our OEM customers experienced the same business conditions that we were experiencing. Because of the excess capacity that continues to exist for our OEM customers’ products, we expect that future revenues from this product line will be increasingly dependent on our success in having our Automation Modules incorporated into new OEM customer product introductions.

      Supply of Significant Components for our Products

     Certain significant components used in our products, including certain contactor components, printed circuit boards, and refrigeration systems, are currently available only from sole or limited sources. We do not maintain long-term supply agreements with most of our suppliers and we purchase most of our components through individual purchase orders. Our inability to obtain components in required quantities or of acceptable quality could result in delays or reductions in product introductions or shipments, which could damage our relationships with our customers and cause our operating results to suffer.

      Failure to meet The Nasdaq National Market Listing Requirements

     On March 5, 2003, we received a letter from The Nasdaq Stock Market, Inc. regarding our noncompliance with the qualification standards for continued listing of our common stock on The Nasdaq National Market as a result of the closing bid price of our common stock being less than $1.00 for thirty consecutive business days. We will be able to maintain our listing if the closing bid price of our common stock meets or exceeds $1.00 for at least 10 and up to 20 consecutive trading days during the 180 day period ending September 2, 2003. If we fail to meet such requirement but we submit an application to transfer our common stock to The Nasdaq SmallCap Market by September 2, 2003 and our transfer application is approved, and provided our shareholders’ equity as of June 30, 2003 is at least $5 million, we would have an additional 180 days, or until March 1, 2004, to meet the The Nasdaq SmallCap Market minimum bid requirement to maintain our listing. Under The Nasdaq SmallCap Market requirement, we would be able to maintain our listing if the closing bid price of our common stock meets or exceeds $1.00 for 10 consecutive trading days during this period. If we failed to meet this requirement by March 1, 2004, but our shareholders’ equity as of September 30, 2003 is at least $5 million, we would be afforded an additional 90 days, or until May 30, 2004, to meet The Nasdaq SmallCap Market minimum bid

32

Table of Contents

requirement to maintain our listing. If we transfer our common stock to The Nasdaq SmallCap Market, we may transfer our common stock back to The Nasdaq National Market without satisfying initial inclusion criteria (which we currently do not satisfy), if certain conditions are satisfied. These conditions are that (a) during the 360 day period ending March 4, 2004, the closing bid price of our common stock meets or exceeds $1.00 for thirty consecutive trading days, and (b) during the period we are on The National SmallCap Market we continually maintain compliance with all other requirements for continued listing on The Nasdaq National Market. For us these requirements are that (i) we have at least 750,000 shares of common stock publicly held, (ii) the market value of our publicly held shares is at least $5 million, (iii) our shareholders’ equity is at least $10 million, (iv) we have at least 400 shareholders of round lots, and (v) we have at least two registered and active market makers. We currently meet these criteria.

     If our common stock is delisted from The Nasdaq National and SmallCap Markets, any trading in our common stock would thereafter be conducted in the over-the-counter market in what are commonly referred to as the “pink sheets” or the National Association of Securities Dealers’ “Electronic Bulletin Board.” Consequently, the liquidity of our common stock could be impaired, not only in the number of shares which could be bought and sold, but also through delays in the timing of the transactions. As a result, prices for the shares of our common stock could be lower than might otherwise prevail.

     We have no obligation to update the above information, including the forward-looking statements, in this Annual Report on Form 10-K.