Zygo Corporation is a worldwide supplier of optical metrology instruments, precision optics, and electro-optical design and manufacturing services, serving customers in the semiconductor capital equipment and industrial markets. We conduct the majority of our manufacturing in our 153,500 square foot facility in Middlefield, Connecticut and our 39,780 square foot facility in Tucson, Arizona.

On October 16, 2008, we and Electro Scientific Industries, Inc. ("ESI") jointly announced the execution of a definitive agreement, providing for the two companies to merge in an all stock transaction, subject to the prior satisfaction of certain enumerated conditions precedent. A copy of the merger agreement was filed with the Securities and Exchange Commission on October 21, 2008 as an Exhibit to our Form 8-K and is publicly available. On January 20, 2009, ZYGO announced that it notified ESI of ZYGO's Board of Directors' withdrawal of its recommendation in favor of the previously announced merger agreement with ESI. A reevaluation of the proposed merger with ESI by ZYGO's Board was necessitated by changes in conditions since the merger agreement was executed on October 15, 2008, and the ZYGO Board's view of the disproportionate impact of these changes on the current and expected longer term performance and operations of ZYGO and ESI. ZYGO and ESI have had dialogue with respect to the ZYGO Board's withdrawal of its recommendation, and to the initially contemplated transaction; and we are continuing to evaluate our options under the merger agreement and applicable law.

Orders for the three months ended December 31, 2008 were $22.3 million, as compared with $42.9 million for the comparable prior year period. Orders from the company's Metrology Solutions segment accounted for 77% of the orders received, with the Optical Systems segment contributing the remaining 23%. The $20.6 million decline in orders from the same period of the prior year occurred primarily in the Metrology segment, which experienced reduced orders for lithography products of $7.7 million, display systems of $6.4 million and instruments of $2.8 million. Within the Optics segment, orders were down $3.7 million primarily due to push out of orders from one of our ophthalmology customers.

Demand for certain of our products is impacted by various conditions affecting the semiconductor industry generally and the impact these conditions have on demand for semiconductor manufacturing equipment. The length and severity of the current downturn in the semiconductor industry is difficult to predict. Based on recent communications with our semiconductor customers and revised external market forecasts, we believe that there will be continued pressure on demand for various of our products at least through the end of fiscal 2009.

In response to the decline in orders, we have taken or will take various actions, including reductions in work force, pay reductions and unpaid furloughs for employees, to mitigate the effects of the downturn in the global economy. These actions are expected to save us approximately $9.0 million on an annualized basis. There may be further restructuring actions and related charges during the fiscal year.

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosures at the date of our condensed consolidated financial statements. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, marketable securities, warranty obligations, income taxes, long-lived assets, and share-based payments. Management bases its estimates and judgments on historical experience and current market conditions and on various other factors that are believed to be reasonable under the circumstances, the results of whic h form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. As discussed in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2008, as amended by Form 10-K/A, management considers the Company's policies on revenue recognition and allowance for doubtful accounts; inventory valuation; other than temporary impairment of marketable securities; share-based compensation; warranty costs; accounting for income taxes; valuation of long-lived assets; and accruals for health insurance to be critical accounting policies due to the estimates, assumptions, and application of judgment involved in each.

As discussed below and in Note 4 to the Condensed Consolidated Financial Statements, we adopted the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("SFAS 157") (with the exception of the application of the statement to non-recurring non-financial assets and non-financial liabilities). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 were effective for our fiscal year beginning July 1, 2008. The adoption of the provisions of SFAS 157 did not have a material effect on us.

RESULTS OF OPERATIONS

Net Sales

                                                                                        Fiscal 2009                            Fiscal 2008
                                                                                                   Net Sales                          Net Sales
(Dollars in millions)                                                              Amount              %              Amount              %
Quarter ended December 31
                                                         Metrology Solutions   $       24.4             73%       $       29.2             72%
                                                         Optical Systems                9.1             27%               11.2             28%
                                                               Total           $       33.5            100%       $       40.4            100%

Six months ended December 31
                                                         Metrology Solutions   $       52.1             73%       $       49.2             68%
                                                         Optical Systems               19.7             27%               22.9             32%
                                                               Total           $       71.8            100%       $       72.1            100%

Overall, net sales for the three months ended December 31, 2008 decreased 17% as compared with the prior year period, reflecting decreases in the Metrology Solutions segment sales of 16% and Optical Systems segment sales of 19%. The decrease in Metrology Solutions segment sales was primarily due to volume decreases in instruments of $4.0 million and in lithography sales of $2.1 million, partially offset by a $1.0 million increase in display systems. The decrease in instruments and lithography sales are due to a reduction in orders that appears to be tied directly to the general global economic downturn, most notably in the semiconductor industry. A decrease in orders from Canon accounted for the majority of the decrease in lithography sales. Total sales to Canon represented 15% of total sales in the three months ended December 31, 2008, as compared with 17% in the comparable prior year period. The decrease in the Optical Systems segment was primarily due to decreases in contract manufacturing of $1.4 million and of $0.5 million in precision optics. The decrease in contract manufacturing sales can be attributed to two significant projects in the second quarter of the prior year, for which there were no corresponding projects in the current year.

Net sales for the six months ended December 31, 2008 decreased marginally from the comparable prior year period, reflecting a decrease in the Optical Systems segment sales of 14%, partially offset by an increase in Metrology Solutions segment sales of 6%. The decrease in the Optics segment was due primarily to decreases in contract manufacturing of $2.2 million and volume decreases of $1.0 million in the laser fusion and precision optics areas. The decrease in contract manufacturing sales was primarily due to two significant projects in the second quarter of the prior year, for which there were no corresponding projects in the current year. The Metrology segment net sales increases were primarily due to increased volume in display systems of $4.5 million and vision systems of $2.1 million (vision systems was purchased during the third quarter of fiscal 2008), partially offset by volume decreases in instruments of $2.7 million and in lithography sales of $1.0 million.

Sales in U.S. dollars for the three and six months ended December 31, 2008 were approximately 76% of total net sales, with the remaining 24% being in Euro or Yen. For our sales which are based in foreign currency, we are exposed to foreign exchange fluctuations from the time customers are invoiced in foreign currency until collection occurs. Significant changes in the values of foreign currencies relative to the value of the U.S. dollar, or in the general economic conditions in our export markets, could materially impact the sales of our products in these markets and our Condensed Consolidated Financial Position and Results of Operations.

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Gross Profit by Segment

                                                                                        Fiscal 2009                         Fiscal 2008
                                                                                                    Gross                                Gross
(Dollars in millions)                                                              Amount         Profit %            Amount           Profit %
Quarter ended December 31
                                                         Metrology Solutions   $       11.0             45%       $       14.0               48%
                                                         Optical Systems                1.3             14%                2.6               23%
                                                               Total           $       12.3             37%       $       16.6               41%
Six months ended December 31
                                                         Metrology Solutions   $       24.6             47%       $       22.2               45%
                                                         Optical Systems                4.5             23%                5.5               24%
                                                               Total           $       29.1             41%       $       27.7               38%

Gross profit as a percentage of net sales for the three months ended December 31, 2008 was 37%, which represents a decrease of four percentage points from the comparable prior year period. Within the Metrology segment, the decrease in gross profit as a percentage of net sales for the three months ended December 31, 2008 as compared with the prior year period is primarily due to inventory write-downs, inventory cancellation charges, and increased freight charges within the various product lines of the segment. Within the Optics segment, the decrease in gross profit as a percentage of net sales for the three months ended December 31, 2008 as compared with the prior year period is primarily due to unabsorbed costs due to lower net sales.

Gross profit as a percentage of net sales for the six months ended December 31, 2008 was 41%, which represents an increase of three percentage points from the comparable prior year period. Within the Metrology segment, the increase in gross profit as a percentage of net sales for the six months ended December 31, 2008 as compared with the prior year period is primarily due to a change in product mix. Display systems had higher sales and margins than in the previous year's comparable period and accounted for a one percentage point increase in the Metrology segment increase in gross profit as a percentage of sales. Vision systems products, which were not part of our operations in the prior year, also contributed to the increase. Within the Optics segment, the decrease in gross profit of one percentage point as a percentage of net sales for the six months ended December 31, 2008 as compared with fiscal 2007 is primarily due to unabsorbed costs due to lower net sal es.

Selling, General, and Administrative Expenses ("SG&A")

                                        Fiscal 2009                      Fiscal 2008
(Dollars in millions)              Amount         % of Sales        Amount        % of Sales

Quarter ended December 31      $         12.5            37%     $        7.8            19%
Six months ended December 31   $         22.0            31%     $       15.2            21%

SG&A expenses increased in the three months ended December 31, 2008 by $4.7 million from the comparable prior year period, primarily due to $2.1 million in merger related costs, $1.1 million in reserves for possible royalty claims, an increase in selling expenses related to developing new business opportunities of $0.5 million, and the inclusion of $0.8 million of vision systems expenses in the current quarter. There were no vision systems expenses in the comparable quarter of fiscal 2008, as we acquired the assets of the vision systems unit in February 2008. SG&A expenses also increased slightly due to increases in contract manufacturing proposal work of $0.1 million and travel of $0.1 million. SG&A expenses increased in the six months ended December 31, 2008 by $6.8 million from the comparable prior year period, primarily due to $2.5 million in merger costs, the inclusion of $2.0 million of vision systems expenses, $1.1 million in reserves for possible royalty claims, and increased selling expenses of $1.3 million most notably for the semiconductor product line.

                                          Fiscal 2009                      Fiscal 2008
(Dollars in millions)                Amount        % of Sales         Amount         % of Sales

Quarter ended December 31         $        5.8            17%     $          5.4            13%
Six months ended December 31      $       11.4            16%     $         11.1            15%

RD&E for the three and six months ended December 31, 2008 remained relatively stable between periods. The inclusion of vision systems increased our RD&E costs by $1.5 million for the six months ended December 31, 2008. This increase was offset by a reduction in RD&E spending in our lithography group. The reduction in lithography RD&E is related to the slowdown in capital spending in the semiconductor market. RD&E spending in the three and six months ended December 31, 2008 was concentrated on our semiconductor initiative and core instruments products.

Provision for Doubtful Accounts and Notes
                                       Fiscal 2009                      Fiscal 2008
(Dollars in millions)             Amount         % of Sales        Amount         % of Sales

Quarter ended December 31      $         0.6             2%     $         1.6             4%
Six months ended December 31   $         1.0             1%     $         1.6             2%

Provision for doubtful accounts and notes for the three and six months ended December 31, 2008 decreased by $1.0 million and $0.6 million, respectively, as compared with the prior year periods, primarily due to changes in the purchase allocation relating to the Solvision asset acquisition in February 2008 which affected the value of the $1.5 million note receivable from Solvision Inc. We originally had loaned $1.5 million to Solvision Inc. in October 2007.

Other Income (Expense)
                                       Fiscal 2009                      Fiscal 2008

(Dollars in millions)             Amount         % of Sales        Amount         % of Sales

Quarter ended December 31      $         1.0             3%     $         0.9             2%
Six months ended December 31   $         1.0             1%     $         2.0             3%

Other income for the three months ended December 31, 2008 increased by $0.1 million from the comparable prior year period despite a decrease in investment income of $0.4 million. The decrease in investment income was offset by other income related to a benefit from a guaranteed dividend payment of $0.3 million related to our minority interest partner in our European operations and $0.2 million related to the settlement of a vendor account. Other income for the six months ended December 31, 2008 decreased by $1.0 million from the comparable prior year period, primarily due to decreased investment income of $0.8 million and mark to market write-downs of $0.5 million on our investment in an auction rate security and a mutual fund related to our deferred compensation program, partially offset by the benefit from a guaranteed dividend payment of $0.3 million related to our German joint venture partner and $0.2 million related to the settlement of a vendor account.

Income Tax Benefit (Expense)
                                       Fiscal 2009                      Fiscal 2008
                                                 Tax Rate                          Tax Rate
(Dollars in millions)             Amount            %              Amount             %

Quarter ended December 31      $        1.9            34%     $        (1.0)            36%
Six months ended December 31   $        1.4            33%     $        (0.6)            36%

The effective income tax rate for the three months ended December 31, 2008 was 34%, as compared with 36% in the comparable prior year period. The effective income tax rate for the six months ended December 31, 2008 was 33%, as compared with 36% in the comparable prior year period. The reduction in the effective income tax rate was primarily due to a change in the mix of income in the various tax jurisdictions.

Sales to Canon Inc., a stockholder, and Canon Sales Co., Inc., a distributor of certain of our products in Japan and a subsidiary of Canon Inc., (collectively referred to as "Canon") amounted to $4.9 million and $12.1 million (15% and 17% of net sales, respectively) for the three and six months ended December 31, 2008, respectively, as compared with $6.7 million and $12.3 million (each 17% of net sales) for the three and six months ended December 31, 2007. Selling prices of products sold to Canon are based, generally, on the terms customarily given to distributors. At December 31, 2008 and June 30, 2008, there were, in the aggregate, $1.4 million and $3.0 million, respectively, of trade accounts receivable from Canon.

We assess our liquidity in terms of our ability to generate cash to fund our operating, investing, and financing activities. Our principal source of liquidity is operating cash flows. In addition to operating cash flows, other significant factors that affect our overall management of liquidity include:
capital expenditures, customer credit requirements, investments in businesses, expenses related to our initially contemplated merger with ESI, common stock repurchases, and the adequacy of available bank lines of credit.

Recent distress in the financial markets, including extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments, and declining valuations of others, has had an adverse impact on financial market activities. We have assessed the implications of these factors on our current business and determined that there has not been a significant impact to our financial position, results of operations, or liquidity during the first six months of fiscal 2009, other than the indirect effect that the current uncertainty in global economic conditions resulting from the recent disruption in credit markets has had on customer demand for our products.

At December 31, 2008, cash and marketable securities were $48.1 million, a decrease of $2.9 million from $51.0 million at June 30, 2008. Our marketable securities consist of corporate bonds ($12.9 million), a mutual fund ($0.4 million), and an auction rate security ($0.1 million). The credit losses taken by major financial institutions and the reduction in the Federal Reserve rate may have an effect on the valuation of the portfolio and our future interest income.

The composition of our marketable securities by industry sector is as follows:
59% Finance; 8% Utilities; 8% Real Estate; 8% Consumer Goods; 7% Healthcare; and 10% other. We hold a total of fourteen corporate bonds with the largest being $1.0 million. We have the ability and intent to hold all the securities to maturity, the last maturity of which is on December 1, 2009. We believe there are no impairments in our investments other than an impairment of $0.5 million on an auction rate security ($0.2 million for the six months ended December 31, 2008).

The cash equivalents balance in our money market account, which is invested primarily in U.S. government securities, is $25.8 million as of December 31, 2008. We do not believe there is any risk to liquidity in the money market account, nor are there currently any limits on redemptions.

In our third quarter of fiscal 2009, a reduction in workforce resulted in severance payments totaling over $0.5 million. It is expected that reduction in workforce, as well as other actions including pay reductions and unpaid furloughs for employees, will save us approximately $9.0 million on an annualized basis. There may be further restructuring actions and related charges during the fiscal year. We believe we have sufficient operating flexibility and cash reserves to maintain adequate amounts of liquidity and to meet our future liquidity requirements for at least the next twelve months, although the impact of continued market volatility cannot be predicted.