Special Note Regarding Forward Looking Statements

Information contained or incorporated by reference in this report contains forward-looking statements. These forward-looking statements are based on current expectations and beliefs and involve numerous risks and uncertainties that could cause actual results to differ materially from expectations. These forward-looking statements should not be relied upon as predictions of future events as we cannot assure you that the events or circumstances reflected in these statements will be achieved or will occur. You can identify forward-looking statements by the use of forward-looking terminology such as "may," "will," "expect," "anticipate," "estimate" or "continue" or the negative thereof or other variations thereon or comparable terminology which constitutes projected financial information. These forward-looking statements are subject to risks, uncertainties and assumptions about Tegal Corporation including, but not limited to, industry conditions, economic conditions, acceptance of new technologies and market acceptance of Tegal Corporation's products and service. For a discussion of the factors that could cause actual results to differ materially from the forward-looking statements, see the "Part Item 1A-Risk Factors" and the "Liquidity and Capital Resources" section set forth in this section and such other risks and uncertainties as set forth below in this report or detailed in our other SEC reports and filings. We assume no obligation to update forward-looking statements.

Tegal Corporation, a Delaware corporation ("Tegal" or the "Company"), designs, manufactures, markets and services plasma etch and deposition systems that enable the production of integrated circuits ("ICs"), memory and related microelectronics devices used in portable computers, cell phones, PDAs and RFID applications; megapixel imaging chips used in digital and cell phone cameras; power amplifiers for portable handsets and wireless networking gear; and micro-electrical mechanical systems ("MEMS") devices including accelerometers for automotive airbags, microfluidic control devices for ink-jet printers; and laboratory-on-a-chip medical test kits. Etching and deposition constitute two of the principal IC and related device production process steps and each must be performed numerous times in the production of such devices.

Semiconductor Industry Background

Over the past twenty years, the semiconductor industry has experienced significant growth. This growth has resulted from the increasing demand for ICs from traditional IC markets, such as personal computers, telecommunications, consumer electronics, automotive electronics and office equipment, as well as developing markets, such as wireless communications, multimedia and portable and network computing. As a result of this increased demand, semiconductor device manufacturers have periodically expended significant amounts of capital to build new semiconductor fabrication facilities ("fabs") and to expand existing fabs. More recently, growth has slowed, and the industry is maturing as the cost of building new wafer fabs has increased dramatically. Similarly, the rate of semiconductor sales growth has slowed as the industry feels the effects of the current economic environment and average selling prices of chips continue to decline. The industry faces a period of uncertainty with a steep decline in consumer confidence and caution in the enterprise segment. There is growing pressure on semiconductor device manufacturers to reduce manufacturing costs while increasing the value of their products. The semiconductor industry has also been historically cyclical, with periods of rapid expansion followed by periods of over-capacity. Currently, the industry is experiencing a down-turn, heightened by tighter credit markets and the negative economic environment. These circumstances have caused customers to delay or reconsider expenditures on capital equipment.

Historically, growth in the semiconductor industry has been driven, in large part, by advances in semiconductor performance at a decreasing cost per function. Advanced semiconductor processing technologies increasingly allow semiconductor manufacturers to produce ICs with smaller features, thereby increasing processing speed and expanding device functionality and memory capacity. As ICs have become more complex, however, both the number and price of state of the art process tools required to manufacture ICs have increased significantly. As a result, the cost of semiconductor manufacturing equipment has become an increasingly large part of the total cost of producing advanced ICs.

To create an IC, semiconductor wafers are subjected to a large number of complex process steps. The three primary steps in manufacturing ICs are (1) deposition, in which a layer of insulating or conducting material is deposited on the wafer surface, (2) photolithography, in which the circuit pattern is projected onto a light sensitive material (the photoresist), and (3) etch, in which the unmasked parts of the deposited material on the wafer are selectively removed to form the IC circuit pattern.

Each step of the manufacturing process for ICs requires specialized manufacturing equipment. Today, plasma-based systems are used for the great majority of both deposition and etching processes. During physical vapor deposition the semiconductor wafer is exposed to a plasma environment that forms continuous thin films of electrically insulating or electrically conductive layers on the semiconductor wafer. During a plasma etch process (also known as "dry etch"), a semiconductor wafer is exposed to a plasma composed of a reactive gas, such as chlorine, which etches away selected portions of the layer underlying the patterned photoresist layer.

Business Strategy

Our business objective is to utilize the technologies that we have developed internally or acquired externally in order to increase our market share in process equipment for both semiconductor manufacturing and nanotechnology device fabrication (i.e., devices smaller than about 100 nanometers). In the recent past, we have focused on competing with more established competitors by being "designed-in" to the advanced device fabrication plans of our customers. We have done so primarily by engaging in research and development activities on behalf of our customers that our more established competitors were unwilling or unable to perform. Many of these advanced devices promise substantial returns as consumer demand for certain functions grows and new markets are created. However, the timing of the emergence of such demand is highly uncertain. In addition, the successful integration by our customers of all the various technical processes required to manufacture a device at an acceptable cost is also highly uncertain. We cannot accurately predict the timing of the stable emergence of these markets. Due to the cyclical nature of our industry, we expect that net orders will continue to fluctuate. In the meantime, our costs for maintaining our research and development efforts and our service and manufacturing infrastructure have remained constant or in some cases increased.

At the present time, we are continuing our transition of the Company's dependence on these highly unpredictable markets to more established equipment markets, where our success is dependent more on our ability to apply successfully our engineering capabilities to solving existing manufacturing problems. We aim to carefully manage this transition by limiting our research and development efforts to the most promising near-term sales opportunities, while at the same time redirecting all our available resources toward new products aimed at established equipment markets. Because of our relatively small size, our ability to meet the needs of individual customers is far more important to our success than either macroeconomic factors or industry-wide factors such as cyclicality, although both of these factors affect our performance as well. As a result, our methods of evaluating our progress will continue to be highly customer-focused.

In order to achieve our business strategy, we are focused on the following key elements:

Maintaining our Technology Leadership Position in New Materials Etch - We are a leading provider of etch process solutions for a set of new materials central to the production of an array of advanced semiconductor and nanotechnology devices in emerging markets. Incorporation of these new materials is essential to achieving the higher device densities, lower power consumption and novel functions exhibited by the newest generation of cell phones, computer memories, fiber optic switches and remote sensors. Currently, we are a leading supplier of etch solutions to makers of various advanced "non-volatile" memories, as well as to device makers incorporating compound metals and certain high-K dielectric materials into their devices. Our new materials expertise also includes the etching of so-called "compound-semi" materials, such as gallium arsenide, gallium nitride and indium phosphide, widely used in telecom device production, as well as expanding use in growth markets such as mobile terminals, digital home appliances as well as enterprise applications, such as wireless local area networks. The advantages of compound semiconductor devices over traditional silicon devices include higher operating speeds, lower power consumption, reduced noise and distortion, higher operable temperature, light emitting and detecting properties, higher light emission efficiency and longer product life. In addition, we are known for our capability to etch certain noble metals, such as gold and platinum, as well as certain proprietary compound metals. This capability is increasingly important in advanced memory development and in the production of Micro-Electrical Mechanical Systems ("MEMS"). We intend to maintain our leadership position in new materials etch through our own internal development efforts and through various joint development programs and production efforts with leading device manufacturers.

Strengthening our Position in Deposition Process Equipment - Since 2002, we have completed two acquisitions of deposition products incorporating the same unique "sputter-up" technology. In December 2006, as a result of the settlement of our litigation with Advanced Modular Systems ("AMS") and others, we also acquired the assets and know-how of a similar deposition system. These deposition tools enable the production of highly-oriented, thin piezoelectric films composed of aluminum nitride. Such films are incorporated into high frequency filters called Bulk Acoustic Wave ("BAW") and Film Bulk Acoustic Resonators ("FBARs") used in cellular telephone and wireless communications. In addition our PVD products are well-suited for applications within so-called "back-end" semiconductor manufacturing processes, including backside metallization of ultra-thin wafers and underbump metal processes. These processes are important to power devices, as well as certain advanced, wafer-level packaging schemes, which are increasingly being used for high-pin-count logic and memory devices.

Introducing a New Product into Established Equipment Market - The continued development of our Nano Layer Deposition ("NLD") technology represents our belief that we have a compelling solution to a critical process need in present day and future semiconductor device fabrication. As device geometries continue to shrink, conventional chemical vapor deposition ("CVD") process equipment is increasingly incapable of depositing thin conformal films in high aspect ratio trenches and vias. In addition, there appear to be significant applications of our NLD technology in barrier films and high-K materials deposition. Atomic Level Deposition ("ALD") is one technology for satisfying this deposition requirement. However, ALD has several shortcomings, including low throughput and limitations on film type and quality, which we believe our NLD technology overcomes.

Maintaining our Service Leadership Position -- Tegal has been consistently recognized by our customers for providing a high level of customer support, a fact that has been noted by our top ranking for eight of the last ten consecutive years in the annual survey conducted by VLSI Research, Inc. We expect to maintain and build on this reputation as we seek new customers in both emerging and established markets.

Critical Accounting Policies and Estimates

Our 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 of America. 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. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, bad debts, sales returns allowance, inventory, intangible and long lived assets, warranty obligations, restructure expenses, deferred taxes and freight charged to customers. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which 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.

We believe the following critical accounting policies are the most significant to the presentation of our consolidated financial statements:

Revenue Recognition

Each sale of our equipment is evaluated on an individual basis in regard to revenue recognition. We have integrated in our evaluation the related interpretative guidance included in Topic 13 of the codification of staff accounting bulletins, and recognize the role of the consensus on Emerging Issues Task Force Issue No. 00-21, "Accouanting for Revenue Arrangements with Multiple Deliverables ("EITF Issue 00-21"). We first refer to EITF Issue 00-21 in order to determine if there is more than one unit of accounting and then we refer to Staff Accounting Bulletin ("SAB") 104 for revenue recognition topics for the unit of accounting. We recognize revenue when persuasive evidence of an arrangement exists, the seller's price is fixed or determinable and collectability is reasonably assured.

For products produced according to our published specifications, where no installation is required or installation is deemed perfunctory and no substantive customer acceptance provisions exist, revenue is recognized when title passes to the customer, generally upon shipment. Installation is not deemed to be essential to the functionality of the equipment since installation does not involve significant changes to the features or capabilities of the equipment or building complex interfaces and connections. In addition, the equipment could be installed by the customer or other vendors and generally the cost of installation approximates only 1% of the sales value of the related equipment.

For products produced according to a particular customer's specifications, revenue is recognized when the product has been tested and it has been demonstrated that it meets the customer's specifications and title passes to the customer. The amount of revenue recorded is reduced by the amount (generally 10%), which is not payable by the customer until installation is completed and final customer acceptance is achieved.

For new products, new applications of existing products, or for products with substantive customer acceptance provisions where performance cannot be fully assessed prior to meeting customer specifications at the customer site, 100% of revenue is recognized upon completion of installation and receipt of final customer acceptance. Since title to goods generally passes to the customer upon shipment and 90% of the contract amount becomes payable at that time, inventory is relieved and accounts receivable is recorded for the entire contract amount. The revenue on these transactions is deferred and recorded as deferred revenue. We reserve for warranty costs at the time the related revenue is recognized.

Revenue related to sales of spare parts is recognized upon shipment. Revenue related to maintenance and service contracts is recognized ratably over the duration of the contracts. Unearned maintenance and service revenue is included in deferred revenue.

Accounting for Stock-Based Compensation

We have adopted several stock plans that provide for issuance of equity instruments to our employees and non-employee directors. Our plans include incentive and non-statutory stock options and restricted stock awards and RSUs. These equity awards generally vest ratably over a four-year period on the anniversary date of the grant, and stock options expire ten years after the grant date. Certain restricted stock awards may vest on the achievement of specific performance targets. We also have an ESPP that allows qualified employees to purchase Tegal shares at 85% of the fair market value on specified dates.

Effective April 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), "Share Based Payment" ("SFAS 123R") using the modified prospective transition method.

The Company maintains an allowance for doubtful accounts receivable for estimated losses resulting from the inability of the Company's customers to make required payments. If the financial condition of the Company's customers were to deteriorate, or even a single customer was otherwise unable to make payments, additional allowances may be required. As of December 31, 2008 one customer accounted for approximately 36% of the accounts receivable balance. As of December 31, 2007 two customers accounted for approximately 81% of the accounts receivable balance.

The Company's return policy is for spare parts and components only. A right of return does not exist for systems. Customers are allowed to return spare parts if they are defective upon receipt. The potential returns are offset against gross revenue on a monthly basis. Management reviews outstanding requests for returns on a quarterly basis to determine that the reserves are adequate.

Inventories

Inventories are stated at the lower of cost or market, reduced by provisions for excess and obsolescence. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis and includes material, labor and manufacturing overhead costs. We estimate the effects of excess and obsolescence on the carrying values of our inventories based upon estimates of future demand and market conditions. We establish provisions for related inventories in excess of production demand. Should actual production demand differ from our estimates, additional inventory write-downs may be required. Any excess and obsolete provision is released only if and when the related inventories is sold or scrapped. The inventory provision balance at December 31, 2008 and March 31, 2008 was $3,541 and $3,760, respectively. During the nine months ended December 31, 2008, and December 31, 2007, the reserve was reduced by $154 and $148, respectively when the Company sold or scrapped previously reserved inventory.

The Company periodically analyzes any systems that are in finished goods inventory to determine if they are suitable for current customer requirements. At the present time, the company's policy is that, if after approximately 18 months, it determines that a sale will not take place within the next 12 months and the system would be useable for customer demonstrations or training, it is transferred to fixed assets. Otherwise, it is expensed.

The carrying value of systems used for demonstrations or training is determined by assessing the cost of the components that are suitable for sale. Any parts that may be rendered unsellable as a result of such use are removed from the system and are not included in finished goods inventory. The remaining saleable parts are valued at the lower of cost or market, representing the system's net realizable value. The depreciation period for systems that are transferred to fixed assets is determined based on the age of the system and its remaining useful life (typically five to eight years).

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If undiscounted expected future cash flows are less than the carrying value of the assets, an impairment loss is recognized based on the excess of the carrying amount over the fair value of the assets. No impairment charge has been recorded for the years ended 2008 and 2007.

Warranty Obligations

We provide for the estimated cost of our product warranties at the time revenue is recognized. Our warranty obligation is affected by product failure rates, material usage rates and the efficiency by which the product failure is corrected. The warranty reserve is based on historical cost data related to warranty. Should actual product failure rates, material usage rates and labor efficiencies differ from our estimates, revisions to the estimated warranty liability may be required. Actual warranty expense is typically low in the period immediately following installation.

Deferred Taxes

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Based on the uncertainty of future taxable income, we have fully reserved our deferred tax assets. In the event we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset would increase income in the period such determination was made.

Results of Operations

The following table sets forth certain financial items as a percentage of
revenue for the three and nine months ended December 31, 2008 and 2007:



                                               Three Months Ended             Nine Months Ended
                                                  December 31,                  December 31,
                                              2008            2007           2008           2007

Revenue                                         100.0 %         100.0 %        100.0 %        100.0 %
Cost of revenue                                  69.6 %          56.4 %         58.0 %         59.8 %
Gross profit                                     30.4 %          43.6 %         42.0 %         40.2 %
Operating expenses:
Research and development                         25.5 %           8.0 %         30.5 %         10.4 %
Sales and marketing                              16.9 %           9.1 %         21.7 %         12.6 %
General and administrative                       19.7 %           9.2 %         32.8 %         14.1 %
Total operating expenses                         62.1 %          26.3 %         85.0 %         37.1 %
Operating income (loss)                         (31.7 %)         17.3 %        (43.0 %)         3.1 %
Other income (expense), net                       1.1 %          10.7 %          1.6 %          7.9 %
Income (loss) before income tax expense
(benefit)                                       (30.6 %)         28.0 %        (41.4 %)        11.0 %
Net income (loss)                               (30.6 %)         28.0 %        (41.4 %)        11.0 %

                                              Three Months Ended           Nine Months Ended
                                                 December 31,                 December 31,
                                              2008          2007           2008          2007

Revenue                                    $    4,476     $  10,145     $   11,215     $  25,543
Cost of revenue                                 3,113         5,725          6,504        15,262
Gross profit                                    1,363         4,420          4,711        10,281
Operating expenses:
Research and development expenses               1,142           810          3,423         2,645
Sales and marketing expenses                      756           923          2,438         3,208
General and administrative expenses               880           938          3,681         3,589
Total operating expenses                        2,778         2,671          9,542         9,442
Operating (loss) income                        (1,415 )       1,749         (4,831 )         839
Other income (expense), net                        50         1,085            176         2,049
(Loss) income before income tax expense
(benefit)                                      (1,365 )       2,834         (4,655 )       2,888
Tax Expense                                         -             -              -             -
Net (loss) income                          $   (1,365 )   $   2,834     $   (4,655 )   $   2,888

Net (loss) income per share:
Basic                                      $    (0.19 )   $    0.40     $    (0.61 )   $    0.41
Diluted                                    $    (0.19 )   $    0.39     $    (0.61 )   $    0.40
Weighted average shares used in per share
computation:
Basic                                           7,368         7,148          7,569         7,120
Diluted                                         7,368         7,281          7,569         7,241

Revenue

Revenue of $4,476 for the three months ended December 31, 2008 decreased by $5,669 from revenue of $10,145 for the three months ended December 31, 2007. Revenue for the three months ended December 31, 2008 was mainly from the sale of one new DRIE (Deep Reactive Ion Etch) system, one new 900 series system, and one used DRIE system. Revenue for the three months ended December 31, 2007 resulted principally from the sale of two new advanced series systems, two new 900 series systems and one new Endeavor system .

Revenue of $11,215 for the nine months ended December 31, 2008 decreased by $14,328 from revenue of $25,543 for the nine months ended December 31, 2007. Revenue for the nine months ended December 31, 2008 resulted from the sale of two new systems (one DRIE and one 900 series) and three used systems (one Advanced Etch, one Endeavor, one DRIE). Revenue for the nine months ended December 31, 2007 resulted principally from the sale of six new advanced series systems and three new 900 series systems, as well as one new Endeavor system and one used Endeavor system.

International sales as a percentage of total revenue for the three and nine months ended December 31, 2008 was approximately 38% and 32% respectively. International sales as a percentage of revenue for the three and nine months ended December 31, 2007 was approximately 67% and 83%, respectively. The decrease in international sales as a percentage of revenue can be attributed to fewer systems sold. The Company typically sells more systems in international markets. Despite this decrease we believe that international sales will continue to represent a significant portion of our revenue.

Gross profit

Gross profit of $1,363 for the three months ended December 31, 2008 decreased by $3,057 from gross profit of $4,420 for the three months ended December 31, 2007, representing a 69% decrease. The decrease in gross profit was attributable to fewer systems sold. Our gross profit margin for the three months ended December 31, 2008 was 30% compared to 44% for the same period last year. The principle . . .