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.

We design, manufacture, market and service plasma etch and deposition systems that enable the production of micro-electrical mechanical systems ("MEMS"), power integrated circuits ("ICs") and optoelectronic devices found in products like smart phones, networking gear, solid-state lighting, and digital imaging. Our plasma etch and deposition tools enable sophisticated manufacturing techniques, such as 3-D interconnect structures formed by intricate silicon etch, also known as Deep Reactive Ion Etching ("DRIE"). Etching and deposition constitute two of the principal device production process steps and each must be performed numerous times in the production of such devices.

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 MEMS and power device fabrication, advanced 3-D packaging, and certain areas of semiconductor manufacturing, including compound semiconductors and light emitting diodes ("LEDs"). In the recent past, we 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, including several applications of our technology in certain types of new, non-volatile memory devices intended as replacements for flash memory, such as MRAM, RRAM and FeRAM. Many of these advanced new memory devices promised substantial returns as consumer demand for certain functions grew and new markets were created. However, the timing of the emergence of such demand was highly uncertain and, as of today, these markets as of today have not developed as expected.

In September 2008, we took the step of acquiring the products lines of AMMS and the related intellectual property of Alcatel, in order to pursue more fully the smaller, but higher-growth markets of MEMS and 3-D packaging. Our acquisition of these products served two purposes: 1) to increase revenues, as demand for our etch and deposition systems in more traditional semiconductor markets fell dramatically with the collapse of semiconductor capital spending; and 2) to enable us to focus our various technologies on specific applications that served the common markets of MEMS and 3-D device manufacturing and packaging.

At the present time, we are continuing to transition our involvement in specialized aspects of traditional semiconductor markets to the faster-growth but smaller markets for MEMS, power devices and specialized compound semiconductors. However, given the severe economic downturn generally, and in the semiconductor capital equipment industry in particular, achieving wins with customers in these markets has been extremely challenging for us. We expect that orders for our systems will continue to fluctuate from quarter to quarter, and we expect demand to continue to be low and our ability to forecast demand will be limited as the global financial crisis and the resulting recession continues. Although we have over the past several years streamlined our cost structure by headcount reductions, salary and benefit reductions and limits on discretionary spending of all types, our costs for maintaining our research and development efforts and our service and manufacturing infrastructure have remained constant or in some cases increased. We intend to continue our cost-containment measures, including outsourcing certain activities, such as engineering and software development, and maintaining or further reducing our headcount as we strive to improve operational efficiency within this challenging economic environment. However, since we are unable to predict the timing of a stable reemergence of demand for our products and services, we believe that the realization of assets and discharge of liabilities are each subject to significant uncertainty and a substantial doubt exists as to whether we will be able to continue as a going concern. In consideration of these circumstances, we have begun the process of evaluating strategic alternatives for the Company, which may include a merger with or into another company, a sale of all or substantially all of our assets and the liquidation or dissolution of the company, including through a bankruptcy proceeding. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

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 audited consolidated financial statements have been prepared using the going concern basis, which assumes that we will be able to realize our assets and discharge our liabilities in the normal course of business for the foreseeable future. However, it is not possible to predict when our business and results of operations will improve in light of the current economic downturn that continues to dramatically affect our industry. Therefore, the realization of assets and discharge of liabilities are each subject to significant uncertainty. Accordingly, substantial doubt exists as to whether we will be able to continue as a going concern. If the going concern basis is not appropriate in future filings, adjustments will not be necessary to the carrying amounts and/or classification of assets and liabilities in our consolidated financial statements included in such filings.

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, Accounting 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

The Company has adopted several stock plans that provide for issuance of equity instruments to the Company's employees and non-employee directors. The Company's plans include incentive and non-statutory stock options and restricted stock awards and restricted stock units ("RSUs"). Stock options and RSUs 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. On occasion RSUs may vest on the achievement of specific performance targets. The Company also has an employee stock purchase plan (an "ESPP") that allows qualified employees to purchase Company shares at 85% of the lower of the common stock's market value on specified dates. The stock-based compensation for our ESPP was determined using the Black-Scholes option pricing model and the provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), Share Based Payment, ("SFAS 123R").

Accounts Receivable - Allowance for Sales Returns and Doubtful Accounts

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 June 30, 2009 two customers accounted for approximately 35% of the accounts receivable balance. As of June 30, 2008 two customers accounted for approximately 60% 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 June 30, 2009 and March 31, 2009 was $626 and $626, respectively. During the three months ended June 30, 2009, and June 30, 2008, the reserve was reduced by $0 and $4, 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. During the fourth quarter of 2009, we reviewed our long-lived assets for indicators of impairment in accordance with SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. Based on reduced estimates of future revenues and future negative cash flow, we identified a potential indicator of impairment. No impairment charge was recorded for the three months ended June 30, 2009. The company recorded an impairment charge, related to intangibles, of $497 for the fiscal year ended 2009. No impairment charges were recorded for the year ended 2008.

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 data for the three months ended
June 30, 2009 and 2008 as a percentage of revenue:


                                   Three Months Ended
                                        June 30,
                                    2009          2008

Revenue                               100.0 %      100.0 %
Cost of revenue                        91.4 %       50.8 %
Gross profit                            8.6 %       49.2 %
Operating expenses:
Research and development              114.6 %       24.0 %
Sales and marketing                    65.0 %       17.8 %
General and administrative            107.1 %       28.2 %
Total operating expenses              286.7 %       70.0 %
Operating loss                       (278.1 %)     (20.8 %)
Other income (expense), net            32.7 %        4.0 %
Loss before income tax benefit       (245.4 %)     (16.8 %)
Tax Expense                            (4.8 %)        -- %
Net loss                             (240.6 %)     (16.8 %)

The following table sets forth certain financial items for the three months ended June 30, 2009 and 2008:

                                                Three Months Ended
                                                     June 30,
                                                 2009          2008

Revenue                                       $     1,083     $ 4,729
Cost of revenue                                       990       2,402
Gross profit                                           93       2,327
Operating expenses:
Research and development expenses                   1,241       1,136
Sales and marketing expenses                          704         843
General and administrative expenses                 1,160       1,330
Total operating expenses                            3,105       3,309
Operating loss                                     (3,012 )      (982 )
Other income (expense), net                           354         190
Loss before income tax benefit                     (2,658 )      (792 )
Income tax benefit                                    (51 )         -
Net loss                                      $    (2,607 )   $  (792 )

Net loss per share:
Basic                                         $     (0.31 )   $ (0.11 )
Diluted                                       $     (0.31 )   $ (0.11 )

Revenue

Revenue of $1,083 for the three months ended June 30, 2009 decreased by $3,646 from revenue of $4,729 for the three months ended June 30, 2008, representing a 77% decrease. The revenue decrease was due principally to the number and mix of systems sold and the global economic recession that dramatically impacted our industry. Revenue for the three months ended June 30, 2009 was mainly from the sale of one new Endeavor system. Revenue for the three months ended June 30, 2008 was mainly from the sale of one used Advanced Etch and one used Endeavor.

As a percentage of total revenue for the three months ended June 30, 2009 international sales was approximately 41%. International sales as a percentage of total revenue for the three months ended June 30, 2008 was approximately 22%. The increase in international sales as a percentage of revenue can be attributed to fewer systems sold. The Company typically sells more systems in international markets. Although the systems sold in the three months ended June 30, 2008 were domestic sales, we believe that international sales will continue to represent a significant portion of our future revenue.

Gross Profit

Gross profit of $93 for the three months ended June 30, 2009 decreased by $2,234 from gross profit of $2,327 for the three months ended June 30, 2008, representing a 96% decrease. The decrease in the gross margin was attributable to the number of systems sold and product mix. Our gross profit margin for the three months June 30, 2009 was 9% compared to 49% for the same period last year. The principle reason for the decreased margin was unabsorbed overhead.

Our gross profit as a percentage of revenue has been, and will continue to be, affected by a variety of factors, including the mix and average selling prices of systems sold and the costs to manufacture, service and support new product introductions and enhancements.

Future gross profit and gross margin are highly dependent on the level and product mix included in net revenues. This includes the mix of sales between lower and higher margin products. Accordingly, we are not able to predict future gross profit levels or gross margins with certainty. However, gross profit improvement is one of our highest priorities. We believe that the completion of the integration of our new product line and the results of our expense reduction efforts will begin to exhibit themselves in gross profit improvements, especially as we expect our sales volume to increase.

Research and Development

Research and development ("R&D") expenses consist primarily of salaries, prototype material and other costs associated with our ongoing systems and process technology development, applications and field process support efforts. The spending increase of $105 for the three months ended June 30, 2009 compared to the three months ended June 30, 2008 resulted primarily from an increase in the amortization and depreciation costs of DRIE assets and intangibles and legal fees for patent maintenance all primarily related to the AMMS acquisition. This increase was offset by a decrease in employee related expenses and R&D project material costs. There have not been any engineering reimbursements during the three months ended June 30, 2009.

Sales and Marketing

Sales and marketing expenses consist primarily of salaries, commissions, trade show promotion and travel and living expenses associated with those functions. The decrease of $139 in sales and marketing spending for the three months ended June 30, 2009, as compared to the same periods in 2008 was primarily due to the decrease of sales commission for systems over the same period last year.

General and Administrative

General and administrative expenses consist of salaries, legal, accounting and related administrative services and expenses associated with general management, finance, information systems, human resources and investor relation's activities. The decrease of $170 for the three months ended June 30, 2009 as compared to the three months ended June 30, 2008 was primarily due to decreases in stock related compensation expense and payroll costs offset by an increase in legal expenses.

Other Income (Expense), net

Other income (expense), net consists of interest income, other income, gains and losses on foreign exchange and gain and losses on the disposal of fixed assets. For the three months ended June 30, 2009 over the three months ended June 30, 2008, other income (expense), net increased by $164 primarily due to the change in fair value of the common stock warrant liability pursuant to the adoption of EITF 07-05.

Contractual Obligation

The following summarizes our contractual obligations at June 30, 2009, and the
effect such obligations are expected to have on our liquidity and cash flows in
future periods (in thousands).


Contractual obligations:                          Less than                                         After
                                    Total          1 Year         1-3 Years       3-5 Years        5 Years
Non-cancelable operating lease
obligations                       $      778     $       528     $       233     $        17     $          -

Certain of our sales contracts include provisions under which customers would be indemnified by us in the event of, among other things, a third party claim against the customer for intellectual property rights infringement related to our products. There are no limitations on the maximum potential future payments under these guarantees. We have accrued no amounts in relation to these provisions as no such claims have been made and we believe we have valid, enforceable rights to the intellectual property embedded in its products.

Liquidity and Capital Resources

For the three months ended June 30, 2009, we financed our operations from existing cash on hand. In fiscal 2009 we financed our operations through net cash provided by operations. The primary significant changes in our cash flow statement for the three months ended June 30, 2009 were decreases in accounts receivable and stock compensation expense and increased depreciation and amortization expense offset by our net loss of $2,607 and increase in inventories. The Company increased both inventories and intangible assets as a result of the AMMS acquisition and in anticipation of manufacturing for the new product line.

Net cash used in operations in the period ending June 30, 2009 was $1,832, primarily due to our net loss of $2,607 and our increase in inventory. This was offset by decreases in accounts receivable, accrued expenses, and product warranty. Net cash used in operations in the period ending June 30, 2008 was $927, due primarily to the net loss of $792. This was offset by decreases in accounts receivable, accrued expenses, and product warranty.

Net cash used in investing activities totaled $183 and $158 for the periods ending June 30, 2009 and 2008, respectively. In both periods, net cash used in investing activities was primarily for capital expenditures principally for demonstration equipment, leasehold improvements and to acquire design tools, analytical equipment and computers.

The consolidated financial statements contemplate the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. We incurred net losses of $2,607 and $792 for the three months ended June 30, 2009 and 2008, respectively. We used cash flows from operations of $1,832 and $927 for the three months ended June 30, 2009 and 2008, respectively. We believe that our outstanding balances, combined with continued cost containment will be adequate to fund operations through fiscal year 2010. Our business is dependent upon the sales of our capital equipment, and projected sales may not materialize and unforeseen costs may be incurred. If the projected sales do not materialize, we will need to reduce expenses further and/or raise . . .