The 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 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 consolidated financial statements. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, marketable securities, share-based compensation, warranty obligations, self-insured healthcare claims, income taxes, and long-lived assets. 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 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 consider certain accounting policies related to revenue recognition and allowance for doubtful accounts, inventory valuation, valuation of marketable securities, share-based compensation, warranty costs, self-insured health insurance costs, accounting for income taxes, and valuation of long-lived assets to be critical policies due to the estimates and judgments involved in each.

Revenue Recognition and Allowance for Doubtful Accounts

We recognize revenue based on guidance provided in SEC Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition" and in accordance with the Emerging Issues Task Force ("EITF") Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, our price is fixed or determinable, and collectibility is reasonably assured. We recognize revenue on our standard products when title passes to the customer upon shipment. While our standard products generally require installation, the installation is considered a perfunctory performance obligation. Standard products do not have customer acceptance criteria. Generally, software is a component of our standard product and, as such, is not separately recognized as revenue. We have standard rights of return for defective products that we account for as a warranty provision under Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies." We do not have any price protection agreements or other post shipment obligations. For custom equipment where customer acceptance is part of the sales agreement, revenue is recognized when the customer has accepted the product. In cases where custom equipment does not have customer acceptance as part of the sales agreement, we recognize revenue upon shipment as long as the system meets the specifications as agreed upon with the customer. Certain transactions have multiple deliverables, with the deliverables clearly defined. To the extent that the secondary deliverables are other than perfunctory, we recognize the revenue on each deliverable, if separable, or on the completion of all deliverables, if not separable, all in a manner consistent with SAB No. 104 and EITF 00-21. Standalone software products are recognized as revenue when they are shipped. Revenue generated from development contracts are recorded on a cost-plus basis in the period services are rendered.

Certain customer transactions include payment terms whereby we receive a partial payment of the total order amount prior to the related sale being recognized in our financial statements. These advance payments are included in accrued progress payments and deferred revenue in the consolidated balance sheet. Generally, these progress payments relate to orders for custom equipment that require a lengthy build cycle and, in some cases, acceptance by the customer. We may negotiate payment terms with these customers on these particular orders and secure certain payments prior to or on shipment of the equipment. These payments remain in accrued progress payments and deferred revenue until our applicable revenue recognition criteria have been met.

We maintain an allowance for doubtful accounts based on a continuous review of customer accounts, payment patterns, and specific collection issues. We perform on-going credit evaluations of our customers and do not require collateral from our customers. For many of our international customers, we require an irrevocable letter of credit from our customer before a shipment is made. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required.

Inventories are valued at the lower of cost or market, cost being determined on a first-in, first-out basis. Management evaluates the need to record adjustments for impairment of inventory on a monthly basis. Our policy is to assess the valuation of all inventories, including raw materials, work-in-process, and finished goods. Obsolete inventory or inventory in excess of management's estimated future usage is written down to its estimated market value, if less than its cost. Contracts with fixed prices are evaluated to determine if estimated total costs will exceed revenues. A loss provision is recorded when the judgment is made that actual costs incurred plus estimated costs remaining to be incurred based on management's estimates will exceed total revenues from the contract. Inherent in the estimates of market value are management's estimates related to current economic trends, future demand for our products, and technological obsolescence. Management estimates future product sales and service requirements, and evaluates technological changes and other possible uses to determine if inventory is excess or obsolete. If actual market conditions are different than those projected by management, additional inventory adjustments negatively or positively affecting earnings may be required.

Other Than Temporary Impairment of Marketable Securities

Marketable securities have been primarily classified as held-to-maturity, which requires them to be carried at amortized cost. We also have certain securities that are classified as available-for-sale and trading. Management evaluates the need to record adjustments for impairment of marketable securities on a quarterly basis. Marketable securities with unrealized depreciation in fair value for twelve or more consecutive months and other securities with unrealized losses are reviewed to determine whether the decline in fair value is other than temporary. Investment ratings, company-specific events, general economic conditions, and other reasons are evaluated in determining if the decline in fair value is other than temporary. If it is judged that a decline in fair value is other than temporary, the marketable security is valued at the current fair value and an impairment charge is reflected in earnings.

Share-Based Compensation

We calculate share-based compensation expense in accordance with SFAS 123(R), "Share-Based Payment (as amended)" using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, dividend yield, and forfeiture rate. The determination of these assumptions is based on past history and future expectations, and is subject to a high level of judgment. To the extent any of the assumptions were to change from year to year, the fair value of new option grants may vary significantly.

Warranty Costs

We provide for the estimated cost of product warranties at the time revenue is recognized. We consider historical warranty costs actually incurred and specifically identified circumstances to establish the warranty liability. The warranty liability is reviewed on a quarterly basis. Should actual costs differ from management's estimates, revisions to the estimated warranty liability would be required. A one percent change in actual costs would have an immaterial impact on our financial condition and results of operations.

Accounting for Income Taxes

Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and operating loss and tax credit carryforwards. SFAS No. 109, "Accounting for Income Taxes," requires the establishment of a valuation allowance to reflect the likelihood of the realization of deferred tax assets. We record a valuation allowance to reduce our deferred tax assets to an estimated realizable amount based on historical and forecasted results. Management has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. In fiscal 2009, management determined that it is more likely than not that we would not be able to realize our deferred tax assets in the future and an adjustment to record a full valuation allowance was charged to income tax expense. Should management determine that it would be able to realize all or part of its net deferred tax assets in the future, an adjustment to the valuation allowance would increase income in the period such determination was made. Our effective tax rate may vary from period to period based on changes to the valuation allowance, changes in pre-tax income between jurisdictions that have higher or lower tax rates, changes to federal, state, or foreign tax laws, and deductibility of certain costs and expenses by jurisdiction.

Valuation of Long-Lived Assets

In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the carrying value of intangible assets and other long-lived assets is reviewed on a regular basis for the existence of facts or circumstances, both internally and externally, that may suggest impairment. Some factors we consider important, which could trigger the impairment review, include a significant decrease in the market value of an asset, a significant change in the extent or manner in which an asset is used, a significant adverse change in the business climate that could affect the value of an asset, an accumulation of costs for an asset in excess of the amount originally expected, a current period operating loss or cash flow decline combined with a history of operating loss or cash flow uses or a projection that demonstrates continuing losses, and a current expectation that, it is more likely than not, a long-lived asset will be disposed of at a loss before the end of its estimated useful life.

If one or more of such facts or circumstances exist, we evaluate the carrying value of long-lived assets to determine if an impairment exists based upon estimated undiscounted future cash flows over the remaining useful life of the assets and comparing that value to the carrying value of the assets. If the carrying value of the assets is greater than the estimated future cash flows, the assets are written down to the estimated fair value. We determine the estimated fair value of the assets based on a current market value of the assets. If a current market value is not readily available, a projected discounted cash flow method is applied using a discount rate determined by management to be commensurate with the risk inherent in the current business model. Our cash flow estimates contain management's best estimates, using appropriate and customary assumptions and projections at the time. During fiscal 2009, we recorded impairment charges on property, plant, and equipment, intangible assets, and marketable securities.

Health Insurance

We are self-insured for the majority of our group health insurance. We rely on claims experience in determining an adequate liability for claims incurred, but not reported. To the extent actual claims exceed estimates, we may be required to record additional expense. A one percent change in actual claims would have an immaterial impact on our financial condition and results of operations.

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. Optical instruments products encompass non-contact optical measurement instruments. Optics products consist of high performance macro-optics components, optical coatings, and optical system assemblies. We conduct the majority of our manufacturing in our 153,500 square foot facility in Middlefield, Connecticut and a 22,560 square foot leased facility in Tucson, Arizona.

The worldwide economic recession has had a severe impact on our orders, sales, and net results. As a result of the economic downturn, among other things, we have reevaluated our strategic initiatives and our overall business strategy and operations. We are focusing sales, marketing, and research and development efforts on our core metrology and optics technologies, including the potential for strategic alternatives, which could include partnerships, joint ventures, divestitures, or alliances similar to the agreement described below.

On June 17, 2009, ZYGO and Nanometrics Incorporated ("Nanometrics") announced that Nanometrics has purchased inventory and certain other assets relating to ZYGO's Semiconductor Solutions business for approximately $3.4 million and that the two companies have entered into a supply agreement. Under an exclusive OEM supply agreement, ZYGO will provide interferometer sensors to Nanometrics for incorporation into the Unifire™ line of products as well as Nanometrics' family of automated metrology systems. Nanometrics will assume all inventory, backlog and customer sales and support responsibilities and ZYGO will provide measurement sensors for integration by Nanometrics. In addition to the applications currently addressed by Nanometrics and ZYGO products, the business partnership allows for the joint development of additional technology solutions targeted at the semiconductor and related industries. This sale and supply agreement enables us to accomplish our goal of accelerating the commercial deployment and market penetration of our core interferometer technology into the worldwide semiconductor industry without the investment associated with system integration, distribution, applications and support.

In response to the decline in sales and orders, we have taken and continue to take various permanent and temporary actions to mitigate the effects on our company of the downturn in the global economy, including reductions in work force, salary adjustments, unpaid furloughs, suspension of our matching 401(k) program, and a reduction in director fees. These actions are expected to save us in excess of over $17 million on an annualized basis. We continue to be mindful of our cash position and to investigate strategic alternatives which may be beneficial to our company.

Our backlog at June 30, 2009 was $38.3 million, a decrease of $34.0 million from June 30, 2008. Orders were $15.3 million in the fourth quarter of fiscal 2009. Orders for the fourth quarter from the Company's Metrology segment accounted for 71% of the orders received, with the Optics segment accounting for the remaining 29%. For fiscal 2009, orders were $82.0 million, a decrease of 48% over fiscal 2008. As a result of a decline in orders related to our PPS product line, which supplies our lithography customers, we evaluated our assets supporting this product for potential impairment. We recorded an impairment charge during the fourth quarter of fiscal 2009 against intangible assets of $2.9 million and property, plant, and equipment of $4.0 million. Based on our backlog and order levels, we also evaluated our inventory levels in our various product lines. We recorded inventory reserves of $5.7 million against various product lines. Indications received from our customers lead us to believe that our order levels have stabilized. While this does not mean a rapid upturn in orders is imminent, it does allow us to focus our attention on growth and concentrate our efforts on our core metrology and optics technologies. We are experiencing a greater than expected order demand in China through our joint venture for our metrology products. We still expect a continued depression in lithography sales, especially to our largest customer.

On February 28, 2008, we acquired certain assets of Solvision, Inc. ("Solvision"), a Canadian-based company, including the shares of its Singapore subsidiary. In fiscal 2009, the final valuation was completed resulting in a final purchase price of $4.2 million in cash (net of cash received of $0.1 million). In addition, the Company had also loaned to Solvision $1.5 million of which substantially none of the loan was recouped as part of the purchase price allocation based on asset values. The Solvision acquisition is currently included in our Metrology Solutions Division as the vision systems business unit. During the third quarter of fiscal 2009 we recorded impairment charges against vision systems's intangible assets of $2.1 million.

Fiscal 2009 Compared with Fiscal 2008

Net Sales


                                                    Year Ended
                                ---------------------------------------------------
                                 June 30,     Net Sales     June 30,     Net Sales
        (Dollars in millions)      2009           %           2008           %
        ---------------------   ----------   -----------   ----------   -----------
        Segment
        Metrology               $     84.1            73 % $    105.7            66 %
        Optics                        31.9            27 %       53.3            34 %
                                -- -------   --- -------   -- -------   --- -------
        Total                   $    116.0           100 % $    159.0           100 %
                                -- -------   --- -------   -- -------   --- -------

Net sales in the Metrology segment decreased 20% in fiscal 2009 as compared with the prior year. The decrease in net sales of $21.6 million within the Metrology segment was primarily due to sales volume decreases in lithography of $14.8 million, instrument sales of $13.4 million, and semiconductor sales of $0.7 million, partially offset by an increase in display sales of $6.8 million and in vision systems sales of $0.6 million. The general economic recession has led to low sales volume. We believe our products are still well accepted in the markets we serve. The lithography market is expected to continue to be depressed for at least the next six months.

Net sales in the Optics segment decreased 40% in fiscal 2009 as compared with the prior year. The decrease in net sales of $21.4 million within the Optics segment was due to a decrease in volume of contract manufacturing of $11.1 million and laser and precision optics of $10.3 million. The decrease in all optics areas generally is related to a decline in the orders from existing customers due primarily to the economic recession.

Approximately 76% of all fiscal 2009 net sales were denominated in U.S. dollars, the same percentage of sales we experienced in fiscal 2008. Significant changes in the values of foreign currencies relative to the value of the U.S. dollar can influence the sales of our products in export markets, as would changes in the general economic conditions in those markets.

Gross Profit


                                                    Year Ended
                                 -------------------------------------------------
                                  June 30,    Net Sales     June 30,    Net Sales
         (Dollars in millions)      2009          %           2008          %
         ---------------------   ----------   ----------   ----------   ----------
         Segment
         Metrology               $     27.5           33 % $     50.5           48 %
         Optics                         4.0           13 %       14.3           27 %
                                 -- -------   --- ------   -- -------   --- ------
         Total                   $     31.5           27 % $     64.8           41 %
                                 -- -------   --- ------   -- -------   --- ------

In fiscal 2009, gross profit as a percentage of net sales in the Metrology segment decreased fifteen percentage points as compared with the prior year. This decrease was due primarily to intangible and fixed asset impairments of $5.6 million and inventory reserves of $4.9 million. Excluding these charges, our gross profit as a percentage of sales for the Metrology segment would have been 45%. The decrease from 48% in fiscal 2008 to 45% in fiscal 2009 (excluding $10.5 million of referenced charges) is due to lower sales volume. Gross profit as a percentage of sales in the Optics segment decreased by fourteen percentage points for fiscal 2009 as compared with the prior year. This decrease included charges of $1.6 million for fixed asset impairments, restructuring, and severance, which account for 5 percentage points of the change year over year. The remainder of the change is primarily related to underutilization of the factory based on low sales volume. Optics components rely upon a capital intensive production facility and certain expenditures, such as depreciation, cannot be reduced as readily as a labor intensive environment.

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

                                                    Year Ended
                                 -------------------------------------------------
                                  June 30,    Net Sales     June 30,    Net Sales
         (Dollars in millions)      2009          %           2008          %
         ---------------------   ----------   ----------   ----------   ----------
                                 $     51.0           44 % $     38.5           24 %
                                 -- -------   --- ------   -- -------   --- ------

SG&A in fiscal 2009 as compared with fiscal 2008 increased $12.5 million primarily due to increases in general and administration costs of $12.1 million, partially offset by a decrease in selling and marketing activities of $0.4 million. The increase in general and administrative costs included $8.3 million in merger-related expenses, $2.9 million in bad debt reserves, $1.4 in legal accruals, and $0.4 million in severance. Sales and marketing expenses for fiscal 2009 also included

Research, Development, and Engineering Expenses ("RD&E")

                                                    Year Ended
                                 -------------------------------------------------
                                  June 30,    Net Sales     June 30,    Net Sales
         (Dollars in millions)      2009          %           2008          %
         ---------------------   ----------   ----------   ----------   ----------
                                 $     24.7           21 % $     24.3           15 %
                                 -- -------   --- ------   -- -------   --- ------

The increase in RD&E costs in fiscal 2009 was primarily related to intangible asset and fixed asset impairment charges of $2.8 million and $0.2 million in severance costs during the year. Excluding these charges, RD&E for fiscal 2009 would have decreased to $21.7 million. The decrease in RD&E from $24.3 million in fiscal 2008 to $21.7 million (excluding $3.0 million in referenced charges) in fiscal 2009 is primarily due to decreases in our stage metrology ($1.2 . . .