UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

|           |                                                                                          
|---------- | -----------------------------------------------------------------------------------------
|(Mark One)
|          
|x          | QUARTERLY
  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly
period ended December 31, 2005

or

|  |                                                                                           
|- | ------------------------------------------------------------------------------------------
|o | TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition
period from ___________ to ____________

Commission File
Number 0-12944

|                                                                                     |                                       
|------------------------------------------------------------------------------------ | --------------------------------------
|ZYGO
  CORPORATION                                                                  
|                                                                                    
|(Exact name of
  registrant as specified in its charter)                            
|                                                                                     |                                       
|Delaware                                                                             | 06-0864500                            
|                                                                                    
|(State or other jurisdiction of incorporation or
  organization)                     | (I.R.S. Employer
  Identification No.)
|                                                                                     |                                       
|Laurel Brook Road, Middlefield, Connecticut                                          | 06455                                 
|                                                                                    
|(Address of principal executive offices)                                             | (Zip Code)                            
|                                                                                     |                                       
|(860) 347-8506                                                                      
|                                                                                    
|Registrants telephone
  number, including area code                                
|                                                                                    
|N/A                                                                                 
|                                                                                    
|(Former name, former
  address, and former fiscal year, if changed from last report)

Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.

xYESoNO

Indicate by check mark whether the registrant is a
large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of accelerated filer and large accelerated filer in Rule 12b-2 of
the Exchange Act.

|                         |                     |                       
|------------------------ | ------------------- | ----------------------
|Large accelerated filero | Accelerated filer x | Non-accelerated filero

Indicate by check mark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act).

oYES
xNO

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of
the issuers classes of common stock, as of the latest practicable date.

18,057,864 shares of Common Stock, $.10 Par Value,
  at February 1, 2006

1

---



FORWARD LOOKING STATEMENTS

All statements other than statements of historical
fact included in this Form 10-Q Quarterly Report regarding our financial
position, business strategy, plans, anticipated growth rates, and objectives of
management for future operations (as well as these factors as they may apply to
our customers, suppliers, and others with whom we have critical business
relationships) are forward-looking statements. Forward-looking statements are
intended to provide managements current expectations or plans for the future
operating and financial performance based upon information currently available
and assumptions currently believed to be valid. Forward-looking statements can
be identified by the use of words such as anticipate, believe, estimate,
expect, intend, plans, strategy, project, and other words of similar
meaning in connection with a discussion of future operating or financial
performance. Actual results could differ materially from those contemplated by
the forward-looking statements as a result of certain factors. Among the
important factors that could cause actual events to differ materially from
those in the forward-looking statements are fluctuations in capital spending of
our customers, fluctuations in net sales to our major customer, manufacturing
and supplier risks, dependence on new product development, rapid technological
and market change, risks in international operations, dependence on proprietary
technology and key personnel, length of the sales cycle, environmental
regulations, and stock price fluctuations. Further information on potential
factors that could affect our business is described in our reports on file with
the Securities and Exchange Commission, including our Form 10-K, as amended,
for the fiscal year ended June 30, 2005.

2

---



PART I - Financial
Information

Item 1. Financial Statements

CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)(Thousands,
except per share amounts)

|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|------------------------------------------------------------------------------- |  | --------------------------------- | ------ | ------------------------------- | - | ------ | - | ---- | ------ | - | - | ------ | -
|                                                                                |  | Three
  Months Ended December 31, |        | Six Months
  Ended December 31, |  
|                                                                                |  |                                   |        |                                 |  
|                                                                                |  | 2005                              |        | 2004                            |   | 2005   |   | 2004 |       
|                                                                                |  |                                   |        |                                 |   |        |   |      |       
|Net sales                                                                       |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Products                                                                        |  | $                                 | 38,212 |                                 | $ | 33,530 |   | $    | 68,833 |   | $ | 59,413 |  
|Development
  services                                                          |  |                                   | 5,611  |                                 |   | 2,477  |   |      | 9,572  |   |   | 4,172  |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|                                                                                |  |                                   | 43,823 |                                 |   | 36,007 |   |      | 78,405 |   |   | 63,585 |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Cost of goods
  sold                                                            |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Products                                                                        |  |                                   | 22,357 |                                 |   | 21,024 |   |      | 40,619 |   |   | 36,193 |  
|Development
  services                                                          |  |                                   | 4,049  |                                 |   | 1,725  |   |      | 6,954  |   |   | 3,021  |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|                                                                                |  |                                   | 26,406 |                                 |   | 22,749 |   |      | 47,573 |   |   | 39,214 |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Gross profit                                                                    |  |                                   | 17,417 |                                 |   | 13,258 |   |      | 30,832 |   |   | 24,371 |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Selling,
  general, and administrative expenses                                 |  |                                   | 8,159  |                                 |   | 5,723  |   |      | 14,570 |   |   | 11,382 |  
|Research,
  development, and engineering expenses                               |  |                                   | 3,428  |                                 |   | 3,672  |   |      | 6,968  |   |   | 6,880  |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Operating profit                                                                |  |                                   | 5,830  |                                 |   | 3,863  |   |      | 9,294  |   |   | 6,109  |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Other income:                                                                   |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Interest income                                                                 |  |                                   | 411    |                                 |   | 175    |   |      | 828    |   |   | 354    |  
|Miscellaneous
  income, net                                                     |  |                                   | 88     |                                 |   | 243    |   |      | 216    |   |   | 214    |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Total other
  income                                                            |  |                                   | 499    |                                 |   | 418    |   |      | 1,044  |   |   | 568    |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Earnings from
  continuing operations before income taxes and minority interest |  |                                   | 6,329  |                                 |   | 4,281  |   |      | 10,338 |   |   | 6,677  |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Income tax
  expense                                                            |  |                                   | (2,142 | )                               |   | (1,542 | ) |      | (3,665 | ) |   | (2,404 | )
|Minority
  interest                                                             |  |                                   | (360   | )                               |   | (275   | ) |      | (510   | ) |   | (397   | )
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Earnings from
  continuing operations                                           |  |                                   | 3,827  |                                 |   | 2,464  |   |      | 6,163  |   |   | 3,876  |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Discontinued
  TeraOptix operations, net of tax                                 |  |                                   |       |                                 |   | (49    | ) |      |       |   |   | (110   | )
|Charges and
  adjustments on the disposal of TeraOptix, net of tax              |  |                                   |       |                                 |   | (114   | ) |      |       |   |   | (118   | )
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Loss from
  discontinued operations                                             |  |                                   |       |                                 |   | (163   | ) |      |       |   |   | (228   | )
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Net earnings                                                                    |  | $                                 | 3,827  |                                 | $ | 2,301  |   | $    | 6,163  |   | $ | 3,648  |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Basic - Earnings
  (loss) per share:                                            |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Continuing
  operations                                                         |  | $                                 | 0.21   |                                 | $ | 0.14   |   | $    | 0.34   |   | $ | 0.22   |  
|Discontinued
  operations                                                       |  |                                   |       |                                 |   | (0.01  | ) |      |       |   |   | (0.02  | )
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Net earnings                                                                    |  | $                                 | 0.21   |                                 | $ | 0.13   |   | $    | 0.34   |   | $ | 0.20   |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Diluted -
  Earnings (loss) per share:                                          |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Continuing operations                                                           |  | $                                 | 0.21   |                                 | $ | 0.14   |   | $    | 0.34   |   | $ | 0.21   |  
|Discontinued
  operations                                                       |  |                                   |       |                                 |   | (0.01  | ) |      |       |   |   | (0.01  | )
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Net earnings                                                                    |  | $                                 | 0.21   |                                 | $ | 0.13   |   | $    | 0.34   |   | $ | 0.20   |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Weighted average
  shares outstanding:                                          |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Basic shares                                                                    |  |                                   | 18,031 |                                 |   | 17,930 |   |      | 18,022 |   |   | 17,926 |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Diluted shares                                                                  |  |                                   | 18,340 |                                 |   | 18,130 |   |      | 18,225 |   |   | 18,099 |  
|                                                                                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  

See
accompanying notes to consolidated financial statements.

3

---



CONSOLIDATED BALANCE SHEETS
(UNAUDITED) 
(Thousands
of dollars, except share amounts)

|                                                                                     |  |                   |         |                 |   |         |  
|------------------------------------------------------------------------------------ |  | ----------------- | ------- | --------------- | - | ------- | -
|                                                                                     |  | December 31, 2005 |         | June 30,
  2005 |  
|                                                                                     |  |                   |         |                 |  
|Assets                                                                               |  |                   |         |                 |   |         |  
|Current assets:                                                                      |  |                   |         |                 |   |         |  
|Cash and cash
  equivalents                                                          |  | $                 | 13,457  |                 | $ | 20,949  |  
|Marketable
  securities                                                              |  |                   | 20,169  |                 |   | 17,242  |  
|Receivables, net
  of allowance for doubtful accounts of $544 and $663, respectively |  |                   | 30,579  |                 |   | 28,125  |  
|Inventories                                                                          |  |                   | 32,980  |                 |   | 33,727  |  
|Prepaid expenses                                                                     |  |                   | 2,064   |                 |   | 2,140   |  
|Deferred income
  taxes                                                              |  |                   | 9,537   |                 |   | 8,895   |  
|                                                                                     |  |                   |         |                 |   |         |  
|Total current
  assets                                                               |  |                   | 108,786 |                 |   | 111,078 |  
|                                                                                     |  |                   |         |                 |   |         |  
|Marketable
  securities                                                              |  |                   | 23,915  |                 |   | 18,711  |  
|Property, plant,
  and equipment, net                                                |  |                   | 31,540  |                 |   | 31,420  |  
|Deferred income
  taxes                                                              |  |                   | 18,100  |                 |   | 21,476  |  
|Intangible
  assets, net                                                             |  |                   | 5,892   |                 |   | 5,638   |  
|Other assets                                                                         |  |                   | 884     |                 |   | 1,017   |  
|                                                                                     |  |                   |         |                 |   |         |  
|Total
  assets                                                                       |  | $                 | 189,117 |                 | $ | 189,340 |  
|                                                                                     |  |                   |         |                 |   |         |  
|                                                                                     |  |                   |         |                 |   |         |  
|Liabilities
  and Stockholders Equity                                               |  |                   |         |                 |   |         |  
|Current
  liabilities:                                                               |  |                   |         |                 |   |         |  
|Payables                                                                             |  | $                 | 11,212  |                 | $ | 13,510  |  
|Accrued progress
  payments                                                          |  |                   | 18,515  |                 |   | 21,846  |  
|Accrued salaries
  and wages                                                         |  |                   | 5,116   |                 |   | 6,220   |  
|Other accrued
  liabilities                                                          |  |                   | 3,973   |                 |   | 4,738   |  
|Income taxes
  payable                                                               |  |                   | 1,540   |                 |   | 1,510   |  
|                                                                                     |  |                   |         |                 |   |         |  
|Total current
  liabilities                                                          |  |                   | 40,356  |                 |   | 47,824  |  
|                                                                                     |  |                   |         |                 |   |         |  
|Other long-term
  liabilities                                                        |  |                   | 97      |                 |   | 96      |  
|Minority
  interest                                                                  |  |                   | 1,138   |                 |   | 1,249   |  
|Commitments and
  contingencies                                                      |  |                   |         |                 |   |         |  
|                                                                                     |  |                   |         |                 |   |         |  
|Stockholders equity:                                                                |  |                   |         |                 |   |         |  
|Common Stock,
  $.10 par value per share:                                            |  |                   |         |                 |   |         |  
|40,000,000
  shares authorized;                                                      |  |                   |         |                 |   |         |  
|18,481,941
  shares issued (18,423,026 at June 30, 2005);                            |  |                   |         |                 |   |         |  
|18,034,736
  shares outstanding (17,975,821 at June 30, 2005)                        |  |                   | 1,848   |                 |   | 1,842   |  
|Additional paid-in
  capital                                                         |  |                   | 143,854 |                 |   | 142,111 |  
|Retained
  earnings                                                                  |  |                   | 9,977   |                 |   | 3,814   |  
|Accumulated
  other comprehensive income (loss):                                     |  |                   |         |                 |   |         |  
|Currency
  translation effects                                                       |  |                   | (2,891  | )               |   | (2,341  | )
|Net unrealized
  gain on marketable securities                                       |  |                   | 25      |                 |   | 32      |  
|                                                                                     |  |                   |         |                 |   |         |  
|                                                                                     |  |                   | 152,813 |                 |   | 145,458 |  
|Less treasury
  stock, at cost (447,205 shares)                                      |  |                   | 5,287   |                 |   | 5,287   |  
|                                                                                     |  |                   |         |                 |   |         |  
|Total
  stockholders equity                                                         |  |                   | 147,526 |                 |   | 140,171 |  
|                                                                                     |  |                   |         |                 |   |         |  
|Total
  liabilities and stockholders equity                                         |  | $                 | 189,117 |                 | $ | 189,340 |  
|                                                                                     |  |                   |         |                 |   |         |  

See accompanying notes to consolidated financial
statements.

4

---



CONSOLIDATED STATEMENTS OF CASH FLOWS 
(UNAUDITED)
(Thousands
of dollars)

|                                                                                             |  |                                 |         |      |   |        |  
|-------------------------------------------------------------------------------------------- |  | ------------------------------- | ------- | ---- | - | ------ | -
|                                                                                             |  | Six Months
  Ended December 31, |        
|                                                                                             |  |                                 |        
|                                                                                             |  | 2005                            |         | 2004 |  
|                                                                                             |  |                                 |         |      |  
|Cash provided by
  operating activities:                                                     |  |                                 |         |      |   |        |  
|Net earnings                                                                                 |  | $                               | 6,163   |      | $ | 3,648  |  
|                                                                                             |  |                                 |         |      |   |        |  
|Adjustments to
  reconcile net earnings to cash provided by (used for) operating activities: |  |                                 |         |      |   |        |  
|Loss from
  discontinued operations                                                          |  |                                 |        |      |   | 228    |  
|Depreciation and
  amortization                                                              |  |                                 | 3,004   |      |   | 3,014  |  
|Deferred income
  taxes                                                                      |  |                                 | 2,734   |      |   | 2,323  |  
|Compensation
  cost related to share-based payments arrangements                             |  |                                 | 1,190   |      |   |       |  
|Excess tax
  benefits from share-based payment arrangements                                  |  |                                 | (14     | )    |   |       |  
|Minority
  interest                                                                          |  |                                 | 510     |      |   | 397    |  
|Other, net                                                                                   |  |                                 | 93      |      |   | 209    |  
|Changes in
  operating accounts:                                                             |  |                                 |         |      |   |        |  
|Receivables                                                                                  |  |                                 | (2,335  | )    |   | 2,830  |  
|Inventories                                                                                  |  |                                 | 841     |      |   | (9,499 | )
|Prepaid expenses                                                                             |  |                                 | 76      |      |   | 402    |  
|Accounts
  payable, accrued expenses, and taxes payable                                      |  |                                 | (8,018  | )    |   | 3,661  |  
|                                                                                             |  |                                 |         |      |   |        |  
|Net cash
  provided by continuing operations                                                 |  |                                 | 4,244   |      |   | 7,213  |  
|Net cash used
  for discontinued operations                                                  |  |                                 |        |      |   | (125   | )
|                                                                                             |  |                                 |         |      |   |        |  
|Net cash
  provided by operating activities                                                  |  |                                 | 4,244   |      |   | 7,088  |  
|                                                                                             |  |                                 |         |      |   |        |  
|Cash used for
  investing activities:                                                        |  |                                 |         |      |   |        |  
|Additions to
  property, plant, and equipment, net                                           |  |                                 | (3,027  | )    |   | (6,015 | )
|Purchase of
  marketable securities                                                          |  |                                 | (19,711 | )    |   | (4,019 | )
|Additions to
  intangibles and other assets                                                  |  |                                 | (487    | )    |   | (515   | )
|Proceeds from
  the maturity of marketable securities                                        |  |                                 | 11,538  |      |   | 2,100  |  
|                                                                                             |  |                                 |         |      |   |        |  
|Net cash used
  for investing activities                                                     |  |                                 | (11,687 | )    |   | (8,449 | )
|                                                                                             |  |                                 |         |      |   |        |  
|Cash provided by
  (used for) financing activities:                                          |  |                                 |         |      |   |        |  
|Employee stock
  purchase                                                                    |  |                                 | 307     |      |   | 339    |  
|Exercise of
  employee stock options                                                         |  |                                 | 252     |      |   | 139    |  
|Excess tax
  benefits from share-based payment arangements                                   |  |                                 | 14      |      |   |       |  
|Dividend payment
  to minority interest                                                      |  |                                 | (622    | )    |   |       |  
|                                                                                             |  |                                 |         |      |   |        |  
|Net cash provided
  by (used for) financing activities                                       |  |                                 | (49     | )    |   | 478    |  
|                                                                                             |  |                                 |         |      |   |        |  
|Net decrease in
  cash and cash equivalents                                                  |  |                                 | (7,492  | )    |   | (883   | )
|Cash and cash
  equivalents, beginning of period                                             |  |                                 | 20,949  |      |   | 17,462 |  
|                                                                                             |  |                                 |         |      |   |        |  
|Cash and cash
  equivalents, end of period                                                   |  | $                               | 13,457  |      | $ | 16,579 |  
|                                                                                             |  |                                 |         |      |   |        |  

See accompanying notes to
consolidated financial statements

5

---



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Dollars in
thousands, except for per share amounts)

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES

Principles of Consolidation and Presentation

Zygo
Corporation is a worldwide developer and supplier of high performance metrology
instruments, high precision optics, optical assemblies, and automation for the
semiconductor and industrial markets. The accompanying consolidated financial
statements include the accounts of Zygo Corporation and its subsidiaries (ZYGO,
we, us, our or Company). All material transactions and accounts with
the subsidiaries have been eliminated from the consolidated financial
statements. The results of operations for the three and six months ended
December 31, 2005 are not necessarily indicative of the results to be expected
for the full fiscal year.


The
Consolidated Balance Sheet at December 31, 2005, the Consolidated Statements of
Operations for the three and six months ended December 31, 2005 and 2004, and
the Consolidated Statements of Cash Flows for the six months ended December 31,
2005 and 2004 are unaudited but, in managements opinion, include all
adjustments, consisting only of normal recurring accruals, necessary for a fair
presentation of the results of the interim periods. The accompanying
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes included in our June 30, 2005
Annual Report on Form 10-K, as amended, including items incorporated by
reference therein.

Earnings Per Share

Basic and
diluted earnings per share are calculated in accordance with Statement of
Financial Accounting Standards (SFAS) No. 128, Earnings Per Share.The
following table sets forth the reconciliation of basic weighted average shares
outstanding and diluted weighted average shares outstanding:

|                                                         |  |                                 |            |                                 |  |            |  |      |            |  |  |            | 
|-------------------------------------------------------- |  | ------------------------------- | ---------- | ------------------------------- |  | ---------- |  | ---- | ---------- |  |  | ---------- | 
|                                                         |  | Three Months Ended December 31, |            | Six Months
  Ended December 31, | 
|                                                         |  |                                 |            |                                 | 
|                                                         |  | 2005                            |            | 2004                            |  | 2005       |  | 2004 |           
|                                                         |  |                                 |            |                                 |  |            |  |      |           
|Basic weighted average
  shares outstanding              |  |                                 | 18,030,783 |                                 |  | 17,929,640 |  |      | 18,022,006 |  |  | 17,926,471 | 
|Dilutive effect of stock
  options and restricted shares |  |                                 | 308,925    |                                 |  | 199,903    |  |      | 203,237    |  |  | 172,265    | 
|                                                         |  |                                 |            |                                 |  |            |  |      |            |  |  |            | 
|Diluted weighted average
  shares outstanding            |  |                                 | 18,339,708 |                                 |  | 18,129,543 |  |      | 18,225,243 |  |  | 18,098,736 | 
|                                                         |  |                                 |            |                                 |  |            |  |      |            |  |  |            | 

Share-Based Payments

In December
2004, the Financial Accounting Standards Board (FASB) issued SFAS 123(R),
Share-Based Payment (as amended). SFAS No. 123(R) eliminates the alternative
to use the intrinsic value method of accounting that was provided in SFAS No.
123, which generally resulted in no compensation expense recorded in the
financial statements related to the issuance of equity awards to employees and
directors. SFAS No. 123(R) requires that the cost resulting from all
share-based payment transactions be recognized in the financial statements.
SFAS No. 123(R) establishes fair value as the measurement objective in
accounting for share-based payment arrangements and requires all companies to
apply a fair-value-based measurement method in accounting generally for all
share-based payment transactions with employees.

On July 1,
2005, we adopted SFAS No. 123(R) using a modified prospective method resulting
in the recognition of share-based compensation expense for the three and six
months ended December 31, 2005 of $524 and $764, net of related tax expense of
$292 and $426, respectively. Prior period amounts have not been restated. Under
this application, we are required to record compensation expense for all awards
granted after the date of adoption and for the unvested portion of previously
granted awards that remain outstanding at the date of adoption. In addition, we
made changes to our employee stock purchase plan for periods beginning after
July 1, 2005, which rendered the plan non-compensatory in accordance with SFAS
No. 123(R).

6

---



Prior to the
adoption of SFAS No. 123(R), we applied Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations in accounting for our plans. The following table details the
effect on net earnings and earnings per share had compensation expense for the
employee share-based awards been recorded in the three and six months ended
December 31, 2004 based on the fair value method under SFAS No. 123.

|                                                                                                                      |  |                                           |       |                                         |   |        |  
|--------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------- | ----- | --------------------------------------- | - | ------ | -
|                                                                                                                      |  | Three Months
  Ended
  December 31
  2004 |       | Six Months
  Ended
  December 31
  2004 |  
|                                                                                                                      |  |                                           |       |                                         |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|Net earnings, as reported                                                                                             |  | $                                         | 2,301 |                                         | $ | 3,648  |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|Deduct: Total stock-based compensation expense determined under fair
  value based method, net of related tax effects |  |                                           | (383  | )                                       |   | (1,636 | )
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|Pro forma net earnings                                                                                                |  | $                                         | 1,918 |                                         | $ | 2,012  |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|Earnings per share:                                                                                                   |  |                                           |       |                                         |   |        |  
|Basic - as reported                                                                                                   |  | $                                         | 0.13  |                                         | $ | 0.20   |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|Basic - pro forma                                                                                                     |  | $                                         | 0.11  |                                         | $ | 0.11   |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|Diluted - as reported                                                                                                 |  | $                                         | 0.13  |                                         | $ | 0.20   |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  
|Diluted - pro forma                                                                                                   |  | $                                         | 0.11  |                                         | $ | 0.11   |  
|                                                                                                                      |  |                                           |       |                                         |   |        |  

Share Based Compensation Plans

Zygo has two
share-based compensation plans, which are described hereafter. The Zygo
Corporation 2002 Equity Incentive Plan (2002 Plan) permits the granting of
stock options to purchase shares of common stock and the granting of restricted
stock up to a total of 1,500,000 shares. The exercise price per share of common
stock covered by an option may not be less than the par value per share on the
date of grant, and in the case of an incentive stock option, the exercise price
may not be less than the market value per share on the date of grant. These
options generally vest over a four year period at a rate of 25% each year.
Generally, restricted stock awards have 50% of their restrictions lapse after
three years and the remaining 50% lapse after four years. The 2002 Plan will
expire on August 27, 2012. Pursuant to the terms of the 2002 Plan, the Board of
Directors may also amend the 2002 Plan to authorize the grant of other types of
equity-based awards, without further action by our stockholders. Options issued
to non-employee directors are now issued under this plan. Non-employee
directors are granted fully exercisable options to purchase 6,000 shares of
common stock on an annual basis and each new non-employee director is granted
fully exercisable options to purchase 12,000 shares of common stock on his or
her first day of service, in all instances at the market value per share on the
date of grant.

The Zygo
Corporation Amended and Restated Non-Employee Director Stock Option Plan
(Director Plan) permits the granting of non-qualified options to purchase a
total of 620,000 shares (adjusted for splits) of common stock at prices not
less than the market value of the stock on the date of grant. Under the terms
of the Director Plan, as amended on September 24, 1999, each new non-employee
director (other than a person who was previously an employee of ZYGO or any of
our subsidiaries) was granted an option to purchase 8,000 shares of common
stock, generally, on his or her first day of service as a non-employee
director; and each other non-employee director was granted an option to
purchase 3,000 shares of common stock on an annual basis. All options were
fully exercisable on the date of grant and had a 10-year term. The Director
Plan, as amended, will expire on November 17, 2009. The Company ceased granting
options under this plan in fiscal 2003 and does not intend to grant further
options under the Director Plan.

7

---



We use 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 the option, stock price volatility, risk-free interest
  rate, dividend yield, exercise price, and forfeiture rate. Many of these assumptions
  are judgmental and highly sensitive in the determination of compensation expense.
  Under the assumptions indicated below, the weighted-average fair value of stock
  option grants for the three and six months ended December 31, 2005 were $6.79
  and $5.41, respectively. The weighted-average fair value of stock option grants
  for the three and six months ended December 31, 2004 were $6.25 and $5.86, respectively.
  The table below indicates the key assumptions used in the option valuation calculations
  for options granted in the three and six months ended December 31, 2005 and
  2004 and a discussion of our methodology for developing each of the assumptions
  used in the valuation model:

|                          |  |                                   |           |                                 |  |           |  |      |           |  |  |           | 
|------------------------- |  | --------------------------------- | --------- | ------------------------------- |  | --------- |  | ---- | --------- |  |  | --------- | 
|                          |  | Three
  Months Ended December 31, |           | Six Months
  Ended December 31, | 
|                          |  |                                   |           |                                 | 
|                          |  | 2005                              |           | 2004                            |  | 2005      |  | 2004 |          
|                          |  |                                   |           |                                 |  |           |  |      |          
|Term                      |  |                                   | 4.1 Years |                                 |  | 4.5 Years |  |      | 4.1 Years |  |  | 4.5 Years | 
|Volatility                |  |                                   | 52.9%     |                                 |  | 71.0%     |  |      | 52.9%     |  |  | 71.0%     | 
|Dividend
  Yield          |  |                                   | 0.0%      |                                 |  | 0.0%      |  |      | 0.0%      |  |  | 0.0%      | 
|Risk-free
  interest rate |  |                                   | 4.4%      |                                 |  | 3.2%-3.4% |  |      | 3.9%-4.4% |  |  | 3.2%-3.5% | 
|Forfeiture
  rate         |  |                                   | 10.6%     |                                 |  | 4.0%      |  |      | 10.6%     |  |  | 4.0%      | 

Term - This is the
period of time over which the options granted are expected to remain
outstanding. Options granted have a maximum term of ten years. An increase in
the expected term will increase compensation expense.

Volatility- This is
a measure of the amount by which a price has fluctuated or is expected to
fluctuate. Volatilities are based on implied volatilities from traded options
of ZYGOs shares, historical volatility of ZYGOs shares, and other factors,
such as expected changes in volatility arising from planned changes in ZYGOs
business operations. An increase in the expected volatility will increase
compensation expense.

Risk-Free Interest Rate
- This is the U.S. Treasury rate for the week of the grant having a term equal
to the expected term of the option. An increase in the risk-free interest rate
will increase compensation expense.

Dividend Yield - We
did not make any dividend payments during the last five fiscal years and we
have no plans to pay dividends in the foreseeable future. An increase in the
dividend yield will decrease compensation expense.

Forfeiture Rate -
This is the estimated percentage of options granted that are expected to be
forfeited or canceled before becoming fully vested. An increase in the
forfeiture rate will decrease compensation expense.

The following
table summarizes information about our stock options granted under our
share-based compensation plans for the six months ended December 31, 2005.
Included in the information below are outstanding options from the Zygo
Corporation Amended and Restated Non-Qualified Stock Option Plan which expired
in fiscal 2003, to the extent the options remain available for exercise.

|                                         |  |                     |           |                                     |   |                                                   |  |                                              |      |  |   |       | 
|---------------------------------------- |  | ------------------- | --------- | ----------------------------------- | - | ------------------------------------------------- |  | -------------------------------------------- | ---- |  | - | ----- | 
|                                         |  | Number of
  Options |           | Weighted
  Average
  Exercise Price |   | Weighted
  Average
  Remaining
  Contractual life |  | Aggregate
  Intrinsic Value
  (in thousands) |     
|                                         |  |                     |           |                                     |   |                                                   |  |                                              |     
|                                         |  |                     |           |                                     |   |                                                   |  |                                              |      |  |   |       | 
|Balance,
  July 1, 2005                  |  |                     | 2,069,175 |                                     | $ | 26.95                                             |  |                                              |      |  |   |       | 
|Granted                                  |  |                     | 186,000   |                                     | $ | 11.80                                             |  |                                              |      |  |   |       | 
|Exercised                                |  |                     | (24,172   | )                                   | $ | 8.47                                              |  |                                              |      |  |   |       | 
|Forfeited                                |  |                     | (31,033   | )                                   | $ | 46.71                                             |  |                                              |      |  |   |       | 
|                                         |  |                     |           |                                     |   |                                                   |  |                                              |      |  |   |       | 
|Options
  outstanding, December 31, 2005 |  |                     | 2,199,970 |                                     | $ | 25.59                                             |  |                                              | 6.30 |  | $ | 6,974 | 
|                                         |  |                     |           |                                     |   |                                                   |  |                                              |      |  |   |       | 
|Options
  exercisable, December 31, 2005 |  |                     | 1,650,042 |                                     | $ | 30.88                                             |  |                                              | 5.99 |  | $ | 4,555 | 
|                                         |  |                     |           |                                     |   |                                                   |  |                                              |      |  |   |       | 

As of December
31, 2005 there was $2,368 of total unrecognized compensation cost related to
stock options. These costs are expected to be recognized over a weighted
average period of 1.6 years.

8

---



The total
intrinsic value of stock options exercised was $145 and the total fair value of
stock awards vested was $1,275 during the six months ended December 31, 2005.

Cash received
from stock option exercises for the six months ended December 31, 2005 was
$205. The income tax benefits from share based arrangements totaled $52, all of
which were attributable to stock option exercises.

The following
table summarizes information about restricted stock awards granted under share-based
compensation plans for the six months ended December 31, 2005:

|                                          |  |        |         |                                             |   |       | 
|----------------------------------------- |  | ------ | ------- | ------------------------------------------- | - | ----- | 
|                                          |  | Shares |         | Weighted
  Average Grant-
  Date Fair Value |  
|                                          |  |        |         |                                             |  
|                                          |  |        |         |                                             |   |       | 
|Non Vested
  Balance at July 1, 2005      |  |        |        |                                             | $ |      | 
|Granted                                   |  |        | 130,500 |                                             | $ | 10.43 | 
|Vested                                    |  |        |        |                                             | $ |      | 
|Forfeited                                 |  |        |        |                                             | $ |      | 
|                                          |  |        |         |                                             |   |       | 
|Non Vested
  Balance at December 31, 2005 |  |        | 130,500 |                                             | $ | 10.43 | 
|                                          |  |        |         |                                             |   |       | 

These
restricted stock awards were issued under the 2002 Equity Incentive Plan and
50% of the restrictions lapse after three years and the remaining 50% lapse after
four years.

As of December
31, 2005 there was $945 of total unrecognized compensation costs related to
restricted stock awards. These costs are expected to be recognized over a
weighted average period of 4.0 years.

At December
31, 2005 an aggregate of 533,112 shares remained available for future grants
under our share-based compensation plans, which cover stock awards and stock
options. The Company issues shares to satisfy stock option exercises and
restricted stock awards.

Comprehensive Income

Our total
comprehensive income was as follows:

|                                                     |  |                                   |       |                                 |   |       |   |      |       |   |   |       |  
|---------------------------------------------------- |  | --------------------------------- | ----- | ------------------------------- | - | ----- | - | ---- | ----- | - | - | ----- | -
|                                                     |  | Three
  Months Ended December 31, |       | Six Months
  Ended December 31, |  
|                                                     |  |                                   |       |                                 |  
|                                                     |  | 2005                              |       | 2004                            |   | 2005  |   | 2004 |      
|                                                     |  |                                   |       |                                 |   |       |   |      |      
|Net earnings                                         |  | $                                 | 3,827 |                                 | $ | 2,301 |   | $    | 6,163 |   | $ | 3,648 |  
|Unrealized loss on marketable securities, net of tax |  |                                   | (3    | )                               |   | (8    | ) |      | (7    | ) |   | (20   | )
|Foreign currency translation effect                  |  |                                   | (283  | )                               |   | 273   |   |      | (550  | ) |   | 71    |  
|                                                     |  |                                   |       |                                 |   |       |   |      |       |   |   |       |  
|Comprehensive income                                 |  | $                                 | 3,541 |                                 | $ | 2,566 |   | $    | 5,606 |   | $ | 3,699 |  
|                                                     |  |                                   |       |                                 |   |       |   |      |       |   |   |       |  

Inventories

Inventories
are stated at the lower of cost (determined on a first-in, first-out basis) or
market. At December 31, 2005 and June 30, 2005, inventories were as follows:

|                                       |  |                       |        |                 |   |        | 
|-------------------------------------- |  | --------------------- | ------ | --------------- | - | ------ | 
|                                       |  | December
  31,
  2005 |        | June 30,
  2005 |  
|                                       |  |                       |        |                 |  
|Raw
  materials and manufactured parts |  | $                     | 15,698 |                 | $ | 14,320 | 
|Work in
  process                      |  |                       | 14,471 |                 |   | 15,927 | 
|Finished
  goods                       |  |                       | 2,811  |                 |   | 3,480  | 
|                                       |  |                       |        |                 |   |        | 
|                                       |  | $                     | 32,980 |                 | $ | 33,727 | 
|                                       |  |                       |        |                 |   |        | 

9

---



Property, Plant, and Equipment

Property,
plant, and equipment are stated at cost. Maintenance and repairs are charged to
expense as incurred. Management evaluates, on an ongoing basis, the carrying
value of our property, plant, and equipment and makes adjustments when
impairments are identified. Depreciation is based on the estimated useful lives
of the various classes of assets and is computed using the straight-line
method. At December 31, 2005 and June 30, 2005, property, plant, and equipment
were as follows:

|                                             |  |                       |         |                 |   |                                   |   |  |       | 
|-------------------------------------------- |  | --------------------- | ------- | --------------- | - | --------------------------------- | - |  | ----- | 
|                                             |  | December
  31,
  2005 |         | June 30,
  2005 |   | Estimated
  Useful Life
  (Years) |  
|                                             |  |                       |         |                 |   |                                   |  
|Land                                         |  | $                     | 615     |                 | $ | 615                               |   |  |      | 
|Building and
  improvements                  |  |                       | 15,750  |                 |   | 15,759                            |   |  | 1540 | 
|Machinery,
  equipment, and office furniture |  |                       | 48,287  |                 |   | 45,501                            |   |  | 38   | 
|Leasehold
  improvements                     |  |                       | 706     |                 |   | 715                               |   |  | 15   | 
|Construction
  in progress                   |  |                       | 2,785   |                 |   | 2,997                             |   |  |      | 
|                                             |  |                       |         |                 |   |                                   |   |  |       | 
|                                             |  |                       | 68,143  |                 |   | 65,587                            |   |  |       | 
|Accumulated
  depreciation                   |  |                       | (36,603 | )               |   | (34,167                           | ) |  |       | 
|                                             |  |                       |         |                 |   |                                   |   |  |       | 
|                                             |  | $                     | 31,540  |                 | $ | 31,420                            |   |  |       | 
|                                             |  |                       |         |                 |   |                                   |   |  |       | 

Depreciation
expense for the three months ended December 31, 2005 and 2004 was $1,431 and
$1,380, respectively. Depreciation expense for the six months ended December
31, 2005 and 2004 was $2,801 and $2,757, respectively.

Intangible Assets

Intangible
assets include patents, trademarks, and license agreements. The cost of
intangible assets is amortized on a straight-line basis over estimated useful
lives ranging from 4-20 years. Intangible assets, at cost, at December 31, 2005
and June 30, 2005 were as follows:

|                           |  |                       |        |                 |   |        |  
|-------------------------- |  | --------------------- | ------ | --------------- | - | ------ | -
|                           |  | December
  31,
  2005 |        | June 30,
  2005 |  
|                           |  |                       |        |                 |  
|Patents and
  Trademarks   |  | $                     | 6,923  |                 | $ | 6,556  |  
|License
  Agreements       |  |                       | 1,350  |                 |   | 1,350  |  
|                           |  |                       |        |                 |   |        |  
|                           |  |                       | 8,273  |                 |   | 7,906  |  
|Accumulated
  amortization |  |                       | (2,381 | )               |   | (2,268 | )
|                           |  |                       |        |                 |   |        |  
|Total                      |  | $                     | 5,892  |                 | $ | 5,638  |  
|                           |  |                       |        |                 |   |        |  

Intangible
amortization expense was $61 and $111 for the three months ended December 31,
2005 and 2004, respectively, and $168 and $224 for the six months ended
December 31, 2005 and 2004, respectively. Amortization expense related to
certain intangible assets is included in cost of goods sold in the Consolidated
Statements of Operations.

Warranty

A limited
warranty is provided on our products for periods ranging from 3 to 12 months
and allowances for estimated warranty costs are recorded during the period of
sale. The determination of such allowances requires management to make
estimates of product return rates and expected costs to repair or replace products
under warranty. If actual return rates or repair and replacement costs, or
both, differ significantly from managements estimates, adjustments to the
expense may be required.

The following
is a reconciliation of the accrued warranty liability, which is included in the
other accrued liabilities in the Consolidated Balance Sheets:

|                                                                         |  |                                 |       |      |   |       |  
|------------------------------------------------------------------------ |  | ------------------------------- | ----- | ---- | - | ----- | -
|                                                                         |  | Six Months
  Ended December 31, |      
|                                                                         |  |                                 |      
|                                                                         |  | 2005                            |       | 2004 |  
|                                                                         |  |                                 |       |      |  
|Beginning balance                                                        |  | $                               | 1,396 |      | $ | 1,486 |  
|Reductions for payments made                                             |  |                                 | (612  | )    |   | (720  | )
|Changes in accruals related to pre-existing
  warranties                 |  |                                 | 144   |      |   | (66   | )
|Changes in accruals related to warranties
  issued in the current period |  |                                 | 647   |      |   | 438   |  
|                                                                         |  |                                 |       |      |   |       |  
|Ending balance                                                           |  | $                               | 1,575 |      | $ | 1,138 |  
|                                                                         |  |                                 |       |      |   |       |  

Supplemental Cash Flow Information

Income tax
payments amounted to $777 and $644 for the six months ended December 31, 2005
and 2004, respectively.

10

---



NOTE 2:
RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the FASB issued SFAS No. 153,
Exchanges of Nonmonetary Assets, that amends Opinion 29 to eliminate the
exception for nonmonetary exchanges of similar productive assets and replaces
it with a general exception for exchanges of nonmonetary assets that do not
have commercial substance. The adoption of SFAS No. 153 in fiscal 2006 is not
expected to have a material effect on our financial position or results of
operations.

In May 2005, the FASB issued SFAS No. 154, Accounting
Changes and Error Corrections, which primarily changes the requirements for
the accounting for and reporting of a change in accounting principle for all
voluntary changes or when an accounting pronouncement does not include specific
transition provisions. This applies to any future accounting changes beginning
in fiscal 2007.

In November 2005, the FASB issued FASB Staff
Positions (FSP) SFAS 115-1 and SFAS 124-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments.
FSP SFAS 115-1 and SFAS 124-1 address the determination as to when an
investment is considered impaired, whether that impairment is other than
temporary, and the measurement of an impairment loss. They also include
accounting considerations subsequent to the recognition of an
other-than-temporary impairment and require certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. We will be adopting FSP SFAS 115-1 and SFAS 124-1 beginning in
fiscal 2007 and expect the effect on our consolidated financial statements to
be immaterial.

NOTE 3:
DIVESTITURES AND DISCONTINUED OPERATIONS

In September 2002, we committed to a planned
disposition of our TeraOptix business unit (TeraOptix). We discontinued all
operations by January 2003. The sale of the facility was completed in March
2005 for $1,918, net of selling expenses.

The results and loss on disposal of the TeraOptix
business unit have been presented as separate line items in the accompanying
Consolidated Statements of Operations as Discontinued TeraOptix operations,
net of tax, for all periods presented. The components of cash flow from
discontinued operations are as follows:

|                                                                      |  |                                                         |      |  
|--------------------------------------------------------------------- |  | ------------------------------------------------------- | ---- | -
|                                                                      |  |                                                         |     
|                                                                      |  | For the six
  months ended 
        December 31,
  2004 |     
|                                                                      |  |                                                         |     
|Cash flow from operating activities from
  discontinued operations:   |  |                                                         |      |  
|Loss from
  discontinued operations                                   |  | $                                                       | (228 | )
|Loss on sale and
  impairment of assets                               |  |                                                         | 179  |  
|Deferred income
  taxes                                               |  |                                                         | (54  | )
|Other, net                                                            |  |                                                         | (22  | )
|                                                                      |  |                                                         |      |  
|Net cash used for operating activities from
  discontinued operations |  | $                                                       | (125 | )
|                                                                      |  |                                                         |      |  

There was no cash flow impact from discontinued
operations in fiscal 2006.

11

---



NOTE 4:
SEGMENT INFORMATION

We operate in two principal business segments
globally: Semiconductor and Industrial. The segment data is presented below in
a manner consistent with managements internal measurement of the business.

|                             |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|---------------------------- |  | --------------------------------- | ------ | ------------------------------- | - | ------ | - | ---- | ------ | - | - | ------ | -
|                             |  | Three
  Months Ended December 31, |        | Six Months
  Ended December 31, |  
|                             |  |                                   |        |                                 |  
|                             |  | 2005                              |        | 2004                            |   | 2005   |   | 2004 |       
|                             |  |                                   |        |                                 |   |        |   |      |       
|Semiconductor                |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Sales                        |  | $                                 | 24,427 |                                 | $ | 18,627 |   | $    | 43,116 |   | $ | 34,629 |  
|Gross profit                 |  |                                   | 9,594  |                                 |   | 7,295  |   |      | 16,998 |   |   | 13,858 |  
|Gross profit as a % of sales |  |                                   | 39     | %                               |   | 39     | % |      | 39     | % |   | 40     | %
|                             |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Industrial                   |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Sales                        |  | $                                 | 19,396 |                                 | $ | 17,380 |   | $    | 35,289 |   | $ | 28,956 |  
|Gross profit                 |  |                                   | 7,823  |                                 |   | 5,963  |   |      | 13,834 |   |   | 10,513 |  
|Gross profit as a % of sales |  |                                   | 40     | %                               |   | 34     | % |      | 39     | % |   | 36     | %
|                             |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Total                        |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Sales                        |  | $                                 | 43,823 |                                 | $ | 36,007 |   | $    | 78,405 |   | $ | 63,585 |  
|Gross profit                 |  |                                   | 17,417 |                                 |   | 13,258 |   |      | 30,832 |   |   | 24,371 |  
|Gross profit as a % of sales |  |                                   | 40     | %                               |   | 37     | % |      | 39     | % |   | 38     | %

Separate financial information by segment for total
assets, capital expenditures, and depreciation and amortization is not
available and is not evaluated by the chief operating decision-maker.

ZYGOs Metrology, which includes development services,
Optical Systems Solutions, and Precision Positioning Systems (PPS) product
lines are sold into its two business segments. Supplementary sales and gross
profit data by product line is as follows:

|                             |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|---------------------------- |  | --------------------------------- | ------ | ------------------------------- | - | ------ | - | ---- | ------ | - | - | ------ | -
|                             |  | Three Months
  Ended December 31, |        | Six Months
  Ended December 31, |  
|                             |  |                                   |        |                                 |  
|                             |  | 2005                              |        | 2004                            |   | 2005   |   | 2004 |       
|                             |  |                                   |        |                                 |   |        |   |      |       
|Metrology                    |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Sales                        |  | $                                 | 24,264 |                                 | $ | 16,089 |   | $    | 40,774 |   | $ | 26,855 |  
|Gross profit                 |  |                                   | 11,184 |                                 |   | 7,614  |   |      | 18,813 |   |   | 12,195 |  
|Gross profit as a % of sales |  |                                   | 46     | %                               |   | 47     | % |      | 46     | % |   | 45     | %
|                             |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Optical Systems Solutions    |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Sales                        |  | $                                 | 9,069  |                                 | $ | 10,692 |   | $    | 18,565 |   | $ | 17,323 |  
|Gross profit                 |  |                                   | 1,791  |                                 |   | 1,733  |   |      | 3,531  |   |   | 3,132  |  
|Gross profit as a % of sales |  |                                   | 20     | %                               |   | 16     | % |      | 19     | % |   | 18     | %
|                             |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|PPS                          |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Sales                        |  | $                                 | 10,490 |                                 | $ | 9,226  |   | $    | 19,066 |   | $ | 19,407 |  
|Gross profit                 |  |                                   | 4,442  |                                 |   | 3,911  |   |      | 8,488  |   |   | 9,044  |  
|Gross profit as a % of sales |  |                                   | 42     | %                               |   | 42     | % |      | 45     | % |   | 47     | %
|                             |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Total                        |  |                                   |        |                                 |   |        |   |      |        |   |   |        |  
|Sales                        |  | $                                 | 43,823 |                                 | $ | 36,007 |   | $    | 78,405 |   | $ | 63,585 |  
|Gross profit                 |  |                                   | 17,417 |                                 |   | 13,258 |   |      | 30,832 |   |   | 24,371 |  
|Gross profit as a % of sales |  |                                   | 40     | %                               |   | 37     | % |      | 39     | % |   | 38     | %

12

---



Substantially all of our operating expenses, assets,
and depreciation and amortization are U.S. based. Sales by geographic area were
as follows:

|            |  |                                   |        |                                 |   |        |  |      |        |  |   |        | 
|----------- |  | --------------------------------- | ------ | ------------------------------- | - | ------ |  | ---- | ------ |  | - | ------ | 
|            |  | Three
  Months Ended December 31, |        | Six Months
  Ended December 31, |  
|            |  |                                   |        |                                 |  
|            |  | 2005                              |        | 2004                            |   | 2005   |  | 2004 |       
|            |  |                                   |        |                                 |   |        |  |      |       
|            |  |                                   |        |                                 |   |        |  |      |        |  |   |        | 
|Domestic    |  | $                                 | 13,975 |                                 | $ | 11,988 |  | $    | 26,985 |  | $ | 20,033 | 
|Europe      |  |                                   | 4,859  |                                 |   | 4,854  |  |      | 7,640  |  |   | 7,501  | 
|Japan       |  |                                   | 19,381 |                                 |   | 15,393 |  |      | 33,543 |  |   | 29,450 | 
|Pacific Rim |  |                                   | 5,608  |                                 |   | 3,772  |  |      | 10,237 |  |   | 6,601  | 
|            |  |                                   |        |                                 |   |        |  |      |        |  |   |        | 
|Total       |  | $                                 | 43,823 |                                 | $ | 36,007 |  | $    | 78,405 |  | $ | 63,585 | 
|            |  |                                   |        |                                 |   |        |  |      |        |  |   |        | 

NOTE 5:
RELATED PARTY TRANSACTIONS AND MAJOR CUSTOMER

Sales to Canon Inc., one of our significant stockholders,
and Canon Sales Co., Inc., a distributor of certain of our products in Japan
and a subsidiary of Canon Inc., amounted to $15,628 (36% of net sales) and
$27,981 (36% of net sales) for the second quarter and six months ended December
31, 2005, as compared with $12,758 (35% of net sales) and $25,350 (40% of net
sales) for the comparable prior year periods. These sales include revenues
generated from the development agreements referenced below. Selling prices of
products sold to Canon Inc. and Canon Sales Co., Inc. are based, generally, on
the terms customarily given to distributors. Revenues generated from the
development agreements are recorded on a cost-plus basis. At December 31, 2005
and June 30, 2005, there were, in the aggregate, $7,431 and $3,951,
respectively, of trade accounts receivable from Canon Inc. and Canon Sales Co.,
Inc.

In September 2002, we entered into a contract with
Canon Inc. related to the development of certain interferometers. In March
2004, we signed a preliminary agreement to begin further add-on work; the
definitive agreement for this additional work was signed in December 2004. In
February 2005, we entered into two additional agreements with Canon Inc.
related to the development of prototype production tools and accessories. During
the three and six months ended December 31, 2005, we recognized revenue in the
semiconductor segment of $5,611 and $9,572, respectively, for these contracts
compared with $2,477 and $4,172, respectively, for the comparable prior year
periods. In addition, Canon Inc. paid us progress payments in accordance with
the terms of the developmental contract. The total progress payments related to
the developmental contract remaining at December 31, 2005 were $9,175.

NOTE 6:
HEDGING ACTIVITIES

During the third quarter of fiscal 2005, we began
entering into foreign currency forward contracts to reduce the impact of
adverse fluctuations on earnings associated with foreign currency exchange rate
changes. We do not enter into any derivative transactions for speculative
purposes. These contracts are not designated as cash flow, fair value, or net
investment hedges under SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, as amended, and therefore, are marked-to-market with
changes in fair value recorded in the Statement of Operations. These contracts
are entered into for periods consistent with the currency transaction
exposures, generally three to six months. Any gains and losses on the fair
value of these contracts would largely offset corresponding losses and gains on
the underlying transactions.

As of December 31, 2005, we had seven foreign currency
forward contracts (yen) outstanding aggregating to $2,641. For the three months
ended December 31, 2005, we recognized a loss from foreign currency forward
contracts of $23. For the six months ended December 31, 2005, we recognized a
gain of $59. These gains and losses are included in other income in the
Consolidated Statements of Operations. These gains and losses are substantially
offset by foreign exchange losses and gains on intercompany balances recorded
by our subsidiaries. We did not enter into any derivative instruments to hedge
foreign currency exposure prior to the third quarter of fiscal 2005.

NOTE 7:
INCOME TAXES

The effective tax rate for the three months ended
December 31, 2005 decreased by two percentage points to 34% as compared with
the prior year period of 36%. The decrease in the effective tax rate was due to
the release of tax reserves in a foreign jurisdiction, accounting for a four
percentage point decrease in the rate. This decrease was partially offset by an
increase in the effective tax rate primarily due to increased income in foreign
operations, which operate in higher tax jurisdictions, and an increase in tax
upon additional monies repatriated from these foreign operations. The effective
tax rate of 36% for the six months ended December 31, 2005, while consistent
with the comparable prior year, was affected by the release of tax reserves and
the increased income in foreign operations.

13

---



Item 2.
Managements Discussion and Analysis of Financial Condition and Results of
Operations

RESULTS
OF OPERATIONS

Introduction

Zygo Corporation designs,
develops, and manufactures ultra-high precision measurement solutions and
optical components and systems. ZYGOs measurement solutions are designed to
improve quality, increase productivity, and decrease the overall cost of
manufacturing and product development for high-technology manufacturing
processes. The Companys optical component and systems products provide
high-end solutions for laser fusion research, imaging systems, and measurement
system components. We conduct the majority of our manufacturing in our
153,500 square foot facility in Middlefield, Connecticut.

We serve the semiconductor and
industrial markets through our three core product lines, metrology, optical
systems solutions, and precision positioning systems. Our semiconductor product
offerings include OEM solutions and major technology development projects for
the semiconductor capital equipment industry and direct supplied in-line
automated yield improvement systems for both flat panel displays and advanced
semiconductor packaging manufacturing. Our industrial market products serve the
automotive, consumer electronics, defense/aerospace, and all markets other than
semiconductor. Industrial market products include optical components, optical
systems and measurement-based process control systems for defense, aerospace,
and medical device customers and measurement-based process control and
yield-enhancement systems for automotive and consumer electronics customers.

Our development services have produced a significant amount of
  our revenue over the past two years. In September 2002, we entered into a contract
  with Canon Inc. related to the development of certain interferometers. In March
  2004, we signed a preliminary agreement to begin further add-on work; the definitive
  agreement for this additional work was signed in December 2004. In February
  2005, we entered into two additional agreements with Canon Inc. related to the
  development of prototype production tools and accessories. During the three
  and six months ended December 31, 2005, we recognized $5.6 million and $9.6
  million, respectively, of revenue from these development services contracts
  as compared with $2.5 million and $4.2 million, respectively, in the prior year
  comparable periods. The development services contracts that were signed in fiscal
  2005 were cost plus contracts and were expected to represent approximately $41.0
  million in additional revenue through the first six months of fiscal 2007. We
  currently expect total revenues of approximately $37.0 million, with the reduction
  due to estimated costs being less than anticipated. To date, a total of $23.8
  million of this revenue has been recognized. To the extent that total actual
  costs on the contracts may be less than currently anticipated, the resulting
  development services revenue could be less than the currently estimated value
  of the contract. Additionally, our period over period comparable sales in the
  future could be adversely affected if we do not continue to provide these development
  services at similar levels or do not expand our overall business sufficiently
  to offset the decline in development services revenue.

We achieved an order level for the second quarter of
fiscal 2006 of $50.3 million as compared with $38.6 million for the first
quarter of fiscal 2006 and $39.6 million for the second quarter of fiscal 2005.
This order flow increased backlog at December 31, 2005 to $77.0 million. Orders
in the semiconductor segment of $26.1 million increased $6.1 million, or 31%,
as compared with the first quarter of fiscal 2006; and increased $5.9 million,
or 29%, as compared with the second quarter of fiscal 2005. We continue to
receive orders from the flat panel market of the semiconductor segment and
expect orders from that market to continue for the immediate future. We also
experienced an increase in lithography orders over the prior year period, which
continued a strengthening in that market area over the last six months. Orders
in the industrial segment of $24.2 million increased by $5.6 million, or 30%,
as compared with the first quarter of fiscal 2006 and $4.8 million, or 25%, as
compared with the second quarter of fiscal 2005. Orders in the industrial
segment were fueled primarily by government contracts for the National Ignition
Facility in both our Tucson and Middlefield facilities.

Beginning in the first quarter of fiscal 2006, we were required
  to record the expense of share-based payment transactions. Under the modified
  prospective method, we were not required to restate the prior year financial
  statements or include in the current year any expenses related to stock option
  grants vested as of June 30, 2005. In the quarter ended December 31, 2005, operating
  income was reduced by $0.8 million of share-based payment compensation expense,
  affecting cost of goods sold by $0.2 million, selling, general, and administrative
  expenses (SG&A) by $0.5 million, and research, development,
  and engineering expenses (RD&E) by $0.1 million. Share-based
  compensation expense reduced our quarterly diluted earnings per share by $0.03.
  For the six months ended December 31, 2005, operating income was reduced by
  $1.2 million of share-based payment compensation expense, affecting cost of
  goods sold by $0.3 million, SG&A by $0.7 million, and RD&E expenses
  by $0.2 million. Share-based compensation expense reduced our six month diluted
  earnings per share by $0.04. The share-based compensation expense related to
  current outstanding stock options and restricted shares and to future issuances
  of stock options which are presently known to us is estimated to be approximately
  $0.4 million in each of the third and fourth quarters of fiscal 2006.

14

---



Net Sales

|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|------------------------------ |  | ----------- | ---- | ----------- |  | ------ | - | --------- | ---- |  |  | --- | -
|                               |  | Fiscal 2006 |      | Fiscal 2005 | 
|                               |  |             |      |             | 
|                               |  |             |      | Net Sales   |  |        |   | Net Sales |     
|(In millions)                  |  | Amount      |      | %           |  | Amount |   | %         |     
|                               |  |             |      |             |  |        |   |           |     
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|Quarter ended December 31      |  |             |      |             |  |        |   |           |      |  |  |     |  
|Semiconductor                  |  | $           | 18.8 |             |  | 43     | % | $         | 16.1 |  |  | 45  | %
|Developmental Services         |  |             | 5.6  |             |  | 13     | % |           | 2.5  |  |  | 7   | %
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|Total Semiconductor            |  |             | 24.4 |             |  | 56     | % |           | 18.6 |  |  | 52  | %
|                              
|Total Industrial               |  |             | 19.4 |             |  | 44     | % |           | 17.4 |  |  | 48  | %
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|Total                          |  | $           | 43.8 |             |  | 100    | % | $         | 36.0 |  |  | 100 | %
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|Six months ended December
  31 |  |             |      |             |  |        |   |           |      |  |  |     |  
|Semiconductor                  |  | $           | 33.5 |             |  | 43     | % | $         | 30.4 |  |  | 48  | %
|Developmental Services         |  |             | 9.6  |             |  | 12     | % |           | 4.2  |  |  | 6   | %
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|Total Semiconductor            |  |             | 43.1 |             |  | 55     | % |           | 34.6 |  |  | 54  | %
|                              
|Total Industrial               |  |             | 35.3 |             |  | 45     | % |           | 29.0 |  |  | 46  | %
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  
|Total                          |  | $           | 78.4 |             |  | 100    | % | $         | 63.6 |  |  | 100 | %
|                               |  |             |      |             |  |        |   |           |      |  |  |     |  

Net sales in the semiconductor segment increased 31%
in the second quarter of fiscal 2006 as compared with the prior year. This
increase was due primarily to an increase in developmental services of $3.1
million and flat panel sales of $0.9 million. For the six month period ended
December 31, 2005, the semiconductor segment increased 25% as compared with the
prior year period due to an increase in developmental services of $5.4 million,
flat panel sales of $2.0 million, and new product sales of $0.5 million.

Net sales in the industrial segment increased by 11%
in the second quarter of fiscal 2006 as compared with the prior year period
primarily due to increased volume related to contract manufacturing shipments
and optical systems assemblies. For the six month period ended December 31,
2005, the industrial segment net sales increased 22% as compared with the prior
year period due to increased volume related to contract manufacturing and
optical systems assemblies of $3.3 million, sales increase of $1.3 million
related to new customers in South Korea and China, and a $0.6 million sales
increase volume increases to automotive customers in Europe.

Sales in U.S. dollars for the three and six months of fiscal 2006 were
$35.0 million, or 80%, and $64.8, or 83%, respectively, of total net sales for
the periods. 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 can impact the
sales of our products in export markets, as would changes in the general
economic conditions in those markets. Management believes the percentage of
sales in foreign currencies may increase in the current year due to an increase
in sales denominated in yen to Japanese customers. In the absence of a substantial
increase in sales orders in currency other than U.S. dollars, we believe a 10%
appreciation or depreciation of the U.S. dollar against the euro and yen would
have an immaterial impact on our consolidated financial position and results of
operations.

15

---



Gross Profit by Segment

|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |   | 
|---------------------------- |  | - | ----------- |  | ----------------- | -- | ------ | - | ----------------- |  |  | -- | - | 
|                             |  |   | Fiscal 2006 |  | Fiscal 2005       |   
|                             |  |   |             |  |                   |   
|(In
  millions)              |  |   | Amount      |  | Gross 
  Profit % |    | Amount |   | Gross 
  Profit % | 
|                             |  |   |             |  |                   |    |        |   |                   | 
|                             |  |   |             |  |                   |    |        |   |                  
|Quarter ended December 31    |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Semiconductor                |  | $ | 8.0         |  |                   | 43 | %      | $ | 6.5               |  |  | 40 | %
|Developmental
  services     |  |   | 1.6         |  |                   | 29 | %      |   | 0.8               |  |  | 32 | %
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Total
  Semiconductor        |  |   | 9.6         |  |                   | 39 | %      |   | 7.3               |  |  | 39 | %
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Total Industrial             |  |   | 7.8         |  |                   | 40 | %      |   | 6.0               |  |  | 34 | %
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Total                        |  | $ | 17.4        |  |                   | 40 | %      | $ | 13.3              |  |  | 37 | %
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Six months ended December 31 |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Semiconductor                |  | $ | 14.4        |  |                   | 43 | %      | $ | 12.7              |  |  | 42 | %
|Developmental
  services     |  |   | 2.6         |  |                   | 27 | %      |   | 1.2               |  |  | 29 | %
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Total
  Semiconductor        |  |   | 17.0        |  |                   | 39 | %      |   | 13.9              |  |  | 40 | %
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Total Industrial             |  |   | 13.8        |  |                   | 39 | %      |   | 10.5              |  |  | 36 | %
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  
|Total                        |  | $ | 30.8        |  |                   | 39 | %      | $ | 24.4              |  |  | 38 | %
|                             |  |   |             |  |                   |    |        |   |                   |  |  |    |  

Gross profit as a percentage of sales for the three
and six months of fiscal 2006 increased over the comparable periods in the
prior year primarily due to an increase in the industrial segment margins while
the semiconductor segment margins remained relatively stable. Industrial
segment margins increased on the improved margins in our optical systems
products. Improved operations and increased volume have led to these improved
margins. During the comparable fiscal 2005 periods, the gross profit percentage
was negatively impacted by new product ramp-up expenses for opto-mechanical
assemblies and under absorbed factory overhead due to a production delay of
certain assemblies. The overall semiconductor segment margins stayed relatively
stable despite a decrease in development services margins. Margins on
semiconductor product sales increased primarily due to improved factory
performance. General factory costs, including warranty, factory efficiency
costs, and inventory related costs, were lower than in the prior year.

SG&A

|                             |  |   |             |  |               |    |        |   |           |  |  |    |   | 
|---------------------------- |  | - | ----------- |  | ------------- | -- | ------ | - | --------- |  |  | -- | - | 
|                             |  |   | Fiscal 2006 |  | Fiscal
  2005 |   
|                             |  |   |             |  |               |   
|(In millions)                |  |   | Amount      |  | %of Sales     |    | Amount |   | %of Sales | 
|                             |  |   |             |  |               |    |        |   |           | 
|                             |  |   |             |  |               |    |        |   |           |  |  |    |  
|Quarter ended December 31    |  | $ | 8.2         |  |               | 19 | %      | $ | 5.7       |  |  | 16 | %
|Six months ended December 31 |  | $ | 14.6        |  |               | 18 | %      | $ | 11.4      |  |  | 18 | %

The second quarter increase in SG&A was primarily
due to increased employee expenses, including management incentives, of $0.9
million,  share-based compensation
expense of $0.5 million, and increased selling expenses related to new market
initiatives of $0.2 million, primarily related to the new offices in Korea,
Taiwan, and mainland China. For the six months ended December 31, 2005, the
increase in SG&A was due to share-based compensation expense of $0.7
million,  increased selling and general
expenses related to new initiatives in our west coast operations of $0.5
million, increased employee expenses, including management incentives, of $0.4
million, and costs associated with increasing our presence in the Pacific Rim
with the opening of new offices within the last year in Korea, Taiwan, and
mainland China, of $0.3 million, to support anticipated future growth.

16

---



RD&E

|                             |  |   |             |  |               |   |        |   |           |  |  |    |   | 
|---------------------------- |  | - | ----------- |  | ------------- | - | ------ | - | --------- |  |  | -- | - | 
|                             |  |   | Fiscal 2006 |  | Fiscal
  2005 |  
|                             |  |   |             |  |               |  
|(In millions)                |  |   | Amount      |  | %of Sales     |   | Amount |   | %of Sales | 
|                             |  |   |             |  |               |   |        |   |           | 
|                             |  |   |             |  |               |   |        |   |           |  |  |    |  
|Quarter ended December 31    |  | $ | 3.4         |  |               | 8 | %      | $ | 3.7       |  |  | 10 | %
|Six months ended December 31 |  | $ | 7.0         |  |               | 9 | %      | $ | 6.9       |  |  | 11 | %

RD&E for the second quarter and first six months
of fiscal 2006 was relatively flat with the prior year comparable period but
was positively impacted by a reimbursement from a customer of $0.7 million for
research costs incurred. Without the customer reimbursement our RD&E would
have increased over the prior year. Current year initiatives are focused in the
semiconductor segment, most notably in the display and packaging markets, and
include the opening of our Oregon engineering and product development office.
Share-based compensation expense included in RD&E for the second quarter
and six month period ended December 31, 2005 was $0.1 million and $0.2 million,
respectively.

Income Tax

|                             |  |   |             |  |                            |    |        |   |                            |  |  |    |   | 
|---------------------------- |  | - | ----------- |  | -------------------------- | -- | ------ | - | -------------------------- |  |  | -- | - | 
|                             |  |   | Fiscal 2006 |  | Fiscal
  2005              |   
|                             |  |   |             |  |                            |   
|(In millions)                |  |   | Amount      |  | Effective 
  Tax Rate 
  % |    | Amount |   | Effective 
  Tax Rate 
  % | 
|                             |  |   |             |  |                            |    |        |   |                            | 
|                             |  |   |             |  |                            |    |        |   |                            |  |  |    |  
|Quarter ended December 31    |  | $ | 2.1         |  |                            | 34 | %      | $ | 1.5                        |  |  | 36 | %
|Six months ended December 31 |  | $ | 3.6         |  |                            | 36 | %      | $ | 2.4                        |  |  | 36 | %

The effective tax rate for the quarter decreased due
to the release of tax reserves in a foreign jurisdiction, which accounted for a
four percentage point decrease in the rate. This decrease was partially offset
by an increase in the effective tax rate of two percentage points primarily due
to increased income in foreign operations, which operate in higher tax
jurisdictions, and an increase in tax upon additional monies repatriated from
these foreign operations. The effective tax rate for the six months ended
December 31, 2005, while consistent with the comparable prior year period, was
affected by the release of tax reserves and the increased income in foreign
operations.

RELATED
PARTY TRANSACTIONS

Sales to Canon Inc., one of
our significant stockholders, and Canon Sales Co., Inc., a distributor of
certain of our products in Japan and a subsidiary of Canon Inc., amounted to
$15.6 million (36% of net sales) and $28.0 million (36% of net sales) for the
second quarter and six months ended December 31, 2005, as compared with $12.8
million (35% of net sales) and $25.4 million (40% of net sales) for the
comparable prior year periods. These sales include revenues generated from the
development agreements referenced below. Selling prices of products sold to
Canon Inc. and Canon Sales Co., Inc. are based, generally, on the terms
customarily given to distributors. Revenues generated from the development
agreements are recorded on a cost-plus basis. At December 31, 2005 and June 30,
2005, there were, in the aggregate, $7.4 million and $4.0 million, respectively,
of trade accounts receivable from Canon Inc. and Canon Sales Co., Inc.

In September 2002, we entered into a contract with
Canon Inc. related to the development of certain interferometers. In March
2004, we signed a preliminary agreement to begin further add-on work; the
definitive agreement for this additional work was signed in December 2004. In
February 2005, we entered into two additional agreements with Canon Inc.
related to the development of prototype production tools and accessories. During
the three and six months ended December 31, 2005, we recognized revenue in the
semiconductor segment of $5.6 million and $9.6 million, respectively, from
these contracts as compared with $2.5 million and $4.2 million, respectively,
for the comparable prior year periods. According to the terms of the
agreements, we also receive progress payments during the course of the
contract. As of December 31, 2005 and June 30, 2005, we received $9.2 million
and $11.3 million, respectively, of progress payments in excess of services
performed.

LIQUIDITY AND CAPITAL RESOURCES

We maintained cash, cash equivalents, and marketable
securities at December 31, 2005 totaling $57.5 million, an increase of $0.6
million, from $56.9 million at June 30, 2005. At December 31, 2005, working
capital was $68.4 million, an increase of $5.1 million from $63.3 million at
June 30, 2005. Major fluctuations in working capital included increases in
accounts receivable of $2.4 million coupled with decreases in progress payments
of $3.3 million, accounts payable of $2.3 million, and accrued liabilities of
$1.9 million, which were partially offset by a $4.6 million decrease in cash
and short term marketable securities as the result of purchasing additional
long term marketable securities. Our $3.0 million line of credit expired during
the quarter. The line of credit

17

---



was renewed subsequent to the end of the quarter in
substantially the same terms as the expired line of credit. There have been no
borrowings under the line of credit.

Acquisitions of property, plant, and equipment totaled
$1.6 million and $3.0 during the three and six months ended December 31, 2005.
Management believes that cash generated from operations, together with the
liquidity provided by existing cash balances, will be sufficient to satisfy our
liquidity requirements for the next 12 months.

CRITICAL ACCOUNTING POLICIES,
SIGNIFICANT JUDGMENTS, AND ESTIMATES

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, warranty obligations, 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, warranty
costs, accounting for income taxes, and valuation of long-lived assets to be
critical policies due to the estimates and judgments involved in each.

Share-Based Payments
In December 2004, FASB issued SFAS 123(R),
Share-Based Payment (as amended).
SFAS No. 123(R) eliminates the alternative to use the intrinsic value
method of accounting that was provided in SFAS No. 123, which generally
resulted in no compensation expense recorded in the financial statements
related to the issuance of equity awards to employees. SFAS No. 123(R) requires
that the cost resulting from all share-based payment transactions be recognized
in the financial statements. SFAS No. 123(R) establishes fair value as the
measurement objective in accounting for share-based payment arrangements and
requires all companies to apply a fair-value-based measurement method in
accounting for generally all share-based payment transactions with employees.
This method includes estimates and judgments pertaining to term, volatility,
risk-free interest rates, dividend yields and forfeiture rates.

Revenue Recognition and Allowance for Doubtful AccountsWe 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 that we account for as a warranty provision under
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.

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 to be issued by the
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.

Inventory Valuation

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

18

---



managements estimated future usage is written down to
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 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. Significant management judgments must be made when
providing for obsolete and excess inventory and losses on contracts. If actual
market conditions are different than those projected by management, additional
inventory write-downs and loss accruals may be required.

Warranty CostsWe 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 or revised estimated costs differ from managements prior
estimates, revisions to the estimated warranty liability would be required.

Accounting for Income TaxesDeferred income tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the consolidated 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. While management has considered future taxable income
and ongoing prudent and feasible tax planning strategies in assessing the need
for the valuation allowance, in the event management were to determine that
ZYGO would be able to realize its deferred tax assets in the future in excess
of its net recorded amount, an adjustment to the valuation allowance would
increase income in the period such determination was made. Likewise, should
management determine that ZYGO would not be able to realize all or part of its
net deferred tax asset in the future, an adjustment to the valuation allowance
would be charged to income in the period such determination was made. Our
effective tax rate may vary from period to period, generally based on changes
in estimated taxable income or loss for domestic and foreign locations, changes
to the valuation allowance, 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 or cash flow loss
combined with a history of operating or cash flow losses or a projection that
demonstrates continuing losses, and a current expectation that, more likely
than not, a long-lived asset will be disposed of significantly before the end
of its estimated useful life.

If such circumstances exist, we evaluate the carrying
value of long-lived assets to determine if impairment exists based upon
estimated undiscounted future cash flows over the remaining useful life of the
assets and comparing that value with 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 are based upon managements best estimates,
using appropriate and customary assumptions and projections at the time.

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 annual impact of approximately
$25,000 on our financial condition and results of operations.

Off-Balance Sheet ArrangementsWe have not created, and are not party to, any special-purpose
or off-balance sheet entities for the purpose of raising capital, incurring
debt, or operating parts of our business that are not consolidated into our
financial statements. We have not guaranteed any obligations of a third party.

19

---



RISK
FACTORS THAT MAY IMPACT FUTURE RESULTS

Risk factors that may impact future results include
those disclosed in our Form 10-K, as amended, for the year ended June 30, 2005.

Item 3. Quantitative and Qualitative Disclosures about Market
Risk

There have been no material changes that have occurred
in our quantitative and qualitative market risk disclosures during the first
six months of fiscal 2006. In the third quarter of fiscal 2005, we began
hedging certain intercompany transactions by entering into forward contracts to
reduce the impact of adverse fluctuations on earnings associated with foreign
currency exchange rate changes. We do not enter into any derivative
transactions for speculative purposes. These contracts are entered into for
periods consistent with the currency transaction exposures, generally three to
six months. Generally, any gains and losses on the fair value of these
contracts are expected to be largely offset by losses and gains on the
underlying transactions.

For discussion of our exposure to market risk, refer
to Item 7a., Quantitative and Qualitative Disclosures about Market Risk,
presented in our Annual Report on Form 10-K, as amended, for the year ended
June 30, 2005 filed with the Securities and Exchange Commission.

Item 4. Controls and Procedures

The effectiveness of our or any system of disclosure
controls and procedures is subject to certain limitations, including the
exercise of judgment in designing, implementing, and evaluating the controls
and procedures, the assumptions used in identifying the likelihood of future
events, and the inability to eliminate misconduct completely. In designing,
implementing, and evaluating the disclosure controls and procedures, our
management recognized that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving  the desired control objectives and our
management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.

Our management evaluated with the participation of our
Chief Executive Officer and Chief Financial Officer the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) of the
Securities Exchange Act of 1934, as amended, or the Exchange Act) as of
December 31, 2005. On the basis of this review and subject to the foregoing,
our management, including our Chief Executive Officer and Chief Financial
Officer, concluded that our disclosure controls and procedures are effective in
ensuring that the information required to be disclosed by us in reports that we
file under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the SEC and to
ensure that information required to be disclosed in the reports filed or
submitted under the Exchange Act is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
to allow timely decisions regarding required disclosure.

There were no changes in our internal control over
financial reporting that occurred in our most recent fiscal quarter that
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.

20

---



PART II - Other
Information

Item 4. Submission of Matters to a Vote of Security Holders

The Annual Meeting of Stockholders was held on
November 10, 2005. The following matter was submitted to a vote of the Companys
stockholders:

Proposal
No. 1 - Election of Board of Directors

| |                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------
| | The following individuals, all whom were Zygo
  Corporation directors immediately prior to the vote, were elected as a result
  of the following vote:

|                   |  |     |            |         |  |  |           |  | 
|------------------ |  | --- | ---------- | ------- |  |  | --------- |  | 
|                   |  | For |            | Against | 
|                   |  |     |            |         | 
|Eugene G. Banucci  |  |     | 15,866,659 |         |  |  | 74,204    |  | 
|Yousef A. El-Mansy |  |     | 15,861,655 |         |  |  | 79,208    |  | 
|Paul F. Forman     |  |     | 15,790,858 |         |  |  | 150,005   |  | 
|Samuel H. Fuller   |  |     | 15,867,476 |         |  |  | 73,387    |  | 
|Seymour E. Liebman |  |     | 15,797,807 |         |  |  | 143,056   |  | 
|Robert G. McKelvey |  |     | 14,703,868 |         |  |  | 1,236,995 |  | 
|J. Bruce Robinson  |  |     | 15,799,880 |         |  |  | 140,983   |  | 
|Robert B. Taylor   |  |     | 15,746,264 |         |  |  | 194,599   |  | 
|Carol P. Wallace   |  |     | 15,862,516 |         |  |  | 78,347    |  | 
|Bruce W. Worster   |  |     | 15,874,168 |         |  |  | 66,695    |  | 
|Carl A. Zanoni     |  |     | 15,852,672 |         |  |  | 88,191    |  | 

There
were no other matters submitted to a vote of our stockholders.

Item 6. Exhibits

|(a) | Exhibits: |                                                                       
|--- | --------- | ----------------------------------------------------------------------
|   
|    | 31.1      | Certification of Chief Executive Officer under Rule
  13a-14(a)       
|    | 31.2      | Certification of Chief Financial Officer under Rule
  13a-14(a)       
|    | 32.1      | Certification of Chief Executive Officer and Chief
  Financial Officer

21

---



SIGNATURE

Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.

| |                                                                   | 
| | ----------------------------------------------------------------- | 
| | Zygo Corporation                                                  | 
| |                                                                   | 
| | (Registrant)                                                      | 
| |                                                                   | 
| | /s/ J. Bruce Robinson                                             | 
| |                                                                   | 
| | J. Bruce Robinson                                                 | 
| | President, Chairman, and Chief Executive Officer                 
| |                                                                   | 
| | /s/ Walter A. Shephard                                            | 
| |                                                                   | 
| | Walter A. Shephard                                                | 
| | Vice President, Finance, Chief Financial Officer,
  and Treasurer

Date: February 7, 2006

22

---