# UNITED STATESSECURITIES AND
EXCHANGE COMMISSIONWashington, D.C. 20549

# FORM 10-Q

(Mark One)

þ
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
          ACT OF 1934

|For the quarterly period
      ended | March
        31, 2005
|------------------------------------ | ----------------------



or

£
    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.

þ
  YES    £  NO

Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

þ
  YES    £  NO

# 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.

17,975,821
shares of Common Stock, $.10 Par Value, at April 29, 2005

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 and
environmental regulations. 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 for the fiscal year ended June 30, 2004.



2



PART
I  Financial Information


Item 1. Financial
Statements


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


Three Months Ended
     Nine Months EndedMarch 31,
2005
     March 26,
2004
     March 31,
2005
     March 26,
2004Net salesProducts
     $ 28,245
        
     $ 23,425
        
     $ 87,658
        
     $ 66,996Development services
     5,442
        
     5,008
        
     9,614
        
     13,33833,687
        
     28,433
        
     97,272
        
     80,334Cost of goods soldProducts
     16,812
        
     14,878
        
     53,005
        
     42,050Development services
     3,745
        
     4,153
        
     6,766
        
     10,71820,557
        
     19,031
        
     59,771
        
     52,768Gross profit
     13,130
        
     9,402
        
     37,501
        
     27,566Selling, general, and administrative expenses
     5,498
        
     5,358
        
     16,880
        
     16,802Research, development, and engineering expenses
     3,809
        
     2,725
        
     10,689
        
     9,344Operating profit
     3,823
        
     1,319
        
     9,932
        
     1,420Other income:Interest income
     189
        
     219
        
     543
        
     638Miscellaneous income (expense), net
     (133
        )
     138
        
     81
        
     213Total other income
     56
        
     357
        
     624
        
     851Earnings from continuing operationsbefore income taxes and minority interest
     3,879
        
     1,676
        
     10,556
        
     2,271Income tax expense
     (1,217
        )
     (637
        )
     (3,621
        )
     (863
        )Minority interest
     (287
        )
     (71
        )
     (684
        )
     (175
        )Earnings from continuing operations
     2,375
        
     968
        
     6,251
        
     1,233Discontinued TeraOptix operations, net of tax
     (100
        )
     (340
        )
     (210
        )
     (1,221
        )Charges and adjustments on the disposal ofTeraOptix, net of tax
     11
        
     (327
        )
     (107
        )
     (1,520
        )Loss from discontinued operations
     (89
        )
     (667
        )
     (317
        )
     (2,741
        )Net earnings (loss)
     $   2,286
        
     $      301
        
     $   5,934
        
     $(1,508
        )BasicEarnings (loss) per share:Continuing operations
     $     0.13
        
     $     0.05
        
     $     0.35
        
     $     0.07Discontinued operations
     $        
        
     $    (0.03
        )
     $    (0.02
        )
     $    (0.15
        )Net earnings (loss)
     $     0.13
        
     $     0.02
        
     $     0.33
        
     $    (0.08
        )DilutedEarnings (loss) per share:Continuing operations
     $     0.13
        
     $     0.05
        
     $     0.35
        
     $     0.07Discontinued operations
     $        
        
     $    (0.03
        )
     $    (0.02
        )
     $    (0.15
        )Net earnings (loss)
     $     0.13
        
     $     0.02
        
     $     0.33
        
     $    (0.08
        )Weighted average shares outstanding:Basic shares
     17,974
        
     17,858
        
     17,942
        
     17,775Diluted shares
     18,226
        
     18,422
        
     18,140
        
     18,248See accompanying notes to
consolidated financial statements.


3



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




March 31, 2005
     June 30, 2004AssetsCurrent assets:Cash and cash equivalents
     $
     16,793
        
     $17,462Marketable securities
     
     9,694
        
     8,428Receivables, less allowance of $653 and $707
     
     28,162
        
     26,338Inventories
     
     33,730
        
     21,547Prepaid expenses
     
     2,142
        
     1,915Deferred income taxes
     
     3,783
        
     3,999Assets of discontinued unit held for sale
     
     
        
     2,012Total current assets
     
     94,304
        
     81,701Marketable securities
     
     7,605
        
     8,503Property, plant, and equipment, net
     
     30,850
        
     27,433Deferred income taxes
     
     29,712
        
     31,738Intangible assets, net
     
     5,425
        
     4,999Other assets
     
     981
        
     1,078Total assets
     $
     168,877
        
     $155,452Liabilities and Stockholders' EquityCurrent liabilities:Payables
     $
     11,733
        
     $10,384Deferred revenue and advance payments
     
     6,263
        
     615Accrued salaries and wages
     
     4,740
        
     5,794Other accrued liabilities
     
     3,885
        
     4,389Income taxes payable
     
     3,435
        
     2,038Total current liabilities
     
     30,056
        
     23,220Other long-term liabilities
     
     151
        
     350Minority interest
     
     1,796
        
     1,238Total liabilities
     
     32,003
        
     24,808Stockholders' equity:Common Stock, $.10 par value per share:40,000,000 shares authorized;18,422,626 shares issued (18,332,933 at June 30, 2004);17,975,421 shares outstanding (17,885,728 at June 30, 2004)
     
     1,842
        
     1,833Additional paid-in capital
     
     142,088
        
     141,151Retained earnings (accumulated deficit)
     
     (62
        )
     (5,996
        )Accumulated other comprehensive income (loss):Currency translation effects
     
     (1,744
        )
     (1,119
        )Net unrealized gain on marketable securities
     
     37
        
     62142,161
        
     135,931Less treasury stock, at cost (447,205 shares)
     
     5,287
        
     5,287Total stockholders' equity
     
     136,874
        
     130,644Total liabilities and stockholders' equity
     $
     168,877
        
     $155,452See accompanying notes to
consolidated financial statements


4



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



Nine Months EndedMarch 31,
2005
     March 26,
2004Cash provided by (used for) operating activities:Net earnings (loss)
     $
     5,934
        
     $(1,508
        )Adjustments to reconcile net earnings (loss) to cashprovided by (used for) operating activities:Loss from discontinued operations
     
     317
        
     2,741Depreciation and amortization
     
     4,379
        
     4,271Deferred income taxes
     
     2,420
        
     629Other, net
     
     259
        
     520Changes in operating accounts:Receivables
     
     (1,705
        )
     (7,086
        )Inventories
     
     (11,903
        )
     (2,684
        )Prepaid expenses
     
     (208
        )
     559Payables and accrued expenses
     
     5,917
        
     2,003Minority interest
     
     558
        
     175Net cash provided by (used for) continuing operations
     
     5,968
        
     (380
        )Net cash used for discontinued operations
     
     (420
        )
     (1,852
        )Net cash provided by (used for) operating activities
     
     5,548
        
     (2,232
        )Cash provided by (used for) investing activities:Additions to property, plant, and equipment, net
     
     (7,718
        )
     (5,521
        )Purchase of marketable securities
     
     (4,763
        )
     (4,941
        )Additions to intangibles and other assets
     
     (868
        )
     (743
        )Proceeds from the sale or maturity of marketable securities
     
     4,325
        
     11,226Net cash (used for) provided by continuing operations
     
     (9,024
        )
     21Net cash provided by discontinued operations
     
     1,918
        
     Net cash (used for) provided by investing activities
     
     (7,106
        )
     21Cash provided by (used for) financing activities:Dividend payments to minority interest
     
     
        
     (235
        )Employee stock purchase
     
     677
        
     578Exercise of employee stock options
     
     212
        
     863Net cash provided by continuing operations
     
     889
        
     1,206Net cash used for discontinued operations
     
     
        
     (11,374
        )Net cash provided by (used for) financing activities
     
     889
        
     (10,168
        )Net decrease in cash and cash equivalents
     
     (669
        )
     (12,379
        )Cash and cash equivalents, beginning of period
     
     17,462
        
     31,209Cash and cash equivalents, end of period
     $
     16,793
        
     $18,830See 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
supplier of optical metrology instruments, precision optics, and electro-optical design
and manufacturing services for customers in the semiconductor capital equipment 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 nine month periods ended March 31,
2005 are not necessarily indicative of the results to be expected for the full fiscal
year.


The Consolidated Balance Sheet at
March 31, 2005, the Consolidated Statements of Operations for the three and nine months
ended March 31, 2005 and March 26, 2004, and the Consolidated Statements of Cash Flows for
the nine months ended March 31, 2005 and March 26, 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, 2004 Annual Report on
Form 10-K, including items incorporated by reference therein.


Revenue Recognition


We recognize revenue based on
guidance provided in Securities and Exchange Commission (SEC) Staff Accounting
Bulletin (SAB) No. 104, Revenue Recognition and in accordance with
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. The standard products do not have customer acceptance criteria. We
have standard rights of return that we account for as a warranty provision under Statement
of Financial Accounting Standards (SFAS) No. 5, Accounting for
Contingencies. We do not have any price protection agreements or other post shipment
obligations. We also sell custom equipment and do have situations where customer
acceptance is part of the sales agreement. In these situations, revenue is not recognized
until 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. Generally,
software is a component of our standard product and, as such, is not separately recognized
as revenue. Standalone software products are recognized as revenue when they are shipped.


Earnings (Loss) Per Share


Basic and diluted earnings (loss) per
share are calculated in accordance with 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
     Nine Months EndedMarch 31,
2005
     March 26,
2004
     March 31,
2005
     March 26,
2004Basic weighted average shares outstanding
     
     
     17,973,834
        
     17,858,346
        
     17,942,028
        
     17,774,599Dilutive effect of stock options
     252,156
        
     563,322
        
     197,737
        
     473,561Diluted weighted average shares outstanding
     18,225,990
        
     18,421,668
        
     18,139,765
        
     18,248,1606



Stock Compensation Plans


As of March 31, 2005, we have two
stock-based compensation plans, which are described below. A third stock-based
compensation plan expired in September 2002. We apply Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations in accounting for our plans. Since all options were granted
with an exercise price equal to the market value of the stock on the date of grant, no
compensation cost has been recognized for our fixed option plans. Pro forma information
regarding net income and earnings per share is required by SFAS No. 123 Accounting
for Stock-Based Compensation, which requires that the information be determined as
if we have accounted for our stock options granted in fiscal years beginning after
December 15, 1994 under the fair value method of the Statement.


The Zygo Corporation Amended and
Restated Non-Employee Director Stock Option 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 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 have a 10-year term. The Plan, as amended, will
expire on November 17, 2009. The Company does not intend to grant further options under
the Non-Employee Director Stock Option Plan.


The Zygo Corporation 2002 Equity
Incentive Plan permits the granting of restricted stock and stock options to purchase
shares of common 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 in quarterly increments (except for the annual option grants to directors
as discussed below). The Plan will expire on August 27, 2012. Pursuant to the terms of the
Plan, the Board of Directors may also amend the Plan to authorize the grant of other types
of equity-based awards, without further action by our stockholders. Non-employee directors
are now 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, generally, on their 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-Qualified Stock Option Plan permitted the granting of non-qualified options
to purchase a total of 4,850,000 shares (adjusted for splits) of common stock at prices
not less than the market value of the stock on the date of grant. Options generally became
exercisable at the rate of 25% of the shares each year commencing one year after the date
of grant. The Plan, as amended, expired on September 3, 2002.


The fair value of options at date of
grant was estimated using the Black-Scholes model. Our pro forma information is as
follows:




Three Months Ended
     Nine Months EndedMarch 31,2005
     March 26,2004
     March 31,2005
     March 26,2004Net earnings (loss), as reported
     
     
     $
     2,286
        
     $301
        
     $5,934
        
     $(1,508
        )Deduct: Total stock-based employeecompensation expense determinedunder fair value based methodfor all awards, net ofrelated tax effects
     
     (474
        )
     (1,446
        )
     (2,110
        )
     (4,272
        )Pro forma net earnings (loss)
     $
     1,812
        
     $(1,145
        )
     $3,824
        
     $(5,780
        )Net earnings (loss) per shareBasic - as reported
     $
     0.13
        
     $0.02
        
     $0.33
        
     $(0.08
        )Basic - pro forma
     $
     0.10
        
     $(0.06
        )
     $0.21
        
     $(0.33
        )Diluted - as reported
     $
     0.13
        
     $0.02
        
     $0.33
        
     $(0.08
        )Diluted - pro forma
     $
     0.10
        
     $(0.06
        )
     $0.21
        
     $(0.32
        )7




Comprehensive Income
(Loss)


Our total comprehensive income (loss)
was as follows:


Three Months Ended
     Nine Months EndedMarch 31,2005
     March 26,2004
     March 31,2005
     March 26,2004Net earnings (loss)
     
     
     $
     2,286
        
     $301
        
     $5,934
        
     $(1,508
        )Unrealized  loss on marketablesecurities, net of tax
     
     (5
        )
     (16
        )
     (25
        )
     (63
        )Unrealized gain on swapagreement, net of tax
     
     
        
     
        
     
        
     337Reclassification adjustmentfor loss on swap agreementincluded in net loss,net of tax
     
     
        
     
        
     
        
     577Foreign currency translationeffect
     
     (696
        )
     (212
        )
     (625
        )
     573Comprehensive income (loss)
     $
     1,585
        
     $73
        
     $5,284
        
     $(84
        )Inventories


Inventories are stated at the lower
of cost (determined on a first-in, first-out basis) or market. At March 31, 2005 and June
30, 2004, inventories were as follows:




March 31,
2005
     June 30,
2004Raw materials and manufactured parts
     
     
     $
     16,519
        
     $11,155Work in process
     
     15,477
        
     9,794Finished goods
     
     1,734
        
     598$
     33,730
        
     $21,547Property, 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 March 31, 2005 and June 30, 2004, property, plant, and equipment
were as follows:



March 31,
2005
     June 30,
2004
     Estimated
Useful Life
(Years)Land
     
     
     $
     615
        
     $615
        
     
     Building and improvements
     
     14,802
        
     11,941
        
     
     15-40Machinery, equipment, and office furniture
     
     43,835
        
     40,602
        
     
     3-8Leasehold improvements
     
     720
        
     657
        
     
     1-5Construction in progress
     
     4,295
        
     3,917
        
     
     64,267
        
     
     57,732Accumulated depreciation
     
     (33,417
        )
     (30,299
        )$
     30,850
        
     $27,433Depreciation expense for the three
months ended March 31, 2005 and March 26, 2004 was $1,207 and $1,131, respectively.
Depreciation expense for the nine months ended March 31, 2005 and March 26, 2004 was
$3,964 and $3,917, respectively.


8



Intangible Assets


Intangible assets include patents,
trademarks, and a license agreement. Costs incurred in obtaining patents and trademarks
are capitalized and the license agreement is valued at the actual dollar amount paid to
obtain the license. The cost of intangible assets is amortized on a straight-line basis
over estimated useful lives ranging from 4-20 years. Costs incurred in maintaining patents
and trademarks are expensed as incurred. If management determines that a patent or
trademark is no longer a useful asset, the remaining unamortized balance is written off
immediately. Intangible assets, at cost, at March 31, 2005 and June 30, 2004 were as
follows:



March 31,
2005
     June 30,
2004Patents
     
     
     $
     6,131
        
     $5,319Trademarks
     
     52
        
     90License agreement
     
     1,350
        
     1,3507,533
        
     6,759Accumulated amortization
     
     (2,108
        )
     (1,760
        )Intangible assets, net
     $
     5,425
        
     $4,999Intangible amortization expense was
$146and $110 for each of the three months ended March 31, 2005 and March 26, 2004,
respectively. Intangible amortization expense was$370 and $322 for the nine months
ended March 31, 2005 and March 26, 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 beginning and ending balances of our accrued warranty liability, which is included in
the Other accrued liabilities line item in the Consolidated Balance Sheets:


Nine Months EndedMarch 31,  2005



     March 26,  2004Beginning balance
     
     
     $
     1,486
        
     $1,215Reductions for payments made
     
     (917
        )
     (1,894
        )Changes  in  accruals  related  to  warrantiesissued in the current period
     
     520
        
     1,216Changes in  accruals  related to  pre-existingwarranties
     
     (40
        )
     757Ending balance
     $
     1,049
        
     $1,294Supplemental Cash Flow
Information


Interest payments on debt were $480
for the nine months ended March 26, 2004. There were no interest payments for the nine
months ended March 31, 2005. We also paid $1,109 in the second quarter of fiscal 2004 in
connection with the settlement of an interest rate swap agreement. Income tax payments,
less income tax refunds, amounted to $482 and $92 for the nine months ended March 31, 2005
and March 26, 2004, respectively.


Reclassifications


Certain amounts included in the
consolidated financial statements for the prior year have been reclassified to conform
with current year presentation.


9



NOTE 2: RECENT
ACCOUNTING PRONOUNCEMENTS


The Financial Accounting Standards
Board (FASB) issued SFAS No. 123R, Share-Based Payment: an amendment of
FASB Statements No. 123 and 95. This statement requires companies to measure and
recognize compensation expense for all share based payments based on their fair value. The
standard becomes effective for interim or annual periods beginning after June 15, 2005. We
will adopt SFAS No. 123R in the first quarter of fiscal 2006. The Company is currently
evaluating the impact of SFAS No. 123R on its consolidated financial position and results
of operations.


The FASB issued SFAS No. 151,
Inventory Costs: an amendment of ARB No. 43, Chapter 4, Inventory Pricing, June
1953. This statement eliminates the so abnormal criteria in Accounting
Research Bulletin (ARB) No. 43 and replaces it with a requirement that
abnormal freight, handling costs, and amounts of wasted materials (spoilage)
should be treated as current-period costs. The standard becomes effective for annual
periods beginning after June 15, 2005. The adoption of SFAS No. 151 in fiscal 2006 is not
expected to have a material effect on our financial position or results of operations.


NOTE 3: DIVESTITURES AND
DISCONTINUED OPERATIONS


In September 2002, we committed to a
planned disposition of our TeraOptix business unit (TeraOptix) which included
recording impairment charges for the facility and equipment. During the first nine months
of fiscal 2004, we took an additional impairment charge on the facility of $1,193 million,
net of tax of $1,111, based on the then current fair value based on an appraisal from an
independent third party. During the fourth quarter of fiscal 2004, management changed the
marketing of the facility to a general purpose manufacturing facility from clean room
space. We received offers on the building during the fourth quarter from two separate
independent third parties. Based on the offers, management determined that the fair value
of the vacant facility was $2,012. An impairment charge of $4,862, net of tax of $2,641,
was recorded in the fourth quarter of fiscal 2004. In fiscal 2005, we recorded an
additional impairment charge and adjustments of $107, net of tax of $60, to reflect the
fair value based on final negotiations of a pending sale. The sale of the facility was
completed in March 2005 for $1,918, net of selling expenses.


In fiscal 2004, we paid off the
mortgage debt of $10,955 on the facility. The mortgage debt had carried interest at 7.5%
per annum at the time of repayment, and required monthly principal payments of $70, plus
interest, until April 2007 and a balloon payment of $8,200 in May 2007. In connection with
the debt repayment, the Company also paid the balance of a related interest rate swap
agreement of $1,109. This payment resulted in an additional charge to discontinued
TeraOptix operations, recorded net of tax. Prior to the payment, in accordance with SFAS
No. 133, as amended, the swap liability was recorded with a corresponding debit, net of
tax, to stockholders equity. The aggregate payment of $12,064 on the mortgage debt
($10,955) and swap agreement ($1,109) was funded from the Companys available cash
and marketable securities.


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:



Nine Months EndedMarch 31,
2005


     March 26,
2004Cash flow from operating activities from discontinued operations:Loss from discontinued operations
     $
     (317
        )
     $(2,741
        )Loss on sale and impairment of assets
     
     94
        
     2,304Deferred income taxes
     
     (178
        )
     (1,413
        )Other, net
     
     (19
        )
     (2
        )Net cash used for operating activities from discontinued operations
     
     (420
        )
     (1,852
        )Cash flows from investing activities:Proceeds from the sale of assets1,918
        
     Net cash provided by investing activities1,918
        
     Cash flow from financing activities from discontinued operations:Payment of long-term debt
     
     
        
     (11,374
        )Net cash used for financing activities from discontinued operations
     
     
        
     (11,374
        )Net cash provided by (used for) discontinued operations
     $
     1,498
        
     $(13,226
        )10




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. The segments are
determined based on managements evaluation of the Companys business. We
evaluate our performance based on the gross profit achieved in each segment. The
accounting policies for both reportable segments are the same as those described in the
summary of significant accounting policies. Selling, general and administrative, and
research and development expenses consistently support both segments and are not allocated
between these two business segments. Our two product categories, metrology and optics, are
sold into each of these segments. Metrology products include optical interferometers for
optical surface and figure measurements and optical surface profilers for nano-technology
applications, both of which are sold into the semiconductor and industrial segments.
Metrology products also include displacement measuring interferometers that are sold
primarily in the semiconductor segment. ZYGOs optics products consist of high
precision optical components, optical coatings, and optical assemblies, all of which are
sold into both business segments.



Three Months Ended
     Nine Months EndedMarch 31,
2005
     March 26,
2004
     March 31,
2005
     March 26,
2004SemiconductorSales
     $
     18,733
        
     $18,027
        
     $53,362
        
     $46,401Gross profit
     
     7,250
        
     6,289
        
     21,109
        
     15,388Gross profit as a % of sales
     
     39%
        
     35%
        
     40%
        
     33%IndustrialSales
     $
     14,954
        
     $10,406
        
     $43,910
        
     $33,933Gross profit
     
     5,880
        
     3,113
        
     16,392
        
     12,178Gross profit as a % of sales
     
     39%
        
     30%
        
     37%
        
     36%TotalSales
     $
     33,687
        
     $28,433
        
     $97,272
        
     $80,334Gross profit
     
     13,130
        
     9,402
        
     37,501
        
     27,566Gross profit as a % of sales
     
     39%
        
     33%
        
     39%
        
     34%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.


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
     Nine Months EndedMarch 31,
2005





     March 26,
2004
     March 31,
2005
     March 26,
2004Domestic
     
     
     $
     12,742
        
     $6,567
        
     $32,774
        
     $21,136Far East:Japan
     
     14,929
        
     16,342
        
     44,379
        
     43,736Pacific Rim
     
     1,799
        
     3,624
        
     8,400
        
     10,491Total Far East
     
     16,728
        
     19,966
        
     52,779
        
     54,227Europe and Other (primarily Europe)
     
     4,217
        
     1,900
        
     11,719
        
     4,971Total
     $
     33,687
        
     $28,433
        
     $97,272
        
     $80,33411


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 $12,839 (38% of net sales)
and $38,189 (39% of net sales) for the three and nine months ended March 31, 2005, as
compared with $16,057 (56% of net sales) and $40,892 (51% 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 March 31, 2005 and
June 30, 2004, there were, in the aggregate, $10,319 and $10,913, 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 months and nine months ended
March 31, 2005, we recognized revenue of $5,442 and $9,615, respectively, for the original
contract and subsequent addon work compared with $5,008 and $13,338, respectively,
for the comparable prior periods.


NOTE 6: HEDGING
ACTIVITIES


During the third quarter of fiscal
2005, we entered 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 to earnings. 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 be largely offset by gains and losses on the underlying transactions.


As of March 31, 2005, we had three
foreign currency forward contracts outstanding. Net recognized gainsfrom foreign
currency forward contracts for both the three and nine month months ended March 31, 2005
was $34, and are included in other income in the consolidated statements of operations.
These gains are substantially offset by foreign exchange losses 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.

12



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


RESULTS OF OPERATIONS


Introduction


Zygo Corporation is a worldwide
supplier of optical metrology instruments, precision optics, and electro-optical design
and manufacturing services for customers in the semiconductor capital equipment and
industrial markets. Optical instruments products encompass non-contact optical measurement
instruments. Optics products consist of high performance macro-optics components, optical
coatings, and optical system assemblies. We conduct the majority of our manufacturing in
our 153,500 square foot facility in Middlefield, Connecticut.


We also perform development services
for our largest customer, Canon, a related party, which have produced a significant amount
of our revenue over the past two years. In September 2002, we entered into a development
services agreement with Canon for work on the development of certain interferometers. In
March 2004, we signed a preliminary agreement to begin further add-on work, with an
amendment to the original contract signed in December 2004. In February 2005, we entered
into two additional agreements with Canon related to the development of prototype
production tools and accessories. In the third quarter of fiscal 2005, we recognized $5.4
million of revenue from these development services agreements as compared with $5.0
million in the prior year comparable quarter. We anticipate revenues of approximately
$29.5 millionfrom these follow-on agreements over the next 12 to 18 months. To the
extent that we do not receive additional development agreements from any customers for
services beyond that period, future period over period comparable sales would be
significantly affected. The Canon development services revenues have historically carried
a lower gross profit as a percentage of sales than our product sales.


Semiconductor manufacturers have
become more cautious in their capital spending outlooks for the remainder of the 2005
calendar year. In the third quarter of fiscal 2005, we experienced a decline in product
sales to Canon; however, this effect was offset by development services revenue returning
to expected levels and by increasing sales to other semiconductor customers. We expect
certain product sales to Canon to be below historical levels in the near term. While this
decline in product sales to Canon was marginal, Canon sales as a percent of total net
sales was significantly lower on a year over year basis. Canon represented 38% and 56% of
total net sales for the third quarter of fiscal 2005 and 2004, respectively, and for the
first nine months of fiscal 2005 and 2004, sales to Canon represented 39% and 51%,
respectively. These year over year decreases were the primary result of increased sales in
other areas of our business, including new initiatives in the flat panel market and growth
in optical business systems.


We achieved an order level for the
third quarter of fiscal 2005 of $37.7 million, as compared with $31.6 million for third
quarter of fiscal 2004.  Orders in the semiconductor segment were $23.6 million, an
increase of $4.7 million, or 25%, as compared with the third quarter of fiscal 2004,
primarily due to increases in flat panel display metrology and stage optics orders of $2.5
million and $3.0 million, respectively.  In the third quarter of fiscal 2005, we
continued a strong order rate in the industrial segment, with aggregate orders of $14.1
million. Orders in this business segment increased by $1.4 million, or 11%, as compared
with the third quarter of fiscal 2004. The industrial orders were highlighted by continued
orders of $2.1 for the production of optics used in laser surgery systems. The order flow
boosted backlog to $68.9 million as of March 31, 2005, up $4.0 million, or 6%, from the
second quarter of fiscal 2005, and up $19.9 million, or 41%, from the third quarter of
fiscal 2004.


We discontinued our
telecommunications TeraOptix business unit during fiscal 2003. Accordingly, the results of
TeraOptix have been presented as a separate line item on the Consolidated Statements of
Operations as Discontinued TeraOptix operations, net of tax, for all periods
presented. In addition, the charges on the disposal of TeraOptix, net of tax, have been
recorded as a separate line item for all periods presented. All continuing operations line
items presented exclude TeraOptix results. In August 2004, we entered into an agreement to
sell our former telecommunications facility located in Westborough, Massachusetts. In the
second quarter of fiscal 2005, we recorded an additional impairment charge and adjustments
of $0.2 million to reflect the fair value based on final negotiations. The sales
transaction was completed in the third quarter of fiscal year 2005 and generated
approximately $1.9 million of cash, net of selling expenses. We do not expect any
additional charges for discontinued operations related to the TeraOptix business unit.






Continuing Operations


We recorded earnings from continuing
operations for the third quarter of fiscal 2005 of $2.4 million, or $0.13 per diluted
share, as compared with the third quarter of fiscal 2004 of $1.0 million, or $0.05 per
diluted share. For the first nine months of



13


fiscal 2005, we recorded earnings from
continuing operations of $6.2 million as compared with $1.2 million for the first nine
months of fiscal 2004. The increase period over period for both the third quarter and the
nine month period reflects higher sales levels leveraging stable operating costs and
overheads.


Net sales of $33.7 million for the
third quarter of fiscal 2005 increased by $5.3 million, or 19%, as compared with the prior
year period. For the nine month period of fiscal 2005, net sales of $97.3 million
increased by $17.0 million, or 21.%, as compared with $80.3 million for the first nine
months of fiscal 2004. Our net sales for the third quarter and nine months ended March 31,
2005 included $5.4 million and $9.6 million, respectively, from development services for
Canon Inc.


Net sales by segment and geographic
regions are as follows:


Net Sales By Segment and Geographic Regions


(In millions)
     Three Months Ended
     Nine Months EndedMarch 31,
2005
     Net Sales
%
     March 26,
2004
     Net Sales
%
     March 31,
2005
     Net Sales
%
     March 26,
2004
     Net Sales
%SegmentSemiconductor
     $
     18.7
        
     
     55
        %
     $18.0
        
     63
        %
     $53.4
        
     55
        %
     $46.4
        
     58
        %Industrial
     
     15.0
        
     
     45
        %
     10.4
        
     37
        %
     43.9
        
     45
        %
     33.9
        
     42
        %Total
     
     33.7
        
     
     100
        %
     28.4
        
     100
        %
     97.3
        
     100
        %
     $80.3
        
     100
        %GeographicDomestic
     
     12.8
        
     
     38
        %
     6.6
        
     23
        %
     32.8
        
     34
        %
     21.1
        
     26
        %Europe/Other
     
     4.2
        
     
     13
        %
     1.9
        
     7
        %
     11.7
        
     12
        %
     5.0
        
     6
        %Japan
     
     14.9
        
     
     44
        %
     16.3
        
     57
        %
     44.4
        
     45
        %
     43.7
        
     55
        %Pacific rim
     
     1.8
        
     
     5
        %
     3.6
        
     13
        %
     8.4
        
     9
        %
     10.5
        
     13
        %Total
     $
     33.7
        
     
     100
        %
     $28.4
        
     100
        %
     $97.3
        
     100
        %
     $80.3
        
     100
        %For the third quarter and first nine
months of fiscal 2005, net sales in the semiconductor sector increased $0.7 million, or
4%, and $7.0 million, or 15%, respectively, as compared with the same periods in the prior
year. The increase for the third quarter of fiscal 2005 was due almost exclusively to
volume increases to lithography customers. The increase for the first nine months of
fiscal 2005 was due primarily to an increase in sales volume to our lithography customers
partially offset by a decrease of $3.7 million in development sales. The increase in sales
to lithography customers was primarily attributable to an increase in number of units sold
in Europe and Japan. The year over year decline in development services revenue of $3.7
million is primarily attributable to the winding down of the initial development agreement
with Canon and a slower than anticipated start on the further add-on work under the
follow-up agreements signed in December 2004 and February 2005.


Sales for the third quarter of fiscal
2005 in the industrial segment increased $4.6 million, or 44%, as compared with the same
period in the prior year. Sales in the industrial segment for the nine month period of
fiscal 2005 increased by $10.0 million, or 29%, over the same period in the prior year.
The increase in industrial segment sales for the third quarter and first nine months of
fiscal 2005 was due primarily to a volume increase in large order optical components
deliveries of $1.3 million and $2.3 million, respectively, and medical system sales of
$1.7 million and $4.5 million, respectively.


Sales in U.S. dollars for the third
quarter of fiscal 2005 were $27.1 million, or 80%, of total net sales for the period. For
the first nine months of fiscal 2005, sales in U.S. dollars were $78.7 million, or 81%, of
total net sales for the period. The majority of our foreign currency transactions and
foreign operations are in the euro and Japanese yen. Management believes the percentage of
sales in foreign currencies may increase in the coming year due to an increase in sales
denominated in yen to Japanese customers. 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. 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. During the third quarter of fiscal 2005, we entered into foreign
currency forward contracts to reduce the impact of adverse fluctuations on earnings
associated with foreign currency exchange rate changes on various intercompany foreign
receivables. We do not enter into any derivative transactions for speculative purposes.


14


Gross profit for the third quarter of
fiscal 2005 totaled $13.1 million, an increase of $3.7 million, or 39%, from $9.4 million
in the third quarter of fiscal 2004. Gross profit as a percentage of sales for the third
quarters of fiscal 2005 and 2004 were 39% and 33%, respectively. Approximately two
percentage points in the quarter over quarter increase is attributable to a reduction in
our quality costs, which include rework, scrap, and warranty expenses. Another
approximately two percentage points of the increase in the gross profit as a percentage of
sales was a result of increased margins on development services. Increased volume in our
optical assembly center helped to reduce unabsorbed costs, and increased volume in Europe
with high margins also contributed to the increase. Gross profit for the first nine months
of fiscal 2005 was $37.5 million, an increase of $9.9 million, or 36%, as compared with
the prior year period. Gross profit as a percentage of sales for the first nine months of
fiscal 2005 and 2004 was 39% and 34%, respectively. The gross profit as a percentage of
sales was helped by increased margins on development services. This contributed two
percentage points to the gross profit as a percentage of sales. In addition, approximately
one percentage point of the increase in the first nine months is attributable to a
reduction in our quality costs, which include rework, scrap, and warranty expenses.


Selling, general, and administrative
expenses (SG&A) in the third quarter of fiscal 2005 amounted to $5.5
million, an increase of $0.1 million, or 2%, from $5.4 million in the third quarter of
fiscal 2004. For the first nine months of fiscal 2005 and 2004, SG&A remained
relatively consistent at $16.9 million in the first nine months of fiscal 2005 as compared
with $16.8 in the first nine months of fiscal 2004. As a percentage of net sales, SG&A
for the third quarter of fiscal 2005 and fiscal 2004 was 16% and 19%, respectively. For
the first nine months of fiscal 2005 and 2004, SG&A as a percentage of sales was 17%
and 21%, respectively. The decrease in SG&A as a percentage of sales for both periods
of fiscal 2005 was due to the costs remaining stable on a higher sales volume.


Research, development, and
engineering expenses (R&D) for the third quarter of fiscal 2005 totaled
$3.8 million, an increase of $1.1 million, or 41%, from $2.7 million in the third quarter
of fiscal 2004. For the first nine months of fiscal 2005 and 2004, R&D expenses were
$10.7 million and $9.3 million, respectively. Our major initiatives this fiscal year are
in the semiconductor segment, most notably for flat panel metrology. R&D as a
percentage of sales for the third quarter and first nine months of fiscal 2005 was 11%.
For the third quarter and first nine months of fiscal 2004, R&D as a percentage of
sales was 10% and 12%, respectively.


The income tax expense from
continuing operations in the third quarter of fiscal 2005 totaled $1.2 million, or31% of pre-tax earnings, as compared with an income tax expense of $0.6 million, or
38% of pre-tax income, in the third quarter of fiscal 2004. The Companys tax rate
for the third quarter of fiscal 2005 was lower than the expected effective rate of 36%
mainly due to an increased deduction on the June 30, 2004 tax return for foreign trade
income that was realized in the third quarter. The income tax expense from continuing
operations for the first nine months of fiscal 2005 totaled $3.6 million, or 34% of
pre-tax earnings, as compared with an income tax expense of $0.9 million, or 38% of
pre-tax income, for the first nine months of fiscal 2004. Our overall effective tax rate,
including discontinued operations, was 36% for the first nine months of fiscal 2005 as
compared with 29% in the comparable prior year period. The increase in the overall
effective tax rate is primarily due to an increase in the percentage of pre-tax income
from foreign operations, which has a higher effective tax rate than income from domestic
operations, and reductions in research and development tax credits. Research and
development credits, which have historically been included in our effective tax rate
calculation, were excluded in the fiscal 2005 rate calculation due to certain statutory
limitations.


RELATED PARTY
TRANSACTIONS


In September 2002, we entered into a
contract with Canon Inc. related to the development of certain interferometers (refer to
Note 5 of our unaudited consolidated financial statements for additional information). In
March 2004, we signed a preliminary agreement to begin further add-on work, with a
definitive agreement signed on December 20, 2004. In February 2005, we entered into two
additional agreements with Canon Inc. related to the development of prototype production
tools and accessories. Our net sales for the third quarter and nine months ended March 31,
2004 included $5.4 million and $9.6 million, respectively, from these development services
for Canon Inc.

15



LIQUIDITY AND CAPITAL
RESOURCES


At March 31, 2005, working capital
was$64.2 million, an increase of $5.7million from $58.5 million at
June 30, 2004. We maintained cash, cash equivalents, and marketable securities at
March 31, 2005 totaling $34.1million, as compared with $34.4 million at June 30,
2004. The increase in working capital was primarily the result of an increase in inventory
of $12.2 due to increased orders partially offset by an increase in deferred revenue and
advance payments of $5.6 million due primarily to flat panel revenue recognition
accounting. There were no borrowings outstanding under our $3.0 million bank line of
credit at March 31, 2005.


During fiscal 2004, we entered into
an agreement to sell our vacant Westborough, Massachusetts, facility. The sale transaction
was completed in the third quarter of fiscal 2005 and generated approximately $1.9 million
in cash, net of selling expenses.


Acquisitions of property, plant, and
equipment were $1.8 million in the third quarter of fiscal 2005, which includes $0.7million for the construction of an addition to our existing Middlefield, Connecticut,
facility. The building addition was completed during the third quarter of fiscal 2005. The
additional space is being used primarily for manufacturing.


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.


Revenue Recognition and
Allowance for Doubtful Accounts


We recognize revenue based on
guidance provided in SEC SAB No. 104, Revenue Recognition and in accordance
with 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. The standard products do
not have customer acceptance criteria. 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. We also
sell custom equipment and do have situations where customer acceptance is part of the
sales agreement. In these situations, revenue is not recognized until 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. Generally, software is a component
of our standard product and, as such, is not separately recognized as revenue. Standalone
software products are recognized as revenue when they are shipped.


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.


16



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
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 Costs


We provide for the estimated cost of
product warranties at the time revenue is recognized. We consider historical warranty
costs actually incurred and specifically identified circumstances to establish the
warranty liability. The warranty liability is reviewed on a quarterly basis. Should actual
costs or revised estimated costs differ from managements prior estimates, revisions
to the estimated warranty liability would be required.


Accounting for Income
Taxes


Deferred 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, changes to the valuation allowance, changes in pre-tax income between jurisdictions
that have higher or lower tax rates, changes to federal, state or foreign tax laws, and
deductibility of certain costs and expenses by jurisdiction.


Valuation of Long-Lived
Assets


In accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, the carrying
value of intangible assets and other long-lived assets is reviewed on a regular basis for
the existence of facts or circumstances, both internally and externally, that may suggest
impairment. Some factors we consider important, which could trigger the impairment review,
include a significant decrease in the market value of an asset, a significant change in
the extent or manner in which an asset is used, a significant adverse change in the
business climate that could affect the value of an asset, an accumulation of costs for an
asset in excess of the amount originally expected, a current period operating 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.

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Health Insurance


Beginning in January 2004, we became
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
Arrangements


We 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.


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RISK FACTORS THAT MAY
IMPACT FUTURE RESULTS


Risk factors that may impact future
results include those disclosed in our Form 10-K for the year ended June 30, 2004.


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 nine months of fiscal 2005. 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 gains and losses 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 filed with the Securities and Exchange
Commission on Form 10-K for the year ended June 30, 2004.


Item 4. Controls and
Procedures


ZYGO maintains disclosure
controls and procedures, as such term is defined under Securities Exchange Act Rule
13a-15(e), that are designed to ensure that information required to be disclosed in our
Exchange Act reports is recorded, processed, summarized, and reported within the time
periods specified in the SECs rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding required
disclosures. In designing 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. We have carried out an
evaluation, as of the end of the period covered by this report, under the supervision and
with the participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures. Based upon their evaluation and subject to the foregoing, the
Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls
and procedures were effective in ensuring that material information relating to ZYGO is
made known to the Chief Executive Officer and Chief Financial Officer by others within our
Company during the period in which this report was being prepared.


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


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PART II  Other
Information


Item 6.     Exhibits



(a)
     Exhibits:10.1
     Development  Agreement  Amendment dated February 26, 2005,
 between Zygo Corporation and Canon Inc. (1)10.2
     Development  Agreement dated February 23, 2005, between Zygo Corporation and Canon Inc. (1)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(1)
Certain
portions of this exhibit have been omitted pursuant to a request for an           order
granting confidential treatment by the Securities and Exchange Commission.           The
omitted non-public information has been filed with the Securities and           Exchange
Commission.20



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 RobinsonPresident, Chairman, and Chief Executive Officer/s/ Walter A. Shephard
Walter A. ShephardVice President, Finance, Chief Financial Officer, and TreasurerDate: May 6, 2005



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