# UNITED STATESSECURITIES 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

# [   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF
1934

# Commission File
Number: 0-26824

# TEGAL CORPORATION(Exact Name of
Registrant as Specified in Its Charter)

|                                                                        |                                               
|----------------------------------------------------------------------- | ----------------------------------------------
|Delaware (State or other jurisdiction of
incorporation or organization) | 68-0370244(I.R.S. Employer Identification No.)

2201 South McDowell
Blvd.Petaluma, California
94954(Address of
Principal Executive Offices)

# 

Telephone Number (707)
763-5600(Registrants
Telephone Number, Including Area Code)

_________________

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 reports) and (2) has
been subject to such filing requirements for the past 90 days.    Yes [X] No
[   ]

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.  (Check One):Large accelerated
filer [   ]     Accelerated filer  [   ]                 Non-accelerated filer  [X]

As
of February 9, 2006 there were 83,973,854 shares of our common stock outstanding.

---

# TEGAL CORPORATION AND
SUBSIDIARIES

# INDEX

|        | PART I. FINANCIAL INFORMATION                                                                                                  | Page
|------- | ------------------------------------------------------------------------------------------------------------------------------ | ----
|ITEM 1. | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)                                                                        |     
|        | Condensed Consolidated Balance Sheets as of December 31, 2005 and March 31, 2005                                               | 3   
|        | Condensed Consolidated  Statements of Operations-- for the three months ended and nine months ended December 31,
2005 and 2004 | 4   
|        | Condensed Consolidated Statements of Cash Flows-- for the nine months ended December 31, 2005 and 2004                         | 5   
|        | Notes to Condensed Consolidated Financial Statements                                                                           | 7   
|ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS                                          | 12  
|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                     | 21  
|ITEM 4. | CONTROLS AND PROCEDURES                                                                                                        | 22  

|           | PART II. OTHER INFORMATION |   
|---------- | -------------------------- | --
|ITEM 1.    | LEGAL PROCEEDINGS          | 23
|ITEM 6.    | EXHIBITS                   | 23
|SIGNATURES |                            | 24

---

# PART I 
FINANCIAL INFORMATION

# Item 1. Condensed Consolidated
Financial Statements

# TEGAL CORPORATION AND
SUBSIDIARIESCONDENSED CONSOLIDATED
BALANCE SHEETS(Unaudited)(In thousands, except
share data)

|                                                                                                    | December 31,2005 | March 31,2005
|--------------------------------------------------------------------------------------------------- | ---------------- | -------------
|
|Current assets:                                                                                     |                  |              
|Cash and cash equivalents                                                                           |                  |              
|Accounts receivable, net of allowances for sales returns and doubtful accounts of $219 and  $533 at |                  |              
|December 31, and March 31, 2005 respectively                                                        |                  |              
|Inventories                                                                                         |                  |              
|Prepaid expenses and other current assets                                                           |                  |              
|                                                                                                    |                  |              
|Total current assets                                                                                |                  |              
|Property and equipment, net                                                                         |                  |              
|Intangible assets, net                                                                              |                  |              
|Other assets                                                                                        |                  |              
|                                                                                                    |                  |              
|Total assets                                                                                        |                  |              
|                                                                                                    |                  |              

|LIABILITIES AND STOCKHOLDERS' EQUITY                                                          
|----------------------------------------------------------------------------------------------
|Current liabilities:                                                                          
|Notes payable and bank lines of credit                                                        
|Accounts payable                                                                              
|Accrued product warranty                                                                      
|Deferred revenue                                                                              
|Accrued expenses and other current liabilities                                                
|                                                                                              
|Total current liabilities                                                                     
|Long-term portion of capital lease obligations                                                
|Other long term obligations                                                                   
|                                                                                              
|Total long term liabilities                                                                   
|                                                                                              
|Total liabilities                                                                             
|                                                                                              
|Stockholders' equity:                                                                         
|Preferred stock; $0.01 par value; 5,000,000 shares authorized; none issued and outstanding    
|Common stock; $0.01 par value; 200,000,000 shares authorized; 83,973,854 and 52,843,520 shares
|issued and outstanding at December 31, 2005 and March 31, 2005 respectively                   
|Restricted Share Units                                                                        
|Deferred Compensation                                                                         
|Additional paid-in capital                                                                    
|Accumulated other comprehensive income (loss)                                                 
|Accumulated deficit                                                                           
|                                                                                              
|Total stockholders' equity                                                                    
|                                                                                              
|Total liabilities and stockholders' equity                                                    
|                                                                                              

See accompanying notes.

---

# TEGAL CORPORATION AND
SUBSIDIARIESCONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS(Unaudited)(In thousands, except
per share data)

|                                      | Three Months EndedDecember 31, | Nine Months EndedDecember 31,
|------------------------------------- | ------------------------------ | -----------------------------
|
|Revenue                               |                                |                              
|Cost of sales                         |                                |                              
|                                      |                                |                              
|Gross profit (loss)                   |                                |                              
|                                      |                                |                              
|Operating expenses:                   |                                |                              
|Research and development              |                                |                              
|Sales and marketing                   |                                |                              
|General and administrative            |                                |                              
|In-process research and development   |                                |                              
|                                      |                                |                              
|Total operating expenses              |                                |                              
|                                      |                                |                              
|Operating loss                        |                                |                              
|Other income (expense), net           |                                |                              
|Interest income (expense), net        |                                |                              
|Other income (expense)                |                                |                              
|                                      |                                |                              
|Total other income (expense), net     |                                |                              
|                                      |                                |                              
|Net loss                              |                                |                              
|                                      |                                |                              
|Net loss per share, basic and diluted |                                |                              
|                                      |                                |                              
|Shares used in per share computation: |                                |                              
|Basic                                 |                                |                              
|Diluted                               |                                |                              

See accompanying notes.

---

# TEGAL CORPORATION AND
SUBSIDIARIESCONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS(Unaudited)(In thousands)

|                                                                                | Nine Months EndedDecember 31,
|------------------------------------------------------------------------------- | -----------------------------
|
|Cash flows from operating activities:                                           |                              
|Net loss                                                                        |                              
|Adjustments to reconcile net loss to cash used in operating activities:         |                              
|Non cash in-process research & development charge                               |                              
|Depreciation and amortization                                                   |                              
|Non cash interest expense - accretion of debt discount and amortization of debt |                              
|issuance costs                                                                  |                              
|Non-cash valuation of marked to market investor warrants                        |                              
|Fair value of warrants issued for services rendered                             |                              
|Provision for doubtful accounts and sales return allowances                     |                              
|Excess and obsolete inventory provision                                         |                              
|Changes in operating assets and liabilities:                                    |                              
|Receivables                                                                     |                              
|Inventories                                                                     |                              
|Prepaid expenses and other assets                                               |                              
|Accounts payable                                                                |                              
|Accrued expenses and other liabilities                                          |                              
|Accrued product warranty                                                        |                              
|Deferred revenue                                                                |                              
|                                                                                |                              
|Net cash used in operating activities                                           |                              
|                                                                                |                              
|Cash flows used in investing activities:                                        |                              
|Purchases of property and equipment                                             |                              
|Loss on disposal of property and equipment                                      |                              
|                                                                                |                              
|Net cash used in investing activities:                                          |                              
|                                                                                |                              
|Cash flows provided by financing activities:                                    |                              
|Net proceeds from issuance of common stock                                      |                              
|Borrowings under lines of credit                                                |                              
|Repayment of borrowings under lines of credit                                   |                              
|Proceeds from and (payments on) capital lease financing                         |                              
|                                                                                |                              
|Net cash provided by financing activities                                       |                              
|                                                                                |                              
|Effect of exchange rates on cash and cash equivalents                           |                              
|                                                                                |                              
|Net increase (decrease) in cash and cash equivalents                            |                              
|Cash and cash equivalents at beginning of period                                |                              
|                                                                                |                              
|Cash and cash equivalents at end of period                                      |                              
|                                                                                |                              
|Supplemental disclosure of non-cash investing and financing activities          |                              
|Transfer of demo lab equipment between inventory and fixed assets               |                              

See accompanying notes.

---

Supplemental Schedule of Non Cash
Investing Activities (in thousands, except share data):

On
May 28, 2004, Tegal Corporation (the Company) purchased substantially all of
the assets and assumed certain liabilities of First Derivative Systems, Inc.
(FDSI), a development stage company for 1,410,632 shares of common stock, $150
in debt forgiveness, approximately $50 in assumed liabilities, and $158 in acquisition
costs. The purchase price was allocated as follows:

|                                    | 
|----------------------------------- | 
|Fair value fixed assets acquired    | 
|Non compete agreements              | 
|Patents                             | 
|In-process research and development | 
|Debt forgiveness                    | 
|Assumed liabilities                 | 
|                                    | 
|                                    | 
|                                    | 

See accompanying notes.

---

# TEGAL CORPORATION AND
SUBSIDIARIES

# NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)(All amounts in
thousands, except share data)

# 1. Basis of Presentation:

In
the opinion of management, the unaudited condensed consolidated interim financial
statements have been prepared on the same basis as the March 31, 2005 audited consolidated
financial statements and include all adjustments, consisting only of normal recurring
adjustments, necessary to fairly state the information set forth herein. The statements
have been prepared in accordance with the regulations of the Securities and Exchange
Commission (the SEC), but omit certain information and footnote disclosures
necessary to present the statements in accordance with generally accepted accounting
principles. These interim financial statements should be read in conjunction with the
consolidated financial statements and footnotes included in the Companys Annual
Report on Form 10-K for the fiscal year ended March 31, 2005. The results of operations
for the three and nine months ended December 31, 2005 are not necessarily indicative of
results to be expected for the entire year.

The
consolidated financial statements contemplate the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company incurred net
losses of $7,092 and $11,514 for the nine months ended December 31, 2005 and 2004,
respectively. The Company generated negative cash flows from operations of $10,909 and
$8,623 for the period ended December 31, 2005 and 2004, respectively. During the current
Fiscal Year 2006 the Company raised a net of $18,161 through a private investment
placement of equity. Management believes that these proceeds, combined with projected
sales, consolidation of certain operations and continued cost containment will be adequate
to fund operations through fiscal 2007. However, projected sales may not materialize and
unforeseen costs may be incurred.If the projected sales do not materialize, the
Companys ability to achieve its intended business objectives may be adversely
affected. The consolidated financial statements do not include any adjustments relating to
the recoverability and classification of recorded assets or the amount or classification
of liabilities or any other adjustments that might be necessary should the Company be
unable to continue as a going concern.

# Concentration of Credit
Risk

Financial
instruments that potentially subject the Company to significant concentrations of credit
risk consist primarily of temporary cash investments and accounts receivable.
Substantially all of the Companys temporary investments are invested in highly
liquid money market funds. The Companys accounts receivables are derived primarily
from sales to customers located in the United States, Europe and Asia. The Company
performs ongoing credit evaluations of its customers and generally requires no collateral.
The Company maintains reserves for potential credit losses. Write-offs during the periods
presented have been insignificant. As of December 31, 2005, two customers accounted for
approximately 76% of the accounts receivables balance. As of December 31, 2004, one
customers accounted for approximately 49% of the accounts receivable balance.

During
the three months ended December 31, 2005 and 2004, two customers accounted for 70% and 28%
of total revenues, respectively. During the nine months ended December 31, 2005 and
December 31, 2004, one customer accounted for 55% and 23% of total revenues, respectively.

# Stock Based Compensation

The
Company accounts for stock-based employee compensation under the recognition and
measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, (APB No. 25) and related interpretations. Under APB No. 25,
compensation cost is equal to the difference, if any, on the date of grant between the
fair value of the Companys stock and the amount an employee must pay to acquire the
stock. SFAS No. 123, Accounting for Stock-based Compensation, established accounting and
disclosure requirements using a fair value based method of accounting for stock-based
employee compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic value based method of accounting described above, and has
adopted the disclosure requirements of SFAS No. 123 and related SFAS No. 148, Accounting
for Stock-Based Compensation  Transition and Disclosure.

The
following assumptions are included in the estimated grant date fair value calculations for
the Companys stock option awards and Employee Qualified Stock Purchase Plan
(Employee Stock Purchase Plan):

|                        | Three Months EndedDecember 31, 2005 | Nine Months Ended December 31, 2005 | Three Months EndedDecember 31, 2004 | Nine Months EndedDecember 31, 2004
|----------------------- | ----------------------------------- | ----------------------------------- | ----------------------------------- | ----------------------------------
|Expected life (years):  |                                     |                                     |                                     |                                   
|Stock options           |                                     |                                     |                                     | 4                                 
|Employee plan           |                                     |                                     |                                     | 4                                 
|Volatility:             |                                     |                                    
|Stock options           |                                     |                                     |                                     | 84                                
|Employee plan           |                                     |                                     |                                     | 84                                
|Risk-free interest rate |                                     |                                     |                                     | 3                                 
|Dividend yield          |                                     |                                     |                                     | 0                                 

The
weighted average estimated grant date fair value, as defined by SFAS No. 123, for stock
option awards granted during three months ended December 31, 2005 was $0.57 per option.

The
following table illustrates the effect on net income (loss) and net income (loss) per
share if the Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based compensation (in thousands, except per share data):

|                                                                     | Three Months EndedDecember 31, | Nine Months EndedDecember 31,
|-------------------------------------------------------------------- | ------------------------------ | -----------------------------
|
|Net loss as reported                                                 |                                |                              
|Add:  Stock-based employee compensation expense included in reported |                                |                              
|net loss                                                             |                                |                              
|Deduct:  Total stock-based employee compensation expense determined  |                                |                              
|under fair value method for all awards                               |                                |                              
|                                                                     |                                |                              
|Proforma net loss                                                    |                                |                              
|                                                                     |                                |                              
|Basic net loss per share:                                            |                                |                              
|As reported                                                          |                                |                              
|                                                                     |                                |                              
|Proforma                                                             |                                |                              
|                                                                     |                                |                              

During
the nine months ended September 30, 2005, the Company awarded 1,000,000 restricted stock
units to Brad Mattson, the Companys Chairman, and 150,000 restricted stock units to
Thomas Mika, the Companys President and Chief Executive Officer at the close of the
2005 PIPE, see note 6. These restricted stock units were accounted for as compensation
expense of $1,004.

During
the nine months ended September 30, 2005, the Company awarded five employees 400,000
restricted shares. These shares were valued at $276, are not vested, and were accounted
for as Restricted Share Units and Deferred Compensation in the equity section of the
balance sheet.

During
the previous fiscal year, the Company entered into a contract with certain consultants of
the Company pursuant to which the Company will issue warrants on a monthly basis in lieu
of cash payments for two years, dependant upon the continuation of the contract and the
achievement of certain performance goals. These warrants are valued and expensed on a
monthly basis upon issuance. During the three and nine months ending December 31, 2005,
the Company issued warrants to purchase 84,999 and 254,997 shares, respectively, of the
Companys common stock to service providers for services rendered. During the three
and nine months ended December 31, 2005, the warrants were valued at $42 and $179
respectively, using the Black-Scholes model with an exercise price at the market value on
the day of the grant and an average interest rate of 3.99% and 3.11% respectively. The
life of the warrants is five and seven years with the volatility of 115% and 118%,
respectively.

On
September 13, 2005 the Company issued 500,000 warrants at $0.69 as consideration for an
amendment to the current lease of the Companys headquarters to reduce the
termination fee. The value of the warrants of $655 was based on the fair value of the
termination penalty reduction offset by the exercise price of the warrant and recorded as
rent expense.

The
disclosure provisions of SFAS No. 123 and SFAS No. 148 require judgments by management as
to the estimated lives of the outstanding options. Management has based the estimated life
of the options on historical option exercise patterns. If the estimated life of the
options increases, the valuation of the options will increase as well.

# 2. Inventories:

Inventories
are stated at the lower of cost or market, reduced by provisions for excess and
obsolescence. Cost is computed using standard cost, which approximates actual cost on a
first-in, first-out basis and includes material, labor and manufacturing overhead costs.
We estimate the effects of excess and obsolescence on the carrying values of our
inventories based upon estimates of future demand and market conditions. We establish
provisions for related inventories in excess of production demand. Should actual
production demand differ from our estimates, additional inventory write-downs may be
required, as was the case in the forth quarter of fiscal 2005. Any excess and obsolete
provision is released only if and when the related inventories is sold or scrapped. During
the three and nine months ending December 31, 2005, the Company sold previously reserved
inventory of $131 and $440, respectively.

Inventories
for the periods presented consisted of:

|                          | December 31,2005 | March 31,2005
|------------------------- | ---------------- | -------------
|Raw materials             |                  |              
|Work in progress          |                  |              
|Finished goods and spares |                  |              
|                          |                  |              
|                          |                  |              
|                          |                  |              

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

# 3. Product Warranty:

The
Company provides warranty on all system sales based on the estimated cost of product
warranties at the time revenue is recognized. The warranty obligation is affected by
product failure rates, material usage rates, and the efficiency by which the product
failure is corrected. Should actual product failure rates, material usage rates and labor
efficiencies differ from estimates, revisions to the estimated warranty liability may be
required.

Warranty
activity for the three-month and nine-month periods ended December 31, 2005 and 2004 was:

|                                                                     | Warranty Activity for the
Three Months Ended December 31, | Warranty Activity for the
Nine Months EndedDecember 31,
|-------------------------------------------------------------------- | --------------------------------------------------------- | -------------------------------------------------------
|
|Balance at the beginning of the period                               |                                                           |                                                        
|Additional warranty accruals for warranties issued during the period |                                                           |                                                        
|Accruals related to pre-existing warranties                          |                                                           |                                                        
|Less settlements made during the period                              |                                                           |                                                        
|                                                                     |                                                           |                                                        
|Balance at the end of the period                                     |                                                           |                                                        
|                                                                     |                                                           |                                                        

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

# 4. Accounting for
Restructure Expenses:

During
the three months ended December 31, 2005, the Company recorded no severance charges.
During the nine months ended December 31, 2005, the Company recorded a severance charge of
approximately $117 related to staff reductions of 5 employees, of which approximately $24
was classified as cost of sales, $85 as research and development and $8 as sales,
marketing and general and administrative expenses. The Company had an outstanding
severance liability of approximately $23 as of December 31, 2005. During the fiscal year
ended March 31, 2005, the Company recorded a severance charge of approximately $129
related to staff reductions of 19 employees, of which approximately $19 was classified as
cost of sales, $18 as research and development and $92 as sales, marketing and general and
administrative expenses.

# 5. Net Loss Per Common
Share:

Basic
net loss per common share is computed using the weighted-average number of shares of
common stock outstanding.

The
following table represents the calculation of basic and diluted net loss per common share
(in thousands, except per share data):

|                                                                                              | Three Months EndedDecember 31, | Nine Months EndedDecember 31,
|--------------------------------------------------------------------------------------------- | ------------------------------ | -----------------------------
|
|Net loss applicable to common stockholders                                                    |                                |                              
|                                                                                              |                                |                              
|Basic and diluted:                                                                            |                                |                              
|Weighted-average common shares outstanding                                                    |                                |                              
|Less weighted-average common shares subject to repurchase                                     |                                |                              
|                                                                                              |                                |                              
|Weighted-average common shares used in computing basic and  diluted net loss per common share |                                |                              
|                                                                                              |                                |                              
|Basic and diluted net loss per common share                                                   |                                |                              
|                                                                                              |                                |                              

Outstanding
options, warrants and restricted stock equivalent to 30,004,852 and 12,699,823 shares of
common stock at a weighted-average exercise price of $1.27 and $2.22 per share on December
31, 2005 and 2004, were not included in the computation of diluted net loss per common
share for the periods presented as a result of their anti-dilutive effect. Such securities
could potentially dilute earnings per share in future periods.

# 6. Stock-Based
Transactions:

Effective
July 6, 2005, the Company entered into a Purchase Agreement with certain accredited
investors pursuant to which it sold to them an aggregate of 30,840,000 shares of our
common stock at a purchase price of $0.65 per share and warrants to purchase an aggregate
of 15,420,001 shares of our common stock at an exercise price of $1.00 per share. All of
these securities were sold in a private placement pursuant to Regulation D of the
Securities Act of 1933, as amended, solely to accredited investors, as defined in Rule 501
of the Act. This financing transaction is referred to herein as the 2005 PIPE.

In
the initial closing of the 2005 PIPE on July 12, 2005, the Company sold 6,300,000 shares
at a purchase price of $0.65 per share and five-year warrants to purchase an aggregate of
3,150,000 shares of common stock at an exercise price of $1.00 per share to the investors
at an aggregate purchase price of $4,095. In connection with the 2005 PIPE, the Company
granted to the investors registration rights. The effective date of the Form S-3
registration statement registering the shares issued in the initial closing was August 25,
2005.

In
the second closing of the 2005 PIPE on September 19, 2005, the Company sold 24,540,000
shares at a purchase price of $.65 per share and five-year warrants to purchase an
aggregate of 12,270,001 shares of common stock at an exercise price of $1.00 per share to
the investors at an aggregate purchase price of $15,951. The effective date of the Form
S-3 registration statement registering the shares issued in the second closing was October
24, 2005.

In
accordance with EITF 00-19, Accounting for Derivative Financial Instruments Indexed
To, and Potentially Settled In a Companys Own Stock, the fair value of the
warrants in the second closing of the 2005 PIPE on the date of grant was estimated to be
$6,621 using the Black-Scholes option-pricing model with the following assumptions: no
dividends; risk-free interest rate of 3.5%, the contractual life of 5 years and volatility
of 115%. The warrants fair value was reported as a liability at the time of grant,
with a corresponding charge to common stock. At September 30, 2005, the fair value of the
warrants was estimated to be $6,295 using the Black-Scholes option pricing model with the
same assumptions. The $326 decrease in the liability has been reported as other income.
The fair value of the warrants was reclassified to common stock when the applicable Form
S-3 registration statement became effective on October 24, 2005, with the difference in
the fair value of the warrants between September 30, 2005, and the effective date
reflected in the statement of operations as other expense of $762. As of December 31,
2005, there is no longer a contingent liablility.

The
Company paid a placement fee of $1,453 (equal to 7% of the Companys gross proceeds
for both transactions) to Dahlman Rose & Company LLC, the Companys financial
advisor for the 2005 PIPE.

Issuance of Warrants to
Consultants

The
Company is party to a contract with certain consultants pursuant to which the Company will
issue warrants on a monthly basis in lieu of cash payments through August 2006, depending
upon the continuation of the contract and the achievement of certain performance goals.
The maximum number of warrants to be issued under these agreements is 990,000 shares.
During the three and nine months ended December 31, 2005, the warrants were valued at $42
and $179 respectively, using the Black-Scholes model with an exercise price at the market
value on the day of the grant and an average interest rate of 3.99% and 3.11%,
respectively. The life of the warrants is five and seven years with the volatility of 115%
and 118%, respectively.

On
September 13, 2005 the Company issued 500,000 warrants with an exercise price of $0.69 per
share as consideration for an amendment to the current lease of the Companys
headquarters to reduce the termination fee. The value of the warrants of $655 was based on
the fair value of the termination penalty reduction offset by the exercise price of the
warrant and recorded as rent expense.

# 7. Lines of Credit:

As
of December 31, 2005, the Companys Japanese subsidiary had borrowed 0.1 million yen
(approximately $8 at exchange rates prevailing on December 31, 2005) under its Japanese
bank line of credit. The credit line has a total borrowing capacity of 150,000 yen
(approximately $1,271 at exchange rates prevailing on December 31, 2005), which is secured
by Japanese customer promissory notes held by such subsidiary in advance of payment on
customers accounts receivable. The Japanese bank line bears interest at Japanese
prime (1.375% as of December 31, 2005) plus 1.0%.

Notes
payable as of December 31, 2005 consisted primarily of one outstanding note to the
California Trade and Commerce Agency for $22. The unsecured note from the California Trade
and Commerce Agency carries an annual interest rate of 5.75% with monthly payments of
approximately $5.5 per month. Although the payment deadlines are being met, the note is
currently in technical default due to the merger of Sputtered Films and Tegal Corporation.

# 8. Geographical
Information

Tegal
operates in one segment for the manufacture, marketing and servicing of integrated circuit
fabrication equipment. In accordance with SFAS No. 131 (SFAS 131) Disclosures About
Segments of an Enterprise and Related Information, Tegals chief operating
decision-maker has been identified as the President and Chief Executive Officer, who
reviews operating results to make decisions about allocating resources and assessing
performance for the entire company. All material operating units qualify for aggregation
under SFAS 131 due to their identical customer base and similarities in: economic
characteristics; nature of products and services; and procurement, manufacturing and
distribution processes. Since Tegal operates in one segment and in one group of similar
products and services, all financial segment and product line information required by SFAS
131 can be found in the consolidated financial statements.

For
geographical reporting, revenues are attributed to the geographic location in which the
customers facilities are located. Long-lived assets consist primarily of property,
plant and equipment, and are attributed to the geographic location in which they are
located. Net sales and long-lived assets by geographic region were as follows:

|                               | Revenue for the 
Three Months EndedDecember 31, | Revenue for the
Nine Months EndedDecember 31,
|------------------------------ | ----------------------------------------------- | ---------------------------------------------
|
|Sales to customers located in: |                                                 |                                              
|United States                  |                                                 |                                              
|Asia, excluding Japan          |                                                 |                                              
|Japan                          |                                                 |                                              
|Europe                         |                                                 |                                              
|                               |                                                 |                                              
|Total sales                    |                                                 |                                              
|                               |                                                 |                                              

|                                 | December 31,2005 | March 31,2005
|-------------------------------- | ---------------- | -------------
|Long-lived assets at period-end: |                  |              
|United States                    |                  |              
|Europe                           |                  |              
|Japan                            |                  |              
|Asia, excluding Japan            |                  |              
|                                 |                  |              
|Total long-lived assets          |                  |              
|                                 |                  |              

# 9. Comprehensive Income
(Loss):

The
components of comprehensive loss for the three and nine-month periods ended December 31,
2005 and 2004 are as follows:

|                                        | Three Months
Ended December 31, | Nine Months
EndedDecember 31,
|--------------------------------------- | ------------------------------- | -----------------------------
|
|Net loss                                |                                 |                              
|Foreign currency translation adjustment |                                 |                              
|                                        |                                 |                              
|                                        |                                 |                              
|                                        |                                 |                              

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

# Special Note Regarding
Forward Looking Statements

Information
herein contains forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, which can be identified by the use of
forward-looking terminology such as may, will, expect,
anticipate, estimate, or continue or the negative
thereof or other variations thereon or comparable terminology or which constitute
projected financial information. The forward-looking statements relate to the near-term
semiconductor capital equipment industry outlook, demand for our products, our quarterly
revenue and earnings prospects for the near-term future and other matters contained
herein. Such statements are based on current expectations and beliefs and involve a number
of uncertainties and risks that could cause the actual results to differ materially from
those projected. Such uncertainties and risks include, but are not limited to, cyclicality
of the semiconductor industry, impediments to customer acceptance of our products,
fluctuations in quarterly operating results, competitive pricing pressures, the
introduction of competitor products having technological and/or pricing advantages,
product volume and mix and other risks detailed from time to time in our SEC reports,
including in the section entitled Risk Factors below. For further information,
refer to the business description and risk factors described below. All forward-looking
statements are expressly qualified in their entirety by the cautionary statements in this
paragraph.

Tegal
designs, manufactures, markets and services plasma etch and deposition systems that enable
the production of integrated circuits (ICs), memory and related
microelectronics devices used in personal computers, wireless voice and data
telecommunications, contact-less transaction devices, radio frequency identification
devices (RFIDs), smart cards, data storage and micro-level actuators.
Etching and deposition constitute two of the principal IC and related device production
process steps and each must be performed numerous times in the production of such devices.

# Critical Accounting
Policies

Our
discussion and analysis of the financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. The preparation
of these financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our estimates,
including those related to inventory, warranty obligations, purchase order commitments,
bad debts, income taxes, intangible assets, restructuring and contingencies and
litigation. We base our estimates on historical experience and on various other
assumptions that we believe to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

We
believe the following critical accounting policies affect our more significant judgments
and estimates used in the preparation of our consolidated financial statements:

# Revenue Recognition

Each
sale of our equipment is evaluated on an individual basis in regard to revenue
recognition. We have integrated in our evaluation the related interpretative guidance
included in Topic 13 of the codification of staff accounting bulletins, and recognize the
role of the FASBs Emerging Issues Task Force (EITF) consensus on Issue
00-21. We first refer to EITF 00-21 in order to determine if there is more than one unit
of accounting and then we refer to SAB104 for revenue recognition topics for the unit of
accounting. We recognize revenue when persuasive evidence of an arrangement exists, the
sellers price is fixed or determinable and collectibility is reasonably assured.

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

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

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

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

# Accounts Receivable
 Allowance for Sales Returns and Doubtful Accounts

We
maintain an allowance for doubtful accounts receivable for estimated losses resulting from
the inability of our customers to make required payments. If the financial condition of
our customers were to deteriorate, or even a single customer was otherwise unable to make
payments, additional allowances may be required.

Our
return policy is for spare parts and components only. Customers are allowed to return
spare parts if they are defective upon receipt, in accordance with SFAS 48. The potential
returns are offset against gross revenue on a monthly basis. Management reviews
outstanding requests for returns on a quarterly basis to determine that the reserves are
adequate.

# Inventories

Inventories
are stated at the lower of cost or market, reduced by provisions for excess and
obsolescence. Cost is computed using standard cost, which approximates actual cost on a
first-in, first-out basis and includes material, labor and manufacturing overhead costs.
We estimate the effects of excess and obsolescence on the carrying values of our
inventories based upon estimates of future demand and market conditions. We establish
provisions for related inventories in excess of production demand. Should actual
production demand differ from our estimates, additional inventory write-downs may be
required, as was the case in the fourth quarter of fiscal 2005. Any excess and obsolete
provision is released only if and when the related inventories is sold or scrapped.

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

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

# Impairment of Long-Lived
Assets

Long-lived
assets are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. If undiscounted expected future cash
flows are less than the carrying value of the assets, an impairment loss is recognized
based on the excess of the carrying amount over the fair value of the assets.

# Warranty Obligations

We
provide for the estimated cost of our product warranties at the time revenue is
recognized. Our warranty obligation is affected by product failure rates, material usage
rates and the efficiency by which the product failure is corrected. Should actual product
failure rates, material usage rates and labor efficiencies differ from our estimates,
revisions to the estimated warranty liability may be required.

# Deferred Taxes

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

# Results of Operations

The
following table sets forth certain financial items for the three and nine month periods
ended December 31, 2005 and 2004:

|                                    | Three Months Ended

December 31, | Nine Months EndedDecember 31,
|----------------------------------- | -------------------------------- | -----------------------------
|
|Revenue                             |                                  |                              
|Cost of sales                       |                                  |                              
|                                    |                                  |                              
|Gross profit (loss)                 |                                  |                              
|                                    |                                  |                              
|Operating expenses:                 |                                  |                              
|Research and development            |                                  |                              
|Sales and marketing                 |                                  |                              
|General and administrative          |                                  |                              
|In-process research and development |                                  |                              
|                                    |                                  |                              
|Total operating expenses            |                                  |                              
|                                    |                                  |                              
|Operating loss                      |                                  |                              
|Other income (expense), net         |                                  |                              
|Interest income (expense), net      |                                  |                              
|Other income (expense)              |                                  |                              
|                                    |                                  |                              
|Total other income (expense), net   |                                  |                              
|                                    |                                  |                              
|Net loss                            |                                  |                              
|                                    |                                  |                              

The
following table sets forth certain financial items as a percentage of revenue for the
three and nine-month periods ended December 31, 2005 and 2004:

|                                    | Three Months
Ended December 31, | Nine Months
EndedDecember 31,
|----------------------------------- | ------------------------------- | -----------------------------
|
|Revenue                             |                                 |                              
|Cost of sales                       |                                 |                              
|                                    |                                 |                              
|Gross profit (loss)                 |                                 |                              
|Operating expenses:                 |                                 |                              
|Research and development            |                                 |                              
|Sales and marketing                 |                                 |                              
|General and administrative          |                                 |                              
|In-process research and development |                                 |                              
|                                    |                                 |                              
|Total operating expenses            |                                 |                              
|                                    |                                 |                              
|Operating loss                      |                                 |                              
|Other income, net:                  |                                 |                              
|Interest expense, net               |                                 |                              
|Other income (expense), net         |                                 |                              
|                                    |                                 |                              
|Other income (expense), net         |                                 |                              
|                                    |                                 |                              
|Net loss                            |                                 |                              
|                                    |                                 |                              

Revenue.          The
increase in revenue for the three months ended December 31, 2005 was
          principally due to the sale of two additional 6500 series systems over the same
          period of the previous year. The increase in revenue for the nine months ended
          December 31, 2005 was principally due to the sale of four additional 6500
series           systems over the same period of the previous year, offset by the lower
revenue           associated with a recertified Endeavor compared to a new Endeavor sold
in the           previous year, and reduced service and spare parts sales. We believe the
          reduction of service and spare parts sales is a result of reduced usage of our
          non-critical etch systems by our customers.

International
sales as a percentage of the Companys revenue for the three and nine months ended
December 31, 2005 were approximately 67% and 76%, respectively, and for the three and nine
months ended December 31, 2004 were approximately 72.2% and 77.5%, respectively. We
believe that international sales will continue to represent a significant portion of our
revenue.

Gross
profit (loss).Gross profit as a percentage to revenue for the three and nine months
ended December 31, 2005 increased by 8.8% and 2.0%, respectively over the comparable
periods in 2004. The increase in gross profit as a percentage to revenue, was principally
attributable to fixed cost allocated over a larger revenue base.

Research
and development.Research and development expenses consist primarily of salaries,
prototype material and other costs associated with our ongoing systems and process
technology development, applications and field process support efforts. The decrease in
research and development spending for the three and nine months ended December 31, 2005
resulted from lower license fees, consulting, employee travel, and recruiting expenses as
compared to the prior year.

Sales
and marketing.Sales and marketing expenses consist primarily of salaries,
commissions, trade show promotion and travel and living expenses associated with those
functions. The decrease in sales and marketing spending for the three and nine months
ended December 31, 2005 was primarily due to temporary reduction of personnel which the
Company believes will return to previous run rates within the next three to six months,
partially offset by commissions paid on sales, as compared to the prior year.

General
and administrative. General and administrative expenses consist primarily of
compensation for general management, accounting and finance, human resources, information
systems and investor relations functions and for legal, consulting and accounting fees of
the Company. The increase in spending for the nine months ended December 31, 2005 was
primarily due to non cash restricted stock units granted and recorded as compensation
expense and warrants issued to the landlord of our principal executive offices as
compensation for the lease termination fee reduction in addition to $500 paid as an
advance on the termination penalty, offset in part by reduced legal and consulting fees
that were associated with the defense of patents and the integration of the acquired
companies in the previous period.

Other
income (expense), net.Other income (expense), net consists principally of, interest
income, interest expense, other income, (expense), gains and losses on the disposal of
fixed assets, and gains and losses on foreign exchange. We recorded net non-operating
expense of $724 and $604 during the three-month and nine-month period ended December 31,
2005 respectively. Other expense was principally due to the net mark to market valuation
of the investor warrants of $436 and $116 loss on the disposal of a fixed asset.

Contractual
obligations.The following summarizes our contractual obligations at December 31,
2005, and the effect such obligations are expected to have on our liquidity and cash flows
in future periods.

|Contractual obligations:                   | Total | Less than1 Year | 1-3 Years | 3-5 Years | After5 Years
|------------------------------------------ | ----- | --------------- | --------- | --------- | ------------
|Non-cancelable capital lease obligations   |       |                 | $         | 17        |             
|Non-cancelable operating lease obligations |       |                 |           | 4,477     |             
|Notes payable and bank lines of credit     |       |                 |           | 26        |             
|                                           |       |                 |           |           |             
|Total contractual cash obligations         |       |                 | $         | 4,520     |             
|                                           |       |                 |           |           |             

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

# Liquidity and Capital
Resources

For
the nine-month period ended December 31, 2005, we financed our operations through the use
of outstanding cash balances, borrowings against our credit facilities in Japan and net
proceeds from the 2005 PIPE.

As
of December 31, 2005, our Japanese subsidiary had borrowed 1,000 yen (approximately $8 at
exchange rates prevailing on December 31, 2005) under its Japanese bank line of credit.
The credit line has a total borrowing capacity of 150,000 yen (approximately $1,271 at
exchange rates prevailing on December 31, 2005), which is secured by Japanese customer
promissory notes held by such subsidiary in advance of payment on customers accounts
receivable. The Japanese bank line bears interest at Japanese prime (1.375% as of December
31, 2005) plus 1.0%.

Notes
payable as of December 31, 2005 consisted primarily of one outstanding note to the
California Trade and Commerce Agency for $22. The unsecured note from the California Trade
and Commerce Agency carries an annual interest rate of 5.75% with monthly payments of
approximately $5.5 per month. Although the payment deadlines are being met, the note is
currently in technical default due to the merger of Sputtered Films and Tegal Corporation.

The
consolidated financial statements contemplate the realization of assets and the
satisfaction of liabilities in the normal course of business. We incurred net losses of
$7,092 and $11,514 for the nine months ended December 31, 2005 and 2004, respectively. We
generated negative cash flows from operations of $10,909 and $8,623 for the period ended
December 31, 2005 and 2004, respectively. During the current Fiscal Year 2006, we raised a
net of $18,161 through the 2005 PIPE. Management believes that these proceeds, combined
with projected sales, consolidation of certain operations and continued cost containment
will be adequate to fund operations through fiscal 2007. However, projected sales may not
materialize and unforeseen costs may be incurred. If the projected sales do not
materialize, our ability to achieve our intended business objectives may be adversely
affected. The consolidated financial statements do not include any adjustments relating to
the recoverability and classification of recorded assets or the amount or classification
of liabilities or any other adjustments that might be necessary should we be unable to
continue as a going concern.

# Risk Factors

We have incurred operating losses
and may not be profitable in the future; Our plans to maintain and increase liquidity may
not be successful; The report of the independent registered public accounting firm
includes a going concern uncertainty explanatory paragraph.

We
incurred net losses of $15.4 million, $12.6 million and $12.6 million for the years ended
March 31, 2005, 2004 and 2003, respectively, and generated negative cash flows from
operations of $7.5 million, $3.2 million and $6.0 million in these respective years. Those
factors raised substantial doubt as to our ability to continue as a going concern, and our
independent registered public accounting firm included a going concern uncertainty
explanatory paragraph in their report dated May 27, 2005 filed with our Annual Report on
Form 10-K/A for the year ended March 31, 2005. We have raised approximately $18.2 million
from the sale of stock and warrants in the 2005 PIPE. During fiscal year 2005, we raised
approximately $10.4 million from stock issued to Kingsbridge. Management believes that
these proceeds, combined with a projected increase in sales, consolidation of certain
operations and continued cost containment will be adequate to fund operations through
Fiscal Year 2007. If the projected sales do not materialize, we will need to reduce
expenses further and raise additional capital through the issuance of debt or equity
securities. If additional funds are raised through the issuance of preferred stock or
debt, these securities could have rights, privileges or preferences senior to those of our
common stock, and debt covenants could impose restrictions on our operations. Moreover,
such financing may not be available to us on acceptable terms, if at all. Failure to raise
additional funds may adversely affect our ability to achieve our intended business
objectives. Our consolidated financial statements do not include any adjustments relating
to the recoverability and classification of recorded assets or the amount or
classification of liabilities or any other adjustments that might be necessary should we
be unable to continue as a going concern.

The exercise of outstanding
warrants, options and other rights to obtain additional shares will dilute the value of
our shares of common stock and could cause the price of our shares of common stock to
decline.

As
of December 31, 2005, there were 83,973,854 shares of our common stock issued and
outstanding and there were 24,984,318 shares of common stock reserved for issuance under
our equity incentive and stock purchase plans.

As
of December 31, 2005, there were warrants, stock options and restricted stock units
outstanding for approximately 30,004,852, shares of our common stock.

The
exercise of these warrants and options and the issuance of the common stock pursuant to
our equity incentive plans will result in dilution in the value of the shares of our
outstanding common stock and the voting power represented thereby. In addition, the
exercise price of the warrants may be lowered under the price adjustment provisions in the
event of a dilutive issuance, that is, if we issue common stock at any time
prior to their maturity at a per share price below such conversion or exercise price,
either directly or in connection with the issuance of securities that are convertible
into, or exercisable for, shares of our common stock. A reduction in the exercise price
may result in the issuance of a significant number of additional shares upon the exercise
of the warrants.

The
warrants do not establish a floor that would limit reductions in such
conversion price or exercise price. The downward adjustment of the exercise price of these
warrants could result in further dilution in the value of the shares of our outstanding
common stock and the voting power represented thereby.

No
prediction can be made as to the effect, if any, that future sales of shares of our common
stock, or the availability of shares for future sale, will have on the market price of our
common stock prevailing from time to time. Sales of substantial amounts of shares of our
common stock in the public market, or the perception that such sales could occur, may
adversely affect the market price of our common stock and may make it more difficult for
us to sell our equity securities in the future at a time and price which we deem
appropriate.

To
the extent our stockholders and the other holders of our warrants and options exercise
such securities and then sell the shares of our common stock they receive upon exercise,
our stock price may decrease due to the additional amount of shares available in the
market. The subsequent sales of these shares could encourage short sales by our
securityholders and others, which could place further downward pressure on our stock
price. Moreover, holders of these warrants and options may hedge their positions in our
common stock by shorting our common stock, which could further adversely affect our stock
price.

If we fail to meet the continued
listing requirements of the Nasdaq Stock Market, our stock could be delisted.

Our
stock is currently listed on The Nasdaq Capital Market. The Nasdaq Stock Markets
Marketplace Rules impose certain minimum financial requirements on us for the continued
listing of our stock. One such requirement is the minimum bid price on our stock of $1.00
per share. Beginning in 2002, there have been periods of time during which we have been
out of compliance with the $1.00 minimum bid requirements of The Nasdaq Capital Market.

On
August 18, 2005, we were notified by the Nasdaq that the bid price of our common stock
closed below the minimum $1.00 per share requirement for continued inclusion under the
Nasdaqs Marketplace rules. We have 180 calendar days, or until February 13, 2006, to
regain compliance. If, at anytime before February 13, 2006, the bid price of our common
stock closes at or above $1.00 per share for a minimum of 10 consecutive business days, we
will regain compliance with the Nasdaqs Marketplace rules. If we do not regain
compliance by February 13, 2006, an additional 180 days will be granted to regain
compliance, so long as we meet the Nasdaq Capital Market initial listing criteria (except
for the bid price requirement).

If
we are unable to regain compliance or fall out of compliance in the future with Nasdaq
listing requirements, we may take actions in order to achieve compliance, which actions
may include a reverse split of our common stock. If an initial delisting decision is made
by the Nasdaqs staff, we may appeal the decision as permitted by Nasdaq rules. If we
are delisted and cannot obtain listing on another major market or exchange, our
stocks liquidity would suffer, and we would likely experience reduced investor
interest. Such factors may result in a decrease in our stocks trading price.
Delisting also may restrict us from issuing additional securities or securing additional
financing.

The semiconductor industry is
cyclical and may experience periodic downturns that may negatively affect customer demand
for our products and result in losses such as those experienced in the past.

Our
business depends upon the capital expenditures of semiconductor manufacturers, which in
turn depend on the current and anticipated market demand for integrated circuits. The
semiconductor industry is highly cyclical and historically has experienced periodic
downturns, which often have had a detrimental effect on the semiconductor industrys
demand for semiconductor capital equipment, including etch and deposition systems
manufactured by us. In response to the current prolonged industry slow-down, we have
initiated a substantial cost containment program and completed a corporate-wide
restructuring to preserve our cash. However, the need for continued investment in research
and development, possible capital equipment requirements and extensive ongoing customer
service and support requirements worldwide will continue to limit our ability to reduce
expenses in response to these downturns. As a result, we may continue to experience
operating losses such as those we have experienced in the past, which could materially
adversely affect us.

Our competitors have greater
financial resources and greater name recognition than we do and therefore may compete more
successfully in the semiconductor capital equipment industry than we can.

We
believe that to be competitive, we will require significant financial resources in order
to offer a broad range of systems, to maintain customer service and support centers
worldwide and to invest in research and development. Many of our existing and potential
competitors, including, among others, Applied Materials, Inc., Lam Research Corporation,
Novellus and Tokyo Electron Limited, have substantially greater financial resources, more
extensive engineering, manufacturing, marketing and customer service and support
capabilities, larger installed bases of current generation etch, deposition and other
production equipment and broader process equipment offerings, as well as greater name
recognition than we do. We cannot assure you that we will be able to compete successfully
against these companies in the United States or worldwide.

We depend on sales of our advanced
products to customers that may not fully adopt our product for production use.

We
have designed our advanced etch and deposition products for customer applications in
emerging new films, polysilicon and metal which we believe to be the leading edge of
critical applications for the production of advanced semiconductor and other
microelectronic devices. Revenues from the sale of our advanced etch and deposition
systems accounted for 30%, 40% and 25% of total revenues in fiscal 2005, 2004 and 2003,
respectively. Our advanced systems are currently being used primarily for research and
development activities or low volume production. For our advanced systems to achieve full
market adoption, our customers must utilize these systems for volume production. We cannot
assure you that the market for devices incorporating emerging films, polysilicon or metal
will develop as quickly or to the degree we expect. If our advanced systems do not achieve
significant sales or volume production due to a lack of full customer adoption, our
business, financial condition, results of operations and cash flows will be materially
adversely affected.

Our potential customers may not
adopt our products because of their significant cost or because our potential customers
are already using a competitors tool.

A
substantial investment is required to install and integrate capital equipment into a
semiconductor production line. Additionally, we believe that once a device manufacturer
has selected a particular vendors capital equipment, that manufacturer generally
relies upon that vendors equipment for that specific production line application
and, to the extent possible, subsequent generations of that vendors systems.
Accordingly, it may be extremely difficult to achieve significant sales to a particular
customer once that customer has selected another vendors capital equipment unless
there are compelling reasons to do so, such as significant performance or cost advantages.
Any failure to gain access and achieve sales to new customers will adversely affect the
successful commercial adoption of our products and could have a detrimental effect on us.

# Our quarterly operating
results may continue to fluctuate.

Our
revenue and operating results have fluctuated and are likely to continue to fluctuate
significantly from quarter to quarter, and we cannot assure you that we will achieve
profitability in the future.

Our
900 series etch systems typically sell for prices ranging between $250,000 and $600,000,
while prices of our 6500 series critical etch systems and our Endeavor deposition system
typically range between $1.8 million and $3.0 million. To the extent we are successful in
selling our 6500 and Endeavor series systems, the sale of a small number of these systems
will probably account for a substantial portion of revenue in future quarters, and a
transaction for a single system could have a substantial impact on revenue and gross
margin for a given quarter.

Other
factors that could affect our quarterly operating results include:

|  |                                                                                                                                                                                                                                                       
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | our timing of new systems and technology announcements and releases and ability to transition between product versions;                                                                                                                               
| | seasonal fluctuations in sales;                                                                                                                                                                                                                       
| | changes in the mix of our revenues represented by our various products and customers;                                                                                                                                                                 
| | adverse changes in the level of economic activity in the United States or other major economies in which we do business;                                                                                                                              
| | foreign currency exchange rate fluctuations;                                                                                                                                                                                                          
| | expenses related to, and the financial impact of, possible acquisitions of other businesses; and                                                                                                                                                      
| | changes in the timing of product orders due to unexpected  delays in the  introduction of our customers'  products,  due to
lifecycles of our customers' products ending earlier than expected or due to market acceptance of our customers' products.

Some of our sales cycles are
lengthy, exposing us to the risks of inventory obsolescence and fluctuations in operating
results.

Sales
of our systems depend, in significant part, upon the decision of a prospective customer to
add new manufacturing capacity or to expand existing manufacturing capacity, both of which
typically involve a significant capital commitment. We often experience delays in
finalizing system sales following initial system qualification while the customer
evaluates and receives approvals for the purchase of our systems and completes a new or
expanded facility. Due to these and other factors, our systems typically have a lengthy
sales cycle (often 12 to 18 months in the case of critical etch and deposition systems)
during which we may expend substantial funds and management effort. Lengthy sales cycles
subject us to a number of significant risks, including inventory obsolescence and
fluctuations in operating results over which we have little or no control.

Because technology changes
rapidly, we may not be able to introduce our products in a timely enough fashion.

The
semiconductor manufacturing industry is subject to rapid technological change and new
system introductions and enhancements. We believe that our future success depends on our
ability to continue to enhance our existing systems and their process capabilities, and to
develop and manufacture in a timely manner new systems with improved process capabilities.
We may incur substantial unanticipated costs to ensure product functionality and
reliability early in our products life cycles. We cannot assure you that we will be
successful in the introduction and volume manufacture of new systems or that we will be
able to develop and introduce, in a timely manner, new systems or enhancements to our
existing systems and processes which satisfy customer needs or achieve market adoption.

Our financial performance may
adversely affect the morale and performance of our personnel and our ability to hire new
personnel.

Our
common stock has declined in value below the exercise price of many options granted to
employees pursuant to our stock option plans. Thus, the intended benefits of the stock
options granted to our employees, the creation of performance and retention incentives,
may not be realized. As a result, we may lose employees whom we would prefer to retain. As
a result of these factors, our remaining personnel may seek employment with larger, more
established companies or companies perceived as having less volatile stock prices.

Provisions in our agreements,
charter documents, stockholder rights plan and Delaware law may deter takeover attempts,
which could decrease the value of your shares.

Our
certificate of incorporation and bylaws and Delaware law contain provisions that could
make it more difficult for a third party to acquire us without the consent of our board of
directors. Our board of directors has the right to issue preferred stock without
stockholder approval, which could be used to dilute the stock ownership of a potential
hostile acquirer. Delaware law imposes some restrictions on mergers and other business
combinations between us and any holder of 15% or more of our outstanding common stock. In
addition, we have adopted a stockholder rights plan that makes it more difficult for a
third party to acquire us without the approval of our board of directors. These provisions
apply even if the offer may be considered beneficial by some of our stockholders.

We may not be able to protect our
intellectual property or obtain licenses for third parties intellectual property and
therefore we may be exposed to liability for infringement or the risk that our operations
may be adversely affected.

Although
we attempt to protect our intellectual property rights through patents, copyrights, trade
secrets and other measures, we may not be able to protect our technology adequately and
competitors may be able to develop similar technology independently. Additionally, patent
applications that we may file may not be issued and foreign intellectual property laws may
not protect our intellectual property rights. There is also a risk that patents licensed
by or issued to us will be challenged, invalidated or circumvented and that the rights
granted thereunder will not provide competitive advantages to us. Furthermore, others may
independently develop similar systems, duplicate our systems or design around the patents
licensed by or issued to us.

Litigation
could result in substantial cost and diversion of effort by us, which by itself could have
a detrimental effect on our financial condition, operating results and cash flows.
Further, adverse determinations in such litigation could result in our loss of proprietary
rights, subject us to significant liabilities to third parties, require us to seek
licenses from third parties or prevent us from manufacturing or selling our systems. In
addition, licenses under third parties intellectual property rights may not be
available on reasonable terms, if at all.

Our customers are concentrated and
therefore the loss of a significant customer may harm our business.

Our
top five customers accounted for 80.0%, 84.8% and 88.2% of our total revenues in fiscal
2005, 2004 and 2003, respectively. Three customers each accounted for more than 10% of
total revenues in fiscal 2005. During the three months ended December 31, 2005, two
customers accounted for 70% of total revenues. During the nine months ended December 31,
2005, one customer accounted for 55% of total revenues. Although the composition of the
group comprising our largest customers may vary from year to year, the loss of a
significant customer or any reduction in orders by any significant customer, including
reductions due to market, economic or competitive conditions in the semiconductor
manufacturing industry, may have a detrimental effect on our business, financial
condition, results of operations and cash flows. Our ability to increase our sales in the
future will depend, in part, upon our ability to obtain orders from new customers, as well
as the financial condition and success of our existing customers and the general economy,
which is largely beyond our ability to control.

We are exposed to additional risks
associated with international sales and operations.

International
sales accounted for 70%, 67% and 66% of total revenue for fiscal 2005, 2004 and 2003,
respectively. International sales are subject to certain risks, including the imposition
of government controls, fluctuations in the U.S. dollar (which could increase the sales
price in local currencies of our systems in foreign markets), changes in export license
and other regulatory requirements, tariffs and other market barriers, political and
economic instability, potential hostilities, restrictions on the export or import of
technology, difficulties in accounts receivable collection, difficulties in managing
representatives, difficulties in staffing and managing international operations and
potentially adverse tax consequences. We cannot assure you that any of these factors will
not have a detrimental effect on our operations, financial results and cash flows.

We
generally attempt to offset a portion of our U.S. dollar denominated balance sheet
exposures subject to foreign exchange rate remeasurement by purchasing forward currency
contracts for future delivery. We cannot assure you that our future results of operations
and cash flows will not be adversely affected by foreign currency fluctuations. In
addition, the laws of certain countries in which our products are sold may not provide our
products and intellectual property rights with the same degree of protection as the laws
of the United States.

Evolving regulation of corporate
governance and public disclosure may result in additional expenses and continuing
uncertainty.

Changing
laws, regulations and standard relating to corporate governance and public disclosure,
including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Market rules are
creating uncertainty for public companies. We continually evaluate and monitor
developments with respect to new and proposed rules and cannot predict or estimate the
amount of the additional costs we may incur or the timing of such costs. These new or
changed laws, regulations and standards are subject to varying interpretations, in many
cases due to their lack of specificity, and as a result, their application in practice may
evolve over time as new guidance is provided by regulatory and governing bodies. This
could result in continuing uncertainty regarding compliance matters and higher costs
necessitated by ongoing revisions to disclosure and governance practices. We are committed
to maintaining high standards of corporate governance and public disclosure. As a result,
we have invested resources to comply with evolving laws, regulations and standards, and
this investment may result in increased general and administrative expenses and a
diversion of management time and attention from revenue-generating activities to
compliance activities. If our efforts to comply with new or changed laws, regulations and
standards differ from the activities intended by regulatory or governing bodies due to
ambiguities related to practice, regulatory authorities may initiate legal proceedings
against us and we may be harmed.

Our stock price is volatile and
could result in a material decline in the value of your investment in Tegal.

We
believe that factors such as announcements of developments related to our business,
fluctuations in our operating results, sales of our common stock into the marketplace,
failure to meet or changes in analysts expectations, general conditions in the
semiconductor industry or the worldwide economy, announcements of technological
innovations or new products or enhancements by us or our competitors, developments in
patents or other intellectual property rights, developments in our relationships with our
customers and suppliers, natural disasters and outbreaks of hostilities could cause the
price of our common stock to fluctuate substantially. In addition, in recent years the
stock market in general, and the market for shares of small capitalization stocks in
particular, have experienced extreme price fluctuations, which have often been unrelated
to the operating performance of affected companies. We cannot assure you that the market
price of our common stock will not experience significant fluctuations in the future,
including fluctuations that are unrelated to our performance.

Potential disruption of our supply
of materials required to build our systems could have a negative effect on our operations
and damage our customer relationships.

Materials
delays have not been significant in recent years. Nevertheless, we procure certain
components and sub-assemblies included in our systems from a limited group of suppliers,
and occasionally from a single source supplier. For example, we depend on MECS
Corporation, a robotic equipment supplier, as the sole source for the robotic arm used in
all of our 6500 series systems. We currently have no existing supply contract with MECS
Corporation, and we currently purchase all robotic assemblies from MECS Corporation on a
purchase order basis. Disruption or termination of certain of these sources, including our
robotic sub-assembly source, could have an adverse effect on our operations and damage our
relationship with our customers.

Any failure by us to comply with
environmental regulations imposed on us could subject us to future liabilities.

We
are subject to a variety of governmental regulations related to the use, storage,
handling, discharge or disposal of toxic, volatile or otherwise hazardous chemicals used
in our manufacturing process. We believe that we are currently in compliance in all
material respects with these regulations and that we have obtained all necessary
environmental permits generally relating to the discharge of hazardous wastes to conduct
our business. Nevertheless, our failure to comply with present or future regulations could
result in additional or corrective operating costs, suspension of production, alteration
of our manufacturing processes or cessation of our operations.

# Item 3. Quantitative and
Qualitative Disclosures About Market Risk

Our
cash equivalents are principally comprised of money market accounts. As of December 31,
2005, we had cash and cash equivalents of $15,111. These accounts are subject to interest
rate risk and may fall in value if market interest rates increase. We attempt to limit
this exposure by investing primarily in short-term securities having a maturity of three
months or less. Due to the nature of our cash and cash equivalents, we have concluded that
there is no material market risk exposure.

We
have foreign subsidiaries that operate and sell our products in various global markets. As
a result, our cash flow and earnings are exposed to fluctuations in interest and foreign
currency exchange rates. We attempt to limit these exposures through the use of various
hedge instruments, primarily forward exchange contracts and currency option contracts
(with maturities of less than three months) to manage our exposure associated with firm
commitments and net asset and liability positions denominated in non-functional
currencies. There have been no material changes regarding market risk since the
disclosures made in our Form 10-K for the fiscal year ended March 31, 2005.

At
December 31, 2005, the Company had forward exchange contracts maturing at various dates to
exchange 296,000 yen into $2,488.

---

# Item 4. Controls and
Procedures

We
maintain disclosure controls and procedures 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 for timely
decisions regarding required disclosure. In designing and evaluating our disclosure
controls and procedures, our management recognizes 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 is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.

(a)       
          Evaluation of Disclosure Controls and Procedures.Based on their
          evaluation as of a date at the end of the quarter covered by this quarterly
          report on Form 10-Q, the Companys Chief Executive Officer and Chief
          Financial Officer have concluded that the Companys disclosure controls and
          procedures (as defined in Rules 13a-14(c) under the Securities Exchange Act of
          1934) are effective at the reasonable assurance level.

(b)       
          Changes in Internal Controls. There has been no change in the
          Companys internal control over financial reporting during the fiscal
          quarter ended December 31, 2005 that has materially affected, or is reasonably
          likely to materially affect, the Companys internal controls over financial
          reporting

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# PART II  OTHER
INFORMATION

# Item 1. Legal Proceedings

Sputtered Films, Inc. v. Advanced
Modular Sputtering, et al., filed in Santa Barbara County Superior Court.

On
December 22, 2003, Sputtered Films, Inc. (SFI), a wholly owned subsidiary of
the Company, filed an action against two former employees, Sergey Mishin and Rose
Stuart-Curran, and a company they formed after leaving their employment with SFI named
Advanced Modular Sputtering, Inc. (AMS). Sergey Mishin and Rose Stuart-Curran
had each signed confidentiality and non-disclosure agreements regarding information
obtained while employed by SFI. The action contains causes of action for specific
performance, breach of contract, breach of the covenant of good faith and fair dealing,
misappropriation of trade secrets, unfair competition, unfair business practices,
interference with prospective economic advantage, conversion, unjust enrichment, and
declaratory relief. These claims arise out of information SFI received evidencing that AMS
possessed and used SFIs confidential, proprietary and trade secret drawings,
specifications and technology to manufacture the sputtering tool marketed by AMS.

The
case is now in the discovery phase, and a trial date has been set for September 5, 2006.
On November 18, 2005, SFI requested leave to add Agilent Technologies, Inc.
(Agilent) as a defendant based on evidence that Agilent and AMS co-developed
the machines which SFI contends were built using SFI proprietary information. The Court
granted SFIs request and Agilent was served as a Doe defendant on December 12, 2005.
SFI has learned that Agilent transferred its Semiconductor Products Group to Avago
effective December 1, 2005, and as such SFI will seek to add certain Avago entities as
defendant in this action.

# Item 6. Exhibits

(a)
Exhibits

|     |                                                                                                                                                  
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 | Lease between Registrant and BRE/PCCP Orchard, LLC, dated December 21, 2005                                                                      
|10.2 | Sublease between Registrant and Silicon Genesis Corporation, dated December 30, 2005                                                             
|31.1 | Certifications of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                         
|31.2 | Certifications of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                         
|32   | Certifications  of  the  Chief  Executive  Officer  and  Chief  Financial  Officer  pursuant  to  Section  906 of the
Sarbanes-Oxley Act of 2002.

---

---

# SIGNATURES

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.

| | TEGAL CORPORATION(Registrant) | /s/ CHRISTINE HERGENROTHER
Christine HergenrotherChief Financial Officer
| | ----------------------------- | --------------------------------------------------------------------------------------

Dated: February 10, 2006