**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      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 September 30, 2007**





**or**





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





**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 o





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 o   Accelerated
      filer o   Non-accelerated
      filer x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes o No x





As
      of
      October 16, 2007 there were
      7,126,912 shares
      of our common stock outstanding. The
      number of shares outstanding reflects a 1 to 12 reverse stock split effected
      by
      the Registrant on July 25, 2006.














**TEGAL
      CORPORATION AND SUBSIDIARIES**





**INDEX**





**Page****PART
                I. FINANCIAL INFORMATION**Item
                1.
            Condensed
                Consolidated Financial Statements (Unaudited)Condensed
                Consolidated Balance Sheets as of September 30, 2007 and March 31,
                2007
            3Condensed
                Consolidated Statements of Operations for the three months and six
                months
                ended September 30, 2007 and September 30, 2006
            4Condensed
                Consolidated Statements of Cash Flows as of September 30, 2007 and
                September 30, 2006
            5Notes
                to Condensed Consolidated Financial Statements
            6Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            12Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            18Item
                4.
            Controls
                and Procedures
            19**PART
                II. OTHER INFORMATION**Item
                1A.
            Risk
                Factors
            19Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            24Item
                6.
            Exhibits
            25Signatures
            
            26




2


**PART
      I — FINANCIAL INFORMATION**





**Item
      1.** ***Condensed
      Consolidated Financial Statements***





**TEGAL
      CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**(Unaudited)**


**(In
      thousands, except share data)**





**September
                30**
              **2007**
            
            **March
                31**
              **2007****ASSETS**Current
              assets:Cash
                and cash equivalents
            
            $
            20,348
            
            $
            25,776Accounts
                receivable, net of allowances for sales returns and doubtful accounts
                of
                $230 and $413 at September 30, 2007 and March 31, 2007,
                respectively
            
            
            8,056
            
            
            6,634Inventories,
                net
            
            
            11,178
            
            
            5,567Prepaid
                expenses and other current assets
            
            
            1,497
            
            
            991Total
                current assets
            
            
            41,079
            
            
            38,968Property
                and equipment, net
            
            
            1,318
            
            
            1,351Intangible
                assets, net
            
            
            1,026
            
            
            1,161Other
                assets
            
            
            107
            
            
            176Total
                assets
            
            $
            43,530
            
            $
            41,656**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Current
                  liabilities:Notes
                payable and bank lines of credit
            
            $
            —
            
            $
            10Accounts
                payable
            
            
            3,863
            
            
            1,974Accrued
                product warranty
            
            
            1,435
            
            
            1,101Deferred
                revenue
            
            
            1,162
            
            
            1,064Litigation
                suspense
            
            
            18,505
            
            
            19,500Accrued
                expenses and other current liabilities
            
            
            3,228
            
            
            3,590Total
                current liabilities
            
            
            28,193
            
            
            27,239Total
                liabilities
            
            
            28,193
            
            
            27,239Commitments
                and contingencies (Note 7)Stockholders’
                equity:Preferred
                stock; $0.01 par value; 5,000,000 shares authorized; none issued
                and
                outstanding
            
            
            —
            
            
            —Common
                stock; $0.01 par value; 50,000,000 shares authorized; 7,126,912 and
                7,106,867shares
                issued and outstanding at September 30, 2007 and March 31, 2007,
                respectively
            
            
            71
            
            
            71Additional
                paid-in capital
            
            
            123,281
            
            
            122,473Accumulated
                other comprehensive income (loss)
            
            
            297
            
            
            240Accumulated
                deficit
            
            
            (108,312
            )
            
            (108,367
            )Total
                stockholders’ equity
            
            
            15,337
            
            
            14,417Total
                liabilities and stockholders’ equity
            
            $
            43,530
            
            $
            41,656





See
      accompanying notes.





3




**TEGAL
      CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**(Unaudited)**


**(In
      thousands, except per share data)**





**Three
                Months Ended**
              **September
                30,**
            
            **Six
                Months Ended**
              **September
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Revenue
            
            $
            10,800
            
            $
            5,113
            
            $
            15,398
            
            $
            11,689Cost
                of revenue
            
            
            6,560
            
            
            2,713
            
            
            9,537
            
            
            6,791Gross
                profit
            
            
            4,240
            
            
            2,400
            
            
            5,861
            
            
            4,898Operating
                expenses:Research
                and development expenses
            
            
            1,057
            
            
            1,066
            
            
            1,835
            
            
            2,062Sales
                and marketing expenses
            
            
            1,279
            
            
            964
            
            
            2,285
            
            
            2,008General
                and administrative expenses
            
            
            1,448
            
            
            3,485
            
            
            2,651
            
            
            5,787Total
                operating expenses
            
            
            3,784
            
            
            5,515
            
            
            6,771
            
            
            9,857Operating
                income (loss)
            
            
            456
            
            
            (3,115
            )
            
            (910
            )
            
            (4,959
            )Other
                income (expense), net
            
            
            237
            
            
            (166
            )
            
            964
            
            
            (124
            )Net
                income (loss)
            
            $
            693
            
            $
            (3,281
            )
            $
            54
            
            $
            (5,083
            )Net
                income (loss) per share, basic and diluted
            
            $
            0.10
            
            $
            (0.47
            )
            $
            0.01
            
            $
            (0.72
            )Shares
                used in per share computation:Basic
            
            
            7,119
            
            
            7,045
            
            
            7,111
            
            
            7,029Diluted
            
            
            7,264
            
            
            7,045
            
            
            7,219
            
            
            7,029





Note:
      Shares used in per share computation for Basic and Diluted reflect a 1 to12
      reverse stock split effected
      by the Company on July 25, 2006





See
      accompanying notes.




4




**TEGAL
      CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(Unaudited)**


**(In
      thousands)**




**Six****Months Ended**
              **September
                30,****2007**
            
            **2006**Cash
                flows from operating activities:Net
                income (loss)
            
            $
            54
            
            $
            (5,083
            )Adjustments
                to reconcile net loss to net cash provided by (used in) operating
                activities:Depreciation
                and amortization
            
            
            394
            
            
            448Stock
                compensation expense
            
            
            776
            
            
            463Stock
                issued under stock purchase plan
            
            
            8
            
            
            —Provision
                for doubtful accounts and sales returns allowances
            
            
            (183
            )
            
            302Loss
                on disposal of property and equipment
            
            
            —
            
            
            657Fair
                value of warrants and options issued for services rendered
            
            
            24
            
            
            48Changes
                in operating assets and liabilities, net of acquisitions:Accounts
                receivable
            
            
            (1,231
            )
            
            465Inventories
                net
            
            
            (5,617
            )
            
            (404
            )Prepaid
                expenses and other assets
            
            
            (437
            )
            
            (312
            )Accounts
                payable
            
            
            1,895
            
            
            (203
            )Accrued
                expenses and other current liabilities
            
            
            (363
            )
            
            (7
            )Accrued
                product warranty
            
            
            357
            
            
            284Litigation
                suspense
            
            
            (995
            )
            
            —Deferred
                revenue
            
            
            98
            
            
            74Net
                cash used in operating activities
            
            
            (5,220
            )
            
            (3,268
            )Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (228
            )
            
            (185
            )Net
                cash used in investing activities
            
            
            (228
            )
            
            (185
            )Cash
                flows from financing activities:Net
                proceeds from issuance of common stock
            
            
            —
            
            
            143(Repayments)
                borrowings under notes payable and bank lines of credit
            
            
            (10
            )
            
            2Payments
                on capital lease financing
            
            
            —
            
            
            (2
            )Net
                cash (used in) provided by financing activities
            
            
            (10
            )
            
            143Effect
                of exchange rates on cash and cash equivalents
            
            
            30
            
            
            (12
            )Net
                decrease in cash and cash equivalents
            
            
            (5,428
            )
            
            (3,322
            )Cash
                and cash equivalents at beginning of period
            
            
            25,776
            
            
            13,787Cash
                and cash equivalents at end of period
            
            $
            20,348
            
            $
            10,465





See
      accompanying notes.




5




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, 2007 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 (“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 audited consolidated
      financial statements and footnotes included in the Company’s Annual Report on
      Form 10-K for the fiscal year ended March 31, 2007. The results of operations
      for the three and six months ended September 30, 2007 are not necessarily
      indicative of results to be expected for the entire year.





Our
      consolidated financial statements contemplate the realization of assets and
      the
      satisfaction of liabilities in the normal course of business. We incurred net
      income (losses) of $54 and ( $5,083) for the
      six month periods ended September 30, 2007 and 2006, respectively. We used
      cash
      flows from operations of $5,220 and $3,268 for the six month periods ended
      September 30, 2007 and 2006, respectively. During the fiscal year 2006 we raised
      approximately $18,410 in net proceeds from the sale of our common stock and
      warrants to institutional investors. We believe that these proceeds, combined
      with the effects of the consolidation of operations and continued cost
      containment, will be adequate to fund operations through fiscal year 2008.
      However, projected sales may not materialize and unforeseen costs may be
      incurred **.** If
      the
      projected sales do not materialize, we will need to reduce expenses further
      and
      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
      common stock, and debt covenants could impose restrictions on our operations.
      The sale of equity or debt could result in additional dilution to current
      stockholders, and such financing may not be available to us on acceptable terms,
      if at all.





On
      July
      25, 2006, Tegal Corporation effected a 1-to-12 reverse stock split of the
      Company’s common stock. The consolidated financial statements for current and
      prior periods have been adjusted to reflect the change in number of shares.





**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 money market funds. The Company’s accounts receivable 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
      September 30, 2007 one customer accounted for 81% of outstanding accounts
      receivable balance. As of March 31, 2007 three customers accounted for
      approximately 86% of the accounts receivable balance. As of September 30, 2006
      four customers accounted for 54% of outstanding accounts receivable balance.





During
      the quarter ended September 30, 2007 and 2006, one customer accounted for 83%
      of
      total revenue and three customers accounted for 49% of total revenue,
      respectively. During the six months ended September 30, 2007 and 2006 one
      customer accounted for 79% of total revenue and three customers accounted for
      53% of total revenue, respectively.




**Stock
      Based Compensation**





The
      Company has adopted several stock plans that provide equity to the Company’s
      employees and non-employee directors. The Company’s plans include incentive and
      non-statutory stock options and restricted stock awards. Stock options and
      restricted stock awards generally vest ratably over a four-year period on the
      anniversary date of the grant, and expire ten years after the grant date. On
      occasion restricted stock awards may vest on the achievement of specific
      performance targets. The Company also has an employee stock purchase plan that
      allows qualified employees to purchase shares of common stock of the Company
      at
      85% of the fair market value on specified dates. The difference between the
      purchase value and the market value is expensed as compensation. Fiscal year
      to
      date, the expense for the ESPP plan is $2.




6





Effective
      April 1, 2006, we adopted the fair value recognition provisions of Statement
      of
      Financial Accounting Standards No. 123 (revised 2004), “ *Share
      Based Payment* ”
(SFAS
      123R) using the modified prospective transition method. Under that transition
      method, compensation expense that we recognized for the three months ended
      September 30, 2006 included: (a) compensation expense for all share-based
      payments granted prior to but not yet vested as of April 1, 2006, based on
      the
      grant date fair value estimated in accordance with the original provisions
      of
      SFAS 123, and (b) compensation expense for all share-based payments granted
      or
      modified on or after April 1, 2006, based on the grant date fair value estimated
      in accordance with the provisions of SFAS 123R. Compensation expense is
      recognized only for those awards that are expected to vest, whereas prior to
      the
      adoption of SFAS 123R, we recognized forfeitures as they occurred. In addition,
      we elected the straight-line attribution method as our accounting policy for
      recognizing stock-based compensation expense for all awards that are granted
      on
      or after April 1, 2006. Results in prior periods have not been
      restated.





Total
      compensation expense for the six months ended September 30, 2007 and 2006 was
      $776 and $463, respectively. Total compensation expense for the three months
      ended September 30, 2007 and 2006 was $395 and $233.





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 (“ESPP”):




**September
                30, 2007**
            
            **September
              30, 2006**Expected
                life (years):Stock
                options
            4.0
            
            4.0ESPP
            0.5
            
            0.5Volatility:Stock
                options
            47%
            
            55%ESPP
            47%
            
            55%Risk-free
                interest rate
            4.51%
            
            4.85%Dividend
                yield
            0.00%
            
            0.00%





***Stock
      Options & Warrants***





A
      summary
      of stock option and warrant activity during the quarter ended September 30,
      2007
      is as follows:





**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Weighted Average
                Remaining Contractual Term**
              **(in
                Years)**
            
            **Aggregate**
              **Intrinsic**
              **Value****BEGINNING
                OUTSTANDING**
            
            
            2,036,496
            
            $
            11.39**GRANTED******Price
                = Market Value
            
            
            12,498
            
            $
            5.62****Total
            
            
            12,498
            
            $
            5.62**EXERCISED**
            
            
            (16,261
            )
            $
            4.20**CANCELLED**Forfeited
            
            
            (5,000
            )
            $
            5.26Expired
            
            
            (10,834
            )
            $
            21.68Total
            
            
            (15,834
            )
            $
            16.50**ENDING
                OUTSTANDING**
            
            
            2,016,899
            
            $
            11.37
            
            
            4.28
            
            $
            300**ENDING
                VESTED + EXPECTED TO VEST**
            
            
            1,933,496
            
            $
            11.65
            
            
            4.08
            
            $
            230**ENDING
                EXERCISABLE**
            
            
            1,727,488
            
            $
            12.45
            
            
            3.53
            
            $
            64




7





The
      exercised shares resulted in a cashless swap. Some 16,261 warrants were
      exchanged for 11,040 shares of stock. The aggregate intrinsic value of options
      and warrants outstanding as of September 30, 2007 is calculated as the
      difference between the exercise price of the underlying options and the market
      price of our common stock as of September 30, 2007.





The
      following table summarizes information with respect to stock options and
      warrants outstanding as of September 30, 2007:


**Range
                  of**
                **Exercise
                  Prices**
              
              **Number**
                  **Outstanding**
                **As
                  of**
                **September
                  30, 2007**
              
              **Weighted**
                    **Average**
                  **Remaining**
                **Contractual**
                **Term**
                **(in
                  years)**
              
              **Weighted
                  Average**
                **Exercise
                  Price**
              
              **Number**
                  **Exercisable**
                **As
                  of**
                **September
                  30,**
                **2007**
              
              **Weighted**
                  **Average**
                **Exercise
                  Price**
                **As
                  of**
                **September
                  30,**
                **2007**$
              4.20
              
              $
              4.20
              
              
              83
              
              
              .94
              
              $
              4.20
              
              
              83
              
              $
              4.204.60
              
              
              4.60
              
              
              296,736
              
              
              8.85
              
              
              4.60
              
              
              55,000
              
              
              4.604.68
              
              
              6.84
              
              
              210,400
              
              
              5.17
              
              
              6.01
              
              
              182,902
              
              
              6.107.08
              
              
              8.28
              
              
              87,079
              
              
              7.65
              
              
              7.86
              
              
              68,329
              
              
              8.0812.00
              
              
              12.00
              
              
              1,284,990
              
              
              2.93
              
              
              12.00
              
              
              1,284,990
              
              
              12.0012.36
              
              
              73.50
              
              
              130,116
              
              
              3.56
              
              
              26.75
              
              
              128,689
              
              
              26.8792.26
              
              
              92.26
              
              
              416
              
              
              2.44
              
              
              92.26
              
              
              416
              
              
              92.2692.52
              
              
              92.52
              
              
              4,165
              
              
              2.38
              
              
              92.52
              
              
              4,165
              
              
              92.5299.00
              
              
              99.00
              
              
              2,498
              
              
              2.49
              
              
              99.00
              
              
              2,498
              
              
              99.00105.00
              
              
              105.00
              
              
              416
              
              
              4.98
              
              
              105.00
              
              
              416
              
              
              105.00$
              4.20
              
              $
              105.00
              
              
              2,016,899
              
              
              4.28
              
              $
              11.37
              
              
              1,727,488
              
              $
              12.45




***Restricted
      Stock***





The
      following table summarizes our restricted stock award activity for the three
      months ended September 30, 2007:





**Number**
              **of**
              **Shares**
            
            **Weighted Avg.**
              **Grant Date**
              **Fair Value**Balance,
                June 30, 2007
            
            
            438,862
            
            $
            6.45Granted
            
            
            —
            
            
            —Vested
            
            
            —
            
            
            —Forfeited
            
            
            —
            
            
            —Released
            
            
            (2,500
            )
            
            4.20Balance,
                September 30,2007
            
            
            436,362
            
            $
            5.41




**Unvested
      restricted stock at September 30, 2007**





As
      of
      September 30, 2007, t he
      total
      unrecognized compensation expense related to unvested restricted
      stock is
      $3,078. This cost is expected to be recognized over a weighted average period
      of
      2.26 years.




**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. Any excess and obsolete
      provision is released only if and when the related inventory is sold or
      scrapped. During the six months ended September 30, 2007 and September 30,
      2006,
      the Company sold or scrapped previously reserved inventory of $139
      and
      $2,594 respectively. The inventory provision balance at September 30, 2007
      and
      September 30, 2006 was $3,769 and $4,542, respectively. During
      the six months ended September 30, 2006 the reserve was reduced by $2,594,
      the
      Company sold or scrapped
      previously reserved inventory of $2,255 and adjusted the reserve balance for
      a
      change in manufacturing overhead related to improved plant efficiencies by
      $339.




8





Inventories
      as of the periods presented consisted of:


**September 30**
              **2007**
            
            **March 31**
              **2007**Raw
                materials
            
            $
            4,499
            
            $
            1,315Work
                in progress
            
            
            4,985
            
            
            2,928Finished
                goods and spares
            
            
            1,694
            
            
            1,324$
            11,178
            
            $
            5,567




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. Warranty activity for the three months
      and six months ended September 30, 2007 and 2006 was:





**Warranty Activity for the**
              **Three
                Months Ended**
              **September
                30,**
            
            **Warranty Activity for the**
              **Six
                Months Ended**
              **September
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Balance
                at the beginning of the period
            
            $
            1,191
            
            $
            668
            
            $
            1,101
            
            $
            723Additional
                warranty accruals for warranties issued during the period
            
            
            292
            
            
            247
            
            
            539
            
            
            498Settlements
                made during the period
            
            
            (48
            )
            
            (116
            )
            
            (205
            )
            
            (422
            )Balance
                at the end of the period
            
            $
            1,435
            
            $
            799
            
            $
            1,435
            
            $
            799




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.
      Net Income (Loss) per Common Share:**





Basic
      net
      income (loss) per common share is computed by
      dividing net income (loss) by the weighted-average number of shares of common
      stock outstanding during the period. For purposes of computing basic net income
      (loss) per share, the weighted-average number of outstanding shares of common
      stock excludes unvested restricted stock awards, which include restricted stock
      and restricted stock units that are settled in stock.





Diluted
      net income (loss) per share is computed using the weighted-average number of
      common and dilutive common equivalent shares outstanding during the period.
      Dilutive common equivalent shares consist primarily of stock options and
      restricted stock awards.





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





9




**Three
                Months Ended**
              **September
                30**
            
            **Six
                Months Ended**
              **September
                30****2007**
            
            **2006**
            
            **2007**
            
            **2006**Net
                income (loss) applicable to common stockholders
            
            $
            693
            
            $
            (3,281
            )
            $
            54
            
            $
            (5,083
            )Basic
                and diluted:Basic
                weighted-average common shares outstanding
            
            
            7,119
            
            
            7,045
            
            
            7,111
            
            
            7,029Dilutive
                common equivalent shares
            
            
            145
            
            
            
            
            
            108Diluted
                weighted-average shares outstanding
            
            
            7,264
            
            
            7,045
            
            
            7,219
            
            
            7,029Basic
                net income (loss) per share
            
            $
            0.10
            
            $
            (0.47
            )
            
            0.01
            
            $
            (0.72
            )Diluted
                net income (loss) per share.
            
            $
            0.10
            
            $
            (0.47
            )
            
            0.01
            
            $
            (0.72
            )





Outstanding
      options, warrants and restricted stock equivalent of 2,453,261 and of
      2,318,464  shares
      of
      common stock at a weighted-average exercise price of $11.37 and $13.54 per
      share
      as of September 30, 2007 and 2006 respectively, 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.





**5.
      Stock-Based Transactions:**





***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
      December 2007. The maximum number of warrants to be issued under these
      agreements is
      5,000
      shares. During
      the six months ended September 30, 2007 the Company issued warrants to purchase
      5,000 shares valued at $9 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 4.51% and a 5 year life .
      None of
      these warrants have been exercised as of September 30, 2007.





**6.
      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 contained
      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 arose 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.




On
      November 13, 2006, following commencement of the trial, all the parties in
      the
      litigation agreed on terms of a settlement, which was filed with the court.
      Among other things, the settlement called for the transfer of assets related
      to
      PVD technology from AMS to SFI, the dissolution of AMS as of March 1, 2007
      and
      the assumption by Tegal of certain warranty obligations of AMS. The Avago
      Cross-Complaint was also dismissed as part of the settlement. A final
      confidential settlement and release of claims was executed among the parties
      on
      December 21, 2006.




The
      two
      law firms representing SFI in this matter claim they are entitled, as a result
      of the settlement, to receive contingent fees from Tegal and SFI. Keker &
Van Nest LLP (“KVN”) claims fees in the amount of $6,717; Gonzalez & Leigh
      LLP (“G&L”) claimed fees in the amount of $2,249. We initiated proceedings
      with the Bar Association of San Francisco (“BASF”), pursuant to California
      statutes, to dispute the claims of both firms. KVN filed suit against us and
      SFI
      in San Francisco Superior Court and the action is stayed pending completion
      of
      the BASF proceedings. G&L did not file suit. We have identified legal and
      factual defenses to substantial elements of the claims and are vigorously
      contesting the claims. Pursuant to an arbitration hearing on September 11,
      2007,
      G&L settled its claim for $995. KVN continues to pursue its original
      claim.




10




As
      a
      result of the dispute described above, as of March 31, 2007, we had placed
      $19,500, representing the gross cash proceeds from the recent settlement of
      this
      litigation into suspense. Since the amount in dispute cannot be determined
      with
      reasonable certainty until the dispute is resolved, we have elected to suspend
      the entire amount, in accordance with Statement of Financial Accounting
      Standards No. *5,
“Accounting for Contingencies.”* Payment
      of G&L’s agreed settlement fees of $995 was released from the litigation in
      suspense proceeds. Tegal
      intends to seek indemnification from KVN for the $995 paid to G&L.




**7.
      Geographical Information**





Tegal
      operates in one segment for the manufacture, marketing and servicing of
      integrated circuit fabrication equipment. In accordance with SFAS No. 131
“ *Disclosures
      About Segments of an Enterprise and Related Information* ”
(SFAS
      131), 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 Ended**
              **September
                30,**
            
            **Revenue
                for the**
              **Six
                Months Ended**
              **September
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Sales
                to customers located in:United
                States
            
            $
            387
            
            $
            809
            
            $
            1,116
            
            $
            3,353Asia,
                excluding Japan
            
            
            2,849
            
            
            766
            
            
            3,202
            
            
            3,445Japan
            
            
            187
            
            
            1,153
            
            
            192
            
            
            1,677Germany
            
            
            809
            
            
            888
            
            
            1,383
            
            
            1,595Italy
            
            
            153
            
            
            22
            
            
            153
            
            
            76Europe,
                excluding Germany and Italy
            
            
            6,415
            
            
            1,475
            
            
            9,352
            
            
            1,543Total
                sales
            
            $
            10,800
            
            $
            5,113
            
            $
            15,398
            
            $
            11,689




**Long-lived**
              **Assets
                as of**
              **September
                30,****2007**
            
            **2006**Long-lived
                assets at period-end:United
                States
            
            $
            2,334
            
            $
            2,461Europe
            
            
            10
            
            
            13Japan
            
            
            —
            
            
            9Total
                long-lived assets
            
            $
            2,344
            
            $
            2,483




**8.
      Recent Accounting Pronouncements**




In
      June
      2006, the Financial Accounting Standards Board (FASB) ratified the consensus
      reached by the Emerging Issues Task Force (“EITF”) regarding EITF Issue No.
      06-03, “ *How
      Taxes Collected from Customers and Remitted to Government Authorities Should
      be
      Presented in the Income Statement (That Is, Gross versus Net
      Presentation)* ”.
      This
      guidance requires that companies disclose this accounting policy related to
      sales tax and other similar taxes, effective for interim and annual reporting
      periods beginning after December 15, 2006. We report these taxes on a net basis,
      excluding them from revenue.





In
      July 2006, FASB issued FASB Interpretation No. 48, “ *Accounting
      for Uncertainties in Income Taxes — An Interpretation of FASB Statement
      No. 109* ”
(FIN
      48), effective for fiscal periods beginning after December 15, 2006. FIN 48
      requires recognition on the financial statements of the effects of a tax
      position when it is more likely than not, based on the technical merits, that
      the position will be sustained upon examination. FIN 48 has no material effect
      on the Company’s consolidated financial statements.




11




In
      September 2006, the FASB issued SFAS No. 157, “ *Fair
      Value Measurements* ”
(SFAS
      157), which established a common definition for fair value to be applied to
      U.S.
      GAAP guidance requiring use of fair value. Also, SFAS 157 establishes a
      framework for measuring fair value, and expands disclosure about such fair
      value
      measurements. SFAS 157 is effective for fiscal years beginning after November
      15, 2007. The Company is currently evaluating the impact of SFAS 157 on its
      consolidated financial statements.





In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
      for Financial Assets and Financial Liabilities—Including an amendment of SFAS
      115” (SFAS 159). The new statement allows entities to choose, at specified
      election dates, to measure eligible financial instruments and certain other
      items at fair value that are not otherwise required to be so measured. If a
      company elects the fair value option for an eligible item, changes in that
      item’s fair value in subsequent reporting periods must be recognized in current
      earnings. SFAS 159 is effective for fiscal years beginning after
      November 15, 2007. The Company is currently evaluating the potential impact
      of SFAS 159 on its consolidated financial statements.




**Item
      2.** ***Management’s
      Discussion and Analysis of Financial Condition and Results of Operations –
(Amounts in 000’s)***





**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” elsewhere in this report. For further information, refer
      to the business description and risk factors described below. These
      forward-looking statements should not be relied upon as predictions of future
      events as we cannot assure you that the events or circumstances reflected in
      these statements will be achieved or will occur. All
      forward-looking statements are expressly qualified in their entirety by the
      cautionary statements in this paragraph.





Tegal
      Corporation, a Delaware corporation (“Tegal” or the “Company”), 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.





**Semiconductor
      Industry Background**





Over
      the
      past twenty years, the semiconductor industry has experienced significant
      growth. This growth has resulted from the increasing demand for ICs from
      traditional IC markets, such as personal computers, telecommunications, consumer
      electronics, automotive electronics and office equipment, as well as developing
      markets, such as wireless communications, multimedia and portable and network
      computing. As a result of this increased demand, semiconductor device
      manufacturers have periodically expended significant amounts of capital to
      build
      new semiconductor fabrication facilities (“fabs”) and to expand existing fabs.
      More recently, growth has slowed, and the industry is maturing as the cost
      of
      building new wafer fabs has increased dramatically. While unit demand for
      semiconductor devices continue to rise, the average selling prices of chips
      continue to decline. There is growing pressure on semiconductor device
      manufacturers to reduce manufacturing costs while increasing the value of their
      products. The semiconductor industry has also been historically cyclical, with
      periods of rapid expansion followed by periods of over-capacity.





Growth
      in
      the semiconductor industry has been driven, in large part, by advances in
      semiconductor performance at a decreasing cost per function. Advanced
      semiconductor processing technologies increasingly allow semiconductor
      manufacturers to produce ICs with smaller features, thereby increasing
      processing speed and expanding device functionality and memory capacity. As
      ICs
      have become more complex, however, both the number and price of state of the
      art
      process tools required to manufacture ICs have increased significantly. As
      a
      result, the cost of semiconductor manufacturing equipment has become an
      increasingly large part of the total cost of producing advanced ICs.




12





To
      create
      an IC, semiconductor wafers are subjected to a large number of complex process
      steps. The three primary steps in manufacturing ICs are (1) deposition, in
      which
      a layer of insulating or conducting material is deposited on the wafer surface,
      (2) photolithography, in which the circuit pattern is projected onto a light
      sensitive material (the photoresist), and (3) etch, in which the unmasked parts
      of the deposited material on the wafer are selectively removed to form the
      IC
      circuit pattern.





Each
      step
      of the manufacturing process for ICs requires specialized manufacturing
      equipment. Today, plasma-based systems are used for the great majority of both
      deposition and etching processes. During physical vapor deposition (also known
      as “PVD”), the semiconductor wafer is exposed to a plasma environment that forms
      continuous thin films of electrically insulating or electrically conductive
      layers on the semiconductor wafer. During a plasma etch process (also known
      as
“dry etch”), a semiconductor wafer is exposed to a plasma composed of a reactive
      gas, such as chlorine, which etches away selected portions of the layer
      underlying the patterned photoresist layer.





**Business
      Strategy**





Our
      business objective is to utilize the technologies that we have developed
      internally or acquired externally in order to increase our market share in
      process equipment for both semiconductor manufacturing and nanotechnology device
      fabrication. In the recent past, we have attempted to “leap frog” more
      established competitors by being “designed-in” to the advanced device
      fabrication plans of our customers. We have done so primarily by engaging in
      research and development activities on behalf of our customers that our more
      established competitors were unwilling or unable to perform. Many of these
      advanced devices promise substantial returns as consumer demand for certain
      functions grows and new markets are created. However, the timing of the
      emergence of such demand, such as broadband wireless communications and RFID
      tags is highly uncertain. In addition, the successful integration by our
      customers of all the various technical processes required to manufacture a
      device at an acceptable cost is also highly uncertain. As a result of our
      inability to accurately predict the timing of the emergence of these markets,
      our sales have declined over the past few years, while our costs for maintaining
      our research and development efforts and our service and manufacturing
      infrastructure have remained constant or in some cases increased.





At
      the
      present time, we are transitioning Tegal from a dependence on these highly
      unpredictable markets to more established equipment markets, where our success
      is dependent more on our ability to apply successfully our engineering
      capabilities to solving existing manufacturing problems. We aim to carefully
      manage this transition by limiting our research and development efforts to
      the
      most promising near-term sales opportunities, while at the same time redirecting
      all our available resources toward new products aimed at established equipment
      markets. Because of our relatively small size, our ability to meet the needs
      of
      individual customers is far more important to our success than either macro
      economic factors or industry-wide factors such as cyclicality, although both
      of
      these areas have some effect on our performance as well. As a result, our
      methods of evaluating our progress will continue to be highly
      customer-focused.





In
      order
      to achieve our business strategy, we are focused on the following key
      elements:





*Maintaining
      our Technology Leadership Position in New Materials Etch* –
      We have become a leading provider of etch process solutions for a set of new
      materials central to the production of an array of advanced semiconductor and
      nanotechnology devices in emerging markets. Incorporation of these new materials
      is essential to achieving the higher device densities, lower power consumption
      and novel functions exhibited by the newest generation of cell phones, computer
      memories, fiber optic switches and remote sensors. Currently, we are a leading
      supplier of etch solutions to makers of various advanced “non-volatile”
memories, as well as to device makers incorporating compound metals and certain
      high-K dielectric materials into their devices. Our new materials expertise
      also
      includes the etching of so-called “compound-semi” materials, such as gallium
      arsenide, gallium nitride and indium phosphide, widely used in telecom device
      production. In addition, we are known for our capability to etch certain noble
      metals, such as gold and platinum, as well as certain proprietary compound
      metals. This capability is increasingly important in advanced memory development
      and in the production of Micro-Electrical Mechanical Systems (“MEMS”), a type of
      commercially produced nanotechnology device, especially useful to the automotive
      industry.





*Strengthening
      our Position in Deposition Process Equipment –* Since
      2002, we have completed two acquisitions of deposition products incorporating
      the same unique “sputter-up” technology. In December 2006, as a result of the
      settlement of our litigation with Advanced Modular Systems (“AMS”) and others,
      we also acquired the assets and know-how of a similar deposition system. These
      deposition tools enable the production of highly-oriented, thin piezoelectric
      films composed of aluminum nitride. Such films are incorporated into high
      frequency filters called Bulk Acoustic Wave (BAW) and Film Bulk Acoustic
      Resonators (FBARs) used in cellular telephony and wireless communications.
      In
      addition our PVD products are well-suited for applications within so-called
      “back-end” semiconductor manufacturing processes, including backside
      metallization of ultra-thin wafers and underbump metal processes. These
      processes are important to power devices, as well as certain advanced,
      wafer-level packaging schemes, which are increasingly being used for
      high-pin-count logic and memory devices.




13





*Introducing
      a New Product into Established Equipment Market -* The
      continued development of our recently acquired NLD technology represents our
      belief that we have a compelling solution to a critical process need in
      present-day and future semiconductor device fabrication. As device geometries
      continue to shrink, conventional chemical vapor deposition (“CVD”) process
      equipment is increasingly incapable of depositing thin conformal films in
      high-aspect ratio trenches and vias. Atomic Level Deposition (“ALD”) is one
      technology for satisfying this deposition requirement. However, ALD has several
      shortcomings, including low throughput and limitations on film type and quality,
      which we believe our NLD technology overcomes.





*Maintaining
      our Service Leadership Position -* Tegal
      has been consistently recognized by our customers for providing a high level
      of
      customer support, a fact that has been noted by our top rankings for several
      consecutive years in the annual survey conducted by VLSI Research, Inc. We
      expect to maintain and build on this reputation as we seek new customers in
      both
      emerging and established markets.





**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 ongoing basis, we evaluate our estimates, including
      those related to revenue recognition, bad debts, sales returns allowance,
      inventory, intangible and long lived assets, warranty obligations, restructure
      expenses, deferred taxes and freight charged to customers .
      We base
      our estimates on historical experience and on various other assumptions that
      we
      believe to be reasonable under the circumstances, the results of which form
      the
      basis for making judgments about the carrying values of assets and liabilities
      that are not readily apparent from other sources. Actual results may differ
      from
      these estimates under different assumptions or conditions





We
      believe the following critical accounting policies are the most significant
      to
      the presentation of our consolidated financial statements:





**Accounting
      for Stock-Based Compensation**





We
      have
      adopted several stock plans that provide equity instruments to our employees
      and
      non-employee directors. Our plans include incentive and non-statutory stock
      options and restricted stock awards. Stock options and restricted stock awards
      generally vest ratably over a four-year period on the anniversary date of the
      grant, and expire ten years after the grant date. On occasion restricted stock
      awards may vest on the achievement of specific performance targets. We also
      have
      employee stock purchase plans that allow qualified employees to purchase Tegal
      shares at 85% of the fair market value on specified dates. The difference
      between the purchase value and the market value is expensed as
      compensation.





Prior
      to
      April 1, 2006 we accounted for these stock-based employee compensation plans
      under the measurement and recognition provisions of Accounting Principles Board
      Opinion No.25, “ *Accounting
      for Stock Issued to Employees* ,”
or
      APB
      25, and related interpretations, as permitted by SFAS No.123, “Accounting for
      Stock Based Compensation” (SFAS 123). With the exception of grants of restricted
      stock awards, we generally, recorded no stock-based compensation expense during
      periods prior to April 1, 2006 as all stock-based grants had exercise prices
      equal to the fair market value of our common stock on the date of grant. We
      also
      recorded no compensation expense in connection with our employee stock purchase
      plan as they qualified as a non-compensatory plan following the guidance
      provided by APB 25.





Effective
      April 1, 2006, we adopted the fair value recognition provisions of Statement
      of
      Financial Accounting Standards No. 123 (revised 2004), “ *Share
      Based Payment* ”
(SFAS
      123R) using the modified prospective transition method. Under that transition
      method, we recognized compensation expense of $1,664 for the fiscal year 2007,
      and $776 for the six month period ended September 30, 2007, which included:
      (a)
      compensation expense for all share-based payments granted prior to but not
      yet
      vested as of April 1, 2006, based on the grant date fair value estimated in
      accordance with the original provisions of SFAS 123, and (b) compensation
      expense for all share-based payments granted or modified on or after April
      1,
      2006, based on the grant date fair value estimated in accordance with the
      provisions of SFAS 123R. Compensation expense is recognized only for those
      awards that are expected to vest, whereas prior to the adoption of SFAS 123R,
      we
      recognized forfeitures as `they occurred. In addition, we elected the
      straight-line attribution method as our accounting policy for recognizing
      stock-based compensation expense for all awards that are granted on or after
      April 1, 2006. Results in prior periods have not been restated.




14





**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 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
      collectability is reasonably assured.





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





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





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





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





**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. We
      consider the aging of individual customer accounts and determine, according
      to
      corporate policy, which accounts should be included in the reserve for doubtful
      accounts. If the financial conditions of our customers were to deteriorate,
      or
      even a single customer was otherwise unable to make payments, additional
      allowances may be required and may
      materially affect our consolidated financial position .





Our
      return policy is for spare parts and components only. A
      right
      of return does not exist for systems. Customers
      are allowed to return spare parts if they are defective upon receipt. The
      potential returns are offset against gross revenue on a monthly basis.
      Management reviews outstanding requests for returns on a quarterly basis to
      determine that the reserves are adequate.





**Inventories**





Inventories
      are stated at the lower of cost or market, reduced by provisions for excess
      and
      obsolescence. Cost is computed using standard cost, which approximates actual
      cost on a first-in, first-out basis and includes material, labor and
      manufacturing overhead costs. We estimate the effects of excess and obsolescence
      on the carrying values of our inventories based upon estimates of future demand
      and market conditions. We establish provisions for related inventories in excess
      of production demand. Should actual production demand differ from our estimates,
      additional inventory write-downs may be required. Any excess and obsolete
      provision is released only if and when the related inventories is sold or
      scrapped. The inventory provision balance at September 30, 2007 and March 31,
      2007 was $3,769 and
      $3,908, respectively. The recovery of previously reserved inventory upon scrap
      of such inventory for the six months ended September 30, 2007 and September
      30,
      2006 was $150
      and
      $2,594, respectively.




15





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 determines that a sale will not take place within the next 12 months, and the
      system would be useable for customer demonstrations or training, it is
      transferred to fixed assets. Otherwise, it is expensed.





The
      carrying value of systems used for demonstrations or training is determined
      by
      assessing the cost of the components that are suitable for sale. Any parts
      that
      may be rendered not saleable 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. The
      warranty reserve is based on historical cost data related to warranty. Should
      actual product failure rates, material usage rates and labor efficiencies differ
      from our estimates, revisions to the estimated warranty liability may be
      required.





**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 as a percentage of revenue
      for the three and six months ended September 30, 2007 and 2006:





**Three Months**
              **Ended**
              **September 30,**
            
            **Six Months**
              **Ended**
              **September 30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Revenue
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of revenue
            
            
            60.7
            
            
            53.1
            
            
            61.9
            
            
            58.1Gross
                profit
            
            
            39.3
            
            
            46.9
            
            
            38.1
            
            
            41.9Operating
                expenses:Research
                and development expenses
            
            
            9.8
            
            
            20.8
            
            
            11.9
            
            
            17.6Sales
                and marketing expenses
            
            
            11.8
            
            
            18.9
            
            
            14.8
            
            
            17.2General
                and administrative expenses
            
            
            13.4
            
            
            68.2
            
            
            17.2
            
            
            49.5Total
                operating expenses
            
            
            35.0
            
            
            107.9
            
            
            43.9
            
            
            84.3Other
                income (expense) net
            
            
            2.1
            
            
            (3.0
            )
            
            6.2
            
            
            (1.1
            )Net
                income (loss)
            
            
            6.5
            %
            
            (64.0
            %)
            
            0.4
            %
            
            (43.5
            %)




16





The
      foll owing
      table sets forth certain financial items for the three and six month periods
      ended September 30, 2007 and 2006.




**Three
                Months**
              **Ended**
              **September
                30,**
            
            **Six
                Months**
              **Ended**
              **September
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Revenue
            
            $
            10,800
            
            $
            5,113
            
            $
            15,398
            
            $
            11,689Cost
                of revenue
            
            
            6,560
            
            
            2,713
            
            
            9,537
            
            
            6,791Gross
                profit
            
            
            4,240
            
            
            2,400
            
            
            5,861
            
            
            4,898Operating
                expenses:Research
                and development expenses
            
            
            1,057
            
            
            1,066
            
            
            1,835
            
            
            2,062Sales
                and marketing expenses
            
            
            1,279
            
            
            964
            
            
            2,285
            
            
            2,008General
                and administrative expenses
            
            
            1,448
            
            
            3,485
            
            
            2,651
            
            
            5,787Total
                operating expenses
            
            
            3,784
            
            
            5,515
            
            
            6,771
            
            
            9,857Other
                income (expense) net
            
            
            237
            
            
            (166
            )
            
            964
            
            
            (124
            )Net
                income (loss)
            
            $
            693
            
            $
            (3,281
            )
            $
            54
            
            $
            (5,083
            )Net
                income per share
            
            
            0.10
            
            
            (0.47
            )
            
            0.01
            
            
            (0.72
            )Number
                of shares outstandingBasic
            
            
            7,119
            
            
            7,045
            
            
            7,111
            
            
            7,029Diluted
            
            
            7,264
            
            
            7,045
            
            
            7,219
            
            
            7,029




***Revenue***





The
      changes in revenue for the three and six months ended September 30, 2007 and
      September 30, 2006 was principally due to the product mix and number of systems
      sold .
      For the
      six months ended September 30, 2007, we sold four new advanced series systems
      and one new 900 series systems, as well as one used Endeavor system. For the
      six
      months ended September 30, 2006, we sold one new advanced series and six new
      900
      series systems, as well as one used advanced series system, two used 900 series
      systems and one used Endeavor system. For the three months ended September
      30,
      2007, we sold three new advanced series systems and one used Endeavor system.
      For the three months ended September 30, 2006, we sold three new 900 series
      systems, as well as one used advanced series system and two used 900 series
      systems.




International
      sales as a percentage of revenue for the three
      and
      six months ended
      September 30, 2007 were 96.% and 93%, respectively. International sales as
      a
      percentage of revenue for the three
      and
      six months ended
      September 30, 2006 were 68% and 74%, respectively. We believe that international
      sales will continue to represent a significant portion of our
      revenue.





***Gross
      profit***





Gross
      profit for the three months ended September 30, 2007 was $4,240, compared to
      $2,400 for the same period last year. Gross profit for the six months ended
      September 30, 2007 was $5,861 compared
      to $4,898 for the same period last year. The
      increase in gross profit is due to the product mix and number of systems sold.
      Gross margin for the three months and six months ended September 30, 2007 was
      lower than for the same period last year mainly due to reduction in lead times
      beginning in mid 2006.





***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. Spending has been
      consistent in total dollars for the three months ended September 30, 2007,
      $1,057 versus $1,066 for the prior year period. In the six months ended
      September 30, 2007, spending decreased to $1,835 from $2,062 for the prior
      year
      period due to reimbursement for prototype costs.





***Sales
      and Marketing*** **





Sales
      and
      marketing expenses consist primarily of salaries, commissions, trade show
      promotion and travel and living expenses associated with those functions. Sales
      and marketing spending for the three and six months ended September 30, 2007
      was
      $1,279 and $2,285, respectively. This increase over the prior year periods
      of
      $964 and $2,008, respectively represents our increased efforts to increase
      world
      wide sales.




17





***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 $2,037 decrease over the prior year’s three-month period and
      the $3,136 decrease over the prior year’s six-month period were primarily due to
      a reduction in legal fees as a result of the settlement of the litigation
      against AMS, Agilent, and Avago Technologies. Other factors include a one-time
      lease termination expense of $500 for the reduction of space in the Petaluma
      facility and the costs associated with moving portions of the operations to
      San
      Jose.





***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
      income of $964 for the six months and $237 for the three months ended September
      2007. The major component of these income (expenses) were net interest income
      from the AMS settlement.




***Contractual
      obligation*** **





The
      following summarizes our contractual obligations at September 30, 2007, and
      the
      effect such obligations are expected to have on our liquidity and cash flows
      in
      future periods:





**Total**
            
            **Less than**
              **1
                Year**
            
            **1-3 Years**
            
            **3-5 Years**
            
            **After**
              **5 Years**Contractual
              obligations:Non-cancelable
                operating lease obligations
            
            
            1,014
            
            
            600
            
            
            379
            
            
            35
            
            
            —Total
                contractual cash obligations
            
            $
            1,014
            
            $
            600
            
            $
            379
            
            $
            35
            
            $
            —





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





***Liquidity
      and Capital Resources***





For
      the
      six month period ended September 30, 2007, we financed our operations through
      the use of outstanding cash balances. The
      consolidated financial statements contemplate the realization of assets and
      the
      satisfaction of liabilities in the normal course of business. We incurred net
      income (loss) of $693 and ($3,281) and $54 and ($5,083) for the three and six
      months ended September 30, 2007 and 2006, respectively. We generated negative
      cash flows from operations of $5,220 and $3,268 for the period ended September
      30, 2007 and September 30, 2006, respectively. During fiscal year 2007, we
      settled our lawsuit with AMS, Agilent and Avago Technologies for $19,500, which
      is currently in litigation suspense, offset by the payment of $995 to settle
      claims with G&L for a litigation suspense balance of $18,505 as of September
      30, 2007. For more information, see Part I, Basis of Presentation, Item 6.
      Legal
      Proceedings. In 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 year 2008. However, projected sales
      may not materialize and unforeseen costs may be incurred **.** Moreover,
      the amount we ultimately receive from the AMS lawsuit settlement is uncertain
      as
      we continue to dispute the claims by one of the two law firms who represented
      us
      in that matter. If the amount we ultimately receive under the lawsuit settlement
      is materially less, or 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.





**Item
      3.** ***Quantitative
      and Qualitative Disclosures about Market Risk***





Our
      cash
      equivalents are principally comprised of money market accounts. As of September
      30, 2007 ,
      we had
      cash and cash equivalents of $20,348 .
      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.




18





We
      have
      foreign subsidiaries which operate and sell our products in various global
      markets. As a result, we are exposed to changes in foreign currency exchange
      rates. We do not hold derivative financial instruments for speculative purposes.
      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, 2007.





**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****.
                -*Under
                the supervision and with the participation of our management, our
                Chief
                Executive Officer and Chief Financial Officer have evaluated the
                effectiveness of our disclosure controls and procedures, as such
                term is
                defined under Rule 13a-15(e) promulgated under the Securities Exchange
                Act
                of 1934, as amended. Based upon that evaluation, our Chief Executive
                Officer and our Chief Financial Officer concluded that the our disclosure
                controls and procedures were effective as of the end of the period
                covered
                by this report.




(b)
            ***Changes
                in Internal Controls over financial reporting***.
                -
                As required by Rule 13a-15(d), our management, including our Chief
                Executive Officer and Chief Financial Officer, also conducted an
                evaluation of our internal control over financial reporting to determine
                whether any changes occurred during the period covered by this report
                that
                have materially affected, or are reasonably likely to materially
                affect,
                our internal control over financial reporting. Based on that evaluation,
                there has been no such change during the period covered by this
                report.






(c)
            ***Limitations
                of the effectiveness of internal control.****-*******A
                control system, no matter how well conceived and operated, can provide
                only reasonable, not absolute, assurance that the objectives of the
                internal control system are met. Because of the inherent limitations
                of
                any internal control system, no evaluation of controls can provide
                absolute assurance that all control issues, if any, within a company
                have
                been detected. Notwithstanding these limitations, our disclosure
                controls
                and procedures are designed to provide reasonable assurance of achieving
                their objectives. Our Chief Executive Officer and Chief Financial
                Officer
                have concluded that our disclosure controls and procedures are, in
                fact,
                effective at the “reasonable assurance”
level.





**PART
      II — OTHER INFORMATION**





**Item
      1A.** ***Risk
      Factors***  ****





*We
      wish to caution you that there are risks and uncertainties that could affect
      our
      business. These risks and uncertainties include, but are not limited to, the
      risks described below and elsewhere in this report, particularly in
“Forward-Looking Statements.” The following is not intended to be a complete
      discussion of all potential risks or uncertainties, as it is not possible to
      predict or identify all risk factors.*





**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 ICs.
      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 have 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 current and any future 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.




19





**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 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.





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





The
      composition of our top five customers has changed from year to year, but net
      system sales to our top five customers in each of fiscal 2007, 2006 and 2005
      accounted for 77.8%, 68.9% and 80.0% respectively, of our total net system
      sales. ST Microelectronics and International Rectifier accounted for 43.1%
      and
      13.4%, respectively, of our total revenue in fiscal 2007. ST Microelectronics
      accounted for 54.3% of our total revenue in fiscal 2006. Fujitsu, Western
      Digital, and RF Micro Devices accounted for 38.2%, 12.8% and 10.1% respectively,
      of our net system sales in fiscal year 2005. ST Microelectronics accounted
      for
      83% of total revenue in the quarter ended September 30, 2007. Other than these
      customers, no single customer represented more than 10% of our total revenue
      in
      fiscal 2007, 2006 and 2005 or the six months ended September 30, 2007. 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 and related device manufacturing
      industry, may have a material adverse effect on us.





**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.





**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 69%, 69% and 30% of total revenue in fiscal
      2007, 2006 and 2005, 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 customer adoption,
      we
      will be materially adversely affected.





**We
      have incurred operating losses and may not be profitable in the future; our
      plans to maintain and increase liquidity may not be successful.**





We
      incurred net losses of $13.2 million, $8.9 million and $15.4 million for the
      years ended March 31, 2007, 2006 and 2005, respectively, and generated (used)
      cash flows from operations of $12.8 million, ($11.6) million, and ($7.5) million
      in these respective years. We have raised approximately $18.4 million from
      the
      sale of stock and warrants to institutional investors in fiscal 2006. While
      we
      believe 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 2008, 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 any needed funds would materially adversely affect
      us.




20





**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 manner.**





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.




21





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





While
      our
      common stock has recently increased in value compared to the exercise price
      of
      many options granted to employees pursuant to our stock option plans, this
      performance level may not be sustained. 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 and may have difficulty in hiring new employees to
      replace them. 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. The loss of any significant employee or
      a
      large number of employees over a short period of time could have a material
      adverse effect on us.





**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
      there under 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
      to protect our intellectual property could result in substantial cost and
      diversion of effort by us, which by itself could have a material adverse 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.





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





International
      sales accounted for 67%, 76%, and 70% of total revenue for fiscal 2007, 2006,
      and 2005, respectively. For the six months ended September 30, 2007,
      international sales accounted for approximately 93% of total revenue.
      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
      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 Securities and
      Exchange Commission (“SEC”) regulations and Nasdaq Stock 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 materially adversely affected.




22





**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.





**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
      September 30, 2007, there were
      7,126,912 sh ares
      of
      our common stock issued and outstanding and there were
      1,858,197 shares of
      common stock reserved for issuance under our equity incentive and stock purchase
      plans. As of the same date, there were warrants outstanding for approximately 1,695,145 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
      outstanding 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 security holders 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.





**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.




23





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





On
      September 18, 2007, the Company held its annual meeting of the stockholders.
      Present at the meeting, in person or by proxy, were the holders of 5,813,998
      shares of common stock of the Company, representing 82% of the total votes
      eligible to be cast, constituting a majority and more than a quorum of the
      outstanding shares entitled to vote.




The
      following individuals were re-elected to the board of directors:





Votes
                For
            
            Votes WithheldEdward
                A. Dohring
            
            
            5,620,757
            
            
            193,241Jeffrey
                M. Krauss
            
            
            5,624,142
            
            
            189,856H.
                Duane Wadsworth
            
            
            5,615,196
            
            
            198,802Thomas
                R. Mika
            
            
            5,625,060
            
            
            188,938




The
      vote
      to approve an amendment to the Company’s Amended and Restated Certificate of
      Incorporation, as amended, pursuant to which the total number of authorized
      shares of capital stock will be reduced from 205 million to 55 million and
      total
      number of authorized common stock will be reduced from 200 million to 50 million
      was approved by the stockholders as follows:




Votes
                ForFor
            
            
            5,593,109Against
            
            
            210,897Abstain
            
            
            9,992Broker
                Non Vote
            
            
            0





The
      vote
      to approve the 2007 Incentive Award Plan was approved by stockholders as
      follows:




Votes
                ForFor
            
            
            2,368,104Against
            
            
            300,751Abstain
            
            
            6,055Broker
                Non Vote
            
            
            3,139,088




The
      vote
      to ratify the appointment of Burr, Pilger & Mayer LLP as our Independent
      Registered Public Accounting Firm for the fiscal year ending March 31, 2008
      was
      approved by stockholders as follows:




Votes
                ForFor
            
            
            5,693,718Against
            
            
            110,288Abstain
            
            
            9,992




24





**Item
      6.*****Exhibits***


(a)  *Exhibits*


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.








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**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
                Hergenrother
              *Chief
                Financial Officer*Dated:
                November 14 , 2007




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