UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-Q





(Mark One)





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





For the quarterly period ended
September 30, 2010





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 þ
No  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (Sec.232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes þ No  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      Accelerated Filer  ̈
            Accelerated
      Filer  ̈Non-Accelerated
      Filer  ̈ (Do
      not check if a smaller reporting company)
            Smaller
      reporting company þ





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





As of
November 11, 2010, there were 8,439,095 of the Registrant’s common stock
outstanding.





1


TEGAL
CORPORATION AND SUBSIDIARIES





INDEX





PagePART
      I. FINANCIAL INFORMATIONItem
      1.
                              Condensed
      Consolidated Financial Statements (Unaudited)
                              3Condensed
      Consolidated Balance Sheets as of September 30, 2010 and March 31,
      2010
                              3Condensed
      Consolidated Statements of Operations for the three and six months ended
      September 30, 2010 and September 30, 2009
                              4Condensed
      Consolidated Statements of Cash Flows for the six months ended September
      30, 2010 and September 30, 2009
                              5Notes
      to Condensed Consolidated Financial Statements
                              6Item
      2.
                              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                              15Item
      3.
                              Quantitative
      and Qualitative Disclosures About Market Risk
                              24Item
      4.
                              Controls
      and Procedures
                              24PART
      II. OTHER INFORMATIONItem
      1A.
                              Risk
      Factors
                              25Item
      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,
                
                
                March 31,2010
                
                
                2010ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                4,373
                
                
                $
                7,298Accounts
      receivable, net of allowances for sales returns and doubtful accounts of
      $196 and $324 at September 30, 2010 and March 31, 2010,
      respectively.
                
                
                2,829
                
                
                
                3,116Notes
      receivable
                
                
                1,527
                
                
                
                1,347Inventories,
      net
                
                
                1,407
                
                
                
                1,221Prepaid
      expenses and other current assets
                
                
                202
                
                
                
                1,243Total
      current assets
                
                
                10,338
                
                
                
                14,225Property
      and equipment, net
                
                
                241
                
                
                
                308Intangible
      assets, net
                
                
                1,118
                
                
                
                1,230Other
      assets
                
                
                6
                
                
                
                540Total
      assets
                
                $
                11,703
                
                
                $
                16,303LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                568
                
                
                $
                1,520Accrued
      product warranty
                
                
                474
                
                
                
                374Common
      stock warrant liability
                
                
                21
                
                
                
                363Deferred
      revenue
                
                
                223
                
                
                
                242Accrued
      expenses and other current liabilities
                
                
                535
                
                
                
                1,867Total
      current liabilities
                
                
                1,821
                
                
                
                4,366Commitments
      and contingencies (Item 2)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; 8,439,095 and
      8,438,115 shares issued and outstanding at September 30, 2010 and March
      31, 2010, respectively.
                
                
                84
                
                
                
                84Additional
      paid-in capital
                
                
                128,549
                
                
                
                128,290Accumulated
      other comprehensive loss
                
                
                (129
                )
                
                
                (149
                )Accumulated
      deficit
                
                
                (118,622
                )
                
                
                (116,288
                )Total
      stockholders’ equity
                
                
                9,882
                
                
                
                11,937Total
      liabilities and stockholders’ equity
                
                $
                11,703
                
                
                $
                16,303


See
accompanying notes to condensed consolidated financial
statements.


3





TEGAL
CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)


(In
thousands, except per share data)





Three Months Ended
                
                
                Six Months EndedSeptember30,
                
                
                September30,2010
                
                
                2009
                
                
                2010
                
                
                2009Revenue
                
                $
                3,183
                
                
                $
                3,117
                
                
                $
                3,502
                
                
                $
                4,200Cost
      of revenue
                
                
                1,952
                
                
                
                2,269
                
                
                
                2,502
                
                
                
                3,259Gross
      profit
                
                
                1,231
                
                
                
                848
                
                
                
                1,000
                
                
                
                941Operating
      expenses:Research
      and development expenses
                
                
                542
                
                
                
                1,170
                
                
                
                1,565
                
                
                
                2,411Sales
      and marketing expenses
                
                
                150
                
                
                
                670
                
                
                
                308
                
                
                
                1,374General
      and administrative expenses
                
                
                927
                
                
                
                810
                
                
                
                2,077
                
                
                
                1,973Total
      operating expenses
                
                
                1,619
                
                
                
                2,650
                
                
                
                3,950
                
                
                
                5,758Operating
      loss
                
                
                (388
                )
                
                
                (1,802
                )
                
                
                (2,950
                )
                
                
                (4,817
                )Other
      income (expense), net
                
                
                527
                
                
                
                114
                
                
                
                623
                
                
                
                471Income
      (loss) before income tax expense (benefit)
                
                
                139
                
                
                
                (1,688
                )
                
                
                (2,327
                )
                
                
                (4,346
                )Income
      tax expense (benefit)
                
                
                5
                
                
                
                1
                
                
                
                7
                
                
                
                (50
                )Net
      income (loss)
                
                $
                134
                
                
                $
                (1,689
                )
                
                $
                (2,334
                )
                
                $
                (4,296
                )Net
      income (loss) per share:Basic
                
                $
                0.02
                
                
                $
                (0.20
                )
                
                $
                (0.28
                )
                
                $
                (0.51
                )Diluted
                
                $
                0.02
                
                
                $
                (0.20
                )
                
                $
                (0.28
                )
                
                $
                (0.51
                )Weighted
      average shares used in per share computation:Basic
                
                
                8,439
                
                
                
                8,415
                
                
                
                8,438
                
                
                
                8,415Diluted
                
                
                8,460
                
                
                
                8,415
                
                
                
                8,438
                
                
                
                8,415





See
accompanying notes to condensed consolidated financial
statements.


4


TEGAL
CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)


(In
thousands)





Six
      Months EndedSeptember 302010
                
                
                2009Cash
      flows from operating activities:Net
      loss
                
                $
                (2,334
                )
                
                $
                (4,296
                )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Stock
      compensation expense
                
                
                258
                
                
                
                313Stock
      issued under stock purchase plan
                
                
                1
                
                
                
                4Fair
      value adjustment of common stock warrants
                
                
                (341
                )
                
                
                (58
                )(Recovery)
      provision for doubtful accounts and sales returns
    allowances
                
                
                (128
                )
                
                
                (47
                )Depreciation
      and amortization
                
                
                209
                
                
                
                617Loss
      on disposal of property and equipment
                
                
                146
                
                
                
                61Changes
      in operating assets and liabilities:Accounts
      receivables and other receivables
                
                
                (52
                )
                
                
                491Inventories,
      net
                
                
                (186
                )
                
                
                (214
                )Prepaid
      expenses and Other assets
                
                
                1,576
                
                
                
                (137
                )Accounts
      payable
                
                
                (951
                )
                
                
                9Accrued
      expenses and other current liabilities
                
                
                (1,333
                )
                
                
                (121
                )Accrued
      product warranty
                
                
                100
                
                
                
                (150
                )Deferred
      revenue
                
                
                (20
                )
                
                
                84Net
      cash used in operating activities
                
                
                (3,055
                )
                
                
                (3,444
                )Cash
      flows used in investing activities:Purchases
      of property and equipment
                
                
                (176
                )
                
                
                (376
                )Net
      cash received on asset disposition
                
                
                250
                
                
                
                —Net
      cash used in investing activities:
                
                
                74
                
                
                
                (376
                )Cash
      flows used in financing activities:Net
      cash used in financing activities
                
                
                —
                
                
                
                —Effect
      of exchange rates on cash and cash equivalents
                
                
                56
                
                
                
                (55
                )Net
      decrease in cash and cash equivalents
                
                
                (2,925
                )
                
                
                (3,875
                )Cash
      and cash equivalents at beginning of period
                
                
                7,298
                
                
                
                12,491Cash
      and cash equivalents at end of period
                
                $
                4,373
                
                
                $
                8,616Supplemental
      disclosure of non-cash activities:Reclassification
      of common stock warrant liability upon adoption of EITF 07-05 (Topic
      815)
                
                $
                -
                
                
                $
                848





See
accompanying notes to condensed consolidated financial
statements.


5


TEGAL
CORPORATION AND SUBSIDIARIES





NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)


(All
amounts in thousands, except per 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, 2010 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 (“GAAP“). 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, 2010. The results of operations
for the three and six months ended September 30, 2010 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 for the foreseeable
future. We incurred net losses of ($2,334) and ($4,296) for the six months ended
September 30, 2010 and 2009, respectively. We incurred net income (loss) of $134
and ($1,689) for the three months ended September 30, 2010 and 2009,
respectively. We used cash flows from operations of ($2,805) and ($3,444) for
the six months ended September 30, 2010 and 2009, respectively. We believe that
our outstanding balances of cash and cash equivalents, combined with continued
cost containment will be adequate to fund operations through fiscal year 2011.
Our declining cash balance is a key support of the Company’s ongoing disclosure
regarding its ability to continue as a going concern. Our business is dependent
upon the sales of DRIE capital equipment, and 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/or raise additional
capital which may include capital raises 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. It is not possible to predict when our business
and results of operations will improve in light of the current economic downturn
that continues to dramatically affect our industry. Therefore, the realization
of assets and discharge of liabilities are each subject to significant
uncertainty. Accordingly, substantial doubt exists as to whether we will be able
to continue as a going concern. If the going concern basis is not appropriate in
future filings, adjustments will be necessary to the carrying amounts and/or
classification of assets and liabilities in our consolidated financial
statements included in such filings. We indicated this concern in our Annual
Report on Form 10-K for fiscal year ended March 31, 2010, which was also
reflected in the audit opinion at that time.





In
consideration of these circumstances, we have engaged Cowen & Co., LLC to
assist us in evaluating strategic alternatives for the Company, which may
include a merger with or into another company, a sale of all or substantially
all of our assets and the liquidation or dissolution of the Company, including
through a bankruptcy proceeding. The condensed consolidated financial statements
include an adjustment to the value of the DRIE related assets to reflect the
value of expected realizable market values that might result from the outcome of
this uncertainty. See Note 6 – Asset Acquisitions and Sales.





Concentration
of Credit Risk





Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist primarily of cash investments and accounts receivable.
Substantially all of the Company’s liquid 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, 2010, three customers accounted for approximately 82% of the
accounts receivable balance. As of September 30, 2009, two customers accounted
for approximately 52% of the accounts receivable balance.





For the
quarter ended September 30, 2010; a leading precision timing device
manufacturer, STMicroElectronics SA, and Uppsala University accounted for 40%,
31%, and 24%, respectively, of total revenue. For the six months ended September
30, 2010; a leading precision timing device manufacturer, STMicroelectronics SA,
and Uppsala University accounted for 39%, 30%, and 23%, respectively, of total
revenue. For the quarter ended September 30, 2009, PerkinElmer and the
University of Michigan accounted for 38% and 23%, respectively, of total
revenue. During the six months ended September 30, 2009, PerkinElmer and the
University of Michigan accounted for 28% and 17%, respectively, of total
revenue.


6


The
Company’s Note Receivable at September 30, 2010 consisted of the outstanding
payments owed by OEM Group in connection with the sale of legacy etch and PVD
assets completed in March 2010. See Note 6 – Assets Acquisitions and
Sales.





Derivative
Instruments





In June
2008, the Financial Accounting Standards Board (“FASB“) ratified the EITF
consensus on EITF Issue No. 07-05, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity's Own Stock (“EITF Issue
07-05“) (Topic 815) which applies to the determination of whether any
freestanding financial instruments or embedded features that have the
characteristics of a derivative, as defined by SFAS No. 133 (Topic 815), Accounting for Derivative
Instruments and Hedging Activities, and to any freestanding financial
instruments are potentially indexed to an entity’s own common stock. EITF Issue
No. 07-05 (Topic 815) became effective for fiscal years beginning after December
15, 2008. The Company adopted EITF 07-05 (Topic 815) as of April 1, 2009. As a
result, warrants to purchase 1,427,272 shares of our common stock previously
treated as equity pursuant to the derivative treatment exemption were no longer
afforded equity treatment. The warrants had exercise prices ranging from
$6.00-$99.00 and expire between February 2010 and September 2013. As such,
effective April 1, 2009, the Company reclassified the fair value of these
warrants to purchase common stock, which had exercise price reset features, from
equity to liability status as if these warrants were treated as a derivative
liability since their date of issue between February 2000 and January 2006. On
April 1, 2009, the Company reclassified from additional paid-in capital, as a
cumulative effect adjustment, $346 to beginning accumulated deficit and $502 to
common stock warrant liability to recognize the fair value of such warrants on
such date. As of March 31, 2010, the fair value of the warrants was estimated
using the Black-Scholes pricing model with the following weighted average
assumptions, risk-free interest rate of 2.55%, expected life of 1.06 years, an
expected volatility factor of 74.2% and a dividend yield of 0.0%. At September
30, 2010, the fair of the warrants was $21; it was calculated using the
Black-Scholes pricing model with the following weighted average assumptions,
risk-free interest rate of 1.79%, expected life of 1.62 years, an expected
volatility factor of 73.1%, and a dividend yield of 0.0%. The Company recorded a
gain related to the warrants of $141 in the quarter ended September 30, 2010 and
a loss of ($58) in the quarter ended September 30, 2009.





Intangible Assets





Intangible
assets include patents and trademarks that are amortized on a straight-line
basis over periods ranging from 5 years to 7 years. The Company performs an
ongoing review of its identified intangible assets to determine if facts and
circumstances exist that indicate the useful life is shorter than originally
estimated or the carrying amount may not be recoverable. If such facts and
circumstances exist, the Company assesses the recoverability of identified
intangible assets by comparing the projected undiscounted net cash flow
associated with the related asset or group of assets over their remaining lives
against their respective carrying amounts. Impairment, if any, is based on the
excess of the carrying amount over the fair value of those assets.





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, as well as at fiscal
year end. 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. During the quarter ended
September 30, 2010, we reviewed our long-lived assets for indicators of
impairment in accordance with SFAS No. 144, (Topic 360). No
impairment charges were recorded for intangible assets for the six months ended
September 30, 2010. For the fiscal year ended March 31, 2010, the Company
recorded a $1,064 impairment charge for intangible assets and a $1,558
impairment charge for its fixed assets.





Stock-Based
Compensation





We have
adopted several stock plans that provide for issuance of equity instruments to
our employees and non-employee directors. Our plans include incentive and
non-statutory stock options and restricted stock awards. These equity awards
generally vest ratably over a four-year period on the anniversary date of the
grant, and stock options expire ten years after the grant date. Certain
restricted stock awards may vest on the achievement of specific performance
targets. We also have an Employee Stock Purchase Plan (“ESPP“) that allows
qualified employees to purchase Tegal shares at 85% of the fair market value on
specified dates.


7


Total
stock-based compensation expense related to stock options and restricted stock
units (“RSUs“) for the three months ended September 30, 2010 and
2009was $151 and $120, respectively. Total stock-based compensation
expense related to stock options and (“RSUs“) for the six months ended September 30, 2010 and
2009was $258 and $313, respectively. The total compensation expense
related to non-vested stock options and RSUs not yet recognized is
$416





The
Company used the following valuation assumptions to estimate the fair value of
options granted for the periods ended September 30, 2010 and 2009,
respectively:





STOCK OPTIONS:
                  
                  2010
                  
                  
                  2009Expected
      life (years)
                  
                  
                  6.0
                  
                  
                  
                  6.0Volatility
                  
                  
                  75.1
                  %
                  
                  
                  80.0
                  %Risk-free
      interest rate
                  
                  
                  1.27
                  %
                  
                  
                  2.31
                  %Dividend
      yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %





ESPP
awards were valued using the Black-Scholes model with expected volatility
calculated using a six-month historical volatility.





ESPP:
                      
                      2010
                      
                      
                      2009Expected
      life (years)
                      
                      
                      0.5
                      
                      
                      
                      0.5Volatility
                      
                      
                      86.2
                      %
                      
                      
                      79.8
                      %Risk-free
      interest rate
                      
                      
                      0.14
                      %
                      
                      
                      0.14
                      %Dividend
      yield
                      
                      
                      0
                      %
                      
                      
                      0
                      %




Valuation
and Other Assumptions for Stock Options




Valuation and Amortization
Method. We estimate the fair value of stock options granted using the
Black-Scholes option valuation model. We estimate the fair value using a single
option approach and amortize the fair value on a straight-line basis for options
expected to vest. All options are amortized over the requisite service periods
of the awards, which are generally the vesting periods.




Expected Term. The expected
term of options granted represents the period of time that the options are
expected to be outstanding. We estimate the expected term of options granted
based on our historical experience of exercises including post-vesting exercises
and termination.




Expected Volatility. We
estimate the volatility of our stock options at the date of grant using
historical volatilities. Historical volatilities are calculated based on the
historical prices of our common stock over a period at least equal to the
expected term of our option grants.




Risk-Free Interest Rate. We
base the risk-free interest rate used in the Black-Scholes option valuation
model on the implied yield in effect at the time of option grant on U.S.
Treasury zero-coupon issues with remaining terms equivalent to the expected term
of our option grants.




Dividends. We have never paid
any cash dividends on common stock and we do not anticipate paying any cash
dividends in the foreseeable future.




Forfeitures. We use
historical data to estimate pre-vesting option forfeitures. We record
stock-based compensation expense only for those awards that are expected to
vest.





The
Company does not use multiple share-based payment arrangements.





During
the three months ended September 30, 2010, no stock option awards were
granted.


8


Stock
Options & Warrants





A summary
of stock option and warrant activity during the quarter ended September 30, 2010is as follows:





WeightedWeighted
                                          
                                          AverageAverage
                                          
                                          Remaining
                                          
                                          AggregateExercise
                                          
                                          Contractual
                                          
                                          IntrinsicShares
                                          
                                          
                                          Price
                                          
                                          Term (in Years)
                                          
                                          ValueBeginning outstanding
                                          
                                          
                                          2,247,519
                                          
                                          
                                          $
                                          8.83GrantedPrice
      = market value
                                          
                                          
                                          —
                                          
                                          
                                          
                                          —Total
                                          
                                          
                                          —
                                          
                                          
                                          
                                          —Exercised
                                          
                                          
                                          —
                                          
                                          
                                          
                                          0.00CancelledForfeited
                                          
                                          
                                          (5,243
                                          )
                                          
                                          
                                          3.15Expired
                                          
                                          
                                          (1,309,151
                                          )
                                          
                                          
                                          11.98Total
                                          
                                          
                                          (1,314,394
                                          )
                                          
                                          
                                          11.95Ending
      outstanding
                                          
                                          
                                          933,125
                                          
                                          
                                          $
                                          4.56
                                          
                                          5.31
                                          
                                          $
                                          —Ending
      vested and expected to vest
                                          
                                          
                                          903,531
                                          
                                          
                                          $
                                          4.63
                                          
                                          5.24
                                          
                                          $
                                          —Ending
      exercisable
                                          
                                          
                                          640,811
                                          
                                          
                                          $
                                          5.41
                                          
                                          4.46
                                          
                                          $
                                          —





The
aggregate intrinsic value of stock options and warrants outstanding at September
30, 2010 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,
2010.





The
following table summarizes information with respect to stock options and
warrants outstanding as of September 30, 2010:





WeightedWeighted
                              
                              
                              
                              
                              
                              
                              
                              
                              AverageNumber
                              
                              
                              Average
                              
                              
                              
                              
                              
                              Number
                              
                              
                              ExerciseOutstanding
                              
                              
                              Remaining
                              
                              
                              Weighted
                              
                              
                              Exercisable
                              
                              
                              PriceAs of
                              
                              
                              Contractual
                              
                              
                              Average
                              
                              
                              As of
                              
                              
                              As ofRange of
                              
                              
                              September 30,
                              
                              
                              Term
                              
                              
                              Exercise
                              
                              
                              September 30,
                              
                              
                              September 30,Exercise Prices
                              
                              
                              2010
                              
                              
                              (in
      years)
                              
                              
                              Price
                              
                              
                              2010
                              
                              
                              2010$
                              1.20
                              
                              
                              1.25
                              
                              
                              
                              24,997
                              
                              
                              
                              0.38
                              
                              
                              
                              1.22
                              
                              
                              
                              14,581
                              
                              
                              
                              1.222.34
                              
                              
                              2.34
                              
                              
                              
                              302,597
                              
                              
                              
                              7.59
                              
                              
                              
                              2.34
                              
                              
                              
                              80,338
                              
                              
                              
                              2.343.44
                              
                              
                              3.94
                              
                              
                              
                              42,706
                              
                              
                              
                              5.60
                              
                              
                              
                              3.64
                              
                              
                              
                              34,789
                              
                              
                              
                              3.624.20
                              
                              
                              4.20
                              
                              
                              
                              160,954
                              
                              
                              
                              6.43
                              
                              
                              
                              4.20
                              
                              
                              
                              113,486
                              
                              
                              
                              4.204.60
                              
                              
                              4.60
                              
                              
                              
                              140,258
                              
                              
                              
                              4.39
                              
                              
                              
                              4.60
                              
                              
                              
                              137,254
                              
                              
                              
                              4.604.63
                              
                              
                              5.62
                              
                              
                              
                              33,350
                              
                              
                              
                              6.40
                              
                              
                              
                              4.97
                              
                              
                              
                              33,350
                              
                              
                              
                              4.976.00
                              
                              
                              6.00
                              
                              
                              
                              126,241
                              
                              
                              
                              0.94
                              
                              
                              
                              6.00
                              
                              
                              
                              126,241
                              
                              
                              
                              6.006.11
                              
                              
                              18.11
                              
                              
                              
                              100,919
                              
                              
                              
                              4.21
                              
                              
                              
                              10.76
                              
                              
                              
                              99,669
                              
                              
                              
                              10.7030.00
                              
                              
                              34.80
                              
                              
                              
                              873
                              
                              
                              
                              1.25
                              
                              
                              
                              30.29
                              
                              
                              
                              873
                              
                              
                              
                              30.2937.08
                              
                              
                              37.08
                              
                              
                              
                              230
                              
                              
                              
                              3.18
                              
                              
                              
                              37.08
                              
                              
                              
                              230
                              
                              
                              
                              37.08$
                              1.20
                              
                              $
                              37.08
                              
                              
                              
                              933,125
                              
                              
                              
                              5.31
                              
                              
                              $
                              4.56
                              
                              
                              
                              640,811
                              
                              
                              $
                              5.41




9





As of
September 30,
2010, there was $396 of total unrecognized compensation cost related to
outstanding options and warrants which the Company expects to recognize over a
period of 1.87 years.





Restricted
Stock Units





The
following table summarizes the Company’s (“RSU“) activity for the
three months ended September 30,
2010:





WeightedAvg.Number
                      
                      
                      Grantof
                      
                      
                      DateShares
                      
                      
                      FairValueBalance,
      June 30, 2010
                      
                      
                      21,619
                      
                      
                      $
                      0.78Granted
                      
                      
                      -
                      
                      
                      $
                      -Forfeited
                      
                      
                      (952
                      )
                      
                      $
                      -Vested
                      
                      
                      (750
                      )
                      
                      $
                      -Balance,
      September 30, 2010
                      
                      
                      19,917
                      
                      
                      $
                      0.49





Unvested
restricted stock at September 30, 2010





As of
September 30, 2010there was $20 of total unrecognized compensation cost related to
outstanding RSUs which the Company expects to recognize over a period of 0.13
years.





2.
            Inventories:





Inventories
are stated at the lower of cost or market. 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. Any excess and obsolete
provision is only released if and when the related inventory is sold or
scrapped. The Company did not sell or scrap previously reserved inventory during
the six months ended September 30, 2010 and 2009, respectively.The inventory provision
balance atSeptember30, 2010
and September 30, 2009 was $729and $549,
respectively.





Net
inventories for the periods presented consisted of:





September 30,
                            
                            
                            March 31,2010
                            
                            
                            2010Raw
      materials
                            
                            $
                            437
                            
                            
                            $
                            386Work
      in progress
                            
                            
                            249
                            
                            
                            
                            39Finished
      goods and spares
                            
                            
                            721
                            
                            
                            
                            796$
                            1,407
                            
                            
                            $
                            1,221





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


10


3.
            Product
      Warranty:





The
Company provides warranties 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 and six months ended September 30, 2010 and 2009 is as
follows:





Warranty Activity for the
                        
                        
                        Warranty Activity for theThree Months Ended
                        
                        
                        Six Months EndedSeptember 30,
                        
                        
                        September 30,2010
                        
                        
                        2009
                        
                        
                        2010
                        
                        
                        2009Balance
      at the beginning of the period
                        
                        $
                        275
                        
                        
                        $
                        522
                        
                        
                        $
                        374
                        
                        
                        $
                        702Additional
      warranty accruals for
                        
                        
                        305
                        
                        
                        
                        201
                        
                        
                        
                        545
                        
                        
                        
                        242warranties
      issued during the periodWarranty
      expense during the period
                        
                        
                        (106
                        )
                        
                        
                        (279
                        )
                        
                        
                        (445
                        )
                        
                        
                        (500
                        )Balance
      at the end of the period
                        
                        $
                        474
                        
                        
                        $
                        444
                        
                        
                        $
                        474
                        
                        
                        $
                        444





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) Income Per Common Share
(EPS):





Basic EPS
is computed by dividing net (loss) income available to common stockholders
(numerator) by the weighted average number of common shares outstanding
(denominator) for the period. Diluted EPS gives effect to all dilutive potential
common shares outstanding during the period. The computation of diluted EPS uses
the average market prices during the period. All amounts in the following table
are in thousands except per share data.





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





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





Three
      Months Ended
                                September
      30,
                              
                              
                              Six
      Months Ended
                                September
      30,2010
                              
                              
                              2009
                              
                              
                              2010
                              
                              
                              2009Net
      income (loss) applicable to common stockholders
                              
                              $
                              134
                              
                              
                              $
                              (1,689
                              )
                              
                              $
                              (2,334
                              )
                              
                              $
                              (4,296
                              )Basic
      and diluted:Weighted-average
      common shares outstanding
                              
                              
                              8,439
                              
                              
                              
                              8,415
                              
                              
                              
                              8,438
                              
                              
                              
                              8,415Plus
      diluted - common stock equivalents
                              
                              
                              21
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —Weighted-average
      common shares used in diluted net income (loss) per common
      share
                              
                              
                              8,460
                              
                              
                              
                              8,415
                              
                              
                              
                              8,438
                              
                              
                              
                              8,415Basic
      net income (loss) per common share
                              
                              $
                              0.02
                              
                              
                              $
                              (0.20
                              )
                              
                              $
                              (0.28
                              )
                              
                              $
                              (0.51
                              )Diluted
      net income (loss) per common share
                              
                              $
                              0.02
                              
                              
                              $
                              (0.20
                              )
                              
                              $
                              (0.28
                              )
                              
                              $
                              (0.51
                              )





Outstanding
options, warrants and RSUs of 953,042 and 2,594,981 shares of common stock at a
weighted-average exercise price per share of $4.71 and $8.69 on September
30, 2010 and 2009, respectively, were not included in the computation of diluted
net (loss) income per common share for the six month periods presented as a
result of their anti-dilutive effect. Such securities could potentially
dilute earnings per share in future periods.


11


5.
            Financial
      Instruments:





The
carrying amount of the Company’s financial instruments, including cash and cash
equivalents, accounts receivable and accounts payable, notes receivable, accrued
expenses and other liabilities approximates fair value due to their relatively
short maturity. The Company sells products in various global markets. As a
result, the Company is exposed to changes in foreign currency exchange rates.
The Company does not hold derivative financial instruments for speculative
purposes. Foreign currency transaction gains and (losses) included in other
income (expense), were $56 and $292 for the six months ended September 30, 2010
and 2009. On September 30, 2010, the Company had no open foreign exchange
contracts to sell Euros or any other foreign currencies. On September 30, 2010,
the Company had 126,241 warrants outstanding with an exercise price of $6.00
expiring between June 2011 and September 2011. The Company recorded a gain
(loss) of $141 and ($58) in the quarter ending September 30, 2010 and September
30, 2009 related to these warrants.





6.
            Asset
      Acquisitions and Sales:





On
September 16, 2008, the Company acquired certain assets from Alcatel Micro
Machining Systems (“AMMS“) and Alcatel Lucent (together, the “Sellers“). With
this acquisition, we entered the DRIE market. DRIE is a highly anisotropic etch
process used to create deep, steep-sided holes and trenches in wafers, with
aspect ratios of 20:1 or more. DRIE was developed for micro-electro-mechanical
systems (“MEMS“), which require these features, but is also used to excavate
trenches for high-density capacitors for DRAM and more recently for creating
TSVs in advanced 3-D wafer level packaging technology. The acquisition was
designed to enable us to pursue the high-growth markets in MEMS and certain
segments of integrated semiconductor device manufacturing and packaging. Current
end-markets include production of a variety of MEMS and power devices, memory
stacking (flash and DRAM), logic, RF-SiP, and CMOS image sensors. The Company
paid $1,000,000 in cash and $4,000,000 in shares of the Company’s common stock.
The 1,044,386 shares of common stock issued by the Company was calculated by
obtaining the quotient of (a) $4,000,000 divided by (b) the average of the
closing sales prices of the Common Stock as reported on the Nasdaq Capital
Market on the five (5) consecutive trading days immediately prior to (but
excluding) the closing date.





In
connection with this acquisition, the Company and Alcatel Lucent entered into an
intellectual property agreement providing for the transfer of specified
intellectual property rights to the Company, a trademark license agreement
allowing for the limited use of the AMMS trademark by the Company, and a
preferred supplier agreement pursuant to which the Company will purchase certain
equipment from an affiliate of the Sellers. AMMS designated Mr. Gilbert Bellini
to serve as a member of the Company’s board of directors. AMMS’ designation
right terminates upon the later of (a) the termination or expiration of certain
customer services related agreements, and (b) when AMMS beneficially owns less
than 5% of the number of shares of Common Stock issued and outstanding
(including the shares to be issued to the Sellers).





The
purchase price was allocated as follows (in thousands):





Assets
      acquired:Trademarks
                  
                  $
                  428Patents
                  
                  
                  2,648Total
      Intangible Assets
                  
                  
                  3,076Fixed
      Assets
                  
                  
                  24Inventory
                  
                  
                  1,900Total
      Tangible Assets
                  
                  
                  1,924Total
      Acquired Assets
                  
                  $
                  5,000





Beginning
in the fiscal third quarter of 2009, following the acquisition of the DRIE
product lines from AMMS, the Company experienced a sharp decline in revenues
related to its legacy Etch and PVD products, a result of the overall collapse of
the semiconductor capital equipment market and the global financial crisis. The
management and the Board of Directors of the Company considered several
alternatives for dealing with this decline in revenues, including the sale of
assets which the Company could no longer support. On March 19, 2010, the Company
and its wholly owned subsidiary, SFI, sold inventory, equipment, intellectual
property and other assets related to the Company’s legacy Etch and PVD products
to OEM Group Inc. (“OEM Group“), a company based in Phoenix, Arizona that
specializes in “life cycle management“ of legacy product lines for several
semiconductor equipment companies. The sale included the product lines and
associated spare parts and service business of the Company’s 900 and 6500 series
plasma etch systems, along with the Endeavor and AMS PVD systems from SFI. In
connection with the sale of the assets, OEM Group assumed the Company’s warranty
liability for recently sold legacy Etch and PVD systems.


12





The
Company and OEM Group entered into related agreements for the transfer and
licensing of patents, trademarks and other intellectual property associated with
the legacy Etch and PVD Products. These included a Trademark Assignment
Agreement for certain trademarks used in the legacy Etch and PVD Products, a
royalty-free Trademark License Agreement allowing for the limited use of the
Tegal trademark by the Purchaser solely in connection with future sales of
legacy Etch and PVD Products and solely in combination with the trademarks
transferred to Purchaser, a Patent Assignment Agreement for the transfer of
certain patents related to the Etch and PVD Products, and a perpetual,
irrevocable, non-exclusive, worldwide, fully-paid, royalty-free, Intellectual
Property Cross License Agreement, pursuant to which the Company granted OEM
Group a license to certain intellectual property owned by the Company for use in
OEM Group’s manufacture and sale of the legacy Etch and PVD Products, and OEM
Group licensed back to the Company certain intellectual property for the
Company’s continued use.





The
consideration paid by OEM Group for the Disposition consisted of the
following:





·
            Cash
      in the amount of $250,000 paid at closing, which occurred on March 19,
      2010;





·
            An
      aggregate of $1,750,000 cash payable to the Company by four installment
      payments of $250,000, $500,000, $500,000 and $500,000 each on July 1,
      2010, October 1, 2010, January 1, 2011 and April 1, 2011, respectively;
      and





·
            A
      contingent payment in cash of up to $1,000,000 payable to the Company by
      April 15, 2011 based on the following percentage of applicable bookings of
      Etch and PVD Products in excess of $6,000,000 received by the Company or
      OEM Group during the period beginning March 19, 2010 through March 31,
      2011:





o
            if applicable bookings are
      greater than or equal to $6,000,000 but less than $8,000,000, the
      contingent payment will be 5% of the applicable bookings in excess of
      $6,000,000;





o
            if
      applicable bookings are greater than or equal to $8,000,000 but less than
      $10,000,000, the contingent payment will be $100,000 plus 10% of the
      applicable bookings in excess of
$8,000,000;





o
            if
      applicable bookings are greater than or equal to $10,000,000 but less than
      $12,000,000, the contingent payment will be $300,000 plus 15% of the
      applicable bookings in excess of $10,000,000;
  and





o
            if applicable bookings are
      greater than or equal to $12,000,000, the contingent payment will be
      $600,000plus20% of the
      applicable bookings in excess of
  $12,000,000.





In no
case will the contingent payment exceed $1,000,000.





The
Company has retained the DRIE products which it had acquired from AMMS, along
with the CompactTMcluster platform and
the NLD technology that it had developed over the past several years. However
the DRIE products and a small amount of associated spares and service revenue,
represent the sole source of the Company’s revenue. Since the DRIE markets have
also been seriously impacted by the downturn in the semiconductor markets and
the lack of available capital for new product development globally, it is not
clear that DRIE sales alone will be enough to support the Company, even with
significant reductions in operating expenses. As a result, the Company continues
to operate with a focus on DRIE and at the same time is seeking a strategic
partner for its remaining business. The Company is also continuing to evaluate
various other alternative strategies, including sale of its DRIE products,
CompactTMplatform
and NLD technology, the transition to a new business model, or its voluntary
liquidation.





7.
            Geographical
      Information:





The
Company operates in one segment for the manufacture, marketing and servicing of
integrated circuit fabrication equipment. In accordance with SFAS No. 131 (Topic
280), Disclosures About
Segments of an Enterprise and Related Information, (“SFAS 131“) (Topic
280) the Company’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.


13





For
geographical reporting, revenues are attributed to the geographic location in
which the customers’ facilities are located. Long-lived assets consist 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
                  
                  
                  Revenue for theThree Months Ended
                  
                  
                  Six Months EndedSeptember30,
                  
                  
                  September30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Sales to customers located in:North
      America
                  
                  $
                  120
                  
                  
                  $
                  2,512
                  
                  
                  $
                  389
                  
                  
                  $
                  3,152Asia
                  
                  
                  4
                  
                  
                  
                  193
                  
                  
                  
                  4
                  
                  
                  
                  395Germany
                  
                  
                  1
                  
                  
                  
                  58
                  
                  
                  
                  11
                  
                  
                  
                  87France
                  
                  
                  829
                  
                  
                  
                  121
                  
                  
                  
                  829
                  
                  
                  
                  181Europe,
      excluding Germany and France
                  
                  
                  2,229
                  
                  
                  
                  233
                  
                  
                  
                  2,269
                  
                  
                  
                  385Total
      sales
                  
                  $
                  3,183
                  
                  
                  $
                  3,117
                  
                  
                  $
                  3,502
                  
                  
                  $
                  4,200





September 30,Long-Lived assets at period-end:
                      
                      2010
                      
                      
                      2009United
      States
                      
                      $
                      130
                      
                      
                      $
                      879Europe
                      
                      
                      111
                      
                      
                      
                      297Total
      long-lived assets
                      
                      $
                      241
                      
                      
                      $
                      1,176





8.
            Recent
      Accounting Pronouncements:





In
February 2010, FASB issued ASU No. 2010-09, which amends the Subsequent Events
Topic of the Accounting Standards Codification (ASC) to eliminate the
requirement for public companies to disclose the date through which subsequent
events have been evaluated. The Company will continue to evaluate subsequent
events through the date of the issuance of the financial statements, however,
consistent with the guidance, this date will no longer be disclosed. The Company
does not expect the adoption of this guidance to have a material impact on the
Company’s consolidated financial statements, financial condition or
liquidity.





In
January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and
Disclosures (Topic 820): Improving Disclosures about Fair Value
Measurements. ASU No. 2010-06 amends ASC 820 and clarifies and provides
additional disclosure requirements on the transfers of assets and liabilities
between Level 1 (quoted prices in active market for identical assets or
liabilities) and Level 2 (significant other observable inputs) of the fair value
measurement hierarchy, including the reasons for and the timing of the
transfers. Additionally, the guidance requires a roll forward of activities on
purchases, sales, issuance, and settlements of the assets and liabilities
measured using significant unobservable inputs (Level 3 fair value
measurements). Adoption of this new guidance will not have a material impact on
our financial statements.


14


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





Special
Note Regarding Forward Looking Statements





Information
contained or incorporated by reference in this report contains forward-looking
statements. These forward-looking statements are based on current expectations
and beliefs and involve numerous risks and uncertainties that could cause actual
results to differ materially from expectations. 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. You can identify forward-looking statements 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 which constitutes projected financial information. These
forward-looking statements are subject to risks, uncertainties and assumptions
about Tegal Corporation including, but not limited to, industry conditions,
economic conditions, acceptance of new technologies and market acceptance of
Tegal Corporation’s products and service. For a discussion of the factors that
could cause actual results to differ materially from the forward-looking
statements, see “Part II, Item 1A.—Risk Factors“ and the “Liquidity and Capital
Resources“ section set forth in this section and such other risks and
uncertainties as set forth below in this report or detailed in our other SEC
reports and filings. We assume no obligation to update forward-looking
statements.





Tegal
Corporation, a Delaware corporation (“Tegal“ or the “Company“), designs,
manufactures, markets and services specialized plasma etch systems used
primarily in the production of micro-electrical mechanical systems (“MEMS“)
devices, such as sensors and accelerometers as well as power devices. The
Company’s Deep Reactive Ion Etch (“DRIE“) systems are also employed in certain
sophisticated manufacturing techniques, such as 3-D interconnect structures
formed by intricate silicon etching, also known as Deep Silicon Etch (“DSE“) for
so-called Through Silicon Vias (“TSVs“). Prior to its fiscal year 2011, Tegal
also sold systems for the etching and deposition of materials found in other
devices, such as integrated circuits (“ICs“) and optoelectronic devices found in
products like smart phones, networking gear, solid-state lighting, and digital
imaging.





In the
recent past, our business objective has been to utilize the technologies that we
have developed internally or acquired externally in order to increase our market
share in process equipment for MEMS and power device fabrication, advanced 3-D
packaging, and certain areas of semiconductor manufacturing. In September 2008,
we acquired the products lines of AMMS and the related intellectual property of
Alcatel, in order to pursue more fully the smaller, but higher-growth markets of
MEMS and 3-D packaging. Our acquisition of these products served two purposes:
(i) to increase revenue, and (ii) to enable us to focus our various technologies
on specific applications that served the common markets of MEMS and 3-D device
manufacturing and packaging.





At the
present time, we are continuing to transition our involvement in specialized
aspects of traditional semiconductor markets to the faster-growth but smaller
markets for MEMS, power devices and specialized compound semiconductors.
However, given the severe economic downturn generally, and in the semiconductor
capital equipment industry in particular, achieving wins with customers in these
markets has been extremely challenging for us. We expect that orders for our
systems will continue to fluctuate from quarter to quarter, and we expect demand
to continue to be low and our ability to forecast demand will be limited as the
global financial crisis and the resulting recession continues. Although we have
over the past several years streamlined our cost structure by headcount
reductions, salary and benefit reductions and limits on discretionary spending
of all types, our costs for maintaining our research and development efforts and
our service and manufacturing infrastructure have remained constant or in some
cases increased. We intend to continue our cost-containment measures, including
outsourcing certain activities, such as manufacturing, engineering and software
development, and maintaining or further reducing our headcount as we strive to
improve operational efficiency within this challenging economic environment.
However, since we are unable to predict the timing of a stable reemergence of
demand for our products and services, we believe that the realization of assets
and discharge of liabilities are each subject to significant uncertainty and a
substantial doubt exists as to whether we will be able to continue as a going
concern. In consideration of these circumstances, we continue to evaluate
strategic alternatives for the Company, which may include a merger with or into
another company, a sale of all or substantially all of our assets and the
liquidation or dissolution of the Company, including through a bankruptcy
proceeding. We cannot assure you that we will be successful in pursuing any of
these strategic alternatives. As we pursue various strategic alternatives and
determine that some are more or less likely than others, the consequences of
such determinations will be reflected in our financial statements as required by
generally accepted accounting principles (“GAAP“) or the Financial Accounting
Standards Board (“FASB“).


15





Beginning
in the fiscal third quarter of 2009, following the acquisition of the DRIE
product lines from AMMS, the Company experienced a sharp decline in revenues
related to its legacy Etch and PVD products, a result of the collapse of the
semiconductor capital equipment market and the global financial crisis. The
management and the Board of Directors of the Company considered several
alternatives for dealing with this decline in revenues, including the sale of
assets which the Company could no longer support. On March 19, 2010, the Company
and its wholly owned subsidiary, SFI, sold inventory, equipment, intellectual
property and other assets related to the Company’s legacy Etch and PVD products
to OEM Group Inc. (“OEM Group“), a company based in Phoenix, Arizona that
specializes in “life cycle management“ of legacy product lines for several
semiconductor equipment companies. The sale included the product lines and
associated spare parts and service business of the Company’s 900 and 6500 series
plasma etch systems, along with the Endeavor and AMS PVD systems from SFI. In
connection with the sale of the assets, OEM Group assumed the Company’s warranty
liability for recently sold legacy Etch and PVD systems.





The
Company retained the DRIE products which it had acquired from AMMS, along with
the CompactTMcluster platform and
the NLD technology that it had developed over the past several years. However,
the DRIE products and a small amount of associated spares and service revenue,
represent the sole source of the Company’s revenue. Since the DRIE markets have
also been seriously impacted by the downturn in the semiconductor markets and
the lack of available capital for new product development globally, it is not
clear that DRIE sales alone will be enough to support the Company, even with
significant reductions in operating expenses. As a result, the Company continues
to operate with a focus on DRIE and at the same time is seeking a strategic
partner for its remaining business. The Company is also continuing to evaluate
various other alternative strategies, including sale of its DRIE products,
CompactTMplatform
and NLD technology, the transition to a new business model, or its voluntary
liquidation.





Critical
Accounting Policies and Estimates





Our
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The audited consolidated financial statements have been prepared using
the going concern basis, which assumes that we will be able to realize our
assets and discharge our liabilities in the normal course of business for the
foreseeable future. However, it is not possible to predict when our business and
results of operations will improve in light of the current economic downturn
that continues to dramatically affect our industry. Therefore, the realization
of assets and discharge of liabilities are each subject to significant
uncertainty. Accordingly, substantial doubt exists as to whether we will be able
to continue as a going concern. If the going concern basis is not appropriate in
future filings, adjustments will be necessary to the carrying amounts and/or
classification of assets and liabilities in our consolidated financial
statements included in such filings.





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.





In
consideration of these circumstances, we continue to evaluate strategic
alternatives for the Company, which may include a merger with or into another
company, a sale of all or substantially all of our assets or the liquidation or
dissolution of the Company, including through a bankruptcy proceeding. We cannot
assure you that we will be successful in pursuing any of these strategic
alternatives. As we pursue various strategic alternatives and determine that
some are more or less likely than others, the consequences of such
determinations will be reflected in our financial statements as required by GAAP
or FASB.





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





Revenue
Recognition





Each sale
of our equipment is evaluated on an individual basis in regard to revenue
recognition. We have integrated in our evaluation the related interpretative
guidance included in Topic 13 of the codification of staff accounting bulletins,
and recognize the role of the consensus on Emerging Issues Task Force Issue No.
00-21, Accounting for Revenue
Arrangements with Multiple Deliverables (“EITF Issue 00-21“) (Topic 605).
We first refer to EITF Issue 00-21 (Topic 605) in order to determine if there is
more than one unit of accounting and then we refer to Staff Accounting Bulletin
(“SAB“) 104 (Topic 605) 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.


16





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 Company relieves the entire amount from inventory at the time of sale, and
the related deferred revenue liability is recognized upon installation and
customer acceptance. 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.





The
Company’s 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.





Accounting
for Stock-Based Compensation





The
Company has adopted several stock plans that provide for issuance of equity
instruments to our employees and non-employee directors. Our plans include
incentive and non-statutory stock options and restricted stock awards. These
equity awards generally vest ratably over a four-year period on the anniversary
date of the grant, and stock options expire ten years after the grant date.
Certain restricted stock awards may vest on the achievement of specific
performance targets. The Company also has an Employee Stock Purchase Plan
(“ESPP“) that allows qualified employees to purchase Tegal shares at 85% of the
fair market value on specified dates. The stock-based compensation for our ESPP
was determined using the Black-Scholes option pricing model and the provisions
of SFAS No. 123 (revised 2004), Share Based Payment(“SFAS
123R“) (Topic 718).





Accounts
Receivable – Allowance for Sales Returns and Doubtful Accounts





The
Company maintains an allowance for doubtful accounts receivable for estimated
losses resulting from the inability of the Company’s customers to make required
payments. If the financial condition of the Company’s customers were to
deteriorate, or even a single customer was otherwise unable to make payments,
additional allowances may be required. As of September 30, 2010, three customers
accounted for approximately 82% of the accounts receivable balance. As of
September 30, 2009, two customers accounted for approximately 52% of the
accounts receivable balance.





The
Company’s 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. 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. Any excess and obsolete
provision is only released if and when the related inventory is sold or
scrapped. The Company did not sell or scrap previously reserved inventory during
the six months ended September 30, 2010 and 2009, respectively. The inventory provision
balanceatSeptember30, 2010 and September 30, 2009 was $729and $549,
respectively.


17


The
Company periodically analyzes any systems that are in finished goods inventory
to determine if they are suitable for current customer requirements. At the
present time, the Company’s policy is that, if after approximately 18 months, it
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 unsellable 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 as well as at fiscal
year end. 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. During the quarter ended
September 30, 2010, we reviewed our long-lived assets for indicators of
impairment in accordance with SFAS No. 144, (Topic 360). No
impairment charges were recorded for long-lived assets for the six months ended
September 30, 2010. For the fiscal year ended March 31, 2010, the Company
recorded a $1,064 impairment charge for intangible assets and a $1,558
impairment charge for its fixed 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. Actual warranty expense is typically low in the
period immediately following installation.





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.


18


Results
of Operations





The
following table sets forth certain financial data for the three and six months
ended September 30, 2010 and 2009as a
percentage of revenue:





Three Months Ended
                
                
                Six Months EndedSeptember30,
                
                
                September30,2010
                
                
                2009
                
                
                2010
                
                
                2009Revenue
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %Cost
      of revenue
                
                
                61.3
                %
                
                
                72.8
                %
                
                
                71.4
                %
                
                
                77.6
                %Gross
      profit
                
                
                38.7
                %
                
                
                27.2
                %
                
                
                28.6
                %
                
                
                22.4
                %Operating
      expenses:Research
      and development
                
                
                17.0
                %
                
                
                37.5
                %
                
                
                44.7
                %
                
                
                57.4
                %Sales
      and marketing
                
                
                4.7
                %
                
                
                21.5
                %
                
                
                8.8
                %
                
                
                32.7
                %General
      and administrative
                
                
                29.1
                %
                
                
                26.0
                %
                
                
                59.3
                %
                
                
                47.0
                %Total
      operating expenses
                
                
                50.8
                %
                
                
                85.0
                %
                
                
                112.8
                %
                
                
                137.1
                %Operating
      loss
                
                
                (12.1
                )%
                
                
                (57.8
                )%
                
                
                (84.2
                )%
                
                
                (114.7
                )%Other
      income (expense), net
                
                
                16.6
                %
                
                
                3.7
                %
                
                
                17.8
                %
                
                
                11.2
                %Income
      (loss) before income tax expense (benefit)
                
                
                4.5
                %
                
                
                (54.1
                )%
                
                
                (66.4
                )%
                
                
                (103.5
                )%Income
      tax expense (benefit)
                
                
                0.2
                %
                
                
                —
                %
                
                
                0.2
                %
                
                
                (1.2
                )%Net
      income (loss)
                
                
                4.3
                %
                
                
                (54.1
                )%
                
                
                (66.6
                )%
                
                
                (102.3
                )%




19





The
following table sets forth certain financial items for the three and six months
ended September 30, 2010 and 2009:





Three Months Ended
                
                
                Six Months EndedSeptember 30,
                
                
                September 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Revenue
                
                $
                3,183
                
                
                $
                3,117
                
                
                $
                3,502
                
                
                $
                4,200Cost
      of revenue
                
                
                1,952
                
                
                
                2,269
                
                
                
                2,502
                
                
                
                3,259Gross
      profit
                
                
                1,231
                
                
                
                848
                
                
                
                1,000
                
                
                
                941Operating
      expenses:Research
      and development expenses
                
                
                542
                
                
                
                1,170
                
                
                
                1,565
                
                
                
                2,411Sales
      and marketing expenses
                
                
                150
                
                
                
                670
                
                
                
                308
                
                
                
                1,374General
      and administrative expenses
                
                
                927
                
                
                
                810
                
                
                
                2,077
                
                
                
                1,973Total
      operating expenses
                
                
                1,619
                
                
                
                2,650
                
                
                
                3,950
                
                
                
                5,758Operating
      loss
                
                
                (388
                )
                
                
                (1,802
                )
                
                
                (2,950
                )
                
                
                (4,817
                )Other
      income (expense), net
                
                
                527
                
                
                
                114
                
                
                
                623
                
                
                
                471Income
      (loss) before income tax expense (benefit)
                
                
                139
                
                
                
                (1,688
                )
                
                
                (2,327
                )
                
                
                (4,346
                )Income
      tax expense (benefit)
                
                
                5
                
                
                
                1
                
                
                
                7
                
                
                
                (50
                )Net
      income (loss)
                
                $
                134
                
                
                $
                (1,689
                )
                
                $
                (2,334
                )
                
                $
                (4,296
                )Net
      income (loss) per share:Basic
                
                $
                0.02
                
                
                $
                (0.20
                )
                
                $
                (0.28
                )
                
                $
                (0.51
                )Diluted
                
                $
                0.02
                
                
                $
                (0.20
                )
                
                $
                (0.28
                )
                
                $
                (0.51
                )Weighted
      average shares used in per share computation:Basic
                
                
                8,439
                
                
                
                8,415
                
                
                
                8,438
                
                
                
                8,415Diluted
                
                
                8,460
                
                
                
                8,415
                
                
                
                8,438
                
                
                
                8,415


20


Revenue





Our
revenue is derived from sales of new and refurbished systems, spare parts and
non-warranty service. Revenue of $3,183 for the three months ended September 30,
2010 increased from revenue for the three months ended September 30, 2009. The
revenue increase was due principally to the sale of three new DRIE systems, as
well as spare parts and service sales. During the three months ended September
30, 2009, we sold one SMT system and one new DRIE system, as well as spare parts
and service sales, including sales derived from our legacy assets. Revenue of
$3,502 for the six months ended September 30, 2010 decreased from revenue for
the six months ended September 30, 2009 of $4,200. The revenue decrease for the
six months ended September 30, 2010 of ($698) was mainly from a narrowed product
mix due to the sale of legacy Etch and PVD assets to OEM Group, as well as the
number and mix of systems sold and the global economic recession that continues
to dramatically impact our industry. Revenue for the six months ended September
30, 2009 was mainly from the sale of two new SMT systems and one new DRIE
system, as well as spare parts and service sales, including sales derived from
our legacy assets.





As a
percentage of total revenue for the three months ended September 30, 2010
international sales were approximately 96%. As a percentage of total revenue for
the three monthsended September 30, 2009 international sales was approximately 19%. The
increase in international sales as a percentage of revenue can be attributed to
the number of systems being sold in the second quarter of fiscal year 2011 to
international markets. As a percentage of total revenue for the six months ended
September 30, 2010 international sales was approximately 89%. As a percentage of
total revenue for the six months ended September 30, 2009 international sales
was approximately 25%. The Company typically sells more systems in international
markets. We believe that international sales will continue to represent a
significant portion of our future revenue.





Gross
Profit





Gross
profit of $1,231 for the three months ended September 30, 2010 increased by $383
from gross profit of $848 for the three months ended September 30, 2009,
representing a 45% increase. Our gross margin for the three months September 30,
2010 was 39% compared to 27% for the same period last year. The increase in the
gross margin was primarily attributable to the number of systems sold and
product mix and significant decrease in fixed manufacturing and related expenses
resulting from the sale of our legacy etch and PVD assets to OEM Group. This
decrease in expenses partially was offset by the increased cost associated with
the outsourcing of the manufacturing of the DRIE systems.





Gross
profit of $1,000 for the six months ended September 30, 2010 increased by $59
from gross profit of $941 for the six months ended September 30, 2009,
representing a 6% increase. The increase in the gross margin was attributable to
the number of systems sold and product mix. The decrease in fixed manufacturing
costs and related expenses also contributed to a higher year to date gross
margin percentage.





Our gross
profit as a percentage of revenue has been, and will continue to be, affected by
a variety of factors, including the mix and average selling prices of systems
sold and the costs to manufacture, service and support new product introductions
and enhancements. Gross margins for our DRIE systems are generally lower than we
have experienced in the past from the sale of our legacy Etch and PVD products,
which were sold to OEM Group in March 2010. The principal reasons for the lower
margins are: (i) price pressure resulting from customers’ historic expectations
for the equipment for MEMS productions versus semiconductors; (ii) extreme
competition from competitors seeking to gain market share; and (iii) our current
manufacturing model, which includes substantial outsourcing of system
assembly.





Gross
margins for our DRIE series systems are typically lower than the margins from
previous product lines sold by Tegal. The Company believes that the dominant
business model driving the lower margins in this market segment is unsustainable
and expects gross margins for this product to normalize to levels comparable
with our previous product lines.





At the
present time, we are focusing our efforts on the continued operation of the
Company with the DRIE product lines acquired from AMMS as our main business. Due
to limited resources, we have discontinued our development efforts in NLD, but
we are offering these assets for sale to third-parties. Since the DRIE markets
have also been seriously impacted by the downturn in the semiconductor markets
and the lack of available capital for new product development globally, we
believe that DRIE sales alone may not be enough to continue supporting the
Company, even with significant reductions in the Company’s operating expenses
resulting from the sale of the legacy Etch and PVD business, as well as a
continuation of cost containment measures. Accordingly, while we continue to
focus our efforts on the operation of the DRIE business, we continue to seek and
evaluate strategic alternatives, which include a continued operation of the
Company as a stand-alone business with a different business plan, a merger with
or into another company, a sale of all or substantially all of our assets, and
the liquidation or dissolution of the Company, including through a voluntary
dissolution or a bankruptcy proceeding. We cannot assure you that we will be
successful in pursuing any of these strategic alternatives.


21


Research and
Development





Research and
development (“R&D“) 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 for our
DRIE product line. The spending decrease of $628 and $846 for the three and six
months ended September 30, 2010, respectively, compared to the three and six
months ended September 30, 2009 resulted primarily from a decrease in
consulting, payroll, and DRIE amortization and depreciation expense. These
decreases were partially offset by increased spending on our R&D operations
conducted by our subsidiary, Tegal France.





Sales and
Marketing





Sales and marketing
expenses consist primarily of salaries, commissions, trade show promotion and
travel and living expenses associated with those functions. The decrease in
sales and marketing spending of $520 and $1,066 for the three and six months
ended September 30, 2010, respectively, as compared to the same period in 2009
was primarily due to
the decrease of employee costs.





General
and Administrative





General
and administrative expenses consist of salaries, legal, accounting and related
administrative services and expenses associated with general management,
finance, information systems, human resources and investor relations activities.
The increase of $113 for the three months ended September 30, 2010 as compared
to the three months ended September 30, 2009 were due primarily to bonuses for
key employees offset by a decrease in legal expenses. The increase of $104 for
the six months ended September 30, 2010 as compared to the six months ended
September 30, 2009 were due primarily to higher bad debt expenses and bonuses
for key employees offset by a decrease in legal expenses, consulting costs, and
stock compensation charges.





Other
Income (expense), net





Other
income, net consists of interest income, other income, gains and losses on
foreign exchange, reimbursements for expenses from the French government and
gain and losses on the disposal of fixed assets. For the three months ended
September 30, 2010 compared to the three months ended September 30, 2009, other
income, net increased by $413, primarily due to a refund in the amount of $127
from the French government, changes in foreign exchange rates and the change in
fair value of the common stock warrant liability pursuant to EITF 07-05 (Topic
815). For the six months ended September 30, 2010 compared to the six months
ended September 30, 2009, other income, net increased by $152, primarily due to
the change in fair value of the common stock warrant liability pursuant to EITF
07-05 (Topic 815) and the refund from the French government for research and
development expenses offset by the changes in foreign exchange
rates.


22


Contractual
Obligation





The
following summarizes our contractual obligations at September 30, 2010, and the
effect such obligations are expected to have on our liquidity and cash flows in
future periods (in thousands).





Contractual obligations:
                  
                  
                  
                  
                  Less than
                  
                  
                  
                  
                  
                  
                  
                  
                  AfterTotal
                  
                  
                  1 Year
                  
                  
                  1-3 Years
                  
                  
                  3-5 Years
                  
                  
                  5 YearsNon-cancelable
      operating lease obligations
                  
                  $
                  212
                  
                  
                  $
                  107
                  
                  
                  $
                  105
                  
                  
                  $
                  -
                  
                  
                  $
                  -





The
Company’s lease for the Petaluma facility expired on September 30, 2010. The
Company entered into 2 separate office leases in Petaluma for a total of approx
4,000 square feet. These offices house the personnel associated with the DRIE
operations and the general and administrative personnel.





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
thesix months ended
September30, 2010, we financed our operations from existing cash on
hand. In fiscal year ended March 31, 2010, we financed our operations through
the use of existing cash balances. The primary significant changes in our cash
flow statement for the six months ended September 30, 2010 were decreases in
prepaid expenses offset by accrued expenses, by our net loss of ($2,334), and
accounts payable. Net cash used in operating activities during the six months
ended September 30, 2009 was ($3,444), due primarily to the net (loss) income of
($4,296), offset by decreases in accounts receivable.





The
consolidated financial statements contemplate the realization of assets and the
satisfaction of liabilities in the normal course of business for the foreseeable
future. We incurred net (loss) income of ($2,334) and ($4,296) for the six months ended
September30, 2010 and 2009, respectively. We used cash flows from
operations of ($2,805) and ($3,444) for the six months ended September 30, 2010
and 2009, respectively. Although we believe that our outstanding cash balances,
combined with continued cost containment will be adequate to fund operations
through fiscal year 2011, we believe there is substantial doubt as to our
ability to continue as a going concern if there is not significant improvement
in the MEMS and semiconductor capital equipment industries that have been
dramatically impacted by the global economic recession. Our long-term viability
of our operations is dependent upon our ability to generate sufficient cash to
support our operating needs, fulfill business objectives and fund continued
investment in technology and product development without incurring substantial
indebtedness that will hinder our ability to compete, adapt to market changes
and grow our business in the future. More specifically, our business is
dependent upon the sales of our capital equipment, and projected sales may not
materialize and unforeseen costs may be incurred. If the projected sales do not
materialize, we would need to reduce expenses further and/or raise additional
capital which may include capital raises through the issuance of debt or equity
securities in order to continue our business. 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. Therefore, the realization of
assets and discharge of liabilities are each subject to significant uncertainty.
Accordingly, substantial doubt exists as to whether we will be able to continue
as a going concern. If the going concern basis is not appropriate in future
filings, adjustments will be necessary to the carrying amounts and/or
classification of assets and liabilities in our consolidated financial
statements included in such filings as the consolidated financial statements
have been prepared using the going concern basis, which assumes that we will be
able to realize our assets and discharge our liabilities in the normal course of
business for the foreseeable future.


23





Item
3. Quantitative and
Qualitative Disclosures About Market Risk





Foreign
Currency Exchange Risk





At
September 30, 2010 and 2009,all of the
Company’s investments were classified as cash equivalents in the consolidated
balance sheets. The investment portfolio at September 30, 2010 and 2009 was comprised of
money market funds. Our exposure to foreign currency fluctuations is primarily
related to purchases in Europe and Japan, which are denominated in the Euro and
Yen. Foreign currency transaction gains and (losses) included in other income
(expense), net were ($241) and ($94) for the three months ended September 30,
2010 and 2009, respectively. For the six months ended September 30, 2010 and
September 30, 2009, the Company recorded transaction gains included in other
income (expense) of $56 and $292. Changes in the exchange rate between the Euro
and the U.S. dollar could adversely affect our operating results. Exposure to
foreign currency exchange rate risk may increase over time as our business
evolves and our products continue to be sold into international markets.
Periodically, the Company enters into foreign exchange contracts to sell Euros,
which are used to hedge a sales transaction in which costs are denominated in
U.S. dollars and the related revenue is generated in Euros. As of September 30,
2010, there were no outstanding foreign exchange contracts.





Interest
Rate Risk





We are
only marginally exposed to interest rate risk through interest earned on money
market accounts. Interest rates that may affect these items in the future will
depend on market conditions and may differ from the rates we have experienced in
the past. We do not hold or issue derivatives, commodity instruments or other
financial instruments for trading purposes.





Item
4. Controls and
Procedures




Disclosure
Controls and Internal Controls for Financial Reporting




Disclosure
controls are procedures that are designed with the objective of ensuring that
information required to be disclosed in our reports filed under the Exchange Act
such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized
and reported within the time periods specified in the SEC’s rules and forms.
Disclosure controls are also designed with the objective of ensuring that such
information is accumulated and communicated to our management, including the
Chief Executive Officer and Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosure. Internal controls for financial
reporting are procedures which are designed with the objective of providing
reasonable assurance that our transactions are properly authorized, our assets
are safeguarded against unauthorized or improper use and our transactions are
properly recorded and reported, all to permit the preparation of our financial
statements in conformity with U.S. GAAP.





Evaluation
of Disclosure Controls and Procedures





As of the
period covered by this quarterly report, management performed, with the
participation of our Chief Executive Officer and Chief Financial Officer, an
evaluation of the effectiveness of our disclosure controls and procedures as
defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure
controls and procedures are designed to ensure that information required to be
disclosed in the report we file or submit under the Exchange Act is recorded,
processed, summarized, and reported within the time periods specified in the
rules and forms of the Securities and Exchange Commission, and that such
information is accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosures. Based on the evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that as of
September 30, 2010, such disclosure controls and procedures were
effective.





Changes
in Internal Control Over Financial Reporting





There
were no changes in our internal control over financial reporting during the
quarter ended September 30, 2010 that materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.


24


PART
II — OTHER INFORMATION





Item
1A. Risk
Factors





We
wish to caution you that there are risks and uncertainties that could affect our
business. A description of the risk factors associated with our business that
you should consider when evaluating our business is included under “Risk
Factors” contained in Item 1A. of our Annual Report on Form 10-K for the year
ended March 31, 2010. In addition to those factors and to other information in
this Form 10-Q, the following updates to the risk factors should be considered
carefully when evaluating Tegal or our business.





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 had
net income (loss) of ($18,469), ($7,902), and $18,104 for the years ended March
31, 2010, 2009, and 2008, respectively. We used cash flows from operations of
($4,887), ($5,541), and ($5,057) in these respective years. For the three months
ended September 30, 2010 and 2009, we had a net income (loss) of $134 and
($1,689), respectively. For the six months ended September 30, 2010 and 2009, we
had a net income (loss) of ($2,334) and ($4,296), respectively. Although we
believe that our outstanding cash balances, combined with continued cost
containment will be adequate to fund operations through fiscal year 2011, we
believe there is substantial doubt as to our ability to continue as a going
concern if there is not significant improvement in the MEMS and semiconductor
capital equipment industries that have been dramatically impacted by the global
economic recession. Our long-term viability of our operations is dependent upon
our ability to generate sufficient cash to support our operating needs, fulfill
business objectives and fund continued investment in technology and product
development without incurring substantial indebtedness that will hinder our
ability to compete, adapt to market changes and grow our business in the future.
More specifically, our business is dependent upon the sales of our capital
equipment, and projected sales may not materialize and unforeseen costs may be
incurred. If the projected sales do not materialize, we would need to reduce
expenses further and/or raise additional capital which may include capital
raises through the issuance of debt or equity securities in order to continue
our business. 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.





In
consideration of these circumstances, we have engaged Cowen & Co., LLC to
assist us in evaluating strategic alternatives for the Company, which may
include a merger with or into another company, a sale of all or substantially
all of our assets and the liquidation or dissolution of the company, including
through a bankruptcy proceeding. We cannot assure you that we will be successful
in pursuing any of these strategic alternatives. If we were to liquidate or
dissolve the company through or outside of a bankruptcy proceeding, you could
lose all of your investment in Tegal common stock.





Item
6. Exhibits





Exhibit
                      Number
                    
                    Description31.1
                    
                    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.


25


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 T.
    HERGENROTHERChristine
      T. HergenrotherChief
      Financial Officer


Date:
November 12, 2010


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