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 1934For
      the quarterly period ended December 31, 2010oro
              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 OtherJurisdiction 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
o





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
þNo
o





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 o
            
            Accelerated
      Filer  oNon-Accelerated
      Filer o
      (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 oNo
þ





As of
February 11, 2011, there were 8,444,714 of the Registrant’s common stock
outstanding.










TEGAL
CORPORATION AND SUBSIDIARIES





INDEX





PagePART
      I. FINANCIAL INFORMATIONItem
      1.
              Condensed
      Consolidated Financial Statements (Unaudited)Condensed
      Consolidated Balance Sheets as of  December 31, 2010 and March
      31, 2010
              3Condensed
      Consolidated Statements of Operations for the three and nine months ended
      December 31, 2010 and December  31, 2009
              4Condensed
      Consolidated Statements of Cash Flows for the nine months ended December
      31, 2010 and December   31, 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
              23Item
      4.
              Controls
      and Procedures
              23PART
      II. OTHER INFORMATIONItem
      1A.
              Risk
      Factors
              24Item
      6.
              Exhibits
              24Signatures
              
              25


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)





See
accompanying notes to condensed consolidated financial statements.





December 31,
                
                
                March 31,2010
                
                
                2010ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                7,890
                
                
                $
                7,298Accounts
      receivable, net of allowances for sales returns and doubtful accounts of
      $181 and $324 at December 31, 2010 and March 31, 2010,
      respectively.
                
                
                1,571
                
                
                
                3,116Notes
      receivable
                
                
                1,026
                
                
                
                1,347Inventories,
      net
                
                
                1,196
                
                
                
                1,221Prepaid
      expenses and other current assets
                
                
                134
                
                
                
                1,243Total
      current assets
                
                
                11,817
                
                
                
                14,225Property
      and equipment, net
                
                
                145
                
                
                
                308Intangible
      assets, net
                
                
                1,062
                
                
                
                1,230Other
      assets
                
                
                6
                
                
                
                540Total
      assets
                
                $
                13,030
                
                
                $
                16,303LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                493
                
                
                $
                1,520Accrued
      product warranty
                
                
                336
                
                
                
                374Common
      stock warrant liability
                
                
                24
                
                
                
                363Deferred
      revenue
                
                
                86
                
                
                
                242Accrued
      expenses and other current liabilities
                
                
                2,293
                
                
                
                1,867Total
      current liabilities
                
                
                3,232
                
                
                
                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; 8,443,714 and
      8,438,115 shares issued and outstanding at December 31, 2010 and March 31,
      2010, respectively.
                
                
                84
                
                
                
                84Additional
      paid-in capital
                
                
                128,605
                
                
                
                128,290Accumulated
      other comprehensive loss
                
                
                (178
                )
                
                
                (149
                )Accumulated
      deficit
                
                
                (118,713
                )
                
                
                (116,288
                )Total
      stockholders’ equity
                
                
                9,798
                
                
                
                11,937Total
      liabilities and stockholders’ equity
                
                $
                13,030
                
                
                $
                16,303


3


TEGAL
CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)


(In
thousands, except per share data)





Three Months Ended
                
                
                Nine Months EndedDecember 31,
                
                
                December 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Revenue
                
                $
                1,345
                
                
                $
                5,072
                
                
                
                4,847
                
                
                $
                9,272Inventory
      Provision
                
                
                -
                
                
                
                7,828
                
                
                
                -
                
                
                
                7,828Cost
      of revenue
                
                
                420
                
                
                
                2,780
                
                
                
                2,922
                
                
                
                6,039Gross
      profit/(loss)
                
                
                925
                
                
                
                (5,536
                )
                
                
                1,925
                
                
                
                (4,595
                )Operating
      expenses:Research
      and development expenses
                
                
                733
                
                
                
                1,503
                
                
                
                2,298
                
                
                
                3,913Sales
      and marketing expenses
                
                
                210
                
                
                
                539
                
                
                
                518
                
                
                
                1,914General
      and administrative expenses
                
                
                554
                
                
                
                957
                
                
                
                2,631
                
                
                
                2,930Total
      operating expenses
                
                
                1,497
                
                
                
                2,999
                
                
                
                5,447
                
                
                
                8,757Operating
      loss
                
                
                (572
                )
                
                
                (8,535
                )
                
                
                (3,522
                )
                
                
                (13,352
                )Other
      income (expense), net
                
                
                480
                
                
                
                (244
                )
                
                
                1,103
                
                
                
                227Loss
      before income tax benefit
                
                
                (92
                )
                
                
                (8,779
                )
                
                
                (2,419
                )
                
                
                (13,125
                )Income
      tax expense (benefit)
                
                
                —
                
                
                
                —
                
                
                
                7
                
                
                
                (50
                )Net
      loss
                
                $
                (92
                )
                
                $
                (8,779
                )
                
                $
                (2,426
                )
                
                $
                (13,075
                )Net
      loss per share:Basic
                
                $
                (0.01
                )
                
                $
                (1.04
                )
                
                $
                (0.29
                )
                
                $
                (1.55
                )Diluted
                
                $
                (0.01
                )
                
                $
                (1.04
                )
                
                $
                (0.29
                )
                
                $
                (1.55
                )Weighted
      average shares used in per share computation:Basic
                
                
                8,442
                
                
                
                8,425
                
                
                
                8,439
                
                
                
                8,418Diluted
                
                
                8,442
                
                
                
                8,425
                
                
                
                8,439
                
                
                
                8,418





See
accompanying notes to condensed consolidated financial
statements.


4


TEGAL
CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)


(In
thousands)





Nine Months Ended
                          December 31,2010
                        
                        
                        2009Cash
      flows from operating activities:Net
      loss
                        
                        $
                        (2,426
                        )
                        
                        $
                        (13,075
                        )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                        
                        
                        553
                        
                        
                        
                        1,075Stock
      compensation expense
                        
                        
                        313
                        
                        
                        
                        513Stock
      issued under stock purchase plan
                        
                        
                        1
                        
                        
                        
                        9Fair
      value adjustment of common stock warrants
                        
                        
                        (339
                        )
                        
                        
                        (4
                        )Decrease
      provision for doubtful accounts and sales returns
    allowances
                        
                        
                        (144
                        )
                        
                        
                        (43
                        )Loss
      on disposal of property and equipment
                        
                        
                        185
                        
                        
                        
                        61Changes
      in operating assets and liabilities:Accounts
      receivables and other receivables
                        
                        
                        1,794
                        
                        
                        
                        (1,569
                        )Inventories,
      net
                        
                        
                        25
                        
                        
                        
                        8,602Prepaid
      expenses and other assets
                        
                        
                        1,143
                        
                        
                        
                        49Accounts
      payable
                        
                        
                        (1,025
                        )
                        
                        
                        746Accrued
      expenses and other current liabilities
                        
                        
                        427
                        
                        
                        
                        (34
                        )Accrued
      product warranty
                        
                        
                        (37
                        )
                        
                        
                        (301
                        )Deferred
      revenue
                        
                        
                        (156
                        )
                        
                        
                        144Net
      cash provided by (used in) operating activities
                        
                        
                        314
                        
                        
                        
                        (3,827
                        )Cash
      flows from investing activities:Purchases
      of property and equipment
                        
                        
                        (406
                        )
                        
                        
                        (798
                        )Net
      cash received on asset disposition
                        
                        
                        750
                        
                        
                        
                        -Net
      cash provided by (used in) investing activities
                        
                        
                        344
                        
                        
                        
                        (798
                        )Effect
      of exchange rates on cash and cash equivalents
                        
                        
                        (66
                        )
                        
                        
                        (34
                        )Net
      increase (decrease) in cash and cash equivalents
                        
                        
                        592
                        
                        
                        
                        (4,659
                        )Cash
      and cash equivalents at beginning of period
                        
                        
                        7,298
                        
                        
                        
                        12,491Cash
      and cash equivalents at end of period
                        
                        $
                        7,890
                        
                        
                        $
                        7,832Supplemental
      disclosure of non-cash financing 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 nine
months ended December 31, 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 ($2,426) and ($13,075) for the nine
months ended December 31, 2010 and 2009, respectively. We incurred net losses of
($92) and ($8,779) for the three months ended December 31, 2010 and 2009,
respectively. We generated (used) cash flows from operations of $314 and
($3,827) for the nine months ended December 31, 2010 and 2009,
respectively.  We believe that our existing balances of cash and cash
equivalents, combined with continued cost containment, will be adequate to fund
operations through fiscal year 2011.  While our cash balance
temporarily improved in the three months ended December 31, 2010, our previously
declining cash balance was 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.  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 are 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, the sale of our DRIE and other
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
December 31, 2010, two customers accounted for approximately 73% of the accounts
receivable balance.  As of December 31, 2009, three customers
accounted for approximately 49% of the accounts receivable balance.





For the
quarter ended December 31, 2010, Ulsan National Institute of Science and
Technology and STMicroelectronics SA accounted for 71% and 10%, respectively, of
total revenue.  For the nine months ended December 31, 2010, a leading
precision timing device manufacturer, Ulsan National Institute of Science and
Technology, STMicroelectronics SA, and Uppsala University accounted for 28%,
20%, 18% and 17%, respectively, of total revenue.  For the quarter
ended December 31, 2009, IHP GmbH, Northrup Grumman Financial Service Center,
Maluri Equipment  Sdn. Bhd, and Canon Marketing Japan Inc accounted
for 24%, 17%, 17%, and 15%, respectively, of total revenue.  For the
nine months ended December 31, 2009, PerkinElmer and the IHP Gmbh each accounted
for 13% of total revenue.


6


The
Company’s Note Receivable at December 31, 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, 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
$346 from additional paid-in capital, as a cumulative effect adjustment, 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 December 31, 2010,
the fair of the warrants was $24.  It was calculated using the
Black-Scholes pricing model with the following weighted average assumptions,
risk-free interest rate of 2.01%, expected life of 1.35 years, an expected
volatility factor of 76.8%, and a dividend yield of 0.0%.  The Company
recorded a non-cash gain related to the warrants of $3 in the quarter ended
December 31, 2010 and a non-cash gain of $53 in the quarter ended December 31,
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
December 31, 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 nine months ended
December 31, 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 December 31, 2010 and 2009was $56 and $201, respectively.  Total stock-based compensation
expense related to stock options and RSUs for the nine months ended December 31, 2010 and 2009was $313 and $513, respectively.  The total compensation
expense related to non-vested stock options and RSUs not yet recognized is
$532





The
Company used the following valuation assumptions to estimate the fair value of
options granted for the three month periods ended December 31, 2010 and 2009,
respectively:





STOCK
      OPTIONS:
                  
                  2010
                  
                  
                  2009Expected
      life (years)
                  
                  
                  6.0
                  
                  
                  
                  6.0Volatility
                  
                  
                  74.3
                  %
                  
                  
                  89.1
                  %Risk-free
      interest rate
                  
                  
                  1.51
                  %
                  
                  
                  2.15
                  %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
                  
                  
                  86.1
                  %
                  
                  
                  75.1
                  %Risk-free
      interest rate
                  
                  
                  0.12
                  %
                  
                  
                  0.06
                  %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 December 31, 2010, 565,181 stock option awards were
granted.





Stock
Options & Warrants





A summary
of stock option and warrant activity during the quarter ended December 31, 2010is as follows:


8





WeightedWeighted
                  
                  
                  AverageAverage
                  
                  
                  Remaining
                  
                  
                  AggregateExercise
                  
                  
                  Contractual
                  
                  
                  IntrinsicShares
                  
                  
                  Price
                  
                  
                  Term (in Years)
                  
                  
                  ValueBeginning outstanding
                  
                  
                  933,125
                  
                  
                  $
                  4.56GrantedPrice
      = market value
                  
                  
                  —
                  
                  
                  
                  —Total
                  
                  
                  —
                  
                  
                  
                  —Exercised
                  
                  
                  —
                  
                  
                  
                  0.00CancelledForfeited
                  
                  
                  (20,010
                  )
                  
                  
                  2.96Expired
                  
                  
                  (15,524
                  )
                  
                  
                  2.70Total
                  
                  
                  (35,534
                  )
                  
                  
                  2.84Ending
      outstanding
                  
                  
                  897,591
                  
                  
                  $
                  4.63
                  
                  
                  
                  5.31
                  
                  
                  $
                  —Ending
      vested and expected to vest
                  
                  
                  880,700
                  
                  
                  $
                  4.67
                  
                  
                  
                  5.26
                  
                  
                  $
                  —Ending
      exercisable
                  
                  
                  719,423
                  
                  
                  $
                  5.08
                  
                  
                  
                  4.73
                  
                  
                  $
                  —




The
aggregate intrinsic value of stock options and warrants outstanding at December
31, 2010 is calculated as the difference between the exercise price of the
underlying options and the market price of our common stock as of December 31,
2010.





The
following table summarizes information with respect to stock options and
warrants outstanding as of December 31, 2010:





WeightedWeighted
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              AverageNumber
                                              
                                              
                                              Average
                                              
                                              
                                              Weighted
                                              
                                              
                                              Number
                                              
                                              
                                              ExerciseOutstanding
                                              
                                              
                                              Remaining
                                              
                                              
                                              Average
                                              
                                              
                                              Exercisable
                                              
                                              
                                              PriceRange of
                                              
                                              
                                              As of
                                              
                                              
                                              Contractual
                                              
                                              
                                              Exercise
                                              
                                              
                                              As of
                                              
                                              
                                              As ofExercise Prices
                                              
                                              
                                              December 31,
                                              
                                              
                                              Term
                                              
                                              
                                              Price
                                              
                                              
                                              December 31,
                                              
                                              
                                              December 31,2010
                                              
                                              
                                              (in years)
                                              
                                              
                                              
                                              
                                              
                                              2010
                                              
                                              
                                              2010$
                                              1.20
                                              
                                              
                                              -
                                              1.20
                                              
                                              
                                              
                                              15,622
                                              
                                              
                                              
                                              7.78
                                              
                                              
                                              
                                              1.20
                                              
                                              
                                              
                                              12,496
                                              
                                              
                                              $
                                              1.202.34
                                              
                                              
                                              -
                                              2.34
                                              
                                              
                                              
                                              290,097
                                              
                                              
                                              
                                              7.63
                                              
                                              
                                              
                                              2.34
                                              
                                              
                                              
                                              155,284
                                              
                                              
                                              
                                              2.343.44
                                              
                                              
                                              -
                                              3.94
                                              
                                              
                                              
                                              38,539
                                              
                                              
                                              
                                              4.61
                                              
                                              
                                              
                                              3.60
                                              
                                              
                                              
                                              35,257
                                              
                                              
                                              
                                              3.624.20
                                              
                                              
                                              -
                                              4.20
                                              
                                              
                                              
                                              155,703
                                              
                                              
                                              
                                              6.37
                                              
                                              
                                              
                                              4.20
                                              
                                              
                                              
                                              120,006
                                              
                                              
                                              
                                              4.204.60
                                              
                                              
                                              -
                                              4.60
                                              
                                              
                                              
                                              136,100
                                              
                                              
                                              
                                              4.16
                                              
                                              
                                              
                                              4.60
                                              
                                              
                                              
                                              136,100
                                              
                                              
                                              
                                              4.604.63
                                              
                                              
                                              -
                                              5.62
                                              
                                              
                                              
                                              33,350
                                              
                                              
                                              
                                              6.15
                                              
                                              
                                              
                                              4.97
                                              
                                              
                                              
                                              33,350
                                              
                                              
                                              
                                              4.976.00
                                              
                                              
                                              -
                                              6.00
                                              
                                              
                                              
                                              126,241
                                              
                                              
                                              
                                              0.69
                                              
                                              
                                              
                                              6.00
                                              
                                              
                                              
                                              126,241
                                              
                                              
                                              
                                              6.006.11
                                              
                                              
                                              -
                                              18.11
                                              
                                              
                                              
                                              100,919
                                              
                                              
                                              
                                              3.96
                                              
                                              
                                              
                                              10.76
                                              
                                              
                                              
                                              99,669
                                              
                                              
                                              
                                              10.7030.00
                                              
                                              
                                              -
                                              34.80
                                              
                                              
                                              
                                              790
                                              
                                              
                                              
                                              1.11
                                              
                                              
                                              
                                              30.28
                                              
                                              
                                              
                                              790
                                              
                                              
                                              
                                              30.2837.08
                                              
                                              
                                              -
                                              37.08
                                              
                                              
                                              
                                              230
                                              
                                              
                                              
                                              2.93
                                              
                                              
                                              
                                              37.08
                                              
                                              
                                              
                                              230
                                              
                                              
                                              
                                              37.08$
                                              1.20
                                              
                                              
                                              
                                              $37.08
                                              
                                              
                                              
                                              897,591
                                              
                                              
                                              
                                              5.31
                                              
                                              
                                              $
                                              4.63
                                              
                                              
                                              
                                              719,423
                                              
                                              
                                              $
                                              5.08





As of
December 31,
2010, there was $336 of total unrecognized compensation cost related
to outstanding options and warrants which the Company expects to recognize over
a period of 1.63 years.





Restricted
Stock Units





The
following table summarizes the Company’s RSU activity for the
three months ended December 31,
2010:


9





Number
                    of
                    Shares
                  
                  
                  Weighted
                    Avg.
                    Grant Date
                    FairValueBalance,
      September 30, 2010
                  
                  
                  19,917
                  
                  
                  $
                  0.49Granted
                  
                  
                  565,181
                  
                  
                  $
                  0.49Forfeited
                  
                  
                  (3,507
                  )
                  
                  $
                  0.51Vested
                  
                  
                  (16,410
                  )
                  
                  $
                  0.51Balance,
      December 31, 2010
                  
                  
                  565,181
                  
                  
                  $
                  0.52





Unvested
restricted stock at December 31, 2010





As of
December 31,2010there was $196 of total unrecognized compensation cost related to
outstanding RSUs which the Company expects to recognize over a period of 3.85
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.  During the nine months ended December 31, 2010 and
2009, the Company sold or scrapped previously reserved inventory of $0 and $74,
respectively.The inventory
provision balance atDecember 31, 2010
and December 31, 2009 was $547 and$7,828,
respectively.The inventory
provision for the three month period ending December 31, 2009 was related to
legacy products, which were sold in the prior fiscal year.





Net
inventories for the periods presented consisted of:





December 31,
                    2010
                  
                  
                  March 31,
                    2010Raw
      materials
                  
                  $
                  380
                  
                  
                  $
                  386Work
      in progress
                  
                  
                  39
                  
                  
                  
                  39Finished
      goods and spares
                  
                  
                  777
                  
                  
                  
                  796$
                  1,196
                  
                  
                  $
                  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.





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 nine months ended December 31, 2010 and 2009 is
as follows:


10





Warranty Activity for the
                  
                  
                  Warranty Activity for theThree Months Ended
                  
                  
                  Nine Months EndedDecember 31,
                  
                  
                  December 31,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Balance
      at the beginning of the period
                  
                  $
                  474
                  
                  
                  $
                  519
                  
                  
                  $
                  374
                  
                  
                  $
                  702Additional
      warranty accruals for warranties issued during the period
                  
                  
                  80
                  
                  
                  
                  320
                  
                  
                  
                  385
                  
                  
                  
                  562Warranty
      expense during the period
                  
                  
                  (218
                  )
                  
                  
                  (445
                  )
                  
                  
                  (423
                  )
                  
                  
                  (870
                  )Balance
      at the end of the period
                  
                  $
                  336
                  
                  
                  $
                  394
                  
                  
                  $
                  336
                  
                  
                  $
                  394





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





4.   Net
Income Loss Per Common Share (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
loss per common share is computed using the weighted-average number of shares of
common stock outstanding.





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





Three Months Ended
                        
                        
                        Nine Months EndedDecember 31,
                        
                        
                        December 31,2010
                        
                        
                        2009
                        
                        
                        2010
                        
                        
                        2009Net
      loss applicable to common stockholders
                        
                        $
                        (92
                        )
                        
                        $
                        (8,779
                        )
                        
                        $
                        (2,426
                        )
                        
                        $
                        (13,075
                        )Basic
      and diluted:Weighted-average
      common shares outstanding
                        
                        
                        8,442
                        
                        
                        
                        8,425
                        
                        
                        
                        8,439
                        
                        
                        
                        8,418Weighted-average
      common shares used in diluted net (loss) income per common
      share
                        
                        
                        8,442
                        
                        
                        
                        8,425
                        
                        
                        
                        8,439
                        
                        
                        
                        8,418Basic
      net loss per common share
                        
                        $
                        (0.01
                        )
                        
                        $
                        (1.04
                        )
                        
                        $
                        (0.29
                        )
                        
                        $
                        (1.55
                        )Diluted
      net loss per common share
                        
                        $
                        (0.01
                        )
                        
                        $
                        (1.04
                        )
                        
                        $
                        (0.29
                        )
                        
                        $
                        (1.55
                        )





Outstanding
options and RSUs of 1,481,299 and 2,539,614 shares of common stock at
a weighted-average exercise price per share of $3.01 and $8.82 on December 31,
2010 and 2009, respectively, were not included in the computation of diluted net
(loss) income per common share for the nine month periods presented as a result
of their anti-dilutive effect.  Such securities could potentially
dilute earnings per share in future periods.





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 $80 and $113 for the nine months ended
December 31, 2010 and 2009, respectively.  On December 31, 2010, the
Company had no open foreign exchange contracts to sell Euros or any other
foreign currencies.  On December 31, 2010, the Company had 125,941
warrants outstanding with an exercise price of $6.00 expiring between June 2011
and September 2011.  The Company recorded a non-cash gain of $3 and
$53 in the quarter ending December 31, 2010 and December 31, 2009 related to
these warrants.


11


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 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 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 currently represent the sole source of the Company’s
revenue.  The DRIE markets were seriously impacted by the downturn in
the semiconductor markets, and as those markets recover the Company is not in a
position to make the needed investments to improve its competitive
position.  In addition, it is not clear that even with additional
investment and significant reductions in operating expenses that DRIE sales
alone will be enough to support the Company.  As a result, the Company
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, a sale of all or
substantially all of its assets, or its voluntary liquidation.  Please
see “Notes to Condensed Consolidated Financial Statements – 9. Subsequent Event
– Update to Reorganization/Strategic Alternatives.”





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.





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:


13





Revenue for the
                    
                    
                    Revenue for theThree Months Ended
                    
                    
                    Nine Months EndedDecember31,
                    
                    
                    December31,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Sales
      to customers located in:United
      States
                    
                    $
                    108
                    
                    
                    $
                    1,777
                    
                    
                    $
                    497
                    
                    
                    $
                    4,929Asia
                    
                    
                    979
                    
                    
                    
                    1,751
                    
                    
                    
                    983
                    
                    
                    
                    2,146Germany
                    
                    
                    —
                    
                    
                    
                    1,153
                    
                    
                    
                    11
                    
                    
                    
                    1,240France
                    
                    
                    125
                    
                    
                    
                    138
                    
                    
                    
                    954
                    
                    
                    
                    319Europe,
      excluding Germany and France
                    
                    
                    133
                    
                    
                    
                    253
                    
                    
                    
                    2,402
                    
                    
                    
                    638Total
      sales
                    
                    $
                    1,345
                    
                    
                    $
                    5,072
                    
                    
                    $
                    4,847
                    
                    
                    $
                    9,272





December 312010
                            
                            
                            2009Long-lived
      assets at period-end:United
      States
                            
                            $
                            137
                            
                            
                            $
                            1,114Europe
                            
                            
                            8
                            
                            
                            
                            1,698Total
      Long-lived assets
                            
                            $
                            145
                            
                            
                            $
                            2,812





8.   Recent
Accounting Pronouncements:





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.





9.   Subsequent
Event – Update to Reorganization/Strategic Alternatives:





Entry
Into a Material Definitive Agreement.





On
February 9, 2011, Tegal Corporation, a Delaware corporation (the “Company”), and
SPP Process Technology Systems Limited, a company incorporated and registered in
England and Wales (together with its subsidiary designees, “Purchaser”), entered
into an Asset Purchase Agreement (the “Purchase Agreement”) pursuant to which
the Company sold to Purchaser (the “Disposition”) all of the shares of Tegal
France, SAS, the Company’s wholly-owned subsidiary (the “Tegal France Shares”),
and product lines and certain equipment, intellectual property and other assets
relating to the Company’s Deep Reactive Ion Etch plasma etch systems and certain
related technology (together with the Tegal France Shares, the “Purchased
Assets”). The Purchaser also assumed existing customer contracts, including all
installation and warranty obligations of existing customers, and other
liabilities arising after the closing of the Disposition (the “Assumed
Liabilities”).




In connection with the Disposition, the
Company and the Purchaser entered into related agreements for the transfer and
licensing of patents, trademarks and other intellectual property associated with
the Included Businesses, including a royalty-free Trademark License Agreement
allowing for the limited use of the Tegal trademark by the Purchaser solely in
connection with future sales related to the Included Businesses and solely in
combination with the trademarks transferred to the Purchaser, as well as written
assignments to the Purchaser of all rights in the patents and trademarks that
are part of the Disposition.




The Disposition closed immediately
after execution of the Purchase Agreement. The consideration paid by the
Purchaser for the Disposition totaled approximately $2.1 million, comprised of
approximately $0.5 million of Assumed Liabilities and $1.6 million in cash, of
which $200,000 in cash will be held in escrow for one year after the closing of
the Disposition to satisfy any indemnification obligations of the Company under
the Purchase Agreement.




14


The
Company will file a Form 8-K by February 15, 2011, giving notice of the above
material definitive agreement.





On
January 14, 2011,  Tegal Corporation (the “Company”), se2quel Partners
LLC, a California limited liability company (“se2quel Partners”), and sequel
Power LLC, a newly formed Delaware limited liability company (“sequel Power”),
entered into a Formation and Contribution Agreement (the “Contribution
Agreement”).  sequel Power is focused on the promotion of solar power
plant development projects worldwide, the development of self-sustaining
businesses from such projects, including but not limited to activities relating
to and supporting, developing, building and operating solar photovoltaic
fabrication facilities and solar farms, and the consideration of other
non-photovoltaic renewable energy projects.  se2quel Partners is owned
by Ferdinand Seemann, who previously served as an independent member of the
Company’s Board of Directors.  Pursuant to the Contribution Agreement,
the Company contributed $2 million in cash to sequel Power in exchange for an
approximate 25% ownership interest and a 51% voting interest in sequel
Power.  In addition, the Company issued warrants (“Warrants”) to
se2quel Partners and se2quel Management GmbH, a German limited liability
company, to purchase an aggregate of 928,884 shares of the Company’s common
stock at an exercise price of $0.63 per share.  The Warrants are
exercisable for a period of four years.  The fair market value of the
warrants issued is $230,000 using the Black Scholes valuation model with the
valuation assumptions of:  Stock Price: $0.53, Exercise Price: $0.53,
Maturity: 4 Years, Risk Free Interest Rate: 0.13%, and Volatility:
61%.  The company is currently evaluating the proper recording of this
transaction under Topic 810 Consolidation.





The
Company filed a Form 8-K on January 21, 2011, giving notice of the above
material definitive agreement.





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.


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 currently represent the sole source of the Company’s
revenue.  The DRIE markets were seriously impacted by the downturn in
the semiconductor markets and and as those markets recover the Company is not in
a position to make the needed investments to improve its competitive
position.  In addition, it is not clear that even with additional
investment and significant reductions in operating expenses that DRIE sales
alone will be enough to support the Company.  As a result, the Company
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, 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
generally accepted accounting principles (“GAAP”) or the Financial Accounting
Standards Board (“FASB”).   Please see “Notes to Condensed
Consolidated Financial Statements – 9. Subsequent Event – Update to
Reorganization/Strategic Alternatives.”





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 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 transition to a new business model, a sale of all or substantially
all of our assets or the liquidation or dissolution of the Company, including
through a bankruptcy proceeding.  Please see “Notes to Condensed
Consolidated Financial Statements – 9. Subsequent Event – Update to
Reorganization/Strategic Alternatives.” 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:


16


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.





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 December 31, 2010, two
customers accounted for approximately 73% of the accounts receivable
balance.  As of December 31, 2009, three customers accounted for
approximately 49% 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.


17


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. During the nine months ended December 31, 2010 and 2009, the
Company sold or scrapped previously reserved inventory of $0 and $74, respectively.The inventory
provision balance atDecember 31, 2010
and December 31, 2009 was $547 and$7,828,
respectively.The inventory
provision for the period ending December 31, 2009 was related to legacy
products, which were sold in the prior fiscal year.





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
December 31, 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 nine months ended
December 31, 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 nine months
ended December 31, 2010 and 2009as a
percentage of revenue:





Three Months Ended
                      
                      
                      Nine Months EndedDecember31,
                      
                      
                      December31,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009Revenue
                      
                      
                      100.0
                      %
                      
                      
                      100.0
                      %
                      
                      
                      100.0
                      %
                      
                      
                      100.0
                      %Cost
      of revenue
                      
                      
                      31.2
                      %
                      
                      
                      209.2
                      %
                      
                      
                      60.3
                      %
                      
                      
                      149.6
                      %Gross
      profit/(loss)
                      
                      
                      68.8
                      %
                      
                      
                      (109.2
                      )%
                      
                      
                      39.7
                      %
                      
                      
                      (49.6
                      )%Operating
      expenses:Research
      and development
                      
                      
                      54.5
                      %
                      
                      
                      29.6
                      %
                      
                      
                      47.4
                      %
                      
                      
                      42.2
                      %Sales
      and marketing
                      
                      
                      15.6
                      %
                      
                      
                      10.6
                      %
                      
                      
                      10.7
                      %
                      
                      
                      20.6
                      %General
      and administrative
                      
                      
                      41.2
                      %
                      
                      
                      18.9
                      %
                      
                      
                      54.3
                      %
                      
                      
                      31.6
                      %Total
      operating expenses
                      
                      
                      111.3
                      %
                      
                      
                      59.1
                      %
                      
                      
                      112.4
                      %
                      
                      
                      94.4
                      %Operating
      loss
                      
                      
                      (42.5
                      )%
                      
                      
                      (168.3
                      )%
                      
                      
                      (72.7
                      )%
                      
                      
                      (144.0
                      )%Other
      income (expense), net
                      
                      
                      35.7
                      %
                      
                      
                      (4.8
                      )%
                      
                      
                      22.8
                      %
                      
                      
                      2.4
                      %Loss
      before income tax benefit
                      
                      
                      (6.8
                      )%
                      
                      
                      (173.1
                      )%
                      
                      
                      (49.9
                      )%
                      
                      
                      (141.6
                      )%Tax
      Expense
                      
                      
                      —
                      %
                      
                      
                      —
                      %
                      
                      
                      0.1
                      %
                      
                      
                      (0.5
                      )%Net
      loss
                      
                      
                      (6.8
                      )%
                      
                      
                      (173.1
                      )%
                      
                      
                      (50.0
                      )%
                      
                      
                      (141.1
                      )%





The
following table sets forth certain financial items for the three and nine months
ended December 31, 2010 and 2009:


19





Three Months Ended
                  
                  
                  Nine Months EndedDecember 31,
                  
                  
                  December 31,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Revenue
                  
                  $
                  1,345
                  
                  
                  $
                  5,072
                  
                  
                  
                  4,847
                  
                  
                  $
                  9,272Inventory
      Provision
                  
                  
                  -
                  
                  
                  
                  7,828
                  
                  
                  
                  -
                  
                  
                  
                  7,828Cost
      of revenue
                  
                  
                  420
                  
                  
                  
                  2,780
                  
                  
                  
                  2,922
                  
                  
                  
                  6,039Gross
      profit/(loss)
                  
                  
                  925
                  
                  
                  
                  (5,536
                  )
                  
                  
                  1,925
                  
                  
                  
                  (4,595
                  )Operating
      expenses:Research
      and development expenses
                  
                  
                  733
                  
                  
                  
                  1,503
                  
                  
                  
                  2,298
                  
                  
                  
                  3,913Sales
      and marketing expenses
                  
                  
                  210
                  
                  
                  
                  539
                  
                  
                  
                  518
                  
                  
                  
                  1,914General
      and administrative expenses
                  
                  
                  554
                  
                  
                  
                  957
                  
                  
                  
                  2,631
                  
                  
                  
                  2,930Total
      operating expenses
                  
                  
                  1,497
                  
                  
                  
                  2,999
                  
                  
                  
                  5,447
                  
                  
                  
                  8,757Operating
      loss
                  
                  
                  (572
                  )
                  
                  
                  (8,535
                  )
                  
                  
                  (3,522
                  )
                  
                  
                  (13,352
                  )Other
      income (expense), net
                  
                  
                  480
                  
                  
                  
                  (244
                  )
                  
                  
                  1,103
                  
                  
                  
                  227Loss
      before income tax benefit
                  
                  
                  (92
                  )
                  
                  
                  (8,779
                  )
                  
                  
                  (2,419
                  )
                  
                  
                  (13,125
                  )Income
      tax expense (benefit)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  7
                  
                  
                  
                  (50
                  )Net
      loss
                  
                  $
                  (92
                  )
                  
                  $
                  (8,779
                  )
                  
                  $
                  (2,426
                  )
                  
                  $
                  (13,075
                  )Net
      loss per share:Basic
                  
                  $
                  (0.01
                  )
                  
                  $
                  (1.04
                  )
                  
                  $
                  (0.29
                  )
                  
                  $
                  (1.55
                  )Diluted
                  
                  $
                  (0.01
                  )
                  
                  $
                  (1.04
                  )
                  
                  $
                  (0.29
                  )
                  
                  $
                  (1.55
                  )Weighted
      average shares used in per share computation:Basic
                  
                  
                  8,442
                  
                  
                  
                  8,425
                  
                  
                  
                  8,439
                  
                  
                  
                  8,418Diluted
                  
                  
                  8,442
                  
                  
                  
                  8,425
                  
                  
                  
                  8,439
                  
                  
                  
                  8,418





Revenue





Our
revenue is derived from sales of new and refurbished systems, spare parts and
non-warranty service.  Revenue of $1,345 for the three months ended
December 31, 2010 decreased by $3,727 from revenue for the three months ended
December 31, 2009.  The revenue decrease was due principally to the
sale of our legacy Etch and PVD assets to OEM Group, as well as the number and
mix of systems sold.  For the three month period ended December 31,
2010, we sold only one new DRIE system, as well as spare parts and service sales
compared to the four new DRIE systems sold in the same period last year, as well
as spare parts and service sales, including sales derived from our legacy
assets.





Revenue
of $4,847 for the nine months ended December 31, 2010 decreased from revenue for
the nine months ended December 31, 2009 of $9,272.  The $4,425
decrease in revenue for the nine months ended December 31, 2010 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.  For the nine
months ended December 31, 2010, we sold four new DRIE systems, as well as spare
parts and service sales, compared to the sale of two SMT systems and five new
DRIE systems, as well as spare parts and service sales, including sales derived
from our legacy assets, in the same period last year.





As a
percentage of total revenue for the three months ended December 31, 2010
international sales were approximately 92%.  As a percentage of total
revenue for the three monthsended
December 31, 2009 international sales were approximately 65%.  The
increase in international sales as a percentage of revenue can be attributed to
the number and mix of systems being sold in the third quarter of fiscal year
2011 to international markets.  As a percentage of total revenue for
the nine months ended December 31, 2010 international sales were approximately
90%.  As a percentage of total revenue for the nine months ended
December 31, 2009 international sales were approximately 47%.  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.


20


Gross
Profit





Gross
profit of $925 for the three months ended December 31, 2010 increased by $6,461
from gross profit (loss) of ($5,536) for the three months ended December 31,
2009.  Gross profit of $1,925 for the nine months ended December 31,
2010 increased by $6,520 from gross profit (loss) of ($4,595) for the nine
months ended December 31, 2009.





Our gross
margin for the three months ended December 31, 2010 was 69% compared to (109%)
for the same period last year.   Our gross margin for the nine
months ended December 31, 2010 was 40% compared to (50%) for the same period
last year.   Gross margins for our DRIE series systems are
typically lower than the margins from previous product lines sold by Tegal.





Our gross
margin 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.





The
increase in the gross profit was primarily attributable to the excess inventory
provision recognized in the third quarter of the prior fiscal
year.  As part of the valuation testing mandated by SFAS No. 144
(Topic 360), and in connection with the evaluation of strategic alternatives
available, the Company reviewed the carrying value of all its
inventory.  As a result of its review, for the three months ended
December 31, 2009, the Company recorded an excess inventory provision of
$7,828.  The gross margin is also affected by the increased costs
associated with the outsourcing of the manufacturing of the DRIE
systems.  With the sale of the legacy etch and PVD assets to OEM
Group, the Company’s fixed manufacturing and related expenses decreased
significantly, offsetting the increased costs associated with the outsourced
manufacturing of the DRIE systems.





During
the quarter ended December 31, 2010, we focused 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 discontinued our development efforts
in NLD, while offering these assets for sale to third-parties.  Since
the DRIE markets were also seriously impacted by the downturn in the
semiconductor markets, the lack of available capital for new product development
globally, and our deteriorating competitive position, it was unclear that DRIE
sales alone would 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 were continuing to focus
our efforts on the operation of the DRIE business, we were also seeking and
evaluating strategic alternatives, including the continued operation of the
Company as a stand-alone business with a different business plan, a merger with
or into another company, a transition to a new business model, 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.  Please see “Notes to Condensed Consolidated Financial
Statements – 9. Subsequent Event – Update to Reorganization/Strategic
Alternatives.”  We cannot assure you that we will be successful in
pursuing any of these strategic alternatives.





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 $770 and $1,615 for the three and
nine months ended December 31, 2010, respectively,  compared to the
three and nine months ended December 31, 2009 resulted primarily from a decrease
in headcount, payroll, consulting expense, DRIE amortization and depreciation
expense and legal fees for patent maintenance.  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 $329 and $1,396 for the three and nine months
ended December 31, 2010, respectively, as compared to the same period in 2009
was primarily due to
the decrease of employee costs.


21


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 decrease of $403 for the three months ended December
31, 2010 as compared to the three months ended December 31, 2009 was due
primarily to decreases in stock related compensation expense.  The
decrease of $299 for the nine months ended December 31, 2010 as compared to the
nine months ended December 31, 2009 was due primarily to decreases in stock
related compensation expense, legal expenses and consulting costs, offset by
bonuses for key employees.





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 for
research and development and gain and losses on the disposal of fixed
assets.  For the three months ended December 31, 2010 compared to the
three months ended December 31, 2009, other income, net increased by $724,
primarily due to a refund in the amount of $458 from the French government and
changes in foreign exchange rates.  For the nine months ended December
31, 2010 compared to the nine months ended December 31, 2009, other income, net
increased by $876, primarily due to the refund from the French government in the
amount of $627 and the $338 change in fair value of the common stock warrant
liability pursuant to EITF 07-05 (Topic 815), offset by the changes in foreign
exchange rates.





Contractual
Obligation





The
following summarizes our contractual obligations at December 31, 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
                  
                  $
                  180
                  
                  
                  $
                  106
                  
                  
                  $
                  74
                  
                  
                  $
                  -
                  
                  
                  $
                  -Total
      contractual cash obligations
                  
                  $
                  180
                  
                  
                  $
                  106
                  
                  
                  $
                  74
                  
                  
                  $
                  -
                  
                  
                  $
                  -





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
thenine months
ended December 31, 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 nine months ended December 31, 2010
were decreases in accounts receivable and prepaid expenses offset by our net
loss of ($2,426), and the decrease in accounts payable.  Net cash used
in operating activities during the nine months ended December 31, 2009 was
($3,827), due primarily to the net loss of $13,075 and the increase in accounts
receivable offset by decreases in inventory and increased depreciation and
amortization expense.


22


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 losses of ($2,426) and ($13,075) forthenine monthsendedDecember 31, 2010
and 2009, respectively. We generated (used) cash flows from operations of $314
and ($3,827) for the nine months ended December 31, 2010 and 2009,
respectively.  Although we believe that our existing 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 our competitive position and sales in the MEMS and semiconductor capital
equipment sectors.  The 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.





Item
3.  Quantitative and
Qualitative Disclosures About Market Risk





Foreign
Currency Exchange Risk





At
December 31, 2010 and 2009,all of the
Company’s investments were classified as cash equivalents in the consolidated
balance sheets. The investment portfolio at December 31, 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 $24 and ($180) for the three months ended December
31, 2010 and 2009, respectively.  For the nine months ended December
31, 2010 and December 31, 2009, the Company recorded transaction gains included
in other income (expense), net of $80 and $113.  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 December 31, 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.


23


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 December 31, 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 December 31, 2010 that materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.





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 December 31, 2010 and 2009, we had
a net losses of ($92) and ($8,779), respectively.  For the nine months
ended December 31, 2010 and 2009, we had a net losses of ($2,426) and ($13,075),
respectively.  Although we believe that our existing 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 our competitive position and sales in the MEMS and semiconductor capital
equipment sectors.  The 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 current results are 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, the sale of our DRIE and other 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





ExhibitNumber
              
              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.


24


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. Hergenrother
                  Chief
      Financial Officer





Date:
February 14, 2011


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