Unassociated Document

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	PART I. FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of September 30, 2007 and March 31, 2007	3
	Condensed Consolidated Statements of Operations for the three months and six months ended September 30, 2007 and September 30, 2006	4
	Condensed Consolidated Statements of Cash Flows as of September 30, 2007 and September 30, 2006	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18
Item 4.	Controls and Procedures	19

	PART II. OTHER INFORMATION

Item 1A.	Risk Factors	19
Item 4.	Submission of Matters to a Vote of Security Holders	24
Item 6.	Exhibits	25
Signatures		26

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

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

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

In the opinion of management, the unaudited condensed consolidated interim financial statements have been prepared on the same basis as the March 31, 2007 audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary to fairly state the information set forth herein. The statements have been prepared in accordance with the regulations of the Securities and Exchange Commission (“SEC”), but omit certain information and footnote disclosures necessary to present the statements in accordance with generally accepted accounting principles. These interim financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2007. The results of operations for the three and six months ended September 30, 2007 are not necessarily indicative of results to be expected for the entire year.

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

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of temporary cash investments and accounts receivable. Substantially all of the Company’s temporary investments are invested in money market funds. The Company’s accounts receivable are derived primarily from sales to customers located in the United States, Europe and Asia. The Company performs ongoing credit evaluations of its customers and generally requires no collateral. The Company maintains reserves for potential credit losses. Write-offs during the periods presented have been insignificant. As of September 30, 2007 one customer accounted for 81% of outstanding accounts receivable balance. As of March 31, 2007 three customers accounted for approximately 86% of the accounts receivable balance. As of September 30, 2006 four customers accounted for 54% of outstanding accounts receivable balance.

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

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

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in Years)		Aggregate Intrinsic Value
BEGINNING OUTSTANDING		2,036,496		$	11.39
GRANTED
Price = Market Value		12,498		$	5.62
Total		12,498		$	5.62
EXERCISED		(16,261	)	$	4.20
CANCELLED
Forfeited		(5,000	)	$	5.26
Expired		(10,834	)	$	21.68
Total		(15,834	)	$	16.50

ENDING OUTSTANDING		2,016,899		$	11.37		4.28	$	300
ENDING VESTED + EXPECTED TO VEST		1,933,496		$	11.65		4.08	$	230
ENDING EXERCISABLE		1,727,488		$	12.45		3.53	$	64

Range of Exercise Prices				Number Outstanding As of September 30, 2007		Weighted Average Remaining Contractual Term (in years)		Weighted Average Exercise Price		Number Exercisable As of September 30, 2007		Weighted Average Exercise Price As of September 30, 2007
$	4.20	$	4.20		83		.94	$	4.20		83	$	4.20
	4.60		4.60		296,736		8.85		4.60		55,000		4.60
	4.68		6.84		210,400		5.17		6.01		182,902		6.10
	7.08		8.28		87,079		7.65		7.86		68,329		8.08
	12.00		12.00		1,284,990		2.93		12.00		1,284,990		12.00
	12.36		73.50		130,116		3.56		26.75		128,689		26.87
	92.26		92.26		416		2.44		92.26		416		92.26
	92.52		92.52		4,165		2.38		92.52		4,165		92.52
	99.00		99.00		2,498		2.49		99.00		2,498		99.00
	105.00		105.00		416		4.98		105.00		416		105.00

$	4.20	$	105.00		2,016,899		4.28	$	11.37		1,727,488	$	12.45

Inventories are stated at the lower of cost or market, reduced by provisions for excess and obsolescence. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis and includes material, labor and manufacturing overhead costs. We estimate the effects of excess and obsolescence on the carrying values of our inventories based upon estimates of future demand and market conditions. We establish provisions for related inventories in excess of production demand. Should actual production demand differ from our estimates, additional inventory write-downs may be required. Any excess and obsolete provision is released only if and when the related inventory is sold or scrapped. During the six months ended September 30, 2007 and September 30, 2006, the Company sold or scrapped previously reserved inventory of $139 and $2,594 respectively. The inventory provision balance at September 30, 2007 and September 30, 2006 was $3,769 and $4,542, respectively. During the six months ended September 30, 2006 the reserve was reduced by $2,594, the Company sold or scrapped previously reserved inventory of $2,255 and adjusted the reserve balance for a change in manufacturing overhead related to improved plant efficiencies by $339.

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

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

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

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

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

Outstanding options, warrants and restricted stock equivalent of 2,453,261 and of 2,318,464 shares of common stock at a weighted-average exercise price of $11.37 and $13.54 per share as of September 30, 2007 and 2006 respectively, were not included in the computation of diluted net loss per common share for the periods presented as a result of their anti-dilutive effect. Such securities could potentially dilute earnings per share in future periods.

The Company is party to a contract with certain consultants pursuant to which the Company will issue warrants on a monthly basis in lieu of cash payments through December 2007. The maximum number of warrants to be issued under these agreements is 5,000 shares. During the six months ended September 30, 2007 the Company issued warrants to purchase 5,000 shares valued at $9 using the Black-Scholes model with an exercise price at the market value on the day of the grant and an average interest rate of 4.51% and a 5 year life. None of these warrants have been exercised as of September 30, 2007.

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

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

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

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

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

	Revenue for the Three Months Ended September 30,				Revenue for the Six Months Ended September 30,
	2007		2006		2007		2006
Sales to customers located in:
United States	$	387	$	809	$	1,116	$	3,353
Asia, excluding Japan		2,849		766		3,202		3,445
Japan		187		1,153		192		1,677
Germany		809		888		1,383		1,595
Italy		153		22		153		76
Europe, excluding Germany and Italy		6,415		1,475		9,352		1,543
Total sales	$	10,800	$	5,113	$	15,398	$	11,689

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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.

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.

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

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

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

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

Research and development expenses consist primarily of salaries, prototype material and other costs associated with our ongoing systems and process technology development, applications and field process support efforts. Spending has been consistent in total dollars for the three months ended September 30, 2007, $1,057 versus $1,066 for the prior year period. In the six months ended September 30, 2007, spending decreased to $1,835 from $2,062 for the prior year period due to reimbursement for prototype costs.

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

General and administrative expenses consist primarily of compensation for general management, accounting and finance, human resources, information systems and investor relations functions and for legal, consulting and accounting fees of the Company. The $2,037 decrease over the prior year’s three-month period and the $3,136 decrease over the prior year’s six-month period were primarily due to a reduction in legal fees as a result of the settlement of the litigation against AMS, Agilent, and Avago Technologies. Other factors include a one-time lease termination expense of $500 for the reduction of space in the Petaluma facility and the costs associated with moving portions of the operations to San Jose.

Other income (expense), net consists principally of, interest income, interest expense, other income, (expense), gains and losses on the disposal of fixed assets, and gains and losses on foreign exchange. We recorded net non-operating income of $964 for the six months and $237 for the three months ended September 2007. The major component of these income (expenses) were net interest income from the AMS settlement.

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.

For the six month period ended September 30, 2007, we financed our operations through the use of outstanding cash balances. The consolidated financial statements contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. We incurred net income (loss) of $693 and ($3,281) and $54 and ($5,083) for the three and six months ended September 30, 2007 and 2006, respectively. We generated negative cash flows from operations of $5,220 and $3,268 for the period ended September 30, 2007 and September 30, 2006, respectively. During fiscal year 2007, we settled our lawsuit with AMS, Agilent and Avago Technologies for $19,500, which is currently in litigation suspense, offset by the payment of $995 to settle claims with G&L for a litigation suspense balance of $18,505 as of September 30, 2007. For more information, see Part I, Basis of Presentation, Item 6. Legal Proceedings. In fiscal year 2006, we raised a net of $18,161 through the 2005 PIPE. Management believes that these proceeds, combined with projected sales, consolidation of certain operations and continued cost containment will be adequate to fund operations through fiscal year 2008. However, projected sales may not materialize and unforeseen costs may be incurred. Moreover, the amount we ultimately receive from the AMS lawsuit settlement is uncertain as we continue to dispute the claims by one of the two law firms who represented us in that matter. If the amount we ultimately receive under the lawsuit settlement is materially less, or if the projected sales do not materialize, our ability to achieve our intended business objectives may be adversely affected. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets or the amount or classification of liabilities or any other adjustments that might be necessary should we be unable to continue as a going concern.

Our cash equivalents are principally comprised of money market accounts. As of September 30, 2007, we had cash and cash equivalents of $20,348. These accounts are subject to interest rate risk and may fall in value if market interest rates increase. We attempt to limit this exposure by investing primarily in short-term securities having a maturity of three months or less. Due to the nature of our cash and cash equivalents, we have concluded that there is no material market risk exposure.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

(a)

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

(b)

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

(c)

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

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

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

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

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

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

We have designed our advanced etch and deposition products for customer applications in emerging new films, polysilicon and metal which we believe to be the leading edge of critical applications for the production of advanced semiconductor and other microelectronic devices. Revenues from the sale of our advanced etch and deposition systems accounted for 69%, 69% and 30% of total revenue in fiscal 2007, 2006 and 2005, respectively. Our advanced systems are currently being used primarily for research and development activities or low volume production. For our advanced systems to achieve full market adoption, our customers must utilize these systems for volume production. We cannot assure you that the market for devices incorporating emerging films, polysilicon or metal will develop as quickly or to the degree we expect. If our advanced systems do not achieve significant sales or volume production due to a lack of customer adoption, we will be materially adversely affected.

We incurred net losses of $13.2 million, $8.9 million and $15.4 million for the years ended March 31, 2007, 2006 and 2005, respectively, and generated (used) cash flows from operations of $12.8 million, ($11.6) million, and ($7.5) million in these respective years. We have raised approximately $18.4 million from the sale of stock and warrants to institutional investors in fiscal 2006. While we believe that these proceeds, combined with a projected increase in sales, consolidation of certain operations and continued cost containment will be adequate to fund operations through fiscal year 2008, if the projected sales do not materialize, we will need to reduce expenses further and raise additional capital through the issuance of debt or equity securities. If additional funds are raised through the issuance of preferred stock or debt, these securities could have rights, privileges or preferences senior to those of our common stock, and debt covenants could impose restrictions on our operations. Moreover, such financing may not be available to us on acceptable terms, if at all. Failure to raise any needed funds would materially adversely affect us.

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

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

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

While our common stock has recently increased in value compared to the exercise price of many options granted to employees pursuant to our stock option plans, this performance level may not be sustained. Thus, the intended benefits of the stock options granted to our employees, the creation of performance and retention incentives, may not be realized. As a result, we may lose employees whom we would prefer to retain and may have difficulty in hiring new employees to replace them. As a result of these factors, our remaining personnel may seek employment with larger, more established companies or companies perceived as having less volatile stock prices. The loss of any significant employee or a large number of employees over a short period of time could have a material adverse effect on us.

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

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

International sales accounted for 67%, 76%, and 70% of total revenue for fiscal 2007, 2006, and 2005, respectively. For the six months ended September 30, 2007, international sales accounted for approximately 93% of total revenue. International sales are subject to certain risks, including the imposition of government controls, fluctuations in the U.S. dollar (which could increase the sales price in local currencies of our systems in foreign markets), changes in export license and other regulatory requirements, tariffs and other market barriers, political and economic instability, potential hostilities, restrictions on the export or import of technology, difficulties in accounts receivable collection, difficulties in managing representatives, difficulties in staffing and managing international operations and potentially adverse tax consequences. We cannot assure you that any of these factors will not have a detrimental effect on our operations, financial results and cash flows.

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

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

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

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

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

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

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

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

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

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

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

	Total		Less than 1 Year		1-3 Years		3-5 Years		After 5 Years
Contractual obligations:

Non-cancelable operating lease obligations		1,014		600		379		35		—
Total contractual cash obligations	$	1,014	$	600	$	379	$	35	$	—

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

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

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

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

31.1	Certifications of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certifications of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

		TEGAL CORPORATION (Registrant)

		/s/ CHRISTINE HERGENROTHER Christine Hergenrother Chief Financial Officer
Dated: November 14 , 2007