ITEM 2.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION
The following discussion should be read in conjunction
with the condensed consolidated financial statements and notes thereto included
elsewhere in this Quarterly Report on Form 10-Q. This report contains forward-looking
statements including, without limitation, statements regarding the transfer of
manufacturing of our 93000 Series platform to China, sales increases in
Asia, manufacturing operations, research and development activities, variations
in quarterly revenues and operating results, trends, cyclicality, seasonality
and growth in the markets we sell into, our strategic direction, expenditure in
research and development, anticipated benefits from our operating model, our
future effective tax rate, new product introductions, product pricing, changes
to our manufacturing processes, our liquidity position, our ability to generate
cash from continuing operations, our expected growth, the potential impact of
adopting new accounting pronouncements, our potential future financial results,
our purchase commitments, our obligation and assumptions about our retirement
and post-retirement benefit plans, the impact of our variable cost structure,
our lease payment obligations and expected savings from our restructuring
programs that involve risks and uncertainties.
Additional forward-looking statements can be identified by words such as
anticipated, expect, believes, plan, predicts, and similar
terms. Our actual results could differ
materially from the results contemplated by these forward-looking statements
due to various factors, including those discussed under Part II, Item
1A., Risk Factors and elsewhere in this report.
Overview
Verigy became an independent company on June 1,
2006, when we separated from Agilent Technologies Inc. We design, develop, manufacture and sell
advanced test systems and solutions for the semiconductor industry. We offer a single platform for each of the
two general categories of devices being tested: our 93000 Series platform,
designed to test System-on-a-Chip (SOC), System-in-a-Package (SIP) and
high-speed memory devices, and our Versatest V5000 Series platform,
designed to test memory devices, including flash memory and multi-chip
packages. Our test solutions are both
scalable and flexible. Our test
platforms are scalable across different frequency ranges, different pin counts
and different numbers of devices. Our
test platforms flexibility allows for a single test system to test a wide
range of applications for semiconductor devices. Our scalable platform architecture provides us
with internal operating model efficiencies such as reduced research and
development costs, engineering headcount, support requirements and inventory
risk. The scalability and flexibility of
our test solutions also provides economic benefits to our customers by allowing
them to get their complex, feature-rich semiconductor devices to market quickly
and to reduce their overall costs. We
also provide test and application expertise, and service and support through
our worldwide service organization.
We have a broad customer installed base, having sold
over 1,700 of our 93000 Series systems and over 2,500 Versatest Series systems
as of January, 31, 2008. Our customers
include integrated device manufacturers, or IDMs, test subcontractors, also
referred to as subcontractors, which includes specialty assembly, package and
test companies as well as wafer foundries, and fabless design companies.
Basis of
Presentation and Separation from Agilent
Our fiscal year end is October 31, and our fiscal
quarters end on January 31, April 30 and July 31. Unless otherwise stated, all dates refer to
our fiscal year and fiscal periods.
Amounts included in the accompanying condensed
consolidated financial statements are expressed in U.S. dollars. The accompanying condensed consolidated
financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC).
Certain
amounts in the condensed consolidated financial statements for the three months
ended January 31, 2007, were reclassified to conform with the presentation
used for the three months ended January 31, 2008.
Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles (GAAP) in the United States
have been condensed or omitted pursuant to such rules and
regulations. The following discussion
should be read in conjunction with our 2007 Annual Report on Form 10-K.
We are incorporated in Singapore. We separated
from Agilent and became a stand-alone company as of June 1, 2006. On
June 13, 2006, we completed our initial public offering.
Overview of Results
Our net revenue for the three months ended January 31,
2008, was $200 million, up $35 million, or 21.2%, from the comparable
period in fiscal year 2007. This
decrease was primarily due to higher revenue from sales of our SOC/SIP test
systems driven by the continued demand in cell phone applications, computer
devices and automotive integrated circuits (ICs). This increase is partially offset by lower
revenue from sales of our memory test systems as customers are delaying memory
tester purchases due to the challenges in their end markets. For the three
months ended January 31, 2008, one of our customers accounted for more
than 10% of our net revenue. For the
three months ended January 31, 2007, three of our customers accounted for
more than 10% of our net revenue.
19
Our total operating expenses, including separation and
restructuring charges, were $64 million in the three months ended January 31,
2008, up $5 million, or 8.5%, from the comparable period in fiscal year
2007. Our research and development and
sales, general and administrative expenses were $64 million in the three
months ended January 31, 2008, up $7 million, or 12.3%, from the
comparable period in fiscal year 2007.
This increase was due to research and development initiatives for
product programs that are planned for introduction during the second half of
fiscal year 2008, increased infrastructure investment costs and higher variable
compensation as a result of the increase in revenue.
In the three months ended January 31, 2008, we
recorded approximately $0.4 million in restructuring expenses, $0.2 million of
which was recorded to cost of sales, compared to a $1 million charge to cost of
sales during the comparable period in fiscal year 2007. Also, in connection with our separation from
Agilent, we incurred separation costs, such as information technology set-up
costs, consulting, legal and other professional fees and other spin-off related
costs. In the three months ended January 31,
2008, we incurred approximately $0.1 million in separation costs, all of
which were recorded in cost of sales, compared to a $2 million charge to
operating expenses in the comparable period in fiscal year 2007.
We derive a significant percentage of our net revenue
from outside North America. Net revenue
from customers located outside of North America represented 85.0% and 51.5% of
total net revenue in three months ended January 31, 2008 and 2007,
respectively. Net revenue in North
America was lower by 62.5% during the three months ended January 31, 2008,
compared to the same period of fiscal year 2007, due to the continuing
outsourcing by our North American customers to contract manufacturers in
Asia. Net revenue in Asia (including
Japan) was higher by 109% in the three months ended January 31, 2008,
compared to the same period of fiscal year 2007. We expect this trend of increasing sales in
Asia (including Japan) to continue as semiconductor manufacturing activities
continue to concentrate in that region.
The sales of our products and services are dependent,
to a large degree, on customers who are subject to cyclical trends in the
demand for their products. These
cyclical periods have had, and will continue to have, a significant effect on
our business since our customers often delay or accelerate purchases in
reaction to changes in their businesses and to demand fluctuations in the
semiconductor industry. Historically,
these demand fluctuations have resulted in significant variations in our
results of operations. Upturns and
downturns in the semiconductor industry in recent years have generally affected
the semiconductor test equipment and services industry more significantly than
the overall capital equipment sector.
Furthermore, we sell to a variety of customers, including
subcontractors. Because we sell to
subcontractors, which during market downturns tend to reduce or cancel orders
for new test systems and test services more quickly and dramatically than other
customers, any downturn may cause a quicker and more significant adverse effect
on our business than on the broader semiconductor industry. In addition, although a decline in orders for
semiconductor capital equipment may accompany or precede the timing of a
decline in the semiconductor market as a whole, recovery in semiconductor
capital equipment spending may lag the recovery by the semiconductor industry.
Critical Accounting Policies and
Estimates
The preparation of financial statements in accordance
with U.S. GAAP requires management to make estimates and assumptions that
affect the amounts reported in our condensed consolidated financial statements
and accompanying notes. Management bases
its estimates on historical experience and various other assumptions management
believes to be reasonable. Although
these estimates are based on managements knowledge of current events and of
actions that may impact the Company in the future, actual results may be
different from the estimates. Our
critical accounting policies are those that affect our financial statements
materially and involve difficult, subjective or complex judgments by
management. Those policies include
revenue recognition, restructuring charges, inventory valuation, warranty,
share-based compensation, retirement and post-retirement plan assumptions,
valuation of goodwill and intangible assets, valuation of marketable securities
and accounting for income taxes.
An accounting policy is deemed to be critical if it
requires an accounting estimate to be made based on assumptions about matters
that are highly uncertain at the time the estimate is made, and if different
estimates that reasonably could have been used or changes in the accounting
estimate that are reasonably likely to occur could materially change the
financial statements. There have been no
significant changes during the three months ended January 31, 2008 to the
items that we disclosed as our critical accounting policies and estimates in
Managements Discussion and Analysis of Financial Condition and Results of
Operations included in our Annual Report on Form 10-K for the year ended October 31,
2007, filed with the Securities and Exchange Commission on December 21,
2007.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
(SFAS No. 157). The purpose of SFAS No. 157 is to define
fair value, establish a framework for measuring fair value and enhance
disclosures about fair value measurements.
In February 2008, the FASB issued FASB Staff Position (FSP) 157-1, Application
of FASB Statement No. 157 to FASB Statement No. 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes of
Lease Classification or Measurement under Statement 13 (FSP 157-1) and FSP
157-2, Effective Date of FASB Statement No. 157 (FSP 157-2). FSP
157-1 amends SFAS No.
20
157 to remove certain leasing transactions from its
scope. FSP 157-2 delays the effective date of SFAS No. 157 for
all non-financial assets and non-financial liabilities, except for items that
are recognized or disclosed at fair value in the financial statements on a
recurring basis (at least annually), until the beginning of the first quarter
of fiscal 2010. The measurement and disclosure requirements related to
financial assets and financial liabilities are effective for us beginning in
the first quarter of fiscal 2009. We are currently evaluating whether SFAS No. 157
will result in a change to our fair value measurements.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Financial Liabilities
(SFAS No. 159), which permits
entities to choose to measure many financial instruments and certain other
items at fair value that are not currently required to be measured at fair
value. SFAS No.159 will be
effective for us beginning in the first quarter of fiscal year 2009. We are currently evaluating the impact of
adopting SFAS No. 159 on our financial position, cash flows and
results of operations.
In December 2007, the FASB issued SFAS No. 141
(revised 2007),
Business Combinations
(SFAS No. 141(R)). SFAS No. 141R amends SFAS 141 and
provides revised guidance for recognizing and measuring identifiable assets and
goodwill acquired, liabilities assumed, and any noncontrolling interest in the
acquiree. It also provides disclosure requirements to enable users of the
financial statements to evaluate the nature and financial effects of the
business combination. It is effective for fiscal years beginning on or after December 15,
2008 and will be applied prospectively.
We are currently assessing the impact that SFAS No. 141(R) may
have on our consolidated financial statements upon adoption in fiscal 2010.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statementsan amendment of ARB No. 51
(SFAS No. 160).
SFAS No. 160 requires that ownership interests in subsidiaries held by
parties other than the parent, and the amount of consolidated net income, be
clearly identified, labeled, and presented in the consolidated financial
statements. It also requires once a subsidiary is deconsolidated, any retained
noncontrolling equity investment in the former subsidiary be initially measured
at fair value. Sufficient disclosures are required to clearly identify and
distinguish between the interests of the parent and the interests of the
noncontrolling owners. It is effective for fiscal years beginning on or after December 15,
2008 and requires retroactive adoption of the presentation and disclosure
requirements for existing minority interests. All other requirements shall be applied
prospectively. We are currently
assessing the impact that SFAS No. 160 may have on our consolidated
financial statements upon adoption in fiscal 2010.
21
Quarterly Results of Operations
Our quarterly results of operations have varied in the
past and are likely to continue to vary in the future primarily due to the
cyclical nature of the semiconductor industry.
Our third and fourth fiscal quarters tend to be our strongest quarters
for new orders, while our first fiscal quarter tends to be our weakest quarter
for orders. We believe that the most
significant factor driving these seasonal patterns is the holiday buying season
for consumer electronics products. The
seasonality of our business is often masked to a significant extent by the high
degree of cyclicality of the semiconductor industry. As such, we believe that period-to-period
comparisons of our results of operations should not be relied upon as an
indication of future performance. In
future periods, the market price of our ordinary shares could decline if our
revenues and results of operations are below the expectations of analysts and
investors. Factors that may cause our
revenue and results of operations to vary include those discussed in the Risk
Factors in Item 1A of Part II of, and else where in, this report.
The following table sets forth certain operating data
as a percent of net revenue for the periods presented:
|
|
Three Months Ended
January 31,
|
|
|
|
2008
|
|
2007
|
|
Net revenue:
|
|
|
|
|
|
Products
|
|
81.5
|
%
|
77.6
|
%
|
Services
|
|
18.5
|
|
22.4
|
|
Total net revenue
|
|
100.0
|
|
100.0
|
|
Cost of sales:
|
|
|
|
|
|
Cost of products
|
|
39.5
|
|
41.8
|
|
Cost of services
|
|
14.0
|
|
15.2
|
|
Total cost of sales
|
|
53.5
|
|
57.0
|
|
Gross margin (1)
|
|
46.5
|
|
43.0
|
|
Operating expenses:
|
|
|
|
|
|
Research and development
|
|
12.5
|
|
13.9
|
|
Selling, general and administrative
|
|
19.5
|
|
20.6
|
|
Separation costs
|
|
|
|
1.2
|
|
Total operating expenses
|
|
32.0
|
|
35.7
|
|
Income from operations
|
|
14.5
|
|
7.3
|
|
Other income (expense),
net
|
|
3.0
|
|
1.8
|
|
Income before income taxes
|
|
17.5
|
|
9.1
|
|
Provision for income taxes
|
|
1.5
|
|
1.2
|
|
Net income
|
|
16.0
|
%
|
7.9
|
%
|
(1) Gross margin represents the ratio of gross
profit to total net revenue
Net Revenue
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
January 31,
|
|
2008 over 2007
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
($ in millions)
|
|
|
|
Net revenue from products:
|
|
|
|
|
|
|
|
SOC / SIP / High-Speed Memory
|
|
$
|
121
|
|
$
|
49
|
|
146.9
|
%
|
Memory
|
|
42
|
|
79
|
|
(46.8
|
)%
|
Net revenue from products
|
|
$
|
163
|
|
$
|
128
|
|
27.3
|
%
|
|
|
|
|
|
|
|
|
Net revenue from services
|
|
37
|
|
37
|
|
|
|
Total net revenue
|
|
$
|
200
|
|
$
|
165
|
|
$
|
21.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
22
Our revenue by geographic region for the three months
ended January 31, 2008 and 2007 is as follows:
|
|
Three Months Ended
|
|
|
|
|
|
January 31,
|
|
2008 over 2007
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
($ in millions)
|
|
|
|
North America
|
|
$
|
30
|
|
$
|
80
|
|
(62.5
|
)%
|
As a percent of total net revenue
|
|
15.0
|
%
|
48.5
|
%
|
|
|
|
|
|
|
|
|
|
|
Europe
|
|
$
|
9
|
|
$
|
8
|
|
12.5
|
%
|
As a percent of total net revenue
|
|
4.5
|
%
|
4.8
|
%
|
|
|
|
|
|
|
|
|
|
|
Asia-Pacific, excluding
Japan
|
|
$
|
137
|
|
$
|
62
|
|
121.0
|
%
|
As a percent of total net revenue
|
|
68.5
|
%
|
37.6
|
%
|
|
|
|
|
|
|
|
|
|
|
Japan
|
|
$
|
24
|
|
$
|
15
|
|
60.0
|
%
|
As a percent of total net revenue
|
|
12.0
|
%
|
9.1
|
%
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
200
|
|
$
|
165
|
|
21.2
|
%
|
Net Revenue.
Net revenue is
derived from the sale of products and services and is adjusted for returns and
allowances, which historically have been insignificant. Our product revenue is generated
predominantly from the sales of our test equipment products. Revenue from services includes extended warranty,
customer support, consulting, training and education activities. Service revenue is recognized over the
contractual period or as services are rendered to the customer.
Net revenue in the three months ended January 31,
2008 was $200 million, an increase of $35 million, or 21.2%, from the
$165 million achieved in the three months ended January 31,
2007. Net product revenue in the three
months ended January 31, 2008 was $163 million, an increase of $35
million, or 27.3%, from the $128 million achieved in the three months
ended January 31, 2007. This
increase was primarily due to higher revenue from sales of our SOC/SIP test
systems driven by the continued demand in cell phone applications, computer
devices and automotive ICs, partially offset by lower revenue from sales of our
memory test systems.
Service revenue for the three months ended January 31,
2008, accounted for $37 million, or 18.5% of net revenue, flat compared to the
three months ended January 31, 2007.
We continue to service our growing installed base through contract
renewals and new shipments; however our revenue for service and support
typically will not fluctuate significantly due to the fact that service revenue
is recognized over the contractual period or as services are rendered.
Net revenue in North America was lower by 62.5% in the
three months ended January 31, 2008, compared to the three months ended January 31,
2007, due continued outsourcing by our North American customers to contract
manufacturers in Asia (including Japan).
Net revenue from customers located in Asia represented 80.5% of total
net revenue for the three months ended January 31, 2008, compared to 46.7%
in the three months ended January 31, 2007. We expect this trend of increasing sales in
Asia (including Japan) to continue as semiconductor manufacturing activities
continue to concentrate in that region.
Cost of Sales
Cost of Products
|
|
Three Months Ended
|
|
|
|
|
|
January 31,
|
|
2008 over 2007
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
($ in millions)
|
|
|
|
Cost of products
|
|
$
|
79
|
|
$
|
69
|
|
14.5
|
%
|
As a percent of product revenue
|
|
48.5
|
%
|
53.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
23
Cost of Products.
Cost of products consists primarily of manufacturing materials, outsourced
manufacturing costs, direct labor, manufacturing and administrative overhead,
warranty costs and provisions for excess and obsolete inventory, partially
offset, when applicable, by benefits from sales of previously written-down
inventory.
The increase in cost of products of approximately $10
million in the three months ended January 31, 2008, compared to the three
months ended January 31, 2007, was primarily due to the increase in
product shipments, higher variable performance-based compensation as well as a
shift in product mix. These increases were
partially offset by $1 million in lower restructuring and separation
costs. Also, our cost of products
included $0.5 million of SFAS No. 123(R) share-based
compensation expense in the three months ended January 31, 2008, compared
to $0.4 million of such charges in the three months ended January 31,
2007.
Cost of products as a percent of net product revenue
increased by 5.4 percentage points in the three months ended January 31,
2008, compared to the three months ended January 31, 2007, primarily due
to higher sales volume and variable performance compensation, product mix and
offset by lower restructuring and separation costs.
Excess and obsolete inventory-related charges were $2
million in both the three months ended January 31, 2008 and 2007. We also sold previously written down
inventory of $1 million in both the three months ended January 31, 2008
and 2007. The sales of previously
written down inventory improved our cost of products gross margins by
approximately 0.3 percentage points in the three months ended January 31,
2008 and by 0.4 percentage points in the three months ended January 31,
2007.
As of January 31, 2008, we held $68 million of
inventory, net of $36 million of reserves, composed of $30 million of raw
materials, $7 million of work in progress and $31 million of finished
goods. Raw materials include
approximately $19 million of support inventory.
We continue to dispose of previously written down inventory on a
recurring basis.
Cost of Services
|
|
Three Months Ended
January 31,
|
|
2008 over 2007
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
($ in millions)
|
|
|
|
Cost of services
|
|
$
|
28
|
|
$
|
25
|
|
12.0
|
%
|
As a percent of service revenue
|
|
75.7
|
%
|
67.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Services.
Cost of services includes cost of field service and support personnel, spare
parts consumed in service activities and administrative overhead allocations.
Cost of services in the three months ended January 31,
2008 increased by $3 million, compared to the three months ended January 31,
2007. Cost of services as a percent of
service revenue increased by 8.1 percentage points, from 67.6% in the three
months ended January 31, 2007, to 75.7% in the three months ended January 31,
2008. This margin deterioration is
primarily due to higher material and overhead costs as well as duty costs needed
to support our installed base. Our cost
of services included $0.2 million of SFAS No. 123(R) share-based
compensation expense in both the three months ended January 31, 2008 and
2007.
As a percent of net services revenue, cost of services
will vary depending on a variety of factors, including our ability to weather
price erosion, the reliability and quality of our products and our need to
maintain customer service and support centers worldwide.
24
Operating
Expenses
Research and
Development Expenses
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
January 31,
|
|
2008 over 2007
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
($ in millions)
|
|
|
|
Research and development
|
|
$
|
25
|
|
$
|
23
|
|
8.7
|
%
|
As a percent of net revenue
|
|
12.5
|
%
|
13.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and Development.
Research and development expense includes costs related to:
·
salaries
and related compensation expenses for research and development and engineering
personnel;
·
materials
used in research and development activities;
·
outside
contractor expenses;
·
depreciation
of equipment used in research and development activities;
·
facilities
and other overhead and support costs for the above; and
·
share-based
compensation.
Research and development costs have generally been
expensed as incurred.
Research and development expense in the three months
ended January 31, 2008 increased in absolute dollars by $2 million
compared to the same time last year.
This increase was primarily due to higher expenses to support new
product introductions planned for release during the later part of 2008. Research and development as a percentage of
revenue decreased by 1.4 percentage points, from 13.9% in the three months
ended January 31, 2007 to 12.5% in the three months ended January 31,
2008. This decrease was primarily due to
increased product shipments in the three months ended January 31,
2008. Research and development expense
also included $0.5 million of SFAS No. 123(R) share-based
compensation expense for both the three months ended January 31, 2008 and
2007.
We believe that we need to maintain our level of
research and development spending in order to remain competitive and, as a
result, we expect our research and development expenses to vary only modestly.
Selling, General
and Administrative Expenses
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
January 31,
|
|
2008 over 2007
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
($ in millions)
|
|
|
|
Selling, general and
administrative
|
|
$
|
39
|
|
$
|
34
|
|
14.7
|
%
|
As a percent of net revenue
|
|
19.5
|
%
|
20.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, General and Administrative.
Selling, general and administrative expense (SG&A) includes costs related
to:
·
salaries
and related expenses for sales, marketing and applications engineering
personnel;
·
sales
commissions paid to sales representatives and distributors;
·
outside
contractor expenses;
·
other
sales and marketing program expenses;
25
·
travel
and professional service expenses;
·
salaries and related expenses for administrative,
finance, human resources, legal and executive personnel;
·
facility
and other overhead and support costs for the above; and
·
share-based compensation.
The $5 million increase in selling, general and
administrative expense in the three months ended January 31, 2008,
compared to the three months ended January 31, 2007, was primarily due to
higher selling costs and variable performance-based compensation, increased
infrastructure investment, increased governance costs and higher SFAS No. 123(R) share-based
compensation expense. SG&A expense
included approximately $2.7 million of SFAS No. 123(R) share-based
compensation expenses in the three months ended January 31, 2008, compared
to $2.6 million of such charges for the three months ended January 31,
2007.
Restructuring
Charges
In connection with the transfer of our manufacturing
activities to Flextronics in fiscal 2006, we transferred approximately 85
employees to Flextronics. As part of
this arrangement, we have a potential obligation in the future of approximately
$2 million associated with these transferred employees. We have deferred these costs and are
recognizing them ratably over the employees period of service until the
respective dates of the employees termination from Flextronics. Restructuring charges incurred for the three
months ended January 31, 2008 was $0.4 million and $1 million for the
three months ended January 31, 2007.
As of January 31, 2008, we had approximately $2
million in accrued restructuring liability.
Separation Costs
In connection with our separation from Agilent, we
incurred one-time internal and external separation costs, such as information
technology set-up costs and consulting and legal and other professional fees in
2007. These expenses totaled $0.1
million and $2 million in the three months ended January 31, 2008 and
2007, respectively.
Other Income
(Expense), net
Interest and other income was $5 million for the three
months ended January 31, 2008, and was $3 million for the three months
ended January 31, 2007. Interest
and other income consists primarily of interest earned on cash, cash
equivalents and investments as well as gains and losses from foreign exchange
transactions. The increase in interest
and other income during the three months ended January 31, 2008, compared
to the comparable period in fiscal year 2007, is primarily a result of
increased interest income from higher cash, cash equivalents and investment
balances.
Provision for
Income Taxes
We recorded income tax expense of approximately $3
million and $2 million in the three months ended January 31, 2008 and
2007, respectively. The higher tax
expense in the three months ended January 31, 2008 is primarily due to a
higher pre-tax income.
Our effective tax rate varies based on a variety of
factors, including overall profitability, the geographical mix of income before
taxes and the related tax rates in the jurisdictions where we operate,
completion of separation, restructuring and other one-time charges, as well as
discrete events, such as settlements of future audits. We may also be subject to audits and
examinations of our tax returns by tax authorities in various jurisdictions,
including the Internal Revenue Service.
We intend to regularly assess the likelihood of adverse outcomes
resulting from these examinations to determine the adequacy of our provision
for income taxes.
On November 1, 2007,
we adopted FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes (FIN 48). This interpretation clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements
in accordance with FASB Statement No. 109, Accounting for Income Taxes.
It prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position as well as
provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. The provision
of FIN 48 is effective for fiscal years beginning after December 15, 2006
and applies to all tax positions upon initial adoption of this standard.
Only tax positions that meet the more-likely-than-not recognition threshold at
the effective date may be recognized or continue to be recognized upon adoption
of FIN 48. As a result of the adoption of FIN 48, we increased our
reserves for unrecognized tax benefits by $0.2 million and increased our
reserves for penalties by $0.2 million, for a total increase of $0.4 million,
which was accounted for as a cumulative adjustment to the beginning balance of
retained earnings. Additionally, we
reclassified $10 million from current income taxes and other taxes
26
payable to long-term
taxes payable. At the adoption date of November 1,
2007, we had $9.8 million of unrecognized tax benefits which would reduce our
income tax expense if recognized. As of January 31,
2008, we had $10.4 million of unrecognized tax benefits which would reduce our
income tax expense if recognized. We
estimate that there will be no material changes in our unrecognized tax
benefits in the next 12 months.
Our continuing practice
is to recognize interest and penalties related to income tax matters as a
component of income tax expense. We had
approximately $0.6 million of accrued interest and penalties at the adoption
date of November 1, 2007 and approximately $0.8 million of accrued
interest and penalties as of January 31, 2008.
Although we file Singapore, U.S. federal, U.S. state
and foreign income tax returns, our three major tax jurisdictions are
Singapore, U.S. and Germany. Our 2006
and 2007 tax years remain subject to examination by the tax authorities in our
major tax jurisdictions. We are not
currently under audit for any tax years.
Financial
Condition
Liquidity and
Capital Resources
As of January 31, 2008, we had $192 million in
cash and cash equivalents, compared to $146 million as of October 31,
2007. This increase was primarily due to
cash proceeds from sale of available for sale securities and cash generated
from our operations partially offset by investments in other private companies
made during the quarter including the acquisition of Inovys.
Net Cash Provided by (Used in)
Operating Activities
In the three months ended January 31, 2008, we
generated $30 million in cash from operating activities, compared to cash
provided by operating activities of $4 million in the three months ended January 31,
2007. The $30 million cash generation
during the three months ended January 31, 2008, was the result of $32
million of net income, a $6 million reduction in receivables and $14 million
increase in other current and long-term assets and liabilities. Also, during the three months ended January 31,
2008, we had non-cash charges of $4 million in depreciation and amortization expense,
$2 million from gross inventory write-offs and $4 million of SFAS No. 123(R) share-based
compensation costs. These impacts were
partially offset by decreases of $8 million in payables, $6 million in employee
compensation and benefits, $11 million in deferred revenue and $7 million in
income taxes and other taxes payable.
In the three months ended January 31,
2007, we generated $4 million in cash
from operating activities. This $4 million cash generation was a result
of $13 million of net income, $45 million reduction in receivables and a $5
million increase in deferred revenue.
Also, during the three months ended January 31, 2007, we had
non-cash charges of $2 million from gross inventory write-offs, $4 million of
SFAS No. 123(R) share-based compensation costs, and $3 million in
depreciation and amortization expense.
These impacts were partially offset by decreases of $40 million in
payables, $8 million in employee compensation and benefits and $14 million in
income and other taxes payable.
Net
Cash Provided by
(Used in) Investing Activities
Net cash provided by investing activities in the three
months ended January 31, 2008, was $12 million, compared to
$6 million used in the three months ended January 31, 2007. The net cash generated was primarily related
to the net proceeds from the purchase and sales of available for sale
marketable securities of $42 million.
Our marketable securities include commercial paper, corporate bond and
government securities and auction rate securities. Auction rate securities are securities that
are structured with short-term interest rate reset dates of generally less than
ninety days but with contractual maturities that can be well in excess of ten
years. At the end of each reset period,
which occurs every seven to thirty-five days, investors can sell or continue to
hold the securities at par. In the
fourth quarter of fiscal year 2007, certain auction rate securities failed
auction due to sell orders exceeding buy orders. In the first quarter of 2008, we continued to
see deterioration in the market for these types of securities. Our auction rate
securities primarily consist of investments that are backed by pools of student
loans guaranteed by the U.S. Department of Education and other asset-backed
securities. We believe that the credit
quality of these securities is high based on these guarantees. Based on an analysis of other-than-temporary
impairment factors, we recorded a temporary impairment within other accumulated
comprehensive loss of approximately $4 million (net of tax of $1 million)
at January 31, 2008 related to these auction rate securities. Our marketable securities portfolio as of January 31,
2008 was $231 million. The
portfolio includes approximately $112 million (at cost) invested in
auction rate securities of which, $49.4 million (at cost) are currently
associated with failed auctions as of January 31, 2008, all of which have
been in a loss position for less than 12 months. The funds associated with failed auctions
will not be accessible until a successful auction occurs, a buyer is found
outside of the auction process, the underlying securities have matured or are
recalled by the issuer. Given the recent
disruptions in the credit markets and the fact that the liquidity for these
types of securities remains uncertain, we have classified substantially all of
our auction rate securities that were not liquidated subsequent to January 31,
2008 as long-term assets in our condensed consolidated balance sheet as our
ability to liquidate such securities in the next 12 months is uncertain.
27
Cash generated from our available-for-sale marketable
securities was partially offset by cash paid for the acquisition of Inovys and
other investments of $28 million, net of cash acquired.
Net cash used in investing activities in the three
months ended January 31, 2007 was $6 million. The $6 million expenditure was primarily
related to cash payments for site-set-ups and leasehold improvements.
Net Cash Provided by Financing
Activities
Net cash provided by financing activities in the three
months ended January 31, 2008, was $4 million, compared to $2 million in
the three months ended January 31, 2007.
The $4 million net cash proceeds in the three months ended January 31,
2008 was comprised of approximately $1 million from the exercise of employee
stock options, $3 million from contributions by participants of our Employee
Share Purchase Plan, for which 155,030
shares were issued in the three months ended January 31, 2008.
The $2 million net cash proceeds in the three months
ended January 31, 2007 was the result of the issuance of 144,481 shares as
part of the semi-annual purchase by participants in our Employee Share Purchase
Plan.
Other
On November 27, 2007, our Board of Directors approved the use of up to
$150 million to repurchase up to 10 percent of Verigys outstanding
ordinary shares. We will seek to obtain shareholder approval for this
repurchase program at our 2008 Annual General Meeting of Shareholders expected
to be held in April 2008.
Our liquidity is affected
by many factors, some of which are based on normal ongoing operations of our
business and some of which arise from fluctuations related to global economics
and markets. Our cash balances are generated
and held in many locations throughout the world. Local government regulations may restrict our
ability to move cash balances to meet cash needs under certain
circumstances. We do not currently
expect such regulations and restrictions to impact our ability to pay vendors
and conduct operations throughout our global organization.
We believe that existing cash, cash equivalents and
short-term marketable securities of approximately $329 million, together
with cash generated from operations, will be sufficient to satisfy our working
capital, capital expenditure and other liquidity needs at least through the
next twelve months. We may require or
choose to obtain debt or equity financing in the future. We cannot assure you that additional
financing, if needed, will be available on favorable terms or at all.
Contractual
Obligations and Commitments
Contractual Obligations
Our cash flows from operations are dependent on a
number of factors, including fluctuations in our operating results, accounts
receivable collections, inventory management and the timing of tax and other
payments. As a result, the impact of contractual obligations on our liquidity
and capital resources in future periods should be analyzed in conjunction with
such factors.
The following table summarizes our contractual
obligations at January 31, 2008:
|
|
|
|
Less than
|
|
One to three
|
|
Three to five
|
|
More than
|
|
(in millions)
|
|
Total
|
|
one year
|
|
years
|
|
years
|
|
five years
|
|
Operating leases
|
|
$
|
57
|
|
$
|
10
|
|
$
|
17
|
|
$
|
11
|
|
$
|
19
|
|
Commitments to contract
manufacturers and suppliers
|
|
121
|
|
121
|
|
|
|
|
|
|
|
Other purchase commitments
|
|
52
|
|
52
|
|
|
|
|
|
|
|
Long-term liabilities
|
|
49
|
|
|
|
14
|
|
35
|
|
|
|
Total
|
|
$
|
279
|
|
$
|
183
|
|
$
|
31
|
|
$
|
46
|
|
$
|
19
|
|
The table above
excludes approximately $10 million of unrecognized tax
benefits as we are unable to make reasonably reliable estimates of the period
of cash settlement with the respective taxing authority.
28
Operating leases.
Commitments under operating leases relate primarily to leasehold property. We have long-term lease arrangements for our
corporate headquarters in Singapore, our U.S. headquarters in Cupertino,
California, and our Boeblingen, Germany facility, currently the site of our
93000 Series platform development.
We also have long-term lease arrangements for our ASIC development
office in Colorado as well as other sales and support facilities around the
world.
Commitments to contract
manufacturers and suppliers.
We purchase components from a variety of suppliers and historically we have
used several contract manufacturers to provide manufacturing services for our
products. During the normal course of
business, we issue purchase orders with estimates of our requirements several
months ahead of the delivery dates. However,
our agreements with these suppliers usually allow us the option to cancel,
reschedule, or adjust our requirements based on our business needs prior to
firm orders being placed. Typically
purchase orders outstanding with delivery dates within 30 days are
non-cancelable. Therefore, only
approximately 19% of our purchase commitments arising from these agreements are
firm, non-cancelable and unconditional commitments. We expect to fulfill the purchase commitments
for inventory within one year.
In addition, we record a liability for firm,
non-cancelable and unconditional purchase commitments for quantities in excess
of our future demand forecasts. Such
liabilities were $5 million as of January 31, 2008 and October 31, 2007
for both periods presented. These amounts are included in other current
liabilities in our condensed consolidated balance sheets at January 31,
2008 and October 31, 2007.
Other purchase commitments.
Other purchase commitments relate primarily to contracts with professional services
suppliers, which include third-party consultants for legal, finance,
engineering and other administrative services.
With the exception of our IT service providers, our purchase commitments
from professional service providers are typically cancelable with a notice of
90 days or less without significant penalties.
Our agreement with our primary IT service provider requires a
notification period of 120 days and includes a termination charge of up to
approximately $1.6 million in order to cancel our long-term contract.
Long-term liabilities.
Long-term liabilities relate primarily
to $34 million of defined benefit and defined contribution retirement
obligations, $12 million of extended warranty and deferred revenue obligations,
$10 million in income taxes payable and approximately $3 million of other long-term
liabilities. Upon our separation from
Agilent, the defined benefit plans for our employees in Germany, Korea, Taiwan,
France and Italy were transferred to us.
With the exception of Italy and France, which involve relatively
insignificant amounts, Agilent completed the funding of these transferred
plans, based on 100% of the accumulated benefit obligation level as of the
separation date. Verigy made approximately
$2 million of contributions to the retirement plans during fiscal year
2007. We expect expenses of
approximately $7 million in fiscal year 2008 for the retirement plans and
will plan on making additional contributions during the second half of 2008.
Off-Balance Sheet Arrangements
We had no off-balance sheet arrangements as of January 31,
2008 or October 31, 2007.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Foreign
Currency Risk
With the exception of
Japan, where products are sold primarily in Yen, our products are generally
sold in U.S. Dollars. Services and
support sales are sold primarily in local currency when sold after the initial
product sale. As such, our revenue,
costs and expenses, and monetary assets and liabilities are somewhat exposed to
changes in foreign currency exchange rates as a result of our global operating
and financing activities.
We have implemented a
hedging strategy that is intended to mitigate our currency exposures by
entering into foreign currency forward contracts that have maturities of three
months or less. These contracts are used
to reduce our risk associated with exchange rate movements, as gains and losses
on these contracts are intended to offset exchange losses and gains underlying exposures. Not withstanding our efforts to mitigate some
foreign currency exposures, we do not hedge all of our foreign currency
exposures, and there can be no assurances that our efforts will adequately
protect us against the risks associated with foreign currency fluctuations. Verigy does not use derivative financial
instruments for speculative or trading purposes.
We performed a
sensitivity analysis assuming a hypothetical 10 percent adverse movement
in foreign exchange rates to the hedging contracts and the underlying exposures
described above. As of January 31,
2008, the analysis indicated that these hypothetical market movements would not
have a material effect on our consolidated financial position, results of
operations or cash flows.
Investment
and Interest Rate Risk
We account for our
investment instruments in accordance with SFAS No. 115,
Accounting for Investments in Debt and Equity
Securities
. All of our cash
and cash equivalents and marketable securities are treated as available for
sale under SFAS No.115. Our marketable
securities include commercial paper, corporate bond and government securities
and auction rate securities.
29
Our cash equivalents and
our portfolio of marketable securities are subject to market risk due to changes
in interest rates. Fixed rate interest
securities may have their market value adversely impacted due to a rise in
interest rates, while floating rate securities may produce less income than
expected if interest rates fall. Due in
part to these factors, our future investment income may fall short of
expectation due to changes in interest rates or we may suffer losses in
principal if we are forced to sell securities that decline in the market value
due to changes in interest rates.
However because we classify our debt securities as available for sale,
no gains or losses are recognized due to changes in interest rates unless such
securities are sold prior to maturity or declines in fair value are determined
to be other than temporary. Should
interest rates fluctuate by 10 percent, the value of our marketable
securities would not have a significant impact as of January 31, 2008 and
our interest income would have changed by approximately $0.5 million for
the three months ended January 31, 2008.
Auction rate securities are securities that are
structured with short-term interest rate reset dates of generally less than
ninety days but with contractual maturities that can be well in excess of ten
years. At the end of each reset period, which occurs every seven to thirty-five
days, investors can sell or continue to hold the securities at par. In the fourth quarter of fiscal year 2007,
certain auction rate securities failed auction due to sell orders exceeding buy
orders. In the first quarter of 2008, we
continued to see deterioration in the market for these types of securities. Our
auction rate securities primarily consist of investments that are backed by
pools of student loans guaranteed by the U.S. Department of Education and other
asset-backed securities. We believe that
the credit quality of these securities is high based on these guarantees. Based on an analysis of other-than-temporary
impairment factors, we recorded a temporary impairment within other accumulated
comprehensive loss of approximately $4 million (net of tax of $1 million)
at January 31, 2008 related to these auction rate securities. Our marketable securities portfolio as of January 31,
2008 was $231 million. The
portfolio includes approximately $112 million (at cost) invested in auction
rate securities of which, $49.4 million (at cost) are currently associated
with failed auctions as of January 31, 2008, all of which have been in a
loss position for less than 12 months.
The funds associated with failed auctions will not be accessible until a
successful auction occurs, a buyer is found outside of the auction process, the
underlying securities have matured or are recalled by the issuer. Given the recent disruptions in the credit
markets and the fact that the liquidity for these types of securities remains
uncertain, we have classified substantially all of our auction rate securities
that were not liquidated subsequent to January 31, 2008 as long-term
assets in our condensed consolidated balance sheet as our ability to liquidate
such securities in the next 12 months is uncertain.
We evaluate our investments periodically for possible
other-than-temporary impairment by reviewing factors such as the length of time
and extent to which fair value has been below cost basis, the financial condition
of the issuer and our ability and intent to hold the investment for a period of
time which may be sufficient for anticipated recovery of market value. In the future, should we determine that the
decline in value of these auction rate securities is other than temporary, it
would result in a loss being recognized in our statement of operations to the
extent that the carrying value of our available for sale securities exceeds the
estimated fair market value of the securities, which could be material.
ITEM 4. CONTROLS AND
PROCEDURES
Evaluation
of Disclosure Controls and Procedures
Our management has
evaluated, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, the effectiveness of our
disclosure controls and procedures as of January 31, 2008, pursuant to and
as required by Rule 13a-15(b) under the Securities Exchange Act of
1934 (the Exchange Act). Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of January 31, 2008, the companys disclosure controls
and procedures, as defined by Rule 13a-15(b) under the Exchange Act,
were effective and designed to ensure that (i) information required to be
disclosed in the companys reports filed under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the SECs
rules and forms, and (ii) information is accumulated and communicated
to management, including the Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosures. Based on their evaluation, Verigys Chief
Executive Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures are effective.
Inherent
Limitations on Effectiveness of Controls
Because of its inherent
limitations, disclosure controls and procedures and internal control over
financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions or that the degree of
compliance with the policies or procedures may deteriorate. Management necessarily applied its judgment
in assessing the benefits of controls relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been
detected. The design of any system of
controls is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions, regardless of
how remote.
30
Managements
Annual Report on Internal Control over Financial Reporting
Our management is
responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the
participation of our management, including our Chief Executive Officer and
Chief Financial Officer, we conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the framework in
Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on the results of this
evaluation, our management concluded that our internal control over financial
reporting was effective as of January 31, 2008.
Changes
in Internal Control over Financial Reporting
There were no changes in
our internal control over financial reporting during the quarter ended January 31,
2008, that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time we are subject to legal proceedings,
claims, and litigation arising in the ordinary course of business.
ITEM 1A. RISK FACTORS
Set forth below and elsewhere in this Quarterly Report on Form 10-Q
and in other documents we file with the SEC, are risks and uncertainties that
could cause actual results to differ materially from the results expressed or
implied by the forward-looking statements contained in this Quarterly
Report. You should carefully consider the risks described below and the
other information in this report before investing in our ordinary shares. Our
business could be seriously harmed by any of these risks. The trading price of
our ordinary shares could decline due to any of these risks, and you may lose
all or part of your investment. The following risk factors, Our
dependence on contract manufacturers may prevent us from delivering our
products on a timely basis, The loss of, or significant reduction in the
number of sales to, our significant customers could materially harm our
business,
We face substantial competition which, among other
things, may lead to price pressure and adversely affect our sales and revenue,
We
sell our products and services worldwide, and our business is subject to risks
inherent in conducting business activities in eographies outside of the United
States and Funds associated with certain of our auction rate securities may
not be accessible for in excess of 12 months and our auction rate securities
may experience an other than temporary decline in value, which would adversely
affect our income have been updated from the version of these risk factors
set forth in our Annual Report on Form 10-K for the year ended October 31,
2007.
A description of the risk
factors associated with our business is set forth below. You should carefully
consider the risks described below and the other information in this report
before investing in our ordinary shares. Our business could be seriously harmed
by any of these risks. The trading price of our ordinary shares could decline
due to any of these risks, and you may lose all or part of your investment.
Risks
Relating to Our Business
Our
dependence on sole source suppliers may prevent us from delivering our products
on a timely basis.
We rely on sole source
suppliers, some of whom are relatively small in size, for many of the
components we use in our products, including custom integrated circuits, relays
and other electronic components. In the past, we experienced, and in the future
may experience, delays in shipping our products due to our dependence on sole
source suppliers. Another sole source supplier substantially extended the order
lead times for the components we rely upon, and those components were difficult
to source in the market. While neither of these situations had a material
impact on our results, any future failure of other sole source suppliers to
meet our requirements in a timely manner could impair our ability to ship
products and to realize the related revenues when anticipated, which could
adversely affect our business and operating results.
Our
dependence on contract manufacturers may prevent us from delivering our
products on a timely basis.
We rely entirely on
contract manufacturers, which gives us less control over the manufacturing
process and exposes us to significant risks, especially inadequate capacity,
late delivery, substandard quality and high costs. Moreover, because our products
are very complex to manufacture, transitioning manufacturing activities from
one location to another, or from one manufacturing partner to another, is
complicated. Flextronics commenced production of our Versatest series products
in China in July 2006 and assumed our manufacturing activities for the
93000 Series products in Germany in June 2006. We expect to complete
the transition of our volume manufacturing activities related to our 93000 Series platform
to Flextronics in China by the end of fiscal year 2008. We cannot be certain that existing or future
contract manufacturers will be able to manufacture our products on a timely and
cost-effective basis, or to our quality and performance specifications. If our contract
manufacturers are unable to meet our manufacturing requirements in a timely
manner, whether as a result of transitional issues or otherwise, our ability to
ship products and to realize the related revenues when anticipated could be
materially affected.
31
Our
quarterly operating results may fluctuate significantly from period to period
and this may cause our share price to decline.
In the past, we have
experienced, and in the future we expect to continue to experience,
fluctuations in revenue and operating results from quarter to quarter for a
variety of reasons, including the risk factors described in this report. As a
result of these and other risks, we believe that quarter-to-quarter comparisons
of our revenue and operating results may not be meaningful, and that these
comparisons may not be an accurate indicator of our future performance. In
addition, sales of a relatively limited number of our test systems account for
a substantial portion of our net revenue in any particular quarter. In
contrast, our costs are relatively fixed in the short-term. Thus, changes in
the timing or terms of a small number of transactions could disproportionately
affect our operating results in any particular quarter. Moreover, our operating
results in one or more future quarters may fail to meet the expectations of
securities analysts or investors. If this occurs, we would expect to experience
an immediate and significant decline in the trading price of our ordinary
shares.
Our
business and operating results could be harmed by the highly cyclical nature of
the semiconductor industry.
Our business and
operating results depend in significant part upon capital expenditures of
semiconductor designers and manufacturers, which in turn depend upon the
current and anticipated market demand for products incorporating semiconductors
from these designers and manufacturers. Historically, the semiconductor
industry has been highly cyclical with recurring periods of diminished product
demand. During these periods, semiconductor designers and manufacturers, facing
reduced demand for their products, have significantly reduced their capital and
other expenditures, including expenditures for semiconductor test equipment and
services such as those we offer. These periods of reduced product and services
demand have been characterized by excessive inventory levels, cancellation of
customer orders and erosion of selling prices, as well as excessive
semiconductor test capacity. As a consequence, during these periods, we have experienced
significant reductions in customer orders for new test equipment, fewer
upgrades to existing test equipment and less demand for our test services. We
have also experienced order cancellations, delays in commitments and delays in
collecting accounts receivable. Furthermore, because we have a high proportion
of customers that are subcontractors, which during market downturns tend to
reduce or cancel orders for new test systems and test services more quickly and
dramatically than other customers, any downturn may cause a quicker and more
significant adverse impact on our business than on the broader semiconductor
industry. In addition, although a decline in orders for semiconductor capital
equipment, including test equipment, may accompany or precede the timing of a
decline in the semiconductor market as a whole, any recovery in spending for
semiconductor capital equipment, including test equipment, may lag any recovery
by the semiconductor industry.
We have
a limited ability to quickly or significantly reduce our costs, which makes us
particularly vulnerable to the highly cyclical nature of the semiconductor
industry.
Historically, downturns
in the semiconductor industry have affected the test equipment and services
market more significantly than the overall semiconductor industry. A
significant portion of our overall costs are fixed. Because a high proportion
of our costs are fixed, we have a limited ability to reduce expenses and
manufacturing inventory purchases quickly in response to decreases in orders
and revenues. Moreover, to remain competitive, even during downturns in the
semiconductor industry or generally, we are required to maintain significant
fixed costs for research and development. As a consequence, in a downturn, we
may not be able to reduce our costs quickly, or by a sufficient amount, and our
financial performance may suffer.
The
market for semiconductor test equipment and services is highly concentrated,
and we have limited opportunities to sell our test equipment and services.
The semiconductor
industry is highly concentrated in that a small number of semiconductor
designers and manufacturers and subcontractors account for a substantial
portion of the purchases of semiconductor test equipment and services
generally, including our test equipment and services. Consolidation in the
semiconductor industry may increase this concentration. Accordingly, we expect
that sales of our products will be concentrated with a limited number of large
customers for the foreseeable future. We believe that our financial results
will depend in significant part on our success in establishing and maintaining
relationships with, and effecting substantial sales to, these potential
customers. Even if we establish these relationships, our financial results will
depend in large part on these customers sales and business results.
The loss
of, or a significant reduction in the number of sales to, our significant
customers could materially harm our business.
For the three months
ended January 31, 2008, revenue from our top ten customers accounted for
approximately 69.8% of our total net revenue, with one customer accounting for
12.3% of our total net revenue. In comparison, for the three months ended January 31,
2007, revenue from our top ten customers accounted for approximately 70.9% of
our total net revenue, with one customer accounting for 15.2% of our total net
revenue.
32
Our relationships with
our significant customers, who frequently evaluate competitive products prior
to placing new orders, could be adversely affected by a number of factors,
including:
·
a
decision by our customers to purchase test equipment and services from our
competitors;
·
a
decision by our customers to pursue the development and implementation of
self-testing integrated circuits or other strategies that reduce their need for
our new or enhanced test equipment;
·
the
loss of market share by our customers in the markets in which they operate;
·
the
shift by our IDM customers to fabless semiconductor models;
·
our
ability to keep pace with changes in semiconductor technology;
·
our
ability to maintain quality levels of our equipment and services that meet
customer expectations;
·
our
ability to produce and deliver sufficient quantities of our test equipment in a
timely manner; and
·
our
ability to provide quality customer service and support.
Generally, our
customers may cancel orders with little or no penalty. Our business and
operating results could be materially adversely affected by the loss of, or any
reduction in orders by, any of our significant customers, particularly if we
are unable to replace that lost revenue with additional orders from new or
existing customers.
If we do
not maintain and expand existing customer relationships and establish new
customer relationships, our ability to generate revenue growth will be
adversely affected.
Our ability to increase
our sales will depend in large part upon our ability to obtain orders for new
test systems, enhancements for existing test systems and services from our
existing and new customers. Maintaining and expanding our existing
relationships and establishing new ones can require substantial investment
without any assurance from customers that they will place significant orders.
Moreover, if we are unable to provide new test systems, enhancements for
existing test systems and services to our customers in a timely fashion or in
sufficient quantities, our business will be harmed. In the past we have
experienced, and in our industry it is not unusual to experience, difficulty in
delivering new test equipment, as well as product enhancements and upgrades.
When we encountered difficulties in the past, our customer relationships and
our ability to generate additional revenue from customers were harmed. Our
inability to meet the demands of customers would severely damage our
reputation, which would make it more difficult for us to sell test equipment,
enhancements and services to existing, as well as new, customers and would
adversely affect our ability to generate revenue.
In addition, we face
significant obstacles in establishing new customer relationships. It is
difficult for us to establish relationships with new customers because such
companies may have existing relationships with our competitors, may be
unfamiliar with our product and service offerings, may have an installed base
of test equipment sufficient for their current needs or may not have the
resources necessary to transition to, and train their employees on, our test equipment.
Even if we do succeed in establishing new relationships, these new customers
may nonetheless continue to favor our competitors, as our competitors may have
had longer relationships with these customers or may maintain a larger
installed base of their competing test equipment in the facilities of new
customers and only purchase limited quantities from us. In addition, we could
face difficulties in our efforts to develop new customer relationships abroad
as a result of buying practices that may favor local competitors or non-local
competitors with a larger presence in local economies than we have. As a
result, we may be forced to partner with local companies in order to compete
for business and such arrangements, if available, may not be achieved on economically
favorable terms, which could negatively affect our financial performance.
Failure
to accurately estimate our customers demand and plan the production of our new
and existing products could adversely affect our inventory levels and our
income.
Given the cyclical nature
of the semiconductor industry, we cannot reliably forecast the timing and size
of our customers orders. In order to meet anticipated demand, we must order
components and build some inventory before we actually receive purchase orders.
Our results could be harmed if we do not accurately estimate our customers
product demands and are unable to adjust our purchases with market
fluctuations, including those caused by the cyclical nature of the
semiconductor industry. During a market upturn, our results could be materially
and adversely affected if we cannot increase our purchases of components, parts
and services quickly enough to meet increasing demand for our products, and
during a market downturn, we could have excess inventory that we would not be
able to sell, likely resulting in inventory write-offs. Either of these results
could have a material adverse effect on our business, financial condition and
results of operations.
33
Further, if we do not
successfully manage the introduction of our new products and estimate customer
demand for such products, our ability to sell existing inventory may be
adversely affected. If demand for our new products exceeds our projections, we
might have insufficient quantities of products for sale to our customers, which
could cause us to miss opportunities to increase revenues during market
upturns. If our projections exceed demand for our new products or if some of
our customers cancel their current orders for our old products in anticipation
of our new products, we may have excess inventories of our new products and
excess obsolete inventories, which could result in inventory write-offs that
would adversely affect our financial performance.
Failure to
accurately predict our customers varying ordering patterns could adversely
affect our inventory levels and our income.
Our customers tend to
make large purchases of our products on an inconsistent basis, rather than
smaller purchases on a consistent basis, which makes it difficult to predict
the timing of customer orders. Failure to accurately predict our customers
varying ordering patterns may cause us to experience insufficient or excess
product inventories. If our competitors are more successful than us at timing
new product introductions and inventory levels to customers ordering patterns,
we may lose important sales opportunities and our business and results of
operations may be harmed.
Existing
customers may be unwilling to bear expenses associated with transitioning to
new and enhanced products.
In order to grow our
business, we need to sell enhancements and upgrades for our existing test
equipment, in addition to selling new test equipment. Certain customers may be
unwilling, or unable, to bear the costs of implementing enhancements and
upgrades to our test equipment platforms, particularly during semiconductor
industry downturns. As a result, it may be difficult to market and sell
enhancements and upgrades to customers. In addition, as we introduce new
enhancements and upgrades, we cannot predict with certainty if and when our
customers will transition to those enhancements or upgrades. Any delay in or
failure of our customers to transition to new enhancements or upgrades could
result in excess inventories or our new or enhanced products, which could
result in inventory write-offs that would adversely affect our financial
performance.
If we do
not introduce new test equipment platforms and upgrade existing test equipment
platforms in a timely manner, and if we do not offer comprehensive and
competitive services for our test equipment platforms, our test equipment and
services will become obsolete, we will lose existing customers and our
operating results will suffer.
The semiconductor design
and manufacturing industry into which we sell our test equipment is
characterized by rapid technological changes, frequent new product
introductions, including upgrades to existing test equipment, and evolving
industry standards. The success of our new or upgraded test equipment offerings
will depend on several factors, including our ability to:
·
properly
identify customer needs and anticipate technological advances and industry
trends, such as the disaggregation of the traditional IDM semiconductor supply
chain into fabless design companies, foundries and packaging, assembly and test
providers;
·
develop
and commercialize new and enhanced technologies and applications that meet our
customers evolving performance requirements in a timely manner;
·
develop
and deliver enhancements and related services for our current test equipment
that are capable of satisfying our customers specific test requirements; and
·
introduce
and promote market acceptance of new test equipment platforms, such as our
Versatest V5500 Series system for memory testing.
In many cases, our test
equipment and services are used by our customers to develop, test and
manufacture their new products. We therefore must anticipate industry trends
and develop new test equipment platforms or upgrade existing test equipment
platforms in advance of the commercialization of our customers products. In
addition, new methods of testing integrated circuits, such as self-testing
integrated circuits, may be developed which would render our test equipment
uncompetitive or obsolete if we failed to adopt and incorporate these new
methods into our new or existing test equipment platforms. Developing new test
equipment platforms and upgrading existing test equipment platforms requires a
substantial investment before we can determine the commercial viability of the
new or upgraded platform.
As our customers product
requirements are diverse and subject to frequent change, we will also need to
ensure that we have an adequate mix of products that meet our customers
varying requirements. If we fail to adequately predict our customers needs and
technological advances, we may invest heavily in research and development of
test equipment that does not lead to significant revenue, or we may fail to
invest in technology necessary to meet changing customer demands. Without the
timely introduction of new or upgraded test equipment that reflects
technological advances, our test equipment and services will likely become
obsolete, we may have difficulty retaining customers and our revenue and
operating results would suffer.
34
Our long
and variable sales cycle depends upon factors outside of our control, could
cause us to expend significant time and resources prior to our ever earning
associated revenues and may therefore cause fluctuations in our operating
results.
Sales of our
semiconductor test equipment and services depend in significant part upon
semiconductor designers and manufacturers upgrading existing manufacturing
equipment to accommodate the requirements of new semiconductor devices and
expanding existing, and adding new, manufacturing facilities. As a result, our
sales are subject to a variety of factors we cannot control, including:
·
the
complexity of our customers fabrication processes, which impacts the number of
our test systems and amount of our product enhancements and upgrades our
customers require;
·
the
willingness of our customers to adopt new or upgraded test equipment platforms;
·
the
internal technical capabilities and sophistication of our customers, which
impacts their need for our test services; and
·
the
capital expenditures of our customers.
The decision to purchase
our equipment and services generally involves a significant commitment of capital.
As a result, our test equipment has lengthy and variable sales cycles during
which we may expend substantial funds and management effort to secure a sale
prior to receiving any commitment from a customer to purchase our test
equipment or services. Prior to completing sales to our customers, we are often
subject to a number of significant risks, including the risk that our
competitors may compete for the sale or that the customer may change its
technological requirements. Our business, financial condition and results of
operations may be materially adversely affected by our long and variable sales
cycle and the uncertainty associated with expending substantial funds and
effort with no guarantee that sales will be made.
Test
systems that contain defects that harm our customers could damage our
reputation and cause us to lose customers and revenue.
Our test equipment is
highly complex and employs advanced technologies. The use of complex technology
in our test equipment increases the likelihood that we could experience design,
performance or manufacturing problems. If any of our products have defects or
reliability or quality problems, we may, in some circumstances, be exposed to
liability, our reputation could be damaged significantly and customers might be
reluctant to buy our products, which could result in a decline in revenues, an
increase in product returns and the loss of existing customers and the failure
to attract new customers.
We face
substantial competition which, among other things, may lead to price pressure
and adversely affect our sales and revenue.
We face substantial
competition throughout the world in each of our product areas. Our most
significant competitors historically have included Advantest Corporation,
Credence Systems Corporation, LTX Corporation, Teradyne, Inc. and Yokogawa
Electric Corporation. Some of our competitors have substantially greater
financial resources, broader product offerings, more extensive engineering,
manufacturing, marketing and customer support capabilities or a greater
presence in certain countries than we do. We may have less leverage with
component vendors than some of our competitors. Also, some of our competitors
have greater resources and may be more willing or able than we are to put
capital at risk to win business. Price reductions by our competitors may force
us to lower our prices. We also expect our current competitors to continue to
improve the performance of their current products and to introduce new
products, technologies or services that could adversely affect sales of our
current and future test equipment and services. Additionally, current and
future competitors may introduce testing technologies, equipment and services,
which may in turn reduce the value of our own test equipment and services. Any
of these circumstances may limit our opportunities for growth and negatively
impact our financial performance.
We may
face competition from Agilent in the future.
Pursuant to the
intellectual property matters agreement between us and Agilent in connection
with our separation from Agilent, except as described below, until October 31,
2009, three years after the date on which Agilent distributed to its
stockholders all of our ordinary shares that it held, Agilent agreed not to
develop, manufacture, distribute, support or service automated semiconductor
test systems for providing high-volume functional test of ICs (including memory
and high speed memory devices and SOCs) or SIPs, or components for such
products. However, during this three-year period, Agilent may compete with us
with respect to:
·
products
(other than automated semiconductor test systems for high-volume functional
test) for providing functional test of ICs or SIPs, whether or not including
parametric test (the testing of selected parameters of a device or group of
devices to identify errors or flaws), design verification or engineering
characterization capabilities;
·
automated
semiconductor test development systems (including hardware and software) that
are intended to enable development of test programs and protocols for use in
high-volume functional test of ICs or SIPs, whether or not such development
test systems themselves are capable of performing such high-volume functional
test; and
35
·
products
(other than automated semiconductor test systems for high-volume functional
test) for providing parametric test, design verification, engineering
characterization or functional test of: (i) wireless communications
devices, such as cellular telephones or wireless networking products, whether
in packaged device or module form, and whether or not implemented as an IC or
SIP; (ii) modules (such as RF front-end modules) containing one or more
ICs connected with other active or passive devices; and (iii) RF and
higher frequency (e.g., microwave and optical) devices and components such as
oscillators, mixers, amplifiers and 3-port devices, to the extent that such
devices or components are in the form of an IC or SIP.
While none of the product
types for which Agilent reserved the right to compete with us has provided
material revenue to us in the past, we can provide no assurance that the
limitations contained in the intellectual property matters agreement, which was
entered into in the context of a parent-subsidiary relationship and may be less
favorable to us than if it had been negotiated between unaffiliated third
parties, will be effective at protecting us from competition from Agilent.
In addition, the
intellectual property matters agreement permits Agilent to fulfill its
obligations under contracts in existence as of March 1, 2006, even though
fulfilling such obligations would otherwise have been precluded during the
non-competition period and even if fulfilling such obligations would result in
Agilent competing with us. This exception will allow Agilent to fulfill its
obligations to a semiconductor manufacturer pursuant to which Agilent will
develop and sell components to the manufacturer for use in the manufacturers
semiconductor test systems purchased from a competitor of Verigy. While we do
not believe that Agilent fulfilling these obligations will have a material
effect on our business or prospects, we may in the future be less successful at
selling test systems to this semiconductor manufacturer than would have been
the case were the manufacturer not able to combine products from Agilent with
the test systems of our competitor.
Although under the
intellectual property matters agreement Agilent transferred all of the
intellectual property rights Agilent held that relate exclusively to our
products to us, Agilent retained and only licensed to us the intellectual
property rights to underlying technologies used in both our products and the
products of Agilent. Under the agreement, Agilent remains free to use the
retained underlying technologies without restriction (other than as described
above with respect to the three-year non-compete period).
After October 31,
2009, Agilent will be free to compete with any portion or all of our business without
restriction, and in doing so will be free to use the retained underlying
technologies. Agilent will not be permitted to use the intellectual property
rights transferred to us, and licensed from us back to Agilent, to compete with
us with respect to our core business of developing, manufacturing, selling and
supporting automated semiconductor test systems for high-volume functional test
of ICs or SIPs. Agilent will, however, be able to use such intellectual
property rights to develop and sell components for such systems, including
systems developed and sold by us as well as those developed and sold by our
competitors. While selling components has not represented a material portion of
our business in the past and is not expected to be an area of focus for the
near future, our business could be adversely affected if systems offered by our
competitors become more competitive as a result of Agilent supplying components
for our competitors systems or if, by buying components from Agilent, our
customers are able to delay or bypass altogether purchasing newer systems from
us.
Competition from Agilent
during or after the three-year non-compete period described above or other
actions taken by Agilent that create real or perceived competition with us,
could harm our business and operating results.
Third
parties may compete with us by using intellectual property that Agilent
licensed to us under the intellectual property matters agreement.
Under the intellectual
property matters agreement, Agilent retained and only licensed to us the
intellectual property rights to underlying technologies used in both our
products and the products of Agilent. Under the agreement, Agilent remains free
to license the intellectual property rights to the underlying technologies to any
party, including our competitors. Any unaffiliated third party that is licensed
to use such retained intellectual property would not be subject to the
non-competition provisions of the intellectual property matters agreement and
could compete with us at any time using the underlying technologies. The
intellectual property that Agilent retained and that can be licensed in this
manner does not relate solely or primarily to one or more of our products, or
groups of products; rather, the intellectual property that Agilent licensed to
us is generally used broadly across our entire product portfolio. Competition
by third parties using the underlying technologies retained by Agilent could
harm our business and operating results.
Third
parties may claim we are infringing their intellectual property, and we could
suffer significant litigation or licensing expenses or be prevented from
selling our products or services.
Our industry has been and
continues to be characterized by uncertain and conflicting intellectual
property claims and vigorous protection and pursuit of these rights. As a
result, third parties may claim that we are infringing their intellectual
property rights, and we may be unaware of intellectual property rights of
others that may cover some of our technology, products and services. Any
litigation regarding patents or other intellectual property could be costly and
time-consuming, and divert our management and key personnel from our business
operations. The complexity of the technology involved and the uncertainty of
intellectual property litigation increase these risks. Claims of intellectual
property infringement might also require us to enter into costly royalty or
license agreements. However, we may not be able to obtain royalty or license
agreements on terms acceptable to us, or at all. We also may be subject to
significant damages or injunctions against development and sale of certain of
our products and services.
36
In addition, there may be
third parties who have refrained from asserting intellectual property
infringement claims against our products while we were a wholly owned
subsidiary of Agilent that elect to pursue such claims against us now that our
separation from Agilent is complete because we no longer have the benefit of
being able to counterclaim based on Agilents patent portfolio, and we are no
longer able to provide licenses of Agilents patent portfolio in order to
resolve such claims.
Third
parties may infringe our intellectual property, and we may expend significant
resources enforcing our rights or suffer competitive injury.
Our success depends in
large part on our proprietary technology. We rely on a combination of patents,
copyrights, trademarks, trade secrets, confidentiality provisions and licensing
arrangements to establish and protect our proprietary rights. If we fail to
protect our intellectual property rights, our competitive position could
suffer, which could harm our operating results. Our pending patent and trademark
registration applications may not be allowed or competitors may challenge the
validity or scope of these patent applications or trademark registrations. In
addition, our patents may not provide us with a significant competitive
advantage.
We may be required to
spend significant resources to monitor and protect our intellectual property
rights. We may not be able to detect infringement and may lose competitive
position in the market before we do so. In addition, competitors may design
around our technology or develop competing technologies. Furthermore, the laws
of some foreign countries do not offer the same level of protection of our
proprietary rights as the laws of the United States, and we may be subject to
unauthorized use of our products or technologies in those countries,
particularly in Asia, where we expect our business to expand significantly in
the foreseeable future.
In addition, our
agreements with Agilent, and in particular the intellectual property matters
agreement, set forth the terms and provisions under which we received the
intellectual property rights necessary to operate our business. Under our
agreements with Agilent, we do not have the right to enforce against third
parties intellectual property rights we license from Agilent, and Agilent is
under no obligation to enforce such rights on our behalf.
Intellectual
property rights are difficult to enforce in the certain countries, which may
inhibit our ability to protect our intellectual property rights or those of our
suppliers and customers in those countries.
Commercial law in certain
countries is relatively undeveloped compared to the commercial law in the U.S.
Limited protection of intellectual property is available under local law.
Consequently, operating in certain countries may subject us to an increased
risk that unauthorized parties may attempt to copy or otherwise obtain or use
our intellectual property or the intellectual property of our suppliers,
customers or business partners. We cannot assure you that we will be able to protect
our intellectual property rights or those of our suppliers and customers or
have adequate legal recourse in the event that we encounter difficulties with
infringements of intellectual property under local law.
We may
incur a variety of costs to engage in future acquisitions of companies,
products or technologies, and the anticipated benefits of any acquisitions we
may make may never be realized.
We may acquire, or make
significant or minority investments in, complementary businesses, products or
technologies. Any future acquisitions or investments could be accompanied by
risks such as:
·
difficulties
in assimilating the operations and personnel of acquired companies;
·
diversion
of our managements attention from ongoing business concerns;
·
our
potential inability to maximize our financial and strategic position through
the successful incorporation of acquired technology and rights into our
products and services;
·
additional
expense associated with amortization of acquired assets;
·
difficulty
in maintaining uniform standards, controls, procedures and policies;
·
impairment
of existing relationships with employees, suppliers and customers as a result
of the integration of new management personnel;
·
dilution
to our shareholders in the event we issue shares as consideration to finance an
acquisition;
·
difficulty
integrating and implementing the accounting controls necessary to comply with
regulatory requirements such as Section 404 of the Sarbanes-Oxley Act; and
·
increased
leverage, if we incur debt to finance an acquisition.
We cannot guarantee that
we will realize any benefit from the integration of any business, products or
technologies that we might acquire in the future, and our failure to do so
could harm our business.
37
Our
executive officers and certain key personnel are critical to our business.
Our future operating
results will depend substantially upon the performance of our executive
officers and key personnel. Our future operating results also depend in
significant part upon our ability to attract and retain qualified management,
manufacturing, technical, application engineering, marketing, sales and support
personnel. Competition for qualified personnel is intense, and we cannot ensure
success in attracting or retaining qualified personnel. Our business is
particularly dependent on expertise which only a very limited number of
engineers possess and it may be increasingly difficult for us to hire personnel
over time. We operate in several geographic locations, including parts of Asia
and Silicon Valley, where the labor markets, especially for application
engineers, are particularly competitive. Our business, financial condition and
results of operations could be materially adversely affected by the loss of any
of our key employees, by the failure of any key employee to perform in his or
her current position, or by our inability to attract and retain skilled
employees, particularly engineers.
Our
effective tax rate may vary significantly from period to period, and we could
owe significant taxes even during periods when we experience low operating
profit or operating losses.
We have negotiated tax
incentives with the Singapore Economic Development Board, an agency of the
Government of Singapore, which have been approved by Singapores Ministry of
Finance and Ministry of Trade and Industry. Under the incentives, a portion of
the income we earn in Singapore during these ten to fifteen year incentive
periods is subject to reduced rates of Singapore income tax. The incentive tax
rates will expire in various fiscal years beginning in fiscal 2011. The
Singapore corporate income tax rate that would apply, absent the incentives, is
18% and 20% for fiscal years 2007 and 2006, respectively. As a result of these
incentives, income taxes decreased by $18 million or $0.30 per share
(diluted) and $8 million or $0.15 per share (diluted) in fiscal years 2007
and 2006, respectively. In order to receive the benefit of the incentives, we
must develop and maintain in Singapore certain functions such as procurement,
financial services, order management, credit and collections, spare parts depot
and distribution center, a refurbishment center and regional activities like an
application development center. In addition to these qualifying activities, we
must hire specified numbers of employees and maintain minimum levels of
investment in Singapore. We have from two to nine years to phase-in the
qualifying activities and to hire the specified numbers of employees. If we do
not fulfill these conditions for any reason, our incentive could lapse, our
income in Singapore would be subject to taxation at higher rates, and our
overall effective tax rate could be between fifteen to twenty percentage points
higher than would have been the case had we maintained the benefit of the
incentives.
In addition, our
effective tax rate may vary significantly from period to period because, for
example, we may owe significant taxes in jurisdictions other than Singapore
during periods when we are profitable in those jurisdictions even though we may
be experiencing low operating profit or operating losses on a consolidated
basis. Our effective tax rate varies based on a variety of factors, including
overall profitability, the geographical mix of income before taxes and the
related tax rates in the jurisdictions where we operate, as well as discrete
events, such as settlements of future audits. Certain combinations of these
factors could cause us to owe significant taxes even during periods when we
experience low income before taxes or loss before taxes.
We sell
our products and services worldwide, and our business is subject to risks
inherent in conducting business activities in geographies outside of the United
States.
Our headquarters are in
Singapore, our manufacturing is outsourced largely to Flextronics, and we sell
our products and services worldwide. As a result, our business is subject to
risks associated with doing business internationally. Revenue from customers in
Japan accounted for approximately 12.0% and 9.1% of total net revenue for the
three months ended January 31, 2008 and 2007, respectively. Revenue from customers in
Asia-Pacific, excluding Japan, accounted for approximately 68.5% and 37.6% for
the three months ended January 31, 2008 and 2007, respectively. The
economies of Asia have been highly volatile and recessionary in the past,
resulting in significant fluctuations in local currencies. Our exposure to the
business risks presented by the economies of Asia will increase to the extent
that we continue to expand our operations in that region, including continuing
to transition our volume contract manufacturing processes to Flextronics in
China.
Our international
activities subjects us to a number of risks associated with conducting
operations internationally, including:
·
difficulties
in managing geographically disparate operations;
·
potential
greater difficulty and longer time in collecting accounts receivable from
customers located abroad;
·
difficulties
in enforcing agreements through non-U.S. legal systems;
·
unexpected
changes in regulatory requirements that may limit our ability to export our
software or sell into particular jurisdictions or impose multiple conflicting
tax laws and regulations;
·
political
and economic instability, civil unrest or war;
·
terrorist
activities and health risks such as bird flu and SARS that impact
international commerce and travel;
38
·
difficulties
in protecting our intellectual property rights, particularly in countries where
the laws and practices do not protect proprietary rights to as great an extent
as do the laws and practices of the United States;
·
changing
laws and policies affecting economic liberalization, foreign investment,
currency convertibility or exchange rates, taxation or employment; and
·
nationalization
of foreign owned assets, including intellectual property.
In addition, we are
exposed to foreign currency exchange movements versus the U.S. dollar,
particularly the Japanese Yen and the Euro. With respect to revenue, our
primary exposure exists during the period between execution of a purchase order
denominated in a foreign currency and collection of the related receivable.
During this period, changes in the exchange rates of the foreign currency to
the U.S. Dollar will affect our revenue, cost of sales and operating margins
and could result in exchange gains or losses. While a significant portion of
our purchase orders to date have been denominated in U.S. Dollars, competitive
conditions may require us to enter into an increasing number of purchase orders
denominated in foreign currencies. We incur a variety of costs in foreign
currencies, including some of our manufacturing costs, component costs and
sales costs. Therefore, as we expand our operations in Asia, we may become more
exposed to a strengthening of currencies in the region against the U.S. dollar.
We cannot assure you that any hedging transactions we may enter into will be
effective or will not result in foreign exchange hedging gains or losses. As a
result, we are exposed to greater risks in currency fluctuations.
Funds
associated with certain of our auction rate securities may not be accessible
for in excess of 12 months and our auction rate securities may experience
an other than temporary decline in value, which would adversely affect our
income.
Our marketable securities portfolio, which totals
$231 million at January 31, 2008, includes auction rate securities of
approximately $112 million (at cost). Auction rate securities are securities
that are structured with short-term interest rate reset dates of generally less
than ninety days, but with contractual maturities that can be well in excess of
ten years. At the end of each reset period, which occurs every seven to thirty-five
days, investors can sell or continue to hold the securities at par. In the
fourth quarter of fiscal year 2007, certain auction rate securities failed
auction due to sell orders exceeding buy orders. In the first quarter of 2008, we continued to
see deterioration in the market for these types of securities and had failed
auctions as of January 31, 2008 with a cost value of
$49.4 million. Our auction rate
securities primarily consist of investments that are backed by pools of student
loans guaranteed by the U.S. Department of Education and other asset-backed
securities. We believe that the credit
quality of these securities is high based on these guarantees. Based on an analysis of other-than-temporary
impairment factors, we recorded a temporary impairment within other accumulated
comprehensive loss of approximately $4 million (net of tax of $1 million)
at January 31, 2008 related to these auction rate securities. Our marketable securities portfolio as of January 31,
2008 was $231 million. The portfolio
includes approximately $112 million (at cost) invested in auction rate
securities of which, $49.4 million (at cost) are currently associated with
failed auctions as of January 31, 2008, all of which have been in a loss
position for less than 12 months.
The funds associated with failed auctions will not be accessible until a
successful auction occurs, a buyer is found outside of the auction process, the
underlying securities have matured or are recalled by the issuer. Given the recent disruptions in the credit
markets and the fact that the liquidity for these types of securities remains
uncertain, we have classified substantially all of our auction rate securities
that were not liquidated subsequent to January 31, 2008 as long-term
assets in our condensed consolidated balance sheet as our ability to liquidate
such securities in the next 12 months is uncertain.
If our facilities or the facilities
of our contract manufacturers were to experience catastrophic loss due to
natural disasters, our operations would be seriously harmed.
Our facilities and the
facilities of our contract manufacturers could be subject to a catastrophic
loss caused by natural disasters, including fires and earthquakes. We and our
contract manufacturers have significant facilities in areas with above average
seismic activity, such as California, Japan and Taiwan. If any of these
facilities were to experience a catastrophic loss, it could disrupt our
operations, delay production and shipments, reduce revenue and result in large
expenses to repair or replace the facility. We do not carry catastrophic
insurance policies that cover potential losses caused by earthquakes.
Risks
Related to the Securities Markets and Ownership of Our Ordinary Shares
Our
securities have a limited trading history, and the price of our ordinary shares
may fluctuate significantly.
There has been a public
market for our ordinary shares for a short period of time. An active public
market for our ordinary shares may not be sustained, which would adversely
impact the liquidity and market price of our ordinary shares. The market price
of our ordinary shares may fluctuate significantly. Among the factors that
could affect the market price of our ordinary shares are the risk factors
described in this section and other factors including:
·
changes
in expectations as to our future financial performance, including financial
estimates or publication of research reports by securities analysts;
39
·
strategic
moves by us or our competitors, such as acquisitions or restructurings;
·
announcements
of new products or technical innovations by us or our competitors;
·
actions
by institutional shareholders; and
·
speculation
in the press or investment community.
We may
become involved in securities litigation that could divert managements
attention and harm our business.
The stock market in
general, and The NASDAQ Global Select Market and the securities of
semiconductor capital equipment companies in particular, have experienced
extreme price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of the affected companies.
Further, the market prices of securities of semiconductor test system companies
have been particularly volatile. These market and industry factors may
materially harm the market price of our ordinary shares, regardless of our
operating performance. In the past, following periods of volatility in the
market price of a particular companys securities, securities class action
litigation has often been brought against that company. We may become involved
in this type of litigation in the future. Such litigation, whether or not
meritorious, could result in the expenditure of substantial funds, divert
managements attention and resources, and harm our reputation in the industry
and the securities markets, which would reduce our profitability and harm our
business.
It may
be difficult for investors to affect service of process within the United
States on us or to enforce civil liabilities under the federal securities laws
of the United States against us.
We are incorporated in
Singapore under the Companies Act, Chapter 50 of Singapore, or Singapore
Companies Act. Some of our officers and directors reside outside the United
States. A substantial portion of our assets is located outside the United
States. As a result, it may not be possible for investors to effect service of
process within the United States upon us. Similarly, investors may be unable to
enforce judgments obtained in U.S. courts predicated upon the civil liability
provisions of the federal securities laws of the United States against us in
U.S. courts. Judgments of U.S. courts based upon the civil liability provisions
of the federal securities laws of the United States are not directly
enforceable in Singapore courts and are not given the same effect in Singapore
as judgments of a Singapore court. Accordingly, there can be no assurance as to
whether Singapore courts will enter judgments in actions brought in Singapore
courts based upon the civil liability provisions of the federal securities laws
of the United States.
Singapore
corporate law may impede a takeover of our company by a third party, which
could adversely affect the value of our ordinary shares.
Under the Singapore Code
on Take-overs and Mergers, generally when a person (or a group of persons
acting together) acquires shares having 30% or more of the voting rights of a
company or holds at least 30% but not more than 50% of the voting rights of a
company and thereafter acquires in any period of six months additional shares
carrying more than 1% of the voting rights, then such person is required by law
to make an offer to acquire the remaining voting shares of the company.
Consequently, the Code of Take-overs and Mergers may discourage potential
acquirers from purchasing substantial but non-majority ownership positions of
our ordinary shares, which could, in turn, impede takeovers of our company by a
third party.
For a
limited period of time, our directors have general authority to issue new
shares on terms and conditions and with any preferences, rights or restrictions
as may be determined by our board of directors in its sole discretion.
Under Singapore law, new
shares may be issued only with the prior approval of our shareholders in a
general meeting. At our 2007 annual general meeting of shareholders, our
shareholders provided our directors general authority to issue new shares until
the earlier to occur of the conclusion of our 2008 annual general meeting or
the expiration of the period within which the next annual general meeting is
required to be held. Subject to the shareholders approval, the provisions of
the Singapore Companies Act and our amended and restated memorandum and
articles of association, our board of directors may allot and issue new shares
on terms and conditions and with the rights and restrictions as they may think
fit to impose. Any additional issuances of new shares by our directors may
adversely impact the market price of our ordinary shares.
Our
shareholders may have more difficulty protecting their interests than they
would as shareholders of a U.S. corporation.
Our corporate affairs are governed by our amended and
restated memorandum and articles of association and by the laws governing
corporations incorporated in Singapore. The rights of our shareholders and the
responsibilities of the members of our board of directors under Singapore law
are different from those applicable to a corporation incorporated in the United
States. Therefore, our public shareholders may have more difficulty in
protecting their interests in connection with actions taken by our management,
members of our board of directors or our controlling shareholder than they
would as shareholders of a corporation incorporated in the United States. For
example, controlling shareholders in U.S. corporations are subject to fiduciary
duties while controlling shareholders in Singapore corporations are not subject
to such duties.
40
ITEM 2.
UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3.
DEFAULT UPON SENIOR SECURITIES
Not applicable
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
Not applicable
ITEM 5.
OTHER INFORMATION
U.S.
Officer Severance Agreements
On
March 6, 2008, the Compensation Committee approved an Amended and Restated
Severance Agreement to be entered into between the Company and each U.S.
officer of the Company. The Amended and Restated Severance Agreements bring such agreements into compliance with Section 409A
of the Internal Revenue Code and the final regulations and other official
guidance thereunder and replace in their entirety the original Severance
Agreements between the Company and the U.S. officers, approved by the
Compensation Committee on December 13, 2006.
The
form of Amended and Restated Severance Agreement is filed with this Quarterly
Report on Form 10-Q as Exhibit 10.11, and is incorporated by
reference in this description.
Amendment
to Pascal Rondé Awards
On
March 6, 2008, the Compensation Committee approved certain modifications
to the existing equity award agreements between the Company and Pascal Rondé in
order to structure the awards in a similar manner to equity awards for executives
worldwide.
Specifically,
Mr. Rondé was granted an
option to purchase 62,500 shares at the time of the Companys initial public
offering. That award provided for 100%
vesting on the fourth anniversary of the date of grant. The Compensation Committee approved a
modification to provide for annual vesting over the same four-year period,
which is consistent with awards made to other executives at that time. The
Compensation Committee also approved a modification to Mr. Rondés share
unit agreement, also granted at the time of the Companys initial public
offering, to provide for 50% vesting after two years and 25% per year
thereafter (fully vesting over the same four-year period as originally
provided).
Mr. Rondés
other share option agreements previously provided that the options were
exercisable four years and one day from the date of grant and expired 90 days
following termination of employment, which means that a vested option could
expire before it became exercisable. The
Compensation Committee approved a modification to Mr. Rondés share option
agreements to provide that the options will expire as to vested shares at the
later of (i) 90 days from termination of employment or (ii) 90 days
after they first become exercisable (but in no event later than the original
term of the option).
Finally,
the Compensation Committee approved modifications to Mr. Rondés other
share unit agreements to provide that RSUs settle as they vest.
The forms of amended award
agreements, as modified by the Compensation Committee as of March 6, 2008,
are attached to this Quarterly Report on Form 10-Q as Exhibits 10.2.7,
10.2.8, 10.2.11, 10.2.13, 10.2.15 and 10.2.16, and are incorporated into this
description under Item 5.
ITEM 6.
EXHIBITS
(a) Exhibits:
Exhibit
|
|
|
|
Incorporated By Reference
|
|
Number
|
|
Exhibit Description
|
|
Form
|
|
File Number
|
|
Exhibit
|
|
Date
|
|
Filed Herewith
|
|
3.1
|
|
Amended and Restated
Memorandum and Articles of Association of Verigy Ltd.
|
|
S-1/A
|
|
333-132291
|
|
3.2
|
|
6/5/2006
|
|
|
|
4.1
|
|
Form of Specimen
Share Certificate for Verigy Ltd.s Ordinary Shares
|
|
S-1/A
|
|
333-132291
|
|
4.1
|
|
6/1/2006
|
|
|
|
10.2.7**
|
|
Verigy Ltd. Amended and
Restated 2006 Equity Incentive Plan Share Option Agreement for the Share
Options Granted to Pascal Rondé on June 12, 2006
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.8**
|
|
Verigy Ltd. Amended and
Restated 2006 Equity Incentive Plan Share Unit Agreement for the Restricted
Share Units Granted to Pascal Rondé on June 12, 2006
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.11**
|
|
Verigy Ltd. Amended and
Restated Replacement Share Unit Agreement for the Restricted Share Units
Granted to Pascal Rondé, on October 31, 2006
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.13**
|
|
Form of Amended and
Restated Four-Tranche Officer Share Option Agreement for Pascal Rondé,
effective March 6, 2008
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.15**
|
|
Verigy Ltd. Amended and
Restated 2006 Equity Incentive Plan Share Unit Agreement for the Restricted
Share Units Granted to Pascal Rondé on December 13, 2006
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.16**
|
|
Form of Verigy Ltd.
2006 Equity Incentive Plan Share Unit Agreement for Pascal Rondé, as revised
2008
|
|
|
|
|
|
|
|
|
|
X
|
|
10.9.1**
|
|
Form of Amended and
Restated Severance Agreement for U.S.-Based Officers
|
|
|
|
|
|
|
|
|
|
X
|
|
31.1
|
|
Certification of
Principal Executive Officer Pursuant to Rule 13a-14 of the Securities
Exchange Act of 1934, As Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
|
|
|
|
X
|
|
31.2
|
|
Certification of
Principal Financial Officer Pursuant to Rule 13a-14 of the Securities
Exchange Act of 1934, As Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
|
|
|
|
X
|
|
32.1
|
|
Certification of
Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
|
|
|
|
X
|
|
32.2
|
|
Certification of
Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
|
|
|
|
X
|
|
** Management contracts or
compensation plans or arrangements in which directors or executive officers are
eligible to participate.
41
SIGNATURE
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.
Dated:
March 7, 2008
|
By:
|
/s/ Robert J.
Nikl
|
|
|
ROBERT J. NIKL
|
|
|
Vice President
and Chief Financial Officer
|
42
Verigy Ltd.
EXHIBIT INDEX
Exhibit
|
|
|
|
Incorporated By Reference
|
|
Number
|
|
Exhibit Description
|
|
Form
|
|
File Number
|
|
Exhibit
|
|
Date
|
|
Filed Herewith
|
|
3.1
|
|
Amended and Restated
Memorandum and Articles of Association of Verigy Ltd.
|
|
S-1/A
|
|
333-132291
|
|
3.2
|
|
6/5/2006
|
|
|
|
4.1
|
|
Form of Specimen
Share Certificate for Verigy Ltd.s Ordinary Shares
|
|
S-1/A
|
|
333-132291
|
|
4.1
|
|
6/1/2006
|
|
|
|
10.2.7**
|
|
Verigy Ltd. Amended and
Restated 2006 Equity Incentive Plan Share Option Agreement for the Share
Options Granted to Pascal Rondé on June 12, 2006
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.8**
|
|
Verigy Ltd. Amended and
Restated 2006 Equity Incentive Plan Share Unit Agreement for the Restricted
Share Units Granted to Pascal Rondé on June 12, 2006
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.11**
|
|
Verigy Ltd. Amended and
Restated Replacement Share Unit Agreement for the Restricted Share Units
Granted to Pascal Rondé, on October 31, 2006
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.13**
|
|
Form of Amended and
Restated Four-Tranche Officer Share Option Agreement for Pascal Rondé,
effective March 6, 2008
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.15**
|
|
Verigy Ltd. Amended and
Restated 2006 Equity Incentive Plan Share Unit Agreement for the Restricted
Share Units Granted to Pascal Rondé on December 13, 2006
|
|
|
|
|
|
|
|
|
|
X
|
|
10.2.16**
|
|
Form of Verigy Ltd.
2006 Equity Incentive Plan Share Unit Agreement for Pascal Rondé, as revised
2008
|
|
|
|
|
|
|
|
|
|
X
|
|
10.9.1**
|
|
Form of Amended and
Restated Severance Agreement for U.S.-Based Officers
|
|
|
|
|
|
|
|
|
|
X
|
|
31.1
|
|
Certification of
Principal Executive Officer Pursuant to Rule 13a-14 of the Securities
Exchange Act of 1934, As Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
|
|
|
|
X
|
|
31.2
|
|
Certification of
Principal Financial Officer Pursuant to Rule 13a-14 of the Securities
Exchange Act of 1934, As Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
|
|
|
|
X
|
|
32.1
|
|
Certification of
Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
|
|
|
|
X
|
|
32.2
|
|
Certification of
Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
|
|
|
|
X
|
|
** Management contracts or
compensation plans or arrangements in which directors or executive officers are
eligible to participate.
43
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