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  • 10-Q (Jun 12, 2008)
  • 10-Q (Mar 13, 2008)
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Credence Systems 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Graphic
  7. Graphic
Form 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

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

For the quarterly period ended May 3, 2008

OR

 

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

For the transition period from                      to                     

Commission file number 0-22366

 

 

CREDENCE SYSTEMS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-2878499

(State or other jurisdiction

of incorporation or organization)

 

(IRS Employer

Identification No.)

1421 California Circle, Milpitas, California

(Address of principal executive offices)

95035

(Zip Code)

(408) 635-4300

(Registrant’s telephone number, including area code)

N/A

Former name, former address and former fiscal year, if changed since last report.

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

 

Large accelerated filer  ¨   Accelerated filer  x   Non-accelerated filer  ¨   Smaller reporting company  ¨
    (Do not check if a smaller reporting company)  

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

At May 30, 2008, there were 102,499,393 shares of the Registrant’s common stock, $0.001 par value per share, outstanding.

 

 

 


CREDENCE SYSTEMS CORPORATION

INDEX

 

          PAGE NO.

PART I.

   FINANCIAL INFORMATION   

Item 1.

   Financial Statements    3
   Condensed Consolidated Balance Sheets    3
   Condensed Consolidated Statements of Operations    4
   Condensed Consolidated Statements of Cash Flows    5
   Notes to Condensed Consolidated Financial Statements    6

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    23

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk    32

Item 4.

   Controls and Procedures    33

PART II.

   OTHER INFORMATION   

Item 1.

   Legal Proceedings    33

Item 1A.

   Risk Factors    33

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    46

Item 3.

   Defaults Upon Senior Securities    46

Item 4.

   Submission of Matters to a Vote of Security Holders    47

Item 5.

   Other Information    47

Item 6.

   Exhibits    47

Signature

      48

 

2


PART I - FINANCIAL INFORMATION

Item 1. - FINANCIAL STATEMENTS

CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

 

     May 3,
2008
    November 3,
2007(a)
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 220,682     $ 179,264

Short-term investments

     7,778       62,869

Accounts receivable, net of allowance of $808 and $883, respectively

     58,114       64,174

Inventories

     50,257       62,506

Income tax receivable

     452       440

Deferred income taxes

     9,473       9,902

Prepaid expenses and other current assets

     19,760       16,260
              

Total current assets

     366,516       395,415

Property and equipment, net

     45,091       75,299

Long-term investments

     4,091       —  

Goodwill

     —         2,606

Other intangible assets, net

     51,039       65,966

Other assets

     41,728       50,026
              

Total assets

   $ 508,465     $ 589,312
              
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 16,179     $ 20,365

Accrued expenses and other liabilities

     34,573       29,500

Accrued payroll and related liabilities

     13,487       16,715

Convertible subordinated notes, current portion

     70,700       70,700

Deferred revenue

     23,774       27,679

Income taxes payable

     (1,847 )     8,563

Accrued warranty

     8,626       12,384

Deferred profit

     2,677       2,703
              

Total current liabilities

     168,169       188,609

Convertible subordinated notes, long-term portion

     120,628       119,728

Long-term restructuring liabilities

     1,291       1,249

Long-term deferred income taxes

     9,473       9,473

Long-term income taxes payable

     7,012       —  

Other liabilities

     33,578       33,998
              

Total liabilities

     340,151       353,057

Stockholders’ equity

     168,314       236,255
              

Total liabilities and stockholders’ equity

   $ 508,465     $ 589,312
              

 

(a) Derived from the audited consolidated balance sheet included in the Company’s Annual Report on Form 10-K for the year ended November 3, 2007.

See accompanying notes.

 

3


CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

     Three Months Ended     Six Months Ended  
     May 3,
2008
    May 5,
2007
    May 3,
2008
    May 5,
2007
 

Net sales:

        

Systems and upgrades

   $ 46,777     $ 95,514     $ 88,070     $ 186,159  

Service and spare parts

     21,336       26,027       43,451       54,500  
                                

Total net sales

     68,113       121,541       131,521       240,659  

Cost of goods sold

        

Systems and upgrades

     23,190       45,928       42,491       92,557  

Service and spare parts

     15,666       20,397       30,950       41,384  

Restructuring charges

     1,300       —         4,081       —    
                                

Total cost of goods sold

     40,156       66,325       77,522       133,941  

Gross margin

     27,957       55,216       53,999       106,718  

Operating expenses:

        

Research and development

     15,741       20,362       32,976       41,540  

Selling, general and administrative

     19,712       29,114       41,234       54,953  

Amortization of purchased intangibles

     3,272       4,454       7,723       8,909  

Impairment charges and loss on disposal of product line

     3,394       —         26,349       —    

Restructuring charges

     1,892       526       12,561       1,018  

Loss on disposal of facilities

     —         —         3,600       —    
                                

Total operating expenses

     44,011       54,456       124,443       106,420  
                                

Operating income (loss)

     (16,054 )     760       (70,444 )     298  

Interest income

     1,864       1,936       4,484       3,096  

Interest expense

     (2,531 )     (2,301 )     (5,061 )     (3,489 )

Other income (expenses), net

     (1,275 )     (1,979 )     (2,383 )     555  
                                

Income (loss) before income tax provision

     (17,996 )     (1,584 )     (73,404 )     460  

Provision for income taxes

     683       1,870       1,402       3,925  
                                

Net loss

   $ (18,679 )   $ (3,454 )   $ (74,806 )   $ (3,465 )
                                

Net loss per share

        

Basic

   $ (0.18 )   $ (0.03 )   $ (0.73 )   $ (0.03 )
                                

Diluted

   $ (0.18 )   $ (0.03 )   $ (0.73 )   $ (0.03 )
                                

Number of shares used in computing per share amount

        

Basic

     102,016       101,028       101,853       100,816  
                                

Diluted

     102,016       101,028       101,853       100,816  
                                

See accompanying notes.

 

4


CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Six Months Ended  
     May 3,
2008
    May 5,
2007
 

Cash flows from operating activities:

    

Net loss

   $ (74,806 )   $ (3,465 )

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     21,575       25,266  

Share-based compensation charges

     1,895       3,221  

Provision for inventory write downs

     757       842  

Recovery for allowance for doubtful accounts

     (39 )     (223 )

Impairment of goodwill and long-lived assets and loss on disposal of product line

     26,349       —    

Disposal of long-term intellectual property asset

     —         679  

Loss on disposal of property and equipment

     3,620       1,901  

Gain on exchanged convertible notes

     —         (2,955 )

Changes in operating assets and liabilities:

    

Accounts receivable, net

     4,662       (7,307 )

Inventories

     614       (8,688 )

Income tax receivable and payable

     850       (4,425 )

Prepaid expenses and other current assets

     (2,445 )     1,172  

Other assets

     (2,601 )     (12,400 )

Accounts payable

     (4,383 )     (6,562 )

Accrued expenses and other current liabilities

     (6,987 )     503  

Deferred profit

     1,070       5,291  
                

Net cash used in operating activities

     (29,869 )     (7,150 )

Cash flows from investing activities:

    

Purchases of available-for-sale securities

     (8,738 )     (40,163 )

Maturities of available-for-sale securities

     56,516       2,000  

Sales of available-for-sale securities

     3,472       —    

Acquisition of property and equipment

     (1,664 )     (3,019 )

Proceeds from sale of property and equipment

     18,959       2,691  
                

Net cash provided by investing activities

     68,545       (38,491 )

Cash flows from financing activities:

    

Issuance of common stock

     494       878  

Proceeds from issuance of convertible notes, net of issue costs

     —         44,129  

Proceeds from direct financing sale-leaseback

     —         30,000  
                

Net cash provided by financing activities

     494       75,007  
                

Effects of exchange rate on cash and cash equivalents

     2,248       (1,297 )
                

Net increase in cash and cash equivalents

     41,418       28,069  

Cash and cash equivalents at beginning of period

     179,264       95,635  
                

Cash and cash equivalents at end of period

   $ 220,682     $ 123,704  
                

Supplemental disclosures of cash flow information:

    

Interest paid

   $ 2,688     $ 1,193  

Income taxes paid

   $ 469     $ 8,080  

Non-cash investing and financing activities:

    

Net transfers of inventory to property and equipment

   $ 495     $ 1,095  

Unrealized gain on available-for-sale securities

   $ (22 )   $ (19 )

See accompanying notes.

 

5


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. Quarterly Financial Statements

The condensed consolidated financial statements and related notes for the three month periods ended May 3, 2008 and May 5, 2007 are unaudited but include all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations of Credence Systems Corporation (Credence or the Company) for the interim periods, in accordance with U.S. generally accepted accounting principles. The results of operations for the three and six month periods ended May 3, 2008 and May 5, 2007 are not necessarily indicative of the operating results to be expected for the full fiscal year. The information included in this report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the fiscal year ended November 3, 2007 included in the Company’s most recent Annual Report on Form 10-K and the additional risk factors contained herein and therein, including, without limitation, risks relating to the importance of timely product introduction, fluctuations in the Company’s quarterly net sales and operating results, limited systems sales, backlog, cyclicality of the semiconductor industry, management of fluctuations in our operating results, expansion of our product lines, limited sources of supply, reliance on the Company’s outsourced manufacturing and logistics, reliance on distributors, the Company’s highly competitive industry, customization of products, rapid technological change, customer concentration, lengthy sales cycles, changes in financial accounting standards and accounting estimates, dependence on key personnel, international operations and sales, proprietary rights, legal proceedings, compliance with environmental regulations, volatility of the Company’s stock price, retention of executive offices and key personnel, requirement of significant cash and future financing, terrorist attacks and other geopolitical instability, effects of the changes in securities law and regulations, Sarbanes-Oxley Act of 2002, and effects of certain anti-takeover provisions, as set forth in this Report. Any party interested in receiving a free copy of the Form 10-K or the Company’s other publicly available documents should write to the Chief Financial Officer of the Company.

Description of Business — Credence was incorporated in California in March 1982 and was reincorporated in Delaware in October 1993. The principal business activity of the Company is the design, development, manufacture, sale and service of integrated test solutions throughout the design, validation and production processes for semiconductors.

Basis of Presentation — The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Effective in the second quarter of fiscal 2008, the Company reclassified certain product revenue as net sales instead of as an offset to cost of goods sold expenses. For the three and six month periods ended May 3, 2008, the total amount of this product classified as net sales is $0.5 million and $0.7 million, respectively. For comparative purposes, for the three and six month periods ended May 5, 2007, $0.4 million and $0.7 million, respectively, of this product revenue has been reclassified as net sales. These reclassifications had no effect on the financial position, results of operations or cash flows for any of the periods presented.

Critical Accounting Policies and Use of Estimates — The preparation of the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the unaudited Condensed Consolidated Financial Statements and accompanying notes. Actual results could differ from those estimates. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, allowance for doubtful accounts, inventory valuation and residual values related to leased products, long-lived assets and intangible valuation, warranty accrual, deferred taxes, restructuring charges and other accrued liabilities, share-based compensation and legal contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Since the Company’s fiscal year ended November 3, 2007, there have been no significant changes in the Company’s critical accounting policies and estimates other than the adoption of Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an Interpretation of FASB Statement No. 109 (FIN 48), — see Note 10 — “Income Taxes.” Please refer to Part II, Item 8, “Financial Statements and Supplementary Data,” Note 1 — “Organization and Summary of Significant Accounting Policies” included in the Company’s most recent Annual Report on Form 10-K for the fiscal year ended November 3, 2007, as filed with the SEC on January 17, 2008, for a discussion of the Company’s critical accounting policies and use of estimates.

Revenue Recognition

The Company recognizes revenue on the sale of semiconductor manufacturing equipment under Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, “Revenue Recognition,” (SAB 104), when title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is fixed

 

6


or determinable, collection is reasonably assured and customer acceptance criteria have been successfully demonstrated. With respect to arrangements with multiple deliverables, the Company follows the guidance in Emerging Issue Task Force No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21), to determine whether there is more than one unit of accounting. To the extent that the deliverables are separable into multiple units of accounting, the Company then allocates the total fee on such arrangements to the individual units of accounting using the residual method. Under the residual method, the amount of consideration allocated to the delivered items equals the total arrangement consideration less the aggregate fair value of the undelivered items. The Company then recognizes revenue for each unit of accounting when the deliverables have been met for following the guidance provided in SAB 104.

Revenue recognition policies are applied consistently among the Company’s semiconductor manufacturing equipment product lines. Product revenue is recognized upon shipment only when achievement of customer acceptance criteria can be demonstrated prior to shipment, which generally is the case with mature products, and when all other deliverables are delivered or the Company has established fair value for the undelivered items. Products are classified as mature after system acceptance has been consistently demonstrated. When the customer acceptance criteria cannot be demonstrated prior to shipment, revenue and the related cost of goods sold are deferred until customer acceptance is obtained. The Company warrants its products to its customers generally for one year from the date of shipment. In addition to standard warranties, the Company may offer customers extended warranty services for a fixed fee. Extended warranty services consist of service contracts which can be purchased at the time of product sale or at the completion of the original warranty period. The Company has established fair value for service contracts based upon the price when sold separately. Revenue for service contracts is recognized on a straight-line basis over the applicable term of the contract. Revenue related to the fair value of the installation obligation is recognized upon completion of the installation.

Deferred revenue primarily consists of the unrecognized portions of extended warranty service contracts and other undelivered services, including installations. Deferred profit consists of the unrecognized gross margin on equipment that was shipped to certain customers, but for which the revenue and cost of goods sold are not recognized because the customer-specified acceptance criteria has not been met as of the fiscal period end or because the customer is deemed to be a high credit risk and payment has not been received as of the fiscal period end.

As the Company introduces new products and enhancements certain revenue from sales of these new systems are deferred until the revenue recognition requirements of the Company’s revenue recognition policy are satisfied. In the past, the Company experienced significant delays in the introduction and acceptance of new testers as well as certain enhancements to the Company’s existing testers. Delays in introducing a product or delays in the Company’s ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by the Company.

The Company has embedded software in its semiconductor manufacturing equipment. The Company believes this embedded software is incidental to its products and therefore it is excluded from the scope of Statement of Position 97-2, “Software Revenue Recognition” (SOP 97-2), since the embedded software in the Company’s products is not sold separately, cannot be used on another vendor’s products, and the Company cannot fundamentally enhance or expand the capability of the equipment with new or revised embedded software. In addition, the equipment’s principal performance characteristics are governed by digital speed and pin count, which are primarily a function of the hardware.

Lease revenue is recorded in accordance with Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” (SFAS 13), which requires that a lessor account for each lease by either the sales-type or operating method. Revenue from sales-type leases is recognized at the net present value of future lease payments. Revenue from operating leases is recognized over the lease period.

Sales in the United States are principally made through the Company’s direct sales organization consisting of direct sales employees and representatives. Sales outside the United States utilize both direct sales employees and distributors. There are no significant differences in revenue recognition policies based on the sales channel, due to the business practices that have been adopted with the Company’s distributor relationships. Because of these business circumstances, the Company does not use “price protection,” “stock rotation” or similar programs with its distributors. In general, the Company sells products to the distributor on the basis of a purchase order received from an end customer. The Company evaluates any revenue recognition issues, in such cases, based on the characteristics of the distributor and the end customer.

For some customers in certain countries where collections may be uncertain, the Company may require a letter of credit to be established or cash receipt in advance before revenue can be recognized. In addition, certain customers, typically those with whom the Company has long-term relationships, the Company may grant extended payment terms. Certain of the Company’s receivables have due dates in excess of 90 days and the Company has a history of successfully collecting these accounts receivable.

 

7


2. Guarantees

The Company accounts for guarantees in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34” (FIN 45). Accordingly, the Company evaluates its guarantees to determine whether (a) the guarantee is specifically excluded from the scope of FIN 45, (b) the guarantee is subject to FIN 45 disclosure requirements only, but not subject to the initial recognition and measurement provisions, or (c) the guarantee is required to be recorded in the financial statements at fair value. The Company has evaluated its guarantees and has concluded that they are either not within the scope of FIN 45 or do not require recognition in the financial statements.

The Company’s corporate by-laws require that the Company indemnify its officers and directors, as well as those who act as directors and officers of other entities at the Company’s request, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceedings arising out of their services to the Company. In addition, the Company has entered into separate indemnification agreements with each director and each executive officer of the Company that provide for indemnification of these directors and officers under similar circumstances and under additional circumstances. The indemnification obligations are more fully described in the by-laws and the indemnification agreements. The Company purchases standard directors and officers insurance to cover claims or a portion of the claims made against its directors and officers. Since a maximum obligation is not explicitly stated in the Company’s by-laws or in the indemnification agreements and will depend on the facts and circumstances that arise out of any future claims, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not been required to make payments related to these obligations, and the fair value for these obligations is zero on the consolidated balance sheet as of May 3, 2008.

As is customary in the Company’s industry and as provided for under local law in the United States and other jurisdictions, many of the Company’s standard contracts provide remedies to customers and others with whom the Company does business, such as defense, settlement, or payment of judgment for intellectual property claims related to the use of the Company’s products. From time to time, the Company indemnifies customers, as well as the Company’s suppliers, contractors, lessors under operating lease agreements for environmental matters, lessees, companies that purchase the Company’s businesses or assets and others with whom the Company enters into contracts, against combinations of loss, expense, or liability arising from various triggering events related to the sale and the use of the Company’s products and services such as warranty, the use of their goods and services, the use of facilities and state of the Company’s owned facilities, the state of the assets and businesses that the Company sells and other matters covered by such contracts, usually up to a specified maximum amount. Based on past experience, claims made under such indemnifications are rare and the associated estimated fair value of the liability is not material.

 

3. Share-Based Compensation

Stock Option Plans

The Company has a share-based compensation program that provides its Board of Directors broad discretion in creating employee equity incentives. This program includes incentive and non-statutory stock options, restricted stock units and other types of equity granted under various plans, the majority of which are stockholder approved. Stock options are generally time-based, vesting over a four-year period with 12.5% of the granted shares vesting six months after the grant date, and the remaining shares vesting at the rate of 6.25% each quarter thereafter for the following 14 quarters over four years and expire seven to ten years from the grant date. Additionally, the Company has an Employee Stock Purchase Plan (ESPP) that allows employees to purchase shares of common stock at 85% of the fair market value at the lower of either the date of enrollment or the date of purchase. Shares issued as a result of stock option exercises and the Company’s ESPP are generally from the Company’s new shares. As of May 3, 2008, the Company had approximately 10,700,000 shares of common stock reserved for future issuance under the stock option plans and ESPP.

On August 9, 2000, the Board of Directors authorized the Company’s Supplemental Stock Option Plan (the “2000 Plan”) and authorized 500,000 shares for issuance. This additional reserve of shares supplements the Company’s 1993 Stock Option Plan and is for issuance to individuals employed by the Company who are neither officers of the Company nor members of the Board. On November 27, 2000 the Board of Directors authorized an additional 500,000 shares for issuance under the Supplemental Stock Option Plan. In addition, on November 27, 2001, the Board of Directors authorized an additional 500,000 shares for issuance under the Supplemental Stock Option Plan.

In fiscal year 2005, the Company’s Board of Directors and stockholders approved the 2005 Stock Incentive Plan (the “2005 Plan”) which provides for the grant of options to purchase shares of the Company’s common stock, stock appreciation rights and restricted stock to employees, members of the Board of Directors and consultants. The maximum number of shares originally available for grant under the 2005 Plan was 5,900,000 shares. On April 1, 2008, the stockholders approved an additional 9,000,000 shares for issuance under the 2005 Plan.

 

8


During fiscal year 2005, the 1993 Stock Option Plan (the “1993 Plan”), under which the Company previously granted options to employees and members of the Board of Directors, expired. However, outstanding options granted under the 1993 Plan remains exercisable in accordance with the terms of the original grant agreements.

In August 2005, the Company’s Board of Directors approved the accelerated vesting of certain unvested and “out-of-the-money” non-qualified stock options previously awarded to employees and officers with option exercise prices equal to or greater than $9.15. Options held by non-employee directors are excluded from the vesting acceleration. In addition, in order to prevent executive officers from unintended personal benefits, the Company’s executive officers have agreed to the imposition of restrictions on any shares received through the exercise of accelerated options. Those restrictions will prevent the sale of any shares received from the exercise of an accelerated option until the earlier of the original vesting date of the option or the executive officer’s termination of employment. The $9.15 price was selected because it was higher than the closing price of the Company’s common stock of $8.84 on August 29, 2005, the date of this acceleration. The accelerated options represent approximately 15% or approximately 2,800,000 shares of the total of all outstanding Credence options on August 29, 2005. The acceleration was intended to reduce the stock option expense the Company would be required to record after the adoption of Statement of Financial Accounting Standard No. 123(R)—”Share-Based Payment” (SFAS 123(R)). This acceleration reduced approximately $10.0 million of stock option expenses under SFAS 123(R) which would have been recognized as an expense through December 2008.

In calculating the compensation cost under SFAS 123 (R), the Company estimates the fair value of each option grant on the date of grant using the Black-Scholes-Merton options pricing and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period or the remaining service (vesting) period. The Black-Scholes-Merton option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes-Merton model requires the input of highly subjective assumptions including the expected stock price volatility and expected term.

In April, July and August 2007 and January 2008, the Company’s Board of Directors approved inducement stock option grants to certain officers of the Company which were made outside of any current Company plan. The inducement stock options are granted out of the Company’s authorized common stock. The Company elected to make inducement option grants to induce and attract higher qualified candidates to accept employment with the Company and to fill open officer positions. These inducement option grants were valued under SFAS 123(R) using the same assumptions and methodology that the Company used for its employee option grants from the Company plan. The fair value is marked to market as compensation until the underlying shares are registered. As of May 3, 2008 there were 930,000 shares issued and outstanding under these awards.

The following table illustrates the share-based compensation expense resulting from stock options and ESPP included in the unaudited condensed consolidated statement of operations for the three and six month periods ended May 3, 2008 and May 5, 2007 (in thousands):

 

     Three Months Ended    Six Months Ended
     May 3, 2008    May 5, 2007    May 3, 2008    May 5, 2007

Cost of goods sold

   $ 125    $ 89    $ 287    $ 187

Research and development

     157      338      414      746

Selling, general and administrative

     460      861      1,194      2,058
                           

Share-based compensation expense before income taxes benefit

   $ 742      1,288    $ 1,895    $ 2,991

Income tax benefit

     —        —        —        —  
                           

Share-based compensation expense after income taxes benefit

   $ 742    $ 1,288    $ 1,895    $ 2,991
                           

As of May 3, 2008 and May 5, 2007, the Company capitalized $0.2 million and $0.2 million of share-based compensation expense as inventory, respectively; therefore, such amounts are excluded in the cost of goods sold amounts above.

 

9


The following is a summary of activity under the Company’s stock option plan for the six months ended May 3, 2008:

 

     Options
Available

for Grant
(In thousands)
    Number of
Options
Outstanding
(In thousands)
    Weighted
Average
Exercise Price
per share
   Aggregate
Intrinsic Value
(In thousands)
   Weighted
Average
Remaining
Contractual Life
(In years)

Balance at November 3, 2007

   2,039     15,266     $ 11.00      

Share plan increase

   9,000     —         —        

Options granted

   (1,712 )   1,708     $ 1.54      

Options canceled

   976     (1,159 )   $ 4.83      

Options forfeited/expired

   —       (1,150 )   $ 13.59      

Options exercised

   —       (78 )   $ 1.07      
                    

Balance at May 3, 2008

   10,303     14,587     $ 10.78    $ 22,491    4.28
                          

Vested or expected to vest at May 3, 2008

     10,072     $ 12.83    $ 8,044    3.79
                      

Exercisable at May 3, 2008

     10,043     $ 12.85    $ 7,982    3.79
                      

Restricted stock units are granted from the pool of options available for grant. The Company’s plan requires that every share underlying a restricted stock unit issued will be counted against the plan limit as 1.4 shares in the above table.

The weighted-average grant date fair value for options granted during the three and six months ended May 3, 2008 was $0.87 and $1.14, respectively. The weighted-average grant date fair value for options granted during the three and six months ended May 5, 2007 was $1.58 and $2.12, respectively. The total intrinsic value of options exercised during the three and six months ended May 3, 2008 was $0 and $1,000, respectively. The total intrinsic value of options exercised during the three and six months ended May 7, 2007 and was $11,000 and $19,000, respectively. Cash proceeds from the exercise of stock options were $0 and $1,000 for the three and six months ended May 3, 2008, respectively. Cash proceeds from the exercise of stock options were $16,000 and $18,000 for the three and six months ended May 5, 2007, respectively. No income tax benefit was realized from the stock option exercises during the three and six month periods ended May 3, 2008 and May 5, 2007. Share-based compensation expense related to stock options recognized under SFAS 123(R) for the three and six months ended May 3, 2008 was $0.7 million and $1.6 million, respectively. Share-based compensation expense related to stock options recognized under SFAS 123(R) for the three and six months ended May 5, 2007 was $1.1 million and $2.5 million, respectively. The Company generally settles employee stock option exercises with newly issued common shares. At May 3, 2008, there was $9.4 million of unrecognized share-based compensation expense related to non-vested options and that is expected to be recognized over a weighted-average period of 2.6 years.

The fair value of option grants was estimated by using the Black-Scholes-Merton model with the following weighted-average assumptions for the three and six months ended May 3, 2008 and May 5, 2007:

 

     Three Months Ended     Six Months Ended  
     May 3, 2008     May 5, 2007     May 3, 2008     May 5, 2007  

Expected volatility

   73 %   56 %   66 %   58 %

Expected Dividend yield

   —       —       —       —    

Risk-free interest rate

   2.60 %   4.5 %   3.06 %   4.5 %

Expected term (in years)

   4.75     4.0     4.75     4.0  

Expected Volatility: The Company’s computation of expected volatility is based on a combination of implied volatilities from traded options on the Company’s stock and historical volatility. The selection of a combination of the implied and historical volatility approach was based upon the availability of actively traded options on the Company’s stock and the Company’s assessment that this combination is more representative of future stock price trends than historical volatility alone.

Dividend Yield: The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.

Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option.

Expected Term: The Company’s expected term represents the period that the Company’s share-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the share-based awards, vesting schedules and expectations of future employee exercise behavior.

 

10


Forfeitures Rate: Compensation expense recognized in the consolidated statement of operations is based on awards ultimately expected to vest and it reflects estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to adoption of SFAS 123(R), the Company accounted for forfeitures as they occurred.

Employee Stock Purchase Plan (ESPP)

In 1994, the Company adopted the 1994 Employee Stock Purchase Plan (the “1994 Plan”), which provides direct employees, employed with the Company for at least thirty consecutive days as of the entry date into any offering period, with the opportunity to acquire shares of the Company’s common stock. Employees may contribute up to 10% of their base salary to the plan. The Company has a six month purchase plan within the offering period. The purchase price is 85% of the fair market value per share of common stock at the beginning of the offering period or the end of the purchase period, whichever is lower. The plan restricts the maximum number of shares that an employee can purchase to 1,500 shares each semi-annual period and to $25,000 worth of common stock each year. At May 3, 2008, there were 400,394 shares reserved for issuance under the 1994 Plan.

The fair value of issuances under the 1994 Plan is estimated on the issuance date by applying the principles of FASB Technical Bulletin 97-1 (FTB 97-1), “Accounting under Statement 123 for Certain Employee Stock Purchase Plan with a Look Back Option” and using the Black-Scholes-Merton options pricing model. During the six months ended May 3, 2008 and May 5, 2007, the Company issued 408,738 and 541,306 shares, respectively, under the 1994 Plan. Total cash received for the issuance of shares under the employee stock purchase plan was approximately $0.5 million and $0.9 million during the six months ended May 3, 2008 and May 5, 2007, respectively. Share-based compensation expense related to employee stock purchases recognized under SFAS 123(R) for the three and six months ended May 3, 2008 was $0.1 million and $0.3 million, respectively. Share-based compensation expense related to employee stock purchases recognized under SFAS 123(R) for the three and six months ended May 5, 2007 was $0.3 million and $0.6 million, respectively. At May 3, 2008, there was $155,000 of unrecognized share-based compensation expense related to outstanding ESPP shares and that is expected to be recognized over a four month period.

The fair value of awards granted under the 1994 Plan was estimated by using the Black-Scholes-Merton model with the following weighted-average assumptions for the three and six months ended May 3, 2008 and May 5, 2007:

 

     Three Months Ended     Six Months Ended  
     May 3, 2008     May 5, 2007     May 3, 2008     May 5, 2007  

Expected volatility

   75 %   61 %   68 %   63 %

Expected Dividend yield

   —       —       —       —    

Risk-free interest rate

   2.49 %   4.8 %   3.19 %   4.9 %

Expected term (in years)

   0.5     0.5     0.5     0.5  

 

4. Balance Sheet Components

Inventories are stated at the lower of standard cost (which approximates first-in, first-out cost) or market. Inventories consist of the following (in thousands):

 

      May 3,
2008
   November 3,
2007

Raw materials

   $ 32,473    $ 43,501

Work-in-process

     15,152      15,837

Finished goods

     2,632      3,168
             

Total

   $ 50,257    $ 62,506
             

 

11


Property and equipment, net consist of the following (in thousands):

 

     May 3,
2008
    November 3,
2007
 

Land

   $ 15,694     $ 19,320  

Buildings

     15,080       36,298  

Machinery and equipment

     104,798       108,839  

Software

     31,066       34,059  

Leasehold improvements

     28,886       41,663  

Furniture and fixtures

     9,595       10,061  
                
     205,119       250,240  

Less accumulated depreciation

     (160,028 )     (174,941 )
                

Total

   $ 45,091     $ 75,299  
                

Prepaid expenses and other current assets consist of the following (in thousands):

 

     May 3,
2008
   November 3,
2007

Receivable for value added taxes

   $ 3,840    $ 4,455

Receivable from disposal of product line, short-term

     2,500      —  

Receivable from contract equipment manufacturers

     2,294      2,098

Other prepaid expenses

     11,126      9,707
             

Total

   $ 19,760    $ 16,260
             

Other assets consist of the following (in thousands):

 

     May 3,
2008
   November 3,
2007

Product spares

   $ 25,428    $ 32,077

Product consignment

     6,382      6,179

Other assets

     9,918      11,770
             

Total

   $ 41,728    $ 50,026
             

Product spare parts that are used in the Company’s service business are classified as other assets and are depreciated using the straight-line method over five years. Amortization expense was approximately $2.4 million and $2.7 million for three months ended May 3, 2008 and May 5, 2007, respectively. Amortization expense was approximately $4.8 million and $5.4 million for six months ended May 3, 2008 and May 5, 2007, respectively.

Product consignments to internal and external customers are classified as other assets and are depreciated using the straight-line method over 36 months. Amortization expense was approximately $0.6 million and $1.2 million for the three months ended May 3, 2008 and May 5, 2007, respectively. Amortization expense was approximately $1.1 million and $2.5 million for the six months ended May 3, 2008 and May 5, 2007, respectively.

Accrued expenses and other liabilities consist of the following (in thousands):

 

     May 3,
2008
   November 3,
2007

Accrued distributor commissions

   $ 1,099    $ 2,024

Accrued bonuses

     650      2,517

Accrued restructuring expenses

     13,246      2,213

Accrued value added taxes

     2,890      3,436

Accrued interest expense

     2,464      2,464

Other accrued liabilities

     14,224      16,846
             

Total

   $ 34,573    $ 29,500
             

 

12


Other long-term liabilities consist of the following (in thousands):

 

     May 3,
2008
   November 3,
2007

Sale-leaseback obligation

   $ 30,000    $ 30,000

Other long-term liabilities

     3,578      3,998
             

Total

   $ 33,578    $ 33,998
             

 

5. Convertible Subordinated Notes

Convertible Subordinated Notes due 2008

In June 2003, the Company issued $180.0 million of 1.5% convertible subordinated notes (the Notes) due May 2008 in a private placement. The Notes are unsecured obligations of the Company and are subordinated to all present and future senior indebtedness of the Company. Interest is payable semiannually on May 15 and November 15, commencing November 15, 2003. The Notes are convertible into common stock of the Company at an initial conversion price of $11.31 per share, subject to adjustment in certain dilution events. The Notes do not include a beneficial conversion feature or financial covenants. Expenses of $5.8 million associated with the offering were capitalized upon issuance and are included in other current assets and in other long-term assets in the unaudited condensed consolidated balance sheets. Such expenses are being amortized to interest expenses over the term of the Notes. The Company continues to use the net proceeds of the offering for general corporate purposes, including working capital and potential acquisitions.

In September 2006, the Company purchased $35.0 million of the Notes for approximately $32.0 million in cash. On December 20, 2006, the Company completed the exchange of an aggregate principal amount of $72.5 million of its Notes for a new series of 3.5% Convertible Senior Subordinated Notes due in May 2010. See below under Convertible Subordinated Notes due 2010, for further discussion of the exchange.

Interest expense associated with the Notes was $0.3 million and $0.3 million for the three months ended May 3, 2008 and May 5, 2007, respectively. Interest expense associated with the Notes was $0.5 million and $0.8 million for the six months ended May 3, 2008 and May 5, 2007, respectively.

Unamortized debt issuance costs associated with the Notes were $0 and $0.3 million at May 3, 2008 and November 3, 2007, respectively. Amortization of debt issuance costs are classified as other income (expense), net on the unaudited condensed consolidated statements of operations. Amortization of debt issuance costs was $0.1 million and $0.1 million for the three months ended May 3, 2008 and May 5, 2007, respectively. Amortization of debt issuance costs was $0.2 million and $0.3 million for the six months ended May 3, 2008 and May 5, 2007, respectively.

Convertible Subordinated Notes due 2010

On December 20, 2006, the Company completed the exchange in an aggregate principal amount of $72.5 million of 1.5% Convertible Subordinated Notes due in May 2008 for a new series of 3.5% Convertible Senior Subordinated Notes (the New Notes) due in May 2010, as well as the issuance of additional New Notes with an aggregate principal amount of $50.0 million in a private placement. The New Notes are unsecured obligations of the Company and are subordinated to all present and future senior indebtedness of the Company. Interest is payable semiannually on May 15 and November 15, commencing May 15, 2007. The New Notes contain a provision known as net share settlement which requires that, upon conversion of the New Notes, the Company will pay holders in cash for the principal amount of the New Notes which are converted. Any amount in excess of converted principal will be settled in shares of the Company’s common stock, or at its option, cash. The New Notes do not have financial covenants.

The New Notes can be converted under certain circumstances, including among others, 1) during any calendar quarter when the volume weighted average price per share of the Company’s common stock has been more than 150% of the conversion price for a specified period ending on the last trading day of the preceding calendar quarter, or 2) during the five business days when the trading price per $1,000 principal amount of the New Notes for each day within a specified period was less than 98% of the product of the volume weighted average price of the common stock for each day in that period and the applicable conversion rate per $1,000 principal amount of the New Note, or 3) if the Company distributes to its stockholders, rights or warrants entitling them to purchase common stock within a specified period at a price less than the closing price of the common stock on the date of issuance, or 4) if the Company distributes to its stockholders, assets or securities of the Company, which distribution has a per share value exceeding 7.5%

 

13


of the volume weighted average price of the common stock on the business day preceding the declaration date for such distribution, or 5) in the event a change in control or cessation of trading of the Company’s stock occurs or is anticipated to occur or 6) at any time during the 60 day period prior to the maturity date. In addition, the Company has the ability to terminate the conversion feature of the New Notes in the event that the volume weighted average price per share of the Company’s common stock has been more than 150% of the conversion price for a specified period. If the Company exercises its right to terminate conversion, the holders of the New Notes may convert their notes within a specified period. The foregoing description of these conversion events is not necessarily complete and reference is made to the Indenture filed as an exhibit to the Company’s Form S-3 Registration Statement filed with the SEC on January 19, 2007.

The Company recorded a discount of $6.1 million related to the New Notes since they were issued at a discount. This amount is being amortized to interest expense over the life of the New Notes, or sooner upon conversion. During the three months ended May 3, 2008 and May 5, 2007, the Company recorded related amortization of $0.4 million and $0.4 million, respectively. During the six months ended May 3, 2008 and May 5, 2007, the Company recorded related amortization of $0.9 million and $0.7 million, respectively.

Interest expense associated with the New Notes was $1.1 million and $1.1 million for the three months ended May 3, 2008 and May 5, 2007, respectively. Interest expense associated with the New Notes was $2.1 million and $1.4 million for the three months ended May 3, 2008 and May 5, 2007, respectively.

Expenses of $3.4 million associated with the New Notes offering were capitalized upon issuance and are included in prepaid expenses and other current assets and in other assets in the unaudited condensed consolidated balance sheets. Such expenses are being amortized over the term of the New Notes. Unamortized debt issuance costs associated with the New Notes were $2.0 million and $2.5 million at February 2, 2008 and November 3, 2007, respectively. Amortization of debt issuance costs are classified as other income (expense), net on the condensed consolidated statements of operations. Amortization of debt issuance costs was $0.3 million and $0.2 million for the three months ended May 3, 2008 and May 5, 2007, respectively. Amortization of debt issuance costs was $0.5 million and $0.4 million for the six months ended May 3, 2008 and May 5, 2007, respectively.

Subordinated Convertible Notes consists of the following (in thousands):

 

     Balance  
     May 3,
2008
    November 3,
2007
 

Current convertible subordinated notes

    

1.5% convertible subordinated notes due May 2008

   $ 72,500     $ 72,500  

Discount on 3.5% convertible senior subordinated notes due May 2010, current portion

     (1,800 )     (1,800 )
                

Net current convertible subordinated notes

     70,700       70,700  
                

Long-term convertible subordinated notes

    

3.5% convertible senior subordinated notes due May 2010

   $ 122,500     $ 122,500  

Discount on 3.5% convertible senior subordinated notes due May 2010, long-term portion

     (1,872 )     (2,772 )
                

Net long-term convertible subordinated notes

     120,628       119,728  
                

Net convertible subordinated notes

   $ 191,328     $ 190,428  
                

 

6. Other Intangible Assets and Goodwill

The Company evaluates the carrying value of its long-lived assets, consisting primarily of its facilities, purchased intangible assets, and property and equipment, in accordance with SFAS 144, “Accounting for the Impairment or Disposal for Long-Lived Assets,” whenever certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Such events or circumstances include, but are not limited to, a prolonged industry downturn, a significant decline in the Company’s market value, or significant reductions in projected future cash flows. In assessing the recoverability of the Company’s long-lived assets, the Company compares the carrying value to the undiscounted future cash flows the assets are expected to generate. Assets are grouped based on the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, impairment is measured based on the excess of the carrying amount over the fair value of the assets. Quoted market prices in an active market are the best evidence of fair value and, if available, should be used as the basis for the fair value measurement; else fair value is generally determined by calculating the discounted future cash flows using a discount rate based upon the Company’s weighted average cost of capital. Significant judgments and assumptions are required in the forecast of future operating results used in the

 

14


preparation of the estimated future cash flows, including useful lives of the primary asset, profit margins, long-term forecasts of the amounts and timing of overall market growth and the Company’s percentage of that market, groupings of assets, discount rates and terminal growth rates. In addition, significant estimates and assumptions are required in the determination of the fair value of the Company’s tangible long-lived assets, including replacement cost, economic obsolescence, and the value that could be realized in liquidation. Changes in these estimates could have a material adverse effect on the assessment of the Company’s long-lived assets, thereby requiring the Company to write down the assets. The purchased intangibles consist of purchased technology, customer relations, trademarks, patents and non-compete agreements and they typically have estimated useful lives of one to ten years.

Based on the considerations outlined in the previous discussion, in November 2007, the Company concluded that sufficient indicators existed to require it to perform an analysis to assess whether a portion of its other intangible assets was impaired. This analysis differs from the goodwill analysis in that an impairment is only deemed to have occurred if the sum of the forecasted undiscounted future cash flows related to the asset are less than the carrying value of the intangible asset being tested for impairment. Since the forecasted cash flows exceeded the carrying value, the Company concluded that there was no impairment to its long-lived assets at November 3, 2007. The Company has performed a similar analysis as of May 3, 2008 and concluded that there was no impairment to its long-lived assets at May 3, 2008.

During the first fiscal quarter of 2008, management committed to sell certain assets and certain liabilities (disposal group) related to the diagnostics and characterization product. The contract associated with this sale was executed in February 2008 (see Note 15 — “Loss on Disposal of Product Line” for further discussion). On January 31, 2008, the Company determined that the plan of sale criteria in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” had been met. Accordingly, the carrying value of the disposal group was adjusted to its fair value less costs to sell, which was determined based on the sale agreement under negotiation. The resulting $22.5 million impairment loss has been classified as an impairment charge and loss on disposal of product line under operating expense on the condensed consolidated statements of operations. Because the disposal group did not constitute a component of the Company, this transaction did not qualify as a discontinued operation under SFAS 144.

In connection with the impairment charge noted above and the realization of certain tax attributes, the Company determined that the remaining goodwill associated with the related disposal group had a carrying amount of zero and was reduced accordingly during the six months ended May 3, 2008.

Other Intangible Assets

Other intangible assets consist primarily of existing technology, customer relationships and trade names acquired in business combinations. Acquired intangibles are amortized on a straight-line basis over the respective estimated useful lives of the assets. Other intangible assets subject to amortization were as follows (in thousands):

 

May 3, 2008

   Cost    Accumulated
Amortization
    Net

Purchased technology

   $ 104,651      (61,932 )     42,719

Customer relations

     18,152      (12,822 )     5,330

Maintenance contracts

     13,800      (10,810 )     2,990

Product backlog

     4,900      (4,900 )     —  

Trademarks

     2,053      (2,053 )     —  

Patents

     862      (862 )     —  
                     

Total

   $ 144,418    $ (93,379 )   $ 51,039
                     

 

November 3, 2007

   Cost    Accumulated
Amortization
    Net

Purchased technology

   $ 128,441    $ (74,185 )   $ 54,256

Customer relations

     21,202      (13,862 )     7,340

Maintenance contracts

     13,800      (9,430 )     4,370

Product backlog

     4,900      (4,900 )     —  

Trademarks

     2,053      (2,053 )     —  

Patents

     862      (862 )     —  

Non-compete agreements

     750      (750 )     —  
                     

Total

   $ 172,008    $ (106,042 )   $ 65,966
                     

Amortization expenses for the other intangible assets were $3.3 million and $4.5 million for the three months ended May 3, 2008 and May 5, 2007, respectively. Amortization expenses for the other intangible assets were $7.7 million and $8.9 million for the six months ended May 3, 2008 and May 5, 2007, respectively.

 

15


The estimated future amortization expense of purchased intangible assets with definite lives for the next five years is as follows (in thousands):

 

Fiscal Years Ending

   Amount

Remainder of fiscal 2008

   $ 6,544

2009

     11,938

2010

     9,153

2011

     7,258

2012

     6,250

Thereafter

     9,896
      

Total

   $ 51,039
      

 

7. Net Loss Per Share

Basic and diluted net loss per share is based upon the weighted average number of common shares outstanding during the period. Diluted net income per share is based upon the weighted average number of common shares and dilutive-potential common shares outstanding during the period.

The following table sets forth the computation of basic and diluted loss per share for periods indicated (in thousands, except per share amounts):

 

     Three Months Ended     Nine Months Ended  
     May 3,
2008
    May 5,
2007
    May 3,
2008
    May 5,
2007
 

Numerator:

        

Net loss

     (18,679 )     (3,454 )   $ (74,806 )   $ (3,465 )
                                

Denominator:

        

Weighted-average shares outstanding

     102,016       101,028       101,853       100,816  
                                

Basic net loss per share

   $ (0.18 )   $ (0.03 )   $ (0.73 )   $ (0.03 )
                                

Diluted net loss per share

   $ (0.18 )   $ (0.03 )   $ (0.73 )   $ (0.03 )
                                

During the three and six months ended May 3, 2008, the Company excluded options to purchase 13,174,934 shares of common stock from the diluted loss per share calculation, as their effect on an as if converted method was anti-dilutive. During the three and six months ended May 5, 2007, the Company excluded options to purchase 16,319,182 shares of common stock from the diluted loss per share calculation, as their effect on an as if converted method was anti-dilutive.

With respect to the convertible subordinated notes issued in June 2003, during the three and six months ended May 3, 2008 and May 5, 2007, the Company excluded 6,410,256 shares issuable under the terms of the notes from the diluted income per share calculation, as their effect on an as if converted method was anti-dilutive.

With respect to the convertible subordinated notes issued in December 2006, in accordance with EITF 90-19 “Convertible Bonds with Issuer Option to Settle for Cash Upon Conversion” and Statement of Financial Accounting Standard No. 128 “Earnings per Share”, there were no shares included in the diluted loss per share calculation for the three and six month periods ended May 3, 2008 and May 5, 2007. The principal portion of the notes were excluded from the per share calculation as this portion of the obligation can only be settled in cash. There were no incremental shares under the as if converted method as the initial conversion per share price of $8.25 exceeded the Company’s share price for the three and six months ended May 3, 2008 and May 5, 2007.

 

8. Recent Accounting Pronouncements

In July 2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company has adopted the provisions of FIN 48 on November 4, 2007. See Note 10 — “Income Taxes,” for further discussion.

 

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In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the fiscal year beginning November 2, 2008. The FASB has deferred the implementation of SFAS 157 by one year for certain non-financial assets and liabilities such as this will be effective for the fiscal year beginning November 1, 2009. The Company is currently evaluating the impact of the provisions of SFAS 157 on its financial position, results of operations and cash flows and does not believe the impact of the adoption will be material.

In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (SFAS 159). Under SFAS 159, a company may choose, at specified election dates, to measure eligible financial instrument and certain other items at fair value that are not otherwise required to be so measured. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 is effective for fiscal year beginning after November 15, 2007. The Company is currently evaluating the impact of SFAS 159 on its financial position, results of operations and cash flows and does not believe the impact of the adoption will be material.

In December 2007, the FASB issued Statement No. 141 (revised 2007), “Business Combinations” (SFAS No. 141(R)). The standard changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company is currently evaluating the impact of the pending adoption of FAS 141(R) on its financial position, results of operations and cash flows.

 

9. Sale-Leasebacks

Milpitas, California

On February 28, 2007, the Company completed a sale-leaseback transaction involving the Company’s corporate headquarters located in Milpitas, California. The properties were sold to NRFC Milpitas Holdings, LLC (purchaser), an unrelated third party, for a total price of $30.0 million. Simultaneously, the Company agreed to lease the properties back from the purchaser for a period of 10 years, along with four, five-year renewal options upon expiration of the initial lease term. The initial lease commenced on February 28, 2007, and will expire on February 28, 2017. The annual rent for the first year of the lease is approximately $2.5 million and will increase 2% for each of the following nine years until the expiration of the initial lease term. As part of the lease agreement, the Company issued a letter of credit in the amount of $5.1 million, which is used as security on the lease. The letter of credit will expire no sooner than December 31, 2010 unless, including among other conditions, the Company retires the 1.5% convertible subordinated notes (the Notes) due May 2008 and does not within six months thereafter issue any new debt or equity. Under the terms of the letter of credit, the purchaser will have the right to draw down the amount of the rental obligations in the event the Company defaults on the terms of the lease including making the monthly payments. The letter of credit is collateralized by restricted cash which is reflected in the other assets section of the consolidated balance sheets.

Due to the letter of credit being collateralized by restricted cash, the Company is accounting for this transaction as a direct financing under SFAS 98. Accordingly, the Company recorded the proceeds on its books as long-term liabilities, and the Company is expensing periodic lease payments as interest expense. The sale will not be recorded until the letter of credit expires or is otherwise terminated and all of the criteria are met.

Hillsboro, Oregon

On January 7, 2008, the Company completed a sale-leaseback transaction involving the Company’s facilities located in Hillsboro, Oregon. The properties were sold to Carlyle Investment Company (purchaser), an unrelated third party, for a total price of $20.0 million. Simultaneously, the Company agreed to lease the properties back from the purchaser for a period of two years, along with a one-year renewal option upon expiration of the initial lease term. The initial lease commenced on January 7, 2008, and will expire on January 6, 2010. The annual rent for the first and second year of the lease is approximately $2.1 million. The transaction meets the requirements under SFAS 98, “Accounting for Leases,” and SFAS 66 “Accounting for Sales of Real Estate” and was recorded as a sale lease-back transaction. The transaction resulted in a loss of $3.6 million during the six months ended May 3, 2008.

 

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10. Income Taxes

The Company adopted the provisions of FIN 48 on November 4, 2007. As a result of the adoption, the Company recognized a decrease in income tax liabilities of approximately $2.0 million and a corresponding increase in retained earnings as of November 4, 2007. As of the adoption date, the Company had gross unrecognized tax benefits of $14.9 million and accrued interest and penalties of $0.8 million. The total amount of unrecognized tax benefit as of November 4, 2007, that, if recognized, would affect the effective tax rate was $5.7 million. Consistent with the provisions of FIN 48, the Company reclassified $6.5 million of current income tax liabilities resulting in a $6.5 million increase to long-term income taxes payable and $9.2 million decrease to long-term deferred tax assets that are subject to a full valuation allowance. In the normal course of business, the Company provides for uncertain tax positions and adjusts unrecognized tax benefits, including related interest, accordingly. In the second fiscal quarter of 2008, those adjustments were not significant.

The Company conducts business globally and, as a result, the Company and its subsidiaries or branches file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business the Company is subject to examination by taxing authorities throughout the world, including such major jurisdictions as the United States and Germany. With few exceptions, the Company is no longer subject to U.S. federal, state and local or non-U.S. income tax examinations for years before 2000. The Company is under examination in Malaysia, France and Germany for 2004, 2005 through 2006 and 2002 through 2004, respectively. The Company expects the examinations will conclude in fiscal 2008. At this time the Company cannot estimate the possible change in unrecognized tax benefits.

 

11. Commitments and Contingencies

The Company leases most of its facilities and equipment under operating leases that expire periodically through 2013.

The future minimum lease payments at May 3, 2008 are as follows (in thousands):

 

     Net Estimated
Future Lease
Expense

Remainder of fiscal 2008

   $ 3,578

2009

     6,896

2010

     4,436

2011

     3,509

2012

     3,322

Thereafter

     11,539
      
   $ 33,280
      

Some of the components that the Company purchases are unique to the Company and must be purchased in relatively high minimum quantities with long (in excess of three months) lead times. These business circumstances can lead to the Company holding relatively high inventory levels and associated risks. In addition, purchase commitments for unique components are relatively inflexible in terms of deferral or cancellation. At May 3, 2008, the Company had open and committed non-cancelable purchase orders totaling approximately $37.1 million.

The following summarizes the Company’s minimum contractual cash obligations and other commitments at May 3, 2008 and the effect of such obligations in future periods (in thousands):

 

     Total    Remainder
of Fiscal
2008
   2009    2010    2011    2012    Thereafter

Contractual Obligations:

                    

Facilities and equipment operating leases

   $ 33,280    $ 3,578    $ 6,896    $ 4,436    $ 3,509    $ 3,322    $ 11,539

Convertible subordinated notes (1)

     195,000      72,500      —        122,500      —        —        —  

Interest on convertible subordinated notes

     11,479      2,731      4,288      4,460      —        —        —  

Open and non-cancelable purchase order commitments

     37,066      27,911      8,998      157      —        —        —  
                                                

Total contractual cash obligations

   $ 276,825    $ 106,720    $ 20,182    $ 131,553    $ 3,509    $ 3,322    $ 11,539
                                                

 

(1) This amount is recorded in the unaudited condensed consolidated balance sheets as convertible subordinated notes.

 

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The Company warrants its products to its customers generally for one year from the date of shipment. The Company provides reserves for the estimated costs of product warranties at the time revenue is recognized. The Company estimates the costs of warranty obligations based on historical experience of known product failure rates, use of materials to repair or replace defective products and service delivery costs incurred in correcting product failures.

Due to the uncertainty with respect to the timing of future cash flows associated with the Company’s FIN 48 liabilities and related interest and penalties at May 3, 2008, the Company is unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $7.0 million of FIN 48 liabilities, interest and penalties have been excluded from the contractual obligations table above. See Note 10 – “Income Taxes” for further discussion.

The following table represents the activity in the warranty accrual for the six months ended May 3, 2008 and May 5, 2007 (in thousands):

 

     Six Months Ended  
     May 3,
2008
    May 5,
2007
 

Beginning balance

   $ 12,384     $ 13,514  

Add: Accruals for warranties issued during the period

     6,215       11,447  

Less: Adjustments of accrual estimates

     (1,073 )     (117 )

Warranty spending

     (8,900 )     (11,263 )
                

Ending balance

   $ 8,626     $ 13,581  
                

The Company also offers warranties in excess of one year. Revenues associated with warranties beyond one year are deferred and recognized over the relevant period. Costs that are directly related to services performed for warranties in excess of one year are charged to expense as incurred.

Legal Proceedings

In accordance with SFAS No. 5, “Accounting for Contingencies,” the Company assesses the probability of an unfavorable outcome of all our material litigation, claims, or assessments to determine whether a liability had been incurred and whether it is probable that one or more future events will occur confirming the fact of the loss. In the event that an unfavorable outcome is determined to be probable and the amount of the loss can be reasonably estimated, we establish an accrual for the litigation, claim or assessment. The Company is involved in various claims arising in the ordinary course of business, none of which, in the opinion of management, if determined adversely against the Company, will have a material adverse effect on the Company’s business, financial condition or results of operations.

 

12. Accumulated Other Comprehensive Loss

The Company’s accumulated other comprehensive loss consists of the accumulated net unrealized gains or losses on available-for-sale investments and foreign currency translation adjustments. At May 3, 2008 and November 3, 2007, the Company had a balance of net unrealized loss of approximately $1,000 and $23,000, respectively, on available-for-sale investments. Additionally, at May 3, 2008 and November 3, 2007, the Company had a balance of $8.3 million and $5.8 million, respectively, of net foreign currency translation gains.

The components of comprehensive loss, net of tax, are as follows for the periods indicated (in thousands):

 

     Three Months Ended     Six Months Ended  
     May 3, 2008     May 5, 2007     May 3, 2008     May 5, 2007  

Net loss

   $ (18,679 )   $ (3,454 )   $ (74,806 )   $ (3,465 )
                                

Unrealized gains on available-for-sale securities

     248       19       22       19  

Currency translation adjustment

     1,803       1,960       2,465       2,312  
                                

Other comprehensive income

     2,051       1,979       2,487       2,331  
                                

Total comprehensive loss

   $ (16,628 )   $ (1,475 )   $ (72,319 )   $ (1,134 )
                                

 

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13. Restructuring Charges

During six months ended May 3, 2008 and in previous years, the Company has recorded restructuring charges as it rationalized operations in light of customer demand declines and economic downturns. The measures, which included reducing the workforce, focus on outsourced manufacturing, consolidating facilities and changing the strategic focus of a number of sites, was largely intended to align the Company’s capacity and infrastructure to anticipated customer demand and transition its operations for higher utilization of facility space.

Severance and benefit costs and other costs associated with restructuring activities are recorded in compliance with Statement of Financial Accounting Standard No. 112, “Employer’s Accounting for Post Employment Benefits,” (SFAS 112) and Statement of Financial Accounting Standard No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” (SFAS 146). A substantial portion of the restructuring charges were recorded under the principles of SFAS 112 when the Company concluded that (a) the Company has a substantive post employment benefit obligation that is attributed to prior services rendered, (b) rights to those benefits have vested, and (c) payment is probable and the amount can be reasonably estimated. The remaining restructuring charges were recorded under the principles of SFAS 146 as they represented one-time benefits. In circumstances when employees are required to render future service and that service period extends beyond a minimum retention period, the restructuring charges are being recognized ratably over the future service period. The accounting for restructuring charges requires the Company to record provisions and charges when it has a formal and committed restructuring plan.

The following table illustrates the activity for the six month period ended May 3, 2008 and the estimated timing of future payouts for major restructuring categories (in thousands):

 

     Balance at
November 3,
2007
    Charges     Utilized    Adjustments     Balance at
May 3, 2008
 

Severance

   $ (995 )   $ (15,691 )   $ 5,601    $ (951 )   $ (12,036 )

Operating leases

     (2,417 )     —         —        (83 )     (2,500 )
                                       

Total

   $ (3,412 )   $ (15,691 )   $ 5,601    $ (1,034 )   $ (14,536 )
                                       

 

Estimated timing of future payouts:

    

Remainder of fiscal 2008

   $ 13,287

Fiscal 2009

     1,249
      

Total

   $ 14,536
      

For the three months ended May 3, 2008 and May 5, 2007, the Company recorded restructuring charges of approximately $1.3 million and $0, respectively, as cost of goods sold related to headcount reductions. For the six months ended May 3, 2008 and May 5, 2007, the Company recorded restructuring charges of approximately $4.1 million and $0, respectively, as cost of good sold related to headcount reductions. For the three months ended May 3, 2008 and May 5, 2007, the Company recorded restructuring charges of approximately $1.9 million and $0.5 million, respectively, as operating expenses related to headcount reductions and facilities. For the six months ended May 3, 2008 and May 5, 2007, the Company recorded restructuring charges of approximately $12.6 million and $1.0 million, respectively, as operating expenses related to headcount reductions and facilities.

 

14. Employee Benefit Plans

The Company maintains a 401(k) retirement savings plan for its full-time domestic employees, which allows them to contribute up to 20% of their pre-tax wages subject to IRS limits. The Company’s contribution to this plan was approximately $0.5 million and $0.6 million for the three months ended May 3, 2008 and May 5, 2007, respectively. The Company’s contribution to this plan was approximately $0.9 million and $1.0 million for the six months ended May 3, 2008 and May 5, 2007, respectively.

Outside of the U.S., the Company also assumed several defined benefit and defined contribution plans that cover substantially all employees as part of its acquisition of NPTest in May 2004. Where applicable, employees are covered by statutory plans. For defined benefit plans, charges to expense are based upon costs computed by independent actuaries. These plans are substantially fully funded with trustees in respect to past and current service. At May 3, 2008, and November 3, 2007 the pension liability was $1.2 million and $1.2 million, respectively. The expenses associated with these plans were not material for the three months ended May 3, 2008 and May 5, 2007.

 

20


The Company has a deferred compensation plan for certain employees (a “Rabbi Trust” or “trust”). The assets in the Rabbi Trust, consisting of cash equivalents and debt and equity securities, are recorded at current market prices. The trust assets are available to satisfy claims of the Company’s general creditors in the event of its bankruptcy. The trust’s assets of approximately $1.3 million and $1.7 million at May 3, 2008 and November 3, 2007, respectively, are included in other assets, and the corresponding deferred compensation liability is included in the other liabilities in the accompanying unaudited condensed consolidated balance sheets.

 

15. Disposal of Product Line

On February 20, 2008, the Company completed the sale of the assets and business of the Company’s diagnostics and characterization product line. The Company may receive up to $10.0 million for the assets, with $2.5 million, subject to certain adjustments, payable on each of the first and second anniversaries of the close of the transaction, and the balance payable on the third anniversary of the close of the transaction contingent on the purchaser’s achievement of revenue targets. The Company transferred approximately $26.1 million of book value of assets (calculated based on values prior to the impairment charges recorded during the first fiscal quarter of 2008), including component inventory, fixed assets, and intangibles to the purchaser and the purchaser assumed various liabilities including certain contractual warranty and service contracts, employee paid time off, and commission obligations. The Company will also provide reimbursable transition services for a limited period of time. In addition, the Company has funded the fulfillment of approximately $4.0 million of existing warranty and service contract obligations through the purchaser. A loss of $3.4 million was recorded during the second fiscal quarter ended May 3, 2008 related to the disposal of the diagnostics and characterization product line.

 

16. Industry Segment

Operating segments are business units that have separate financial information and are separately reviewed by the Company’s chief decision makers. The Company’s chief decision makers are the Chief Executive Officer and Chief Financial Officer. The Company and its subsidiaries currently operate in a single industry segment: the design, development, manufacture, sale and service of advanced semiconductor test and diagnostic systems used in the production of semiconductors. All of the Company’s advanced semiconductor test and diagnostic systems operations are subject to similar economic characteristics, have similar production processes, have common customers, and are distributed using the same channels.

The Company’s net sales by product line consisted of:

 

     Three Months Ended     Six Months Ended  
     May 3,
2008
    May 5,
2007
    May 3,
2008
    May 5,
2007
 

SoC

   35 %   49 %   32 %   45 %

Analog Mixed Signal

   31     21     32     25  

Memory

   —       1     —       1  

Diagnostics and Characterization

   2     8     3     6  

Service and Other

   32     21     33     23  
                        

Total

   100 %   100 %   100 %   100 %
                        

Most of the Company’s products are manufactured in the U.S. Export sales from the U.S. are primarily denominated in U.S. dollars but occasionally denominated in Japanese Yen or in the Euro. The Automotive product line is manufactured in Germany and these sales are denominated in U.S. dollars, Japanese Yen and the Euro. All of the Company’s products are shipped to the Company’s customers throughout North America, Asia Pacific, Europe, and the Middle East. The Company reports revenue net of sales taxes, use taxes and value-added taxes directly imposed by governmental authorities on the Company’s revenue producing transactions with its customers. Sales by the Company to customers in different geographic areas, expressed as a percentage of revenue, for the periods ended were:

 

     Three Months Ended     Six Months Ended  
     May 3,
2008
    May 5,
2007
    May 3,
2008
    May 5,
2007
 

United States of America

   30 %   25 %   30 %   22 %

Germany

   14     16     12     15  

Taiwan

   14     14     11     12  

China

   11     5     14     5  

Singapore

   7     19     9     26  

Rest of World

   24     21     24     20  
                        

Total net sales

   100 %   100 %   100 %   100 %
                        

 

21


A distributor in Taiwan, Spirox Corporation, accounted for approximately 17% and 13% of the Company’s net sales for the three months ended May 3, 2008 and May 5, 2007, respectively. Spirox Corporation accounted for approximately 16% and 12% of the Company’s net sales for the six months ended May 3, 2008 and May 5, 2007. Spirox Corporation accounted for 21% and 29% of gross accounts receivable at May 3, 2008 and November 3, 2007, respectively.

For the three months ended May 3, 2008, three customers accounted for approximately 23%, 13% and 12%, respectively, of the Company’s net sales. For the three months ended May 5, 2007, three customers accounted for 37%, 11% and 10% of the Company’s net sales. For the six months ended May 3, 2008, three customers accounted for approximately 23%, 12% and 11%, respectively, of the Company’s net sales. For the six months ended May 5, 2007, one customer accounted for 40% of the Company’s net sales.

At May 3, 2008, three customers accounted for approximately 20%, 16% and 13% of the Company’s gross receivables, respectively. At November 3, 2007, one customer accounted for approximately 17% of the Company’s gross receivables.

As of May 3, 2008 and November 3, 2007, the majority of the Company’s long-lived assets were attributable to its United States operations.

 

17. Subsequent Event

On May 13, 2008, the Company completed the repayment of the principal balance of its 1.5% Convertible Subordinated Notes due 2008, in the amount of $72.5 million (see Note 5 – “Convertible Subordinated Notes” for further discussion).

 

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ITEM 2. - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements using terminology such as “believes,” “may,” “will,” “expects,” “plans,” “anticipates,” “goals,” “estimates,” “potential,” or “continue,” or the negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. Forward-looking statements include statements regarding our intention to prioritize our research and development activities on our Diamond and ASL platforms; our intention to focus Sapphire platform development on the high-end consumer markets; our intention to double our sales and support headcount in Asia; our intention to divest or reduce our commitment to businesses and products that are unrelated to our consumer semiconductor markets; our intention to scale down our service; our intention to continue outsourced manufacturing activities; that we use our proprietary technologies to design products which are intended to provide a lower total cost of ownership than many competing products currently available while meeting the increasingly demanding performance requirements of today’s engineering validation test and ATE markets; our belief that our net sales, gross margins and operating results will continue to fluctuate depending on a variety of factors; factors relating to the fluctuations in our net sales, gross margins and operating results; our intention to introduce new products and enhance existing products through acquisitions of other companies, product lines, technologies and personnel; our belief that our gross margins on systems sales will continue to vary significantly; our expectation that our top ten customers in the aggregate will continue to account for a large portion of our net sales for the foreseeable future, and the loss of one or more of these customers will harm our business and operating results; our dependence on the capital expenditures of manufacturers of semiconductors and other companies; significant portions of our new orders being dependent upon demand from semiconductor device manufacturers building or expanding fabrication facilities and new device testing requirements; our quarterly net sales and operating results depending upon obtaining orders for systems to be shipped in the same quarter in which the order is received; the continued acceptance, volume production, timely delivery and customer satisfaction of our newer digital and mixed signal memory testers being of critical importance to our future financial results; our ability to maintain or increase sales levels in Taiwan; our anticipation that international sales will continue to account for a significant portion of our total net sales; our expectation that we will continue to receive notice of third party claims for infringement; that our future operating results depend substantially upon the continued service of our executive officers and key personnel; our dependence upon our ability to attract and retain qualified personnel; our belief that none of the claims brought in the ordinary course of business will have a material adverse effect on our business, financial condition or results of operation; our anticipation that net sales will be $64.0 million to $68.0 million in the third quarter of fiscal year 2008; our anticipation that restructuring charges will be $1.5 to $2.5 million in the third quarter of fiscal 2008; our anticipation of reducing our net worldwide headcount by 400 people by the end of fiscal 2008; our belief that gross margin percent could be flat to slightly higher in the third quarter of fiscal year 2008 compared to the second quarter of fiscal year 2008; our anticipation that R&D expenses will be flat to slightly lower in the third quarter of fiscal 2008 compared to the second quarter of fiscal year 2008; our expectation that SG&A expenses will be flat to slightly lower in the third fiscal quarter of 2008 compared to the second quarter of fiscal year 2008; our anticipation that the amortization of intangible assets will be $3.3 million in the third quarter of fiscal 2008; our belief that investments in inventory will continue to represent a significant portion of our working capital; the highly cyclical semiconductor industry which experiences downturns; our expectation that a 10% change in the interest rate will not have any material effect on our interest expense; that we expect to maintain a full valuation allowance on United States deferred tax assets until we can sustain an appropriate level of profitability to insure utilization of existing assets; our expectation that we will not recognize any significant tax benefits in our results of operations; future minimum lease payments; minimum contractual cash obligations and the effect of such obligations in future periods; the highly competitive nature of the automatic test equipment industry which is subject to rapid technological change; our belief that it is probable that orders will be canceled and delayed in the future; our belief that a significant portion of investments will provide the marketing, administration and after-sales service and support required for these new products; our plan to continue recognizing compensation expense for all share-based payment awards; our intent to outsource in the future and our expectation that we will achieve operational flexibility and costs savings as a result of outsourcing; that we will continue to assess the need for derivatives in the future; expectation that our business, financial condition and results of operations would be materially adversely affected by our long and variable sales cycle; that our business, financial condition or results of operations will continue to be materially adversely affected by continuing competitive pressure and continued intense price-based competition; that the increases in inventory on hand for new product development and customer support requirements will continue to increase the risk of significant inventory write-offs; that any success we may have in developing new and enhanced systems and new features to our existing systems will depend upon a variety of factors; provisions in the New Notes known as net share settlement which required that, upon conversion of the New Notes, we will pay holders in cash for up to the principal amount of the converted New Notes and under which an amount in excess of this cash will be settled in shares of our common stock, or at our option, cash; that we believe that the adoption of SFAS 159 will not have a material impact; that the sale of our Milpitas facility will not be recorded until the letter of credit expires or is otherwise terminated and all of the criteria are met; that the initial lease for our Hillsboro facility will expire on January 6, 2010; that we will provide reimbursable transition services for a limited period of time; that we will continue to evaluate our estimates, including those relate to revenue recognition, allowance for doubtful accounts, inventory valuation and residual values related to leased products, long-lived assets valuation, warranty accrual, deferred taxes, restructuring charges and share-based compensation; that certain critical accounting policies affect our more significant judgments and estimates used in the

 

23


preparation of our consolidated financial statements; our belief that our current cash and investment positions combined with our ability to borrow funds will be sufficient to meet our anticipated business requirements for the next twelve months; that we do not believe that the adoption of SFAS 157 will be material; that we intend to introduce new products and product enhancements in the future, the timing and success of which will affect our business, financial condition and results of operations; that we currently do not anticipate any material adverse effects based on the nature of our operations and the effect of such laws; that we are continuing to invest significant resources in the expansion of our product lines; that once a semiconductor manufacturer has selected a particular ATE vendor’s tester, the manufacturer is likely to use that tester for a majority of its testing requirements for the market life of that semiconductor; that our competitors are continuing to improve the performance of their current products and to introduce new products, enhancements and new technologies; our belief that to remain competitive we must continue to expend significant financial resources in order to, among other things, invest in new product development and enhancements and to maintain customer service and support centers worldwide; that we believe that many of the risks detailed here and in our other SEC filings are part of doing business in the semiconductor industry and will likely be present in all periods reported; that delays in introducing a product or delays in our ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by us; our need for continued significant expenditures for research and development, marketing and other expenses for new products, capital equipment purchases and worldwide training and customer service and support will impact our sales and operating results in the future; that our maximum amount of obligation under indemnification claims by directors and officers will depend on the facts and circumstances that arise out of any future claims; that restrictions on shares received through the exercise of accelerated options will prevent the sale of any shares received from the exercise of an accelerated option until the earlier of the original vesting date of the option or the executive officer’s termination of employment; certain expectations regarding the fair value of option grants; that the letter of credit will expire no sooner than December 31, 2010 unless other conditions are met; that we expect examinations to conclude in fiscal 2008; that stock options are generally time-based; that at May 3, 2008, there was $0.2 million of unrecognized share-based compensation expense related to outstanding ESPP shares that is expected to be recognized over a month period; that actual expenditures will vary based on the volume of transactions and the length of contractual service provided; that our quarterly net sales and operating results will continue to fluctuate; that many of our expenses are fixed and will be difficult to reduce in a particular period if our net sales goal for that period is not met; that we invested and continue to invest significant resources in property, plan and equipment, purchased and leased facilities, inventory, personnel and other costs to begin or prepare to increase production of these products; that international sales will continue to be subject to certain risks; and that we also expect these developments to continue to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future.

These forward-looking statements involve important factors that could cause our actual results to differ materially from those in the forward-looking statements. Such important factors involve risks and uncertainties including, but not limited to difficulties in utilizing different technologies; delays in bringing products to market due to development problems; difficulties in developing new engineering validation test systems; the possibility that our existing systems will become obsolete; excessively high costs in the future related to enhancing our existing systems; significant changes in customer preferences; difficulties in integrating acquired technology with our product lines; the possibility that competitors will introduce products faster than us; unanticipated difficulties in building close working relationships with vendors; difficulties in developing the Sapphire platform; less sales of the Sapphire, Diamond or ASL platform products than anticipated; product defects sustained during the manufacturing process; the risk that we may not be successful in obtaining new orders from major customers; unanticipated decreases in demand for our products in foreign countries; difficulties in providing extensive support to major customers; unanticipated difficulties in manufacturing and delivering new products, enhancement tools; unanticipated difficulties in integrating our products with customers’ operations; unanticipated difficulties in integrating developed technology; substantial technological changes in the semiconductor industry; a lack of the required resources to invest in the development of new products; uncertainties as to the current products provided by our competitors; unanticipated difficulties in locating and evaluating potential product lines, technologies and business to acquire; the viability of legal claims brought against us; our failure to accurately predict the effect of the ultimate outcome of claims on our business, financial condition or results of operations; lower than expected revenues; the risk that we may be required to expend more cash in the future than anticipated; difficulties in obtaining orders from manufacturers of semiconductors and companies that specialize in contract packaging and/or testing of semiconductors; the timing of orders; an unanticipated lack of resources to invest in property, plant and equipment, purchased and leased facilities, inventory, personnel and other costs; changing market conditions in Taiwan; uncertainties as to the nature and extent of any potential cyclical downturn in the semiconductor industry; uncertainties as to the prospect of future orders and sales levels; changes in laws applicable to us regarding revenue recognition practices relating to our new products; uncertainties as to the future level of sales and revenues; unanticipated budgetary constraints; uncertainties as to the assumptions underlying our calculations regarding estimated annual amortization expenses for purchased intangible assets; uncertainties as to the effects of the adoption by us of certain accounting policies; the risk that our future working capital will not be sufficient to invest significant portions of such working capital in inventories; uncertainties as to the effect of the adoption of certain accounting pronouncements; unanticipated difficulties in the remediation of internal control deficiencies; our ability to maintain the requisite level of assets under our deferred compensation plan; increased fragmentation in the ATE industry; cost overruns, delayed deliveries, shortages, quality issues or other problems resulting from outsourcing; and other factors set forth in “Risk Factors” and elsewhere herein. Reference is made to the discussion of risk factors detailed in our filings with the Securities and Exchange Commission, including our reports on Form 10-K and 10-Q. All projections in this Quarterly Report on Form 10-Q are based on limited information

 

24


currently available to us, which is subject to change. Although any such projections and the factors influencing them will likely change, we will not necessarily update the information, since we are only to provide guidance at certain points during the year. Actual events or results could differ materially and no reader of this Form 10-Q should assume that the information provided today would still be valid in the future. Such information speaks only as of the date of this Form 10-Q.

OVERVIEW

We design, manufacture, sell and service engineering validation test equipment and ATE used for testing semiconductor ICs. We serve a broad spectrum of the semiconductor industry’s testing needs through a wide range of products that test digital logic, mixed-signal, system-on-a-chip and radio frequency semiconductors. We utilize our proprietary technologies to design products which are intended to provide a lower total cost of ownership than many competing products currently available while meeting the increasingly demanding performance requirements of today’s engineering validation test and ATE markets. Our hardware products are designed to test semiconductors at two stages of their lifecycle; first, at the prototype stage, and, second, as they are produced in high volume. Collectively, our customers include major semiconductor manufacturers, fabless design houses, foundries and assembly and test services companies.

Major business developments during and subsequent to the six months ended May 3, 2008 included:

 

   

Kevin C. Eichler, with more than twenty years of experience in the high tech industry at companies including MarketTools, MIPS Technologies and Microsoft, was appointed senior vice president and chief financial officer, effective January 7, 2008.

 

   

On January 7, 2008, we completed the sale of our facilities located at 5975 NW Pinefarm Place, Hillsboro, Oregon. The sales price for the property was $20.0 million. As part of the agreement, we entered into an agreement to lease back the property for a two-year period, with renewal options.

 

   

In January 2008, we announced our plans to divest or otherwise reduce our commitment to business and products that are unrelated to our consumer semiconductor market focus, scale down our service infrastructure, and continue with outsourced manufacturing activities. We anticipate that these initiatives will result in a net worldwide headcount reduction of approximately 400 people by the end of fiscal 2008. These actions resulted in restructuring charges of $16.6 million in the first fiscal half of 2008 and will result in additional restructuring charges of approximately $1.5 to $2.5 million during the third fiscal quarter of 2008.

 

   

In February 2008, we completed the sale of certain assets and business related to the diagnostics and characterization product line to DCG Systems, Inc. During the six months ended May 3, 2008, we recorded impairment charges and a loss on the disposal of the product line for an aggregate amount of $26.3 million.

Our net sales, gross margins and operating results have in the past fluctuated significantly and will, in the future, fluctuate significantly depending upon a variety of factors. The factors that have caused and will continue to cause our results to fluctuate include cyclicality or downturns in the semiconductor market and the markets served by our customers, the timing of new product announcements and releases by us or our competitors, market acceptance of new products and enhanced versions of our products, manufacturing inefficiencies associated with the start up of new products, changes in pricing by us, our competitors, customers or suppliers, the ability to volume produce systems and meet customer requirements, excess and obsolete inventory, patterns of capital spending by customers, delays, cancellations or rescheduling of orders due to customer financial difficulties or otherwise, expenses associated with acquisitions and alliances, our ability to effectively integrate acquisitions, product discounts, product reliability, the proportion of direct sales and sales through third parties, including distributors and original equipment manufacturers, the mix of products sold, the length of manufacturing and sales cycles, natural disasters, political and economic instability, new accounting pronouncements, regulatory changes and outbreaks of hostilities. Due to these and additional factors, historical results and percentage relationships discussed in this Quarterly Report on Form 10-Q will not necessarily be indicative of the results of operations for any future period. For a further discussion of our business, and risk factors affecting our results of operations, please refer to the section entitled “Risk Factors” included elsewhere herein.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, inventory valuation and residual values related to leased products, long-lived assets valuation, warranty accrual, deferred taxes, restructuring charges and share-based compensation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the

 

25


results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discuss the development and selection of the critical accounting estimates with the Audit Committee of our board of directors on a quarterly basis, and the audit committee has reviewed our disclosure relating to them in this quarterly report on Form 10-Q.

Since our fiscal year ended November 3, 2007, there have been no significant changes in our critical accounting policies and estimates other than the adoption of FIN 48 (see Note 10 — “Income Taxes,” of the notes to the consolidated financial statements for further discussion). Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended November 3, 2007, as filed with the SEC on January 17, 2008, for a discussion of our critical accounting policies and use of estimates.

RESULTS OF OPERATIONS

The following table sets forth items from the unaudited condensed consolidated statements of operations as a percentage of net sales for the periods indicated (unaudited):

 

     Three Months Ended     Six Months Ended  
     May 3,
2008
    May 5,
2007
    May 3,
2008
    May 5,
2007
 

Net sales

   100.0 %   100.0 %   100.0 %   100.0 %

Cost of goods sold

   59.0     54.6     58.9     55.7  
                        

Gross margin

   41.0     45.4     41.1     44.3  

Operating expenses

        

Research and development

   23.1     16.7     25.1     17.3  

Selling, general and administrative

   28.9     24.0     31.4     22.8  

Amortization of purchased intangibles

   4.8     3.7     5.9     3.7  

Impairment charges and loss on disposal of product line

   5.0     —       20.0     —    

Restructuring charges

   2.8     0.4     9.6     0.4  

Loss on disposal of facilities

   —       —       2.7     —    
                        

Total operating expenses

   64.6     44.8     94.7     44.2  
                        

Operating loss

   (23.6 )   0.6     (53.6 )   0.1  
                        

Net loss

   (27.4 )%   (2.8 )%   (56.9 )%   (1.4 )%
                        

Net sales consist of revenues from systems sales, upgrades, spare parts sales, maintenance contracts, engineering consulting, customized services and lease income. Net sales were $68.1 million for the three months ended May 3, 2008 representing a decrease of 44.0% from sales of $121.5 million during the three months ended May 5, 2007. The decrease in net sales was due to a decrease in SoC product sales to one customer of $29.9 million combined with a decrease of $8.2 million in net sales related to the diagnostics and characterization product line and a 22% reduction of units sold of the analog mixed signal product. Net sales were $131.5 million for the six months ended May 3, 2008 representing a decrease of 45.3% from sales of $240.7 million during the six months ended May 5, 2007. The decrease in net sales was due to a decrease in SoC product sales to one customer of $66.2 combined with a decrease of $10.7 million in net sales related to the diagnostics and characterization product line and a 15% reduction of units sold of the analog mixed signal product. Sustainability of our revenue levels is dependent upon the economic and geopolitical climate as well as other risks described under the title “Risk Factors” herein. We anticipate net sales will be approximately $64.0 million to $68.0 million for the third quarter of fiscal year 2008.

The Company’s net sales by product line consisted of:

 

     Three Months Ended     Six Months Ended  
     May 3, 2008     May 5, 2007     May 3, 2008     May 5, 2007  

SoC

   35 %   49 %   32 %   45 %

Analog Mixed Signal

   31     21     32     25  

Memory

   —       1     —       1  

Diagnostics and Characterization

   2     8     3     6  

Service

   32     21     33     23  
                        

Total

   100 %   100 %   100 %   100 %
                        

 

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International net sales accounted for approximately 70% and 75% of total net sales in the three months ended May 3, 2008 and May 5, 2007, respectively. International net sales accounted for approximately 70% and 78% of total net sales in the six months ended May 3, 2008 and May 5, 2007, respectively. Our net sales to the Asia Pacific region accounted for approximately 47% and 51% of total net sales in the three months ended May 3, 2008 and May 5, 2007, respectively. Our net sales to the Asia Pacific region accounted for approximately 49% and 56% of total net sales in the six months ended May 3, 2008 and May 5, 2007, respectively. The demand for automated test and engineering capital equipment in Asian markets historically has been highly volatile, and in some Asian regions there has been geopolitical unrest, both of which have resulted in economic instabilities. These potential economic instabilities could materially adversely affect demand for our products.

Gross Margin

Our gross margin as a percentage of net sales decreased to 41.0% during the three months ended May 3, 2008 from 45.4% during the months ended May 5, 2007. The decrease in gross margin for the three months ended May 3, 2008 compared to May 5, 2007 was primarily due to $1.3 million of restructuring charges being allocated to manufacturing costs, combined with a decrease in product revenue as a percentage of total revenue which has more favorable gross margin than service revenues. Our gross margin as a percentage of net sales decreased to 41.1% during the six months ended May 3, 2008 from 44.3% during the six months ended May 5, 2007. The decrease in gross margin for the six months ended May 3, 2008 compared to May 5, 2007 was primarily due to $4.1 million of the restructuring charges being allocated to manufacturing costs. Our gross margin has been and will continue to be affected by a variety of factors, including manufacturing efficiencies, excess and obsolete inventory write downs, sell through of previously written down inventory, pricing by competitors or suppliers, new product introductions, product sales mix, production volume, customization and reconfiguration of systems, international and domestic sales mix and field service margins. We believe gross margin percent could be flat to slightly higher in the third quarter of fiscal year 2008 compared to the second quarter of fiscal year 2008.

Research and Development

Research and development, or R&D, expenses were $15.7 million in the three months ended May 3, 2008, representing a decrease of 22.7% from $20.4 million in the three months ended May 5, 2007. The decrease in expenses in the three months ended May 3, 2008 resulted primarily from a $1.9 million decrease in project related spending, a $1.7 million decrease in compensation and other employee related expenses and a $0.7 million decrease in depreciation and maintenance costs. R&D expenses were $33.0 million in the six months ended May 3, 2008, representing a decrease of 20.6% from $41.5 million in the six months ended May 5, 2007. The decrease in expenses in the six months ended May 3, 2008 resulted primarily from a $4.3 million decrease in project related spending, a $2.4 million decrease in compensation and other employee related expenses and a $1.0 million decrease in depreciation and maintenance costs. R&D expenses as a percentage of net sales were 23.1% and 16.7% in the three months ended May 3, 2008 and May 5, 2007, respectively. R&D expenses as a percentage of net sales were 25.1% and 17.3% in the six months ended May 3, 2008 and May 5, 2007, respectively. The increase in R&D expenses as a percentage of net sales was primarily attributable to lower net sales. We anticipate that R&D expenses will be flat to slightly lower in the third quarter of fiscal year 2008 compared to the second quarter of fiscal 2008.

Selling, General and Administrative

Selling, general and administrative, or SG&A, expenses were $19.7 million in the three months ended May 3, 2008, representing a decrease of 32.3% from $29.1 million in the three months ended May 5, 2007. The decrease was primarily due to the reduction of compensation and other employee related expenses of $7.3 million, a decrease in travel expenses of approximately $0.4 million and a decrease in share-based compensation expense of $0.4 million. SG&A expenses were $41.2 million in the six months ended May 3, 2008, representing a decrease of 25.0% from $55.0 million in the six months ended May 5, 2007. The decrease was primarily due to the reduction of compensation and other employee related expenses of $11.1 million, a decrease in travel expenses of approximately $0.9 million and a decrease in share-based compensation expense of $0.9 million. As a percentage of net sales, SG&A expenses were 28.9% and 24.0% in the three months ended May 3, 2008 and May 5, 2007, respectively. As a percentage of net sales, SG&A expenses were 31.4% and 22.8% in the six months ended May 3, 2008 and May 5, 2007, respectively. The increase in SG&A expenses as a percentage of net sales is primarily attributable to lower net sales. We anticipate that SG&A expenses will be flat to slightly lower the third quarter of fiscal year 2008 compared to the second quarter of fiscal 2008.

Amortization of Purchased Intangibles

Amortization of purchased intangible assets expenses were $3.3 million and $4.5 million in the three months ended May 3, 2008 and May 5, 2007, respectively. Amortization of purchased intangible assets expenses were $7.7 million and $8.9 million in the six months ended May 3, 2008 and May 5, 2007, respectively. The decrease in amortization expense is primarily due to the impairment of other intangibles recorded at the end of the first fiscal quarter of 2008. We anticipate that amortization of intangibles will be $3.3 million in the third quarter of the fiscal year 2008.

 

27


Impairment Charges and Loss on Disposal of Product Line

During the six months ended May 3, 2008, we recorded impairment charges and loss on disposal of product line of approximately $26.3 million. During the first fiscal quarter of 2008, we committed to sell certain assets related to the diagnostics and characterization product and determined that the plan of sale criteria in SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” had been met. Accordingly, the carrying value of the disposal group was adjusted to its fair value less costs to sell, resulting in $22.5 million in impairment charges. In addition, we determined that our goodwill was impaired at January 31, 2008, and an impairment charge of $0.4 million was recorded in the first quarter of fiscal 2008. In addition, we recorded an additional loss of $3.4 million associated with the disposal during the second fiscal quarter of 2008. See Note 6 — “Goodwill and Other Intangible Assets” and Note 15 – “Disposal of Product Line,” of the notes to the consolidated financial statements for further discussion.

Restructuring Charges

During the three months ended May 3, 2008 and May 5, 2007, we recorded a restructuring charge of approximately $1.9 million and $0.5 million, respectively, for severance charges in operating expenses related to headcount reductions and facility consolidation related expenses. During the three months ended May 3, 2008, we recorded a restructuring charge of approximately $1.3 million in cost of goods sold related to headcount reduction related expenses. During the six months ended May 3, 2008 and May 5, 2007, we recorded a restructuring charge of approximately $12.6 million and $1.0 million, respectively, for severance charges in operating expenses related to headcount reductions and facility consolidation related expenses. During the six months ended May 3, 2008, we recorded a restructuring charge of approximately $4.1 million in cost of goods sold related to headcount reduction related expenses. The restructuring charges recorded in the six months ended May 3, 2008 were for severance and other benefit charges which accounted for a headcount reduction of approximately 320 employees resulting from plans to divest or otherwise reduce our commitment to business and products that are unrelated to our consumer semiconductor market focus, scale down our service infrastructure, and continue with outsourced manufacturing activities. We anticipate that restructuring charges will be $1.5 to $2.5 million related to these actions during the third fiscal quarter of 2008. See Note 13 — “Restructuring Charges,” of the notes to the consolidated financial statements for further discussion.

Loss on Disposal of Facilities

During the six months ended May 3, 2008, we recorded a loss on disposal of facilities of $3.6 million related to the sale-leaseback transaction involving the Company’s facilities located in Hillsboro, Oregon. See Note 9 – “Sale-Leasebacks,” of the notes to the consolidated financial statements for further discussion.

Interest Income

We generated interest income of $1.9 million and $1.9 million in the three months ended May 3, 2008 and May 5, 2007, respectively. We generated interest income of $4.5 million and $3.1 million in the six months ended May 3, 2008 and May 5, 2007, respectively. The increase in the six months ended May 3, 2008 was primarily due to higher average cash balances compared to the six months ended May 5, 2007.

Interest Expense

Interest expense was $2.5 million and $2.3 million for the three months ended May 3, 2008 and May 5, 2007, respectively. The increase in interest expense is primarily due to an increase of $0.2 million related to the sale-leaseback in Milpitas, California. Interest expense was $5.1 million and $3.5 million for the six months ended May 3, 2008 and May 5, 2007, respectively. The increase in interest expense during the six months ended May 3, 2008 was primarily attributable to an increase of $0.9 million related to the sale-leaseback in Milpitas combined with an increase of $0.6 million attributable to the interest and amortization of the discount on the subordinated convertible notes.

Other Income (Expenses), Net

Other income (expenses), net was $1.3 million and $2.0 million of expense for the three months ended May 3, 2008 and May 5, 2007, respectively. The net change was primarily due to a favorable change in foreign currency valuation of $0.9 million combined with a decrease in non-operating loss on disposal of fixed assets of $0.7 million partially offset by an increase in realized losses on securities of $0.7 million during the three months ended May 3, 2008 compared with the three months ended May 5, 2007. Other income (expense), net was $2.4 million of expense and $0.6 million of income for the six months ended May 3, 2008 and

 

28


May 5, 2007, respectively. The net change was primarily due to a gain of $3.0 million related to the exchange of convertible notes recorded during the six months ended May 5, 2007 combined with an unfavorable change in foreign currency valuation of $0.3 million and an increase in realized losses on securities of $0.9 million partially offset by a decrease in non-operating loss on disposal of fixed assets of $1.6 million during the six months ended May 3, 2008 compared with the six months ended May 5, 2007.

Income Taxes

We recorded an income tax provision of $0.7 million and $1.9 million for the three months ended May 3, 2008 and May 5, 2007, respectively. We recorded an income tax provision of $1.4 million and $3.9 million for the six months ended May 3, 2008 and May 5, 2007, respectively. The income tax expense for the periods consists primarily of foreign tax on earnings generated in foreign jurisdictions.

We expect to maintain a full valuation allowance on United States deferred tax assets until we can sustain an appropriate level of profitability to insure utilization of existing assets. Until such time, we would not expect to recognize any significant tax benefits in our results of operations.

Stock Options and Incentive Plan

We have a share-based compensation program that provides our Board of Directors broad discretion in creating employee equity incentives. This program includes incentive and non-statutory stock options, restricted stock units and other types of equity granted under various plans, the majority of which are stockholder approved. Stock options are generally time-based, vesting over a four-year period with 12.5% of the granted shares vesting six months after the grant date, and the remaining shares vesting at the rate of 6.25% each quarter thereafter for the following 14 quarters over four years and expire seven to ten years from the grant date. Additionally, we have an Employee Stock Purchase Plan (ESPP) that allows employees to purchase shares of common stock at 85% of the fair market value at the lower of either the date of enrollment or the date of purchase. Shares issued as a result of stock option exercises and our ESPP are generally from our new shares. As of May 3, 2008, we had approximately 10.7 million shares of common stock reserved for future issuance under the stock option plans and ESPP.

At May 3 2008, there was $9.4 million of unrecognized share-based compensation expense related to non-vested options that is expected to be recognized over a weighted-average period of 2.6 years. At May 3, 2008, there was $0.2 million of unrecognized share-based compensation expense related to outstanding ESPP shares that is expected to be recognized over a month period.

See our share-based compensation discussion in Note 3 “Share-Based Compensation” of the Notes to the unaudited condensed consolidated financial statements for further discussion.

LIQUIDITY AND CAPITAL RESOURCES

In the six months ended May 3, 2008, net cash used in operating activities was $29.9 million. The net cash flows used in operating activities for the six months ended May 3, 2008 were due to a net loss of $74.8 million and changes in operating assets and liabilities of $9.2 million, offset by impairment charges related to goodwill and long-lived assets and the disposal of the diagnostics and characterization line resulting in total charges of $26.3 million, depreciation and amortization of $21.6 million, loss on the sale of the Oregon real property of $3.6 million, share-based compensation expense related to employee stock options and employee stock purchases under SFAS 123(R) of $1.9 million and the non-cash charges related to provision for inventory write-downs of $0.8 million.

Net cash provided by investing activities was $68.5 million during the six months ended May 3, 2008, attributable to proceeds from sales and maturities of available-for-sale securities of $60.0 million, proceeds from the Oregon real property of $19.0 million offset by purchases of available-for-sale securities of $8.7 million and $1.7 million used to purchase property and equipment to support our business.

Net cash provided by financing activities was approximately $0.5 million during the six months ended May 3, 2008. The cash provided by financing activities was attributable to the issuance of common stock.

As of May 3, 2008, we had working capital of $198.3 million, including cash and short-term investments of $228.5 million, and accounts receivable and inventories totaling $108.4 million. We believe that because of the relatively long manufacturing cycles of many of our testers and the new products we presently offer and plan to introduce, investments in inventories will continue to represent a significant portion of our working capital. The semiconductor industry has historically been highly cyclical and has experienced downturns, which have had a material adverse effect on the semiconductor industry’s demand for automatic test equipment, including equipment we manufacture and market. In addition, the automatic test equipment industry is highly competitive

 

29


and subject to rapid technological change. It is reasonably possible that events related to these factors may occur in the near term, which would cause a change to our estimate of the net realizable value of receivables, inventories or other assets, and the adequacy of accrued liabilities.

We believe our current cash and investment positions combined with our ability to borrow funds will be sufficient to meet our anticipated business requirements for the next twelve months.

We lease some of our facilities and equipment under operating leases that expire periodically through 2017. The approximate future minimum lease payments at May 3, 2008 are as follows (in thousands):

 

     Net Estimated
Future Lease
Expense

Remainder of fiscal 2008

   $ 3,578

2009

     6,896

2010

     4,436

2011

     3,509

2012

     3,322

Thereafter

     11,539
      
   $ 33,280
      

The following summarizes our minimum contractual cash obligations and other commitments at May 3, 2008, and the effect of such obligations in future periods (in thousands):

 

     Total    Remainder
of Fiscal
2008
   2009    2010    2011    2012    Thereafter

Contractual Obligations:

                    

Facilities and equipment operating leases

   $ 33,280    $ 3,578    $ 6,896    $ 4,436    $ 3,509    $ 3,322    $ 11,539

Convertible subordinated notes (1)

     195,000      72,500      —        122,500      —        —        —  

Interest on convertible subordinated notes

     11,479      2,731      4,288      4,460      —        —        —  

Open and non-cancelable purchase order commitments

     37,066      27,911      8,998      157      —        —        —  
                                                

Total contractual cash obligations

   $ 276,825    $ 106,720    $ 20,182    $ 131,553    $ 3,509    $ 3,322    $ 11,539
                                                

 

(1) This amount is recorded in the unaudited condensed consolidated balance sheets as convertible subordinated notes.

Some of the components that we purchase are unique to us and must be purchased in relatively high minimum quantities with long (in excess of three months) lead times. These business circumstances can lead us to hold relatively high inventory levels giving rise to associated risks. In addition, purchase commitments for unique components often are relatively inflexible in their deferral or cancellation terms. At May 3, 2008, we had open and committed non-cancelable purchase orders totaling approximately $37.1 million. The contractual cash obligations and commitments table presented above contains our minimum obligations at May 3, 2008 under these arrangements and others. Actual expenditures will vary based on the volume of transactions and the length of contractual service provided. In addition to minimum spending commitments, certain of these arrangements provide for charges in the event of cancellation.

Due to the uncertainty with respect to the timing of future cash flows associated with our FIN 48 liabilities and related interest and penalties at May 3, 2008, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $7.0 million of FIN 48 liabilities, interest and penalties have been excluded from the contractual obligations table above. See Note 10 – “Income Taxes,” of the notes to the consolidated financial statements for further discussion.

 

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As of May 3, 2008, our principal sources of liquidity consisted of approximately $220.7 million of cash and cash equivalents and short-term investments of $7.8 million.

 

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RECENT ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We adopted the provisions of FIN 48 on November 4, 2007. See Note 10 — “Income Taxes,” of the notes to the consolidated financial statements for further discussion.

In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the fiscal year beginning November 1, 2008. We are currently evaluating the impact of the provisions of SFAS 157 on our financial position, results of operations and cash flows and do not believe the impact of the adoption will be material.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (SFAS 159). Under SFAS 159, a company may choose, at specified election dates, to measure eligible financial instrument and certain other items at fair value that are not otherwise required to be so measured. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 is effective as of the beginning of the fiscal year beginning after November 15, 2007. We are currently evaluating the impact of SFAS 159 on our financial position, results of operations and cash flows.

In December 2007, the FASB issued Statement No. 141 (revised 2007), “Business Combinations” (SFAS No. 141(R)). The standard changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. We are currently evaluating the impact of the pending adoption of FAS 141(R) on our financial position, results of operations and cash flows.

ITEM 3. — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk from changes in interest rates relates primarily to our cash equivalents and investment portfolio. We maintain a strict investment policy, which ensures the safety and preservation of our invested funds by limiting default risk, market risk, and reinvestment risk. Our investments consist primarily of commercial paper, medium term notes, asset backed securities, U.S. Treasury notes and obligations of U.S. Government agencies, bank certificates of deposit, corporate bonds and municipal bonds. The table below presents notional amounts and related weighted—average interest rates by year of maturity for our investment portfolio (in thousands, except percent amounts).

 

     Balance
November 3,
2007
    Balance
May 3,
2008
    Future maturities of investments held at May 3, 2008  
       2008     2009     2010    2011     Thereafter  

Cash equivalents

               

Amounts

   $ 179,264     $ 220,682     $ 220,682       —         —        —         —    

Average rate

     4.58 %     2.67 %     2.67 %     —         —        —         —    

Short-term investments

               

Amounts

   $ 62,869     $ 7,778       7,778       —         —        —         —    

Average rate

     5.27 %     2.97 %     2.97 %     —         —        —         —    

Long-term investments

               

Amounts

   $ —       $ 4,091     $ —         175       —        590       3,326  

Average rate

     —         2.92 %     —         3.36 %     —        3.09 %     2.87 %
                                                       

Total investment

   $ 242,133     $ 232,551     $ 228,460     $ 175     $ —      $ 590     $ 3,326  

Average rate

     4.76 %     2.68 %     2.68 %     3.36 %     —        3.09 %     2.8 %

We mitigate default risk by attempting to invest in high credit quality securities and by constantly positioning our portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer or guarantor. The portfolio substantially includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity and maintains a prudent amount of diversification.

 

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The sensitivity analysis model used by us for interest rate exposure compares interest income on current investment interest rates versus current investment levels at current interest rates with a 10% increase. Based on this model, a 10% increase or decrease would result in an increase or a decrease in interest income of approximately $0.3 million. There can be no assurances that the above projected interest rate increase will materialize. Fluctuations of interest rates are beyond our control.

Foreign Exchange

We generate a significant portion of our sales from customers located outside the United States, principally in Asia and, to a lesser extent, Europe. International sales are made mostly to foreign distributors and some foreign subsidiaries and are typically denominated in U.S. dollars, but occasionally are denominated in the local currency for European and Japanese customers. The subsidiaries also incur most of their expenses in the local currencies. Our automotive product line is developed and manufactured in Germany and thus, those expenses are Euro based. Accordingly, some of our foreign subsidiaries use the local currency as their functional currency. Foreign currency losses were approximately $0.3 million and $1.2 million for the three months ended May 3, 2008 and May 5, 2007, respectively. Foreign currency losses were approximately $1.2 million and $0.9 million for the six months ended May 3, 2008 and May 5, 2007, respectively.

Our international business is subject to risks typical of an international business including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors. We do not currently use derivatives, but will continue to assess the need for these instruments in the future.

Interest Rate Risk

Our 1.5% Convertible Subordinated Notes with a maturity date of May 2008 bear interest at a fixed rate of 1.5%, and therefore changes in interest rates do not impact our interest expense on this debt. In addition, our 3.5% Convertible Subordinated Notes with a maturity date of May 2010 bear interest at a fixed rate of 3.5%, and therefore changes in interest rates do not impact our interest expense on this debt. We, from time to time, have outstanding short-term borrowings with variable interest rates. The total average amount of these borrowings outstanding annually has been insignificant. Therefore, we expect that a 10% change in interest rate will not have any material effect on our interest expense.

ITEM 4. — CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. Based on our management’s evaluation (with the participation of our chief executive officer and chief financial officer), as of the end of the period covered by this report, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) are effective. We confirm that our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and that our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective at that reasonable assurance level.

Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting during the three months ended May 3, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. — OTHER INFORMATION

 

Item 1. Legal Proceedings.

We are involved in various claims arising in the ordinary course of business, none of which, in the opinion of management, if determined adversely against us, will have a material adverse effect on our business, financial condition or results of operations.

 

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. The fact that some of the risks may be the same or similar to our past filings means only that the risks are present in multiple periods. We believe that many of the risks detailed here and in our other SEC filings are part of doing business in the semiconductor industry and will likely be present in all periods reported. The fact that certain risks are endemic to the industry does not lessen the significance of the risk. There are no material changes to the risk factors described under the title “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended November 3, 2007 filed with the SEC

 

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Our operating results have fluctuated significantly which has adversely affected and may continue to adversely affect our stock price.

LOGO

A variety of factors could affect our results of operations. The above graph illustrates that our quarterly net sales and operating results have fluctuated significantly. We believe they will continue to fluctuate for several reasons, including:

 

   

worldwide economic conditions in the semiconductor industry in general and capital equipment industry specifically;

 

   

loss of certain key customers who account for large portions of our revenue;

 

   

patterns of capital spending by our customers, including delays, cancellations or reschedulings of customer orders due to customer financial difficulties or otherwise;

 

   

the costs and risk inherent in the restructuring of our business to focus on the consumer IC business;

 

   

market acceptance of our new products and enhanced versions of existing products;

 

   

changes in overhead absorption levels due to changes in the number of systems manufactured, the timing and shipment of orders, availability of components including custom ICs subassemblies and services, customization and reconfiguration of our systems and product reliability;

 

   

our ability to attract and retain qualified employees in a competitive market;

 

   

timing of new product announcements and new product releases by us or our competitors;

 

   

labor and materials supply constraints;

 

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expenses associated with acquisitions and alliances, including expenses charged for any impaired acquired intangible assets and goodwill;

 

   

operating expense reductions associated with cyclical industry downturns, including costs relating to facilities consolidations and related expenses;

 

   

the proportion of our direct sales and sales through third parties, including distributors and OEMs, the mix of products sold, the length of manufacturing and sales cycles, and product discounts; and

 

   

natural disasters, political and economic instability, currency fluctuations, regulatory changes and outbreaks of hostilities, especially in Asia.

We intend to introduce new products and product enhancements in the future, the timing and success of which will affect our business, financial condition and results of operations. Our gross margins on systems sales have varied significantly and will continue to vary significantly based on a variety of factors including:

 

   

long-term pricing decreases by us and our competitors and pricing by our suppliers;

 

   

the success of efforts to outsource our manufacturing activities to third party contract manufacturers;

 

   

manufacturing volumes;

 

   

hardware product sales mix;

 

   

absorption levels and the rate of capacity utilization;

 

   

inventory write-downs;

 

   

product reliability;

 

   

possible sale of inventory previously written-down;

 

   

international and domestic sales mix and field service margins; and

 

   

ceasing investment in underperforming or redundant product lines.

New and enhanced products typically have lower gross margins in their early stages of commercial introduction and production, and we may build substantial finished goods inventories of such new products. If delays in or cancellations of orders for those products occur, it may require a future inventory write-down, which would negatively affect our future financial performance. Although we have recorded and continue to record inventory write-downs, product warranty costs, and deferred revenue, we cannot be certain that our estimates will be adequate.

We cannot forecast with any certainty the impact of these and other factors on our sales and operating results in any future period. Results of operations in any period, therefore, should not be considered indicative of the results to be expected for any future period. Because of this difficulty in predicting future performance, our operating results may fall below the expectations of securities analysts or investors in some future quarter or quarters. Our failure in the past to meet these expectations has adversely affected the market price of our common stock and may continue to do so. In addition, our need for continued significant expenditures for research and development, marketing and other expenses for new products, capital equipment purchases and worldwide training and customer service and support will impact our sales and operating results in the future. Other significant expenditures may make it difficult for us to reduce our significant fixed expenses in a particular period if we do not meet our net sales goals for that period. Many of our expenses are fixed and will be difficult to reduce in a particular period if our net sales goal for that period is not met. As a result, we cannot be certain that we will be profitable in the future.

 

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We have a limited backlog and obtain most of our net sales from products that typically range in price from $80,000 to $3.0 million and generally ship products generating most of our net sales near the end of each quarter, which can result in fluctuations of quarterly results.

We obtain most of our net sales from the sale of a relatively few number of systems that typically range in selling price from $80,000 to $3.0 million. This has resulted and could continue to result in our net sales and operating results for a particular period being significantly impacted by the timing of recognition of revenue from a single transaction. Our net sales and operating results for a particular period could also be materially adversely affected if an anticipated order from just one customer is not received in time to permit shipment during that period. Backlog at the beginning of a quarter typically does not include all orders necessary to achieve our sales objectives for that quarter. Orders in backlog are subject to cancellation, delay, deferral or rescheduling by customers with limited or no penalties. Throughout the recent fiscal years, we have experienced customer-requested shipment delays and order cancellations, and we believe it is probable that orders will be canceled and delayed in the future. Consequently, our quarterly net sales and operating results have in the past, and will in the future, depend upon our obtaining orders for systems to be shipped in the same quarter in which the order is received.

Furthermore, we generally ship products generating most of our net sales near the end of each quarter. Accordingly, our failure to receive an anticipated order or a delay or rescheduling in a shipment near the end of a particular period or a delay in receiving customer acceptance from a customer may cause net sales in a particular period to fall significantly below expectations, which could have a material adverse effect on our business, financial condition or results of operations. The relatively long manufacturing cycle of many of our testers has caused and could continue to cause future shipments of testers to be delayed from one quarter to the next. Furthermore, as our competitors announce new products and technologies, and as we complete acquisitions of similar technologies, customers may defer or cancel purchases of our existing systems. We cannot forecast the impact of these and other factors on our sales and operating results.

If our restructuring activities are unsuccessful, our business could be harmed.

During the first fiscal quarter of 2008, we announced a series of restructuring activities, including our intention to prioritize our research and development activities on our Diamond and ASL platforms, to focus our Sapphire platform development on high end consumer markets, to double our sales and support headcount in Asia, to reduce our commitment to businesses and products unrelated to the consumer semiconductor markets, to modify our service business and to reduce our headcount world-wide on a net basis by approximately 400 employees. We cannot be certain that we will successfully anticipate the product needs of our customers or that the products and features we develop as a result of this change in focus will gain customer acceptance. In addition, there can be no assurance that we will not experience delays in product and enhancement development as a result of the changes in our staffing and headcount. Customers may curtail purchases as a result of these changes in focus, delays in product and enhancement development and changes in our service model. Any curtailment of purchases by customers could have a material adverse effect on our business and financial condition.

Some of our net sales are generated from a small number of key customers and the loss of a key customer or material reductions in capital spending by a key customer could substantially reduce our revenues and be perceived as a loss of momentum in our business.

Over time, we have expanded our base of customers; however, a large portion of our net sales are generated from a small number of key customers. In particular, one customer, Advanced Micro Devices, Inc. accounted for 23%, 27% and 23% of our net sales for the six months ended May 3, 2008, fiscal years 2007 and 2006, respectively. In addition, Intel Corporation accounted for 12%, 16% and 15% of our net sales for the six months ended May 3, 2008, fiscal years 2007 and 2006, respectively. Our top ten customers accounted for 65%, 72% and 64% of our net sales for the six months ended May 3, 2008, fiscal years 2007 and 2006, respectively. We expect that our top ten customers in the aggregate will continue to account for a large portion of our net sales for the foreseeable future, and the loss of one or more of these customers or collaborative partners or material reductions in capital spending by one or more of these customers or collaborative partners would harm our business and operating results. The loss of a significant customer could also be perceived as a loss of momentum in our business and an adverse impact on our financial results, and this may cause the market price of our common stock to fall.

Increased reliance on outsourced manufacturing and logistics may affect our business.

We are increasingly outsourcing manufacturing and logistics activities to third-party service providers, which decreases our control over the performance of these functions.

 

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We have already outsourced certain manufacturing and spare parts logistics functions to third-party service providers, and we intend to outsource more of those functions in the future. While we expect to achieve operational flexibility and cost savings as a result of this outsourcing, outsourcing has a number of risks and reduces our control over the performance of the outsourced functions. Significant performance problems by these third-party service providers could result in cost overruns, delayed deliveries, shortages, quality issues or other problems that could result in significant customer dissatisfaction and could materially and adversely affect our business, financial condition and results of operations.

If for any reason one or more of these third-party service providers becomes unable or unwilling to continue to provide services of acceptable quality, at acceptable costs and in a timely manner, our ability to deliver our products or spare parts to our customers could be severely impaired. We would quickly need to identify and qualify substitute service providers or increase our internal capacity, which could be expensive, time-consuming and difficult, and could result in unforeseen operations problems. Substitute service providers might not be available or, if available, might be unwilling or unable to offer services on acceptable terms.

Compliance with current and future environmental regulations may be costly which could impact our future earnings.

We may be subject to environmental and other regulations due to our production and marketing of products in certain states and countries. We also face increasing complexity in our product design and procurement operations as we adjust to new and upcoming requirements relating to the materials composition of our products, including the restrictions on lead and certain other substances in electronics that apply to specified electronics products put on the market in the European Union as of July 1, 2006 (Restriction of Hazardous Substances in Electrical and Electronic Equipment Directive (EU RoHS)). The European Union has also finalized the Waste Electrical and Electronic Equipment Directive (WEEE), which makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The deadline for enacting and implementing this directive by individual European Union governments was August 13, 2004 (WEEE Legislation), although extensions were granted in some countries. Producers became financially responsible under the WEEE Legislation beginning in August 2005. Other countries, such as the United States, China and Japan, have enacted or may enact laws or regulations similar to the EU RoHS or WEEE Legislation. These and other environmental regulations may require us to reengineer certain of our existing products and develop new strategies for the design of new products to utilize components which are more environmentally compatible. Such reengineering and component substitution may result in delays in product design and manufacture and could cause us to incur additional costs. Although we currently do not anticipate any material adverse effects based on the nature of our operations and the effect of such laws, there is no assurance that such existing laws or future laws will not have a material adverse effect on our business.

The semiconductor industry is cyclical.

The semiconductor equipment industry is highly cyclical. Our business and results of operations depend largely upon the capital expenditures of manufacturers of semiconductors and companies that specialize in contract packaging and/or testing of semiconductors. This includes manufacturers and contractors that are opening new or expanding existing fabrication facilities or upgrading existing equipment, which in turn depends upon the current and anticipated market demand for semiconductors and products incorporating semiconductors. The timing, length and severity of the up-and-down cycles in the semiconductor equipment industry are difficult to predict. This cyclical nature of the industry in which we operate affects our ability to accurately predict future revenue and, thus, future expense levels. When cyclical fluctuations result in lower than expected revenue levels, operating results may be adversely affected and cost reduction measures may be necessary in order for us to remain competitive and financially sound. During a down cycle, we must be in a position to adjust our cost and expense structure to prevailing market conditions and to continue to motivate and retain our key employees. In addition, during periods of rapid growth, we must be able to increase manufacturing capacity and personnel to meet customer demand. We can provide no assurance that these objectives can be met in a timely manner in response to industry cycles. If we fail to respond to industry cycles, our business could be seriously harmed.

As a result of the cyclical nature of the semiconductor industry, we have experienced shipment delays, delays in commitments and restructured purchase orders by customers and we expect this activity to continue. Accordingly, we cannot be certain that we will be able to achieve or maintain our current or prior level of sales or rate of growth. We anticipate that a significant portion of new orders may depend upon demand from semiconductor device manufacturers building or expanding fabrication facilities and new device testing requirements that are not addressable by currently installed test equipment, and there can be no assurance that such demand will develop to a significant degree, or at all. In addition, our business, financial condition or results of operations may continue to be materially adversely affected by any factor materially adversely affecting the semiconductor industry in general or particular segments within the semiconductor industry.

Implementation or changes to our enterprise resource planning system and other related systems may affect our business.

We may experience difficulties in implementing, making changes to or enhancing our enterprise resource planning, or ERP, system and other related systems that could disrupt our ability to timely and accurately process and report key components of the results of our consolidated operations, our financial position and cash flows. Any disruptions or difficulties that may occur in

 

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connection with implementing, making changes to or enhancing our ERP system or any future systems could also adversely affect our ability to complete the evaluation of our internal controls and attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. System failure or malfunctioning may result in disruption of operations and the inability to process transactions and could adversely affect our financial results.

Changes to financial accounting standards may affect our reported results of operations.

A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing standards or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.

For example, the Financial Accounting Standards Board (FASB) issued changes to U. S. GAAP that requires us to record a charge to earnings for our various share-based compensation programs beginning on November 1, 2005 which resulted in us recording additional share-based compensation expenses of $1.9 million, $3.5 million and $3.3 million for the six months ended May 3, 2008, fiscal years 2007 and 2006, respectively.

We may continue to experience delays in development, introduction, production in volume, and recognition of revenue from sales of our products.

We have in the past experienced significant delays in the development, introduction, volume production and sales of our new systems and related feature enhancements. These delays related to our inability to successfully complete product hardware engineering within the time frame originally anticipated, including design errors and redesigns of ICs. As a result, some customers have experienced significant delays in receiving and using our testers in production. Delays in introducing a product or delays in our ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by us. We cannot be certain that these or additional difficulties will not continue to arise or that delays will not continue to materially adversely affect customer relationships and future sales. Moreover, we cannot be certain that we will not encounter these or other difficulties that could delay future introductions or volume production or sales of our systems or enhancements. In the past, we have incurred and we may continue to incur substantial unanticipated costs to increase feature sets in our systems. If our systems experience reliability, quality or other problems, or the market perceives our products to be feature deficient, we may continue to suffer reduced orders, higher manufacturing costs, delay in collecting accounts receivable and higher service, support and warranty expenses, and/or inventory write-offs, among other effects. Our failure to have a competitive test system available when required by a customer could make it substantially more difficult for us to sell testers to that customer for a number of years. We believe that the continued acceptance, volume production, timely delivery and customer satisfaction of our newer digital and mixed signal testers are of critical importance to our future financial results. As a result, our inability to correct any technical, reliability, parts shortages or other difficulties associated with our systems or to manufacture and ship the systems on a timely basis to meet customer requirements could damage our relationships with current and prospective customers and would continue to materially adversely affect our business, financial condition and results of operations. In addition, the consolidation of our manufacturing operations in a single site exposes us to the increased risk of manufacturing delays or disruption in the event of natural disasters or other calamities at the site. Any delays or disruptions could materially adversely affect our business, financial condition and results of operations.

Competition in the ATE market requires rapid technological enhancements and new products and services.

Our ability to compete in the ATE market depends upon our ability to successfully develop and introduce new products and enhancements with enhanced features on a timely and cost-effective basis, including products under development internally as well as products obtained in acquisitions. Our customers require test systems with additional features, higher performance and other capabilities. Therefore, it is necessary for us to develop new systems and/or enhance the performance and other capabilities of our existing systems to adequately address these requirements. Any success we may have in developing new and enhanced systems and new features to our existing systems will depend upon a variety of factors, including:

 

   

product selection;

 

   

timely and efficient completion of product design;

 

   

implementation of manufacturing and assembly processes;

 

   

product performance;

 

38


   

reliability in the field;

 

   

effective worldwide sales and marketing; and

 

   

labor and supply constraints.

Because we must make new product development commitments well in advance of sales, new product decisions must anticipate both future demand and the availability of technology to satisfy that demand. We cannot be certain that we will be successful in selecting, developing, manufacturing and marketing new hardware products or enhancements. Our inability to introduce new products that contribute significantly to net sales, gross margin and net income would have a material adverse effect on our business, financial condition and results of operations. New product or technology introductions by our competitors could cause a decline in sales or loss of market acceptance of our existing products. If we introduce new products, existing customers may curtail purchases of the older products resulting in inventory write-offs and they may delay new product purchases. Any decline in demand for our hardware products could have a material adverse effect on our business, financial condition or results of operations.

We are continuing to invest significant resources in the expansion of our product lines and there is no certainty that our net sales will increase or remain at historical levels or that new products will contribute to revenue growth.

We are currently devoting and intend to continue to devote significant resources to the development, enhancement, production and commercialization of new products and technologies. During fiscal years 2007 and 2006, we introduced several enhancements as well as new products that are evolutions or derivatives of existing products as well as products that were largely new. Under our revenue recognition policy adopted in accordance with SAB 104 we defer revenue for transactions that involve newly introduced products or when customers specify acceptance criteria that cannot be demonstrated prior to the shipment. This results in a delay in the recognition of revenue as compared to the historic norm of recognizing revenue upon shipment. Product introduction delays, if they occur in the future, will delay the recognition of revenue and gross profit and may result in delayed cash receipts by us that could materially adversely affect our business, financial condition and results of operations. We invested and continue to invest significant resources in property, plant and equipment, purchased and leased facilities, inventory, personnel and other costs to begin or prepare to increase production of these products. A significant portion of these investments will provide the marketing, administration and after-sales service and support required for these new products. Accordingly, we cannot be certain that gross profit margin and inventory levels will not continue to be materially adversely affected by delays in new product introductions or start-up costs associated with the initial production and installation of these new product lines. We also cannot be certain that we can manufacture these systems per the time and quantity required by our customers. The start-up costs include additional manufacturing overhead, additional inventory and warranty reserve requirements and the enhancement of after-sales service and support organizations. In addition, the increases in inventory on hand for new product development and customer support requirements continue to increase the risk of significant inventory write-offs. We cannot be certain that our net sales will increase or remain at historical levels or that any new products will be successfully commercialized or contribute to revenue growth or that any of our additional costs will be covered.

The ATE industry is intensely competitive which can adversely affect our ability to maintain or increase our net sales and revenues growth.

With the substantial investment required to develop test application and interfaces, we believe that once a semiconductor manufacturer has selected a particular ATE vendor’s tester, the manufacturer is likely to use that tester for a majority of its testing requirements for the market life of that semiconductor and, to the extent possible, subsequent generations of similar products. As a result, once an ATE customer chooses a system for the testing of a particular device, it is difficult for competing vendors to achieve significant ATE sales to such customer for similar use. Our inability to penetrate any particular large ATE customer or achieve significant sales to any ATE customer could have a material adverse effect on our business, financial condition or results of operations.

We face substantial competition from ATE manufacturers throughout the world. A substantial portion of our net sales is derived from sales of mixed-signal testers. We face in some cases seven and in other cases nine competitors in our primary market segments of digital, mixed signal, and RF wireless ATE. We believe that the ATE industry in total has not been profitable for the last three years, indicating a very competitive and volatile marketplace. Several of these competitors have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing and distribution of their products. Certain competitors have introduced or announced new products with certain performance or price characteristics equal or superior to products we currently offer. These competitors have introduced products that compete directly against our products. We believe that if the ATE industry continues to consolidate through strategic alliances or acquisitions, we will continue to face significant additional competition from larger competitors that may offer product lines and services more complete than ours. Our competitors are continuing to improve the performance of their current products and to introduce new products, enhancements and new technologies that provide improved cost of ownership and performance characteristics. New product introductions by our competitors could cause a decline in our sales or loss of market acceptance of our existing products.

 

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Moreover, our business, financial condition or results of operations will continue to be materially adversely affected by continuing competitive pressure and continued intense price-based competition. We have experienced and continue to experience significant price competition in the sale of our products. In addition, pricing pressures typically have become more intense during cyclical downturns when competitors seek to maintain or increase market share, at the end of a product’s life cycle and as competitors introduce more technologically advanced products. We believe that, to be competitive, we must continue to expend significant financial resources in order to, among other things, invest in new product development and enhancements and to maintain customer service and support centers worldwide. We cannot be certain that we will be able to compete successfully in the future.

We may not be able to deliver custom hardware options to satisfy specific customer needs in a timely manner.

We must develop and deliver customized hardware to meet our customers’ specific test requirements. The market requires us to manufacture these systems on a timely basis. Our test equipment may fail to meet our customers’ technical or cost requirements and may be replaced by competitive equipment or an alternative technology solution. Our inability to meet such hardware requirements could impact our ability to recognize revenue on the related equipment. Our inability to provide a test system that meets requested performance criteria when required by a device manufacturer would severely damage our reputation with that customer. This loss of reputation may make it substantially more difficult for us to sell test systems to that manufacturer for a number of years, which could have a material adverse effect on our business, financial condition or results of operations.

We rely on Spirox Corporation and customers in Taiwan for a significant portion of our revenues and the termination of this distribution relationship would materially adversely affect our business.

Spirox Corporation, a distributor in Taiwan that sells to end-user customers in Taiwan and China, accounted for approximately 16%, 16% and 13% of our net sales in the six months ended May 3, 2008 and fiscal years 2007 and 2006, respectively. Our agreement with Spirox has no minimum purchase commitment and can be terminated for any reason on 180 days prior written notice. On May 31, 2005, we entered into an agreement with Spirox to combine our Taiwan operation with Spirox’s T1 division into a corporation named Credence Spirox Integration Corporation, an operation owned 90% by Spirox and 10% by us. This corporation is dedicated to supporting our products in the Taiwan region. Consequently, our business, financial condition and results of operations could be materially adversely affected by the loss of or any reduction in orders by Spirox, any termination of the Spirox relationship, or the loss of any significant Spirox customer, including the potential for reductions in orders by assembly and tester service companies due to technical, manufacturing or reliability problems with our products or continued slow-downs in the semiconductor industry or in other industries that manufacture products utilizing semiconductors. Our ability to maintain or increase sales levels in Taiwan will depend upon:

 

   

our ability with Spirox to obtain orders from existing and new customers;

 

   

our ability to manufacture systems on a timely and cost-effective basis;

 

   

our ability to timely complete the development of our new hardware products;

 

   

Spirox and its end-user customers’ financial condition and success;

 

   

general economic conditions; and

 

   

our ability to meet increasingly stringent customer performance and other requirements and shipment delivery dates.

We have substantial indebtedness and if we need additional financing, it could be difficult to obtain.

As of May 3, 2008, we had $72.5 million principal amount of 1.5% Convertible Subordinated Notes, or 1.5% Notes, due in May 2008 and $122.5 million principal amount of 3.5% Convertible Senior Subordinated Notes, due 2010 (the New Notes). The New Notes contain net share settlement provisions which require that, upon conversion of the New Notes, we will pay holders in cash up to the principal amount of the converted New Notes. Any amounts in excess of this converted amount will be settled in shares of our common stock or, at our option, cash. The initial conversion price is $8.25.

 

40


The level of indebtedness, among other things, could:

 

   

make it difficult for us to make payments on our debt and other obligations, particularly upon maturity of the 1.5% Notes in May 2008 and the maturity or conversion of the New Notes, due 2010 if we were unable to cause the conversion of this debt into equity;

 

   

make it difficult for us to obtain any necessary future financing for working capital, capital expenditures, debt service requirements or other purposes;

 

   

require the dedication of a substantial portion of any cash flow from operations to service the indebtedness, thereby reducing the amount of cash flow available for other purposes, including capital expenditures;

 

   

limit our flexibility in planning for, or reacting to changes in our business and the industries in which we compete;

 

   

place us at a possible competitive disadvantage with respect to less leveraged competitors and competitors that have better access to capital resources; and

 

   

make us more vulnerable in the event of a further downturn in our business.

There can be no assurance that we will be able to meet our debt service obligations, including our obligations under the New Notes.

We expect that our existing cash and short-term investments will be sufficient to meet our cash requirements to fund operations and expected capital expenditures for the next twelve months. In the event we may need to raise additional funds, we cannot be certain that we will be able to obtain such additional financing on favorable terms if at all. Further, if we issue additional equity securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. Future financings may place restrictions on how we operate our business. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to develop or enhance our products and services, take advantage of future business opportunities, grow our business or respond to competitive pressures, which could seriously harm our business.

Changes in the accounting treatment of our 3.5% Convertible Senior Subordinated Notes could decrease our net income and earnings per share amounts.

New or different accounting pronouncements or regulatory rulings may emerge which could impact the way we are required to account for our convertible debt instruments that would have an adverse impact on our results of operations and earnings per share amount. With respect to our 3.5% Convertible Senior Subordinated Notes, we are required under U.S. GAAP as presently in effect to include in outstanding shares for purposes of computing earnings per share only a number of shares underlying the convertible notes that, at the end of a given quarter, have a value in excess of the outstanding principal amount of the convertible notes. This is because of the “net share settlement” feature of the convertible notes, under which we are required to pay the principal amount of the convertible notes in cash. The recently issued exposure draft from the FASB, FSP ARB 14-A “Accounting for convertible debt that may be settled in cash upon conversion (including partial cash settlement)” is proposing a new method of accounting for net share settled convertible debt instruments under which the debt and equity components of the instrument would be bifurcated and accounted for separately. If the proposed position is adopted by the FASB it could impact our net income and earnings per share amounts. While the recently issued exposure draft from FASB contemplated that this change would take effect for fiscal years beginning after December 15, 2007, this change has not yet been adopted and we are unable to estimate the likelihood that the proposed change will be adopted, whether it will apply to the 3.5% Convertible Senior Subordinated Notes or the date it would be effective if adopted.

We require a significant amount of cash, and our ability to generate cash may be affected by factors beyond our control.

Our business may not generate cash flow in an amount sufficient to enable us to fund our liquidity needs, including payment of the principal of, or interest on, our indebtedness, working capital, capital expenditures, product development efforts, strategic acquisitions, investments and alliances and other general corporate requirements. Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot be assured that our business will generate sufficient cash flow from operations or that future borrowings or other sources of funding will be available to us, in amounts sufficient to enable us to fund our liquidity needs or with terms that are favorable to us.

 

41


We may repatriate cash from our foreign subsidiaries, which could result in additional income taxes that could negatively impact our results of operations and financial position. In addition, if foreign countries’ currency policies limit our ability to repatriate the needed funds, our business and results of operations could be adversely impacted.

One or more of our foreign subsidiaries hold a portion of our cash and cash equivalents. If we need additional cash to acquire assets or technology, or to support our operations in the United States, and if the currency policies of these foreign countries allow us, we may repatriate some of our cash from these foreign subsidiaries to the United States. For example, during the first quarter of fiscal year 2007, we repatriated $7.1 million from our Hong Kong operations. Depending on our financial results and the financial results of our subsidiaries at the time that the cash is repatriated, we may incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position. In addition, if the currency policies of these foreign countries prohibit or limit our ability to repatriate the needed funds, our business and results of operations could be adversely impacted.

Our long and variable sales cycle depends upon factors outside of our control and could cause us to expend significant time and resources prior to earning associated revenues.

Sales of our systems depend in part upon the decision of semiconductor manufacturers to develop and manufacture new semiconductor devices or to increase manufacturing capacity. As a result, sales of our products are subject to a variety of factors we cannot control. The decision to purchase our products generally involves a significant commitment of capital, with the attendant delays frequently associated with significant capital expenditures. For these and other reasons, our systems have lengthy sales cycles during which we may expend substantial funds and management effort to secure a sale, subjecting us to a number of significant risks, including a risk that our competitors may compete for the sale, a further downturn in the economy or other economic factors causing our customers to withdraw or delay their orders or a change in technological requirements of the customer. As a result, our business, financial condition and results of operations would 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 a sale will be made.

There are limitations on our ability to find the supplies and services necessary to run our business.

We obtain certain components, subassemblies and services necessary for the manufacture of our testers from a limited group of suppliers. We do not maintain long-term supply agreements with most of our vendors, and we purchase most of our components and subassemblies through individual purchase orders. The manufacture of certain of our components and subassemblies is an extremely complex process. We also rely on outside vendors to manufacture certain components and subassemblies and to provide certain services. We have experienced and continue to experience significant reliability, quality and timeliness problems with several critical components including certain custom ICs. We cannot be certain that these or other problems will not continue to occur in the future with our suppliers or outside subcontractors. Our reliance on a limited group of suppliers and on outside subcontractors involves several risks, including an inability to obtain an adequate supply of required components, subassemblies and services and reduced control over the price, timely delivery, reliability and quality of components, subassemblies and services. Shortages, delays, disruptions or terminations of the sources for these components and subassemblies have delayed and in the future may delay shipments of our systems and new products and could have a material adverse effect on our business. Our continuing inability to obtain adequate yields or timely deliveries or any other circumstance that would require us to seek alternative sources of supply or to manufacture such components internally could also have a material adverse effect on our business, financial condition or results of operations. Such delays, shortages and disruptions would also damage relationships with current and prospective customers and have and could continue to allow competitors to penetrate our customer accounts. We cannot be certain that our internal manufacturing capacity or that of our suppliers and subcontractors will be sufficient to meet customer requirements.

Our international business exposes us to additional risks.

International sales accounted for approximately 70%, 71% and 69% of our total net sales for the six months ended May 3, 2008, fiscal years 2007 and 2006, respectively. We anticipate that international sales will continue to account for a significant portion of our total net sales in the foreseeable future. These international sales will continue to be subject to certain risks, including:

 

   

changes in regulatory requirements;

 

   

tariffs and other barriers;

 

   

political and economic instability;

 

42


   

adverse effects of fears surrounding any health risks on our business and sales and that of our customers, especially in Taiwan, Hong Kong and China;

 

   

outbreak of hostilities in markets where we sell our products, including Korea and Israel;

 

   

integration and management of foreign operations of acquired businesses;

 

   

foreign currency exchange rate fluctuations;

 

   

difficulties with distributors, outsourcing partners and supply chain, original equipment manufacturers, foreign subsidiaries and branch operations;

 

   

potentially adverse tax consequences;

 

   

possibility of difficulty in accounts receivable collection;

 

   

greater difficulty in complying with United States accounting standards; and

 

   

greater difficulty in protecting intellectual property rights.

We are also subject to the risks associated with the imposition of domestic and foreign legislation and regulations relating to the import or export of semiconductor equipment products. We cannot predict whether the import and export of our products will be adversely affected by changes in or new quotas, duties, taxes or other charges or restrictions imposed by the United States or any other country in the future. Any of these factors or the adoption of restrictive policies could have a material adverse effect on our business, financial condition or results of operations. Net sales to the Asia Pacific region accounted for approximately 49%, 52% and 50% of our total net sales for the six months ended May 3, 2008, fiscal years 2007 and 2006, respectively, and thus demand for our products is subject to the risk of economic instability in that region and health risks. No single end-user customer headquartered in Asia or Europe accounted for more than 10% of our net sales during the three months ended May 3, 2008, or during fiscal years 2007 and 2006.

In addition, one of our major distributors, Spirox Corporation, which accounted for 16%, 16% and 13% of our net sales for the six months ended May 3, 2008, fiscal years 2007 and 2006, respectively, is a Taiwan-based company. This subjects a significant portion of our receivables and future revenues to the risks associated with doing business in a foreign country, including political and economic instability, currency exchange rate fluctuations, fears related to health risks and regulatory changes. Disruption of business in Asia caused by the previously mentioned factors could continue to have a material impact on our business, financial condition or results of operations.

We operate in a volatile industry—indicators of goodwill and other long-lived assets impairment under SFAS 142 and SFAS 144 may be present from time-to-time.

Effective November 1, 2002, we adopted Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), which was issued by the FASB in July 2001. Under this standard, we ceased amortizing goodwill and acquired workforce costs effective November 1, 2002.

As mandated by SFAS 142, we test goodwill for possible impairment on an annual basis and at any other time if events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable. Circumstances that could trigger an impairment test include but are not limited to: our market value falling below our net book value for a significant period of time, a significant adverse change in the business climate or legal factors; unanticipated competition; loss of key personnel; a significant change in direction with respect to investment in a product or market segment; the likelihood that a significant portion of the business will be sold or disposed of; or the results of testing for recoverability of a significant asset group within a reporting unit determined in accordance with SFAS 142.

Based on a combination of factors that came into existence and were identified during the third quarter of fiscal year 2006, particularly: (1) our changed current and projected operating results reflecting lower demand from major customers; and (2) our current market capitalization which was significantly less than our book value for the preceding 10 weeks prior to the end of the third quarter, we concluded there were sufficient indicators to require us to assess whether any portion of our recorded goodwill balance was impaired. We determined, based on our estimates of forecasted discounted cash flows and our market capitalization, that our goodwill was impaired at July 31, 2006. Further analysis indicated that goodwill was impaired and charges of $423.9 million were recorded in the third quarter of fiscal year 2006. Other long-lived assets were assessed for impairment prior to the performance of the SFAS 142 analysis and were determined not to be impaired.

 

43


During the first fiscal quarter of 2008, we committed to sell certain assets related to the diagnostics and characterization product line. The contract associated with this sale was executed in February 2008. On January 31, 2008, we determined that the plan of sale criteria in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” had been met. Accordingly, the carrying value of the disposal group was adjusted to its fair value less costs to sell, which was determined based on the purchase agreement under negotiations, resulting in a $22.5 million impairment charge.

If economic conditions in our industry continue to deteriorate and adversely affect our business, we could be required to record impairment charges related to our long-lived assets in accordance with SFAS 144, “Accounting for Impairment or Disposal for Long-Lived Assets” (SFAS 144) which could have a material adverse effect on our results of operations and financial condition.

Future acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert management attention.

Our growth depends upon market growth, our ability to enhance our existing products, and our ability to introduce new products on a timely basis. We intend to continue to address the need to develop new products and enhance existing products through acquisitions of other companies, product lines, technologies, and personnel. Acquisitions involve numerous risks, including the following:

 

   

Difficulties in integrating the operations, technologies, products, and personnel of the acquired companies;

 

   

Diversion of management’s attention from normal daily operations of the business;

 

   

Potential difficulties in completing projects associated with in-process research and development;

 

   

Difficulties in entering markets in which we may have no or limited direct prior experience and where competitors in such markets may have stronger market positions;

 

   

Initial dependence on unfamiliar supply chains or relatively small supply partners;

 

   

Insufficient revenue to offset increased expenses associated with acquisitions; and

 

   

Potential loss of key employees of the acquired companies.

Acquisitions may also cause us to:

 

   

Issue common stock that would dilute our current shareholders’ percentage ownership;

 

   

Assume liabilities;

 

   

Record goodwill and non-amortizable intangible assets that will be subject to impairment testing on a regular basis and potential periodic impairment charges;

 

   

Incur amortization expenses related to certain intangible assets;

 

   

Incur large and immediate write-offs and restructuring and other related expenses; and

 

   

Become subject to intellectual property or other litigation.

Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results. Prior acquisitions have resulted in a wide range of outcomes, from successful introduction of new products and technologies to an inability to do so. Even when an acquired company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that pre-acquisition due diligence will have identified all possible issues that might arise with respect to such products.

 

44


From time-to-time, we have made acquisitions that resulted in in-process research and development expenses being charged in a single quarter. These charges may occur in any quarter, contributing to variability in our quarterly earnings. Risks related to new product development also apply to acquisitions.

Our executive officers and certain key personnel are critical to our business.

Our future operating results depend substantially upon the continued service of our executive officers and key personnel. Our chief executive officer, Lavi A. Lev, joined us in December 2006 and has limited experience in our business. Our future operating results also depend in significant part upon our ability to attract and retain qualified management, manufacturing, technical, engineering, marketing, sales and support personnel. Competition for qualified personnel is intense, and we cannot ensure success in attracting or retaining qualified personnel. There may be only a limited number of persons with the requisite skills to serve in these positions and it may be increasingly difficult for us to hire personnel over time. During fiscal year 2007 and 2008, we experienced turnover in our chief executive officer, chief financial officer, sales and marketing senior executive, senior engineering executive and senior executive legal positions. In addition, our current chief financial officer joined us in January 2008. 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.

If the protection of our proprietary rights is inadequate, our business could be harmed.

We attempt to protect our intellectual property rights through patents, copyrights, trademarks, maintenance of trade secrets and other measures, including entering into confidentiality agreements. However, we cannot be certain that others will not independently develop substantially equivalent intellectual property or that we can meaningfully protect our intellectual property. Nor can we be certain that our patents will not be invalidated, deemed unenforceable, circumvented or challenged, or that the rights granted there under will provide us with competitive advantages, or that any of our pending or future patent applications will be issued with claims of the scope we seek, if at all. Furthermore, we cannot be certain that others will not develop similar products, duplicate our products or design around our patents, or that foreign intellectual property laws, or agreements into which we have entered will protect our intellectual property rights. Inability or failure to protect our intellectual property rights could have a material adverse effect upon our business, financial condition and results of operations. In addition, from time to time we encounter disputes over rights and obligations concerning intellectual property, including disputes with parties with whom we have licensed technologies. We cannot assume that we will prevail in any such intellectual property disputes. We have been involved in extensive, expensive and time-consuming reviews of, and litigation concerning, patent infringement claims.

Our business may be harmed if we are found to infringe proprietary rights of others.

We have at times been notified that we may be infringing intellectual property rights of third parties and we have litigated patent infringement claims in the past. We expect to continue to receive notice of such claims in the future. We cannot be certain of the success in defending patent infringement claims or claims for indemnification resulting from infringement claims.

We cannot be certain of success in defending current or future patent or other infringement claims or claims for indemnification resulting from infringement claims. Our business, financial condition and results of operations could be materially adversely affected if we must pay damages to a third party or suffer an injunction or if we expend significant amounts in defending any such action, regardless of the outcome. With respect to any claims, we may seek to obtain a license under the third party’s intellectual property rights. We cannot be certain, however, that the third party will grant us a license on reasonable terms or at all. We could decide, in the alternative, to continue litigating such claims. Litigation has been and could continue to be extremely expensive and time consuming, and could materially adversely affect our business, financial condition or results of operations, regardless of the outcome.

We may be materially adversely affected by legal proceedings.

We have been and may in the future be subject to various legal proceedings, including claims that involve possible infringement of patent or other intellectual property rights of third parties. It is inherently difficult to assess the outcome of litigation matters, and there can be no assurance that we will prevail in any litigation. Any such litigation could result in substantial cost and diversion of our efforts, which by itself could have a material adverse effect on our financial condition and operating results. Further, adverse determinations in such litigation could result in loss of our property rights, subject us to significant liabilities to third parties, require us to seek licenses from third parties or prevent us from manufacturing or selling our products, any of which could materially adversely affect our business, financial condition or results of operations.

 

45


Recently enacted and proposed changes in securities laws and regulations have increased our costs.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, have increased our expenses as we evaluate the implications of new rules and devote resources to respond to the new requirements. Sarbanes-Oxley Act mandates, among other things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers and directors for securities law violations. In addition, The NASDAQ Global Market, on which our common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations. We also expect these developments to continue to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. Further, our board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which would adversely affect our business.

We are subject to the internal control evaluation and attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

Section 404 of the Sarbanes-Oxley Act of 2002 requires that we include in our annual report our assessment of the effectiveness of our internal control over financial reporting and our audited financial statements as of the end of each fiscal year. Furthermore, our independent registered public accounting firm (Firm) is required to report on whether it believes we maintained, in all material respects, effective internal control over financial reporting as of the end of the year. We successfully completed our assessment and obtained our Firm’s attestation as to the effectiveness of our internal control over financial reporting as of November 3, 2007, October 31, 2006 and 2005. In future years, if we fail to timely complete this assessment, or if our Firm cannot timely attest, we could be subject to regulatory sanctions and a loss of public confidence in our internal control. In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to timely meet our regulatory reporting obligations.

Terrorist attacks, terrorist threats, geopolitical instability and government responses thereto, may negatively impact all aspects of our operations, revenues, costs and stock price.

The terrorist attacks in September 2001 in the United States and ensuing events and the resulting decline in consumer confidence had a material adverse effect on the economy.

Any similar future events may disrupt our operations or those of our customers and suppliers. Our markets currently include Taiwan, Korea and Israel, which are experiencing political instability. In addition, these events have had and may continue to have an adverse impact on the United States and world economy in general and consumer confidence and spending in particular, which could harm our sales. Any of these events could increase volatility in the United States and world financial markets, which could harm our stock price and may limit the capital resources available to us and our customers or suppliers. This could have a significant impact on our operating results, revenues and costs and may result in increased volatility in the market price of our common stock.

We are subject to anti-takeover provisions that could delay or prevent an acquisition of our company.

Provisions of our amended and restated certificate of incorporation, equity incentive plans, bylaws and Delaware law may discourage transactions involving a change in corporate control. In addition to the foregoing, our classified board of directors and the ability of our board of directors to issue preferred stock without further stockholder approval could have the effect of delaying, deferring or preventing a third party from acquiring us and may adversely affect the voting and other rights of holders of our common stock.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None

 

Item 3. Defaults upon Senior Securities.

None

 

46


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

Our stockholders voted upon the following proposals at the Annual Meeting of Stockholders held on April 1, 2008:

 

   

A proposal to elect two directors, each to serve for a three-year term ending in 2011 or until a successor is elected and qualified, was approved as follows:

 

Name

   For     Withheld

Lori Holland

   90,832,011                2,409,903

David L. House

   90,841,523     2,400,391

The following directors’ terms of office continued after the Annual Meeting of Stockholders: Lavi A. Lev, Henk J. Evenhuis, Bruce R. Wright and Ping Yang.

 

   

A proposal to ratify the appointment of Ernst & Young, LLP as our independent registered accounting firm was approved as follows:

 

For   Against   Abstain   Non-Vote
91,535,084     1,600,916   105,914           0        

 

   

A proposal granting the Compensation Committee of the Board of Directors the authority to implement a stock option exchange program pursuant to which eligible employees will be offered the opportunity to exchange their eligible options to purchase shares of common stock outstanding under our existing equity incentive plans for new stock options at an expected lower exercise price, which approval includes the approval of an amendment to the 2005 Stock Incentive Plan to increase the number of shares available for issuance under that plan by 1,200,000 shares of common stock to implement such stock option exchange program, was approved as follows:

 

For   Against   Abstain   Non-Vote
47,830,573   15,503,519     29,540   29,878,282

 

   

An amendment and restatement of the 2005 Stock Incentive Plan to increase the number of shares available for issuance under that plan by 7,800,000 shares of common stock in addition to the amount set forth in the proposal above and to make repricings of stock appreciation awards subject to stockholder approval was approved as follows:

 

For   Against   Abstain   Non-Vote
54,044,325     9,286,491     32,816   29,878,282

 

   

A stockholder proposal regarding pay-for-superior performance was approved as follows:

 

For   Against   Abstain   Non-Vote
85,109,933     8,068,203     63,718           0        

 

Item 5. Other Information.

None

 

Item 6. Exhibits.

 

  (a) See Exhibit Index

 

47


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    CREDENCE SYSTEMS CORPORATION
    (Registrant)

Date June 12, 2008

    /s/    Kevin C. Eichler        
    Kevin C. Eichler
    Senior Vice President, Chief Financial Officer and
    Secretary
    (Principal Financial and Chief Accounting Officer)

 

48


EXHIBIT INDEX

 

Exhibit
Number

   
  3.1(1)     Amended and Restated Certificate of Incorporation of the Company, as currently in effect.
  3.2(2)     Amended and Restated Bylaws of the Company, as currently in effect.
  4.1(3)     Indenture, dated as of June 2, 2003 between Credence Systems Corporation and The Bank of New York, as Trustee.
  4.2(3)     Form of global 1.5% Convertible Subordinated Note due 2008 (included in Exhibit 4.3).
  4.3(4)     Indenture, dated as of December 20, 2006, between the Company and The Bank of New York, as Trustee.
  4.4(4)     Form of global 3.5% Convertible Senior Subordinated Note due 2010 (included in Exhibit 4.4).
10.1(5)     Form of Indemnification Agreement between the Company and each of its officers and directors.
10.13(6)   Purchase Agreement dated as of February 14, 2008, by and between Credence Systems Corporation and DCG Systems, Inc.
10.14(7)   Credence Systems Corporation 2008 Executive Incentive Plan
10.15(8)   Credence Systems Corporation 2005 Stock Incentive Plan (as amended and restated April, 2008)
31.1         Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2         Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1         Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2         Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(1) Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2000.

 

(2) Incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended January 31, 2002.

 

(3) Incorporated by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-3 (File No. 333-108069) as filed with the Commission on August 19, 2003.

 

(4) Exhibits 4.5, 4.5, 10.30 and 10.31 are incorporated herein by reference to Exhibit 4.1, 4.2, 10.1 and 10.2 to the Company’s Current Report on Form 8-K (File No. 000-22366) filed on December 21, 2006.

 

49


(5) Exhibit 10.1 is incorporated herein reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003.

 

(6) Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 14, 2008.

 

(7) Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 14, 2008.

 

(8) Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 4, 2008.

 

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