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Verigy 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-10.3
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10-Q
Table of Contents

 

 

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 January 31, 2010

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: 000-52038

 

 

Verigy Ltd.

(Exact Name of Registrant as Specified in Its Charter)

 

SINGAPORE   N/A

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

NO. 1 YISHUN AVE 7

SINGAPORE 768923

  N/A
(Address of Principal Executive Offices)   (Zip Code)

(+65) 6755-2033

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    ¨  No

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

 

Large accelerated filer  x    Accelerated filer  ¨    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

As of March 2, 2010, there were 59,328,427 outstanding ordinary shares, no par value.

 

 

 


Table of Contents

VERIGY LTD.

TABLE OF CONTENTS

 

              Page
Number
Part I. Financial Information   
 

Item 1.

  

Financial Statements (Unaudited)

   3
    

Condensed Consolidated Financial Statements

  
    

Condensed Consolidated Statements of Operations for the three months ended January 31, 2010 and 2009

   3
    

Condensed Consolidated Balance Sheets at January 31, 2010 and October 31, 2009

   4
    

Condensed Consolidated Statements of Cash Flows for the three months ended January 31, 2010 and 2009

   5
    

Notes to Condensed Consolidated Financial Statements

   6
 

Item 2.

  

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

   26
 

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risks

   38
 

Item 4.

  

Controls and Procedures

   40
Part II. Other Information   
 

Item 1.

  

Legal Proceedings

   40
 

Item 1A.

  

Risk Factors

   40
 

Item 2

  

Unregistered Sales of Equity Securities and Use of Proceeds

   50
 

Item 3.

  

Defaults Upon Senior Securities

   50
 

Item 4.

  

Submission of Matters to a Vote of Security Holders

   50
 

Item 5.

  

Other Information

   50
 

Item 6.

  

Exhibits

   51

Signature

   52

Exhibit Index

   53

 

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Table of Contents

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

VERIGY LTD.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

     Three Months Ended
January 31,
 
     2010     2009  
     (in millions, except share and
per share amounts)
 

Net revenue:

    

Products

   $ 76      $ 33   

Services

     30        35   
                

Total net revenue

     106        68   

Costs of sales:

    

Cost of products

     40        36   

Cost of services

     19        23   
                

Total costs of sales

     59        59   

Operating expenses:

    

Research and development

     22        25   

Selling, general and administrative

     29        31   

Restructuring charges

     1        4   
                

Total operating expenses

     52        60   

Loss from operations

     (5     (51

Other (expense) income, net

     (1     2   

Impairment of investments

     —          (14
                

Loss before income taxes

     (6     (63

Provision for income taxes

     —          1   
                

Net loss

   $ (6   $ (64
                

Net loss per share – basic:

   $ (0.10   $ (1.09

Net loss per share – diluted:

   $ (0.10   $ (1.09

Weighted average shares (in thousands) used in computing net loss per share:

    

Basic

     59,148        58,149   

Diluted

     59,148        58,149   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

VERIGY LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

     January 31,
2010
    October 31,
2009
 
     (in millions, except share
amounts)
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 213      $ 197   

Short-term marketable securities

     147        167   

Trade accounts receivable, net

     70        54   

Inventory

     61        55   

Other current assets

     40        42   
                

Total current assets

     531        515   

Property, plant and equipment, net

     41        41   

Long-term marketable securities

     67        75   

Goodwill and other intangibles, net

     19        20   

Other long-term assets

     62        62   
                

Total assets

   $ 720      $ 713   
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 51      $ 40   

Employee compensation and benefits

     27        32   

Deferred revenue, current

     32        26   

Other current liabilities

     21        27   
                

Total current liabilities

     131        125   

Long-term liabilities:

    

Convertible senior notes

     138        138   

Income taxes payable

     16        15   

Other long-term liabilities

     33        33   
                

Total liabilities

     318        311   
                

Commitments and contingencies (Note 22)

    

Shareholders’ equity

    

Ordinary shares, no par value; 59,259,463 and 58,841,248 issued and outstanding at January 31, 2010 and October 31, 2009, respectively

    

Additional paid in capital

     436        429   

Accumulated deficit

     (29     (23

Accumulated other comprehensive loss

     (5     (4
                

Total shareholders’ equity

     402        402   
                

Total liabilities and shareholders’ equity

   $ 720      $ 713   
                

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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VERIGY LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Three Months Ended
January 31,
 
     2010     2009  
     (in millions)  

Cash flows from operating activities:

    

Net loss

   $ (6   $ (64

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation and amortization

     5        4   

Gross excess and obsolete inventory-related provisions

     2        13   

Share-based compensation

     5        5   

Impairment of investments

     —          14   

Realized gain on marketable securities

     1        —     

Changes in assets and liabilities:

    

Trade accounts receivable, net

     (15     33   

Inventory

     (9     (3

Accounts payable

     11        (29

Employee compensation and benefits

     (5     (11

Deferred revenue, current

     5        (11

Income taxes and other taxes payable

     (4     2   

Other current assets and accrued liabilities

     (3     —     

Other long-term assets and long-term liabilities

     2        —     
                

Net cash used in operating activities

     (11     (47

Cash flows from investing activities:

    

Investments in property, plant and equipment

     (3     (2

Proceeds from disposition of assets

     —          2   

Purchases of available for sale marketable securities

     (70     (3

Proceeds from sales of available for sale marketable securities

     68        4   

Proceeds from maturities of available for sale marketable securities

     30        72   
                

Net cash provided by investing activities

     25        73   

Cash flows from financing activities:

    

Issuance of ordinary shares under employee stock plans

     2        3   

Repurchase and retirement of ordinary shares

     —          (2
                

Net cash provided by financing activities

     2        1   

Effect of exchange rate movements

     —          (1
                

Net increase in cash and cash equivalents

     16        26   

Cash and cash equivalents at beginning of period

     197        144   
                

Cash and cash equivalents at end of period

   $ 213      $ 170   
                

Supplemental disclosures of cash flow information:

    

Cash paid for income taxes

   $ 1      $ 1   

Cash paid for interest expense

   $ 4      $ —     

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

VERIGY LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. OVERVIEW

Overview

Verigy Ltd. (“we,” “us” or the “Company”) designs, develops, manufactures and sells advanced test systems and solutions for the semiconductor industry.

We offer a single platform for each of the general categories of devices being tested: our V93000 Series platform, designed to test System-on-a-Chip (“SOC”), System-in-a-Package (“SIP”) and high-speed memory devices; our V6000 Series platform, which is the successor to the V5000 platform, designed to test both flash memory and dynamic random access memory (“DRAM”) devices, and our V101 platform, introduced in the third quarter of fiscal year 2009, designed to test highly cost-sensitive devices such as 4, 8 and 16-bit micro-controller units (“MCUs”). Also during the third quarter of fiscal year 2009, we acquired the assets and business of Touchdown Technologies, a manufacturer of advanced memory probe cards.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation. The accompanying financial data has been prepared by us pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Our fiscal year end is October 31, and our fiscal quarters end on January 31, April 30, July 31 and October 31. Unless otherwise stated, all dates refer to our fiscal years and fiscal periods. Amounts included in the accompanying consolidated financial statements are expressed in U.S. dollars.

In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments—which are of a normal and recurring nature—necessary to fairly state the financial position, results of operations and cash flows for the dates and periods presented.

On June 15, 2009, we acquired Touchdown Technologies (“Touchdown”), a privately held company. Touchdown provides advanced MEMS probe cards which are designed to improve wafer throughput and yields for memory manufacturers. From the acquisition date, the results of operations of Touchdown’s business are included in our consolidated statements of operations. Also see Note 11, “Acquisition of Touchdown Technologies.”

Reclassifications. Certain amounts disclosed in the notes to the condensed consolidated financial statements for the three months ended January 31, 2009, were reclassified to conform to the presentation used for the three months ended January 31, 2010.

Principles of consolidation. The condensed consolidated financial statements include the accounts of the Company and our wholly-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated.

Use of estimates. The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions it believes to be reasonable. Although these estimates are based on management’s knowledge of current events and actions that may impact us in the future, actual results may be different from the estimates. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management. Those policies are revenue recognition, restructuring, inventory valuation, warranty, share-based compensation, retirement and post-retirement plan assumptions, valuation of goodwill and other long-lived assets, valuation of marketable securities and accounting for income taxes.

 

3. RECENT ACCOUNTING PRONOUNCEMENTS

In December 2007, the FASB issued an amendment to the accounting guidance for business combinations. This amendment provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed and any noncontrolling interest in an acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of a business combination. In April 2009, the FASB issued another amendment for assets acquired and liabilities assumed in a business combination that arise from contingencies. This amendment clarifies the previous amendment and addresses application issues raised by preparers, auditors and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination.

 

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It is effective for fiscal years beginning on or after December 15, 2008, and will be applied prospectively. This guidance was effective for us in the first quarter of fiscal year 2010, and upon adoption, did not have a significant impact on our condensed consolidated financial statements.

In December 2007, the FASB revised the accounting guidance for noncontrolling interests in condensed consolidated financial statements, which requires that ownership interests in subsidiaries held by parties other than the parent, and the amount of consolidated net income, be clearly identified, labeled and presented in the condensed consolidated financial statements. It also requires that once a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value. Sufficient disclosures are required to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. It is effective for fiscal years beginning on or after December 15, 2008, and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements will be applied prospectively. This guidance was effective for us in the first quarter of fiscal year 2010, and upon adoption, did not have a significant impact on our condensed consolidated financial statements.

In December 2008, the FASB issued new guidance for employers’ disclosures about postretirement benefit plan assets. The new guidance provides revised guidance on the disclosure requirement of employers’ disclosures about pensions and other postretirement benefits. It requires companies to provide qualitative disclosures about how investment allocation decisions are made, the inputs and valuation techniques used to measure the fair value of plan assets and the concentration of risk within plan assets. Additionally, quantitative disclosures are required showing the fair value of each major category of plan assets, the level in which each assets is classified within the fair value hierarchy and a reconciliation for the period of plan assets that are measured using significant unobservable inputs. It is effective for fiscal years ending after December 15, 2009. We are currently assessing the impact that the guidance may have on our condensed consolidated financial statements upon adoption in our fourth quarter of fiscal year 2010.

In June and December 2009, the FASB amended the accounting guidance for transfers of financial assets. This amendment requires greater transparency and additional disclosures for transfers of financial assets and the entity’s continuing involvement with them and changes the requirements for derecognizing financial assets. In addition, this amendment eliminates the concept of a qualifying special-purpose entity. The amendment must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. We are currently assessing the impact that this amendment may have on our condensed consolidated financial statements upon adoption in fiscal year 2011.

In June 2009, the FASB amended the accounting guidance for the consolidation of variable interest entities. This amendment revised the evaluation criteria to identify the primary beneficiary of a variable interest entity. Additionally, this amendment requires ongoing reassessments of whether an enterprise is the primary beneficiary of the variable interest entity. In December 2009, the FASB amended consolidation guidance previously issued in June to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity, among other changes. The amendments are effective for our first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. We are currently assessing the impact that this amendment may have on our condensed consolidated financial statements upon adoption in fiscal year 2011.

In August 2009, the FASB amended the accounting guidance for the fair value measurement of liabilities. The amended guidance clarifies that in circumstances in which a quoted price in an active market for the identical liability is not available, we are required to use the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities, or quoted prices for similar liabilities when traded as assets. If these quoted prices are not available, we are required to use another valuation technique, such as an income approach or a market approach. The amended guidance is effective for the first reporting period (including interim periods) beginning after issuance, and it was effective for us in the first quarter of fiscal year 2010, and upon adoption, did not have a significant impact on our condensed consolidated financial statements.

In October 2009, the FASB issued new accounting guidance for revenue recognition with multiple deliverables. The new guidance impacts the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, the guidance modifies the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of revenue recognition in accounting for multiple deliverable arrangements. The guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and will be effective for us in the first quarter of fiscal year 2011, however early adoption is permitted. We are currently assessing the impact that the guidance may have on our condensed consolidated financial statements upon adoption in fiscal year 2011.

In October 2009, the FASB issued new accounting guidance for the accounting for certain revenue arrangements that include software elements. The new guidance amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. The new guidance will be

 

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effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and will be effective for us in the first quarter of fiscal year 2011, however early adoption is permitted. We are currently assessing the impact that the guidance may have on our condensed consolidated financial statements upon adoption in fiscal year 2011.

In January 2010, the FASB issued new accounting guidance that requires new disclosures related to fair value measurements. The new guidance requires expanded disclosures related to transfers between Level 1 and 2 activities and a gross presentation for Level 3 activity. The new accounting guidance is effective for fiscal years and interim periods beginning after December 15, 2009, except for the new disclosures related to Level 3 activities, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those years. The new guidance will be effective for us in the second quarter of fiscal year 2010, except for the new disclosures related to Level 3 activities, which will be effective for us in the first quarter of fiscal year 2012. We are currently assessing the impact that the guidance may have on our condensed consolidated financial statements upon adoption in the second quarter of fiscal year 2010 and in the first quarter of fiscal year 2012, respectively.

 

4. FAIR VALUE MEASUREMENTS

In fiscal year 2009, we adopted accounting guidance for fair value measurements, which defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Concurrently with the adoption of the guidance for fair value measurements, we adopted accounting guidance for the fair value option for financial assets and financial liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value. As of January 31, 2010, we did not elect the fair value option for any financial assets and liabilities that were not previously measured at fair value.

The accounting guidance for fair value measurements requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

Level 1:

Valuations based on quoted prices in active markets for identical assets or liabilities as of the reporting date. Our Level 1 assets consist of various money market fund deposits, certificate of deposits, U.S. government agency securities and corporate debt securities, all of which are traded in an active market with sufficient volume and frequency of transactions.

Level 2:

Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions, or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. Our Level 2 assets and liabilities consist of derivative assets and liabilities, U.S. government agency securities and corporate debt securities which are priced using inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. Our derivative assets were immaterial as of January 31, 2010.

Level 3:

Valuations based on unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. Our Level 3 assets consist of auction rate securities and money market investments in the Reserve International Liquidity Fund.

 

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The following table sets forth our financial assets and liabilities that were measured at fair value on a recurring basis as of January 31, 2010:

 

     Fair Value Measurement as of January 31, 2010 Using
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
           Total        
     (in millions)

Assets

           

Money market funds

   $ 159    $ —      $ 1    $ 160

U.S. government agency securities and certificate of deposits

     15      73      —        88

Corporate debt securities

     8      71      —        79

Auction rate securities

     —        —        55      55
                           

Total assets measured at fair value

   $ 182    $ 144    $ 56    $ 382
                           

Liabilities

           

Derivative liabilities

   $ —      $ 1    $ —      $ 1
                           

Total liabilities measured at fair value

   $ —      $ 1    $ —      $ 1
                           
The amounts in the table above are reported in the condensed consolidated balance sheet as of January 31, 2010 as follows:
     Fair Value Measurement as of January 31, 2010 Using
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
           Total        
     (in millions)

Assets

           

Cash equivalents

   $ 168    $ —      $ —      $ 168

Short-term marketable securities

     2      144      1      147

Long-term marketable securities

     12      —        55      67
                           

Total assets measured at fair value

   $ 182    $ 144    $ 56    $ 382
                           

Liabilities

           

Other current liabilities

   $ —      $ 1    $ —      $ 1
                           

Total liabilities measured at fair value

   $ —      $ 1    $ —      $ 1
                           

The following table provides a summary of changes in fair value of our Level 3 financial assets as of January 31, 2010:

 

     Auction Rate
Securities
    Money
Market
Funds
 
     (in millions)  

Balance as of October 31, 2009

   $ 56      $ 3   

Money market redemptions

     —          (2

Unrealized gain included in other comprehensive loss

     1        —     

Sale of investment

     (2     —     
                

Balance as of January 31, 2010

   $ 55      $ 1   
                

The following table presents the financial instruments that are not carried at fair value but which require fair value disclosure.

 

     As of January 31, 2010
     Carrying
Value
   Fair Value

Convertible senior notes due July 15, 2014

   $ 138    $ 150
             

Total convertible notes

   $ 138    $ 150
             

The fair value of the convertible notes at each balance sheet date is determined based on recent quoted market prices for these notes. (Also see Note 12, “Convertible Senior Notes”.)

 

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5. DERIVATIVES AND HEDGING ACTIVITIES

We use derivative instruments primarily to manage exposures to foreign currency. Our primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency. The program is not designated for trading or speculative purposes. Our derivatives expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. We seek to mitigate such risk by limiting our counterparties to major financial institutions and by spreading the risk across several major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored on an ongoing basis.

In accordance with accounting principles generally accepted in the U.S., we recognize derivative instruments as either assets or liabilities on the balance sheet at fair value. Changes in fair value (i.e. gains or losses) of the derivatives are recorded as cost of sales, other (expense) income, net, or as accumulated other comprehensive income (loss).

In fiscal year 2009, we adopted the accounting guidance for expanded disclosures relating to derivative instruments and hedging activities. The guidance requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements.

Cash Flow Hedges

We use forward contracts designated as cash flow hedges to hedge a portion of future forecasted purchases in Japanese yen, Chinese yuan, Singapore dollar and the euro. Changes in the fair value of derivatives that do not qualify for hedge accounting treatment, as well as the ineffective portion of hedges, if any, are recognized in the consolidated statement of operations. The effective portion of the foreign exchange gain (loss) is reported as a component of accumulated other comprehensive income (loss) in shareholders’ equity and is reclassified into the statement of operations when the hedged transaction affects earnings. All amounts included in accumulated other comprehensive loss as of January 31, 2010 will generally be reclassified into earnings within twelve months. Changes in the fair value of foreign currency forward exchange due to changes in time value are excluded from the assessment of effectiveness and are recognized in earnings. If the transaction being hedged fails to occur, or if a portion of any derivative is deemed to be ineffective, we will recognize the gain (loss) on the associated financial instrument in other (expense) income, net in the statement of operations. We did not have any ineffective hedges during the periods presented. As of January 31, 2010, the total notional amount of outstanding forward contracts in place that hedged future purchases was approximately $56.0 million, based upon the exchange rate as of January 31, 2010. The forward contracts cover future purchases that are expected to occur over the next twelve months.

Balance Sheet Hedges

Other derivatives not designated as hedging instruments consists primarily of forward contracts to minimize the risk associated with the foreign exchange effects of remeasuring monetary assets and liabilities. Monetary assets and liabilities denominated in foreign currencies and the associated outstanding forward contracts are marked-to-market as of January 31, 2010, with realized and unrealized gains and losses included in other (expense) income, net. As of January 31, 2010, we had foreign currency forward contracts in place to hedge exposures in euro, Israeli shekel, Japanese yen, Singapore dollar, Malaysian ringgit, Canadian dollar, Korean won, Chinese yuan and the Taiwanese dollar. As of January 31, 2010, the total notional amount of outstanding forward contracts in place for foreign currency purchases was approximately $12.4 million and the total outstanding forward contracts in place for foreign currency sales was $8.1 million, based upon the exchange rates as of January 31, 2010.

For the three months ended January 31, 2010, non-designated foreign currency forward contracts resulted in a gain of $0.3 million. For the three months ended January 31, 2010, the remeasurement of the foreign currency exposures hedged by these forward contracts resulted in a loss of $0.4 million. All of the above noted gains and losses are included in other (expense) income, net in our consolidated statements of operations.

The amounts in the tables below include fair value adjustments related to our own credit risk and counterparty credit risk.

 

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Fair Value of Derivative Contracts

Fair value of derivative contracts was as follows:

 

     Derivative Assets Reported
in Other Current Assets
   Derivative Liabilities Reported
in Other Current Liabilities
     January 31,
2010
   October 31,
2009
   January 31,
2010
   October 31,
2009
     (in millions)

Foreign exchange contracts designated as cash flow hedges

   $ —      $ 1.5    $ 1.3    $ —  

Foreign exchange contracts not designated as cash flow hedges

     0.3      0.4      0.2      0.1
                           

Total derivatives costs

   $ 0.3    $ 1.9    $ 1.5    $ 0.1
                           

Effect of Designated Derivative Contracts on Accumulated Other Comprehensive Loss

The following table represents only the amounts recognized in other comprehensive loss for designated derivative contracts and the associated impact that was reclassified to the statement of operations as an (increase) decrease in cost of sales:

 

     Change Recognized in OCI
(Effective Portion)
    Location of Amounts
Reclassified from
Accumulated OCI
into Earnings
(Effective Portion)
   Amounts Reclassified from
Accumulated OCI into Earnings
(Effective Portion)
     Three Months
Ended
January 31, 2010
       Three Months
Ended
January 31, 2010
     (in millions)          (in millions)

Foreign exchange contracts

   $ (1.8   Cost of Sales    $ 1.0

Foreign exchange contracts designated as cash flow hedges relate to employee payroll and benefits as well as other costs primarily related to manufacturing. The associated gains and losses are expected to be recorded in cost of sales when reclassified from accumulated other comprehensive loss.

We expect to realize the accumulated other comprehensive loss balance related to foreign exchange contracts within the next twelve months.

Effect of Designated Derivative Contracts on the Consolidated Statements of Operations

The effect of designated derivative contracts on results of operations recognized as an (increase) decrease in cost of sales was as follows:

 

     Three Months Ended 
January 31,
 
     2010    2009  
     (in millions)  

Foreign exchange contracts designated as cash flow hedges

   $ 1.0    $ (3.7

Effect of Non-Designated Derivative Contracts on the Consolidated Statements of Operations

The effect of non-designated derivative contracts on results of operations recognized in other (expense) income, net was as follows:

 

     Three Months Ended 
January 31,
 
     2010    2009  
     (in millions)  

Gain (loss) on foreign exchange contracts

   $ 0.3    $ (2.5

 

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6. NET LOSS PER SHARE

The following is a reconciliation of the basic and diluted net loss per share computations for the periods presented below:

 

     Three Months Ended
January 31,
 
     2010     2009  

Basic Net Loss Per Share:

    

Net loss (in millions)

   $ (6   $ (64

Weighted average number of ordinary shares (1)

     59,148        58,149   

Basic net loss per share

   $ (0.10   $ (1.09

Diluted Net Loss Per Share:

    

Net loss (in millions)

   $ (6   $ (64

Weighted average number of ordinary shares (1)

     59,148        58,149   

Potentially dilutive common stock equivalents—stock options, restricted share units and other employee stock plans (1) (2)

     —          —     
                

Total shares for purpose of calculating diluted net loss per share (1)

     59,148        58,149   

Diluted net loss per share

   $ (0.10   $ (1.09

 

(1) Weighted average shares are presented in thousands.

 

(2) The dilutive effect of our convertible senior notes will be reflected in diluted net income per share by application of the if-converted method. The conversion is not assumed for purposes of computing diluted earnings per share if the effect would be anti-dilutive. Also see Note 12, “Convertible Senior Notes.”

The dilutive effect of outstanding options and restricted share units is reflected in diluted net income per share, but not loss per share, by application of the treasury stock method, which includes consideration of share-based compensation required by accounting principles generally accepted in the U.S.

The following table presents those options to purchase ordinary shares, restricted share units outstanding and convertible senior notes which were not included in the computation of diluted net loss per share because the effect of their inclusion was anti-dilutive:

 

     Three Months Ended
January 31,
     2010    2009
     (in thousands)

Non-qualified share options:

     

Number of options to purchase ordinary shares

   4,464    3,647

Restricted share units:

     

Number of restricted share units

   1,710    1,500

Convertible Senior Notes:

     

Number of potential ordinary shares to be converted

   10,526    —  

 

7. PROVISION FOR INCOME TAXES

For the three months ended January 31, 2010 and 2009, we recorded an income tax provision of approximately $0.2 million and $1.0 million, or effective tax rates of (3.6)% and (1.6)%, respectively.

Our effective tax rate varies based on a variety of factors, including overall profitability, the geographical mix of income before taxes and the related tax rates in the jurisdictions in which we operate, restructuring and other one-time charges, as well as discrete events, such as tax settlements.

At January 31, 2010, the total unrecognized tax benefits of $16.1 million included approximately $0.4 million of unrecognized tax benefits that have been netted against the related deferred tax assets and $15.7 million of unrecognized tax benefits which are reflected in other long term liabilities. Unrecognized tax benefits of $16.1 million would reduce our income tax provision if recognized.

Our continuing practice is to recognize interest and penalties related to income tax matters as a component of income tax expense. We have approximately $1.9 million of accrued interest and penalties as of January 31, 2010 and approximately $1.4 million of accrued interest and penalties as of January 31, 2009.

 

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Although we file Singapore, U.S. federal, U.S. state and foreign income tax returns, our three major tax jurisdictions are Singapore, the U.S. and Germany. Our 2006, 2007 and 2008 tax years remain subject to examination by the tax authorities in our major tax jurisdictions. Our U.S. federal income tax returns are currently under audit by the Internal Revenue Service for fiscal years ending October 31, 2006 and 2007. As a result of uncertainties regarding the timing of the completion of tax audits and their possible outcomes, we can not estimate whether we would have a material change in our unrecognized tax benefits over the next twelve months.

 

8. SHARE-BASED COMPENSATION

2006 Equity Incentive Plan

On June 7, 2006, our board of directors adopted the Verigy Ltd. 2006 Equity Incentive Plan (the “2006 EIP”). A total of 10,300,000 ordinary shares were authorized for issuance under the plan. The 2006 EIP provides for grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock and restricted share units. As of January 31, 2010, there were approximately 1,800,000 ordinary shares available for new awards under the 2006 EIP and approximately 6,800,000 ordinary shares reserved for issuance for outstanding stock option and restricted share unit awards.

Except for replacement options granted in connection with Verigy’s separation from Agilent Technologies, Inc. (“Agilent”), employee nonqualified stock options have an exercise price of no less than 100% of the fair market value of an ordinary share on the date of grant and, generally, vest at a rate of 25% per year over 4 years. The maximum allowable term is 10 years. Restricted share units awarded to employees pay out in an equal number of ordinary shares and, generally, vest quarterly over 4 years. Options and restricted share units cease to vest upon termination of employment. If an employee terminates employment due to death, disability or retirement, the vested portion of the employee’s option and restricted share unit awards is determined by adding 12 months to the length of his or her actual service or full acceleration for Agilent replacement options. These vested awards are exercisable for one year after the date of termination or three years from the date of termination for Agilent replacement options, or, if earlier, the expiration of the term of the option.

Stock options granted to outside directors have a maximum term of 5 years. Options and restricted share units granted to outside directors prior to the second quarter of fiscal year 2008 vested on the first anniversary of the grant date, and options and restricted share units granted to outside directors beginning in the second quarter of fiscal year 2008 vest in four equal quarterly installments from the grant date. Restricted share units granted to outside directors are paid out on the third anniversary of the grant date. All awards granted to an outside director become fully vested upon the director’s termination of services if due to death, disability, retirement at or after age 65, or if in connection with a change in control.

Restricted share units are paid out in an equal number of ordinary shares upon vesting for employee awards and three years from the grant date for non-employee director awards. With respect to a majority of the awards, shares are withheld to cover the tax withholding obligation. As a result, the actual number of shares issued will be less than the number of restricted share units granted. Prior to vesting, restricted share units do not have dividend, voting or other rights associated with ordinary shares.

2006 Employee Shares Purchase Plan

On June 7, 2006, our board of directors adopted the 2006 Employee Shares Purchase Plan (the “Purchase Plan”). The Purchase Plan is intended to qualify for favorable tax treatment under section 423 of the U.S. Internal Revenue Code. The total number of shares that were authorized for purchase under the plan is 1,700,000.

Under the Purchase Plan, eligible employees may elect to purchase shares from payroll deductions up to 10% of eligible compensation during 6-month offering periods. The purchase price is (i) 85% of the fair market value per ordinary share on the trading day before the beginning of an offering period or (ii) 85% of the fair market value per ordinary share on the last trading day of an offering period, whichever is lower. The maximum number of shares that an employee can purchase is 2,500 shares each offering period and $25,000 in fair market value of ordinary shares each calendar year.

As of January 31, 2010, a cumulative plan total of 1,699,576 ordinary shares had been issued since inception as a result of purchases made by participants in our Purchase Plan, including 285,899 shares issued in the first quarter of fiscal year 2010.

Share-Based Compensation for Verigy Options and Purchase Plan

We adopted accounting guidance for share-based compensation, which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including employee stock option awards, restricted share units and employee share purchases made under the Purchase Plan.

 

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We have recognized compensation expense based on the estimated grant date fair value method required under the accounting guidance using a straight-line amortization method. As the accounting guidance requires that share-based compensation expense be based on awards that are ultimately expected to vest, estimated share-based compensation is reduced for estimated forfeitures. We expense restricted share units based on fair market value of the shares at the date of grant over the period during which the restrictions lapse.

Share-Based Compensation for Agilent Options Held by Verigy Employees

Prior to our separation from Agilent, some of our employees participated in Agilent’s stock-based compensation plans. Until November 1, 2005, we accounted for stock-based awards, based on Agilent’s stock, using the intrinsic value method of accounting in accordance with accounting principles generally accepted in the U.S. Under the intrinsic value method, we recorded compensation expense related to stock options in our consolidated statements of operations when the exercise price of our employee stock-based award was less than the market price of the underlying Agilent stock on the date of the grant. We had no stock option expenses resulting from an exercise price that was less than the market price on the date of the grant in any of the periods presented.

Share-Based Award Activity

The following table summarizes stock option activity during the three months ended January 31, 2010:

 

     Options
     Shares     Weighted
Average
Exercise
Price
     (in thousands)      

Outstanding as of October 31, 2009

   4,331      $ 14.90

Granted

   161      $ 10.85

Exercised (1)

   (17   $ 9.36

Cancelled / Expired

   (11   $ 20.73
        

Outstanding as of January 31, 2010

   4,464      $ 14.76
        

 

(1) The total pretax intrinsic value of stock options exercised during the three months ended January 31, 2010 was immaterial.

The following table summarizes restricted share unit activity during the three months ended January 31, 2010:

 

     Restricted Share Units (RSU)
     Shares     Weighted Average
Grant Date
Share Price
     (in thousands)      

Outstanding as of October 31, 2009

   1,777      $ 13.85

Granted

   707      $ 12.01

Vested and paid out

   (167   $ 15.87

Forfeited

   (9   $ 12.88
        

Outstanding as of January 31, 2010 (2) (3) (4)

   2,308      $ 13.15
        

For the majority of restricted stock units granted, the number of shares issued on the date the restricted stock units vest is net of the statutory withholding requirements that we pay on behalf of our employees. During the three months ended January 31, 2010, we withheld approximately 50,700 ordinary shares to satisfy $0.5 million of employees’ tax obligations.

 

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The following table summarizes information about all outstanding stock options to purchase ordinary shares of Verigy at January 31, 2010:

 

     Options Outstanding

Range of Exercise Prices

   Number
Outstanding
   Weighted
Average
Remaining
Contractual
Life
   Weighted
Average
Exercise
Price
   Aggregate
Intrinsic Value
     (in thousands)              (in thousands)

$6.49 — 15.00

   2,619    4.70 years    $ 11.65    $ 1,962

$15.01 — 20.00

   1,346    4.83 years    $ 16.70      —  

$20.01 — 25.00

   111    4.18 years    $ 23.89      —  

$25.01 — 30.00

   388    3.95 years    $ 26.44      —  
                 
   4,464    4.66 years    $ 14.76    $ 1,962
                 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on Verigy’s closing stock price of $10.84 on January 29, 2010, which would have been received by award holders had all award holders exercised their awards (both vested and unvested) that were in-the-money as of that date. As of January 31, 2010, approximately 2,802,000 outstanding options were vested and exercisable and the weighted average exercise price was $15.40. The total number of exercisable stock options that were in-the-money was approximately 601,000 and the weighted average exercise price per share of the in-the-money options was $9.43.

The following table summarizes information about all outstanding restricted share unit awards of Verigy ordinary shares at January 31, 2010:

 

     Restricted Share Units Outstanding

Range of Grant Date Share Prices

   Number
Outstanding
   Weighted Average
Grant Date
Share Price
     (in thousands)     

$6.46 — 15.00 (2)

   1,714    $ 10.41

$15.01 — 20.00 (3)

   220    $ 18.57

$20.01 — 25.00

   264    $ 20.86

$25.01 — 30.00 (4)

   110    $ 26.42
       
   2,308    $ 13.15
       

 

(2) The outstanding restricted share units as of January 31, 2010 include approximately 37,000 fully vested units held by outside directors.

 

(3) The outstanding restricted share units as of January 31, 2010 include approximately 23,000 fully vested units held by outside directors.

 

(4) The outstanding restricted share units as of January 31, 2010 include approximately 18,500 fully vested units held by outside directors.

As of January 31, 2010, the total grant date fair value of our outstanding restricted share units was approximately $30.3 million and the aggregate market value of the ordinary shares underlying the outstanding restricted share units was $25.0 million.

Share-Based Compensation

The impact on our results for share-based compensation for Verigy options, restricted share units and employee share purchases made under the Purchase Plan for the three months ended January 31, 2010 and 2009, respectively, was as follows:

 

     Three Months Ended
January 31,
     2010    2009
     (in millions)

Cost of products and services

   $ 0.8    $ 0.8

Research and development

     0.4      0.5

Selling, general and administrative

     3.4      3.5
             

Total share-based compensation expense

   $ 4.6    $ 4.8
             

For the three months ended January 31, 2010 and 2009, share-based compensation capitalized within inventory was insignificant.

 

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The weighted average grant date fair value of Verigy options granted during the three months ended January 31, 2010 and 2009 was $4.53 and $4.36 per share, respectively, and was determined using the Black-Scholes option pricing model. The tax benefit realized from equity compensation for the three months ended January 31, 2010 and 2009 was insignificant.

As of January 31, 2010 and 2009, the total compensation cost related to share-based awards not yet recognized, net of expected forfeitures, was approximately $31.6 million and $36.4 million, respectively. We expect to recognize the compensation cost related to these share-based awards over a weighted average of 2.72 years.

Valuation Assumptions for Verigy Options

The fair value of Verigy options granted during the three months ended January 31, 2010 and 2009 was estimated at grant date using a Black-Scholes options-pricing model with the following weighted average assumptions:

 

     Three Months Ended
January 31,
 
     2009     2009  

Risk-free interest rate for options

   1.88    1.41 

Dividend yield

   0.0    0.0 

Volatility for options

   48.4    57.0 

Expected option life

   4.50 years      4.50 years   

Valuation Assumptions for the Purchase Plan

 

     Three Months Ended
January 31,
 
     2010     2009  

Risk-free interest rate for ESPP

   0.35   0.35

Dividend yield

   0.0   0.0

Volatility for ESPP

   51.9   59.5

Expected ESPP life

   6 months      6 months   

The Black-Scholes model requires the use of highly subjective and complex assumptions, including the option’s expected life and the price volatility of the underlying ordinary shares. The price volatility of our share price was determined on the date of grant using a combination of the average daily historical volatility and the average implied volatility of publicly traded options for our ordinary shares. Management believes that using a combination of historical and implied volatility is the most appropriate measure of the expected volatility of our share price. Because we have limited historical data, we used data from peer companies to determine our assumptions for the expected option life. For the risk-free interest rate, we used the rate of return on U.S. Treasury Strips as of the grant dates.

 

9. ORDINARY SHARE REPURCHASES

2008 Repurchase Plan

On April 15, 2008, at our 2008 annual general meeting of shareholders, our shareholders approved our repurchase of up to 10 percent of Verigy’s outstanding ordinary shares, or approximately 6 million ordinary shares. This program was effective through the 2009 annual general meeting of shareholders.

2009 Repurchase Plan

On April 14, 2009, at our 2009 annual general meeting of shareholders, our shareholders approved a resolution to renew the share repurchase program to extend through the 2010 annual general meeting of shareholders. This approval allows the repurchase of up to 10 percent of Verigy’s outstanding ordinary shares, or approximately 6 million ordinary shares, incremental to the ordinary shares repurchased through the 2008 Repurchase Plan. The 2009 Repurchase Plan will expire at our 2010 annual general meeting of shareholders.

 

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The following repurchases under the 2008 repurchase program and the 2009 repurchase program were completed in the periods presented below:

 

    Number of
Ordinary Shares
Repurchased
  Weighted
Average Price
Per Share
  Amount of
Ordinary Shares
Repurchased
    (in thousands)       (in thousands)

2008 and 2009 Repurchase Programs to date as of October 31, 2009

  2,834   $ 19.25   $ 54,570

Three months ended January 31, 2010

  —     $ —     $ —  
           

2008 and 2009 Repurchase Programs to date as of January 31, 2010

  2,834   $ 19.25   $ 54,570
           

All repurchased shares are immediately retired and will not be available for future resale.

 

10. COMPREHENSIVE LOSS

The components of comprehensive loss, net of tax, are as follows:

 

     Three Months Ended
January 31,
 
     2010     2009  
     (in millions)  

Net loss

   $ (6   $ (64

Other comprehensive loss income:

    

Foreign currency translation adjustments

     —          (2

Change in unrealized losses on marketable securities and investments in other long-term assets, net of tax

     —          (1

Change in minimum pension liability, net of tax

     1        —     

Change in unrealized (losses) gains on derivative instruments qualifying as cash flow hedges, net of tax

     (2     3   
                

Total comprehensive loss

   $ (7   $ (64
                

 

11. ACQUISITION OF TOUCHDOWN TECHNOLOGIES

On June 15, 2009, we completed the acquisition of substantially all of the assets and assumption of certain liabilities of Touchdown Technologies, Inc. The consideration payable in the acquisition consists of contingent consideration payable based on revenue from probe card sales during a five year period beginning November 1, 2009. There is no minimum or maximum amount of contingent consideration payable pursuant to the acquisition agreement and we have not made any payments as of January 31, 2010.

We accounted for the acquisition using the purchase method of accounting in accordance with accounting principles generally accepted in the U.S. Under the purchase method of accounting, the estimated purchase price was allocated to the tangible assets and identifiable intangible assets acquired and liabilities assumed based on their fair values. As we did not pay any purchase consideration at the time of the acquisition, the fair value of acquired net assets over purchase consideration of zero is recorded as a deferred acquisition credit included within other liabilities in the balance sheet. When the contingencies are resolved, any contingent consideration paid will reduce this liability. Any excess of the contingent payments over this liability will be recognized as an additional cost of the acquisition. Any excess of this liability over the contingent payments will reduce the recognized value of the acquired net assets on a pro rata basis. Any amount that remains after reducing those assets to zero will be recognized as an extraordinary gain.

 

12. CONVERTIBLE SENIOR NOTES

On July 15, 2009, we issued $138 million of convertible senior notes (the “notes”). The notes will mature on July 15, 2014, and bear interest at a fixed rate of 5.25% per annum. The interest is payable semi-annually on January 15th and July 15th of each year and payments commenced on January 15, 2010. We incurred issuance costs of $5 million in connection with the senior notes. These costs were capitalized in other assets on the condensed consolidated balance sheet, and the costs are being amortized to interest expense over the term of the senior notes using the effective interest method. The initial conversion rate for the notes is 76.2631 ordinary shares per $1,000 principal amount, equal to a conversion price of approximately $13.11 per ordinary share. This conversion rate is subject to adjustment in some events, but will not be adjusted for accrued interest. Holders may convert their notes at any time prior to the maturity date.

 

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We may not redeem the notes prior to July 20, 2012, except upon the occurrence of certain tax-related events. On or after July 20, 2012, we may redeem for cash all or part of the notes if the last reported sale price per ordinary share has been at least 130% of the conversion price then in effect for at least 20 trading days during any 30 consecutive trading day period ending within five trading days prior to the date on which we provide notice of redemption. The redemption price will equal 100% of the principal amount of the notes being redeemed, plus accrued and unpaid interest, up to the date of redemption.

If we undergo a fundamental change, subject to certain conditions, holders may require us to purchase their notes in whole or in part for cash at a purchase price equal to 100% of the principal amount being purchased, plus accrued and unpaid interest, up to the date of purchase. In addition, upon the occurrence of a fundamental change, for holders who elect to convert their notes in certain circumstances, we will increase the conversion rate not to exceed 95.3288 per $1,000 principal amount, equal to a conversion price of $10.49 per ordinary share. Upon default, holders of at least 25% of the convertible notes can declare 100% of the principal and accrued and unpaid interest to become due and payable. In the event of insolvency or bankruptcy, the aggregate principal and accrued and unpaid interest automatically become due and payable.

 

13. MARKETABLE SECURITIES

We account for our short-term marketable securities in accordance with accounting principles generally accepted in the U.S. In fiscal year 2009, we adopted the accounting guidance for recognition and presentation of other-than-temporary impairments. This accounting guidance is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The accounting guidance also requires increased and more timely disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses.

We classify our marketable securities as available for sale at the time of purchase and re-evaluate such designation as of each condensed consolidated balance sheet date. We amortize premiums and discounts against interest income over the life of the investment. Our marketable securities are classified as cash equivalents if the original maturity, from the date of purchase, is ninety days or less. We record other-than-temporary impairment charges in earnings representing both credit and non-credit losses for those investments that we intend to sell or more likely than not would be required to sell before recovery of the amortized cost basis.

Our marketable securities include commercial paper, corporate bonds, government securities, money market funds and auction rate securities. Auction rate securities are securities that are structured with interest rate reset periods of generally less than ninety days but with contractual maturities that can be well in excess of 10 years. At the end of each interest rate reset period, investors can buy, sell or continue to hold the securities at par. As of January 31, 2010, all of our auction rate securities experienced failed auctions. The funds associated with these auctions will not be accessible to us until a successful auction occurs, a buyer is found outside of the auction process, or the underlying securities have matured or are called by the issuer. Given the ongoing disruptions in the credit markets and the fact that the liquidity for these types of securities remains uncertain, we have classified all of our auction rate securities as long-term assets in our condensed consolidated balance sheet as of January 31, 2010, as our ability to liquidate such securities in the next 12 months is uncertain.

Our auction rate securities primarily consist of investments that are backed by pools of student loans guaranteed by the U.S. Department of Education and other asset-backed securities. Our marketable securities portfolio as of January 31, 2010 had a carrying value of $382 million, of which approximately $55 million consisted of illiquid auction rate securities. Given the ongoing disruption in the market for auction rate securities, there is no longer an actively quoted market price for these securities. Accordingly, we utilized a model to estimate the fair value of these auction rate securities based on, among other items: (i) the underlying structure of each security and the underlying collateral quality; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (iii) consideration of the probabilities of default, auction failure or repurchase at par for each period; and (iv) estimates of the recovery rates in the event of default for each security. These estimated fair values could change significantly based on future market conditions.

We evaluate our investments periodically for possible other-than-temporary impairment by reviewing factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and insurance guarantor, and our ability and intent to hold the investment for a period of time sufficient for anticipated recovery of market value. Based on an analysis of other-than-temporary impairment factors, we did not incur any other-than-temporary impairments for the three months ended January 31, 2010 related to our auction rate securities. We have recorded an unrealized gain within accumulated other comprehensive loss of approximately $0.5 million (net of tax of $0.1 million), primarily for our auction rate securities that are backed by pools of student loans as of January 31, 2010. We also recognized a realized gain of approximately $0.4 million on the sale of long-term investments.

Investments in money market funds include investments in the Reserve Primary Fund and the Reserve International Liquidity Fund (collectively referred to as the “Reserve Funds”). The net asset value for the Reserve Funds fell below $1 because the funds had holdings of commercial paper and other notes with a major investment bank which filed for bankruptcy on September 15, 2008. As a

 

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result of these events, these funds are no longer classified as cash and cash equivalents. We have classified these investments as short-term marketable securities because, based on the maximum maturity date of the underlying securities as well as the proposed liquidation plan and distribution updates received for the funds, we believe that within one year, these investments will be redeemable. We received the final distribution from our investment in the Reserve Primary Fund during the three months ended January 31, 2010 and recorded a realized gain of $0.1 million. We received approximately $1.9 million from the distribution of these funds during the three months ended January 31, 2010, reducing the value of our remaining holding in the Reserve International Liquidity Fund to $1.2 million as of January 31, 2010.

The following table summarizes our marketable security investments as of January 31, 2010:

 

     Cost    Gross Unrealized
Gains (Losses)
   Estimated Fair
Market Value
          (in millions)     

Cash equivalents and short-term marketable securities:

        

Money market funds

   $ 160    $ —      $ 160

U.S. government agency securities and certificate of deposits

     76      —        76

Corporate debt securities

     79      —        79
                    

Total cash equivalents and short-term marketable securities

   $ 315    $ —      $ 315
                    
     Cost    Gross Unrealized
Gains (Losses)
   Estimated Fair
Market Value
          (in millions)     

Long-term marketable securities:

        

Certificate of deposits

   $ 12    $ —      $ 12

Auction rate securities

     55      —        55
                    

Total long-term available for sale investments

   $ 67    $ —      $ 67
                    

As Reported:

        

Cash equivalents

         $ 168

Short-term marketable securities

           147

Long-term marketable securities

           67
            

Total at January 31, 2010

         $ 382
            

The amortized cost, which is net of other-than-temporary impairment losses, and estimated fair value of cash equivalents and marketable securities classified as available for sale as of January 31, 2010 are shown in the table below by their contractual maturity dates:

 

     Cost    Gross Unrealized
Gains (Losses)
   Estimated Fair
Market Value
          (in millions)     

Less than 1 year

   $ 221    $ —      $ 221

Due in 1 to 2 years

     106      —        106

Due after 2 years

     55      —        55
                    

Total at January 31, 2010

   $ 382    $ —      $ 382
                    

 

14. INVENTORY

Inventory, net of related reserves, consists of the following:

 

     January 31,
2010
   October 31,
2009
     (in millions)

Raw materials

   $ 32    $ 26

Finished goods

     29      29
             

Total inventory

   $ 61    $ 55
             

There were approximately $15 million of demonstration products included in finished goods inventory as of January 31, 2010, and $15 million as of October 31, 2009.

The total cost of products in the condensed consolidated statements of operations for the three months ended January 31, 2010 and 2009 included gross inventory-related provisions of $2 million and $13 million, respectively, for excess and obsolete

 

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inventory at our sites, as well as inventory at our contract manufacturers and suppliers where we have non-cancelable purchase commitments. In addition, our gross margins were favorably impacted by the sale of previously written-down inventory of $4 million and $7 million, respectively, for the same periods.

 

15. PROPERTY, PLANT AND EQUIPMENT, NET

 

     January 31,
2010
    October 31,
2009
 
     (in millions)  

Leasehold improvements

   $ 13      $ 13   

Software

     21        21   

Machinery and equipment

     63        60   
                

Total property, plant and equipment

     97        94   

Accumulated depreciation and amortization

     (56     (53
                

Total property, plant and equipment, net

   $ 41      $ 41   
                

We recorded approximately $5 million and $4 million of depreciation and amortization expense for the three months ended January 31, 2010 and 2009, respectively.

 

16. OTHER (EXPENSE) INCOME, NET

The following table presents the components of other income (expense), net for the three months ended January 31, 2010 and 2009:

 

     Three Months Ended
January 31
     2010     2009
     (in millions)

Interest and other income

   $ 1      $ 2

Interest expense

     (2     —  
              

Other (expense) income, net

   $ (1   $ 2
              

Other (expense) income, net consists primarily of interest on cash, cash equivalents and investments, gain on sale of investments and money market redemptions, and interest expense primarily related to our convertible senior notes. Other (expense) income, net also includes gains and losses from the remeasurement of assets and liabilities denominated in currencies other than the functional currency, as well as gains and losses on foreign exchange balance sheet hedge transactions. These transactions are intended to offset foreign exchange gains and losses from remeasurement, which are generally for a period of 30 days or less and settled by the end of the month. The net foreign currency remeasurement impact was not material during both the three months ended January 31, 2010 and 2009.

The following table presents the components of impairment of investments for the three months ended January 31, 2010 and 2009:

 

     Three Months Ended
January 31
 
     2010    2009  
     (in millions)  

Impairment of cost-based investments

   $ —      $ (6 )

Impairment of auction rate securities

     —        (8 )
               

Impairment of investments

   $ —      $ (14 )
               

During the three months ended January 31, 2009, we incurred a $6.2 million charge related to the write-off of a cost method investment that was determined to be impaired on an other-than-temporary basis. We also recorded a $7.7 million other-than-temporary impairment charge for the three months ended January 31, 2009 for our auction rate securities.

 

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17. GOODWILL AND OTHER LONG-LIVED ASSETS

Our goodwill balance as of both January 31, 2010 and 2009 was $18 million and represents an allocation of goodwill recorded during our separation from Agilent in 2006. We review our goodwill for impairment annually in the fourth quarter of our fiscal year, or more frequently if impairment indicators arise. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. The fair values of the reporting units are estimated using a combination of the income approach that uses discounted cash flows and the market approach that utilizes comparable companies’ data. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss. We have two reporting units for which we assess goodwill for impairment.

During fiscal year 2009, we recorded $2 million of intangible assets related to our acquisition of Touchdown Technologies with a weighted-average amortization period of 4 years. These assets will be amortized on a straight-line basis with an estimated future amortization expense of approximately $0.5 million a year. Intangibles assets as of January 31, 2010 were approximately $1 million. We continually monitor events and changes in circumstances that could indicate carrying amounts of long-lived assets may not be recoverable. When such events or changes in circumstances occur, we assess the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the undiscounted future cash flows is less than the carrying amount of those assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets.

 

18. GUARANTEES

Standard Warranty

A summary of our standard warranty accrual activity for the three months ended January 31, 2010 and 2009 is shown in the table below:

 

     Three Months Ended
January 31,
 
     2010     2009  
     (in millions)  

Beginning balance at November 1,

   $ 3      $ 5   

Accruals for warranties issued during the period

     1        1   

Accruals related to pre-existing warranties (including changes in estimates)

     (1     (1

Settlements made during the period

     —          (1
                

Ending balance at January 31,

   $ 3      $ 4   
                

In our condensed consolidated balance sheets, standard warranty accrual is presented within other current liabilities.

Also see Note 21, “Other Current Liabilities and Other Long-Term Liabilities.”

Extended Warranty

A summary of our extended warranty deferred revenue activity for the three months ended January 31, 2010 and 2009 is shown in the table below:

 

     Three Months Ended
January 31,
 
     2010     2009  
     (in millions)  

Beginning balance at November 1,

   $ 8      $ 16   

Revenue recognized during the period

     (2     (3

Deferral of revenue for new contracts

     1        1   
                

Ending balance at January 31,

   $ 7      $ 14   
                

In our condensed consolidated balance sheets, current deferred revenue is presented separately and long-term deferred revenue is included in other long-term liabilities. See Note 21, “Other Current Liabilities and Other Long-Term Liabilities.”

 

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Indemnifications

As is customary in our industry and provided for in local law in the U.S. and other jurisdictions, many of our standard contracts provide remedies to our customers and others with whom we enter into contracts, such as defense, settlement or payment of judgment for intellectual property claims related to the use of our products. From time to time, we indemnify customers, as well as our suppliers, contractors, lessors, lessees and others with whom we enter into contracts, against combinations of loss, expense or liability arising from various triggering events related to the sale or the use of our products, the use of their goods and services, the use of facilities and state of our owned facilities and other matters covered by such contracts, usually up to a specified maximum amount. In addition, from time to time, we also provide protection to these parties against claims related to undiscovered liabilities, additional product liability or environmental obligations.

Under the agreements we entered into with Agilent at the time of the separation, we will indemnify Agilent in connection with our activities conducted prior to and following our separation from Agilent in connection with our businesses and the liabilities that we specifically assumed under the agreements we entered into in connection with the separation. These indemnification obligations cover a variety of aspects of our business, including, but not limited to, employee, tax, intellectual property and environmental matters.

 

19. RESTRUCTURING

In order to address the cyclical downturn and the negative impact on our results driven by the deteriorating global economy, in fiscal year 2009 we implemented restructuring actions to streamline our organization and reduce our operating costs. As part of these restructuring actions, we reduced our global workforce through a combination of attrition, voluntary and involuntary terminations and other workforce reduction programs consistent with local legal requirements.

The total charge incurred during our first quarter of fiscal 2010 for these restructuring actions was approximately $1.3 million, $0.3 million recorded within cost of sales and the remainder of which was recorded within operating expenses.

As of January 31, 2010, we had approximately $4.1 million of accrued restructuring liability included within other current liabilities on the condensed consolidated balance sheet. The accrued amount relates to severance and benefit payments and is expected to be primarily paid out by the end of fiscal year 2010.

The table below summarizes the impact to the statement of operations resulting from all restructuring actions for the three months ended January 31, 2010 and 2009 is shown below:

 

     Three Months Ended
January 31,
     2010    2009
     (in millions)

Restructuring charges (included in cost of sales)

   $ 0.3    $ 1.5

Restructuring charges (included in operating expenses)

     1.0      4.2
             

Total restructuring charges

   $ 1.3    $ 5.7
             

A summary of restructuring activity for all restructuring actions through January 31, 2010 is shown in the table below:

 

     Workforce
Reduction
 
     (in millions)  

Beginning balance at October 31, 2009

   $ 4.9   

Total charges

     1.3   

Cash payments

     (1.5

Other

     (0.6
        

Ending balance at January 31, 2010

   $ 4.1   
        

 

20. RETIREMENT PLANS AND POST-RETIREMENT BENEFITS

We recognize the funded status of our defined benefit postretirement plans on our condensed consolidated balance sheets, and our changes in the funded status are reflected in comprehensive income.

 

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General. Substantially all of our employees are covered under various Verigy defined benefit and/or defined contribution plans. Additionally, we sponsor retiree medical accounts for certain eligible U.S. employees.

U.S. Retirement and Post-retirement Health Care Benefits for U.S. Employees

Effective June 1, 2006, we established a defined contribution benefit plan (“Verigy 401(k) plan”) for our U.S. employees. Our 401(k) plan provides matching contribution of up to 4% of eligible compensation. Eligible compensation consists of base and variable pay. In addition, we also offer a profit sharing plan for our U.S. employees, whereby we will make a maximum 2% contribution to the employee’s 401(k) plan if certain annual financial targets are achieved. A small number of our U.S. employees meeting certain age and service requirements will also receive an additional 2% profit sharing contribution to their 401(k) plan accounts if certain annual financial targets are achieved.

For the three months ended January 31, 2010 and 2009, our matching expenses for our U.S. employees under the Verigy 401(k) plan were $0.4 million and $0.6 million, respectively. We did not incur any expense for the Verigy profit sharing plans for both periods presented.

Effective June 1, 2006, Verigy made available certain retiree benefits to U.S. employees meeting certain age and service requirements upon termination of employment through Verigy’s Retiree Medical Account (RMA) Plan. At June 1, 2006, the present value of our responsibility for the retiree medical benefit obligation was approximately $2.3 million. We are ratably recognizing this obligation over a period of 6.4 years, the shorter of the estimated average working lifetime or retirement eligibility of these employees. For the three months ended January 31, 2010 and 2009, the amount of expenses recognized under the RMA plan was approximately $0.2 million for both period presented. There are no plan assets related to these obligations, and we currently do not have any plans to make any contributions.

Non-U.S. Retirement Benefit Plans. Eligible employees outside the U.S. generally receive retirement benefits under various retirement plans based upon factors such as years of service and employee compensation levels. Eligibility is generally determined in accordance with local statutory requirements.

Costs for All U.S. and Non-U.S. Plans. The following tables summarize the principal components of total costs associated with the retirement-related benefit plans of Verigy for the three months ended January 31, 2010 and 2009:

 

     U.S. Plans    Non-U.S. Plans    Total
     Three Months Ended January 31,
     2010    2009    2010    2009    2010    2009
     (in millions)

Defined benefit pension plan costs

   $ —      $ —      $ 0.9    $ 1.3    $ 0.9    $ 1.3

Defined contribution pension plan costs

     0.4      0.6      0.2      0.3      0.6      0.9

Non-pension post-retirement benefit costs

     0.2      0.2      —        —        0.2      0.2
                                         

Total retirement-related plans costs

   $ 0.6    $ 0.8    $ 1.1    $ 1.6    $ 1.7    $ 2.4
                                         

Non-U.S. Defined Benefit. For the three months ended January 31, 2010 and 2009, the net pension costs related to participation in our non-U.S. defined benefit plans were comprised of:

 

     Three Months Ended
January 31,
 
     2010     2009  
     (in millions)  

Service cost — benefits earned during the year

   $ 0.6      $ 0.8   

Interest cost on benefit obligation

     0.9        0.9   

Expected return on plan assets

     (0.7     (0.6

Amortization and deferrals:

    

Actuarial loss

     0.1        0.2   
                

Total net plan costs

   $ 0.9      $ 1.3   
                

Measurement date. We use October 31 as the measurement date to measure our plan assets and benefit obligations for all of our non-U.S. plans and U.S. retiree medical account.

 

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21. OTHER CURRENT LIABILITIES AND OTHER LONG-TERM LIABILITIES

Other current accrued liabilities as of January 31, 2010 and October 31, 2009, were as follows:

 

     January 31,
2010
   October 31,
2009
     (in millions)

Supplier liabilities

   $ 7    $ 8

Derivatives

     1      —  

Restructuring accrual

     4      5

Accrued warranty costs

     3      3

Leases payable

     2      2

Interest payable

     —        2

Other taxes payable

     1      5

Other

     3      2
             

Total other current liabilities

   $ 21    $ 27
             

Supplier liabilities reflect the amount by which our firmly committed inventory purchases from our suppliers exceed our current forecasted production and service and support needs. Also see Note 18, “Guarantees” for additional information regarding warranty accruals and Note 19, “Restructuring” for additional information regarding our restructuring accrual.

Other long-term liabilities as of January 31, 2010 and October 31, 2009, were as follows:

 

     January 31,
2010
   October 31,
2009
     (in millions)

Long-term extended warranty and deferred revenue

   $ 3    $ 3

Retirement plan accruals

     24      24

Deferred acquisition credit (see note 11)

     6      6
             

Total other long-term liabilities

   $ 33    $ 33
             

Also see Note 20, “Retirement Plans and Post-Retirement Benefits” for additional information regarding retirement plan accruals and Note 11, “Acquisition of Touchdown Technologies” for additional information regarding the deferred acquisition credit.

 

22. COMMITMENTS AND CONTINGENCIES

As of January 31, 2010, there was no material change in our capital lease obligations, operating lease obligations, purchase obligations or any other long-term liabilities reflected on our condensed consolidated balance sheets as compared to such obligations and liabilities as of October 31, 2009.

At January 31, 2010, the total unrecognized tax benefits of $16.1 million included approximately $0.4 million of unrecognized tax benefits that have been netted against the related deferred tax assets and $15.7 million of unrecognized tax benefits which are reflected in other long term liabilities. Unrecognized tax benefits of $16.1 million would reduce our income tax provision if recognized.

Rent expense was $1.7 million and $1.6 million for the three months ended January 31, 2010 and 2009, respectively.

From time to time, we are involved in lawsuits, claims, investigations and proceedings, which arise in the ordinary course of business. As of January 31, 2010, there were no matters that impacted our condensed consolidated financial statements.

 

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23. SEGMENT & GEOGRAPHIC INFORMATION

The accounting principles generally accepted in the U.S. requires us to identify the segment or segments we operate in. We have two operating segments but aggregate the information into one reportable segment: we provide test system solutions that are used in the manufacture of semiconductor devices. Below is the revenue detail for the two product platforms within this segment:

 

     Three Months Ended
January 31,
     2010    2009
     (in millions)

Net revenue from products:

     

SOC / SIP / High-Speed Memory

   $ 69    $ 24

Memory

     7      9
             

Net revenue from products

     76      33

Net revenue from services

     30      35
             

Total net revenue

   $ 106    $ 68
             

Major customers

For the three months ended January 31, 2010, we had two customers that accounted for greater than 10% of our total net revenue, one of which accounted for 20.6% of our total net revenue and the other accounted for 14.0% of our total net revenue.

For the three months ended January 31, 2009, we had two customers that accounted for greater than 10% of our total net revenue, one of which accounted for 15.7% of our total net revenue and the other accounted for 13.6% of our total net revenue.

Geographic Net Revenue Information:

Historically, we have provided revenue by geography based on where the revenue is billed versus where the products are shipped. Since our fourth quarter of fiscal year 2009, we have reported revenue by geography based on where the products are shipped. The amounts for the three months ended January 31, 2009 were reclassified to conform to the presentation used for the three months ended January 31, 2010.

 

     Three Months Ended
January 31,
     2010    2009
     (in millions)

United States

   $ 11    $ 15

Singapore

     25      4

Taiwan

     48      22

Japan

     5      9

Korea

     7      3

Rest of the World

     10      15
             

Total net revenue

   $ 106    $ 68
             

Net revenue is attributed to geographic areas based on the country in which the customer takes title of our products.

Geographic Location of Property, Plant and Equipment Information:

 

     January 31,
2010
   October 31,
2009
     (in millions)

United States

   $ 16    $ 17

Singapore

     11      11

Germany

     4      4

Taiwan

     5      5

Rest of the World

     5      4
             

Total geographic location of property, plant and equipment

   $ 41    $ 41
             

 

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

This report contains forward-looking statements including, without limitation, statements regarding changes in the global economy and improvement in our market and the anticipated effect on our business, an increase in revenue in our second fiscal quarter, manufacturing operations, research and development activities and expenses, variations in quarterly revenues and operating results, our liquidity position, our foreign currency risk, the potential impact of adopting new accounting pronouncements, expected revenue and operating results for future periods, the quality of our marketable securities, our purchase commitments, our obligation and assumptions about our retirement and post-retirement benefit plans, and our lease payment obligations that involve risks and uncertainties. Additional forward-looking statements can be identified by words such as “anticipated,” “expect,” “believes,” “plan,” “predicts,” and similar terms. Our actual results could differ materially from the results contemplated by these forward-looking statements due to various factors, including those discussed under “Part II, Item 1A., Risk Factors” and elsewhere in this report.

Overview

We design, develop, manufacture and sell advanced test systems and solutions for the semiconductor industry. We offer a single platform for each of the general categories of devices being tested: our V93000 Series platform, designed to test System-on-a-Chip (“SOC”), System-in-a-Package (“SIP”) and high-speed memory devices; our V6000 Series platform, which is the successor to the V5000 platform, designed to test both flash memory and dynamic random access memory (“DRAM”) devices, and our V101 platform, introduced in the third quarter of fiscal year 2009, designed to test highly cost-sensitive devices such as 4, 8 and 16-bit micro-controller units (“MCUs”). Also during the third quarter of fiscal year 2009, we acquired the assets and business of Touchdown Technologies, a manufacturer of advanced memory probe cards.

Each of our test platforms is scalable across different frequency ranges, pin counts and numbers of devices under simultaneous test. The test platforms’ flexibility also allows for a single test system to test a wide range of semiconductor device applications. Our platform strategy allows us to optimize operational efficiencies such as research and development investments, engineering headcount, support requirements and inventory risk. This platform strategy also provides economic benefits to our customers by allowing them to bring their complex, feature-rich semiconductor devices to market quickly and to reduce their overall costs. In addition to our test platforms, our product portfolio includes advanced analysis and yield learning tools as well as consulting, service and support offerings such as start-up assistance, application services and system calibration and repair.

As of January 31, 2010, we have installed more than 2,100 V93000 Series systems and nearly 2,600 V5000 Series systems worldwide. The V6000 Series systems and V101 began shipping in fiscal year 2009 and have not yet shipped in material quantities. We have a broad customer base which includes integrated device manufacturers (“IDMs”), fabless companies, and test subcontractors, also referred to as subcontractors or “OSAT” (outsourced sub-assembly and test) providers. OSATs include specialty assembly, package and test companies as well as wafer foundries, and companies that design, but contract with others for the manufacture of, integrated circuits (known as fabless design companies).

Basis of Presentation

The accompanying financial data has been prepared by us pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). For a full understanding of our financial position and results of operations, this discussion should be read in conjunction with the condensed consolidated financial statements and related notes presented in this report on Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States have been combined and or omitted pursuant to such rules and regulations.

Our fiscal year end is October 31, and our fiscal quarters end on January 31, April 30, July 31 and October 31. Unless otherwise stated, all dates refer to our fiscal years and fiscal periods.

Amounts included in the accompanying condensed consolidated financial statements are expressed in U.S. dollars. Certain amounts in the condensed consolidated financial statements for the three months ended January 31, 2009 were reclassified to conform to the presentation used for the three months ended January 31, 2010.

On June 15, 2009, we acquired Touchdown Technologies (“Touchdown”), a privately held company. Touchdown provides advanced MEMS probe cards which are designed to improve wafer throughput and yields for memory manufacturers. From the acquisition date, the results of operations of Touchdown’s business are included in our condensed consolidated statements of operations. Also see Note 11, “Acquisition of Touchdown Technologies” of our condensed consolidated financial statements.

 

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Overview of Results

Our total net revenue for the three months ended January 31, 2010, was $106 million, up $38 million, or 55.9%, from the comparable period in fiscal year 2009, and was up $9 million or 9.3% sequentially. This marks the fourth consecutive quarter of increasing revenue. The increase was primarily due to higher revenue from sales of our SOC platforms, representing growth of more than 100% from the same time last year. This reflects the sustained demand in the RF product segment particularly for cellular handsets and smart phones. We experienced continued weakness in our memory business, which reflected only a slight increase in revenue. Much of the revenue generated during the first quarter of fiscal year 2010 was driven by our semiconductor manufacturer customers. As these customers increase their manufacturing requirements, we believe that we will see more capacity driven purchases from their subcontractor test partners to which we also sell our products. We are encouraged by the increased market activity that we saw in the first quarter of fiscal year 2010. Our customer sentiment is more positive which we believe will lead to higher capital spending levels in the second half of the year. We expect a modest improvement in revenue for the second quarter of fiscal year 2010.

Our gross margin for the three months ended January 31, 2010, was 44.3%, an increase of 31.1 percentage points from the comparable period in fiscal year 2009. Gross margin improvement was primarily driven by the lower excess and obsolete inventory charges as well as savings from our restructuring actions. We also incurred restructuring charges of approximately $0.3 million during the three months ended January 31, 2010, compared to $1.5 million for the three months ended January 31, 2009. These improvements in gross margin were offset by the incremental costs incurred of approximately $3.4 related to our manufacturing transition which was substantially complete during the first quarter of fiscal year 2010.

Our research and development and selling, general and administrative expenses totaled $51 million in the first quarter of fiscal year 2010, down $5 million, or 8.9%, from the comparable period in fiscal year 2009. The decrease in these expenses from the comparable quarter of fiscal year 2009 were primarily driven by a write down of purchased intangible property of approximately $3 million incurred during the three months ended January 31, 2009. It also reflected cost savings from our restructuring actions, primarily lower compensation and benefits, and lower overall discretionary spending. These savings were partially offset by the incremental costs associated with our acquisition of Touchdown Technologies.

Net loss for the three months ended January 31, 2010 was $6 million, compared to net loss of $64 million in the comparable period in fiscal year 2009. The year over year improvement from fiscal year 2009, reflects the increased revenue levels, costs savings from our restructuring actions as well as lower restructuring and impairment charges. However, this was offset by the incremental operating costs associated with our acquisition of Touchdown Technologies, acquired in the third quarter of fiscal year 2009, as well as costs associated with our manufacturing transition. In the first quarter of fiscal year 2010, we used $11 million in cash for operating activities, and our cash and cash equivalents balance as of January 31, 2010 was $213 million.

The sales of our products and services are dependent, to a large degree, on customers who are subject to cyclical trends in the demand for their products. These cyclical periods have had, and will continue to have a significant effect on our business since our customers often delay or accelerate purchases in reaction to changes in their businesses and to demand fluctuations in the semiconductor industry. Historically, these demand fluctuations have resulted in significant variations in our results of operations. This was particularly relevant beginning in the first quarter of fiscal year 2009 when we saw a significant decrease in revenue from our SOC platform due to the deteriorating global economy and the downturn that impacted the entire semiconductor industry. The sharp swings in the semiconductor industry in recent years have generally affected the semiconductor test equipment and services industry more significantly than the overall capital equipment sector.

While we sell to a variety of customers, subcontractors represent a large portion of our customer base. During market troughs, these subcontractors tend to decrease or postpone orders for new test systems and test services more quickly and dramatically as they are more capacity-driven than other customers. As a result, industry downturns may cause a quicker and more significant adverse effect on our business than on the broader semiconductor industry. In addition, although a decline in orders for semiconductor capital equipment may accompany or precede the timing of a decline in the semiconductor market as a whole, recovery in semiconductor capital equipment spending may lag the recovery by the semiconductor industry.

We are optimistic about the improving business environment. Over the past year, our product development efforts in DRAM and low end SOC as well as our acquisition of Touchdown Technologies have strengthened our product portfolio and have broadened our markets. As a result of these investments and the improving industry environment, we expect a modest improvement in revenue for the second quarter of fiscal year 2010. As part of our restructuring actions that were implemented in fiscal year 2009, we instituted a number of temporary costs savings measures, including employee salary reductions and furloughs. Effective February 1, 2010, we restored full pay to our employees and eliminated furloughs. Although this will increase our overall expenses, we will continue to maintain tight financial management.

 

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Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management’s knowledge of current events and of actions that may impact the company in the future, actual results may be different from the estimates. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management. Those policies are revenue recognition, restructuring, inventory valuation, warranty, share-based compensation, retirement and post-retirement plan assumptions, valuation of goodwill and other long-lived assets, valuation of marketable securities and accounting for income taxes.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. There have been no significant changes to our critical accounting policies and estimates from our Annual Report on Form 10-K for the year ended October 31, 2009, filed with the Securities and Exchange Commission on December 21, 2009.

Recent Accounting Pronouncements

In December 2007, the FASB issued an amendment to the accounting guidance for business combinations. This amendment provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed and any noncontrolling interest in an acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of a business combination. In April 2009, the FASB issued another amendment for assets acquired and liabilities assumed in a business combination that arise from contingencies. This amendment clarifies the previous amendment and addresses application issues raised by preparers, auditors and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. It is effective for fiscal years beginning on or after December 15, 2008, and will be applied prospectively. This guidance was effective for us in the first quarter of fiscal year 2010, and upon adoption, did not have a significant impact on our condensed consolidated financial statements.

In December 2007, the FASB revised the accounting guidance for noncontrolling interests in condensed consolidated financial statements, which requires that ownership interests in subsidiaries held by parties other than the parent, and the amount of consolidated net income, be clearly identified, labeled and presented in the condensed consolidated financial statements. It also requires that once a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value. Sufficient disclosures are required to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. It is effective for fiscal years beginning on or after December 15, 2008, and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements will be applied prospectively. This guidance was effective for us in the first quarter of fiscal year 2010, and upon adoption, did not have a significant impact on our condensed consolidated financial statements.

In December 2008, the FASB issued new guidance for employers’ disclosures about postretirement benefit plan assets. The new guidance provides revised guidance on the disclosure requirement of employers’ disclosures about pensions and other postretirement benefits. It requires companies to provide qualitative disclosures about how investment allocation decisions are made, the inputs and valuation techniques used to measure the fair value of plan assets and the concentration of risk within plan assets. Additionally, quantitative disclosures are required showing the fair value of each major category of plan assets, the level in which each assets is classified within the fair value hierarchy and a reconciliation for the period of plan assets that are measured using significant unobservable inputs. It is effective for fiscal years ending after December 15, 2009. We are currently assessing the impact that the guidance may have on our condensed consolidated financial statements upon adoption in our fourth quarter of fiscal year 2010.

In June and December 2009, the FASB amended the accounting guidance for transfers of financial assets. This amendment requires greater transparency and additional disclosures for transfers of financial assets and the entity’s continuing involvement with them and changes the requirements for derecognizing financial assets. In addition, this amendment eliminates the concept of a qualifying special-purpose entity. The amendment must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual

 

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reporting periods thereafter. Earlier application is prohibited. We are currently assessing the impact that this amendment may have on our condensed consolidated financial statements upon adoption in fiscal year 2011.

In June 2009, the FASB amended the accounting guidance for the consolidation of variable interest entities. This amendment revised the evaluation criteria to identify the primary beneficiary of a variable interest entity. Additionally, this amendment requires ongoing reassessments of whether an enterprise is the primary beneficiary of the variable interest entity. In December 2009, the FASB amended consolidation guidance previously issued in June to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity, among other changes. The amendments are effective for our first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. We are currently assessing the impact that this amendment may have on our condensed consolidated financial statements upon adoption in fiscal year 2011.

In August 2009, the FASB amended the accounting guidance for the fair value measurement of liabilities. The amended guidance clarifies that in circumstances in which a quoted price in an active market for the identical liability is not available, we are required to use the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities, or quoted prices for similar liabilities when traded as assets. If these quoted prices are not available, we are required to use another valuation technique, such as an income approach or a market approach. The amended guidance is effective for the first reporting period (including interim periods) beginning after issuance, and it was effective for us in the first quarter of fiscal year 2010, and upon adoption, did not have a significant impact on our condensed consolidated financial statements.

In October 2009, the FASB issued new accounting guidance for revenue recognition with multiple deliverables. The new guidance impacts the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, the guidance modifies the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of revenue recognition in accounting for multiple deliverable arrangements. The guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and will be effective for us in the first quarter of fiscal year 2011, however early adoption is permitted. We are currently assessing the impact that the guidance may have on our condensed consolidated financial statements upon adoption in fiscal year 2011.

In October 2009, the FASB issued new accounting guidance for the accounting for certain revenue arrangements that include software elements. The new guidance amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. The new guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and will be effective for us in the first quarter of fiscal year 2011, however early adoption is permitted. We are currently assessing the impact that the guidance may have on our condensed consolidated financial statements upon adoption in fiscal year 2011.

In January 2010, the FASB issued new accounting guidance that requires new disclosures related to fair value measurements. The new guidance requires separate disclosure for transfers between Level 1 and 2 and the activities in Level 3 reconciliation on a gross basis. The new accounting guidance is effective for fiscal years and interim periods beginning after December 15, 2009, except for the new disclosures related to Level 3 activities, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those years. The new guidance will be effective for us in the second quarter of fiscal year 2010, except for the new disclosures related to Level 3 activities, which will be effective for us in the first quarter of fiscal year 2012. We are currently assessing the impact that the guidance may have on our condensed consolidated financial statements upon adoption in the second quarter of fiscal year 2010 and in the first quarter of fiscal year 2012, respectively.

Quarterly Results of Operations

Our quarterly results of operations have varied in the past and are likely to continue to vary in the future primarily due to the cyclical nature of the semiconductor industry. Historically, the semiconductor industry has been highly cyclical, with recurring periods of diminished product demand. During these periods, semiconductor designers and manufacturers, facing reduced demand for their products, have significantly reduced their capital and other expenditures, including expenditures for the semiconductor test equipment and services that we offer. Historically, our third and fourth fiscal quarters have tended to be our strongest quarters for new orders, while our first fiscal quarter have tended to be our weakest. We believe that the most significant factor driving these seasonal patterns is the holiday buying season for consumer electronics products. The seasonality of our business is often masked to a significant extent by the high degree of cyclicality of the semiconductor industry. During the first quarter of fiscal year 2010, we continued to experience weakness in our memory business but have experienced an increase in our SOC business compared to the levels of revenue generated during the first quarter of fiscal year 2009. Due to our limited operating history, seasonality in orders, and the unpredictable cyclicality of our industry, we believe that period-to-period comparisons of our results of operations should not be relied

 

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upon as an indication of future performance. In future periods, the market price of our ordinary shares could decline if our revenue and results of operations are below the expectations of analysts and investors. Factors that may cause our revenue and results of operations to vary include those discussed in the “Risk Factors” in Item 1A of Part II of, and elsewhere in, this report.

The following table sets forth certain operating data as a percent of net revenue for the periods presented:

 

     Three Months Ended
January 31,
 
     2010     2009  

Net revenue:

    

Products

   71.7   48.5

Services

   28.3      51.5   
            

Total net revenue

   100.0      100.0   

Cost of sales:

    

Cost of products

   37.8      53.0   

Cost of services

   17.9      33.8   
            

Total cost of sales

   55.7      86.8   
            

Gross margin (1)

   44.3      13.2   

Operating expenses:

    

Research and development

   20.8      36.8   

Selling, general and administrative

   27.3      45.6   

Restructuring charges

   0.9      5.8   
            

Total operating expenses

   49.0      88.2   

Loss from operations

   (4.7   (75.0

Other (expense) income, net

   (1.0   2.9   

Impairment of investments

   —        (20.5
            

Loss before income taxes

   (5.7   (92.6

Provision for income taxes

   —        1.5   
            

Net loss

   (5.7 )%    (94.1 )% 
            

 

(1) Gross margin represents the ratio of gross profit to total net revenue.

Net Revenue

 

     Three Months Ended
January 31,
    2010 over
2009
Change
 
     2010     2009    
     ($ in millions)        

Net revenue from products:

      

SOC/SIP/High-Speed Memory

   $ 69      $ 24      187.5

As a percent of total net revenue

     65.1     35.3  

Memory

     7        9      (22.2 )% 

As a percent of total net revenue

     6.6     13.2  
                  

Net revenue from products

   $ 76      $ 33      130.3
                  

Net revenue from services

     30        35      (14.3 )% 

As a percent of total net revenue

     28.3     51.5  
                  

Total net revenue

   $ 106      $ 68      55.9
                  

Historically, we have provided revenue by geography based on where the revenue is billed versus where the products are shipped. Since our fourth quarter of fiscal year 2009, we have reported revenue by geography based on where the products are shipped. The amounts for the three months ended January 31, 2009 were reclassified to conform to the presentation used for the three months ended January 31, 2010.

 

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Our net revenues by geographic region for the three months ended January 31, 2010 and 2009 are as follows:

 

     Three Months Ended
January 31,
    2010 over
2009
Change
 
     2010     2009    
     ($ in millions)        

North America

   $ 11      $ 15      (26.7 )% 

As a percent of total net revenue

     10.4     22.0  

Europe

   $ 6      $ 11      (45.5 )% 

As a percent of total net revenue

     5.6     16.2  

Asia

   $ 89      $ 42      111.9

As a percent of total net revenue

     84.0     61.8  
                  

Total net revenue

   $ 106      $ 68      55.9
                  

Net Revenue. Net revenue is derived from the sale of products and services and is adjusted for estimated returns and allowances, which historically have been insignificant. Our product revenue is generated predominantly from the sales of our test equipment products. Revenue from services includes extended warranty, customer support, consulting, training and education activities. Service revenue is recognized over the contractual period or as services are rendered to the customer.

Net revenue in the three months ended January 31, 2010 was $106 million, an increase of $38 million, or 55.9%, from $68 million achieved in the three months ended January 31, 2009. Net product revenue in the three months ended January 31, 2010 was $76 million, an increase of $43 million, or 130.3%, from $33 million achieved in the three months ended January 31, 2009. This marks the fourth consecutive quarter of increasing revenue. The increase was primarily due to higher revenue from sales of our SOC platforms representing growth of more than 100% from the same time last year. This reflects the sustained demand in the RF product segment particularly for cellular handsets and smart phones. We experienced continued weakness in our memory business, with only a slight increase in revenue. Much of the revenue generated during the first quarter of fiscal year 2010 was driven by our semiconductor manufacturer customers. As these customers increase their manufacturing requirements, we believe that we will see more capacity driven purchases from their subcontractor test partners to which we also sell our products. We are encouraged by the increased market activity that we saw in the first quarter of fiscal year 2010. Our customer sentiment is more positive which we believe will lead to higher capital spending levels in the second half of the year. We expect a modest improvement in revenue for the second quarter of fiscal year 2010.

We derive a significant percentage of our net revenue from outside of North America. Net revenue from customers located outside of North America represented 89.6% and 78.0% of total net revenue in the three months ended January 31, 2010 and 2009, respectively. Net revenue in North America as a percentage of total net revenue was lower by 11.6 percentage points in the three months ended January 31, 2010, compared to the three months ended January 31, 2009, while net revenue in Asia as a percentage of total net revenue, was higher by 22.2 percentage points in the three months ended January 31, 2010, compared to the three months ended January 31, 2009. We expect a majority of our sales to continue to be generated in the Asia region as semiconductor manufacturing activities continue to concentrate in that region.

Service revenue for the three months ended January 31, 2010 accounted for $30 million, or 28.3% of net revenue, compared to $35 million, or 51.5% of net revenue in the three months ended January 31, 2009. Unlike product revenue, service revenue tends not to experience significant cyclical fluctuations due to the fact that service contracts generally extend for one to two years and revenue is recognized over the contractual period or as services are rendered. As such, the decline in service revenue is due to lower systems product sales and service contracts that customers did not renew during the downturn. We expect to see a gradual increase in service revenue overtime as product sales begin to increase.

Cost of Sales

Cost of Products

 

     Three Months Ended
January 31,
    2010 over
2009
Change
 
     2010     2009    
     ($ in millions)        

Cost of products

   $ 40      $ 36      11.1

As a percent of product revenue

     52.6     109.1   

 

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Cost of Products. Cost of products consists primarily of manufacturing materials, outsourced manufacturing costs, direct labor, manufacturing and administrative overhead, warranty costs and provisions for excess and obsolete inventory, partially offset, when applicable, by benefits from sales of previously written-down inventory.

The increase in cost of products of approximately $4 million in the three months ended January 31, 2010, compared to the three months ended January 31, 2009, was primarily due to the increase in sales of our SOC products. Cost of products included $0.3 million of restructuring expense in the three months ended January 31, 2010, compared to $1.5 million of such charge in the three months ended January 31, 2009. Cost of products also included $0.5 million of share-based compensation expense for both periods presented in the three months ended January 31, 2010 and 2009.

Cost of products as a percent of net product revenue decreased by 56.5 percentage points in the three months ended January 31, 2010, compared to the three months ended January 31, 2009, primarily due to the higher product revenue generated during the quarter due to the increase in sales of our SOC products. This reduction also reflects the cost savings from our restructuring actions, primarily lower compensation and benefit costs as well as lower charges for excess and obsolete inventory and restructuring. This was partially offset by the incremental costs incurred of approximately $3.4 million related to our manufacturing transition which was substantially complete during the first quarter of fiscal year 2010.

Gross excess and obsolete inventory-related charges in the three months ended January 31, 2010 and 2009 were $1.8 million and $13.4 million, respectively. We also sold previously written down inventory of $4.1 million and $7.1 million in the three months ended January 31, 2010 and 2009, respectively. The sales of previously written down inventory improved our gross margins on product sales by approximately 3.0 percentage points in the three months ended January 31, 2010 and 29.9 percentage points in the three months ended January 31, 2009.

As of January 31, 2010, we held $61 million of inventory, net of $50 million of reserves, composed of $32 million of raw materials, and $29 million of finished goods. Raw materials include approximately $34 million of support inventory. We continue to dispose of previously written down inventory on a recurring basis.

Cost of Services

 

     Three Months Ended
January 31,
    2010 over
2009
Change
 
     2010     2009    
     ($ in millions)        

Cost of services

   $ 19      $ 23      (17.4 )% 

As a percent of service revenue

     63.3     65.7   

Cost of Services. Cost of services includes cost of field service and support personnel, spare parts consumed in service activities and administrative overhead allocations.

Cost of services for the three months ended January 31, 2010 was $4 million lower compared to the three months ended January 31, 2009. Cost of services as a percent of service revenue decreased by 2.4 percentage points, from 65.7% in the three months ended January 31, 2009 to 63.3% in the three months ended January 31, 2010. This margin improvement reflected cost savings from our restructuring actions, primarily lower compensation and benefit costs, cost savings from lower discretionary spending as well as lower repair volume. Our cost of services included $0.3 million of share-based compensation expense for both periods presented in the three months ended January 31, 2010 and 2009.

As a percent of service revenue, cost of services will vary depending on a variety of factors, including the effect of price erosion, the reliability and quality of our products and our need to maintain customer service and support centers worldwide.

 

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Operating Expenses

Research and Development Expenses

 

     Three Months Ended
January 31,
    2010 over
2009
Change
 
     2010     2009    
     ($ in millions)        

Research and development

   $ 22      $ 25      (12.0 )% 

As a percent of total net revenue

     20.8     36.8   

Research and Development. Research and development expense includes costs related to salaries and related compensation expenses for research and development and engineering personnel, materials used in research and development activities, outside contractor expenses, depreciation of equipment used in research and development activities, facilities and other overhead and support costs for the personnel, as well as in-process research and development related to our acquisitions. Research and development costs have generally been expensed as incurred.

Research and development expense decreased by $3 million in absolute dollars during the three months ended January 31, 2010, compared to the three months ended January 31, 2009. This decrease was primarily driven by a write down of purchased intellectual property of approximately $3 million incurred during the three months ended January 31, 2009. It also reflected lower expenses from cost savings from our restructuring actions, primarily lower compensation and benefit costs. This was partially offset by incremental operating expenses related to our acquisition of Touchdown Technologies. Research and development expense also included $0.4 million and $0.5 million of share-based compensation expense for the three months ended January 31, 2010 and 2009, respectively. Research and development expense as a percentage of revenue decreased by 16.0 percentage points from 36.8% in the three months ended January 31, 2009 to 20.8% in the three months ended January 31, 2010. The decrease in research and development expense as a percent of revenue reflected the significantly lower revenue levels in the first quarter of fiscal year 2009 compared to the first quarter of fiscal year 2010.

We believe that we need to maintain a significant level of research and development spending in order to remain competitive and, as a result, we expect our research and development expenses to only vary modestly in dollar amount from period to period, and to fluctuate as a percentage of revenue based on revenue levels.

Selling, General and Administrative Expenses

 

     Three Months Ended
January 31,
    2010 over
2009
Change
 
     2010     2009    
     ($ in millions)        

Selling, general and administrative

   $ 29      $ 31      (6.5 )% 

As a percent of total net revenue

     27.3     45.6   

Selling, General and Administrative. Selling, general and administrative expense includes costs related to salaries and related expenses for sales, marketing and applications engineering personnel, sales commissions paid to sales representatives and distributors, outside contractor expenses, other sales and marketing program expenses, travel and professional service expenses, salaries and related expenses for administrative, finance, human resources, legal and executive personnel, facility and other overhead and support costs for these personnel.

Selling, general and administrative expense decreased by $2 million in absolute dollars in the three months ended January 31, 2010, compared to the three months ended January 31, 2009. The decrease was due to cost savings from our restructuring actions, primarily lower compensation and benefit costs and lower discretionary spending. These costs were partially offset by incremental operating expenses related to our acquisition of Touchdown Technologies. Selling, general and administrative expense included approximately $3.4 million of share-based compensation expenses in the three months ended January 31, 2010, compared to $3.5 million of such expenses in the three months ended January 31, 2009.

Restructuring Charges

In order to address the cyclical downturn and the negative impact on our results driven by the deteriorating global economy, in fiscal year 2009 we implemented restructuring actions to streamline our organization and reduce our operating costs. As part of these restructuring actions, we reduced our global workforce through a combination of attrition, voluntary and involuntary terminations and other workforce reduction programs consistent with local legal requirements.

 

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The total charge incurred during our first quarter of fiscal year 2010 for our restructuring actions was approximately $1.3 million, $0.3 million of which was recorded within cost of sales and the remainder of which was recorded within operating expenses.

As of January 31, 2010, we had approximately $4.1 million of accrued restructuring liability included within other current liabilities on our condensed consolidated balance sheet. The accrued amount relates to severance and benefit payments and is expected to be primarily paid out by the end of fiscal year 2010.

Other (expense) income, net

The following table presents the components of other income (expense), net for the three months ended January 31, 2010 and 2009:

 

     Three Months Ended
January 31
     2010     2009
     (in millions)

Interest and other income

   $ 1      $ 2

Interest expense

     (2     —  
              

Other (expense) income, net

   $ (1   $ 2
              

Other (expense) income, net consists primarily of interest on cash, cash equivalents and investments, gain on sale of investments and money market redemptions, and interest expense primarily related to our convertible senior notes. Other (expense) income, net also includes gains and losses from the remeasurement of assets and liabilities denominated in currencies other than the functional currency, as well as gains and losses on foreign exchange balance sheet hedge transactions. These transactions are intended to offset foreign exchange gains and losses from remeasurement, which are generally for a period of 30 days or less and settled by the end of the month. The net foreign currency remeasurement impact was not material during both the three months ended January 31, 2010 and 2009.

The following table presents the components of impairment of investments for the three months ended January 31, 2010 and 2009:

 

     Three Months Ended
January 31
 
     2010    2009  
     (in millions)  

Impairment of cost-based investments

   $ —      $ (6 )

Impairment of auction rate securities

     —        (8 )
               

Impairment of investments

   $ —      $ (14 )
               

During the three months ended January 31, 2009, we incurred a $6.2 million charge related to the write-off of a cost method investment that was determined to be impaired on an other-than-temporary basis. We also recorded a $7.7 million other-than-temporary impairment charge for the three months ended January 31, 2009 for our auction rate securities. See Note 13 “Marketable Securities.”

Provision for Income Taxes

For the three months ended January 31, 2010 and 2009, we recorded an income tax provision of approximately $0.2 million and $1.0 million, or effective tax rates of (3.6)% and (1.6)%, respectively.

Our effective tax rate varies based on a variety of factors, including overall profitability, the geographical mix of income before taxes and the related tax rates in the jurisdictions in which we operate, restructuring and other one-time charges, as well as discrete events, such as tax settlements.

At January 31, 2010, the total unrecognized tax benefits of $16.1 million included approximately $0.4 million of unrecognized tax benefits that have been netted against the related deferred tax assets and $15.7 million of unrecognized tax benefits which are reflected in other long term liabilities. Unrecognized tax benefits of $16.1 million would reduce our income tax provision if recognized.

 

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Our continuing practice is to recognize interest and penalties related to income tax matters as a component of income tax expense. We have approximately $1.9 million of accrued interest and penalties as of January 31, 2010 and approximately $1.4 million of accrued interest and penalties as of January 31, 2009.

Although we file Singapore, U.S. federal, U.S. state and foreign income tax returns, our three major tax jurisdictions are Singapore, the U.S. and Germany. Our 2006, 2007 and 2008 tax years remain subject to examination by the tax authorities in our major tax jurisdictions. Our U.S. federal income tax returns are currently under audit by the Internal Revenue Service for fiscal years ending October 31, 2006 and 2007. As a result of uncertainties regarding the timing of the completion of tax audits and their possible outcomes, we can not estimate whether we would have a material change in our unrecognized tax benefits over the next twelve months.

Goodwill and Long-Lived Assets

Our goodwill balance as of both January 31, 2010 and 2009 was $18 million and represents an allocation of goodwill recorded during our separation from Agilent in 2006. We review our goodwill for impairment annually in the fourth quarter of our fiscal year, or more frequently if impairment indicators arise. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. The fair values of the reporting units are estimated using a combination of the income approach that uses discounted cash flows and the market approach that utilizes comparable companies’ data. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss. We have two reporting units for which we assess goodwill for impairment.

During fiscal year 2009, we recorded $2 million of intangible assets related to our acquisition of Touchdown Technologies with a weighted-average amortization period of 4 years. These assets will be amortized on a straight-line basis with an estimated future amortization expense of approximately $0.5 million a year. Intangibles assets as of January 31, 2010 were approximately $1 million. We continually monitor events and changes in circumstances that could indicate carrying amounts of long-lived assets may not be recoverable. When such events or changes in circumstances occur, we assess the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the undiscounted future cash flows is less than the carrying amount of those assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets.

Financial Condition

Liquidity and Capital Resources

As of January 31, 2010, we had $213 million in cash and cash equivalents, compared to $197 million as of October 31, 2009. This increase in cash was primarily due to cash proceeds from the maturities of available for sale securities, partially offset by the net loss of $6 million.

Net Cash (Used in) by Operating Activities

In the three months ended January 31, 2010, we used $11 million in cash for operating activities, compared to $47 million used in the three months ended January 31, 2009. The $11 million cash used during the three months ended January 31, 2010, was primarily a result of $6 million of net loss, an $11 million increase in payables, and $5 million increase in deferred revenue. Also during the three months ended January 31, 2010, we had non-cash charges of $5 million from depreciation and amortization expense, $2 million from gross excess and obsolete inventory provisions, $5 million of net share-based compensation costs, and a $1 million realized gain on marketable securities. These impacts were partially offset by increases of $15 million in receivables, $9 million in inventory, and decreases of $5 million in employee compensation and benefits, $4 million in income tax and other taxes payable, and a change in net assets of $1 million in other current and long-term assets and liabilities.

In the three months ended January 31, 2009, we used $47 million in cash for operating activities. The $47 million cash used during the three months ended January 31, 2009, was a result of $64 million of net loss, a $33 million reduction in receivables as a result of customer payments, and $2 million increase in income tax and other taxes payable. Also during the three months ended January 31, 2009, we had non-cash charges of $4 million from depreciation and amortization expense, $13 million from gross excess and obsolete inventory provisions, $5 million of net share-based compensation costs and a $14 million impairment loss on marketable securities and cost method investments. These impacts were partially offset by an increase of $3 million in inventory and decreases of $29 million in payables, $11 million in employee compensation and benefits, and $11 million in deferred revenue.

 

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Net Cash Provided by Investing Activities

Net cash provided by investing activities in the three months ended January 31, 2010 was $25 million, compared to $73 million provided in the three months ended January 31, 2009. The net cash provided was primarily generated by the proceeds from the maturities and sale of available for sale marketable securities of $98 million. This was partially offset by purchases of available for sale marketable securities of $70 million and investments made for property, plant and equipment of $3 million. Our marketable securities include commercial paper, corporate bonds, government securities, money market funds and auction rate securities. Auction rate securities are securities that are structured with interest rate reset periods of generally less than ninety days but with contractual maturities that can be well in excess of 10 years. At the end of each interest rate reset period, investors can buy, sell or continue to hold the securities at par. As of January 31, 2010, all of our auction rate securities experienced failed auctions. The funds associated with these auctions will not be accessible to us until a successful auction occurs, a buyer is found outside of the auction process, or the underlying securities have matured or are called by the issuer. Given the ongoing disruptions in the credit markets and the fact that the liquidity for these types of securities remains uncertain, we have classified all of our auction rate securities as long-term assets in our condensed consolidated balance sheet as of January 31, 2010, as our ability to liquidate such securities in the next 12 months is uncertain.

Our auction rate securities primarily consist of investments that are backed by pools of student loans guaranteed by the U.S. Department of Education and other asset-backed securities. Our marketable securities portfolio as of January 31, 2010 had a carrying value of $382 million, of which approximately $55 million consisted of illiquid auction rate securities. Given the ongoing disruption in the market for auction rate securities, there is no longer an actively quoted market price for these securities. Accordingly, we utilized a model to estimate the fair value of these auction rate securities based on, among other items: (i) the underlying structure of each security and the underlying collateral quality; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (iii) consideration of the probabilities of default, auction failure or repurchase at par for each period; and (iv) estimates of the recovery rates in the event of default for each security. These estimated fair values could change significantly based on future market conditions.

We evaluate our investments periodically for possible other-than-temporary impairment by reviewing factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and insurance guarantor, and our ability and intent to hold the investment for a period of time sufficient for anticipated recovery of market value. Based on an analysis of other-than-temporary impairment factors, we did not incur any other-than-temporary impairments for the three months ended January 31, 2010 related to our auction rate securities. We have recorded an unrealized gain within accumulated other comprehensive loss of approximately $0.5 million (net of tax of $0.1 million), primarily for our auction rate securities that are backed by pools of student loans as of January 31, 2010. We also recognized a realized gain of approximately $0.4 million on the sale of long-term investments.

Investments in money market funds include investments in the Reserve Primary Fund and the Reserve International Liquidity Fund (collectively referred to as the “Reserve Funds”). The net asset value for the Reserve Funds fell below $1 because the funds had holdings of commercial paper and other notes with a major investment bank which filed for bankruptcy on September 15, 2008. As a result of these events, these funds are no longer classified as cash and cash equivalents. We have classified these investments as short-term marketable securities because, based on the maximum maturity date of the underlying securities as well as the proposed liquidation plan and distribution updates received for the funds, we believe that within one year, these investments will be redeemable. We received the final distribution from our investment in the Reserve Primary Fund during the three months ended January 31, 2010 and recorded a realized gain of $0.1 million. We received approximately $1.9 million from the distribution of these funds during the three months ended January 31, 2010, reducing the value of our remaining holding in the Reserve International Liquidity Fund to $1.2 million as of January 31, 2010.

Net cash provided by investing activities in the three months ended January 31, 2009 was $73 million. The net cash provided was primarily generated by the proceeds from the maturities and sale of available for sale marketable securities of $76 million and proceeds from the disposition of assets of $2 million. This was partially offset by purchases of available for sale marketable securities of $3 million and investments made for property, plant and equipment of $2 million.

Net Cash Provided by Financing Activities

Net cash provided by financing activities in the three months ended January 31, 2010 was $2 million, compared to $1 million provided in the three months ended January 31, 2009. The $2 million net cash provided by in the three months ended January 31, 2010 was comprised of approximately $2 million from the issuance of shares under the employee stock plans including contributions by participants to our employee shares purchase plan, pursuant to which 285,899 shares were issued in first quarter of fiscal year 2010.

 

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Net cash provided by financing activities in the three months ended January 31, 2009 was $1 million. The $1 million net cash provided in the three months ended January 31, 2009 was comprised of approximately $3 million from the issuance of shares under the employee stock plans including contributions by participants to our employee shares purchase plan, pursuant to which 375,885 shares were issued in first quarter of fiscal year 2009, offset by approximately $2 million of repurchases of our ordinary shares pursuant to the repurchase program approved by our shareholders in the second quarter of fiscal year 2008.

Other

Our liquidity is affected by many factors, some of which are based on normal ongoing operations of our business and some of which arise from fluctuations related to global economics and markets. Our cash balances are generated and held in many locations throughout the world. Local government regulations may restrict our ability to move cash balances to meet cash needs under certain circumstances. We do not currently expect such regulations and restrictions to affect our ability to pay vendors and conduct operations throughout our global organization.

We believe that existing cash, cash equivalents and short-term marketable securities of approximately $360 million as of January 31, 2010, will be sufficient to satisfy our working capital, capital expenditure and other liquidity needs at least for the next twelve months. However, we may require or choose to obtain debt or equity financing in the future. It is uncertain that additional financing, if needed, will be available on favorable terms, or at all.

Contractual Obligations and Commitments

Contractual Obligations

Our cash flows from operations are dependent on a number of factors, including fluctuations in our operating results, accounts receivable collections, inventory management and the timing of tax and other payments. As a result, the impact of contractual obligations on our liquidity and capital resources in future periods should be analyzed in conjunction with such factors.

The following table summarizes our contractual obligations at January 31, 2010 (in millions):

 

(in millions)

   Total    Less than
one year
   One to three
years
   Three to five
years
   More than
five years

Operating and capital leases

   $ 52    $ 13    $ 16    $ 13    $ 10

Commitments to contract manufacturers and suppliers

     91      91      —        —        —  

Other purchase commitments

     60      60      —        —        —  

Convertible senior note and related interest

     170      7      14      149      —  

Long-term liabilities

     27      —        3      —        24
                                  

Total

   $ 400    $ 171    $ 33    $ 162    $ 34
                                  

The contractual obligations table excludes our long-term income taxes payable liabilities and earn out payments related to our acquisition in Touchdown because we cannot make a reliable estimate of the timing of cash payments. As of January 31, 2010, we had total unrecognized tax benefits of $16.1 million, of which $15.7 million is reflected in other long-term liabilities, with the remaining $0.4 million netted against the related deferred tax assets.

Operating and capital leases. Commitments under operating leases relate primarily to leasehold property. We have entered into long-term lease arrangements for our corporate headquarters in Singapore, our principal U.S. facility in Cupertino, California, and our Boeblingen, Germany facility. We have also entered into long-term lease arrangements for our ASIC development office in Colorado, as well as other sales and support facilities around the world. As part of our acquisition of Touchdown, we assumed certain capital lease obligations primarily for machinery and equipment.

Commitments to contract manufacturers and suppliers. We purchase components from a variety of suppliers and, historically, we have used several contract manufacturers to provide manufacturing services for our products. During the normal course of business, we issue purchase orders with estimates of our requirements several months ahead of the delivery dates. However, our agreements with these suppliers usually allow us the option to cancel, reschedule or adjust our requirements based on our business needs prior to firm orders being placed. Typically purchase orders outstanding with delivery dates within 30 days are non-cancelable. Less than 1% of our purchase commitments arising from these agreements are firm, non-cancelable and unconditional commitments. We expect to fulfill the purchase commitments for inventory within one year.

 

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In addition, we record a liability for firm, non-cancelable and unconditional purchase commitments for quantities in excess of our future demand forecasts. Such liabilities were $7 million as of January 31, 2010, and $8 million as of October 31, 2009. These amounts are included in other current liabilities in our condensed consolidated balance sheets at January 31, 2010 and October 31, 2009.

Other purchase commitments. Other purchase commitments relate primarily to contracts with professional services suppliers, which include third-party consultants for legal, finance, engineering and other administrative services. With the exception of our IT service providers, our purchase commitments from professional service providers are typically cancelable with a notice of 90 days or less without significant penalties. The agreement with our primary IT service provider requires notice of 120 days and includes a termination charge of up to approximately $0.8 million in order to cancel our long-term contract.

Convertible senior notes. On July 15, 2009, we issued $138 million of convertible senior notes. The notes will mature on July 15, 2014, and bear interest at a fixed rate of 5.25% per annum. The interest is payable semi-annually on January 15th and July 15th of each year and payments commenced on January 15, 2010.

Long-term liabilities. Long-term liabilities relate primarily to $24 million of defined benefit and defined contribution retirement obligations, $3 million of extended warranty and deferred revenue obligations, a $6 million deferred acquisition credit related to the Touchdown Technologies acquisition. Upon our separation from Agilent, the defined benefit plans for our employees located in Germany, Korea, Taiwan, France and Italy were transferred to us. With the exception of Italy and France, which involve relatively insignificant amounts, Agilent completed the funding of these transferred plans, based on 100% of the accumulated benefit obligation level as of the separation date. We expect expenses of approximately $4 million in fiscal year 2010 for the retirement plans, and we plan on making cash contributions of approximately $2 million.

Off-Balance Sheet Arrangements

We had no material off-balance sheet arrangements as of January 31, 2010 or October 31, 2009.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Foreign Currency Risk

We conduct business on a global basis in a number of major international currencies. As such, we are potentially exposed to adverse as well as beneficial movements in foreign currency exchange rates. The majority of our sales are denominated in U.S. dollars except for certain of our revenues that are denominated in Japanese yen. Services and support sales are denominated primarily in local currency after the initial product sale. A significant amount of expenses are denominated in euro for certain expenses such as employee payroll and benefits as well as other expenses that are paid in local currency. In addition, other expenses related to our non-U.S. and non-European offices are denominated in the countries’ local currency. As such, we enter into cash flow and balance sheet hedges to mitigate our foreign currency risk.

We currently enter into foreign currency forward contracts to minimize the short-term impact of the exchange rate fluctuations on euro-denominated cash flows, where the U.S. dollar is the functional currency, and Japanese yen-denominated cash flows and forecasted Japanese yen-denominated revenue. We currently believe these are our primary exposures to currency rate fluctuation. We have implemented a cash flow hedging strategy that is intended to mitigate our currency exposures by entering into foreign currency forward contracts that have maturities in excess of one month. These contracts are used to reduce our risk associated with exchange rate movements, as gains and losses on these contracts are intended to mitigate the effect of exchange rate fluctuations on certain foreign currency denominated revenues, costs and eventual cash flows.

These foreign currency forward contracts are designated as cash flow hedges and are carried on our balance sheet at fair value with the effective portion of the foreign exchange gain (loss) being reported as a component of accumulated other comprehensive income (loss) in shareholders’ equity and later reclassified into the statement of operations as part of income from operations when the hedged transaction affects earnings. If the underlying foreign currency requirement being hedged fails to occur, or if a portion of any derivative is deemed to be ineffective, we will recognize the gain (loss) on the associated financial instrument in operating income in the statement of operations. As of January 31, 2010, the fair value of foreign currency forward contracts designated as cash flow hedges is approximately $1.3 million. This amount is included within current liabilities and the related loss of $0.9 million (net of tax of $0.4 million) is included within unrealized losses in accumulated other comprehensive loss.

We also enter into foreign currency forward contracts to hedge the gains and losses generated by the remeasurement of assets and liabilities denominated in currencies other than the functional currency. These contracts are generally for a period of 30 days or

 

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less and settled by the end of the month. The change in fair value of these balance sheet hedge contracts is recorded into earnings as a component of other (expense) income, net and offsets the foreign currency impact of the remeasured assets and liabilities.

We performed a sensitivity analysis assuming a hypothetical 10 percent adverse movement in foreign exchange rates to the hedging contracts and the underlying exposures described above. As of January 31, 2010, the analysis indicated that these hypothetical market movements would not have a material effect on our condensed consolidated financial position, results of operations or cash flows.

Investment and Interest Rate Risk

We account for our investment instruments in accordance with accounting principles generally accepted in the U.S. All of our cash and cash equivalents and marketable securities are treated as “available for sale”. Our marketable securities include commercial paper, corporate bonds, government securities, and money market funds which we believe will be redeemed within one year and auction rate securities.

Our cash equivalents and our portfolio of marketable securities are subject to market risk due to changes in interest rates. Fixed rate interest securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectation due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in the market value due to changes in interest rates. However, because we classify our debt securities as “available for sale”, no gains or losses are recognized due to changes in interest rates unless such securities are sold prior to maturity or declines in fair value are determined to be other-than-temporary. Should interest rates fluctuate by 10 percent, the value of our marketable securities would not have a significant impact as of January 31, 2010, and our interest income would have changed by approximately $0.1 million for the three months ended January 31, 2010.

Auction rate securities are securities that are structured with interest rate reset periods of generally less than ninety days but with contractual maturities that can be well in excess of 10 years. At the end of each interest rate reset period, investors can buy, sell or continue to hold the securities at par. As of January 31, 2010, all of our auction rate securities experienced failed auctions. The funds associated with these auctions will not be accessible to us until a successful auction occurs, a buyer is found outside of the auction process, or the underlying securities have matured or are called by the issuer. Given the ongoing disruptions in the credit markets and the fact that the liquidity for these types of securities remains uncertain, we have classified all of our auction rate securities as long-term assets in our condensed consolidated balance sheet as of January 31, 2010, as our ability to liquidate such securities in the next 12 months is uncertain.

Our auction rate securities primarily consist of investments that are backed by pools of student loans guaranteed by the U.S. Department of Education and other asset-backed securities. Our marketable securities portfolio as of January 31, 2010 had a carrying value of $382 million, of which approximately $55 million consisted of illiquid auction rate securities. Given the ongoing disruption in the market for auction rate securities, there is no longer an actively quoted market price for these securities. Accordingly, we utilized a model to estimate the fair value of these auction rate securities based on, among other items: (i) the underlying structure of each security and the underlying collateral quality; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (iii) consideration of the probabilities of default, auction failure or repurchase at par for each period; and (iv) estimates of the recovery rates in the event of default for each security. These estimated fair values could change significantly based on future market conditions.

We evaluate our investments periodically for possible other-than-temporary impairment by reviewing factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and insurance guarantor, and our ability and intent to hold the investment for a period of time sufficient for anticipated recovery of market value. Based on an analysis of other-than-temporary impairment factors, we did not incur any other-than-temporary impairments for the three months ended January 31, 2010 related to our auction rate securities. We have recorded an unrealized gain within accumulated other comprehensive loss of approximately $0.5 million (net of tax of $0.1 million), primarily for our auction rate securities that are backed by pools of student loans as of January 31, 2010. We also recognized a realized gain of approximately $0.4 million on the sale of long-term investments.

Investments in money market funds include investments in the Reserve Primary Fund and the Reserve International Liquidity Fund (collectively referred to as the “Reserve Funds”). The net asset value for the Reserve Funds fell below $1 because the funds had holdings of commercial paper and other notes with a major investment bank which filed for bankruptcy on September 15, 2008. As a result of these events, these funds are no longer classified as cash and cash equivalents. We have classified these investments as short-term marketable securities because, based on the maximum maturity date of the underlying securities as well as the proposed liquidation plan and distribution updates received for the funds, we believe that within one year, these investments will be redeemable. We received the final distribution from our investment in the Reserve Primary Fund during the three months ended January 31, 2010 and recorded a realized gain of $0.1 million. We received approximately $1.9 million from the distribution of these funds during the three months ended January 31, 2010, reducing the value of our remaining holding in the Reserve International Liquidity Fund to $1.2 million as of January 31, 2010.

 

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The fair value of our convertible senior notes is subject to interest rate risk, market risk and other factors due to the convertible feature. The fair value of the convertible notes will generally increase as interest rates fall and decrease as interest rates rise. In addition, the fair value of the convertible notes will generally increase as our share price increases and decreases as the share price declines. The interest and market value changes affect the fair value of our convertible notes but do not impact our financial position, cash flows or results of operations due to the fixed nature of the our debt. Additionally, we do not carry the convertible senior notes at fair value. We present the fair value of the convertible notes as required and for disclosure purposes only.

 

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of January 31, 2010, pursuant to and as required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of January 31, 2010, our disclosure controls and procedures, as defined by Rule 13a-15(b) under the Exchange Act, were effective and designed to ensure that (i) information required to be disclosed in the company’s reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. Based on their evaluation, Verigy’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of January 31, 2010.

Inherent Limitations on Effectiveness of Controls

Because of its inherent limitations, disclosure controls and procedures and internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Management necessarily applied its judgment in assessing the benefits of controls relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the fiscal quarter ended January 31, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

From time to time, we are subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of litigation is uncertain, we do not expect that the ultimate costs to resolve ordinary-course matters that may arise to have a material adverse effect on our condensed consolidated financial position, results of operations or cash flows.

 

ITEM 1A. RISK FACTORS

The following risk factors, “Current global economic conditions may continue to adversely affect our business,” “ We are dependent on contract manufacturers with whom we do not have long-term contracts, and changes to those relationships, expected or unexpected, may result in delays or disruptions that could cause us to lose revenue and damage our customer relationships,” “The market for semiconductor test equipment and services is highly concentrated, and we have limited opportunities to sell our test equipment and services,” “Failure to accurately estimate our customers’ demand and plan the production of our new and existing products could adversely affect our inventory levels and our income,” “Funds associated with certain of our auction rate securities

 

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may not be accessible for in excess of 12 months and our auction rate securities may experience an other-than-temporary decline in value, which would adversely affect our income,” “We sell our products and services worldwide, and our business is subject to risks inherent in conducting business activities in geographies outside of the United States,” “At times, our stock price has fluctuated significantly, and such fluctuations in the future could result in substantial losses for our investors,” have been updated from the version of these risk factors set forth in our Annual Report on Form 10-K for the year ended October 31, 2009.

A description of the risk factors associated with our business is set forth below. You should carefully consider the risks described below and the other information in this report before investing in our ordinary shares. Our business could be seriously harmed by any of these risks. The trading price of our ordinary shares could decline due to any of these risks, and you may lose all or part of your investment.

Risks Relating to Our Business

Current global economic conditions may continue to adversely affect our business.

Our operations and financial results depend on worldwide economic conditions and their impact on levels of business spending. Throughout fiscal year 2009, the semiconductor industry experienced a severe downturn that drove companies to reassess their use of cash and negatively impacted consumer confidence. Since fiscal year 2009, many of our customers have undertook restructuring activities and significant cost cuts to their capital spending budgets. At the same time, the tightening of credit markets and concerns regarding the availability of credit have made it more difficult for some of our customers to raise capital to finance their purchases of capital equipment, including the products we sell. If our customers are unable to obtain financing, our product sales and revenues may decline, harming our business and operating results.

While our revenue for the three months ended January 31, 2010 increased to $106 million, a 55.9 % increase from the $68 million recorded in the three months ended January 31, 2009, we can not be certain that market conditions will continue. If the market conditions deteriorate it may negatively affect sales of our products and services, and we may experience increased collection times and greater write-offs, either of which could have a material adverse effect on our operating results, cash flow and liquidity.

Our business and operating results could be harmed by the highly cyclical nature of the semiconductor industry.

Our business and operating results depend in significant part upon capital expenditures of semiconductor designers and manufacturers, which in turn depend upon the current and anticipated market demand for products incorporating semiconductors from these designers and manufacturers. Historically, the semiconductor industry has been highly cyclical with recurring periods of diminished product demand. During these periods, semiconductor designers and manufacturers, facing reduced demand for their products, have significantly reduced their capital and other expenditures, including expenditures for semiconductor test equipment and services such as those we offer. Furthermore, because we have a high proportion of customers that are subcontractors, which during market downturns tend to reduce or cancel orders for new test systems and test services more quickly and dramatically than other customers, any downturn may cause a quicker and more significant adverse impact on our business than on the broader semiconductor industry. As a consequence, during these periods, we have experienced significant reductions in new orders for the products and services we offer, postponement or cancellation of existing customer orders, erosion of selling prices and write-offs of excess and obsolete inventory and related charges for liabilities to our contract manufacturing partners. The downturn we experienced in fiscal year 2009 went beyond the normal cycles of the semiconductor industry, and seemed to be driven by the overall global economic conditions. We expect our business to continue to be subject to cyclical downturns even when the overall economic conditions improve.

Our quarterly operating results may fluctuate significantly from period to period, and this may cause our share price to decline.

In the past, we have experienced, and in the future we expect to continue to experience, fluctuations in revenue and operating results from quarter to quarter for a variety of reasons. For example, sales of a relatively limited number of our test systems account for a substantial portion of our net revenue in any particular quarter. At the same time, our costs are relatively fixed in the short-term. Thus, changes in the timing or terms of a small number of transactions could disproportionately affect our operating results in any particular quarter. In addition, a substantial portion of our quarterly sales have historically been made in the last month of the quarter, and a substantial portion of those sales occur in the last week of the quarter. The timing of theses sales at the end of the quarter increases the risk of unanticipated variations in quarterly results. As a result of these and other risks described elsewhere in this report, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance. If our operating results in one or more future quarters fail to meet the expectations of securities analyst or investors, an immediate and significant decline in the trading price of our ordinary shares may occur.

 

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Our cost saving actions may harm our operations and may not be sufficient to attain or sustain profitability.

In fiscal year 2009, we implemented restructuring actions to streamline our organization and further reduce operating costs in order to address the cyclical downturn in both the memory and SOC businesses. Among other things, our restructuring actions included reducing our global workforce, which may impair our ability to effectively develop and market products, to remain competitive in the markets in which we compete and to operate effectively. Our cost saving actions could have long-term effects on our business by reducing our pool of technical talent, decreasing or slowing improvements in our products, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our products increases and limiting our ability to hire and retain key personnel. We cannot ensure that our cost saving actions will be sufficient to attain or sustain profitability.

We have a limited ability to quickly or significantly reduce our costs, which makes us particularly vulnerable to the highly cyclical nature of the semiconductor industry.

Historically, downturns in the semiconductor industry have affected the test equipment and services market more significantly than the overall semiconductor industry. A significant portion of our overall costs are fixed. Because a high proportion of our costs are fixed, we have a limited ability to reduce expenses and inventory purchases quickly in response to decreases in orders and revenues. Moreover, to remain competitive even during downturns in the semiconductor industry or generally, we must maintain a significant level of costs, including fixed costs. As a consequence, the actions we have taken to reduce costs, and similar actions we may take in future downturns, may not be sufficient to attain or sustain profitability.

Our dependence on sole source suppliers may prevent us from delivering our products on a timely basis.

We rely on sole source suppliers, some of whom are relatively small in size, for many of the components we use in our products, including custom integrated circuits, relays and other electronic components. In the past, we experienced, and in the future may experience, delays in shipping our products due to our dependence on sole source suppliers. Failure of our sole source suppliers to meet our requirements in a timely manner could impair our ability to ship products and to realize the related revenues when anticipated, which could adversely affect our business and operating results.

We are dependent on contract manufacturers with whom we do not have long-term contracts, and changes to those relationships, expected or unexpected, may result in delays or disruptions that could cause us to lose revenue and damage our customer relationships.

We rely entirely on contract manufacturers, which gives us less control over the manufacturing process and exposes us to significant risks, including limited control over capacity, late delivery, quality and costs. Moreover, because our products are very complex to manufacture, transitioning manufacturing activities from one location to another, or from one manufacturing partner to another, is complicated. Although we have contracts with our contract manufacturers, those contracts do not require them to manufacture our products on a long-term basis in any specific quantity or at any specific price. In addition, it is time consuming and costly to qualify and implement additional contract manufacturer relationships. Therefore, if we fail to effectively manage our contract manufacturer relationships or if one or more of them should experience delays, disruptions or quality control problems, or if we had to change or add additional contract manufacturers or contract manufacturing sites, our ability to ship products to our customers could be delayed.

We completed the transition of our principal manufacturing activities to Jabil’s facility in Penang, Malaysia in the first quarter of fiscal year 2010. If Jabil is unable to meet our manufacturing requirements in a timely manner, whether as a result of transitional issues or otherwise, our ability to ship products and to realize the related revenues when anticipated could be materially impacted. In addition, we may incur additional costs as part of this transition.

The market for semiconductor test equipment and services is highly concentrated, and we have limited opportunities to sell our test equipment and services.

The semiconductor industry is highly concentrated in that a small number of semiconductor designers and manufacturers and subcontractors account for a substantial portion of the purchases of semiconductor test equipment and services generally, including our test equipment and services. For the three months ended January 31, 2010, revenue from our top ten customers accounted for approximately 64.0% of our total net revenue, with two customers individually accounting for more than 10% of our total net revenue. Consolidation in the semiconductor industry is increasing this concentration. Accordingly, we expect that sales of our products will continue to be concentrated with a limited number of large customers for the foreseeable future. Our financial results will depend in large part on this concentrated base of customers’ sales and business results. Our relationships with our significant customers, who frequently evaluate competitive products prior to placing new orders, could be adversely affected by a number of factors, including:

 

   

a decision by our customers to purchase test equipment and services from our competitors;

 

   

a decision by our customers to pursue the development and implementation of self-testing integrated circuits or other strategies that reduce their need for our products;

 

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the loss of market share by our customers in the markets in which they operate;

 

   

the shift by our IDM customers to out-sourced manufacturing models;

 

   

our ability to keep pace with changes in semiconductor technology;

 

   

our ability to maintain quality levels of our equipment and services that meet customer expectations;

 

   

our ability to produce and deliver sufficient quantities of our test equipment in a timely manner; and

 

   

our ability to provide quality customer service and support.

In addition, the global economic downturn in fiscal year 2009 caused significant disruption among the semiconductor manufacturing companies, including our customers. Two customers, Qimonda and Spansion, filed for protection under applicable bankruptcy laws. The loss of a significant customer, whether as a result of a failure or consolidation, will further concentrate, and could adversely impact, the market for our products.

If we do not maintain and expand existing customer relationships and establish new customer relationships, our ability to generate revenue growth will be adversely affected.

Our ability to increase our sales will depend in large part upon our ability to obtain orders for new test systems, enhancements for existing test systems and services from our existing and new customers. Maintaining and expanding our existing relationships and establishing new ones can require substantial investment without any assurance from customers that they will place significant orders. Moreover, if we are unable to provide new test systems, enhancements for existing test systems and services to our customers in a timely fashion or in sufficient quantities, our business will be harmed. In the past we have experienced, and in our industry it is not unusual to experience, difficulty in delivering new test equipment, as well as product enhancements and upgrades. When we encountered difficulties in the past, our customer relationships and our ability to generate additional revenue from customers were harmed. Our inability to meet the demands of customers would severely damage our reputation, which would make it more difficult for us to sell test equipment, enhancements and services to existing, as well as new, customers and would adversely affect our ability to generate revenue.

In addition, we face significant obstacles in establishing new customer relationships. It is difficult for us to establish relationships with new customers because such companies may have existing relationships with our competitors, may be unfamiliar with our product and service offerings, may have an installed base of test equipment sufficient for their current needs or may not have the resources necessary to transition to, and train their employees on, our test equipment. Even if we do succeed in establishing new relationships, these new customers may nonetheless continue to favor our competitors, as our competitors may have had longer relationships with these customers or may maintain a larger installed base of their competing test equipment in the facilities of new customers and only purchase limited quantities from us. In addition, we could face difficulties in our efforts to develop new customer relationships abroad as a result of buying practices that may favor local competitors or non-local competitors with a larger presence in local economies than we have. As a result, we may be forced to partner with local companies in order to compete for business and such arrangements, if available, may not be achieved on economically favorable terms, which could negatively affect our financial performance.

Failure to accurately estimate our customers’ demand and plan the production of our new and existing products could adversely affect our inventory levels and our income.

Given the cyclical nature of the semiconductor industry, we cannot reliably forecast the timing and size of our customers’ orders. In order to meet anticipated demand, we must order components and build some inventory before we actually receive purchase orders, which includes inventory at our contract manufacturers and suppliers where we have non-cancelable purchase commitments. Our results could be harmed if we do not accurately estimate our customers’ product demands and are unable to adjust our purchases with market fluctuations, including those caused by the cyclical nature of the semiconductor industry. During a market upturn, our results could be materially and adversely affected if we cannot increase our purchases of components, parts and services quickly enough to meet increasing demand for our products, including securing sufficient capacity from our contract manufacturers. During a market downturn, we could have excess inventory that we would not be able to sell, resulting in inventory write-downs and in potential related liabilities to our contract manufacturing partners. For the three months ended January 31, 2010, we recorded gross inventory-related provisions of $1.8 million. Having insufficient or excess inventory could have a material adverse effect on our business, financial condition and results of operations.

Further, if we do not successfully manage the introduction of our new products and estimate customer demand for such products, our ability to sell existing inventory may be adversely affected. If demand for our new products exceeds our projections, we might have insufficient quantities of products for sale to our customers, which could cause us to miss opportunities to increase revenues during market upturns. If our projections exceed demand for our new products or if some of our customers cancel their current orders for our old products in anticipation of our new products, we may have excess inventories of our new products and excess obsolete inventories, which could result in material future inventory write-downs that would adversely affect our financial performance.

 

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Existing customers may be unwilling to bear expenses associated with transitioning to new and enhanced products.

In order to grow our business, we need to sell new and enhanced products. Certain customers may be unwilling, or unable, to bear the costs of implementing new test equipment platforms or enhancements, particularly during semiconductor industry downturns. As a result, it may be difficult to market and sell these products and customers may continue to buy upgrades to older existing product lines which may be a lower cost alternative. As we introduce new test equipment and enhancements, we cannot predict with certainty when or if our customers will transition to those new product platforms. Any delay in or failure of our customers to transition to new products and enhancements could result in excess inventories, which could result in inventory write-downs that would adversely affect our financial performance.

If we do not introduce new test equipment platforms and upgrade existing test equipment platforms in a timely manner, and if we do not offer comprehensive and competitive services for our test equipment platforms, our test equipment and services will become obsolete, we will lose existing customers and our operating results will suffer.

The semiconductor design and manufacturing industry into which we sell our test equipment is characterized by rapid technological changes, frequent new product introductions, including upgrades to existing test equipment, and evolving industry standards. The success of our new or upgraded test equipment offerings will depend on several factors, including our ability to:

 

   

properly identify customer needs and anticipate technological advances and industry trends, such as the disaggregation of the traditional IDM semiconductor supply chain into fabless design companies, foundries and packaging, assembly and test providers;

 

   

develop and commercialize new and enhanced technologies and applications that meet our customers’ evolving performance requirements in a timely manner;

 

   

develop and deliver enhancements and related services for our current test equipment that are capable of satisfying our customers’ specific test requirements; and

 

   

introduce and promote market acceptance of new test equipment platforms, such as our V6000 Series system for memory testing.

In many cases, our test equipment and services are used by our customers to develop, test and manufacture their new products. We therefore must anticipate industry trends and develop new test equipment platforms or upgrade existing test equipment platforms in advance of the commercialization of our customers’ products. In addition, new methods of testing integrated circuits, such as self-testing integrated circuits, may be developed which would render our test equipment uncompetitive or obsolete if we failed to adopt and incorporate these new methods into our new or existing test equipment platforms. Developing new test equipment platforms and upgrading existing test equipment platforms requires a substantial investment before we can determine the commercial viability of the new or upgraded platform.

As our customers’ product requirements are diverse and subject to frequent change, we also need to ensure that we have an adequate mix of products that meet our customers’ varying requirements. If we fail to adequately predict our customers’ needs and technological advances, we may invest heavily in research and development of test equipment that does not lead to significant revenue, or we may fail to invest in technology necessary to meet changing customer demands. Without the timely introduction of new or upgraded test equipment that reflects technological advances, our test equipment and services would likely become obsolete, we may have difficulty retaining customers and our revenue and operating results would suffer.

Our long and variable sales cycle depends upon factors outside of our control, and we may expend significant time and resources prior to our ever earning associated revenues.

Sales of our semiconductor test equipment and services depend in significant part upon semiconductor designers and manufacturers upgrading existing manufacturing equipment to accommodate the requirements of new semiconductor devices and expanding existing, and adding new, manufacturing facilities. As a result, our sales are subject to a variety of factors we cannot control, including:

 

   

the complexity of our customers’ fabrication processes, which impacts the number of our test systems and amount of our product enhancements and upgrades our customers require;

 

   

the willingness of our customers to adopt new or upgraded test equipment platforms;

 

   

the internal technical capabilities and sophistication of our customers, which impacts their need for our test services; and

 

   

the capital expenditures of our customers.

 

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The decision to purchase our equipment and services generally involves a significant commitment of capital. As a result, our test equipment has lengthy and variable sales cycles during which we may expend substantial funds and management effort to secure a sale prior to receiving any commitment from a customer to purchase our test equipment or services. Prior to completing sales to our customers, we are often subject to a number of significant risks, including the risk that our competitors may compete for the sale or that the customer may change its technological requirements. Our business, financial condition and results of operations may be materially adversely affected by our long and variable sales cycle and the uncertainty associated with expending substantial funds and effort with no guarantee that sales will be made.

We face substantial competition which, among other things, may lead to price pressure and adversely affect our sales and revenue.

We face substantial competition throughout the world in each of our product areas. Our most significant competitors historically have included Advantest Corporation, LTX-Credence Corporation, Teradyne, Inc. and Yokogawa Electric Corporation. Some of our competitors have substantially greater financial resources, broader product offerings, more extensive engineering, manufacturing, marketing and customer support capabilities or a greater presence in certain countries than we do. We may have less leverage with component vendors than some of our competitors. Also, some of our competitors have greater resources and may be more willing or able than we are to put capital at risk to win business. Price reductions by our competitors may force us to lower our prices. We also expect our current competitors to continue to improve the performance of their current products and to introduce new products, technologies or services that could adversely affect sales of our current and future test equipment and services. Additionally, current and future competitors may introduce testing technologies, equipment and services, which may in turn reduce the value of our own test equipment and services. Any of these circumstances may limit our opportunities for growth and negatively impact our financial performance.

Test systems that contain defects that harm our customers could damage our reputation and cause us to lose customers and revenue.

Our test equipment is highly complex and employs advanced technologies. The use of complex technology in our test equipment increases the likelihood that we could experience design, performance or manufacturing problems. If any of our products have defects or reliability or quality problems, we may, in some circumstances, be exposed to liability, our reputation could be damaged significantly and customers might be reluctant to buy our products, which could result in a decline in revenues, an increase in product returns, loss of existing customers and the failure to attract new customers.

We may face competition from Agilent.

Pursuant to the intellectual property matters agreement between us and Agilent that was entered into in connection with our separation from Agilent, Agilent transferred all of the intellectual property rights Agilent held that relate exclusively to our products to us and agreed that, prior to October 31, 2009, it would not to develop, manufacture, distribute, support or service automated test equipment for providing high-volume functional test of integrated circuits (“ICs”) (including memory and high-speed memory devices and SOCs) or SIPs, or components for automated semiconductor test systems. There were certain exceptions to Agilent’s agreement not to compete, and Agilent retained and only licensed to us the intellectual property rights to underlying technologies used in both our products and the products of Agilent.

With the expiration of the agreement not to compete on October 31, 2009, Agilent is now free to compete with any portion or all of our business without restriction, and in doing so will be free to use the retained underlying technologies. Agilent will not be permitted to use the intellectual property rights transferred to us, and licensed from us back to Agilent, to compete with us with respect to our core business of developing, manufacturing, selling and supporting automated semiconductor test systems. Agilent will, however, be able to use such intellectual property rights to develop and sell components for such systems, including systems developed and sold by us as well as those developed and sold by our competitors. While selling components has not represented a material portion of our business in the past and is not expected to be an area of focus for the near future, our business could be adversely affected if systems offered by our competitors become more competitive as a result of Agilent supplying components for our competitors’ systems or if, by buying components from Agilent, our customers are able to delay or bypass altogether purchasing newer systems from us.

Third parties may compete with us by using intellectual property that Agilent licensed to us under the intellectual property matters agreement.

Under the intellectual property matters agreement, Agilent retained and only licensed to us the intellectual property rights to underlying technologies used in both our products and the products of Agilent. Under the agreement, Agilent remains free to license the intellectual property rights to the underlying technologies to any party, including our competitors. The intellectual property that Agilent retained and that can be licensed in this manner does not relate solely or primarily to one or more of our products, or groups of products, rather, the intellectual property that Agilent licensed to us is generally used broadly across our entire product portfolio. Competition by third parties using the underlying technologies retained by Agilent could harm our business and operating results.

 

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Third parties may claim we are infringing their intellectual property, and we could suffer significant litigation or licensing expenses or be prevented from selling our products or services.

Our industry has been and continues to be characterized by uncertain and conflicting intellectual property claims and vigorous protection and pursuit of these rights. As a result, third parties may claim that we are infringing their intellectual property rights, and we may be unaware of intellectual property rights of others that may cover some of our technology, products and services. Any litigation regarding patents or other intellectual property could be costly and time-consuming, and divert our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements. However, we may not be able to obtain royalty or license agreements on terms acceptable to us, or at all. We also may be subject to significant damages or injunctions against development and sale of certain of our products and services.

Third parties may infringe our intellectual property, and we may expend significant resources enforcing our rights or suffer competitive injury.

Our success depends in large part on our proprietary technology. We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect our proprietary rights. If we fail to protect our intellectual property rights, our competitive position could suffer, which could harm our operating results. We may be required to spend significant resources to monitor and protect our intellectual property rights and there can be no assurance that, even with significant expenditures, we will be able to protect our intellectual property rights.

In addition, our agreements with Agilent, and in particular the intellectual property matters agreement, set forth the terms and provisions under which we received the intellectual property rights necessary to operate our business. Under our agreements with Agilent, we do not have the right to enforce against third parties intellectual property rights we license from Agilent, and Agilent is under no obligation to enforce such rights on our behalf.

Intellectual property rights are difficult to enforce in certain countries, which may inhibit our ability to protect our intellectual property rights or those of our suppliers and customers in those countries.

The laws of some countries do not offer the same level of protection of our proprietary rights as the laws of the United States, and we may be subject to unauthorized use of our products or technologies in those countries, particularly in Asia, where we expect our business to continue to expand in the foreseeable future. Consequently, we cannot assure you that we will be able to protect our intellectual property rights or have adequate legal recourse in the event that we encounter difficulties with infringements of intellectual property under local law.

We may incur a variety of costs to engage in future acquisitions of, or investments in, companies, products or technologies, and the anticipated benefits of any acquisitions we may make may never be realized.

We may acquire, or make significant or minority investments in, complementary businesses, products or technologies. For example, in fiscal year 2009, we acquired substantially all of the assets of Touchdown Technologies. Any future acquisitions or investments could be accompanied by risks such as:

 

   

difficulties in assimilating the operations and personnel of acquired companies;

 

   

diversion of our management’s attention from ongoing business concerns;

 

   

our potential inability to maximize our financial and strategic position through the successful incorporation of acquired technology and rights into our products and services;

 

   

additional expense associated with amortization of acquired assets;

 

   

difficulty in maintaining uniform standards, controls, procedures and policies;

 

   

impairment of existing relationships with employees, suppliers and customers as a result of the integration of new management personnel;

 

   

dilution to our shareholders in the event we issue shares as consideration to finance an acquisition;

 

   

impairment of goodwill associated with the acquisition or investment, requiring us to record a significant charge to earnings;

 

   

difficulty integrating and implementing the accounting controls necessary to comply with regulatory requirements such as Section 404 of the Sarbanes-Oxley Act; and

 

   

increased leverage, if we incur debt to finance an acquisition.

 

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We cannot guarantee that we will realize any benefit from the integration of any business, products or technologies that we might acquire in the future, and our failure to do so could harm our business.

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

Our future operating results will depend substantially upon the performance of our executive officers and key personnel. Our future operating results also depend in significant part upon our ability to attract and retain qualified management, manufacturing, technical, application engineering, marketing, sales and support personnel. Competition for qualified personnel is intense, and we cannot ensure success in attracting or retaining qualified personnel. Our business is particularly dependent on expertise which only a very limited number of engineers possess and it may be increasingly difficult for us to hire personnel over time. We operate in several geographic locations, including parts of Asia and Silicon Valley, where the labor markets, especially for application engineers, are particularly competitive. Our business, financial condition and results of operations could be materially adversely affected by the loss of any of our key employees, by the failure of any key employee to perform in his or her current position, or by our inability to attract and retain skilled employees, particularly engineers.

Funds associated with our auction rate securities may not be accessible for in excess of 12 months and our auction rate securities may experience an other-than-temporary decline in value, which would adversely affect our income.

As of January 31, 2010, all of our auction rate securities experienced failed auctions. The funds associated with these auctions will not be accessible to us until a successful auction occurs, a buyer is found outside of the auction process, or the underlying securities have matured or are called by the issuer. Given the ongoing disruptions in the credit markets and the fact that the liquidity for these types of securities remains uncertain, we have classified all of our auction rate securities as long-term assets in our condensed consolidated balance sheet as of January 31, 2010, as our ability to liquidate such securities in the next 12 months is uncertain.

Our auction rate securities primarily consist of investments that are backed by pools of student loans guaranteed by the U.S. Department of Education and other asset-backed securities. Our marketable securities portfolio as of January 31, 2010 had a carrying value of $382 million, of which approximately $55 million consisted of illiquid auction rate securities. Given the ongoing disruption in the market for auction rate securities, there is no longer an actively quoted market price for these securities. Accordingly, we utilized a model to estimate the fair value of these auction rate securities based on, among other items: (i) the underlying structure of each security and the underlying collateral quality; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (iii) consideration of the probabilities of default, auction failure or repurchase at par for each period; and (iv) estimates of the recovery rates in the event of default for each security. These estimated fair values could change significantly based on future market conditions.

We evaluate our investments periodically for possible other-than-temporary impairment by reviewing factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and insurance guarantor, and our ability and intent to hold the investment for a period of time sufficient for anticipated recovery of market value. Based on an analysis of other-than-temporary impairment factors, we did not incur any other-than-temporary impairments for the three months ended January 31, 2010 related to our auction rate securities. We have recorded an unrealized gain within accumulated other comprehensive loss of approximately $0.5 million (net of tax of $0.1 million), primarily for our auction rate securities that are backed by pools of student loans as of January 31, 2010. We also recognized a realized gain of approximately $0.4 million on the sale of long-term investments.

Our effective tax rate may vary significantly from period to period, and we could owe significant taxes even during periods when we experience low operating profit or operating losses.

We are incorporated in Singapore and have negotiated tax incentives with the Singapore Economic Development Board, an agency of the Government of Singapore, which have been approved by Singapore’s Ministry of Finance and Ministry of Trade and Industry. Under the incentives, a portion of the income we earn in Singapore during these ten to fifteen year incentive periods is subject to reduced rates of Singapore income tax. The incentive tax rates will expire in various fiscal years beginning in fiscal 2011. The Singapore corporate income tax rate that would apply, absent the incentives, is 18% for fiscal years 2009 and 2008. Without these incentives, our income taxes would have been lower by $22 million or an increase of $0.37 per share (diluted) for fiscal year 2009 and higher by $4 million or a decrease of $0.07 per share (diluted) for fiscal year 2008. In order to receive the benefit of the incentives, we must develop and maintain in Singapore certain functions such as procurement, financial services, order management, credit and collections, spare parts depot and distribution center, a refurbishment center and regional activities like an application development center. In addition to these qualifying activities, we must hire a specified number of employees and maintain minimum levels of investment in Singapore. If we do not fulfill these conditions for any reason, our incentive could lapse, our income in Singapore would be subject to taxation at higher rates, and our overall effective tax rate could be between fifteen to twenty percentage points higher than would have been the case had we maintained the benefit of the incentives.

 

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In addition, our effective tax rate may vary significantly from period to period because, for example, we may owe significant taxes in jurisdictions other than Singapore during periods when we are profitable in those jurisdictions even though we may be experiencing low operating profit or operating losses on a consolidated basis. Our effective tax rate varies based on a variety of factors, including overall profitability, the geographical mix of income before taxes and the related tax rates in the jurisdictions where we operate, as well as discrete events, such as settlements of future audits. Certain combinations of these factors could cause us to owe significant taxes even during periods when we experience low income before taxes or loss before taxes.

Currently, we do not maintain a valuation allowance for any deferred tax assets, except for capital losses, as we believe that it is more likely than not that all deferred tax assets will be realized. However, due to the significant amount of losses generated, we may be required to establish a valuation for deferred tax assets depending on our future profitability. This would result in an incremental tax provision and could adversely impact our results of operations.

We sell our products and services worldwide, and our business is subject to risks inherent in conducting business activities in geographies outside of the United States.

Our headquarters are in Singapore, and we sell our products and services worldwide. As a result, our business is subject to risks associated with doing business internationally. Revenue from customers in Asia accounted for approximately 84.0% and 61.8% for the three months ended January 31, 2010 and 2009, respectively. The economies of Asia have been highly volatile and recessionary in the past, resulting in significant fluctuations in local currencies. Our exposure to the business risks presented by the economies of Asia will increase to the extent that we continue to expand our operations in that region.

Our international activities subjects us to a number of risks associated with conducting operations internationally, including:

 

   

difficulties in managing geographically disparate operations;

 

   

potential greater difficulty and longer time in collecting accounts receivable from customers located abroad;

 

   

difficulties in enforcing agreements through non-U.S. legal systems;

 

   

unexpected changes in regulatory requirements that may limit our ability to export our software or sell into particular jurisdictions or impose multiple conflicting tax laws and regulations;

 

   

political and economic instability, civil unrest or war;

 

   

terrorist activities and health risks such as the “flu epidemic” and SARS that impact international commerce and travel;

 

   

difficulties in protecting our intellectual property rights, particularly in countries where the laws and practices do not protect proprietary rights to as great an extent as do the laws and practices of the United States;

 

   

changing laws and policies affecting economic liberalization, foreign investment, currency

 

   

convertibility or exchange rates, taxation or employment; and

 

   

nationalization of foreign owned assets, including intellectual property.

In addition, we are exposed to foreign currency exchange movements versus the U.S. dollar, particularly the euro and the Japanese yen. With respect to revenue, our primary exposure exists during the period between execution of a purchase order denominated in a foreign currency and collection of the related receivable. During this period, changes in the exchange rates of the foreign currency to the U.S. dollar will affect our revenue, cost of sales and operating margins and could result in exchange gains or losses. While a significant portion of our purchase orders to date have been denominated in U.S. dollars, competitive conditions may require us to enter into an increasing number of purchase orders denominated in foreign currencies. We incur a variety of costs in foreign currencies, including some of our manufacturing costs, component costs and sales costs. Therefore, as we expand our operations in Asia, we may become more exposed to a strengthening of currencies in the region against the U.S. dollar. We cannot assure you that any hedging transactions we may enter into will be effective or will not result in foreign exchange hedging gains or losses. As a result, we are exposed to greater risks in currency fluctuations.

If our facilities or the facilities of our contract manufacturers were to experience catastrophic loss due to natural disasters, our operations would be seriously harmed.

Our facilities and the facilities of our contract manufacturers could be subject to a catastrophic loss caused by natural disasters, including fires and earthquakes. We and our contract manufacturers have significant facilities in areas with above average seismic activity, such as California, Japan and Taiwan. If any of these facilities were to experience a catastrophic loss, it could disrupt our operations, delay production and shipments, reduce revenue and result in large expenses to repair or replace the facility. We do not carry catastrophic insurance policies that cover potential losses caused by earthquakes.

 

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Risks Related to the Securities Markets and Ownership of Our Ordinary Shares.

If we were classified as a passive foreign investment company, there would be adverse tax consequences to U.S. holders of our ordinary shares.

If we were classified as a “passive foreign investment company” or “PFIC” under section 1297 of the Internal Revenue Code, of 1986, as amended, or the Code, for any taxable year during which a U.S. holder holds ordinary shares, such U.S. holder generally would be taxed at ordinary income tax rates on any gain realized on the sale or exchange of the ordinary shares and on any “excess distributions” (including constructive distributions) received on the ordinary shares. Such U.S. holder could also be subject to a special interest charge with respect to any such gain or excess distribution.

We would be classified as a PFIC for U.S. federal income tax purposes in any taxable year in which either (i) at least 75% of our gross income is passive income or (ii) on average, the percentage of our assets that produce passive income or are held for the production of passive income is at least 50% (determined on an average gross value basis). We were not classified as a PFIC in the first quarter of fiscal year 2010 or in any prior taxable year. Whether we will, in fact, be classified as a PFIC for any subsequent taxable year depends on our assets and income over the course of the relevant taxable year and, as a result, cannot be predicted with certainty. In particular, because the total value of our assets for purposes of the asset test will be calculated based upon the market price of our ordinary shares, a significant and sustained decline in the market price of our ordinary shares and corresponding market capitalization relative to our passive assets could result in our being classified as a PFIC. There can be no assurance that we will not be classified as a PFIC in the future or the IRS will not challenge our determination concerning PFIC status for any prior period.

At times, our stock price has fluctuated significantly, and such fluctuations in the future could result in substantial losses for our investors.

The trading price of our ordinary shares has at times fluctuated significantly. For example, during the three months ended January 31, 2010, the trading price of our ordinary shares ranged from a low of $8.95 to a high of $13.75. Fluctuations have occurred and may continue to occur in response to various factors, many of which we cannot control, including:

 

   

general economic and political conditions and specific conditions in the semiconductor industry;

 

   

changes in expectations as to our future financial performance, including financial estimates or publication of research reports by securities analysts;

 

   

strategic moves by us or our competitors, such as acquisitions or restructurings;

 

   

announcements of new products or technical innovations by us or our competitors;

 

   

actions by institutional shareholders; and

 

   

speculation in the press or investment community.

Accordingly, you may not be able to resell your ordinary shares at or above the price you paid.

We may become involved in securities litigation that could divert management’s attention and harm our business.

The stock market in general, and The NASDAQ Global Select Market and the securities of semiconductor capital equipment companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the affected companies. These market and industry factors may materially harm the market price of our ordinary shares, regardless of our operating performance. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Such litigation, whether or not meritorious, could result in the expenditure of substantial funds, divert management’s attention and resources, and harm our reputation in the industry and the securities markets, which would reduce our profitability and harm our business.

It may be difficult for investors to effect service of process within the United States on us or to enforce civil liabilities under the U.S. federal securities laws of the United States against us.

We are incorporated in Singapore. Some of our officers and directors reside outside the United States. A substantial portion of our assets is located outside the United States. As a result, it may not be possible for investors to effect service of process within the United States upon us. Similarly, investors may be unable to enforce judgments obtained in U.S. courts predicated upon the civil liability provisions of the federal securities laws of the United States against us in U.S. courts. Judgments of U.S. courts based upon the civil liability provisions of the federal securities laws of the United States are not directly enforceable in Singapore courts and are not given the same effect in Singapore as judgments of a Singapore court. Accordingly, there can be no assurance as to whether Singapore courts will enter judgments in actions brought in Singapore courts based upon the civil liability provisions of the federal securities laws of the United States.

 

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

 

ITEM 5. OTHER INFORMATION

On March 6, 2008, the Compensation Committee approved Amended Severance Agreements between the Company and its U.S. officers. On December 16, 2008, the Compensation Committee approved a Second Amended and Restated Severance Agreement between the Company and each of its U.S. officers in order to bring the Amended Severance Agreements into compliance with Section 409A of the Internal Revenue Code. It was subsequently discovered that the Second Amended & Restated Severance Agreement between the Company and Keith Barnes contained an error, which the parties corrected by executing and delivering the Corrected Second Amended and Restated Severance Agreement on March 5, 2010 (the “Corrected Agreement”). The Corrected Agreement properly reflects the Company’s agreement with Mr. Barnes that, in the event that his employment is terminated by Verigy without cause or by him for good reason, that all of his outstanding share options and restricted share unit awards will immediately vest in full, rather than vest as to an additional 12 months.

The form of Corrected Agreement is filed with this Quarterly Report on Form 10-Q as Exhibit 10.3, and is incorporated by reference in this description.

 

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ITEM 6. EXHIBITS

(a) Exhibits:

 

Exhibit        Incorporated By Reference

Number

 

Exhibit Description

   Form    File Number    Exhibit    Date    Filed Herewith
  3.1   Amended and Restated Memorandum and Articles of Association of Verigy Ltd.    S-1/A    333-132291    3.2    6/5/2006   
  4.1   Form of Specimen Share Certificate for Verigy Ltd.’s Ordinary Shares    S-1/A    333-132291    4.1    6/1/2006   
  4.2   Indenture, dated as of July 15, 2009, between Verigy Ltd. and U.S. Bank National Association, as trustee    8-K    000-52038    4.1    7/9/2009   
  4.3   Form of Note for Verigy Ltd.’s 5.25% Convertible Senior Notes due 2014    8-K    000-52038    4.1    7/9/2009   
10.1*   Form of Acknowledgement & Agreement between Verigy and each of its executive officers with regard to Verigy’s Policy Regarding Recoupment of Certain Compensation    8-K    000-52038    10.1    1/21/2010   
10.2*   2006 Equity Incentive Plan, as amended as of January 19, 2010.    8-K    000-52038    10.2    1/21/2010   
10.3* (1)   Corrected Second Amended and Restated Severance Agreement with Keith L. Barnes, dated March 3, 2010                X
31.1   Certification of Principal Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                X
31.2   Certification of Principal Financial Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                X
32.1   Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                X
32.2   Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                X

 

* Management contracts or compensation plans or arrangements in which directors or executive officers are eligible to participate.

 

(1) Refer to Item 5 for a description of the background of the Corrected Second Amended and Restated Severance Agreement.

 

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SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated: March 5, 2010     By:   /S/ ROBERT J. NIKL
        ROBERT J. NIKL
        Vice President and Chief Financial Officer

 

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Table of Contents

VERIGY LTD.

EXHIBIT INDEX

 

Exhibit        Incorporated By Reference

Number

 

Exhibit Description

   Form    File Number    Exhibit    Date    Filed Herewith
  3.1   Amended and Restated Memorandum and Articles of Association of Verigy Ltd.    S-1/A    333-132291    3.2    6/5/2006   
  4.1   Form of Specimen Share Certificate for Verigy Ltd.’s Ordinary Shares    S-1/A    333-132291    4.1    6/1/2006   
  4.2   Indenture, dated as of July 15, 2009, between Verigy Ltd. and U.S. Bank National Association, as trustee    8-K    000-52038    4.1    7/9/2009   
  4.3   Form of Note for Verigy Ltd.’s 5.25% Convertible Senior Notes due 2014    8-K    000-52038    4.1    7/9/2009   
10.1*   Form of Acknowledgement & Agreement between Verigy and each of its executive officers with regard to Verigy’s Policy Regarding Recoupment of Certain Compensation    8-K    000-52038    10.1    1/21/2010   
10.2*   2006 Equity Incentive Plan, as amended as of January 19, 2010.    8-K    000-52038    10.2    1/21/2010   
10.3*(1)   Corrected Second Amended and Restated Severance Agreement with Keith L. Barnes, dated March 3, 2010                X
31.1   Certification of Principal Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                X
31.2   Certification of Principal Financial Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                X
32.1   Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                X
32.2   Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                X

 

* Management contracts or compensation plans or arrangements in which directors or executive officers are eligible to participate.

 

(1) Refer to Item 5 for a description of the background of the Corrected Second Amended and Restated Severance Agreement.

 

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