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| VRGY > SEC Filings for VRGY > Form 10-K on 19-Dec-2008 | All Recent SEC Filings |
19-Dec-2008
Annual Report
Overview
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 combined and consolidated financial statements and related notes presented in this report on Form 10-K.
Our fiscal year end is October 31, and our fiscal quarters end on January 31, April 30, and July 31. Unless otherwise stated, all dates refer to our fiscal years and fiscal periods.
Amounts included in the accompanying combined and consolidated financial statements are expressed in U.S. dollars. The accompanying combined and consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain amounts in the combined and consolidated financial statements for fiscal years 2006 and 2007 were reclassified to conform to the presentation used for fiscal year 2008.
In the third quarter of fiscal year 2008, we recorded a $2.6 million adjustment in interest income and other, related to foreign currency remeasurement gains. These gains relate to a failure to remeasure certain foreign currency assets and liabilities, primarily value added tax receivables, arising in fiscal years 2006, 2007 and the first two quarters of fiscal year 2008. Approximately $0.9 million relates to the unrecorded amounts arising from fiscal years 2006 and 2007. Management has assessed the impact of this adjustment and does not believe the amounts are material, either individually or in the aggregate, to any of the prior years' financial statements, and the impact of correcting these errors in the current year was not material to the full fiscal year 2008 financial statements.
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.
Prior to June 1, 2006, we operated as part of Agilent, and not as a stand-alone company. Therefore, the accompanying combined and consolidated financial statements, prior to June 1, 2006, were derived from the accounting records of Agilent using the historical basis of assets and liabilities of Verigy. The expense and cost allocations, prior to June 1, 2006, have been determined on a basis we consider to be a reasonable reflection of the utilization of services provided by Agilent or the benefit received by us from Agilent.
Business Summary
Prior to our initial public offering, we were a wholly-owned subsidiary of Agilent Technologies, Inc. ("Agilent"). We became an independent company on June 1, 2006, when we separated from Agilent. On June 13, 2006, we completed our initial public offering and became a separate stand-alone publicly-traded company focused on technology and innovation in semiconductor testing. We design, develop, manufacture and sell advanced test systems and solutions for the semiconductor industry.
We offer a single platform for each of the two general categories of devices being tested: our V93000 Series platform, designed to test System-on-a-Chip ("SOC"), System-in-a-Package ("SIP") and high-speed memory devices and our V5000 Series platform, designed to test memory devices, including flash memory and multi-chip packages. In the first quarter of fiscal year 2009, we introduced our V6000 Series platform which is the successor to the V5000 platform and was designed to test both flash memory and dynamic random access memory ("DRAM") devices. Our test platforms are scalable across different frequency ranges, different pin counts and different 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 single platform strategy allows us to maximize operational efficiencies such as relatively lower research and development costs, engineering headcount, support requirements and inventory risk. This platform strategy also provides economic benefits to our customers by allowing them to move 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 tools as well as consulting, service and support offerings such as start-up assistance, application services and system calibration and repair.
As of October 31, 2008, we have installed more than 1,900 V93000 Series systems and nearly 2,600 V5000 Series systems worldwide. We have a broad customer base which includes integrated device manufacturers ("IDMs"), test subcontractors, also referred to as subcontractors or "OSATs" (outsourced sub-assembly and test providers), which includes 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 ("ICs") (known as fabless design companies).
Overview of Results
Our total net revenue for fiscal year 2008, was $691 million, down $70 million, or 9.2%, from $761 million in fiscal year 2007. This decrease was due to lower revenue from sales of our memory test systems in fiscal year 2008, partially offset by higher sales of our SOC products and services. The decline in our memory test revenues resulted from substantial declines in the capital spending patterns of our memory device manufacturer customers and of their subcontractor test partners to which we also sell systems. The overall decline in the memory market capital spending reflects continued excess supply and price erosion for memory products, which has resulted in lower manufacturing output and excess test capacity. These factors have caused our customers to delay test system orders and delay delivery of systems ordered. In addition to the memory market downturn, uncertainties in the financial and credit markets, have caused our customers to postpone purchases which have negatively impacted our revenue particularly during our fourth quarter for our SOC business.
Notwithstanding the cyclical weakness in the memory test industry, our SOC business showed considerable strength during fiscal year 2008, with an increase of 40% from fiscal year 2007. We experienced increased demand for our V93000 platform for SOC applications, in particular our Port Scale RF products, driven primarily by strong demand for our customers' devices targeted at wireless, PC and consumer mixed-signal device markets. However, during the fourth quarter of fiscal year 2008, our SOC business weakened, and we began to see an onset of a cyclical downturn. In response to the overall deterioration in the global economy, customers are delaying purchases of capital equipment due to excess capacity as well as to ensure that they are able to sustain operations during this economic crisis.
Our gross margin for fiscal year 2008 was down slightly compared to fiscal year 2007. We recorded net excess and obsolescence inventory charges of $27 million for fiscal year 2008, compared to $8 million recorded for fiscal year 2007, primarily related to our memory business as well as the impact of the introduction of our new V6000 Series system which was released during the first quarter of fiscal year 2009. This was offset by a stronger mix of SOC systems, which generally have a higher gross margin than our memory systems.
Our total operating expenses, including restructuring charges of $2 million, were $259 million in fiscal year 2008, up $18 million, or 7.5%, from fiscal year 2007. This increase in operating expenses from fiscal year 2007 was primarily due to increased spending on research and development initiatives for memory products that were introduced in the first quarter of fiscal year 2009 and SOC products planned for release later in fiscal year 2009, higher share-based compensation, operating expenses associated with the acquisition of Inovys and increases in field selling and governance costs.
Net income for fiscal year 2008 was $28 million, a decrease of 71.1% from the $97 million achieved in fiscal year 2007. The decrease for fiscal year 2008 was primarily due to the overall decline in our memory business, other-than-temporary impairments of $30.7 million related to write-downs of our investments and net excess and obsolescence inventory charges of $27 million in cost of sales. In fiscal year 2008, we generated operating cash flows of $97 million and our cash and cash equivalents balance as of October 31, 2008 was $144 million.
We derive a significant percentage of our net revenue from outside of North America. Net revenue from customers located outside of North America represented 82.6%, 70.8% and 68.4% of total net revenue in fiscal years 2008, 2007 and 2006, respectively. Net revenue in North America was lower by 45.9% in fiscal year 2008 compared to fiscal year 2007 due to the continuing outsourcing by our North American customers to contract manufacturers in Asia. Net revenue in Asia (including Japan) was higher by 5.3% in fiscal year 2008 compared to fiscal year 2007. We expect this trend of increasing sales in Asia to continue as semiconductor manufacturing activities continue to concentrate in that region.
The sales of our products and services are dependent, to a large degree, on customers who are subject to cyclical trends in the demand for their products. These cyclical periods have had, and will continue to have a significant effect on our business since our customers often delay or accelerate purchases in reaction to changes in their businesses and to demand fluctuations in the semiconductor industry. Historically, these demand fluctuations have resulted in significant variations in our results of operations. This was particularly relevant during the second and third quarters of fiscal year 2008 where we saw a significant decrease in revenue from our memory platform and experienced some order postponements. Due to our product diversification, however, we were able to partially offset the effect of this downturn in demand for flash memory systems with increased demand for our SOC products fueled by the wireless, PC and consumer mixed-signal device markets. However, during the fourth quarter of fiscal year 2008, we also began to see the SOC business weaken due to the deteriorating global economy, which has negatively 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.
Furthermore, we sell to a variety of customers, including subcontractors. Because we sell to subcontractors, which during market troughs tend to decrease or postpone orders for new test systems and test services more quickly and dramatically than other customers, 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.
Although our visibility into when the semiconductor industry will recover remains poor, we will continue to invest in products in anticipation of a cyclical recovery in the market, and are working on initiatives to expand our customer base. We remain committed to projects and programs which we believe will allow us to increase our market share and expand into higher growth segments. In addition, in response to the weakened economic conditions, we have commenced actions targeted at reducing our quarterly operating cost structure to enable us to achieve break-even results at revenue levels of $125 million a quarter. In order to achieve this objective, we announced in the first quarter of fiscal year 2009, that we are implementing a restructuring program to streamline our organizations and further reduce our operating costs. As part of this restructuring program, we plan to reduce our global workforce through a combination of attrition, voluntary and involuntary terminations and other workforce reduction programs consistent with local legal requirements. We estimate that we will incur restructuring charges in the range of $6 million to $9 million for employee terminations costs, asset impairments, costs of consolidating facilities, and other related costs in fiscal year 2009. We anticipate quarterly costs savings of between $12 million and $15 million when this restructuring program is
substantially completed in fiscal year 2009, of which $4 million to $6 million relate to restructuring activities as described above and the remaining amounts relate to other cost saving initiatives.
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 combined and 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 include revenue recognition, restructuring charges, inventory valuation, warranty, separation costs, share-based compensation, retirement and post-retirement plan assumptions, valuation of goodwill and intangible assets, valuation of marketable securities, and accounting for income taxes.
Revenue recognition. Net revenue is derived from the sale of products and services and is adjusted for estimated returns and allowances, which historically have been insignificant. Consistent with the SEC's Staff Accounting Bulletin No. 104, or "SAB 104," we recognize revenue on the sale of semiconductor test equipment when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is fixed or determinable and collectibility is reasonably assured. Delivery is considered to have occurred when title and risk of loss have transferred to the customer, for products, or when service has been performed. We consider the price to be fixed or determinable when the price is not subject to refund or adjustments. At the time we take an order, we evaluate the creditworthiness of our customers to determine the appropriate timing of revenue recognition. For sales or arrangements that include customer-specified acceptance criteria, including those where acceptance is required upon achievement of performance milestones or fulfillment of other future obligations, revenue is recognized after the acceptance criteria have been met. If the criteria are not met, then revenue is deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered. To the extent that a contingent payment exceeds the fair value of the undelivered element, we defer the portion of revenue related to the contingent payment.
Our product revenue is generated predominantly from the sales of various types of test equipment. Software is embedded in many of our test equipment products, but the software component is considered to be incidental. For revenue arrangements that include multiple elements, we recognize revenue in accordance with EITF 00-21. For products that include installation, if we have previously successfully installed similar equipment, product revenue is recognized upon delivery, and recognition of installation revenue is delayed until the installation is complete. Otherwise, neither the product nor the installation revenue is recognized until the installation is complete. Revenue from services includes extended warranty, customer support, consulting, training, and education services. Service revenue is deferred and recognized over the contractual period or as services are rendered to the customer. For example, customer support contracts are recognized ratably over the contractual period, while training revenue is recognized as the training is provided to the customer. In addition, all of the revenue recognition criteria described above must be met before service revenue is recognized. We use objective evidence of fair value to allocate revenue to elements in multiple element arrangements and recognize revenue when the criteria for revenue recognition have been met for each element. In the absence of objective evidence of fair value of a delivered element, we allocate revenue to the fair value of the undelivered elements and the residual revenue to the delivered elements. The price charged when an element is sold separately generally determines fair value.
Restructuring. We recognize a liability for restructuring costs when the liability is incurred. The restructuring accruals are based upon management estimates at the time they are recorded. These
estimates can change depending upon changes in facts and circumstances subsequent to the date the original liability was recorded. The three main components of our restructuring charges are workforce reductions, consolidating facilities and asset impairments. Workforce-related charges are accrued when it is determined that a liability has been incurred, which is generally when individuals have been notified of their termination dates and expected severance payments. Plans to eliminate excess facilities result in charges for lease termination fees and future commitments to pay lease charges, net of estimated future sublease income. We recognize charges for elimination of excess facilities when we have vacated the premises. Asset impairments primarily consist of property, plant and equipment associated with excess facilities being eliminated, and are based on an estimate of the amounts and timing of future cash flows related to the expected future remaining use and ultimate sale or disposal of the property, plant and equipment. The charges associated with consolidating facilities and asset impairment charges incurred by Agilent prior to our separation were allocated to Verigy to the extent the underlying benefits related to our business. These estimates were derived using the guidance of Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), Staff Accounting Bulletin 100, "Restructuring and Impairment Charges" ("SAB 100"), Emerging Issues Task Force 94-3, "Liability Recognition for Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" ("EITF 94-3") and lastly, Statement of Financial Accounting Standards No. 146, "Accounting for Exit or Disposal Activities" ("SFAS No. 146"), which was effective for exit and disposal activities initiated after December 31, 2002. If the amounts and timing of cash flows from restructuring activities are significantly different from what we have estimated, the actual amount of restructuring and asset impairment charges could be materially different, either higher or lower, than those we have recorded. In order to address the cyclical downturn and the negative impact on our results driven by the deteriorating global economy, we announced in the first quarter of fiscal year 2009, that we are implementing a restructuring program to streamline our organizations and further reduce our operating costs. As part of this restructuring program, we plan to reduce our global workforce through a combination of attrition, voluntary and involuntary terminations and other workforce reduction programs consistent with local legal requirements. We estimate that we will incur restructuring charges in the range of $6 million to $9 million for employee terminations costs, asset impairments, costs of consolidating facilities, and other related costs in fiscal year 2009. We anticipate quarterly costs savings of between $12 million and $15 million when this restructuring program is substantially completed in fiscal year 2009, of which $4 million to $6 million relates to restructuring activities as described above and the remaining amounts relate to other cost saving initiatives.
Inventory valuation. We assess the valuation of our inventory, including demonstration inventory, on a quarterly basis based upon estimates about future demand and actual usage. To the extent that we determine that we are holding excess or obsolete inventory, we write down the value of our inventory to its net realizable value. Such write-downs are reflected in cost of products and can be material in amount. We recorded net inventory charges of $27 million, $8 million and $7 million in fiscal years 2008, 2007 and 2006, respectively. Our inventory assessment involves difficult estimates of future events and, as a result, additional write-downs may be required. If actual market conditions are more favorable than anticipated, inventory previously written down may be sold to customers, resulting in lower cost of products and higher income from operations than expected in that period. Excess and obsolete inventory resulting from shifts in demand or changes in market conditions for raw materials and components can result in significant volatility in our costs of products.
In our inventory valuation analysis, we also include inventory that we could be obligated to purchase from our suppliers based on our production forecasts. To the extent that our committed inventory purchases exceed our forecasted productions needs, we write down the value of those inventories by taking a charge to our cost of products and increasing our supplier liability.
Warranty. We generally provide a one-year warranty on products commencing upon installation or delivery. We accrue for warranty costs in accordance with Statement of Financial Standards No. 5, "Accounting for Contingencies" ("SFAS No. 5"), based on historical trends in warranty charges as a percent of gross product shipments. Estimated warranty charges are recorded within cost of products at the time revenue is recognized and the liability is reported in other current liabilities on the consolidated balance sheets. The accrual is reviewed regularly and periodically adjusted to reflect changes in warranty cost estimates. For some products, we also offer extended warranties beyond one year. Costs associated with our extended warranty contracts beyond one year are expensed as incurred.
Share-based compensation. We account for share-based awards in accordance with Statement of Financial Accounting Standards No. 123(R), "Shared-Based Payment" ("SFAS No. 123(R)"), which was effective November 1, 2005 for Verigy. Under this standard, share-based compensation expense is primarily based on estimated grant date fair value using the Black-Scholes option pricing model and is recognized on a straight-line basis for awards granted after November 1, 2005 over the vesting period of the award. For awards issued prior to November 1, 2005, we recognize share-based compensation expense based on FASB Interpretation 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans an interpretation of APB Opinions No. 15 and 25", which provides for accelerated expensing. Our estimate of share-based compensation expense requires a number of complex and subjective assumptions including our stock price volatility, employee exercise patterns (expected life of the options), future forfeitures and related tax effects. The assumptions used in calculating the fair value of share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. Although we believe the assumptions and estimates we have made are reasonable and appropriate, changes in assumptions could materially impact our reported financial results. We incurred $17 million, $14 million, and $10 million in share-based compensation expense during fiscal years 2008, 2007, and 2006, respectively. Also see Note 6 "Share-Based Compensation" for additional information.
Retirement and post-retirement plan assumptions. Retirement and post-retirement benefit plan costs are a significant cost of doing business. They represent obligations that will ultimately be settled sometime in the future and therefore are subject to estimation. Pension accounting is intended to reflect the recognition of future benefit costs over the employees' average expected future service based on the terms of the plans and the investment and funding decisions made by us. To estimate the impact of these future payments and our decisions concerning funding of these obligations, we are required to make assumptions using actuarial concepts within the framework of U.S. GAAP. Two critical assumptions are the discount rate and the expected long-term return on plan assets. Other important assumptions include the health care cost trend rate, expected future salary increases, expected future increases to benefit payments, expected retirement dates, employee turnover and retiree mortality rates. We evaluate these assumptions at least annually.
The discount rate is used to determine the present value of future benefit payments at each measurement date (October 31 for U.S. plans and September 30 for non-U.S. plans). The discount rate for U.S. plans was determined based on published rates for high quality corporate bonds. The discount rate for non-U.S. plans was generally determined in a similar manner. Differences between the expected future cash flows of our plans and the maturities of the high quality corporate bonds are not expected to have a material impact on the selection of discount rates. As discount rates decrease, we would expect our net plan costs to increase and as discount rates increase we would expect our net plan costs to decrease. Statement of Financial Accounting Standards No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132(R)" ("SFAS No. 158"), became effective for us as of October 31, 2007 and requires recognition of an asset or liability in the statement of financial position reflecting the funded status of pension and postretirement benefit plans such as retiree health and life, with current year changes recognized in shareholders' equity. In fiscal year 2007, in order to recognize the funded status of its
pension and post-retirement benefit plans in accordance with SFAS No. 158, the Company recorded additional liabilities by a cumulative amount of $18 million, of which $12 million (net of tax of $6 million) was recorded as an increase to accumulated other comprehensive loss. These losses are being recognized over the expected average future service lives of plan participants. Also see Note 17 "Retirement Plans and Post-Retirement Benefits."
The expected long-term return on plan assets is estimated using current and expected asset allocations, as well as historical and expected returns. . . .
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