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Article by DailyStocks_admin    (03-27-08 06:59 AM)

The Daily Magic Formula Stock for 03/27/2008 is Verigy Ltd. According to the Magic Formula Investing Web Site, the ebit yield is 13% and the EBIT ROIC is >100%.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

Overview

Verigy designs, develops, manufactures, sells and supports advanced test systems and solutions for the semiconductor industry. We offer a single platform for each of the two general categories of devices being tested: our 93000 Series platform, designed to test System-on-a-Chip (SOC), System-in-a-Package (SIP) and high-speed memory devices, and our Versatest V5000 Series platform, designed to test memory devices, including flash memory and multi-chip packages containing a mix of memory devices. Our test solutions are both scalable and flexible. Our test platforms are scalable across different frequency ranges, different pin counts and different numbers of devices. Our test platforms' flexibility allows for a single test system to test a wide range of applications for semiconductor devices. Our scalable platform architecture provides us with internal operating model efficiencies such as reduced research and development costs, engineering headcount, support requirements and inventory risk. The scalability and flexibility of our test solutions also provide economic benefits to our customers by allowing them to get their complex, feature-rich semiconductor devices to market quickly and to reduce their overall costs. We also provide test and application expertise, service and support through our worldwide service organization.

We have a broad installed customer base, having sold over 1,650 of our 93000 Series systems and over 2,500 Versatest Series systems. Our customers include integrated device manufacturers, or IDMs, test subcontractors, also referred to as subcontractors, which includes specialty assembly, package and test companies as well as wafer foundries, and fabless design companies. Verigy became an independent company on June 1, 2006, when we separated from Agilent Technologies Inc. As of October 31, 2007, we had approximately 1,550 employees worldwide.

The Semiconductor Test Equipment Industry

Industry Background. Semiconductor devices, also referred to as integrated circuits, or ICs, are the fundamental building blocks used in all electronic systems. They have played an important role in enabling the proliferation of computing, communications and consumer electronic products. As technology continues to penetrate most aspects of daily life, semiconductor devices are playing an increasingly important role in a growing number and variety of products. Consequently, the global semiconductor industry, while experiencing significant cyclical fluctuations in its growth rate, has exhibited strong overall growth over the last 30 years. With the continued development of new growth segments within the semiconductor market, we believe the semiconductor market should continue to experience periods of strong growth.

The design and manufacture of semiconductor devices is a complex and capital-intensive multi-step process. This process involves different types of equipment used to manufacture, assemble and test semiconductor devices. Semiconductor test equipment and services are a critical part of this complex design and manufacturing process and are utilized in each of the key design and manufacturing stages.

Demand for new semiconductor test equipment is driven by two primary forces: growth in semiconductor unit volume that drives the need for additional testing capacity, and the adoption of new technologies in semiconductor design, manufacturing and packaging that require new types of semiconductor testing equipment.

Due to the different architectures and functionalities of semiconductors, semiconductor test equipment and services are generally categorized by the type of semiconductors tested. The two general categories are equipment used to test memory semiconductors, referred to as memory testing, and equipment used to test non-memory semiconductors, which includes testers for testing less complex, discrete semiconductors, and testers designed to test very complex, highly integrated semiconductors commonly referred to as System-on-a-Chip, or SOC, or System-in-a-Package, or SIP, testing.

SOCs and SIPs are semiconductors that integrate the functionality of multiple individual ICs onto a single IC or package of ICs, and often contain both digital and analog functionalities, including radio frequency (RF) capabilities, communication interfaces and embedded memory. By combining multiple technologies onto a single, more complex chip or package, these devices provide the benefits of lower cost, smaller size, higher performance and lower power consumption and facilitate faster time-to-market that is critical, particularly for products targeted to the consumer electronics market.

Memory devices, particularly flash memory devices, represent a significant and growing portion of the semiconductor industry. The flash memory market for NAND and NOR flash, as measured by megabits shipped, has doubled every year since 2000. This growth has been fueled largely by the extensive use of flash memory in consumer products such as MP3 players, cell phones, digital cameras and other handheld devices. There are two key types of flash memory: NAND flash, which is suited to the storage of large amounts of data in devices such as MP3 players and digital cameras, and NOR flash, which is typically used for the storage of basic operating instructions and programs that enable devices such as cell phones to start-up and function. Given the compact nature of consumer electronics products and the increasing need for more memory in these products, complex and more compact memory device packaging techniques, such as stacked and multi-chip packages, or MCPs, are being adopted. Verigy tests devices using NOR, NAND and MCPs, that provide memory for the cellular handset, MP3 players, digital still cameras and gaming. Increasingly, flash is being used in laptop computers and DTV accessories, where the attributes of flash add to consumer enjoyment of devices.

Semiconductor test equipment plays an important role by enabling semiconductor designers and manufacturers to lower their overall costs and get products to market quickly in addition to improving the quality and reliability of their end products. By detecting and sometimes repairing manufacturing defects, test equipment enables semiconductor designers and manufacturers to improve manufacturing yield, meaning the proportion of semiconductor devices that perform to specifications. In addition, we believe that scalable and flexible test equipment represents a key competitive advantage because it reduces test time, assists in achieving faster time to market and lowers capital investment requirements by allowing semiconductor designers and manufacturers to test different types of semiconductors with the same test equipment.

Bringing semiconductor products to market is a multi-step process, which includes stages referred to as production prototype, production ramp and high-volume production. Semiconductor test equipment plays an important role in each of these stages.

Production Prototype. Once an initial design of a semiconductor has been created, the first stage in bringing an actual IC to market is to produce a small quantity of prototype ICs to validate the design and ensure that it performs according to its specifications. What the semiconductor designer needs most from the test equipment and services provider at this stage is advanced test equipment and test strategy expertise. The engineering validation and device characterization that occurs at this stage requires high precision test equipment to ensure accuracy and high flexibility to modify test procedures and parameters, because the IC design may iterate multiple times. Test strategies and methodologies are developed early to ensure that the test solution implemented is capable of testing the ICs across the entire manufacturing process. Of all the stages of bringing a new semiconductor to market, it is at this stage that the most advanced test equipment is required.

Production Ramp. Once a semiconductor passes the production prototype stage, the next stage in bringing it to market is the ramp to high volume production. In the production ramp stage the semiconductor designer and manufacturer is focused on transitioning as quickly as possible to the high-volume production stage. What the semiconductor designer and manufacturer needs from the test equipment and services provider at this stage is application expertise and an understanding of manufacturing processes. Test solutions at this stage are no longer focused on validating the product design, but are focused on fine-tuning the manufacturing process to optimize yield. Test optimization is critical in this step, with software analysis being used to determine which tests are unnecessary and can be streamlined or eliminated in order to save time in the manufacturing process while maintaining the appropriate thoroughness of the test process.

High Volume Production. The final stage in bringing a semiconductor to market is high-volume production. The key focus for the semiconductor manufacturer at this stage is to reduce the overall cost of test by achieving high throughput of quality semiconductor devices. To achieve this goal, semiconductor manufacturers require high-reliability test equipment with maximum up-time, and tailored service and support, from their semiconductor test equipment and services provider. Integration of the test equipment into the production process is optimized to improve efficiency and minimize the time that test equipment is not utilized. In order to achieve high throughput, test equipment that is not only fast but can test multiple devices at the same time is critical, especially in the testing of memory devices.

Semiconductor Test Market Challenges

Because of the competitiveness of the broader consumer electronics market, semiconductor designers and manufacturers are increasingly focused on bringing high quality complex ICs to market faster and at lower costs. As a result, semiconductor test equipment and services suppliers are facing new challenges confronted by semiconductor designers and manufacturers due to:

Increased pressure to reduce overall cost of test

Continued cost pressures are driving semiconductor designers and manufacturers to demand higher utilization of test systems, as well as test systems that can be re-used across different types and generations of ICs. Test systems are required to demonstrate the scalability and flexibility necessary to permit desired levels of utilization and extend their useful life. Rapid technology change within the semiconductor industry can quickly render non-scalable test equipment obsolete for the testing of new generations of semiconductors.

Increased pressure to improve time-to-market

Today's semiconductor market is characterized by shortening product life cycles as a result of increased exposure to and reliance on the consumer electronics market. Semiconductor designers and manufacturers that are first to market and that quickly adapt to changing technological advances gain a significant competitive advantage. The complex nature of manufacturing semiconductor devices requires that test solutions providers offer their customers more than just delivery of test equipment. Semiconductor designers and manufacturers require tailored test solutions and a breadth of application expertise in order to accelerate their time-to-market with new ICs and maximize their revenue opportunity. Equipment suppliers that are not able to complement their hardware systems with application expertise have limited ability to impact their customers' time to market.

Increased complexity and performance requirements of test

The trend towards SOCs, SIPs and MCPs has created new challenges for semiconductor designers and manufacturers. These increasingly complex semiconductor designs, which enable improved performance, form and function, require sophisticated test solutions. In addition, advances in interface technology, the adoption of new design protocols and process technology innovations have only added to this complexity. Low cost test equipment that lacks a high level of sophistication and broad application can end up being more costly in the long run.

Meeting the needs of test subcontractors

Test subcontractors face specific test challenges. Subcontractors provide test services to a diverse group of semiconductor designers and manufacturers, which include both fabless design companies and integrated device manufacturers, referred to as IDMs. As a result, subcontractors are continually challenged to provide the capabilities to test a wide range of ICs. Optimizing the utilization of a subcontractor's installed capital equipment is therefore important to its success. In order to optimize this utilization, subcontractors require flexible semiconductor test systems that are capable of testing a broad spectrum of ICs. Additionally, subcontractors require systems that can test ICs with varying pin counts while maintaining cost efficiencies and high throughput levels. For this reason, test solutions providers who fail to offer scalable and flexible architectures, as well as a breadth of application expertise, may fall short in meeting the needs of subcontractors.

Our Solution

We design, develop, manufacture, sell and support advanced test systems and solutions for the semiconductor industry. Unlike competitors who provide multiple platforms for SOC/SIP/high-speed memory and memory test, we provide a single platform for each of the two general categories of devices being tested. As part of our single scalable platform strategy, we develop and offer performance and capability enhancements to our platforms as part of our product development roadmap. Our 93000 Series platform is designed to test SOC, SIP and high-speed memory devices, and our Versatest V5000 Series platform is designed to test memory devices, including flash memory and MCPs. We also provide a range of services that assist our customers in quickly and cost effectively delivering the innovative, feature-rich products demanded by their end users.

More than a decade ago, we introduced the concept of a scalable platform architecture for semiconductor testing, and we are continuing to capitalize on the benefits of that strategy today. Our scalable platform architecture provides us with internal operating model efficiencies, such as reduced research and development costs, engineering headcount, support requirements and inventory risk. The scalability and flexibility of our solution also provide economic benefits to our customers by allowing them to get their complex, feature-rich semiconductor devices to market quickly and to reduce overall costs. We believe our advanced SOC/SIP/high-speed memory and memory test solutions provide optimal combinations of flexibility, cost and performance to a wide range of designers and manufacturers in the semiconductor industry at all stages of bringing a semiconductor product to market, from design to production prototype to high-volume manufacturing. The key elements of our solutions are:

Scalable platform across a broad range of performance levels

Reducing the overall cost of test is critical for our customers. Our test platforms are scalable in a number of ways, including frequency range of the applied test signals, the number of pins to accommodate ICs with different pin counts and the number of devices that can be tested in parallel. This scalability allows semiconductor manufacturers considerable flexibility in selecting the right test solution to meet their needs, at an optimal level of capital investment. In addition, our test systems can be quickly reconfigured or upgraded as requirements change. The combination of scalability, speed and ease of reconfiguration of our test systems enables our customers to reduce their long-term capital equipment requirements and minimize manufacturing downtime.

The scalability of our test platforms is enabled by a "tester-per-pin" architecture, in the case of our SOC/SIP/high-speed memory test platform, and a "tester-per-site" architecture, in the case of our memory test platform. Our "tester-per-pin" architecture utilizes a separate and independent test processor for each pin of each device being tested, enabling each pin to be tested independently and in parallel to the testing of other pins. Our "tester-per-site" architecture is tailored to make use of the parallel structure of memory devices to test a large number of devices in parallel because it utilizes a separate and independent test processor for each physical interface of the test system to a device under test. We refer to those interfaces as test sites. With our optional Programmable Interface Matrix, our Versatest V5500 System for the final test of packaged devices can further capitalize on the parallel structure of memory devices to test multiple devices per test site, thereby increasing its parallel testing capabilities. For our SOC/SIP/high-speed memory test systems, the process of frequency performance scaling is often done "instantly" through a software upload as the device test program is loaded into the system. For all of our test systems, the process of scaling up the number of devices a test system is capable of testing in parallel is often accomplished quickly, typically requiring only a few hours for basic scaling and only a few days for more extensive scaling. The per-pin architecture of our SOC/SIP/high-speed memory test systems also enables us to offer customers innovative licensing models. For example, we currently offer our customers the unique ability to purchase and share performance licenses across different devices on a per-pin basis. As a result, our customers are able to buy only the performance they need for each pin of the system.

Flexible platforms across a breadth of applications

Our test platforms are also highly flexible in that they allow a single test system to test a wide range of applications for semiconductor devices. The high level of software reconfigurability of our test platforms, and the support and enhancements we offer, enable our customers to implement a broad range of application tests tailored to their needs, including tests for high-speed digital, analog/mixed signal, flash memory, RF and high-speed memory devices. In addition to enabling our customers to test a broad range of products, our test systems also support through software reconfiguration a number of advanced test methodologies, such as built-in self test, or BIST, design-for-test, or DFT, reduced pin count test, or RPC, and concurrent test. These methodologies can simplify testing complex devices, thereby increasing our customers' throughput as well as improving their time to market. We are continually developing additional enhancements to our test platforms to support additional application tests and test methodologies.

Competing test platforms often require an IC device manufacturer to have devices tested by multiple test systems in order to complete the tests required for different applications contained in the devices. This process is not only expensive, cumbersome and time-consuming, but it also takes up valuable floor space in the manufacturing facility. In comparison, our test platforms are able to run the tests for a significant number of different applications without having to move devices to different test systems. The flexible test capabilities of our 93000 Series and V5000 Series test platforms enable our customers to reduce their overall cost of equipment acquisition, employee training and test equipment maintenance while simultaneously increasing equipment utilization.

Advanced, innovative test technology

As a result of the competitive pressures our customers face, they continually need to develop and bring to market increasingly complex products. We develop advanced technology solutions in order to assist our customers in accomplishing this goal in a cost effective and timely manner. From our history as part of Agilent, which was part of Hewlett Packard until its spin-off in 1999, we have a legacy of introducing new and innovative designs to market. Some of these key innovations include the development of scalable platforms for both SOC/SIP/high-speed memory and memory test through our "tester-per-pin" and "tester-per-site" architectures, our test processors utilizing high performance application-specific integrated circuits, or ASICs, and our liquid cooling technology for our test system hardware.

Since 1991, we have used ASICs for our test processors in place of larger, less integrated and less sophisticated designs, allowing our test processors to be very small and providing our test systems with the high performance and accuracy expected from an ASIC-based design. The small size of our ASIC-based test processors enables our "tester-per-pin" and "tester-per-site" architectures. Along with the additional performance, scalability and flexibility benefits of those architectures, our ASIC-based architectures result in test systems that are able to test large numbers of devices in parallel in a small test platform footprint.

Our products use liquid cooling technology, which provides lower operating temperatures, greater system reliability, reduced operating costs, improved accuracy and speed and quieter and cooler operation than the traditional air cooled technology used in some competitive products. This allows our test platforms to achieve high performance, accuracy, reliability and parallelism while simultaneously achieving a small test platform footprint. We released our first liquid cooled tester in 1991 and have extensive experience in the application of liquid cooling technology to semiconductor test systems.

Global delivery of expert application knowledge

Getting semiconductors to market quickly is vital for our customers. Our worldwide professional staff of highly trained applications engineers provides our customers with a high level of technical expertise to assist our customers as they develop test applications for their semiconductor devices. Our extensive expertise spans a broad range of semiconductor devices, including chipsets and graphics, wireless and wired communication, flash memory, video and audio, high-speed memory and complex multi-chip memory packages. We also produce leading-edge innovative test technologies and deliver, on a global basis, superior expertise across a wide range of applications to assist our customers in quickly delivering new feature-rich products to the market.

Lowered overall cost of test for customers

We have designed our platforms to be versatile and reconfigurable. As a result, our customers are able to select a configuration to meet their current test requirements and, as those requirements change, to upgrade the capabilities of their test equipment to meet their future needs without having to purchase completely new systems. Our high quality and reliable test solutions provide high uptime as measured by the reliability of the test equipment. Additionally, our ability to provide innovative solutions and technical expertise across a wide variety of applications helps our customers optimize test equipment performance for the specific semiconductor device being tested, which reduces test times and increases both yield and cost efficiencies. Consequently, we believe our solutions lower our customers' cost of test in high volume manufacturing.

Shortened time-to-market

To achieve fast time to market, our customers require scalable and flexible test platforms and application expertise and support at each stage of the manufacturing process. We provide scalable and flexible test platforms based on our established architectures, which can be changed and reconfigured quickly to address new test technologies. Our highly trained applications engineers provide support for the development of test strategies, test applications analysis and optimization and test equipment utilization for our customers.

Our Strategy

Our objective is to be the leading semiconductor test solutions and services supplier, providing the highest return on our customers' investment in test operations. We will continue to maintain our focus on our customers' evolving needs by offering innovative and versatile semiconductor test solutions that address the challenges facing semiconductor designers and manufacturers, and we will remain committed to providing outstanding service and support to our customers. We intend to maintain efficiency in our business and capitalize on our research and development resources in an effort to sustain profitable growth in excess of the broader semiconductor test industry. We are executing on our flexible operating model and cost structure to enable us to increase and decrease our capabilities and spending in response to cycles in the semiconductor industry, and thereby deliver continued customer responsiveness as well as improved overall profitability. Key elements of our strategy include:

Maintaining the rapid pace of product innovation on scalable platforms

We believe scalable platforms offer our customers the best return on their investment in test equipment. The scalable architecture of our solutions coupled with the proven stability of our platforms facilitates our focus on innovative enhancements, application improvements and technical solutions in step with our customers' needs. The pace of innovation in the semiconductor industry is so rapid that performance doubles roughly every 18 months. Semiconductor companies thus require substantial technical expertise and constant innovation to successfully compete. We believe that with our scalable product architecture, wide-ranging technical capabilities and expertise and established global delivery platform, we are well positioned to be an innovator in the semiconductor test market and to assist our customers in competing successfully in the semiconductor market.

Continuing to focus on emerging opportunities for profitable growth

We will continue to seek increased market penetration by focusing on market opportunities where we can capitalize on our technical expertise and add value to our customers who demand the most advanced and cost-effective test solutions. We believe that these opportunities have attractive characteristics, such as the potential for increased customer adoption of our solutions and the potential for high returns on our investment. Recent examples of such emerging opportunities include single-chip cell phone devices that feature radio frequency circuits integrated into CMOS die and other portable consumer electronics that utilize high-speed memory and complex SOCs, SIPs and MCPs.

Capitalizing on our success with test subcontractors to increase our success with IDMs

The scalability and flexibility of our platform architecture has led to our success in attracting subcontractors to our test solutions. We believe that the same advantages of our solutions that subcontractors find compelling will continue to drive the increased adoption of our solutions by IDM customers. Today, all of the top ten IDMs utilize Verigy platforms for either engineering or production applications, or both. IDMs are facing increasingly intense competition, time-to-market pressures and shorter product lifecycles associated with consumer driven demand, which has led them to begin to outsource an increasing percentage of their semiconductor test business. We believe that our success with our subcontractor customers will drive IDMs to direct a greater percentage of their test business to us, as IDMs have an interest in maintaining consistency across their internal and external test platforms. These factors, combined with the cost and capital expenditures restrictions that many IDMs experience, are increasing the need for better asset utilization by IDMs.

Continuing to deliver an outstanding total customer experience throughout the product life cycle

Application support through all phases of the product life cycle is critical to our customers' ability to achieve fast time-to-market for their products while achieving a high return on their test solution investments. We will strive to continue to provide our customers with extensive application expertise, to maintain the global delivery capabilities of our customer-facing teams, and to efficiently service our customers with an emphasis on responsiveness. We will continue to expand our presence in Asia in the areas of applications engineering, research and development and order fulfillment in order to maintain favorable proximity to and further strengthen our relationships with customers in Asia. Additionally, we will continue to accentuate and reward the values of professionalism, technical expertise and uncompromising integrity in all our employees in an effort to continually enhance our customers' experience.

Optimizing our operating model to generate sustainable profitability

The semiconductor industry has historically been cyclical. This cyclicality requires semiconductor test suppliers to have flexible cost structures in order to sustain profitability through the peaks and troughs of the industry's cycles. We continue to focus on increasing our profit margins and managing our business for sustained profitability. To accomplish this, we employ flexible supply agreements, flexible compensation structures for all employees and an optimized business infrastructure. We rely on several contract manufacturers that have a global presence and expect to continue to achieve greater economies of scale through our global supply chain, our leveraged research and development model and our efficient global delivery system. These efficiencies will support our efforts to be profitable notwithstanding the cyclical industry that we compete in.

CEO BACKGROUND

C. Scott Gibson (age 55) —C. Scott Gibson has served as a member of our Board of Directors and as the chairperson of our Nominating and Governance and Compensation Committees since June 2006. Mr. Gibson has served as our Lead Independent Director since July 2007. Mr. Gibson has served as a director of Radysis Corporation, a global supplier of embedded computing solutions for automation, telecommunications and other industries, since June 1993 and as chairperson of its Board of Directors since October 2002. From January 1983 through March 1992, Mr. Gibson co-founded Sequent Computer Systems, Inc., a computer systems company, and served as president from January 1988 to March 1992. Before co-founding Sequent, Mr. Gibson served as General Manager, Memory Components Operation, at Intel Corporation. Mr. Gibson serves on the Board of Directors of several other companies, including Triquint Semiconductor, Inc., Pixelworks, Inc., Northwest Natural Gas Company, Electroglas, Inc., Oregon Health and Science University, Oregon Community Foundation, Radysis Corporation and Franklin W. Olin College of Engineering. Mr. Gibson holds a BSEE degree and an MBA degree from the University of Illinois.

Eric Meurice (age 51) —Eric Meurice has served as a member of our Board of Directors since November 2006. Mr. Meurice has served as the President and Chief Executive Officer of ASML Holding, a manufacturer of lithography equipment and supplier to the semiconductor industry, since October 2004. From March 2001 until he joined ASML, Mr. Meurice was Executive Vice President, Thomson Television Worldwide. Between 1995 and 2001, Mr. Meurice served as Vice President of Dell Computer, where he ran the Western and Eastern Europe regions and Dell's emerging markets business within Europe, the Middle East and Africa. Mr. Meurice holds a Master's degree in applied economics from the Sorbonne University, Paris, a Master's degree in mechanics and energy generation from the École Centrale de Paris, and an MBA from Stanford University.

Claudine Simson (age 54) —Claudine Simson has served as a member of our Board of Directors and of our Audit and Compensation Committees since November 2006. Dr. Simson is Executive Vice President and Chief Technology Officer of LSI Corporation. Dr. Simson served as Corporate Vice President and Chief Technology Officer of Motorola Inc. and its semiconductor product sector spin-off, Freescale Semiconductor, from April 2003 to April 2006. Prior to joining Motorola, from September 2002 to March 2003, Dr. Simson served as Chief Technology Officer at IPVALUE Management Inc., an emerging company specializing in the commercialization of corporate intellectual property. Prior to joining IPVALUE, Dr. Simson was with Nortel Networks for 23 years, holding senior executive positions including General Manager of Nortel's Semiconductor Business, and Vice President of Technology Solutions. Dr. Simson received a Bachelor's degree in electrical engineering and a Ph.D. in semiconductor physics from l'Institut National des Sciences Appliquées in Toulouse, France.

Edward C. Grady (age 60) —Edward C. Grady has served as a member of our Board of Directors since July 2007. Mr. Grady is the president and CEO at Brooks Automation Inc. Prior to joining Brooks in 2003, he ran several divisions at KLA-Tencor, served as president and CEO of Hoya Micro Mask and was Vice President of Worldwide Sales for the EPI division of Monsanto/MEMC, where he started his career. Mr. Grady serves on the Board of Directors of Evergreen Solar Inc., Integrated Materials Inc., Finesse, LLC, Molecular Imprints Inc. and Electro Scientific Inc. He holds a Bachelor of Science degree in engineering from Southern Illinois University and an MBA degree from the University of Houston.

Ernest L. Godshalk (age 62) —Ernest L. Godshalk has served as a member of our Board of Directors, as chairperson of our Audit Committee and as a member of the Nominating and Governance Committee since June 2006. Mr. Godshalk is Managing Director of ELGIN Management Group, a private investment company. From February 2001 until he retired in December 2004, Mr. Godshalk served as President, Chief Operating Officer and a director of Varian Semiconductor Equipment Associates, Inc., a supplier of semiconductor manufacturing equipment. From April 1999 until February 2001, Mr. Godshalk served as Varian Semiconductor's Vice President and Chief Financial Officer. Mr. Godshalk serves on the Board of Directors of GT Solar International Inc. and Gloucester Adventure, Inc. He holds a BA degree from Yale University and an MBA degree from Harvard Business School.

Steven W. Berglund (age 56) —Steven W. Berglund has served as a member of our Board of Directors and as a member of our Audit Committee since January 2008. Mr. Berglund joined Trimble Navigation as President and CEO in March 1999, and has diverse industry experience, including engineering, manufacturing, finance, and global operations. Prior to joining Trimble, he was President of Spectra Precision, a unit of Spectra-Physics AB, and a pioneer in the development of laser systems. He spent 14 years at Spectra, in several senior leadership positions. In the early 1980s, Berglund spent a number of years at Varian Associates in Palo Alto, Calif., where he held roles in planning and manufacturing. He began his career as a process engineer at Eastman Kodak in Rochester, N.Y. He attended the University of Oslo and the University of Minnesota, where he received a BS in chemical engineering in 1974. He later received his MBA from the University of Rochester in 1977.

Keith L. Barnes (age 56) —Keith L. Barnes has served as our President and Chief Executive Officer since May 2006, as a member of our Board of Directors since June 2006, and as Chairman of Verigy's Board of Directors since July 2007. From October 2003 through April 2006, Mr. Barnes was Chairman and Chief Executive Officer of Electroglas, Inc., an integrated circuit probe manufacturer located in San Jose, California. From August 2002 to October 2003, Mr. Barnes was Vice Chairman of the Board of Directors of Oregon Growth Account and a management consultant. He served as Chief Executive Officer of Integrated Measurement Systems, Inc. ("IMS"), a manufacturer of engineering test stations and test software, from 1995 until 2001, and also as Chairman of the Board of Directors of IMS from 1998 through 2001 when it was acquired by Credence Systems Corporation. Prior to becoming CEO of IMS, Mr. Barnes was a Division President at Valid Logic Systems and later Cadence Design Systems. Mr. Barnes is on the Board of Directors of Cascade Microtech, Inc. and a Regent at The University of Portland. Mr. Barnes holds a BSES degree from California State University, San Jose.

Paul Chan Kwai Wah (age 53) —Paul Chan Kwai Wah has served as a member of our Board of Directors and as a member of our Compensation and Nominating and Governance Committees since June 2006. Mr. Chan Kwai Wah served as Senior Vice President and Managing Director, Asia Pacific, for Hewlett-Packard Asia Pacific Pte Ltd., from May 2002 until April 2006. From August 1995 to April 2002, Mr. Chan Kwai Wah served as Vice President and Managing Director, Asia Pacific, for Compaq Computer Asia/Pacific Pte Ltd. Mr. Chan Kwai Wah currently serves on the Board of Directors of Singapore Power Limited, SIA Engineering Company Limited, Bethesda (Katong) Church Ltd. and National Healthcare Group Pte. Ltd. Mr. Chan Kwai Wah holds a BS degree in physics from the University of Singapore and a marketing diploma from the Chartered Institute of Marketing, UK.

COMPENSATION

Under the laws of Singapore, our shareholders must approve all cash compensation paid to our non-employee directors. In addition to the compensation provided to our non-employee directors detailed below, each non-employee director receives reimbursement of reasonable out-of-pocket expenses incurred in connection with attending in-person meetings of the Board of Directors and of committees of the Board of Directors, as well as reimbursement of expenses incurred for attendance at continuing education courses for directors. No director who is our employee receives compensation for services rendered as a director. Accordingly, Mr. Barnes, our Chairman, Chief Executive Officer and President, does not receive compensation for his role as a director.

Equity Compensation

Initial Option Grants. Under the automatic equity grant provisions of our 2006 Equity Incentive Plan, which we refer to as the 2006 Plan, each individual who first becomes a non-employee director receives:

•
a one-time grant of a non-statutory stock option to purchase that number of whole ordinary shares with an accounting value of $110,000; and

•
a one-time grant of restricted ordinary share units with an accounting value of $110,000.

If our shareholders approve Proposal 9, each individual who first becomes a non-employee director will receive:

•
a one-time grant of a non-statutory stock option to purchase that number of whole ordinary shares with an accounting value of $120,000; and

•
a one-time grant of restricted ordinary share units with an accounting value of $120,000.

The initial one-time option grants are granted on the date when the outside director first joins the Board of Directors. For purposes of determining the accounting value of the initial stock option grant, the accounting value is the value calculated using the same methodology that we applied for purposes of determining the accounting charge associated with similar equity-based awards for the fiscal period immediately preceding the grant date. We measure the fair value of option awards using the Black-Scholes option pricing model which requires a number of complex and subjective assumptions including our stock price volatility, option exercise patterns (expected life of the options), future forfeiture rates and related tax effects. The fair value of restricted share units is determined based on the fair market value of Verigy's shares on the date of grant. The restricted share units initially issued to non-employee directors vest in full on the first anniversary of the grant date. Settlement of the restricted share units occurs in a lump sum on the third anniversary of the grant date. During 2007, Mr. Grady received an initial stock option to purchase 10,443 ordinary shares at an exercise price of $29.16 per share, and an initial grant of 3,773 restricted ordinary share units. Employee directors and outside directors who were previously employees of Verigy are not eligible for the initial equity-based awards.

Yearly Option Grants. Under the terms of the automatic option grant provisions of the 2006 Plan, on the date of each Annual General Meeting of Shareholders, each non-employee director automatically receives a non-statutory stock option covering ordinary shares with an accounting value of $55,000. These options vest and are exercisable on the first anniversary of the grant date. If, however, our shareholders approve Proposal 9, the accounting value of the annual non-statutory stock option award will increase to $60,000, and future annual option awards will vest quarterly over a period of four quarters from the date of grant. Employee directors and outside directors who were previously employees of Verigy are not eligible for the annual equity-based awards.

Yearly Restricted Share Unit Awards. Under the terms of the automatic restricted share unit grant provisions of the 2006 Plan, on the date of each Annual General Meeting of Shareholders, each non-employee director automatically receives a restricted share unit award consisting of such number of ordinary shares having an accounting value of $55,000 on the date of grant. The restricted share unit awards vest on the first anniversary of the date of grant. If, however, our shareholders approve Proposal 9, the accounting value of the annual restricted share unit awards will increase to $60,000, and future awards of restricted share units will vest quarterly over a period of four quarters from the date of grant. Employee directors and outside directors who were previously employees of Verigy are not eligible for the annual equity-based awards.

Discretionary Grants. Under the terms of the discretionary option grant provisions of the 2006 Plan, non-employee directors are eligible to receive non-statutory stock options, restricted shares, share units, or SARs granted at the discretion of the Compensation Committee. To date, our Compensation Committee has not made any discretionary grants to our non-employee directors.

Cash Compensation. Verigy provides annual cash compensation to its non-employee directors as follows:

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An annual cash retainer of $55,000 for service on our Board of Directors and for service on any committees on which a director serves;

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A supplemental annual retainer of $10,000 per year payable to the chairperson of the Audit Committee and to the chairperson of the Compensation Committee for the additional services rendered in connection with chairing such committees; and

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A supplemental annual retainer of $5,000 per year payable to the chairperson of the Nominating & Governance Committee for the additional services rendered in connection with chairing such committee.


In addition, at this Annual General Meeting of Shareholders, we are seeking your approval to provide a supplemental annual retainer of $15,000 per year payable to our Lead Independent Director for the additional services rendered in connection with this position for the period of approximately 12 months, from April 16, 2008 until the 2009 Annual General Meeting of Shareholders.

Annual Cash Compensation. Verigy's cash-based compensation for non-employee directors is paid following each Annual General Meeting of Shareholders rather than at the outset of the fiscal year, making cash compensation—like the annual equity compensation—coincide with the directors' terms of office.

The Compensation Committee reviewed the cash compensation levels payable to non-employee directors and elected to retain the annual rates approved by our shareholders at our 2007 Annual General Meeting of Shareholders, with the addition of $15,000 per year payable to our Lead Independent Director, subject to shareholder approval.

MANAGEMENT DISCUSSION FROM LATEST 10K

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.

Prior to June 1, 2006, we had 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.

Agilent historically used a centralized approach to cash management and financing of its operations. Transactions relating to Verigy prior to June 1, 2006 were accounted for through the Agilent invested equity account for Verigy. Accordingly, none of the cash, cash equivalents or debt at the Agilent corporate level has been assigned to Verigy in the combined and consolidated financial statements prior to June 1, 2006.

Business Summary

We design, develop, manufacture and sell advanced test systems and solutions for the semiconductor industry. As part of our single scalable platform strategy, we develop and offer performance and capability enhancements to our platforms as part of our product development roadmap. We offer a single platform for each of the two general categories of devices being tested: our 93000 Series platform, designed to test SOCs, SIPs and high-speed memory devices, and our Versatest V5000 Series platform, designed to test memory devices, including flash memory and multi-chip packages. We also provide a range of services that assist our customers in quickly and cost effectively delivering the innovative, feature-rich products demanded by their end users.

More than a decade ago, we introduced the concept of scalable platform architecture for semiconductor testing, and we are continuing to capitalize on the benefits of that strategy today. Our scalable platform architecture provides us with internal operating model efficiencies such as reduced research and development costs, engineering headcount, support requirements and inventory risk.

We sell our products and services directly to a wide range of customers, including integrated device manufacturers, or IDMs, test subcontractors, which includes specialty assembly, package and test companies as well as wafer foundries, and fabless design companies. We have a broad installed customer base, having sold over 1,650 of our 93000 Series systems and over 2,500 of our Versatest Series systems.

Overview of Results

In fiscal year 2007, two customers, ChipMos Technologies (Bermuda) Ltd. and Spansion Inc., accounted for more than 10% of our net revenue. In fiscal year 2006, one customer, ChipMos Technologies (Bermuda) Ltd., accounted for more than 10% of our net revenue. In fiscal year 2005, no single customer accounted for more than 10% of our net revenue.

We derive a significant percentage of our net revenue from outside North America. Net revenue from customers located outside of North America represented 70.8%, 68.4% and 72.8% of total net revenue in fiscal years 2007, 2006, and 2005, respectively. Net revenue in North America was lower by 9.8% in fiscal year 2007, compared to fiscal year 2006, due to the continuing outsourcing by our North American customers to contract manufacturers in Asia. Net revenue in Asia (including Japan) was higher by 4.8% in fiscal year 2007, compared to fiscal year 2006. We expect this trend of increasing sales in Asia (including Japan) to continue as semiconductor manufacturing activities continue to concentrate in that region.

The sales of our products and services are dependent, to a large degree, on customers who are subject to cyclical trends in the demand for their products. These cyclical periods have had and will have significant impacts on our business since our customers often delay or accelerate purchases in reaction to changes in their businesses and to demand fluctuations in the semiconductor industry. Historically, these demand fluctuations have resulted in significant variations in our results of operations. Upturns and downturns in the semiconductor industry in recent years have generally affected the semiconductor test equipment and services industry more significantly than the overall capital equipment sector. Furthermore, we sell to a variety of customers, including subcontractors. Because we sell to subcontractors, which during market downturns tend to reduce or cancel orders for new test systems and test services more quickly and dramatically than other customers, any downturn may cause a quicker and more significant adverse impact 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.

In connection with our separation from Agilent in June 2006, we transitioned the manufacturing processes for the 93000 Series products that we previously conducted internally to Flextronics Telecom Services Ltd. ("Flextronics"). As a result of this transition, we now rely entirely on contract manufacturers. Flextronics commenced production of our Versatest series products in China in July 2006 and assumed our manufacturing activities for the 93000 Series products in Germany in June 2006. Our volume manufacturing activities related to our 93000 Series platform will ultimately transition to Flextronics in China. However, given the recent increased demand for our SOC products, coupled with our customers' tight delivery schedule requirements, we have decided to maintain additional manufacturing capacity at Flextronics in Germany. We expect this manufacturing model to improve our ability to manage costs in a cyclical market, drive down inventory costs and exposure, improve our responsiveness to customer demand and place us closer to emerging markets.

We believe that relying upon independent contract manufacturers will decrease our fixed costs and better position us to respond to changes in the demand for our products. With our selection of Flextronics as our primary independent manufacturing supplier, we are leveraging their worldwide processes, tools and infrastructure and are expanding our manufacturing in Asia, where Flextronics already has a significant capability for manufacturing complex technologies. As a result of this outsourcing arrangement, we expect to lower our fixed costs by reducing our capital investments and manufacturing equipment and by reducing the size of our manufacturing work force located in high-cost geographies. In addition, although we will continue to retain some key strategic procurement activities, we expect to reduce our material costs by leveraging Flextronics' tactical supply chain expertise and securing local suppliers. As a result of these actions, we expect to have improved gross margins and reduced inventory when compared to historical levels.

Our third and fourth fiscal quarters tend to be our strongest quarters for new orders, while our first fiscal quarter tends to be our weakest quarter for orders. We believe that the most significant factor driving these seasonal patterns is the holiday buying season for consumer electronics products. The seasonality of our business is often masked to a significant extent, however, by the high degree of cyclicality of the semiconductor industry.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. ("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 best knowledge of current events and of actions that may impact the company in the future, actual results may be different from the estimates. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management. Those policies include revenue recognition, restructuring charges, inventory valuation, warranty, share-based compensation, retirement and post-retirement plan assumptions, valuation of goodwill and intangible assets and accounting for income taxes.

Revenue recognition. Net revenue is derived from the sale of products and services and is adjusted for 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 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 charges. We recognize a liability for restructuring costs at fair value only when the liability is incurred. 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 ("SFAS") 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, SFAS 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.

Results of Operations

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

Net revenue for fiscal year 2007 was $761 million, a decrease of $17 million, or 2.2%, from the $778 million achieved in fiscal year 2006. Net product revenue for fiscal year 2007 was $615 million, a decrease of $31 million, or 4.8%, from $646 million achieved in fiscal year 2006. The decrease in product revenue was primarily due to lower sales volume of our SOC/SIP test systems, partially offset by higher revenue from sales of our memory test systems, spurred by continued strong demand for hand-held consumer products as well as the expansion of the markets that we serve into NAND flash and flash final test.

Net product revenue from sales of our SOC/SIP/High-speed memory test systems decreased by $109 million, or 24.7%, in fiscal year 2007, compared to fiscal year 2006, primarily due to weakness in demand for our SOC/SIP/High-speed memory test systems during the first half of fiscal year 2007, particularly from sub-contractors. During the second half of fiscal year 2007, however, we did experience an increase in demand for our SOC/SIP/High-speed memory test systems, driven by our new product introductions. Net product revenue from sales of our memory test systems increased by $78 million, or 38.2%, in fiscal year 2007, compared to fiscal year 2006, primarily due to strong sales of flash memory devices as a result of greater demand for hand-held consumer products, as well as expansion of our addressable markets into NAND flash and flash final test.

Service revenue in fiscal year 2007 accounted for $146 million, an increase of $14 million, or 10.6%, compared to the $132 million achieved in fiscal year 2006. The increase in service revenue is primarily attributable to our growing installed base.

Net revenue in fiscal year 2006 was $778 million, an increase of $322 million, or 70.6%, from the $456 million achieved in fiscal year 2005. Net product revenue in fiscal year 2006 was $646 million, an increase of $291 million, or 82.0%, from the $355 million achieved in fiscal year 2005. The increase in net product revenue was primarily a result of a higher volume of sales enabled by increased overall demand for our products. Net product revenue from our SOC/SIP/high-speed memory test systems increased by $175 million, or 65.5%, with most of the sales being of the enhanced version of our 93000 Series platform. Continued customer demand for our 93000 Series platform increased our penetration in a breadth of applications, from next generation graphics and wireless gaming, to high-end SOC applications and digital consumer applications as well as SOC solutions with RF capabilities. During the fourth quarter of fiscal 2006, we experienced some weakness in demand for our SOC/SIP/high-speed memory test systems, particularly from sub-contractors. As a result, a higher portion of our net revenue during the latter part of fiscal 2006 has come from our IDM customers. Sales of our memory test systems also contributed to the net product revenue increase, with net product revenue from our memory test systems increasing by $116 million, or 131.8%. Substantially all of these sales were of the enhanced version of our Versatest V5000 Series platform, which was introduced in late fiscal year 2004. This demand was primarily a result of strong sales of flash memory devices as a result of greater demand for hand-held consumer products, as well as expansion of our addressable markets into NAND flash and flash final test. Service revenue for fiscal year 2006 accounted for $132 million, or 17.0% of net revenue, compared to $101 million, or 22.1% of net revenue for fiscal year 2005. The increase in service revenue is attributed to our growing installed base and increased services associated with a strong demand for products at the end of fiscal year 2006.

We derive a significant percentage of our net revenue from outside North America. Net revenue from customers located outside of North America represented 70.8%, 68.4% and 72.8% of total net revenue in fiscal years 2007, 2006, and 2005, respectively. Net revenue in North America was lower by 9.8% in fiscal year 2007, compared to fiscal year 2006, due to the continuing outsourcing by our North American customers to contract manufacturers in Asia. Net revenue in Asia (including Japan) was higher by 4.8% in fiscal year 2007, compared to fiscal year 2006. We expect this trend of increasing sales in Asia (including Japan) to continue as semiconductor manufacturing activities continue to concentrate in that region.

Cost of Sales

Cost of Products

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 decrease in cost of products of approximately $13 million, or 3.9%, in fiscal year 2007, compared to fiscal year 2006, was primarily due to a decrease in product shipments, cost savings realized from the streamlining of our infrastructure costs, $8 million lower restructuring and separation costs and $6 million lower excess and obsolete inventory-related charges. These decreases were partially offset by $5 million higher freight and duty expenses and $4 million higher warranty costs. Cost of products as a percent of net product revenue increased by 0.5 percentage points in fiscal year 2007, compared to fiscal year 2006, primarily as a result of a decrease in product shipments and product mix, partially offset by less inventory write-offs for discontinued products and cost savings realized from the streamlining of our infrastructure costs. Excess and obsolete inventory-related charges in fiscal year 2007 were $12 million, compared to $18 million in fiscal year 2006. In addition, we sold previously written down inventory of $4 million and $11 million in fiscal years 2007 and 2006, respectively. The sales of previously written down inventory reduced cost of products as a percentage of product revenue by approximately 0.3 and 0.9 percentage points for fiscal years 2007 and 2006, respectively.

Our cost of products included approximately $4.4 million of restructuring and separation charges in fiscal year 2007, compared to approximately $12 million in fiscal year 2006. Our cost of products also included approximately $1.7 million of SFAS No. 123(R) share-based compensation expense in both fiscal years 2007 and 2006. As of October 31, 2007, we held inventory that was previously written down by $35 million and is primarily composed of component raw material. We continue to dispose of the remaining inventory on a recurring basis.

The increase in cost of products of $103 million, or 45.2%, in fiscal year 2006, compared to fiscal year 2005, was directly related to the increase in products shipped in 2006. The decrease in cost of products as a percent of net product revenue, compared to fiscal year 2005, was a result of higher revenue, higher margins from both our product lines, less inventory write-offs for discontinued products as well as our cost savings realized from our move to a new manufacturing model. This decrease was partially offset by higher performance-based variable compensation costs in fiscal year 2006. Excess and obsolete inventory-related charges in fiscal year 2006 were $18 million, compared to $25 million in fiscal year 2005. In addition, we sold previously written down inventory of $11 million and $7 million in fiscal years 2006 and 2005, respectively. The sales of previously written down inventory reduced cost of products as a percentage of product revenue by approximately 0.9 and 1.3 percentage points for fiscal years 2006 and 2005, respectively.

Our costs of products in absolute amount are expected to increase or decrease with revenue. As a percent of net product revenue, these costs will vary depending on a variety of factors, including the mix of system configurations in a particular period, competitive and other pressures on pricing and our ability to manage inventory levels to avoid excess and obsolete inventory charges. In order to mitigate the risk and to manage our costs through the peaks and troughs of the semiconductor industry, we have streamlined our cost structure by reducing our fixed costs and adding more flexibility to our manufacturing model through the outsourcing of our manufacturing. We believe our efforts will provide us with the flexibility to respond more rapidly to changes in industry conditions and to better capitalize on market opportunities during market upturns, and will provide us with more consistent cost of products.

Cost of Services

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 increased by $6 million, or 6.2%, in fiscal year 2007, compared to fiscal year 2006, primarily due to the $14 million increase in services revenue and our increased costs needed to support a higher installed base, partially offset by cost savings realized from the streamlining of our infrastructure costs. Cost of services as a percent of service revenue decreased by 3 percentage points, from 73.5% in fiscal year 2006 to 70.5%, reflecting our better utilization of our service personnel as our installed base has increased as well as the benefit of the improved reliability and quality of our current product offering. Our cost of services also included approximately $0.8 million of SFAS No. 123(R) share-based compensation expense in fiscal year 2007, compared to approximately $0.2 million in fiscal year 2006.

Cost of services increased by $9 million, or 10.2%, in fiscal year 2006, compared to fiscal year 2005, primarily due to higher service revenue being generated from product shipments. Cost of services as a percent of service revenue decreased by 13.6 percentage points, from 87.1% in fiscal year 2005 to 73.5% in fiscal year 2006. The improvement in the cost of services margin is primarily due to the $31 million higher services revenue as well as better utilization of our service personnel as our installed base increased and benefits from the improved reliability and quality of our products. Our cost of services also included approximately $0.4 million of restructuring charges in fiscal year 2006, compared to no such charges in fiscal year 2005 and approximately $0.2 million of SFAS No. 123(R) share-based compensation expense in fiscal year 2006, compared to no such charges for fiscal year 2005.

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.

Operating Expenses

Research and Development Expenses

Research and Development. Research and development ("R&D") expense includes costs related to:

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salaries and related compensation expenses for research and development and engineering personnel;

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materials used in R&D activities;

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outside contractor expenses;

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depreciation of equipment used in R&D activities;

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facilities and other overhead and support costs for the above; and

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effective fiscal year 2006, share-based compensation.

R&D costs have generally been expensed as incurred.

Research and development expense declined by $8 million, or 8.1%, in fiscal year 2007, compared to fiscal year 2006, primarily due to lower project materials as well as cost savings realized from the streamlining of our infrastructure costs, partially offset by $0.4 million higher share-based compensation expenses. R&D expenses included approximately $1.7 million of SFAS No. 123(R) share-based compensation expenses in fiscal year 2007, compared to approximately $1.3 million for fiscal year 2006.

Research and development expense declined by $2 million, or 2.0%, in fiscal year 2006, compared to fiscal year 2005, primarily due to lower allocated cost from Agilent prior to our separation as well as our continued progress in lowering our post-separation cost structure partially offset by higher performance-based variable compensation expenses and share-based compensation expenses that were recorded in accordance with SFAS No. 123(R). R&D expenses decreased significantly as a percent of net revenue in fiscal year 2006, compared to fiscal year 2005, primarily due to the increase in revenue despite higher performance-based variable compensation expenses and share-based compensation expenses that were recorded in accordance with SFAS No. 123(R). R&D expenses included approximately $1.3 million of SFAS No. 123(R) share-based compensation expenses in fiscal year 2006, compared to no such expenses for fiscal year 2005.

We believe that we need to maintain a significant level of research and development spending in order to remain competitive and, as a result, our research and development expenses have varied only modestly in dollars but vary more significantly as a percent of revenue. As part of our separation from Agilent, we have consolidated our R&D teams in Boeblingen, Germany, for our principal SOC developments and in Cupertino, California, for our memory test products. We believe this will help us concentrate on our technology innovation and decrease our time to market with new products.

Selling, General and Administrative Expenses

Selling, General and Administrative. Selling, general and administrative ("SG&A") expense includes costs related to:

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salaries and related expenses for sales, marketing and applications engineering personnel;

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sales commissions paid to sales representatives and distributors;

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outside contractor expenses;

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other sales and marketing program expenses;

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travel and professional service expenses;

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salaries and related expenses for administrative, finance, human resources, legal and executive personnel;

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facility and other overhead and support costs for the above; and

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effective fiscal year 2006, share-based compensation.

Selling, general and administrative expenses decreased by $4 million, or 2.7%, in fiscal year 2007, compared to fiscal year 2006 primarily as a result of cost savings realized from the streamlining of our infrastructure costs, partially offset by wage increases, higher performance-based variable compensation expenses and higher share-based compensation expenses. SG&A expenses included approximately $9.6 million of SFAS No. 123(R) share-based compensation expenses in fiscal year 2007, compared to approximately $7.2 million for fiscal year 2006.

Selling, general and administrative expenses increased by $15 million, or 11.2%, in fiscal year 2006, compared to fiscal year 2005. This increase was primarily a result of higher performance-based variable compensation expenses, wage increases, higher commission costs on increased sales, and higher share-based compensation expenses that were recorded in accordance with SFAS No. 123(R). These increases were partially offset by cost savings from lower IT and infrastructure costs we experienced subsequent to our separation from Agilent. SG&A expenses included approximately $7.2 million of SFAS No. 123(R) share-based compensation expenses in fiscal year 2006, compared to no such expenses for fiscal year 2005.

In general, we believe our SG&A expenses will decrease in absolute amount compared to prior periods due to our efforts to streamline our infrastructure and consolidate excess facilities. The expected savings realized from our cost reduction efforts will be partially offset by incremental costs associated with operating as a stand-alone public company, including professional fees such as legal, regulatory and accounting compliance costs that we will incur and share-based compensation expenses that are now being recorded in accordance with SFAS No. 123(R). SG&A expenses can fluctuate due to changes in commission expenses which are tied to changes in sales volume and customer mix.

We incurred restructuring charges of $4 million, $24 million and $8 million for fiscal years 2007, 2006 and 2005, respectively. These charges were a result of Agilent's 2005 restructuring plan and Verigy's continued efforts aimed at reducing operational costs, primarily through closing, consolidating and relocating some sites and reducing and realigning our workforce.

As of October 31, 2007, we had approximately $1.8 million accrued restructuring liabilities, compared to no accrued restructuring liability as of October 31, 2006. In accordance with the separation agreements with Agilent, Agilent retained and paid for all restructuring liabilities associated with its 2005 restructuring plan, except for those liabilities related to 85 employees who were transferred to Flextronics for whom we paid approximately $3 million and are recognizing as expense over the transferred employees requisite service period.

See Note 17 "Restructuring" of the combined and consolidated financial statements for a description of the restructuring and asset impairment activity.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Quarterly Results of Operations



Our quarterly results of operations have varied in the past and are likely to continue to vary in the future primarily due to the cyclical nature of the semiconductor industry. Our third and fourth fiscal quarters tend to be our strongest quarters for new orders, while our first fiscal quarter tends to be our weakest quarter for orders. We believe that the most significant factor driving these seasonal patterns is the holiday buying season for consumer electronics products. The seasonality of our business is often masked to a significant extent by the high degree of cyclicality of the semiconductor industry. As such, we believe that period-to-period comparisons of our results of operations should not be relied upon as an indication of future performance. In future periods, the market price of our ordinary shares could decline if our revenues and results of operations are below the expectations of analysts and investors. Factors that may cause our revenue and results of operations to vary include those discussed in the “Risk Factors” in Item 1A of Part II of, and else where in, this report.

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



Net revenue in the three months ended January 31, 2008 was $200 million, an increase of $35 million, or 21.2%, from the $165 million achieved in the three months ended January 31, 2007. Net product revenue in the three months ended January 31, 2008 was $163 million, an increase of $35 million, or 27.3%, from the $128 million achieved in the three months ended January 31, 2007. This increase was primarily due to higher revenue from sales of our SOC/SIP test systems driven by the continued demand in cell phone applications, computer devices and automotive ICs, partially offset by lower revenue from sales of our memory test systems.



Service revenue for the three months ended January 31, 2008, accounted for $37 million, or 18.5% of net revenue, flat compared to the three months ended January 31, 2007. We continue to service our growing installed base through contract renewals and new shipments; however our revenue for service and support typically will not fluctuate significantly due to the fact that service revenue is recognized over the contractual period or as services are rendered.



Net revenue in North America was lower by 62.5% in the three months ended January 31, 2008, compared to the three months ended January 31, 2007, due continued outsourcing by our North American customers to contract manufacturers in Asia (including Japan). Net revenue from customers located in Asia represented 80.5% of total net revenue for the three months ended January 31, 2008, compared to 46.7% in the three months ended January 31, 2007. We expect this trend of increasing sales in Asia (including Japan) to continue as semiconductor manufacturing activities continue to concentrate in that region.

Cost of Sales



Cost of Products

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



The increase in cost of products of approximately $10 million in the three months ended January 31, 2008, compared to the three months ended January 31, 2007, was primarily due to the increase in product shipments, higher variable performance-based compensation as well as a shift in product mix. These increases were partially offset by $1 million in lower restructuring and separation costs. Also, our cost of products included $0.5 million of SFAS No. 123(R) share-based compensation expense in the three months ended January 31, 2008, compared to $0.4 million of such charges in the three months ended January 31, 2007.



Cost of products as a percent of net product revenue increased by 5.4 percentage points in the three months ended January 31, 2008, compared to the three months ended January 31, 2007, primarily due to higher sales volume and variable performance compensation, product mix and offset by lower restructuring and separation costs.



Excess and obsolete inventory-related charges were $2 million in both the three months ended January 31, 2008 and 2007. We also sold previously written down inventory of $1 million in both the three months ended January 31, 2008 and 2007. The sales of previously written down inventory improved our cost of products gross margins by approximately 0.3 percentage points in the three months ended January 31, 2008 and by 0.4 percentage points in the three months ended January 31, 2007.



As of January 31, 2008, we held $68 million of inventory, net of $36 million of reserves, composed of $30 million of raw materials, $7 million of work in progress and $31 million of finished goods. Raw materials include approximately $19 million of support inventory. We continue to dispose of previously written down inventory on a recurring basis.



Cost of Services

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



Cost of services in the three months ended January 31, 2008 increased by $3 million, compared to the three months ended January 31, 2007. Cost of services as a percent of service revenue increased by 8.1 percentage points, from 67.6% in the three months ended January 31, 2007, to 75.7% in the three months ended January 31, 2008. This margin deterioration is primarily due to higher material and overhead costs as well as duty costs needed to support our installed base. Our cost of services included $0.2 million of SFAS No. 123(R) share-based compensation expense in both the three months ended January 31, 2008 and 2007.



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

Research and Development. Research and development expense includes costs related to:



• salaries and related compensation expenses for research and development and engineering personnel;



• materials used in research and development activities;



• outside contractor expenses;



• depreciation of equipment used in research and development activities;



• facilities and other overhead and support costs for the above; and



• share-based compensation.



Research and development costs have generally been expensed as incurred.



Research and development expense in the three months ended January 31, 2008 increased in absolute dollars by $2 million compared to the same time last year. This increase was primarily due to higher expenses to support new product introductions planned for release during the later part of 2008. Research and development as a percentage of revenue decreased by 1.4 percentage points, from 13.9% in the three months ended January 31, 2007 to 12.5% in the three months ended January 31, 2008. This decrease was primarily due to increased product shipments in the three months ended January 31, 2008. Research and development expense also included $0.5 million of SFAS No. 123(R) share-based compensation expense for both the three months ended January 31, 2008 and 2007.



We believe that we need to maintain our level of research and development spending in order to remain competitive and, as a result, we expect our research and development expenses to vary only modestly.

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