**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

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**(Mark One)**

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

 

**For the quarterly period ended February 2,2008**

 

**OR**

 

**o****                          TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from             to**

 

**Commissionfile number 0-22366**

 

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**CREDENCE SYSTEMS CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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| **Delaware**                                                    | ** ** | **94-2878499**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |       | (IRS Employer  Identification No.) |

 

**1421California Circle, Milpitas, California**

**95035**

(Address ofprincipal executive offices)

(Zip Code)

 

**(408)635-4300**

(Registrant’s telephonenumber, including area code)

 

**N/A**

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

 

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

 

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

 

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

 

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

 

At February 28,2008, there were 102,188,655 shares of the Registrant’s common stock, $0.001par value per share, outstanding.

 

 

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**CREDENCE SYSTEMS CORPORATION**

 

**INDEX**

 
| ** **    | ** **                                                                                  | **PAGE NO.** |
|---------------|---------------------------------------------------------------------------------------------|-------------------|
| PART I.  | FINANCIAL INFORMATION                                                                       |              |
|          |                                                                                        |              |
| Item 1.       | Financial Statements                                                                        | 3                 |
|          |                                                                                        |              |
|          | Condensed  Consolidated Balance Sheets                                                      | 3                 |
|          |                                                                                        |              |
|          | Condensed  Consolidated Statements of Operations                                            | 4                 |
|          |                                                                                        |              |
|          | Condensed  Consolidated Statements of Cash Flows                                            | 5                 |
|          |                                                                                        |              |
|          | Notes to  Condensed Consolidated Financial Statements                                       | 6                 |
|          |                                                                                        |              |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 24                |
|          |                                                                                        |              |
| Item 3.       | Quantitative  and Qualitative Disclosures about Market Risk                                 | 32                |
|          |                                                                                        |              |
| Item 4.       | Controls and  Procedures                                                                    | 33                |
|          |                                                                                        |              |
| PART II. | OTHER INFORMATION                                                                           |              |
|          |                                                                                        |              |
| Item 1.       | Legal Proceedings                                                                           | 33                |
|          |                                                                                        |              |
| Item 1A. | Risk Factors                                                                                | 33                |
|          |                                                                                        |              |
| Item 2.       | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 47                |
|          |                                                                                        |              |
| Item 3.       | Defaults Upon  Senior Securities                                                            | 47                |
|          |                                                                                        |              |
| Item 4.       | Submission of  Matters to a Vote of Security Holders                                        | 47                |
|          |                                                                                        |              |
| Item 5.       | Other Information                                                                           | 47                |
|          |                                                                                        |              |
| Item 6.       | Exhibits                                                                                    | 47                |
|          |                                                                                        |              |
| **Signature** |                                                                                        | 48                |

 

2

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** **

**PART I - FINANCIAL INFORMATION**

 

**Item 1. - F****INANCIAL****S****TATEMENTS**

 

**CREDENCESYSTEMS CORPORATION**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(inthousands)**

**(unaudited)**

 
| ** **                                                            | ** ** | **February 2,  2008** | ** ** | **November 3,  2007(a)** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| **ASSETS**                                                            |       |                       |       |                          |       |
| Current assets:                                                       |       |                       |       |                          |       |
| Cash and cash  equivalents                                            |       | $                          | 215,502    |                          | $          | 179,264 |   |
| Short-term  investments                                               |       | 25,275                     |       | 62,869                        |       |
| Accounts  receivable, net of allowance of $851 and $883, respectively |       | 58,319                     |       | 64,174                        |       |
| Inventories                                                           |       | 51,339                     |       | 62,506                        |       |
| Income tax  receivable                                                |       | 444                        |       | 440                           |       |
| Deferred income  taxes                                                |       | 9,885                      |       | 9,902                         |       |
| Prepaid expenses  and other current assets                            |       | 11,778                     |       | 16,260                        |       |
| Total current  assets                                                 |       | 372,542                    |       | 395,415                       |       |
| Property and equipment, net                                           |       | 46,730                     |       | 75,299                        |       |
| Goodwill                                                              |       | —                     |       | 2,606                         |       |
| Other intangible assets, net                                          |       | 54,311                     |       | 65,966                        |       |
| Other assets                                                          |       | 43,807                     |       | 50,026                        |       |
| Total assets                                                          |       | $                          | 517,390    |                          | $          | 589,312 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                        |       |                       |       |                          |       |
| Current liabilities:                                                  |       |                       |       |                          |       |
| Accounts payable                                                      |       | $                          | 14,078     |                          | $          | 20,365 |   |
| Accrued expenses  and other liabilities                               |       | 32,329                     |       | 29,500                        |       |
| Accrued payroll  and related liabilities                              |       | 13,079                     |       | 16,715                        |       |
| Convertible  subordinated notes, current portion                      |       | 70,700                     |       | 70,700                        |       |
| Deferred revenue                                                      |       | 22,830                     |       | 27,679                        |       |
| Income taxes  payable                                                 |       | (1,114                     | )          | 8,563                         |       |
| Accrued warranty                                                      |       | 8,827                      |       | 12,384                        |       |
| Deferred profit                                                       |       | 1,536                      |       | 2,703                         |       |
| Total current  liabilities                                            |       | 162,265                    |       | 188,609                       |       |
| Convertible subordinated notes, long-term portion                     |       | 120,178                    |       | 119,728                       |       |
| Long-term restructuring liabilities                                   |       | 1,270                      |       | 1,249                         |       |
| Long-term deferred income taxes                                       |       | 9,473                      |       | 9,473                         |       |
| Long-term income taxes payable                                        |       | 6,629                      |       | —                        |       |
| Other liabilities                                                     |       | 33,807                     |       | 33,998                        |       |
| Total liabilities                                                     |       | 333,622                    |       | 353,057                       |       |
| Stockholders’ equity                                             |       | 183,768                    |       | 236,255                       |       |
| Total  liabilities and stockholders’ equity                      |       | $                          | 517,390    |                          | $          | 589,312 |   |

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

 

See accompanying notes.

 

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**CREDENCESYSTEMS CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands, except per share amounts)**

**(unaudited)**

 
| ** **                                          | ** ** | **Three Months Ended**     | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|
| ** **                                          | ** ** | **February 2,  2008** | ** ** | **February 3,  2007** | ** ** |
| Net sales:                                          |       |                       |       |   |   |
| Systems and  upgrades                               |       | $                          | 41,087     |   | $ | 90,324 |   |
| Service and  spare parts                            |       | 22,115                     |       | 28,473 |   |
| Total net sales                                     |       | 63,202                     |       | 118,797 |   |
| Cost of goods sold                                  |       |                       |       |   |   |
| Systems and upgrades                                |       | 19,095                     |       | 46,308 |   |
| Service and  spare parts                            |       | 15,284                     |       | 20,987 |   |
| Restructuring  charges                              |       | 2,781                      |       | — |   |
| Total cost of  goods sold                           |       | 37,160                     |       | 67,295 |   |
| Gross margin                                        |       | 26,042                     |       | 51,502 |   |
| Operating expenses:                                 |       |                       |       |   |   |
| Research and  development                           |       | 17,235                     |       | 21,178 |   |
| Selling, general  and administrative                |       | 21,522                     |       | 25,839 |   |
| Amortization of  purchased intangibles              |       | 4,451                      |       | 4,455 |   |
| Impairment  charges                                 |       | 22,955                     |       | — |   |
| Restructuring  charges                              |       | 10,669                     |       | 492 |   |
| Loss on disposal  of facilities                     |       | 3,600                      |       | — |   |
| Total operating  expenses                           |       | 80,432                     |       | 51,964 |   |
| Operating loss                                      |       | (54,390                    | )          | (462 | ) |
| Interest income                                     |       | 2,620                      |       | 1,160 |   |
| Interest expense                                    |       | (2,530                     | )          | (1,188 | ) |
| Other income (expenses), net                        |       | (1,108                     | )          | 2,491 |   |
| Income (loss) before income tax provision           |       | (55,408                    | )          | 2,001 |   |
| Provision for income taxes                          |       | 719                        |       | 2,012 |   |
| Net loss                                            |       | $                          | (56,127    | ) | $ | (11 | ) |
| Net loss per share                                  |       |                       |       |   |   |
| Basic                                               |       | $                          | (0.55      | ) | $ | (0.00 | ) |
| Diluted                                             |       | $                          | (0.55      | ) | $ | (0.00 | ) |
| Number of shares used in computing per share amount |       |                       |       |   |   |
| Basic                                               |       | 101,691                    |       | 100,612 |   |
| Diluted                                             |       | 101,691                    |       | 100,612 |   |

 

See accompanying notes.

 

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**CREDENCESYSTEMS CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**

 

 
| ** **                                                                                 | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                 | ** ** | **February 2,  2008** | ** ** | **February 3,  2007** | ** ** |
| **Cash flows from operating activities:**                                                  |       |                       |       |   |   |
| Net loss                                                                                   |       | $                          | (56,127    | ) | $ | (11 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                       |       |   |   |
| Depreciation and  amortization                                                             |       | 11,568                     |       | 12,565 |   |
| Share-based  compensation charges                                                          |       | 1,153                      |       | 1,821 |   |
| Provision for  inventory write downs                                                       |       | 465                        |       | 281 |   |
| Provision  (recovery) for allowance for doubtful accounts                                  |       | 33                         |       | (357 | ) |
| Impairment of  goodwill and long-lived assets                                              |       | 22,955                     |       | — |   |
| Loss on disposal  of property and equipment                                                |       | 3,600                      |       | 859 |   |
| Gain on  exchanged convertible notes                                                       |       | —                     |       | (2,955 | ) |
|                                                                                       |       |                       |       |   |   |
| Changes in  operating assets and liabilities:                                              |       |                       |       |   |   |
| Accounts  receivable, net                                                                  |       | 3,523                      |       | 2,672 |   |
| Inventories                                                                                |       | (527                       | )          | (2,852 | ) |
| Income tax  receivable and payable                                                         |       | 1,188                      |       | (779 | ) |
| Prepaid expenses  and other current assets                                                 |       | 4,260                      |       | (401 | ) |
| Other assets                                                                               |       | (1,765                     | )          | (4,585 | ) |
| Accounts payable                                                                           |       | (6,329                     | )          | 763 |   |
| Accrued expenses  and other current liabilities                                            |       | (5,389                     | )          | (7,275 | ) |
| Deferred profit                                                                            |       | 973                        |       | 1,478 |   |
| Net cash  provided by (used in) operating activities                                       |       | (20,419                    | )          | 1,224 |   |
| **Cash flows from investing activities:**                                                  |       |                       |       |   |   |
| Purchases of  available-for-sale securities                                                |       | (3,194                     | )          | — |   |
| Maturities of  available-for-sale securities                                               |       | 37,566                     |       | — |   |
| Sales of  available-for-sale securities                                                    |       | 3,472                      |       | — |   |
| Acquisition of  property and equipment                                                     |       | (745                       | )          | (253 | ) |
| Proceeds from  sale of property and equipment                                              |       | 18,959                     |       | 2,691 |   |
| Net cash  provided by investing activities                                                 |       | 56,058                     |       | 2,438 |   |
| **Cash flows from financing activities:**                                                  |       |                       |       |   |   |
| Issuance of  common stock                                                                  |       | 1                          |       | 2 |   |
| Proceeds from  issuance of convertible notes, net of issue costs                           |       | —                     |       | 44,129 |   |
| Net cash  provided by financing activities                                                 |       | 1                          |       | 44,131 |   |
| Effects of exchange rate on cash and cash  equivalents                                     |       | 598                        |       | (498 | ) |
| Net increase in cash and cash equivalents                                                  |       | 36,238                     |       | 47,295 |   |
| Cash and cash equivalents at beginning of period                                           |       | 179,264                    |       | 95,635 |   |
| Cash and cash equivalents at end of period                                                 |       | $                          | 215,502    |   | $ | 142,930 |   |
| **Supplemental disclosures of cash flow  information:**                                    |       |                       |       |   |   |
| Interest paid                                                                              |       | $                          | 635        |   | $ | 1,193 |   |
| Income taxes  paid (refunded)                                                              |       | $                          | (445       | ) | $ | 2,380 |   |
| **Non-cash investing and financing activities:**                                           |       |                       |       |   |   |
| Net transfers of  inventory to property and equipment                                      |       | $                          | 294        |   | $ | 541 |   |
| Unrealized loss  on available-for-sale securities                                          |       | $                          | 226        |   | $ | — |   |

 

See accompanying notes.

 

5

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**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.****                                     ****Quarterly FinancialStatements**

 

The unauditedcondensed consolidated financial statements and related notes for the threemonth periods ended February 2, 2008 and February 3, 2007 areunaudited but include all adjustments (consisting solely of normal recurringadjustments) which are, in the opinion of management, necessary for a fairpresentation of the financial position and results of operations of CredenceSystems Corporation (Credence or the Company) for the interim periods, inaccordance with U.S. generally accepted accounting principles. The results ofoperations for the three-month period ended February 2, 2008 and February 3,2007 are not necessarily indicative of the operating results to be expected forthe full fiscal year. The information included in this report should be read inconjunction with the Company’s audited consolidated financial statements andnotes thereto for the fiscal year ended November 3, 2007 included in theCompany’s most recent Annual Report on Form 10-K and the additional riskfactors contained herein and therein, including, without limitation, risksrelating to the importance of timely product introduction, fluctuations in theCompany’s quarterly net sales and operating results, limited systems sales,backlog, cyclicality of the semiconductor industry, management of fluctuationsin our operating results, expansion of our product lines, limited sources ofsupply, reliance on the Company’s outsourced manufacturing and logistics,reliance on distributors, the Company’s highly competitive industry,customization of products, rapid technological change, customer concentration,lengthy sales cycles, changes in financial accounting standards and accountingestimates, dependence on key personnel, international operations and sales,proprietary rights, legal proceedings, compliance with environmentalregulations, volatility of the Company’s stock price, retention of executiveoffices and key personnel, requirement of significant cash and futurefinancing, terrorist attacks and other geopolitical instability, effects of thechanges in Securities law and regulations, Sarbanes-Oxley Act of 2002, andeffects of certain anti-takeover provisions, as set forth in this Report. Anyparty interested in receiving a free copy of the Form 10-K or the Company’sother publicly available documents should write to the Chief Financial Officerof the Company.

 

*Descriptionof Business* —Credence was incorporated in California in March 1982 and wasreincorporated in Delaware in October 1993. The principal businessactivity of the Company is the design, development, manufacture, sale andservice of integrated test solutions throughout the design, validation andproduction processes for semiconductors.

 

*Basisof Presentation —*Theaccompanying unaudited condensed consolidated financial statements include theaccounts of the Company and its wholly-owned subsidiaries. All significantintercompany transactions and balances have been eliminated.

 

*CriticalAccounting Policies and Use of Estimates* — The preparation of the accompanying unauditedcondensed consolidated financial statements in accordance with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the amounts reported in the unauditedCondensed Consolidated Financial Statements and accompanying notes. Actualresults could differ from those estimates. On an on-going basis, the Companyevaluates its estimates, including those related to revenue recognition,allowance for doubtful accounts, inventory valuation and residual valuesrelated to leased products, long-lived assets and intangible valuation,warranty accrual, deferred taxes, restructuring charges and other accruedliabilities, share-based compensation and legal contingencies. The Companybases its estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources.

 

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

 

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*Revenue Recognition*

 

The Companyrecognizes revenue on the sale of semiconductor manufacturing equipment underSecurities and Exchange Commission’s Staff Accounting Bulletin No. 104,“Revenue Recognition,” (SAB 104), when title and risk of loss have passed tothe customer, there is persuasive evidence of an arrangement, delivery hasoccurred or services have been rendered, the sales price is fixed ordeterminable, collection is reasonably assured and customer acceptance criteriahave been successfully demonstrated. With respect to arrangements with multipledeliverables, the Company follows the guidance in Emerging Issue Task ForceNo. 00-21, “Revenue Arrangements with Multiple Deliverables”(EITF 00-21), to determine whether there is more than one unit ofaccounting. To the extent that the deliverables are separable into multipleunits of accounting, the Company then allocates the total fee on sucharrangements to the individual units of accounting using the residual method.Under the residual method, the amount of consideration allocated to thedelivered items equals the total arrangement consideration less the aggregatefair value of the undelivered items.  TheCompany then recognizes revenue for each unit of accounting when the deliverableshave been met for following the guidance provided in SAB 104.

 

Revenuerecognition policies are applied consistently among the Company’s semiconductormanufacturing equipment product lines. Product revenue is recognized upon shipmentonly when achievement of customer acceptance criteria can be demonstrated priorto shipment, which generally is the case with mature products, and when allother deliverables are delivered or the Company has established fair value forthe undelivered items.  Products areclassified as mature after system acceptance has been consistentlydemonstrated. When the customer acceptance criteria cannot be demonstratedprior to shipment, revenue and the related cost of goods sold are deferreduntil customer acceptance is obtained. The Company warrants its products to its customers generally for oneyear from the date of shipment. In addition to standard warranties, the Companymay offer customers extended warranty services for a fixed fee.  Extended warranty services consist of servicecontracts which can be purchased at the time of product sale or at thecompletion of the original warranty period. The company has established fair value for service contracts based uponthe price when sold separately.  Revenuefor service contracts is recognized on a straight-line basis over theapplicable term of the contract.  Revenuerelated to the fair value of the installation obligation is recognized uponcompletion of the installation. 

 

Deferred revenueprimarily consists of the unrecognized portions of extended warranty servicecontracts and other undelivered services, including installations.  Deferred profit consists of the unrecognizedgross margin on equipment that was shipped to certain customers, but for whichthe revenue and cost of goods sold are not recognized because the customer-specifiedacceptance criteria has not been met as of the fiscal period end or because thecustomer is deemed to be a high credit risk and payment has not been receivedas of the fiscal period end.

 

As the Companyintroduces new products and enhancements certain revenue from sales of thesenew systems are deferred until the revenue recognition requirements of theCompany’s revenue recognition policy are satisfied.  In the past, the Company experiencedsignificant delays in the introduction and acceptance of new testers as well ascertain enhancements to the Company’s existing testers. Delays in introducing aproduct or delays in the Company’s ability to obtain customer acceptance, if theyoccur in the future, will delay the recognition of revenue and gross profit bythe Company.

 

The Company hasembedded software in its semiconductor manufacturing equipment. The Companybelieves this embedded software is incidental to its products and therefore itis excluded from the scope of Statement of Position 97-2, “Software RevenueRecognition” (SOP 97-2), since the embedded software in the Company’s productsis not sold separately, cannot be used on another vendor’s products, and theCompany cannot fundamentally enhance or expand the capability of the equipmentwith new or revised embedded software. In addition, the equipment’s principalperformance characteristics are governed by digital speed and pin count, whichare primarily a function of the hardware.

 

7

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Lease revenue isrecorded in accordance with Statement of Financial Accounting StandardNo. 13, “Accounting for Leases,” (SFAS 13), which requires that alessor account for each lease by either the sales-type or operating method.Revenue from sales-type leases is recognized at the net present value of futurelease payments. Revenue from operating leases is recognized over the leaseperiod.  

 

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

 

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

 

**2.****                                     ****Guarantees**

 

The Companyaccounts for guarantees in accordance with Financial Accounting Standards Board(FASB) Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees to Others, aninterpretation of FASB Statements No. 5, 57 and 107 and a rescission ofFASB Interpretation No. 34” (FIN 45). Accordingly, the Companyevaluates its guarantees to determine whether (a) the guarantee isspecifically excluded from the

 

8

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scope of FIN 45, (b) theguarantee is subject to FIN 45 disclosure requirements only, but notsubject to the initial recognition and measurement provisions, or (c) theguarantee is required to be recorded in the financial statements at fair value.The Company has evaluated its guarantees and has concluded that they are eithernot within the scope of FIN 45 or do not require recognition in thefinancial statements.

 

The Company’scorporate by-laws require that the Company indemnify its officers anddirectors, as well as those who act as directors and officers of other entitiesat the Company’s request, against expenses, judgments, fines, settlements andother amounts actually and reasonably incurred in connection with anyproceedings arising out of their services to the Company. In addition, theCompany has entered into separate indemnification agreements with each directorand each executive officer of the Company that provide for indemnification ofthese directors and officers under similar circumstances and under additionalcircumstances. The indemnification obligations are more fully described in theby-laws and the indemnification agreements. The Company purchases standarddirectors and officers insurance to cover claims or a portion of the claimsmade against its directors and officers. Since a maximum obligation is notexplicitly stated in the Company’s by-laws or in the indemnification agreementsand will depend on the facts and circumstances that arise out of any futureclaims, the overall maximum amount of the obligations cannot be reasonablyestimated. Historically, the Company has not been required to make paymentsrelated to these obligations, and the fair value for these obligations is zeroon the consolidated balance sheet as of February 2, 2008.

 

As is customary inthe Company’s industry and as provided for under local law in the United Statesand other jurisdictions, many of the Company’s standard contracts provideremedies to customers and others with whom the Company does business, such asdefense, settlement, or payment of judgment for intellectual property claimsrelated to the use of the Company’s products. From time to time, the Companyindemnifies customers, as well as the Company’s suppliers, contractors, lessorsunder operating lease agreements for environmental matters, lessees, companiesthat purchase the Company’s businesses or assets and others with whom theCompany enters into contracts, against combinations of loss, expense, orliability arising from various triggering events related to the sale and theuse of the Company’s products and services such as warranty, the use of theirgoods and services, the use of facilities and state of the Company’s ownedfacilities, the state of the assets and businesses that the Company sells andother matters covered by such contracts, usually up to a specified maximumamount. Based on past experience, claims made under such indemnifications arerare and the associated estimated fair value of the liability is not material.

 

**3.****                                     ****Share-Based compensation**

 

**Stock Option Plans**

 

The Company has ashare-based compensation program that provides its Board of Directors broaddiscretion in creating employee equity incentives. This program includesincentive and non-statutory stock options, restricted stock units and othertypes of equity granted under various plans, the majority of which are stockholderapproved. Stock options are generally time-based, vesting over a four-yearperiod with 12.5% of the granted shares vesting six months after the grantdate, and the remaining shares vesting at the rate of 6.25% each quarterthereafter for the following 14 quarters over four years and expire seven toten years from the grant date. Additionally, the Company has an Employee StockPurchase Plan (ESPP) that allows employees to purchase shares of common stockat 85% of the fair market value at the lower of either the date of enrollmentor the date of purchase. Shares issued as a result of stock option exercisesand the Company’s ESPP are generally from the Company’s new shares. As of February 2,2008, the Company had approximately 2.7 million shares of common stockreserved for future issuance under the stock option plans and ESPP.

 

On August 9,2000, the Board of Directors authorized the Company’s Supplemental Stock OptionPlan (the “2000 Plan”) and authorized 500,000 shares for issuance. Thisadditional reserve of shares supplements the Company’s 1993 Stock Option Planand is for issuance to individuals employed by the Company who are neitherofficers of the Company nor members of the Board. On November 27, 2000 theBoard of Directors authorized an additional 500,000 shares for issuance underthe Supplemental Stock Option Plan. In addition, on November 27, 2001, theBoard of Directors authorized an additional 500,000 shares for issuance underthe Supplemental Stock Option Plan.

 

In fiscal year2005, the Company’s Board of Directors and stockholders approved the 2005 StockIncentive Plan (the “2005 Plan”) which provides for the grant of options topurchase shares of the Company’s common stock, stock appreciation rights andrestricted stock to employees, members of the Board of Directors andconsultants. The maximum number of shares available for grant under the 2005Plan is 5.9 million shares.

 

During fiscal year2005, the 1993 Stock Option Plan (the “1993 Plan”), under which the Companypreviously granted options to employees and members of the Board of Directors,expired. However, outstanding options granted under the 1993 Plan remainsexercisable in accordance with the terms of the original grant agreements.

 

9

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In August 2005,the Company’s Board of Directors approved the accelerated vesting of certainunvested and “out-of-the-money” non-qualified stock options previously awardedto employees and officers with option exercise prices equal to or greater than$9.15. Options held by non-employee directors are excluded from the vestingacceleration. In addition, in order to prevent executive officers fromunintended personal benefits, the Company’s executive officers have agreed tothe imposition of restrictions on any shares received through the exercise ofaccelerated options. Those restrictions will prevent the sale of any sharesreceived from the exercise of an accelerated option until the earlier of theoriginal vesting date of the option or the executive officer’s termination ofemployment. The $9.15 price was selected because it was higher than the closingprice of the Company’s common stock of $8.84 on August 29, 2005, the dateof this acceleration. The accelerated options represent approximately15 percent or approximately 2.8 million shares of the total of alloutstanding Credence options on August 29, 2005. The acceleration wasintended to reduce the stock option expense the Company would be required torecord after the adoption of Statement of Financial Accounting Standard No. 123(R)—“Share-BasedPayment” (SFAS 123(R)). This acceleration reduced approximately$10.0 million of stock option expenses under SFAS 123(R) whichwould have been recognized as an expense through December 2008.

 

In calculating thecompensation cost under SFAS 123 (R), the Company estimates the fair value ofeach option grant on the date of grant using the Black-Scholes-Merton optionspricing  formula and a single optionaward approach. This fair value is then amortized on a straight-line basis overthe requisite service periods of the awards, which is generally the vestingperiod or the remaining service (vesting) period. The Black-Scholes-Mertonoption pricing model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable. Inaddition, the Black-Scholes-Merton model requires the input of highlysubjective assumptions including the expected stock price volatility andexpected term.

 

In April, July andAugust 2007 and January 2008, the Company’s Board of Directorsapproved inducement stock option grants to certain officers of the Companywhich were made outside of any current Company plan. The inducement stockoptions are granted out of the Company’s authorized common stock. The Companyelected to make inducement option grants to induce and attract higher qualifiedcandidates to accept employment with the Company and to fill open officerpositions. These inducement option grants were valued under SFAS 123(R) usingthe same assumptions and methodology that the Company used for its employeeoption grants from the Company plan. The fair value is marked to market untilthe underlying shares are registered. As of February 2, 2008 there were976,875 shares issued and outstanding under these awards.

 

The followingtable illustrates the share-based compensation expense resulting from stockoptions and ESPP included in the unaudited condensed consolidated statement ofoperations for the three-month periods ended February 2, 2008 and February 3,2007 (in thousands):

 

 
| ** **                                                    | ** ** | **Three Months  Ended  February 2, 2008** | ** ** | **Three Months  Ended  February 3, 2007** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Cost of goods sold                                            |       | $                                                        | 162        |                                                     | $          | 98 |   |
| Research and development                                      |       | 257                                                      |       | 408                                                      |       |
| Selling, general and administrative                           |       | 734                                                      |       | 1,197                                                    |       |
| Share-based compensation expense before income taxes  benefit |       | $                                                        | 1,153      |                                                     | $          | 1,703 |   |
| Income tax benefit                                            |       | —                                                   |       | —                                                   |       |
| Share-based compensation expense after income taxes  benefit  |       | $                                                        | 1,153      |                                                     | $          | 1,703 |   |

 

As of February 2,2008 and February 3, 2007, the Company capitalized $0.1 million and $0.1million of share-based compensation expense as inventory, respectively;therefore, such amounts are excluded in the cost of goods sold amounts above.

 

The following is asummary of activity under the Company’s stock option plan for the three monthsended February 2, 2008:

 

10

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| ** **                                           | ** ** | **Options  Available  for Grant  (In thousands)** | ** ** | **Number of  Options  Outstanding  (In thousands)** | ** ** | **Weighted  Average  Exercise Price  per share** | ** ** | **Aggregate  Intrinsic Value  (In thousands)** | ** ** | **Weighted  Average  Remaining  Contractual Life  (In years)** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| Balance at  November 3, 2007                    |       | 2,039                                                  |       | 15,266                                                   |       | $                                                     | 11.00      |                                                |       |                                                                |       |   |
| Options granted                                      |       | (169                                                   | )          | 550                                                      |       | $                                                     | 2.17       |                                                |       |                                                                |       |   |
| Options canceled                                     |       | 475                                                    |       | (607                                                     | )          | $                                                     | 5.11       |                                                |       |                                                                |       |   |
| Options forfeited/expired                       |       | —                                                 |       | (444                                                     | )          | $                                                     | 14.85      |                                                |       |                                                                |       |   |
| Options  exercised                                   |       | —                                                 |       | (51                                                      | )          | $                                                     | 1.07       |                                                |       |                                                                |       |   |
| Balance at  February 2, 2008                    |       | 2,345                                                  |       | 14,714                                                   |       | $                                                     | 10.79      |                                                | $          | 23,801                                                              |       | 4.53 |   |
| Vested or  expected to vest at February 2, 2008 |       |                                                   |       | 10,564                                                   |       | $                                                     | 13.01      |                                                | $          | 7,699                                                               |       | 4.02 |   |
| Exercisable at  February 2, 2008                |       |                                                   |       | 10,514                                                   |       | $                                                     | 13.01      |                                                | $          | 7,633                                                               |       | 4.02 |   |

 

Restricted stockunits are granted from the pool of options available for grant. The Company’splan requires that for every share of restricted stock unit issued, the Companywill be counted against the plan limit as 1.4 shares in the above table.

 

Theweighted-average grant date fair value per options granted during the threemonths ended February 2, 2008 and February 3, 2007 was $1.20 and$2.63, respectively. The total intrinsic value of options exercised during thethree months ended February 2, 2008 and February 3, 2007 was $1,000and $7,000, respectively. Cash proceeds from the exercise of stock options were$1,000 and $2,000 for the three months ended February 2, 2008 and February 3,2007, respectively. No income tax benefit was realized from the stock optionexercises during the three-month periods ended February 2, 2008 and February 3,2007. Share-based compensation expense related to stock options recognizedunder SFAS 123(R) for the three months ended February 2, 2008 and February 3,2007 was $0.9 million and $1.4 million, respectively. The Company generallysettles employee stock option exercises with newly issued common shares. At February 2,2008, there was $10.3 million of unrecognized share-based compensation expenserelated to non-vested options and that is expected to be recognized over aweighted-average period of 2.7 years.

 

The fair value ofoption grants was estimated by using the Black-Scholes-Merton model with thefollowing weighted-average assumptions for the three months ended February 2,2008 and February 3, 2007, respectively:

 

 
| ** **               | ** ** | **Three Months Ended**     | ** ** |
|--------------------------|------------|----------------------------|------------|
| ** **               | ** ** | **February 2,  2008** | ** ** | **February 3,  2007** | ** ** |
| Expected volatility      |       | 64                         | %          | 59 | % |
| Expected Dividend yield  |       | —                     |       | — |   |
| Risk-free interest rate  |       | 3.17                       | %          | 4.6 | % |
| Expected term (in years) |       | 4.75                       |       | 4.0 |   |

 

*ExpectedVolatility*: TheCompany’s computation of expected volatility for the three-month periods ended February 2,2008 and February 3, 2007 is based on a combination of impliedvolatilities from traded options on the Company’s stock and historicalvolatility. The selection of a combination of the implied and historicalvolatility approach was based upon the availability of actively traded optionson the Company’s stock and the Company’s assessment that this combination ismore representative of future stock price trends than historical volatilityalone.

 

*DividendYield:*Thedividend yield assumption is based on the Company’s history and expectation ofdividend payouts.

 

*Risk-FreeInterest Rate:*Therisk-free interest rate is based on the U.S. Treasury yield curve in effect atthe time of grant for the expected term of the option.

 

11

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* *

*Expected Term:*The Company’s expected term representsthe period that the Company’s share-based awards are expected to be outstandingand was determined for the three-month periods ended February 2, 2008 and February 3,2007 based on historical experience of similar awards, giving consideration tothe contractual terms of the share-based awards, vesting schedules andexpectations of future employee exercise behavior.

 

*Forfeitures Rate:* Compensation expense recognized inthe consolidated statement of operations for the three-month periods ended February 2,2008 and February 3, 2007 is based on awards ultimately expected to vestand it reflects estimated forfeitures. SFAS 123(R) requires forfeitures tobe estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates. Prior to adoption ofSFAS 123(R), the Company accounted for forfeitures as they occurred.

 

**Employee Stock Purchase Plan (ESPP)**

 

In 1994, the Company adopted the 1994 Employee StockPurchase Plan (the “1994 Plan”), which provides direct employees, employed withthe Company for at least thirty consecutive days as of the entry date into anyoffering period, with the opportunity to acquire shares of the Company’s commonstock. Employees may contribute up to 10% of their base salary to the plan. TheCompany has a six-month purchase plan within the offering period. The purchaseprice is 85% of the fair market value per share of common stock at thebeginning of the offering period or the end of the purchase period, whicheveris lower. The plan restricts the maximum number of shares that an employee canpurchase to 1,500 shares each semi-annual period and to $25,000 worth of commonstock each year. At February 2, 2008, there were 309,000 shares reservedfor issuance under the 1994 Plan.

 

The fair value of issuances under the 1994 Plan isestimated on the issuance date by applying the principles of FASB TechnicalBulletin 97-1 (FTB 97-1), “Accounting under Statement 123 for Certain EmployeeStock Purchase Plan with a Look Back Option” and using the Black-Scholes-Mertonoptions pricing model. There were no awards granted and no stock purchasesunder our ESPP during the three months ended February 2, 2008 and February 3,2007. Share-based compensation expense related to employee stock purchasesrecognized under SFAS 123(R) for the three months ended February 2,2008 and February 3, 2007 was $0.2 million and $0.3 million, respectively.At February 2, 2008, there was $76,000 of unrecognized share-basedcompensation expense related to outstanding ESPP shares and that is expected tobe recognized over one month period.

 

**4.****                                     ****Balance Sheet Components**

 

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

 
| ** **      | ** ** | **February 2,  2008** | ** ** | **November 3,  2007** | ** ** |
|-----------------|------------|----------------------------|------------|----------------------------|------------|
| Raw materials   |       | $                          | 34,301     |                       | $          | 43,501 |   |
| Work-in-process |       | 13,735                     |       | 15,837                     |       |
| Finished goods  |       | 3,303                      |       | 3,168                      |       |
| Total           |       | $                          | 51,339     |                       | $          | 62,506 |   |

 

12

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

 
| ** **                    | ** ** | **February 2,  2008** | ** ** | **November 3,  2007** | ** ** |
|-------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Land                          |       | $                          | 15,664     |                       | $          | 19,320 |   |
| Buildings                     |       | 14,864                     |       | 36,298                     |       |
| Machinery and equipment       |       | 103,779                    |       | 108,839                    |       |
| Software                      |       | 33,207                     |       | 34,059                     |       |
| Leasehold improvements        |       | 29,468                     |       | 41,663                     |       |
| Furniture and fixtures        |       | 10,051                     |       | 10,061                     |       |
|                          |       | 207,033                    |       | 250,240                    |       |
| Less accumulated depreciation |       | (160,303                   | )          | (174,941                   | )          |
| Total                         |       | $                          | 46,730     |                       | $          | 75,299 |   |

 

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

 
| ** **                                       | ** ** | **February 2,  2008** | ** ** | **November 3,   2007** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| Receivable from contract equipment manufacturers |       | $                          | 100        |                        | $          | 2,098 |   |
| Other prepaid expenses                           |       | 11,678                     |       | 14,162                      |       |
| Total                                            |       | $                          | 11,778     |                        | $          | 16,260 |   |

 

Other assets consist of the following (in thousands):

 
| ** **          | ** ** | **February 2,  2008** | ** ** | **November 3,  2007** | ** ** |
|---------------------|------------|----------------------------|------------|----------------------------|------------|
| Product spares      |       | $                          | 27,549     |                       | $          | 32,077 |   |
| Product consignment |       | 4,886                      |       | 6,179                      |       |
| Other assets        |       | 11,372                     |       | 11,770                     |       |
| Total               |       | $                          | 43,807     |                       | $          | 50,026 |   |

 

Product spare parts that are used in the Company’sservice business are classified as other assets and are depreciated using thestraight-line method over five years. Amortization expense was approximately$2.3 million and $2.7 million for three months ended February 2, 2008 and February 3,2007, respectively.

 

Product consignments to internal and externalcustomers are classified as other assets and are depreciated using thestraight-line method over 36 months. Amortization expense was approximately$0.5 million and $1.3 million for the three months ended February 2, 2008and February 3, 2007, respectively.

 

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

 
| ** **                      | ** ** | **February 2,  2008** | ** ** | **November 3,  2007** | ** ** |
|---------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Accrued distributor commissions |       | $                          | 1,029      |                       | $          | 2,024 |   |
| Accrued bonuses                 |       | 399                        |       | 2,517                      |       |
| Accrued restructuring expenses  |       | 13,958                     |       | 2,213                      |       |
| Accrued value added taxes       |       | 1,450                      |       | 3,436                      |       |
| Accrued interest expense        |       | 1,120                      |       | 2,464                      |       |
| Other accrued liabilities       |       | 14,373                     |       | 16,846                     |       |
| Total                           |       | $                          | 32,329     |                       | $          | 29,500 |   |

 

**5.****                                     ****Convertible SubordinatedNotes**

 

***ConvertibleSubordinated Notes due 2008***

 

In June 2003, theCompany issued $180.0 million of 1.5% convertible subordinated notes (theNotes) due May 2008 in a private placement. The Notes are unsecuredobligations of the Company and are subordinated to all present and futuresenior indebtedness of the Company. Interest is payable semiannually on May 15and November 15, commencing

 

13

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November 15, 2003. The Notes are convertibleinto common stock of the Company at an initial conversion price of $11.31 pershare, subject to adjustment in certain dilution events. The Notes do notinclude a beneficial conversion feature or financial covenants. Expenses of$5.8 million associated with the offering were capitalized upon issuance andare included in other current assets and in other long-term assets in theunaudited condensed consolidated balance sheets. Such expenses are beingamortized to interest expenses over the term of the Notes. The Companycontinues to use the net proceeds of the offering for general corporatepurposes, including working capital and potential acquisitions.

 

In September 2006, the Company purchased $35.0million of the Notes for approximately $32.0 million in cash. This purchasegenerated a net gain of approximately $2.8 million which was recorded as otherincome (expenses), net on the unaudited condensed consolidated statement ofoperations.

 

On December 20, 2006, the Company completed theexchange of an aggregate principal amount of $72.5 million of its Notes for anew series of 3.5% Convertible Senior Subordinated Notes due in May 2010.See below under Convertible Subordinated Notes due 2010, for further discussionof the exchange.

 

Interest expense associated with the Notes was $0.3million and $0.4 million for the three months ended February 2, 2008 and February 3,2007, respectively.

 

Unamortized debt issuance costs associated with the Noteswere $0.2 million and $0.3 million at February 2, 2008 and November 3,2007, respectively. Amortization of debt issuance costs are classified as otherincome (expense), net on the unaudited condensed consolidated statements ofoperations. Amortization of debt issuance costs were $0.1 million and $0.2million for the three months ended February 2, 2008 and February 3,2007, respectively.

 

***ConvertibleSubordinated Notes due 2010***

 

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

 

The New Notes can be converted under certaincircumstances, including among others, 1) during any calendar quarter when thevolume weighted average price per share of the Company’s common stock has beenmore than 150% of the conversion price for a specified period ending on thelast trading day of the preceding calendar quarter, or 2) during the fivebusiness days when the trading price per $1,000 principal amount of the NewNotes for each day within a specified period was less than 98% of the productof the volume weighted average price of the common stock for each day in thatperiod and the applicable conversion rate per $1,000 principal amount of theNew Note, or 3) if the Company distributes to its stockholders, rights orwarrants entitling them to purchase common stock within a specified period at aprice less than the closing price of the common stock on the date of issuance,or 4) if the Company distributes to its stockholders, assets or securities ofthe Company, which distribution has a per share value exceeding 7.5% of thevolume weighted average price of the common stock on the business day precedingthe declaration date for such distribution, or 5) in the event a change incontrol or cessation of trading of the Company’s stock occurs or is anticipatedto occur or 6) at any time during the 60 day period prior to the maturity date.In addition, the Company has the ability to terminate the conversion feature ofthe New Notes in the event that the volume weighted average price per share ofthe Company’s common stock has been more than 150% of the conversion price fora specified period. If the Company exercises its right to terminate conversion,the holders of the New Notes may convert their notes within a specified period.The foregoing description of these conversion events is not necessarilycomplete and reference is made to the Indenture filed as an exhibit to theCompany’s Form S-3 Registration Statement filed with the SEC on January 19,2007.

 

The Company recorded a discount of $6.1 millionrelated to the New Notes since they were issued at a discount. This amount isbeing amortized to interest expense over the life of the New Notes, or soonerupon conversion. During the three months ended February 2, 2008 and February 3,2007, the Company recorded related amortization of $0.4 million and$0.2 million, respectively.

 

Interest expense associated with the New Notes was$1.0 million and $0.5 million for the three months ended February 2, 2008and February 3, 2007, respectively.

 

14

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Expenses of $3.4 million associated with the New Notesoffering were capitalized upon issuance and are included in prepaid expensesand other current assets and in other assets in the unaudited condensedconsolidated balance sheets. Such expenses are being amortized over the term ofthe New Notes. Unamortized debt issuance costs associated with the New Noteswere $2.3 million and $2.5 million at February 2, 2008 and November 3,2007, respectively. Amortization of debt issuance costs are classified as otherincome (expense), net on the condensed consolidated statements of operations.Amortization of debt issuance costs was $0.2 million and $0.1 million for thethree months ended February 2, 2008 and February 3, 2007,respectively.

 

Subordinated Convertible Notes consists of thefollowing (in thousands):

 
| ** **                                                                                   | ** ** | **For the year ended**     | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                   | ** ** | **February 2,  2008** | ** ** | **November 3,  2007** | ** ** |
| Current convertible  subordinated notes                                                      |       |                       |       |   |   |
| 1.5% convertible  subordinated notes due May 2008                                       |       | $                          | 72,500     |   | $ | 72,500 |   |
| Discount on 3.5%  convertible senior subordinated notes due May 2010, current portion   |       | (1,800                     | )          | (1,800 | ) |
| Net current  convertible subordinated notes                                                  |       | 70,700                     |       | 70,700 |   |
| Long term  convertible subordinated notes                                                    |       |                       |       |   |   |
| 3.5% convertible  senior subordinated notes due May 2010                                |       | $                          | 122,500    |   | $ | 122,500 |   |
| Discount on 3.5%  convertible senior subordinated notes due May 2010, long term portion |       | (2,322                     | )          | (2,772 | ) |
| Net long term  convertible subordinated notes                                                |       | 120,178                    |       | 119,728 |   |
| Net convertible  subordinated notes                                                          |       | $                          | 190,878    |   | $ | 190,428 |   |

 

**6.****                                     ****Goodwill and OtherIntangible Assets**

 

The Company evaluates thecarrying value of its long-lived assets, consisting primarily of its facilities,purchased intangible assets, and property and equipment, in accordance withSFAS 144, “Accounting for the Impairment or Disposal for Long-LivedAssets,” whenever certain events or changes in circumstances indicate that thecarrying amount of these assets may not be recoverable. Such events orcircumstances include, but are not limited to, a prolonged industry downturn, asignificant decline in the Company’s market value, or significant reductions inprojected future cash flows. In assessing the recoverability of the Company’slong-lived assets, the Company compares the carrying value to the undiscountedfuture cash flows the assets are expected to generate. Assets are grouped basedon the lowest level for which identifiable cash flows are largely independentof the cash flows of other groups of assets and liabilities. If the total ofthe undiscounted future cash flows is less than the carrying amount of theassets, impairment is measured based on the excess of the carrying amount overthe fair value of the assets. Quoted market prices in an active market are thebest evidence of fair value and, if available, should be used as the basis forthe fair value measurement; else fair value is generally determined bycalculating the discounted future cash flows using a discount rate based uponthe Company’s weighted average cost of capital. Significant judgments andassumptions are required in the forecast of future operating results used inthe preparation of the estimated future cash flows, including useful lives ofthe primary asset, profit margins, long-term forecasts of the amounts andtiming of overall market growth and the Company’s percentage of that market,groupings of assets, discount rates and terminal growth rates. In addition,significant estimates and assumptions are required in the determination of thefair value of the Company’s tangible long-lived assets, including replacementcost, economic obsolescence, and the value that could be realized inliquidation. Changes in these estimates could have a material adverse effect onthe assessment of the Company’s long-lived assets, thereby requiring theCompany to write down the assets. The purchased intangibles consist ofpurchased technology, customer relations, trademarks, patents and non-competeagreements and they typically have estimated useful lives of one to ten years.

 

15

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Based on the considerations outlined in the previousdiscussion, in November 2007, the Company concluded that sufficientindicators existed to require it to perform an analysis to assess whether aportion of its other intangible assets was impaired. This analysis differs fromthe goodwill analysis in that an impairment is only deemed to have occurred ifthe sum of the forecasted undiscounted future cash flows related to the assetare less than the carrying value of the intangible asset being tested forimpairment. Since the forecasted cash flows exceeded the carrying value, theCompany concluded that there was no impairment to its long-lived assets at November 3,2007.

 

During the first fiscal quarter of 2008, managementcommitted to sell certain assets and certain liabilities (disposal group)related to the diagnostics and characterization product line with a carryingvalue of approximately $22.5 million prior to the impairment.  The contract associated with this sale wasexecuted in February 2008 (see Note 16 — “Subsequent Events” for furtherdiscussion).  On January 31, 2008,the Company determined that the plan of sale criteria in SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” had been met.  Accordingly, the carrying value of thedisposal group was adjusted to its fair value less costs to sell, which wasdetermined based on the sale agreement under negotiation.  The resulting $22.5 million impairment losshas been classified as an impairment charge under operating expense on thecondensed consolidated statements of operations.  Because the disposal group did not constitutea component of the Company, this transaction did not qualify as a discontinuedoperation under SFAS 144.

 

In connection with the impairment loss noted above andthe realization of certain tax attributes, the Company determined that theremaining goodwill associated with the related disposal group had a carryingamount of zero and was reduced accordingly.

 

***Other Intangible Assets***

 

Other intangible assets consist primarily of existingtechnology, customer relationships and trade names acquired in businesscombinations. Acquired intangibles are amortized on a straight-line basis overthe respective estimated useful lives of the assets. Other intangible assetssubject to amortization were as follows (in thousands):

 
| **February 2, 2008** | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|---------------------------|------------|----------|------------|-------------------------------|------------|---------|------------|
|                      |       |     |       |                          |       |    |       |
| Purchased technology      |       | $        | 104,651    |                          | $          | (59,782 | )          | $ | 44,869 |   |
| Customer relations        |       | 18,152   |       | (12,390                       | )          | 5,762   |       |
| Maintenance contracts     |       | 13,800   |       | (10,120                       | )          | 3,680   |       |
| Product backlog           |       | 4,900    |       | (4,900                        | )          | —  |       |
| Trademarks                |       | 2,053    |       | (2,053                        | )          | —  |       |
| Patents                   |       | 862      |       | (862                          | )          | —  |       |
| Total                     |       | $        | 144,418    |                          | $          | (90,107 | )          | $ | 54,311 |   |

 
| **November 3, 2007** | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net**  | ** ** |
|---------------------------|------------|----------|------------|-------------------------------|------------|----------|------------|
|                      |       |     |       |                          |       |     |       |
| Purchased technology      |       | $        | 128,441    |                          | $          | (74,185  | )          | $ | 54,256 |   |
| Customer relations        |       | 21,202   |       | (13,862                       | )          | 7,340    |       |
| Maintenance contracts     |       | 13,800   |       | (9,430                        | )          | 4,370    |       |
| Product backlog           |       | 4,900    |       | (4,900                        | )          | —   |       |
| Trademarks                |       | 2,053    |       | (2,053                        | )          | —   |       |
| Patents                   |       | 862      |       | (862                          | )          | —   |       |
| Non-compete agreements    |       | 750      |       | (750                          | )          | —   |       |
| Total                     |       | $        | 172,008    |                          | $          | (106,042 | )          | $ | 65,966 |   |

 

Amortization expenses for the other intangible assetswere $4.5 million and $4.5 million for the three months ended February 2,2008 and February 3, 2007, respectively.

 

The estimated future amortization expense of purchasedintangible assets with definite lives for the next five years is as follows (inthousands):

 
| **Fiscal Years Ending**  | ** ** | **Amount** | ** ** |
|--------------------------|------------|------------|------------|
| Remainder of fiscal 2008 |       | $          | 9,816      |   |
| 2009                     |       | 11,938     |       |
| 2010                     |       | 9,153      |       |
| 2011                     |       | 7,258      |       |
| 2012                     |       | 6,250      |       |
| Thereafter               |       | 9,896      |       |
| Total                    |       | $          | 54,311     |   |

 

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**7.****                                     ****Net Loss Per Share**

 

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

 

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

 
| ** **                           | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **February 2,  2008** | ** ** | **February 3,  2007** | ** ** |
| Numerator:                           |       |                       |       |   |   |
| Net loss                             |       | $                          | (56,127    | ) | $ | (11 | ) |
| Denominator:                         |       |                       |       |   |   |
| Weighted-average  shares outstanding |       | 101,691                    |       | 100,612 |   |
| Basic net loss  per share            |       | $                          | (0.55      | ) | $ | (0.00 | ) |
| Diluted net loss  per share          |       | $                          | (0.55      | ) | $ | (0.00 | ) |

 

During the three monthsended February 2, 2008, the Company excluded options to purchase14,714,078 shares of common stock from the diluted income per sharecalculation, as their effect on an as if converted method was anti-dilutive.During three months ended February 3, 2007, the Company excluded optionsto purchase 16,748,548 shares of common stock from the diluted loss per sharecalculation, as their effect on an as if converted method was anti-dilutive.

 

With respect to the convertible subordinated notesissued in June 2003, during the three months ended February 2, 2008and February 3, 2007, the Company excluded 6,410,256 shares issuable underthe terms of the notes from the diluted income per share calculation, as theireffect on an as if converted method was anti-dilutive.

 

With respect to the convertible subordinated notesissued in December 2006, in accordance with EITF 90-19 “Convertible Bondswith Issuer Option to Settle for Cash Upon Conversion” and Statement ofFinancial Accounting Standard No. 128 “Earnings per Share”, there were noshares included in the diluted earnings per share calculation for the threemonths ended February 2, 2008 and February 3, 2007.  The principal portion of the notes wereexcluded from the per share calculation as this portion of the obligation canonly be settled in cash. There were no incremental shares under the as ifconverted method as the initial conversion per share price of $8.25 exceededthe Company’s share price for the three months ended February 2, 2008 and February 3,2007.

 

**8.****                                     ****Recent AccountingPronouncements**

 

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

 

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

 

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

 

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

 

**9.****                                     ****Sale-Leasebacks**

 

***Milpitas, California***

 

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

 

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Due to the letterof credit being collateralized by restricted cash, the Company is accountingfor this transaction as a direct financing under SFAS 98. Accordingly, theCompany recorded the proceeds on its books as long-term liabilities, and theCompany is expensing periodic lease payments as interest expense. The sale willnot be recorded until the letter of credit expires or is otherwise terminatedand all of the criteria are met.

 

***Hillsboro,Oregon***

 

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

 

**10.****                              ****Income Taxes**

 

The Company adopted the provisions of FIN 48on November 4, 2007.  As a result ofthe adoption, the Company recognized a decrease in income tax liabilities ofapproximately $2.0 million and a corresponding increase in retained earnings asof November 4, 2007.  As of theadoption date, the Company had gross unrecognized tax benefits of $14.9 millionand accrued interest and penalties of $0.8 million.  The total amount of tax as of November 4,2007, that, if recognized, would affect the effective tax rate was $5.7million.  Consistent with the provisionsof FIN 48, the Company reclassified $6.5 million of current income taxliabilities resulting in a $6.5 million increase to long-term income taxes payableand $9.2 million decrease to long-term deferred tax assets that are subject toa full valuation allowance.  Consistentwith prior year treatment, the Company has elected to recognize interest andpenalties accrued related to unrecognized tax benefits in income tax expense.

 

The Company conducts business globally and,as a result, the Company and its subsidiaries or branches file income taxreturns in the U.S. federal jurisdiction and various state and foreignjurisdictions.  In the normal course ofbusiness the Company is subject to examination by taxing authorities throughoutthe world, including such major jurisdictions as the United States andGermany.  With few exceptions, theCompany is no longer subject to U.S. federal, state and local or non-U.S.income tax examinations for years before 2000. The Company is under examination in Malaysia, France and Germany for2004, 2005 through 2006 and 2002 through 2004, respectively.  The Company expects the examinations willconclude in fiscal 2008.  At this timethe Company cannot estimate the possible change in unrecognized tax benefits.

 

**11.****                              ****Commitments andContingencies**

 

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

 

The future minimum lease payments at February 2,2008 are as follows (in thousands):

 
| ** **               | ** ** | **Net Estimated  Future Lease  Expense** | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|
| Remainder of fiscal 2008 |       | $                                                  | 6,967      |   |
| 2009                     |       | 6,659                                              |       |
| 2010                     |       | 4,193                                              |       |
| 2011                     |       | 3,344                                              |       |
| 2012                     |       | 3,310                                              |       |
| Thereafter               |       | 11,539                                             |       |
|                     |       | $                                                  | 36,012     |   |

 

Some of the components that the Company purchasesare unique to the Company and must be purchased in relatively high minimumquantities with long (in excess of three months) lead times. These businesscircumstances can lead to the Company holding relatively high inventory levelsand associated risks. In addition, purchase commitments for unique componentsare relatively inflexible in terms of deferral or cancellation. At February 2,2008, the Company had open and committed non-cancelable purchase orderstotaling approximately $50.6 million.

 

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The following summarizes the Company’s minimumcontractual cash obligations and other commitments at February 2, 2008 andthe effect of such obligations in future periods (in thousands):

 
| ** **                                          | ** ** | **Total** | ** ** | **Remainder  of Fiscal  2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** |
|-----------------------------------------------------|------------|-----------|------------|--------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Contractual Obligations:                            |       |      |       |                           |       |     |       |     |       |     |       |     |       |           |       |
| Facilities and  equipment operating leases          |       | $         | 36,012     |                           | $          | 6,967    |       | $        | 6,659      |     | $          | 4,193    |       | $              | 3,344      |   | $ | 3,310 |   | $ | 11,539 |   |
| Convertible  subordinated notes (1)            |       | 195,000   |       | 72,500                         |       | —   |       | 122,500  |       | —   |       | —   |       | —         |       |
| Interest on  convertible subordinated notes         |       | 11,307    |       | 2,731                          |       | 4,288    |       | 4,288    |       | —   |       | —   |       | —         |       |
| Open and  non-cancelable purchase order commitments |       | 50,582    |       | 42,785                         |       | 7,596    |       | 187      |       | 14       |       | —   |       | —         |       |
| Total  contractual cash obligations                 |       | $         | 292,901    |                           | $          | 124,983  |       | $        | 18,543     |     | $          | 131,168  |       | $              | 3,358      |   | $ | 3,310 |   | $ | 11,539 |   |

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

 

The Company warrants its products to its customersgenerally for one year from the date of shipment. The Company provides reservesfor the estimated costs of product warranties at the time revenue isrecognized. The Company estimates the costs of warranty obligations based onhistorical experience of known product failure rates, use of materials torepair or replace defective products and service delivery costs incurred incorrecting product failures.

 

Due to the uncertainty with respect to thetiming of future cash flows associated with the Company’s FIN 48 liabilitiesand related interest and penalties at February 2, 2008, the Company is unableto make reasonably reliable estimates of the period of cash settlement with therespective taxing authority. Therefore, $6.6 million of FIN 48 liabilities,interest and penalties have been excluded from the contractual obligationstable above. See Note 10 – “Income Taxes” for further discussion.

 

The following table represents the activity in thewarranty accrual for the three months ended February 2, 2008 and February 3,2007 (in thousands):

 
| ** **        | ** **                                       | **Three Months Ended** | ** ** |
|-------------------|--------------------------------------------------|-----------------------------|------------|
| ** **        | ** **                                       | **February 2,  2008**  | ** ** | **February 3,  2007** | ** ** |
| Beginning balance |                                             | $                           | 12,384     |   | $ | 13,514 |   |
| Add:              | Accruals for warranties issued during the period |                        | 1,753      |   | 5,631 |   |
| Less:             | Adjustments of prior period accrual estimates    |                        | —     |   | (330 | ) |
|              | Warranty spending                                |                        | (5,310     | ) | (4,650 | ) |
| Ending balance    |                                             | $                           | 8,827      |   | $ | 14,165 |   |

 

The Company also offers warranties in excess of oneyear. Revenues associated with warranties beyond one year are deferred andrecognized over the relevant period. Costs that are directly related toservices performed for warranties in excess of one year are charged to expenseas incurred.

 

*Legal Proceedings*

 

In accordance with SFAS No. 5, “Accounting for Contingencies,” theCompany assesses the probability of an unfavorable outcome of all our materiallitigation, claims, or assessments to determine whether a liability had beenincurred and whether it is probable that one or more future events will occurconfirming the fact of the loss. In the event that an unfavorable outcome isdetermined to be probable and the amount of the loss can be reasonablyestimated, we establish an accrual for the litigation, claim or assessment. TheCompany is involved in various claims arising in the ordinary course ofbusiness, none of which, in the opinion of management, if determined adverselyagainst the Company, will have a material adverse effect on the Company’sbusiness, financial condition or results of operations.

 

**12.****                              ****Comprehensive Loss**

 

The Company’s accumulated other comprehensive incomeconsists of the accumulated net unrealized gains or losses onavailable-for-sale investments and foreign currency translation adjustments. AtFebruary 2, 2008 and February 3, 2007, the Company had a balance ofnet unrealized loss of approximately $249,000 and $18,000, respectively, onavailable-for-sale investments. Additionally, at February 2, 2008 and February 3,2007, the Company had a balance of $6.5 million and $2.5 million, respectively,of net foreign currency translation gains.

 

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Thecomponents of comprehensive loss, net of tax, are as follows for the periodsindicated (in thousands):

 
| ** **                                         | ** ** | **Three Months Ended**         | ** ** |
|----------------------------------------------------|------------|--------------------------------|------------|
| ** **                                         | ** ** | **February 2, 2008** | ** ** | **February 3, 2007** | ** ** |
| Net loss                                           |       | $                              | (56,127    | ) | $ | (11 | ) |
| Unrealized losses on available-for-sale securities |       | (226                           | )          | — |   |
| Currency translation adjustment                    |       | 662                            |       | 352 |   |
| Other comprehensive income                         |       | 436                            |       | 352 |   |
| Total  comprehensive income (loss)                 |       | $                              | (55,691    | ) | $ | 341 |   |

 

**13.****                              ****Restructuring Charges**

 

During the first fiscal quarter of 2008 and inprevious years, the Company has recorded restructuring charges as itrationalized operations in light of customer demand declines and economicdownturns. The measures, which included reducing the workforce, focus onoutsourced manufacturing, consolidating facilities and changing the strategicfocus of a number of sites, was largely intended to align the Company’scapacity and infrastructure to anticipated customer demand and transition itsoperations for higher utilization of facility space.

 

Severance and benefit costs and other costsassociated with restructuring activities are recorded in compliance with Statementof Financial Accounting Standard No. 112, “Employer’s Accounting for PostEmployment Benefits,” (SFAS 112) and Statement of Financial Accounting StandardNo. 146, “Accounting for Costs Associated with Exit or DisposalActivities,” (SFAS 146).   A substantialportion of the restructuring charges were recorded under the principles of SFAS112  when the Company concluded that(a) the Company has a substantive post employment benefit obligation thatis attributed to prior services rendered, (b) rights to those benefitshave vested, and (c) payment is probable and the amount can be reasonablyestimated.  The remaining restructuringcharges were recorded under the principles of SFAS 146 as they representedone-time benefits. In circumstances when employees are required to render futureservice and that service period extends beyond a minimum retention period, therestructuring charges are being recognized ratably over the future serviceperiod.  The accounting for restructuringcharges requires the Company to record provisions and charges when it has aformal and committed restructuring plan.

 

The following table illustrates the activity for thethree-month period ended February 2, 2008 and the estimated timing offuture payouts for major restructuring categories (in thousands):

 
| ** **       | ** ** | **Balance at  November 3, 2007** | ** ** | **Charges** | ** ** | **Utilized** | ** ** | **Adjustments** | ** ** | **Balance at  February 2, 2008** | ** ** |
|------------------|------------|--------------------------------------------|------------|-------------|------------|--------------|------------|-----------------|------------|-------------------------------------------------|------------|
| Severance        |       | $                                          | (995       | )           | $          | (13,450      | )          | $               | 1,701      |                                            | $          | — |   | $ | (12,744 | ) |
| Operating leases |       | (2,417                                     | )          | —      |       | —       |       | (41             | )          | (2,458                                          | )          |
| Total            |       | $                                          | (3,412     | )           | $          | (13,450      | )          | $               | 1,701      |                                            | $          | (41 | ) | $ | (15,202 | ) |

 
| **Estimated timing of future  payouts:** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|------------|------------|
| Remainder of fiscal 2008                 |       | $          | 14,057     |   |
| Fiscal 2009                              |       | 1,145      |       |
| Total                                    |       | $          | 15,202     |   |

 

For the three months ended February 2, 2008 andFebruary 3, 2007, the Company recorded restructuring charges ofapproximately $2.8 million and $0, respectively, as cost of goods sold relatedto headcount reductions. For the three months ended February 2, 2008 and February 3,2007, the Company recorded restructuring charges of approximately $10.7 millionand $0.5 million, respectively, as operating expenses related to headcountreductions.

 

**14.****                              ****Employee Benefit Plans**

 

The Company maintains a 401(k) retirementsavings plan for its full-time domestic employees, which allows them tocontribute up to 20% of their pre-tax wages subject to IRS limits. The Company’scontribution to this plan was approximately $0.4 million and $0.4 million forthe three months ended February 2, 2008 and February 3, 2007,respectively.

 

Outside of the U.S., the Company also assumedseveral defined benefit and defined contribution plans that cover substantiallyall employees as part of its acquisition of NPTest in May 2004. Whereapplicable, employees are covered by statutory plans. For defined benefitplans, charges to expense are based upon costs computed by independentactuaries. These 

 

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plansare substantially fully funded with trustees in respect to past and currentservice. At February 2, 2008, and November 3, 2007 the pensionliability was $1.2 million and $1.2 million, respectively. The expensesassociated with these plans were not material for the three months ended February 2,2008 and February 3, 2007.

 

The Company has a deferred compensation plan forcertain employees (a “Rabbi Trust” or “trust”). The assets in the Rabbi Trust,consisting of cash equivalents and debt and equity securities, are recorded atcurrent market prices. The trust assets are available to satisfy claims of theCompany’s general creditors in the event of its bankruptcy. The trust’s assetsof approximately $1.5 million and $1.7 million at February 2, 2008 and November 3,2007, respectively, are included in other assets, and the correspondingdeferred compensation liability is included in the other liabilities in theaccompanying unaudited condensed consolidated balance sheets.

 

**15.****                              ****Industry Segment**

 

Operating segments are business units that haveseparate financial information and are separately reviewed by the Company’schief decision makers. The Company’s chief decision makers are the ChiefExecutive Officer and Chief Financial Officer. The Company and its subsidiariescurrently operate in a single industry segment: the design, development,manufacture, sale and service of advanced semiconductor test and diagnosticsystems used in the production of semiconductors. All of the Company’s advancedsemiconductor test and diagnostic systems operations are subject to similareconomic characteristics, have similar production processes, have commoncustomers, and are distributed using the same channels.

 

The Company’s net sales by product line consistedof:

 

 
| ** **                       | ** ** | **Three Months Ended** | ** ** |
|----------------------------------|------------|----------------------------------|------------|
| ** **                       | ** ** | **February 2,  2008**       | ** ** | **February 3,  2007** | ** ** |
| SoC                              |       | 28                               | %          | 45 | % |
| Analog Mixed Signal              |       | 34                               |       | 31 |   |
| Memory                           |       | —                           |       | 1 |   |
| Diagnostics and Characterization |       | 3                                |       | 4 |   |
| Service and Other                |       | 35                               |       | 19 |   |
| Total                            |       | 100                              | %          | 100 | % |

 

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

 
| ** **                            | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **February 2,  2008**       | ** ** | **February 3,  2007** | ** ** |
| North America                         |       | 32                               | %          | 19 | % |
| Singapore                             |       | 10                               |       | 32 |   |
| Taiwan                                |       | 9                                |       | 10 |   |
| China                                 |       | 16                               |       | 5 |   |
| Japan & rest of Asia Pacific |       | 14                               |       | 14 |   |
| Germany                               |       | 9                                |       | 13 |   |
| Europe & Middle East         |       | 10                               |       | 7 |   |
| Total net sales                       |       | 100                              | %          | 100 | % |

 

A distributor inTaiwan, Spirox Corporation, accounted for approximately 15% and 10% of theCompany’s net sales for the three months ended February 2, 2008 and February 3,2007, respectively.  Spirox Corporationaccounted for 18% and 29% of gross accounts receivable at February 2, 2008and November 3, 2007, respectively.

 

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For the three months ended February 2, 2008,three customers accounted for approximately 23%, 11% and 11%, respectively, ofthe Company’s net sales.  For the threemonths ended February 3, 2007, one customer accounted for 43% of theCompany’s net sales.

 

At February 2, 2008, three customers accountedfor approximately 24%, 14% and 12% of the Company’s gross receivables,respectively.  At November 3, 2007,one customer accounted for approximately 17% of the Company’s grossreceivables.

 

As of February 2, 2008 and November 3,2007, the majority of the Company’s long-lived assets were attributable to itsUnited States operations.

 

**16.****                              ****Subsequent Event**

 

On February 20, 2008, the Company completed thesale of the assets and business of the Company’s diagnostics andcharacterization product line.  TheCompany may receive up to $10.0 million for the assets, with $2.5 million,subject to certain adjustments, payable on each of the first and secondanniversaries of the close of the transaction, and the balance payable on thethird anniversary of the close of the transaction contingent on the purchaser’sachievement of revenue targets.  The Company transferred approximately$22.5 million of book value of assets (prior to the impairment charges recordedduring the first fiscal quarter of 2008), including component inventory, fixedassets, and intangibles to the purchaser and the purchaser assumed variousliabilities including certain contractual warranty and service contracts,employee paid time off, and commission obligations.  The Company will alsoprovide reimbursable transition services for a limited period of time.  Inaddition, the Company will fund the fulfillment of approximately $4.0 millionof existing warranty and service contract obligations through the purchaser.

 

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**I****TEM ****2. - M****ANAGEMENT****’****S****D****ISCUSSION********AND****A****NALYSIS********OF****F****INANCIAL****C****ONDITION********AND****R****ESULTS********OF****O****PERATIONS**

 

This quarterlyreport on Form 10-Q contains forward-looking statements within the meaningof Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, including statements usingterminology such as “believes,” “may,” “will,” “expects,” “plans,” “anticipates,”“goals,” “estimates,” “potential,” or “continue,” or the negative thereof orother comparable terminology regarding beliefs, plans, expectations orintentions regarding the future. Forward-looking statements include statementsregarding our intention to prioritize our research and development activitieson our Diamond and ASL platforms; our intention to focus Sapphire platformdevelopment on the high-end consumer markets; our intention to double our salesand support headcount in Asia; our intention to divest or reduce our commitmentto businesses and products that are unrelated to our consumer semiconductormarkets; our intention to scale down our service infrastructure and align witha self-service model; our intention to reduce our headcount word-wide on a netbasis by approximately 400 employees; our intention to continue outsourcedmanufacturing activities; that we use our proprietary technologies to designproducts which are intended to provide a lower total cost of ownership thanmany competing products currently available while meeting the increasinglydemanding performance requirements of today’s engineering validation test and ATEmarkets; our future results being dependent on attracting and retaining highlyskilled employees; our belief that our net sales, gross margins and operatingresults will continue to fluctuate; factors relating to the fluctuations in ournet sales, gross margins and operating results; our intention to introduce newproducts and enhance existing products through acquisitions of other companies,product lines, technologies and personnel; our belief that our gross margins onsystems sales will continue to vary significantly; our expectation that our topten customers in the aggregate will continue to account for a large portion ofour net sales for the foreseeable future, and the loss of one or more of thesecustomers will harm our business and operating results; our intent to continueto address the need to develop new products and enhance existing productsthrough acquisitions of other companies, product lines, technologies andpersonnel; our existing cash and short-term investments being sufficient tomeet our cash requirements for the next twelve months; our dependence on thecapital expenditures of manufacturers of semiconductors and other companies;significant portions of our new orders being dependent upon demand fromsemiconductor device manufacturers building or expanding fabrication facilitiesand new device testing requirements; our dependence upon obtaining orders forsystems to be shipped in the same quarter in which the order is received; thecontinued acceptance, volume production, timely delivery and customersatisfaction of our newer digital and mixed signal memory testers being ofcritical importance to our future financial results; the possibility that wemay repatriate additional cash from our foreign subsidiaries; our ability tomaintain or increase sales levels in Taiwan; our anticipation thatinternational sales will continue to account for a significant portion of ourtotal net sales; our expectation that we will continue to receive notice ofthird party claims for infringement; that our future operating results dependsubstantially upon the continued service of our executive officers and key personnel;our dependence upon our ability to attract and retain qualified personnel; ourbelief that none of the claims brought in the ordinary course of business willhave a material adverse effect on our business, financial condition or resultsof operation; our anticipation that net sales will be $64.0 million to$68.0 million in the second quarter of fiscal year 2008; our anticipationthat restructuring charges will be $1.0 to $2.0 million in the secondquarter of fiscal 2008; our anticipation of reducing our net worldwideheadcount by 400 people by the end of fiscal 2008; our belief that grossmargin percent could be flat to slightly higher in the second quarter of fiscalyear 2008 compared to the first quarter of fiscal year 2008; our anticipation thatR&D expenses will be lower in the second quarter of fiscal 2008 compared tothe first quarter of fiscal year 2008; our expectation that SG&A expenseswill be flat to lower in the second fiscal quarter of 2008 compared to thefirst quarter of fiscal year 2008; our anticipation that the amortization ofintangible assets will be $3.3 million in the second quarter of fiscal2008; our belief that investments in inventory will continue to represent asignificant portion of our working capital; the highly cyclical semiconductorindustry which experiences downturns; our expectation that a 10% change in theinterest rate will not have any material effect on our interest income orexpense; that we expect to maintain a full valuation allowance on United Statesdeferred tax assets until we can sustain an appropriate level of profitabilityto insure utilization of existing assets; our expectation that we will notrecognize any significant tax benefits in our results of operations; that it ismore than not that some or all of the deferred tax assets will not be realized;future minimum lease payments; minimum contractual cash obligations and theeffect of such obligations in future periods; the highly competitive nature ofthe automatic test equipment industry which is subject to rapid technologicalchange; our belief that it is probable that orders will be canceled and delayedin the future; our intent to maintain the rapid pace of product innovation onscalable platforms; our belief that a significant portion of investments willprovide the marketing, administration and after-sales service and supportrequired for these new products; our plan to continue recognizing compensationexpense for all share-based payment awards; our intent to outsource in thefuture and our expectation that we will achieve operational flexibility andcosts savings as a result of outsourcing; that we do not anticipate paying anydividends on our common stock in the foreseeable future; our expected revenuerecognition practice; our recording of the impairment loss related to goodwill;that we will continue to assess the need for derivatives in the future;expectation that our business, financial condition and results of operationswould be materially adversely affected by our long and variable sales cycle;that our business, financial condition or results of operations will continueto be materially adversely affected by continuing competitive pressure and 

 

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continued intenseprice-based competition; that the increases in inventory on hand for new productdevelopment and customer support requirements will continue to increase therisk of significant inventory write-offs; that any success we may have indeveloping new and enhanced systems and new features to our existing systemswill depend upon a variety of factors; provisions in the New Notes known as netshare settlement which required that, upon conversion of the New Notes, we willpay holders in cash for up to the principal amount of the converted New Notesand under which an amount in excess of this cash will be settled in shares ofour common stock, or at our option, cash; that we believe that the impact ofthe adoption of SFAS 159 will not have a material impact on our financialposition, results of operations and cash flows; that the sale of our Milpitasfacility will not be recorded until the letter of credit expires or isotherwise terminated and all of the criteria are met; that the initial leasefor our Hillsboro facility will expire on January 6, 2010; that we willprovide reimbursable transition services for a limited period of time; that wewill fund the fulfillment of approximately $4.0 million of existing warrantyand service contact obligations through the purchaser; that we will continue toevaluate our estimates, including those relate to revenue recognition,allowance for doubtful accounts, inventory valuation and residual valuesrelated to leased products, long-lived assets valuation, warranty accrual,deferred taxes, restructuring charges and share-based compensation; that certaincritical accounting policies affect our more significant judgments andestimates used in the preparation of our consolidated financial statements; ourbelief that our current cash and investment positions combined with our abilityto borrow funds will be sufficient to meet our anticipated businessrequirements for the next 12 months; that we do not believe that the adoptionof SFAS 157 will be material; that the timing and success of new products andproduct enhancements will affect our business, financial condition and resultsof operations; that we currently do not anticipate any material adverse effectsbased on the nature of our operations and the effect of such laws; that we arecontinuing to invest significant resources in the expansion of our product lines;that once a semiconductor manufacturer has selected a particular ATE vendor’stester, the manufacturer is likely to use that tester for a majority of itstesting requirements for the market life of that semiconductor; that ourcompetitors are continuing to improve the performance of their current productsand to introduce new products, enhancements and new technologies; our beliefthat to remain competitive we must continue to expend significant financialresources in order to, among other things, invest in new product developmentand enhancements and to maintain customer service and support centersworldwide; that we believe that many of the risks detailed here and in ourother SEC filings are part of doing business in the semiconductor industry and willlikely be present in all periods reported; that delays in introducing a productor delays in our ability to obtain customer acceptance, if they occur in thefuture, will delay the recognition of revenue and gross profit by us; and ourneed for continued significant expenditures for research and development,marketing and other expenses for new products, capital equipment purchases andworldwide training and customer service and support will impact our sales andoperating results in the future.

 

These forward-looking statements involve importantfactors that could cause our actual results to differ materially from those inthe forward-looking statements. Such important factors involve risks anduncertainties including, but not limited to difficulties in utilizing differenttechnologies; delays in bringing products to market due to developmentproblems; difficulties in developing new engineering validation test systems;the possibility that our existing systems will become obsolete; excessivelyhigh costs in the future related to enhancing our existing systems; significantchanges in customer preferences; difficulties in integrating acquiredtechnology with our product lines; the possibility that competitors willintroduce products faster than us; unanticipated difficulties in building closeworking relationships with vendors; difficulties in developing the Sapphireplatform; less sales of the Sapphire, Diamond or ASL platform products thananticipated; product defects sustained during the manufacturing process; therisk that we may not be successful in obtaining new orders from majorcustomers; unanticipated decreases in demand for our products in foreigncountries; difficulties in providing extensive support to major customers;unanticipated difficulties in manufacturing and delivering new products,enhancement tools; unanticipated difficulties in integrating our products withcustomers’ operations; unanticipated difficulties in integrating developedtechnology; substantial technological changes in the semiconductor industry; alack of the required resources to invest in the development of new products;uncertainties as to the current products provided by our competitors;unanticipated difficulties in locating and evaluating potential product lines,technologies and business to acquire; the viability of legal claims broughtagainst us; our failure to accurately predict the effect of the ultimateoutcome of claims on our business, financial condition or results ofoperations; lower than expected revenues; the risk that we may be required toexpend more cash in the future than anticipated; difficulties in obtainingorders from manufacturers of semiconductors and companies that specialize incontract packaging and/or testing of semiconductors; the timing of orders; anunanticipated lack of resources to invest in property, plant and equipment,purchased and leased facilities, inventory, personnel and other costs; changingmarket conditions in Taiwan; uncertainties as to the nature and extent of anypotential cyclical downturn in the semiconductor industry; uncertainties as tothe prospect of future orders and sales levels; changes in laws applicable tous regarding revenue recognition practices relating to our new products;uncertainties as to the future level of sales and revenues; unanticipatedbudgetary constraints; uncertainties as to the assumptions underlying ourcalculations regarding estimated annual amortization expenses for purchasedintangible assets; 

 

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uncertaintiesas to the effects of the adoption by us of certain accounting policies; therisk that our future working capital will not be sufficient to investsignificant portions of such working capital in inventories; uncertainties asto the effect of the adoption of certain accounting pronouncements;unanticipated difficulties in the remediation of internal control deficiencies;our ability to maintain the requisite level of assets under our deferredcompensation plan; increased fragmentation in the ATE industry; cost overruns,delayed deliveries, shortages, quality issues or other problems resulting fromoutsourcing; and other factors set forth in “Risk Factors” and elsewhereherein. Reference is made to the discussion of risk factors detailed in ourfilings with the Securities and Exchange Commission, including our reports on Form 10-Kand 10-Q. All projections in this Quarterly Report on Form 10-Q are basedon limited information currently available to us, which is subject to change.Although any such projections and the factors influencing them will likelychange, we will not necessarily update the information, since we are only toprovide guidance at certain points during the year. Actual events or resultscould differ materially and no reader of this Form 10-Q should assume thatthe information provided today would still be valid in the future. Suchinformation speaks only as of the date of this Form 10-Q.

 

**OVERVIEW**

 

We design,manufacture, sell and service engineering validation test equipment and ATEused for testing semiconductor ICs. We serve a broad spectrum of thesemiconductor industry’s testing needs through a wide range of products thattest digital logic, mixed-signal, system-on-a-chip and radio frequencysemiconductors. We utilize our proprietary technologies to design productswhich are intended to provide a lower total cost of ownership than manycompeting products currently available while meeting the increasingly demandingperformance requirements of today’s engineering validation test and ATEmarkets. Our hardware products are designed to test semiconductors at twostages of their lifecycle; first, at the prototype stage, and, second, as theyare produced in high volume. Collectively, our customers include majorsemiconductor manufacturers, fabless design houses, foundries and assembly andtest services companies.

 

Major business developments during and subsequent tothe three months ended February 2, 2008 included:

 

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

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

·                      In January 2008, weannounced our plans to divest or otherwise reduce our commitment to businessand products that are unrelated to our consumer semiconductor market focus,scale down our service infrastructure, and continue with outsourcedmanufacturing activities. We anticipate that these initiatives will result in anet worldwide headcount reduction of approximately 400 people by the end offiscal 2008. These actions resulted in restructuring charges of $13.5 millionin the first fiscal quarter of 2008 and will result in additional restructuringcharges of approximately $1.0 to $2.0 million during the second fiscalquarter of 2008.

·                      In February 2008, wecompleted the sale of certain assets and business related to the diagnosticsand characterization product line to DCG Systems, Inc. The carrying valueof the disposal group was adjusted to its fair value less costs to sell, whichresulted in an impairment charge of $22.5 million during the first fiscalquarter of 2008.

 

Our net sales,gross margins and operating results have in the past fluctuated significantlyand will, in the future, fluctuate significantly depending upon a variety offactors. The factors that have caused and will continue to cause our results tofluctuate include cyclicality or downturns in the semiconductor market and themarkets served by our customers, the timing of new product announcements andreleases by us or our competitors, market acceptance of new products andenhanced versions of our products, manufacturing inefficiencies associated withthe start up of new products, changes in pricing by us, our competitors, customersor suppliers, the ability to volume produce systems and meet customerrequirements, excess and obsolete inventory, patterns of capital spending bycustomers, delays, cancellations or rescheduling of orders due to customerfinancial difficulties or otherwise, expenses associated with acquisitions andalliances, our ability to effectively integrate acquisitions, productdiscounts, product reliability, the proportion of direct sales and salesthrough third parties, including distributors and original equipmentmanufacturers, the mix of products sold, the length of manufacturing and salescycles, natural disasters, political and economic instability, new accountingpronouncements, regulatory changes and outbreaks of hostilities. Due to theseand additional factors, historical results and percentage relationshipsdiscussed in this Quarterly Report on Form 10-Q will not necessarily beindicative of the results of operations for any future period. For a furtherdiscussion of our business, and risk factors affecting our results ofoperations, please refer to the section entitled “Risk Factors” includedelsewhere herein.

 

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** **

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Our discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith United States generally accepted accounting principles. The preparation ofthese financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, aswell as the disclosure of contingent assets and liabilities. On an on-goingbasis, we evaluate our estimates, including those related to revenuerecognition, allowance for doubtful accounts, inventory valuation and residualvalues related to leased products, long-lived assets valuation, warrantyaccrual, deferred taxes, restructuring charges and share-based compensation. Webase our estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions. We discuss the development and selection of the critical accountingestimates with the audit committee of our board of directors on a quarterlybasis, and the audit committee has reviewed our disclosure relating to them inthis quarterly report on Form 10-Q.

 

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

 

**RESULTSOF OPERATIONS**

 

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

 
| ** **                             | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **February 2,  2008**  | ** ** | **February 3,  2007** | ** ** |
| Net sales                              |       | 100.0                       | %          | 100.0 | % |
| Cost of goods sold                     |       | 58.8                        |       | 56.6 |   |
|                                   |       |                        |       |   |   |
| Gross margin                           |       | 41.2                        |       | 43.4 |   |
| Operating expenses                     |       |                        |       |   |   |
| Research and  development              |       | 27.3                        |       | 17.8 |   |
| Selling, general  and administrative   |       | 34.1                        |       | 21.8 |   |
| Amortization of  purchased intangibles |       | 7.0                         |       | 3.8 |   |
| Impairment  charges                    |       | 36.3                        |       | — |   |
| Restructuring  charges                 |       | 16.9                        |       | 0.4 |   |
| Loss on disposal  of facilities        |       | 5.7                         |       | — |   |
|                                   |       |                        |       |   |   |
| Total operating  expenses              |       | 127.3                       |       | 43.8 |   |
|                                   |       |                        |       |   |   |
| Operating loss                         |       | (86.1                       | )          | (0.4 | ) |
|                                   |       |                        |       |   |   |
| Net loss                               |       | (88.8                       | )%         | (0.0 | )% |

 

Net sales consistof revenues from systems sales, upgrades, spare parts sales, maintenancecontracts, engineering consulting, customized services and lease income. Netsales were $63.2 million for the three months ended February 2, 2008 representinga decrease of 46.8% from sales of $118.8 million during the three months ended February 3,2007. The decrease in net sales was due to a decrease in SoC sales to onecustomer of $36.4 million combined with an 82.4% reduction in the number ofwireless units sold and a decrease of $6.5 million in service revenues forlegacy products in the first fiscal quarter of 2008 compared to the firstfiscal quarter of 2007.  Sustainabilityof our revenue levels is dependent upon the economic and geopolitical climateas well as other risks described under the title “Risk Factors” herein. Weanticipate net sales will be approximately $64.0 million to $68.0 million forthe second quarter of fiscal year 2008.

 

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The Company’s netsales by product line consisted of:

 
| ** **                       | ** ** | **Three Months Ended** | ** ** |
|----------------------------------|------------|----------------------------------|------------|
| ** **                       | ** ** | **February 2, 2008**        | ** ** | **February 3, 2007** | ** ** |
| SoC                              |       | 28                               | %          | 45 | % |
| Analog Mixed Signal              |       | 34                               |       | 31 |   |
| Memory                           |       | —                           |       | 1 |   |
| Diagnostics and Characterization |       | 3                                |       | 4 |   |
| Service                          |       | 35                               |       | 19 |   |
|                             |       |                             |       |   |   |
| Total                            |       | 100                              | %          | 100 | % |

 

International netsales accounted for approximately 68% and 81% of total net sales in the threemonths ended February 2, 2008 and February 3, 2007, respectively. Ournet sales to the Asia Pacific region accounted for approximately 49% and 60% oftotal net sales in the three months ended February 2, 2008 and February 3,2007, respectively. The demand for automated test and engineering capitalequipment in Asian markets historically has been highly volatile, and in someAsian regions there has been geopolitical unrest, both of which have resultedin economic instabilities. These potential economic instabilities couldmaterially adversely affect demand for our products.

 

**Gross Margin**

 

Our gross marginas a percentage of net sales decreased to 41.2% during the three months ended February 2,2008 from 43.4% during the months ended February 3, 2007. The decrease ingross margins was primarily due to $2.8 million of the restructuring chargesbeing allocated to manufacturing costs. Our gross margin has been and will continue to be affected by a varietyof factors, including manufacturing efficiencies, excess and obsolete inventorywrite downs, sell through of previously written down inventory, pricing bycompetitors or suppliers, new product introductions, product sales mix,production volume, customization and reconfiguration of systems, internationaland domestic sales mix and field service margins. We believe gross marginpercent could be flat to slightly higher in the second quarter of fiscal year2008 compared to the first quarter of fiscal year 2008.

 

**Research and Development**

 

Research anddevelopment, or R&D, expenses were $17.2 million in the three months ended February 2,2008, representing a decrease of 18.6% from $21.2 million in the three monthsended February 3, 2007. The decrease in expenses in the three months endedFebruary 2, 2008 resulted primarily from a $2.4 million decrease inproject related spending, a $0.8 million decrease in compensation and otheremployee related expenses and a $0.3 million decrease in depreciation andmaintenance costs. R&D expenses as a percentage of net sales were 27.3% and17.8% in the three months ended February 2, 2008 and February 3,2007, respectively. The increase in R&D expenses as a percentage of netsales was primarily attributable to lower net sales. We anticipate that R&Dexpenses will be lower in the second quarter of fiscal year 2008 compared tofirst quarter of fiscal 2008.

 

**Selling, General and Administrative**

 

Selling, generaland administrative, or SG&A, expenses were $21.5 million in the threemonths ended February 2, 2008, representing a decrease of 16.7% from $25.8million in the three months ended February 3, 2007. The decrease wasprimarily due to the reduction of compensation and other employee relatedexpenses of $3.7 million,  a decrease intravel expenses of approximately $0.5 million and a decrease in share-basedcompensation expense of $0.5 million. As a percentage of net sales, SG&Aexpenses were 34.1% and 21.8% in the three months ended February 2, 2008and February 3, 2007, respectively. The increase in SG&A expenses as apercentage of net sales is primarily attributable to lower net sales. Weanticipate that SG&A expenses will be lower the second quarter of fiscalyear 2008 compared to first quarter of fiscal 2008.

 

**Amortization of Purchased Intangibles**

 

Amortization ofpurchased intangible assets expenses were $4.5 million and $4.5 million in thethree months ended February 2, 2008 and February 3, 2007,respectively. We anticipate that amortization of intangibles will be $3.3million in the second quarter of the fiscal year 2008.

 

**Impairment Charges**

 

During the threemonths ended February 2, 2008, we recorded impairment charges ofapproximately $23.0 million.  During thefirst fiscal quarter of 2008, we committed to sell certain assets related tothe diagnostics and characterization product line with a carrying amount ofapproximately $22.5 million and determined that the plan of sale criteria inSFAS 

 

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144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” had been met.  Accordingly, the carrying value of thedisposal group was adjusted to its fair value less costs to sell, resulting in$22.5 million impairment charges.  Inaddition, we determined that our goodwill was impaired at January 31,2008, and an impairment charge of $0.4 million was recorded in the firstquarter of fiscal 2008.   See Note 6 — “Goodwilland Other Intangible Assets,” of the notes to the consolidated financialstatements for further discussion.

 

**Restructuring Charges**

 

During the threemonths ended February 2, 2008 and February 3, 2007, we recorded arestructuring charge of approximately $10.7 million and $0.5 million forseverance charges in operating expenses related to headcount reductions andfacility consolidation related expenses. During the three months ended February 2,2008, we recorded a restructuring charge of approximately $2.8 million in costof goods sold related to headcount reduction related expenses. Therestructuring charges recorded in the three months ended February 2, 2008were for severance and other benefit charges which accounted for a headcountreduction of approximately 320 employees resulting from plans to divest orotherwise reduce our commitment to business and products that are unrelated toour consumer semiconductor market focus, scale down our service infrastructure,and continue with outsourced manufacturing activities. We anticipate thatrestructuring charges will be $1.0 to $2.0 million related to these actionsduring the second fiscal quarter of 2008. See Note 13 — “Restructuring Charges,” of the notes to the consolidatedfinancial statements for further discussion*.*

 

**Loss on Disposal of Facilities**

 

During the threemonths ended February 2, 2008, we recorded a loss on disposal of facilities of$3.6 million related to the sale-leaseback transaction involving the Company’sfacilities located in Hillsboro, Oregon. See Note 9 – “Sale-Leasebacks,” of the notes to the consolidatedfinancial statements for further discussion.

 

**Interest Income**

 

We generatedinterest income of $2.6 million and $1.2 million in the three months ended February 2,2008 and February 3, 2007, respectively. The increase in the three monthsended February 2, 2008 was primarily due to higher average cash balancescompared to the three months ended February 3, 2007.

 

**Interest Expense**

 

Interest expenseswere $2.5 million and $1.2 million for the three months ended February 2,2008 and February 3, 2007, respectively. The increase in interest expensewas primarily attributable to an increase of $0.7 million interest expenserelated to the sale leaseback in California combined with an increase of $0.7million interest expense attributable to the interest and amortization of thediscount on the subordinated convertible notes.

 

**Other Income (Expenses), Net**

 

Other income(expenses), net was $1.1 million of expense and $2.5 million of income for thethree months ended February 2, 2008 and February 3, 2007,respectively. The net change  wasprimarily due to an unfavorable change in foreign currency valuation of $1.2 millionduring the three months ended February 2, 2008 compared with the threemonths ended February 3, 2007.  Alsocontributing the change, we recorded a gain of $3.0 million related to theexchange of convertible notes during the three months ended February 3,2007.

** **

**Income Taxes**

 

We recorded anincome tax provision of $0.7 million and $2.0 million for the three monthsended February 2, 2008 and February 3, 2007, respectively. The incometax expense for the periods consists primarily of foreign tax on earningsgenerated in foreign jurisdictions.

 

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

 

**Stock Options and Incentive Plan**

 

We have ashare-based compensation program that provides our Board of Directors broaddiscretion in creating employee equity incentives. This program includesincentive and non-statutory stock options, restricted stock units and othertypes of equity granted under various plans, the majority of which arestockholder approved. Stock options are generally time-based, vesting over afour-year period with 12.5% of the granted shares vesting six months after thegrant date, and the remaining shares vesting at the rate of 6.25% each quarterthereafter for the following 14 quarters over four years and expire seven toten years from the grant date. Additionally, we have an Employee Stock PurchasePlan (ESPP) that allows employees to purchase shares of common stock at 85% ofthe fair market value at the lower of either the date of enrollment or the dateof purchase. Shares issued as a result of stock option exercises and our ESPPare generally from our new shares. As of February 2, 2008, we hadapproximately 2.7 million shares of common stock reserved for futureissuance under the stock option plans and ESPP.

 

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At February 22008, there was $10.3 million of unrecognized share-based compensation expenserelated to non-vested options that is expected to be recognized over aweighted-average period of 2.7 years. At February 2, 2008, there was $0.2million of unrecognized share-based compensation expense related to outstandingESPP shares that is expected to be recognized over a month period.

 

See ourshare-based compensation discussion in Note 4 “Share-Based Compensation” of theNotes to the unaudited condensed consolidated financial statements for furtherdiscussion.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

In the threemonths ended February 2, 2008, net cash used in operating activities was$20.4 million. The net cash flows used in operating activities for the threemonths ended February 2, 2008 were due to a net loss of $56.1 million andan increase in working capital of $4.1 million, offset by impairment chargesrelated to goodwill and long-lived assets of $23.0 million, depreciation andamortization of $11.6 million, loss on the sale of the Oregon real property of$3.6 million, share-based compensation expense related to employee stockoptions and employee stock purchases under SFAS 123(R) of $1.2 million andthe non-cash charges related to provision for inventory write-downs of $0.5million.

 

Net cash providedby investing activities was $56.1 million during the three months ended February 2,2008, attributable to proceeds from sales and maturities of available-for-salesecurities of $41.0 million, proceeds from the Oregon real property of $19.0million offset by purchased of available-for-sale securities of $3.2 millionand $0.7 million used to purchase property and equipment to support ourbusiness.

 

Net cash providedby financing activities was approximately $1,000 during the three months ended February 2,2008. The cash provided by financing activities was attributable to theissuance of common stock.

 

As of February 2,2008, we had working capital of $210.3 million, including cash and short-terminvestments of $240.8 million, and accounts receivable and inventories totaling$109.7 million. We believe that because of the relatively long manufacturingcycles of many of our testers and the new products we presently offer and planto introduce, investments in inventories will continue to represent asignificant portion of our working capital. The semiconductor industry hashistorically been highly cyclical and has experienced downturns, which have hada material adverse effect on the semiconductor industry’s demand for automatictest equipment, including equipment we manufacture and market. In addition, theautomatic test equipment industry is highly competitive and subject to rapidtechnological change. It is reasonably possible that events related to thesefactors may occur in the near term, which would cause a change to our estimateof the net realizable value of receivables, inventories or other assets, andthe adequacy of accrued liabilities.

 

We believe ourcurrent cash and investment positions combined with our ability to borrow fundswill be sufficient to meet our anticipated business requirements for the next12 months.

 

We lease some ofour facilities and equipment under operating leases that expire periodicallythrough 2017. The approximate future minimum lease payments at February 2,2008 are as follows (in thousands):

 
| ** **               | ** ** | **Net Estimated Future Lease Expense** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|
| Remainder of fiscal 2008 |       | $                                                | 6,967      |   |
| 2009                     |       | 6,659                                            |       |
| 2010                     |       | 4,193                                            |       |
| 2011                     |       | 3,344                                            |       |
| 2012                     |       | 3,310                                            |       |
| Thereafter               |       | 11,539                                           |       |
|                     |       | $                                                | 36,012     |   |

 

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The followingsummarizes our minimum contractual cash obligations and other commitments at February 2,2008, and the effect of such obligations in future periods (in thousands):

 
| ** **                                          | ** ** | **Total** | ** ** | **Remainder  of Fiscal  2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** |
|-----------------------------------------------------|------------|-----------|------------|--------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Contractual Obligations:                            |       |      |       |                           |       |     |       |     |       |     |       |     |       |           |       |
| Facilities and  equipment operating leases          |       | $         | 36,012     |                           | $          | 6,967    |       | $        | 6,659      |     | $          | 4,193    |       | $              | 3,344      |   | $ | 3,310 |   | $ | 11,539 |   |
| Convertible  subordinated notes (1)            |       | 195,000   |       | 72,500                         |       | —   |       | 122,500  |       | —   |       | —   |       | —         |       |
| Interest on  convertible subordinated notes         |       | 11,307    |       | 2,731                          |       | 4,288    |       | 4,288    |       | —   |       | —   |       | —         |       |
| Open and  non-cancelable purchase order commitments |       | 50,582    |       | 42,785                         |       | 7,596    |       | 187      |       | 14       |       | —   |       | —         |       |
|                                                |       |      |       |                           |       |     |       |     |       |     |       |     |       |           |       |
| Total  contractual cash obligations                 |       | $         | 292,901    |                           | $          | 124,983  |       | $        | 18,543     |     | $          | 131,168  |       | $              | 3,358      |   | $ | 3,310 |   | $ | 11,539 |   |

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

 

Some of thecomponents that we purchase are unique to us and must be purchased inrelatively high minimum quantities with long (four and five month) lead times.These business circumstances can lead us to hold relatively high inventorylevels giving rise to associated risks. In addition, purchase commitments forunique components often are relatively inflexible in their deferral orcancellation terms. At February 2, 2008, we had open and committednon-cancelable purchase orders totaling approximately $50.6 million. Thecontractual cash obligations and commitments table presented above contains ourminimum obligations at February 2, 2008 under these arrangements andothers. Actual expenditures will vary based on the volume of transactions andthe length of contractual service provided. In addition to minimum spendingcommitments, certain of these arrangements provide for charges in the event ofcancellation.

 

Due to theuncertainty with respect to the timing of future cash flows associated with ourFIN 48 liabilities and related interest and penalties at February 2, 2008, weare unable to make reasonably reliable estimates of the period of cashsettlement with the respective taxing authority. Therefore, $6.6 million of FIN48 liabilities, interest and penalties have been excluded from the contractualobligations table above. See Note 10 – “Income Taxes,” of the notes to theconsolidated financial statements for further discussion.

 

As of February 2,2008, our principal sources of liquidity consisted of approximately $215.5million of cash and cash equivalents and short-term investments of $25.3million.

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

In July 2006,the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes,”which clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with SFAS No. 109, “Accountingfor Income Taxes.” This interpretation prescribes a recognition threshold andmeasurement attribute 

 

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for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. This interpretation also provides guidance onde-recognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. FIN No. 48 is effective for fiscalyears beginning after December 15, 2006. We adopted the provisions of FIN48 on November 4, 2007.   See Note 10— “Income Taxes,” of the notes to the consolidated financial statements forfurther discussion.

 

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

 

In February 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities—Including an amendment of FASB Statement No. 115”(SFAS 159). Under SFAS 159, a company may choose, at specifiedelection dates, to measure eligible financial instrument and certain otheritems at fair value that are not otherwise required to be so measured. If acompany elects the fair value option for an eligible item, changes in that item’sfair value in subsequent reporting periods must be recognized in currentearnings. SFAS 159 is effective as of the beginning of the fiscal yearbeginning after November 15, 2007. We are currently evaluating the impactof SFAS 159 on our financial position, results of operations and cashflows.

 

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

 

**ITEM 3. — QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

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

 
| ** **             | ** ** | ** **                          | ** ** | ** **                          | ** ** | **Future maturities of investments held at February 2, 2008** | ** ** |
|------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| ** **             | ** ** | **Balance  November 3,  2007** | ** ** | **Balance  February 2,  2008** | ** ** | **2008**                                                                                              | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Cash equivalents       |       |                                |       |                                |       |                                                                                                  |       |   |   |   |   |   |   |   |   |
| Amounts                |       | $                                   | 179,264    |                                | $          | 215,502                                                                                               |       | $ | 215,502 |   | — |   | — |   | — |   | — |   |
| Average rate           |       | 4.58                                | %          | 4.07                                | %          | 4.07                                                                                                  | %          | — |   | — |   | — |   | — |   |
| Short-term investments |       |                                |       |                                |       |                                                                                                  |       |   |   |   |   |   |   |   |   |
| Amounts                |       | $                                   | 62,869     |                                | $          | 25,275                                                                                                |       | $ | 25,275 |   | — |   | — |   | — |   | — |   |
| Average rate           |       | 5.27                                | %          | 4.67                                | %          | 4.67                                                                                                  | %          | — |   | — |   | — |   | — |   |
| Total investment       |       | $                                   | 242,133    |                                | $          | 240,777                                                                                               |       | $ | 240,777 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Average rate           |       | 4.76                                | %          | 4.12                                | %          | 4.12                                                                                                  | %          | — |   | — |   | — |   | — |   |
|                        |            |                                     |            |                                     |            |                                                                                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We mitigatedefault risk by attempting to invest in high credit quality securities and byconstantly positioning our portfolio to respond appropriately to a significantreduction in a credit rating of any investment issuer or guarantor. Theportfolio includes only marketable securities with active secondary or resalemarkets to ensure portfolio liquidity and maintains a prudent amount ofdiversification.

 

The sensitivityanalysis model used by us for interest rate exposure compares interest incomeon current investment interest rates versus current investment levels atcurrent interest rates with a 10% increase. Based on this model, a 10% increaseor decrease would result in an increase or a decrease in interest income ofapproximately $0.2 million. There can be 

 

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no assurances that theabove projected interest rate increase will materialize. Fluctuations ofinterest rates are beyond our control.

 

*ForeignExchange*

 

We generate asignificant portion of our sales from customers located outside the UnitedStates, principally in Asia and, to a lesser extent, Europe. Internationalsales are made mostly to foreign distributors and some foreign subsidiaries andare typically denominated in U.S. dollars, but occasionally are denominated inthe local currency for European and Japanese customers. The subsidiaries alsoincur most of their expenses in the local currencies. Our automotive productline is developed and manufactured in Germany and thus, those expenses are Eurobased. Accordingly, some of our foreign subsidiaries use the local currency astheir functional currency. Foreign currency losses were approximately $0.9million and foreign currency gains were approximately $0.3 million for thethree months ended February 2, 2008 and February 3, 2007,respectively.

 

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

 

*InterestRate Risk*

 

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

 

**ITEM 4. — CONTROLS AND PROCEDURES**

 

*Evaluationof Disclosure Controls and Procedures.*Based on our management’s evaluation (with theparticipation of our chief executive officer and chief financial officer), asof the end of the period covered by this report, our chief executive officerand chief financial officer have concluded that our disclosure controls andprocedures (as defined in Securities Exchange Act Rules 13a-15(e) and15d-15(e)) are effective to provide reasonable assurance that the informationrequired to be disclosed by us in reports that we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rules andforms.

 

*Changesin Internal Control over Financial Reporting.* There was no change in our internal control overfinancial reporting during the three months ended February 2, 2008 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II. — OTHER INFORMATION**

 

**Item 1.****                                   ****Legal Proceedings.**

 

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

 

**Item 1A.****                       ****Risk Factors.**

 

Set forth below and elsewhere in this QuarterlyReport on Form 10-Q and in other documents we file with the SEC, are risksand uncertainties that could cause actual results to differ materially from theresults expressed or implied by the forward looking statements contained inthis Quarterly Report.  The fact thatsome of the risks may be the same or similar to our past filings means onlythat the risks are present in multiple periods. We believe that many of the risks detailed here and in our other SECfilings are part of doing business in the semiconductor industry and willlikely be present in all periods reported. The fact that certain risks are endemic to the industry does not lessenthe significance of the risk.  There areno material changes to the risk factors described under the title “Risk Factors”in our Annual Report on Form 10-K for the fiscal year ended November 3,2007 filed with the SEC

 

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**Ouroperating results have fluctuated significantly which has adversely affectedand may continue to adversely affect our stock price.**

 

**OperatingResults**

** **

****

 

A variety offactors could affect our results of operations. The above graph illustratesthat our quarterly net sales and operating results have fluctuatedsignificantly. We believe they will continue to fluctuate for several reasons,including:

 

·                  worldwide economic conditions in thesemiconductor industry in general and capital equipment industry specifically;

 

·                  loss of certain key customers who accountfor large portions of our revenue;

 

·                  patterns of capital spending by ourcustomers, including delays, cancellations or reschedulings of customer ordersdue to customer financial difficulties or otherwise;

 

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

 

·                  market acceptance of our new products andenhanced versions of existing products;

 

·                  changes in overhead absorption levels dueto changes in the number of systems manufactured, the timing and shipment oforders, availability of components including custom ICs subassemblies andservices, customization and reconfiguration of our systems and productreliability;

 

·                  our ability to attract and retainqualified employees in a competitive market;

 

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

 

·                  labor and materials supply constraints;

 

·                  expenses associated with acquisitions andalliances, including expenses charged for any impaired acquired intangibleassets and goodwill;

 

·                  operating expense reductions associatedwith cyclical industry downturns, including costs relating to facilitiesconsolidations and related expenses;

 

·                  the proportion of our direct sales andsales through third parties, including distributors and OEMs, the mix ofproducts sold, the length of manufacturing and sales cycles, and productdiscounts; and

 

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·                  natural disasters, political and economicinstability, currency fluctuations, regulatory changes and outbreaks ofhostilities, especially in Asia.

 

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

 

·                  long-term pricing decreases by us and ourcompetitors and pricing by our suppliers;

 

·                  the success of efforts to outsource ourmanufacturing activities to third party contract manufacturers;

 

·                  manufacturing volumes;

 

·                  hardware product sales mix;

 

·                  absorption levels and the rate ofcapacity utilization;

 

·                  inventory write-downs;

 

·                  product reliability;

 

·                  possible sale of inventory previouslywritten-down;

 

·                  international and domestic sales mix andfield service margins; and

 

·                  ceasing investment in underperforming or redundant product lines.

 

New and enhancedproducts typically have lower gross margins in their early stages of commercialintroduction and production, and we may build substantial finished goodsinventories of such new products. If delays in or cancellations of orders forthose products occur, it may require a future inventory write-down, which wouldnegatively affect our future financial performance. Although we have recordedand continue to record inventory write-downs, product warranty costs, and deferredrevenue, we cannot be certain that our estimates will be adequate.

 

We cannot forecastwith any certainty the impact of these and other factors on our sales andoperating results in any future period. Results of operations in any period,therefore, should not be considered indicative of the results to be expectedfor any future period. Because of this difficulty in predicting futureperformance, our operating results may fall below the expectations ofsecurities analysts or investors in some future quarter or quarters. Ourfailure in the past to meet these expectations has adversely affected themarket price of our common stock and may continue to do so. In addition, ourneed for continued significant expenditures for research and development,marketing and other expenses for new products, capital equipment purchases andworldwide training and customer service and support will impact our sales andoperating results in the future. Other significant expenditures may make itdifficult for us to reduce our significant fixed expenses in a particularperiod if we do not meet our net sales goals for that period. Many of ourexpenses are fixed and will be difficult to reduce in a particular period ifour net sales goal for that period is not met. As a result, we cannot becertain that we will be profitable in the future.

 

**Wehave a limited backlog and obtain most of our net sales from products thattypically range in price from $80,000 to $3.0 million and generally shipproducts generating most of our net sales near the end of each quarter, whichcan result in fluctuations of quarterly results.**

 

We obtain most ofour net sales from the sale of a relatively few number of systems thattypically range in selling price from $80,000 to $3.0 million. This hasresulted and could continue to result in our net sales and operating resultsfor a particular period being significantly impacted by the timing ofrecognition of revenue from a single transaction. Our net sales and operatingresults for a particular period could also be materially adversely affected ifan anticipated order from just one customer is not received in time to permitshipment during that period. Backlog at the beginning of a quarter typicallydoes not include all orders necessary to achieve our sales objectives for thatquarter. Orders in backlog are subject to cancellation, delay, deferral orrescheduling by customers with limited or no penalties. Throughout the recentfiscal years, we have experienced customer-requested shipment delays and ordercancellations, and we believe it is probable that orders will be canceled anddelayed in the future. Consequently, our quarterly net sales and operatingresults have in the past, and will in the future, depend upon our obtainingorders for systems to be shipped in the same quarter in which the order isreceived.

 

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Furthermore, we generallyship products generating most of our net sales near the end of each quarter.Accordingly, our failure to receive an anticipated order or a delay orrescheduling in a shipment near the end of a particular period or a delay inreceiving customer acceptance from a customer may cause net sales in aparticular period to fall significantly below expectations, which could have amaterial adverse effect on our business, financial condition or results ofoperations. The relatively long manufacturing cycle of many of our testers hascaused and could continue to cause future shipments of testers to be delayedfrom one quarter to the next. Furthermore, as our competitors announce newproducts and technologies, and as we complete acquisitions of similartechnologies, customers may defer or cancel purchases of our existing systems.We cannot forecast the impact of these and other factors on our sales andoperating results.

 

**Ifour restructuring activities are unsuccessful, our business could be harmed.**

 

During the firstfiscal quarter of 2008, we announced a series of restructuring activities,including our intention to prioritize our research and development activitieson our Diamond and ASL platforms, to focus our Sapphire platform development onhigh end consumer markets, to double our sales and support headcount in Asia,to reduce our commitment to businesses and products unrelated to the consumersemiconductor markets, to modify our service business and to reduce ourheadcount world-wide on a net basis by approximately 400 employees. We cannotbe certain that we will successfully anticipate the product needs of ourcustomers or that the products and features we develop as a result of thischange in focus will gain customer acceptance. In addition, there can be noassurance that we will not experience delays in product and enhancementdevelopment as a result of the changes in our staffing and headcount. Customersmay curtail purchases as a result of these changes in focus, delays in productand enhancement development and changes in our service model. Any curtailmentof purchases by customers could have a material adverse effect on our businessand financial condition.

 

**Some of our net sales are generated from a small number ofkey customers and the loss of a key customer or material reductions in capitalspending by a key customer could substantially reduce our revenues and beperceived as a loss of momentum in our business.**

 

Over time, we haveexpanded our base of customers; however, a large portion of our net sales aregenerated from a small number of key customers. In particular, one customer,Advanced Micro Devices, Inc. accounted for 23%, 27% and 23% of our netsales for the three months ended February 2, 2008, fiscal years 2007 and2006, respectively. In addition, Intel Corporation accounted for 11%, 16% and15% of our net sales for the three months ended February 2, 2008, fiscalyears 2007 and 2006, respectively.  Ourtop ten customers accounted for 65%, 72% and 64% of our net sales for the threemonths ended February 2, 2008, fiscal years 2007 and 2006, respectively.We expect that our top ten customers in the aggregate will continue to accountfor a large portion of our net sales for the foreseeable future, and the lossof one or more of these customers or collaborative partners or materialreductions in capital spending by one or more of these customers orcollaborative partners would harm our business and operating results. The lossof a significant customer could also be perceived as a loss of momentum in ourbusiness and an adverse impact on our financial results, and this may cause themarket price of our common stock to fall.

 

**Increasedreliance on outsourced manufacturing and logistics may affect our business.**

 

We areincreasingly outsourcing manufacturing and logistics activities to third-partyservice providers, which decreases our control over the performance of thesefunctions.

 

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

 

If for any reasonone or more of these third-party service providers becomes unable or unwillingto continue to provide services of acceptable quality, at acceptable costs andin a timely manner, our ability to deliver our products or spare parts to ourcustomers could be severely impaired. We would quickly need to identify andqualify substitute service providers or increase our internal capacity, whichcould be expensive, time-consuming and difficult, and could result inunforeseen operations problems. Substitute service providers might not beavailable or, if available, might be unwilling or unable to offer services onacceptable terms.

 

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**Compliancewith current and future environmental regulations may be costly which couldimpact our future earnings.**

 

We may be subjectto environmental and other regulations due to our production and marketing ofproducts in certain states and countries. We also face increasing complexity inour product design and procurement operations as we adjust to new and upcomingrequirements relating to the materials composition of our products, includingthe restrictions on lead and certain other substances in electronics that applyto specified electronics products put on the market in the European Union as ofJuly 1, 2006 (Restriction of Hazardous Substances in Electrical andElectronic Equipment Directive (EU RoHS)). The European Union has alsofinalized the Waste Electrical and Electronic Equipment Directive (WEEE), whichmakes producers of electrical goods financially responsible for specifiedcollection, recycling, treatment and disposal of past and future coveredproducts. The deadline for enacting and implementing this directive byindividual European Union governments was August 13, 2004 (WEEELegislation), although extensions were granted in some countries. Producersbecame financially responsible under the WEEE Legislation beginning in August 2005.Other countries, such as the United States, China and Japan, have enacted ormay enact laws or regulations similar to the EU RoHS or WEEE Legislation.These and other environmental regulations may require us to reengineer certainof our existing products and develop new strategies for the design of newproducts to utilize components which are more environmentally compatible. Suchreengineering and component substitution may result in delays in product designand manufacture and could cause us to incur additional costs. Although wecurrently do not anticipate any material adverse effects based on the nature ofour operations and the effect of such laws, there is no assurance that suchexisting laws or future laws will not have a material adverse effect on ourbusiness.

 

**Thesemiconductor industry is cyclical.**

 

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

 

As a result of thecyclical nature of the semiconductor industry, we have experienced shipmentdelays, delays in commitments and restructured purchase orders by customers andwe expect this activity to continue. Accordingly, we cannot be certain that wewill be able to achieve or maintain our current or prior level of sales or rateof growth. We anticipate that a significant portion of new orders may dependupon demand from semiconductor device manufacturers building or expandingfabrication facilities and new device testing requirements that are notaddressable by currently installed test equipment, and there can be noassurance that such demand will develop to a significant degree, or at all. Inaddition, our business, financial condition or results of operations maycontinue to be materially adversely affected by any factor materially adverselyaffecting the semiconductor industry in general or particular segments withinthe semiconductor industry.

 

**Implementationor changes to our enterprise resource planning system and other related systemsmay affect our business.**

 

We may experiencedifficulties in implementing, making changes to or enhancing our enterpriseresource planning or ERP system and other related systems that could disruptour ability to timely and accurately process and report key components of theresults of our consolidated operations, our financial position and cash flows.Any disruptions or difficulties that may occur in connection with implementing,making changes to or enhancing our ERP system or any future systems could alsoadversely affect our ability to complete the evaluation of our internalcontrols and attestation activities pursuant to Section 404 of theSarbanes-Oxley Act of 2002. System failure or malfunctioning may result indisruption of operations and the inability to process transactions and couldadversely affect our financial results.

 

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**Changesto financial accounting standards may affect our reported results ofoperations.**

 

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

 

For example, theFinancial Accounting Standards Board (FASB) issued changes to U. S. GAAP thatrequires us to record a charge to earnings for our various share-basedcompensation programs beginning on November 1, 2005 which resulted in usrecording additional share-based compensation expenses of $1.2 million,$3.5 million and $3.3 million for the three months ended February 2,2008, fiscal years 2007 and 2006, respectively.

 

**Wemay continue to experience delays in development, introduction, production involume, and recognition of revenue from sales of our products.**

 

We have in thepast experienced significant delays in the development, introduction, volumeproduction and sales of our new systems and related feature enhancements. Thesedelays related to our inability to successfully complete product hardwareengineering within the time frame originally anticipated, including designerrors and redesigns of ICs. As a result, some customers have experiencedsignificant delays in receiving and using our testers in production. Delays inintroducing a product or delays in our ability to obtain customer acceptance,if they occur in the future, will delay the recognition of revenue and grossprofit by us. We cannot be certain that these or additional difficulties willnot continue to arise or that delays will not continue to materially adverselyaffect customer relationships and future sales. Moreover, we cannot be certainthat we will not encounter these or other difficulties that could delay futureintroductions or volume production or sales of our systems or enhancements. Inthe past, we have incurred and we may continue to incur substantialunanticipated costs to increase feature sets in our systems. If our systemsexperience reliability, quality or other problems, or the market perceives ourproducts to be feature deficient, we may continue to suffer reduced orders,higher manufacturing costs, delay in collecting accounts receivable and higherservice, support and warranty expenses, and/or inventory write-offs, amongother effects. Our failure to have a competitive test system available whenrequired by a customer could make it substantially more difficult for us tosell testers to that customer for a number of years. We believe that thecontinued acceptance, volume production, timely delivery and customersatisfaction of our newer digital and mixed signal testers are of criticalimportance to our future financial results. As a result, our inability tocorrect any technical, reliability, parts shortages or other difficultiesassociated with our systems or to manufacture and ship the systems on a timelybasis to meet customer requirements could damage our relationships with currentand prospective customers and would continue to materially adversely affect ourbusiness, financial condition and results of operations. In addition, theconsolidation of our manufacturing operations in a single site exposes us tothe increased risk of manufacturing delays or disruption in the event ofnatural disasters or other calamities at the site. Any delays or disruptions couldmaterially adversely affect our business, financial condition and results ofoperations.

 

**Competitionin the ATE market requires rapid technological enhancements and new productsand services.**

 

Our ability tocompete in the ATE market depends upon our ability to successfully develop andintroduce new products and enhancements with enhanced features on a timely andcost-effective basis, including products under development internally as wellas products obtained in acquisitions. Our customers require test systems withadditional features, higher performance and other capabilities. Therefore, itis necessary for us to develop new systems and/or enhance the performance andother capabilities of our existing systems to adequately address theserequirements. Any success we may have in developing new and enhanced systemsand new features to our existing systems will depend upon a variety of factors,including:

 

·                  product selection;

 

·                  timely and efficient completion of product design;

 

·                  implementation of manufacturing and assembly processes;

 

·                  product performance;

 

·                  reliability in the field;

 

·                  effective worldwide sales and marketing; and

 

·                  labor and supply constraints.

 

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Because we mustmake new product development commitments well in advance of sales, new productdecisions must anticipate both future demand and the availability of technologyto satisfy that demand. We cannot be certain that we will be successful inselecting, developing, manufacturing and marketing new hardware products orenhancements. Our inability to introduce new products that contributesignificantly to net sales, gross margins and net income would have a materialadverse effect on our business, financial condition and results of operations.New product or technology introductions by our competitors could cause adecline in sales or loss of market acceptance of our existing products. If weintroduce new products, existing customers may curtail purchases of the olderproducts resulting in inventory write-offs and they may delay new productpurchases. Any decline in demand for our hardware products could have amaterial adverse effect on our business, financial condition or results ofoperations.

 

**Weare continuing to invest significant resources in the expansion of our productlines and there is no certainty that our net sales will increase or remain athistorical levels or that new products will contribute to revenue growth.**

 

We are currentlydevoting and intend to continue to devote significant resources to thedevelopment, enhancement, production and commercialization of new products andtechnologies. During fiscal years 2007 and 2006, we introduced severalenhancements as well as new products that are evolutions or derivatives ofexisting products as well as products that were largely new. Under our revenuerecognition policy adopted in accordance with SAB 104 we defer revenue fortransactions that involve newly introduced products or when customers specifyacceptance criteria that cannot be demonstrated prior to the shipment. This resultsin a delay in the recognition of revenue as compared to the historic norm ofrecognizing revenue upon shipment. Product introduction delays, if they occurin the future, will delay the recognition of revenue and gross profit and mayresult in delayed cash receipts by us that could materially adversely affectour business, financial condition and results of operations. We invested andcontinue to invest significant resources in property, plant and equipment,purchased and leased facilities, inventory, personnel and other costs to beginor prepare to increase production of these products. A significant portion ofthese investments will provide the marketing, administration and after-salesservice and support required for these new products. Accordingly, we cannot becertain that gross profit margin and inventory levels will not continue to bematerially adversely affected by delays in new product introductions orstart-up costs associated with the initial production and installation of thesenew product lines. We also cannot be certain that we can manufacture thesesystems per the time and quantity required by our customers. The start-up costsinclude additional manufacturing overhead, additional inventory and warrantyreserve requirements and the enhancement of after-sales service and supportorganizations. In addition, the increases in inventory on hand for new productdevelopment and customer support requirements continue to increase the risk ofsignificant inventory write-offs. We cannot be certain that our net sales willincrease or remain at historical levels or that any new products will besuccessfully commercialized or contribute to revenue growth or that any of ouradditional costs will be covered.

 

**TheATE industry is intensely competitive which can adversely affect our ability tomaintain or increase our net sales and revenues growth.**

 

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

 

We facesubstantial competition from ATE manufacturers throughout the world. Asubstantial portion of our net sales is derived from sales of mixed-signaltesters. We face in some cases seven and in other cases nine competitors in ourprimary market segments of digital, mixed signal, and RF wireless ATE. Webelieve that the ATE industry in total has not been profitable for the lastthree years, indicating a very competitive and volatile marketplace. Several ofthese competitors have substantially greater financial and other resources withwhich to pursue engineering, manufacturing, marketing and distribution of theirproducts. In addition, three of our competitors recently completed initialpublic offerings. The success of these companies could make the competitiveenvironment substantially more severe. Certain competitors have introduced orannounced new products with certain performance or price characteristics equalor superior to products we currently offer. These competitors have introducedproducts that compete directly against our products. We believe that if the ATEindustry continues to consolidate through strategic alliances or acquisitions,we will continue to face significant additional competition from largercompetitors that may offer product lines and services more complete than ours.Our competitors are continuing to improve the performance of their currentproducts and to introduce new products, enhancements and new technologies thatprovide improved cost of ownership and performance characteristics. New productintroductions by our competitors could cause a decline in our sales or loss ofmarket acceptance of our existing products.

 

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Moreover, ourbusiness, financial condition or results of operations will continue to bematerially adversely affected by continuing competitive pressure and continuedintense price-based competition. We have experienced and continue to experiencesignificant price competition in the sale of our products. In addition, pricingpressures typically have become more intense during cyclical downturns whencompetitors seek to maintain or increase market share, at the end of a product’slife cycle and as competitors introduce more technologically advanced products.We believe that, to be competitive, we must continue to expend significantfinancial resources in order to, among other things, invest in new productdevelopment and enhancements and to maintain customer service and supportcenters worldwide. We cannot be certain that we will be able to competesuccessfully in the future.

 

**Wemay not be able to deliver custom hardware options to satisfy specific customerneeds in a timely manner.**

 

We must developand deliver customized hardware to meet our customers’ specific testrequirements. The market requires us to manufacture these systems on a timelybasis. Our test equipment may fail to meet our customers’ technical or costrequirements and may be replaced by competitive equipment or an alternativetechnology solution. Our inability to meet such hardware requirements couldimpact our ability to recognize revenue on the related equipment. Our inabilityto provide a test system that meets requested performance criteria whenrequired by a device manufacturer would severely damage our reputation withthat customer. This loss of reputation may make it substantially more difficultfor us to sell test systems to that manufacturer for a number of years, whichcould have a material adverse effect on our business, financial condition orresults of operations.

 

**We rely on Spirox Corporation and customers in Taiwan for asignificant portion of our revenues and the termination of this distributionrelationship would materially adversely affect our business.**

 

SpiroxCorporation, a distributor in Taiwan that sells to end-user customers in Taiwanand China, accounted for approximately 15%, 16% and 13% of our net sales in thethree months ended February 2, 2008 and fiscal years 2007 and 2006,respectively. Our agreement with Spirox has no minimum purchase commitment andcan be terminated for any reason on 180 days prior written notice. On May 31,2005, we entered into an agreement with Spirox to combine our Taiwan operationwith Spirox’s T1 division into a corporation named Credence Spirox IntegrationCorporation, an operation owned 90% by Spirox and 10% by us. This corporationis dedicated to supporting our products in the Taiwan region. Consequently, ourbusiness, financial condition and results of operations could be materiallyadversely affected by the loss of or any reduction in orders by Spirox, anytermination of the Spirox relationship, or the loss of any significant Spiroxcustomer, including the potential for reductions in orders by assembly andtester service companies due to technical, manufacturing or reliabilityproblems with our products or continued slow-downs in the semiconductorindustry or in other industries that manufacture products utilizingsemiconductors. Our ability to maintain or increase sales levels in Taiwan willdepend upon:

 

·                  our ability with Spirox to obtain orders from existingand new customers;

 

·                  our ability to manufacture systems on a timely andcost-effective basis;

 

·                  our ability to timely complete the development of ournew hardware products;

 

·                  Spirox and its end-user customers’ financial conditionand success;

 

·                  general economic conditions; and

 

·                  our ability to meet increasingly stringent customerperformance and other requirements and shipment delivery dates.

 

**Wehave substantial indebtedness and if we need additional financing, it could bedifficult to obtain.**

 

As of February 2,2008, we had $72.5 million principal amount of 1.5% ConvertibleSubordinated Notes, or 1.5% Notes, due in May 2008 and $122.5 millionprincipal amount of 3.5% Convertible Senior Subordinated Notes, due 2010 (theNew Notes). The New Notes contain net share settlement provisions which requirethat, upon conversion of the New Notes, we will pay holders in cash up to theprincipal amount of the converted New Notes. Any amounts in excess of thisconverted amount will be settled in shares of our common stock or, at ouroption, cash. The initial conversion price is $8.25.

 

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The level ofindebtedness, among other things, could:

 

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

 

·                  make it difficult for us to obtain any necessary future financing forworking capital, capital expenditures, debt service requirements or otherpurposes;

 

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

 

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

 

·                  place us at a possible competitive disadvantage with respect to lessleveraged competitors and competitors that have better access to capitalresources; and

 

·                  make us more vulnerable in the event of a further downturn in ourbusiness.

 

There can be noassurance that we will be able to meet our debt service obligations, includingour obligations under the 1.5% Notes or the New Notes.

 

We expect that ourexisting cash and short-term investments will be sufficient to meet our cashrequirements to fund operations and expected capital expenditures for the next12 months. In the event we may need to raise additional funds, we cannotbe certain that we will be able to obtain such additional financing onfavorable terms if at all. Further, if we issue additional equity securities,stockholders may experience additional dilution or the new equity securitiesmay have rights, preferences or privileges senior to those of existing holdersof common stock. Future financings may place restrictions on how we operate ourbusiness. If we cannot raise funds on acceptable terms, if and when needed, wemay not be able to develop or enhance our products and services, take advantageof future business opportunities, grow our business or respond to competitivepressures, which could seriously harm our business.

 

**Changesin the accounting treatment of our 3.5% Convertible Senior Subordinated Notescould decrease our net income and earnings per share amounts.**

 

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

 

**Werequire a significant amount of cash, and our ability to generate cash may beaffected by factors beyond our control.**

 

Our business maynot generate cash flow in an amount sufficient to enable us to fund ourliquidity needs, including payment of the principal of, or interest on, ourindebtedness, working capital, capital expenditures, product developmentefforts, strategic acquisitions, investments and alliances and other generalcorporate requirements. Our ability to generate cash is subject to generaleconomic, financial, competitive, legislative, regulatory and other factorsthat are beyond our control. We cannot be assured that our business willgenerate sufficient cash flow from operations or that future borrowings orother sources of funding will be available to us, in amounts sufficient toenable us to fund our liquidity needs or with terms that are favorable to us.

 

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** **

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

 

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

 

**Ourlong and variable sales cycle depends upon factors outside of our control andcould cause us to expend significant time and resources prior to earningassociated revenues.**

 

Sales of oursystems depend in part upon the decision of semiconductor manufacturers todevelop and manufacture new semiconductor devices or to increase manufacturingcapacity. As a result, sales of our products are subject to a variety offactors we cannot control. The decision to purchase our products generallyinvolves a significant commitment of capital, with the attendant delaysfrequently associated with significant capital expenditures. For these andother reasons, our systems have lengthy sales cycles during which we may expendsubstantial funds and management effort to secure a sale, subjecting us to anumber of significant risks, including a risk that our competitors may competefor the sale, a further downturn in the economy or other economic factorscausing our customers to withdraw or delay their orders or a change in technologicalrequirements of the customer. As a result, our business, financial conditionand results of operations would be materially adversely affected by our longand variable sales cycle and the uncertainty associated with expendingsubstantial funds and effort with no guarantee that a sale will be made.

 

**Thereare limitations on our ability to find the supplies and services necessary torun our business.**

 

We obtain certaincomponents, subassemblies and services necessary for the manufacture of our testersfrom a limited group of suppliers. We do not maintain long-term supplyagreements with most of our vendors, and we purchase most of our components andsubassemblies through individual purchase orders. The manufacture of certain ofour components and subassemblies is an extremely complex process. We also relyon outside vendors to manufacture certain components and subassemblies and toprovide certain services. We have experienced and continue to experiencesignificant reliability, quality and timeliness problems with several criticalcomponents including certain custom ICs. We cannot be certain that these orother problems will not continue to occur in the future with our suppliers oroutside subcontractors. Our reliance on a limited group of suppliers and onoutside subcontractors involves several risks, including an inability to obtainan adequate supply of required components, subassemblies and services andreduced control over the price, timely delivery, reliability and quality ofcomponents, subassemblies and services. Shortages, delays, disruptions orterminations of the sources for these components and subassemblies have delayedand in the future may delay shipments of our systems and new products and couldhave a material adverse effect on our business. Our continuing inability toobtain adequate yields or timely deliveries or any other circumstance thatwould require us to seek alternative sources of supply or to manufacture suchcomponents internally could also have a material adverse effect on ourbusiness, financial condition or results of operations. Such delays, shortagesand disruptions would also damage relationships with current and prospectivecustomers and have and could continue to allow competitors to penetrate ourcustomer accounts. We cannot be certain that our internal manufacturingcapacity or that of our suppliers and subcontractors will be sufficient to meetcustomer requirements.

 

**Ourinternational business exposes us to additional risks.**

 

Internationalsales accounted for approximately 68%, 71% and 69% of our total net sales forthe three months ended February 2, 2008, fiscal years 2007 and 2006,respectively. We anticipate that international sales will continue to accountfor a significant portion of our total net sales in the foreseeable future.These international sales will continue to be subject to certain risks,including:

 

·                  changes in regulatory requirements;

 

·                  tariffs and other barriers;

 

·                  political and economic instability;

 

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

 

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

 

·                  integration and management of foreign operations of acquiredbusinesses;

 

·                  foreign currency exchange rate fluctuations;

 

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

 

·                  potentially adverse tax consequences;

 

·                  possibility of difficulty in accounts receivable collection;

 

·                  greater difficulty in complying with United States accountingstandards; and

 

·                  greater difficulty in protecting intellectual property rights.

 

We are alsosubject to the risks associated with the imposition of domestic and foreignlegislation and regulations relating to the import or export of semiconductorequipment products. We cannot predict whether the import and export of ourproducts will be adversely affected by changes in or new quotas, duties, taxesor other charges or restrictions imposed by the United States or any othercountry in the future. Any of these factors or the adoption of restrictivepolicies could have a material adverse effect on our business, financial conditionor results of operations. Net sales to the Asia-Pacific region accounted forapproximately 49%, 52% and 50% of our total net sales for the three monthsended February 2, 2008, fiscal years 2007 and 2006, respectively, and thusdemand for our products is subject to the risk of economic instability in thatregion and health risks. No single end-user customer headquartered in Asia orEurope accounted for more than 10% of our net sales during the three monthsended February 2, 2008, or during fiscal years 2007 and 2006.

 

In addition, oneof our major distributors, Spirox Corporation, which accounted for 15%, 16% and13% of our net sales for the three months ended February 2, 2008, fiscalyears 2007 and 2006, respectively, is a Taiwan-based company. This subjects asignificant portion of our receivables and future revenues to the risksassociated with doing business in a foreign country, including political andeconomic instability, currency exchange rate fluctuations, fears related tohealth risks and regulatory changes. Disruption of business in Asia caused bythe previously mentioned factors could continue to have a material impact onour business, financial condition or results of operations.

 

**Weoperate in a volatile industry—indicators of goodwill and other long-livedassets impairment under SFAS 142 and SFAS 144 may be present fromtime-to-time.**

 

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

 

As mandated bySFAS 142, we test goodwill for possible impairment on an annual basis andat any other time if events occur or circumstances indicate that the carryingamount of goodwill may not be recoverable. Circumstances that could trigger animpairment test include but are not limited to: our market value falling belowour net book value for a significant period of time, a significant adversechange in the business climate or legal factors; unanticipated competition;loss of key personnel; a significant change in direction with respect toinvestment in a product or market segment; the likelihood that a significant portionof the business will be sold or disposed of; or the results of testing forrecoverability of a significant asset group within a reporting unit determinedin accordance with SFAS 142.

 

Based on acombination of factors that came into existence and were identified during thethird quarter of fiscal year 2006, particularly: (1) our changed currentand projected operating results reflecting lower demand from major customers;and (2) our current market capitalization which was significantly lessthan our book value for the preceding 10 weeks prior to the end of the thirdquarter, we concluded there were sufficient indicators to require us to assesswhether any portion of our recorded goodwill balance was impaired. Wedetermined, based on our estimates of forecasted discounted cash flows and ourmarket capitalization, that our goodwill was impaired at July 31, 2006.Further analysis indicated that goodwill was impaired 

 

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and charges of$423.9 million were recorded in the third quarter of fiscal year 2006.Other long-lived assets were assessed for impairment prior to the performanceof the SFAS 142 analysis and were determined not to be impaired.

 

During the firstfiscal quarter of 2008, we committed to sell certain assets related to thediagnostics and characterization product line with a carrying amount ofapproximately $22.5 million.  Thecontract associated with this sale was executed in February 2008.  On January 31, 2008, we determined thatthe plan of sale criteria in SFAS No. 144, “Accounting for the Impairmentor Disposal of Long-Lived Assets,” had been met.  Accordingly, the carrying value of thedisposal group was adjusted to its fair value less costs to sell, which wasdetermined based on the purchase agreement under negotiations, resulting in a $22.5million impairment charge.

 

If economicconditions in our industry continue to deteriorate and adversely affect ourbusiness, we could be required to record impairment charges related to ourlong-lived assets in accordance with SFAS 144, “Accounting for Impairmentor Disposal for Long-Lived Assets” (SFAS 144) which could have a materialadverse effect on our results of operations and financial condition.

 

**Futureacquisitions may be difficult to integrate, disrupt our business, dilutestockholder value or divert management attention.**

 

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

 

·                  Difficulties in integrating the operations, technologies, products, andpersonnel of the acquired companies;

 

·                  Diversion of management’s attention from normal daily operations of thebusiness;

 

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

 

·                  Difficulties in entering markets in which we may have no or limiteddirect prior experience and where competitors in such markets may have strongermarket positions;

 

·                  Initial dependence on unfamiliar supply chains or relatively smallsupply partners;

 

·                  Insufficient revenue to offset increased expenses associated withacquisitions; and

 

·                  Potential loss of key employees of the acquired companies.

 

Acquisitions mayalso cause us to:

 

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

 

·                  Assume liabilities;

 

·                  Record goodwill and non-amortizable intangible assets that will besubject to impairment testing on a regular basis and potential periodicimpairment charges;

 

·                  Incur amortization expenses related to certain intangible assets;

 

·                  Incur large and immediate write-offs and restructuring and otherrelated expenses; and

 

·                  Become subject to intellectual property or other litigation.

 

Mergers andacquisitions of high-technology companies are inherently risky, and noassurance can be given that our previous or future acquisitions will besuccessful and will not materially adversely affect our business, operatingresults, or financial condition. Failure to manage and successfully integrateacquisitions could materially harm our business and operating results. Prioracquisitions have resulted in a wide range of outcomes, from successfulintroduction of new products and technologies to an inability to do so. Evenwhen an acquired company has already developed and marketed products, 

 

44

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there can be no assurancethat product enhancements will be made in a timely fashion or thatpre-acquisition due diligence will have identified all possible issues thatmight arise with respect to such products.

 

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

 

**Our executive officers and certain key personnel are criticalto our business.**

 

Our futureoperating results depend substantially upon the continued service of ourexecutive officers and key personnel. Our chief executive officer, Lavi A. Lev,joined us in December 2006 and has limited experience in our business. Ourfuture operating results also depend in significant part upon our ability toattract and retain qualified management, manufacturing, technical, engineering,marketing, sales and support personnel. Competition for qualified personnel isintense, and we cannot ensure success in attracting or retaining qualifiedpersonnel. There may be only a limited number of persons with the requisiteskills to serve in these positions and it may be increasingly difficult for usto hire personnel over time. Duringfiscal year 2007, we experienced turnover in our chief executive officer, chieffinancial officer, sales and marketing senior executive and senior engineeringexecutive positions.  In addition, ourcurrent chief financial officer joined us in January 2008.  Our business, financial condition and resultsof operations could be materially adversely affected by the loss of any of ourkey employees, by the failure of any key employee to perform in his or hercurrent position, or by our inability to attract and retain skilled employees.

 

**Ifthe protection of our proprietary rights is inadequate, our business could beharmed.**

 

We attempt toprotect our intellectual property rights through patents, copyrights,trademarks, maintenance of trade secrets and other measures, including enteringinto confidentiality agreements. However, we cannot be certain that others willnot independently develop substantially equivalent intellectual property orthat we can meaningfully protect our intellectual property. Nor can we becertain that our patents will not be invalidated, deemed unenforceable,circumvented or challenged, or that the rights granted there under will provideus with competitive advantages, or that any of our pending or future patentapplications will be issued with claims of the scope we seek, if at all.Furthermore, we cannot be certain that others will not develop similarproducts, duplicate our products or design around our patents, or that foreignintellectual property laws, or agreements into which we have entered willprotect our intellectual property rights. Inability or failure to protect ourintellectual property rights could have a material adverse effect upon ourbusiness, financial condition and results of operations. In addition, from timeto time we encounter disputes over rights and obligations concerningintellectual property, including disputes with parties with whom we have licensedtechnologies. We cannot assume that we will prevail in any such intellectualproperty disputes. We have been involved in extensive, expensive andtime-consuming reviews of, and litigation concerning, patent infringementclaims.

 

**Ourbusiness may be harmed if we are found to infringe proprietary rights ofothers.**

 

We have at timesbeen notified that we may be infringing intellectual property rights of thirdparties and we have litigated patent infringement claims in the past. We expectto continue to receive notice of such claims in the future. We cannot becertain of the success in defending patent infringement claims or claims forindemnification resulting from infringement claims.

 

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

 

**Wemay be materially adversely affected by legal proceedings.**

 

We have been andmay in the future be subject to various legal proceedings, including claimsthat involve possible infringement of patent or other intellectual propertyrights of third parties. It is inherently difficult to assess the outcome oflitigation matters, and there can be no assurance that we will prevail in anylitigation. Any such litigation could result in 

 

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substantial cost anddiversion of our efforts, which by itself could have a material adverse effecton our financial condition and operating results. Further, adversedeterminations in such litigation could result in loss of our property rights,subject us to significant liabilities to third parties, require us to seeklicenses from third parties or prevent us from manufacturing or selling ourproducts, any of which could materially adversely affect our business,financial condition or results of operations.

 

**Recentlyenacted and proposed changes in securities laws and regulations have increasedour costs.**

 

Recently enactedand proposed changes in the laws and regulations affecting public companies,including the provisions of the Sarbanes-Oxley Act of 2002, have increased ourexpenses as we evaluate the implications of new rules and devote resourcesto respond to the new requirements. Sarbanes-Oxley Act mandates, among otherthings, that companies adopt new corporate governance measures and imposescomprehensive reporting and disclosure requirements, sets stricter independenceand financial expertise standards for audit committee members and imposesincreased civil and criminal penalties for companies, their chief executiveofficers and chief financial officers and directors for securities lawviolations. In addition, The NASDAQ Global Market, on which our common stock islisted, has also adopted comprehensive rules and regulations relating tocorporate governance. These laws, rules and regulations have increased thescope, complexity and cost of our corporate governance, reporting anddisclosure practices, which could harm our results of operations and divertmanagement’s attention from business operations. We also expect thesedevelopments to continue to make it more difficult and more expensive for us toobtain director and officer liability insurance in the future, and we may berequired to accept reduced coverage or incur substantially higher costs toobtain coverage. Further, our board members, Chief Executive Officer and ChiefFinancial Officer could face an increased risk of personal liability inconnection with the performance of their duties. As a result, we may havedifficulty attracting and retaining qualified board members and executiveofficers, which would adversely affect our business.

 

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

 

Section 404of the Sarbanes-Oxley Act of 2002 requires that we include in our annual reportour assessment of the effectiveness of our internal control over financialreporting and our audited financial statements as of the end of each fiscalyear. Furthermore, our independent registered public accounting firm (Firm) isrequired to report on whether it believes we maintained, in all materialrespects, effective internal control over financial reporting as of the end ofthe year. We successfully completed our assessment and obtained our Firm’sattestation as to the effectiveness of our internal control over financialreporting as of November 3, 2007, October 31, 2006 and 2005. Infuture years, if we fail to timely complete this assessment, or if our Firmcannot timely attest, we could be subject to regulatory sanctions and a loss ofpublic confidence in our internal control. In addition, any failure toimplement required new or improved controls, or difficulties encountered intheir implementation, could harm our operating results or cause us to fail totimely meet our regulatory reporting obligations.

 

**Terroristattacks, terrorist threats, geopolitical instability and government responsesthereto, may negatively impact all aspects of our operations, revenues, costsand stock price.**

 

The terroristattacks in September 2001 in the United States and ensuing events and theresulting decline in consumer confidence had a material adverse effect on theeconomy.

 

Any similar futureevents may disrupt our operations or those of our customers and suppliers. Ourmarkets currently include Taiwan, Korea and Israel, which are experiencingpolitical instability. In addition, these events have had and may continue tohave an adverse impact on the United States and world economy in general andconsumer confidence and spending in particular, which could harm our sales. Anyof these events could increase volatility in the United States and worldfinancial markets, which could harm our stock price and may limit the capitalresources available to us and our customers or suppliers. This could have a significantimpact on our operating results, revenues and costs and may result in increasedvolatility in the market price of our common stock.

 

**Weare subject to anti-takeover provisions that could delay or prevent anacquisition of our company.**

 

Provisions of ouramended and restated certificate of incorporation, equity incentive plans,bylaws and Delaware law may discourage transactions involving a change incorporate control. In addition to the foregoing, our classified board ofdirectors and the ability of our board of directors to issue preferred stockwithout further stockholder approval could have the effect of delaying,deferring or preventing a third party from acquiring us and may adverselyaffect the voting and other rights of holders of our common stock.

 

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**Item 2.****                                   ****Unregistered Sales ofEquity Securities and Use of Proceeds.**

 

None

 

**Item 3.****                                   ****Defaults upon SeniorSecurities.**

 

None

 

**Item 4.****                                   ****Submission of Matters toa Vote of Security Holders.**

 

None

 

**Item 5.****                                   ****Other Information.**

 

None

 

**Item 6.****                                   ****Exhibits.**

 

(a)                  See Exhibit Index

 

 

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** **

**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the registranthas duly caused this Report to be signed on its behalf by the undersignedthereunto duly authorized.

 
|   |                | CREDENCE SYSTEMS  CORPORATION                       |
|--------|---------------------|-----------------------------------------------------|
|   |                | (Registrant)                                        |
|   |                |                                                |
|   |                | /s/ Kevin C.  Eichler                               |
| Date   | March 13, 2008 | Kevin C. Eichler                                    |
|   |                | Senior Vice  President, Chief Financial Officer and |
|   |                | Secretary                                           |
|   |                | (Principal  Financial and Chief Accounting Officer) |

 

 

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** **

**EXHIBIT INDEX**

** **
| **Exhibit** | ** ** | ** **                                                                                                                                      |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | ** **                                                                                                                                      |
| 3.1(1)      |       | Amended and Restated  Certificate of Incorporation of the Company, as currently in effect.                                                      |
|        |       |                                                                                                                                            |
| 3.2(2)      |       | Amended and Restated  Bylaws of the Company, as currently in effect.                                                                            |
|        |       |                                                                                                                                            |
| 4.1(3)      |       | Indenture, dated as of  June 2, 2003 between Credence Systems Corporation and The Bank of New  York, as Trustee.                           |
|        |       |                                                                                                                                            |
| 4.2(3)      |       | Form of global  1.5% Convertible Subordinated Note due 2008 (included in Exhibit 4.3).                                                |
|        |       |                                                                                                                                            |
| 4.3(4)      |       | Indenture, dated as of  December 20, 2006, between the Company and The Bank of New York, as  Trustee.                                      |
|        |       |                                                                                                                                            |
| 4.4(4)      |       | Form of global  3.5% Convertible Senior Subordinated Note due 2010 (included in  Exhibit 4.4).                                        |
|        |       |                                                                                                                                            |
| 10.1(5)     |       | Form of  Indemnification Agreement between the Company and each of its officers and  directors.                                            |
|        |       |                                                                                                                                            |
| 10.8(6)     |       | Executive Employment  Agreement, dated January 1, 2008, by and between the Company and Kevin  C. Eichler.                                  |
|        |       |                                                                                                                                            |
| 10.9(7)     |       | Purchase and Sale  Agreement and Receipt for Earnest Money, dated November 8, 2007, by and  between the Company and Carlyle Investment Co. |
|        |       |                                                                                                                                            |
| 10.10(7)    |       | First Amendment to  Purchase and Sale Agreement, dated December 10, 2007, by and between the  Company and Carlyle Investment Co.           |
|        |       |                                                                                                                                            |
| 10.11(7)    |       | Absolutely Net Office  Lease, dated January 7, 2008, by and between the Company and Five Oaks  Flex, LLC.                                  |
|        |       |                                                                                                                                            |
| 10.12(7)    |       | Absolutely Net Office  Lease, dated January 7, 2008, by and between the Company and Five Oaks  Office, LLC.                                |
|        |       |                                                                                                                                            |
| 31.1        |       | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002              |
|        |       |                                                                                                                                            |
| 31.2        |       | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002              |
|        |       |                                                                                                                                            |
| 32.1        |       | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002              |
|        |       |                                                                                                                                            |
| 32.2        |       | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002              |

 

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| (1) |   | Incorporated by  reference to Exhibit 3.1 to the Company’s Quarterly Report on  Form 10-Q for the quarterly period ended April 30, 2000.                                                                        |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Incorporated by  reference to Exhibit 3.2 to the Company’s Quarterly Report on  Form 10-Q for the quarterly period ended January 31, 2002.                                                                      |
| (3) |   | Incorporated by  reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-3  (File No. 333-108069) as filed with the Commission on August 19,  2003.                                     |
| (4) |   | Exhibits 4.5, 4.5,  10.30 and 10.31 are incorporated herein by reference to Exhibit 4.1,  4.2, 10.1 and 10.2 to the Company’s Current Report on Form 8-K (File  No. 000-22366) filed on December 21, 2006. |
| (5) |   | Exhibit 10.1 is  incorporated herein reference to Exhibit 10.1 to the Company’s Annual  Report on Form 10-K for the fiscal year ended October 31, 2003.                                                    |
| (6) |   | Incorporated by  reference to Exhibit 10.1 to the Company’s Current Report on  Form 8-K filed on January 8, 2008.                                                                                               |
| (7) |   | Exhibits 10.9, 10.10,  and 10.2 are incorporated by reference to Exhibit 10.31, 10.32, 10.33,  and 10.34 to the Company’s Annual Report on Form 10-K (File  No. 000-22366), filed on January 17, 2008.     |

 

 

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