Certain statements in this Annual Report on Form 10-K are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements involve a number of risks, uncertainties and other factors that could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Factors which could materially affect such forward-looking statements can be found in the section entitled “Risk Factors” in Part 1, Item 1A. in this Annual Report on Form 10-K. Investors are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date hereof and we will undertake no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.

 

References in this Annual Report on Form 10-K to “Eagle Test,” the “Company,” “we,” “us” or “our” are to Eagle Test Systems, Inc., a Delaware corporation, and its subsidiaries.

 

Overview

 

We design, manufacture, sell and service high-performance automated test equipment, or ATE, for the semiconductor industry. Our test equipment is designed to address our customers’ volume production needs and to enable them to achieve low cost-of-test per device. Our customers, including semiconductor manufacturers and assembly and test subcontractors, use our products to test analog, a combination of digital and analog, known as mixed-signal, and radio frequency, or RF, semiconductors. Our proprietary SmartPin^tm technology enables multiple semiconductor devices to be tested simultaneously, or in parallel, on an individual test system, permitting greater test throughput. We believe that our technology and ATE architecture offer significant test speed and precision, leading to high production yields and repeatable results. Our modular and scalable test systems are designed to provide our customers with cost-efficient, customized solutions. Semiconductors tested by our systems are incorporated into a wide range of products in high-growth markets, including digital cameras, MP3 players, cellular telephones, video/multimedia products, automotive electronics, computer peripherals, and notebook and desktop computers.

 

Semiconductor manufacturers continuously strive for manufacturing and process improvements in order to satisfy the demand for smaller, better performing and lower cost semiconductors. Semiconductor manufacturers are aggressively pursuing strategies to reduce their overall cost-of-test by increasing the throughput of their test systems. Cost-of-test includes the initial ATE and ancillary equipment purchase price, as well as set-up and operating costs, and is often the most significant manufacturing cost, particularly for high-volume, low-cost devices. For these types of devices, ATE throughput, or the number of devices that can be tested in a given unit of time on a single test system, is a key determinant of cost-of-test per device and of a manufacturer’s ability to compete profitably.

 

We were founded and began providing test solutions in 1976. Since October 1, 2003, we have delivered over 900 test systems to more than 70 customers worldwide including Allegro MicroSystems, Inc., Carsem Sdn. Bhd, Fairchild Semiconductor International, Inc., Infineon Technologies, Intersil Corporation, National Semiconductor Corporation, ON Semiconductor Corporation, STMicroelectronics N.V., Texas Instruments Incorporated and UTAC Thai Ltd. Our global headquarters and manufacturing facility is located in Buffalo Grove, Illinois which opened in January 2005. We operate sales, services and engineering support facilities in the United States through regional offices and globally through our offices in Korea, Singapore, Taiwan, Italy, Germany, China, Malaysia and the Philippines. We completed our initial public offering on March 14, 2006.

Industry Background

 

Semiconductor devices are the foundation of the modern electronic world. Semiconductors are typically divided into two broad categories, digital and analog. Digital semiconductors, such as microprocessors, digital signal processors, or DSPs, and memory devices, are used to process and store data in a binary format using electrical signals to represent the binary digits, “1” and “0.” In contrast, analog semiconductors, such as amplifiers, RF devices, voltage regulators and other power management devices, are used to measure, control and transform physical properties, such as light, sound and movement, into a digital format by producing electrical signals that have a continuous range of values. Mixed-signal semiconductors contain both analog and digital elements on a single device but are generally classified as analog semiconductors.

 

Semiconductor prices typically decline as new devices are introduced and as devices advance through their product life cycles. This price compression takes place against a backdrop of increasing device complexity. Consequently, semiconductor device manufacturers, especially those serving high-volume markets, must continually seek cost reductions in all aspects of their manufacturing process.

 

The Importance of Testing in Semiconductor Production; The ATE Market

 

The process of designing and manufacturing semiconductors is complex and capital intensive. The wafer fabrication process, or “front-end” process, involves numerous and repetitive processing steps during which hundreds or even thousands of copies of a device are formed simultaneously on a single wafer. The subsequent testing and assembly of devices into packaged products ready for sale is commonly referred to as the “back-end” process.

 

Device testing is a critical part of the semiconductor production process and is a significant component of the cost of manufacturing semiconductors. Test equipment is typically used in the back-end process where each device is often tested several times to validate functional and electrical performance prior to shipment. ATE is generally used in two steps in the back-end semiconductor production process:

 

 

In addition to identifying devices that do not function properly in the back-end process, ATE also generates information that semiconductor manufacturers use to improve the yield of their overall production process and to assist in the semiconductor design and development phase. Demand for ATE is driven by increases in semiconductor unit production, increases in the complexity of semiconductor devices and the need to improve the overall cost-effectiveness of the semiconductor manufacturing process.

 

Current Test Challenges

 

Device manufacturers have continually focused on manufacturing and process improvements to satisfy the demand for smaller, better performing and lower cost semiconductors. Technological advances, such as smaller device geometries, higher transistor density and the introduction of larger, 300 mm wafers, have led to significant economies of scale in the front-end process and a general decline in overall manufacturing cost per device. However, as front-end costs have been decreasing, back-end costs, of which testing costs can be the most significant component, have not enjoyed the same rate of improvement. As a result, test cost has become a growing percentage of overall manufacturing cost and can be the most significant cost associated with manufacturing a semiconductor, especially in the case of high-volume devices. Consequently, semiconductor manufacturers are aggressively pursuing strategies to reduce their overall cost-of-test.

In analyzing total cost-of-test, semiconductor manufacturers focus on the initial ATE purchase price, equipment throughput, the range of products that can be effectively tested, costs associated with test application development, ability to upgrade, on-going maintenance and training requirements, and the need for ancillary equipment and floor space. Reducing the total cost-of-test is an important consideration for all device manufacturers, but is of particular significance to vendors of high-volume, low-cost devices for whom overall manufacturing cost is a critical factor in the ability to compete profitably. Significant challenges for device manufacturers in achieving lower overall cost-of-test include:

 

 

Our Solution

 

Our products are designed to enable our customers to achieve low overall cost-of-test per device. We believe our test systems deliver increased test throughput for high-volume, price-sensitive semiconductors in the analog, mixed-signal and RF markets. We offer test systems that enable our customers to achieve a high level of test accuracy and repeatability, and our flexible system architecture can be easily reconfigured and adapted to meet our customers’ current and evolving testing needs. By focusing on low cost-of-test per device and based on informal feedback from customers, we believe that our test systems offer customers a competitive overall test solution that enables them to lower their semiconductor production costs and improve their profit opportunity. The aspects of our solution that facilitate low cost-of-test include:

 

Increased Throughput.  Our test systems are designed to enable our customers to improve throughput, which lowers total cost-of-test. We improve throughput in the following manner:

 

 

Improved Yield with Precision and Repeatability.  Our proprietary technology and product architecture are designed to achieve test precision and repeatable results in order to deliver higher yields. We believe our solution improves yield in the following ways:

 

 

Scalable and Flexible Architecture.  Our test system architecture is designed to enable our customers to quickly and cost-effectively upgrade or reconfigure their test systems as their testing needs evolve. Our architecture offers the following benefits:

 

compatibility across a wide range of products, as well as easy replacement and support of individual resource boards. In addition, our entire test system product line operates under a uniform software environment, allowing customers to move seamlessly to different test system types by utilizing a common operating environment.

 

Lower Switching Costs.  We have developed a proprietary, adaptable interface that enables our test systems to operate using other vendors’ DUT boards, as well as earlier generations of our DUT boards, which is a significant advantage to us as our customers’ testing needs change. This proprietary architecture, which we call Chameleon^tm technology enables customers to easily migrate from some competing test platforms or earlier generations of our own product line, to a newer and more cost-effective Eagle Test solution. Our test systems are designed to offer customers a low-cost and time-saving option for migrating test platforms.

 

During the sales process, prospective and existing customers generally engage in an evaluation process in which they compare the costs and test results, such as yield and repeatability, of their current test solution against our proposed test solution. The customer’s current test solution may consist of a test system provided by one of our competitors, such as Credence Systems Corporation, LTX Corporation or Teradyne, Inc., a test system internally developed by the customer, or one of our previous generation test systems. An important consideration in the comparative evaluation process is the overall cost-of-test, which includes factors such as the number of devices to be tested, the total test system acquisition cost, the amount of required floor space, test time and the number of test systems required, and also considers system flexibility, upgradeability and maintenance costs. Customers often share with us their conclusions from their comparative evaluation of the cost-of-test of their current test solution versus our proposed test solution. This feedback, together with our experience with customers selecting our test solution after employing this evaluation process, supports our belief that our test systems often provide a low cost-of-test, as compared to the customer’s current test solution. We believe that in most cases in which a customer decides to switch to our proposed test solution, the customer has concluded that the cost of switching to a new test platform is outweighed by the reduction in the overall cost-of-test. In addition, customers also consider other relevant factors, such as service and technical support capabilities, brand awareness, financial viability and production capacity.

 

Our test systems are currently not designed to address the test requirements of semiconductors with large digital content, such as memory devices or microprocessors, which are typically tested by more costly test systems with different capabilities.

 

Products

 

Test Systems

 

We design, manufacture, sell and service a family of high-performance test systems that test analog, mixed-signal and RF semiconductors. Our current products are designed to provide our customers with the optimal level of test performance and functionality for their particular testing needs. The following table sets forth our current product offerings, their features and the devices tested by each product.

 

 

ETS-600 and ETS-364.  Introduced in 2001, the ETS-600 and ETS-364 offer our highest performance analog, mixed-signal and RF test platforms across a broad range of semiconductors. The systems were designed to maximize throughput capability by enabling SimulTest^tm multi-site testing for up to 64 sites, through our SmartPin^tm technology, our highest digital capabilities, and our custom designed RF6000

architecture. The RF6000 is a resource board and accessory to the ETS-600 or ETS-364 that enables the tester to simultaneously source and measure RF signals across multiple RF devices in a fully calibrated environment through the use of a proprietary RF Source Distribution Module. This functionality allows users to distribute RF source signals simultaneously to multiple device ports and calibrate each port to ensure that each port receives the precise desired RF signal to each device. The RF6000’s unique measurement capabilities are achieved through the use of RF signal “down converters” per port, which allow users to simultaneously measure the RF signal output of each RF device under test. These key features minimize RF device test times in multi-site applications by avoiding unnecessary switching between RF signal source and measurement functions while maintaining the signal integrity needed in an RF test environment.

 

The ETS-600 delivers our highest level of performance and functionality with up to 256 digital pins, over 480 analog channels, and up to 32 RF ports. The ETS-364 delivers up to 128 digital pins, over 240 analog channels, and up to 16 RF ports. The ETS-364 was designed to be fully compatible with the ETS-600 test system. Utilizing a common DUT interface and software command structure, the ETS-600 and ETS-364 offer customers a natural migration path between medium and large-scale, multi-site testing.

 

ETS-300 and ETS-200.  We introduced the ETS-300 and ETS-200 in 1998 as low-cost, high-performance analog and mixed-signal test systems. The ETS-300 delivers up to 32 digital pins and over 240 analog channels. This system offers SimulTest^tm multi-site testing with up to 32 site capability. The ETS-300 is an attractive solution for analog applications and applications requiring less significant digital capabilities for testing devices such as switching regulators, power factor controllers, and various automotive devices.

 

The ETS-200 serves a similar market, but delivers up to 16 digital pins and up to 120 analog channels of throughput. The ETS-200 offers SimulTest^tm multi-site testing with up to 16 site capability. The ETS-200 is intended for targeted applications such as operational amplifiers, low dropout regulators, and other analog applications, and/or applications requiring limited digital capabilities. The ETS-200 was designed to be fully compatible with the ETS-300 test system. Utilizing a common DUT interface and software command structure, the ETS-300 and ETS-200 offer customers a scalable migration path for multi-site, analog applications.

 

ETS-200T.  We introduced the ETS-200T in 2003 to test specific types of semiconductors known as a Field Effect Transistors, or FETs. The ETS-200T delivers high throughput with up to 16 site testing capability and a custom designed software environment to make FET program development easy and effective. Since its introduction, the 200T has received positive early customer acceptance for its unique ability to test these devices in highly parallel applications.

 

ETS-200T-FT.  A new product offering for 2007, the ETS-200T-FT provides capability for testing packaged power FET and IGBT devices at final test. This product is designed for use with rotary and other sequential device handlers, where a full suite of tests is performed incrementally as devices are contacted multiple times throughout the handling process. The product leverages existing ETS-200T technology, and also requires some additional specialized hardware and software to provide a robust product offering. This new product allows us to address the discrete final test market, which represents a new business opportunity.

 

New Instrumentation.  A number of new test instruments (known as resources) were introduced in the last 12 months that expand and enhance the capabilities of our existing test platforms and broaden the markets we serve. The new resources introduced are:

 

 

 

Each of these new products expands the range of devices and markets that can be addressed by our platforms. Consistent with our core product development strategy, these resources are modular “plug-in” units capable of operating within our existing test platforms, making it possible for existing and future customers to immediately take advantage of their important features with incremental capital expense.

 

Software Products

 

ATE operating software is required to design and run test routines, and to record and analyze the results of such test routines. Our Eagle Vision software is a feature-rich, user-friendly software platform, designed to help our customers rapidly develop test programs on our platforms. For example, our plotting tools facilitate quick and easy graphing of response data. Our automatic code generation tools help programmers avoid incorrect entries and our point-and-click status screens allow easy monitoring and adjustment of test system settings. The production environment offers numerous data aggregation options and supports multiple data output formats. Our software includes user-friendly tools for generation and analysis of test data that are enabled by simple point-and-click operations.

 

We have developed our Eagle Vision software as the uniform operating environment for all of our various test platforms. This approach reduces our customers’ overall cost of ATE ownership by reducing the employee training and platform set-up time usually associated with bringing new test platforms on line. Eagle Vision, when combined with our Chameleon^tm device interface hardware, provides our customers with a compatible test system upgrade path, allowing our customers to migrate devices to our new platforms without abandoning their investment in their existing Eagle Test systems and associated software and device interface hardware.

 

We offer software licenses and maintenance contracts for the Eagle Vision software environment, the core operating software for our test systems. Additional licenses are also available for use with off-line programming stations as well that allow customers to develop and optimize (de-bug) programs without taking a test system out of production. Software updates and enhancements are available for the first 12 months after the purchase of a system under standard warranties. Under our software maintenance contracts, customers continue to receive updates for both on-line and off-line licenses.

 

We continue to provide additional value to our customers through our Eagle Vision software updates. We provide two major software enhancement releases each year. The software release process allows us to provide customers with substantial new capabilities each year. We concentrate on providing new tools and features that reduce the amount of time required to develop new tests on the test system. These changes enhance the effectiveness of both customer employed test engineers and our own test engineers, and decreases the time required to introduce new device test routines and increases the number of devices that can be tested in production.

 

Technology

 

SmartPin^tm.  Our patented SmartPin^tm technology enables our products to generate and measure both current and voltage signals at each device pin. Furthermore, our SmartPin^tm technology enables digital signal processing to be performed locally at each pin, which eliminates the need to move test data through a common signal bus for processing, thereby decreasing processing time, reducing interference and improving accuracy and yield. In addition to these features, SmartPin^tm technology provides the capability to generate multiple signals of various ranges, which allows our customers to execute a full set of test routines with a single starting signal, eliminating the time required for additional software programming commands. In this way,

SmartPin^tm technology optimizes simultaneous, or parallel, testing across multiple sites on the same test system. We refer to this capability as SimulTest^tm.

 

Chameleon^tm.  Our Chameleon^tm technology provides interoperability among different test platforms by allowing test application hardware from one test system to be used on another test system. Chameleon^tm provides hardware compatibility among our various test platforms, as well as with test hardware from some of our competitors’ test platforms.

 

Pattern-Based Testing^tm.  Our Pattern-Based Testing^tm is enabled by our SmartPin^tm technology in conjunction with our Eagle Vision software. In Pattern-Based Testing^tm, predetermined digital and analog waveforms are presented to a DUT in a time synchronized sequence. Pattern-Based Testing^tm technology provides the capability to simultaneously capture and analyze both analog and digital waveforms that are emitted from the DUT, thus reducing device test times and permitting increased throughput and lower cost-of-test.

 

Floating Resources.  Our test platform architecture provides electrical separation between disparate test sites on the same piece of test equipment by eliminating the need for our test instrumentation resources to access power or move signals across a common electrical pathway. Because our floating resources have independent ground connections, interference normally associated with a common ground pathway is minimized, allowing each device’s results to remain isolated from the results of other adjacent sites. This leads to better test accuracies and fewer devices failing due to device-to-device errors and is particularly important in analog test environments where common grounding noise may be as large as the signal a device manufacturer may be trying to measure or source.

 

Sales and Marketing

 

With the exception of the United Kingdom and Japan, we market and sell our products exclusively through our direct sales organization, which consists of sales professionals, application engineers (technical sales support) and technical marketing personnel. In the United Kingdom, we utilize a combination of direct sales representatives and distributors while in Japan we use direct distributors. Our account managers oversee and manage our worldwide sales activity. As of September 30, 2007, we had 97 people in sales, marketing and applications engineering, including 22 direct sales representatives, who provide account management and sales administration. Because we focus on the development of long-term relationships with major customers, the majority of our sales and technical sales support personnel is located in close proximity to key customer sites. For foreign customers, this support is typically provided through one of our foreign subsidiaries. As of September 30, 2007 we had 66 foreign personnel providing sales, service and applications support to our foreign customers.

 

Our customers generally undertake an extensive evaluation of new test technology prior to adopting such technology. We work with potential customers with the goal of offering them a superior solution for their test requirements. In typical situations, our applications engineers are required to develop a custom test program designed to demonstrate our equipment’s performance and capability to address the customer’s specific needs. In cases involving existing customers, we typically work closely with their respective product development and production groups to help maximize the utility of our test systems throughout their organization and to align our product development efforts with their anticipated test requirements.

 

We employ a sales model that emphasizes reducing the customer’s total cost-of-test per device rather than the acquisition cost of the individual test system. We demonstrate how a customer’s test costs can be reduced by utilizing our products in lieu of competitors’ test systems.

 

We believe that strong service and support are critical to providing an overall lower cost-of-test solution. In addition to our applications engineering support staff, we maintain a global network of service personnel who seek to maximize test system up-time. We also offer services to enable our customers to maintain and effectively use our test systems, and to enhance our customer relationships. Our standard product warranty includes coverage of hardware products for one year from the date of purchase and warrants against defects in design, materials and workmanship. In order to minimize system down-time in the event of a service

requirement, we typically ship a replacement product for any non-functional standard equipment within 24 hours of the service request. We also offer our customers additional support after the warranty period in the form of maintenance contracts or extended warranties.

 

Customers

 

We target analog, mixed-signal and RF semiconductor manufacturers and related companies that serve a broad range of market segments. Since October 1, 2003, we have delivered over 900 test systems to more than 70 customers. Our customers include many of the world’s leading semiconductor manufacturers, IDMs, fabless design companies, and assembly and test subcontractors. Companies that use our systems include:

 

 

Our customers have historically been semiconductor device manufacturers, but our customer base has expanded to include assembly and test subcontractors, such as STATS ChipPAC Ltd. and Carsem Sdn. Bhd. Semiconductor manufacturers and fabless semiconductor companies utilize these subcontractors to provide incremental capacity and to lower their fixed production costs.

 

For the fiscal years ended September 30, 2007, 2006 and 2005, sales to Texas Instruments Incorporated accounted for 30.7%, 52.9% and 44.3% of our net revenue, respectively. This customer is the only customer who has accounted for 10% or more of our net revenue during these periods. We expect that a small number of customers will continue to represent a significant portion of our net revenue for the foreseeable future. Sales to customers in the United States accounted for approximately 35.2%, 30.6% and 46.2% of net revenue for the years ended September 30, 2007, 2006 and 2005, respectively. Sales to customers in Malaysia accounted for approximately 17.6%, 38.8% and 21.4% of net revenue for the fiscal years ended September 30, 2007, 2006 and 2005, respectively. Sales to customers in other locations accounted for approximately 47.2%, 30.6% and 32.4% of net revenue for the fiscal years ended September 30, 2007, 2006 and 2005, respectively.

 

Manufacturing and Assembly

 

Our test platforms consist of standard products that we custom configure based on each customer’s specific needs. A large portion of our subassembly manufacturing is outsourced to contract manufacturers for printed circuit board fabrication, automated assembly and the supply of machine parts. Our major contract manufacturers include Millennium Electronics, Inc., Plexus Corporation and Universal Electronics, Inc., all of which manufacture our printed circuit board assemblies, including surface mount and through-hole technologies, and Sentral Assemblies & Components, which manufactures our cable assemblies and power supplies. We contract with these manufacturers on an individual purchase order basis and do not have long term contracts with them. We believe this selected outsourcing strategy provides us with the flexibility to respond more rapidly to changes in industry conditions or demand for our test systems. We perform mechanical assembly, subassembly testing operations and final systems integration at our Illinois manufacturing facility in order to ensure quality. We focus on quality assurance by monitoring the various stages of the manufacturing process to identify areas for improvement and manage potential manufacturing issues.

 

Although our products consist mainly of standard components and prefabricated parts manufactured to our specifications, some components and subassemblies are purchased from a limited number of suppliers or sole source suppliers. Our major suppliers include Arrow Electronics, Inc. and Future Electronics, both of

which provide us with electronic components and integrated circuits, as well as Pickering Electronics Limited, which provides us with relays, switches and integrated circuits, and Marcel Electronics International, which provides us with printed circuit boards. We work closely with our suppliers to plan our inventory procurement in quantities that will minimize our inventory risks; however, we cannot be certain that shortages will not develop in the future. We purchase components and subassemblies through separate purchase orders and do not currently have long-term purchase contracts with our suppliers. We believe our ability to procure components and subassemblies is a key determinant of our ability to provide our customers with quality products on a timely basis and we continue to evaluate alternative sources for the supply of our inventory.

 

Research and Development

 

Our continued commitment to research and development and the timely introduction of new products, features and upgrades are integral to maintaining our competitive position. Our research and development efforts seek to address new opportunities and demands within our customer base. Our efforts are focused on the design of test systems that lower the overall cost-of-test for semiconductor companies. We concentrate on advancements in electrical performance, software tools, parallel test efficiency and test system resource density. We also focus on the design of modular hardware for rapid implementation of new features and a uniform software platform for operating compatibility across our entire line of test systems. This strategy reduces our overall product development cycles and development costs and maximizes our research and development resources. Our research and development activities are directed by individuals with significant expertise and industry experience. As of September 30, 2007, we had 67 employees dedicated to research and development.

 

Our research and development organization is segmented into specific product development groups, including mixed-signal, high performance data converters and automotive products, discrete components and RF products, which provides highly dedicated focus for the investigation of new technical opportunities in our target markets, and the development of solutions specifically targeted at those opportunities.

 

We leverage our engineering efforts by utilizing standard components whenever possible. We generally avoid the use of customized components, such as Application-Specific Integrated Circuits, or ASICs, when implementing functionality because it is easier to adapt standard semiconductor designs to changing requirements. This also eliminates high engineering risks and costs associated with ASIC design. We use standard PCs with Microsoft Windows as the main control computer of our test systems. The strategy of using industry standard products has proven successful, allowing us to leverage the significant investments made by the largest companies in the technology field, with minimal cost to us.

 

Our historical research and development expenditures for the fiscal years ended September 30, 2007, 2006 and 2005 were $9.1 million, $8.9 million and $7.9 million, respectively, representing 10.6%, 7.2% and 12.4% of net revenue in each of the respective fiscal years.

 

Competition

 

We face substantial competition in the ATE market throughout the world. Our principal competitors include Credence Systems Corporation, LTX Corporation and Teradyne, Inc., all of which are major manufacturers of ATE for the analog, mixed-signal and RF markets, in addition to other markets in which we do not compete. Some of our competitors’ products that test analog, mixed-signal and RF semiconductors have higher digital pin counts than our products, and accordingly may be considered to have a greater functional testing range and the ability to test types of devices that our products do not test. Accordingly, a customer that manufactures high-end digital semiconductors, for example, as well as analog, mixed-signal or RF devices, may be more inclined to purchase a test system from one of our competitors. We believe, based on the published report of an independent industry research organization, that our competitors named above each have a larger share of our addressable market than we do. Additionally, some of our competitors, including those named above, have greater brand recognition and greater financial, engineering, manufacturing and marketing resources than we do. As a result, our competitors may be able to respond more quickly to new or emerging technologies or market developments by devoting greater resources to the development, promotion

and sale of products. Some of our competitors also have broader product offerings, larger installed customer bases and more extensive customer support capabilities than we do. We expect our competitors to continue to improve the performance of and support for their current products and to introduce new products, technologies or services that could adversely affect sales of our current and future products. In addition, other test companies that do not currently focus on our target markets could choose to do so.

 

We believe the primary competitive factors in the analog, mixed-signal, discrete and RF ATE markets are the overall cost-of-test, test accuracy, throughput, yield and support infrastructure. We believe we compete favorably with respect to each of these factors in the markets that we address. Based on our experience in marketing our products in competition against those of our competitors, we believe we are a very strong competitor within the analog, mixed-signal markets and discrete, and also an effective competitor in the RF market. However, in contrast to a number of our competitors, we do not compete for opportunities to test primarily digital semiconductors, such as memory devices or microprocessors, where more costly test systems with different capabilities are required to compete effectively.

 

Intellectual Property

 

Our success depends in large part on our proprietary technology. We rely on a combination of patents, copyrights, trademarks, service marks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect our proprietary rights. We own two U.S. patents. These patents will expire in approximately 15 years. While these patents are important and relate to some of our distinct technology, we have relied primarily on our trade secrets and copyright protection as well as confidentiality provisions to protect our intellectual property.

 

There are always risks that third parties may claim that we are infringing upon their intellectual property rights and we could be prevented from selling our products or services, or suffer significant litigation or licensing expenses as a result of these claims. In addition, third parties may infringe or design around our intellectual property rights, and we may expend significant resources enforcing our rights or suffer competitive injury with adverse effects on our results of operations. Our efforts to protect our intellectual property rights may be less effective in some foreign countries where intellectual property rights are not as well protected as in the U.S. For additional, important information, review the information set forth in “Risk Factors — Risks Related to Intellectual Property.”

 

Employees

 

As of September 30, 2007, we had 351 full time employees. Of our total employees, 67 were dedicated to research and development and 97 were dedicated to sales, marketing and applications. None of our employees located in the United States is represented by a union. Our employees in Europe are represented by workers’ councils. We believe our relationships with our employees are good.

 

Backlog

 

Our backlog, calculated on the basis of unfilled purchase orders with a firm delivery date for all products and services, was $24.3 million at September 30, 2007, compared with $13.2 million at September 30, 2006. Since customers may cancel or delay their orders with little regard for potential penalties, and since new order volume may decrease very rapidly, our backlog at any particular date is not necessarily indicative of our future backlog or actual sales that may be generated for any succeeding period. In the past, our test systems have generally shipped within six to eight weeks from the time we receive a customer’s purchase order, and we expect at least 85% of our backlog as of September 30, 2007 to ship prior to the end of December 2007. Any change in our manufacturing capacity and the time it takes to ship our products will affect our level of backlog. Historically, our backlog levels have also fluctuated based on our customers’ ordering patterns and their inability to predict order trends in the semiconductor industry with any certainty.

 

 

Set forth below are certain risk factors that could harm our business, results of operations and financial condition. You should carefully read the following risk factors, together with the financial statements, related notes and other information contained in this Annual Report on Form 10-K. This Annual Report on Form 10-K contains forward-looking statements that contain risks and uncertainties. Please refer to the discussion of “Forward-Looking Statements” on page one of this Annual Report on Form 10-K in connection with your consideration of the risk factors and other important factors that may affect future results described below.

 

Risks Related to Our Business and Industry

 

The highly cyclical nature of the semiconductor industry could adversely affect our operating results.

 

Our business and operating results depend to a significant extent on capital expenditures by companies in the semiconductor industry that purchase our ATE. Historically, the semiconductor industry has been highly cyclical with recurring periods of over-supply. These cycles typically have a disproportionately negative impact on capital equipment manufacturers, including providers of test systems like Eagle Test. In most cases, the decrease in capital expenditures for test systems by our customers is more pronounced than the downturn in the overall semiconductor industry.

 

We believe that semiconductor industry downturns will likely recur, and because they often occur very rapidly, we cannot adequately foresee their timing and extent, or their effect on customer orders and revenues. If we do not accurately predict the timing or extent of a downturn, we may not adequately reduce our operating expenses in light of decreased revenue, which will adversely affect our financial performance, and potentially our stock price. During downturns we experienced, and in the future we may experience:

 

 

As a result of these and other factors, industry downturns are expected to negatively impact our business and financial performance. Moreover, such downturns, or the speculation about such downturns by investors or industry analysts, may have a material adverse effect on our stock price.

 

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

 

In the past we have experienced, and in the future we expect to experience, fluctuations in revenues and results of operations from quarter to quarter. These fluctuations can be caused by a variety of factors including:

 

 

 

A significant portion of our revenue is derived from the sale of a relatively small number of test systems. Accordingly, a decline in the number, or change in the timing or terms, of the test systems we sell from quarter-to-quarter may also cause significant changes in our results of operations. This, in turn, would likely cause a decline in the market price of our common stock.

 

We believe that quarter-to-quarter comparisons of our revenue and operating results are not necessarily meaningful or an accurate indicator of our future performance. Because of this difficulty in predicting future performance, our results of operations may fall below the expectations of securities analysts or investors in future quarters. Our failure to meet these expectations would likely cause a decline in the market price of our common stock.

 

We depend on a small number of customers for a significant portion of our sales, and the loss of any of these customers will adversely affect our revenue.

 

A small number of customers has accounted for a significant portion of our revenue in any particular period. We expect that we will continue to depend on a small number of customers to account for a significant percentage of our revenue for the foreseeable future. Our customers, including our most significant customers, are not obligated by long-term contracts to purchase our test systems, and may cancel orders with little regard for potential penalties. If any of our large customers reduces or cancels its purchases from us for any reason, it could have an adverse effect on our revenue and results of operations. For additional information, see the section entitled “Business — Customers” in Part I, Item 1. in this Annual Report on Form 10-K.

 

We face difficulty in obtaining new customers because of the high cost of switching test equipment vendors in our markets.

 

Semiconductor companies typically select one vendor’s systems for testing an entire product family of semiconductors, and make substantial investments to obtain test systems and ancillary equipment, and to develop related test program software. Once a semiconductor company has implemented a test system for a product family of semiconductors, it is often difficult and costly to switch to another vendor’s test system because the test system is often part of the product specifications for a newly developed device. Accordingly, unless our test systems offer substantial performance or cost advantages that materially outweigh a customer’s expense of switching to our test systems, it will be difficult for us to achieve significant sales to that customer once it has selected another vendor’s test system for an application.

Our sales cycle is long, requires significant investment, and may not result in additional sales.

 

Our customers generally take considerable time to evaluate our test systems, and many people are involved in the evaluation and decision-making process. Our product sales cycle typically ranges from six to nine months. Sometimes our sales cycle can be much longer, particularly when the sales process involves developing new test progr