Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Thomas H. Reslewic – President, Chief Executive Officer

Sean B. O’Connor – Vice President – Finance, Chief Financial Officer

David Calusdian – Investor Relations, Sharon Merrill Associates

Analysts

John Harmon – Needham & Co.

Ajit Pai – Thomas Weisel Partners

Michael Crawford – B. Riley and Company

Brian Riley – B. Riley and Company

LeCroy Corporation (LCRY) F2Q09 Earnings Call January 28, 2009 10:00 AM ET

Operator

Good day, everyone, and welcome to LeCroy Corporation’s second quarter fiscal 2009 financial results conference call. Today’s call is being recorded. There will be an opportunity for questions and comments after the prepared remarks. (Operator Instructions).

At this time, for opening remarks and introductions, I’d like to turn the call over to Mr. David Calusdian of Sharon Merrill Associates. Thank you, Sir. You may begin.

David Calusdian

Good morning, everyone, and welcome. In connection with this conference call LeCroy wishes to take advantage of the safe harbour provisions of the Private Securities Litigation Reform Act of 1995 with respect of statements that may be deemed to be forward-looking under the act. All such forward-looking statements are only estimates of future results and there can be no assurance that actual results will not differ materially from these expectations.

Information on all of the potential factors that could affect LeCroy Corporation’s business are described in the company’s reports on file with the Securities Exchange Commission as well as in this morning’s press release. Any forward-looking statements only represent the company’s views as of today, January 28, 2009. While LeCroy may choose to update these forward-looking statements at a later date, the company specifically disclaims any duty to do so.

On the call with me this morning are LeCroy’s president and chief executive officer, Tom Reslewic, and vice president and chief financial officer, Sean O’Connor. I’ll now turn the call over to Tom.

Thomas H. Reslewic

Thank you, David. Good morning, everyone. We’re glad you could join us today.

I’ll start things off with our second quarter highlights and then Sean will take you through the financials. After that I’ll return with some colour on the order trends, the product road map, the new business pipeline, as well as our guidance and outlook. At that point we’ll turn it over for questions.

As you saw in our news release this morning, we wrote off $105.8 million in goodwill this quarter. As with other companies that have made acquisitions in the past few years, external market conditions triggered the impairment of our goodwill on our balance sheet associated with our two protocol acquisitions, CATC and Catalyst. Having to take a charge like this is enormously disappointing to us, as is the downturn in the public equity markets that lead to the write-off in the first place. As a non-cash charge, however, it has no impact on our liquidity and our ability to generate cash going forward. Nor does it affect our banking relationships, how we’re running the business, or our ability to capitalize on growth opportunities and execute on our product road map.

LeCroy actually performed quite well in the second quarter despite seeing signs of softening in the demand environment starting in mid to late November. Now we all know what’s happened to the economy since then. Everything you’ve been reading in the newspapers is consistent with what we’re now seeing in our orders and the implications for Q3 and Q4 fiscal 2009 are not encouraging. Before going back to the outlook let me briefly take you through the second quarter business highlights.

Our oscilloscope business turned in a solid quarter with orders for scope units the highest in the company’s history. In fact, on a local currency basis, second quarter oscilloscope revenues increased 6% compared to a year ago. Late in the first quarter we entered a completely new market segment when we launched our WaveAce series of low cost oscilloscopes. WaveAce is our first scope in the sub-100-MHz space at price points as low as $1,000.

WaveAce did especially well in Europe in the December quarter. We continued to increase our penetration in Europe. We have a strong overall presence in the market and that helps us get new products like the WaveAce out of the gate that much faster.

Although overall European demand was relatively strong in the second quarter orders softened in the US and Asian markets where more customers postponed their spending as the economic outlook deteriorated. Our protocol solutions group rebounded from a soft first quarter in our December quarter as revenues increased greater than 20% from the summer quarter. We’re clearly benefiting from our strong position for PCI Express Gen II and USB 3.0, and in our storage protocols SAS and SATA. In fact, our storage protocol orders were up 35% from the sequential first quarter.

Our order linearity, or the percentage of total orders that we receive in the first nine weeks of a quarter, was 65% in the second quarter compared with our target of 61%. When we have strong linearity like this that can sometimes indicate late quarter softening, which was certainly the case in the December quarter. Linearity figure for the quarter and the early order trends in the subsequent quarter generally paint a pretty accurate picture of overall demand. Orders in early January were off about 20% compared to a year ago, which is consistent with our expectations for the early part of this quarter.

Total sales for the December quarter were $39.1 million compared with $40.6 million in Q2 last year and $40.7 million in the sequential first quarter. Our overall non-GAAP gross margin increased to 59% for the second quarter, mainly due to lower production costs associated with our latest high-end scope products and a higher percentage of protocol business in the quarter.

Our ability to improve gross margins this quarter was particularly encouraging considering the significant unfavourable impact of foreign currency in the quarter of almost $2 million compared to last year. This figure highlights the relatively strong Q2 performance of the sales and the product margins in local currencies.

In mid-November we started to see some lengthening of the sales cycles and saw order delays that foreshadowed the weakening demand environment that we saw in December and are continuing to see today. We responded with aggressive actions to reduce our cost structure and focus our business on key growth opportunities, including a 10% workforce reduction, termination of several projects that we believed would yield limited return on investment, and as a result we exited our optical scope product line in one of our programs and protocol incurring a non-cash inventory charge of $2.7 million. We also cut salaries across the board by 10%, reduced variable compensation, and suspended the company’s 401K match plan. We expect these initiatives, in addition to those implemented at the beginning of the current quarter, to generate cost savings of approximately $8 million annually. In our current quarter we’ll get a significant benefit from these actions, but it will be in the fourth quarter that we’ll see the full benefit.

Our non-GAAP net income for the second quarter was $1.7 million compared with $2.4 million for the second quarter of 2008. This translates into non-GAAP EPS of $0.14 a diluted share for the quarter compared with $0.20 in the same quarter a year ago. With that I’ll turn it over to Sean to review the financials in more detail.

Sean B. O’Connor

Thank you, Tom, and good morning, everyone. In my discussion I’ll occasionally be referring to non-GAAP operating results. We use non-GAAP results as a supplement to our results based on GAAP because we believe this provides additional insight into our underlying results and can enhance the understanding of the company’s ongoing business. The press release we issued this morning contains a reconciliation of the non-GAAP results to their most closely related GAAP results. The non-GAAP adjustments in the second quarter include the following special charges.

First, a non-cash goodwill impairment charge of approximately $105.771 million, which was primarily generated from the CATC and Catalyst protocol analyzer acquisitions. I’d just like to spend a few minutes providing additional background on this item.

It was the volatility in decline in the public equity markets that unfortunately had an adverse effect on our stock price during the most recent quarter. Since our market capitalization value was below our net book value, including goodwill, we were required to reassess our goodwill impairment analysis. So following FAS 142, we performed with the assistance of an outside valuation expert a fair value analysis which included valuing the company’s tangible and then significant intangible assets. However, the company is not allowed to record these much higher values on the books. The result of this analysis established that the estimated fair value was fully applied to identifiable assets, which results in a goodwill impairment charge.

While this large non-cash charge has an impact on our GAAP earnings for the second quarter it is important to note that it does not affect the company’s operations, liquidity, or ability to generate future cash flows. The second special charge we incurred was the recording of a severance restructuring charge of $1.471 million. Third, a non-cash inventory business realignment charge of $2.736 million, plus $16,000 for the purchase accounting fair value adjustment of Catalyst inventory that was sold. And last, a non-cash share-based compensation expense of approximately $158,000.

Turning to the second quarter results, as Tom mentioned, primarily due to currency headwinds revenue for the second quarter decreased 3.6% to $39.1 million from $40.6 million for the year-earlier quarter. Revenues were down approximately 4% from the sequential first quarter.

Our cost of sales in the second quarter was $18.8 million. This includes first the $2.7 million non-cash inventory write down and the $16,000 charge for the incremental purchase accounting adjustment for Catalyst inventory that was sold. Second, $55,000 for restructuring severance charges. And last, $14,000 of share-based compensation expense.

Excluding the non-cash inventory write down and the other charges our non-GAAP gross margin for the second quarter was 59%. This compares with 58.7% non-GAAP gross margin for the same period last year and 56.7% for the sequential first quarter.

Gross margins are up 230 basis points from the first quarter, primarily due to the higher mix of protocol products relative to scope products, as well as the improved cost of goods associated with new scope product introductions.

Total operating expense for the second quarter was approximately $127.4 million. This included $105 million non-cash goodwill impairment charge, $1.4 million in severance restructuring charges of which $849,000 was charged to SG&A and $567,000 was charged to R&D, $144,000 in share-based compensation expense of which approximately $71,000 was charged to SG&A and $73,000 was charged to R&D. Excluding these items non-GAAP R&D expense was $8.2 million or 20.9% of revenues. Due to certain NREs associated with the new WaveMaster 8 series we launched in January, this is slightly higher from an R&D expense of $7.8 million or 19.2% of revenues for Q2 last year.

Excluding the special non-cash cost I just mentioned, non-GAAP SG&A expense in the second quarter was $11.9 million or 30.5% of revenues, which is in line compared with $11.9 million or 29.4% of revenues in the same period last year.

Turning to operating income on a GAAP basis, including the non-cash charges, we generated a second quarter loss of $107.2 million compared to a $2.3 million profit for Q2 last year. excluding the non-cash goodwill impairment and other charges our Q2 2009 non-GAAP operating income was $3 million or 7.7% non-GAAP operating margin. This compares with $4.1 million or 10.1% non-GAAP operating margin in the second quarter of last year.

Other expense was $883,000 for the second quarter. This consisted primarily of net interest expense of $916,000 offset by a $33,000 foreign currency gain. In the corresponding quarter of fiscal 2008 we reported other expense of $1.2 million, primarily net interest expense and foreign currency loss.

Our effective tax rate on a GAAP basis for the second quarter was approximately 1.1% compared with 10.3% for the same period last year. excluding the impact of the primarily non-deductable goodwill impairment and share-based compensation expense and other special charges, the full year normalized tax rate was approximately 30% compared to 31.5% in the year-ago period. In addition, the company benefitted this quarter from [inaudible] associated with the filing of our tax return, as well as the impact of the retroactive reinstatement of the R&D credit.

For the second quarter of 2009 we recorded a GAAP net loss of $106.8 million or $8.93 per share. This includes the after-tax effects of the goodwill and other non-cash 123R charges previously noted. Excluding those charges our non-GAAP net income was $1.7 million or $0.14 per diluted share. This compares with non-GAAP net income of $2.4 million or $0.20 per share in the same period last year.

The number of shares outstanding used to compute the second quarter GAAP EPS was 11.962 million shares. This compares with 12.1 million diluted shares outstanding in the same period last year, which is approximately the same amount of shares we used for our current non-GAAP earnings per share.

Now turning to the balance sheet. Our cash position was approximately $9.2 million at the end of the quarter. During the quarter we repurchased approximately 65,000 shares of company stock paying approximately $393,000 or an average price of $6.04.

Our Q2 net accounts receivable balance decreased to $32 million compared with a prior year-end balance of $33.3 million.

Inventory decreased by approximately $400,000 during the quarter to $35 million. This is primarily due to the write down of inventory previously described offset by the demo inventory built for the new WaveMaster 8 product launch.

In Q2 we used cash from operations of approximately $770,000 due primarily to the increased inventory requirements associated with the WaveMaster introduction.

Capital expenditures for the second quarter was approximately $870,000 and depreciation and amortization was $1.6 million.

Today the company currently employees 419 employees, down from 462 employees last quarter. About 65% are in the United States, 21% in Europe, and 14% in Asia-Pacific. Our annualized revenue per employee was $345,000 in the second quarter of fiscal 2009, down slightly from $353,000 last quarter.

So to wrap up, as Tom mentioned, although we’re generally pleased with our second quarter operating results we believe there will be challenges in 2009. However, our reduced cost structure positions us well to manage this economic cycle. We have a strong team, clear vision, and confidence that the company’s recently launched product portfolio, as well as upcoming exciting new product introductions, will enable us to come out of this economic down cycle in even stronger company and better position for future growth.

I’ll now turn the call back to Tom.

Thomas H. Reslewic

Okay. Thank you, Sean. I’ll pick up here with a little bit more colour on the business starting with the oscilloscope products. We’re certainly in the midst of a recession and some complicated balance sheet moves, but it’s also true that we’re in the midst of the most ambitious product roll-out campaign in LeCroy’s history. Q2 was a very strong quarter for scopes. Despite the slowdown in the economy in November and December, oscilloscope unit sales were up more than 20% compared to last year. It was a record quarter for oscilloscope units at LeCroy.

As I mentioned, orders for the new WaveAce in Europe drove a lot of this growth in units. We entered the low-cost space with some uncertainty about future developments in this market, but we are very pleased with our results to date.

We’re developing a strong third-party distribution channel primarily to sell our low-end product lines starting with the WaveSurfer and the WaveJet. Adding the WaveAce has given our distributors a sub-$1000 product to sell for the first time and this has greatly improved their effectiveness in the market.

In addition, by opening up a presence for LeCroy in the low-cost market, WaveAce enables us to put a great new product in the hands of engineers, students, and others involved at levels of the design process where brand familiarity and loyalty are typically created, not just in Europe but in the rest of the markets around the world.

So if you look at the scope market overall, the segment that’s been affected the most by the economic slowdown is the mid range of the market, our WaveRunners and WavePros. Our WavePro 7 series launched in Q1 with great customer feedback, very strong initial sales pipeline, a lot of orders and so forth. While the sales funnel remains very high, orders are coming out of the pipeline rather slowly. Contributing to this effect is a sharp slowdown in orders from data storage customers.

The very high-end products, on the other hand, seem to be somewhat less affected. If you’re running an R&D project that absolutely depends on the performance of a high-end tool you have a better chance of getting your purchases approved for budget and for spending. We launched our latest high-end scope, the WaveMaster 8 Zi in the beginning of the current third quarter. We’re having a very enthusiastic response from customers. The sales funnel is developing nicely. We’re actually seeing more early orders than we might have expected due to the high ticket price. At the other end of the spectrum, products like the WaveAce and WaveSurfer seem to sit below certain sign-off thresholds, so those orders are also moving through the sales pipeline. It really seems to be the mid-range product line where the slowness has impacted us the most.

As I mentioned earlier, this mid-range is also hurting due to segment issues. The erosion in the disc drive market in particular. When the disc drive industry sneezes our mid-range scopes, like the Runner and the Probe, get sick. What looked like mid-range sniffles in the second quarter is developing into a full-blown cold here in the third quarter.

In terms of our market segments, data storage isn’t the only one facing major headwinds. The computer, semi-conductor, and consumer electronics segment remain the largest component of our business at 32% of total in the second quarter, but many companies in this space have made the front page recently announcing conservative outlooks and spending cutbacks.

Our next largest segment is the automotive electronics industry which, despite being part of a generally weak industry, increased to 23% of our total business in the second quarter.

Data storage, which is in deep recession, represented only about 11% of our total business in Q2, which is the lowest level in many, many quarters for a disc drive at LeCroy.

Looking at the business geographically, the strong performance of our European scope business was born out in the numbers again this quarter as sales in Europe were up more than 9% year over year. We believe that LeCroy is continuing to gain share in that region. North America was down substantially in the second quarter as sales declined about 15% from the second quarter last year. In the Asia-Pacific region overall business was roughly flat year on year with Japan actually posting about 15% growth while the rest of Asia declined by about the same amount.

Turning to our protocol business, as I mentioned before, the top line of PSG was up about 20% from the sequential first quarter. But sales were still down by about 10% compared to a year ago. In fact, the sequential quarter comparison was fairly easy because Q1 was unusually slow. A number of customers delayed orders waiting for the new storage and USB 3.0 solutions, and in addition demand for PCI Express in the summer quarter was relatively soft.

As we expected, orders for our Voyager USB 3.0 solution were a significant uptick in Q2. Voyager’s been very well received because it allows customers to buy USB 2.0 capability today with a migration path to 3.0, which offers significantly higher speeds.

The PSG unit remains very profitable and we feel good about where we’ve positioned the business. We’re number one in market share in every segment we serve. Our growth trajectory in protocol will depend on three factors. First, the underlying evolution of the standards and their adoption rates in areas like PCI Express, storage, and super speed USB 3.0. The second driver, of course, is the economy, in particular its impact on the computer and storage markets. We don’t have any special insight into where the economy’s going, but what we can do and are doing is preparing ourselves with new solutions that can drive growth when demand recovers. The final growth factor for the protocol business is our ability to deploy our protocol technology into new product areas. We’ve started a number of organic developments in this area and we expect to launch a series of new products in the next several months. The good thing about protocol is that the product development cycles are much shorter than in the scope business and our road map is very well aligned with where we believe the industry will be in terms of standards, adoption, and deployment when the market’s ready.

Now let’s turn to our outlook and financial guidance. As I mentioned before, we believe that LeCroy is well positioned to weather this recession and its impact on the test-to-measurement market. We have significantly trimmed our fixed costs and expect to maintain positive operating margins in the low single digits during the down turn.

We also expect to reliably generate cash as we reduce our inventory in the next few quarters. Inventory has increased due to the significant roll out of new products and our initial plans for much higher production rates during the current quarter.

The products we’ve recently launched are generating strong interest and will gain market share for LeCroy. We’ve enhanced and focused our R&D capabilities, and on the heels of our latest WaveMaster 8 Zi series of scopes we expect to continue launching new products based on this Apollo chip set throughout calendar 2009. The market reaction thus far to our new WaveMaster 8 Zi has been excellent and our initial order indications are also excellent. Our sales force will continue to aggressively call in our customers and we’ll be prepared with high performance products when the economy improves and our customers are ready to increase their investments and test equipment.

Now, due to the unusually volatile markets and uncertain economy, we do not have strong visibility beyond the current third fiscal quarter. As a result, we’re rescinding our full-year 2009 guidance and until further notice we will provide guidance solely on a quarter basis.

While we did not experience a dramatic slowdown in the December quarter, we are concerned about the strength of the demand environment for the first half of the calendar 2009. We’ve modelled our business to anticipate year over year revenue declines in the range of 10% to 20% from our $40 million quarter baseline. I should point out that modelling means just that; we’ve prepared ourselves for this range of outcomes and we know that we can manage under a wide variety of circumstances like these ones I’ve described. We’re still not comfortable predicting where the demand market will settle out.

These cost reductions we’ve taken would enable us to be profitable even in the event of a decrease in revenue of more than 20% from our baseline of $40 million should market conditions deteriorate to those levels. That said, we currently expect to report revenues for the third quarter of fiscal 2009 in the range of $32 million to $36 million with non-GAAP operating margins in the range of 3% to 5%.

With that we’ll stop and take your questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, we’ll now be conducting a question-and-answer session. (Operator Instructions).

Your first question comes from John Harmon – Needham & Co.

John Harmon – Needham & Co.

Hi. Good morning. Tom, just first of all clarification. I think in your remarks you, I’m talking about the product line that you said you exited. You almost, it sounded like you started to say scope, but then you said a protocol analyzer. It was a protocol analyzer, right?

Thomas H. Reslewic

Actually, two products. We eliminated one protocol program and we eliminated a development effort and some products in optical, a part of our sampling scope product line. So yes, some optical products we have exited were in the scope line.

John Harmon – Needham & Co.

Okay. Thank you. And just curious, I mean, you said your new high-end oscilloscope ATI is selling well. Could there have been enough demand for oscilloscopes with bandwidth greater than 18 GHz out there?

Thomas H. Reslewic

I don’t think that’s the right way to look at it. In fact, you know, we’ve launched a product line with bandwidths that ranged, in this high-end product line the product line has bandwidths from 4 to 30 GHz. But we haven’t really been able to show or ship the 30 GHz products at this point. We expect to do that maybe as soon as in the next couple of weeks we expect to be able to show those products for the first time.

Most of the demand that we’re seeing and the early orders are all in what I would consider the sweet spot of the high end at 13 and 16 GHz with some interest around 20 GHz as well. But really it’s been the 13 and 16 GHz products that have generated the most interest and that happens to be a bandwidth space where we’re not first. Our competitors have products in those spaces. So we’re pretty confident that many of the traditional LeCroy advantages play very well, particularly when we can now offer signal acquisition capabilities for signals that require bandwidths up in the 13 and 16 GHz range.

And I just want to clarify, too, I think there are very good signs in the early orders for these high-end products. But we really didn’t, these are not super high-volume products. We really did not count on a huge number of these things on a per-quarter basis. Surprisingly, early in this third quarter, we’ve already booked more orders for this WaveMaster 8 Zi than we would have initially expected in a full quarter. So that’s really great. The other side of that, though, is that the mid-range products, you know, you really need the mid-range products to provide a very, very steady base business that your high-end products can sit up on top of. It’s that base business from the mid-range products that just seems to be taking much more of a beating in the demand environment.

John Harmon – Needham & Co.

Thank you. And just finally, remind us about in general how long your technology cycles for oscilloscopes are. In other words, how long in general does it take for a newly introduced technology like your Apollo chip set to proliferate from a high end towards more mid-range and [inaudible] oscilloscopes?

Thomas H. Reslewic

All right. So just take the page right out of history. The last time we launched a chip set like Apollo was 2002. That chip set was called Genie, in fact. We started working on the Genie chip set in 1999. It took us three years from the time we started working on the chip set to deploy. We deployed it at the highest end of the product line and only at the highest end of the product line. That Genie chip set today powers today’s WaveRunner, which is the highest volume and most profitable product line in LeCroy’s entire portfolio. So here we are six years after launch and almost 10 years after we started the development program and the devices from the Genie chip set are really driving the mid-range of our product line. So I think that gives you a sensation. We’ve been working on this Apollo chip set for a couple of years. We’re now seeing the chip set deployed in the WaveMasters and the WavePros, and there’s no doubt in my mind that this chip set and its variance and its children will populate mid-range and high-end LeCroy scopes for quite some time to come.

John Harmon – Needham & Co.

Okay. Thank you very much.

Operator

Your next question comes from Mike Crawford – B. Riley and Company.

Michael Crawford – B. Riley and Company

Thanks. Now I understand, I know your protocol business has gross margins closer to 80%. Where would you expect the scope margins to trend given the better cost structure you have with your new products?

Thomas H. Reslewic

Yeah, I think, to clarify, the product margins in the protocol business are closer to 80%, but the overall gross margin in that business sits more like in the mid-70s. And the scope business has been sitting in the low 50s, but I expect that will just continue to tick up. I would think that, I need a normal demand environment first of all. I need the demand environment to be somewhat consistent with what we’ve seen in the last couple of quarters and certainly maybe not such the currency headwinds. But on a comparable basis to where we were I think there’s five full points of margin to be gained in the scope business as a function of the new product structure and our overall product mix. I think we could get closer to 60%.

There are a couple of asterisk on that. So for example, if the WaveAce product line, which is at the low end of our product line, has a pretty different cost structure. We don’t spend the same in R&D, we don’t spend the same in selling, our gross margins there are net of selling costs effectively because we sell through buy-and-sell distributor channels. If that product were to really take off and substantially change the mix structure in our business that would have a very positive effect on gross margin dollars and on revenue growth. But it would certainly take it the other way in terms of gross margin percentage.

So all things being equal, I’d say our gross margin percentage is going to eek up a fair amount due to the new products, but there is that asterisk on substantial change if the WaveAce product line at the low end suddenly becomes more successful than we thought.

Michael Crawford – B. Riley and Company

Right. So, two kind of points sprout out of that regarding what are you looking for in WaveAce say in, maybe not in 2009, but in 2010 if that were a more normalized environment.

Thomas H. Reslewic

Well, I think again the answer to that is it depends. We’ve got, we’ve already got what we’re originally looking for. Which is we’re not looking t make a major play in the economy space. We don’t really feel that’s the main element of our strategy. What we wanted to do in the economy segment is to provide just enough economy products so that our third party distribution partners have a broad enough product portfolio to make them feel comfortable. So the distributors that we’ve worked with really like our WaveJet and WaveSurfer, but they sit at pretty much the high end of a distributor’s product line. These distributors like to have products that reach all the way down to this thousand dollar and below price point. so we wanted to make sure that we had an offering that really gave the distributors a feeling that they could really be a full scope product line distributor with us. That’s why we embarked on the WaveAce program and that’s worked very well.

The volumes are already starting to look like they could be higher than we expected. And we’re really in the beginning of our WaveAce product development. Today we have just a number of two-channel products over several bandwidths. There’s quite a healthy road map in front of us for what we want to do with the WaveAce.

I think it’s a little too early to call it. I think that the good news is we are not depending on big volumes from the WaveAce. We’re kind of getting what we wanted and I think there’s nothing but upside there. We’re kind of new to this space as well, so I think we’re going to learn a lot from our distributors and from the run rates and from the customers who tell us how to enhance and improve the features of our WaveAce. I kind of see it as a work in progress. It’s certainly going to be hard for me to tell how the current demand environment will alter those expectations. But I’d say that we have a good road map that we plan to pursue and in a year from now I think we’ll be a lot smarter on the WaveAce and we’ll know a lot more about what our real possibilities in this space might look like.

Michael Crawford – B. Riley and Company

Okay. Great. And final question is, in an environment where LeCroy’s business is down 10% to 20% is that an environment where you think you’re going to be taking market share in the test-and-measurement industry? I’m wondering what your outlook is for the whole environment and, in that regard, I think [Deniner] reported the other day that the tectronics business was down kind of mid-single digits I think last quarter right?

Thomas H. Reslewic

Yeah. I thought they said the high-single digits in the scope business in the December quarter. That doesn’t tell me very much about what’s going to happen in the upcoming quarter because from our perspective on a local currency basis our scope business was actually up 6% in the December quarter and just about flat on a net of exchange rates. But I really do not see the December quarter finish as very indicative of what’s in front of us from a demand perspective. You may remember from hearing me speak on this matter before, I’m reasonably conservative and even a bit concerned that the demand environment in the next couple of quarters could be rather difficult. I think that we’ve said 10% to 20%; I don’t know exactly where we’ll land across that spectrum. I’d sure love to land at the not-so-bad end of that spectrum. We’re prepared for a lot worse.

And also I think the other thing that’s important is to really look at the segments that we’re in. Our business is really very focused on three segments: data storage, computers and consumer electronics type accounts, and the automotive electronics business. That automotive electronics business is largely centred in Europe, which performed very, very well in 2008. But I expect that the Europeans will now get on their new business plans for 2009 that will be a little bit more conservative.

I would say certainly in all of these major segments, which I think make up a very, very large chunk of the scope market, there’s no doubt in my mind that when I look at the product portfolio that we have and the reception that we’re getting from customers I would really believe that we’re going to take share in the places where we play.

The government and military applications space is not a huge business for LeCroy. It’s probably about 13% or 14% of our business overall this past quarter. I think other players with a larger percentage in government and military, I might do a little bit better there because I think that segment seems to initially be a little bit more insulated from some of the problems in anything sort of in the flow of chips from chip makers to computer makers to consumer electronics device makers.

Michael Crawford – B. Riley and Company

Okay. Thank you.

Operator

Your next question comes from Ajit Pai – Thomas Weisel Partners.

Ajit Pai – Thomas Weisel Partners

Yeah. Good morning. A few questions, actually. The first one is, you mentioned that you did some share buy backs. What is the average price for the shares that you purchased during the quarter?

Sean B. O’Connor

It was $6.04, Ajit.

Ajit Pai – Thomas Weisel Partners

Yet how could you, I’m just looking at your stock price during that quarter and how could it, I mean, did you do everything in the first week?

Sean B. O’Connor

It was very early in the quarter, yes.

Ajit Pai – Thomas Weisel Partners

Okay. The second question, I’m just looking at your financial liquidity, especially given the kind of guidance you’ve provided right now with the low to middle single-digit operating margins. Your overall cash position right now is about $9 million and then the debt is $70.9 million. Two questions regarding that. One is that the charges that you took, I know that in your [inaudible] that you had I think a covenant for the total net worth. Is that impacted at all by this or was that only tangible? I haven’t had a chance to go through the document itself.

Over and beyond that, you know, with this drop in your revenue and the cash [inaudible] that you’re seeing right now, how would you prioritize the users of cash flows or the EBIDTA that you’d be getting and what is going to happen in terms of your debt schedule in terms of repayment? Can you, have you renegotiated it? Are you in discussions on that? Some colour there would be helpful.

Sean B. O’Connor

Sure. With regard to the first question, the goodwill impairment charge did not count against the net worth nor any of the other covenants. So there’s no issues with regard to that. We expect to, in terms of the priority of our future cash flow, to quickly pay off the remaining bank debt and then reassess during that same time period because the stock is fairly low, the bond itself is trading at a discount, we’re going to reassess on a case by case to repurchase at a later point.

Ajit Pai – Thomas Weisel Partners

But can you buy your bonds in the market rather than paying down the bank debt? Or that’s not an option?

Sean B. O’Connor

No, we can do either or.

Ajit Pai – Thomas Weisel Partners

Either or. But if you repay your bank debt then you’ll have to do it at full price, but the bonds you can actually buy at a discount, right?

Sean B. O’Connor

That’s exactly right.

Ajit Pai – Thomas Weisel Partners

Okay. And then when you’re looking very broadly at the opportunities that are open to you in terms of financing right now, given that you had, you know, the term loan and it will revolving with a debt on the horizon, are you in discussions for any other form of financing right now as far as your debt is concerned?

Sean B. O’Connor

So we have, because we still have a couple years, Ajit, it’s kind of far out. It’s a little premature. We think our current facility is fairly adequate, is very adequate. This doesn’t come up until, we figure we’ll start looking at it in another year or year-plus.

Ajit Pai – Thomas Weisel Partners

A year or year-plus. Which means that so far, and then when you’re looking at the, like, the distributors, especially since your working capital requirements are quite significant right now. I also wanted to get some colour onto the, are the distributors feeling any kind of impact from the credit crisis right now? Are you being forced to use more of your capital and inventory that they keep? What is the payment terms of the distributors right now? Is it a percentage of what you’re putting out there on consignment or is it all sort of bought by the distributors? Could you give us some colour as to how that works?

Thomas H. Reslewic

Yeah. Actually, I would say that for the most part where we feel we’re in very good shape with the distributors. So we don’t finance or carry any of the distributors inventory. All of the inventory distributors is purchased on conventional terms. We haven’t had to do anything about that at this point. in fact, our business has been running relatively smoothly on the distribution side, particularly in Europe where typically the distribution orders are occurring at the beginnings of quarters, not the ends of quarters. So we feel like our distributors have been very responsible in terms of how much inventory they’ve taken and we’ve been very careful to make sure that they don’t have too much. It’s all been done on a conventional buy-sell basis. So it hasn’t been a working capital drain on us at all from the inventory side. We have some situations in Asia where the receivables have gotten a little bit long due to the erosion in some of the end markets there, but we don’t have anything that’s really out of the ordinary in that respect.

Ajit Pai – Thomas Weisel Partners

And what percentage of your overall revenue right now is through distribution?

Thomas H. Reslewic

It’s still relatively low. It’s probably somewhere in the 15% to 20% range.

Ajit Pai – Thomas Weisel Partners

And the vast majority of that is on traditional terms. It’s bought the moment it’s received, I mean, on regular terms, right?

Sean B. O’Connor

Yeah. A hundred percent.

Ajit Pai – Thomas Weisel Partners

A hundred percent?

Sean B. O’Connor

Yeah.

Ajit Pai – Thomas Weisel Partners

Okay. Got it. Thank you so much.

Operator

(Operator Instructions). Your next question comes from Brian Riley – B. Riley and Company.

Brian Riley – B. Riley and Company

Hey, guys. A couple questions. Can you talk about working capital and where in this environment ideally that would sit? In other words, how much money is in working capital that you can pull out of the business?

Thomas H. Reslewic

I would say that the largest near-term opportunity is in the inventory and that’s largely within our control. So we don’t feel that the environment per se is causing us any particular issues there. I’ll kind of give you the broad picture in terms of the strategy and then I’ll let Sean take you through some of the details of the numbers.

The inventory has really been a function of two things right now. The first is we’ve had a wave of three relatively significant new product launches. New product launches in terms of platforms. So the new WavePro platform, the new WaveMaster platform, the WaveAce platform, and all these things while we’ve kept supporting the customers with the Legacy platforms and haven’t discontinued any of our older products, that’s put significant uptick in terms of demo inventory for the sales force demonstration as well as production oriented inventory.

Our production plans, as we stated to launch these products our production plans and sales plans for the December quarter as well as the March quarter were significantly higher than what we’re expecting to experience now. So that’s caused a little bit of a swell in inventory as well. At the point we’re at now we feel like we’re really in a position to start letting that inventory work itself down. We’re pulling back a lot of the demos. We’re not starting to make some moves on the Legacy products. So all those things that are starting to give us an opportunity to probably yank, I would say, $7 million or $8 million out of the inventory over the next couple quarters and maybe as much as $10 million over the next year.

A/R is a little different. I think A/R will tend to come back in as well. I don’t think there’s as much of an opportunity there because a lot of that gets driven by this overall environment and big customers and important customers and distributors who tend to pay a little bit more slowly in this environment.

Maybe I’ll give you Sean to give a couple of the numbers.

Sean B. O’Connor

I think you kind of covered it all, Tom. We really believe that there’s several million dollars that we can take out in the near term in the inventory line, particularly with some aggressive demo inventory sell-off. We had to bring in a lot of inventory for higher production plans that we expected in this quarter and as well as next quarter. There’s definitely opportunity, Brian, to take out significant inventory and turn it into cash.

Brian Riley – B. Riley and Company

Okay. Can you talk a little bit, obviously when you make cuts you’re taking all the data that you have and maybe within your industry and some external data and doing the best you can. Can you talk about (a) if the environment got worse how much more room, are we at like knock one right now and what would it mean. Secondarily, if the world gets better, with some of the things that you’ve done now, how will that affect the business in a year if the world got better and given some of the cuts you’ve made.

Thomas H. Reslewic

When you say cuts you’re talking about the moves that we’ve made on all the expenses?

Brian Riley – B. Riley and Company

Yeah. Write offs and that.

Thomas H. Reslewic

Okay. I think that we felt that we wanted to be on the conservative side. We wanted to be comfortable that we could maintain not just the break-even point but generate enough operating income to cover all of our debt services and steer clear of any covenant issues and so forth. Even if the business were to drop not 20% off of our plans but 20% off of the baseline run rate, which was $40 million. We believe that we’ve set ourselves up to run in the very low 30s if necessary and probably even $30 million a quarter if we had to and still be safe in all operating dimensions. We’ve made a lot of adjustments in our personnel. A lot of the actions that we’ve taken have been in the areas of compensation reduction and discretionary expense reductions. So those things don’t impact programs quite as much. We did do our across the board 10% reduction in headcount and so that has a little bit more bearing.

But I think if I look at the R&G programs that are in place and all the projects I still feel very good about executing our road map in the near term. We were very careful not to take out some key chip developments. So we expect that whether it’s a year, year and a half, two years, however many quarters it takes before we’re back into an up cycle, we want to be hitting that up cycle with next generation of products and that requires technology development. So we did not take out some rather expensive programs in chip developments. Those are really expensive. You could imagine saying, oh, we’d rather lose less jobs and defer big chip developments, but that would be a real mistake for the company. So we feel that keeping our technology programs on track is something that we’ve managed to do during this process.

Now, if things uptick a little bit faster I think that just means that we can resume some of the, take some of the programs off the shelf, some of the extra extraordinary things that we’d like to do and dust off some of those plans and get back to them a little bit faster. Right now we feel reasonably well set up for a reasonably extreme drop off in demand.

Brian Riley – B. Riley and Company

Okay. Thank you. Just in terms of capital or asset management, just a thought for whatever it’s worth. I guess, you know, our view would be certainly appreciate the stock buyback and taking advantage of that. One has always been a proponent. But we’ve got a $30 million market capital. We’ve got a tonne of leverage equity upside given the leverage in the company. I think really what’s going to concern people more, and I think you’ve heard a little bit with the previous gentleman, is what 2011. And to the extent that you can provide clarity or confidence, whether it’s buying back bonds or whatever it is, I think it’s a good thing. Having said that, I do think that nothing sends a message to vendors, customers, employees, and shareholders alike inside buybacks or inside purchases. The board and the management team, I think you guys have done a good job and really reacted quickly, but I think from my perspective I’d like to see the money put in. It’s one thing to own stock through [inaudible] and things like that, but it’s a different one and sends a different message if you put your own money to work and those things are difficult and all that. I just would want to emphasize that. I think it would send a positive message to everybody. Thank you.

Thomas H. Reslewic

Yeah. We completely understand your views there and it’s something that we take seriously. I want to make one remark on the bonds because I think we have not really said anything definitively about that. We see these bonds as extremely attractive from a pricing perspective. We really would love to be in a position to be pursuing them a bit more. Our priorities, though, are very clear and they have been for some time. To me the absolute first priority is to be confident of where this top line is going to settle out. I do believe that it will, what seems murky and unclear right now will reveal itself over the next, whether it’s six weeks, eight weeks, or 13 weeks, I’m not sure, but I do not believe a quarter from now that the outlook will be as uncertain. It might be lower. It might not be a pleasant place from a demand environment. But I think it will be a bit more clear.

Once we have a clear sensation of the top line and we understand how our cost structures map into that and we get a very, very clear bead on our cash generation, then I think it’s quite appropriate for us to start asking the questions about how do we capitalize on opportunities to strengthen our overall position by looking at these discounted bonds or by looking at the inexpensive shares. We’re all over that, but we really want to make sure that we keep our priorities straight and make sure that we have taken care of the primary function, which is to make sure that the business can remain profitable under all circumstances. That requires a bit more clarity on where the top line is going to settle out.

I appreciate your patience in us kind of getting through that first piece before we attack the second one.

Operator

Your next question comes from John Harmon – Needham & Co.

John Harmon – Needham & Co.

Hi. In that same vein I’d like to harp on the bonds a little bit more, please. More referring to Ajit’s question. Clearly your stock is in a different place than it was a quarter ago. But at least at that time how did you make the decision to do buybacks versus buying back these bonds at a discount? Certainly we’re in an environment where investors are very sensitive to credit related issues. Would it be likely that you would be more likely to buy back bonds versus share buybacks in the future?

Thomas H. Reslewic

Yes. The answer to that is yes. We see the bonds as a more attractive and even more appropriate thing to do with excess cash that’s generated beyond immediate needs. So I think we’re all on the same page there. We see a real opportunity to reduce the leverage by capitalizing on the market situation. I just reiterate as I have many times that priority one is making sure that we’re cash generative under all circumstances and that our liquidity is safe. Our priority two is to go look at those bonds.

John Harmon – Needham & Co.

Okay. Now that that’s settle a more product related question. A while ago you gave three drivers for the protocol business and you said it was up 20% in the quarter. In prior calls you’ve been saying that the final adopt standards have been holding the business back. That probably didn’t change in the last quarter, so what works in the quarter that drove growth in protocol?

Thomas H. Reslewic

Yeah. I think we have a bit of a saw tooth going on in protocol. So it’s far more useful to look at protocol over a longer trend than just quarter to quarter because we have some effects quarter to quarter that are based on things like customers’ adoption of new platforms and products that we’ve released. So we released towards the end of the summer quarter both new products in the USB 3.0 as well as in the storage market. I think we had some customer hold off in the first quarter waiting for some of those new products to get to market and have software releases that they could evaluate and fully understand. Of course, a lot of that stuff did happen and it drove some of the adoption in the second quarter. So we’ve got this choppiness that’s related somewhat to us rolling out new products and software releases and so forth. The scope business is such that the product development cycles and the market conditions are such that you can time your product launches and we usually try to time them around the beginnings of quarters and things like that. The protocol business with four and five months product development cycles you can’t have a 90-day window or interval with which you can launch products. So we get a little bit of that choppiness.

I wouldn’t say that there’s any magic elixir that we took that made us go up 20% in the second quarter. It’s kind of what got held back in Q1 got made up for in q2.

John Harmon – Needham & Co.

That helps. Thank you.

Operator

Your next question comes from Ajit Pai – Thomas Weisel Partners.

Ajit Pai – Thomas Weisel Partners

Just looking at your tax rate, it’s been quite volatile recently. I think you’ve had some of these R&D credits and the changes in geography. But it’s come down from the very high 30s on an average basis to the low 30s. Can you help us think about what a tax rate would be like over the next couple of quarters and potentially into next year as well what we should be considering?

Sean B. O’Connor

Sure. So currently we’ve seen a lot of talk in Washington about making the R&D credit permanent. That kind of does a number on a lot of companies’ effective tax rate. But we are modelling today at a 30% rate and we think that is the go-forward rate at this point.

Ajit Pai – Thomas Weisel Partners

And the charges that you took in this particular quarter, do they help your tax rate for the next couple of quarters to be substantially lower than 30?

Sean B. O’Connor

No. We essentially set up deferred tax, we take the deferred tax impact of those in the quarter that it happens.

Ajit Pai – Thomas Weisel Partners

Got it. And then just looking at competitive dynamics. You’ve talked about how you’ve made some tremendous progress in terms of new products and the traction you’re getting, but in terms of competitive response what are you seeing out of your two largest competitors on the oscilloscope side? The pricing environment, I think you talked about why your gross margin is not necessarily to do with pricing the other factors at play, but whether that is something that could potentially see some pressure if you see the slowdown continue. And then also from an MNA perspective right now, just given the current scale of your business, the current scale of your competitors, whether it’s something that you can still be active on or the fact that your stock price and leverage on your balance sheet is sort of limiting some of those options right now.

Thomas H. Reslewic

Okay. So I’ll start with the competitive dynamic first and then touch base and move on to the MNA point second.

We have two very strong and worthy competitors in the market. Their competitive dynamics are on an ongoing basis everybody, somebody innovates in a new area, pushes ahead, brings out a new capability and the other guys need to react and try to address those capabilities with customers. In general, all of the competitors do a good job at that. I think what’s different today is that for the past two or three years we haven’t really been in the high end of the market with our end game. We haven’t really had the current generation of silicon to really be able to stand up and compete nose to nose with our top competitors. I think that’s the difference today. The idea that somehow we’ve now done something that our competitors can’t respond to or won’t respond to, I don’t tend to look at it that way. I think that we’ve just really given ourselves an opportunity to play at the high end and bring traditional LeCroy advantages in wave shape analysis and deep analysis tools that customers have long liked into those particular segments of the market up at the high end. Competitors do what you would expect; they look at their own products, they try to position what they consider to be their best features against ours, and this is a standard process that goes around and around. The difference is that in the world of 13, 16, 20 GHz, the high-end serial data signals that count, we are in the game and have a real good opportunity to play and win. And I think that’s really the difference there. The long-term competitive dynamic remains somewhat constant in this business and I’m just glad to be part of it up here with high bandwidth.

Ajit Pai – Thomas Weisel Partners

And no one has competed on prices yet as far as that goes, right? It’s all on differentiation of the product.

Thomas H. Reslewic

Yeah. You know, I’ve really been answering the pricing question for many, many years in really the good up cycle times as well as the down cycle times. To say that the business is not price competitive would be incorrect. We do battle on price. But at the end of the day we all have relatively high gross margin products. We are all trying to differentiate technically. We are each trying to figure out the one special thing that the customer needs to do more than anything else and figure out which key feature or capability of ours or the other guy’s product is the best fit. So the battles, while the purchasing department likes to get a discount and likes to participate in the process, the technical buyers and users have tremendous amounts of control over what gets selected because they’re the guys with the big problem that’s trying to get solved. That means the battle is still primarily one of technical differentiation, not pricing.

Ajit Pai – Thomas Weisel Partners

Got it. And then the MNA.

Thomas H. Reslewic

Yeah, I think MNA is one of those things that’s kind of hard to speculate in the hypothetical. There’s no situation where the phone would ring and somebody would say there’s this company that is a very good fit for your thing here or they’re interested in your piece of business for this or that. There’s no phone call that you would turn away by saying sorry, the balance sheet isn’t right, or sorry, the share prices isn’t right or the demand environment isn’t right. So I think you can’t generalize these things. You have to talk to people that bring opportunities forward. you have to look around and see what’s available that might make your business or somebody else’s business work a little bit better. Having said that in general, you’re right. At this point in time we’re really trying to focus on making sure that our core business operates successfully in this environment. We have a couple of very interesting organic developments under way that are about to actually bear fruit relatively in the near future, things that we haven’t been into before that could be quite interesting. We’re tending right now to drive more organic things and to focus on our core business and profitability and liquidity. But we just never say never to any opportunities that may come along.

Ajit Pai – Thomas Weisel Partners

Got it. Thank you so much.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for any closing comments.

Thomas H. Reslewic

Okay. Great. Thanks, everyone, for listening. We appreciate your interest in LeCroy this morning and we’ll look forward to speaking to you again when we announce our third quarter results in April. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s conference call. Thank you for joining us.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: LeCroy Corporation F2Q09 (Qtr End 12/31/08) Earnings Call Transcript
This Transcript
All Transcripts