LTX-Credence Corporation F2Q10 (Qtr End 01/31/10) Earnings Call Transcript

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LTX-Credence Corporation (LTXC) F2Q10 (Qtr End 01/31/10) Earnings Call Transcript February 25, 2010 10:00 AM ET

Executives

Mark Gallenberger – VP, CFO and Treasurer

David Tacelli – CEO and President

Analysts

Vernon Essi – Needham & Company

Christian Schwab – Craig-Hallum Capital

Patrick Ho – Stifel Nicolaus

Dave Duley – Steelhead Securities

Sarkis Sherbetchyan – B. Riley & Company

Operator

Good morning and welcome to the LTX-Credence Corporation’s second quarter earnings conference call. During the presentation, all participants will be in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions).

At the request of LTX-Credence, this conference call is being recorded. Speakers for today’s call will be David Tacelli, Chief Executive Officer and President; and Mark Gallenberger, Vice President and Chief Financial Officer.

At this time, I would like to turn the conference over to Mr. Mark Gallenberger. Sir, you may begin.

Mark Gallenberger

Thank you and welcome to LTX-Credence Corporation’s second quarter fiscal year 2010 conference call for the period ended January 31st, 2010. Joining me on today’s call is Dave Tacelli, CEO and President. After my introductory comments, Dave will discuss the company’s performance for the second quarter and discuss the business outlook. Then I will provide further detail on the company’s financial performance during the second quarter, as well as provide guidance for the third quarter of fiscal year 2010. We will take your questions after our prepared remarks.

A replay of this call will be made available through March 27th, by dialing 888-286-8010, and the passcode is 10770686, or you can visit our website at www.ltxc.com. As a reminder, the only authorized spokespeople for the company are Dave Tacelli, Rich Yerganian, and myself.

Now, for our Safe-Harbor statement. During the course of this conference call, we may make projections or other forward-looking statements regarding LTX-Credence’s business outlook or the future financial performance of the company. We wish to caution you that these statements such as projected revenues, net income, earnings per share, operating expenses, gross margin, cash flow, non-GAAP measures, and breakeven targets are only predictions, and that actual events or results may differ materially.

The guidance provided during this call represents the company’s estimates as of this day and the company assumes no obligation to update this guidance. Please refer to our Safe Harbor statement in our earnings release for more information on important factors that could cause actual results to differ.

Now, onto the call, Dave.

David Tacelli

Thank you, Mark and good afternoon, everyone. On today's call, I'll make a few brief comments on our second fiscal quarter performance, provide insight as to how we see the current growth cycle unfolding, and offer more in-depth review of our progress with the marketing initiatives we spoke about on our last conference call.

During the second quarter, we achieved an important financial milestone for the company by returning to profitability for the first time since the merger closed in August of 2008. As we've discussed in the past, our plan was to streamline the company, focus on market segments where we have a competitive advantage and build a business model that leads the industry.

As you can see from the performance over the past several quarters and continuing with our guidance for the April quarter, we have delivered on our commitments. With the industry's best business model, our focus will be on expanding market penetration in order to grow top line revenue for the company.

Over the last 90 days, we've experienced strong demand in several market areas that have been key targets for us. Our revenue increased 15% quarter-over-quarter and we are expected to grow another 10% to 15% in the April time period. If you look at the rate of growth in product revenues for the SOC test space and compare LTX-Credence to the other major ATE suppliers, you will see that over the last five quarters, LTX-Credence has outpaced the growth of all the other competitors in this market. Our products, compelling technology, and value proposition is resonating with customers.

As revenue continues to increase, it is important for all our customers that LTX-Credence deliver what they need exactly when they need it, because we are the first ATE supplier that totally outsource our manufacturing operation, we have a tremendous amount of experience in planning for rapid changes in demand. With this experience, we continue to maintain short lead times, giving our customers the ability to meet changing requirements in some fast-moving market segments.

So with the industry's leading business model, what are we doing about capturing additional market share and growing the company? Our plan to expand the top line will come from two sources, growth in the general industry cycle and market share expansion as we capitalize on opportunities and markets with both existing and new customers.

Although we have started to see the beginning of an upturn in the AT industry, the AT industry overall still remains below normalized revenue levels. By taking a close look at the industry, you will see that for the past three years, the SOC market segment has been a decline. We hit the bottom in 2009 when the buy rate for SOC test was calculated at approximately 0.8% of semiconductor IC revenue, the lowest spending on SOC equipment in the last 15 years. This is the reason why multiple research organizations that follow our industry are forecasting growth over the next three years. This of course assumes continued improvement in the global economic environment.

Customers around the world are telling us they are seeing a more broad-based recovery and higher demand in the first quarter, better than they've seen in the last few years. At the same time, they do not see any significant buildup with chip inventory levels. As I meet with the top executives of our customers throughout the U.S., Europe, and Asia, they are confident in their business through the first half of the year and very optimistic about the second half.

The SOC test industry has not seen a robust up cycle since 2006 and has been well below the buy rate trend. The result was a down cycle, driven by end demand rather than over-capacity. As demand recovers, excess capacity is reclaimed quickly, leading to a faster recovery in our business. With utilization rates now typically above 90%, most customers are either purchasing or planning to purchase additional equipment.

The need for incremental capacity is not yet across the full spectrum of end markets, but we see evidence that the demand picture is continuing to broaden. For example, our wireless RF business increased 50% quarter-over-quarter, accounting for almost 30% of sales. I commented on our last call that we expected some of our historically significant customers to begin adding capacity as we move through 2010. As expected, in our current quarter, we are starting to see purchases from several of these customers with more growth coming as we move the calendar year.

We are seeing all our main product lines gain market momentum, which will continue to increase revenue and drive market share gains throughout the entire fiscal year. Some of this momentum comes from new market initiatives such as the expansion into microcontroller or wafer probe. Some of it comes from winning business with new customers with additional growth coming from our expansion inside existing accounts.

Based on our current progress, we expect to gain several points of share in the overall SOC market over the next 24 months, which translates into $50 million to $75 million in annual revenue increase over our current market share position.

What I'd like to do now is review in more detail the progress we've made on the three initiatives I highlighted in the last conference call. These include microcontroller, wafer probe, and precision analog test, and also review why our product and marketing strategies are resonating with customers.

The first initiative I’d like to review is our progress in microcontroller test. The estimated market size for this market is $165 million in test equipment for 2010. Our share of this market in 2009 was approximately 8% with virtually all of those sales coming in the second half of the calendar year.

Prior to 2009, we had no share in the microcontroller market. So the question is why are winning? The reason is simple. Our next-generation product offers differentiating capability that meets or exceeds the performance requirements for these devices, while providing a compelling reduction in the cost of test. That product is Diamond. Diamond offers the highest resource density of any test system available for this market coupled with the analog capability needed for these devices.

All of that is packed into a tester slightly larger than the size of a PC tower. Add several high-density analog and mixed signal instrument options, including a power supply instrument with 72 channels per board and you have a powerful combination of capability in a very compact footprint.

Our goal is to grow our share from an estimated 8% in 2009 to 30% by 2012. We can already count one of the fastest growing companies in this space among our core microcontroller customers.

So why did they switch from another supplier to LTX-Credence? Well, you start with the test that stands on its own merit and then you add to it the unique capability to utilize this tester using revolutionary integrated multisystem architecture, IMA. The IMA implementation on Diamond enables our customers to deploy massive multisite test solutions for microcontrollers with industry-leading efficiency, using arrays of standard Diamond test systems. This new level of efficiency provides cost to test savings of 40% to 50% compared to competitive offerings.

The second area we targeted for growth is general purpose wafer probe. This segment includes wafer probe test for a wide range of end markets including digital consumer, computing, networking, automotive, and mobile applications. The estimated market size for testers in this segment is approximately $300 million in 2010.

Our estimated share in 2009 was 5% with almost all sales coming in the second half of the calendar year. With this initiative well underway, we expect to capture 20% share of this area over the next two years. One of the attributes of this market segment is that it's primarily served by OSATs.

Wafer probe tests, even for complex SOCs, usually requires a lower level of test. This lower level of test requirement allows OSATs flexibility and what test systems they use for cost-down wafer probe solutions. Similar to the microcontroller market, a Diamond standalone or Diamond IMA configuration offers significant cost to test reductions to our customers.

The bottom line, over the last two quarters, Diamond wafer probe purchases have resulted in more than 50 testers being installed. One particular customer in Asia has adopted Diamond as their primary wafer probe test platform and has purchased and installed a significant number of units. We are aggressively pursuing additional opportunities in this market and I expect more customers to adopt Diamond as they probe solution in the coming quarters.

The third initiative we announced on our last conference call was in the precision analog area. This market includes devices such as analog-to-digital and digital-to-analog converters. The total available market for testers focused on these devices is estimated to be $50 million in 2010. By itself, this is not a large market. However, most customers that sell precision analog converters are large IDMs that offer a broad range of other analog and mixed signal devices.

Winning a decision in the precision analog area creates a point of entry to aggressively pursue other devices in that customer's portfolio. This is the path we are following at one of our larger customers, leveraging market-leading technology to win a key evaluation and then use that entry point to grow share in other segments of their business.

At that particular customer, we are making good progress in building our business and the Data Converted Test Module, DCTM instrument we announced a quarter ago is the main reason why. The DCTM is a perfect example of what we are doing by combining innovative technology and with driving down test costs. The DCTM's performance rivals bench-top equipment, which historically has been the gold standard for this capability. With the DCTM, our customers can test either their highest precision devices with extreme accuracy or lower precision devices at a cost to test much lower than any competitive offering.

Two major manufacturers of data converters have adopted the DCTM as their precision converter solution. Between these two companies, more than two dozen testers have been sold specifically for testing converters. We are targeting 35% share of the precision market over the next two years and are aggressively pursuing new opportunities. Our revenue more than doubled quarter-over-quarter in this market segment and we expect additional revenue growth over the next several quarters.


So what does this all mean? Our top line revenue is growing faster than our competitors, our business model is delivering industry-leading financial results, we are at the early stages of a potential multiyear growth cycle, and our new initiatives are already starting to deliver to the top line. We expect to gain share over the next two years from our existing portfolio of customers and we will add some strategic new accounts which will extend those share gains even further.

In closing, I want to send out a special thanks to all the employees of LTX-Credence. When we made the decision to put the two companies together, we communicated a plan that would focus the new company on strategic markets, use the best technology by combining our products, streamline all operations, grow our market share, and deliver financial results that would lead the industry. All of you made this happen.

With the recent facility move in Hillsboro, Oregon, we have now closed the book on the integration plan we established. To all the employees, specifically in Hillsboro and those involved with that move, job well done.

I'd like to now the turn over to Mark for a detailed review of the quarter and comment on our outlook for the third fiscal quarter. Mark?

Mark Gallenberger

Thanks. Dave. Revenue for the quarter was $48 million, up 15% from the prior year. Gross margin expanded to 54.1%, up from 48.3% last quarter due to higher revenue absorption of fixed costs and better variable margin on the product mix.

R&D spending was $12 million and essentially flat from the last quarter. SG&A was $9.2 million, up from last quarter primarily due to variable expenses that are tied to revenue and profits such as sales commissions and employee profit sharing. Amortization of purchased intangible assets related to the Credence merger was $2.7 million. The restructuring charge in the quarter of $816,000 was due to a change in sublease assumptions related to previously written off excess office space.

Net income for the quarter was $813,000 or $0.01 per share on a GAAP basis. Excluding the $816,000 restructuring charge, a one-time benefit of $600,000 related to the recovery of a previously written off receivable, and amortization of purchased intangible assets of $2.7 million, the net income for the quarter was $3.7 million or $0.03 per share, which is better than our original guidance of zero to $0.02. Excluding these special items and stock-based compensation of $1.1 million, the EBITDA for the quarter was $9.4 million or 20% of revenue.

Next, I’ll provide a breakdown of revenue for the quarter. 62% of revenue came from IDMs, while 38% came from subcontract tests and fabless companies. 76% of revenue was for products and 24% for service. For the quarter, we had two greater than 10% customers and one at 20% and the other at 11% of revenue.

Now, onto the balance sheet. We ended the quarter with gross cash of approximately $84 million and net cash of approximately $11.5 million. For the quarter, net cash increased approximately $4.5 million, which is better than our original plan of an increase of $2 million to $3 million.

We finished with quarter with trade accounts receivable of $32.9 million. DSO increased to 62 days from 52 days in the prior quarter as revenue growth outpaced collections and due to timing of certain shipments in the quarter. Inventory was $29.8 million this quarter, which is down nearly $5 million from the prior quarter, driven by consumption of existing inventory used for revenue shipments.

Net capital expenditures during the quarter was $1 million as we continue to keep all expenditures to a minimum. Depreciation expense was $3.5 million. We ended the quarter with accounts payable of $13.9 million and stockholders' equity of $106 million.

Guidance for Q3 is as follows. We expect revenue to be in a range of $53 million to $55 million, which is a sequential increase of 10% to 15%. Non-GAAP earnings per share is projected to be in the range of $0.04 to $0.05, assuming 129 million shares outstanding. The non-GAAP earnings guidance excludes amortization of purchased intangible assets of $2.7 million. We also expect EBITDA to be in the low-20% range and we expect net cash to further increase sequentially by approximately $8 million or 15% of revenue.

In summary, the business model continues to perform very well as demonstrated by the strong profit leverage realized over the past three quarters. With the business model completely proven out, the top priority for the company is to grow revenue faster than the competition and gain sustainable market share.

This concludes our prepared remarks. And at this time, we will take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And your first question is from the line of Vernon Essi with Needham & Company. Please proceed.

Vernon Essi – Needham & Company

Thank you very much and congratulations on some solid results here. Wondering if you could elaborate a little bit on how you see the environment. Everybody is obviously wondering just in terms of how you see your customers' order rates going into the 2010 time frame. You've discussed that you are going to see some demand you think more towards the back-half of this fiscal year. Has anything changed in that? And how, maybe specifically to get more granular, has the linearity been in the most recent quarter versus sort of where you are heading into the April quarter in terms of orders?

David Tacelli

Thank you, Vernon. What I would say first about coming into 2010, the order rate has actually picked up as we enter January, which is an anomaly. If you look at prior years, January has typically been a slow quarter for the industry, but order rate remained and actually picked up in the January time period. I think in the February period, it slowed down a little bit because of Chinese New Year, but we are starting to see that come back as well. So strong order growth in the first part of this calendar year.

Linearity through the quarter, in our prior quarter, the November to January time period, like I said, it actually picked up as we approached later in the quarter in January. So it was more skewed towards the back-half of our second fiscal quarter.

Vernon Essi – Needham & Company

Any color on the April quarter?

David Tacelli

What I would say, if you look at the guidance and we have a pretty tight range on guidance. We feel pretty confident right now of where we are and we are getting solid signs from all our customers, specifically our customers that have been significant in the past and some of the new initiatives continue to drive more volume.

Vernon Essi – Needham & Company

Okay. And can you go over the – obviously, there was some interesting news about the PAC rim with Taiwan allowing investment into mainland China. How do you think that's going to impact the business? Do you see a lot of demand because of that or is it sort of a wait-and-see approach with your customers? Just explain sort of the atmosphere over there and how things are progressing.

David Tacelli

Well, the one thing I would say is when we put the two companies together, we picked up a very, very strong value-added partner in Spirox, and our business in the whole Taiwan market has picked up quite nicely, not only for the products that they served in the past, but also for some of the LTX products that they did not have in the portfolio. We've seen good growth in both areas.

I don't see any dramatic change for us in the – in China as a result of Taiwan now making additional investments. I think those investments were made in Asia beforehand. So I don't see any dramatic change. What I do see is the big upside that we have experienced because of dealing now with Spirox and having a broader portfolio of products.

Vernon Essi – Needham & Company

Okay. And then lastly, also – well, congratulations on the success of the IMA platform and it seems like you are getting some adoption there. Is there any – I guess I use the word color, but any granularity you can give us in terms of how you may see that progressing with regards to penetration rates and sort of your customers that are looking at that? Is this something that you expect to take time or do you think the conversion process in ramping that is going to be faster than originally anticipated?

David Tacelli

No, I think it's going to follow the plan that we laid out, which right now we have product in beta test and with a significant customer that's already a purchaser of the Diamond product. Once that rolls out, I see fast adoption at that customer. What I then see is further on penetration with other customers that are currently Diamond users and that will be towards the back-half of the calendar year. But all according to the plan that we laid out to make sure that we could get this product out there, support it, and the customers would see that gains that we've committed to.

Vernon Essi – Needham & Company

Okay, that's helpful. Thanks a lot.

Operator

And your next question comes from the line of Christian Schwab with Craig-Hallum Capital. Please proceed.

Christian Schwab – Craig-Hallum Capital

Great, thank you. Guys, can you walk us through what drove the strength so far? We bottomed in the April at $25 million of almost doubled, it appears that the majority of that strength was driven so far by Spirox and now – don't want to put words in your mouth, but it appears that your typical customer or a historic customer, the TIs, STMicro, Maxim, et ceteras of the world are now beginning to finally kick in and spend. Is that a fair way of looking at it?

David Tacelli

Yes. The one thing I – let's break it down a little bit. When we talk about Spirox, Spirox being our value-added partner, you really got to look at the broad base of customers that they deal with in the markets they deal with. So when we are talking about Spirox, we are talking about selling into a broad list of Taiwanese and China customers. And what I would also say, if you look at the prior-quarter results, an interesting data point is about 30% of the revenue in the quarter – total revenue came from the new initiative that I've outlined. So it's not just the initiatives that we are hoping to generate top line revenue, they are generating.

If I look and go back a quarter, the growth from Q1 to Q2, we started to see purchases from some of the companies you named and the expectation or the forecast from those companies is that they will continue to increase as we go through the next couple of quarters. So we are seeing that growth. When we talk about Spirox, it's really broad base with a wide variety accounts and we are also starting to see very, very good traction delivered to the top line from the initiatives that we put in place.

So all three of those are happening. I think it will continue as we go through the next couple of quarters and some of the historically significant accounts will drive more business as we approach Q3, Q4, and then Q1 of next year. That's our expectation.

Christian Schwab – Craig-Hallum Capital

Right. So I guess, kind of continuation of great operational performance and baby steps potentially, if you will, in top line growth as confidence gains in the global economic recovery, it would be logical that ladder steps up, if you will, or potential to more normalized order patterns to units being produced in kind of the second half of this year going into 2011 event. Is that fair?

David Tacelli

Right. That's a fair statement.

Christian Schwab – Craig-Hallum Capital

Perfect. No other questions. Thanks.

David Tacelli

Thanks.

Operator

And your next question comes from the line of Patrick Ho with Stifel Nicolaus. Please proceed.

Patrick Ho – Stifel Nicolaus

Thanks a lot. Congrats, guys. First, just a few housekeeping questions. What was the cash flow from operations this quarter and what's the expected tax rate for the rest of the year?

Mark Gallenberger

Cash flow from operations this quarter, I believe it was $5 million to – around about $5 million for the quarter. And your question on taxes right now, because of the NOLs we've got that was built up post-merger and because of the NOLs that are limited pre-merger, I would – for your modeling purposes, I would still assume about a 2% AMT tax rate for the balance of this year.

Patrick Ho – Stifel Nicolaus

Great, that’s helpful. Dave, I think you mentioned in your prepared remarks, you commented that wireless was strong during the quarter. Can you give a little more color in what other market segments you saw that were strong in both January and what you anticipate in the April quarter being the drivers for this current quarter?

David Tacelli

We saw very, very good strength in what I'd call the base analog market. So we had a lot of sales of what I call straight analog testers. That was very, very strong exiting January and it continued into February. We saw very, very good strength in the microcontroller market, above expectations. And based on a lot of customers in Taiwan and China and our penetration into general purpose wafer probe, we saw very, very good strength in the wafer probe market as well.

So really all the initiatives we targeted, we saw very good strength. We had two customers that have been significant in the past where we had made great penetration into either hard disk drive, or some of their analog portions or more complex SOCs also come back in and start buying. I wouldn't call it overall upside yet, but I – additional capacity buys. And I think as we go through the next several months into April and beyond, the expectation by those customers is to continue to drive more capacity.

Patrick Ho – Stifel Nicolaus

Okay. So basically some of the same ones that you saw in January will carry into April, but just at a higher degree?

David Tacelli

At a higher rate, yes. And again, some of the markets – we talk about some of our significant customers in the past were starting to see buys, but I don't think they will be significant – they will be there, but they won't be significant until we hit probably the Q4 July time frame.

Patrick Ho – Stifel Nicolaus

Great. You guys posted obviously really good gross margins for the quarter and I think Mark, you mentioned it was better product mix. Can you give a little bit of color in terms of shifting your Credence products, or the ones from that side of this, to your traditional LTX outsourcing model and what the benefits have been in that transition? Is it complete and is that also helping the margin profile now and on a going-forward basis?

Mark Gallenberger

Well, one thing I want to be clear is we haven't shifted any of the legacy Credence products from one outsource manufacturer to another. And so our plan is to continue to have our existing outsource partners, which is primarily Jabil Circuit and Plexus. Benchmark is also doing the Sapphire products, but there is not a huge demand right now for Sapphire, but Plexus is doing the Credence – other Credence.

Our plan of record is to maintain those key strategic partners. And so the drive is really not through consolidation. The drive is continuing to work with our outsource partners that really drive down fixed costs and – or at least maintain it as revenue ramps and that's actually giving us much better drop-through rates. And so that was part of the equation. The other part of the equation is inside each product line, we saw better variable margins that we had going out the door this quarter. That, as you know, will vary from quarter to quarter. This – it just so happened we had very, very good variable margins in the product profiles that went out the door this quarter.


And lastly, what you are going to see is additional benefits with the Hillsboro move that we just completed last quarter. And we saw a partial benefit inside of our January quarter. You'll start to realize the full benefit going forward now that we are completely out of the space up in Hillsboro and we've right-sized that location.

Patrick Ho – Stifel Nicolaus

Great. Final question from me. In terms of the IMA product and maybe just to follow up on the earlier question is, you mentioned that Diamond is not where you are focused with IMA. Typically from what I understand, OSATs because of the various customers they have and the flexibility that they are always looking for with testers, is that kind of the target market first for you guys and then expanding to the IDMs? Or do you see it covering both IDMs and OSATs with the IMA product?

David Tacelli

It's covering both IDMs and OSATs. It's really right now targeted at a market segment, not a division between IDMs and OSATs. The market segment that's targeted at today, Patrick, is the microcontroller market because microcontrollers are things like EEPROMs are more going to strip tests. As more products migrate to strip tests, the IMA becomes far more viable and far more effective for those people doing the tests. So OSATs is a significant piece, but also those companies that are doing their own test, but in the microcontroller market, IMA becomes a valuable commodity for them.

Patrick Ho – Stifel Nicolaus

Great. Thanks a lot, guys.

David Tacelli

Thank you.

Operator

And your next question line of Dave Duley with Steelhead Securities. Please proceed.

Dave Duley – Steelhead Securities

Good morning.

David Tacelli

Good morning.

Mark Gallenberger

Good morning.

Dave Duley – Steelhead Securities

I was wondering if you could take a stab at a couple of questions. For calendar 2010, what do you think the biggest driver of growth will be for your company? Will it be new customers or will it be revenue from existing customers?

David Tacelli

For fiscal 2010?

Dave Duley – Steelhead Securities

Yes. Or calendar – I'm just trying to do –

David Tacelli

Let's take fiscal year, because we kind of deal in fiscal quarters. I would say the biggest growth driver over the next – it has been and will be over the next couple of quarters, new market initiatives. I also expect the customers that we've seen or have been significant in the past to start to drive, but if you were to look year-over-year and kind of do a comparison, I think the new market initiatives will drive more revenue.

Dave Duley – Steelhead Securities

So new customers?

David Tacelli

I think it's new – it's new customers and new market initiatives because some of the initiatives are with existing customers where we have not played in the past.

Dave Duley – Steelhead Securities

Okay. And I guess, if you look back historically, I think the cycles unfolded for LTX-Credence kind of as, I recollect, previous cycles has unfolded. You kind of have the lower-end analog and consumer business turning on first and then you have that higher-end stuff from your big IDMs turning on a little bit later. I believe that's the pattern of the last few cycles, from my recollection.

But one thing I was wondering to get your opinion on is does it seem like it's a little bit longer this time for the higher-end business to turn on and perhaps take a stab at if you agree or disagree with that statement or perhaps give an explanation as to why that is why it isn’t?

David Tacelli

Well, I think you hit on a very interesting point, which we've seen and continue to see, which is the base analog product does seem to turn on quicker. I think what's changed maybe in this cycle versus the prior of cycles and we've talked about this many times, what's going to be the real drive for these and I say high performance, I don't mean high-performance SOCs, but you get into more high-performance digital types of devices, what's going to be the drive for that and will customers – our customers look to change the test profile of what they do to get more lower cost.

So we talk about complex – or you are talking about complex devices in the future and how that's going to generate, let's say, sales of upper-end test equipment. I think it maybe a little bit different, maybe more muted this time. The thing that I like about our business is we are now diverse with customers and we've got some really good market penetration into these other analog or consumer digital markets. I don't think we are going to see as much fluctuation, some of my competitors may see more. They may not see the rapid expansion of their high-end test platforms as we go through the cycle.

Dave Duley – Steelhead Securities

One question. You mentioned the Hillsboro cost savings was going to be fully recognized in the April quarter. How much additional savings is there between January and April there?

David Tacelli

Yes, we've estimated about an annual savings of approximately $3 million. And so you will see basically one-fourth of that $3 million fully realized in April and since we had exited this space in early January, you basically got one month's worth in the first – or in the second quarter – fiscal quarter.

Dave Duley – Steelhead Securities

Okay. Final question my from is – I talked a little bit about it, but I just wanted to make sure, should there be any reason that the drop rate to the gross margin line changes over the next quarter or two, given what you expect in the mix or what not?

David Tacelli

Well, you – you can't go on last quarter's drop-through rates because drop-through rates were close to 100% if you did that math. But you got to go back to what we've talked about historically, which is the steady-state business model, which talks about a 60% drop-through rate to gross margin and anywhere from 50% to 55% drop-through rate to the bottom line. And so those numbers and those assumptions are still in tact.

Dave Duley – Steelhead Securities

Okay. So we had an unusually good drop rate this quarter, but there is no reason to think the overall model really changes? It should still be in that –

Mark Gallenberger

No, the overall model is still as we have talked about, which is about $45 breakeven on a non-GAAP net income basis. That excludes the amortization of purchased intangibles and about a $36 million revenue breakeven for EBITDA. Those – that business model is still in tact.

Dave Duley – Steelhead Securities

Okay. And should we expect – what should we expect for cash flow generation? I think you did $8 million – net cash was up $8 million, I'm not quite sure. I think you said cash flow from ops was $5 million. Should that be kind of the target quarterly number going forward or?

Mark Gallenberger

Yes, what we talked about was net cash actually grew about $4.5 million in the January quarter and net cash flow or cash flow from operations was just over $5 million for the January quarter. For April quarter, given the guidance that we are providing, we are estimating net cash to grow approximately $8 million quarter-over-quarter.

Dave Duley – Steelhead Securities

And do you think you can kind of keep that run rate up?

Mark Gallenberger

Well, obviously it's a function of revenue and keeping tight controls on working capital, as well as capital expenditures. Those are really the three primary drivers. I mean, we've got the business model really working nicely right now and I don't see any changes to the business model.

So really, it's a function of the revenue, the CapEx, which we obviously can control and then, working capital changes and we've done a pretty good job at keeping working capital in check even as the revenue is ramping pretty strongly here. So I would expect that net cash – assuming that revenue continues to grow, we can continue to grow net cash commensurate with the revenue.

Dave Duley – Steelhead Securities

Okay. Final question from me was did the backlog grow sequentially?

Mark Gallenberger

Yes, we don't talk about backlog or orders.

Dave Duley – Steelhead Securities

I tried to soften you up.

Mark Gallenberger

Yes, sorry, Dave. I knew that question would come from you.

Dave Duley – Steelhead Securities

All right. Thank you.

Mark Gallenberger

All right. See you.

Operator

(Operator Instructions). And your next question is from the line of Mike Crawford with B. Riley & Company. Please proceed.

Sarkis Sherbetchyan – B. Riley & Company

Hi, guys. Can you hear me well? This is Sarkis stepping in for Mike.

David Tacelli

Yes, we can hear you.

Sarkis Sherbetchyan – B. Riley & Company

Going – revisiting the margins question, I guess, what is the best way to think of how your margins lever above the break even fulcrum point?

Mark Gallenberger

Yes, it really kind of – it's fairly straightforward. So if you look at any sort of incremental revenue above the breakeven point, we are – we model about 60% plus or minus, some quarters it could be higher than that. Last quarter, obviously, was significantly higher than that. And other quarters that maybe below it. But on average, we believe that we can drive incremental revenues and drop-through by about 60% to the gross margin line. So that's the way you should kind of model it.

So if you sort of look at last quarter, which we did about 54% gross margins and look at the guidance that we gave for Q3, if you make the assumption about 60% of it will drop through the gross margin line, then you are probably at around a 55% gross margin target for the April quarter. And you – if you want to do any sort of your own models on different revenue assumptions, that's the way I would recommend you do it.

Sarkis Sherbetchyan – B. Riley & Company

Thank you. And can you elaborate on your thinking on what comprises the mid cycle base case going forward?

Mark Gallenberger

Yes, we've looked at – we've looked at that from several different angles and if you look at some of the third-party research data out there, which gives forecast over the next several yeas and if you also look at our historical market shares and you pro forma those figures to includes LTX and Credence combined, we are currently running between 12% to 13% market share for SOC and if you look at some of the third-party data and you sort of average what a normalized run rate could be for the company, you are approaching basically the $65 million per quarter revenue run rate.

So with the current revenue that we are at and the guidance that we have given, that would suggest we are – the industry, as well as LTX-Credence is below normalized levels still.

Sarkis Sherbetchyan – B. Riley & Company

Okay, great. Thank you very much.

Operator

And you have a follow-up question from the line of Christian Schwab with Craig-Hallum Capital. Please proceed.

Christian Schwab – Craig-Hallum Capital

Great, thank you. Along the lines of the previous question, peak cycle being harder than mid cycle, but mid cycle being roughly around $65 million depending upon market share gains in your initiatives there, should we assume – if we want to figure out peak cycle, it would probably range anywhere from $80 million to $100 million a quarter?

David Tacelli

Here is the way I'd look at it, Christian. If you take Mark's analysis of industry data and the 12% to 13% share and some of my comments where I talked about different market segments and how much share that we think we will gain and how that translates to annualized dollars, it probably changes the normalized revenue from about $65 million up to about $80 million a quarter. That's kind of the difference.

Christian Schwab – Craig-Hallum Capital

So $80 million would be mid cycle with market share gains?

David Tacelli

Right. So you would have peak quarters above that.

Christian Schwab – Craig-Hallum Capital

Correct.

David Tacelli

But normalized with where we are today, industry data, and some of the market share gains that we know that we will get because we are already penetrated those markets. I'd say $80 million is with the upside.

Christian Schwab – Craig-Hallum Capital

Fabulous. And then if we look at your gross margin, which is 54% in the quarter, in presentations during the downturn, you didn’t think you could get to a targeted 54% gross margin range until potentially closer to mid cycle at 65%. Is there something – was the previous expectation conservative or is something happening regarding profitability currently that is just better than previously assumed?

David Tacelli

Well, I think it does move around from quarter to quarter. And I think the business model is performing a bit better than what we had originally set out over a year ago. And so I think some of those are factored in there. The top line though is going to be sort of limited on gross margins because of the drop-through rate of 60%. You are starting to kind of converge to that correct.

Christian Schwab – Craig-Hallum Capital

Correct.

David Tacelli

And so I wouldn't expect anything to be in excess of that, but as you get higher and higher revenue levels – you know how the math works, so just on a percent basis, the growth starts to – the growth curve starts to flatten off on the gross margin line. But it could ultimately converge in the mid-to-high 50s.

So we are starting to approach those numbers and I think for the products we have today, I don't see any changes to that, whether it's positive or negative. I think it's a very solid product lineup and we've got very good products that have been designed for the right markets that we are attacking. So we can enjoy these kind of industry-leading margins.

Christian Schwab – Craig-Hallum Capital

Right. I just wanted to make sure there wasn't something specific to mix today that was dramatically different that might not be able to be the case three or four quarters from now. That was – I guess that's what I was asking.

David Tacelli

Well, yes. The other thing I would add to that is when we put the plan together, we really didn’t factor in any potential operational gains we'd get through our subcontract suppliers. And I think the operational team has done an excellent job, as Mark said earlier, of keeping that fixed cost down, if not, in some cases lowering it on higher revenue. So I think you are getting a little bit benefit there because we didn’t kind of talk about that in our planning process. And now that's starting to happen as well.

Christian Schwab – Craig-Hallum Capital

Great. So then if we look at mid cycle earnings – this is my last question, I'm sorry, I asked too many. Is – kind of thinking – assuming the business model holds the way that we are today, it kind of assumes mid cycle at $65 million a quarter, we are approaching annualized earnings power of $0.40, should we able to gain market share given the initiatives that you outlined, assuming the market share is probably closer to 15%, we are setting up mid cycle with annualized earnings power of $0.60, give or take. Is that fair?

David Tacelli

That's fair.

Mark Gallenberger

Yes.

Christian Schwab – Craig-Hallum Capital

Great. Thank you, guys.

Operator

As there are no further questions in the queue at this time, I would like to turn the call back over to Mr. Mark Gallenberger for closing remarks.

Mark Gallenberger

Okay. Well, I just want to conclude by thanking everybody for joining us today and look forward to speaking with you all very soon. Have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation, you may now disconnect. Have a great day.

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