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Executives

David Tacelli – President, Chief Executive Officer

Mark Gallenberger – Vice President, Chief Financial Officer

Analysts

Patrick Ho – Stifel, Nicolaus

CJ Muse - Barclays Capital

Christian Schwab - Craig Hallum Capital

Vernon Essi – Needham & Co.

David Duley – Steelhead Securities

Tom Diffely – D.A. Davidson

David Wu - Indaba Global Research

LTX-Credence (LTXC) Q4 2011 Results August 31, 2011 11:00 AM ET

Operator

Good morning and welcome to LTX-Credence Fourth Quarter Analyst Conference Call. [Operator instructions.] 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, please go ahead.

Mark Gallenberger

Thank you, operator. Welcome to LTX-Credence Corporation’s Fourth Quarter Fiscal Year 2011 conference call for the period ended July 31, 2011. 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 fourth quarter and discuss the business outlook. Then I will provide further detail on the company’s financial performance during the fourth quarter as well provide guidance for the first quarter of fiscal year 2012. We will take your questions after our prepared remarks.

A replay of this call will be made available through September 30 by dialing 855-859-2056 and the pass code is 91228808. 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.

Also, the company will be presenting at the Kaufman Brothers conference in New York City on Thursday, September 8, at 11:30 in the morning.

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 or loss, earnings or loss 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, on to the call. Dave?

David Tacelli

Thank you Mark, and good morning everyone. On today’s call, in addition to providing some detail on our fourth quarter and fiscal year performance, I’ll also review two of the market segments we’re focused on, microcontrols and handsets.

Before I talk about the financial performance of the company and the two individual market segments, I’d like to provide some commentary on the current business environment.

Our industry as a whole has clearly hit a soft patch in the current business cycle. As our guidance for the first quarter indicates, there is a slowdown among our customers, both IDMs and OSATs, driving them to scale back capital purchases. This is not an unusual event for our industry, as all ATE suppliers rely on unit volume expansion as the key driver for business growth. When our customers’ growth either stagnates or declines, it has a dramatic impact on our industry.

That is why at LTX-Credence, we have built a flexible business model. Our goal is to make our cost structure as variable as possible so that when an industry slowdown does occur, we can maintain our aggressive approach at developing new products and gaining additional market share.

Once the integration of LTX and Credence was completed, the model has been proven to generate strong profits and cash. Since our first quarter of fiscal year 2010, the company has generated over $120 million of EBITDA. As we have always maintained, visibility for our business is limited to the very near term, so forecasting the direction of the business beyond this window is extremely difficult.

An encouraging sign for us is that utilization of our equipment at a large number of significant accounts remains relatively high at more than 80%, which means that any upside in demand would translate into immediate orders to us. Of course, if that were to occur, our outsource manufacturing model puts us in a strong position to react quickly.

Industry conditions aside, we remain keenly focused on winning new customers. We expect these new wins to translate into market share gains and revenue growth for LTX-Credence. Over the last several quarters, we have made solid progress at transitioning some of these new accounts from the development stage into volume production. The number of new opportunities remains high and I see additional wins in volume purchases from these customers driving our top line growth.

So how did we do in the fourth quarter? Product revenues were 7% higher than they were in Q3, driven by strong growth in our application-specific and power management market segments. Product sales for application-specific devices grew more than 70% quarter-over-quarter. Our RF power amplifier business was flat compared to Q3, but the mix of systems heavily transitioned to our PAx tester, which has now become our primary revenue generator in that market segment.

Business related to handsets showed the most weakness, declining by 60% quarter-over-quarter. We expect this segment to begin building positive momentum as smart phone suppliers introduce new phones for the holiday season.

We had a strong quarter for new customer wins, with five. These represent companies or product lines with existing customers that were previously using competitive products but are now moving forward with LTX-Credence, translating to true market share shifts. These wins were in multiple market segments, including RF, battery power management, and automotive. Our market position as the lowest cost test solution continues to be our key to success. Several of these customers contributed to revenue in the fourth quarter, and we’ll work to transition others from engineering development to volume production as rapidly as possible.

The business model once again delivered about expectations. While revenues were at the low end of our guidance, EPS, at $0.27, came in at the middle of the range. Our balance sheet was further strengthened from better than expected cash generation from opportunities, ending the quarter with approximately $163 million in cash and no debt.

For the fiscal year, revenues were up 14% over fiscal 2010, while EPS from operations more than doubled. We led the industry in gross margin performance, and the drop through to the bottom line was almost 100% on the additional revenue. We generated $70 million of EBITDA during the year, growing our net cash position from $90 million in 2010 to $163 million in 2011.

We had several key product introductions during the fiscal year, including the ASLx, the first test system to combine formerly Credence and LTX technology into a single product. The ASLx extends the capability of the ASL test platform to higher levels of performance and enhanced multi-site testing. Compatible with more than 3,500 ASLs installed worldwide, the ASLx is an important piece of our future growth in the power analog market segment.

We also introduced a new X Series tester called the PAx. The PAx has allowed us to extend our already dominant position in commercial RFPA test and has now become the lead revenue generator for us in this segment.

Starting last quarter, I began a detailed review of the target markets we’re focused on, providing a more detailed review of the business segments, how our solutions are differentiated from the competition, and the business outlook for those markets. This quarter, I’ll talk about the microcontrol and handset markets.

First, a closer look at the microcontroller market. More than 14.5 billion microcontrollers will be shipped in 2011. From both a unit volume and revenue perspective, these devices are expected to grow at a compound annual growth rate of 9% through 2016. Microcontrollers have a wide range of applications, from the brains behind much of the electronics in today’s automobiles and most consumer electronics, to the touchscreen controllers that allow people to easily control smartphones, tablets, radios, navigation systems, and a whole host of other electronic devices.

While most people think of a microcontroller as a digital device, in many applications, analog or even RF circuitry is integrated into the chip. For example, in luxury automobiles, there are well over 100 microcontrollers per car, controlling everything from engine performance to navigation to radar avoidance systems. Devices for these types of applications could have either RF or specialized power testing requirements.

You can find microcontrollers in digital cameras, televisions, and even microwave ovens and refrigerators. Just about any product that requires some degree of electronic intelligence has at least one microcontroller in it. As with most devices that end up in consumer electronics, volumes are very high and cost is critically important. So from a test perspective, the solution has to meet stringent cost-of-test requirements without sacrificing quality of test.

Both our Diamond and X Series platforms are used to test microcontrollers. The primary test platform is our Diamond product line, which tests a wide range of microcontroller applications including touchscreen devices. The X Series is targeted at more specialized microcontroller market segments that require RF or specialized power instruments as in the case of some automotive devices.

In both cases, our solutions have consistently delivered the lowest cost-of-test compared to our competition. Because of the high volume of certain types of microcontrollers, manufacturers have moved to strict testing, meaning instead of testing a single device as a standalone package, they test multiple devices as part of a strip.

This significantly increases the number of devices that can be tested at the same time. Our Diamond-based IMA, or integrated multisystem architecture, solution is a unique way to expand the number of devices that can be tested in parallel resulting in lower test costs. Our standalone Diamond product is a tough competitor because of its low capital cost, small footprint, and overall low cost of ownership, and when combined with the innovative IMA technology, it’s really tough to beat.

In one example, using Diamond IMA, we were able to increase the number of devices tested compared to a competitive solution, delivering an overall cost savings of 55%. In another example, we were able to increase the number of devices tested on a competitive platform from 32 in parallel to 144 in strip on Diamond.

When we engage with a customer that is willing to make a change from a competitive test platform to lower their cost of test in the microcontroller space, we are consistently lowering capital cost, bettering throughput, and lowering overall operating expense.

Our share in the microcontroller space has grown dramatically over the last year, and we’re optimistic that we can continue to win over customers from their existing solutions. Our goal is to win 30% share in the microcontroller market by the end of 2012 and we are well on our way to achieving that objective.

The second market I’d like to review today is the handset market, which is more of an end driver space because inside the handset space you have a variety of different device technologies, such as power management, microcontroller, RFPAs, and application specific products. While devices we test end up in all types of mobile phones, my comments today will be based on smartphones.

This is because smartphones represent the fast growth segment of the handset market. From a test perspective, this represents the biggest growth opportunity. According to Gartner, worldwide smartphone sales will reach 468 million units in 2011, a 58% increase over 2010, and smartphone unit volumes are forecasted to surpass 1 billion units by 2015.

The reasons for the rapid expansion of the smartphone include a declining average price, increased functionality, and the continued expansion of the social network phenomenon. Each smartphone includes upwards of seven RF power amplifiers, a touchscreen controller, multiple power management chips, in addition to several other devices. So just within the target market segments, there are upwards of 10 devices per smartphone we can test.

For the fiscal year, handsets represented about 15-20% of our product revenues. All three of our test platforms, ASL, Diamond, and X Series, test devices for the handset market. All three deliver the customer’s solution with the overall lowest cost-of-test.

The Diamond’s primary application for smartphones is testing touchscreen controllers, and is used by one of the dominant suppliers of these devices for all final test. Diamond offers to overall lowers cost-of-test compared to competitive test platforms when you consider technical capability, throughput, and operating cost.

The X Series’ primary application, as it relates to smartphones, is for RFPAs. In this market segment, the X Series has approximately 80% share of the commercial test equipment supply for testing these devices. The X Series is dominant because of a combination of its RF performance, cost-of-test advantages, and our deep team of application experts that have consistently developed innovative techniques for effectively testing these types of devices.

The ASL platform’s primary application is for power management devices. The ultra-low cost ASL provides compelling cost-of-test advantages and has been a major platform for power management devices for 15 years. With the introduction of the ASLX, a combination of ASL and X Series technology, we expect the ASL platform to remain a major player in the power management market segment.

While fourth quarter business from handsets was weak, we see this as a temporary event. We expect handsets, which have historically represented about 25% of our business, to grow to 30% over the next several years.

In closing, while the short term business environment is challenging, we remain confident in the company’s ability to continue to win new customers and maintain a flexible business model. We remain bullish on our ability to grow share, develop new products for the markets, and deliver strong financial results.

I’d now like to turn the call over to Mark for detailed comments on the quarter and fiscal year. Mark?

Mark Gallenberger

Thanks Dave. Revenue for the quarter was $62.7 million, an increase of 7% compared to the prior quarter revenue of $58.7 million. Gross margin was 62.4%, which exceeded the plan of 60% due to better than expected product mix and a benefit of approximately $1 million from the sale of previously written off inventory.

Total operating expenses were slightly down from last quarter by approximately $200,000. Amortization of purchased intangible assets was $1.5 million, and net income for the quarter was $12.1 million, or $0.24 per diluted share on a GAAP basis.

Excluding amortization and merger-related expenses, our non-GAAP net income for the quarter was $13.8 million or $0.27 per diluted share. Our EBITDA for the quarter was $18.2 million, or 29% of revenue. This calculation excludes stock based compensation expense of $1 million and $189,000 of merger-related expenses.

For the 12-month period ended July 31, 2011, sales were $250 million, up 14% compared to the prior fiscal year. Net income was $60.1 million, or $1.19 per diluted share, on a GAAP basis, compared to $18.1 million, or $0.39 per diluted share in the prior fiscal year.

The non-GAAP net income for the year was $56.3 million, or $1.12 per diluted share, which excludes amortization of purchased intangible assets and other special one-time items, compared with $27.2 million, or $0.57 per diluted share, last fiscal year.

Excluding stock based compensation expense of $3.8 million, EBITDA for the fiscal year was $71.5 million, or 29% of revenue, compared to $48 million, or 22% of revenue, last fiscal year. Net cash grew by $70 million year over year, as we were able to maintain strong working capital management throughout the year, resulting in strong cash flow from operations.

Next, I’ll provide a breakdown of revenue for the quarter. 65% of revenue came from IDMs, while 35% came from subcontract test and fabless companies. 84% of revenue was for product, while 16% was for service. For the quarter, we had four customers each represent greater than 10% of revenue as we continued to diversify and build our customer base.

Now on to the balance sheet. We ended the quarter with net cash of approximately $163 million. Net cash increased approximately $16 million due to strong profitability and solid working capital management.

We finished the quarter with trade accounts receivable of $42.6 million, DSOs decreased to 61 days from 64 days in the prior quarter. Inventory was $21.1 million, which is down approximately $200,000 from the prior quarter.

Net capital expenditures during the quarter were $2 million, while depreciation expense was $2.7 million. We ended the quarter with accounts payable of $15.2 million, and stockholders’ equity of $241 million.

Now guidance for Q1 is as follows. We expect revenues to be in the range of $35 million to $39 million and non-GAAP loss per share to be in the range of $0.10 to $0.06, assuming 50 million shares outstanding.

The non-GAAP guidance excludes amortization of purchased intangible assets of $800,000, which is a change from the prior fiscal year of $1.5 million. We also expect gross margins to be in the low 50% range, and to be EBITDA breakeven at the midpoint of guidance.

As part of our continuous effort to streamline our business model and drive further operational efficiency, we are consolidating the manufacturing of all of our products with Jabil Circuit in Malaysia. This decision will enable us to further drive down our manufacturing costs and allow us to streamline our processes with a single outsource manufacturing partner. The savings we expect to realize will enable us to fund our growth initiatives while maintaining our strong profit model and current breakeven levels.

We expect the transition to be complete no later than the end of this calendar year. As a result of this decision, we are building a buffer in our inventory that will ensure customers are not impacted as a result of this decision. Accordingly, you should expect inventory to temporarily increase by approximately $8 million this quarter and then decline back to current levels by the end of the fiscal year.

Because of this, working capital is expected to increase resulting in a decline in cash in Q1 of approximately $8 million to $9 million, even though we expect to be EBITDA breakeven for the quarter.

In summary, although our industry is experiencing a period of weakness, we’ve designed the company’s business model to adapt to the inherent volatility of the semiconductor equipment cycle. By streamlining our business and manufacturing processes, we’ve successfully built a model that adapts to the cycles, enabling us to continue to focus on our primary objective of winning new customers and growing our market share.

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

Question-and-Answer Session

Operator

Thank you sir. [Operator instructions.] And our first question comes from the line of Patrick Ho from Stifel Nicolaus.

Patrick Ho – Stifel, Nicolaus

Dave, you mentioned that in the fourth quarter handsets experienced a pretty sizable drop quarter-over-quarter. As you look ahead to the October quarter, in which market segments do you see the drops on a going forward basis?

David Tacelli

What I’ve seen is a slowdown in, specifically for us, the PA space. I’ve also seen a slowdown in touchscreen controllers as it relates to smartphones.

Patrick Ho – Stifel, Nicolaus

Right. Now you mentioned that you’d be building a little bit of a buffer in inventory as it relates to the transition in manufacturing, could some of this buildup in inventory also be related to the uncertainty with a lot of your customers and the need, potentially, to have a very, very quick turnaround if the business environment changes? Or is that build that you’re talking about all related to the transaction to Jabil Malaysia.

David Tacelli

No, it’s the latter, Patrick. With any transition, which we’ve done in the past, by the way, we always tend to build some buffer, just in case there’s any issues with the transition. We obviously don’t expect any at this point in time, but it’s always better to be safe and we’ve got the strong balance sheet that allows us to build some of this buffer inventory. So if you’ll recall, in the past we’ve done a couple of these transitions and they’ve all worked out very smoothly with no customer impact. But as we’ve done in the past, we just tend to build that buffer inventory.

Patrick Ho – Stifel, Nicolaus

And final question from me, in terms of the market share wins and some of the opportunities on a going forward basis, Dave, you mentioned in the past that a lot of times during these kind of pauses or downturns, this allows you to work even closer with certain customers and position you more favorably coming out of a downturn. Without getting specific in terms of customers, can you describe which market segments you see that opportunity? That you could capitalize upon on the engineering side of the development work right now so whenever we come out of it those will be potential volume ramps in future upturns?

David Tacelli

We’re attacking on all five of the market segments we focus on, but the ones that I would say have the most near-term impact would be in the automotive segment and the power management segment.

Operator

And our next question comes from the line of CJ Muse from Barclays Capital.

CJ Muse - Barclays Capital

I guess first question, I was hoping to dig a little bit deeper in terms of market share and recent trends. So if we look back a month ago, with Teradyne, it looked like they guided to roughly about a $1.9 million SOC run rate for the third quarter. And with your implied guidance, if I assume kind of flattish market share, I get to like $1.4 billion, so I’m just curious, is that mix related in terms of your weakness relative to them? Is it one more month in terms of visibility in a weakening end market? If you could provide some help that would be very helpful.

David Tacelli

One of the things that I would say is if you look at the industry overall, and specifically at all SOC, so not trying to carve it into specific market segments, we’re down relatively the same percentage compared to Teradyne, when you look at their SOC business. I think the other major player in the space has seen somewhat of an uptick, mainly driven by certain microprocessor companies. I think outside of that, I think we’re relatively all in the same bucket as we go through the back half of this year.

CJ Muse - Barclays Capital

And then I guess looking at the various end markets, into October, can you identify places where you are seeing potential areas of strength? And I guess just to follow through to complete the picture, identify also what you told Patrick in terms of where you’re seeing weakness as well. If you could complete the whole picture that would be helpful.

David Tacelli

Where we’re seeing strength, I’ll drill again, on the automotive market. We’ve had at least three wins in that space and all three wins they’re moving into production. So I would continue to see, for us, strengthening in the automotive space. The biggest weakness is we’ve seen a slowdown in touchscreen controllers, and I don’t think it’s anyone losing share. I think it’s a situation where the volume has curtailed. And the company that we supply to has just slowed down their production. That would be the positive on the automotive side, and on the negative on the touchscreen controller side. PAs have been about flat, up a little bit, down a little bit, quarter-over-quarter. On the application-specific product side, it’s been a mixed bag. Where we’ve won some new business, I’ve seen some volume, and in other cases we’ve had customers just slow down.

CJ Muse - Barclays Capital

And then last quarter for me, in terms of where your stock’s indicated now, and the cash position that you have, can you talk about the [unintelligible]?

David Tacelli

Well, let’s start with our position all along is we’re going to do whatever’s possible to strategically grow the business. We’re going to be aggressive at that. That covers a wide range of things. That could cover everything from being very aggressive at market share gains, and some of those situations you’ll have to put consigned capital in place to prove your capability. Some of that could be trying to expand into markets, advancing your technology. Some of that could be looking into new markets, and how do you grow into a whole new market? And that’s the number one focus for what I’ll call the surplus cash that we have today. Beyond that, we will look at other financial things to do with that cash. If we exhaust all those possibilities, then things like a share buyback would fall right into the heart of the target.

CJ Muse - Barclays Capital

So it sounds like it’s not something that would be imminent then.

David Tacelli

I don’t want to say it is or it isn’t. What I want to say right now is there are a lot of activities underway in the first part of the strategic growth piece.

Operator

Thank you sir. And our next question comes from the line of Christian Schwab from Craig Hallum Capital.

Christian Schwab - Craig Hallum Capital

As you guys look at the overall system on chip test market this year, given what you’re seeing, do you still think it shakes out between $2.3 billion and $2.4 billion?

David Tacelli

Given the current weakness in the market right now, you would say that it’s lower than that. You would say that it’s sub-$2 billion with the current environment that we’re in.

Christian Schwab - Craig Hallum Capital

Just wanted to double check on that. And give short term corrections typically, kind of excluding ’08 and ’09 types of corrections, typically we’ve seen a couple quarters of sequential order declines ranging in the 30-50% range, peak to trough. It appears, by the guidance that you gave, unless there’s a significant change in service, you’re almost guiding to that one quarter. Is that fair?

David Tacelli

That’s fair. The one thing I would say is if you look back in history for LTX-Credence, the January quarter is typically the slowest quarter because people are coming out of the calendar year. People have slowed down their capital buys as they exit the year. People are looking at inventory levels as they approach the January to March period. The October quarter for us, so the September quarter for other competitors, is usually a decent quarter. I mean, even back four quarters ago, it was the high point. I think this is a little unusual, coming this fast. It wouldn’t surprise me to see it down consistent quarter-over-quarter. It would not surprise me, based on some of the utilization rates that we’re seeing at some customers, to have a slight snapback and be unusual, to be a little bit up in the January quarter. Right now it’s just too hard to call based on all the dynamics that are changing and I’ll call it the general economy.

Christian Schwab - Craig Hallum Capital

Teradyne earlier in the year won some automotive design wins and had some very strong ordering patterns in the beginning of their year. And then saw a very sharp decline later. The types of automotive design wins that you’re getting, do you think there’s a little bit more stability with them? Or do you think there’s that type of risk that they could be very strong and then fade?

David Tacelli

I don’t see that they’re going to be very strong and fade, because they’re just coming into volume production, so it’s not like we’re going to lose a significant amount of business if it were to drop off. We’re just in the growth phase. So as those devices get accepted, they’ll have to buy equipment to support those new designs and devices, so if anything I see slight growth. I don’t see a risk of decline.

Operator

And our next question comes from the line of Vernon Essi from Needham & Company.

Vernon Essi – Needham & Co.

I was wondering if we could revisit the manufacturing consolidation, and if you could just go over the details of what you’re willing to share in terms of what products you’re dovetailing together and the timing of this, and why particularly. Is it just because you’ve got a lull in demand and your risk is probably less in doing this? If you’d discuss that, I’d appreciate it.

David Tacelli

Sure, no problem. Right now Jabil is performing the X Series product line for us, and they’ve been doing that for at least the last seven years, and prior to that they were doing HF and HFI. So we’ve had a long term relationship with Jabil, which goes beyond 10 years. So they will be now picking up the Diamond and the ASL/ASLx product lines, which, if you look at the products, they’re actually relatively easier to integrate because of their lower complexity relative to the X Series product lines.

So that’s why we’re pretty confident that we can make this transition go pretty smoothly and fairly quickly by the end of the calendar year. In terms of the timing, this has been talked about for a while. We made the decision because it just made sense strategically and it just so happened to coincide with the downtick in the business.

I think that actually works in our favor, because we’re not making the transition during a steep ramp in business, and so it gives us actually more comfort that we’re going to be able to make the transition, the goals and the objectives, that much quicker, and have an even higher probability of success, because we’re not under pressure with a revenue ramp. So it just happened to coincide that way. We didn’t purposely try to time it that way.

Vernon Essi – Needham & Co.

And do you have any, or care to take a shot at any, cost saving metrics you may give out as a result of this?

David Tacelli

Nothing that we want to get too specific on, at this point in time. We have some goals and objectives, but I’d like to see how that plays out in reality. However, from a modeling perspective, I wouldn’t have you model anything in terms of lowering breakeven because what we want to do with the cost savings is continue to invest in growing the top line. So from a cost savings perspective, absolutely there will be some, but our plans, internally, is take those dollars and reinvest them into the company so that we can further differentiate our products and continue to aggressively grow the top line. So I would not be modeling cost savings as a result of this decision.

Vernon Essi – Needham & Co.

That’s a great segue to my second question here. Just for the record, what was the cash flow from operations in the July quarter?

David Tacelli

In the July quarter, the cash flow from operations was about $17.5 million.

Vernon Essi – Needham & Co.

And I’m hearing a lot about working capital demands from both this manufacturing transition and potentially - I don’t know if you’re specifically saying this is inevitable, but using capital on a consignment basis in terms of trying to garner more market share. Can you kind of walk through what your thresholds are internally for where you may extend your working capital needs and how we, on the other side of this, could look at what your durable cash flow would look like in a stagnant revenue scenario. And can you just walk us through the metrics around that?

Mark Gallenberger

Yeah, you know, it sort of ebbs and flows depending on where you are in the fiscal year in terms of consignments. But our goal, obviously, is to make that consignment pool self-funded, so in a sense what we want to do is make investments in these consignments and then have those turn into wins and then those consignments get monetized. Once they get monetized, then we’ve got those dollars freed up to reinvest them in new opportunities. So what you’ll typically see is an ebbing and a flowing of the consignment pool that we’ve got. And so I personally would not see any significant increases or decreases to that consignment pool, and when things increase in terms of consignment pool, that means we’re just being a little bit more aggressive on adding consignments, but we fully expect those consignments to either turn into customer wins and monetize or we may redeploy them elsewhere.

David Tacelli

One of the things that I’d add, Vern, is when we approach a brand new customer, with a consignment basically proving out the technology, or proving out the cost of test profile that we’ve indicated in the whole sales process, when that goes exceedingly well, and it has over the past year, sometimes we choose to actually add even more consignments in that current customer to expedite the process of more devices. And that’s done under the blanket of we’re going to win the business. So sometimes you’ll see us bump in consignments or bump in inventory related to that, but as Mark said, then it finds its way back into the revenue line somewhere down the road, in the three to nine month window.

Vernon Essi – Needham & Co.

Okay, and then my final question I guess is if you could just walk through - I know you sort of discussed this in a roundabout way, and I know we’re not going to get any detail on orders and what have you, but I guess mechanically what happened over the last couple of months with your customers? And I know that the line of thinking seems to be using sort of a top down market share approach to your revenue levels. But I’m wondering, kind of going in the other direction, from bottoms up, where are we at with regard, just generally speaking, the customers? Are these situations where you’ve had orders in hand and you felt pretty confident that you were going to have delivery schedules into the October quarter and now this is just being put on ice for a while? Has the radio completely gone silent with some of these customers? How should we be thinking about the nature of what’s happened over the last couple of months, and how that might play out?

David Tacelli

I think the number one thing is customers had growth plans for their revenue that haven’t materialized. Those growth plans were originally shared with us, because we were designed in on a lot of those products, and it’s just a matter of them slowing down their growth plans based on their end demand. And that translates back to slowing of orders to us. So there’s no cancellation of orders. There’s no push outs. It really is they shared a forecast with us that somewhat changed and it got progressively worse over the last month or so.

Vernon Essi – Needham & Co.

And I guess to follow on that, I’m obviously hearing from the device side that their order visibility is extremely thin right now, talking maybe two to three weeks in some instances, for some pretty large programs. Are you feeling adequately prepared and in contact, if for some reason these things may turn rather quickly? Do you feel that your customers are maybe being too cautious given the environment we’re in?

David Tacelli

You know, one of the things I would say is we’ve had many years to practice and work with an outsource model. And we’re very confident that if this thing turns, and if you look at our space and you look at our industry, it turns rapidly. Without much visibility, we’ll be able to respond to what the needs are. That’s what our customers count on. Our customers count on short lead times. Our customers count on us to be able to supply - when we win a socket, if that socket ramps, we have to be there with the capacity. So we’ve proven that over history and going forward it will be no different. If it changes, we’ll be able to respond.

Operator

Thank you. And our next question comes from the line of David Duley from Steelhead.

David Duley – Steelhead Securities

You mentioned what your goal is in the microcontroller market for market share. I think you mentioned a number at the end of 2012. Could you give us an update where you are right now with your share in the microcontroller market? And how many customers does that represent?

David Tacelli

I’ll break it into two pieces. The goal was 30% by 2012. And based on the customers we already have in place, I don’t see a problem hitting that goal by 2012. As far as where we are, depending on who’s buying, at what period of time, there are quarters where we’re actually at the number, quarters we’re slightly below, but on average we’re on track to hit the 30%. As far as what number of customers make that up, I really don’t want to get into thinking about the number. I can tell you that it’s a group of companies that are in the top five of the microcontroller production in the world. That’s the best way for me to describe it.

David Duley – Steelhead Securities

So over the last year or two, you’ve added a couple customers in this space?

David Tacelli

That is correct.

David Duley – Steelhead Securities

Okay. Now, I think I understand what you’re going to answer, but I’m just a little bit more curious here. You talked about how the smartphone market has got all this growth, yet you’ve seen big declines in the PA business and the touchscreen controller business that go into those smartphones. Could you just talk about the disconnect there and why you’re seeing such a decline in those segments?

David Tacelli

I think in some cases there was exuberance in the forecast. Let me give you an example. When I talk about touchscreen displays, really it’s a combination of touchscreen displays for smartphones and tablets. I think there was aggressive, or I call it exuberance, with multiple makers or producers of tablets that thought they were going to garner the world. And I think there was capital put in place, either by them directly or put in place with subcontractors, that’s now being absorbed by let’s call them the winners in that market.

From a PA standpoint, I think we’ve done a few things in the PA space. We continually look to advance throughput. We continually look to advance the cost of test. Number of units is staying what I’d call consistent. And we’ve got more throughput for our customers than we anticipated. So that’s causing, from a PA side, to be a little bit flat touchscreen side, to be a little bit down. That’s the best way to describe it, the two major pieces that we deal with.

On the power management side, we’ve seen consistent sales. So I talk about the handsets being down. I think the major driver for us that’s been a decline has been the touchscreen display. I say smartphones, but probably it’s a combination of smartphones and tablets to be exact.

David Duley – Steelhead Securities

Okay. And it is year-end. Can you give us a backlog number?

Mark Gallenberger

Yeah, the backlog number is approximately $53 million.

David Duley – Steelhead Securities

And that’s up, I think, from last year, right?

Mark Gallenberger

No, I don’t have that number, but I believe it might be down a couple million dollars. It’s in the same zipcode. I think maybe last year was maybe $57 if I’m remembering correctly, but don’t quote me on that number.

David Duley – Steelhead Securities

And just to kind of dig on my previous question, Dave, to summarize, it just sounds like the tablet guys overestimated how many units they were going to sell, so they’ve got a backup of tablets, and therefore they don’t need more microcontrollers to go into those tablets.

David Tacelli

That’s what we’ve seen.

Operator

Thank you sir. And our next question comes from the line of Tom Diffely from D.A. Davidson.

Tom Diffely – D.A. Davidson

Hoping first to talk about maybe some relative strengths and weaknesses between the IDMs and the OSATs. Which of those groups are weaker now? Which would you expect to come back first?

David Tacelli

That’s an interesting question. I don’t see either one as being overly weak at this point. But the typical reaction is when demand picks up, the first people that are in the queue to buy would be the IDMs.

Tom Diffely – D.A. Davidson

And then you talked about the utilization rates being relatively healthy at 80%. If this was a more serious downturn, where would you expect to see utilization rates? How low do they go typically?

David Tacelli

If I go back to the last down period, which was in that 2009 window, there were some products and some customers we saw 55-60% utilization.

Tom Diffely – D.A. Davidson

Okay. And so maybe for the average customer, if they’re above 80, it’s seemingly a pretty healthy position. Does it have to get above 90 before they actually start ordering? Or are there certain metrics for that?

David Tacelli

You know, it’s all the relative comfort in their forecast. If they think that their forecast is solid and going to increase, it starts hitting 85-90%, they buy. If they think it’s a short lived demand blip, they may go all the way to 90-95%. They count on us. And it’s not just me. They count on us and all the competitors to deliver on a very short window.

Tom Diffely – D.A. Davidson

Can you give us a feel, then, for what your average lead times are, how much of your business is turns at this point?

David Tacelli

The turns hasn’t changed. If I look over the last four quarters, on a percent basis, it really has not been impacted. And our lead times still run, I would say industry leading, in the four to eight week window, depending on the configuration you need and the instrument.

Tom Diffely – D.A. Davidson

Okay, so things could turn pretty quickly in the other direction for you then.

David Tacelli

Right.

Tom Diffely – D.A. Davidson

So I guess in this cycle, because of those lead times, are you just seeing a better balance of supply and demand as we go through the cycle? Less double ordering during the good times, and leaner inventories, I guess, during the down times?

David Tacelli

It’s a great lead in. I’ve seen no double ordering over the last few years, the reason being is everyone is on a short cycle time. Everyone is looking at turning it in the current quarter, myself and my competitors. And that’s what the customers have come to count on.

Tom Diffely – D.A. Davidson

And if you look at your customers out there, some of them still build their own test systems, what do you see is the opportunity from just replacing internally developed test systems with your test systems?

David Tacelli

The challenge is when you’re competing against an internally built product, it’s just like competing against a major competitor. It’s an internal group of a customer that has a vested interest in continuing their employment. So where you’re able to gain traction is where the technology goes fast enough where they can’t keep up. So either you can do something that they can’t do, you can do something at such a low cost that they can’t compete, or you start to reach what I’ll call the economic equation where external capital, and their decisions on external capital, purely align with what they’re doing internally, and then they make the determination why do I want to support and build my own test platform? Some customers have moved on from that years ago. Some customers are in the transition phase, and some other customers I would say have still not embraced that. They think building their own tester is still the best thing in the world.

Tom Diffely – D.A. Davidson

And when you look at your cost of test, and your low cost of test, is it really kind of the manufacturing prowess, or the architecture? What do you think gives you the real advantage on the cost of test right now?

David Tacelli

It’s the innovation that’s been put into the products. When you have the will to innovate, for market segments, you can do it. Some of the competitors do not have the will to innovate and what they do is they just price products to shoehorn them into markets. From our perspective, it’s the way the products were designed. So they were designed that way to use lower power. They were designed that way to occupy less space. They were designed that way so that they could be air cooled instead of liquid cooled. They were designed that way so they fit a specific market segment or segments. So it’s not just pricing the product differently, it’s from the design up. And a lot of it’s in the innovation of the product.

Tom Diffely – D.A. Davidson

And when you look at the last several cycles, when you had a very strong October quarter, how often did the sequential growth into January kind of trump normal seasonality? Was it unprecedented to say that the business could bounce back in a January quarter, or does that just not bear out with the data?

David Tacelli

I won’t say in my 23 or 24 years, never, but I have very rarely seen, if you have a real strong October, January kind of maintain or bounce. I have seen the reverse. I have seen, in my 23 years, the October be lighter and January be equal or better. And it’s market specific, economic driven, or it could be that people just got a little too cautious in one period and said, you know, we’ve really got to ramp up because the forecasts are pretty solid in the first half of the next calendar year.

Operator

And our next question comes from the line of David Wu from Indaba Global Research.

David Wu - Indaba Global Research

Hopefully next year you guys are going to bring good news in July. [Laughter] It’s probably low probability, but the economists, in terms of forecasting global economies, have been cutting the numbers in the last month or so. I was thinking how bad would it have to get in a macro sense for you folks to rethink how to further improve your breakeven point?

David Tacelli

That’s a really good question. I’ll break it into two pieces. First thing is we constantly look at ways to drive breakeven down, but most recently those opportunities to drive breakeven down we’ve translated and put those dollars in a bucket to help us grow the business.

If we were to continue to see depressed market conditions, and customers not wanting to make - because typically in depressed market conditions customers don’t make new product decisions if it’s going to last for a period of time - we would then let those dollars that we’re saving or streamlining go to the bottom line and you’d see the breakeven drift down.

Today, we’re keeping all our development plans in place, we’re keeping all of our attack plans in place on new customers. Again, if we saw the market changing dramatically, if this was going to be a period of decline for some stretch of time, then we’d bring into play all other things we could do to reduce cost to drive the breakeven down.

We don’t see that today, so that’s why we’re sticking with our plans of design, development growth on the products, but also growth in the customers. We want to be aggressive here, and when I say aggressive there’s a lot of tools you can do to be aggressive. We want to be very aggressive, because growing the top line with the products we have is the right thing to do.

David Wu - Indaba Global Research

I see. One other clarification I’d like to ask, and that is the touchscreen part of the market. If I look at the tablet market other than Apple, the other guys basically have failed to make any meaningful market share gains this year. Does your customer base have exposure to the Apple iPad? Or do they have exposure to all the Android, ARM based tablets that look very good on paper but haven’t sold through to the end market?

David Tacelli

We’ve got exposure to both.

Operator

Thank you. And our next question comes from the line of John Nelson from the state of Wisconsin.

John Nelson

A couple of questions. Any significant changes in competition as far as new entrants or old entrants or exits from some of your various markets that you compete in?

David Tacelli

One of the things I would add is in the RF PA space we have seen kind of combination entries where, let’s say, a current competitor today doesn’t really have the product that’s fit for a market so they try to combine with technology from instrument companies to go after the PA space. And typically what happens in a situation like that is it’s really not the same quality of test. All they’re really striving for there is to get a lower price point, a capital point. It doesn’t solve the overall issue, which is I need quality of test and I need the price point. But I have seen competition try to do that.

What I also have seen, because a lot of discussion on the surface is about pricing, in the pricing environment, from competitors and the way they approach their pricing, hasn’t changed in a lot of the market segments. What has changed is because we have designed products and innovated products for markets, and because of that we’re experiencing better gross margins, I think the pricing practices of some of the competitors have changed because they’re trying to shoehorn products into markets that don’t fit, because they don’t have the technology to really go after those markets. So when I look at new competition, or pricing, I kind of lump them into how we’re being attacked, where we have either a dominant position or we have such innovative products that they’re having to challenge us.

John Nelson

And could you discuss the significance of patents in your space? Big issue? Small issue as far as how important those are to you?

David Tacelli

Again, I’ll go back to my 24 years. I’ve seen a couple of instances where people attack each other based on a portion of technology. I haven’t seen it be a big issue in our space. Everyone has the access to low-cost FPGAs. Everyone has the access to certain pieces of RF technology. It’s do you have the right experts to apply it in such a way to give you a competitive advantage. But I haven’t seen much of that.

John Nelson

And I guess one other point I’d like to make as a large shareholder, I would suggest that you do have a stock buyback program in place in case, given the goofy market that we’ve seen, and the impact of some elements like high frequency traders and the trading that’s created by ETFs, and the rolling mini-panics that sometimes occur, you may have a compelling opportunity, even if it’s not compelling at this time, that presents itself over a very short period of time that your stock price is at a level where repurchasing it trumps anything else that you could consider at the time.

David Tacelli

I think you make an excellent point, and it is something that we’re looking at right now.

Operator

Thank you. And our next question is a followup from the line of CJ Muse from Barclays Capital.

CJ Muse - Barclays Capital

Real quickly, just was hoping to get a little help from you. Within your implied revenue EPS guide, what should we be thinking about in terms of gross margin and opex? And I guess as part of that, how we should think about the trajectory for R&D going forward.

David Tacelli

In terms of the gross margin, we expect this to be in the low 50s, so call it between 50% and 52%, given the guidance range. In terms of total opex, it’s probably going to come in, I would estimate, at about $23 million. So that would be R&D, SG&A, plus the $800,000 of amortization. In terms of going forward, quite frankly I don’t see it materially changing right now. So we’re not expecting to see any wild swings to our breakeven estimates right now. I expect it to be fairly constant throughout the year. So for modeling purposes I’d leave it about flat throughout the year.

CJ Muse - Barclays Capital

And in terms of the downtick relative to July, can I assume that all of that’s in SG&A? Or are you slowing down certain programs on the R&D side?

David Tacelli

No, I would model that primarily SG&A, because that’s the variable portion of our SG&A. So you could pick up commissions for inside sales individuals, as well as commissions to our distributors, and because those are tied to revenue, those would swing up and down with the revenues. And then also we’ve got the profit sharing, which is purely tied to net income or operating income and because those are expected to be negative, those are modeled to go to zero. So that’s why you’re seeing natural declines in SG&A, because of some of those variable expenses tied to revenue or profits.

Operator

And that concludes our question and answer session for today. I’d like to turn the conference back over to management for any final remarks.

David Tacelli

Okay. Well, I want to thank everybody for joining us today, and once again I just wanted to remind everyone we’ll be in New York City next Thursday, September 8, for the Kaufman Brothers conference. And we’ll be presenting at 11:30 in the morning. Have a good day.

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