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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-26634
LECROY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 13-2507777
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
700 CHESTNUT RIDGE ROAD
CHESTNUT RIDGE, NEW YORK 10977
(Address of Principal Executive Office) (Zip Code)
(845) 425-2000
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark ("X") whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
YES |X| NO [ ]
Indicate by check mark ("X") whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES |X| NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT APRIL 27, 2004
------------------------------------ ---------------------------------
Common stock, par value $.01 share 11,528,740
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LECROY CORPORATION
FORM 10-Q
INDEX
Page No.
--------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 2004 (Unaudited)
and June 30, 2003................................................... 3
Condensed Consolidated Statements of Operations (Unaudited) for the
Three and Nine Months ended March 31, 2004 and 2003................. 4
Condensed Consolidated Statements of Cash Flows (Unaudited) for the
Nine Months ended March 31, 2004 and 2003.......................... 5
Notes to Condensed Consolidated Financial Statements (Unaudited)....... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................. 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk............. 35
Item 4. Controls and Procedures................................................ 35
PART II OTHER INFORMATION
Item 1. Legal Proceedings...................................................... 36
Item 6. Exhibits and Reports on Form 8-K....................................... 37
Signature ....................................................................... 37
LeCroy(R), Wavelink(TM), WaveMaster(R), WavePro(R), WaveRunner(R),
WaveSurfer(TM) and MAUI(TM) are our trademarks. All other trademarks,
servicemarks or tradenames referred to in this Form 10-Q are the property of
their respective owners.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LECROY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, JUNE 30,
IN THOUSANDS, EXCEPT PAR VALUE AND SHARE DATA 2004 2003
- ---------------------------------------------------------------------- ------------ ---------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents.......................................... $ 24,951 $ 30,851
Accounts receivable, net........................................... 24,313 20,523
Inventories, net................................................... 22,132 24,720
Other current assets............................................... 11,749 10,012
--------- ---------
Total current assets............................................. 83,145 86,106
Property and equipment, net........................................... 19,624 20,021
Other assets.......................................................... 13,462 16,025
--------- ---------
TOTAL ASSETS.......................................................... $ 116,231 $ 122,152
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt and current portion of long-term debt.............. $ 4,101 $ 95
Accounts payable................................................... 11,477 10,937
Accrued expenses and other liabilities............................. 13,280 12,243
--------- ---------
Total current liabilities........................................ 28,858 23,275
Deferred revenue and other non-current liabilities.................... 1,809 3,028
--------- ---------
Total liabilities................................................ 30,667 26,303
Redeemable convertible preferred stock, $.01 par value (authorized
5,000,000 shares of preferred stock; 0 and 500,000 shares issued and
outstanding designated as redeemable convertible preferred stock;
liquidation value, $0 and $15,735 at March 31, 2004 and
June 30, 2003, respectively)........................................ -- 15,335
Stockholders' equity:
Common stock, $.01 par value (authorized 45,000,000 shares; 10,802,240
and 10,412,562 shares issued and outstanding as of
March 31, 2004 and June 30, 2003, respectively).................... 108 104
Additional paid-in capital.......................................... 78,837 79,864
Warrants to purchase common stock................................... 2,165 2,165
Accumulated other comprehensive income (loss)....................... 177 (1,598)
Retained earnings (accumulated deficit)............................. 4,277 (21)
--------- ---------
Total stockholders' equity............................................ 85,564 80,514
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................ $ 116,231 $ 122,152
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
LECROY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
--------------------- -----------------
IN THOUSANDS, EXCEPT PER SHARE DATA 2004 2003 2004 2003
- ------------------------------------------------ ----------- --------- ------- -------
Revenues:
Oscilloscopes and related products............ $29,968 $21,009 $81,592 $67,864
Service and other............................. 2,862 5,527 8,428 10,300
------- ------- ------- -------
Total revenues............................... 32,830 26,536 90,020 78,164
Cost of sales (see Note 4)...................... 13,794 11,478 38,448 38,875
------- ------- ------- -------
Gross profit................................. 19,036 15,058 51,572 39,289
Operating expenses:
Selling, general and administrative (see Note 4) 11,319 9,552 31,411 29,605
Research and development (see Note 4)......... 4,120 4,667 11,585 13,537
------- ------- ------- -------
Total operating expenses..................... 15,439 14,219 42,996 43,142
Operating income (loss)......................... 3,597 839 8,576 (3,853)
Other income (expense), net................... 147 (10) (95) (161)
------- ------- ------- --------
Income (loss) before income taxes............... 3,744 829 8,481 (4,014)
Provision for (benefit from) income taxes..... 1,385 307 3,138 (1,485)
------- ------- ------- -------
Net income (loss)............................... 2,359 522 5,343 (2,529)
Charges related to convertible preferred stock.. -- 518 -- 1,550
Redemption of convertible preferred stock....... -- -- 7,665 --
------- ------- ------- -------
Net income (loss) applicable to common
stockholders.................................. $ 2,359 $ 4 $(2,322) $(4,079)
======= ======= ======= =======
Net income (loss) per common share applicable to
common stockholders:
Basic...................................... $ 0.22 $ -- $ (0.22) $ (0.39)
Diluted.................................... $ 0.21 $ -- $ (0.22) $ (0.39)
Weighted average number of common shares:
Basic...................................... 10,721 10,348 10,545 10,337
Diluted.................................... 11,271 10,404 10,545 10,337
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
LECROY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
MARCH 31,
-------------------
IN THOUSANDS 2004 2003
- -------------------------------------------------------------------------- ---------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................................... $ 5,343 $ (2,529)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization........................................... 4,849 4,949
Deferred income taxes................................................... 1,573 (1,871)
Recognition of deferred license revenue................................. (972) (972)
Impairment of intangible assets......................................... -- 2,030
Net loss on disposal of property and equipment.......................... 76 --
Tax benefit from exercise of stock options.............................. 1,067 --
Change in operating assets and liabilities:
Accounts receivable..................................................... (2,811) 4,195
Inventories............................................................. 3,266 2,088
Other current and non-current assets.................................... (1,109) (314)
Accounts payable, accrued expenses and other liabilities................ 1,582 (4,787)
--------- --------
Net cash provided by operating activities................................. 12,864 2,789
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment...................................... (3,861) (2,032)
Net proceeds from sale of property...................................... 584 --
Purchase of intangible assets........................................... (150) (1,260)
--------- --------
Net cash used in investing activities..................................... (3,427) (3,292)
---------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of borrowings................................................. (6,070) (62)
Borrowings under line of credit......................................... 10,000 --
Redemption of convertible preferred stock............................... (23,000) --
Payments related to common stock offering............................... (285) --
Proceeds from employee stock purchase and option plans.................. 4,511 259
Payment of seller-financed intangible assets............................ (500) --
---------- --------
Net cash (used in) provided by in financing activities.................... (15,344) 197
--------- --------
Effect of exchange rate changes on cash................................... 7 410
--------- --------
Net (decrease) increase in cash and cash equivalents.................... (5,900) 104
Cash and cash equivalents at beginning of the period.................... 30,851 27,322
--------- --------
Cash and cash equivalents at end of the period.......................... $ 24,951 $ 27,426
========= ========
Supplemental Cash Flow Disclosure
Cash paid during the period for:
Interest............................................................... $ 156 $ 74
Income taxes........................................................... 108 514
Non-cash investing and financing activities:
Acquisition of distributor in exchange for amounts due to the Company... -- 300
Acquisition of seller-financed intangible assets........................ -- 750
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying interim condensed consolidated financial statements include
all the accounts of LeCroy Corporation (the "Company," "LeCroy," "us," "we" or
"our") and its wholly-owned subsidiaries. These condensed consolidated financial
statements are unaudited and should be read in conjunction with the audited
consolidated financial statements included in the Company's Annual Report on
Form 10-K/A for the fiscal year ended June 30, 2003. The condensed consolidated
balance sheet as of June 30, 2003 has been derived from these audited
consolidated financial statements. Certain reclassifications have been made to
prior-year amounts to conform to the current-year presentation. All material
inter-company transactions and balances have been eliminated.
The Company's condensed consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America, which require management to make estimates and assumptions. These
estimates and assumptions affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the condensed
consolidated financial statements and the revenues and expenses reported during
the period. Examples include the allowance for doubtful accounts, allowance for
excess and obsolete inventory, warranty accrual, intangible asset valuation,
determining if and when impairments have occurred, and the assessment of the
valuation of deferred income taxes and income tax reserves. These estimates and
assumptions are based on management's judgment and available information and,
consequently, actual results could differ from these estimates.
These unaudited condensed consolidated financial statements reflect all
adjustments, consisting of normal recurring adjustments, that are, in the
opinion of management, necessary for a fair presentation of the financial
position and the results of operations for the interim periods. Interim period
operating results may not be indicative of the operating results for a full
year. The operations of the U.S. parent company, LeCroy Corporation, have a
period ending on the Saturday closest to March 31 (March 27, 2004 and March 29,
2003). Each of these fiscal quarterly and year-to-date periods represented a
13-week and 39-week periods, respectively. The condensed consolidated financial
statement period-end references are stated as March 31.
2. STOCK PLANS AND AWARDS
The Company accounts for stock-based compensation plans under the recognition
and measurement principles of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25"), and related
interpretations. No stock-based employee and director compensation cost for the
stock option plans is reflected in the Company's Condensed Consolidated
Statements of Operations, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. Compensation cost for restricted stock is recorded based on the
market value on the date of grant. The fair value of restricted stock is charged
to Stockholders' Equity and amortized to expense over the requisite vesting
periods.
In March 2004, the Financial Accounting Standards Board issued the exposure
draft "Share-Based Payment." The proposed statement would require all
equity-based awards to employees to be recognized in the income statement based
on their fair value for fiscal years beginning after December 15, 2004. The new
standard, if accepted in its present form, would apply to all awards granted,
modified or settled after the effective date. The Company is in the process of
analyzing the potential impact of this proposed standard on its consolidated
results of operations and financial position.
The following table illustrates the effect on net income (loss) and net
income (loss) per common share applicable to common stockholders as if the
Company had applied the fair value recognition provisions for stock-based
employee compensation of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure."
6
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------- ------------------
2004 2003 2004 2003
------- ------- ------- -------
IN THOUSANDS
Net income (loss), as reported.................. $ 2,359 $ 522 $ 5,343 $(2,529)
Add: stock-based compensation expense included
in reported net income (loss), net of income
taxes......................................... 5 10 14 29
Deduct: stock-based compensation expense
determined under fair value based method for
all awards, net of income taxes............... (587) (666) (2,445) (2,461)
------- ------- ------- -------
Pro forma net income (loss)..................... 1,777 (134) 2,912 (4,961)
Charges related to convertible preferred stock.. -- 518 7,665 1,550
------- ------- ------- -------
Pro forma net income (loss) applicable to
common stockholders........................... $ 1,777 $ (652) $(4,753) $(6,511)
======= ======= ======= =======
Net income (loss) per common share applicable
to common stockholders:
Basic, as reported............................ $ 0.22 $ -- $ (0.22) $ (0.39)
Diluted, as reported.......................... $ 0.21 $ -- $ (0.22) $ (0.39)
Basic, pro forma.............................. $ 0.17 $ (0.06) $ (0.45) $ (0.63)
Diluted, pro forma............................ $ 0.16 $ (0.06) $ (0.45) $ (0.63)
3. REVENUE RECOGNITION
Revenue is recognized when products are shipped or services are rendered to
customers, net of allowances for anticipated returns. The Company's
revenue-earning activities generally involve delivering or producing goods, and
revenues are considered to be earned when we have completed the process by which
we are entitled to such revenues. The following criteria are used for revenue
recognition: persuasive evidence of an arrangement exists, delivery has
occurred, selling price is fixed or determinable and collection is reasonably
assured. A revenue deferral is recorded for service contracts and any other
future deliverables included within the sales contract agreement. Revenues from
service contracts are recognized ratably over the contract period. Revenue from
other future deliverables, if any, is recognized as those products or services
are delivered.
During the third quarter of fiscal 2004, the Company shipped its new
WaveSurfer family of oscilloscopes, designed for value-oriented users in the
low-end 200 Megahertz to 500 Megahertz bandwidth class. One component of the
Company's strategy for distributing this new family of oscilloscopes is the use
of a buy-sell distribution channel. The Company expects that most distributors
will purchase the WaveSurfer for inventory and therefore, the Company has
determined that it is appropriate to record revenue when the WaveSurfer is sold
by the distributors to their customers. This method of revenue recognition
reflects the Company's initial entry into this channel and the associated
uncertainty about sell-through volumes. Until revenue is recognized, WaveSurfers
sold to distributors are included in inventory. In the third quarter of fiscal
2004, WaveSurfers invoiced to distributors were recorded in deferred revenue,
included in accrued expenses and other liabilities, in the accompanying March
31, 2004 Condensed Consolidated Balance Sheet.
In addition to the Company's suite of oscilloscopes, the Company sells
related products such as probes, accessories and application solutions.
Application solutions, which provide the oscilloscope with additional analysis
capabilities, are either delivered via compact disc read-only memory or already
loaded in the oscilloscope and activated via a key code after the sale is made
to the customer for such application solution. All sales of these related
products are based upon separate established prices for these items and are
recorded as revenue according to the above revenue recognition criteria. No
post-contract support is provided on the application solutions. Revenues from
these related products are included in revenues from oscilloscopes and related
products on the Condensed Consolidated Statements of Operations.
7
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
The Company recognizes software license revenue in accordance with American
Institute of Certified Public Accountants Statement of Position 97-2, "Software
Revenue Recognition" ("SOP 97-2"), as amended by Statement of Position 98-9,
"Modifications of SOP 97-2 with Respect to Certain Transactions" ("SOP 98-9").
Revenues from perpetual software license agreements are recognized upon shipment
of the software if evidence of an arrangement exists, pricing is fixed and
determinable, and collectibility is probable. If an acceptance period is
required, revenues are recognized upon the earlier of customer acceptance or the
expiration of the acceptance period. The Company allocates revenue on software
arrangements involving multiple elements to each element based on the relative
fair values of the elements. The determination of fair value of each element in
multiple element-arrangements is based on vendor specific objective evidence
("VSOE"). The Company analyzes all of the elements and determines if there is
sufficient VSOE to allocate revenue to maintenance included in multiple
element-arrangements. Accordingly, assuming all other revenue recognition
criteria are met, revenue is recognized upon delivery using the residual method
in accordance with SOP 98-9, where the fair value of the undelivered elements is
deferred and the remaining portion of the arrangement fee is recognized as
revenue. The revenue allocated to licenses is recognized upon delivery of the
products. The revenue allocated to software maintenance is recognized ratably
over the term of the support agreement.
In the third quarter of fiscal 2003, the Company licensed its proprietary
MAUI Instrument Operating System technology and recognized $3.0 million of
license revenue included in service and other revenue in the Condensed
Consolidated Statement of Operations. Maintenance fees (post-contract support or
"PCS") were included in the agreement and are recognized pro rata for each year
of maintenance purchased. The only two elements in this agreement were the
license and the PCS. The Company recognizes revenue on the license, in
accordance with the contract, upon delivery of the source code. The Pricing
Committee established VSOE of fair value for the PCS prior to the sale of the
software, and accordingly, the Company recognizes revenue allocated to PCS
ratably over the term of the maintenance purchased. The Company did not
recognize any software license revenue during the nine months ended March 31,
2004.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which summarizes certain of the SEC Staff's views in applying
accounting principles generally accepted in the United States to revenue
recognition in financial statements. Under SAB 101 (superseded by SAB 104),
which the Company adopted in fiscal 2001, certain previously recognized license
fee revenue was deferred and recognized in future periods over the terms of the
agreements. The adoption of SAB 101 was recorded as of the beginning of fiscal
2001 and resulted in a non-cash charge for the cumulative effect of an
accounting change of $4.4 million, net of a related tax benefit of $2.7 million.
The deferred revenue is being amortized into revenue over 5.5 years through the
second quarter of fiscal 2006. The Company recognized pre-tax deferred license
fee revenue of $0.3 million during each of the three-month periods ended March
31, 2004 and 2003 and $1.0 million during each of the nine-month periods ended
March 31, 2004 and 2003. Such license fees are included in service and other
revenue for such periods. As of March 31, 2004, the remaining balance of pre-tax
deferred license fee revenue was $2.3 million, $1.3 million of which is included
in accrued expenses and other liabilities and the remaining $1.0 million of
which is included in deferred revenue and other non-current liabilities on the
Condensed Consolidated Balance Sheet.
4. RESTRUCTURING
During the fourth quarter of fiscal 2003, the Company adopted a plan to
consolidate its probe development activities into its Chestnut Ridge, New York
facility. In connection with this plan, the Company closed its Beaverton, Oregon
facility and recorded lease termination costs of $0.3 million and a charge for
severance of $0.6 million ($0.1 million of which was recorded in cost of sales,
$0.6 million was recorded in selling, general and administrative expense and
$0.2 million was recorded in research and development expense). As of March 31,
2004, $0.7 million of the total $0.9 million has been paid and $0.2 million
remains in accrued expenses and other liabilities in the Condensed Consolidated
Balance Sheet. Lease termination costs under this plan will be paid by the end
of the third quarter of fiscal 2006 and severance will be paid by the end of the
fourth quarter of fiscal 2004.
8
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
During the second quarter of fiscal 2003, the Company recorded a $2.1 million
charge for the impairment of technology, manufacturing and distribution rights
and a $0.2 million charge for a related future royalty payment, both of which
are recorded in cost of sales. The impairment resulted from the Company's
strategic decision to exit certain older product lines and to make significant
changes to its manufacturing strategy to further improve operating efficiency.
The Company estimated the fair value of the impaired asset based on the present
value of forecasted future cash inflows using a discount rate commensurate with
its weighted average cost of capital.
During the first quarter of fiscal 2003, the Company adopted a plan to scale
down fixed infrastructure due to the difficult economic environment and to
implement new management operating systems designed to improve processes in
sales, order management, customer relationship management and financial
performance management. In connection with the adoption of this plan, the
Company recorded a charge for severance and other related expenses in the first
quarter of fiscal 2003 of $2.7 million ($0.1 million of which was recorded in
cost of sales, $2.1 million was recorded in selling, general and administrative
expense and $0.5 million was recorded in research and development expense). As
of March 31, 2004, $2.4 million of the total $2.7 million has been paid and $0.3
million remains in accrued expenses and other liabilities in the Condensed
Consolidated Balance Sheet. Severance and other related amounts under this plan
will be paid by the end of the second quarter of fiscal 2006.
The Company took steps during fiscal 2002 to reduce its expenses in response
to the continued weakness in the technology sector of the economy. In connection
with these workforce reductions, the Company recorded a $4.2 million charge
($1.0 million recorded in cost of sales, $3.0 million in selling, general and
administrative expense and $0.2 million in research and development expense) for
severance and related expenses, including costs associated with the succession
of the Company's Chief Executive Officer during the second quarter of fiscal
2002. Of the $4.2 million total charge, $4.0 million was initially credited to
accrued expenses and other liabilities and $0.2 million, representing a non-cash
expense for the amendment of employee stock options, was credited to additional
paid-in capital. As of December 31, 2003, the 2002 restructuring plan was
completed. Cumulative through the completion of this plan, $3.9 million of the
total $4.0 million was paid and $0.1 million of unused restructuring reserve was
credited to selling, general and administrative expense in the fourth quarter of
fiscal 2003.
5. DERIVATIVES
The Company enters into foreign exchange forward contracts to minimize the
risks associated with foreign currency fluctuations on assets or liabilities
denominated in other than the functional currency of the Company or its
subsidiaries. These foreign exchange forward contracts are not accounted for as
hedges, therefore any gains or losses are recorded in the Condensed Consolidated
Statement of Operations. These foreign exchange forward contracts are recorded
on the Condensed Consolidated Balance Sheet at fair value. The changes in fair
value of these contracts are highly inversely correlated to changes in the value
of certain of the Company's foreign currency-denominated assets and liabilities.
The net gains or (losses) resulting from changes in the fair value of these
derivatives and on transactions denominated in other than their functional
currencies were $0.1 million and ($0.1) million for the three-month periods
ended March 31, 2004 and 2003, respectively, and $0.3 and ($0.4) million for the
nine-month periods ended March 31, 2004 and 2003, respectively, and are included
in other income (expense), net in the Condensed Consolidated Statements of
Operations. At March 31, 2004 and June 30, 2003, the notional amounts of the
Company's open foreign exchange forward contracts, all with maturities of less
than six months, were approximately $10.4 million and $6.7 million,
respectively.
9
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
6. COMPREHENSIVE INCOME (LOSS)
The following table presents the components of comprehensive income (loss):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------- ------------------
2004 2003 2004 2003
------- ------- ------- -------
IN THOUSANDS
Net income (loss)......................... $ 2,359 $ 522 $ 5,343 $(2,529)
Cumulative unrealized foreign
currency translation gains (losses)... (432) 301 1,775 1,214
-------- ------- ------- -------
Comprehensive income (loss)............... $ 1,927 $ 823 $ 7,118 $(1,315)
======= ======= ======= =======
7. ACCOUNTS RECEIVABLE, NET
The Company has agreements with two of its customers, who are also vendors,
that provide the Company with the legal right to offset outstanding accounts
receivable balances against outstanding accounts payable balances. At March 31,
2004 and June 30, 2003, the Company netted approximately $2.1 million and $1.7
million, respectively, of accounts receivable against accounts payable on the
Condensed Consolidated Balance Sheets related to these agreements.
8. INVENTORIES, NET
Inventories, including demonstration units in finished goods, are stated at
the lower of cost (first-in, first-out method) or market. Inventories consist of
the following:
MARCH 31, JUNE 30,
2004 2003
-------- --------
IN THOUSANDS
Raw materials................................. $ 6,697 $ 6,372
Work in process............................... 4,795 5,696
Finished goods................................ 10,640 12,652
-------- --------
$ 22,132 $ 24,720
======== ========
The value of demonstration units included in finished goods was $7.4 million
and $9.1 million at March 31, 2004 and June 30, 2003, respectively. The
Company's demonstration units are held for sale and are sold regularly in the
ordinary course of business through its normal sales distribution channels and
existing customer base.
9. OTHER CURRENT ASSETS
Other current assets consist of the following:
MARCH 31, JUNE 30,
2004 2003
-------- --------
IN THOUSANDS
Deferred tax assets, net...................... $ 8,000 $ 7,200
Other receivables............................. 564 560
Other......................................... 3,185 2,252
-------- --------
$ 11,749 $ 10,012
======== ========
10
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
10. PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following:
MARCH 31, JUNE 30,
2004 2003
--------- ---------
IN THOUSANDS
Land and building................................. $ 13,579 $ 13,288
Furniture, machinery and equipment................ 36,721 34,427
Computer software................................. 6,190 6,190
--------- ---------
56,490 53,905
Less: Accumulated depreciation and amortization... (36,866) (33,884)
--------- ---------
$ 19,624 $ 20,021
========= =========
Depreciation and amortization expense was $1.4 and $1.2 million for the three
month periods ended March 31, 2004 and 2003, respectively. Depreciation and
amortization expense for the nine month periods ended March 31, 2004 and 2003
was $3.8 million and $3.4 million, respectively.
11. OTHER ASSETS
Other assets consist of the following:
MARCH 31, JUNE 30,
2004 2003
--------- ---------
IN THOUSANDS
Intangibles, net.................................... $ 4,415 $ 5,232
Deferred tax assets, net............................ 5,561 7,934
Goodwill............................................ 1,874 1,874
Other............................................... 1,612 985
-------- --------
$ 13,462 $ 16,025
======== ========
Under SFAS No. 142 "Goodwill and Other Intangible Assets," goodwill is not
amortized but reviewed for impairment annually or more frequently if certain
indicators arise. The Company completed the annual impairment test required
under SFAS No. 142 during the fourth quarter of fiscal 2003 and 2002 and
determined that there was no impairment to its recorded goodwill balances.
The following table reflects the gross carrying amount and accumulated
amortization of the Company's goodwill and intangible assets included in other
assets on the Condensed Consolidated Balance Sheets as of the dates indicated:
WEIGHTED MARCH 31, JUNE 30,
AVERAGE LIVES 2004 2003
------------- -------- --------
IN THOUSANDS
Intangible assets:
Amortizable intangible assets:
Technology, manufacturing and distribution
rights.......................................... 4.7 years $ 7,160 $ 7,010
Patents and other intangible assets.............. 4.4 years 661 661
Effect of currency translation on intangible
assets......................................... 135 105
Accumulated amortization......................... (3,541) (2,544)
------- --------
Net carrying amount............................... $ 4,415 $ 5,232
======= ========
Non-amortizable intangible assets:
Goodwill....................................... $ 1,874 $ 1,874
======= ========
11
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Amortization expense for those intangible assets with finite lives was $0.3
million for the three months ended March 31, 2004 and 2003, and $1.0 million and
$1.5 million for the nine months ended March 31, 2004 and 2003, respectively.
The cost of technology, manufacturing and distribution rights acquired is
amortized primarily on the basis of the higher of units shipped over the
contract periods through December 2008 or on a straight-line basis. Patents and
other intangible assets are amortized on a straight-line basis. Management
estimates that intangible assets amortization expense on a straight-line basis
in fiscal 2004 through 2009 will approximate $1.3 million, $1.7 million, $0.7
million, $0.7 million, $0.6 million and $0.3 million, respectively.
12. ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities consist of the following:
MARCH 31, JUNE 30,
2004 2003
-------- --------
IN THOUSANDS
Compensation and benefits............................ $ 3,983 $ 4,489
Income taxes......................................... 2,882 2,595
Deferred license fee revenue, current portion........ 1,296 1,296
Warranty............................................. 1,246 1,235
Retained liabilities from discontinued operations.... 346 456
Other................................................ 3,527 2,172
-------- --------
$ 13,280 $ 12,243
======== ========
13. WARRANTIES AND GUARANTEES
The Company provides a warranty on its products, typically extending three
years after delivery and accounted for in accordance with SFAS No. 5,
"Accounting for Contingencies." Estimated future warranty obligations related to
products are provided by charges to operations in the period that the related
revenue is recognized. These estimates are derived from historical data of
product reliability. The expected failure rate is arrived at in terms of units,
which are then converted into labor hours to which an average fully burdened
cost per hour is applied to derive the amount of accrued warranty required. On a
quarterly basis, the Company studies trends of warranty claims and performance
of specific products and adjusts its warranty obligation through charges or
credits to operations.
The following table is a reconciliation of the changes in the Company's
aggregate product warranty liability during the three and nine months ended
March 31, 2004 and 2003.
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
--------------------- ------------------
2004 2003 2004 2003
----------- --------- ------- -------
IN THOUSANDS
Balance at beginning of period............ $ 1,243 $ 1,235 $ 1,235 $ 1,247
Accruals for warranties issued
during the period...................... 345 280 983 898
Warranty costs incurred during the
period................................. (342) (282) (972) (912)
------- ------- ------- -------
Balance at end of period.................. $ 1,246 $ 1,233 $ 1,246 $ 1,233
======= ======= ======= =======
12
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
In connection with an agreement to license the Company's MAUI Instrument
Operating System technology entered into by the Company during the third quarter
of fiscal 2003, the Company agreed to indemnify the licensee against losses
arising from any third party claim against the licensee to the extent such claim
arose directly out of the infringement of a U.S. or Japanese patent by any
LeCroy software components delivered under the license agreement. As of March
31, 2004, there have been no claims under such indemnification provisions.
As is customary in the Test and Measurement industry, and as provided for by
local law in the U.S. and other jurisdictions, the Company's standard terms of
sale provide remedies to customers, such as defense, settlement, or payment of a
judgment for intellectual property claims related to the use of the Company's
products. Such indemnification provisions are accounted for in accordance with
SFAS No. 5, "Accounting for Contingencies." To date, there have been no claims
under such indemnification provisions.
14. DEBT
On November 13, 2003, the Company amended its existing $15.0 million
revolving credit facility with The Bank of New York. The amended agreement
provides the Company with a $25.0 million revolving credit facility expiring on
November 30, 2006, which can be used to provide funds for general corporate
purposes and acquisitions. Borrowings under this line bear interest at prime
plus a margin not to exceed 1.00%, or at the London Interbank Offering Rate
(LIBOR) plus a margin of between 1.25% and 2.25%, depending on the Company's
leverage ratio, as such term is defined in the credit agreement. A commitment
fee of .375% per annum is payable on any unused amount under the facility. This
revolving line of credit is secured by a lien on substantially all of the
domestic assets of the Company. As of March 31, 2004, the Company had $4.0
million outstanding under this credit facility (see subsequent events Note 17)
and was in compliance with its financial covenant requirements.
15. REDEEMABLE CONVERTIBLE PREFERRED STOCK
On September 27, 2003, the Company repurchased from the holders of its
redeemable convertible preferred stock all 500,000 issued and outstanding shares
of the preferred stock for $23.0 million in cash. The shares of preferred stock
were entitled to a 12% cumulative dividend on the original purchase price of
$10.0 million, with redemption rights beginning on June 30, 2004 at the sole
discretion of the holders of such shares. At June 30, 2004, the redemption value
of the preferred stock would have been approximately $17.6 million.
In connection with the repurchase of preferred stock, the Company recorded a
charge of approximately $7.7 million to stockholders' equity representing the
premium paid to the holders of its preferred stock ($1.0 million charged to
retained earnings and $6.7 million charged to additional paid-in capital) and
recognized transaction costs of $0.4 million included in other income (expense),
net in the Condensed Consolidated Statements of Operations for the nine months
ended March 31, 2004. In accordance with the Securities and Exchange
Commission's position published in an Emerging Issues Task Force ("EITF") Topic
No. D-42 relating to induced conversions of preferred stock, the Company
recorded the $7.7 million premium paid to purchase the preferred stock as a
charge to arrive at net loss applicable to common stockholders for the nine
months ended March 31, 2004.
The Company and the holders of its preferred stock agreed that the final
repurchase of preferred stock would be negotiated as though the transaction had
occurred at the beginning of the first quarter of fiscal 2004. As a result, the
Company accounted for the transaction as though no dividends had accrued in
fiscal 2004 and that the charge for the value originally attributed to the
warrants at the point of issue that remained unaccreted at the time of
redemption was accelerated and combined with the redemption premium to reflect
the total charge related to the redemption of convertible preferred stock in the
Condensed Consolidated Statement of Operations.
13
LECROY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
16. COMMITMENTS AND CONTINGENCIES
On April 28, 2003, Tektronix, Inc. ("Tektronix") filed a complaint against
the Company in the United States District Court for the District of Oregon
claiming that it infringed on eight of its U.S. patents. In the Company's
responsive pleading, the Company denied that it has infringed, or is infringing,
any of these patents, and contends that the patents are invalid. Four of these
patents concern software user interface features for oscilloscopes, two concern
circuitry and two concern probes. On August 5, 2003, the Company filed a
counterclaim in the United States District Court for the District of Oregon
claiming that Tektronix infringed on four of its patents. The Company believes
it has meritorious defenses and it intends to vigorously defend this action.
On January 15, 2003, LeCroy was sued by Sicom Systems ("Sicom") in the United
States District Court for the District of Delaware for patent infringement of a
U.S. patent relating to the graphical display of test limits. LeCroy answered
the complaint denying infringement and asserted a counterclaim alleging the
invalidity of the patent and that Sicom had abused the judicial process by
bringing a baseless patent infringement claim. On July 16, 2003, LeCroy filed a
Motion to Dismiss Sicom's case, contending that Sicom did not have standing to
bring the litigation. On November 20, 2003, the Court granted LeCroy's Motion to
Dismiss. On December 18, 2003, Sicom filed a Notice of Appeal to the United
States Court of Appeals for the Federal Circuit. On December 30, 2003, Sicom
filed a new patent infringement lawsuit against LeCroy in the United States
District Court for the District of Delaware. Tektronix and Agilent Technologies
are also co-defendants in this new litigation. The complaint in this new case is
essentially the same as the complaint filed by Sicom on January 15, 2003, except
that Sicom now states that it entered into an amendment to its license agreement
with the Canadian government on December 19, 2003, and that Sicom now has the
exclusive right to bring suit for infringement of the patent in the United
States. On January 5, 2004, Sicom filed a Notice and Order of Dismissal of
Appeal of its appeal to the Court of Appeals for the Federal Circuit and the
Order was entered on the following day. In LeCroy's responsive pleading, LeCroy
has denied that it has infringed, or is infringing, the patent, and contends
that the patent is invalid. LeCroy intends to vigorously defend itself in this
litigation.
From time to time, the Company is involved in lawsuits, claims,
investigations and proceedings, including patent and environmental matters, that
arise in the ordinary course of business. There are no matters pending,
including those described above, that the Company expects to be material to its
business, results of operations, financial condition or cash flows.
17. SUBSEQUENT EVENTS
On April 14, 2004, the Company closed an underwritten public follow-on
offering of 1,500,000 shares of its common stock at $19.00 per share (less the
underwriting discount) adding approximately $8.0 million, net of $1.1 million in
offering costs and expenses, in cash to its balance sheet. Of these shares,
500,000 were newly issued by the Company and 1,000,000 were offered by ValueAct
Capital Partners, L.P. and its affiliates. The Company granted the underwriters
an option to purchase up to an additional 15 percent of the shares of common
stock included in the offering to cover over-allotments, if any, within 30 days.
On April 27, 2004, pursuant to the exercise of this over-allotment option, the
Company sold an additional 225,000 shares at $19.00 per share (less the
underwriting discount), which added $4.1 million, net of expenses to its balance
sheet.
On April 23, 2004, the Company used proceeds from this offering to repay $4.0
million of indebtedness outstanding under its revolving credit facility.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
other financial information and consolidated financial statements and related
notes appearing elsewhere in this Form 10-Q. This discussion contains forward
looking statements that involve risks and uncertainties. Our actual results
could differ materially from those anticipated in the forward looking statements
as a result of a variety of factors, including those discussed in "Risk Factors"
and elsewhere in this Form 10-Q.
We utilize fiscal quarters that end on the Saturday nearest to March 31, June
30, September 30, and December 31. For clarity of presentation, we have
described all periods as if they end at the end of the calendar quarter.
OVERVIEW
We develop, manufacture, sell and license oscilloscopes and related test and
measurement equipment. Our oscilloscopes are tools used by designers and
engineers to measure and analyze complex electronic signals in order to develop
high-performance systems, to validate electronic designs and to improve time to
market. We currently offer four families of oscilloscopes, which address
different solutions to the markets we serve: WaveMaster, our highest performance
product family; WavePro, which is targeted at the mid- to high- performance
sector; WaveRunner, designed for the mid-performance sector; and WaveSurfer,
designed for value-oriented users in the low-performance bandwidth sector of the
market. We were founded in 1964 to develop, manufacture and sell high
performance signal analysis tools to scientists engaged in high energy physics
research and, in 1985, we introduced our first oscilloscope using our core
competency of designing signal acquisition and digitizing technology.
We generate revenue in a single segment within the Test and Measurement
market, primarily from the sale of our oscilloscopes, probes, accessories, and
applications solutions, and to a lesser extent, our extended warranty contracts
and repairs and calibrations we perform on our instruments after the expiration
of their warranties. Revenue is recognized when products are shipped or services
are rendered to customers net of allowances for anticipated returns. We sell our
products into a broad range of end markets, including computer and
semiconductor, data storage devices, automotive and industrial, and military and
aerospace markets. We believe designers in all of these markets are developing
products which rely on increasingly complex electronic signals to provide the
features and performance their customers require. Our customers include leading
original equipment manufacturers, or OEMs, such as BAE Systems, IBM, Maxtor,
Raytheon, Robert Bosch, Seagate, Samsung and Siemens VDO.
We deploy a direct sales model and employ a highly skilled global sales force
where it makes economic sense to do so. We supplement our direct sales force
with a combination of manufacturers' representatives and distributors in areas
where demand levels do not justify direct distribution by us. We segment the
world into three areas - North America, Europe/Middle East and Asia/Pacific. In
North America we sell our products directly in the United States. In Europe, we
sell our products directly in Switzerland, Germany, Italy, France, the United
Kingdom and Sweden. In Asia/Pacific we sell our products directly in Japan,
South Korea, Singapore and five regions in China. During the third quarter of
fiscal 2004, we shipped our new WaveSurfer family of lower bandwidth
oscilloscopes. One component of our strategy for selling this new family of
oscilloscopes in Europe and Asia/Pacific is the use of a buy-sell distribution
channel. Our geographic breakdown of revenues by area in total dollars and as a
percentage of total revenues has been:
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
(UNAUDITED) (UNAUDITED)
------------------- ------------------
(IN THOUSANDS) 2004 2003 2004 2003
------- ------- ------- -------
North America............. $ 9,320 $ 6,714 $28,250 $23,197
Europe/Middle East........ 10,396 7,043 27,501 22,561
Asia/Pacific.............. 13,114 12,779 34,269 32,406
------- ------- ------- -------
Total revenues......... $32,830 $26,536 $90,020 $78,164
======= ======= ======= =======
15
THREE MONTHS ENDED NINE MONTHS ENDED
UNAUDITED MARCH 31, MARCH 31,
------------------ ---------------------
2004 2003 2004 2003
----- ------ ----- -----
North America............. 28.3% 25.3% 31.4% 29.7%
Europe/Middle East........ 31.7 26.5 30.5 28.9
Asia Pacific.............. 40.0 48.2 38.1 41.4
----- ----- ----- -----
Total revenues......... 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
Generally, we transact revenues and pay our operating expenses in the local
currencies of the countries in which we have a direct distribution presence or
other operations, with limited exceptions, most notably in China where our sales
and operating expenses are denominated in U.S. dollars. In Europe/Middle East,
we transact business in Euro, Swiss francs, British pounds, Swedish krona and
U.S. dollars. In Japan we transact business in Japanese yen. In South Korea we
transact business in Korean won and in Singapore we transact business in both
U.S. dollars and Singapore dollars. For a discussion of our foreign currency
exchange rate exposure, see Item 3 of this Part I entitled "Quantitative and
Qualitative Disclosure About Market Risk" below.
We have historically experienced lower sales activity during our first fiscal
quarter than in other fiscal quarters which, we believe, is due principally to
the lower level of orders and general market activity during the summer months,
particularly in Europe.
Cost of sales represents manufacturing costs, which primarily comprise
materials, labor and factory overhead. Gross margins represent revenues less
cost of sales. Additional factors integral to gross margins earned on our
products are mix, as the average selling prices of our products range from
$5,000 to $80,000, and foreign currencies, as approximately two-thirds of our
revenues are derived overseas, much of which is denominated in local currencies
while manufacturing costs are U.S. dollar denominated.
Selling, general and administrative expenses consist of salaries and related
overhead costs for sales, marketing and administrative, personnel, and legal,
accounting and other professional services.
Research and development expenses consist primarily of salaries and related
overhead costs associated with employees engaged in research, design and
development activities, as well as the cost of masks, wafers and other materials
and related test services and equipment used in the development process.
In response to the economic downturn in 2001, 2002 and 2003, we took steps to
change our manufacturing strategy, discontinue older product lines and reduce
our operating expenses in an effort to better position our business for the long
term. The resultant charges taken to accomplish these efforts were:
NINE MONTHS ENDED
MARCH 31,
YEAR ENDED JUNE 30, (UNAUDITED)
------------------------- ----------------
(IN THOUSANDS) 2001 2002 2003 2003 2004
------- -------- ------- ------- -------
Charges for:
Impaired intangible assets... $ -- $ -- $ 2,280 $ 2,280 $ --
Severance and related costs.. 70 1,035 163 90 --
----- ------- ------- ------- -------
Cost of sales............... $ 70 $ 1,035 $ 2,443 $ 2,370 $ --
===== ======= ======= ======= =======
Charges for:
Severance and related costs.. $ 117 $ 185 $ 670 $ 523 $ --
----- ------- ------- ------- -------
Research and development... $ 117 $ 185 $ 670 $ 523 $ --
===== ======= ======= ======= =======
Charges for:
Severance and related costs.. $ 724 $ 3,020 $ 2,382 $ 2,041 $ --
Plant closure................ -- -- 286 -- --
Unused restructuring reserve. (243) -- (78) -- --
----- ------- ------- ------- -------
Selling, general and
administrative............ $ 481 $ 3,020 $ 2,590 $ 2,041 $ --
===== ======= ======= ======= =======
16
As of March 31, 2004, all amounts accrued under the 2001 and 2002
restructurings were paid in full. For the 2003 plan, $3.1 million of the total
$3.6 million has been paid and $0.5 million remains in accrued expenses and
other liabilities. Under the fourth quarter of fiscal 2003 restructuring plan,
lease termination costs will be paid by the end of the third quarter of fiscal
2006 and severance will be paid by the end of the fourth quarter of fiscal 2004.
Severance and other related amounts under the first quarter of fiscal 2003
restructuring plan will be paid by the end of the second quarter of fiscal 2006.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial position and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the condensed consolidated financial
statements and the reported revenues and expenses during the period. The
accounting policies that we believe are the most critical in understanding and
evaluating our reported financial results include the following:
Revenue Recognition. We recognize revenue when products are shipped or
services are rendered to customers, net of allowances for anticipated returns.
Our revenue-earning activities generally involve delivering or producing goods,
and revenues are considered to be earned when we have completed the process by
which we are entitled to such revenues. The following criteria are used for
revenue recognition: persuasive evidence of an arrangement exists, delivery has
occurred, selling price is fixed or determinable and collection is reasonably
assured. A revenue deferral is recorded for service contracts and any other
future deliverables included within the sales contract agreement. Revenues from
service contracts are recognized ratably over the contract period. Revenue from
other future deliverables, if any, is recognized as those products or services
are delivered.
During the third quarter of fiscal 2004, we shipped our new WaveSurfer family
of oscilloscopes, designed for value-oriented users in the low-end 200 Megahertz
to 500 Megahertz bandwidth class. One component of our strategy for distributing
this new family of oscilloscopes is the use of a buy-sell distribution channel.
We expect that most distributors will purchase the WaveSurfer for inventory and
therefore, we have determined that it is appropriate to record revenue when the
WaveSurfer is sold by the distributors to their customers. This method of
revenue recognition reflects our initial entry into this channel and the
associated uncertainty about sell-through volumes. Until revenue is recognized,
WaveSurfers sold to distributors are included in inventory. In the third quarter
of fiscal 2004, WaveSurfers invoiced to distributors were recorded in deferred
revenue, included in accrued expenses and other liabilities, in the accompanying
March 31, 2004 Condensed Consolidated Balance Sheet.
In addition to our suite of oscilloscopes, we sell related products such as
probes, accessories and application solutions. Application solutions, which
provide the oscilloscope with additional analysis capabilities, are either
delivered via compact disc read-only memory or already loaded in the
oscilloscope and activated via a key code after the sale is made to the customer
for such application solution. All sales of these related products are based
upon our separate established prices for these items and are recorded as revenue
according to the above revenue recognition criteria. No post-contract support is
provided on the application solutions. Revenues from these related products are
included in revenues from oscilloscopes and related products on our Condensed
Consolidated Statements of Operations.
We recognize software license revenue in accordance with American Institute
of Certified Public Accountants Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"), as amended by Statement of Position 98-9,
"Modifications of SOP 97-2 with Respect to Certain Transactions" ("SOP 98-9").
Revenues from perpetual software license agreements are recognized upon shipment
of the software if evidence of an arrangement exists, pricing is fixed and
determinable, and collectibility is probable. If an acceptance period is
required, revenues are recognized upon the earlier of customer acceptance or the
expiration of the acceptance period. We allocate revenue on software
arrangements involving multiple elements to each element based on the relative
fair values of the elements. The determination of fair value of each element in
multiple element-arrangements is based on vendor specific objective evidence
17
("VSOE"). We analyze all of the elements and determine if there is sufficient
VSOE to allocate revenue to maintenance included in multiple
element-arrangements. Accordingly, assuming all other revenue recognition
criteria are met, revenue is recognized upon delivery using the residual method
in accordance with SOP 98-9, where the fair value of the undelivered elements is
deferred and the remaining portion of the arrangement fee is recognized as
revenue. The revenue allocated to licenses is recognized upon delivery of the
products. The revenue allocated to software maintenance is recognized ratably
over the term of the support agreement.
In the third quarter of fiscal 2003, we licensed our proprietary MAUI
Instrument Operating System technology and recognized $3.0 million of license
revenue included in service and other revenue in the Condensed Consolidated
Statement of Operations. Maintenance fees (post-contract support or "PCS") were
included in the agreement and are recognized pro rata for each year of
maintenance purchased. The only two elements in this agreement were the license
and the PCS. We recognized revenue on the license, in accordance with the
contract, upon delivery of the source code. The Pricing Committee established
VSOE of fair value for the PCS prior to the sale of the software, and
accordingly, we recognize revenue allocated to PCS ratably over the term of the
maintenance purchased. We did not recognize any software license revenue during
the nine months ended March 31, 2004.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which summarizes certain of the SEC Staff's views in applying
accounting principles generally accepted in the United States to revenue
recognition in financial statements. Under SAB 101, (superseded by SAB 104)
which we adopted in fiscal 2001, certain previously recognized license fee
revenue was deferred and recognized in future periods over the terms of the
agreements. The adoption of SAB 101 was recorded as of the beginning of fiscal
2001 and resulted in a non-cash charge for the cumulative effect of an
accounting change of $4.4 million, net of a related tax benefit of $2.7 million.
The deferred revenue is being amortized into revenue over 5.5 years through the
second quarter of fiscal 2006. We recognized pre-tax deferred license fee
revenue of $0.3 million during each of the three-month periods ended March 31,
2004 and 2003 and $1.0 million during each of the nine-month periods ended March
31, 2004 and 2003. Such license fees are included in service and other revenue
for such periods. As of March 31, 2004, the remaining balance of pre-tax
deferred license fee revenue was $2.3 million, $1.3 million of which is included
in accrued expenses and other liabilities and the remaining $1.0 million of
which is included in deferred revenue and other non-current liabilities on the
Condensed Consolidated Balance Sheet.
Allowance for Excess and Obsolete Inventory. We assess the valuation of our
inventory on a quarterly basis and periodically provide an allowance for the
value of estimated excess and obsolete inventory. Our marketing department plays
a key role in our inventory review process by providing updated sales forecasts,
managing product rollovers and working with manufacturing to maximize recovery
of excess inventory. Based upon managements forecast, inventory items no longer
expected to be used in the future are considered obsolete and the difference
between an inventory items quantity and its forecasted usage are classified as
excess. The allowance for excess and obsolete inventory was $2.4 million at
March 31, 2004 and $2.1 million at June 30, 2003. If actual market conditions
are less favorable than those projected by management, additional inventory
allowances for excess or obsolete inventory may be required. If actual market
conditions are more favorable than anticipated, inventory previously written
down may be sold, resulting in lower cost of sales and higher income from
operations than expected in that period.
Deferred Tax Assets. We have recorded $13.6 million of net deferred tax
assets as of March 31, 2004 for the future tax benefits of certain expenses
reported for financial statement purposes that have not yet been deducted on our
tax returns. Significant components of our deferred tax assets are federal,
state and foreign net operating loss and credit carryforwards, inventory
reserves and other reserves. The recognition of this deferred tax asset is based
on the assessment that it is more likely than not that we will be able to
generate sufficient future taxable income within statutory carryforward periods
to realize the benefit of these tax deductions. The factors that management
considers in assessing the likelihood of realization include the forecast of
future taxable income and available tax planning strategies that could be
implemented to realize the deferred tax assets. Based on this information, we
have recorded a valuation allowance of $5.1 million as of March 31, 2004 to
reserve for those tax assets we believe are not likely to be realized in future
periods. Adjustments to the valuation allowance may be made in the future if it
is determined that the realizable amount of net operating losses and other
deferred tax assets is greater or less than the amount recorded. Such
adjustments may be material to our results of operations when made.
18
Warranty. Provisions for estimated expenses related to product warranties are
made at the time products are sold. These estimates are derived from historical
data of product reliability. The expected failure is arrived at in terms of
units, which are then converted into labor hours to which an average fully
burdened cost per hour is applied to derive the amount of accrued warranty
required. On a quarterly basis, we study trends of warranty claims and take
action to improve the quality of our products and minimize our warranty
exposure. The warranty reserve was $1.2 million at March 31, 2004 and June 30,
2003. Management believes that the warranty reserve is appropriate; however,
actual claims incurred could differ from the original estimates, requiring
adjustments to the reserve.
Allowance for Doubtful Accounts. We maintain an allowance for doubtful
accounts relating to the portion of the accounts receivable which we estimate is
non-collectible. We analyze historical bad debts, customer concentrations,
customer creditworthiness, current economic trends and changes in customer
payment terms when evaluating the adequacy of the allowance for doubtful
accounts. The allowance for doubtful accounts, which includes the allowance for
anticipated returns, was $0.4 million at both March 31, 2004 and June 30, 2003.
Changes in the overall economic environment or in the financial condition of our
customers may require adjustments to the allowance for doubtful accounts which
could have a material adverse effect on our financial condition, results of
operations and cash flows.
Valuation of Long-Lived and Intangible Assets. The carrying values of
long-lived assets and identifiable amortizable intangibles (including
technology, manufacturing and distribution rights) are assessed for impairment
whenever events or changes in circumstances indicate that the carrying values
may not be recoverable. When such events or changes in circumstances occur, we
assess the recoverability of long-lived assets by determining whether the
carrying values of such assets will be recovered through undiscounted expected
future cash flows. If the undiscounted cash flows are less than the carrying
amounts, an impairment loss is recorded to the extent that the carrying amounts
exceed the fair value. Factors which could trigger an impairment review include
the following: significant underperformance by us relative to historical or
projected operating results; significant changes in the manner of our use of the
assets or the strategy for the overall business; and significant negative
industry or economic trends. We recognized an intangible asset impairment of
$2.3 million during the nine months ended March 31, 2003. We estimated the fair
value of the impaired asset based on the present value of forecasted future cash
inflows using a discount rate commensurate with our weighted average cost of
capital.
The cost of technology, manufacturing and distribution rights acquired is
amortized primarily on the basis of the higher of units shipped over the
contract periods or on a straight-line basis. Management assesses the
recoverability of these rights on the basis of actual and forecasted production
units as well as the average selling price and standard costs of the related
products after the amortization of the rights to determine profitability. If
required, an impairment charge is recorded as described above.
Goodwill. Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets," requires goodwill to be tested for
impairment annually under a two-step approach, or more frequently, if events or
changes in circumstances indicate that the asset might be impaired. Impairment
is assessed at the "reporting unit" level by applying a fair value-based test. A
reporting unit is defined as the same as or one level below the operating
segment level as described in SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information."
The first step is to identify if an impairment of goodwill has occurred by
comparing the fair value of a reporting unit with its carrying amount, including
goodwill. If the fair value of a reporting unit exceeds its carrying amount,
goodwill of the reporting unit is not considered impaired. If the carrying
amount of the reporting unit exceeds its fair value, the second step of the
goodwill test is performed to measure the amount of the impairment loss, if any.
In this second step, the "implied" fair value (as defined in SFAS No. 142) of
the reporting unit's goodwill is compared with the carrying amount of the
goodwill. If the carrying amount of the reporting unit's goodwill exceeds the
implied fair value of that goodwill, an impairment loss is recognized in an
amount equal to that excess, not to exceed the carrying amount of the goodwill.
We completed the annual impairment test required under SFAS No. 142 during the
fourth quarter of fiscal 2003 and determined that there was no impairment to our
recorded goodwill balance of $1.9 million at June 30, 2003. There were no
impairment indicators during the nine months ended March 31, 2004.
19
CONSOLIDATED RESULTS OF OPERATIONS
The following table indicates the percentage of total revenues represented by
each item in the Company's Condensed Consolidated Statements of Operations for
the three and nine months ended March 31, 2004 and 2003.
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------- -----------------
(UNAUDITED) 2004 2003 2004 2003
----- ----- ----- -----
Revenues:
Oscilloscopes and related
products................. 91.3% 79.2% 90.6% 86.8%
Service and other......... 8.7 20.8 9.4 13.2
----- ----- ----- -----
Total revenues........... 100.0 100.0 100.0 100.0
Cost of sales............... 42.0 43.3 42.7 49.7
----- ----- ----- -----
Gross profit............. 58.0 56.7 57.3 50.3
Operating expenses:
Selling, general and
administrative........... 34.5 36.0 34.9 37.9
Research and development.. 12.5 17.6 12.9 17.3
----- ----- ----- -----
Total operating expenses 47.0 53.6 47.8 55.2
Operating income (loss)..... 11.0 3.1 9.5 (4.9)
Other income (expense),
net...................... 0.4 -- (0.1) (0.2)
----- ---- ----- -----
Income (loss) before income
taxes..................... 11.4 3.1 9.4 (5.1)
Provision for (benefit
from) income taxes....... 4.2 1.1 3.5 (1.9)
----- ----- ----- -----
Net income (loss)........... 7.2 2.0 5.9 (3.2)
Charges related to
convertible preferred
stock..................... -- 2.0 8.5 2.0
---- ----- ----- -----
Net income (loss)
applicable to common
stockholders.............. 7.2% --% (2.6)% (5.2)%
===== ---- ===== =====
COMPARISON OF THE THREE MONTH PERIODS ENDED MARCH 31, 2004 AND 2003
Total revenues were $32.8 million in the third quarter of fiscal 2004,
compared to $26.5 million in the third quarter of fiscal 2003, an increase of
23.7%, or $6.3 million. Included in service and other revenue in the third
quarter of fiscal 2003 was $3.0 million of revenue associated with licensing our
proprietary MAUI Instrument Operating System technology. This net increase was
all in oscilloscopes and related products which grew 43% over last year fueled
by WaveRunner revenues, which doubled over last year on a 74% unit increase
combined with a 15% increase in average selling prices as a result of the
successful launch of our WaveRunner 6000 family of oscilloscopes in the second
quarter of fiscal 2004. The effects of the increase in units and average selling
prices on revenues compared to last year were approximately $1.9 million and
$5.2 million, respectively, in the three months ended March 31, 2004. In
addition, increased demand for WaveMaster oscilloscopes highlighted by 40% unit
growth year on year resulted in $1.9 million increase in revenues.
Gross profit in the third quarter of fiscal 2004 was $19.0 million, or 58.0%
gross margin, compared to $15.1 million, or 56.7% gross margin in the same
period in fiscal 2003. Gross margin last year included the effect of the $3.0
million associated with licensing our MAUI Instrument Operating System
technology. The increase in gross margin was primarily due to higher margins on
our WaveRunner 6000 oscilloscopes, higher average selling prices in our Serial
Data Analyzer version of our high-end WaveMaster oscilloscopes and a higher
proportion of sales internationally where we benefit from higher average selling
prices and favorable exchange rates.
Selling, general and administrative expense was $11.3 million in the third
quarter of fiscal 2004 compared to $9.6 million in the third quarter of fiscal
2003, an increase of 18.5% or $1.8 million. This increase was primarily due to
increased variable selling costs related to higher revenues, salary increases,
certain legal and compliance expenses and expenses related to performance
bonuses that were suspended in the first three quarters in fiscal 2003 due to
20
the weakness in the technology sector of the economy. Variable selling and order
generation costs increased by $1.5 million and general and administrative costs
increased by $0.3 million in the third quarter of fiscal 2004 compared to the
same period in the prior year. As a percentage of sales, selling general and
administrative expense decreased from 36.0% in the third quarter of fiscal 2003
to 34.5% in the third quarter of fiscal 2004. This decrease as a percentage of
sales was primarily due to our ability to leverage expenses over the incremental
revenues in the third quarter of fiscal 2004. In the fourth quarter of fiscal
2004, we estimate selling, general and administrative expense will increase when
compared to the fourth quarter of fiscal 2003 due to increased variable selling
costs on higher forecasted revenues and higher performance bonuses compared to
the same period in fiscal 2003.
Research and development expense was $4.1 million in the third quarter of
fiscal 2004, compared to $4.7 million in the third quarter of fiscal 2003, a
decrease of 11.7% or $0.5 million. The decrease was primarily due to cost
savings realized from the consolidation of our probe development activities into
our Chestnut Ridge, New York facility in the fourth quarter of fiscal 2003 and
the timing of certain non-recurring engineering expenses. As a percentage of
sales, research and development expense decreased from 17.6% in the third
quarter of fiscal 2003 to 12.5% in the third quarter of fiscal 2004, which is
consistent with our long-term operating model of spending 13% of sales on
product development and reflects our ability to leverage expenses over the
higher sales base in the third quarter of fiscal 2004.
Other income (expense), net, which consists primarily of net interest income
or expense and foreign exchange gains or losses, was $0.1 million in the third
quarter of fiscal 2004, compared to ($10,000) in the third quarter of fiscal
2003. The increase in other income (expense), net was primarily due to foreign
exchange gains of $0.1 million in the third quarter of fiscal 2004, compared to
foreign exchange losses of ($0.1) million for the comparable period in the prior
year. Partially offsetting the foreign exchange gains in the third quarter of
fiscal 2004 was higher interest expense of approximately $0.1 million due to
outstanding borrowings under our revolving line of credit during the third
quarter of fiscal 2004.
Our effective tax rate was 37.0% in the third quarter of fiscal 2004 and
2003.
In the third quarter of fiscal 2003, charges related to our redeemable
convertible preferred stock, the dividend on the preferred stock and the
accretion for the value of fully exercisable warrants granted in connection with
the outstanding preferred stock, were $0.5 million.
COMPARISON OF THE NINE MONTH PERIODS ENDED MARCH 31, 2004 AND 2003
Total revenues were $90.0 million in the nine months ended March 31, 2004,
compared to $78.2 million in the nine months ended March 31, 2003, an increase
of 15.2%, or $11.9 million. Included in service and other revenue in the
nine-month period ended March 31, 2003 was $3.0 million of revenue associated
with licensing our proprietary MAUI Instrument Operating System technology. The
net increase in revenues, which was substantially all in oscilloscopes and
related products, was primarily due to higher average selling prices combined
with increased demand for our WaveMaster, WavePro 7000 and WaveRunner 6000
oscilloscopes resulting in a $14.2 million increase in revenues from
oscilloscopes and related products, and a $2.5 million increase in revenues from
sales of probes and accessories, consistent with the increase in oscilloscope
revenues.
Gross profit in the nine months ended March 31, 2004 was $51.6 million, or
57.3% gross margin, compared to $39.3 million, or 50.3% gross margin, in the
same period in fiscal 2003. Included in cost of sales for the nine months ended
March 31, 2003 is a $2.1 million charge for the impairment of technology,
manufacturing and distribution rights, a $0.2 million charge for a future
royalty payment and a $0.1 million charge for severance expense. The impairment
and royalty cost resulted from our strategic decision to exit certain older
product lines and to make significant changes to our manufacturing strategy to
improve operating efficiency. Additionally, included in gross margin in the nine
months ended March 31, 2003 was the positive effect of the $3.0 million in
license revenues included in service and other revenues on the Condensed
Consolidated Statement of Operations. The increase in gross margin in the nine
months ended March 31, 2004 was primarily due to higher margins on our
WaveRunner 6000 oscilloscopes, higher average selling prices in our Serial Data
Analyzer version of our high-end WaveMaster oscilloscopes and a higher
proportion of sales internationally where we benefit from higher average selling
prices and favorable exchange rates, lower manufacturing costs resulting from
continued improvements in operational efficiency and the ongoing benefit of our
shift to a direct sales model in China and Singapore.
21
Selling, general and administrative expense was $31.4 million for the nine
months ended March 31, 2004, compared to $29.6 million in the same period in
fiscal 2003, an increase of 6.1% or $1.8 million. Included in selling, general
and administrative expense in the nine months ended March 31, 2003 was a $2.1
million charge for severance expense. The increase in the 2004 period was
primarily due to increased variable selling costs related to higher revenues,
salary increases, certain legal and compliance expenses and the expenses related
to performance bonuses that were suspended in the first three quarters in fiscal
2003 due to the weakness in the technology sector of the economy. As a
percentage of sales, selling general and administrative expense decreased from
37.9% in the nine months ended March 31, 2003 to 34.9% in the nine months ended
March 31, 2004. This decrease as a percentage of sales was primarily due to our
ability to leverage expenses over the higher sales base in the first nine months
of fiscal 2004.
Research and development expense was $11.6 million for the nine months ended
March 31, 2004, compared to $13.5 million in the same period in fiscal 2003, a
decrease of 14.4% or $2.0 million. The decrease was primarily due to cost
savings realized from the consolidation of our probe development activities into
our Chestnut Ridge, New York facility in the fourth quarter of fiscal 2003, the
benefit of cost reduction initiatives taken in fiscal 2003, a $0.5 million
charge for severance expense included in research and development expense in the
nine months ended March 31, 2003 and the timing of certain non-recurring
engineering expenses. As a percentage of sales, research and development expense
decreased from 17.3% for the nine months ended March 31, 2003 to 12.9% for the
nine months ended March 31, 2004, which is consistent with our long-term
operating model of spending 13% of sales on product development and reflects our
ability to leverage expenses over the higher sales base in the third quarter of
fiscal 2004.
Other income (expense), net, was ($0.1) million for the nine months ended
March 31, 2004, compared to ($0.2) million in the nine months ended March 31,
2003. Included in other income (expense), net for the nine months ended March
31, 2004 was $0.4 million in transaction costs related to the repurchase of our
Preferred Stock and higher interest expense due to outstanding borrowings under
our revolving line of credit, partially offset by foreign exchange gains of $0.3
million. Included in other income (expense), net, for the nine months ended
March 31, 2003 was foreign exchange losses of ($0.4) million, partially offset
by net interest income on higher average cash balances.
Our effective tax rate was 37.0% during the nine months ended March 31, 2004
and 2003.
On September 27, 2003, we repurchased from the holders of our redeemable
convertible preferred stock all 500,000 issued and outstanding shares of the
preferred stock for $23.0 million in cash. The shares of preferred stock were
entitled to a 12% cumulative dividend on the original purchase price of $10.0
million, with redemption rights beginning on June 30, 2004 at the sole
discretion of the holders of such shares. At June 30, 2004, the redemption value
of the preferred stock would have been approximately $17.6 million.
In connection with the repurchase of preferred stock, we recorded a charge of
approximately $7.7 million to stockholders' equity representing the premium paid
to the holders of our preferred stock ($1.0 million charged to retained earnings
and $6.7 million charged to additional paid-in capital) and recognized
transaction costs of $0.4 million included in other income (expense), net in the
Condensed Consolidated Statements of Operations for the nine months ended March
31, 2004. In accordance with the Securities and Exchange Commission's position
published in an Emerging Issues Task Force ("EITF") Topic No. D-42 relating to
induced conversions of preferred stock, we recorded the $7.7 million premium
paid to purchase the preferred stock as a charge to arrive at net loss
applicable to common stockholders for the nine months ended March 31, 2004.
For the nine months ended March 31, 2003, charges related to our redeemable
convertible preferred stock, the dividend on the preferred stock and the
accretion for the value of fully exercisable warrants granted in connection with
the private placement of the preferred stock, were $1.6 million.
22
LIQUIDITY AND CAPITAL RESOURCES
Working capital was $54.3 million at March 31, 2004, which represented a
working capital ratio of 2.9 to 1, compared to $62.8 million, or 3.7 to 1 at
June 30, 2003. The reduction of our working capital ratio was primarily due to
the repurchase of our redeemable convertible preferred stock for $23.0 million,
which was funded by $13.0 million of cash and $10.0 million of borrowings under
our revolving credit facility in the first fiscal quarter of 2004. As of March
31, 2004, we had repaid $6.0 million of the $10.0 million that was outstanding
under our revolving credit facility at September 30, 2003 from cash provided by
operations and the exercise of employee stock options during the second and
third fiscal quarters of 2004. The remaining $4.0 million outstanding under the
revolving credit facility was repaid on April 23, 2004 as described below.
Net cash provided by operating activities for the nine months ended March 31,
2004 was $12.9 million, compared with $2.8 million for the comparable period in
the prior year. The increase in net cash provided by operating activities was
primarily due to the $7.9 million improvement in net income, the consumption of
$1.6 million of deferred tax assets, the tax benefit of $1.1 million from the
exercise of stock options, continued reductions in inventory due to increased
operating efficiencies and the decrease in severance-related payments, partially
offset by the increase in other current and non-current assets caused by the
prepayment of advertising and promotion expense, value added tax and insurance
premiums. The accounts receivable increase of $2.8 million was primarily due to
the lower shipment linearity in the third quarter of fiscal 2004 compared to the
prior quarter because of WaveRunner 6000 ramp up issues and increased shipments
to Asia where collection terms run slightly longer.
Net cash used in investing activities for the nine months ended March 31,
2004 was $3.4 million, compared with $3.3 million for the comparable period in
the prior year. This increase in net cash used in investing activities was
primarily due to an increase of $1.8 million in capital expenditures during the
nine months ended March 31, 2004, partially offset by a $1.1 million net
decrease of acquisition of technology licenses and net proceeds of $0.6 million
from the sale of property during the nine months ended March 31, 2004. The
increase in capital expenditures for the nine months ended March 31, 2004 was
primarily due to $0.5 million of capital improvements to our principal office
and manufacturing facility and increased capital spending on furniture,
machinery and equipment.
Net cash used in financing activities for the nine months ended March 31,
2004 was $15.3 million, compared with net cash provided by financing activities
of $0.2 million for the comparable period in the prior year. This increase in
net cash used in financing activities was primarily due to the repurchase of our
preferred stock for $23.0 million partially offset by net borrowings of $4.0
million under our revolving credit facility and $4.5 million of proceeds from
employee stock purchases and stock option exercises.
On November 13, 2003, we amended our its existing $15.0 million revolving
credit facility with The Bank of New York. The amended agreement provides us
with a $25.0 million revolving credit facility expiring on November 30, 2006,
which can be used to provide funds for general corporate purposes and
acquisitions. Borrowings under this line bear interest at an annual rate of
prime plus a margin not to exceed 1.00%, or at the London Interbank Offering
Rate (LIBOR) plus a margin of between 1.25% and 2.25%, depending on our leverage
ratio, as such term is defined in the credit agreement. A commitment fee of
0.375% per annum is payable on any unused amount under the facility. This
revolving credit facility is secured by a lien on substantially all of our
domestic assets. As of March 31, 2004, we had $4.0 million outstanding under
this credit facility and were in compliance with our financial covenant
requirements.
On April 14, 2004, we closed an underwritten public follow-on offering of
1,500,000 shares of our common stock at $19.00 per share (less the underwriting
discount) adding approximately $8.0 million, net of $1.1 million in offering
costs and expenses, in cash to our balance sheet. Of these shares, 500,000 were
newly issued by us and 1,000,000 were offered by ValueAct Capital Partners, L.P.
and its affiliates. We granted the underwriters an option to purchase up to an
additional 15 percent of the shares of common stock included in the offering to
cover over-allotments, if any, within 30 days. On April 27, 2004, pursuant to
the exercise of this over-allotment option, we sold an additional 225,000 shares
at $19.00 per share (less the underwriting discount), which added $4.1 million,
net of expenses to our balance sheet.
23
On April 23, 2004, we used proceeds from this offering to repay $4.0 million
of indebtedness outstanding under our revolving credit facility, and we intend
to use the remaining net proceeds for general corporate and working capital
purposes. We may also use a portion of the net proceeds of this offering to
acquire or invest in businesses, products, services or technologies
complementary to our current business, through mergers, acquisitions, joint
ventures or otherwise. Pending application of any of the proceeds to any
specific uses, we intend to invest the net proceeds of this offering in
short-term, interest-bearing investment grade securities.
We have a $2.0 million capital lease line of credit to fund certain capital
expenditures. As of March 31, 2004, we had $0.2 million outstanding under this
line of credit, $0.1 million of which was included in short-term debt and
current portion of long-term debt and the remaining $0.1 million of which was
included in deferred revenue and other non-current liabilities. As of June 30,
2003, we had $0.3 million outstanding under this line of credit, $0.1 million of
which was included in short-term debt and current portion of long-term debt and
the remaining $0.2 million of which was included in deferred revenue and other
non-current liabilities. Outstanding borrowings under this line bear interest at
an annual rate of 12.2%.
In addition to the above U.S.-based facilities, we maintain certain
short-term foreign credit facilities, principally facilities with two Japanese
banks totaling 150 million yen ($1.4 million as of March 31, 2004). No amounts
were outstanding under these facilities as of March 31, 2004 and June 30, 2003.
We believe that our cash on hand, cash flow generated by our continuing
operations and our availability under our revolving credit lines will be
sufficient to fund working capital and capital expenditure requirements for at
least the next twelve months and provide funds for potential acquisition
opportunities.
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
Our contractual obligations and commitments include obligations associated
with our revolving credit facility, capital and operating leases, employee
severance agreements and a technology license agreement as set forth in the
table below:
PAYMENTS DUE BY PERIOD AS OF MARCH 31, 2004
-------------------------------------------------
LESS THAN MORE THAN 5
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS YEARS
------- ------- ------- --------- -----------
(IN THOUSANDS)
Revolving credit facility (1)....... $ 4,000 $ 4,000 $ -- $ -- $ --
Capital lease obligations........... 221 101 120 -- --
Employee severance agreements....... 253 199 54 -- --
Operating lease obligations......... 4,762 1,659 2,165 769 169
Other contractual commitments to
purchase technology............... 250 250 -- -- --
------- ------- ------- ------- -------
Total............................... $ 9,486 $ 6,209 $ 2,339 $ 769 $ 169
======= ======= ======= ======= =======
(1) Outstanding balances under our revolving credit facility were repaid on
April 23, 2004 using a portion of net proceeds raised in our follow-on offering
of our common stock.
FORWARD-LOOKING INFORMATION
This Form 10-Q contains forward-looking statements. When used in this Form
10-Q, the words "anticipate," "believe," "estimate," "will," "plan," "intend,"
and "expect" and similar expressions identify forward-looking statements.
Although we believe that our plans, intentions, and expectations reflected in
any forward-looking statements are reasonable, these plans, intentions, or
expectations may not be achieved. Our actual results, performance, or
achievements could differ materially from those contemplated, expressed, or
implied, by the forward looking statements contained in this Form 10-Q.
Important factors that could cause actual results to differ materially from our
forward looking statements are set forth in this Form 10-Q, including under the
heading "Risk Factors." All forward looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
cautionary statements set forth in this Form 10-Q. Except as required by federal
securities laws, we are under no obligation to update any forward looking
statement, whether as a result of new information, future events, or otherwise.
24
RISK FACTORS
An investment in our common stock involves a high degree of risk. You should
carefully consider the risks described below together with all of the other
information included in this Form 10-Q when evaluating the Company and its
business. If any of the following risks actually occurs, our business, financial
condition, or results of operations could suffer. In that case, the trading
price of our common stock could decline and our stockholders may lose all or
part of their investment.
RISKS RELATED TO OUR BUSINESS
OUR OPERATING RESULTS ARE EXPECTED TO CONTINUE TO FLUCTUATE AND MAY NOT MEET
OUR FINANCIAL GUIDANCE OR PUBLISHED ANALYST FORECASTS, WHICH MAY CAUSE THE
PRICE OF OUR COMMON STOCK TO DECLINE SIGNIFICANTLY.
Our past operating results, and our gross margins, have fluctuated from
fiscal period to fiscal period. We expect our future operating results and gross
margins will continue to fluctuate from fiscal period to fiscal period due to a
number of factors, many of which are outside our control and any of which could
cause our stock price to fluctuate. The primary factors that affect us include
the following:
o changes in overall demand for our products;
o the timing of the introduction and market acceptance of new products
by us or competing companies;
o the timing and magnitude of research and development expenses;
o changes in the estimation of the future size and growth rate of our
markets;
o changes in our production efficiency;
o disruptions in operations at any of our facilities or the facilities of
any of our contract manufacturers for any reason; and
o changes in our selling prices.
In addition, we have historically experienced somewhat lower activity during
our first fiscal quarter than in other fiscal quarters which, we believe, is due
principally to the lower level of orders and market activity during the summer
months, particularly in Europe. We believe this seasonal aspect of our business
is likely to continue in the future.
OUR STOCK PRICE MAY BE VOLATILE IN THE FUTURE, AND OUR STOCKHOLDERS MAY NOT
BE ABLE TO RESELL THEIR SHARES AT OR ABOVE THE PRICE THEY PAID.
The market price of our common stock fluctuates significantly. The stock
price could fluctuate in the future due to a number of factors, some of which
are beyond our control. These factors include:
o historically low trading volume in our stock;
o announcements of developments related to our business;
o announcements of technological innovations or new products or
enhancements by us or our competitors;
o sales by competitors, including sales to our customers;
o sales of common stock into the public market, including by directors
and members of management;
o developments in our relationships with our customers, partners,
distributors, and suppliers;
25
o shortfalls or changes in revenue, gross margins, earnings or losses, or
other financial results from analysts' expectations;
o regulatory developments;
o fluctuations in results of operations;
o trends in the seasonality of our sales; and
o general conditions in our market or the markets served by our customers.
In addition, in recent years the stock market in general and the market for
shares of technology stocks in particular have experienced extreme price
fluctuations, which have often been due largely to factors other than the
operating performance of the affected companies. We cannot ensure that the
market price of our common stock will not decline substantially, or otherwise
continue to experience significant fluctuations in the future, including
fluctuations that are unrelated to our operating performance.
IF DEMAND FOR OUR PRODUCTS DOES NOT MATCH MANUFACTURING CAPACITY, WE MAY
UNDERUTILIZE OUR CAPACITY OR, ALTERNATIVELY, BE UNABLE TO FULFILL ORDERS IN
A TIMELY MANNER, AND IN EITHER SITUATION OUR EARNINGS MAY SUFFER.
The sale of our products is dependent, to a large degree, on customers whose
industries are subject to cyclical trends in the demands for their products. We
may not be able to adapt production capacity and related cost structures to
rapidly changing market conditions in a timely manner. When demand does not meet
expectations, manufacturing capacity will likely exceed production requirements.
We have at times increased our production capacity and the overhead that
supports production based on anticipated market demand which has not always
developed as expected. As a result, we have periodically underutilized our
capacity, which has adversely affected our earnings due to existing fixed costs.
In addition, conversely, if during a market upturn we cannot increase
manufacturing capacity to meet product demand, we will not be able to fulfill
orders in a timely manner, which in turn may have a negative effect on earnings
and our overall business.
IF OUR OPERATING RESULTS DO NOT CONTINUE TO IMPROVE IN THE LONG-TERM, WE MAY
BE REQUIRED TO ESTABLISH A VALUATION ALLOWANCE AGAINST OUR NET DEFERRED
TAX ASSETS.
We evaluate whether our deferred tax assets can be realized and assess the
need for a valuation allowance on an ongoing basis. As of March 31, 2004, we had
recorded $13.6 million of net deferred tax assets for the future tax benefit of
certain expenses reported for financial statement purposes that have not yet
been deducted on our tax returns. Realization of our net deferred tax assets is
dependent on our ability to generate future taxable income. We have recorded a
valuation allowance of $5.1 million as of March 31, 2004 to reserve for those
tax assets we believe are not likely to be realized in future periods. An
additional valuation allowance would be recorded if it were more likely than not
that some or all of our net deferred assets will not be realized. If we
establish additional valuation allowances, we might record a tax expense in our
condensed consolidated statement of operations, which would have an adverse
impact on our operating results.
WE FACE RISKS FROM FLUCTUATIONS IN THE VALUE OF FOREIGN CURRENCY VERSUS THE
U.S. DOLLAR AND THE COST OF CURRENCY EXCHANGE, WHICH AFFECT OUR COST OF
SALES AND OPERATING MARGINS AND COULD RESULT IN EXCHANGE LOSSES.
A large portion of our sales and expenses are denominated in foreign
currencies. We purchase materials from suppliers and sell our products around
the world and maintain investments in foreign subsidiaries, all denominated in a
variety of currencies. As a consequence, we are exposed to risks from
fluctuations in foreign currency exchange rates with respect to a number of
currencies, changes in government policies and legal and regulatory
requirements, political instability, transportation delays and the imposition of
tariffs and export controls. We are exposed to adverse changes in interest rates
primarily due to our investment in cash and cash equivalents. Changes in the
relation of foreign currencies to the U.S. dollar will affect our cost of sales
and operating margins and could result in exchange losses. Among the more
significant potential risks to us of relative fluctuations in foreign currency
exchange rates is the relationship among and between the U.S. dollar, the
European monetary unit, Swiss franc, British pound, Swedish krona, Japanese yen,
Korean won, Singapore dollar and Hong Kong dollar.
26
We have a program of entering into foreign exchange forward contracts to
minimize the risks associated with currency fluctuations on assets or
liabilities denominated in other than the functional currency of us or our
subsidiaries. It cannot be assured, however, that this program will effectively
offset all of our foreign currency risk related to these assets or liabilities.
These foreign exchange forward contracts do not qualify for hedge accounting.
Other than this program, we do not attempt to reduce our foreign currency
exchange risks by entering into foreign currency management programs. As a
consequence, there can be no assurance that fluctuations in foreign currency
exchange rates in the future as a result of mismatches between local currency
revenues and expenses, the translation of foreign currencies into the U.S.
dollar, our financial reporting currency, or otherwise, will not adversely
affect our results of operations. Moreover, fluctuations in exchange rates could
affect the demand for our products.
No assurance can be given that our strategies will prevent future currency
fluctuations from having a material adverse affect on our business, financial
condition and results of operations.
WE MAY NOT BE SUCCESSFUL IN THE EXPANSION OF OUR BUSINESS OPERATIONS IN
CHINA, WHICH COULD RESULT IN A LOSS OF OUR INVESTMENT AND THEREBY HARM OUR
OPERATING RESULTS.
We intend to continue to expand our business operations and sales in China.
However, we may be unsuccessful in implementing this strategy as planned or at
all. Factors that could inhibit our successful expansion into China include its
highly cyclical business environment, historically poor recognition of
intellectual property rights and poor performance in stopping counterfeiting and
piracy activity.
WE FACE NUMEROUS RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS, WHICH
COULD CAUSE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND RESULTS OF
OPERATIONS SINCE APPROXIMATELY TWO-THIRDS OF OUR REVENUES DERIVE FROM
INTERNATIONAL SALES.
We market and sell our products and services outside the United States,
and currently have employees located in China, France, Germany, Italy, Hong
Kong, Japan, Singapore, South Korea, Sweden, Switzerland and the United Kingdom.
Many of our customers and licensees are located outside the United States. As
part of our strategy, we intend to expand our international sales, particularly
in China. We face numerous risks in doing business outside the United States,
including:
o dependence on sales representatives or foreign distributors and their
sales channels;
o longer accounts receivable collection cycles;
o less effective and less predictable protection of intellectual property;
o trade protection measures, import or export licensing requirements,
tariffs and other trade barriers;
o unusual or burdensome foreign laws or regulatory requirements or
unexpected changes to those laws or requirements;
o changes in the political or economic condition of a specific country
or region, particularly in emerging markets; and
o potentially adverse tax consequences.
Such factors could cause our future international sales to decline.
Our business practices in international markets are also subject to the
requirements of the Foreign Corrupt Practices Act. If any of our employees is
found to have violated these requirements, we could be subject to significant
fines and other penalties.
27
Our products are also subject to United States export control restrictions.
In certain cases, we may not be permitted to export products without obtaining
an export license. U.S. export laws also prohibit the export of our products to
a number of countries deemed by the United States to be hostile. The export of
our high-performance oscilloscopes from the United States, which accounts for a
material portion of our internationally derived revenue, is also subject to
regulation under the Treaty for Nuclear Non-Proliferation. However, only a small
portion of those oscilloscopes are sold in countries where that treaty restricts
the end-user. These restrictions may make foreign competitors facing less
stringent controls on their products more competitive in the global market. We
cannot be certain that the U.S. government will approve any pending or future
export license requests. In addition, the list of products and countries for
which export approval is required, and the regulatory policies with respect
thereto, could be revised. Our international sales and, because approximately
two-thirds of our revenue is derived from sales outside the United States, our
sales in general, could be materially harmed by our inability to obtain required
licenses or by the costs of compliance.
We may be greatly impacted by the political, economic, and military
conditions in China, Taiwan, North Korea, and South Korea. These countries have
recently conducted military exercises in or near the others' territorial waters
and airspace. Such disputes may continue or escalate, resulting in economic
embargos, disruptions in shipping, or even military hostilities. This could
severely harm our business by interrupting or delaying shipment of our products
to or through these areas and/or reducing our sales in these areas.
WE DEPEND ON SINGLE-SOURCE SUPPLIERS FOR SOME OF OUR PRODUCTS, AND THE LOSS
OF THESE SUPPLIERS COULD HARM OUR BUSINESS BY INTERRUPTING OR TERMINATING
OUR MANUFACTURE OF THOSE PRODUCTS.
We purchase a small number of parts from single-source suppliers. In
particular, several key integrated circuits that we use are made by
International Business Machines, or IBM. Although we have not experienced
significant production delays attributable to supply changes, we believe that,
for integrated circuits in particular, alternative sources of supply would be
difficult to develop over a short period of time. Because we have no direct
control over our third-party suppliers, interruptions or delays in the products
and services provided by these third parties may be difficult to remedy in a
timely fashion. In addition, if such suppliers are unable or unwilling to
deliver the necessary parts or products, we may be unable to redesign or adapt
our technology to work without such parts or find alternative suppliers or
manufacturers. In such events, we could experience interruptions, delays,
increased costs, or quality control problems.
WE DEPEND UPON KEY PERSONNEL AND QUALIFIED FUTURE HIRES TO IMPLEMENT OUR
EXPANSION STRATEGY, AND IF WE ARE UNABLE TO RETAIN OR ATTRACT PERSONNEL WE
MAY NOT BE ABLE TO MANAGE AND OPERATE SUCCESSFULLY AND WE MAY NOT BE ABLE TO
MEET OUR STRATEGIC OBJECTIVES.
Our success depends on the efforts and abilities of senior management and
key employees in the sales, marketing, research and development, and
manufacturing areas. Many of these employees would be difficult to replace. We
do not have employment contracts with most of our key personnel. If we cannot
retain existing key managers and employ additional qualified senior employees,
our business, financial condition, and results of operations could be materially
and adversely affected. We do not maintain "key man" life insurance policies on
any of our personnel. Future expansion of operations will require us to attract,
train and retain new personnel. In addition, we may be limited by
non-solicitation agreements entered into by our key personnel with respect to
hiring employees from our competitors. These factors could increase our
operating expenses. If we are unable to recruit or retain a sufficient number of
qualified employees, or the costs of compensation or employee benefits increase
substantially, our business, results of operations or financial condition could
be materially and adversely affected.
28
THE ACTIONS WE TOOK AT THE END OF FISCAL 2001 THROUGH FISCAL 2003 IN
RESPONSE TO THE REDUCED DEMAND FOR OUR PRODUCTS COULD HAVE LONG-TERM ADVERSE
EFFECTS ON OUR BUSINESS.
We experienced operating losses beginning in the fourth quarter of fiscal
2001 and ending in the fourth quarter of fiscal 2002 due to reduced demand for
our products. In an effort to decrease expenses in response to this reduced
demand, beginning at the end of fiscal 2001 and continuing through fiscal 2003,
we consolidated certain operations, reduced the size of our workforce and
increased operating efficiencies.
There are several risks inherent in our cost-cutting initiatives to
transition to a reduced cost structure. These include the risk that cost-cutting
initiatives have impaired our ability to develop and market products effectively
and remain competitive in the industries in which we compete. Cost reduction
measures could have long-term adverse effects on our business by reducing our
pool of technical talent, decreasing or slowing improvements in our products,
making it more difficult for us to respond to customers, limiting our ability to
increase production quickly if and when the demand for our products increases
and limiting our ability to hire and retain key personnel. These circumstances
could have a material adverse effect on our business, results of operations or
financial condition.
WE MAY NOT BE SUCCESSFUL IN PROTECTING OUR INTELLECTUAL AND PROPRIETARY
RIGHTS, WHICH WOULD DEPRIVE US OF A COMPETITIVE ADVANTAGE AND THEREBY
NEGATIVELY IMPACT OUR ABILITY TO COMPETE.
As a technology-based company, our success depends on developing and
protecting our intellectual property. We rely generally on patent, copyright,
trademark and trade secret laws in the United States and abroad. Electronic
equipment as complex as most of our products, however, is generally not
patentable in its entirety. We also license intellectual property from third
parties and rely on those parties to maintain and protect their technology. We
cannot be certain that actions we take to establish and protect proprietary
rights will be adequate, particularly in countries where intellectual property
rights are not highly developed or protected. If we are unable to adequately
protect our technology, or if we are unable to continue to obtain or maintain
licenses for protected technology from third parties, it may be difficult to
design alternatives to such technology without incurring significant costs.
Thus, the loss of intellectual property rights to technology could have a
material adverse effect on our business, results of operations or financial
condition.
We are engaged in intellectual property litigation, including with
Tektronix, Inc. ("Tektronix"). On April 28, 2003, Tektronix filed a complaint
against us in the United States District Court for the District of Oregon
claiming that we infringed on eight of its U.S. patents. In our responsive
pleading, we denied that we have infringed, or are infringing, any of these
patents, and contend that the patents are invalid. Four of these patents concern
software user interface features for oscilloscopes, two concern circuitry and
two concern probes. On August 5, 2003, we filed a counterclaim in the United
States District Court for the District of Oregon claiming that Tektronix
infringed on four of our patents.
From time to time in the ordinary course of business, we receive notices
from third parties regarding intellectual property infringement or take action
against others with regard to intellectual property rights. Even where we are
successful in defending or pursuing such claims, we may incur significant costs.
In the event of a successful claim against us, we could lose our rights to
needed technology or be required to pay license fees for the infringed rights,
either of which could have an adverse impact on our business.
WE LICENSE CERTAIN INTELLECTUAL PROPERTY FROM THIRD PARTIES, AND THE LOSS OF
THESE LICENSES COULD DELAY DEVELOPMENT OF FUTURE PRODUCTS OR PREVENT THE
SALE OR ENHANCEMENT OF EXISTING PRODUCTS.
We rely on licenses of intellectual property for our businesses, including
technology used in our products. We cannot ensure that these licenses will be
available in the future on favorable terms or at all. The loss of these licenses
or the ability to maintain any of them on acceptable terms could delay
development of future products or prevent the further sale or enhancement of
existing products. Such loss could adversely affect our business, results of
operations and financial condition.
29
OUR ACQUISITIONS, STRATEGIC ALLIANCES AND JOINT VENTURES MAY RESULT IN
FINANCIAL RESULTS THAT ARE DIFFERENT THAN EXPECTED.
In the normal course of business, we engage in discussions with third
parties relating to possible acquisitions, strategic alliances, and joint
ventures. As a result of transactions which may be consummated, our financial
results may differ from the investment community's expectations in a given
quarter. In addition, acquisitions and strategic alliances may require us to
integrate a different company culture, management team and business
infrastructure. We may have difficulty developing, manufacturing and marketing
the products of a newly-acquired company in a way that enhances the performance
of our combined businesses or product lines to realize the value from expected
synergies. Depending on the size and complexity of an acquisition, our
successful integration of the entity depends on a variety of factors, including:
o the retention of key employees;
o the management of facilities and employees in different geographic
areas;
o the retention of key customers; and
o the integration or coordination of different research and development,
product manufacturing and sales programs and facilities.
Any impairment of the value of purchased assets or goodwill could have a
significant negative impact on our future operating results.
All of these efforts require varying levels of management resources, which
may divert our attention from other business operations. Further, if market
conditions or other factors lead us to change our strategic direction, we may
not realize the expected value from such transactions. If we do not realize the
expected benefits or synergies of such transactions, our consolidated financial
position, results of operations, cash flows and stock price could be negatively
impacted.
WE MAY NOT BE ABLE TO OBTAIN THE CAPITAL WE NEED TO MAINTAIN OR GROW OUR
BUSINESS.
Our ability to execute our long-term strategy may depend to a significant
degree on our ability to obtain long-term debt and equity capital. We have no
commitments for additional borrowings, other than our existing credit facility,
or for sales of equity, other than under our existing employee benefit plans. We
cannot determine the precise amount and timing of our funding needs at this
time. We may be unable to obtain future additional financing on terms acceptable
to us, or at all. If we fail to comply with certain covenants relating to our
indebtedness, we may need to refinance our indebtedness to repay it. We also may
need to refinance our indebtedness at maturity. We may not be able to obtain
additional capital on favorable terms to refinance our indebtedness.
The following factors could affect our ability to obtain additional financing
on favorable terms, or at all:
o our results of operations;
o general economic conditions and conditions in our industry;
o the perception in the capital markets of our business;
o our ratio of debt to equity;
o our financial condition;
o our business prospects; and
o changes in interest rates.
30
In addition, certain covenants relating to our existing indebtedness impose
certain limitations on additional indebtedness. If we are unable to obtain
sufficient capital in the future, we may have to curtail our capital
expenditures and reduce research and development expenditures. Any such actions
could have a material adverse effect on our business, financial condition,
results of operations and liquidity.
WE COULD INCUR SUBSTANTIAL COSTS AS A RESULT OF VIOLATIONS OF OUR
LIABILITIES UNDER ENVIRONMENTAL LAWS.
Our operations are subject to laws and regulations relating to the protection
of the environment, including those governing the discharge of pollutants into
the air or water, the management and disposal of hazardous substances or wastes
and the cleanup of contaminated sites. Some of our operations require
environmental permits and controls to prevent and reduce air and water
pollution, and these permits are subject to modification, renewal and revocation
by issuing authorities. We could incur substantial costs, including cleanup
costs, fines and civil or criminal sanctions and third-party claims for property
damage and personal injury as a result of violations of or liabilities under
environmental laws or non-compliance with environmental permits.
Our former subsidiary, Digitech Industries, Inc., has been involved in
environmental remediation activities, the liability for which was retained by us
after the sale of the Vigilant Networks segment and the residual assets of
Digitech. Any liability beyond what is currently expected and reserved for could
have a material adverse effect on our results of operations.
WE ARE SUBJECT TO LAWS AND REGULATIONS GOVERNING GOVERNMENT CONTRACTS, AND
FAILURE TO ADDRESS THESE LAWS AND REGULATIONS OR COMPLY WITH GOVERNMENT
CONTRACTS COULD HARM OUR BUSINESS BY LEADING TO A REDUCTION IN REVENUE
ASSOCIATED WITH THESE CUSTOMERS.
We have agreements relating to the sale of our products to government
entities and, as a result, we are subject to various statutes and regulations
that apply to companies doing business with the government. The laws governing
government contracts differ from the laws governing private contracts. For
example, many government contracts contain pricing terms and conditions that are
not applicable to private contracts. We are also subject to investigation for
compliance with the regulations governing government contracts. A failure to
comply with these regulations might result in suspension of these contracts, or
administrative penalties.
IF WE ARE REQUIRED TO ACCOUNT FOR OPTIONS UNDER OUR EMPLOYEE STOCK PLANS AS
A COMPENSATION EXPENSE, OUR NET INCOME AND EARNINGS PER SHARE WOULD BE
SIGNIFICANTLY REDUCED.
There has been an increasing public debate about the proper accounting
treatment for employee stock options. In April 2004, the Financial Accounting
Standards Board ("FASB") issued an exposure draft entitled "Share-based Payment
an amendment of FASB Statements No. 123 and No. 95," requiring companies to
expense the fair value of all employee equity-based awards granted, modified or
settled. The tentative requirements would be effective for us in our 2006 fiscal
year commencing July 2005 and would require any options issued or vesting on or
after that date to be recognized as compensation expense in accordance with the
future statement. Currently, we record compensation expense only in connection
with option grants that have an exercise price below fair value. It is possible
that future laws, regulations and accounting pronouncements will require us to
record the fair value of all stock options as compensation expense in our
consolidated statement of operations, which would have an adverse effect on our
results of operations.
WE HAVE A REVOLVING CREDIT FACILITY THAT CONTAINS FINANCIAL COVENANTS, AND
THE FAILURE TO COMPLY WITH THESE COVENANTS COULD HARM OUR FINANCIAL
CONDITION BECAUSE OUR CREDIT FACILITY MAY BE UNAVAILABLE TO US.
We have a $25.0 million revolving credit facility with The Bank of New
York. On April 23, 2004, we used proceeds from our recent follow-on offering in
which we sold 500,000 shares of our common stock to repay $4.0 million of
indebtedness outstanding under our revolving credit facility. Following this
repayment, we will continue to be subject to financial covenants under our
credit facility, including interest coverage ratio, minimum total net worth,
minimum total tangible net worth and liquidity ratio requirements. We expect
that existing cash and cash equivalents, cash provided from operations, and
borrowings pursuant to our existing credit facility with The Bank of New York
will be sufficient to meet ongoing cash requirements. Failure to generate
sufficient cash or comply with the financial covenants under our credit facility
may adversely affect our business, results of operations and financial
condition.
31
ISSUANCE OF SHARES IN CONNECTION WITH FINANCING TRANSACTIONS OR UNDER STOCK
PLANS AND OUTSTANDING WARRANTS WILL DILUTE CURRENT STOCKHOLDERS.
Pursuant to our stock plans, our management is authorized to grant stock
awards to our employees, directors and consultants. In addition, we also have
warrants outstanding to purchase shares of our common stock. Our stockholders
will incur dilution upon exercise of any outstanding stock awards or warrants.
In addition, if we raise additional funds by issuing additional common stock, or
securities convertible into or exchangeable or exercisable for common stock,
further dilution to our existing stockholders will result, and new investors
could have rights superior to existing stockholders.
ANTI-TAKEOVER PROVISIONS UNDER OUR STOCKHOLDER RIGHTS PLAN, CHARTER
DOCUMENTS AND DELAWARE LAW COULD DELAY OR PREVENT A CHANGE OF CONTROL AND
COULD ALSO LIMIT THE MARKET PRICE OF OUR STOCK.
Our stockholder rights plan, certificate of incorporation and bylaws contain
provisions that could delay or prevent a change of control of our company that
our stockholders might consider favorable. Certain provisions of our certificate
of incorporation and bylaws allow us to:
o authorize the issuance of preferred stock which can be created and
issued by the board of directors without prior stockholder approval,
with rights senior to those of the common stock;
o provide for a classified board of directors, with each director serving
a staggered three-year term;
o prohibit stockholders from filling board vacancies, calling special
stockholder meetings, or taking action by written consent; and
o require advance written notice of stockholder proposals and director
nominations.
In addition, we are governed by the provisions of Section 203 of the Delaware
General Corporate Law, which may prohibit certain business combinations with
stockholders owning 15% or more of our outstanding voting stock. These and other
provisions in our certificate of incorporation, bylaws and stockholder rights
plan and Delaware law could make it more difficult for stockholders or potential
acquirors to obtain control of our board of directors or initiate actions that
are opposed by the then-current board of directors, including delay or impede a
merger, tender offer, or proxy contest involving our company. Moreover, certain
provisions of our license agreement with Tektronix, which expires in September
2004, could discourage certain companies or other third parties from attempting
to acquire control of us or limit the price that such parties might be willing
to pay for our common stock until the expiration of such agreement. Any delay or
prevention of a change of control transaction or changes in our board of
directors could cause the market price of our common stock to decline.
RISKS RELATED TO OUR INDUSTRY
WE OPERATE IN HIGHLY COMPETITIVE MARKETS AND THIS COMPETITION COULD REDUCE
OUR MARKET SHARE AND HARM OUR BUSINESS.
The oscilloscope market is highly competitive and characterized by rapid
and continual advances in technology. Our principal competitors in this market
are Tektronix and Agilent Technologies, Inc. Both of our principal competitors
have substantially greater sales and marketing, development and financial
resources than we do. We believe that Tektronix, Agilent Technologies and other
competitors each offer a wide range of products that attempt to address most
sectors of the oscilloscope market.
32
We have historically engaged in intense competition with Tektronix. Some of
our senior managers, including our chief executive officer and chief operating
officer, are former employees of Tektronix. In 1994, we settled litigation with
Tektronix alleging that our oscilloscope products infringed certain patents held
by Tektronix by entering into a license agreement for the right to use that
intellectual property. We are currently engaged in another intellectual property
litigation with Tektronix in which both sides have claimed that the other is
infringing its patents. This litigation is described in more detail under Item 1
of Part II of this Form 10-Q.
We believe that the principal bases of competition in the oscilloscope
market are a product's performance (bandwidth, sample rate, memory length and
processing power), its price and quality, the vendor's name recognition and
reputation, product availability and the quality of post-sale support. If any of
our competitors surpass us or are perceived to have surpassed us with respect to
one or more of these factors, we may lose customers. We also believe that our
success will depend in part on our ability to maintain and develop the advanced
technology used in our oscilloscope products and our ability to offer
high-performance products at a favorable "price-to-performance" ratio. We cannot
assure that we will continue to compete effectively.
A PROLONGED ECONOMIC DOWNTURN COULD MATERIALLY HARM OUR BUSINESS BY
DECREASING CAPITAL SPENDING.
Negative trends in the general economy, including trends resulting from
actual or threatened military action by the United States and threats of
terrorist attacks on the United States and abroad, could cause a decrease in
capital spending in many of the markets we serve. In particular, a downward
cycle affecting the computer and semiconductor, data storage devices, automotive
and industrial, and military and aerospace markets would likely result in a
reduction in demand for our products and would have a material adverse effect on
our business, results of operations, financial condition and liquidity. In
addition, if customers' markets decline, we may not be able to collect
outstanding amounts due to us. Such declines could harm our consolidated
financial position, results of operations, cash flows and stock price, and could
limit our ability to maintain profitability.
WE MUST SUCCESSFULLY EXECUTE OUR STRATEGY TO INTRODUCE NEW PRODUCTS.
One of our key strategies is to expand our addressable portion of the
oscilloscope market by introducing new products such as sampling oscilloscopes
and additional oscilloscopes in the lower bandwidth market. We have in the past
withdrawn a product line due to implementation concerns. In August 2000, we
divested our Vigilant Networks business segment because, while its technology
was potentially viable, the additional capital investment required for its
commercial success was judged to be too high. The success of our new product
offerings will depend on a number of factors, including our ability to identify
customer needs properly, manufacture and deliver products in sufficient volumes
on time, differentiate offerings from competitors' offerings, price products
competitively and anticipate competitors' development of new products or
technological innovations.
WITHOUT THE TIMELY INTRODUCTION OF COMPETITIVE PRODUCTS, OUR PRODUCTS MAY
BECOME TECHNOLOGICALLY OBSOLETE.
We generally sell our products in industries that are characterized by
rapid technological changes, frequent new product introductions and changing
industry standards. Without the timely introduction of new products, services
and enhancements, our products may become technologically obsolete, in which
case our revenue and operating results could suffer. The success of new product
offerings will depend on several factors, including our ability to identify
customer needs properly, innovate and develop new technologies, manufacture and
deliver products in sufficient volumes on time, differentiate offerings from
competitors' offerings, price products competitively and anticipate competitors'
development of new products or technological innovations.
33
WE COULD BE AFFECTED BY GOVERNMENT REGULATION AND OTHER LEGAL UNCERTAINTIES.
We manufacture our products in the United States, and sell our products and
purchase parts, components and sub-assemblies in a number of countries. We are
therefore subject to various significant international, federal, state and local
regulations, including but not limited to health and safety, product content,
labor and import/export regulations. For example, the export of high-performance
oscilloscopes from the United States is subject to regulation under the Treaty
for Nuclear Non-Proliferation. These regulations are complex, change frequently
and have tended to become more stringent over time. We may be required to incur
significant expenses to comply with these regulations or to remedy violations of
these regulations. Any failure by us to comply with applicable government
regulations could also result in cessation of our operations or portions of our
operations, product recalls or impositions of fines and restrictions on our
ability to carry on or expand our operations. In addition, because many of our
products are regulated or sold into regulated industries, we must comply with
additional regulations in marketing our products.
34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We purchase materials from suppliers and sell our products around the world
and maintain investments in foreign subsidiaries, all denominated in a variety
of currencies. As a consequence, we are exposed to risks from fluctuations in
foreign currency exchange rates with respect to a number of currencies, changes
in government policies and legal and regulatory requirements, political
instability, transportation delays and the imposition of tariffs and export
controls. Among the more significant potential risks to us of relative
fluctuations in foreign currency exchange rates is the relationship among and
between the U.S. dollar, the European monetary unit, Swiss franc, British pound,
Swedish krona, Japanese yen, Korean won, Singapore dollar and Hong Kong dollar.
We have a program of entering into foreign exchange forward contracts to
minimize the risks associated with currency fluctuations on assets or
liabilities denominated in other than the functional currency of us or our
subsidiaries. It cannot be assured, however, that this program will effectively
offset all of our foreign currency risk related to these assets or liabilities.
These foreign exchange forward contracts do not qualify for hedge accounting.
Other than this program, we do not attempt to reduce our foreign currency
exchange risks by entering into foreign currency management programs. As a
consequence, there can be no assurance that fluctuations in foreign currency
exchange rates in the future as a result of mismatches between local currency
revenues and expenses, the translation of foreign currencies into the U.S.
dollar, our financial reporting currency, or otherwise, will not adversely
affect our results of operations. Moreover, fluctuations in exchange rates could
affect the demand for our products.
The net gains or (losses) resulting from changes in the fair value of these
derivatives and on transactions denominated in other than their functional
currencies were $0.1 million and ($0.1) million for the three-month periods
ended March 31, 2004 and 2003, respectively, and $0.3 and ($0.4) million for the
nine-month periods ended March 31, 2004 and 2003, respectively, and are included
in other income (expense), net in the Condensed Consolidated Statements of
Operations. At March 31, 2004 and June 30, 2003, the notional amounts of our
open foreign exchange forward contracts, all with maturities of less than six
months, were approximately $10.4 million and $6.7 million, respectively.
We performed a sensitivity analysis at our fiscal 2003 year end assuming a
hypothetical 10% adverse change in foreign currency exchange rates on our
foreign exchange forward contracts and our assets or liabilities denominated in
other than their functional currencies. In management's opinion, a 10% adverse
change in foreign currency exchange rates would not have a material effect on
these instruments or, therefore, our results of operations, financial position
or cash flows.
We are exposed to adverse changes in interest rates primarily due to our
investment in cash and cash equivalents. Market risk is estimated as the
potential change in fair value resulting from a hypothetical 1% adverse change
in interest rates, which would not have been significant to our results of
operations, financial position or cash flows.
ITEM 4. CONTROLS AND PROCEDURES
We carried out an evaluation required by the Securities Exchange Act of 1934,
under the supervision and with the participation of our chief executive officer
and chief financial officer, of the effectiveness of the design and operation of
our disclosure controls and procedures as of the end of the period covered by
this report. Based on that evaluation, our chief executive officer and chief
financial officer have concluded that, as of the end of the period covered by
this report, our disclosure controls and procedures were effective in timely
alerting them to material information required to be included in our periodic
Securities and Exchange Commission reports.
During the most recent fiscal quarter, there has been no change in our
internal control over financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
35
LECROY CORPORATION
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 28, 2003, Tektronix filed a complaint against us in the United
States District Court for the District of Oregon claiming that we infringed on
eight of its U.S. patents. In our responsive pleading, we denied that we have
infringed, or are infringing, any of these patents, and contend that the patents
are invalid. Four of these patents concern software user interface features for
oscilloscopes, two concern circuitry and two concern probes. On August 5, 2003,
we filed a counterclaim in the United States District Court for the District of
Oregon claiming that Tektronix infringed on four of our patents. We believe we
have meritorious defenses and we intend to vigorously defend this action.
On January 15, 2003, we were sued by Sicom Systems ("Sicom") in the United
States District Court for the District of Delaware for patent infringement of a
U.S. patent relating to the graphical display of test limits. We answered the
complaint denying infringement and asserted a counterclaim alleging the
invalidity of the patent and that Sicom had abused the judicial process by
bringing a baseless patent infringement claim. On July 16, 2003, we filed a
Motion to Dismiss Sicom's case, contending that Sicom did not have standing to
bring the litigation. On November 20, 2003, the Court granted our Motion to
Dismiss. On December 18, 2003, Sicom filed a Notice of Appeal to the United
States Court of Appeals for the Federal Circuit. On December 30, 2003, Sicom
filed a new patent infringement lawsuit against us in the United States District
Court for the District of Delaware. Tektronix and Agilent Technologies are also
co-defendants in this new litigation. The complaint in this new case is
essentially the same as the complaint filed by Sicom on January 15, 2003, except
that Sicom now states that it entered into an amendment to its license agreement
with the Canadian government on December 19, 2003, and that Sicom now has the
exclusive right to bring suit for infringement of the patent in the United
States. On January 5, 2004, Sicom filed a Notice and Order of Dismissal of
Appeal of its appeal to the Court of Appeals for the Federal Circuit and the
Order was entered on the following day. In our responsive pleading, we have
denied that we have infringed, or are infringing, the patent, and contend that
the patent is invalid. We intend to vigorously defend ourselves in this
litigation.
From time to time, we are involved in lawsuits, claims, investigations and
proceedings, including patent and environmental matters, that arise in the
ordinary course of business. There are no matters pending, including those
described above, that we expect to be material to our business, results of
operations, financial condition or cash flows.
36
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
ITEM 6(A) EXHIBITS
31.1 Certification by the Chief Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934
31.2 Certification by the Chief Financial Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934
32.1 Certification by the Chief Executive Officer pursuant to
18 U.S.C. Section 1350
32.2 Certification by the Chief Financial Officer pursuant to
18 U.S.C. Section 1350
ITEM 6(B) REPORTS ON FORM 8-K DURING THE QUARTER ENDED MARCH 31, 2004
The Company filed a Form 8-K with the SEC on January 6, 2004, reporting under
Item 7 "Financial Statements and Exhibits" and under Item 12 "Results of
Operations and Financial Condition" the Company's press release announcing that
it anticipates better-than-expected revenues and operating income for the second
quarter ended December 31, 2003.
The Company filed a Form 8-K with the SEC on January 14, 2004, reporting under
Item 7 "Financial Statements and Exhibits" and under Item 12 "Results of
Operations and Financial Condition" the Company's earnings for the three-and
six-month periods ended December 31, 2003.
The Company filed a Form 8-K with the SEC on February 9, 2004, reporting under
Item 5 "Other Events" and under Item 7 "Financial Statements and Exhibits" the
Company's announcement that it had filed a Registration Statement on Form S-3
with the Securities and Exchange Commission relating to a proposed underwritten
follow-on public offering of shares of its common stock.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: April 30, 2004 LeCROY CORPORATION
/s/Scott D. Kantor
-------------------------------------------
Scott D. Kantor
Vice President and Chief Financial Officer,
Secretary and Treasurer
37
EXHIBIT INDEX
EXHIBITS NO. DESCRIPTION
31.1 Certification by the Chief Executive Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2 Certification by the Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934
32.1 Certification by the Chief Executive Officer pursuant to
18 U.S.C. Section 1350
32.2 Certification by the Chief Financial Officer pursuant to
18 U.S.C. Section 1350
38