LeCroy Corporation (the "Company," "LeCroy," "us," "we" or "our") was founded in 1964 and is incorporated in the State of Delaware. Our principal executive offices and manufacturing facilities are located at 700 Chestnut Ridge Road, Chestnut Ridge, New York 10977 and our telephone number is (845) 425-2000. Our website is located at www.lecroy.com. We sell our products and provide service worldwide through wholly-owned subsidiaries, representatives and distributors.
We develop, manufacture, sell and license high-performance oscilloscopes and global communication protocol analyzers. Our oscilloscopes are tools used by designers and engineers to measure and analyze complex electronic signals in order to develop high-performance systems, validate electronic designs and improve time to market. We offer six families of oscilloscopes, which address different solutions for the markets we serve: WaveExpert, our line of Sampling Oscilloscopes; WaveMaster, one of our high performance product families; WavePro, which is targeted at the mid- to high-performance sector; WaveRunner, designed for the mid-performance sector; WaveSurfer, designed for value-oriented users in the low-performance bandwidth sector of the market; and WaveJet, our entry-level oscilloscope products. Our protocol analyzers are used to reliably and accurately monitor communications traffic and diagnose operational problems in a variety of communications devices to ensure that they comply with industry standards. Our protocol analyzers are used by designers and engineers whose products are in development and production and also for products deployed in the field.
We generate revenue in a single segment within the Test and Measurement market, primarily from the sale of our oscilloscopes, protocol analyzers, probes, accessories, and applications solutions. To a lesser extent, we also generate revenue from the sales of our extended warranty contracts, maintenance contracts and repairs and calibrations on our instruments after their warranties expire. Revenue is recognized when products are shipped or services are rendered to customers and other revenue recognition criteria are met, net of allowances for anticipated returns. We sell our products into a broad range of end markets, including Computer/Semiconductor/Consumer Electronics, Data Storage, Automotive/Industrial, and Military/Aerospace. 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.
TEST AND MEASUREMENT MARKET
Test and Measurement equipment is used in the design, development, manufacture, deployment and operation of electronic products and systems. This equipment is required to verify functionality and performance of new product designs and to ensure compliance to industry standards and overall product quality. These instruments are used across all electronic equipment industries, including computer, semiconductor, communications, consumer, automotive, defense, and video. In addition, Test and Measurement instruments are utilized to install, maintain and monitor wireless and wire-line communications and broadcast networks. This Test and Measurement equipment aids in the research and development of new products, testing of products in production, and maintenance and service of products in the field.
According to Prime Data, Inc., an independent market research firm tracking the Test and Measurement industry, the market for this equipment exceeded $7 billion in 2005. Certain segments of the Test and Measurement industry have historically experienced greater volatility than the overall industry because of their exposure to certain end markets, such as communications, that experienced rapid growth in the late 1990s, followed by rapid declines.
Growth in the Test and Measurement market is driven by improvements in electronic systems performance, growth in the electronics market and emerging technologies and standards. Designers in a wide variety of industries are being constantly driven to increase the performance of their products and to add new features and capabilities. These improvements rely on advanced semiconductor technology and require the design of faster, more powerful and complex
electronic systems. As a result, the underlying technological advances in communications and electronic signals are increasing exponentially in complexity and speed. This is driving the demand for analysis tools that allow designers and manufacturers of these devices to improve new product cycle time. With each advance in technology, engineers designing next generation technologies and products must contend with both a reduced margin for error and a progressively more difficult task of fully characterizing new product design.
While the overall market for test and measurement equipment is made up of hundreds of different types of instruments and measurement tools, one of the largest single product categories is oscilloscopes. We estimate that oscilloscopes represented approximately $1.1 billion of the overall $7 billion market in 2005. In addition, protocol analyzers, an emerging product category, represented approximately $300 million in sales in 2005. Protocol analyzers address specific communications standards in the wide area network (WAN), local area network (LAN), storage area network (SAN), voice mail and computer peripheral interconnect market spaces. LeCroy presently focuses on the computer peripheral interconnect space. We believe the potential for these products lies somewhere in the $70 to $80 million range of the total protocol analyzer product category.
OSCILLOSCOPE PRODUCT CATEGORY
Oscilloscopes are the primary instrument used by engineers for testing and analyzing electronic signals. Historically, oscilloscope products within the Test and Measurement industry have experienced less volatility than the industry as a whole because of their widespread use across many applications and end markets. Thorough testing of complex electronic signals requires a measurement tool capable of physically attaching to the signal of interest, capturing data with high resolution for long periods of time and supporting detailed signal analysis while providing additional insight into data characteristics and signal trends over time. An oscilloscope utilizes a graphical display device that allows an engineer to view an electronic signal. The most basic display of an oscilloscope plots a signal's voltage versus time (typically in billionths and trillionths of a second), providing a user insight into the performance of an electronic circuit. In many cases, a user is trying to either verify that the circuit is behaving as designed or measure the signal to gain a basic understanding of signal performance.
Today's oscilloscopes are digital devices which capture electronic signals and convert the voltage values to digital representations, which are stored in computer memory, allowing the instrument not only to display the signal on a screen, but also to utilize a computer to analyze the signal's characteristics. The ability of an oscilloscope to conduct in-depth analysis of a complex electronic signal's characteristics and trends is referred to as wave shape analysis, which is increasingly important as signals become more complex.
The three primary specifications of an oscilloscope are its bandwidth, or capacity to capture a signal of a particular speed; sample rate, or number of data points that can be captured within a specific time, typically billions of samples per second in modern oscilloscopes; and memory length, or the number of data points that may be captured at one time. Higher bandwidths allow capture of higher speed signals, increased sample rate improves resolution, and longer memory allows capture of longer, more complex signals. The merit of a specific oscilloscope depends on the combination of these specifications. Real-time oscilloscopes with bandwidths ranging from 20 Megahertz ("MHz") up to 18 Gigahertz ("GHz") are currently available. Generally, the prices of oscilloscopes increase as the primary specifications increase. We believe the oscilloscope market can be generally divided into four major categories:
o High-end oscilloscopes. The largest part of the market, which we believe currently accounts for slightly more than half of the market based on revenues generated, comprises instruments with the ability to capture and analyze signals ranging from 300 MHz up to the highest available real-time bandwidths. These instruments generally sell from $4,000 up to over $100,000 depending on their capabilities.
o Lower-end oscilloscopes. We believe about one-third of the market's revenue comes from these products which include less complex instruments with the ability to capture and analyze signals ranging from 20 MHz to 300 MHz. These instruments generally sell for below $5,000.
o Handheld oscilloscopes. This includes a variety of handheld oscilloscopes which we believe currently comprise less than 10% of the overall market. Selling prices for these handheld instruments are generally between $1,000 and $3,000.
o Sampling oscilloscopes. For certain high signal speed applications, such as optical communications, instruments with bandwidths of up to 100 GHz are required. At these speeds, real-time oscilloscopes do not have the ability to track the signal shape in real time and take samples quickly enough to be effective. We believe this category currently comprises less than 10% of the overall market, but because of their ability to provide extremely high bandwidths, sampling oscilloscopes can range in price generally from $50,000 to $100,000.
PROTOCOL ANALYZER PRODUCT CATEGORY
The demand for digital information has accelerated the need for communication among multiple electronic devices in various markets, including computers, telecommunications, networking, storage, consumer electronics, aerospace, automotive, industrial automation and medical instrumentation. This growing demand centers on the widespread need to transmit digital information. Communication among digital devices, or connectivity, occurs over a variety of physical media, such as copper wire and fiber optic cable, as well as over wireless frequencies.
Computer technology initially provided connectivity only among internal devices, such as the processor, memory and storage, and with external peripheral devices, such as the keyboard, mouse and printer. Today, computer technology also enables connectivity among multiple computing devices and across networks, such as local area networks, wide area networks, storage area networks, home area networks, personal area networks and the Internet. Telecommunications technology also enables connectivity among multiple devices, such as telephones, fax machines, pagers and personal digital assistants. Consumer electronics technology is progressively enabling connectivity among devices, such as Internet appliances, digital cameras, audio systems and televisions.
Digital devices communicate by sending electronic signals through a transmission channel according to a specified protocol. A protocol is a set of detailed rules that governs and regulates the manner in which the signals are sent, received, and interpreted. The channel and the protocol are both typically specified in a formal communications standard. For communication to be successful, each device must implement and conform to the same standard.
Early communications standards were relatively simple, typically involving low-speed communications between two simple devices connected directly by copper wire. Current standards are increasingly complex, typically involving high-speed communications among multiple sophisticated devices indirectly linked to other devices and across various physical media, including copper wire, fiber optic cables, and wireless technologies with rapidly fluctuating frequencies. As a result, standards that were specified initially in only a few pages of text may now extend to over one thousand pages. The specifications for these standards are broadly available, which facilitates interoperability of hardware and software products from different manufacturers.
A standard is typically introduced by several leading technology and infrastructure companies. These core promoter companies comprise the nucleus of independent standards groups. These groups are sometimes referred to as implementers' forums, trade associations or special interest groups which assist in the development, implementation, promotion, and compliance with the standards. As commercial interest in a standard increases, the communications standards group typically expands to include system and device manufacturers and service providers. The promoter companies typically remain closely associated with the standard throughout its lifecycle.
A standard is implemented over a lifecycle that includes three overlapping phases: development, production and market deployment. During the development phase, key component manufacturers develop and produce important building blocks such as semiconductors, embedded software, protocol stacks and device drivers which will be used by others in the industry to create products. During the production phase, system and device manufacturers apply these building blocks to construct their unique products and applications. The market deployment phase includes the introduction and sale of products and applications to end users in the market. Similarly, products associated with a particular standard follow their own unique lifecycle from development through production and deployment.
Protocol analyzers are "standard specific" tools; they enable a design engineer to analyze the "conversation" between two devices. Many distinct communications standards are emerging to meet the growing demand for digital connectivity in the Computer/Semiconductor/Consumer Electronics, Data Storage, Automotive/Industrial, and Military/Aerospace industries. The characteristics of each standard, including its principal uses, physical medium, transmission speed
and distance covered, vary greatly. Examples of existing and emerging standards in the computer peripheral interconnect space include the following:
o Bluetooth(R). The Bluetooth standard, or Bluetooth wireless technology, enables low speed, wireless connectivity among computers, telecommunication devices, such as mobile telephones, and consumer electronics devices, such as personal digital assistants and headphones. Bluetooth was introduced in 1998. The promoter group consists of Agere, Ericsson, IBM, Intel, Microsoft, Motorola, Nokia and Toshiba. Bluetooth operates through radio waves with rapidly fluctuating frequencies at speeds of up to 1 million bits (megabits) per second, or Mbps, over distances of up to 100 meters. In 2005, over 500 million Bluetooth chipsets were shipped - primarily in the handset and mobile computing markets. Bluetooth has recently been enhanced further with updates to the specification to improve the performance and usability of the interface. In March of 2006, the Bluetooth Special Interest Group announced a next generation high-speed Bluetooth wireless technology to be based on WiMedia Ultra-Wideband platform. Collaboration between the WiMedia Alliance and the Bluetooth community should help define Bluetooth technology as a key personal area network technology for today and the future.
o Ethernet. Ethernet enables high-speed connection among computers and peripheral devices in local area networks. Ethernet was introduced in 1980 by Digital Equipment Corporation, Intel, and Xerox and, in 1983, the Institute of Electrical and Electronics Engineers, Inc. (IEEE) released the first IEEE standard for Ethernet technology. Ethernet technology operates over coaxial cable, twisted pair wiring or fiber optic cable at speeds of up to 10 Mbps over distances of up to 2,000 meters. The IEEE has released newer versions of the Ethernet technology including: Fast Ethernet in 1995, which operates at speeds of up to 100 Mbps, Wireless Ethernet in 1997, that operates at speeds up to 10 Mbps, Gigabit Ethernet in 1998, which operates at speeds of up to 1 billion bits (gigabits) per second, or Gbps, and 10 Gbps Ethernet released in June 2002.
o Fibre Channel. Fibre Channel enables reliable, cost-effective information storage and delivery at very high-speeds. Fibre Channel development started in 1988 and the American National Standards Institute (ANSI) standards body approved the first revision in 1994. Fibre Channel is designed to operate at speeds of 1, 2, and 4 Gbps and gives users the option to develop storage networks with configuration choices at different price points, levels of scalability and availability. Fibre Channel is a layered protocol that supports additional storage or networking protocols such as SCSI, IP, VI, and ESCON, thus offering many choices for storage connectivity, cluster computing and network interconnect.
o IEEE 1394. The IEEE 1394 standard, commonly known as 1394, FireWire or i.Link, enables high-speed connectivity among computers, peripheral devices and consumer electronic devices, including audio systems, television sets, digital cameras, video recorders, video players and game consoles. 1394a was introduced in 1987 and was ratified by the IEEE in 1995. The promoter group includes Apple, Canon, Hewlett-Packard, IBM, Intel, Microsoft, NEC, Philips, Sony, Sun Microsystems, Texas Instruments and Yamaha. 1394a enables connectivity through copper wire at speeds of up to 400 Mbps over distances of up to four and one-half meters. This speed increases to up to 3.2 Gbps over distances of up to 100 meters in the 1394b standard approved by the IEEE in April 2002.
o InfiniBand. The InfiniBand standard enables high-speed connectivity inside computers and among computers and storage devices in complex storage area networks. InfiniBand was introduced in 1999 and is used largely in enterprise database, high performance computing (HPC) and storage applications. The promoter group consists of Dell, Hewlett-Packard, IBM, Intel, Microsoft and Sun Microsystems. InfiniBand operates over copper wire and fiber optic cable at speeds of up to 10 Gbps over distances of up to ten meters for copper wire and ten kilometers for fiber optic cable.
o PCI Express. PCI Express is an emerging standard first introduced in 2002 and is intended to enhance the Peripheral Connect Interface (PCI) architecture spanning multiple computer market segments: clients (desktop and mobile), servers (standard and enterprise), embedded computers and communication devices. PCI Express provides system original equipment manufacturers, or OEMs, and peripheral developers the ability to realize product versatility and market differentiation without the burden of maintaining obsolete interfaces or losing compatibility. The promoter group consists of Hewlett-Packard, Dell, IBM, Intel and Microsoft. PCI Express currently runs at 2.5 Gbps per
lane in each direction, providing a total bandwidth of 80 Gbps in a 16-lane configuration. The next generation of PCI Express, Generation 2 or Gen 2, will run at 5.0 Gbps per lane in each direction, providing a total bandwidth of 160 Gbps for a 16-lane configuration. Adoption of PCI Express Gen2 will begin in the first half of fiscal 2007.
o Serial ATA. The Serial ATA standard (SATA) enables high-speed, low-cost internal storage connections for desktops and mobile computers. Serial ATA was introduced in 2000 and is expected to replace Parallel ATA, the standard used to connect storage devices such as hard drives, DVD and CD drives to the motherboard. Serial ATA operates over copper wire at speeds up to 3 Gbps over distances of up to one meter. In 2006, Serial ATA volume is expected to surpass legacy Parallel ATA device shipments for the first time. Broad based adoption of Serial ATA in the storage market has led to the use of SATA in new applications including server, networked storage and consumer electronics devices.
o Serial Attached SCSI. Initiated in December 2001 by the Small Computer System Interface (SCSI) Trade Association, Serial Attached SCSI (SAS) was designed to be the logical evolution of SCSI to satisfy the data center requirements of scalability, performance, reliability and manageability, while leveraging a common low-cost electrical and physical connection interface from Serial ATA. SAS provides universal interconnect with Serial ATA, while offering logical SCSI compatibility along with the reliability, performance and manageability of parallel SCSI. SAS is positioned primarily for enterprise class storage applications. SAS allows each host to address up to 4,096 devices via expanders. SAS's flexibility allows single or multiple lane communications with devices, with a 3 Gbps four lane wide connection providing 12 Gbps total throughput. The SAS-2 specification initiated in May of 2005 will run at 6.0 Gbps per lane in each direction, providing a total bandwidth of 24 Gbps. Early adopters are expected to begin sampling 6.0 Gbps devices in the 2nd half of fiscal 2007.
o Universal Serial Bus. The Universal Serial Bus standard (USB) enables low, medium and high-speed connectivity between computers and peripheral devices, including keyboards, mice, printers, scanners, joysticks and cameras, using plug and play technology. In addition, it is becoming widely used as the replacement technology for proprietary cabling on medical and industrial control equipment. USB was introduced in 1995 and replaces the serial, parallel, mouse and keyboard ports. The specifications for the second version of USB, or USB 2.0, were released in April 2000. The promoter group for USB consists of Agere, Hewlett-Packard, Intel, Lucent, Microsoft, NEC and Philips. USB enables connectivity through copper wires at speeds of up to 480 Mbps over distances of up to five meters. USB technology continued its impressive growth in 2005 with higher shipments in MP3 players, mobile handsets, digital televisions, set top boxes and DVD recorders. Market research firm In-Stat forecasts that USB-enabled electronics device annual shipments will double from 1.4 billion in 2005 to 2.8 billion in 2010.
o Wireless USB. Certified Wireless USB is the new wireless extension to USB that combines the speed and security of wired technology with the ease-of-use of wireless technology. Certified Wireless USB will support robust high-speed wireless connectivity by utilizing the WiMedia MB-OFDM Ultra-wideband (UWB) radio platform as developed by the WiMedia Alliance. This emerging wireless technology is endorsed for use in the U.S. and Japan; with regulatory approval underway in Europe. The combination of a low-cost, low-power wireless transport with the ubiquitous USB protocol layer is expected to become a key enabler for next-generation consumer electronic devices.
LeCroy is a provider of protocol analyzers for these existing and emerging digital communications standards. Our products are used by semiconductor, device, system and software companies at each phase of their products' lifecycles from development through production and market deployment. We have expertise in the Bluetooth, Ethernet, Fibre Channel, IEEE 1394, InfiniBand, PCI Express, SCSI, Serial ATA, SAS and wireless USB standards and are actively engaged with our customers throughout their development and production processes in order to deliver solutions that meet their needs. Utilizing our easy to use, color-coded expert analysis software called CATC Trace(TM), our products generate, capture, filter and analyze high-speed communications traffic, allowing our customers to quickly discover and correct persistent and intermittent errors and flaws in their product design. Our production products are used during the manufacturing process to ensure that our customers' products comply with standards and operate with other devices, as well as assist system manufacturers to download software onto new computers.
OUR COMPETITIVE STRENGTHS
We are a leading, worldwide provider of oscilloscopes and protocol analyzers as well as a provider of related test and measurement equipment used by electronic designers and engineers to measure and analyze complex electronic signals. Our key competitive strengths include:
Technology leadership. We are a recognized technology leader in the Test and Measurement industry and continue to leverage our core strengths to develop new and innovative products for the changing requirements of the markets we serve. Most recently, we have focused on incorporating our internally developed operating system and our advanced methodology for enabling high-speed signal acquisition into our entire oscilloscope product line. We believe this has allowed us to transform general purpose oscilloscopes into application-specific analysis tools, providing a competitive advantage to our products. These, and our other core technologies, are currently protected by 57 U.S. patents and 25 foreign patents, with approximately 47 other U.S. patents pending.
Broad product portfolio. We offer a broad range of oscilloscope and protocol analyzer products which are designed to capture and analyze a wide range of electronic signals and data packets. We believe our breadth of product offerings, coupled with our ability to create application-specific analysis tools, address the specific needs of design engineers and systems integration teams in many industries.
Leading customer relationships. Our major customers are leaders in a range of industries, including computer/semiconductor/consumer electronics, data storage, automotive/industrial, and military/aerospace. Our ability to work with innovative, industry-leading customers allows us to continuously refine our products to better address the needs of the latest technologies.
Global sales and distribution. We have a global sales force and distribution structure covering North America, Europe/Middle East, Japan and Asia/Pacific. Each of these regions is a major contributor to our revenue and provided between approximately 14% and 32% of our revenues in the last three fiscal years. We currently have direct sales personnel in 12 countries and operate in 53 smaller markets through regional managers, distributors and sales representatives. We believe that our sales force is recognized by our customers for their technical expertise. Our sales force often works in tandem with design engineers to create solutions to complex applications.
Experienced management team. Our management team has a long and successful track record in the Test and Measurement industry with an average of over 17 years of experience in the industry. Our management team has overseen the introduction of many new products over the past four years and has restructured our operations, enhancing our focus on our core markets while developing our ongoing business strategy, which encourages product innovation.
OUR STRATEGY
In order to enhance our position as a leading provider of oscilloscopes and protocol analyzers, our objective is to grow our company and our market share in the markets in which we operate. In addition, we may pursue strategic acquisitions that have strong adjacent market positions or complement our current product lines. Key strategic goals include:
Focus on the general purpose oscilloscope market. We have a competitive product offering and ongoing engineering development efforts underway to address customer needs for oscilloscope solutions in market sectors representing the largest and most profitable portion of the oscilloscope market.
Focus on the market for serial data test applications. The market for testing important serial data standards including PCI Express, Serial ATA, SAS, USB2.0, wireless USB and Bluetooth, is a rapidly growing market - on the order of 30% Compound Annual Growth Rates (CAGR) according to internal estimates. The primary tools associated with testing serial data links are oscilloscopes (to test the electrical signals and paths or the "physical layer") as well as specialized protocol analyzers (to observe, decode and verify that the desired data traffic and device specific messages are flowing from node to node). Our high end real-time oscilloscope and sampling oscilloscope development efforts are aimed primarily at satisfying the needs of customers in this important applications area. We believe our offering in these two primary product categories combined with an intense focus on ensuring the right capability is
available to our customers at the right time in the most important applications will allow us to continue to grow in this market segment.
PRODUCTS AND SERVICES
OSCILLOSCOPES
We currently offer five major real-time oscilloscope families: WaveMaster, WavePro, WaveRunner, WaveSurfer and WaveJet and one sampling oscilloscope family, WaveExpert. Each oscilloscope model is capable of capturing and analyzing electronic signals at different bandwidth and performance points in the market. Each oscilloscope family is also offered with a selection of general software packages that expand its capabilities and allow customization of the operation and measurements of the specific product.
NUMBER PRODUCT OF BANDWIDTH U.S. LIST MARKET FAMILY MODELS RANGE PRICE RANGE INTRODUCTION -------------------- ------ -------------- ----------------- ------------ WaveExpert Sampling Oscilloscope 3 Up to 100 GHz $28,000 - $90,000 April 2005 Series............... WaveMaster/SDA/DDA Series............... 22 3 - 18 GHz $47,000 - $128,000 January 2002
WavePro 7000A Series......... 7 1 - 3 GHz $20,000 - $33,000 January 2003 WaveRunner 6000A Series......... 10 350 MHz - 2 GHz $8,250 - $19,990 October 2003 WaveRunner Xi Series............ 3 400 - 600 MHz $9,250 - $11,250 January 2006 WaveSurfer Xs Series............ 4 400 - 600 MHz $5,590 - $9,690 January 2006 WaveSurfer 400 Series........... 11 200 - 500 MHz $4,490 - $8,790 April 2004 WaveJet 300 Series........... 8 100 - 500 MHz $2,890 - $7,490 January 2006
SUPPORTING ANALYZERS AND APPLICATION SOFTWARE
Our general purpose oscilloscope products are tailored with proprietary software and hardware to create application specific analyzers which function as industry-specific oscilloscopes for use in:
o Data storage applications -- Disk Drive Analyzer products and DDA5000 series, using WaveMaster and WavePro platforms;
o Serial data applications -- Serial Data Analyzer products, SDA3000 series, SDA4000, SDA5000 series, SDA6000 series, SDA11000 series and the SDA18000 series, based on the WaveMaster platform;
o Automotive applications -- Hardware and software applications based on the WaveRunner platform for use in understanding serial communications in automobiles and industrial systems; and
o Power measurement applications -- Hardware and software applications based on the WaveRunner and WaveSurfer platforms for use in a variety of industries.
PROTOCOL ANALYZERS
Our protocol analyzer products are advanced verification systems that assist hardware and software manufacturers in the efficient design of reliable and interoperable systems and devices. Most of these systems utilize our proprietary intuitive expert analysis software, the CATC Trace, which displays communications traffic in searchable, color-coded packets. Highlights include:
o PETracer(TM) and PETracer ML. PETracer and PETracer ML are advanced verification systems introduced in 2003. The PETracer is a high
impedance, non-intrusive analyzer, capturing, processing and analyzing 5 Gbps PCI Express traffic on a single link. The PETracer ML allows for full bi-directional decode and capture of up to 8 PCI Express links. Both analyzers are based on the UPAS 10000 platform.
o PETrainer(TM). The PETrainer, announced in 2003, is a PCI Express(TM) exerciser supporting up to 4 links. PETrainer is a critical test and verification tool intended to assist engineers in improving the reliability of their solutions, while providing advanced capabilities for stress and compliance testing. Together with the CATC PETracer and PETracer ML analyzers, the PETrainer reduces time to market by enabling users to quickly identify logic and design flaws.
o SATracer(TM). The SATracer was first introduced in 2001 for SATA 1.5 Gbps speed and the second generation was introduced in the fourth quarter of 2003 for 3 Gbps. SATracer is a non-intrusive protocol analysis system that facilitates efficient and accurate debug, test and verification of Serial ATA semiconductors, devices and systems.
o SATrainer(TM). The SATrainer, introduced in 2003, is an add-on traffic generation module for our SATracer. It allows designers and validation engineers to transmit valid and invalid traffic to emulate host or device-side SATA communications. SATrainer features error injection capabilities that permit observation of device behavior under faulty link conditions.
o SASTracer(TM). The SASTracer, our Serial Attached SCSI development product introduced in 2003, is the Company's first system that supports the advanced protocol analysis of 1.5 and 3 Gbps SAS in 1-, 2- and 4-wide configurations. The SASTracer is able to logically group multiple related bus transactions allowing developers to quickly understand complex SAS transactions. SASTracer's features were especially designed for the multiple ways in which SAS systems can be configured.
o USBTracer/Trainer(TM). The USBTracer/Trainer system, introduced in 2001, is a powerful development and test tool based on the UPAS 2500 platform. The USBTracer captures, displays and analyzes all speeds of USB bus traffic. The USBTrainer serves as a flexible USB host for the development of USB devices, hubs and integrated circuits, enabling stress/limit testing of USB designs and observation of design behavior under faulty bus conditions.
OTHER PRODUCTS AND SERVICES
We offer our customers a variety of complementary oscilloscope probes and accessory products. Probes provide the critical physical electrical or optical connection from the customer's circuit to the oscilloscope. We believe our WaveLink high frequency differential probes provide the high bandwidth performance necessary to measure serial data signals in the expanding serial data communications market. We also offer digitizing modules from 150 MHz to 1 GHz bandwidths.
We also provide technical support services, repairs, maintenance, recalibration and a variety of post sale upgrades and installations. We maintain field service centers in Chestnut Ridge, New York; Geneva, Switzerland; Tokyo, Japan; Seoul, South Korea; and Shanghai, China.
OUR CUSTOMERS AND END MARKETS
Our oscilloscope products are used primarily by electronic designers and engineers principally in the research and development of new products. These end users typically employ our oscilloscopes to validate the performance of electronic designs and components. Our protocol analyzers are used by designers and engineers whose products are in development and production and also for products deployed in the field. These end users typically use our products to monitor communications traffic and diagnose operational problems in a variety of communications devices to ensure that they comply with industry standards. We currently provide products to customers in four primary end markets, including Computer/Semiconductor/Consumer Electronics, Data Storage, Automotive/Industrial, and Military/Aerospace. Our customers also include leading original equipment manufacturers.
Computer/Semiconductor/Consumer Electronics. These markets include companies providing components, interfaces, subsystems and complete products for high speed and general purpose computing, network servers, and related devices and systems. Requirements in this end market have been driven by:
o growth in the capability and complexity of devices, which now provide a higher level of integration and functionality;
o a dramatic increase in the use of high speed serial data communications interfaces in both the computer and semiconductor market;
o new interface standards, which enable increased interoperability and higher levels of bandwidth between devices and peripherals, including: PCI Express -- a high speed serial data interface for connection to high performance subsystems, such as a graphics card, inside a computer; Serial ATA -- a high speed serial data interface for computer disk drives; USB 2.0 -- the latest version of the Universal Serial Bus standard, a high speed computer peripheral expansion interface; Wireless USB - new wireless extension to USB that combines the speed and security of wired USB with the ease of use of wireless; XAUI -- a 10 Gigabit Ethernet standard that improves the routing of electrical interconnections; and Firewire -- a high-speed serial interface for computer peripheral expansion; and
o system-on-a-chip validation.
Data Storage Devices. This market includes companies that provide magnetic and optical storage devices such as hard disk drives, removable media, tape, CDs and DVDs. Requirements in this end market are being driven by:
o continued pressure to reduce product development life cycle time;
o increasing need to store more information on storage media, which requires the encoding of signals to achieve higher density;
o migration of hard disk drives to portable media applications and consumer devices, such as MP3 players and digital video recorders;
o evolution to perpendicular magnetic recording for higher capacity storage; and
o adoption of faster point-to-point connections through the use of the Serial Advanced Technology Attachment, or Serial ATA, and Serial Attached Storage, or SAS, interface standards.
Automotive/Industrial. The automotive market includes automobile OEMs, component suppliers to automobile OEMs and industrial equipment manufacturers. Requirements in this end market are being driven by:
o proliferation of Electronic Control Units, or ECUs, to various automotive subsystems, such as engine control, braking, and traction control;
o progression to networked ECUs;
o serial data topologies managing complex inbound and outbound signals; and
o evolution to 42 V power systems to provide adequate power with lower current.
Military/Aerospace. The military and aerospace market includes companies that provide components and systems for defense and commercial airplane applications. Requirements in this end market are being driven by:
o applications that use complex communications signals in challenging environments;
o extraordinarily high need for precision and reliability given the consequences of failure; and
o need for long-term support due to long military program life.
SALES, MARKETING AND DISTRIBUTION
We maintain a direct sales force of highly trained, technically sophisticated sales engineers who are knowledgeable in the use of oscilloscopes and protocol analyzers and the features and advantages of our products. In addition, because of our focus on high-performance oscilloscopes and protocol analyzers, our sales engineers are skilled in performing product demonstrations for current and prospective customers.
We sell our oscilloscopes and protocol analyzers through our own direct sales force in the United States, Switzerland, Germany, Italy, France, the United Kingdom, Sweden, Japan, China, South Korea and Singapore, with regional sales headquarters located in Chestnut Ridge, New York; Geneva, Switzerland; and Tokyo, Japan. In territories where the sales potential does not currently justify the maintenance of a direct sales force, we use manufacturers' representatives and distributors in support of our direct selling efforts.
We support our customers through a worldwide network of specialized applications engineers. We maintain service, repair and calibration facilities in Chestnut Ridge, New York; Santa Clara, California, Geneva, Switzerland; Seoul, South Korea; Tokyo, Japan; and Shanghai, China.
In order to raise market awareness of our products, we maintain an informative website (www.Lecroy.com), advertise in trade publications, distribute promotional materials, conduct marketing programs and seminars, issue press releases regarding new products, publish technical articles and participate in industry trade shows and conferences.
TECHNOLOGY AND PRODUCT DEVELOPMENT
We believe we are a technology leader in both the oscilloscope and protocol analyzer markets. We have developed core capabilities in the design of high-performance, high-speed signal conditioning, sampling and analog-to-digital conversion circuitry. We believe we are also a leader in the design of technologies related to the storage, movement and processing of the large amounts of data produced by oscilloscopes and protocol analyzers.
In protocol analyzers, with the acquisition of Computer Access Technology Corporation ("CATC)" in October 2004 (See " Management's Discussion and Analysis of Financial Condition and Results of Operations - CATC Acquisition"), we believe we have a competitive advantage as a result of our knowledge and expertise in multiple communications standards, computer and software architecture and advanced ASIC and programmable logic design. This expertise is enhanced by our advanced design tools and collaboration among our various design teams. We have a broad, vertically integrated technology base that includes the knowledge and expertise to design advanced ASICs, use programmable logic in the form of microcontrollers and programmable logic devices in real-time embedded applications, design electronic circuit boards and systems, and design and develop embedded software, software drivers and software applications.
Our product development efforts are focused on hardware, software and mechanical development initiatives. Our hardware product development team is focused on developing innovative signal conditioning, data acquisition and electrical circuit probing technologies that allow better waveform fidelity and circuit connection capabilities. This is accomplished through the use of advanced integrated circuit techniques and processes, innovative design tools and methodologies and key technology partnerships.
In June 2002, we entered into a technology development agreement with IBM, in order to gain access to IBM's next-generation silicon germanium technology. This development agreement is set to expire in December 2006 but can be renewed at no additional cost. During fiscal 2005, this agreement was renewed at no cost for an additional term of two years.
Our software engineering group continues to develop and advance our protocol, wave shape analysis and measurement technologies in order to offer new
and innovative analysis tools for our customers. This group also develops application solutions to perform specific analysis for specific communications protocols, data storage, power measurement, communications and other markets.
We have also entered into technology partnerships that have provided us access to technologies that enable extremely high-speed, high-fidelity signal capture capabilities and very high throughput data movement capabilities. We intend to continue to develop and leverage such key partnerships in areas that complement or enhance our own internal strengths.
MANUFACTURING AND SUPPLIERS
We have consolidated and streamlined our manufacturing and operational activity to focus on our core expertise of oscilloscope and protocol analyzer product introduction and development. Our WaveMaster, WaveExpert and WavePro oscilloscopes and related products are manufactured at our facility in Chestnut Ridge, New York. Protocol analyzer products are manufactured in both our Chestnut Ridge, NY and Santa Clara, California facilities. Our focus on supply chain execution has allowed us to improve the cycle time required to build our instruments as well as reduce the time required to test and deliver products to our customers. For example, we have partnered with manufacturing companies in the U.S. and Asia that have allowed us to design and develop innovative products at reduced costs. This has allowed us to lower the overall costs of our products to our customers while improving our overall margin efficiency. Our WaveJet and WaveSurfer 4X products are manufactured by our strategic partner, Iwatsu, and our WaveRunner 6000A and WaveSurfer XS products are manufactured by a contract manufacturer, Plexus Corporation.
We purchase a small number of parts from single-source suppliers. In particular, several key integrated circuits that we use are made by 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 and loss of revenues.
COMPETITION
Oscilloscopes
The oscilloscope market is highly competitive and characterized by rapid and continual advances in technology. Our principal competitors in this market are Tektronix, Inc. ("Tektronix") and Agilent Technologies, Inc. ("Agilent"). Both of our principal competitors have substantially greater sales and marketing, development and financial resources than we do. We believe that Tektronix, Agilent and other competitors offer a range of products that attempt to address most sectors of the oscilloscope market.
We believe that the principal bases of competition in the oscilloscope market are a product's performance characterized by the confluence of 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. We believe that we currently compete effectively with respect to each of the principal bases of competition in the oscilloscope market in the general price range ($2,900 to $128,000) in which our oscilloscopes are focused. 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.
Protocol Analyzers
Our protocol analyzer markets are highly competitive, and we expect competition to intensify in the future. We compete with a number of companies,
with Agilent and Finisar Corporation representing the largest competitors. These competitors are diverse and offer a variety of solutions directed at various segments of this marketplace. We believe the principal factors of competition include:
o Product functionality;
o Time to market with new products;
o Ease of product use;
o Product speed, reliability, stability and accuracy;
o Price performance;
o Flexibility and programmability of products;
o Upgradeability of products;
o Local support and service for products; and
o Breadth of product offerings.
We believe we compete favorably with respect to each of these factors and have gained significant market share in some of our target markets as a result. We believe our success has been driven by our vertically integrated technology, ability to generate customer loyalty and ability to anticipate market trends.
BACKLOG
Our backlog of unshipped customer orders was approximately $11.2 million and $8.5 million as of June 30, 2006 and 2005, respectively. Backlog at June 30, 2005 excluded $0.7 million of deferred revenue established in connection with the adoption of the Securities and Exchange Commission's Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements," in fiscal 2001. This revenue was fully recognized in fiscal 2006. Customers may cancel or reschedule orders at any time. We believe that our level of backlog at any particular time is not necessarily indicative of our future operating performance.
PATENTS, TRADEMARKS AND LICENSES
We rely on a combination of patents, trademarks and trade secret laws, non-disclosure agreements and other intellectual property protection methods, as well as technical expertise and continuing technological research and development to establish and protect proprietary rights in our products. We believe, however, that because of the rapid pace of change and advancement in oscilloscope technology, legal intellectual property protection is and will continue to be a less significant factor in our success than our core competency of wave shape analysis and the experience and expertise of our personnel.
We protect significant technologies, products and processes that we consider important to our business by, among other things, filing applications for patent protection. We currently hold 57 U.S. and 25 foreign patents, and approximately 47 pending applications covering a range of products with various expiration dates. Although none of our products depends exclusively on any single patent, we believe our patents, in the aggregate, are important to our business and contribute to our competitive advantage.
We license or otherwise acquire key enabling technologies from third parties in order to gain access to technologies that would be too expensive or too time consuming to develop internally or that would give us a competitive advantage or shorten our product development time-to-market. We are currently party to a license agreement with Perigee LLC pursuant to which we license fast data readout technology for use in our WaveRunner 6000 Series family of products. This license is perpetual. We also license a patent from William A. Farnbach, which relates to the triggering characteristics of an oscilloscope.
This license extends for the term of the patent, which expires in October 2008. In June 2002, we entered into a technology development agreement with IBM, as described in more detail in the "Business - Technology and Product Development" section, in order to gain access to IBM's next-generation silicon germanium technology. With the exception of our technology development agreement with IBM, the capabilities licensed or otherwise acquired through these agreements, and additional license agreements we entered into, could be developed by us, but would require considerable time and expense.
From time to time, we license our technology to third parties. The revenue generated from these licenses is a small percentage of our total revenue. We generally do not actively seek out licensing opportunities, but will take advantage of opportunities that arise in the normal course of business.
Although we believe that our products and technologies do not infringe the proprietary rights of third parties, there can be no assurance that third parties will not assert claims against us based on the infringement or alleged infringement of any such rights. Such claims are typically costly to defend, regardless of the legal outcome. There can be no assurance that we would prevail with respect to any such claim, or that a license to third party rights, if needed, would be available or available on acceptable terms. In any event, patent and proprietary rights litigation can be extremely protracted and expensive.
REGULATION
As 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 subject to legal and regulatory requirements, particularly the imposition of tariffs and customs, in a variety of countries. 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 is also subject to regulation under the Treaty for Nuclear Non-Proliferation. 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.
EMPLOYEES
As of June 30, 2006, we had 458 full-time employees, 215 of whom work in our Chestnut Ridge, New York facility. Our employees are not represented by a labor union and we have not experienced any work stoppages. We believe that our employee relations are satisfactory.
INVESTOR INFORMATION
Our Internet website address is www.lecroy.com. We make available, free of charge on our website, by clicking on "About LeCroy" and then selecting the "Investor Relations" link and the "SEC Filings" link, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the Securities and Exchange Commission, or SEC.
EXECUTIVE OFFICERS OF THE REGISTRANT
Unless otherwise set forth, below are the name, age, position, and a brief account of the business experience of each of our executive officers as of August 31, 2006:
Thomas H. Reslewic was named to our Board of Directors in January 2002. He joined us in 1990 and has served as President and Chief Executive Officer since January 2002. Mr. Reslewic previously served as President from October 2000 until December 2001, and Executive Vice President and Chief Operating Officer from February 1998 until October 2000. Mr. Reslewic has a Bachelor of Science degree in physics from the College of the Holy Cross and a Master of Business Administration degree from the University of Oregon.
R. Scott Bausback has served as Executive Vice President, Chief Operating Officer since joining us in August 2001. In August 2006, he was given the additional responsibility of managing LeCroy's worldwide sales force. Previously, he held a variety of sales and marketing management positions during an 18-year tenure at Tektronix, culminating in his role as Vice President and General Manager of Tektronix's Communications Business Unit from September 1998 until June 2001. Mr. Bausback has a Bachelor of Science degree in electrical engineering from Rutgers College of Engineering and completed the YEI Executive Education program at Kenan-Flagler Business School at the University of North Carolina at Chapel Hill.
Carmine J. Napolitano was appointed Vice President and General Manager of LeCroy's Product Divisions in August 2006. Previously he held the position of Vice President, President - Serial Data Division, with the acquisition of CATC in November 2004, (See "Management's Discussion and Analysis of Financial Condition and Results of Operations - CATC Acquisition,") having served as a CATC Director, President and Chief Executive Officer since July 2004. Mr. Napolitano joined CATC in September 2002 as Vice President, Chief Financial Officer and Secretary. He was named Chief Legal Officer in August 2003 and was promoted to President in November 2003. Before joining CATC, from August 1995 until August 2002, Mr. Napolitano was Vice President of Finance & Administration and Chief Financial Officer at Centric Software, a leader in collaborative product development software. Mr. Napolitano received a BS in Mechanical Engineering from the University of California, Santa Barbara and an MBA in Finance from New York University.
David C. Graef has served as Vice President, Chief Technology Officer since April 2003. Previously, he served as Vice President, Research and Development from January 1999 through March 2003, Engineering Manager from June 1996 through January 1999 and Senior Engineer from January 1989 through May 1996. Mr. Graef has a Bachelor of Science degree in Electrical Engineering from the University of Bridgeport.
Sean B. O'Connor was appointed Vice President, Finance and Chief Financial Officer in November 2005. Previously he served as Vice President, Legal Affairs and Chief Compliance Officer and from August 2001 to May 2005, he served as the Company's Tax Director. Prior to joining LeCroy, he was an attorney at the law firm of McDermott, Will and Emory. Previously Mr. O'Connor served as Director of Taxation and Finance at Movado Group and as a senior consultant in the New York office of PricewaterhouseCoopers LLC. Mr. O'Connor, a CPA, received his B.B.A. from Pace University and his J.D. from Seton Hall University School of Law.
Conrad J. Fernandes was appointed Vice President of Corporate Development and Strategy in August 2006. Previously he served as Vice President, Worldwide Sales from July 2001 to August 2006, Vice President, International Sales from 1999 until 2000, Director of Asia / Pacific Sales from 1994 until 1999 and Product Marketing Manager from 1990 until 1994. Mr. Fernandes has a Bachelor of Electronic Engineering degree and a Master of Business Administration degree from City University of London.
Dr. Corey Hirsch has served as Vice President, Information Systems and Facilities since January 2002, and was named Chief Information Officer in May 2005. He joined LeCroy in September 2001, after a 24-year tenure at Tektronix, most recently as Director of European Operations, and Acting European Vice President. He completed his Doctorate degree in Business Administration from Brunel University, London and his Masters in Business Administration from the University of Oregon, and has recently earned a Certification in Information Security Management (CISM) from Information Systems Audit and Control Association (ISACA).
FORWARD-LOOKING INFORMATION
This Form 10-K contains forward-looking statements. When used in this Form 10-K, 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-K. Important factors that could cause actual results to differ materially from our forward-looking statements are set forth in this Form 10-K, 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-K. 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.
ITEM 1A. 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-K 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, including our gross profits, have fluctuated from fiscal period to fiscal period. We expect our future operating results and gross profits 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 our operating results include the following:
o changes in overall demand for our products;
o the timing of the announcement, 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 rates 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;
o changes in the selling prices of our products; and
o changes in foreign currency exchange risks.
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 BE UNABLE 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 relative to alternative investments;
o announcements of developments related to our business, including additions or departures of key personnel;
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 those by directors and members of management;
o developments in our relationships with our customers, partners, distributors and suppliers;
o shortfalls or changes from analysts' expectations in revenue, gross profits, earnings or losses, or other financial results;
o discontinuance of our recent stock repurchase program;
o regulatory developments;
o fluctuations in results of operations;
o failure to meet our financial obligations under any loans or financing agreements;
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 OPERATING RESULTS 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 be unable to fulfill orders in a timely manner, which in turn may have a negative effect on operating results and our overall business.
IF OUR OPERATING RESULTS DECLINE IN THE LONG-TERM, WE MAY BE REQUIRED TO ESTABLISH AN ADDITIONAL 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 June 30, 2006, our Consolidated Balance Sheet includes approximately $15.5 million of deferred tax assets after valuation allowance related to the future tax benefit of certain temporary differences between our financial statements and our tax returns. Realization of our deferred tax assets is mainly dependent on our ability to generate future taxable income. As of June 30, 2006, we recorded a valuation allowance of approximately $0.3 million to reserve for those deferred tax assets we believe are not more likely than not to be realized in future periods. An additional valuation allowance would be recorded if it was deemed more likely than not that some or all of our deferred assets will not be realized. If we establish additional valuation allowances, we would record a tax expense in our Consolidated Statements of Operations, which would have an adverse impact on our operating results.
WE FACE RISKS FROM FLUCTUATIONS IN THE VALUE OF FOREIGN CURRENCIES VERSUS THE U.S. DOLLAR AND THE COST OF CURRENCY EXCHANGE, WHICH AFFECT OUR REVENUE, COST OF REVENUE 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. Changes in the relation of foreign currencies to the U.S. dollar will affect revenues, our cost of revenue 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, European monetary unit (Euro), Swiss franc, British pound, Swedish krona, Japanese yen, Korean won, and Singapore dollar.
We have a program of entering into foreign exchange forward contracts to minimize the risks associated with currency fluctuations on assets, liabilities or other transactions 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 will not result in mismatches between local currency revenues and expenses, and 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, results of operations or liquidity.
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 ARE DERIVED 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, 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 have expanded 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 recognition, protection and enforcement of intellectual property rights, specifically in areas of Asia and particularly in China;
o trade protection measures, import or export licensing requirements, tariffs and other trade barriers;
o highly cyclical business environments;
o unusual or burdensome foreign laws or regulatory requirements or unexpected changes to those laws or requirements;
o strengthening of the U.S. dollar, which could make our products more expensive;
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 are found to have violated these requirements, we could be subject to significant fines and other penalties.
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 embargoes, 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 ("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 some 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.
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. 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.
POTENTIAL 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. On October 29, 2004, we acquired all of the outstanding shares of common stock of CATC. As a result of our acquisition of CATC or other transactions which may be consummated, our financial results may differ from the investment community's expectations in a given quarter and year. 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 the 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 at this time, other than $46.5 million remaining under the Revolver with The Bank of New York and the other lenders party thereto, 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 or 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.
In addition, certain covenants relating to our $100.0 million credit facility impose 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 OR LIABILITIES UNDER ENVIRONMENTAL LAWS.
Our operations and products 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 noncompliance with environmental permits.
Our former subsidiary, Digitech Industries, Inc., has been involved in environmental remediation activities, the liability for which was retained by us and entirely reserved for after the sale of the Vigilant Networks business and the residual assets of Digitech. Any liability beyond what is currently expected and reserved for could have a material adverse affect 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.
WE HAVE A 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 $100.0 million credit facility with The Bank of New York and the other lenders party thereto. We are subject to financial covenants under our credit facility, including interest coverage ratio, minimum total net worth, leverage ratio and fixed charge coverage ratio requirements. Failure to comply with the financial covenants under our credit facility may adversely affect our business, results of operations, liquidity and financial condition.
ISSUANCE OF SHARES IN CONNECTION WITH FINANCING TRANSACTIONS OR UNDER STOCK PLANS WILL DILUTE CURRENT STOCKHOLDERS.
Pursuant to our stock plans, our management is authorized to grant restricted stock awards or stock options to our employees, directors and consultants. Our stockholders will incur dilution upon exercise of any outstanding stock options. 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 acquirers 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. 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.
WE FACE BURDENS RELATING TO THE RECENT TREND TOWARD STRICTER CORPORATE GOVERNANCE AND FINANCIAL REPORTING STANDARDS.
Recently adopted or new legislation or regulations that follow the trend of imposing stricter corporate governance and financial reporting standards, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002, have led to an increase in our costs of compliance. A failure to comply with these new laws and regulations may impact market perception of our financial condition, could materially harm our business and could cause the market price of our common stock to decline. Additionally, it is unclear what additional laws or regulations may develop, and we cannot predict the ultimate impact of any future changes.
WE MUST SUCCESSFULLY EXECUTE OUR STRATEGY TO INTRODUCE NEW PRODUCTS.
One of our key strategies is to expand our addressable portion of the oscilloscope and protocol analysis markets by introducing new products such as sampling oscilloscopes and protocol exercisers and probes. We have in the past withdrawn product lines due to implementation and financial concerns. The success of our new product offerings will depend on a number of factors, including our ability to identify customers' existing and future needs properly and quickly, timely manufacture and deliver products that address these needs in sufficient volumes, differentiate offerings from competitors' offerings, price products competitively and anticipate competitors' developments 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 announcements and introductions and changing industry standards. The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation, highly skilled engineering and development personnel and accurate anticipation of technological and market trends. Consequently, product development delays are typical in our industry. If we fail to introduce competitive products in a timely manner, customers may defer placing orders in anticipation of future releases or may purchase products from competitors. Product development delays may result from numerous factors, including:
o changing product specifications and customer requirements;
o unanticipated engineering complexities;
o difficulties with or delays by contract manufacturers or suppliers of key components or technologies;
o difficulties in allocating engineering resources and overcoming resource limitations; and
o difficulties in hiring and retaining necessary technical personnel.
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.
IF WE DEVOTE RESOURCES TO DEVELOPING PRODUCTS FOR EMERGING COMMUNICATIONS STANDARDS THAT ULTIMATELY ARE NOT WIDELY ACCEPTED, OUR BUSINESS COULD BE HARMED.
Our future growth depends, in part, upon our ability to develop, manufacture and sell in volume advanced verification systems for existing, emerging and yet unforeseen communications standards. We have little or no control over the conception, development or adoption of new standards. Moreover, even in relation to currently emerging standards, the markets are rapidly evolving and we have virtually no ability to impact the adoption of those standards. As a result, there is significant uncertainty as to whether markets for new and emerging standards ultimately will develop at all or, if they do develop, their potential size or future growth rate. We may incur significant expenses and dedicate significant time and resources to develop products for standards that fail to gain broad acceptance. Failure of a standard for which we devote substantial resources to gain widespread acceptance would likely harm our business.
IF WE FAIL TO MAINTAIN AND EXPAND OUR RELATIONSHIPS WITH THE CORE OR PROMOTER COMPANIES IN OUR TARGET MARKETS, WE MAY HAVE DIFFICULTY DEVELOPING AND MARKETING CERTAIN PROTOCOL ANALYZER PRODUCTS.
It is important to our success that we establish, maintain and expand our relationships with technology and infrastructure leader companies developing emerging communications standards in our target markets. We must work closely with these companies to gain valuable insights into new market demands, obtain early access to standards as they develop and help us design new or enhanced products. Generally, we do not enter into contracts obligating these companies to work or share their technology. Industry leaders could choose to work with other companies in the future. If we fail to establish, maintain and expand our industry relationships, we could lose first-mover advantage with respect to emerging standards and it would likely be more difficult for us to develop and market products that address these standards.
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 and protocol analysis markets are highly competitive and characterized by rapid and continual advances in technology. Our principal competitors in these markets are Tektronix and Agilent. Both of our principal competitors have substantially greater sales and marketing, development and financial resources. We believe that Tektronix, Agilent and other competitors each offer a wide range of products that attempt to address most sectors of the oscilloscope and many sectors of the protocol analysis markets.
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 fiscal 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. In fiscal 2005, we settled intellectual property litigation with Tektronix in which both sides claimed patent infringement. This settlement is described in more detail in Note 22 to the Consolidated Financial Statements.
We believe that the principal bases of competition in the oscilloscope and protocol analysis markets 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 protocol analyzers and our ability to offer high-performance products timely and 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 in 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 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
There are no unresolved comments to be reported pursuant to Item 1B.
