Interview with André Harari, Chairman of the Board of Directors and Daniel Harari, Chief Executive Officer

(February 22, 2008) 

Did Lectra’s financial performance in 2007 meet your expectations?

Daniel Harari. We started out in a position of strength, and the first months of the year clearly reflected the momentum stemming from the global launch of our new offering. So if anyone was disappointed, we certainly were: in the end, neither our revenues, nor our income from operations, nor our free cash flow matched up to our expectations.

Yet the order flow was very strong.

Daniel Harari. Yes, our orders were up 11% overall, and the new generation of Vector cutting systems scored a record success, with a spectacular 43% jump in the number of Vectors sold compared to 2006. I’d like to recognize the excellent performance of our industrial teams who, at the end of the year, managed to overcome the difficulties which arose out of the change of generation and the size of our backlog. I must also highlight the reliability of the new Vectors installed, with a 97% customer satisfaction rate.

Regarding our software offering, our new solutions play an increasingly structural role in our clients’ organization. Customers recognize the benefits they bring, but we need to consider the time it takes to gain acceptance among users and within organizations. That is truer still for our PLM offering in the fashion market, a major stake for Lectra. We will be continuing to develop our solution, launched at the beginning of 2006, so that customers can progressively integrate it into their different departments and activities. Having said that, based on available industry research studies, we probably overestimated the speed at which this market would take off, as the number and scale of projects signed up by software vendors as a whole is still low worldwide. So far, these projects have proved to be coming more from the large retailers than from fashion brands or luxury goods companies, which form our core market. But even if the market is still in an observational phase, we continue to place great hopes in PLM for fashion.

André Harari. From a geographic standpoint, Europe produced a standout performance, with orders for new software licenses and equipment up 32%, powered by Italy, France, and Eastern Europe. Orders to be delivered in Eastern Europe soared by 80% and represented 14% of the entire group.

Turning to our market segments, fashion registered a remarkable 21% growth in orders. Two major contracts with a French world leader in luxury goods, totaling €8 million, confirmed the value of our solutions. In the automotive sector, Johnson Controls—one of the world’s largest equipment markers, with whom we had already signed a large contract in late 2005—gave us further grounds for confidence with significant orders for the new VectorAuto MX9.

Why don’t the financial results reflect these sales achievements?

André Harari. For reasons concerning both Lectra and the economic environment. On Lectra’s side, I would reiterate that we did foresee these difficulties a year ago, when we pointed out that the product launches might disrupt our activity somewhat and could cause temporarily reduced orders, revenues, earnings, and free cash flow in the first half. In actual fact the turbulence lasted practically twelve months. But we also underestimated the success of the new Vectors. As for the disappointing under-performance of sales in the United States, China, and Japan, we have now identified the causes and are responding appropriately.

Daniel Harari. First of all, the economic environment penalized us due to the weakening U.S. dollar. This put increasing pressure on prices, squeezed our margins, and boosted our main competitor, who is American. Despite this, we strengthened our leadership status, with revenues of nearly $300 million, close to 50% more than that of our American competitor, whereas ten years ago we were Number Two with $205 million. What’s more, while it is hard to assess the precise impact of the “sub-prime crisis,” we saw several Chief Financial Officers postpone investment decisions just on the point of signing, due to uncertainty over the future. In the automotive market, temporary over-capacity among equipment makers led to a 50% drop in orders for our airbag cutting systems.

Do the 2007 results encourage you to continue your strategy?

André Harari. The strategy that we developed a few years ago will create maximum value for our company, our customers, and our shareholders. In short, our strategy is to speed up Lectra’s development, primarily through organic growth, and to maximize its potential by boosting its technological and market leadership. And we intend to do that while remaining a “pure player,”—a specialist working continuously to enhance its expertise in its core business.

Remember, we serve just one market, namely industries which manufacture their products using soft materials: textiles, leather, industrial fabrics, and composite materials. These industries represent major global market sectors such as fashion, automotive, and furniture, as well as a broad array of other sectors: the aeronautical, marine, and wind power industries, plus  personal protective equipment, sporting goods, etc. The challenges facing these sectors are often the same, and 70% of our know-how and of the technologies we supply is common to all of them. Our innovations benefit all of our customers. Additionally, for each sector we add value through solutions geared precisely to their specific businesses or technical functions. This diversity gives us a strategic advantage and represents a stabilizing factor. What’s more, thanks to our worldwide presence, we can benefit from major, ongoing global changes such as delocalization, since a loss of revenues in one place translates into a gain elsewhere.

Daniel Harari. Our strategy is geared to medium-term trends in these markets. Businesses face growing demands to renew their model ranges. Shorter product lifespans mean they need to display ever greater creativity and flexibility and to boost their productivity in order to design and manufacture competitively. Companies are under pressure to produce faster, better, and at lower cost, to globalize their manufacturing operations, and to manage an ever more extended supply chain in real time, while ensuring a secure exchange of information. Technology is clearly key in meeting these challenges. And Lectra offers them the best and most sustainable response. Not only do we provide them with the most advanced solutions on the market, but we also accompany them over the long-term. In the early stages, we closely monitor their evolving needs. Further down the line, we help them optimize their investments.

André Harari. That’s what our “relational value player” strategy is all about, and that is what sets us radically apart from our competitors. Our customers know they can rely on our expertise and our knowledge of their business fields. 

How do you view the future?
André Harari. With both confidence and caution. Our 2007 financial results, combined with particularly uncertain macroeconomic conditions, mean we will not be able to achieve the 2009 financial goals we set for ourselves. In fact, given the current financial and banking crisis, turmoil in the financial markets, the risk of recession in the United States, downward revisions of growth forecasts in Europe, and the persistently weak dollar, formulating a view of the outlook proves to be a difficult exercise.

Even so, we are confident in our company’s medium-term prospects. Lectra has consistently demonstrated its capacity to withstand turbulence. Both Daniel and I have committed our personal wealth to the company, holding 40% of its capital stock. That means we will continue to make swift, tough decisions when called for, while taking carefully calculated and monitored risks. It also makes us all the better stewards of our shareholders’ assets.

That was the philosophy behind the public stock buyback tender offer we issued in 2007. Daniel and I refrained from taking part in it precisely to signal our confidence in the future. With our three 2004 acquisitions fully paid and a total renewal of our technology offering in 2007, Lectra chose to set out on a different path. We considered the time had come to offer our shareholders a clear alternative. Those who wanted to withdraw from our capital were given the opportunity to do so. And those who wanted to stay with us through a new phase of development over the long-term, in full knowledge of our strategy, its associated risks and challenges, as well as its upside potential, could raise their percentage of ownership or maintain their existing percentage and receive the proceeds from the disposal of some of their shares. The buyback, concerning 20% of the capital stock or 7.1 million shares, was a success, and we expect to see its accretive effects starting in 2008.

Daniel Harari. Just look how far we have come over the last few years. The company has never been as strong as it is today. We have further improved our operating ratios. Lectra has confirmed its position as World Number One. It has consolidated its leadership in Europe and reinforced its presence in new regions such as Eastern Europe, Russia, and India—where we have opened a subsidiary.

We have strengthened our competitive position, with two-thirds of the products in our catalog less than a year old. We have continued to concentrate our resources, reallocating competencies wherever they are needed and recruiting people with the profiles required to help us achieve our objectives. We have renewed and reinforced our teams, especially in the United States in 2006, and at headquarters in 2007, in marketing and communications, and in Asia-Pacific with a new management team for the next step up in our development.

What are your key priorities?

André Harari. Our three objectives are: to accelerate our organic growth, to boost our profitability by regularly improving our operating margin, and to generate free cash flow in excess of net income. To achieve these goals we are leveraging our five growth accelerators, namely, our leadership in the fashion sector—notably through our value-added software product line and PLM; our major accounts in the automotive industry; the United States; China; and, finally, our installed base of 20,000 customers.

Daniel Harari. That’s probably the most powerful of our five growth accelerators and our priority in 2008. As we saw in 2007, the launch of our new technology offering and associated services gives this customer base a strong incentive to upgrade. A thousand Lectra automated cutting systems are now between 7 and 10 years old and will need to be replaced in the next 3 to 5 years. In 2007, replacements accounted for 30% of total Vector orders. Nearly a third of those orders were to replace competitors’ machines: we plan to tackle that potential vigorously.

For 2008 overall, and assuming a parity of $1.50 / €1, we are cautiously forecasting 5 to 10% revenue growth like-for-like, with a slight shift in the product mix in favor of software, and a 33-67% increase in income from operations. Plus a return to a positive free cash flow, in excess of net income.