Nanometrics Inc. (NANO) moved up in price Friday about 30% from Thursday's close. Volume also moved up from an average of about 500K shares traded daily to over 5 million shares by the end of the day on Friday. Option trading in the calls on Friday was especially notable with volume in some strikes many times the open interest. One would guess that with a move up in price like today that NANO just came up with the cure or reported unexpected blow out earnings. NANO actually reported nothing. Intel (INTC) reported better than expected on Thursday and also stated that they would increase capital spending in the semiconductor arena according to Edgar Online reporting.
This must have taken everyone by surprise including the insiders of NANO based on insider selling of more than 100K shares a month for the last six months according to Yahoo Finance. Institutional sales appears to have been at a higher rate with the liquidation of 13% of the total shares held. The CEO, Dr. Timothy Stultz, appears to have sold 15K shares as recently as about a week and a half ago leaving the doctor with about 58K shares left. In all fairness there can be many reasons why insiders are selling stock in the company they work for. Usually the sign that really can be important is if the insiders are buying the stock because they believe they are going to improve. I could find no open market buying by any insiders being reported in the last six months. From what I read it appears that Dr. Stultz sells his stock received from options as quickly as he exercises them in the most recent time frame.
I feel that this type of information is important because at first glance I see a company that has a forward PE of around 10 and it appears they are about to have a huge increase in sales/profit. Unfortunately, like with so many things, what the big print gives the small print takes away.
Starting with the $10 Million share repurchase program, we start to find the cracks in the foundation. One of the main reasons reported in the SEC filing for the repurchase program is to keep the stock from being diluted from all the insider sales as a result of what I consider a large amount of options being granted and sold off into the market. Someone just reading the headline that NANO is buying back its own stock may think that the float out there is getting smaller and their shares more valuable, when it only means that they are just keeping even with all the insider sales.
The next thing that seems to make NANO a value buy is that the PE is not sky high for a technology company. I believe this is a result of several factors. As recently as first quarter 2010 NANO was reporting losses. The last two quarters are the first quarters to report a profit since before 2008. I had to go back to 2005 to find two quarters in a row that were profitable. Lack of consistent profits may make it a little difficult for the market to have faith that the management team will be able to continue a path of profitability. The real smashing numbers come from the revenue reporting. It appears that 2007 NANO sales peaked at about $146 million. In 2008 revenue fell to $102 million. In 2009 revenue basically fell off the cliff at about $77 million or about half what they were just two years before. Looking at the 2010 quarters it looks like NANO did turn around the sales drop off and will report higher sales in 2010. The question the market is pricing in to the stock is can NANO maintain what it has not been able to before.
How much more in revenue / profit can NANO expect from increased orders from Intel Inc.? Edgar Online's report of NANO 10-Q quarterly report filed 11/12/2010 shows that Intel provides orders that amount to about 11% of the total revenue of the quarter. In an article from the online Wall Street Journal, it states that Intel plans on increasing plant and equipment spending by 73%. While the WSJ article cited other companies as being the most to benefit from the increased spending, if we increase the amount of purchases by Intel to NANO by 73% we should be able to make a reasonable guess. Currently in the nine months ending Oct 2, 2010 Intel spent an average of about $27 million with NANO per quarter. Increase $27M by 73% and we get a quarterly sales of about $47M or an increase of $20M per quarter in revenue. This equates to an increase in total sales of about only FIVE PERCENT if NANO gets an increase of 73%, all else being equal. Calculating a profit margin of about 17%, which is the best NANO has done in recent years, results in an increase of profit of $3.4M per quarter or about $14M per year. With Friday’s increase in the stock price of about 30%, NANO’s market cap increased by about $86M from Thursday's closing price. These numbers may be overly generous for two main reasons: the last quarter Intel orders had fallen in proportion of total sales from a considerably higher proportion in earlier quarters and NANO may not experience anywhere near a 73% increase in revenue from Intel.
In the last annual report by NANO, foreign sales accounted for about 70% of revenue, including China. NANO includes in its risk factors that protecting intellectual property rights may not be as easy as in the United States. The wording is highly diplomatic to say the least. China has, in my opinion, virtually no respect for foreign intellectual property rights. It’s hard to get a grip on how much risk there is, but I would estimate the risk is more of the ability to grow revenue in the Chinese / Asian market than losses in United States.
The next risk factor listed in the annual report is in relation to a possible increase in revenue from Intel. The risk is the possible lack of infrastructure and resources to scale up and be able to meet demand growth. NANO is relatively small compared to some of the competitors in the space and this could result in expected increases in revenue not being met.
NANO has also taken anti-takeover provisions in the company charter and other actions that may discourage a change in control of the company. Most companies do this to some level, but it is important to read and understand how difficult a company may make it to be taken over. I consider this a factor in trading a stock.
With the increase in options being traded and the rise in price of the stock, the implied volatility of the options really shot up. I believe that with earnings coming out next month and a desire to see how much, if any, of an Intel' increase NANO gets, the stock price will retrace back down into the $15-16 range next week. The three day weekend is going to give people a lot of time to crunch the numbers and move past the headlines. I believe that will give pause to increasingly more coming into NANO. I shorted the stock and I also shorted the Jan 16 calls as a result of my belief that the stock went a little ahead of itself and while my target is not as aggressive I would not be surprised at all to see a full retracement back to the $14 price area once the dust settles. I think it is pretty safe to say that after this five day run up, the price reflects a picture perfect earnings report and a press release that they will soon have orders in hand from Intel. Anything short of that and the $14 retracement may seem too high of a price to give this one.
Disclosure: I am short NANO.